Schwab Charles Corp Q3 FY2020 Earnings Call

And we are live. Good morning everyone, welcome to Schwab's Fall 2020 Business Update. This is Rich Fowler, Head of Investor Relations coming to you from a still sparsely populated 211 Main Street in San Francisco. Well I want to extend a particular welcome to those of you attending this session as new owners or followers of Schwab, due to our recent acquisition of TD Ameritrade, we certainly hope everyone on the call and your families remain safe and well in this environment. And we thank you for spending time with us today. There's a full lineup of earnings reports for many of you to deal with. And we certainly have a full agenda here. So we're going to get things underway quickly. Joining me today, both virtually and literally are Walt Bettinger, our President and CEO; Joe Martinetto, Senior EVP and COO, and Chief Financial Officer Peter Crawford. Now those of you experienced with our interim updates will immediately recognize that Joe's participation signals, that we're not following traditional practice today. And we are indeed planning to spend a longer than normal session, say around an hour and a quarter with these three, bringing you up to date on life at Schwab right now, starting off with some prepared comments and following up with Q&A until it's time to wrap up. Our goal is always to keep you current regarding management's thinking as efficiently as possible. We will follow tradition on questions. So we'll do so via the webcast console, as well as the dial-in, and as always, to help us get to as many folks as possible, we very much appreciate your sticking to one plus follow on in the approach to questions. Walt will start us off today to discuss our strategic picture, which includes both the continuing story of the company's performance during the pandemic and the implications of closing the Ameritrade acquisition. And then Joe is here to share an update on the integration process as we dig in on this front. Peter will review the recent financial performance of both firms on a standalone basis and then move to discussing the current outlook for the combined company before taking us into Q&A. Before that, let's spend a second on the wonderful wall of words, holding steady at a single riveting page, the main point of which is to remind everyone that outcomes can differ from expectations. So please keep an eye on our disclosures. Finally, the slides will be posted on the IR side during Peter's prepared remarks. I think that's it administratively. So Walt, I think we're ready to get going over to you.

Thank you, Rich, and good morning, everyone. Thanks for joining us during what continues to be extraordinary times. We all recognize that we're living in a unique and challenging time for everyone. And my best wishes for good health and safety go out to all of you who are joining us on the call. It's really times like these that have focused and consistent strategy means more than ever. The noise around us from a struggling economy, record low interest rates, and a degree of political turmoil can shake those less committed to a sound long-term approach. At Schwab, we remain as committed as ever to our two client side strategy and our key strategic initiatives, scale monetization and segmentation. Our approach is winning in the market. And we believe that our combination with TD Ameritrade will deliver outstanding financial results along with furthering our competitive position in key client segments. As I've said before, we are on offense. And the response from our clients with record and near-record metrics supports the efforts that we're making to offer world-class value, service, advice and transparency. Now as of October 6, we have successfully completed the four acquisitions that were announced in the past 15 months. Each of these transactions is strategically important for us but of course in different ways and each slots in perfectly with those key strategic initiatives I mentioned previously of scale monetization and segmentation. USAA adds to our scale of existing clients. And our exclusive Wealth Management referral arrangement that we have with USAA continues, adding scale for us and should be effective for years to come. Motif delivers highly talented technologists along with a platform that is helping accelerate our efforts to deliver thematic investing, as well as direct indexing to investors and advisors. And of course, that will in time contribute to our efforts around monetization. That is good for clients. Wasmer, Schroeder accomplishes a similar goal, monetization that's good for our clients but with maybe a more traditional approach to investment solutions in the fixed-income area, and of course their expertise in tax-smart fixed-income investing is likely to prove especially valuable, as tax rates potentially become an increasingly important consideration for investors after the election. Of course, the TD Ameritrade acquisition not only builds tremendous scale, but it also delivers outstanding capabilities that serve our segmentation objective. We know that they had a best-in-class platform for traders, several capabilities that are highly valued within the investment advisor community also. This slide graphically illustrates the scale impact of the TD Ameritrade acquisition. Also it shows the powerful combination of our firms with net new assets in excess of $75 billion, and almost 1.5 million new brokerage accounts in the third quarter alone, keeping in mind that that third quarter included tax payments, unlike in most years. Now, Peter's going to speak a little bit later regarding the near-term and longer-term financial benefits of our transaction. But for now, I will simply say that they are significant. Now as strong as our asset-gathering and overall financial performance has been, we see many untapped opportunities to drive significant asset and revenue growth by leveraging our scale, better monetizing assets in ways that are good for clients, and developing leading offers for key segments of our client base. The M&A has played an important role in pursuing these initiatives. But M&A activity is only one way that we will drive these efforts forward with all three key initiatives contributing to our strong growth. Through the first three quarters of 2020, and of course, this is looking exclusively at Schwab results, clients entrusted us with core net new assets in excess of $160 billion, a 5% organic growth rate, which is consistent with our long-term results. Included in there is an all-time monthly record for the month of September with $20 billion in core net new assets. I remember when we reached $2 trillion in firm-wide assets, the number one question I received was always could Schwab continue to capture an organic net new asset growth rate in that 5% to 7% range even on such a large base. Of course, we were confident that we could back down and we remain equally confident today. That being said, we talk about a range because as we all recognize that there will be some variability driven by market conditions as well as employment conditions, and those contribute to either accelerating or decelerating money in motion, and therefore, new assets in our category. I think what's clear, though, is that what won't change is our ability to keep winning assets and continue gaining market share, regardless of whatever the environment is around us. Our organic efforts around scale are also paying dividends in terms of operating efficiency, with almost two-thirds of our client households now digitally active, over half of the arrays we serve are leveraging our digital service capabilities. And over three-quarters of our client base is now enrolled in paperless reporting. Here is an example of where the pandemic that we're dealing with has actually contributed to more rapid adoption of digital capabilities. And of course, digital adoption and digital initiatives are what I like to refer to as triple wins. And by that I mean that they result in a better experience for our clients through both faster processing as well as a richer overall experience. They contribute to lowering error rates, and also lower costs for Schwab. And, of course, that in turn benefits both our stockholders as well as our employees as our employees are able to engage in more value-added interactions with our clients. Let me emphasize though, that adoption of digital does not mean that people, and specifically, our branches in our service centers don't matter. In fact, arguably, they matter as much or more than ever. What digital adoption does mean is that employees can focus on relationships, more than simply processing transactions. And of course, that's exactly what we want, what our clients want, and what we mean when we talk about bringing together really the best of people and technology to our no tradeoffs value proposition. We've demonstrated that when we offer clients, and this is both on the retail side and on the RA side, when we offer them high-quality solutions at very competitive prices, they vote with their fee. Usage of Schwab managed ETFs is growing again, after a slowdown earlier in 2020, largely due to tax-loss harvesting. Clients continue to enroll in our retail advisory programs, we now have assets exceeding $360 billion and clients are increasingly turning to Schwab bank for their lending needs, with loans up over 30% from one year ago. Our success with our asset management and lending products also fuels our confidence in continuing to extend our capabilities. And part of that is ensuring that third-party managers provide appropriate compensation for the many services that we provide them and the investors who invest in their products through our platform. These types of efforts will further diversify our model and decrease our reliance on spread-based revenue. Whether it's from ongoing negotiations with fund complexes that rely on Schwab to provide shareholder servicing, without helping us cover those costs, to substantial opportunities in thematic investing and direct indexing, to the growth opportunities in the area of retail advisory services and last but not least to the opportunity to deliver premier fixed-income advisory to clients at a great value through in-house Wasmer Schroeder. At the same time, we're working hard to build and deliver increasingly segmented capabilities to delight clients of all sizes and types. Whether they are targeted at newer younger investors, which certainly gets a lot of press today, new and creative ways to invest in a more customized or personalized manner through themes and direct indexing, better serving the fastest-growing segment of our retail business, which is high net worth and ultra-high net worth investors. And creating new and more streamlined experiences for independent investment advisors that we serve and of course, we serve all sides, investment advisors large, small, and in between. As I've said for a number of years, the future in our industry, in our view belongs to the organizations that deliver a no tradeoffs approach to investing, great value, transparency and trust, omni-channel service, a single place to meet all of investors' needs all of this from a company that is both a challenger to the rest of the industry, as well as a beacon of confidence due to our size and scale. In our words, it's no tradeoffs, no limits, and all done through client size. At Schwab, we call that modern wealth management. And we think that uniquely defines Schwab and is only achievable by a firm with our size, scale, and importantly our focus. In our view, our capabilities, our rather simple strategy, our enormous scale, our culture of service, and our commitment as a challenger company, to continue disrupting to benefit investors and advisors is a combination that no one else in the market can match. Our transfer of account or asset figures tell the story better than I ever could, attracting $2 from core competitors for every dollar they take from us. Strong results versus the global banks and warehouses at 2.2 to 1. Strong results versus the independent broker dealers at 1.8 to 1 and exceptionally strong results versus the mono-line fintech companies that were asked about so frequently at a ratio of over 200 to 1. All contributing to a firm-wide TOA ratio of two to one and as successful as both TD Ameritrade and Schwab have been in taking share for the past four decades, the reality is we still collectively have a very small share of an enormous wealth management market in the US. So just in closing, we know that we are dealing with record low interest rates, and those create short-term headwinds. Eventually we'll have relief from this pandemic. Eventually, the economy will get fully back on its feet. Eventually, our belief is that interest rates won't remain at all-time record lows. But in the meantime, we won't be here off course. We won't deviate from our through client-side strategy. We won't stop being on offense with our key strategic initiatives of scale monetization and segmentation. And we surely won't stop pursuing disruptive actions that benefit clients, the very soul of a challenger. For those of you who know Schwab well, you know that we don't measure our progress in quarters, and generally not even in years, but rather in decades. And I've never been more optimistic about what the future decades hold for Schwab. So I want to transition over to Joe Martinetto, I'm pleased that we're now in a position to begin the process that actually unleashes the potential from combining Schwab and TD Ameritrade as all of you know, Joe is leading that effort. And I know he's looking forward to sharing an initial update on our integration efforts. So Joe, let me turn it over to you.

Great, thanks Walt and good morning, everybody. So today, I would characterize my presentation as more of a cameo than a full update. I'd remind everybody that we just closed the transaction a couple of weeks ago. And we were able to do a fair amount of integration planning prior to close. But there are a lot of details that we've just recently been able to share; while we feel very good about the work we've done, and what we're seeing, we're going to need a little time to firm up the executional plans and financial implications before we can provide you with that fuller update. That said, we've already made a number of decisions about platforms and client experience that we'll share today. And we've also moved quickly to recognize some of the closer-in synergies; I'll update you on those activities as well. So let's start with the expense synergies first. Just a reminder, our targets at the time of announcement called for us to realize between $1.8 billion and $2 billion in expense reduction synergies. We spent the last 10 plus months developing plans to achieve this level of savings. And by close we had high-level plans at the business unit level to achieve it. We still believe it will take 18 to 36 months to get through broker-dealer consolidation, account conversion, and the shutdown of all the redundant systems and functions that are necessary to achieve this level of savings. I'll have more to say about the timeline in a couple of slides. I'm also focused today on expense synergies as those are likely to occur in a more material way more quickly than revenue synergies. As we've discussed before, the bigger revenue synergies come from the repatriation of the BDA balances, but we do expect that there will also be revenue synergies that are tied to the account conversion, when we'll be able to offer the best of both companies' products and services to the combined client base. Those outcomes will be a little longer coming as we're still operating as two separate broker-dealers today. With respect to the expense actions, we've already taken steps to achieve between $250 million and $300 million in expense reductions. We've aligned the management structure, and across management in the branch network eliminated over about 1000 roles. We moved aggressively to rationalize the branch network; there was a significant amount of overlap across our footprints which we're eliminating. Of their roughly 260 branches, we're retaining about 55; the majority of the rest will co-locate into nearby Schwab branches, where we'll have both Schwab and TD Ameritrade employees. Our combined branch footprint after the consolidation will be larger, with over 400 branches, 140 of which will be shared through conversion, and 90% of our clients will have a branch within 25 miles up from 80% before the transaction. We've also closed the number of previously open management positions, as well as reduced our anticipated marketing spend. While it'll take some time to recognize the full level of synergies, we expect to see additional reductions over the course of the next 36 months. And with the meaningful reductions that I just noted along with other actions that we plan to take, we're thinking we'll exit the first year after the transaction with between one-quarter and one-third of the expense synergy total in the run rate. Moving on to some of the platform decisions as we've said all along we expect to realize the best of both when it comes to customer-facing platforms. Both companies have well regarded and recognized platforms with very complementary strengths. We expect to leverage the existing Schwab's websites, mobile applications for investors, independent advisors and automated investing solutions. We'll be adding the thinkorswim web and mobile experiences for traders and supplementing the advisor experience with the trading and rebalancing capabilities from TD Ameritrade's advisor platform. That said, we expect that there'll be changes to all of these platforms that we'll need to make for a seamless experience for our combined clients. For example, the trading experience on schwab.com will evolve a bit to serve the more active traders from TD Ameritrade who prefer to use the web. The Schwab Advisor Center will incorporate more integrations with third-party platforms to accommodate the advisors who use services where we don't currently have an easy-to-use integration. I promised I'd have more to say about the timeline for integration earlier and I'd like to remind folks that this is an extraordinarily complex integration. Both firms are large in their own rights and when you combine them and look to add the headroom that's necessary to handle potential spikes in activity, there's a geometric effect on the capacity necessary to run the firm safely. While we're availing ourselves of our own recent experience with integration as well as the expertise available to us as part of the team that is joining from TD Ameritrade and we're eager to get to full synergy recognition, we of course have to balance that with the client experience considerations. We want this to be an incredibly smooth experience for all of our clients, both the retail investors and advisors, and we expect to continue to serve the vast majority of them long past integration. At this point, I'll turn the mic over to Peter, and he'll give you details on how all of this works into the financial picture.

Thank you very much, Joe. It's great to have you back for the business update, even if it is just a brief appearance. Walt and Joe highlighted our enthusiasm regarding the TD Ameritrade acquisition and our belief in its benefits for clients, stockholders, and our combined team. They discussed the strong momentum we are experiencing in the marketplace despite the challenging conditions we face, and the progress we are making in executing our strategy to leverage our scale, capitalize on monetization opportunities for clients, and create superior experiences for our key client segments. Today, I will talk about how this momentum has helped to mitigate the current challenging market environment, especially the impact of low interest rates. I will also share the operating and financial results for TD Ameritrade for the quarter ending September 30, which shows that we are merging with a very healthy business that is performing well in the current conditions. Finally, I will provide an update on our Q4 outlook, incorporating TD Ameritrade for the first time, and some initial thoughts on 2021. The main message is that we are aware of the challenges in the environment that are affecting our financial results, and we recognize there may be tough weeks and months ahead. However, we remain optimistic and confident about the future of this company. We feel that we have reached an inflection point due to our strong market momentum, our early successes with the TD Ameritrade acquisition and integration, and our ongoing progress both organically and through M&A in line with our strategic priorities. We focus on what we can control. We can't control the equity markets, which have become a tailwind for us, nor can we control the interest rate environment, which is a significant headwind. What we can control is our positioning, which, combined with high investor engagement, has led to substantial year-over-year increases in new retail households. In a business founded on trust, we work hard to maintain that trust, giving our clients confidence in us, including their uninvested cash, which has risen over 50% year-over-year. Given the mixed factors of tailwinds and strong headwinds from interest rates, it is not surprising that our revenue declined 10% year-over-year in the third quarter, entirely due to an 18% fall in net interest revenue. Average interest-earning assets rose significantly by 45% year-over-year, but this was not enough to offset a 105 basis point reduction in our net interest margin due to Fed cuts, an increase in premium amortization, and the impact of investing almost $100 billion of new cash at rates lower than our average portfolio yield. Asset management and administration fees were up 4% year-over-year, despite the return of money fund waivers totaling $44 million in the quarter. Trading was down 12% even with a considerable increase in trading activity due to last year’s commission reductions. Expenses increased roughly 6%, but they would have risen only about 2% without the acquisition and integration expenses for TD Ameritrade, and the additional acquired intangible amortization from the USA, Motif, and Wasmer acquisitions. Even this modest adjusted expense growth includes ongoing expenses from those three new businesses, which contributed just over two percentage points of growth. Overall, we achieved a 36% pretax margin and a 39% adjusted pretax margin, with a 10% return on equity and a 12% return on tangible common equity, negatively impacted by a $5.7 billion net unrealized gain in our available-for-sale portfolio. Our balance sheet continues to grow due to both substantial organic growth and client allocation decisions. Typically, we see client cash on the balance sheet rise more swiftly when interest rates are low, as clients recognize less benefit from fixed income instruments, leaving more cash in their accounts and a larger portion in our bank and broker-dealer sweep options. Following a significant surge in client cash at the end of the first quarter, we have observed slower but still considerable growth in sweep cash balances over the past two quarters, including a 6% sequential increase in Q3. This growth in our balance sheet reduced our Tier 1 leverage ratio to 5.7% for the third quarter. While this is below our operational target of 6.75% to 7%, it remains well above the regulatory minimum. The TD Ameritrade acquisition will help us rebuild our capital ratios more quickly than we could otherwise. A concern with acquiring a business while there’s a delay between signing and closing is the state of that business upon takeover. The operating and financial results for TD Ameritrade for the quarter ending September 30 indicate we are acquiring a very healthy business performing exceptionally well in this environment, and we owe thanks to the many TD Ameritrade employees who have been dedicated over the past 10 to 12 months. Before I highlight a few details from the TD Ameritrade seller quarter, I want to remind you that additional standalone operating and financial information for TD Ameritrade has been posted on Schwab’s Investor Relations site. The strong operating metrics reflect significant market momentum, including a 20% increase in net new assets, a more than 300% increase in net new funded accounts, and a 355% rise in trading activity, along with a 23% increase in average margin balances. This substantial business growth and heightened investor engagement translated into impressive financial results, with revenue up 5%, as increases in trading and margin balances more than compensated for the impact of lower interest rates. Operating expenses decreased by 2%, resulting in an operating margin exceeding 50% and a 16% increase in earnings per share to $1.16. While each firm has excelled independently, together they create a more resilient and powerful company. Our combined third quarter results would suggest over $4 billion in revenue, a pretax margin exceeding 45%, and approximately $53 billion in stockholders' equity. The revenue mix is different from what Schwab has seen in the past, with over 50% from spread-based revenue and net interest revenue, 24% from asset management and admin fees, and 21% from trading. Long-term, we have emphasized our low reliance on trading as a positive, especially when trading faced secular headwinds due to reducing equity commissions. Now that pricing erosion is largely behind us, the increased exposure to trading is beneficial as it diversifies our revenue streams, reduces capital intensity, and establishes a more resilient business model evident in the current environment. This year has unfolded differently than anticipated several quarters ago and relative to the scenarios shared in April. The equity markets have risen much faster, while interest rates remain historically low. Trading activity has increased, and our balance sheet growth has exceeded previous forecasts. Overall, our revenue has leaned towards the lower end of expectations, despite increases in key workload drivers like new accounts and trade calls, and we have managed to keep adjusted expense growth at the lower end of the range. Thus far, we have achieved an adjusted pretax margin just above 40%. Scenarios previously shared did not encompass the impact of TD Ameritrade, but with its closure behind us, we can now communicate a scenario for Q4 based on this integration. For the full year, we expect year-over-year revenue growth of 7.5% to 8%, assuming slight market appreciation from recent levels, sustained elevated trading, and stabilizing prepayment speeds. We also anticipate the net interest margin for Q4 to be in the 150 basis point range, potentially 10 basis points or more higher than our Q3 average. We expect full-year adjusted total expense growth of 15.5% to 16.5%, reflecting roughly 4% year-over-year growth for the Schwab standalone business, aligning with previous scenarios. This also accounts for the initial realization of synergies described by Joe earlier, but excludes acquisition integration costs and anticipated amortization of acquired intangibles of approximately $445 million in Q4. Overall, this scenario indicates a potential increase in adjusted EPS of 25% to 35% compared to our Q3 results. In terms of our balance sheet, we expect it to grow by over 70% thanks to the addition of TD Ameritrade’s $70 billion balance sheet and ongoing client cash balance increases, which typically accelerate in Q4. The acquisition not only enhances EPS immediately but also boosts our capital ratios promptly. Our Q3 Tier 1 leverage ratio stands at 5.7% based on average assets, and the spot ratio, considering that the balance grew during the quarter, is likely 10 to 15 basis points lower. However, the TD Ameritrade acquisition pushes that spot ratio nearly to 6%. The capital benefits from this acquisition extend beyond closing, as we aim to keep the ratio of preferred to Tier 1 capital below 25%, and TD Ameritrade's capital structure does not include preferred equity, creating additional preferred capacity we expect to access over the coming quarters. Moreover, the acquisition increases our organic capital formation as well. Despite the current interest rate environment, we feel optimistic and confident as we look towards 2021. We believe that the momentum both firms have experienced will provide a strong foundation for continued success next year. The financial advantages we expect to see in our Q4 results should continue to grow as we capture more expense and revenue synergies. While we'll present our projections for 2021 in February, we hope you recognize the powerful firm we've developed, with $6 trillion in client assets, 29 million brokerage accounts, and projected adjusted pretax income of $6.5 billion to $7 billion based on our combined third and fourth quarter results. With interest rates and prepayment speeds showing signs of stabilization, there is potential for sequential increases in net interest revenue after several declines, assuming we continue to see organic growth in client cash balances and similar levels of margin balances. As we focus on integrating TD Ameritrade efficiently, we will also advance our strategies around scale, monetization, and market segmentation. Finally, we are mindful of our capital position, ensuring we have adequate capital to support our balance sheet growth and transfers from the IDA starting as early as July 1 next year. In closing, while we have spent ample time discussing the TD Ameritrade acquisition, and rightly so, it is a significant part of our story. However, it is not the entirety; we are also actively pursuing numerous other initiatives to better serve our clients, tackle our competition, and enhance efficiency across our operations. While the acquisition is transformative, increasing our scale and capabilities, it does not change our principles or how we operate, including our focus on clients, disciplined management, and long-term vision, which have contributed to our success for over four decades and will continue to do so in the future. Now, I’ll turn it over to Rich for questions.

All right. Thank you all. We'll go to Q&A now, Operator. Would like to start us off on how to pose questions?

Thank you. We will now begin the question and answer session. Our first question comes from Dan Fannon with Jefferies. Your line is open. You may ask your question.

Thanks. Good morning. So a lot of factors have changed since the deal was announced or you think about rates, client engagement, asset levels, things like you're reiterating the expense, synergies that you've outlined or originally outlined, but I assume some of the areas of potential revenue and/or expense reduction have changed given all the external factors that have happened between announcement and close. So if you could talk about that, and ultimately, accretion from how you originally stated it to where it sits now.

This is Peter. Let me address that in a couple of ways. First, the short-term accretion calculations have improved over the past year due to the earnings trends of both TD Ameritrade and Schwab. Regarding the realization of synergies, it seems that the synergy opportunities have actually increased. On the cost synergy side, despite changes in the environment, our perspective on the cost synergy potential hasn’t changed fundamentally. We continue to believe that those figures are quite attainable and will primarily come from the same areas we identified a year ago. On the revenue side, a significant portion of the revenue synergies is coming from rebanking the balances in the IDA. At the time of the acquisition, those balances were around $115 billion, and now they exceed $150 billion. This benefits us in a couple of ways: first, we've seen a 10-basis point improvement in the net fee, which is now applied to a larger base; and second, we can add more cash to the balance sheet, which generates additional spread revenue. I believe that has added to the positives as well. Additionally, as we've delved deeper into the business and gained more understanding, we've identified other smaller revenue opportunities where we can leverage the combination of both firms to capture more incremental revenue. We will have more to say about those in the future, but our confidence, excitement, and enthusiasm about this situation have only grown over the past year.

Thank you. Our next question comes from Will Nance with Goldman Sachs, you may ask your question.

Hi, everyone. Good morning. Maybe I could start off with a quick question on balance sheet growth from here. If I think about pro forma for Ameritrade, and this is rough math, but it seems like the percentage of your client cash that is now on balance sheet is in kind of the 50% ballpark, and that's kind of in the backdrop of that being below the long-term average, all-time low rate, loss of liquidity, money markets being kind of flat to even shrinking. So when we think about the tailwind of BDA sweeps going forward, as well as what you could call reverse sorting and the lower rate environment, do you think we could be talking about something like double-digit balance sheet growth for the next couple of years, as we kind of rebase the allocation of cash between on and off balance sheet?

That does sound like a repeated question. So, Will, there are a few key factors that tend to drive organic balance sheet growth, particularly when we look at Legacy Schwab. One factor is the interest rate environment. In a lower interest rate scenario, clients are less likely to invest in purchase money funds and CDs due to diminished yield, which results in them leaving more cash in their accounts on our balance sheet. The second factor is organic growth, as a portion of the net new assets we bring in every quarter and year consists of cash. The third factor is client sentiment regarding the equity markets, influencing whether they are purchasing or selling equities, which is harder to predict compared to the first two factors. In this low-interest rate environment, our balance sheet has grown at a notable pace following the end of the first quarter, with annualized growth in the double digits, a trend that could persist as long as interest rates remain low. However, if interest rates rise, we would expect that growth pace to decline, and a more bullish sentiment in the equity markets could also slow down balance sheet growth.

Got it. That's very helpful. And then, secondly, kind of on the same topic, I'll keep asking a few other questions. As we think about the continued growth in the securities portfolio, you've had a big opportunity over the past year or so to continue to shift the mix toward fixed-rate securities and away from the floating rate allocations, just maybe looking for an update on how long that can kind of continue, when you would kind of need to start keeping that balance in line and what the rates on those sorts of securities look like in today's environments, I guess, from a credit perspective.

We are currently at approximately 85% fixed and 15% floating in our investment portfolio, and we believe this is the right balance to maintain. We plan to keep it close to this ratio, which results in a duration in the upper threes. As for the re-investment rates on the fixed portion, they are currently in the range of 90 to 105 basis points, although this can fluctuate on a daily or weekly basis, generally remaining within that range.

That's helpful. Thanks for taking my questions.

Thank you. Your question comes from Mike Carrier with Bank of America, you may ask your question.

Good morning, and thank you for your questions. It appears that you provide great value in several areas and have shown innovation in your various offerings. One topic you mentioned pertains to the higher end, specifically regarding RIAs. When considering more comprehensive and full-service offerings, how do you view Schwab's provision of services like lending, insurance, and other increasingly sought-after options? Do you think about these on a proprietary basis or through third parties? I would like to hear your thoughts on this.

You're referring on the retail side or on the RIA side or both?

Yeah, both, but I would say probably you're going to see more demand through the RIAs.

Certainly, we observe growth on both sides. The RIA business continues to experience remarkable organic growth, and on the retail front, high net worth and ultra-high net worth clients are our fastest-growing segment. These clients often differ in that those coming to us through retail are generally more self-directed, sometimes coming from a financial background and familiar with managing their own money. Conversely, RIA clients typically rely on professional investment advisors for money management. Both segments are growing rapidly, and our strategy is to enhance the services and capabilities that high net worth and ultra-high net worth investors seek, adapting to the different approaches to money management on the retail and RIA sides. We aim to provide specialized services, dedicated relationships, and access to products that cater to both types of investors. Notably, those on the retail side choose Schwab specifically and prefer to consolidate their assets here. It’s crucial that we deliver the service experience they expect, given their significant asset levels. Therefore, we will keep expanding our capabilities to fulfill the needs of retail clients at Schwab, who want to remain with us, while those working with RIAs are doing so because it aligns best with their needs.

Great. Okay. And then, Peter, just one clarification. I think that you mentioned that the NIM for the fourth quarter around the 150, and I don't know if you had to break out between Schwab and Ameritrade and not looking for that going forward, but just given the moving pieces this quarter. I don't know if you can provide some context, you know, on the moving pieces. Thanks.

We observed an incremental benefit in net interest margin from the TD Ameritrade acquisition, which we calculated to be 19 basis points. This suggests that the legacy Schwab business is operating in the low 130s range. Various factors have influenced net interest margin over recent quarters, including declining short-term rates, increased premium and amortization, and reduced credit spreads. Additionally, we've seen a significant rise in cash balances that we've reinvested at rates lower than our average portfolio yield. While credit spreads have stabilized and short-term rates have also remained steady, there is currently less cash available to invest, leading to a smaller difference between the rates we are investing at and our average portfolio yield. We do not anticipate a significant further increase in premium amortization. Therefore, while we expect net interest margin to decrease from Q3 to Q4, the decline for the legacy Schwab business is unlikely to be as substantial as it was from Q2 to Q3.

That makes sense. Thanks.

Thank you. Your next question comes from Steven Chubak with Wolfe Research. You may ask your question.

Hi, good morning. So I wanted to start with a question just on the election impact. There's some speculation that a blue wave could drive a steeper yield curve, which will certainly be beneficial, but also could come with the cost of either increase in tax rates and tougher regulation, whether it's DOL, transaction tax, higher capital requirements for banks, which will clearly present some headwinds. And I was hoping you can just provide some perspective on how you're thinking about the different election scenarios and what the potential implications could be?

Okay, maybe, Walt would you like to start us off on that? And then maybe Peter can pick up after? Sure. I believe our main focus right now is to ensure we are supporting our clients during what could be a tumultuous election period. Our ability to predict the election outcome is no better than anyone else's, so we are not planning any strategic changes at this moment. The factors you mentioned are valid, provided the election yields the results you referred to. At that point, we would need to assess how a steeper yield curve interacts with some potential challenges for our business, should they arise. For now, our priority is ensuring system availability, capacity, and service for our clients as we enter this potentially volatile time. It might take a while to get clarity on the election outcomes, particularly for some offices. Peter, do you have anything to add?

I think you answered it well, Walt. I'll just say that I think we have shown our ability to prosper in different environments and different administrations over our 40-something years. And as long as we continue to focus on clients, folks at home can do the math on what changes in corporate tax rates might do or changes in the long end of the curve. That's not really any mystery. But for the long term and the way that we manage this business, it's as Walt says, it's really continuing to focus on our clients, continue to execute on our strategy. And we think we will benefit from a lot of the secular trends that are taking shape in our industry. And so we think that'll continue to benefit us, regardless of the administration in the political environment.

Thank you both for that perspective. And just for my follow up, I wanted to ask on capital. Following the deal you spoke to the capital accretion, Peter, and the additional preferred capacity getting you back well above 6%, but just given your target of 6.75% to 7% coupled with the fact that you continue to see really strong organic cash growth, it looks like by the time you can onboard the BDA in July of next year, that you're still going to be below that target level and was hoping you could speak to how you're managing to those capital constraints, how it might impact the decision-making to onboard the BDA as quickly and how you're just balancing that pace with a commensurate capital drag?

Yes, our plan is to add those balances to our balance sheet starting July 1 of next year. We have various options available regarding capital, and we want to ensure we have sufficient capital to support the organic growth of our balance sheet. Therefore, it is reasonable to expect that we will tap into the periphery markets. However, if we are not at 6.75% in tier one leverage by July 1, it should not be assumed that we won’t bring those balances on. We believe we can proceed even if we fall short of that level.

Thank you. Your next question comes from Brian Bedell with Deutsche Bank, you may ask your question.

Great. Thanks. Good morning, folks. Let me just start with the interest rate, headwind dynamic. Peter, you mentioned the 90 to 105 basis points, fixed reinvestment rates, maybe you could share the floating reinvestment rates if you continue to keep that at 15%. And then any commentary on money market fee waivers into 4Q, given the exit run rate was higher than the entry run rate and tricky.

Regarding the money fund fee waivers, we might anticipate a slight increase between Q3 and Q4, as we are moving towards a faster pace. However, this depends on the balances in the money funds. If we observe a decline in balances across most purchase money funds, this would naturally decrease the fee waivers. Nevertheless, I believe an increase from Q3 to Q4 is a reasonable expectation, which is already factored into our full-year revenue outlook shared earlier. As for floating rate yields, they are currently around 40, depending on our purchases. A significant amount of the credit we typically acquire is floating rate, which leads to higher yields compared to when we purchase agencies. Therefore, there is a considerable spread in our investments.

Okay, understood. I have a question for Walt. Regarding the long-term interest rate trends, if we remain in a lower rate environment longer than anticipated, what are your views on diversifying the revenue mix away from areas sensitive to interest rates? How do you envision developing more sustainable fee revenue streams, and could this connect to the revenue synergies we may discuss further in February? How do you plan to adjust that mix, if at all?

We have a long-term goal of achieving a balance between spread income and other revenue sources, which is evident in two of our three strategic initiatives, particularly in monetization and segmentation. I want to highlight that all our monetization efforts are intended to benefit our clients. You can observe these efforts in our recent technology and talent acquisition from Motif, the acquisition of Wasmer Schroeder, and our ongoing negotiations with firms that utilize our platform without compensating us for the services we provide. These actions align with our plans to enhance our advisory solutions. Ultimately, our priority is to ensure that all our initiatives are in the best interest of our clients. We are confident that we can move toward a more balanced revenue mix in a scenario where interest rates remain low for an extended period. However, if rates increase and the yield curve steepens, our spread income could rise significantly and quickly, presenting challenges. Nevertheless, we are optimistic about our strategies to achieve a balanced approach within a reasonable timeframe and are committed to taking all necessary actions to reach that goal.

Okay, thanks for your color. Thank you.

Thank you. Your next question comes from Devin Ryan with JMP Securities, you may ask your question.

Great. Good morning. First question here just on expenses. And I know we're going to find our point on this. But if we think beyond the immediate $250 million to $300 million synergies here, if you can just help us maybe bridge a bit to the $1.8 billion to $2 billion, and just remind us of some of the key milestones that are going to be required to hit those types of levels. And just also, if you can, whether you're feeling the same around the timing here because obviously, the range is the same, but a lot has changed. It was previously stated to just try to think about the timing of expense synergies relative to what you guys were thinking when the deal was announced.

Sure, this is Joe again. So I'd say there's very little that's changed in our thinking around how to recognize the synergies and clearly the company's continued to operate and to the extent that we've had some very active service level requirements and those kinds of things this year, both companies have added some staff to take advantage of that. But those kinds of changes haven't had a material impact on the way we've been thinking about actually achieving the synergies. So the first pass through was dominantly focused on senior and executive level management and branches. Over the nearer term, there will be a series of other functions as we look to continue to consolidate predominantly in headquarters types of roles, as you get through things like converting to a single HR platform, there's savings both on the technology and on the people side that they come with those kinds of activities. And those will occur over the course of the next couple of years. A little further out is when you actually get another opportunity to get a bigger bang and expense synergies when you get to that point or we get to that point of being able to do the account conversion. There are a lot of synergies tied up in moving to a single broker-dealer from two broker-dealers. And there's a material amount of reduction, summon staff to support for a lot across things like technology platforms, real estate footprint that come down once we get to the place where we can really get to a single broker-dealer and run on a single platform. Then I would say there's a little bit of cleanup that goes on past that big bang date as we move to full retirement of some of those platforms and systems and just the cleanup work that doesn't come immediately upon conversion. You get a couple of big events in there that will drive some bigger reductions so we do expect over the course of the next 36 months that you will see continuous recognition of synergies over time, maybe not completely evenly over that window but you should see.

Thank you. Your next question comes from Chris Sadler with William Blair. You may ask your question.

Good morning. Any early update on the revenue synergies which you would outline particularly payment for overflow? I'm sure you've had a chance to kind of at least get an early look at the extent to which Ameritrade's greater order routing revenues due to product mix technology or just different philosophies.

I'd say that's one of those areas where we weren't able to get into a lot of detail prior to close for competitive purposes. So we are parsing that data today. If anything, I'd say we probably feel a little bit more optimistic about our ability to maintain the majority of that revenue than we did prior to close. But it's still a little early for us to get into a lot of detail on exactly how that's going to play out.

Okay, thanks, Joe. Then just one other one on the pricing landscape or marketing landscape. Walt, you noted a few quarters ago that you had seen some increased competition around some of the offers that some larger banks were offering to try to drive client acquisition. Just any update on that front will be great.

Sure. It remains a highly competitive market and there is some activity around paying cash in order to get balances so that is still an activity that exists and continues to be an activity that we have questions about its long-term logic for companies that intend to be independent and stay in the market over time. I would just say that I guess I would add, I remain optimistic that rational business leadership moves to rational and economically rational decision-making over time.

Thank you. Next question comes from Brennan Hawken with UBS. You may ask your question.

Hey, good afternoon now, I guess. Thanks for taking my question. At least good afternoon on the east coast. So it seems as though near-term accretion from the deal is better but it didn't sound like you were changing the long-term. In fact, it sounded like from an expense perspective, you specifically didn't change the long term. But is it right for us to assume that the experience that you're having here in the early days is clickable and that the better than expected accretion off the bat, therefore, would also translate into better accretion in total? Or is it just that things are happening maybe a little sooner than expected and it's just timing? Sorry, if you touched on it, that just wasn't completely clear to me.

I'll try to answer that and maybe Joe would be ready to add on to that. I guess, I would say is we are very, very excited about this deal. We're excited about this deal from an accretion standpoint. But I think even more importantly than that, we're excited about this deal, what this means for us long term, and our ability, or the position we have in the market, and the way that we can serve clients. Certainly, the math is compelling again, in the near term because of the accretion and over the longer term because of the revenue and expense synergies that Joe has talked about and I've talked about on previous calls. I think those numbers have on the revenue side, as I mentioned, have gotten bigger on the cost side probably similar, but it's really nothing to suggest they've gotten any smaller, and maybe over time, perhaps we'll discover more there. But I think also one of the things we've discovered is just the compatibility between the two organizations and over the last several months and bringing these two teams together and the alignment that we have around our focus on clients and that cultural compatibility is so very, very important on a complex integration like this. So that's also made us very, very enthusiastic and excited about the future as well. So I think on every dimension, we're feeling very, very enthusiastic about the acquisition.

Thank you. Next question comes from Craig Siegenthaler with Credit Suisse, you may ask your question.

Thank you hope you're all doing well. Just following your June acquisition of motif, we wanted to see if we get an update on the timing behind it direct indexing launch and also, do you have plans to launch the capability first to the RAA channel or potentially both to return advisors at the same time?

Craig, I'll take that. Unfortunately, this is going to be one of those questions. So I'll just say upfront, I'm not going to answer to your satisfaction. We're not going to discuss timing on the introduction for competitive reasons nor are we going to discuss which organizations might go first, but we certainly have every intention of making it available to both. That'll be used slightly differently by retail and by the RAA and so the determinant will be not trying to benefit one segment of our business over another, it'll just be which one we can get it to quicker because of the way they'll utilize the product.

Thank you.

Thank you. Next question comes from Chris Harris with Wells Fargo. You may ask your question.

Just a couple of clarifying questions on the synergies. Should we be assuming the account conversion is a year-to-event? Then the $250 million to $300 million you guys are unveiling today, are those going to be realized very quickly, like in a few months or is that more of a gradual thing to be realized to the year?

Is it $250 million to $300 million we talked about today or already accomplished? They will show up in the run rate beginning in Q4. A little bit of timing there and that some of the staff reductions here have happened through October, but they will start to show in Q4 before embedded in Q1, those are done and executed on. And we're not, at this point, providing target dates for account conversion, but you start thinking to some of the other comments here around the 18 to 36 months and you got to get the accounts conversion in that window, with the time to be able to do some of the clean-up at the back end, to be able to get to the full synergy number. Then you can start to back into what some of our thinking is probably around the conversion date.

Thank you. Next question comes from Kyle Voigt with KBW. You may ask your question.

Hi, thank you. Wondering if you can give us an update on the strategy around pricing at clearing conversion? And specifically, I think Joe mentioned that there will be some revenue synergies realized at the conversion date. I just want to get some more details on those. And then secondly, I'm wondering whether Ameritrade's margin book, which is much higher yielding right now, will that migrate towards Schwab's blended rate after conversion? Or will pricing be maintained for that book thereafter? Thank you.

So my guess is, we will be in a position at that winter business update to write more details on all of these components. From a revenue perspective, I would echo some of Peter's earlier comments to say that we were pretty enthusiastic about what we're finding. And today thinking through some of the pricing and recognition, implications of decisions that we're going to have to face around how we bring these organizations together. But I would say, we're feeling optimistic about what we're seeing and what some of the recognition opportunities might look like. As you look forward to post conversion, I'd say that a couple of big buckets that we're going to have to dimensionalize here are around being able to provide some of the better trading opportunities in the systems, the TD Ameritrade has built to the Schwab client base, as well as being able to provide some of the more extensive wealth management capabilities that Schwab has built as the TD Ameritrade existing client base. And if I had to guess a little bit today, I would say we might see those trading benefits happen a little bit faster than wealth management. Wealth management has to be more of a relationship-type activity that we expect to build over time. We do think that those opportunities are significant, that may take a little longer to recognize post conversion.

That's great color. Thank you very much.

Thank you. And this question comes from Michael Cypryss with Morgan Stanley, you may ask your question.

Hey, good afternoon. Thanks for taking the question. I was just hoping for a little bit more color on the net new assets and new customers that are coming over to Schwab here. What portion would you say are new households coming over to Schwab for the first time, versus a wallet share from existing customers? And then, for those new customers that are coming in the door, where would you say they're coming from? And as others are also reporting growth and seeing growth in accounts and customers, how do you think about the profile and where those customers are coming from and the profile of them? Thank you.

Walt, do you want to start us off on new customers?

Sure. So there's no question there are new entrants into the space. And that is leading to some of the new household formation, it's probably why we tried to share both net new assets figures, which of course, are a very broad definition, right? That net number is made up of new-to-firm households, as well as existing clients, as well as transfers from other financial services or investment services providers. So I don't know that we historically want to break down the components of that net new assets, but we try to give you enough metrics to give you a solid understanding. We report the total net new assets. We give you the new-to-firm household growth, which I think was on one of the pages that Peter shared. And of course, we give you the transfer numbers, which gives you an idea of whether we are winning or losing on a net basis relative to competitors with existing clients who may be residing at Schwab and residing at our competitor. I think we're having success with all three of those, as evidenced by our net new assets, including the record September, and the TOA numbers speak for themselves.

And just maybe a follow up on the lending side, just hoping you could just give a little bit more color around some of the initiatives there, and how meaningful could this be as you look out over the next couple of years? On the lending side, more pledged asset lines among other lending products that you have, that you're prioritizing or even thinking about bringing to the marketplace?

We are very pleased with the momentum in our lending business. Our overall bank loans have increased by 30% year over year, which coincides with a refinancing wave. Our investor advantage pricing has significantly benefited both our clients and our client-facing employees, providing exceptional pricing while still delivering a favorable economic benefit to us and strengthening our relationships with key clients. This has helped us maintain our position against other firms looking to work with these clients. There is certainly more potential for growth, particularly with pledged asset lines, as we still have room for greater penetration compared to wirehouse firms. This is true for both our legacy Schwab clients and even more so for TD Ameritrade clients, creating a very promising opportunity. We are excited about the potential for growth that aligns with our strategy. I want to emphasize that while we are pleased with the short-term EPS benefits and the acquisition supports the 25% to 35% target I mentioned, it is the long-term prospects that truly excite us. We are aggressively moving forward in a manner consistent with our strategy and purpose. As our efforts begin to yield results, whether quickly or gradually over time, it reinforces our confidence and enthusiasm. We look forward to seeing you all at the February business update, whether virtually or in person. Thank you for your time today and stay safe.

Thank you, that does conclude today's call.