Charles Schwab reported Q1'25 earnings and hosted its "2025 Spring Business Update" last week (see the transcript here). CFO Mike Verdeschi tells us, "We saw solid growth across all fronts during the first quarter as we continued to meet the evolving needs of our growing client base. New account formation was approximately 1.2 million during the period, our highest total in several years.... This combination of organic growth and increased client utilization of our leading products and solutions resulted in year-over-year revenue and adjusted earnings growth of 18% and 41% respectively. Transactional cash levels continue to reflect normalized cash behaviors inclusive of organic growth, seasonality and investor sentiment. And we made additional progress on reducing the level of bank supplemental funding to approximately $38 billion, down more than 60% from peak levels."
He explains, "In terms of rates, the outlook for 2025 remains dynamic with the forward curve moving between three to four 25 basis point cuts to the Fed's target rate versus the one cut assumed back in January for our financial scenario. At this point in time, these potential incremental cuts are expected to be mostly in the back half of the year. Under such a scenario, we still expect full year 2025 net interest margin to expand into the 2.55% to 2.65% range. We also could see average 4Q NIM contracted slightly from the level indicated in our January financial scenario. Of course, movements in the forward curve is nothing new and we'd expect it to continue to change as investors assess the shifting macroeconomic picture. And while the drivers of earnings are evolving with stronger cash levels and higher trading volumes versus lower equity markets and additional future rate cuts, the combination of our strong 1Q '25 results and diversified model has us currently tracking around the upper end of the full year scenario outlined at the winter business update in January.
Verdeschi says, "Moving to our balance sheet.... As expected, we saw the seasonal outflow in client transactional sweep cash to begin the year and then cash building slightly during February and March. This activity represents normal behavior in this type of environment as client redeployment of the 4Q cash build was offset by net equity selling as investors to exposure to risk assets. With another quarter of encouraging cash performance, we use the cash flows coming off of the securities portfolio plus some cash on hand to further reduce high-cost supplemental funding at the banks."
He continues, "In terms of Q2, we still expect to see typical drawdown in client cash due to tax disbursement payments in April. Similar to past years, we expect this activity to impact both transactional sweep cash as well as other liquid cash alternatives, such as purchase money market funds. However, it is possible that a continuation of market volatility in this quarter could influence client cash allocations. Given the increasing uncertainty in today's environment, we're focusing on flexibility in managing the balance sheet to remain well positioned to navigate a wide range of potential outcomes."
Verdeschi adds, "Some additional thoughts on bank supplemental funding. Following the $15 billion paydown during the fourth quarter, we reduced the balances by another $11.8 billion during the first quarter of '25, bringing the outstanding balance as of March 31st to $38.1 billion or down approximately 60% from the peak. As previously mentioned, we would not necessarily expect to reduce funding levels by the same magnitude every quarter. For example, sizable tax related outflows in 2Q will likely make it more challenging to replicate the level of paydown observed over the past two quarters. However, as we move forward, we still expect to make additional progress each quarter until the supplemental funding at the banks is reduced to a level consistent with our diversified long term funding profile."
During the Q&A, CEO Rick Wurster comments, "April has brought levels of engagement that are historical for us.... The ability for a client to call up and quickly get an answer to walk into a branch and talk to someone to talk with their advisor and know that Schwab stands behind them and supports that, this is a period where we shine. And we've seen the first part of April, 2 times to 3 times the level of new accounts being opened.... In terms of what that translates to and some of the metrics that you described, in aggregate, we've seen a slight risk off tone from our investors in the first few weeks of April. And by that we've seen higher levels of cash growth than we would have expected in a month where we've got April tax payments due, some slight reduction in margin and net equity selling."
Verdeschi states, "So when you think about the volume of transactions that we're seeing, and even though you see some of that margin coming back a bit, the fact that we're picking up cash, the cash alone more than offsets the earnings impact of some of that margin coming off. So when you look at just the beginning of April, it continues to give us confidence about that earnings range that I provided, certainly the upper end of that range."
Analyst Bill Katz of TD Cowen asks, "Now that you're getting much closer in terms of normalizing the balance sheet in terms of paying down some of the higher cost deposits, [it] seems like client cash sorting has peaked for the cycle and your growth is accelerating and you ended the quarter slightly north of your capital ratio.... How are you thinking about balance sheet growth into the second half of this year?"
Verdeschi responds, "So as you highlight, as we think about the balance sheet this year, yes, our focus continues to be managing balance sheet in the way that's going to meet our client needs, while at the same time, driving some of those broader objectives of bringing down the supplemental borrowings.... If you're heading for a lower rate environment, it's possible you could see more growth in the mortgage portfolio. We haven't seen as much there. But we're going to continue to manage the balance sheet in a way to support that lending activity. And of course, over time, as we pay down those supplemental borrowings, we have a securities portfolio that we will begin to roll and reinvest."
Asked about the NIM (net interest margin), Verdeschi answers, "Regarding NIM, we still feel good about the ability to expand NIM. And of course, the interest rate environment is evolving. As I mentioned in my prepared remarks, when we came into the year in our financial scenario, we assumed one cut in May and now the market is as much as four cuts over the course of the year. So when you take some of the puts and takes here, you're right, the pickup in cash, we performed a little bit better in cash that's enabled a faster reduction of supplemental borrowings. Of course, that could continue over the course of the year; it remains to be seen how the environment evolves.... But putting that all together, we still feel very good about the ability to expand net interest margin over the course of the year and importantly, continue to grow earnings and we're growing them organically and building capital."
Ben Rubin of UBS asks, "Another question here for Mike on the balance sheet. You paid down nearly $30 billion in supplemental funding over the past two quarters alone, which is encouraging to see. But in your prepared remarks, you spoke to achieving more funding diversity over the long term between sweep deposits, other products like brokered CDs, as well as potential third party arrangements. So just curious, how do you view the optimal mix across your different funding sources over the long term?"
Verdeschi responds, "Funding diversification to me is just a basic capability that we want to maintain. But at the same time, that funding diversification is going to be done in a way is efficient and achieve the financial outcomes we want to achieve. Starting with the bank, yes, good progress in paying down that bank supplemental funding. And we're going to continue to make progress there. I think having some mix of secured and unsecured borrowings in the bank makes sense.... So that diversification creates efficiency and it creates flexibility to meet the ongoing client needs. So that's how I think about that approach to funding diversification. And again, we're going to continue to progress the paydown of that bank supplemental funding over the course of the year."
In other earnings news, Morgan Stanley also briefly discusses sweep accounts during its Q1'25 earnings call. (See the Seeking Alpha transcript here.) CFO Sharon Yeshaya comments, "Total deposits of $375 billion were up quarter-over-quarter as demand for our savings offering was partially offset by the modest decline in sweep balances. Within sweeps, we saw clients consistently deploy cash into markets during each month of the first quarter."
She adds, "Overall, deposit movements in the quarter were generally in line with seasonality and our expectations. Net interest income was up modestly quarter-over-quarter to $1.9 billion. Looking ahead to the second quarter, we expect a seasonal decline in sweeps related to tax payments, which would result in a modest decline in NII. However, over the course of the recent two weeks, we have seen a notable increase in sweep balances, exceeding our internal forecasts. While this is likely associated with recent market uncertainty, it could have offsetting impacts to the NII in the second quarter should this continue. For the second quarter, deposit mix will remain the key driver of NII."
