| 16 April 2010

The Charles Schwab Corporation (SCHW) reported their first quarter results yesterday, as most of you probably already know. We've taken a moment to give those results a more thorough going-over.

One of the things we love about Schwab is that they don't mince words in their earnings release like some companies are known to do. While the headline was of the affable and glowing sort you would expect, the first sentence makes things clear for anyone who might have missed it: "net income was $119 million for the first quarter of 2010, down 45% from the first quarter of 2009."

Got it! With the bad news dispensed of quickly, the firm was able to get down to the task of delivering the positives like record assets under management and the highest number of accounts since the first quarter of 2008.

The message this quarter from Schwab execs was clear: they want to balance profitability with the opportunity to expand and grow. This is unique to us in the sense that most of the brokerages, especially the smaller firms, have been preaching the hunker-down mentality and licking the wounds inflicted by a "tough economic environment" (a notion we have always thought was suspect.)

"Our first quarter operating results embody our commitment to building value for stockholders and clients over the long term as we continue to balance current profitability with investing for growth," commented their CFO, Joe Martinetto. "We remain convinced that our chosen path of sustaining and even enhancing our investment for future growth during 2010 is the right one for the company."

But this is the message you have to go with when your net revenues decline by 12% year-over-year and your net income declines by 45%. Shareholders are getting pinched so Schwab execs need to show there is a strategic shift occuring to offset the steady decline in the core brokerage metrics all brokers have experienced over the last 12 months.

As with other broker results we've started compiling some trend charts to analyze the performance of the brokers over time. First we check in on DARTs. Schwab, like optionsXpress (OXPS) and TD Ameritrade (AMTD), has been "trading activity challenged" this quarter. Though they spiked a bit in January, the firm has stayed below long-term averages in terms of activity. But this is not necessarily unusual.

In Schwab's case, they're less focused on DARTs (which more and more don't drive income) and are more focused on accounts which they then hope to convert to a fee-based advisory service.




Next up, we look at total accounts. Schwab has done well in this category, as well they should given the investment they give it. As mentioned in their release, Schwab's total accounts hit a record. The firm ended the quarter with 7.8 million brokerage accounts. You can see this record was driven by a substantial increase in new account activity in March.



But when you layer the new account growth against their marketing spend, you can see the correlation. The firm cooled off its efforts to generate new accounts dramatically in Q3, but ramped them back up to record levels in Q1. This, in part, explains why account growth is up while income is off.



Finally, customer assets shows an impressive climb to the record $1.49 trillion, a bump of $23 billion in the first quarter.

To be clear, much of this asset growth has been driven by 1) spending to acquire new accounts and 2) record market performance. (We want to commend Schwab for always including a comparative snapshot of the Dow and S&P 500 in their performance metrics -- they get the correlation.) The company gained an additional $50 billion in assets in March alone, for example, thanks to nothing more than market gains in customer accounts. (They lost $28 billion in January.)



Two things unique to Schwab that drive their numbers: 1) they've announced plans to issue more stock to drive their banking business, and 2) they're actively pursuing the fee-based advisor business. Schwab's banking business continued to grow at a slow but steady pace. The firm ended March with 768,000 banking accounts, up 51% from last March and up 2% from last month. We expect the real gains to hit the banking business when the firm completes their public offering.

Advisor services also grew at slow but steady clip. The firm ended March with $624 billion in assets in their advisor segment, a 37% increase over March 2009. This segment is important because, as most firms decrease prices, firms like Schwab are pushing fee-based services as an alternative to low commission accounts which generate little margin.

Bottom line is that Schwab is a case-study in diversification and understanding their results requires that you understand their future objectives and the changes happening in the industry. If all goes as planned we'll probably have to start reporting more on their banking and advisor business than we will on their brokerage business. They're starting to view self-directed brokers as more like "leads" than an end game.