Charles Schwab 2014 Annual Report Download - page 13

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expense growth, a 350 basis point improvement in our
pre-tax prot margin, and a 23% rise in net income, our
nancial formula has returned to stride.
Something to keep in mind: After years of environmental
headwinds negating our progress, we aimed for
extraordinary improvement in our prot margin in 2014 to
help accelerate Schwab’s return to the level of nancial
performance we and you have come to expect. With
U.S. investable wealth at $30+ trillion and growing, we
have tremendous opportunities still ahead, and it may
not be practical or wise to deliver margin improvement of
2014’s magnitude every year as we invest to pursue those
opportunities. That said, we expect to continue producing
meaningful operating leverage on a consistent basis.
No
We achieved our record nancial performance in 2014
in the face of an enormous impediment that remains
in place to this day—abnormally low interest rates. The
low rate environment caused us to waive $751 million
in money market fund fees, and our net interest margin
(NIM) on $139 billion of average interest-earning assets
was 164 basis points versus the NIMs of 300–400 basis
points or more that we were earning before the Fed
began lowering rates. So we are not there yet in
terms of demonstrating our earnings power in anything
approaching a normalized rate environment.
Something else to keep in mind: Regardless of when rates
do rise, the recovery of that earnings power does not
mark the limit of our growth opportunities—the two are
completely unrelated. What it will mark is the advent of
more fully protable client relationships and a substantial
lift in our overall prot margin. We expect to drive strong
growth in our business for years to come. Normalizing
rates will improve our exibility in making investment
and pricing decisions to pursue that growth while also
enabling us to build our prot margins toward sustainably
higher levels.
Maybe
As I’m writing this to you, there’s a pretty broad
consensus that the economic recovery is progressing in
a way that will push the Fed to begin raising rates before
the end of 2015, a consensus that we nd credible. So
this might well be the year our full earnings power begins
to emerge. I have to say, though, that we remain wary
of those head fakes—having to reset a spending plan
midstream yet again would be inef cient, disruptive, and
dispiriting. So our baseline scenario for 2015 assumes
the recovery continues and the S&P 500® rises another
6.5%. The scenario also includes modest growth in
client revenue trades. The rate environment, however,
is assumed to remain unchanged from late-2014 levels.
Under this scenario, we’d expect to produce mid- to
upper-single-digit revenue growth, a gap between
revenue and expense growth of at least 150 basis points,
and a pre-tax prot margin of around 36%. Conservative
again? It may seem so now, but it still represents solid
performance and progress even if the environment isn’t
quite as strong as 2014.
To the extent the environment supports increasing rates
in 2015, we’d expect to pass approximately 75% of that
revenue lift to pre-tax prots; we have established a
set of investment priorities that we can pursue with
the remaining 25%, including adding more nancial
consultants and retail branches, bolstering our marketing
effort, and funding a variety of client-facing and operating
initiatives to improve efciency and service quality.
One more thing to keep in mind: With the ultra-low
interest rate environment dragging on, we’ve been talking
about allowing at least 75% of any rate-related surge
in revenues to drop to pre-tax earnings for a few years
now, starting back when our margins were hovering below
30%. With those margins now well into the mid-30s and
likely to continue building even without rising rates, the
relationship between reinvestment rates and incremental
prot margin will probably need to evolve over time. We
see no structural impediments to matching and then
surpassing our prior record margin of 39.4%, which was
set back in 2008. To the extent interest rates do return
to longer-term norms, supporting and enhancing our
business growth into the future may call for a greater share
of that incremental rate-driven revenue to be reinvested
in the business, but rest assured we remain committed to
reaching the highest sustainable margin consistent with
delivering that growth.
Are we there yet? Yes, no, and maybe, but that’s ne.
We view 2015 with condence and optimism and see
great opportunities ahead. Whatever the future has
in store for us environmentally, you can expect us to
remain focused on keeping Schwab’s core nancial
story as simple as possible—solid business growth, solid
revenue growth through diversied sources, and expense
discipline leading to improved performance. We are
committed to being good stewards of your capital and
to maximizing the return on that capital over the long
term. We recognize that your ongoing support is crucial
to our ability to take that long-term view, and we hope
to continue earning your support in the months and
years ahead.
Joe Martinetto
March 6, 2015
LETTER FROM THE CHIEF FINANCIAL OFFICER / 11