The Charles Schwab Corporation (SCHW) Earnings Call Transcript & Summary

All right. We are live. Good morning, everyone. Welcome to Schwab's Fall 2021 Business Update. This is Rich Fowler, Head of Investor Relations, coming to you on a not quite top-down day. And no, I'm not talking about the Giants losing to the Dodgers, not talking about the rather -- I don't know, lackluster, Jeff, unfortunate football seasons that both Stanford and Cal seem to be having. I am talking about the fact that we're actually finally seeing a few drops of rain out here, which will at least help settle the dust. Given the drought we've been living through, I guess I can't whine too much, but there are people here who said they didn't think my car had a top. So now there's proof otherwise. Anyway, as always, we hope everyone on the call and your families remain safe and well. We thank you for spending the time with us today. And we were talking about this earlier. I think today's program is about as straightforward as an interim update can get. So hopefully, we'll have a good chunk of time for discussion at the end. Joining me, both virtually and literally, are Schwab's CEO, Walter Bettinger; and Chief Financial Officer, Peter Crawford. We'll plan to spend around an hour with these two to bring you up-to-date on life at Schwab right now, starting off with some prepared comments and then following up with Q&A until it's time to wrap up. We'll follow established practice on questions, so we'll take them via the dial-in as well as the webcast console. [Operator Instructions]. Walt will start us off today to discuss our strategic picture, and then Peter will review our recent financial performance and then move to discussing the current financial outlook before taking us into Q&A, which Jeff Edwards will once again moderate. But before that, it's time for our moment on the wonderful wall of words, which we continue to battle to a single riveting page. Main point, as always, is to remind us that outcomes can differ from expectations, and so please keep an eye on our disclosures and stay in touch. Finally, the Schwab -- sorry, the slides will be posted on the IR side during Peter's prepared remarks per our recent practice. With that, I think we're ready to get going. So Walt, over to you.

Well, thank you, Rich, and good morning, everyone. Thank you for joining us. I continue to be impressed, Rich, that you have that wall of words on a single page. As I get older, the font gets a little smaller, but still, congrats are in order. So when I evaluate the client-oriented and financial performance of Schwab, my high-level thoughts tend to gravitate toward 3 areas. First, our clients and prospects voting with their wallets by bringing their hard-earned dollars to us; second, our clients engaging with our platforms, our education and various solutions; and then third, in the context of serving our clients well are we generating quality earnings for our stockholders. And the order of those is not by accident. At Schwab, it starts with serving our clients well. If we do so, and we make prudent decisions to continually enhance our services, both for today and for the longer term, then earnings follow. And as all of you know, we've referred to that as the virtuous cycle for many years. And our third quarter results are really a perfect illustration of this approach in action. Our momentum was strong across our core businesses. Client engagement was relatively high. We continue to make the right investments for today and the future. And of course, our financial results were outstanding. So let's go ahead and dive into some of the details here on Page 5. It was an uneven quarter from a macro standpoint. We saw the equity markets reach new highs intra-quarter. And then by quarter end, they had fallen, so that the quarter ended up relatively flat. Client sentiment, driven at least in part by growing concern about inflation issues in the country, reflected this as it slid actually into bear territory by year-end, its lowest level anytime within the past 12 months. Despite the uneven quarter, our organic growth was really exceptional. Core net new assets in the quarter were almost $140 billion. That takes us to nearly $400 billion year-to-date, about an 8% organic growth rate. This is almost 50% ahead of the same period for 2020 when looking at the combined Schwab and former Ameritrade. It also means that in the first 12 months as a combined company that clients have entrusted us with over $0.5 trillion in core net new assets. A pretty remarkable number, particularly when one considers that the primary source of our net new assets are really retail investors, those that come to us directly or via the independent investment adviser model, which, again, principally serves retail investors themselves. Of course, new brokerage accounts remained quite strong also. We exceeded $1 million for the fourth consecutive quarter. So we've done a lot over the last several years to make our offerings more appealing to younger and newer investors. There's a lot more to come on that. We have removed barriers. We've enhanced digital capabilities, expanded access to advice, and we continue to enhance our award-winning checking account. And it's gratifying to see that those investments have been noticed by younger and newer investors. We're now at about -- 60% of our new-to-firm households are under age 40. More than half of those under 30. Some of these clients have come to us because they've been attracted to tremendous value, others by our industry-leading service, others by the quality of our trade execution. Really, regardless of why they came to Schwab, we are confident that with our broad set of solutions, quality advice or client orientation, we're well positioned to continue to serve these clients as their needs evolve over their lifetimes. Over in the RIA custody space, we've built a platform and a business that's viewed as best-in-class by a diverse array of clients. If you look at our net new assets in the RIA business to date, firms with less than $500 million in client assets contributed almost 40% of our overall net new asset growth. And I think this validates the long-standing statements as well as commitment that we have made striving to be the top RIA custodian for firms of all sizes. So while I mentioned that client engagement did moderate a bit from really what were extraordinary and record-breaking levels earlier this year, trade levels remained quite strong. And as our client calls moderated, our level of customer service has returned to its historic high levels. You can see the chart on the right here on Page 8. It shows just how dramatic that first quarter was in terms of client calls and, of course, the pressure that that contributed to from a service standpoint. Over on Page 9. Clients continued to take advantage of borrowing opportunities with us. They utilized different types of borrowing that best fit their personal needs. When a client capitalizes on our attractive mortgage or Pledged Asset Line pricing, it's good for the client. It's also good for us, both strategically and financially. It strengthens our relationship with the client. Often, it lowers the cost of borrowing for the -- for our client. Also provides us with an attractive yield relative to what we might otherwise be able to invest that cash in. So perfect example of what I talk about often, a win-win monetization. In terms of volumes, mortgage volumes remained quite strong. Client usage of Pledged Asset Lines and margin lending continued to grow, as you can see in the middle column and the right column here on Page 9. So talking a little bit about the trading side. We continue to see growth in retail trading activity, certainly, relative to the Advisor business. Also higher levels of trading by investors under the age of 40. Very importantly, clients continue to take advantage of our educational opportunities of helping them become more effective traders and investors. I also think one of the important factors on this slide, as I was studying in these metrics, is that it's not simply brand new clients that are driving the volume of trading activity, actually, the largest increase in trading occurred from existing clients. Maybe a bit surprising to some folks who maybe have followed some of the trading activity here throughout 2021. Given the discussions in the marketplace around order flow, I wanted to provide a slide and talk for a bit about our approach to order routing. It remains consistent with prior periods, and we think it's a balanced approach that serves our clients well. Let me first emphasize by saying we do not route orders based on which third party pays us the most. We set a rate for order flow payment and then allow the third parties to compete for our flow based on the quality of their execution for our clients. When you bring that down into math, for every $1 in order flow revenue we received from third parties to date this year in 2021, those same third parties generated $6.50 in price improvement for our clients. Also another important metric that maybe is not always well understood, over 80% of the revenue that we generated from order flow came via orders that were executed on exchanges. Now again, as I mentioned, we recognize that the idea of payment for order flow is actively being debated today in various venues. We hope that these metrics help inform that debate. So moving over to Page 12. Any discussion of our growth, success and future opportunities as a company has to revolve around our dedicated employees, or Schwabies, as we like to call ourselves. We are committed to continue investing in our workforce, whether it be via training, hiring, appropriate levels of compensation and benefits, work location flexibility, diversity as well as a culture that we believe is second to none in our industry, and of course, many third parties view it in the same way. Earlier this year, we were proud to share with our dedicated Schwabies a 5% base salary increase in recognition of their hard work and to help offset some of the increases that many are experiencing in their cost of living. Of course, that increase will also filter through and lift our Schwabies' bonuses in future years. And these dedicated Schwabies, who now number in excess of 30,000, are helping ensure we deliver on our 3 key strategic initiatives: scale and efficiency, win-win monetization and client segmentation. And of course, many are fast at work on the integration of our TD Ameritrade acquisition. It is on track for our clients. And as we have shared with you a number of times, delivering financial results that are measurably in excess of what was anticipated at the time we announced that transaction. But for all that's happening in and around Schwab, all the changes in the market, the growth of the firm, the evolving regulatory and competitive landscapes, I think what's important is what doesn't change. We remain consistent in the areas that matter most: strategy based on seeing the world through client's eyes; a set of competitive advantages that we continue to enhance; and our commitment, as I referenced earlier to the virtuous cycle that continually rewards our clients, our employees and our long-term stockholders. It's been a winning approach for almost 5 decades at Schwab. And with modest overall market share in the U.S., we believe that great days are ahead of us. So just, Peter, before I turn it over to you, I wanted to spend one moment and comment on our recent announcement of Rick Wurster to the position of President of the company. When I assumed the dual role of President and CEO in 2008, Schwab was a vastly different company. Our market cap was between 10% and 15% of what it is today. Our workforce was a fraction of what it is today, as was our revenue and earnings. And of course, our regulatory oversight was relatively simple and straightforward. Today, it makes sense to begin allocating some of the duties that I've carried for the last 13 or 14 years to a colleague. And Rick Wurster is the ideal person for me to partner with. I feel very confident that for those of you who don't know Rick, as you get the opportunity to know him in the future, you'll recognize his intellect, his leadership skills, his passion for clients, and at the top of the list, his personal integrity. So Peter, let me turn it over to you to cover your slides.

All right. Well, thank you very much, Walt. So Walt talked about the success we're having winning clients of all shapes and sizes; the continued strong engagement by those clients, both in the market generally and with many of our solutions; the tremendous progress we've made in the year since we closed the TD Ameritrade acquisition; and finally, about the exciting opportunities we see to continue to take market share and advance our strategic priorities. In my time today, I'll talk about how we're able to translate that strong client engagement and business momentum into a record financial performance in Q3. I'll provide an update on the growth of our balance sheet and our thinking about capital management. And finally, I'll provide an outlook for the fourth quarter and some early thinking on 2022. The message you should hear is one of consistency. This company is driving consistently strong operating and financial performance despite an anticipated moderation of trading activity and continued low interest rates. And that itself is, we believe, an outcome of the consistency with which we operate the company, which starts, as Walt mentioned, and ends with our unwavering focus on clients. It also includes that -- the durable business model we've created and our strong competitive position. In a short while, the prospects are increasing for higher interest rates in the future, which will be an enormous benefit to our clients and our business. We have demonstrated that we don't need high interest rates to be successful. And that's why we continue to navigate through this period with a lot of momentum and a lot of confidence. So let's talk about some of the dynamics that influenced our financial performance in the third quarter. Relative to the second quarter, and really the first half of the year, we faced frankly more headwinds than tailwinds. As Walt mentioned, the equity markets interrupted. They're much higher due to various concerns about the economy, the pandemic and the political situation. Client trading activity continued to moderate, though the sequential drop-off I'd note was -- from the second quarter was less than we typically have seen during prior summer months. We actually saw a significant increase in margin utilization. Interest rates fell for most of the quarter before climbing towards the end and, of course, in the early part of the fourth quarter, but it still finished the third quarter below Q2 levels. Now the one tailwind that we've always been able to count on is our ability to drive robust organic growth, nearly $400 billion in core net new assets year-to-date and nearly 6 million new accounts. Despite some of those challenging dynamics, we're able to deliver very strong financial performance across the board. Revenue increased 1% sequentially, driven by slight increases across all 3 primary sources. Net interest revenue increased for the fourth consecutive quarter despite a decline in securities lending activity and reinvestment rates that remained lower than our overall portfolio yield as interest-earning assets and margin utilization increased and premium amortization fell sharply from the second quarter. Asset management and admin fees increased due to higher balances and a stabilization of money fund waivers. And defying the often seasonal slowdown, trading revenue actually increased 1% despite a reduction in daily average trades or DATs. And this is due to a quarter-over-quarter increase in derivatives trades, which produced a higher revenue per trade than equities. Our adjusted expenses decreased 8% sequentially, reflecting the $200 million reserve we recorded in the second quarter related to an ongoing SEC investigation and relatively flat compensation and benefits expense due to mostly flat headcount through the quarter. With an increase in revenue and a significant decrease in expenses from the second quarter, our key profitability metrics rose substantially. Our adjusted pretax margin finished just shy of 50% and a return on tangible common equity reached 23%, both measures that would have seemed unimaginable the last time we were in the midst of a ZIRP environment. Turning our attention to the balance sheet. Our balance sheet grew 6% sequentially to over $600 billion, reflecting increased client cash balances as well as the initial migrations from the IDA to our balance sheet. We continue to see increasing margin utilization despite a slight decrease in investor sentiment that Walt alluded to and a slowdown in equity trading. And as Walt mentioned, we are gratified that clients have turned to Schwab Bank in increasing numbers for their borrowing needs. Bank loans were up 9% sequentially and 42% over the last 12 months. We issued another $850 million in long-term debt at a coupon of under 2% and also completed our exchange of some TD Ameritrade debt for equivalent debt to The Charles Schwab Corporation. Stockholders' equity stayed flat, as our organic capital formation was offset by a decrease in AOCI, resulting from the increase in interest rates at the end of the quarter. And with a sharp increase in our balance sheet assets, we saw a slight decline in our Tier 1 leverage ratio, which, however, remains well above the regulatory minimum. I mentioned that client cash balances were up sharply in the quarter, and that was a function of continued strong asset gathering and a reduction in net equity purchases, reflecting the somewhat more subdued investor sentiment. On the flattish equity markets, client cash allocations increased to 10.8% of assets. We thought it'd be interesting, now that we're 3 quarters of the way through the year, to take a step back and look at how our business has performed relative to the so-called "mathematical illustrations" we unveiled with the Winter Business Update back in February. That seems like a long time ago. But as you may recall, we just closed the books on our first quarter as a newly combined company and our experience in Q4 2020 when at the time was an unprecedented level of client engagement, represented by trading activity, margin utilization, et cetera. And then in early Q1, we had the beginning of the vaccine rollout and then the meme stock craze. And so given the uncertainty around how key drivers of our performance would unfold, we shared 3 illustrations based on different levels of trading, margin balances and client cash balance growth. Now what those 3 illustrations shared in common were assumptions about moderate equity market appreciation, rates that followed the forward curve at the time, sec lending revenue consistent with recent quarters and the expectation that we begin to move balances from TD Bank to our balance sheet in July. Now I think it's safe to say that the year has generally unfolded in a way that has been beneficial to our performance, with equity markets up sharply based off of reopening enthusiasm; long-term rates that have bounced around, but on average, have been above the level of the forward curve -- or the level of the forward curve anticipated at that time; somewhat stronger securities lending revenue due to interest in some hard-to-borrow stocks; and some early synergies from combining the Schwab and TD Ameritrade trade operations; and the initial IDA migrations occurring in July as expected. And what happened with the 3 variables about which there was less certainty? Those have been folded in a way that was, on balance, most similar to that upside illustration with trading levels and balance sheet growth just under the level of the highest illustration and margin utilization well above. Given that performance, it should not be surprising that our revenue growth has been significantly higher than the top level outlined in those illustrations, with adjusted expense growth falling just above the range before the impact of the sec reserve. And our adjusted pretax margin thus far well above the 40% level that we communicated. And we achieved those results even as we improve service levels and invested appropriately in the TD Ameritrade integration and our other strategic priorities, which I think reinforces the tremendous operating leverage we retain in our business through the cycle. Now with 3 quarters of the year now behind us and some of the major uncertainties regarding client engagement and operating with somewhat more predictability, at least in the near term, we're now in a position to return to our historic practice of sharing with all of you a specific scenario rather than the 3 mathematical illustrations. And we now expect revenue to increase by 9.5% to 10.5% for the full year relative to Q4 2020 annualized. And very importantly, that assumes trading activity similar to the third quarter; 13% to 15% balance sheet expansion over the course of the year, including Q4 growth consistent with what we typically see at the end of the year, which tends to be a stronger quarter for cash balance growth; our fourth quarter net interest margin in the mid-140s, so near the recent level; and equity markets to grow modestly from here and rates to follow the forward curve. And we'd also expect full year adjusted expenses to be in the 6% to 7% higher than our Q4 annualized level under those same set of assumptions. And those expenses will reflect the impact of the 5% across-the-board salary increase we announced earlier and Walt referenced in his remarks, which took effect in early October. That combination would produce an adjusted pretax margin near where we have trended year-to-date. So as we look ahead to 2022, our strategic agenda remains quite consistent, focused on working towards a successful TD Ameritrade client conversion in 2023 while advancing our other priorities around scale and efficiency, win-win monetization and segmentation. Our financial outlook, however, continues to evolve with changes in the environment, expectations for interest rates and client activity. And we'll share our specific scenario or perhaps scenarios with you at the Winter Business Update in February, but a few thoughts in the meantime. If the market is correct and predicting that the first Fed increase will be in the middle of the year, we clearly see a material benefit on the roughly 40% of our balance sheet tied to short rates and on the amount of money fund fee waivers. Now in the appendix that we've shared, you'll see that we sized that combination at $750 million to $950 million of revenue lift over the 12 months following the increase. We'll continue to monitor trends in trading activity, margin utilization, securities lending. But the longer we maintain these high levels, the more confident we'll be that we may, in fact, be seeing something akin to a new normal. On the expense side, we're likely to enter a bit of a transitional year, with our expenses being influenced by some unusual items including the full year impact of the base salary increases we announced earlier; the resetting of our bonus funding back to 100% from the much higher level we've been accruing in 2021; some infrastructure and software amortization and depreciation that is related to client conversion, but per accounting rules, will still be included in our adjusted expense numbers; and the continued realization of expense synergies related to the integration. And finally, our priorities in terms of capital management remain the same, ensuring we have sufficient capital to support the growth in our client base. And the timing to return those capital levels back to our operating objective depends in large part on the path of interest rates, with higher rates bringing the date forward due to a stronger capital formation as well as a likely return of client cash sorting. Let me close with a few thoughts. We're certainly encouraged about the improvement in the environment and very excited about what the prospect of higher rates will mean for our clients and our business, and that excitement is fueled by the success we're enjoying today; our ability to continue driving strong organic growth, in part, by appealing to the next generation of investors; the continued engagement of our clients, even as the markets have become somewhat more choppy and their increased usage of our broad array of solutions; the progress we're making across all of our strategic priorities and the success we're having in continuing to drive greater efficiency and productivity throughout our business; the strength and resilience of our business model; and finally, the considerable opportunities we have in front of us, remaining focused on the items within our control, most importantly, maintaining our Through Clients' Eye strategy, that is the mechanism that has enabled us to deliver for clients and stockholders for close to 50 years. So Jeff, let me turn it over to you to facilitate our Q&A.

Great. Thank you so much, Peter and Walt. Operator, let's turn to the phones and see if we have any questions.

[Operator Instructions] Our first question today comes from Dan Fannon.

Peter, I was hoping we could follow up on the outlook for '22 just in terms of -- I know it's early around expenses. And it might be helpful just to remind us where you are in terms of realized synergies and then kind of what's left and maybe the time period for that realization for the remaining level of expense synergies.

Sure. Thank you for the question. So as Walt mentioned, we've achieved roughly 40% of the $1.8 billion to $2 billion of expense synergies in the first year post legal day 1. We'd expect to realize probably roughly 1/3 maybe or so on a run rate basis between that period and client conversion. And then maybe the last 1/3 or so, at client conversion in the months following. So there's sort of a significant amount in that first year, a bit of a slowdown, if you will, on a kind of a monthly basis and then a big chunk at the end with the actual client conversion and moving from 2 platforms down to 1 platform.

Great. That's helpful. And then as a follow-up, Walt, I was hoping we could talk about the Advisor business. You just wrapped up your kind of big IMPACT conference. And could you talk about kind of the outlook for Advisor ads? And maybe what advisers are looking for you to add in terms of capabilities or services they are hoping that you can expand and offer going forward?

Sure. Thanks. So we continue to really like that business. The independent investment Advisor model continues to win in the marketplace. And the organizations that they compete with continue to try to adjust their business models to look more and more like independent advisers. I think any discussion of our services for them begins with stability and never being in a position to have to say to their clients any concern around the safety of their assets at a custodian. Then we move into ensuring they have competitive capabilities, whether it's on the lending side, whether it's quality of trading and execution. Certainly, an area that there is tremendous interest in right now is personalization, and I spoke about that a bit at IMPACT. RIAs have always done a degree of personalization, but I think we're getting close to a step-function in terms of what RIAs and others can do for their clients to personalize investing. And along with that will be a great focus on tax-efficient investing. I think we all probably agree that taxes are likely to be higher at some point in the future. And the opportunity to more efficiently manage portfolios, taking into consideration taxes, is also something that a lot of advisers are looking for and counting on us to deliver.

Our next question comes from Ken Worthington.

Walt, in the past, you suggested a closer relationship with certain third-party asset manager, partners, and Rick Wurster has commented on a more curated experience that might distinguish third-party managers. And we saw the news about Fidelity and Vanguard funds sold on the Schwab platform this quarter. So I guess the question is, how is the evolution of these relationships with your third-party managers developing? And does the great market environment that you highlighted alter these plans to work more closely and better monetize these third-party manager relationships?

Yes. So I'm not able to go into any detail at this point, but those conversations are progressing. And I certainly hope that by the time we are meeting again next time that I'll be able to share a fair amount of detail around this. We continue to think that opportunities to help curate for investors can lead them to better outcomes, quality performance, keeping costs as low as reasonably possible. So we remain very committed to the strategies that I've spoken of and that Rick has spoken of. We're just a little bit early in being able to communicate some of the details around that.

Okay. That's fair. And then maybe just separately, Schwab has dedicated significant resources to growing advice in digital advice services. It is a big business for you, but it's also one that seems to be growing maybe a bit faster or maybe in line with the overall franchise rather than seeing noticeably faster growth. So is advice an offering that should be relatively bigger at Schwab than it is today? And if so, what is sort of holding it back? Is it the environment? Is it the need for new products and innovation? What are your thoughts here on growth of advice at Schwab?

Yes. I think all your assumptions are fair. What I might add is that if you look at the type -- and when you're speaking of advice, I think you're speaking on the retail side because virtually all the assets on the RIA side are under advisory relationships. But I think you have to look at the clients who come to Schwab Retail. Generally speaking, those clients come to us as more on the self-directed side, whereas some of the firms, who might be comparing advisory growth rates to their clients, may more traditionally come to them looking for advice. There's also a somewhat different relationship model and compensation structures at some of the firms you might be comparing to. So we've got a different type of client on average in a somewhat different type of relationship model, which probably means that our growth rate on the advice side is not going to align with some of the firms that you're thinking of. That said, I think there is a tremendous opportunity for us to continue to grow our advice business as our clients age and have increasing levels of wealth. They do tend to turn to who they trust and that is often us for those advisory services that they want. The other thing I would encourage you to think about is that the lines are going to be blurring. So when I referenced in the earlier question around personalization, let's just talk briefly about direct indexing. Direct indexing, it depends on how you think of it. It's not necessarily advice, right? I mean direct indexing appeals significantly to individuals who are historically self-directed and are index-oriented. But it's, in many cases, can be a more effective way to be self-directed in an index that maybe historically they just bought a fund or an ETF. And so the lines between advice and self-directed are also on the cusp of starting to blur. And I think as you see over the next 12 months, the quality of the offering that we'll put out there and the enhancements that it will bring over its first 12 months after introduction, you'll see some of what I'm referring to showing up in the numbers.

Our next question comes from Rich Repetto.

I guess my question goes to Peter, and we had a significant change in rates towards the end of the quarter over the 10-year popping into the 120s, 130s, and now we're at close to 1 -- I think close to 170 in the 5-year part 2. So I guess the question is, can you give us a feel for reinvestment rates? I don't want to say real time, but given the rate levels we're seeing. And when you did give the guidance for the full year, I know the change in rates doesn't really impact a big -- but what sort of NIM are we sort of factoring for, I guess, for 4Q?

Yes. Thanks, Rich. So this is -- certainly, these numbers are changing in real time. So even as I was -- had been preparing with the team over the last several days or weeks for the update today, we're putting together sort of thoughts on reinvestment rates. And frankly, even some of that information may be a little bit old now. But what I'd say is that, up until probably a week or so ago, I would have said reinvestment rates are probably in the 120 to 130 basis point range. That's a combination of maybe 30-ish basis points on floating rate securities, kind of 130 plus on some of the MBS, the fixed rate MBS that we buy and a little bit on the lower end of that range for treasuries, which we've been leaning into a little bit more recently to build up our Level 1 purchases as we are subject to the full LCR on October 1. In the last week, though, with rates moving even higher, I would say, we're a little bit north of that range as we're sitting here right now today on the reinvestment. So it's probably more in the 130s range overall.

Great. That's helpful, Peter. And while I apologize upfront for the detailed question here, it's got to do with the regulatory scenario out there. But you did highlight that 80% of your flow goes to exchanges. And I guess that has to assume -- or take into account that option flow goes to option exchanges. And I guess the question is, what's your -- if you're highlighting the 80% flow, which includes the option flow, do you think option flow is immune or not being -- or won't be the impact of the same as potentially equity flow, if anything, if the SEC did anything on payment for order flow?

Yes. Thanks, Rich. Very difficult for me to say on that or to speculate on what might happen from a regulatory standpoint, from a challenge standpoint. So I wish I had a better answer to share it to you, Rich. Unfortunately, I really don't.

Our next question comes from Steven Chubak.

So maybe just to start off, a follow-up question for Peter, just on the securities yield. You mentioned the significant benefit from premium am contracting in the quarter. And just given some signs of continued prepayment normalization and rates moving higher at the long end, I was hoping you could help size the potential impact to the overall securities yield if prepayment speeds reverted to pre-pandemic levels, just to frame what normal might actually look like in terms of the go-forward yield. And how big of a drag is premium am on your securities portfolio today on a dollar basis?

So thanks for the question. So let me say a couple of things maybe and then I'll try to get into the meat of the question here. I mean I think it's safe to say that we think the worst of the premium amortization is behind us. If you look at the roughly 60% now, I think I heard recently, 60% of the mortgage universe now was originated in 2020 and 2021. So obviously, very low rates during that period of time. And we saw -- going from Q2 to Q3, we saw about a 7 or 8 basis point reduction in the premium amortization flow through the investment portfolio. Now we said back in July -- at the July update that with a 25 basis point increase in rates, we'd expect to see roughly 5 to 7 basis point reduction in the premium amortization effect. And frankly, the decrease we saw from Q2 to Q3 doesn't really reflect that because rates, of course, move towards the end of the quarter. And that benefit that you see from higher rates, it takes a couple of months, typically, a few months typically to work its way through the system. So we'd expect the benefit from the most recent increase in rates to start being translated into lower premium amortization in probably the latter part of Q4 and then heading into Q1. So we think that that number, that the rule of thumb, if you will, is still quite valid. Now the reason it's hard to answer your question and get you exactly back to sort of where we were previously is that the premium amortization is as you buy more security -- as you grow your securities portfolio and you buy securities that have an embedded premium in them, there is just some amount of premium amortization you're going to get, that's kind of normal. And that's just -- that's how you -- when you buy a premium, that's how you amortize it through the -- per the accounting guidance. So I can give you a number, I mean, it's in the hundreds of millions of dollars per quarter, but to just tell you exactly what that's going to be in the future depends on what securities we're buying and the relative premium in those securities. We think there could be certainly a material benefit, and it will be embedded in our -- as we share our 2022 outlook with you, we'll have more specific perspective on that, and that will show up in our revenue scenario that we share with you in February.

Maybe just a follow-up on sec lending. You reported a pretty meaningful sequential decline in the quarter. And relative to the guidance, not the start of the year, which I know you guys provided, but just at the summer update, it came in a bit below that $200 million per quarter assumption. I don't want to call it a target. But just wanted to better understand, what were the drivers of the decline? Where are you in terms of harmonizing the 2 sec lending platforms? And what do you see as a sustainable run rate for sec lending just for modeling purposes?

Yes. So I appreciate your clarifying your question because we're trying to be very clear when we talked about the sec lending numbers, it wasn't per se guidance, but more was an assumption for sake of simplicity to talk about it in terms of an average of the previous 2 quarters. Because quarter-to-quarter, it is hard to predict the exact amount of sec lending because it's really a function very heavily in terms of the relative interest, and often times, a very small number of hard-to-borrow stocks that create a lot of the revenue. What I can say is, over a longer time frame, we believe that sec lending revenue should grow with the growth of our client base, our growth of our total client assets and the growth of margin balances. We are -- have taken steps to bring together the 2 operations from TD Ameritrade and Charles Schwab together. We are now passing through the entire TD Ameritrade inventory through the Schwab tools and systems and presenting one unified box to the street. And that allows us to capture some of early synergies, to harmonize our pricing, to take advantage of the greater automation that we've had on the Schwab sec lending side of things, which allows our traders to spend more of their time on the smaller number of securities that generate higher returns and really work those and optimize the price on those. Also over time to capitalize on some of the capabilities that we've had on the Schwab side for a longer period of time such as the fully paid program. So we think that there's going to continue to be opportunities to bring out the best of both of those respective businesses and operations and capture additional synergies. And we think that over time, this -- we should see, through the cycle over time, a meaningful increase in sec lending as our overall client base grows.

But is this new jumping-off point? Like should we contemplate growth off the 1 -- roughly $160 million?

I think in terms of -- as you're thinking about modeling this, I think the best bet is to look at it over the previous several quarters and kind of take an average because you've seen it can jump around from one quarter to the next. But if you're modeling something over 3 years, 5 years, 7 years, I think it's fair to assume that that grows with the growth of the client base.

Our next question comes from Bill Katz.

Just maybe a couple of things to unpack. I didn't see a transfer of asset ratio this particular quarter. And I was sort of wondering if you could be willing to sort of answer the question of how are some of these trends playing through when you look at wirehouse share gain versus maybe fintech share gain?

Sure. I can talk a little bit about that. So our TOA numbers are relatively consistent. There weren't any big changes from Q2 to Q3, weren't any significant changes in terms of who we're winning from. Again, very significant wins from the fintech side, very significant wins from the traditional firms on average. And then a lot of swapping at least in the retail side among the more traditional firms that started as discounters. What's different is that in the RIA side, the numbers continue to get better and better and are exceptionally strong against all competitors in the RIA side. The traditional custodians that we compete against for independent RIAs as well as the wins from the wirehouses. So relatively consistent across the board with particular strength in the RIA side. I think you saw that reflected a bit in some of the net new asset numbers. And then the last thing I'd share is that as you would probably expect, the Ameritrade business model is a little bit different, in that clients tend to come to Ameritrade with cash. And if they do leave, they leave with securities. And so when we look back historically many years at the TOA ratios at Ameritrade, they're very different than Schwab's because of the nature of the client base. And so those numbers, if you isolate them, they're softer now than Schwab's. They were softer 3 years ago, 5 years ago, 10 years ago, they've always been softer at Ameritrade. But our overall corporate numbers remain quite consistent with some degree of outperformance relative to recent past in the RIA side.

Okay. And then maybe one for Peter, just coming back to sort of the sensitivity to the first rate hike. Can you sort of unpack that a little bit? And how should we think about the incremental margin on that? And then what is the deposit beta assumption that underlies the revenue pickup?

Well, I think if you look in our history, in terms of deposit betas -- and I don't think that in this rising rate environment, I don't know anything that would suggest that the deposit betas would be certainly any higher than what they were previously. We tended to keep those deposit betas very, very low in the -- for the -- certainly, the first couple of rate hikes. And in fact, I think last time, we didn't move our deposit rates until we had seen maybe a 2 or even 3 rate hikes. So that's the assumption that will be built into there. The first part of your question was -- oh, the incremental margin on that. So with the -- the nice thing about the benefit from higher rates is it doesn't come with any incremental expense. And so certainly, the incremental margin on that is very, very high. Now you've seen, of course, in periods of time in our history when we get periods of time where we get significant revenue growth, I think, we had 1 year back in 2016, 2017, maybe we were in the upper teens in terms of revenue growth, we have tended to take advantage of that opportunity to lean a little bit more heavily into some of our growth initiatives. But in terms of -- but that's a conscious decision that we make as a management team. The incremental margin on the revenue itself is very, very high because as I said, it doesn't come with incremental expense.

Our next question comes from Devin Ryan.

I guess first question here, numerous announcements over the past couple of months on both the brokerage side and also neo banks that are either entering the crypto markets or they're expanding an existing offering. And I'm just curious whether you're seeing increasing demand from Schwab customers for either more access and functionality. And I guess, also, how you're just more broadly thinking about the space and the evolution and ability to offer those types of products to your customers and whether you would potentially do an acquisition there to scale up.

So we do offer a variety of means by which investors can get crypto exposure at Schwab. What we don't offer at this point is direct trading. And I think if you look at the firms that are offering direct trading and those that are not, there is consistency in terms of the regulatory oversight of the firms that are not. And so -- I mean, you can take the cue from that, that some issues need to be resolved there for firms like us to consider offering direct trading. Now in terms of crypto as an investment, I don't have any opinion on that any more than I do an opinion on any other item that price is based on supply and demand, whether it be art or baseball cards. I think we've all read people commenting that if there's a willing buyer and seller, they set the price for an item. But if and when there is greater regulatory clarity for firms under our regulatory regime, we would look forward to being able to offer direct trading, again subject to all appropriate regulatory oversight for our clients. And as I believe I said last time we were together, we would look to do so in a Schwab manner, which would be great service, great experience and disruptive value.

Okay. Great. Just a quick follow-up here on order routing and kind of the harmonization opportunity. Where are you right now in terms of what you've actually already done? And just give us an update on timing of kind of the procedure here just to kind of close that gap on the revenue synergy.

Walt, you want me to take that one?

Yes, Peter, why don't you go ahead?

Sure. Yes. So we already -- we actually already harmonized our rates as of the end of the second quarter, beginning of the third quarter. So the rates are harmonized. That's in our numbers for the third quarter going forward.

Okay. Is there's no additional opportunity from here? Or just trying to make sure I understand that kind of where we are, if there's anything else that could potentially be moving forward.

Nothing else on the harmonization front that we'd be looking ahead to, no.

Looking at the clock, operator, I think we have time for maybe one last question.

Our final question comes from Brian Bedell.

Great. Just I want to come back to the NIM for the fourth quarter, Peter, on the mid-140s. I guess what would be holding that back given what we're seeing in the rate environment? Is that maybe a function a little bit more of that quarterly -- or seasonal surge in deposits that would maybe not be deployed yet into securities at that time? Or a [ view ] that that premium am won't be nearly as strong of a delta in the fourth quarter as it was in the third?

Yes. So thanks for the question. So there's, I think, a couple of things. And again, this is rapidly evolving. So even that perspective is probably a few days old even. But the -- I would say a couple of things. So one is it's a little bit of a NIM versus NIR dynamic as you alluded to, which is we typically get much stronger growth in client cash balances towards the -- over the course of the fourth quarter. We tend to keep a little bit more of that liquid because it tends to get deployed in the early part of the following year. And so we want to make sure we increase our liquidity profile a little bit. So that's one of them. And then the second is, as I mentioned, while we expect a significant improvement in premium amortization, our current thinking is that that will be a little bit backloaded into the first quarter. So the quarter-over-quarter benefit may be less from Q3 to Q4 than we expect from Q4 to Q1. So I think those might be the 2 dynamics that are at play there. And of course -- remember, of course, the net interest margin is heavily influenced now by also the relative trends in margin utilization and securities lending. So of course, those have an influence as well.

And then -- that's super clear. And then just on expenses, you mentioned next year is more of a transitional year for obvious reasons. And then I think you also said or at least it was in the deck that the intention is for the longer-term expense trajectory to be more scalable and a little bit lower than the Schwab's historical expense growth. I'm just looking back, say, over the last 10 years, if I'm doing my math right, it's ballpark 7% type of annual average expense growth rate, obviously, with a lot of volatility around that. But as we think about the transitional year, I assume it would be something higher than that. Would it be double digit, I guess, depending on revenue? And then the lower than historical expense trajectory later on, is that -- I guess, is that 7% accurate, so we should think of more of a mid type of -- mid-single-digit type of expense growth rate longer term?

So I'm not going to get into the specific numbers for 2022 yet. We're still working through that, and I want to give you a good reason to come to our Winter Business Update in February. But we've talked about core expense growth as being in that mid-single-digit level over the course of the cycle. The period that you talked about, we consciously decided to make some significant investments that, in certain years, pushed the expense growth above that level. But as we think about over the cycles our core expense growth in that mid-single-digit level, and we think that very much is still quite valid. And a lot of the investments we're making to get to client conversion on the TD Ameritrade integration, we -- there are things like digital transformation and technology modernization that we think will help us deliver some significant efficiencies, both at conversion, but also in the years following to make it a more -- even more scalable business than we have today. So we feel very good about that getting back to that trend or even potentially a little bit lower in the out years. All right. Well, I think that takes us to our hour. I just want to thank all of you for your time today. This has clearly been a year that has tested our company and tested our employees. And as we sit here approaching the end of the year, we feel very proud, as Walt mentioned, of the team's performance and gratified by the results of their hard work. At the same time, we have a lot of work ahead of us, and we know that the environment can change quickly. But we're confident we're on the right track. And if we stay true to our mission, to our strategy, our operating priorities, we will continue to be successful over the long term. Thank you all, and we'll look forward to seeing you in February.