Charles Schwab Is Quietly One of the Biggest Banks in America. That’s a Problem.

Illustration by Christy Lundy

Illustration by Christy Lundy

Schwab CEO Walt Bettinger’s plan to attract the rich, lock in the young, and crush the threat of Robinhood.

Walt Bettinger, chief executive of Charles Schwab Corp., had just signed a deal to acquire the company’s main trading rival — TD Ameritrade — for a massive $26 billion in Schwab shares. But rather than crow about Schwab’s bulging market clout, he surprisingly called the takeover a “unique opportunity to build a firm with the soul of a challenger.”

Almost a year after that November announcement, Bettinger still insists Schwab is a defiant David rather than the new Goliath.

“Being disruptive defines Schwab when it was a little, itty-bitty startup and what Schwab will be even after this acquisition,” he tells Institutional Investor in an exclusive interview.

But competitors don’t buy the underdog pitch.

Instead, they are out of breath trying to keep up with Schwab’s market-shattering moves. In recent years, Wall Street firms have hastened to match the company’s Main Street initiatives, such as eliminating fees for online stock and exchange-traded fund trades and convincing clients to use robo-advisers rather than humans for financial planning and portfolio management.

In the meantime, Schwab has remade itself into much more than a discount brokerage firm. Schwab Bank, now one of the country’s largest by deposits, has become the main generator of revenues and profits. Schwab is the dominant player in a key segment of the custody market, servicing independent registered investment advisers and their clients. And in wealth management, it is moving beyond its affluent mass-market clients to high-net-worth and even ultrahigh-net-worth investors.

To be sure, the company faces daunting challenges. Upstart firms like Robinhood Markets are drawing vastly greater numbers of younger investors than Schwab. And a long-established rival, Fidelity Investments, dented Schwab’s reputation as an innovator by launching its popular fractional-share trading well before Schwab.

But Schwab is widely viewed as a powerhouse that is transforming personal finance as dramatically as Amazon has done with retail commerce. “What started as a firm to trade stocks became a full-service financial institution that changed the way Americans save and invest,” says Robert Siegel, a lecturer in management at the Stanford University School of Business.

Most of this transformation has taken place over the dozen years that Bettinger, 59, has been CEO. Yet he maintains a deference, bordering on filial piety, for 83-year-old founder-chairman Chuck Schwab that other chief executives might find unnerving.

Both have offices on the next-to-top floor of Schwab’s 18-story San Francisco headquarters. The two are in constant communication — by phone or in person or through lengthy, detailed work memos that Bettinger passes on for the chairman’s approval or comment twice a month. (Until recently, it was every Friday.)

The latest missive was 16 single-spaced pages. “He reads every word,” says Bettinger — a win for a man who was not the founder’s first choice to succeed him as CEO.


Walt Bettinger (Illustration by II; Bloomberg photo)

In 2003, Schwab elevated longtime confidant David Pottruck to the top management post.

Pottruck quickly misstepped.

With the firm still smarting from the tech-led market downturn of 2000, he raised client fees to make up for lower trading revenues. That move led to even sharper falls in revenues, and Pottruck was let go in 2004, barely a year after his appointment.

Schwab retook the reins. He got his brokerage firm back into Main Street’s good graces by slashing fees and promoting a just-folks image with a media campaign titled “Talk to Chuck.”

In 2008 he named Bettinger as CEO.

This time the transition was seamless. Bettinger attributes the smooth passing of the baton to the fact that he shares the founder’s approach and outlook. His company mantra — “Through Clients’ Eyes” — could easily have been coined by Chuck Schwab. “We both operate on the same time horizon — decades, not quarters,” says Bettinger. As an example, he cites the introduction last year of no-fee trading, which Schwab first set as a goal 15 years earlier.

Eliminating trading commissions was possible because Schwab was making so much money from its bank. So is the company nowadays more a bank than a discount brokerage?

It’s a question that makes Schwab executives uncomfortable, but is nonetheless worth asking. After all, the bank accounted for 58 percent of Schwab’s total net revenues in the first half of this year, and 60 percent in 2019.

Schwab Bank was founded in 2003 to allow brokerage clients to temporarily park their cash before investing it in stocks and bonds. It has since mushroomed into the 12th-largest U.S. bank by deposits, with almost $300 billion in its coffers.

Until recently, the bank’s net interest margins were eye-popping. Last year it paid out a miserly 0.34 percent interest on client deposits and had an average yield rate of 3.47 percent on loans. Moreover, its expenses are the lowest in the industry. Entirely an online bank, Schwab has no brick-and-mortar branches. Instead it covers fees for clients who make withdrawals from any other bank’s ATMs.

Schwab Bank also regularly records the lowest nonperforming loan rates in the industry because it lends only to Schwab clients and has intimate knowledge of their financial histories. “In its loan portfolio, Schwab maintains very high-credit quality,” notes Kyle Voigt, an analyst at investment bank Keefe, Bruyette & Woods.

One would expect Schwab to trumpet its banking prowess. But the bank isn’t listed as a separate entity in the company’s financial reports. Its CEO, Paul Woolway, meets rarely with analysts and never with journalists. Schwab executives refer to the bank as “a relationship deepener” for clients — inducing them to move beyond their trading accounts into mortgages, home refinancing, and pledged asset lines. They point out that Schwab Bank makes no business loans and doesn’t seek customers beyond its brokerage account holders.

Lately there has been another reason for Schwab to be bashful about its banking arm: The company has grown far too dependent on bank revenue, just when net interest margins are being compressed by falling interest rates. Last year’s sterling 3 percent NIM shrank by half in the first half of 2020. And Schwab doesn’t expect margins to improve the rest of the year.

So new revenue streams are needed. Says Michael Cyprys, director of financial equities research at Morgan Stanley: “That’s increasingly a top priority for this management team.”

Owning a bank was the furthest thing from Chuck Schwab’s mind when he founded Charles Schwab & Co. in 1973 as a ho-hum discount brokerage. Its upward trajectory began two years later, when the Securities and Exchange Commission deregulated the securities industry. Until then share trading had been dominated by traditional Wall Street brokerage firms that agreed among themselves to set high commissions that only affluent investors could afford.

“I thought if I could strip away all the fluff surrounding the purchase and sale of stocks — the tainted research, the bogus analysis, the flimsy recommendations, all the ways that Wall Street had historically justified high commissions — and sell just the plain-vanilla service of executing trades, I could slash overhead, focus on efficiency, cut prices dramatically — by as much as 75 percent — and still make a profit,” wrote Schwab in his 2019 autobiography, Invested.

He was right.

Schwab discouraged chummy relationships between investors and his brokers. There would be no wining and dining of clients, no outings on golf courses, no unsolicited advice on stocks. Visits to Schwab offices were unnecessary; phone calls would suffice.

Wall Street firms were outraged by the newcomer. They bad-mouthed Chuck Schwab for allegedly lacking class and financial acumen. They pressured commercial landlords not to lease Schwab space in buildings where white-shoe brokerages had offices.

But as Charles Schwab & Co. — later renamed Charles Schwab Corp. — scooped up billions of dollars from new investors, Wall Street began to emulate the upstart by offering financial services that appealed to middle-class clients.

Schwab kept a step ahead of traditional rivals and newer discount brokerages. And when organic growth proved insufficient, the firm spent billions on acquisitions. The aim was to prevent defections by increasingly affluent clients while adding younger ones to the roster.

“The idea is that once somebody becomes a Schwab client, they won’t outgrow us,” explains Jonathan Craig, who as head of Schwab investor services and marketing oversees the core retail client business. As outlined by Craig, 48, the current favorite to someday succeed Bettinger as chief executive, Schwab has built a multigenerational client world that ideally — though not often enough — looks something like this:

Imagine a 16-year-old girl gets a Schwab custodial account as a birthday gift from her Schwab client parents. She adds $50 three or four times a year. By the time she turns 18, her custodial account includes dozens of stocks. When she becomes an adult, she converts that account into a brokerage account and continues to buy fractions of shares using the newly introduced Schwab Stock Slices.

After graduating college and entering the job market, she might be disciplined and flush enough to set aside part of her salary to acquire more investable assets, but she doesn’t have the time or inclination to figure out what additional stocks and bonds to purchase. So she opens a Schwab Intelligent Portfolio account, where a no-fee robo-adviser invests her money in a diversified array of assets without involving her in everyday decisions.

The next big stage of her life is marriage and a family. Though her investments have grown, she now needs financial planning, including help with questions about college debt. Schwab nudges her over to Schwab Intelligent Portfolio Premium, where her investments stay the same but she is also given access to a certified financial planner at $30 a month.

When she reaches midlife, assuming she can afford to do so, she moves into Schwab Private Client, a more sophisticated wealth management portfolio, customizable to her family situation. The minimum investment level is $500,000, at a 0.80 percent annual fee. “And if all that goes well, she hopefully opens up custodial accounts for her kids,” Craig concludes.

This virtuous circle is most vulnerable in its early stages, because of new players like Robinhood. Among its peers, Schwab was first to eliminate trading fees from its brokerage accounts. But in fact, Robinhood had launched itself as an online brokerage six years earlier, in 2013, guaranteeing clients no trading fees or account minimums.

At the time, it was easy for the likes of Schwab, Vanguard Group, and Fidelity to ignore the newcomer. Schwab was in the midst of a decade-long expansion (beginning in 2010) that lifted its brokerage accounts by more than 5 million, to the current total of more than 13 million. During the same period, Schwab’s average household account value grew from $210,000 to $320,000. And Schwab takes special pride in having lowered its average client age by two years — to 52 — since 2010. “Winning with the younger generation has been a priority,” says Craig.

But that is also a priority at Robinhood, which has enjoyed a lot more success among the young and restless than Schwab. In its brief existence, Robinhood has gathered 13 million users with a median age of 31 — fully a generation younger than the average Schwab client. Its one-click app has stoked controversy for allegedly inducing users to treat the stock market like a Las Vegas crapshoot and to trade far more frequently and at greater risk than Schwab clients. And Robinhood’s screen display — with bright colors, falling confetti, and emoji notifications — can make trading seem like a video game rather than a serious investment.

At the other end of the financial services spectrum, Schwab also faces plenty of competition from established rivals. Though Schwab is famed as an innovator, it was a laggard in embracing this year’s hottest brokerage product: fractional-share trading. This idea is especially appealing to younger clients who can’t afford to pay $3,000 for a single share of Amazon but can purchase a basket of fractions in high-techs and blue-chips for as little as $5 per company.

The market leader here is Fidelity, which rolled out its fractional-share product in January and racked up 450,000 accounts by August 31. Schwab introduced its Schwab Stock Slices in June and now has 109,000 accounts.

Although youth must be served, Schwab is also concerned with expanding its ranks of high-net-worth clients. One way to entice those investors is with the especially low mortgage rates available to Schwab clients. Viewed as a defensive strategy, they might keep high-net-worth investors from migrating over to money center banks like JPMorgan Chase and Wells Fargo. “Those firms not only want our clients’ mortgages, but also to leverage that mortgage relationship to access our clients’ investments,” notes Peter Crawford, Schwab’s CFO.

Money center banks are also ahead of Schwab in income from advisory fees. Partly because self-directed investing is a Schwab tradition, only 20 percent of retail client assets receive some form of advisory assistance. That figure is more than 40 percent at JPMorgan Chase.

Pressures from competitors make it tough to remain a market leader by depending solely on organic growth. So over the past year, Schwab has gone on a massive buying spree.

The timing was right. When asked if Schwab was fortunate to have made its acquisitions just months before the pandemic began, Bettinger replies: “Good assumption.”

At the top of the list was Schwab’s big rival TD Ameritrade. The backstory of the deal was the announcement by Schwab on October 1, 2019, that it would no longer charge retail customers for trading shares, ETFs, or options online. TD Ameritrade was forced to follow suit, but its share price plummeted by 25 percent, in line with a predicted fall in revenue.

And on November 25 it agreed to be acquired by Schwab.

The deal sparked another big consolidation move in the brokerage industry. In February of this year, E*Trade, also a big Schwab rival, consented to an all-stock, $13 billion offer by Morgan Stanley. The Wall Street investment bank has shifted over the past decade toward wealth management and was anxious to expand into mass-market retail brokerage. Morgan Stanley CEO James Gorman asserted that the acquisition would allow his firm to better compete with Schwab.

That will be a tall order. With TD Ameritrade in its grasp, Schwab will almost double its brokerage accounts, to more than 25 million clients with more than $5 trillion in assets. (Only BlackRock and Vanguard have more assets under management.) The deal also provides access to TD Ameritrade’s $150 billion in client accounts at TD Bank, $10 billion of which can be transferred to Schwab Bank each year.

“Scale matters, especially in expense management,” says Crawford. He estimates the deal will cut costs by $1.8 billion to $2 billion annually.

Scale helps in other ways, too. Before the merger, Schwab controlled roughly half of the so-called small end of the custody market, represented by registered investment advisers handling less than $50 million in client assets. TD Ameritrade accounts for an additional 20 percent, boosting Schwab’s share of that market to 70 percent, or about $2.5 trillion, according to Morgan Stanley research.

That potential market domination threatened to delay or even derail the merger on antitrust grounds. But the Department of Justice gave its approval in June after accepting Schwab’s argument that a more accurate way to figure out market share is to look at overall financial adviser assets, which were approximately $24.4 trillion in 2018, according to Cerulli Associates. Schwab and TD Ameritrade’s combined custody platforms account for only about 10 percent of that total.

None of the other recent acquisitions by Schwab come close to the size and impact of the TD Ameritrade deal. But they do reflect a determination to extend Schwab’s footprint into every significant corner of brokerage and wealth management.

In February, Schwab bought — at an undisclosed all-cash price — Wasmer Schroeder, a Naples, Florida–based fixed-income specialist. Its $10.5 billion in assets belongs mainly to retirees and high-net-worth clients close to retirement. Before the acquisition, Schwab had been sending its separately managed fixed-income business for high-net-worth clients to third parties. “We have to split the fees with those third-party managers,” says Crawford. “Wasmer Schroeder gives us the opportunity to capture 100 percent of the fees.”

Another recent Schwab acquisition was the $1.6 billion all-cash purchase, completed in May, of the brokerage and managed-portfolio accounts of USAA’s investment management company. The deal, covering 1.1 million accounts and $81 billion in client assets, moves Schwab deeper into wealth management. It also adds $10 billion in client cash to Schwab Bank.

Because of the pandemic, more than 95 percent of Schwab employees now work from home. Not Bettinger, who still shows up at his nearly deserted headquarters every weekday — though he often forgoes a suit and sometimes skips shaving. Before the pandemic he flew four out of every five weeks. But over the past six months, he has taken only two business trips.

Post-pandemic, Bettinger predicts he and other executives will permanently cut down on business travel. “And our employees will be given more work location flexibility,” he says.

He also expects some enduring shifts in client interaction with Schwab. Because of Covid-19, client acceptance of digitization and advisory services has grown dramatically.

When Chuck Schwab began his discount brokerage almost a half-century ago, he disparaged the advice handed out by Wall Street firms as an unnecessary expense foisted on investors. But today, Schwab is laser-focused on fee-based advisory services, especially those linked to digitization and algorithms. Growing numbers of clients are comfortable with the notion of entrusting their investments to digital technology, as evidenced by a survey Schwab did two years ago. When clients were asked whether they preferred robots or humans to build their financial plans and manage their portfolios, half said they favored robots.

The conventional wisdom that the young are the early adopters no longer holds. The most popular robo-advisory product in Schwab’s arsenal — the Intelligent Portfolio — has as many clients over 40 as under.

The pandemic has accelerated these changes.

“We have probably achieved three to four years of digital adoption from our clients in the past three to four months,” says Craig. Partly because Schwab brokerage branches were closed, an avalanche of clients turned to mobile apps for inquiries and investments. The firm reports that in July the number of Schwab mobile app downloads climbed by more than 200 percent over the previous July. Less time spent on the phone or in person with clients translates into millions of dollars in cost savings for Schwab.

Still, the pandemic’s impact has been felt on the bottom line. Total net revenues for the first half of 2020 were $5.1 billion, a 6.4 percent decrease from the same period the year before. Net income dropped 22.6 percent, to $1.5 billion. The declines are linked to Schwab’s dependence on its bank, which saw its net interest margins shrink. Boosted by digitization, asset management advisory fee income showed a slight increase in the first half of 2020 from the first six months of 2019.

Schwab isn’t waiting for the end of the pandemic to push digitization in new directions. In June it acquired, for an undisclosed price, the technology and intellectual property of Motif, a pioneer in customized thematic portfolios and direct indexing for investors.

Motif allows clients, for example, to ask for shares in ESG companies. Or if they work for Apple or Alphabet and have stock options, they might want to forgo exposure to high-tech shares. And Motif can generate additional alpha by creating tax benefits for portfolios.

On the near horizon is the expansion of digitization to help investors measure their performance against a variety of benchmarks. Apparently, Schwab clients are no longer satisfied with comparing their portfolio results to the S&P 500 or Nasdaq. They want to know where they stand in relation to people their age or gender, or who live in their community. “We call this the ‘How am I doing?’ area,” says Neesha Hathi, Schwab’s chief digital officer. “It’s a great opportunity for us.”

Meanwhile, there’s still a pandemic to overcome.

Bettinger points out that Schwab was built to withstand the crises that will inevitably arise. Above all that means ensuring that its balance sheet is invested far more conservatively than most clients’ brokerage accounts — with some 70 percent of Schwab’s own portfolio taken up by U.S. government-backed debt. And though Bettinger insists that Schwab is interested in clients whether they bring $20,000 or $20 million to the table, he expects an expansion upmarket for the firm.

This dual formula has worked well in the past. “We made tremendous market share gains coming out of the 2008 crisis,” says Bettinger. “We feel it will lead to the same this time as well.”

And every other week, Chuck can count on getting a detailed progress memo from Walt.