Schwab's CEO, Walter Bettinger, said all the things that registered investment advisors would want to hear from their asset custodian chief on Thursday during an earnings call with analysts. Obviously, Schwab shareholders did not see it the same way: Shares of the San Francisco broker plunged by 7.7 percent to $13.59 by the close of trading Friday (near a three-year low after hitting $28 in 2008) in the wake of the company's Thursday teleconference with analysts.

This morning, Sanford C. Bernstein analyst Brad Hintz downgraded Schwab to "market perform," noting that the company will make less money due to hibernating retail clients (and therefore lower commissions), forecasted declining assets under management and decreased net interest income.

"Although we believe the firm's long-term business strategy is sound and the firm will almost certainly emerge as a winner from the credit crisis, it is becoming increasingly apparent that the retail slowdown that is just beginning to unfold will be long and severe," Hintz concludes in his research report dated February 2. Therefore, Hintz reduced his earnings expectations for 2009 to $0.68 a share, down from an estimate of $0.84. (In 2008, Schwab netted $1.03 per share.)

In his remarks on Thursday, Bettinger seemed to reassure RIAs that Schwab would gut out 2009 without hurting its service to RIAs. In fact, Bettinger placed cost cuts "off the table" if they could have a negative impact on client experience, despite plans to cut up to 600 jobs during the first three months of this year.

"This is a balancing act," he said. "We made the mistake of cutting too much in the past. The greater threat to our long-term organic growth is that we make compromises on client experience."

Additional items that Bettinger declared untouchable were investments in technology and risk management, rebuilding of the Schwab website and continued innovation in supporting affiliated RIAs.

This commitment is obvious to Schwab RIAs, said James Ferrare, senior vice president of Pinnacle Associates, a Schwab client firm that manages more than $3 billion from Red Bank, N.J., and New York. "They haven't skipped a beat" in servicing RIA clients, he said.

Schwab is also not planning to cut its fees and commissions; that said, if competitors slash fees, Schwab will respond, according to Bettinger. Schwab also plans to keep advertising aggressively, he says. "This is precisely the time we need to make ever-clearer what makes us different" from the competition.

Of course, Bettinger's plan to keep spending would prove difficult if he didn't enjoy a rare advantage: healthy profits and scads of new assets. But Bernstein's Hintz is forecasting new assets to plummet in 2009 due to a weakening economy and higher unemployment. Fees on assets represent about 40 percent of Schwab's total revenue. He forecasts "new asset trends will continue a steep decline through 2009 and begin a steady rebound in Q1 2010." Hintz reckons fee income will drop by 14 percent in 2009 versus 2008.

The Charles Schwab Corp. had record-operating profits of $1.2 billion and $1.06 per share in 2008, up 10 percent from the year-earlier period. It also gathered $113 billion of net new assets, which is down from $160 billion for 2007. RIAs accounted for $60 billion of net new assets in 2008 including $13 billion from brokers turning independent—though Bettinger warned against too much optimism in this ballyhooed area of growth at the firm.

"We tend to be balanced in saying that we don't expect there is some massive transformation [of brokers to RIAs]" in the works, he says.
But there is a transformation brewing. Schwab has 1,100 advisor teams with $145 billion of assets in its recruiting pipeline, of which teams with $45 billion are discussing the move "seriously," according to a Schwab spokesman.

Meanwhile, Schwab's record profits got a tailwind from RIAs who upped their allocation of assets to money market funds to 20 percent from the more traditional level of 10 percent, says Bettinger. Money market funds are a key profit source for Schwab, which takes, for instance, a 0.63 percent fee on Schwab Investor Money Fund.

Another line of business putting pressure on Schwab is interest rates. Schwab CFO Joe Martinetto said that if interest rates continue to plunge in 2009, it may necessitate Schwab issuing "fee waivers" (essentially pricing concessions) on its money market funds totaling as much as $200 million over the course of the year. These fee waivers become necessary if money market yields plunge near to the level of the funds' fees. These waivers prevent clients from realizing negative returns.