Okay. We are live. Good morning, everyone, and welcome to Schwab's Fall 2019 Business Update. This is Rich Fowler, Head of Investor Relations coming to you on a beautiful October day and we hope it's also top down weather wherever you are. Thanks for joining us at the end of an almost ridiculously busy week.
With me today are Peter Crawford, our CFO and Walt Boettinger, our President and CEO. For our usual practice with interim updates, we'll spend a focused hour with these 2 sharing their perspectives on life at Schwab right now, starting off with some prepared comments and following up with Q and A until it's time to wrap up. Our goal as always is to keep you current regarding management's thinking as efficiently as possible. With regard to questions, as usual, we'll do so via the webcast console as well as the dial in. To help us get to as many folks as possible, we very much appreciate your sticking to a 1 plus follow on approach to questions.
Given the recent course of events, we thought we'd ask Peter to start us off this time around, taking a look at our recent financial performance and current outlook. Then Walt, of course, will discuss the strategic picture, including our pricing moves earlier this month and take us into Q and A. First, let's spend a second on the wonderful wall of words, the main point of which is to remind everyone that outcomes can differ from expectations, so please keep an eye on our disclosures. And finally, per our usual practice, the slides will be posted on the IR site as we work through the prepared remarks. And with that, think we're ready to get going.
So Peter, we've got some great client metrics and financial results to talk about. So please take it away.
All right. Well, thank you very much, Rich, and good morning, everyone. It's certainly great to be here today at the end of what has been a very exciting and momentous quarter for us. So my time today, I'll look back on what made Q3 such a remarkable quarter and specifically dive into this business momentum and financial performance we delivered. And then we'll look ahead to Q4 very briefly to 2020, recognizing that we still have a few months before we firm up our plans for next year.
But the overarching themes you should hear today are about performance, resilience and most importantly, confidence as we move forward. Now we often in these business updates talk about the virtuous cycle that describes the self sustaining formula that has enabled us to reward clients and stockholders for over 4 decades. And now rarely has that virtuous cycle been more evident than in the Q3 of this year. It starts at the top of course with our through client size strategy and no trade offs positioning that we've established over multiple years, leading to nearly $57,000,000,000 in core net new assets in the quarter, a record for Q3. Now as we move around the cycle, we turn that asset growth into revenue growth, another record at $2,700,000,000 and a pretax margin over 45% in spite of our $62,000,000 severance charge.
And then by combining growth with disciplined capital management, we turned our top line growth into an even higher level of EPS growth and an ROE over 20%. And that success is what gives us the opportunity, the confidence to continue to invest in our clients, most recently by becoming the 1st major broker to eliminate online equity commissions. Now our success in Q3 was achieved despite a macro environment that would hardly be described as helpful to our business. Equity markets ground their way higher, interest rates fell dramatically across the curve and investor sentiment turned somewhat more apprehensive. And despite the lack of environmental tailwinds and even as our client base has grown, we've still been able to attract nearly $150,000,000,000 in net new assets year to date, a 6% organic growth rate.
That 6% organic growth rate was matched by a similar growth rate in accounts and total client assets and a slightly higher growth rate in advised assets, which of course include both our RIA business and our retail advised offers. Our business growth combined with our business model that combines brokerage, banking and asset management helped produce record financial results in spite of the mix and conditions I described earlier. Our revenue was up 5% year over year, driven by 7% growth in net interest revenue, a function of higher balances and higher investment yields. As you probably noticed, investment yields held up better in the quarter than we expected when we spoke with you 3 months ago with the summer business update, a function of both actions we took as well as some environmental factors that worked in our favor. Asset management and admin fees were up slightly year over year due to an increase in revised assets and purchase money fund balances.
Expenses were up 8%, but that would have been only 4% without the one time severance charge. That strong top line growth and continued expense discipline allowed us to deliver a pre tax margin of 45.6 percent including the severance charge or almost 48% without it and a 20% return on equity. Now turning our attention to the balance sheet. The balance sheet increased by roughly $2,500,000,000 from the end of the second quarter, boosted by growth in both bank deposits and our broker dealer client cash. Even our even as our balance sheet grew, we bought back almost 20,000,000 shares of stock.
And even so, our Tier 1 leverage ratio remained at 7.3%, above our operating objective of 6.75% to 7%. And I guess sometimes why Tier 1 leverage seems to hover right above our objective. And One reason is that we generally execute some or all of our buybacks via 10b5-1 plan, which we cannot adjust mid quarter midstream. There are a number of variables that impact Tier 1 leverage, of course, during a specific quarter, organic capital formation, balance sheet growth, volume and price of Schwab stock, level of interest rates, which impacts AOCI. And most of these factors help boost Tier 1 leverage this quarter above the level we might have anticipated.
Now there was a lot of interest in this page at the last business update, so we decided to bring it back for non core. As a reminder, it shows the month by month flows into bank sweep and our Schwab 1 broker dealer sweep option. We last spoke in July, we said client cash sorting wasn't over, but it seemed to be slowing. As we sit here 3 months later, I'd make the same statement with 4 months in a row of organic growth. Now some of the growth in September was due to an end of month swing in client cash balances at the broker dealer, which reversed the next day.
But October is only half over. We're seeing a continuation of the 4 month trend with month to date flows between the level of the last 2 months. As I said before, I think it's still too early to announce the end of client cash sorting, but I think there's little doubt that the behavior is slowing, consistent with our expectations. And to the extent that rates continue to remain low, it's reasonable to expect the sorting process to end sooner than it would otherwise. As we look to the future, we think we're well positioned to weather the environment, continue to grow organically and produce solid financial performance.
For 2019, our expectation is that Q4 NIM will be lower than Q3 assuming the Fed cuts rates further as the market expects. Of course, we'll have almost a full quarter of impact of the reduced commission revenue, which we'd estimate was about 60% of Q3 commissions. Even so, we'd expect full year revenue growth now to be in the 5% to 6% range and likely in the upper part of that range. And by taking actions to reduce our planned spending levels below what we anticipated earlier in the year, we're projecting our expense growth to be around 5 percent, including importantly, including the severance charge and any one time expenses related to the USAA acquisition. For 2020, it's too early to begin setting expectations around revenue growth, but it clearly depends on interest rates and what happens with the balance sheet growth.
We took the expense actions this year with an eye towards our 2020 spending levels. We're also mindful of making sure we're continuing to invest at an appropriate level in the initiatives that will ensure long term profitable growth of the business, especially at a time when we're seeing strong organic growth. While we think it's quite possible to have another year of operating expense growth at the low to mid single digit level, we will likely have a half year of USAA revenue and expense on top of that. And finally, capital management and capital return remain a very important part of our financial formula. We expect the 2019 end of year balance sheet to be somewhere around 3% to 4% smaller than where we ended 2018, so somewhat higher than where we are today.
Now that should create the opportunity for some capital return in the months and quarters ahead. So at some point, need to build capital to support the USAA acquisition in the middle of next year. I want to be really, really clear that our objective is for our capital levels to return to the 6.75% to 7% range the day after the conversion. Now let me close by saying that we are in a very strong position as we finish 2019 and turn our attention to 2020. And that strength is what gives us the confidence to invest in our clients as we have, most recently by cutting commissions to 0.
Despite the environment, we are producing financial results unmatched in this company's nearly 45 year history. We're pulling back from the level of spending growth we've seen in the last few years, while still ensuring appropriate investment in our clients, our infrastructure and our competitive advantages. And even as we grow, we're returning robust levels of excess capital to our stockholders and continue to exercise discipline in everything that we do. In short, we're controlling the things we can control and producing a growing resilient profitable and competitively strong business. With that, let me turn it over to Walt.
Thank you, Peter, and good morning, everyone. Thanks for joining us. A lot has changed since we last spoke 3 months ago. However, in the areas of what really matters for our long term strategy at Schwab, nothing has changed. Our focus on through client's eyes and our execution of the strategy via the virtuous cycle has been at work.
Much has been written recently about various competitors, whether it's large banks or fintechs or other investing and brokerage firms. But I do want to be crystal clear, we are on offense at Schwab. We are not resting on our laurels at $3,750,000,000,000 in client assets. We're pushing ahead aggressively. And our emphasis on clients and executing the virtuous cycle is not tied to economic environments where the wind is at our back.
That's something that we live every day, whether we're benefiting from tailwinds or facing headwinds. Reality, that's the very essence of a long term client oriented strategy. And I emphasize long term because that is the way that Schwab's management and Board approaches the business. Long term, looking beyond today's rate environment or even tomorrow's potential recession. For any of you who have had the opportunity to read Chuck's recently published memoir that was titled Invested, you know that a long term focus on disrupting on behalf of investors has been the mantra of this firm for over 4 decades and there's nothing in sight to change that approach.
Peter mentioned the virtuous cycle and we emphasize that because it builds trust with our clients. When they see us consistently sharing the fruits of our growth and success with them, they choose to bring more assets to Schwab. 10 years ago, we sat in the middle of the pack among publicly traded investment services firms with about $1,400,000,000,000 in client assets. Today, we approach $4,000,000,000,000 in client assets and lead our nearest publicly traded competitor by an amount approaching $1,000,000,000,000 Our goal is simple. It's to widen that lead in the coming years by continuing our commitment to understandable client strategy.
In our retail business, the headline is that we're attracting younger, more affluent households who are seeking professional advice from us. This headline is important for what it says, but it's also very important for dispelling some of the myths that I periodically hear about our retail business. About 57% of our new to retail households are under the age of 40, clearly dispelling the myth that Schwab is not seen as a viable investing alternative for younger investors. We're approaching 1,000,000 affluent households, dispelling the myth that Schwab Retail is not effective at attracting investors with meaningful assets. We're approaching 20% of our retail client assets under an advisory relationship, dispelling the myth that our clients are unwilling to pay us for high quality investment guidance and advice.
And almost 3 fourths of our flows into our retail advisory solutions are from investors opting into an advisory relationship for the first time, dispelling the myth that our retail clients are simply moving among advisory solutions and cannibalizing advisory fees in one part of the business to move to a different solution. Over on the RIA side of our business, we continue to be without doubt the leading advocate for the RIA model in our actions. We spend 1,000,000 of dollars promoting and advertising the RIA difference to affluent investors across the country. We've now passed over a 1,000,000,000 views of our ads in our efforts to help RIA clients grow their firms. And on the right side of the page, you can see from an asset standpoint, the temporary slowdown that we indicated was happening earlier in 2019 proved in fact to be temporary.
As in the Q3 of 2019, we saw a significant jump in net new assets exceeding even the outstanding quarter Q3 of last year 2018. Importantly, this growth is being driven by not only our existing RIA clients, but it's also being driven by RIA's newly joining Schwab for our custody and other services. As I mentioned earlier, we're aggressively on offense. Our efforts include an emphasis on scale and efficiency with a goal to continue driving down our cost of doing business, completely consistent with the virtuous cycle. I'd say we're just at the tip of the iceberg in terms of the impact from our digital transformation.
We're starting to measure early metrics like minutes saved internally, while at the same time investing in our omnichannel service approach which helps encourage clients to opt for the most efficient and convenient channel to complete their service or investing needs. And consistent with our push to add scale, our acquisition of the brokerage and wealth management business of USAA will add about a 1000000 investors to our retail side and open the door for significant referral potential from the 12,000,000 USAA members who do not currently invest on the USAA brokerage and wealth management platform. I think importantly also USAA members will now have access to a more robust platform overall, one offering better value. This was a key objective for the executive management of USAA in selecting Schwab as the firm to partner with on this transaction. Pricing.
Of course by now everyone is aware of the pricing move we led with an announcement on October 1st, coordinated with the introduction of Chuck's book, where we eliminated online and mobile equity and ETF commissions for all investors. Combined with our 0 account minimum, we've now removed the final barrier for many more Americans to become investors and participate in the growth of our country and economy as Chuck has been traveling and speaking about throughout the press in the last couple of weeks. Now the competitor responses were precisely as we expected. This elimination of commissions is something that we have been anticipating was inevitable for over a decade. And we've been aggressively at work over the last couple of decades executing on strategies that reduced our reliance on commissions from a level of almost half of our revenue down to mid single digits.
And while some might have been surprised by the timing of our move, our view is that anyone carefully following our commitment to the virtuous cycle would likely have anticipated it. Now importantly, price is only one aspect of our commitment to delivering the best combination of value, service and capabilities to all investors. Whether it's our industry leading client service, our broad range of solutions, our robust research tools and our industry first and still only satisfaction guarantee, we're committed to serving investors in a manner unmatched by any competitor. Combine all this with the transparency and resolving client confidence that comes from being a public company, along with a company holding in excess of $20,000,000,000 in capital, a number that dwarfs the capital held by any of our largest direct public or private online competitors. So let me close by walking everyone through our virtuous cycle again.
But this quarter, I'd like to do so in a manner that is consistent with the long term strategy that I emphasized earlier. Because we often talk about the virtuous cycle in terms of a quarterly impact or even showing annual results, But in reality, the virtuous cycle is not intended for short term timeframes. It's designed to be effective over years, many years and even over decades. So let's take a quick look step by step at how it's performed over the longer timeframes, the type of timeframes that Schwab Management and our Board actually look at. It begins at 12 o'clock by challenging the status quo total for our services has declined by about 80% over the last 30 years.
And as we share years. And as we share the benefits of our scale and efficiency with our clients, they bring us more assets, with assets growing exponentially over the same 30 year time horizon. Our commitment to operating efficiency and technology investments has enabled us consistently grow our pre tax margin over the last 30 years, even as our revenue per dollar of client assets again has declined by about 80%. And our stockholders have benefited as our net income and earnings per share have grown dramatically. Keeping in mind that the $0.70 shown here in the 3rd quarter also includes the severance costs that Peter referenced, which reduced our EPS by approximately 0 point 0 $4 And of course the virtuous cycle works because we continue to make a variety of investments that benefit our clients.
Sometimes we do so in services, products, capabilities, sometimes in price as we did a couple of weeks ago. But before I turn it, Rich, back over to you for our Q and A, I'd just like to emphasize a couple of last points. First, our commitment to being on offense. 2nd, we have a multi decade heritage of serving clients as well as also rewarding our stockholders. And 3rd, we believe that every important investor trend is in our favor, whether it's a focus on transparency, awareness of the importance of low cost, the power of omni channel service and interaction, the continuing growth and success of the RIA channel, the importance of scale and a commitment to a fiduciary status when offering fee based advisory services, all areas where we believe our positioning is absolutely ideal.
So Rich, let me turn it over to you. We might have a question or 2.
I'm guessing maybe 1 or 2. All right. So let's get started with the calls. First, perhaps, operator, could you get us going on that front, please?
Thank you. We will now begin the question and answer session. Our first question would be coming in from the line of Dan Fannon. Your line is now
open. Early, but could you talk about the feedback thus far from the commission cuts you're hearing internally and from clients? And then also, how you think about payback in terms of either net new assets, net new accounts in terms of these changes and what you're anticipating to get in return?
Sure. Thanks, Dan. I think the feedback as you would likely expect on the part of clients, prospects and internal is very positive, very exciting. As Chuck has been discussing during his book tour, this is removing the last barrier for investors of all size and all type to participate in the opportunities of ownership. And so the feedback has been quite positive.
And I think early metrics that we've seen support that, although again, I emphasize this is not a decision that we made based on what it's going to do for us from a near term client metric standpoint. In terms of the decision, I think you have both a qualitative aspect and a quantitative aspect. And maybe to go into a little bit more depth on those. From a quantitative standpoint, you really ask yourself a question of do you believe that commissions were going to go to 0 at some point? In other words, was it inevitable?
And once you arrive at a conclusion, which we did, that commissions were likely going to 0, then it just becomes a matter of when, how long. And although I'm not going to go into the details in terms of what we anticipated how long they would get to 0. We felt that the timeframe was in close enough that when we looked at the breakeven that the quantitative aspect of our move made sense. Then you switch over to the qualitative side and we recognize that in making this move virtually all of our online competitors would be likely to follow us. And we felt that we would actually be in a stronger competitive position after all of the online competitors followed us to 0.
And of course, a fair number of the competitors who might not be necessarily online focused would probably remain where they were.
Great. Thank you.
Thank you. Our next question I'm sorry, go ahead.
No, next question please.
Thank you. Our next question would be coming in from the line of Devin Ryan. Your line is now open.
Great. Good morning and thanks. So I guess first question, if you go back 20 years, you guys were making over $30 per trade and I think trading was over 40% of revenues. And today, as you talked about, even at 0 on commissions, you're substantially more profitable, profit margins are higher. So you've always found ways to service customers in different ways and ultimately get paid for that.
And even though it's evolved, there's kind of new channels to do so. And so I'm curious as you kind of look into the future, what's next? Is especially as cash is becoming maybe a more competitive field and people are competing there as well and maybe there's some erosion longer term. I'm just curious kind of what other areas do you see kind of evolution or areas that are less commoditized where you feel confident that there's still going to be a strong economic potential going forward?
Sure. I think there's certainly a couple that I'll call out. One is we believe we just begin to make inroads in of investment advisory capabilities. Our clients are very interested as I referenced in the slides earlier in enrolling in solutions where we provide them investment advice and guidance. And that is an area where although there is arguably some modest level of fee pressure, there is still a lot of revenue opportunity there to be generated while serving clients in their best interest.
I also think there is opportunity for us on the asset management side. You've seen us capitalize that on that in a few areas. One example we did was the acquisition of Thomas as we were able to expose their high quality performance to a much broader audience. So there are a number of opportunities but that's just 2 ones I'd call out quickly.
Okay, great. Thank you. And then just a follow-up here on expenses. Peter maybe just to make sure I heard kind of initial thought into next year would be low to mid single digit expense growth and that includes USAA. Just want to confirm there.
And what does that imply on marketing, kind of the trajectory there? How much pullback would there be? And then what other areas are you looking at on expenses to potentially mitigate some of the revenue pressure from the Zero commission?
Sure. So on 2020, what we're talking about is in that low to mid single digit level excluding the USAA acquisition, thinking about more on an operating basis. Again, recognizing that it's still early, so we still have a lot of work to do to firm up our plans for next year. The way I would think about our expense planning, I would say is from a couple of standpoints. One is we are continuing to try to drive down that expense on client assets.
We view that as a very important competitive advantage, and we are very, very focused on continuing to drive that down over time by continuously becoming more and more efficient. And really it's while there's a linkage between the moves that we made recently and expenses, I would say it's kind of the reverse. It's not so much that we're looking for new expense offsets to offset the commissions, it's that our ongoing scale and our ongoing drive for efficiency is what enables us to make a move like what we just made. And so that's really the way that we think about it. It is this continual journey versus where there is a sort of a new opportunity out there that we just haven't tapped.
What we really don't want to do is offset the impact of the commission reductions on the backs of our clients. Say we're going to cut expense, we're going to cut our service levels or do something that takes away from our clients that would not be a good trade off or do something that undermines our ability to continue driving strong organic growth or undermines our ability to drive greater efficiency in 2021 2022 and the outlying year. So that's really our focus. It's really an ongoing commitment and ongoing journey.
Thank you very much.
Okay. Thanks. Next call.
Thank you. Our next question would be coming in from the line of Rich Repetto. Your line is now open.
Yes. Good morning, Walt. Good morning, Peter. I guess I have to laugh. Each year period everyone says with commissions at 0 that puts them in the best competitive they're in the best position to compete now that that's a level playing field.
But anyway, my question is on cash. It definitely contributed to the outperformance on the NIM and the deposit betters that were higher as you sort of guided to on the way down. So I guess, Walt, how do you think about cash? It doesn't seem like it's a sensitive you've seen Fidelity out there talking about the higher cash yields. Could you give us a little bit more color on the effects that you did or didn't see from other people putting the focus here on it?
Yes. So, Rich, with your comment about the humor, I guess, time will tell in terms of who benefits most from the majority of the online providers being at 0 commission.
I
think when we view cash, we view cash through the lens of the way consumers cash. There are different types of cash. And what we want to do is offer the best possible solutions for each differing type of cash. So there is transactional cash in which the single most important thing revolves more around service access, liquidity, being able to utilize that transactional cash in a manner that works for what it is. Then there's investment cash, which is cash that people intend to have invested for a period of time.
And there, we focus on providing a high quality lineup of money market funds with very competitive expense ratios that are near at the lowest in the industry based on the size of the investments that retail investors make. So our strategy is a wide array, a breadth of cash services and from the feedback we get from our clients that meets the vast majority of their needs and I think has helped contributed to our organic growth.
Got it. Got it. Thank you. And then my follow-up, Walt, would be about Charles Schwab, because I was able to see him on some interviews and also listen to him on some web interviews as well. And with your focus on the long term, when he was asked about consolidation in the space, he obviously wasn't taken by surprise off guard.
It's something that it appeared that he had thought about that you guys had thought about. So I guess I'd like to get a better idea of your view of consolidation. What did you expect what do you expect given the commission moves and whether it's weakened competitive whether there's things you can see playing out over the next couple of years
so? Well, I think we've been clear in stating that consolidation in our industry is something that we would expect over some time horizon out in the future. And our view is consistent with what we've said in the past that we want to look at every opportunity and evaluate whether those opportunities balance appropriately the benefits that they could deliver for scale in serving clients and rewarding stockholders relative to the cost of what consolidation might entail. So we're going to have the same view that we've always had and time will tell whether the pricing move influences any of the timing around that.
Got it. Thank you.
Okay. Thanks, Rich. Let's do another call.
Thank you. Our next question will be coming in from the line of Chris Harris. Your line is now open.
Thanks. I wanted to come back to the topic of the timing of the commission cut. I guess the commentary around the view that this was essentially inevitable, it would seem kind of logical to maybe seek to do this cut when interest rates were going up or you're realizing the benefits of tax reform. I think it caught people by surprise because we obviously had interest rates not going the other way. So I guess the question is, was there something that changed in the last 6 months or so where you guys decided, hey, gee, we have to do this now or that kind of increased your sense of urgency?
Yes. So
I guess there are 2 things I would say. 1 is that we don't try to time the execution of the virtuous cycle based on near term economic environment factors. So whether it's rates going up or going down or tax reform active benefit, that's not the way we think about the virtuous cycle. Our virtuous cycle is based on many years and continuing to execute on sharing benefits with our clients. So there's just really no linkage between those things when
you operate under the long term viewpoint
that we operate under. The second part of your question was what again?
Yes, that was essentially it. It was just whether something changed in the last few months where you decided, gee, you had to make the move. I mean, I know we had the interactive brokers offering that was out there but that you wouldn't imagine that would be much of a competitive threat to you guys.
That's correct. That was not a weighing factor in our decision. This is rather again as I indicate the combination of planning that we've done for many, many years and we execute on these type of things without regard to near term economic factors.
Okay. Got it. Thank you.
Thank you. Our next question will be coming in from the line of Kyle Voigt. Your line is now open.
Hi, good morning. You mentioned you're in a better competitive positioning versus your competitors after the commission cut and after others follow you down to 0. I guess the conclusion is obvious to us when looking at your positioning versus Robinhood and other bank offerings. But you did lose the low cost advantage on commission versus some of your public e broker competitors. So just maybe can you just elaborate why you think the competitive positioning has improved versus those players within the industry?
Well, I don't really necessarily believe that there was some major So I So I think that might be what you're referring to that we were a couple of dollars lower cost then. I think that their issues are far more complex in the competitive landscape than just the near term commission pricing. It has to do with resource availability to invest in the business. It has to do with competitors that are not the traditional online ones, but rather well run, large sophisticated organizations that have resources available at their disposal that are vastly different than the online competitors that many people think of and certainly far outside the realm of some form of startup or FinTech type of organization. So I think the competitive issues are vastly more complex than pricing or a couple of dollar pricing difference.
And again, I think it all comes back to the timeframe that you're operating under. And when we looked at the timeframe that we're operating under, we think that our decision from a long term standpoint is the right one for all the stakeholders, the clients as well as our stockholders.
That's really helpful. And if I just ask a follow-up on just order routing revenue. I'm just wondering, it's a really small part of your revenues now. Fidelity had recently highlighted that it doesn't accept revenue payments for equity order flow specifically. Just wondering if you think this is something that resonates with customers?
Thanks.
Well, I have a lot of respect for Fidelity as an organization. But I do think of late they are not necessarily telling the whole story. The first key point is that our equity execution quality is better than Fidelity's. All you have to do is go look at the disclosures to validate that. The second thing is that it's very nuanced to talk about whether Fidelity is accepting payment for order flow because they do in fact take payment for order flow on their options.
And on their equity order flow on the retail side, they simply internalize it and trade it against their institutional book in addition to taking equity rebates from exchanges. So I think that it's not the whole story that is being told. And from a consumer standpoint, I think they're actually far the ones who care are far more knowledgeable than to be influenced by some of the statements made publicly.
Thank you.
Thank you. Our next question will be coming in from the line of Craig Siegenthaler. Your line is now open.
Thanks. Good morning, Walt, Peter.
Good morning. Good morning.
How do
you think your revenue streams, including cash sweep, asset management fees, shelf fees, payment for order flow will trend relative to AUA growth in the future? And then also I just wanted your perspective on what streams you think are the least and most competitive?
Yes. So I'll take that one. Gosh, so hard to say in terms of how the revenue streams will trend. We think there's certainly opportunity across all of them. Walt talked about I think some of the opportunities we have in the asset management area with doing with sort of more asset management opportunities.
I'd also add to that list more around the advice area. We think that's a real opportunity. That's a real opportunity too. In terms of the pricing, I think we'd I think if we're going to go fast forward 20 years from now, I think we most of us would agree that the average mutual fund expense ratio is probably going to be lower 20 years from now than it is today. Probably the average ETF expense ratio is probably going to be lower than it is today.
But if we're in a similar interest rate environment today, I don't see any reason why our net interest margin or the spreads that we earn should be any lower than they are today. We think that is a very defensible pricing lever, if you will. And so we do believe that over time, those our cash balances will grow with the growth in total client assets and the growth in total accounts. And over the course of a cycle, means that our net interest revenue should grow at a similar level.
Thank you, Peter. And just for my follow-up here, do you believe the commission cuts will benefit the ETF vehicle relative to mutual funds, and also could reduce shelf fees as the commission free platforms essentially end here? And I don't know if you have a view here, but do you have any view on if there will be a preference for scaled ETF managers now like Vanguard and iShares relative to smaller managers and even proprietary ETF providers like yourself?
Yes. So fair question. I mean, I don't know that we see it as having a significant impact. So many such a broad array of ETFs were available previously at a zero commission level. And someone who was really interested in buying an ETF from a provider who was not participating in some of the commission free programs, I think was unlikely to not make that decision based on a $4.95 commission cost.
I suppose you could make an argument. I know some of the leadership of some of the large scale firms have said this will benefit them. I suppose you could make some argument that there could be a modest impact in that area. But I'm just not sure that it's going to make anything that is overly meaningful when you're talking about the difference between paying $5 on the way in versus 0. I just don't see it dramatically changing the flows for to the benefit to scale players who might not have been participating in Well, certainly that's from our perspective.
That's from our perspective. I thought you were asking more from that. Well, certainly that's from our perspective. I thought you were asking more from the asset managers' perspective.
Thank you.
Okay. Next
caller? Thank you. Our next question would be coming in from the line of Mike Carrier. Your line is now open.
Hi. Good morning. Thanks for taking the questions. I guess first on the strategy front, Walt, you pointed out a lot of the historical success, which has been impressive, but it also seems beginning maybe a little bit more competitive with some new entrants in the space. You cleared the commissions as a competitive advantage for some.
You're more weighted to NII, which may be more defensive, though maybe a little risky just given so many negative rates globally. And then you have a competitive advice offering. But I guess just looking ahead, what do you view as the most value add offering at Schwab or maybe the most defensive that can continue to drive the same success that you had over the last 20 years or so?
I think it's difficult to call out a single most value add. The strength of Schwab is in the breadth of our platform and the breadth of capabilities that we can deliver to individuals and to RIAs across their entire financial relationship. So I think that really is part of the strength of the franchise as well as the trust and confidence that comes from a company as transparent as we are from being publicly traded, from holding over $20,000,000,000 in capital relative to online type competitors. I just think it's broader than any one thing. But I would encourage all of us to keep in mind that over the long term, those things that I referenced at the close of my prepared comments, we think are perfectly aligned.
The market is headed increasingly to a world of transparency, of fiduciary expectation, of a concentration on value, of an expectation of broad platform, broad capabilities, broad services and all those things into our strength rather than calling out a single or one area of particular advantage.
Okay, that's helpful. And then Peter, just a quick clarification. I think you mentioned the 5% expense growth in 2019, including the severance and USAA charges. I don't know if you had the expected like USAA charges or what it would be maybe core, I mean, without that? And then same thing on the September end broker dealer cash, I think you mentioned some seasonality and just more curious if you can quantify that.
Thanks.
Sure. So, yes, I mentioned the 5% expense growth year over year for 2019 versus 2018, which severance charge we took in Q3 as well as any initial one time expenses related to USAA. I mean, those aren't I don't think in Q4, those are going to be huge, not certainly they'll certainly be significantly smaller than the severance expense that we had in Q3. In terms of the cash, we typically we expected in later in the year that as we saw last year and years prior that cash balances tend to grow a bit more in November December. So that's part of what's in our anticipation around the overall where the balance sheet ends at the end of the year.
But in terms of quantifying it, it really is a function of what we see around certainly level interest rates, what we see in terms of consumer or investor confidence in the markets because that's certainly an important factor. And so I don't know I want to say sort of exactly what the numbers are likely to be in October, November, December.
Okay, thanks. Thank you. Our next question will be
first question Walt maybe for yourself. So you mentioned a couple of times in your prepared commentary about being on your front foot and I think no change in being aggressive in terms of being a disruptor. When I think of your business model and I look at the yield on the asset management business, you're around very low basis points now of what's coming in the door. Obviously, trading now has gone down significantly based on Peter's comments. Your NIM discussion is relatively durable.
So where as you think going forward are the greatest points of disruption? And how might that feather through? Just sort of trying to understand where might be next that you might look to unlock incremental value?
Well, I think you've
got ongoing disruption in a variety different places and opportunity. Certainly the blending of technology and people we think is going to have a significant impact. The technology opportunity, leveraging relationships and providing for a closer understanding of client needs, I think will play out over the coming years in a fairly meaningful way. I think that price disruption is probably less likely to play a bigger role. Obviously, I suppose some would say from where we are today.
Although I suppose you could see some price disruption that goes on the advisory side. But the advisory side tends to get talked about as if it's one large pool, everyone in other words, everyone operating in the same manner when in fact there's a lot of different levels of advice and arguably some disruption has already occurred there for example in the digital the digital advisory world where we don't charge an advisory fee. But potentially you could see some price disruption there. But I think most of the some ongoing scale pressure and power that could put some pressure around certain pricing.
Okay. Thank you. And just
a follow-up Peter, I apologize for making a second maybe perhaps third time. Just on expenses for 2020, can you sort of walk through the guidance there? Was there some specific numbers you gave? Or was it just low single digits? And I didn't hear if that was with or without the impact of USSA.
So what I was talking about was more in the low to mid single digits, and that was excluding USAA. But again, I want to caution everyone this is early in our planning and we'll have a couple of opportunities to come back to you or certainly a key opportunity to come back to you in the winter business update and give you more guidance on that. But that's what our current thinking is today.
Thank you.
Thank you. Our next question would be coming in from the line of Ken Worthington. Your line is now open.
Hi, good morning. My questions are with regard to Open Access. So maybe first, will you extract more value from manufacturers such as ETF companies and other financial services companies that have access to your distribution platform compared to what you currently charge now, now that we move to a commission free world? Maybe next to what extent can you or would you be willing to further restrict access to those unwilling to pay for access to your platform? Could you actually restrict those willing to buy a Vanguard ETF, for example?
And then ultimately bigger picture, what are your thoughts with regard to complete open access in a zero commission world? It seems like there may be a trade off between the 2, but what are your thoughts here?
Well, I think the history has shown that the closer you are to the client, the greater share of the overall value chain you're able to capture. And so our proximity to our clients probably puts us in a position that if we so choose that we could extract more of the value overall in a variety of ways, one of which you identified as possibly us pursuing, which is striving for a higher percentage of what we might receive shared from asset managers. I think the second area I think you were trying to get into is around our commitment to open architecture and actually what is the definition of open architecture. And I think that is an unresolved issue for our industry overall. The open architecture is viewed through a lot of lenses from the extreme of absolutely no limit whatsoever to some of the more traditional firms which actually do close off access to certain products that might not compensate the minimum error they consider appropriate.
So I would say this is in a state of flux right now, it's fluid. And although we have a commitment to providing our clients with the absolute best products and services that we can, I don't know that I'd go so far as to say that we're committed to allowing anyone and anything onto our platform without regard to the economic implications?
Okay, great. Thank you very much.
Okay. Let's pause for a second on the calls and I'll take one from the webcast that is an angle that hasn't been posed yet, gents. So we've been asked whether we see the 0 commission environment at all changing how we think about monetizing our advisor relationships, particularly as they tend to hold a different cash allocation than retail side of the business?
Yes. I think our scale as far and away the largest custodian serving RIAs enables us to serve them profitably at our current pricing. And of course that was as you would expect something that we looked at decision to move to 0 pricing for online and mobile equity and ETF trade. So I would say that at this time, we do not have any plans to look to change the way RIAs compensate us for the custody and other services we provide. We think the RIA model is an important one.
It's a critical part of our strategy. Our goal is to help support them and to help them grow, not necessarily to try to extract more economic value from them.
Okay. Let's go back to the calls please, operator.
Thank you. Our next question would be coming in from the line of Chris Shutler. Your line is now open.
Hi, good morning. Walt, what are your thoughts on the potential for growth of direct indexing, especially now that commissions are 0? And do you have any solutions on the roadmap related to direct indexing?
So we believe that direct is a very important part of the future in the area of investment management and for a variety of reasons, not just the logic behind it for the investor, but also the ability to start from the base of a recognized and appreciated index and then to do a degree of customization to meet client needs more effectively. And so with or without 0 commissions, we would have expected direct indexing to grow. And I would suggest that direct indexing will play an important role in our company's future serving clients both on the retail side and potentially through the RA channel.
Okay, great. And then on a separate topic, can you give us an update on the build out of the fixed income capabilities that you talked about on the last call? And just what exactly you're working on? And any sense of how much wallet share you might be leaving on the table that you could better address?
Yes. So I think it is a significant opportunity as I talked about. If you just look at demographics of those investors with money, there seems to be no question that they will be measurably increasing their weighting to fixed income investments over the coming decades. And so rather than offering specifics on some of the things that we have in flight right now, I would just I would put it in this context. Our firm has grown over 4 plus decades with principally a focus on equity oriented investments.
They came in a variety of forms, stocks, mutual funds, ETFs. And we have built capabilities to help investors around that type of vehicle or vehicles. I would suggest to you that our commitment is to offer a degree of capabilities and a breadth of capabilities around fixed income that is consistent with that that we've offered historically on equities. So that would cover every aspect of fixed income that would be consistent with a corresponding capability on the equity side.
All right. Thank you.
Okay. Thanks. Let's keep going here. We got a couple of minutes left. Let's see what we can get in here.
Operator, another call.
Thank you. Our next question would be coming in from the line of Brian Bedell. Your line is now
open. Great. Thanks so much. Maybe just sticking with the competitive backdrop, obviously Schwab has been a leader over several decades in certainly on price. But if we consider that the next battle round might be the sweep rates given that's the largest sort of pool of revenues, just looking at your commission cuts, clients gained about $400,000,000 or so depending on what you're modeling for trades back in their wallet.
But at the same time, they are giving up about 3 $1,000,000,000 if they were in money market funds instead of the sweep rates that you're paying. So, I guess, with Fidelity out there targeting this with their sweep money market fund vehicle, I guess, why don't you think you need to respond to that? And could it be possible that you would bulk transfer some sweep accounts back to money market funds in response?
So this
whole area around sweep cash I think we tend to think about just as you described it, which is in the big numbers. And the reality is the way it's made up of is millions and millions of people with very modest amounts of money on average sitting in transactional cash. And it is our view that the idea that people will change brokerage firms in mass in significant numbers over a very modest difference in actual dollars over transactional cash yields is not going to be an effective long term approach. If that was the most effective approach then things like high yield checking accounts would have taken over the checking deposits from the major banks that we have across the country today. That said, we are always watching very carefully from a competitive standpoint, looking at TOA type figures, surveying consumers, talking with them and looking to understand their perspective on transactional cash.
I think the issue is a far bigger one around investment cash, which is where we sit in an advantageous position relative to Fidelity with the quality of our funds, the rate of our expenses and therefore the net yields available to clients. That's where the real cash dollars are and I think our competitive position is very strong.
Okay. Thanks for that. And then just one housekeeping for Peter. The net interest margin outlook of mid-230s in 4Q that's I think you said that was on the December cut. What if we switch that cut to October instead of how would that impact the NIM outlook for 4Q?
Yes. I mean the mid-230s is a range. So I think I still think it could be within that range. I don't think that October versus December doesn't make a huge, huge difference on that outlook.
Okay. Great. Thank you.
All right. We are at the top of the hour. So I am going to call our hour. I was happy to follow-up with folks going forward to debrief on this. So thank you everyone for spending the time with us.
Thank you gentlemen for speaking and everybody have a great weekend and we'll talk soon. Take care.
That concludes today's conference. Thank you all for