Schwab Charles Corp Q3 FY2022 Earnings Call

And we’re on. Hi, Everyone, and welcome to Schwab’s 2022 Fall Business Update. This is Jeff Edwards, Managing Director of Investor Relations, and I’m joined today by our Co-Chairman and CEO, Walt Bettinger; President, Rick Wurster; and CFO, Peter Crawford. We have a Texas-sized amount of ground to cover today, so I’m going to do my best to not be the bottleneck here. However, I do want to cover a few items before we jump into prepared remarks. Per standard setup, I’ll help moderate Q&A following management’s presentation. We will be accepting questions via both the phone line and the web console for the usual. One thing that’s important to note is starting with today’s update, we are implementing a one question only, no follow-up format. However, we certainly encourage folks to jump back into the queue if additional questions come to mind. And of course, you can always check back in with IR after the session with any questions. As always, today’s slides will be posted to the IR site at the start of Peter’s portion of the programming. And finally, please don’t forget about the enduring wall of words, which reminds us all that the future is uncertain, please stay up to date with our disclosures. With that, Walt, take it away.

That began in 2020 and many other periods faced skepticism. Recently, I reviewed reports and articles about Schwab from those times. While I respect the opinions of our doubters, I have full confidence in our firm and our people. I believe in our ability to serve over 30 million clients and to deliver for our long-term shareholders. The third quarter proved challenging for investors, as the Federal Reserve pursued aggressive policies to combat persistent inflation with significant rate increases, while equity markets declined for a third consecutive quarter. The S&P 500 and NASDAQ experienced year-to-date losses between 25% and 32%. Despite these investment challenges, our resilient business model continued to perform well. Our strong organic asset growth rate of 7% resulted in $115 billion of net new assets, and our retail net new assets in the third quarter were 20% higher than the same period last year. This clearly indicates that our strategy of seeing through clients’ eyes is effective and contributes significantly to our organic growth. Additionally, our long-term investment approach was mirrored in our clients’ behavior. Despite low investor sentiment, our clients showed resilience, with net equity purchases surpassing net sales. Our clients also continued to trust our advisory services, with over $8 billion flowing into these solutions during the quarter. As expected in tough investment environments, cash played a vital role in our clients' strategies. We’ve always recognized the importance of cash in asset allocation, especially for investors who have endured bear markets. Recently, there has been much discussion concerning client cash sorting, often presented negatively, but we see it as anticipated and beneficial. We actively help our clients maximize their cash potential. Our approach includes competitive yields on transactional cash and various investment options for cash, including money market funds and CDs. Decisions regarding cash are influenced by interest rates; during low rates, there is little motivation to shift funds from cash accounts to investments, but clients are encouraged to make that shift when rates rise. We support clients in moving their investment cash to higher-yielding alternatives through proactive outreach, seminars, and marketing efforts. While this may mean some revenue reduction as money moves from bank sweeps to money market funds, we believe this is the right action for our clients. If you understand Schwab, you can see we are acting as expected in a rising rate environment, and our client actions align with what we anticipated. This should not hinder our growth in revenue or net interest margin, nor our ability to achieve earnings growth in line with our financial goals in the future. Before I hand it over to Rick to discuss our strategic efforts more closely, I want to update you on the Ameritrade integration and conversion process. As we wrap up our second full year of preparation, we're pleased with our progress. We have achieved significant scale and capacity, exceeding our initial expectations when we announced the acquisition. We're committed to keeping our high-end clients happy by integrating features from both firms, such as iRebal, thinkorswim, and thinkpipes. We've streamlined the conversion process for our clients and have retained key talent despite managing all of this during a global pandemic. Once we complete the integration, we believe we will provide the best overall investing experience in the industry. Naturally, a project of this size presents challenges. Beyond pandemic-related issues, we're facing inflationary pressures that will increase our total integration costs by about 10% relative to our initial estimates. The first contributing factor is inflation across technology, cloud contracts, and employee compensation. Additionally, due to the war in Ukraine, we made the right decision to cease relying on Russian-based developers who supported the thinkorswim system, while training a new team of engineers, which has proven costly yet necessary. To summarize, despite challenges from the pandemic, high client engagement, record inflation, and market volatility, we remain on track to convert 98% to 99% of our clients in 2023, achieve the promised expense synergies, and maintain an integration budget just slightly above early 2021 estimates. Rick, I'll turn it over to you for a more in-depth discussion of our strategic initiatives.

Thank you, Walt. Walt shared the success we’re having with clients, and it starts with seeing through clients’ eyes and making a difference in clients’ financial lives. We continue to be guided by our through clients’ eyes approach and have additional opportunities to expand how we help clients. We are currently focused on 3 strategic focus areas: scale and efficiency, win-win monetization and client segmentation. Within scale and efficiency, Walt just shared an update on our firm’s number one priority, integration. As part of the integration, we’ve accelerated investments in technology and the client experience to make it even easier for clients to do business with us. Seeing through clients’ eyes by making it easier to invest and build wealth has been a hallmark of both Schwab and Ameritrade. Our ongoing efforts to enhance experiences for our clients and our field will continue to be a key differentiator. I’ll spend our time today going into more detail on 3 opportunities: wealth management, lending and our RIA client segment. We said it before, and it remains true today, we are bullish on advice. Although investor sentiment has fallen in this current market environment, our clients are still highly engaged in our wealth and advice solutions and flows continue to be strong. I’ve spoken in prior quarters about how Schwab is uniquely positioned to deliver a continuum of wealth management experiences to meet a range of client needs. On one end of the continuum, we offer clients access to investment solutions they can use for part of their portfolios. The acquisition of Wasmer Schroeder Strategies is a clear example of a win-win opportunity for both clients and our firm. We brought down the cost of access to fixed income managed accounts on our platform and flows have moved to Schwab. The strategies have attracted over $5 billion in net flows over the last 2 years. This includes $1 billion in net flows in the third quarter alone, the highest quarterly net flows we’ve seen since launching these strategies on the retail platform in January of 2021. Another investment solution I’ll highlight briefly is Schwab Personalized Indexing. We are still in the early days, and our efforts are focused on educating clients in the field about the potential benefits direct indexing can provide. We expect it will grow more rapidly as clients continue to learn about it. Moving along the continuum, we’re also meeting client needs with our 2 full-service wealth offerings, Schwab Wealth Advisory and Schwab Advisor Network, or SAN. Despite a challenging market environment, clients are highly engaged. Both Schwab Wealth Advisory and SAN attracted strong quarterly net flows in the third quarter at $2.6 billion and $5.2 billion, respectively. This is an opportunity for win-win monetization as it is an area where we are investing in the client experience and have several levers to improve our economics. First, we believe there’s an opportunity to attract more clients to the programs, particularly at Ameritrade, where less than 7% of assets are engaged in advice, and we have already seen 40% of Ameritrade FCs enroll a client in Schwab Wealth Advisory and over 80% of Ameritrade FCs have enrolled a client in some form of Schwab Advice. Second, we believe we can increase flows into Schwab Wealth Advisory through continuing to enhance the program for clients and making it easier for our field to use. Third, we are reviewing our SAN program economics to make sure we are capturing our fair share given the value Schwab brings to the program, including our track record of successful new client acquisition, our sustained marketing investment, our brand and the important role our field plays in the process and with clients. Schwab Wealth Advisory consistently has the highest Client Promoter Scores at the firm, and we are investing in the program to make sure it remains that way and increases its growth. As I’ve shared previously, we are adding to our capacity to sustain growth, training advisers in new ways to add to the wealth expertise we’re bringing to clients and making investments in the sales team that supports this offer. We’re enhancing the client experience, including making it easier to access our supporting expert teams and beginning to add to our digital experiences. And we are expanding our capabilities, and, over time, plan to provide a discretionary wealth management experience. We believe that demand for advice will continue to increase, and we expect to see growth in both Schwab Wealth Advisory and SAN. With through clients’ eyes as our North Star, we want to make sure that no matter what type of advice and investor needs that we can connect them with the right model. When we think about long-term growth, we believe lending is a win-win opportunity as well. We know that retail clients want to consolidate as much of their financial lives as possible in one place. We know that RIAs want to reduce the number of relationships their clients need to have with financial institutions. Clients who do their borrowing at Schwab today are delighted by our competitive rates, and our Client Promoter Scores exemplify that. And with a large balance sheet, this is a productive use of capital for us. With our lending offer, we are making investments today so we can be the preferred lending provider for clients on our platform. We introduced a preferred rate program, and we are enhancing the digital experience. We are building out our service teams to provide more tailored service, akin to what you might see at the largest banks or wealth firms. In the third quarter, we expanded the rollout of the ultra-high net worth senior lending team model to 6 more retail regions in preparation for full retail rollout by the end of the year. In the last quarter, we started to train and license more than 600 Ameritrade FCs so they can offer PAL and mortgage loans to their clients. We’ve also seen increased retail FC adoption of lending despite rising rates. And we’ve partnered with adviser services to help onboard some significant new RIAs with billions in assets through our lending capabilities. These efforts have been met with very positive feedback. Even in a difficult lending environment, we are seeing growth. PAL demand continues to grow, it is up 31% compared to last year because demand is driven by factors outside of the rate cycle. As we continue to build out the offer for the future, we will take the no trade-offs approach to lending that clients expect from Schwab, attractive rates, enhanced digital experiences and a tailored service model. As we’ve shared previously, about 2% of retail clients turned to Schwab for their borrowing needs. We see about the same level of utilization among RIA clients as well. We believe there is an attractive amount of potential upside here. Now let’s turn to client segmentation. We are continuing to enhance and expand the services and solutions that we offer to our RIA client segment. Expanding our institutional no transaction fee or INTF mutual fund offering for RIAs who custody at Schwab and Ameritrade makes us even more attractive. Earlier this month, we added more than 800 institutional funds without a transaction fee from 15 leading third-party asset managers. This is in addition to over 130 funds already available through our strategic relationship with T. Rowe Price. We’re thrilled to offer this expanded lineup to advisers. With more choices for low-cost share classes without a transaction fee, RIAs can personalize their clients’ investment portfolios and put more of their clients’ initial investments to work. It is a win for RIAs and their clients, and it is a win for us at Schwab. As I look at opportunities on the horizon, our through clients’ eyes approach continues to be both our North Star and our winning strategy. Clients are continuing to turn to Schwab, and they remain engaged despite economic uncertainty. This challenging environment reinforces the importance of our strategy and delivering on our strategic priorities. I’m energized by the momentum we’ve built. By continuing to keep clients at the forefront of everything we do, I’m confident that Schwab remains well positioned to capitalize on the key opportunities ahead of us. And with that, I’ll turn it over to Peter.

Thank you very much, Rick. You've heard Walt and Rick discuss how our strategy focusing on clients' perspectives continues to resonate with investors despite the challenging environment and low investor sentiment. Our cash strategy aligns with this approach, and we are making progress with the Ameritrade acquisition despite unforeseen challenges. I will talk about how strong business momentum and rising interest rates have helped us achieve another quarter of record financial performance, even in a tough equity market. I'll also provide our outlook for the rest of the year and discuss our confidence in navigating the current environment while maintaining strong financial performance in the future. It's clear that we are benefiting from higher rates and are positioned to gain even more in the coming quarters and years, while also managing the challenges that higher rates present. These challenges are manageable, and the most crucial factor for our long-term success is the strength of our business and our strategy focused on clients' perspectives, which is creating strong momentum and preparing us to thrive even when rates normalize. Now let's discuss the factors that contributed to our record financial performance in the third quarter. Compared to the second quarter, we faced more challenges than benefits, with equity markets declining and negative investor sentiment impacting trading activity and margin utilization. However, we benefited from continually rising rates. Despite the market volatility, we achieved strong organic growth, with approximately $300 billion in net new core assets in the first nine months of the year, alongside over one million new accounts per quarter. Despite these challenges, our financial performance in the third quarter set multiple records. Revenue rose 20% year-over-year and 8% sequentially, driven by a 44% increase in net interest revenue and a 52-basis-point year-over-year increase in our net interest margin to 197 basis points, which was also up 35 basis points sequentially. This more than compensated for a decline in asset management and administrative fees due to falling equity markets. Adjusted expenses were up 12% year-over-year, as expected due to a higher headcount and the 5% salary increase we implemented late last year. We increased our adjusted pretax margin to 53% and achieved a record adjusted EPS of $1.10. Bank deposits fell 10% sequentially due to client cash allocation decisions that were in line with our expectations given the significant rate increases. The decrease in stockholders' equity resulted from unrealized losses in our available-for-sale portfolio, $1.5 billion in common share buybacks, and the redemption of our $400 million Series A preferred. Despite this nearly $2 billion capital return, our consolidated Tier 1 leverage ratio was above our operating target. We remain confident in our ability to continue driving revenue growth while maintaining a high level of capital return. Assuming the Fed funds rate ends 2022 at 4.5%, we project an 11% to 13% year-over-year revenue increase, consistent with our earlier scenario. This reflects an expansion of our net interest margin to the mid-210s in Q4, a decline in average interest-earning assets, and net interest revenue surpassing Q3 figures despite continued client cash allocation decisions and some temporary borrowing from the FHLB to manage outflows. We are taking steps to manage expense growth and expect full-year growth to be on the lower end of the 7% to 8% range we communicated previously. Looking ahead to 2023, we see no reason for client cash allocation to differ significantly from the last rising rate cycle, suggesting a trough in balances next year. We have substantial liquidity to support our clients and anticipate growth in both net interest margin and net interest revenue from Q4 of this year to Q4 of next year and beyond. The higher pace of capital return we initiated in Q3 will also continue. There's been significant commentary on client cash allocation, and we acknowledge the questions we’ve received. I want to stress that we view this situation as temporary, manageable, and not a long-term concern for our performance. I want to highlight a few key observations regarding sorting dynamics, with further details available in the appendix for discussion with the IR team after the call. First, data suggests that the rate we offer on transactional cash has little to no impact on the pace or magnitude of sorting, meaning we won’t change our sweep deposit pricing approach to influence client behavior. Second, our experience indicates that client cash reallocations slow once the Fed halts rate hikes. Third, clients generally maintain a minimum level of transactional cash in their accounts, and as we reach that threshold, any remaining client cash sorting will be offset by organic cash inflows to both new and existing accounts. Fourth, accounts with higher cash balances tend to decrease their activity first, and we’ve already noticed this decrease. Lastly, our current client base contains more clients who maintain higher levels of transactional cash. Overall, we are confident that the current activity will diminish, and as stated in our recent CFO commentary, we believe we are in the middle innings of this process. There’s also speculation about actions we may need to support these client cash allocation decisions, so I’d like to share some facts. We have access to roughly $100 billion to $150 billion of readily available cash in the next 15 months, with half coming from excess cash on hand or generated through our investment portfolio, and the other half from cash from net new assets. Additionally, we have significant funding options from the FHLB, retail CDs that we plan to offer, and various forms of supplemental funding. Recently, we began borrowing roughly $10 billion from the FHLB and expect this usage to be limited—perhaps no more than a mid-single-digit percent of our liabilities and temporary. However, we do have the capacity to increase this as needed. Any potential asset sales will likely be minimal and opportunistic. It is essential to recognize that even after reaching peak rates in this cycle, we have the potential to continue expanding our net interest margin in subsequent years as our fixed investment portfolio matures. This margin expansion will contribute positively to our long-term financial formula that we have successfully delivered over the years. I won’t elaborate much on capital return as we’ve discussed our expectations for higher levels of capital return, which began in the third quarter. Before I conclude, I want to take a step back from our near-term dynamics and remind everyone of our long-term financial formula that has been effective over decades and will continue to be so. This formula relies on our strategy focused on clients' perspectives, consistent organic growth without trade-offs, and our capability to convert that growth into asset, revenue, and margin growth while maintaining expense discipline and achieving EPS growth of over 20%. This has been Schwab's investment thesis for much of our history, and it remains the same today. A member of the investment community recently noted that last quarter demonstrated our ability to "walk and chew gum at the same time," highlighting our success in growing revenue and delivering capital return concurrently. While this may be more challenging for many firms, it is an expectation we set for ourselves. Significantly, we’ve effectively supported our clients and our business through this unprecedented environment while taking necessary steps to enhance long-term operational and financial performance. Over the past 20 years, we've navigated two full rate cycles, and while we receive questions about capital and liquidity during fluctuations, our operational engine consistently adds clients, identifies new revenue opportunities, enhances efficiency, returns capital to stockholders, grows earnings potential, and rewards long-term-oriented stockholders. I am confident that all these elements will continue to define our story during this cycle. Jeff, I'll now turn it over to you for Q&A.

Great. Operator, can we please go ahead and go to the first question?

Our first question will come from Ken Worthington with JPMorgan.

On win-win monetization, as these programs that you have in place season, so just the existing ones you have, what do you think that could add to revenue as they season sort of annually? And then on the 800 funds, as that — how much in AUM do those 800 funds have on the platform right now? And how quickly do you expect that to ramp into the fee-free institutional offering?

Ken, thanks for the question. So in terms of win-win monetization opportunities, we believe we have a lot of upside. I mean both wealth management and lending, 2 examples of programs that we’re focused on today. We think there’s enormous upside there. And I shared some of the levers we’re trying to pull on wealth. And in lending, of course, we think we’ll see more of the upside when we get back into a more normalized interest rate environment. But essentially, what we’ve done is we’ve set the table. We’ve created the digital experiences, the product capabilities, and we’ve educated our field to be ready to engage clients in those discussions. And so when the interest rate environment becomes more favorable, we expect there to be benefits there. When we think about personalized indexing, which is another one of the programs we’ve talked about for a while, we expect that to be a 10-year ride of money moving from active strategies and some taxable assets that are in taxable ETFs to move in there. So we think there’s a long runway to all 3 of these programs that we think will provide meaningful upside in the coming years. As it relates to the INTF platform, it is very new. We are seeing assets flow there. And our expectation there, of course, is also strong. I think part of what we’re seeing, or part of the challenge broadly, whether it’s INTF or our relationship with T. Rowe Price is it’s just it’s been a difficult time for active management. And so that’s one that we believe over the long run, again, we’ll pay dividends, but it will, in part, depend on it being an environment where active management is in favor.

Our next question comes from Rich Repetto with Piper Sandler.

First, thanks, Walt, for emphasizing the long-term franchise value related to cash allocation. That’s a helpful reminder for us. I guess my question would be, Peter, as you offered some reasons why you thought that cash sorting had reached the middle innings, and why you won’t — it won’t exceed the last cycle? Can you put any numbers behind that? And maybe a little bit more detail on why you expect that? And is it do — well, that would be the question, I guess.

Thank you, Rich, for the question. So we have some details in the appendix, which you can certainly reference, and I encourage you to follow up with the IR team to — if you want more explanation on those. But it really comes back to a number of different factors that contribute to that view. It comes back to the fundamentals of our cash strategy. We look at the evidence from what we’ve seen in the empirical experience that we have from the last rising rate cycles. We look at the dynamics we see with what we’re seeing thus far, which are fitting the patterns that we’ve seen in that prior rate cycle. In fact, I was looking at some model output just the other day that suggested that what we’ve seen thus far is entirely consistent with what we saw in the last rising rate cycle when you control for the fact that the rates have moved up much more quickly than they did that last cycle. So we’re really not seeing anything that is shaking our view that this is proceeding exactly how we would anticipate.

Our next question comes from Dan Fannon with Jefferies.

I wanted to follow up on that just with regards to the funding of some of the sorting, and you talked about utilizing the FHLB line, but I think you also said that will be short term. So thinking about the access that you have, the capital and the uses, what gives you confidence that you’re not going to need to tap into that for longer periods?

So it comes back to our view on when the we’ve seen over time that these client cash allocation decisions at the level of transactional cash reaches a certain floor, and as it starts to approach that floor, it starts to taper off — the allocation starts to taper off, and then it’s offset by cash that comes in through new accounts. And so we view — our view is that, that’s going to trough at some point in 2023. And then as new cash comes in, we’ll be able to reduce the use of the FHLB and any retail CD offers that we have or any other forms of funding that we access.

Our next question comes from Steven Chubak with Wolfe Research.

So, Peter, I wanted to ask a question on capital. You’ve announced a large buyback authorization. As you’ve noted, under your binding regulatory constraint of Tier 1 leverage, you’re already in an excess position, but your TCE ratio is running at low levels, largely a function of negative AOCI marks, but it’s prompted questions as to whether you’re a lower TCE might preclude buyback. If it turns negative, it could even preclude tapping of the FHLB facility. So to what extent does the TCE ratio impact your ability to execute buybacks or tapping the FHLB? And how should we think about your philosophy around optimizing capital ratios to ensure you’re not running with too much excess?

Yes. Thanks for the question. So I think I said last time in the business update that our AOCI was not at all a factor in our capital planning decisions, and that remains the case. We’re — I would say that the idea of negative TCE or something like that is not at all a major source of concern. We actually are now in the process of transferring additional securities from available for sale to held to maturity. And as we do that, it would take an instantaneous several hundred basis point increase in rates for our tangible common equity to go negative, which certainly seems like a very remote possibility. And given the fact that the duration on that available-for-sale portfolio is under 3.5, that amortizes down relatively quickly. So, over time, it would take even a larger increase in interest rates for TCE to go negative. And while you’re right that negative TCE means that prevents us from initiating new borrowings from the FHLB without Fed approval, it doesn’t affect existing borrowings. It also doesn’t affect any of the other forms of funding that I talked about, the CDs or some of the other forms of funding. So we really don’t think that this is a meaningful issue or a meaningful concern.

And optimizing the buybacks, sorry?

Sorry, and on the buybacks, I think no change in our thinking on the buybacks. We still — as you point out, if AOCI is not part of our regulatory capital. That is what we manage to. And we continue to — as we’ve seen in Q3, continue to pursue the opportunistic return of capital to our stockholders.

Let’s take a question from the web console. This is from Ben Budish at Barclays. Walt, maybe you can take this. Can you speak a little bit to the pipeline for new RIAs coming in? And if we should think about any — how the integration and conversion might factor into that train going forward?

Sure. Thanks, Ben, for the question. We — I was actually just looking at a report on pipeline for new RIAs moving independent, and those numbers remain very robust. They are on par with what we have seen over recent quarters. Actually, if I were to think about a slowdown in RIAs moving into the independent model, I wouldn’t think of it correlated to integration. I would think of it more correlated to the market environment. And that’s what I was interested in when I actually asked this exact question myself a week or so ago to see whether the equity market decline had made it less apt for RIAs to consider moving to independents. And the fact that the pipeline was comparable to what it’s been over recent quarters actually was very encouraging to me. So I guess, in summary, I would say I would not expect the integration to have an impact on breakaways, but I do think you have to watch the equity markets because, over time, it can be more difficult for someone to break away when they’re asking their clients to follow them after a period in which the equity markets have suffered as much as they have of late.

Our next question comes from Devin Ryan with JMP Securities.

Just another one on the balance sheet, so I understand. So the $10 billion in FHLB, does that provide liquidity for additional cash sorting from here, so you’re getting ahead of something? Or is that just meeting kind of what you’ve seen thus far? Just trying to understand the strategy around that. And then any help that you can provide just thinking about the kind of the blended borrowing cost to get to the $3 billion in NIR, and how you’re thinking about deposit beta on future Fed hikes?

Yes. So this may be one where we want to take this offline and have a conversation with the IR team around going through those costs, Devin. But the FHLB borrowing was a bit to cover some of what we’ve seen thus far in October and also a bit to get ahead of it. We always want to be ahead of the game around from a liquidity standpoint. And then in terms of the cost and all that, we can get into that in more detail offline with the IR team.

Our next question comes from Kyle Voigt with KBW.

Maybe just a follow-up on the disclosure of the $100 billion to $150 billion of cash flows that are available from cash on hand, cash from net new accounts and the portfolio cash flows. I guess, given the current pace of sorting, I was wondering if you could provide a little bit more granularity on some of those buckets. So what was the — the current excess cash on hand on the balance sheet as of the third quarter? And then maybe over the next 12-month period, what percentage of the securities portfolio would you expect to mature, or even given that in dollar terms would also be very helpful?

Kyle, it’s Jeff. Definitely happy to follow up with you kind of after the call on some of those more tactical questions. I definitely would point to the appendix and some of the things we’ve talked about and has good directional proxies on that. But again, we’re happy to take that.

Our next question comes from Brian Bedell with Deutsche Bank.

Looking ahead at the development of NIM that you mentioned, how are you considering protecting it in the future? I realize this is somewhat speculative, but if the Fed decides to significantly reduce rate cuts at some point, is there a way to naturally hedge that through the reinvestment of the securities portfolio? Alternatively, would you think about using derivatives to secure some of the benefits from the recent rate increases?

It’s an interesting question. So I’d say a couple of things. We — the way we think about managing the duration on the asset side of the equation is really very much an outcome of what we view as the liability duration. And in different rate environments, of course, that liability duration changes. So in a higher rate environment, liability duration shrinks. And so on the margin, you tend to shrink your asset duration, and the reverse is obviously true. We do — we have recently resumed the capability to have derivatives. We’re not thinking about that in the context necessarily of hedging sort of downside risk, but we see that as — sometimes, in some cases, a more efficient way to manage our overall asset duration. I would say that — so I don’t think — I wouldn’t anticipate a dramatic change in our philosophy than what we have done previously. And there’s certainly no assumption in that chart that you saw there that we shared any assumption there that we manage our investing philosophy differently than what in the past.

Our next question comes from Bill Katz with Credit Suisse.

I think I’ll switch up the topic here a little bit, and maybe we can talk a little bit out expense outlook. So Walt, you mentioned a little bit of inflation on some of the integration charges. And then Peter, you sort of took down the guidance to the low end of the range for the fourth quarter, which is great to see. Looking into 2023 and thinking about incremental margin on the revenue growth coming off of NII and some of these inflationary type of factors. How should we think about maybe core expense growth for ‘23, maybe even to ‘24%, particularly as you get a greater line of sight to residual savings with the Ameritrade integration?

Thank you. Thanks, Bill. So if I tell you everything about expenses, now you won’t come to the winter business update in February. So I want to make sure — I want to know, in all seriousness, we’re still working through our expense planning for 2023 and certainly 2024. I would say maybe a couple of things. First, maybe to take a step back, I mean, our number one priority from an expense standpoint is always to support our clients. And this is a time period where our clients certainly need us. Beyond that, our priorities are really around driving down expense on client assets and through the cycle, not every year, but through the cycle, delivering operating leverage, which is a key part of our financial formula. And then, of course, making appropriate investments in the long-term profitable growth of our business. It’s certainly a — it’s a delicate balance to manage all 3, but I think you’ve seen us do that in the past. When times are — when we’re facing more headwinds and tailwinds, we tend to pull back on that third one, and when we got the wind at our backs, we tend to lean a little bit more into some of those longer-term investments. In terms of the — as you think about 2024, Walt talked about this, but maybe just to reiterate it on the expense there is really no changes in our thinking around expense — or expectations around expense synergies. Certainly the magnitude of those synergies, we continue to be very committed to and confident in our ability to deliver on those. We’d expect, by the end of this year, we’ll probably have achieved, on a run rate basis, roughly 60%, 65% of those expense synergies. And then with the integration timeline that Walt talked about, we would expect to deliver the vast majority of those remaining synergies by the end of 2024.

Our next question comes from Michael Cyprys with Morgan Stanley.

I was just hoping you could update us on the securities portfolio, reinvestment strategy and yields? How is that evolving? And it also looked like duration on the portfolio shortened a little bit. So I was hoping you could unpack some of the moving pieces that drove that? As rates did increase, do you feel like at this point, the book has sort of fully extended? And how do you think about any sort of risk of additional extension risk from here?

So from a reinvestment rate standpoint, we are focused on cash right now and maintaining cash. There’s not much reinvestment going on. On duration, you’re absolutely right. Actually, despite the significant increase in rates across the curve in the last quarter, our duration on our investment portfolio actually shrank by a tenth, so we went from roughly 4.1 to a little under 4. And that reflects the types of securities that we have purchased that we really very much target securities that don’t have that degree of extension risks. So we feel really good about that. If you look at actually, there’s a chart in the appendix, I encourage you to take a look at, that looks at the duration profile of our portfolio over time versus what you see in some of the benchmarks. So we feel very, very good about the lack of duration extension risk in the portfolio.

Our next question comes from Brennan Hawken with UBS.

I just would like to maybe dig in a little bit on your current understanding that the situation is fluid. But — and thanks for the incremental $10 billion so far borrowing on FHLB and the color around that. Where do you think that that would peak out? I’d assume, given the pace we’re running at and the fact that you don’t think we’re going to see any worse experience than what we saw last cycle, we’re not very far from that period. And so is embedded within your guidance that the FHLB will ramp up into the beginning of next year and then be paid down as you hit that plateau, and you see cash begin to grow normally and then it’s off the balance sheet by the end of the year? Is that what’s reflected, or could you give a little color around what your expectations are for that funding?

Sure. So I mean the important point is we definitely view this as very much a temporary funding source as it has been in the past. We’ve used FHLB previously as a temporary funding source, and we absolutely view it the same way today. I mentioned earlier that we would expect it to be no higher than a mid-single-digit percent of our overall interest-earning assets, and that — to be clear, that is the combination of FHLB as well as these other funding sources like CD issuance and so forth. And given our expectations that the client cash balances on the balance sheet trough at some point in 2023, that would be the period where we’d be at the peak level. And then as we get to the cash balances grow that, that replaces the higher cost, but — temporary higher cost, but temporary FHLB, CDs, et cetera, which, again, is helpful from a — clearly, from a NIM standpoint as we start to pay those balances off and replace them with the client cash balances.

Great. Just one quick follow-up. The CDs, is there any term or yes...

Just remember, just one thing and Peter’s CFO commentary, right, he talked about a percentage that he thought might be appropriate through the remainder of the cycle. So that’s definitely a good aiming point. And we aren’t accepting follow-ups. So I think we are it looks like the queue is now empty. So I’ll turn it over to Walt to take us home.

Thanks again, Jeff. And I want to thank everyone for joining us today. Today is actually a special day, an important milestone. As many of you know, our own Rich Fowler, he of the top-down days, this is his last quarter as Head of Investor Relations. My understanding is he’s going to sprint off into retirement. Those of you who know Rich, know that he was a college-level sprinter, which is no surprise to any of us who know Rich, but he’s going to sprint off into retirement. Rich is the only CIRO that we have ever had at Schwab. That’s pretty remarkable. He’s been here through 3 CFOs, over 100 quarterly earnings cycles. But when I think of Rich, the things that stand out are his integrity, clarity, transparency, whether it’s disclosures, interactions with all of you, incredibly special. And as great of a CIRO as he is, he is an even better person. We’re going to miss you, Rich. You’ve done a wonderful job of preparing Jeff and team to step into your shoes. And I just — and speaking directly to Rich, want him to rest assured that the priorities and values that he’s embodied at Schwab will continue long after he has crossed the next finish line in his sprint. So thanks again, Rich, and thanks to all of you for joining us, and we look forward to speaking with you again in a future business update. Bye-bye.