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We are live. Good morning, everyone. Welcome to the Schwab Summer 2019 Business Update. This is Rich Fowler with a slightly cold-ridden voice here coming to you, as always, from beautiful San Francisco. Just to be clear, we're sitting in a windowless conference room, but beautiful San Francisco is somewhere right outside. Thanks for joining us at the end of a very busy week. With me today are Peter Crawford, our CFO, and Walt Bettinger, our President and CEO. Per our usual practice with interim updates, we'll spend a focused hour with these two, sharing their perspectives on life at Schwab right now, starting off with some prepared comments and following up with Q&A until it's time to wrap up. Our goal, as always, is to keep you current regarding management's thinking as efficiently as possible.
Regarding questions, as usual, we'll do so by the webcast console as well as the dial-in. To help us get to as many folks as possible, we very much appreciate on the dial-in that you stick to a one-plus-follow-on approach to questions. I believe the queue has just been opened, so please press star one to make sure you get into the phone queue for Q&A. Please press star one now if you haven't already. Okay. Walt's going to start us off with a strategic picture, and then Peter will take a look at our recent financial performance and current outlook. First, let's spend a second on the wonderful wall of words. That's my favorite phrase for this. The main point of which is to remind everyone that outcomes can differ from expectations. Please keep an eye on our disclosures.
Finally, per our usual practice, the slides will be posted on the IR site approximately at the end of prepared comments, you can start looking for them then. With that, I think we're ready to get going. Walt, I know it's been an eventful quarter. We've got plenty to talk about, please take it away.
Thank you, Rich. Good morning, everyone. Thanks for joining us, being with us here in this summer update. Second quarter was a continuation of our strong growth and momentum with clients. We recognize it was a mixed period. Client investing sentiment actually turned somewhat negative despite what was very strong performance in the equity markets. Despite that negative sentiment, we had excellent client acquisition and account growth. From a rate standpoint, although the yield curve was flat and at some points during the quarter inverted, as well as the anticipation of falling short-term interest rates, we know those things can impact our growth. We also know that environmental issues tend to be temporary, and while adding clients is key to long-term growth, no matter where the environment is at any one point in time.
Just I think in summary, our solid organic growth, combined with strong profit margins, ensure that we can deliver both top-line revenue growth as well as return excess capital to our stockholders. Our Through Clients' Eyes strategy remains intact. We continue to operate the firm based on the virtuous cycle. You're all very familiar with this, but we challenge the status quo to benefit investors. They reward us with more assets, in turn leads to solid, consistent financial results, long-term stockholder value creation. Some of the profits are reinvested to drive further growth and allow us to further challenge the status quo on the benefit of investors. Very consistent. Moving a little bit to 2019, particularly the first half of 2019. We recognize that we're off to a mixed start from an environmental standpoint.
The equity markets were very strong, about 17% growth in the first six months of this year. At the same time, the yield curve initially lowered, then flattened. It inverted as of June 19th. Of course, if you're looking at 90-day data to 10-year, it's quite flat as of this morning. All that occurred against a backdrop, as you can see in the chart on the right, against negative sentiment on the part of investors. Quite fascinating time period, particularly with the equity markets up 17%. This mixed environment had a clear impact on investor optimism as well as their behavior. We saw that new brokerage accounts, DARTs, margin balances, even dollars invested in our retail advisory solutions were generally solid, but also relatively flat when we compare them to the record-breaking period in the first half of 2018.
We know in 2018 that we had everything lined up in the first half of the year from a positive standpoint environmentally and to deliver results relatively in line with that during a much more mixed period, I think is something that gives us great optimism and encouragement for the future. We also continue to see some record-breaking growth in other areas of the firm. High levels of growth in Schwab Managed ETFs or purchased money funds, Schwab Managed Mutual Funds. Also fixed income, an area where we have been making substantial investments and plan to in the future, was another bright spot. We saw client balances here grow by about 20% during just the first half of this year. From an NNA standpoint, I think consistent with a period of investor sentiment turning a bit more negative.
When you measure our growth rate against overall client assets, they were modestly softer than the same period in 2018 and 2017. As you can see from this chart, which carries us all the way back to 2014, they stayed within our long-term range of 5%-7% that we feel fairly confident we can deliver throughout all turns of the economic cycle. If you look at a longer-term horizon, our solid growth continues in the retail channel. Assets have been compounding at about a 20% CAGR for the prior five years, and accounts enrolled in our various retail advisory solutions compounding at about 12%. I do want to briefly mention that our recently reintroduced Schwab Intelligent Portfolios Premium, the program that we're offering the subscription pricing, seems to have really taken off in terms of client interest and response.
Volumes are up significantly in enrollment, asset flows, and of course, that along with the continuing success of our base Schwab Intelligent Portfolios program, pushed our assets in Intelligent Portfolio solutions up over $40 billion. Lastly, on the far right, I think a very important chart, the assets in our retail advisory solutions continue to grow faster than company assets overall as we push our way up toward a 20% level of retail assets in some form of advisory solution. Our business serving RIAs also continued to demonstrate solid growth. We saw the breakaway trend begin to pick up a bit again in the second quarter. There were four relatively substantial teams that we added. You can see that reflected in the average size of teams that moved.
Some of that is a function of the outstanding relationship that we have with Dynasty Partners, who has done a relatively masterful job at building their business and working with independent advisory teams. In this business, our key competitor transfer ratios continued at relatively elevated levels as they have for most of the last year and a half, just below 3:1 from a net relative transfer ratio. All of the conversations here around organic growth and clients, this is where our focus remains, on clients, on clients' needs, on building capabilities that are consistent with where we believe the puck is going in our businesses, offering no trade-offs, and doing so all in a competitive environment where we believe that frankly, we've barely scratched the surface of the market share that we can attain.
When you look at numbers here from 2018, somewhere around 7%, there remains an enormous opportunity for us to continue to have organic growth and building the value of the franchise and building long-term stockholder value. Slide 15 here shares a few of the areas where we have been putting significant emphasis and where we will continue to do so over the next few quarters in building out and adding capabilities. In some cases, adding capabilities to areas we already have some, in others, building new ones. A few that I'll just mention, we're adding capabilities to serve some of our higher net worth clients who invest directly through Schwab or through an investment advisor in a number of different ways. We continue to invest very aggressively in our fixed income capabilities as we have a population that looks increasingly at ways to generate income from their assets.
We're also building capabilities to assist investors in their plans for when they need to convert some of those assets into a paycheck, and you'll see some news coming out on that in the coming quarters also. Of course, we're not going to go into too many levels of specifics for obvious competitive reasons, but hopefully this slide gives listeners a few of the ideas of ways that we are on offense from a growth standpoint and looking again, to build long-term growth and shareholder value creation. Consistent with our past conversations, and hopefully consistency is something that you can always count on from us at Schwab, all the decisions that we make strategically are informed by the long-term views that we share with you transparently on a regular basis about where the future of investing is going.
We believe our positioning is ideal to continue building market share domestically, as well as adding to our scale advantages, growing revenue and earnings now and in the future. It really is our belief that future success revolves around great value, which has to be driven by scale, omni-channel servicing models accompanied by people where desired, pricing transparency. We think that passive investing in all its various forms will continue to take share in the future. Of course, fiduciary-driven advice, consistent with the RIA model or the way we deliver advice within our retail channel. I guess here, before I turn it over to you, Peter, let me just reiterate again, second quarter was a continuation of what we see as strong momentum with clients. We executed consistently on our through client size strategy, during a mixed period from an environmental standpoint.
It's another quarter in which we delivered solid revenue growth in the 8% range and returned meaningful excess capital to our stockholders. That's a formula that we believe in and one that we are focused on executing as we move into the future. Peter, let me turn it over to you.
All right. Well, thank you very much, Walt. It is great to be here with all of you in the midst of the summer to review our second quarter results and talk a little bit more about how we see the future and the actions we're taking. Walt talked about the strong momentum we have in both our retail and our advisor businesses, the opportunity we see to continue winning in the marketplace, and a few of the specific areas we're investing in to capture the growth and strengthen our relationship with clients. In my time today, I'll talk about how that business momentum and some of the actions we've taken over the last year helped produce strong financial results despite a somewhat mixed macro environment.
I'll give you an update on how we're responding to the environment, specifically our evolving perspective on expenses, deposit pricing, and of course, on capital management, which as you've seen, has resumed its role as a key pillar of our financial formula. What you'll hopefully take away is that this company is performing quite well. While we don't know what the future holds, we're quite confident we can thrive regardless of the circumstances. Walt shared a number of indicators of our continued success in the market and our ability to maintain a high level of organic growth even as our client base has grown. That growth has translated into 7%-10% growth in accounts, client assets and advised assets, which include, of course, our retail advised assets and those assets managed by an RIA. As Walt discussed earlier, it's been a somewhat tumultuous year.
Back in February, we outlined a range of possible outcomes in terms of our financial performance. That range was anchored around a set of macro assumptions, and on the whole, I think it's safe to say that we've faced more headwinds than tailwinds. The equity markets have been a clear positive, but interest rates have dropped across the board as you all know. Market expectations for Fed activity have frankly shifted 180 degrees from tightening to easing. And we've seen a bit of skepticism, as Walt mentioned, from retail investors compelling them to not engage as much this year as they did at last year's record levels. Now our financial results for the quarter are quite strong considering the somewhat mixed conditions I just described. Our revenue was up 8% year-over-year, driven by 14% growth in net interest revenue, a function of higher rates and higher balances.
Asset management and admin fees were down slightly year-over-year, mostly due to balances that we moved out of sweep money market funds that were either transferred to Bank Sweep or the clients reallocated into purchased money funds and other products. Other revenue was up mostly due to a one-time gain related to the sale of our PortfolioCenter software platform. Expenses were up 7%, which was generally consistent with our expectations. The biggest driver of the increase continues to be an increase in staffing as we've been ramping up our digital and technology areas to drive greater efficiency over the next several years. Offsetting that has been the elimination of the FDIC surcharge that ended at the end of the third quarter of last year.
With 120 basis points of year-over-year operating leverage in the quarter, we increased our pre-tax margin by more than a half point from Q2 of 2018 to over 46%, and we delivered an ROE of 19%. Turning our attention to the balance sheet. Our balance sheet declined by $6.5 billion quarter-over-quarter due to tax-related outflows in April, as well as a continuation of that "sorting process" we've discussed extensively. Now I'd note that at the end of period balance sheet figure includes about $3 billion of forward-settling portfolio securities trades, something we do quite routinely, but not something you typically see at the end of the quarter. Now having executed the last $200 million of transfers, we are now done with our decade-long journey to make Bank Sweep and Schwab One interest the default for all client accounts.
We utilized some of our excess capital to purchase nearly 30 million shares of stock. Even so, our Tier 1 leverage ratio ticked up slightly to 7.3%, above our operating objective of 6.75%-7%. Most of that quarter-over-quarter increase was due to the impact of AOCI, which actually flipped from a negative to a positive due to the decline in rates. With the sweep transfers now firmly in the rearview mirror, this will hopefully, I say hopefully, be the last time this page appears in our business update. It's actually a little bit different than the previous versions. It shows the behavior of our clients with regard to their cash, their sweep money market funds, Bank Sweep, and for the first time, Schwab One, since that is now the default for all new accounts.
If you start on the left, you can see at the end of 2018, there was roughly $30 billion remaining in sweep money market funds. About $7 billion of that moved on its own, either in accounts impacted by the transfer, but ahead of us moving the money or in accounts completely separate from this process. We moved $12 billion, leaving us with about $13 billion remaining. What was the impact on bank sweep and Schwab One? If you look at the graph on the right, you can see that we ended last year with about $234 billion in bank sweep and Schwab One. Now some of the nearly $90 billion in net new assets in the first half of the year came in the form of cash.
We continued to see some sorting as we expected, and then we saw the benefit of transfers, some new flows into those accounts, and then a very small amount of sorting of those transferred accounts. Now when you look at the month-by-month view, it appears the sorting process that we've discussed so often is slowing. As we mentioned in our last update, we saw a decrease in that activity from January to February and then February to March. You can see that on the graph on the left, which shows flows to purchased money funds. On the right, which shows the overall organic Bank Sweep and Schwab One flows, which includes net new assets, flows into and out of equity markets, and so forth.
While April is a bit of an outlier due to seasonal tax-related outflows, we saw the sorting process slow again in May and also in June. In fact, organic flows were slightly positive in June for the first time in many months. July is only half over, but we're seeing a similar trend this month as well with slightly positive inflows month to date. It's too early to ring the bell and call the end of client cash sorting, but I think there is little doubt that the behavior is slowing, consistent with our expectations. To the extent that short rates continue to decline, it's reasonable to expect that this process should end sooner than it would otherwise. As we turn our attention from the past to the future, we'll start with net interest margin.
Our net interest margin, NIM, declined six basis points this last quarter to 2.40%, lower, of course, than our expectations at the start of the year. That quarter-over-quarter decline was a function of a few things: lower interest rates across the curve, a buildup in liquidity at the end of Q1 in anticipation of tax-related outflows in April, some continuation of the sorting in May and June, and the acceleration of premium amortization, given the lower long-term rates. Assuming stable long-term rates, I wouldn't expect that premium amortization to increase. In fact, if history is any guide, it should decrease after a few quarters. Given the environment, our forecast for the trajectory of NIM has drifted a bit lower, not surprisingly.
With deposit rates above some of our e-broker peers, we have the capacity to offset some of the decline in yield via lower deposit rates, as you've seen us actually already start to do this quarter. Depending on the number of rate cuts over the next three months, we'd now anticipate fourth quarter 2019 NIM could range in the mid to high 230 basis points. Turn our attention to expenses. Our expected spending level in 2019 has come down by $50 million-$100 million from what we anticipated at the start of the year. You've seen over the course of this company's history our willingness and ability to adjust our spending plans in light of the market environment. We're always looking to balance investment and long-term growth of the franchise with delivering near-term results.
When the winds are at our back and revenue growth is higher, we tend to invest more in our future. When the winds turn, we tend to pull back a little bit. We're doing that now. We're prioritizing initiatives that drive greater efficiency and ensuring we harvest the benefits of the initiatives that have already borne fruit. We're pulling back on some discretionary activities, we're also scouring our operations to find any other savings opportunities. What we're not doing is reducing expenses on the back of our clients. All these actions should further reduce our planned expense growth from the bottom end of the 6%-7% range we communicated back in April to more like 5%-6% as of now. Continuing to move us within that mid-single digit expense growth we've communicated previously as being the long-term expectation.
We talked about NIM and about our evolving thinking on expenses. Let's talk about the overall picture in terms of our financial performance for the year. As I noted earlier, there are a lot of moving pieces this year, which continue to make developing expectations for financial results this year even more challenging than usual. In addition to the usual dependencies, interest rates, Fed policy, equity markets, trading, we have this additional dependency around how long the sorting process will take to complete. As I discussed a moment ago, this year is starting off to be a bit more challenging than those baseline assumptions we communicated nearly six months ago. Client cash allocation activity has generally been within the range we expected, and if anything, somewhat better than the lower bound we'd considered possible. What does that mean in terms of our potential financial performance?
If we assume the equity markets continue to rise modestly, the Fed cuts one time in July, longer-term rates stay roughly where they are now, and client engagement remains somewhat softer than last year, we'd expect our end-of-year balance sheet to fall somewhere in between a 6%-7% reduction, so roughly where it is today, or a 0%-1% increase versus the December 2018 level, depending on when that sorting process ultimately stops. We've narrowed the bookends of the range we communicated at the outset of the year. Depending on how the balance sheet evolves, these assumptions would lead to full-year revenue growth in the 5%-7% range, with expense growth, as I mentioned earlier, at around 5%-6%. That was the range given a single Fed decrease. The market, of course, is anticipating more rate cuts this year.
Each of you, I know, have your own house views on what is going to happen, so we always like to give you the sensitivities. Most of these should look pretty similar to what you've seen previously. The biggest change is the one on the upper left, which suggests a next 12-month revenue impact of $75 million-$150 million for each Fed cut, or at least the next two Fed cuts. That is clearly a much smaller number than the $200 million-$300 million impact we had shared for each Fed increase previously. That's a function of a few things. A somewhat smaller balance sheet today versus six months ago. Higher percentage of fixed investments.
With the decline in rates, we've seen our asset duration decrease towards the lower end of our 250-275 target, which has enabled us to put a substantial majority of new investments into fixed rate assets and increase the fixed to floating percent in our investment portfolio from the typical sort of 60/40 to more like 70/30 today. That shields us a bit from some of the impact, of course, of the decline in short-term rates. Finally, an expectation that, as I mentioned earlier, the deposit betas could be a bit higher on the way down than they have been on the way up, given where our rates are today, what we've seen from competitors, and what we've seen and heard from our clients. As Walt mentioned, we are demonstrating this year our ability to drive solid revenue growth even as we return capital to stockholders.
With the transfers now behind us, we should be in a position to continue creating excess capital. You should expect our dividend to increase as our earnings increase. While it's been in the lower part of our 20%-30% range over the last several years as we've conserved capital to enable transfers, I think it's likely we'll look to keep it more in the mid to upper part of that range in the near future. We will continue to prioritize the use of capital to support ongoing growth, either organic or via disciplined M&A. To the extent we have capital in excess of our 6.75%-7% operating objective for Tier 1 leverage, our focus will be on continuing to utilize what's left of the $4 billion buyback authorization that the board authorized back earlier this year.
Now remember, this does not mean that you should expect our reported Tier 1 leverage ratio to be pegged at 7% every single quarter. There's going to be some lumpiness to all of this. Let me close by reinforcing a few things that hopefully came through today. First, our strategy is working to produce strong business momentum and strong financial results, even in the midst of a more challenging environment. Second, we are actively managing the levers in our control, including our spending plans and priorities and how we manage capital and doing right by clients, which has allowed us to be the premier asset gatherer in our industry. Third, while there are a number of uncertainties in the market, our business model is remarkably resilient.
Whether winds are blowing against us or behind us, that's what we're focused on, and that's what has allowed us to be successful through multiple cycles. With that, let me turn over to Rich for some Q&A.
All right, gents, thanks very much. I see we have a pretty good queue lined up. Operator, you want to take it away on Q&A for us?
Certainly. We will now begin the question and answer session. If you would like to ask a question, you may press star followed by the number one. Please unmute your phone and record your name slowly and clearly when prompted. Your name is needed to introduce your question. To cancel the request, press star two. Our first question comes from Craig. Please proceed, Craig.
Hey, good morning. This is Craig Siegenthaler from Credit Suisse. Just given the softer revenue growth outlook, and that'll likely extend into 2020 given the variables, how should we think about expense growth into next year? What I'm wondering is, can you pull back enough on expenses to preserve positive or stable operating leverage even if revenue growth is less than 5% next year?
Thanks, Craig, for the question. It is still early in our planning for 2020. We are in the midst of, as I mentioned earlier, we've taken some actions already year to date. We're still in the process of, I would say, formalizing and finalizing our expense planning for 2020. I think this is a situation where history is a good guide. If you look at that slide I showed earlier, you can see that in many environments including some challenging environments, we were able to achieve positive operating leverage, but not in every single one. I would say it's still a little early to make a commitment around what our level of expense growth is going to be. We'll come back to you in either the next update or the one after that to be able to give you a little bit more certainty around that.
Thank you, Peter.
Thank you. Our next question comes from Rich Repetto. Please proceed.
Yeah. Hi, Walt. Hi, Peter. I guess my question is a follow-up on the client sorting process, and I know you gave some nice detail on slide 26. I guess could you walk through that again, is it simply because the client cash flows are positive and they're exceeding the purchase money market purchases in the month of June?
Rich, our expectation all along has been that this sorting process would flow over time, and that at some point that dynamic would be more than offset by the organic growth as we bring on new accounts and as our existing clients add cash to their accounts. Our expectation is the most rate sensitive cash tends to move earlier, you're looking at less and less rate sensitive cash. Our expectation has always been that this process would slow down over time, cash balances would grow consistent with the growth in total accounts and total client balances. I think there is certainly an interest rate portion to that. When we look at the dynamics to what we've seen thus far, nothing is different from those expectations. We are seeing that dynamic slow down across multiple tiers, multiple asset levels of clients.
The flows into purchased money funds have decreased. The flows into other products have decreased. You do see month-to-month, you see changes in flows in and out of equity markets. That overriding dynamic of this sorting process between transactional cash and investment cash has slowed in the last couple of months. Again, we do believe that over time, that'll slow to a point where it'll be more than offset by the growth in organic balances.
Just to add something, Rich, and thanks for your question. Two things. One, I think it's important also to bear in mind that these first six months have unfolded under an environment where the equity markets have been racing forward. You also have folks looking at opportunities available to them there. The second thing I think is important to remember is this cash sorting process is not happening passively. We have been aggressively reaching out and have for over a year to both our retail clients directly as well as with all of the RIAs that we work with, encouraging them on the sorting process, ensuring that they understood exactly how to take advantage of higher yielding solutions for their long-term investment cash. We have been aggressively managing and working this in the best interest of the client.
I think it's safe to say that after doing so for an extended period of time, we've had effectively the majority, if not virtually all of those conversations.
That's interesting, the encouragement that you're giving to this. Just one quick follow-up, Walt. You had on one of the slides, one of the priorities is wealth management, and you've also talked about building scale in the presentation. Can you talk about what parameters, there's certainly been some media reports out there, but how you look at potentially adding scale, say in an acquisition perspective, and what metrics or parameters would be key to you if you were going to do an inorganic addition?
As you know, we can't comment and don't comment on any specific market rumor or speculation. I think our criteria for considering acquisitions remain the same as it's been, which is we look for either capabilities that would fill in gaps that we may feel we have in our offer, or we look for scale-driven acquisitions that are consistent with our approach, our model in serving clients in the retail world and or the RIA world. That criteria has remained consistent, and we look at every opportunity that comes along through that type of lens.
Got it. Thank you, Walt. Thank you, Peter.
Okay. Thanks, Rich. Next question.
Thank you. Our next question comes from Devin Ryan. Please proceed, Devin.
Great. Thanks. Good morning, Walt and Peter. You guys were obviously aggressive on the buyback in the quarter, and I think that highlights your view on the stock at these levels, and you still have plenty of capacity on capital today. I'm curious how you think about the notion of getting even more aggressive to free up capital, potentially migrating some of the deposits off balance sheet to create capacity for more share buybacks or maybe even what share price or yield curve could that make sense, if at all?
Yeah. I would say that is not something that we are looking at, kind of shrinking our balance sheet. If you look at the spread on the balances that we have, it is well above the cost of capital. I think more importantly, the model that we have, those deposits are a core part of our clients' relationship with us. We're using Bank Sweep as part of our clients existing balance with us, their existing account with us. It's not like we've gone out in the market and tried to buy deposits with investors or depositors that have no other relationship with us. I don't even know what it would actually even mean to run off deposits in that way. That's not something we are looking at.
Okay. Just a follow-up on just deposit rates. I hear your comments that you guys have a kind of a higher starting point, maybe some more flexibility than some of your peers. I'm just curious how you're thinking about the cadence of potential reductions there if the Fed does cut as kind of the forward curve is projecting. Also how you think about that in connection with sorting, and whether that could maybe be a catalyst to reignite sorting and how you balance that.
Let me take a step back here and talk about how we think about deposit rates, and it might be worth just setting some context here. When we think about the deposit rate for Bank Sweep, which is obviously our primary liability if you will, we want our Bank Sweep rate to be above the rates of the big banks' checking accounts because many of our clients have multiple accounts. They have an account with us, and they have a checking account with one of the traditional banks. We want it to be within the range of our brokerage competitors.
That's the lens through which we look at our deposit rates. You've seen traditionally, on the way up, we increase our deposit rates, generally speaking, concurrently with the Fed activity. I think on the way down, I don't want to prejudge exactly how we'll move rates and exactly when. I think it's reasonable to expect that as interest rates fall, either because of Fed activity or in anticipation of Fed activity, that we would look to move our deposit rates consistent with that. In terms of your second part of your question around sorting. The sorting process is fundamentally a judgment or a decision among the clients between transactional cash and investment cash. That is the most important dynamic, and you see that dynamic play out, frankly, whether there's a relatively small differential between the alternatives or a large differential between the alternatives.
I think there is an aspect of that which is a function of the spread between purchased money funds and Bank Sweep. If in an environment like this, purchased money fund yields are falling as well. By decreasing deposit rates, we're not necessarily increasing that differential between those two alternatives.
Thank you very much.
Thank you. Our next question comes from Michael Carrier. Please proceed, Michael.
Good morning. Thanks for taking the question. While you guys are seeing good growth and demand on the advice side and some of the advisory solutions, where is the traction coming from? You guys did the subscription pricing. It seems like that's gone well. Just any color there? Then if I can just squeeze in a clarifying question for Pete. I think you mentioned something on the period-end balances just being a little elevated. I think you mentioned some portfolio trades, if you could just explain that or just quantify that, just so we know going forward. Thanks.
Thanks, Michael. The consistent growth in our advisory solutions really comes from both a combination of existing clients moving toward an advisory-type relationship. There does tend to be a bit more of that as some of the clients age. At the same time, we're getting significant flows into our advisory solutions from new-to-firm households. Particularly as we acquire new-to-firm households from other organizations who maybe their principal business model is advisory and they're not very much into a self-directed model. Those clients tend to come over and enroll right away into an advisory-type program.
I think maybe the third key point from a color standpoint is we're having strong success with investors under the age of 40 in coming to our firm, both in, again, the self-directed means, but many of them coming to our firm and going right into advisory solutions like one of our Intelligent Portfolio programs. It's really coming from all different sources in the retail space, and that's how we've, again, pushed it up close to the 20% level, and we think there's meaningful room for that to run well above that level in the coming years. Peter, take that second part.
Yeah. This is going to get a little bit into the minutiae of portfolio management. We will, on a relatively routine basis, make trades in bank's investment portfolio that are forward settling, meaning we get the securities at a later date and we pay for those at a later date. From an accounting standpoint, those count as another asset on the balance sheet as another liability. Neither of those, no interest, no revenue or expense associated with that asset and liability. We don't typically have those over the end of quarter period. We did this time in an amount about $3 billion, as I mentioned. Part of that was because we actively managed the portfolio in the second quarter to rotate from a floating component to a heavier fixed component.
We actually sold some floating-rate securities, bought some fixed-rate securities, and again, some of that was settling in July. I don't know that that's something you should expect to see at the end of the third quarter necessarily, something that we'll likely continue to do over the course of the third quarter. It is something we do routinely, but it's a little bit rarer to see that at the end of quarter period.
Got it. Thanks a lot.
Okay. Thanks, Mike. Next question.
Thank you. Our next question comes from Brennan Hawken. Please proceed.
Hey, good morning. Thanks for taking the question. Peter, I was hoping maybe you could walk through some of the assumptions embedded in your 4Q NIM expectations in the mid to high 230s. I think you said one Fed cut. We got that on the short-term rates, what are the assumptions embedded in the long-term rates? How about deposit costs?
The mid to upper 230s for the fourth quarter NIM was that range is one cut or two cuts, just to be clear. Clearly if it's one cut, we would expect it to be somewhere in the upper 230s. If it's two cuts, probably somewhere in the mid 230s. Let me walk through a few components to them because there are many components. Deposit pricing I mentioned. Our assumption is the deposit betas would be a bit north of where they have most recently ended. I think if you look at our most recent deposit betas, they were in the upper 20s to around 30. If you assume deposit beta is going forward maybe in the 30s range. That's the first piece of it. The rate environment, that assumes somewhat of a steepening of the yield curve.
Again, in the short term, that dynamic doesn't have a huge impact on a near-term NIM expectation. I think the biggest change perhaps is around this ALM positioning, our asset and liability management positioning, which I mentioned increasing the proportion of our investment portfolio and thereby by doing so, the investment, the portion of our overall balance sheet to a heavier fixed component. From a liquidity standpoint, you saw liquidity decrease from the end of the first quarter to the end of the second quarter. I'd expect that to decrease further to the end of the third quarter when we have to have liquidity that costs us a little bit of yield. That premium amortization, that was something that was a little bit of a drag on NIM, but assuming relatively stable long-term rates, that shouldn't get worse.
In other words, that shouldn't depress NIM from where it is today. I would say those are the four or five key factors that influence that NIM forecast.
Sorry. Just one follow-up. Does that mean that we should think about duration extending as you guys shrink the liquidity profile and then shift to a mix that's a little more fixed-rate oriented? Thanks for taking the questions.
I mentioned our duration has been on the lower end of our 250-275 range. We are working to get it up into more the middle part of that range as we go forward. Both the releasing liquidity does a part of that, as well as some of those buying more fixed rate assets. That increases that duration a bit as well. Within that range, within that 250-275 range.
That's clear. Thanks a lot, Peter.
All right.
Thank you. Our next question comes from Steven Chubak. Please proceed.
Hey, good morning. Wanted to start with a question on capital management. One of the benefits to your model is the embedded countercyclicality during periods of equity market stress, where you see that offset from higher cash. At the same time, the increase in cash consumes substantial amounts of capital, and that really seemed to limit your ability to buy back stock in the early part of this year. Peter, I know you talked about maybe demonstrating some increased flexibility on the capital side, maybe running towards the higher end of the target. I'm wondering if you'd consider actually increasing the cushion so that during the next equity market downturn, you can support both an influx of cash at the bank as well as repurchase your stock more aggressively if it proves to be opportunistic.
Yeah. It's a great question, and something we have thought about. I guess I would say that would require sort of perfect foresight, I think, to be able to know exactly when those moments are going to come, and clearly if you knew your stock price was going to be under pressure, you wouldn't buy back stock. You'd wait to do so. That being said, we do have a fair amount of cushion. Even if we manage our Tier 1 leverage ratio down to that 7% level, if we do get a period where we get unexpected balance sheet growth, we do have flexibility to be able to absorb that balance sheet growth. We can run that Tier 1 leverage ratio from 7% down to 6.75%. We can raise some preferred equity. Our preferred to total capital has been frankly below our 15%-20% range.
That gives us some incremental capacity as well. We have some levers at our disposal there to be able to absorb some of that unexpected balance sheet growth.
Okay, understood. I guess I'm thinking back to what happened in the fourth quarter, where we saw very little buyback in the first quarter as a result of the tick down in Tier 1 leverage, but appreciate your thoughts there. One question follow-up for me just on purchased money funds. Peter, you spoke of the more favorable cash sorting trends. Slide 26 certainly reinforces that. It looks like purchased money market funds are currently 38% of total cash. I think you had talked about 36% being the peak last rate cycle. I'm just wondering how has your thinking evolved here? Do you have a new expectation for where you think that could peak out, just given that it's exceeded what we saw in the previous rate cycle here?
I think it really depends a little bit on the interest rate environment. I mean, we do think that traditionally we have seen roughly 2/3 of our clients' cash beyond balance sheet. We're a bit below that right now as we've been going through the sorting process that we've talked about extensively. Could it go a little bit further below that level? Perhaps, but it really is a function of the interest rate environment. If we see interest rates go down, I would expect that two-thirds on the balance sheet could get back up to that level, and if interest rates do a reversal here and end up higher, maybe that number trickles down a little bit further.
Great. Thanks for taking my questions.
Thank you. Our next question comes from Brian Bedell. Please proceed, Brian.
Great. Thanks very much. Maybe just staying along the lines on the balance sheet first. Maybe a different question on your assumptions for the 6%-7% drop versus the 0%-1% increase. Your thoughts, Peter, on the impact of client behavior in terms of net buying of securities. If we are in an environment where the Fed does one or two insurance cuts and that propels equity markets higher, is your thought clients may become even more engaged in the markets and therefore be net buyers, and how does that influence the range that you gave for the balance sheet?
Well, that's why we gave a range because we don't exactly know what that behavior is going to be over the next four or five months. We do see that activity happen as a function of the equity markets. Our expectation is that in the latter part of the year, that organic balance sheet growth tends to be stronger. The lower end of that range would presume that balances perhaps decline a bit in the first few months, and then would rebound in kind of November, December timeframe. The upper end of that range assumes that the sorting process essentially stops when we get the consistent balance sheet growth consistent with the growth in accounts.
Again, we don't know exactly what's going to happen with flows in the equity markets, which is why we hesitate to give you a firm number and instead are talking about a range of possible outcomes.
I think what further complicates it is if the scenario unfolds as you indicated, it also has to unfold under the shadow of investor sentiment, which is quite negative. You could get a situation where the equity markets move forward in a strong manner, but the consumer just doesn't generally participate because of their sentiment.
Right. That's very interesting. Maybe, Walt, let me ask you about a little bit on the M&A strategy. In terms of just categorically, I guess, as you describe the scale part of the acquisition strategy, what is your view of getting more deeply into proprietary wealth management, thinking back to U.S. Trust in the early part of the decade, and do you view that as potentially, if you do go back into that type of area of proprietary wealth management, does that conflict at all with your RIA strategy? Would you rather potentially do a bunch of roll-ups if they are accretive?
I think you have to nuance the type of wealth management. If it's unique, customized, one-off type of wealth management like U.S. Trust was back when that deal was done a long time ago, that is probably not something we're interested in. If it is highly scalable, relatively straightforward type of wealth management, that is very consistent with what we do today in retail. I think we would not be interested in the former and would be potentially interested in the latter. I don't think it has any impact whatsoever on our relationship with the RIAs because there's already great clarity that we offer high quality, highly scalable wealth management and investment advisory services in retail today.
Right. Okay. Would any acquisition and, yep.
We're going to need to move on.
Okay.
Thanks. We'll move on to the next question.
Thank you. Our next question comes from Bill Katz. Please proceed.
Okay. Thank you very much for squeezing me in. Maybe a two-part question as well, a little bit different angles to it. Peter, maybe start with you. Just in terms of thinking through maybe aggregate payout between dividends and buyback, how might we think about that and how might that be changing just given the flattening of the rate backdrop? Walt, I was wondering if you could talk a little bit more about fixed income. I know you don't want to give away specifics, but just conceptually, you mentioned spending some time on that. Wondering what sort of broad strokes things you're looking at.
On the aggregate payout, it's a really tough question to answer because I can tell you what I think our dividend payout ratio would be, as I mentioned in that 20%-30% range. In terms of the level of buybacks or other capital return we do, it really is a function of what we see in terms of the growth of the balance sheet. In an environment where the balance sheet is growing quickly, we need to use that excess capital to support that growth in the balance sheet. In an environment where the balance sheet is growing more slowly, that would free up excess capital to do more buybacks. It really is hard to give you an exact number on that one, unfortunately.
On the fixed income side, I guess what I would respond is just think about client capabilities. Think about client needs. Everything that clients need and are looking for from someone they work with fixed income are the areas that we're investing in, have been investing in, and will continue in the coming quarters. We really do believe that if you were to look at the long-term history of our firm, that much of the growth that we've experienced has been a result of working with investors on their equity investing. Now, it's taken a lot of different forms. Stocks in the early years, and then mutual funds and ETFs today. Still was largely an equity-driven type of organization.
We believe that for the success of the organization in the long term, that our capabilities in the fixed income space need to be at least as good as those that we have developed over the years in the equity space. Just think about it through the lens of the client and hopefully that context and that offers you some information without sharing too much too early with those listening in who we compete with.
Okay. Thank you.
Thank you. Our next question comes from Chris Harris. Please proceed.
Thank you. Peter, I believe your interest rate sensitivity guidance is just the first-year impact. How should we be thinking about the impact as we go beyond the first year, particularly now that more of your securities are fixed rate?
Let me perhaps talk about that in the context of our reinvestment rates. If you look at our reinvestment rates on the fixed rate portion of the portfolio, they are a few basis points below the averaged fixed rate yield today. You may say, "Why is that?" Obviously, fixed rates or long-term rates are down a fair amount, but they're still above where they have spent the majority of, frankly, the last four or five years. We're not giving up as much on the fixed rate side of the portfolio as one might expect. In terms of a longer range sort of NIM forecast, again, hard to say right now. We'll come back on that as we get closer into 2020. I think that's a helpful, important context as you think about the fixed rate side of the portfolio.
Okay. Thank you.
Thank you. Our next question comes from Will Nance. Please proceed.
Hey, guys. Good afternoon. Thanks for squeezing me in today. Maybe I'll try a question that was asked earlier in a slightly different way. We've seen kind of two approaches here towards what to do with the yield curve the way it is. One of your competitors last night took steps that would kind of lead to a much shorter duration on the balance sheet to kind of preserve optionality and build dry powder should the rate curve evolve in a more favorable way over the next couple of months. Another one of your competitors tends to run much longer duration, and you seem to be taking steps that would extend the duration here. Like you highlighted, lower reinvestment rates than where the portfolio is currently at.
I guess maybe can you just talk conceptually how you're thinking about managing the duration of the balance sheet and just how to respond to the current environment when, I guess there's not a lot of great decisions?
Yeah. Thanks, Will. Let me just correct you first. We're not extending duration beyond our traditional range. Our traditional range for years has been that 250-275. When I talk about extending duration, just to be really clear, it's been running on the lower part of that range, and I'm talking about bringing it more into the upper part of that range, which is frankly where it was even as recently as probably one year ago. When we think about our duration target, it's not something that we are actively managing because of a proprietary view of the shape of the yield curve, interest rate expectations. I don't know that we're uniquely positioned to have any insights around what the interest rates are going to do.
When we think about our duration target, we think about it from an ALM standpoint relative to our liability duration and making sure we're managing that and matching that in a good way. Now, that being said, I do think that over time, as we've seen some of this sorting process unfold, the yield sensitivity of what remains on the liability side has become somewhat less yield sensitive by definition, which would imply that the duration on the liability side is likely a bit longer than it maybe was a year or so ago. Perhaps at some point over time, that might allow us to extend duration a bit on the asset side. Again, that's not what we're doing now. What we're really doing now is making adjustments to stay within that 250-275 duration target.
Got it. Appreciate that. I didn't mean to overstate the impact. If I could squeeze one more in, just you mentioned on the sorting chart, I think the chart on the right that you're seeing better trends month to date in terms of organic flows into the sweep. I guess, could you kind of tie together the other side? Are you seeing lower flows out of the sweep and into purchased money funds such that we could actually see the net of the two begin to trend positive in July? Is it just too early to say?
Well, what I said was that we've actually seen overall positive organic flows in Bank Sweep month to date in July. Slightly positive. I don't want to overstate it. Slightly positive. That encompasses flows into and out of the equity markets, flows into and out of purchased money funds, other fixed income securities and so forth. The point is not to say that July we're going to have this dramatic increase in organic flows like what we had two years ago, let's say. The point is that we're not seeing the outflows that we saw previously, which indicates again, the sorting process definitely seems to be slowing.
Got it. Thanks for taking my questions.
All right, thanks. I think we're actually at the end of the queue. We're going to hold there and I'm going to squeeze in one last question from the console before we close. There's been interest with regard to as sort of the M&A topic has come up again, how we think about the potential for using cash in those sorts of circumstances versus we'll say other financing and whether that choice would as a follow-on effect impact our share repurchase activity. How do we think about sort of that capital allocation dynamic?
Yeah, I mean that is one of the considerations. When we are looking at opportunities, typically we need to fund those opportunities because we're targeting a certain level of leverage. That's our binding constraint.
To the extent we're purchasing something above its book value, we need to basically use equity mostly to fund that gap. We recognize there are alternative uses for that capital, including buying back stock. When we look at an opportunity, and again, this is not new, this is something we've always done. We look at it relative to the return if we were to be buying back stock because we recognize that on the margin would reduce the amount of capital we have available for repurchases.
At that moment, of course, I mean over time, again, the dynamic we'd expect to continue and so that authorization remains open and usable when the time comes if maybe it's pushed off. The IR guy wants to make sure people hear that we'd still be open to that over time.
Absolutely. I mean it's a temporarily dynamic, if you will.
Well, thanks. Why don't we close?
All right. Well, thanks everyone. Really appreciate your time today. Really appreciate your questions. We clearly talked a lot about the environment, and we don't know how the environment's going to unfold. I don't know that anybody really knows. What we do know is our strategy is really an all-weather strategy, that our competitive position doesn't depend on the level of interest rates, it doesn't depend on the shape of the yield curve, and that our business model is quite resilient. That's what really gives us the confidence, the optimism to focus on the things that we can control, which are about delighting clients, about operating with discipline, and about making the investments that we need to help this company prosper in the years ahead. We'll look forward to talking to you at our next update. Have a great rest of the summer. Thanks, everyone.
Thank you. That concludes today's conference. Thank you all for joining. You may now disconnect.