Schwab Charles Corp Q2 FY2022 Earnings Call

Good morning, everyone. Welcome to Schwab's 2022 Summer Business Update. This is Jeff Edwards, Managing Director of Investor Relations. I can only imagine how unsettling it might be for some of our more tenured update attendees to not hear the soothing rhythm of Mr. Fowler's voice kicking off the webcast this morning. But fear not, he is here comfortably perched right next to me in his best Ariat boots as we broadcast live from our headquarters in Westlake, Texas. We once again have our esteemed trio of presenters for our 60-minute session today, which will include prepared remarks followed by Q&A. Walt Bettinger, along with Rick Wurster, will provide a strategic update including insights into the current investor mindset as they navigate what has proven to be a challenging time in the market. Peter Crawford will then review our recent record financial performance as well as discuss our current financial outlook before taking us to Q&A, which I will help moderate. A friendly reminder that today's materials will be posted to the IR website at the beginning of Peter's remarks. Lastly, but certainly not least, please do not forget to review our lovely wall of words, which reminds us all that outcomes can differ from expectations. So please stay updated with our disclosures. With all that behind us, it's time to dive in. Walt, over to you.

Thanks a lot, Jeff, and good morning, everyone. Thank you for investing some time to listen in on our July business update. So 3 months ago, I emphasized the word consistency during our time together. And I stressed the way consistency plays a critical role at Schwab. A consistent business strategy, a consistent commitment to feeding the virtuous cycle and innovating on behalf of investors, a consistent financial reporting cadence, a consistent commitment to our employees and the communities that we live and work in. And a consistent long-term approach that is focused not just on the current year, but on years to come. And today, as we discuss our second quarter results and our viewpoint for the future, the benefits of our consistent strategy and commitment to clients, I think, is highly evident. Because it's times like these, when investor sentiment is negative and the equity markets are falling, that these are the times that separate companies who chase headlines and/or focus on short-term success from a company like Schwab, a company built to last, a company built to succeed in all environments. By serving investors and advisers in good times and difficult times, while also delivering the superior financial results that you see. Now before we discuss the second quarter in a bit more specifics, I want to touch on the announcement this morning from our Board of Directors that I would be joining our founder, Chuck Schwab, as Co-Chair of our Board. Although it's personally a tremendous honor that Chuck and the Board have seen fit to entrust me with this additional responsibility, the reality is this announcement is not about me. The announcement is aligned with the consistency theme that I just spoke of. Consistency and continuity are hallmarks of Schwab. They add to a sense of confidence that our clients, our employees, stockholders and the communities where we live and work can rely on. Our consistent strategy that we refer to as 'Through Clients' Eyes' is not a catchy slogan. It's a timeless strategy. It's timeless because, in our view, it is the only business strategy that can stand the test of time. A strategy that places our clients at the forefront of the decisions we make. And a key part of my new responsibilities as Co-Chair of the Board will be to ensure that our focus on clients, our consistent focus on clients remains the hallmark of Schwab for years to come. As all of you know well, in the second quarter, the equity markets officially entered bear market territory. Volatility remained quite high and the Federal Reserve advanced their efforts to bring inflation under control by raising interest rates. And of course, this continued with another 75 basis point increase yesterday, moving the target rate to between 2.25% and 2.5%. Now not surprisingly, investors felt this pain. They felt the pain from the equity market declines with investor sentiment falling sharply and reaching levels that we haven't seen in many, many years. Interestingly, however, Schwab clients continued to invest for the long haul. I guess you could say consistency is a hallmark of our clients also. The net buy/sell ratio of our clients during the quarter, as punishing as the second quarter was, was only modestly lower than it was during the meme stock quarter back in Q1 of last year. I guess the takeaway is that our clients are investors. And with well over 30 million investor accounts, yes, there are different approaches for certain. Some are buy and hold, some trade actively, some rely on an independent adviser. Of course, many are a combination of all these. But what's important is that collectively, they take a long-term view of the markets. Collectively, they understand the power of being in the market. Collectively, they know that consistency, again, is the path to success when it comes to long-term investing. This long-term focus by our clients is not an accident. It's an outcome of our purpose and our strategy at Schwab because we focus on attracting long-term investors and cultivating them on educating them on the power of long-term diversified investing and being in the market and staying in the market and being consistent with their investing strategies. And of course, there it is, again, that word, consistency. We believe that a major part of why our clients can feel confident with taking a long-term approach to their investing is the confidence that they have in us at Schwab. Despite, again, what anyone would describe as a relatively brutal equity and bond market of late. Our clients still give us Net Promoter Scores in the mid- to high 60s. And with our fastest-growing client base, high net worth investors offering us our highest scores overall. Our client ease score is now more than 90, reflecting our commitment to making it easy for our clients to do business with us. And meanwhile, 83% of our clients rate their phone-based service experience with us as perfect, a score of 7 out of 7. In addition to our efforts, of course, around ease of business and quality of service being recognized by our clients, we're gratified that many third parties do as well. The importance of service quality, timely and responsive service, it's especially critical during difficult times for investors because it's service quality that helps keep these investors informed, aware and as confident as possible. It contributes to client engagement and optimism for the future. I just encourage you not to make the mistake of thinking that given where the markets are, our clients are not highly engaged, optimistic and investing for the long term. And I think as evidence reflecting this optimism, our clients continue to add money to their investing strategies at a relatively high rate despite the bear market with annualized organic growth about 5% and really rather astonishing for a bear market, 6% when we exclude April. And of course, it's record-breaking levels of tax payments. So this is a picture of a strong, healthy company excelling during a quarter as difficult as any quarter in many years. But I think what's also incredibly important is it's a picture of a healthy client base. A client base taking a long-term approach to investing a consistent long-term philosophy. Now with over $180 billion in core net new assets in the first half of this year and our seventh consecutive quarter with over 1 million new brokerage accounts, our organic growth is indisputable. We still maintain a net TOA ratio of approximately 1.6:1. That means we're winning $1.60 from competitors for every dollar they win from us. Again, reflecting our competitive strength from a relative market as well. Importantly, our efforts to ensure long-term organic growth continues as we diversify our client base. You can see that over half of our new retail clients are under the age of 40 and they drove over half of our new client net new assets. So this is particularly important because it illustrates that not only are we winning in the under 40 segment, but we are winning under 40 investors with substantial investable assets, not simply winning younger investors who have little money with which to invest. And as we've repeatedly emphasized, our business-serving independent investment advisers continues its success serving the needs of all sizes of advisers. So we aim to provide the best platform for every RIA regardless of size or business model or specialty. And our success in winning clients of all shapes and sizes clearly indicates we're succeeding. Now while we continue to be the leader in serving the largest advisers, again, what's fascinating about this chart, is that our largest share of net new assets year-to-date have actually come from smaller advisers, those who manage less than $500 million. As we've repeatedly stated, and I don't know how many more times we can continue, but we will keep saying it, our RIA custody business is committed to serving advisers of all sizes, in a world-class manner and without charging custodial fees. So, Rick, let me turn it over to you, and you can cover some more details of some of our efforts.

Thanks, Walt, and hello, everyone. I'll spend the next few minutes talking more about why clients continue to turn to us in good times and in challenging times, and I'll share an update on several of our strategic initiatives. At the heart of our success is our Through Clients' Eyes strategy, which has been our consistent strategy for years. When we see Through Clients' Eyes, our priorities are clear. And what we continue to hear from clients is they want the combination of low-cost and high-quality experiences and solutions that deliver great value. The transparency that is the foundation of any trusted relationship, multichannel experiences that meet them where they are and ease. Clients expect their interactions with us to be easy. And they also want to consolidate as much of their financial lives as possible in one place. The reason clients continue to turn to Schwab is our consistent no trade-offs approach that you've heard Walt talk about. At Schwab, clients don't have to choose between low-cost and stellar service. Access to some of the best service professionals in the industry and the digital and technology platforms and experiences they expect from a modern firm, straightforward foundational investment offers, and more personalized solutions. Tools and capabilities for those who want to take investing into their own hands and a spectrum of advised offers that help clients get to where they want to go with the help of a professional. Proprietary and third-party products that give them the choice they want. They don't need to make any trade-offs because Schwab is uniquely positioned to deliver it all here with our strength as a wealth manager, as a bank, and as an asset manager. Our size and our focus uniquely enable us to deliver for clients in a way that sets us apart in the industry. And this focus, which starts with seeing Through Clients' Eyes drives the virtuous cycle. This means we will continue to put clients at the forefront and challenge the status quo to benefit investors. And when we do that, investors will reward us by trusting us with more of their assets. This leads to consistent financial results and outstanding stockholder value, which enables us to continue to invest in our business to serve our clients' needs, and that brings us back to the start of the virtuous cycle. You see on this page what no trade-offs looks like for our clients. It is a competitive blended advice rate and the ability to talk to us quickly when you call for support. It is making investments to hire more client-facing employees who are there when a client walks in the door and investments in technology to make their experiences with us as easy as possible. It is a continuum of offerings ranging from straightforward to personalized that meets the needs of investors who are just starting out and the needs of our high-net-worth clients who are seeking advice. It is industry-recognized tools and resources for self-directed investors and advised offerings that continue to attract investors with more complex financial needs. And it is the product choice that our clients want. Our consistent strategy is supporting our clients through a challenging environment. At the same time, we remain focused on strengthening our offer to meet client needs into the future through our strategic focus areas. First, we're achieving even more scale and efficiency. Integration remains our #1 priority. The integration is bringing capabilities that make our combined offering experiences stronger than either firm was on its own. Our Schwab clients will benefit from thinkorswim, iRebal, and thinkpipes, while our Ameritrade clients will benefit from the advice capabilities, banking solutions, and digital experiences at Schwab. Together, our no trade-offs approach is even stronger. As we look to client day 1 beginning in 2023, we have already multiplied the scalability in our systems and increased our capacity to support client needs and growth well into the future. For example, we've increased systems capacity to support the volumes of the combined company with plenty of capacity for spikes in transaction volumes. The modernization work on our platforms has made them both more resilient as well as much easier to scale as the client base continues to expand. Our systems now support 4 to 6x the previous volume of transactions with faster processing times across the board, including for trades and client communications. We also remain focused on easing, making it easier for clients to do business with us and enhancing our operating model to support future growth. We're essentially accelerating several years of digital transformation into the integration window, enabling us to support a smooth client transition, deliver on our expense synergy commitments, and limit expense growth after client conversion. Turning now to win-win monetization opportunities. We remain focused on 3 key areas: wealth management, asset management, and lending. And I'll speak more about wealth and asset management in a moment, and I'll start with lending. The bank continues to be a differentiator for Schwab. We won the J.D. Power Award for being ranked highest in customer satisfaction with direct retail banking 4 years in a row. When we look at our lending business, even in the current interest rate environment, our TOA portfolio balance or pledged asset line portfolio balance was $14.8 billion, 42% above the prior year. And as we look ahead, we're excited to roll out a number of enhancements that will make it even easier to go through the loan process at Schwab. Finally, we're doing more to meet the segmented needs of our clients, including our high-net-worth clients, RIAs, and other key client segments. As Walt mentioned in his opening comments, a key aspect of being an enduring company is serving a broad range of clients and continuing to meet their needs as their circumstances and behavior change. We compete, however, against a number of firms that focus on specific client segments. To successfully compete against these firms, we will stay focused on our clients and leverage our scale to meet the needs of the various client segments that we serve. I'll wrap up today with a deeper look into how we're delivering a continuum of wealth management experiences, and I'll share more about our Trader segment in particular. Looking at the continuum of our wealth management offer, we have attractive full-service wealth programs and investing solutions that clients are turning to in the current market environment. When you look at our full-service wealth programs, we recently rebranded our premier wealth management offer Schwab Private Client to be named Schwab Wealth Advisory to better reflect what the offer does for clients. We are investing in the offer, including enhancing our digital experience, providing resources and support to advisers to ensure even greater advice and service, and bringing more of our wealth expertise at Schwab to the client. We also have investing solutions that clients often use as a part of their portfolio. With the increase in interest rates, we've seen record flows into Wasmer Schroeder on the Schwab platform. We've also launched new personalized investing solutions to complement the core offering. Schwab personalized indexing launched and is delivered for clients in a volatile market and has delivered on the promised tax savings. We continue to make progress on expanding our thematic investing offer. And in the second quarter, we further expanded our ESG tools with the introduction of MSCI's ESG ratings for individual stocks. There is tremendous opportunity ahead to enhance the wealth management experience. Over time, we'll look at providing a discretionary wealth management experience for clients and have plans to add digital capabilities to meet clients where they are. Now I'd like to turn to the work we are doing to support traders, one of our key segments. One of the benefits of integration is we will be able to offer Schwab and Ameritrade clients a leading end-to-end trading experience with thinkorswim, one of the strongest active trader platforms in the industry. In August 2020, we announced plans to adopt thinkorswim and integrate its award-winning trading platforms, education, and tools into our trader offerings for clients. This will provide our trader clients with 3 interconnected channels of engagement across desktop, web, and mobile, all integrated with one another. It's enhanced trading experiences and a comprehensive set of trading tools across the product space, supporting equities, options, ETFs, futures, and foreign exchange trading and a tightly integrated trade and portfolio analysis capability. In fact, we recently rolled out new enhancements that reinforce our commitment to the thinkorswim platform, including providing clients with greater opportunities for customization. And in April, we launched a virtual active trader branch. Here, active trader financial consultants focus on trader coaching and wealth management to help meet the unique needs of qualifying self-directed traders. Finally, I'd point out that one of our biggest focus areas for our trader clients is trading platform stability. Nothing is more important to our business than safeguarding our systems and ensuring our clients have reliable access to their accounts. I'll wrap up where Walt started, with our Through Clients' Eyes approach as our consistent strategy, we continue to be there for our clients even as the market has become more challenging for them. This approach sets us apart in the industry and puts us in a strong competitive position, allowing us to continue to invest in the strategic initiatives that will meet client needs into the future, while enabling the outstanding financial performance that Peter is about to discuss.

Well, thank you very much, Rick. So Walt and Rick talked about our ability to build and maintain the loyalty of our clients despite the challenging environment and very low investor sentiment. How that loyalty has translated into continued robust organic growth? The strong positioning we have built around modern wealth management and our progress and plans for making that position even more formidable. In my time today, I'll talk about how the combination of strong business momentum, a more subdued, but still quite active client base, and rising interest rates produced record financial performance in the second quarter. I'll also provide an updated outlook for the rest of the year, which demonstrates the power of our all-weather business model and the benefits we derive from higher rates. And finally, I'll provide an update on our capital planning with our capital ratios having reached their highest level since the pandemic began, enabling us to potentially accelerate our capital return activities. What you'll hopefully hear is that this company continues to drive exceptional operating and financial performance, that we're clearly benefiting from higher rates and are poised to benefit even more in the quarters ahead. But that's only part of the story. In short, we're demonstrating once again the enduring power of Schwab's strategy and business model, one that combines growth, profitability, and capital return with a lot more opportunity ahead of us. Let's talk about some of the factors that contributed to our strong financial performance in the second quarter. Our performance was obviously helped by higher interest rates across the curve, which boosted our net interest margin and BDA yield and eliminated money fund fee waivers by the end of the quarter. While falling equity markets weighed on asset management fees, and the ensuing decline in investor sentiment that Walt talked about resulted in trading activity and margin utilization that were lower than the first quarter but still at historically high levels. What endures amidst this choppy environment is our unmatched ability to drive robust organic growth. Roughly $185 billion in core net new assets in the first half of the year despite record high tax payments by clients, and 5% growth in active accounts on the heels of the unprecedented new account formation we saw in the first half of 2021. Despite some cross currents, our financial performance in the second quarter broke multiple records. Revenue increased 13% year-over-year and 9% sequentially, driven by a 31% increase in net interest revenue reflecting a 16 basis point year-over-year increase on our net interest margin, up 24 basis points from the first quarter and interest-earning assets that largely were in line with expectations. Flat asset management and administrative fees, as the elimination of money fund fee waivers and organic inflows offset the impact of the market decline. And trading revenue that was lower than last year despite a slight increase in daily average trades. We limited adjusted expense growth to 2% year-over-year, all of which helped produce an adjusted pretax margin of 49.5%, a record $2 billion in adjusted net income, and a record $0.97 in adjusted EPS. That was the income statement. Let's turn our attention briefly to the balance sheet. Our balance sheet assets declined 4% year-to-date due mostly to those record tax payments in April as well as some sorting activity in the second quarter that was consistent with our expectations given the rate environment. Our strong earnings, combined with that slight decrease in assets, boosted our capital ratios to the highest level we've seen in roughly 2.5 years. Despite the challenging equity markets, we feel very confident about our ability to drive strong revenue growth and resume a higher pace of capital return. Assuming the Fed follows through as the market predicts with a Fed funds rate exiting 2022 at 3.5%, we'd expect to produce an 11% to 13% year-over-year increase in revenue despite the market downturn. That reflects continued expansion of our net interest margin to just over 2% by Q4. Deposit betas that we expect to continue to run a bit lower than the last rising rate cycle and a continuation of clients moving some of their investment cash off our balance sheet in search of higher yields. But remember, when they do that, it frees up capital that we can return to our stockholders. We continue to thoughtfully and responsibly manage our expenses, navigating this inflationary environment, driving efficiency throughout our business and prioritizing our investments to advance the strategic agenda that Rick discussed. Controlling for an increase in the pass-through fee that boosts both revenue and expense and which we do not control, our full year expense outlook remains the same as what we shared back in February. And with our inaugural CCAR submission now behind us, which demonstrated the strength of our balance sheet as reflected in the fact that we're the only firm to see an increase in capital ratios during the stress event. And our capital levels are in the mid-6s, we are nearing the point at which we can accelerate capital return. You saw that the Board approved a 10% increase in our quarterly dividend to $0.22 as well as a new $15 billion buyback authorization that we'd expect to utilize as soon as later this year and beyond. And at the same time, we also have the option of redeeming one or more of our outstanding preferreds. I want to close by picking up on a theme that Walt discussed in his opening comments, how this is a company built and managed for the long term. So we're certainly pleased with our current financial performance despite the difficult macro environment. We are much more gratified by our ability to consistently drive a set of behaviors and outcomes that have enabled us to deliver for clients and stockholders for over 4 decades. Continuing to be the premier asset gatherer as indicated by our net new assets, new accounts and TOA ratio, a reflection of our Through Clients' Eyes strategy and formidable competitive position. Building a diversified and resilient business model that converts business growth into revenue growth, producing record revenue in the second quarter, maintaining discipline in how we manage expenses, producing operating leverage through the cycle, and increasing margins, which have now reached nearly 50% and have an opportunity to continue to climb. And being very efficient in how we deploy the capital that has been entrusted to us or, as we're now poised to do, return excess capital back to our stockholders. Make no mistake, challenging conditions in all this is a good environment for both our actual financial results and our future financial prospects, and we intend to pursue those prospects as we remain focused on serving clients and being good stewards of our stockholders' capital. With that, Jeff, let me turn it over to you to facilitate our Q&A.

Operator, let's open up the phone lines and turn to the first person in the queue.

Our first question today will come from Ken Worthington with JPMC.

I guess first, what was the level of cash sorting that you saw in the second quarter? And what is your outlook for the size of the balance sheet or interest-earning assets, however you want to answer it? For 2022, given what you're learning about cash sorting and your internal outlook or whatever for net new assets? And then any thought on the mix of your balance sheet in terms of cash and the investment portfolio as we continue to walk through this cash sorting process through the rest of the year and beyond.

Thank you for the question, Ken. Overall, the cash sorting dynamics in the second quarter met our expectations. I anticipate there will be many questions about sorting, so let me share some key insights. Our expectation is that sorting levels will not exceed those seen during the last rising rate cycle and may even be slightly lower since we aren’t engaged in the bulk transfer process we had previously, and we have more smaller accounts that typically sort less. Additionally, our clients are trading more actively now, which means they tend to retain more transactional cash. Historically, we know that total cash, including on-balance sheet cash, will stabilize and then grow along with the increase in accounts and client assets. Importantly, the cash is staying with Schwab. We have developed a broad range of cash solutions and are actively working to ensure our clients are aware of them, allowing them to make informed cash management choices. We want our clients satisfied and to keep their cash with us, and we are seeing that outcome. When considering sorting alone, it's essential to remember it's part of a larger picture. The rate increases that lead to sorting also help us earn more from the interest on the remaining cash. Therefore, in the scenario we outlined, we expect to generate about $500 million more in net interest revenue in the fourth quarter compared to the second quarter, even with a continuing trend of client cash sorting. Lastly, if cash balances decrease, it allows us to free up capital for stock buybacks and enhance EPS growth. I hope that addresses your question, Ken.

Awesome. And then just on the win-win monetization as a key priority. You've announced the enhanced relationship with T. Rowe. I guess how is that proceeding? And then can you talk about plans to further build on what you started with T. Rowe with other asset managers? What's the road map? And what should we be expecting for the $1.5 trillion or so of third-party fund assets that you're not charging asset managers directly for right now.

Thank you for the question. First thing I would say as it relates to your specific question, Ken, on T. Rowe, I would say that it's very early days. We're just getting that program going. We are seeing some enthusiasm for it among our clients. And we are seeing a simpler process that we've built around our clients finding the product that they want to be well received by our clients. So we're making it easier for clients to find the right product for them. In terms of specifics, I would say that we've launched the T. Rowe program into a challenging market, where we're seeing both active management and interest and equities declined to some extent because of the volatility in the market. And so we've seen some headwinds, but with those headwinds, of course, I'd bring it back to our all-weather model when active management is out of favor, passive is in favor, and we've seen strong growth in our ETF business. We're third this year in flows with relatively strong inflows. So again, we think about it as an all-weather model. And importantly, we also think about delivering the choice clients want. So the program is doing exactly what we'd want it to so far. We've got plans in the future to leverage the program to a greater extent. And we're also investing in our experience for advisers through an institutional no transaction fee platform, I think shows again our commitment to delivering for advisers. In terms of your final part of your question, Ken, I think the philosophy of making sure that we create a win-win deal for clients, for ourselves and for managers is important and one that we will continue to strike across our third-party platform. So that's certainly a part of our future plans.

Next question comes from Rich Repetto with Piper Sandler.

Walt, Rick, and Peter, first, congratulations, Walt, on being named co-Chairman of Schwab. That is a significant honor for you. My first question is a follow-up regarding the sorting. Peter, you didn't address one of the questions about the balance sheet or the average interest-earning assets at the end of the year. Can you provide a more quantitative comparison of the sorting in the second quarter to your expectations and what you anticipate for the rest of the year?

Thanks, Rich. So you'll see in the appendix, we have a lot of detail around the assumptions in the scenario that we shared. And you'll see in the appendix an assumption that the balance sheet contracts by a similar aggregate level as what we saw in the first half of the year. Bearing in mind, of course, that the first half of the year was influenced by the tax payments in April as well as the changes in the mark-to-market value of the available-for-sale securities. And of course, in the second half of the year, you typically have a seasonal tax buildup in December.

Okay. I'll look at the appendix closer. I guess a follow-up question would be for Walt. And it's on regulation, and I think everybody is aware, Chair Gensler, SEC Chair Gensler made some remarks in early June about things that he was looking at, not formal proposals, but things that he was going to emphasize in regards to retail equity market structure. And I just wanted to get Walt, what sort of Schwab's view on some of the changes that at least he has spoken out in favor, including the minimum price increments, the smaller NBBO protected sizes in this order-by-order competition?

Sure. Thank you, Rich. And also thank you for the kind words. I'm excited and as I mentioned, honored to add the additional responsibilities as Co-Chair to my duties as CEO. So of course, we all watched with great interest your interview with Chair Gensler. And we have great respect for the Chair as well, frankly, as his objective of striving to improve the trading experience for investors overall. I think in fairness, we have to wait and see what any actual proposal might be and what it might entail. It's also important for us to bear in mind that I think it's safe to say that retail investors have never had a better overall experience, including the quality and timeliness of their execution. It's difficult to comment on all the various items that Chair Gensler spoke on, but maybe I'll just identify the last one to provide some thoughts for everyone, around the idea from an auction. I mean, certainly, an auction idea is interesting. But I do worry a bit about whether it contemplates auctions in all different types of market environments. We know that in the current structure, execution, timeliness, and speed is assured no matter what the environment is. And when I just take a step back, say, from the equity markets and just think of auctions in general, whether you're auctioning a home or art or something near and dear to my heart, baseball cards, since I'm a baseball card collector. Auctions tend to work really well when you have a favorable economic environment and a lot of liquidity in a system. Conversely, auctions tend to struggle during a more difficult economic environments or when there's less liquidity. You start to get wide gaps and spreads between what maybe the seller in the case of an auction was hoping to receive and the price that they actually receive. So again, I'm not suggesting that, that illustration says that an auction couldn't be workable. But I just think these are the kind of things that have to be very carefully thought through. The math needs to be done very thoughtfully and evaluated to see whether we're actually creating a better environment for investors overall. And I am confident that that appropriate process will be followed if, in fact, these rules are formally proposed.

Our next question comes from Dan Fannon with Jefferies.

I wanted to follow up just on the expense outlook and understand the guidance for this year. Looking at the second half of the year, maybe what the incremental spend outside of the exchange fee rate increase, where those levels might be? And then thinking a little bit forward into next year, can you remind us what's left in terms of synergies and how we can think about maybe that rolling through in 2023 and maybe a more normalized kind of growth rate for expenses longer term?

Thank you for the question. Regarding the expense outlook, I mentioned what we anticipate for the full year. Typically, we see lighter expenses in the third quarter and heavier expenses in the fourth quarter. It's important to consider this pattern. Our key goal is to continue reducing our expenses on client assets while also delivering operating leverage, which is vital to our financial strategy. At the same time, we need to invest in our clients and ensure the long-term growth of our business. This balance is challenging, but we've managed to achieve it over time, as evidenced by the decline in our cost per client asset and the increase in our margins. This will remain our focus. Now, regarding your second question, let me take another shot at that.

Just longer term, the expense synergies as we think about '23 coming back.

We have delivered almost half of the total expense synergies. We mentioned earlier that the pace of delivery will slow down compared to the first couple of years post-acquisition. The next significant milestone for achieving these expense synergies will come once we finish the client conversions and can eliminate duplicate systems. At that point, you should see a substantial portion of the expense synergies emerge. We remain very confident in our ability to achieve the expense synergy targets we have previously outlined.

And then just as a follow-up, Walt, just thinking about the adviser backdrop and attracting new advisers in a more volatile backdrop. Can you talk about the backlog? And is that harder for maybe those advisers to move their books when clients are maybe not doing as well? Or are you seeing just as robust a pipeline as you have previously?

Yes, that's a good question. Right now, I believe the pipeline is as strong as we've ever seen. However, your assumption is somewhat correct; in a challenging equity market, advisors might find it more difficult to transition to independence. This is likely a lagging effect, which explains why it's not currently evident in our business. More immediately, some investors may hesitate to entrust their funds to an advisor during a tough market. So, the near-term impact is more pronounced in that regard, while the effect of a weaker equity market on advisors transitioning independently may show up later. Nevertheless, at this moment, our pipeline remains strong, and we are very optimistic about our ability to support those advisors in becoming independent and transferring their assets to us.

Our next question comes from Brennan Hawken with UBS.

I'm glad she said UBS because I did not catch the name she said. So Peter, wanted to follow up with you on the appendix and the reference cash? And just clarify some of your prior comments about sorting. I think previously on the spring update, you had indicated that a roughly 20% decline in sweep cash would be the expectation based upon the experience last cycle. And when we look at the pie chart that shows the cash breakdown, I would assume that, that 20% would apply to really just the universe that doesn't include, obviously, sweep money fund. BDA has a different profile, as you said, more active-oriented and checking and savings. Is that the base that we should be thinking about when we're applying that 20%?

Thank you for the question. To clarify, in the spring business update, we indicated that we did not expect it to exceed that level. As I mentioned today, it might actually be lower than that. However, when considering the pool we're discussing, it primarily involves the Bank Sweep and, to a lesser extent, the free credit broker-dealer balances shown in the pie chart. You're correct that this does not pertain to the total pool of cash.

Great. And when we think about the 2Q experience, it's a little tricky because we had some sorting get started. You had said it was roughly in line with your expectations, which is encouraging. But there was some tax noise in there too. When we think about the reductions in the quarter, it might have been partially offset by some increase in cash due to volatility. Can you maybe help us think through the sorting experience to date so we can know how to calibrate for that less than 20% threshold, just so for those who are keeping score at home.

Yes. So that's maybe one we want to have you follow up with the IR team to kind of walk you through some of the numbers and go through the smart reports to get to that level of detail on the timing on all of that. I think that's probably the best path on that.

Okay. Fair enough. Maybe since that's a bit of a mulligan, maybe I'll try for my second question with something a little different. You give in the appendix some greater profile of the securities portfolio, which is really great and really helpful. When we're thinking about the potential for cash needs in the coming year as potentially sorting might happen a little faster, who knows. What does the profile of maturities in the securities book look like over the next roughly 12 months, let's say? Do you have an idea or a projection about how much cash will be generated from that portfolio?

We are actively managing our portfolio duration, which is currently just over 4%, though it’s closer to around 3.5% when factoring in the cash we are holding. We are maintaining a more liquid portfolio and are focusing on making very short-term new investments. This approach provides us with significant asset sensitivity and liquidity, allowing us to support a wide range of potential client activity outcomes.

I'm stepping in here with a couple of questions from the web console. I'm going to try to aggregate them. I think the first one here is for you, Rick. Given the recent backdrop and kind of shifting environment, where have we seen clients kind of gravitate from an advice and asset management solution perspective? Where are they most interested?

Well, top line, I would say, our advice flows continue at pace, roughly in line with where they have been. The areas of particular interest, I would say, there continues to be interest in full-service wealth advice capabilities. So we're seeing flows into our Schwab Advisor Network program and we're seeing flows into our Schwab Wealth Advisory program, both of which are full-service wealth offerings. So that would be the #1 theme we're seeing. Second theme I would highlight is that in this interest rate environment, we're seeing more interest in fixed income solutions. And so our acquisition of Wasmer Schroeder a couple of years ago has been timely as flows have increased, and Wasmer Schroeder has captured a meaningful share of those and is setting records each month in terms of flows into Wasmer Schroeder on our platform. And then the third thing I would say is we are seeing stability outside of those programs. So Windhaven and Thomas Partners and different offerings you've heard about over the years have been stable and returned to inflows. The one area where we're running a little bit behind what we typically see would be our Intelligent portfolios. And I think that's to be expected in this period of more volatility where clients who tend to have lower balances are a little bit shy of making that commitment in a volatile equity market. But overall, our flows continue into the managed investing and wealth area. And those are the areas that have been of particular interest to clients.

Great. And here, maybe one for Walt. Just around, let's say, Schwab's persistent and steady business momentum through shifting environments and a changing competitive landscape over the years. What are some of the main forces you'd attribute to this steady growth, secular growth? And anything that you note that's changing or evolving on that front?

Thanks, Jeff. I think Rick really did a great job of addressing this in his prepared remarks. But it starts with our long-time strategy Through Clients' Eyes. And we strive to make decisions that put the needs of our clients at the forefront. Basically, the golden rule applied in a business context. And we execute on our strategy by striving for no trade-offs. We've always believed that wonderful service, first-rate advice, and quality client solutions can be delivered at a world-beating value, that no trade-off is required there. Again, it might not be snappy and might not generate a lot of press, but serving others in the way that we would want to be served, it has been and is the right strategy in our view for long-term growth. And in terms of changes, we're not really seeing any meaningful changes in this trajectory. I mean, obviously, different market environments are going to lead to modestly different client metrics as they always have. But as I spoke about earlier, our clients are long-term investors and they're remaining committed to their investing strategies even during this difficult environment.

Operator, go ahead with the next caller.

Our next question comes from Craig Siegenthaler with Bank of America.

Organic growth has declined at the new retail trading platforms, and we would like to receive an update on the competitive landscape in your retail business. Additionally, please highlight the trends you are observing among younger first-time investors.

I'll start by addressing that. Thanks for the question, Craig. Our retail business continues to perform excellently, with substantial net new assets surpassing some of our projections. We have added a significant number of new brokerage accounts this quarter, over 1 million. Importantly, more than half of our new retail households are under the age of 40, and they're contributing significantly to our new net assets. These are genuine investors with real money, and they are coming to Schwab in large numbers. Our retail business is very strong, and our ratios compared to competing firms remain robust. We are optimistic about this trend continuing despite the challenging environment.

Thank you. And my follow-up, similar topic, retail trading platforms. So now that you're finishing up digesting your last set of deals. And I know one of them is going to take a couple more years for the revenue synergies really to kick in. But how would you think about inorganic opportunities relating to retail trading platforms, especially given that you're freeing up some excess capital, where these platforms could allow you to acquire a larger number of younger clients?

Well, I think we try to apply the same level of discipline and thoughtfulness to any M&A opportunity that we would in the future as we have in the past. We recognize that there may well be opportunities in the future, just as there have been in the past. We've looked carefully at everything that's been there in the past, and we'll look carefully at anything that may present itself in the future. That said, particularly given our strong profitability and capital creation, we would want to weigh any possible M&A activity against the other alternatives for deploying capital, including buying back stock in a company that we know very, very well. And have tremendous confidence in its ability to continue to grow organically, of course, I'm talking about Schwab. So we'll look at everything carefully, but it will be a meaningful threshold for us to consider deploying capital in a manner other than investing in a business as strong as ours.

Coming in with one other kind of set of questions from the webcast. We've got some stuff, Peter, for you around AOCI and something that's been top of mind for folks. Maybe you could quickly hit on that just to address those questions.

Thanks, Jeff. I've noted the interest in the questions and commentary regarding AOCI and its potential impact on our capital planning and activities, which is understandable given its size. However, our negative AOCI is not among my top concerns as CFO. It's important to remember that these are mark-to-market unrealized losses and only become a regulatory concern if we maintain over $700 billion in assets for four consecutive quarters. We will have advance notice if that situation arises. Additionally, AOCI decreases with lower interest rates and amortizes steadily over time, about 15% to 20% annually over the next four to five years. The only scenario where it could pose an issue is if interest rates are high and balances are increasing, which would also mean we are generating strong net interest revenue and earnings. Furthermore, if we find ourselves in such a situation, we can use our sweep tower to transfer some balances off our balance sheet into sweep money funds. In summary, AOCI considerations are not currently affecting our capital planning activities.

Great. Thank you, Peter. Operator, maybe we have time for one more question from the queue.

Our last question will come from Brian Bedell with Deutsche Bank.

Congratulations to you, Walt. Regarding cash sorting, could you clarify the 6% to 10% drop in the balance sheet? Was that based on total assets at the end of the period, an average, or just for interest-earning assets? Also, Peter, what is your perspective on cash sorting after the Fed's tightening cycle? If the Fed were to stop by the end of the year, do you still expect a significant amount of cash sorting into 2023, or do you think that will subside? Lastly, did you transfer any BDA assets in July, and if not, do you have the capacity to move $10 billion this year?

Okay, so that was three questions. Let me try to address all of them. In the previous rate hiking cycle, we observed that when the Federal Reserve stops increasing rates, sorting tends to decrease over time. The sorting pace diminishes as the most yield-sensitive cash adjusts, and eventually, cash balances stabilize and begin to grow again. I recommend you follow up with the investor relations team regarding the assumptions in the appendix. They pertain to end-of-period assets. Regarding your third question about the BDA, we have removed a significant amount of balances from the BDA in the first half of the year. I wouldn’t necessarily anticipate further removals in the second half. It’s crucial to view the BDA as another interest-earning asset; it has approximately a 20% floating allocation that adjusts quickly with increases in the Fed funds rate. The securities portfolio has a duration of just over 2 to 2.5 years. Additionally, if you examine the portfolio's maturity schedule, we can share it with you, you will notice that some balances we fixed during the last cycle will start to mature in a few years, creating an excellent opportunity to enhance the yield on the BDA or transfer them to our balance sheet over time.

And if I could just follow up on the roll-off on the securities portfolio. Again, great color on the appendix on the reinvestment rates. What are the current roll-off rates on that securities portfolio? And then do you have any update on the premium amortization from your last guidance in the first quarter?

I'm stepping in with my mic here. So we certainly do. And definitely one of the things that we look to actively manage. Our overall portfolio duration now is down to about a little over 4%. It's probably more like 3.5-ish when you consider the cash we're holding more cash. And so we are definitely maintaining a much more liquid portfolio today, targeting new investments to be very short. Now that gives us a lot of asset sensitivity, but also gives us a lot of liquidity to be able to support a wide range of possible outcomes around this client activity.

Thank you, everyone, for participating in today's call. The information provided in this call will be made available on our website shortly. We appreciate your time and attention. This concludes our call.