SARA EISEN: Thank you, Kelly. And, Walt, thank you for joining me. I know you don’t speak out very often, but we’re going through some pretty extraordinary times in your world right now. Thank you.
WALT BETTINGER: Yes, and thanks for the invitation. I actually learned last night about 10:00 PM that your network had emailed a staffer in our organization about me coming on yesterday. And, unfortunately, I didn’t… as I mentioned, I didn’t realize that until last evening. And, of course, I’ve been on many, many times with you before, and so I just wanted to apologize for that. If I would have known, I likely would have been on, but wasn’t aware.
SARA: Well, we’re happy to have you today. And we have to address what’s happened with your stock first and foremost. It’s not necessarily the first place you would think about for contagion after a collapse of a bank in Silicon Valley that did a lot of lending to venture capital firms, but that’s what’s happened. Your stock is down almost 30% over the past week, including today’s bounce. Why?
WALT: Well, I think there’s been a degree of confusion on two sides of our firm. The first one is the difference between a brokerage operation and a banking operation. I see people speaking about FDIC and they have a fairly good understanding of that, that when you deposit at a bank, the bank takes those deposits and invests them, they’re part of the bank balance sheet, and then the FDIC provides insurance up to $250,000. At least that’s the way it’s been since, I believe, 2008.
Brokerage assets are completely different. So, we have about $7.4 trillion that clients have entrusted us with at Schwab, and over $7 trillion of that sits on the brokerage side. Brokerage assets are held separate. They are segregated from Schwab, segregated from Schwab assets. This is done under what’s called the SEC Consumer Protection Rule. And so those assets are not commingled with us. I even have heard some pundits talk about SIPC and tried to compare it relative to FDIC, and, of course, there’s no comparison. These are segregated assets and SIPC kicks in largely only in a situation of fraud. Of course, the SEC requires us to report on the segregation, and we do so regularly, and they audit it.
So I think that’s the first bit of confusion that went on. People began to conflate SIPC and FDIC, and didn’t really understand the segregation of client securities from the rest of Schwab.
SARA: But you do have…
WALT: And then I think the second one…
SARA: But you do have deposits, right? I mean, you do have a pretty robust bank business inside of the company.
WALT: We do.
SARA: And that, I think, is where the concerns are.
WALT: We do, and that’s the second one that I wanted to try to address. Our bank is very conservatively managed. If you look at the holdings of the bank, we have about 10% of client deposits outstanding in loans that are over collateralized, almost exclusively to our clients, very, very low risk. And then we have about 80% in US government-backed paper. Within that… effectively you’re operating with virtually no credit risk. From a liquidity standpoint, we have access to very substantial liquidity. Arguably, we have a level of liquidity over a 12-month period equal to our entire bank sweep deposits, around $280 billion.
So I understand that there were banks that got into trouble. We have a reasonable understanding as to how they did so, but those applications we don’t believe apply at Schwab at all. We do understand, though, that when our stock price went down at a rate that was, in some manner, consistent with some of the regionals, that people easily put us up on slides and talked about us in a manner consistent with some of the regional banks. Completely different model, completely different. I mentioned… or you mentioned earlier that 80%-plus of our deposits in FDIC insured balances…
SARA: …are insured.
WALT: Banks that have run into trouble are at fractions of that number.
SARA: But, as you say, you’ve been swept in. Have you seen any deposit outflows? What are you seeing from customers?
WALT: No, actually, what we’re seeing is asset inflows to the firm in significant numbers. So in February, our clients brought in almost $42 billion in net new assets to us. March, to-date, they’ve averaged about $2 billion a day. Interestingly enough, last Friday when we were maybe at the heart of… the peak maybe of some of these challenges before the actions taken by the Federal Reserve around liquidity, our clients actually brought about $4 billion into the firm that day alone. Another interesting factoid, the number one stock that our clients bought on Friday was Schwab stock.
SARA: Schwab. Yeah, saw a bargain out there, I guess. So as I understand it, Walt, there are concerns about this so-called cash sorting. I don’t want to get too esoteric here, but this idea that clients have been moving money from deposits into money markets, for instance, and that really pressures margins. We’ve been seeing that. Has that accelerated? Is that something to be concerned about?
WALT: Well, we haven’t seen an acceleration, and let me just quickly walk through what that is. That’s simply clients moving assets from transactional oriented accounts, like a checking account or a brokerage sweep account, into a higher-yielding investment. It might be a CD, a money market fund, a treasury security. That’s a good thing. That’s what we want clients to do with their investment cash. In fact, we reach out to clients by the thousands, by the tens of thousands every day, encouraging them to do so with their investment cash. It’s the right thing to do for clients. It’s the way we operate our firm, and we think it’s a very prudent action on their part.
SARA: And then you addressed the concerns about unrealized losses. Can you just put some perspective on this for us, what they look like on the asset side for you? Because I hear that you do have a deeply underwater mortgage portfolio.
WALT: Well, it’s not really… it’s not a mortgage portfolio, it’s a security portfolio. So let me talk a little bit about this concept of paper losses in a rapidly rising rate environment. So, again, I’m going to contrast our bank to a typical bank. We only have 10% of loans outstanding of our total deposits. We’re holding 80% US government-backed paper. So we go and buy securities with these deposits and we look to match the duration of those to client holdings. If you look at our overall portfolio, somewhere around three years, somewhere in that range is the duration of this almost exclusively US government-backed portfolio of securities. Now, we have to be realistic, whether you are making loans out of a bank or you’re buying US treasuries or any government paper, anyone who has done any of that in the last handful of years is sitting on paper losses. It’s not unique to Schwab. In fact, if I were to go back to my early career, working in the actuarial area in the pension world, I think a 30-year mortgage at, say, 3-1/2%, as was talked about in a earlier segment, on paper, is probably worth about half of what it was originally. So, yes, we have some marks because… paper marks, because interest rates have gone up so rapidly, but those marks are not relevant unless were to have to sell. And we don’t see any reasonable scenario whatsoever that we would’ve to sell.
I guess I’d pose this question back to think of. If you were investing your money at a bank, would you rather be at a bank that takes your money and has it in US government-backed paper, or would you rather deposit to a bank that is lending it out on, say, a 10-year commercial office building or a 30-year residential mortgage? These are all the reasons why, again, Schwab has been a safe port in the storm for five decades, and we are the same safe port in a storm today.
SARA: The difference between you and the big banks, between some of the regional banks and you and others, and Silicon Valley Bank, unfortunately, and the big banks, is that because of regulations, it gets excluded from mark to market from capital ratios. Is that what got us into trouble here? Is that what got Silicon Valley Bank into trouble here?
WALT: Well, it’s difficult for me to speculate on Silicon Valley Bank and all the issues that may have played in to what unfolded there. I will say that we didn’t have any direct exposure to them, given the conservative nature of the way we operate our firm or any of the other banks that are in the news today. But we do have an unusual scenario around the way we treat these temporary paper losses. And that is if you hold a security, you publish it, you’re transparent about it, and you make sure the whole world knows about those on paper losses. Whereas if you hold those loans I talked about, a commercial mortgage on an office building or a residential loan, you don’t mark those. And so the whole world doesn’t see the paper losses that would have been there. Again, I would prefer the transparency.
SARA: You said you don’t have to tap that. Would you ever access that at a time of a crunch? How important was that step? Or do you think there’s a negative stigma there?
WALT: Well, again, it’s difficult to say. I know that they’re going to disclose those who utilized it in a couple years. I guess I would say this. We don’t see any need for us to access that facility. If the need were to arise, well, certainly, then we would consider it along with other liquidity raising opportunities. But we don’t see any need to do so. We haven’t at this point, and our liquidity needs are being met by just our normal operations of business. And those are the things that we, again, have been transparent about for a long time, where we would go in the event of spike and rates. We would issue CDs and we would look at our relationship with FHLB, as well as we have tremendous flows from new clients. Again, back to the metrics I talked about earlier, $2 billion a day coming in, $4 billion on Friday alone. There’s a lot of cash that comes in along with that. So we’ll look at it if we need to, but we just don’t see it on the horizon right now.
SARA: You also have a pretty big investment advisory business, Walt. I wonder if any of that has been affected in the last few days, just around the perceptions of risk around the firm?
WALT: Sure. Well, back to my opening apology, Sara, that’s, in part, why I maybe didn’t find out about your request until late last evening. I spent most of yesterday engaging with our clients, serving them, talking with them, listening to them, because that’s what’s really important. When you have a diversified client base like we do, 35 million clients across all types of individuals, investors, traders, investment advisors, as you referenced, that’s great diversity and it provides tremendous stability for our firm.
What I’ve heard from the advisors that I spoke with yesterday is great confidence in our firm. Most of them have utilized us for decades in serving their clients. They know how conservative we are. They know we don’t take risks. They know that our viewpoint is it’s OPM, it’s other people’s money. That’s why we buy conservative securities, that’s why we don’t go out a long way in terms of duration, and that’s why we maintain access to liquidity in the way that we do. So the RIAs are comfortable with what we’re doing.
It is important, though, that we continue to educate those who may not understand this segregation of client securities from all other assets at Schwab. That is an important message, and I don’t know that that message has been delivered as well across the press or, in fairness, by us at Schwab as it could have been.
SARA: Okay, fair enough. So what regulation, Walt, ultimately, do you think will come out of this? Because what we’ve heard from the Biden Administration, from Secretary Yellen, is that that’s where this is heading, to prevent something like this from happening again. And we still have this mismatch between the assets and the liabilities, and I’m not sure that was fixed by what they presented. So where does all this go?
WALT: Well, one thing I can feel confident in is we’re going to see an impact in FDIC premiums, right? Because if we’re going to have depositors made whole for uninsured balances, and that’s going to come from banks, then we’re going to have higher premium rates there. Beyond that, it just depends on how all this shakes out. Time will tell. We might have some adjustments in terms of the way available-for-sale or held-to-maturity investments are treated, things along those lines. But whatever direction it goes, we feel really confident about our ability to continue to serve our clients, continue to be that conservative safe port in a storm. None of that is going to change whatever occurs going forward from a regulatory standpoint.
SARA: I mean, one of the reasons that a lot of these banks including yours have sold off in the last few days, according to investors and analysts, is just the business model is going to change, the higher regulations, higher cost of capital, as you mentioned, higher fees now as a result of funding all of this for uninsured depositors. What are you telling investors about what that looks like, how that impacts your revenues and profitability going forward if it’s going to be a re-rating?
WALT: Well, I think this may be… you opened up with a question about our stock price, and I might suggest that this could be one of the factors that has weighed on it, and that is just simply an uncertainty about what the future will bring in terms of earnings, really for any organization in the financial services world. And I think in time as we better understand what changes might occur, we’ll be transparent as always, and we’ll be able to share scenarios as to what our earnings might be.
It is possible that you could see some contraction within margins. But, again, looking at us at Schwab, the last several quarters we’ve delivered a 50% pre-tax adjusted margin. And adjusted is only adjusting for the cost related to the integration of TD Ameritrade. So we’re a very profitable firm, and if there is some modest impact to margins in a couple of points, I don’t see that having any meaningful long-term implication for the performance of our stock, but time will tell.
I’ll say this, this morning, as soon as our trading window opened, I was waiting at the door and bought 50,000 shares for my personal account right as the market opened. That much confidence, I certainly have in this company
SARA: You bought this morning. I was going to ask you if the company, if you bought back stock over the last few days.
WALT: Yeah, I don’t know the exact company decisions at this point, given the last few days, I’ve been very focused on the client side. We’ve been buying back stock in fairly large quantities in recent months, but I can’t comment here on just the last couple days. But, again, I personally went ahead and bought stock. I’m not suggesting that for anyone else, that’s just a personal decision for me, so I’m not promoting the stock. But it made sense for me when I saw the stock price, given my insights of the company to go ahead and make a substantial buy.
SARA: I was going to ask you, how big of a buy did you make?
WALT: I bought about 50,000 shares personally at market open today.
SARA: All right, you and Ron Barron telling Squaw Box earlier that he was buying your stock as a result of this…
WALT: I could do far worse than being… I’m sorry. I could do far worse than being an investor as capable as Ron Barron.
SARA: All right, there you go. Thank you so much for taking the time and all the questions. Obviously, a lot of swirl and a lot of noise. It’s good to hear from you directly.
WALT: Thanks for the invitation, and, again, my apologies about missing your note yesterday.
SARA: Oh, no, you came on that, that’s good. And I know our viewers who, who have a lot of money at Schwab and were potentially worried about it, not to mention the stock, we’re eager to hear from you. So thank you Walt. Walt Bettinger.
WALT: Thank you, Sara.