Charles Schwab 2015 Annual Report Download - page 13

11
LETTER FROM THE CHIEF FINANCIAL OFFICER
The crux of Schwab’s story for 2015 was
execution–disciplined, focused, grind-it-out
execution of our operating plan during yet
another year of environmental challenges.
Our ongoing success in serving investors and
growing our client base is certainly impressive
and worthy of celebration. We should also recognize, however,
another of Schwab’s core values that enables success over
the long term: We work hard to ensure that the day-to-day
cost of running the company does not impede our ability to
both invest for the future and deliver strong and improving
protability today. Building, maintaining and leveraging scale
is critical–the better we are at containing operating costs,
the more resources we have available for reinvestment in
our clients, and for prots that strengthen our capital base
and support business growth. Last year’s course of events
provides a textbook example of this principle at work, so let’s
start there before turning to the picture for 2016.
What we expected
We began 2015 with baseline assumptions that included a
continued economic recovery and a 6.5% increase in the S&P
500® Index from the year-end 2014 level. The scenario also
included modest growth in client revenue trades, basically
in line with expected account growth. The rate environment,
however, was assumed to remain unchanged from late-2014
levels. Under this scenario we expected to produce mid- to
upper-single-digit revenue growth. By limiting growth in day-
to-day operating costs, which we call fundamental operating
expenses (FOE), to approximately 5% to 6%, we expected
to be able to target our project and marketing investments
at healthy levels consistent with 2014 spending and still
achieve a gap between revenue and expense growth of at
least 150 basis points. That gap, in turn, would enable us
to deliver a pre-tax prot margin of at least 36%, up from
approximately 35% the year before. Overall expected result:
solid performance and good progress on our journey to higher
protability, assuming a still-constrained environment.
What happened
Reality, though, moved away from our assumptions almost
immediately. The S&P 500 struggled to hold positive territory
throughout the rst half, fell signicantly into the red during
the summer, and then wheezed its way back to essentially
breakeven by year-end. Client revenue trades started 2015
below year-earlier levels and ended with a full-year decrease
of 2%. Even our at interest rate assumption turned out to
be generally optimistic, with the 10-year Treasury yield falling
below our baseline scenario for much of the year.
The bright spot in the environment came late in the year,
as short-term rates nally began to lift ahead of the Fed’s
expected rate move, and then the move itself delivered
the rest of the roughly 25 basis point impact from mid-
December on. We did see improvement in our money fund
fees and net interest revenue right away, but the move came
too late in the year to have a meaningful effect for 2015.
So notwithstanding another year of gathering assets faster
than any other publicly traded U.S. investment services rm
and the resiliency of our multiple revenue stream model, the
environment weighed on our results–trading revenue fell
5% year-over-year and the lift in asset management and
administration fees was limited to 5%, while strong growth
in interest-earning assets helped net interest revenue rise
by 11%. Overall, our revenues rose approximately 5% year-
over-year, not what we hoped or expected starting out,
barely scratching the low end of our baseline scenario range.
With the environment buffeting our revenues, we
recognized that following our overall expense plan was
crucial to maintaining that balance between reinvesting
to drive growth and delivering improved protability. But
we also knew that the issue was not as simple as telling
every Schwab unit to hit their budgets, because conditions
inevitably differ from plan as a given year progresses.
Hiring goes faster or slower than expected; development
projects get accelerated or hit roadblocks; new information