Good morning, everyone. Welcome to Schwab's 2018 Fall Business Update. This is Jennifer Comeaux, Vice President of Investor Relations for Schwab coming to you from a somewhat foggy San Francisco. Also here with me in the studio today are Walt Bettinger, our President and CEO Peter Crawford, our CFO and Rich Fowler, our Head of Investor Relations. In our agenda today, we will spend a focused hour sharing our perspectives on Schwab.
Walt's going to start us off with the strategic picture and Peter will take a look at our recent financial performance and current outlook. Rich will then facilitate the Q and A until it's time to wrap up. And while we're on the topic of Q and A, let's review the process. 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 you sticking to our question guideline, which is one question plus a follow-up.
Before we start, let's spend a minute on the ever important forward looking statement page. The main point of which is to remind everyone that outcomes can differ from expectations. So please keep an eye on our disclosures. Last, for those of you looking for the slides, we plan to post them on the IR site following the prepared remarks. And with that, I think we're ready to begin.
Walt?
Thanks, Jen. Good morning, everyone. Normally at this time of year, I make some kind of comment about my beloved Baltimore Orioles. But after a 115 loss season, I think I'll just move right on to talking about the Q3, which by the way I've been incredibly excited for our webcast this morning because it was just such an extraordinary quarter and a continuation of our strong organic growth. So let's start off and talk a little bit about our operating model.
It's very simple and straightforward. As you all know for years we have referred to it as the virtuous cycle and it's working again in 2018 just as it should, begins with challenging the status quo of our industry on behalf of investors. They in turn reward us by investing their hard earned money at Schwab and that grows our base of client dollars contributing to strong revenue growth and financial results. The results of this lead to more earnings, enhance our returns for our owners and then we turn around and we reinvest. We reinvest a part of those results back in the business to be able to better serve and reward our clients and prospects And of course, then the cycle starts all over again.
So maybe what we'll do right now is go a little bit deeper and do a couple of the components of the Virtuous cycle. Let's start off with prospect and client response to some of our efforts to challenge the status quo. You can see extraordinary results again here in the Q3. New accounts continued to grow rapid rate, up about 13% year over year and 80% over the course of the last decade. At the same time, our clients are very engaged with us and you can see that reflected in our daily average trades up about 20% year over year and about 80% again over the course of the last decade.
One thing that's very interesting in the trades is to see that in the details it reflects the changing way that investors are choosing to invest with us with relatively significant growth there in the asset based trade side as well as trades that are processed as part of some form of typically fee based advisory solution. Strong core net new assets. Net new assets brought to the firm here in the 1st 3 quarters of the year are over $170,000,000,000 Again, that's core. Well ahead of the same timeframe from last year, which of course was a record breaking year and puts us on pace to exceed 2017. Other interesting factor is that they're higher through September of this year than any full year in our firm's history with the exception of 2017.
So the asset gathering machine that sometimes Schwab is referred to as seems to be continuing to play out. And as clients trust us with more and more of their assets, put that together of course with a favorable macro environment we've been operating in this year, it leads to record financial results. Year to date, we're just shy of 45% from a pre tax margin standpoint. That continues a very consistent rate of expansion that you can see on this page since the depths of the crisis in 2010. We achieved this margin even as we made very, very substantial investments in the business.
We achieved this margin maybe a little bit earlier in the cycle than we'd anticipated because rates have risen a bit faster And as a result, we've been outperforming the baseline scenarios that we've shared with you on a pretty regular basis. Of course, this is something that we'll watch very carefully as we do our planning for next year and, and of course, for 2020. Put those margins together and you get very strong return on equity. Year to date here, 19%. I think in the Q3, we may have hit the 2 handle, hit the 20% in terms of our return on equity.
And of course, this is the 13th quarter in a row that we've had record pre tax earnings. You can see why I was so excited to have this webcast today. What a great quarter. I think what's very important also though is that in addition to delivering these record financial results, we've been We know that our business operates in cycles. There are going to be cycles that are better and worse and we're trying to take advantage of this positive time in the cycle to invest in our franchise, invest in our clients.
And of course, this is reflected in higher spending at this point in time, whether it's staffing, technology, marketing all areas that we're putting a concentrated effort around. So a quick wrap up on the virtuous cycle part. It's working as intended. We expect to continue to execute on the operating model. And maybe what we'll do right now is go a little bit deeper into a couple of competitive and financial issues here before I turn it over to Peter.
So as you know our strategic approach to serving clients involves what we call the no trade offs. And this is a deliberate effort on our part based on the belief that when you have a focused strategy, when you have a consistent strategy around serving investors as well as the advisors who work with them that we can deliver for them world class value, world class service and world class guidance that it's not an or in any part of that sentence. We really believe that in today's economy that old paradigm that you quote sort of get what you pay for that's been shattered. That's just not the way that the environment works today and certainly not the way we think successful firms and investment services will operate as we move forward. So really today with our combination of scale, people, technology as well as we shouldn't forget the courage to be disruptive.
We can keep delivering for clients in a way that we think few if any of our competitors are able to do so. It really continues to show up in one of our simplest most direct metrics. If you look at our TOA or transfer of assets or accounts, we continue to win more than $2 from competitors for every dollar they win from us. That's a metric that we've not seen documented at least in any kind of publicly reviewed forum or achieved by any competitor. And of course, one of our key structural advantages is our scale and our operating efficiency.
Our cost structure is about half, in some cases a little less than half of a number of our online competitors and less than a third that of the warehouse firms. Now if you go back and review our guiding principles, you know that we believe that price matters. And in an industry where price matters, this is a very important competitive tool. It enables us to offer unbeatable pricing in the areas that matter most to clients. And of course, just as importantly, it helps our clients keep more of their hard earned money in their pocket where it belongs.
As we always remind ourselves, after all, is there money to begin with. I think these numbers are based here as of maybe the end of 2017, but it shows that we only have about 7 percent market share here domestically. So we're confident that we have a long runway in front of us to be able to continue to drive organic growth. And the investments that we're making today whether it be in the areas of digital delivery or the rebuild of our core brokerage systems, automation of operational processes, all those things are going to improve our ability to keep delivering this no trade proposition for our clients and for prospects considering Schwab. And that sort of takes us to in some ways what is a new chapter or at least a chapter we haven't seen at Schwab for quite a number of years in terms of our ability to reward our owners.
Right now, we're right on the cusp of being in a position to begin returning capital to our stockholders in a quite meaningful way. All of you know that our operating objective has been somewhere between 6.75% and 7% from a Tier 1 leverage ratio and our capital levels have been fairly far above that in recent years to some extent due to the operating environment improving rates. But also we were quite mindful of crossing the $250,000,000,000 level last year in 2017. In addition, we've been using a fair amount of our capital that we've created in recent years to fund the growth of our balance sheet, but those needs are starting to wane. And so our Board is right now deep in the process of analyzing options for the most effective way for us to leverage this excess capital we're creating and should create in quite meaningful levels as we move forward.
So we're going to have more information for you on that development very, very soon. So let me just wrap up here. Virtuacycle operating our operating model is working exactly as it's intended. Our client oriented no trade offs, competitive position never been stronger as you can see in our asset flows as well as in our net TOA ratios. The opportunity in front of us domestically is quite large.
7% market share means that there's prospects out there looking at Schwab that we believe can become Schwab clients over time. We're on the cusp of expanding the role of capital returns in our financial model to benefit our stockholders. And at the same time, we look at that, we continue to deliver top line revenue growth. So now you're looking at a company that is combining both top line growth as well as robust capital returns to owners of Schwab stock. Again, we're quite excited and pleased to be able share with you this information from Q3.
And Peter, I think you're going to have even more information from a financial standpoint. So let me turn it over to you.
All right. Well, thank you, Walt, and good morning, everyone. So Walt talked about what we call the virtuous cycle and how well it worked in Q3 and over the course of 2018. In my time today, I'll dive deeper into the financial performance note of the wheel, sharing how our record business momentum that Walt talked about in the Q3 combined with a generally helpful macro environment led to record financial results as well. Also talk more about the balance sheet and capital management, a story which as Walt mentioned, we are evolving as we near the end of sweep transfers.
And finally, I'll share our thoughts in the Q4 and some very, very high level thinking on 2019, recognizing of course that we're still working on our plans for the year. 2018 has definitely been a tumultuous year for investors, but on the whole a positive one. Our winter business update, we communicated 2 different financial scenarios given the range of possible interest rate paths. And with the strength in the equity markets and the increase in both short term and longer term rates, conditions have on the whole been even better than our 3 hike scenario. With the equity market a bit ahead of our scenario at least until recently, 3 rate hikes now behind us and prospects looking good for a 4th in December, longer term rates finally rising and trading much stronger than we'd anticipated.
Now while the macro environment has generally provided some much appreciated tailwinds, financial results would not have been possible without our continued success in driving strong organic growth. I'll talk about our record core net new assets enabled in part by robust transfers from our competitors. We're seeing momentum in both our Investor Services and Advisor Services businesses and with both existing clients as well as prospects. You can see here a 24% increase in new to retail households with a majority under the age of 40. We enjoyed healthy growth in advised assets, which of course includes both our advisor services business and our retail advisory assets and an 18% increase year over year in end of period interest earning assets.
You've all had a chance to read the earnings release we shared on Monday. It was as Walt mentioned another remarkable quarter from a financial standpoint. We produced a 19% increase in revenue year over year, our 13th consecutive quarterly record. Revenue was boosted by both net interest revenue and trading, which more than offset a decline in asset management and admin fees due mostly to declines in Suite money fund balances we transferred over to Bank Suite. Expenses were up 11% year over year, a function of hiring we've done to support our growing client base and investments we made to drive growth in the years ahead.
With that 19% increase in revenue and 11% increase in expenses, our pre tax pre tax profit increased 29% year over year and our pre tax profit margin jumped nearly 4 points from the Q3 of last year. And our return on equity hit 20%, the highest level in 9 years. Turning our attention to the balance sheet. We ended the quarter with $272,000,000,000 in assets, thanks in part to $23,000,000,000 in transfers from sweep money funds to bank sweep in the 3rd quarter, bringing the total year to date transfers to $68,000,000,000 We have another $33,000,000,000 remaining in sweep money funds and we expect a majority of that to be moved by the first half of twenty nineteen. And with that balance sheet growth, our Tier 1 leverage ratio ticked down a tenth of a point, remaining above our operating objective of 6.75% to 7%.
And one of the questions we are frequently asked is about the increasing proportion of our revenue that comes from net interest revenue and whether this is good or bad. From our perspective, there is no doubt that this trend has been a positive one. That's because cash has always been an important contributor to our revenue mix. We much prefer the relative stability and recurring nature of both asset management fees and net interest revenue versus the volatility of commission revenue. Utilizing our balance sheet to monetize our clients' uninvested cash has allowed us to establish that no trade off position that Walt referenced, enabling us to invest in a better experience for our clients even as we take steps to lower prices for investors.
It also creates a sort of internal hedge since client cash allocations tend to rise with volatility or equity market weakness, meaning net interest revenue often grows more quickly as asset management falls and vice versa. So this focus on utilizing our balance sheet has enabled us to grow faster organically, while avoiding the credit risk that other banks may take on and allowing us to produce returns on equity that are both 2x our cost of capital and the ROEs of other large cap financials. Now another question we're often asked is about our deposit betas. And as we said previously, we expect betas to generally be low and to edge up over time as interest rates increase. As you can see, deposit rates have been lower this cycle than in the last tightening cycle in 2004 through 2006.
We have no reason to believe betas will be higher this time around. Though again, we do expect it will increase a bit over time as rates rise. And while our betas have been lower than some of the traditional banks, that seems to be a function of our retail versus institutional or commercial client base and of our segmented approach to meeting the needs of our clients. I mean that by offering the option of purchase money funds, which essentially have a 100% beta, the client cash that remains on our balance sheet is less yield sensitive and therefore can have a lower beta. So if we combine those two products, our weight average beta and client cash is probably around 60% plus or minus with some at 100% and some in the 20s and low 30s.
A few thoughts as we look to the future. We continue to believe full year NIM will be in the high-220s and revenue growth in the mid- to upper teens. On the expense side, in addition to the typical 4th quarter seasonality, we have made the decision to move forward on 2 one time expenditures and emphasis on one time. First is to invest more in our marketing to capitalize on the strong momentum we have and the effectiveness of our no trade offs positioning. And second is our recent announcement to give all non officers $2,000 in stock to reward them for our outstanding year and help them become owners and investors as well.
Even with its roughly $60,000,000 in added spending in the Q4, we still expect to deliver 400 to 600 basis points of operating leverage for the year. For 2019, it's still early and there is a lot influx, including expectations for interest rates, client activity, what happens in the equity markets, etcetera, all of which will take into account as we develop our plan. Our current thinking is to prioritize investments that build on the cost advantage that Walt talked about, which is so important to our success. And as we do, it seems likely that the rate of spending growth will moderate from the level of the last few years, even as we continue driving strong business growth. Now turning our attention to capital and the balance sheet.
We expect the balance sheet to grow by roughly 15% for the year. And as Walt mentioned, we'll be soon discussing with the Board and already have been discussing with the Board some options around enhanced capital returns. So stay tuned for that. Let me quickly summarize what you hopefully heard from both Walt and me today. 1st, strong business momentum combined with a helpful environment have produced record financial results even as we invested in growing the company and building on our cost advantage.
2nd, as we near the end of Suite Chancers, capital return will likely become a more important piece of our financial equation and something we'll be discussing in more detail soon. 3rd, though we made the decision to green light some incremental Q4 spending, we still expect to achieve the 400 to 600 basis points of operating leverage that we outlined at the July business update. And 4th and finally, our priorities as we move forward should look pretty familiar, focusing on clients, focusing on what has made us successful and never settling. With that, let me turn it back to Rich for some Q and A.
All right. Thank you, gentlemen. Well done once again. Let's plunge right in. We're going to follow the same practice as always.
So star 1 or use the webcast console. Operator, you want to start us off?
Certainly.
Well, maybe first one for you. You mentioned the net new assets, the transfer of assets. Everything continues to be very strong, Schwab. The competitive dynamics, it seems like it started to pick up again through the summer. So just wanted to get your thoughts on how you kind of view Schwab's competitiveness in the industry and if you feel like there is any hurdles for kind of bringing in the customers given some of the competitive moves by some of your peers?
Thanks, Mike. I think our view is really the same that we like our pricing position right now. And at the same time as I've indicated in the past, we are committed to the idea that we will not have core competitors who go underneath us from a pricing standpoint in important areas. And so we're pleased with our position right now. I don't believe that pricing is a barrier to clients or prospects coming to Schwab.
I think the metrics bear that out. And at the same time, as you would expect, we monitor on a ongoing and very regular basis whether any competitor core competitor makes changes that are things that we feel would change that current dynamic.
Okay. Thanks. And then, Peter, maybe just one for you. Given what you guys have been investing, some of the investments in infrastructure and kind of improving like the cost structure, Just wanted to get your sense when we look at that EOCA or the expense per client asset, like what initiatives are in place that could continue to lower that, particularly if we see more competition in the industry or more pressure on the revenue side?
Sure. So thanks, Mike. So driving down EOKA as expense on client assets, as Walt mentioned, is a really important imperative for us and something we've have a track record of having done for many decades now. And the way that you do that is really three things. One is you grow assets allowing you to amortize your fixed costs over a larger client base.
2nd is you operate with discipline and prioritization. And 3rd is you make investments on an ongoing basis that improve the productivity and efficiency and remove friction. I think a couple of things that Walt highlight earlier are some of the big initiatives that I'm very excited about in terms of what they can do in terms of continuing to reduce costs, while at the same time improving the experience for our clients. Because what we don't want to do is remove cost at the expense of our clients. But I'd highlight something like our digital transformation, which I don't use that word, that transformation word lightly.
I do think that can be a transformation. When you consider the number of calls, for example, that we take every year that are password resets or status updates, If we can eliminate the need for a client to have to call for that or allow them to do that on their mobile device or on Schwab.com, eliminate that call. That's better for the client and it's better for us as well because that's a call we don't have to take. We can use that time talk to them about something else. Application modernization creates a more scalable infrastructure and a lower cost infrastructure over time.
We're doing a lot of work on business process transformation, straight through processing in our operations area. There's a lot of technology now that we are leveraging to try to remove friction and again lower the cost of serving clients. But in a way that ends up being good for the clients as well.
Okay. Thanks a lot.
Okay. Thanks, Collyn.
Thank you. Our next question is from the line of Rich Repetto. Your line is open.
Yes. Good morning, Walt. Good morning, Peter. So I guess just I'm hearing an echo here, but that's okay. So the first the question I hear most often, Walt and Peter, is that how is Schwab going to grow the bank balance sheet?
And you're in a good position where interest rate hikes help, but cash is leaving and one investor has estimated it's $10,000,000,000 to $15,000,000,000 leaving each rate hike. So I guess given that sweeps are now limited to that $33,000,000,000 that are left and I totally get the NNA growth, but how do you grow the bank balance sheet and to offset, I guess, the headwind of cash leaving with rate hikes?
Yes. Thanks for the question, Rich. And let me maybe just take a step back and provide a little more perspective on what's going on with the balance sheet and cash dynamics because I know it's
been the subject of a
lot of questions and a lot of commentary and say that what's been happening, what's been unfolding this year in 2018 is very much consistent with our expectations. If you go back to our February business update, talked about we expected at least 15% balance sheet growth over the course of 2018. And we did that contemplating only a single Fed increase and relatively modest market appreciation. And of course, the year has unfolded a bit differently than that with 3 nearly 4 rate increases and a the equity markets being pretty much a straight line up from March through the end of September. So a very, I would say, conducive environment for investors to get invested, to be engaged in the market.
And despite all that, we're at 12% balance sheet growth through the Q3. We'll obviously see what happens in the Q4, but we're pretty close to those assumptions that we had, those expectations we communicated back in February. What's really important to us is to make sure that, that cash is staying at Schwab, and we're seeing that. We're seeing that on our net new assets. We're seeing that in transfers to and from some of the online banks that are out there.
And that maybe is a bit different than what you might see at a traditional bank where they don't really have another place for that cash. And what's happening here is a couple of things. One is clients are reassessing their asset allocation in light of what they're seeing happening in the market. And second is there's sort of a sorting process going on where clients are sorting their investment versus transaction cash. Over the last 10 years, those have gotten kind of commingled and now putting those into different buckets and for the transaction cash, leaving that on the balance sheet and for the investment cash, putting that to work.
This is something we absolutely want them to do. We actually do a lot of things to help them do that. We while that may be less economic for us in the short term, having an engaged client, an informed client, an invested client, a client that is putting their money to work improves the odds of their success and that's a client that we're going to keep for their lifetime. So this is absolutely something we're encouraging. We reach out to those clients in multiple ways to help make that happen.
So this is going to take we'll see at some point, these cash balances will settle out if you look at history and reach some equilibrium. And then they should grow consistent with our growth in total client assets and our growth in accounts. And that's where our strength as premier asset gatherer, the premier asset gatherer, the asset gathering machine that Walt talked about and others have talked about should translate into growth in the balance sheet. I'd say just one other point, which is that to the extent that investors are choosing to move off balance sheet with their cash, that frees up capital. And that's capital that creates capacity for us to do more capital returns to our stockholders.
And so more balance sheet growth means probably a little bit less in capital return, less balance sheet growth means more opportunities for capital return, allowing us to reward our shareholders, reward our stockholders one way or the other.
Got it. Okay. That's very helpful how you look at that balance, Peter. So I guess the follow-up question, Walt. In the slides, you talked about how important net interest or the percentage of revenue, especially cash, the cash portion of it when you include money markets.
So I guess, would you I guess the question is, would you ever entertain it's an M and A question, would you ever entertain M and A that helps you grow the balance sheet and helps you grow cash? Is that one of the areas that you look at as a potential opportunity?
Well, Rich, I think our philosophy on M and A is consistent, which is, we look at every opportunity that may present itself. We do have a fairly high threshold for a serious consideration and often it revolves around strategic capabilities that help clients. Acquisitions that are pure balance sheet oriented or financial engineering oriented and I'm not sure that that's what you're referring to, but those types of acquisitions probably fall pretty far down the list in terms of things that we would give serious consideration to.
Got it. Thank you. That's very helpful. Thanks.
Okay. Operator, we're going to take one from the webcast for a second here before going back to calls. Just to follow on the thinking around pricing while we do get asked versions of this. So given the philosophy of not being undercut or not allowing things to get in the way of people choosing Schwab, is it possible that we could see a fee free mutual fund or ETF from Schwab in the not too distant future?
Yes. So I think it's I mean, there's a question of the relevancy of fee free. The difference between 2 or 3 basis points and 0 is pretty small. That said, we know that there's at least one competitor with a free or at least 0 operating expense ratio fund out there and we'll continue to study it and watch carefully how clients feel about something that is categorized as free. We all know that every company that is for profit is in the business of serving clients in the best way they can and making money.
And so we are very careful in studying how clients feel about that in the day and age we operate in of transparency and clarity with clients. All right.
Thanks, Walt. Can we go back to the next call?
Thank you. And your next question is from the line of Devin Ryan. Your line is now open.
Great. Thanks. Good morning. Just first one here on the comments around spending growth moderating in 2019. I guess, just to think about that, should we still be contemplating a relationship between revenues and expenses?
So essentially, if the revenue environment were to improve more than expected, then hypothetically, that could still pull expenses higher? Or is it really just an absolute drop in expenses year over year? Just trying to think about the relationship given that it's 2019 in more detail.
And I would say is, 2019 in more detail. And I would say is we'll talk about that more in more detail at the winter business update in February. But I do want to clarify and make sure it was clear what I said. What I was talking about was not necessarily a spending cut, but a moderation in the increase in our spending levels versus if you look at the 3 years, our spending our annual increase in expenses has been sort of 11 ish percent. I'm talking about is a likely moderation of that level that we're looking at it heading into 2019.
But again, in terms of the exact how that might flex or not flex with the environment, as we talked about back in this last February. I'll have to tell you what you have to show up in San Francisco in February to get more details on that.
Okay, great. And then just a follow-up kind of on the conversation around competition and appreciate some of the comments. Obviously, the cadence of pricing actions have been accelerating and a lot of focus is being put on something that's free or 0, whether it be commissions or investment product fees. And there's clearly offerings that are at those price points, and you're not necessarily at that for all of them. So is this something where the value of the holistic relationship with Schwab is maybe getting overlooked?
And are there ways to, I guess, add new ways to monetize the relationship outside of just that maybe commoditized or more commoditized element whether it be in trading or certain types of investment product fees?
Yes. Interesting there Devin and good question. I guess first I'd say is I don't know that it's being overlooked when you look at the flows that are occurring as well as the competitive position we have on TOAs. I think the consumer understands that there is nothing free. If it's free trading, it's being made up probably somewhere execution quality or other factors, free investment funds might be being made up as sort of the typical grocery discount the milk to sell more bread type thing.
And even on our side where we offer intelligent portfolios without an investment advisory fee, we're very clear in all our disclosures that we generate revenue from some of the underlying exchange traded funds as well as the cash holding within those portfolios that that's the way that we generate revenue in the program that doesn't have advisory fees. I think consumers are pretty sophisticated for the most part. That's not to say every consumer, but consumers for the most part are pretty sophisticated in understanding that they're going to pay for things one way or another. It's a matter of how they choose to do so. And I think our organic growth results are a reflection that we're at a pretty nice point in terms of finding the right balances here.
Thank you.
Okay. Next call.
Thank you. And our next question is from the line of Brian Bedell. Your line is now open.
Great. Thanks. Good morning, folks. Maybe just to go back to the balance sheet side and the bulk transfer activity. Just Peter, if you can you alluded to this on the last business update in terms of the process that obviously you're going to be slowing down the pace of that over the next couple of quarters.
And you mentioned the timing of that and I think the need to make sure that clients were getting a better yield on their cash. So can you just talk a little bit more about what your thought process is around in the next one to two quarters for those clients that are getting swept from the 100 and 50 basis point or so sweep money market funds to a 30 basis point deposit rate. To what extent are you reaching out to those clients to get them to have a better yield on that cash? Is there a threshold for that for who you would reach out to on that?
Sure. So first on the timing, our expectation is that we'll probably do about a few $1,000,000,000 of transfers in October and then likely paused in November December, just given the end of the year volumes and client activity until early 2019. In terms of the process, it's a process that is we definitely try to engage those clients in a conversation. It has proven to be, with many of our clients a really good catalyst to have a conversation with them about their about why they have that cash, how they're invested, what their financial goals are and so forth. We do written communications to them that are very transparent and upfront about their alternatives, so about what's happening to them and about the alternatives if they are seeking higher yield.
And then if they are working on the retail side, if they're working with a financial consultant, we the financial consultant will try to reach out to them and talk to them about having a live conversation with them about that as well. On the advisors side of business, of course, we don't talk to the end clients there, but we do talk to the advisors about it and make sure they understand what's happening. And typically, we have the advisors. We typically try to move all the advisors' accounts at the same time from an operational standpoint, so it makes it easier for them.
Right. So this process is ongoing, I assume, as opposed to sort of almost concluding? Or do you expect to continue to do these type of activity for the next few quarters?
So it's not like it yes, it's not like we contact them just a day ahead of transfer. It is a process. We talk to them ahead of the transfer as the transfer is happening. And then many of these clients we're talking with on an ongoing basis as well just as part of the overall relationship with the client.
Right. Okay. And then just on the back to the sort of the competitive disruption that we've seen this summer. Maybe just more to the point, obviously, JPMorgan came out with somewhat of a disruptive online trading rate. It looks like it was mostly targeted at keeping Chase customers internal to their franchise and growing that internally.
But maybe if you can talk about have you seen any impact to your transfer account activity in September October as a result of that? Or do you think this is I think, Walt, you initially said, do you maybe not view this as a core competitor? Therefore, it wouldn't influence your view on trade pricing behavior?
Yes. I don't know that I'd categorize anything that has occurred over the summer from any firms as really disruptive. I think whether it is pricing on funds or pricing on trading, trading with a 0 trade cost or a temporary number of free trades for new clients or free trades for a year or if you maintain a certain amount of cash balances you get free trades. I mean that's been in our industry for years. So I don't know that I categorize anything that I've seen as disruptive.
I don't really comment on individual competitors. We have respect for all of our competitors and pay close attention to everyone small and large.
Okay. And then just from pricing in the future, I guess, you have been disruptive yourself in terms of trade price cuts. Is that something you still view as a weapon in the competitive toolkit? I guess what your organic growth is so strong right now. Last move really did accelerate dramatically.
Would you wait until your organic growth eased to do that again? Or was that something you think you could do more in the near term?
Well, since we know there's no competitors on the phone, I can answer that directly. But I I think the move that we made in early 2017,
we were removing a barrier
to people coming to Schwab. When we had core competitors consistently priced underneath our commission rate, that was a barrier because we know that switchers in our industry struggle at the outset of a decision where to move their money to. And so the differentiation between firms, so therefore they default to something as simplistic as commission rate. So I think the organic the step up in organic growth rate that you're referring to after the commission price changes in early 2017 was more a reflection of us just simply removing that barrier. I think everyone in the industry will probably look long and hard at additional pricing moves as to whether others will simply match and ensure that no gap is created again in the future and therefore have to evaluate whether there is market share gains to be achieved by that whether that's us or anyone we compete with.
Great. Thanks for all the additional color. Thanks, Brian. All right. Next call.
Thank you. Our next question is from the line of Vincent Hong. Your line is now open.
Hi. So we talked a lot about competition on pricing, etcetera, and it seems to have manifested through commissions, commission for ETFs, account minimums, lots of stuff. But I haven't really seen any movement in things like intro bonuses. Have you thought about competing for new accounts through higher intro offers, etcetera?
That's always been an area of competition, Vincent, where incentives are offered to new clients around possible cash or free trades. It's certainly not something that we necessarily like because it's not an ideal way to build a long term relationship with a client. Unfortunately, I would say in some ways promotions like that work. And so therefore as long as they are commonly utilized in the industry, it's difficult to take a hard stand that we're not going to have similar types of promotional offers. But they are inconsistent with our long term approach of building trust based relationships with clients.
Got it. And any indication of cash levels in October just given the recent market sell off?
So it's really too early to tell. I mean, we see when the markets sell off in that day, we typically see clients moving to cash and then the markets rally and they get invested again. So it's really too early to tell. What we've typically seen in the past is it takes a bit of a more of a pronounced market sell off, sort of a 10% kind of correction that really compels clients to rethink their asset allocation and move in a more significant way into cash.
Thanks.
Okay. Another call.
Thank you. Our next question is from the line of Jeremy Campbell. Your line is now open.
Hey, thanks guys. So I think you guys have previously mentioned that the advisory channel keeps somewhere between like around the high single digit kind of client cash allocation and the retail channel is probably more like mid to high teens. But I think there's this idea floating out there that most or all the advisory cash is kind of migrating the money funds versus deposits. Can you just kind of comment at all about the proportion of cash versus money funds in the 2 channels? Maybe kind of your understanding of the advisor rationale for using 1 versus the other?
So, good question, Jeremy. The advisor probably is more diligent at moving longer term cash into higher yielding investments whether it be purchased money funds, bonds, treasuries, things of that nature. But the reality is advisors need liquid cash also. And in general, it is averaged somewhere around half of the overall client cash balances that RIAs hold. They need it for everything from transactions they have going on.
Their clients are spending some of the money they have, of course, particularly those who are retired or close to retirement, they need it for the collection of their own advisory fees. So the notion that that fifty-fifty type ratio is either broken down or no longer applicable is just simply not correct. That ratio is generally holding true.
Great. And then just on a big picture perspective, I think you guys had done a study a while back where you thought, I think maybe if I'm remembering correctly, like 2 thirds of your kind of cash overall cash balances maybe in the deposit side and 1 third maybe in the money fund side. Do you guys still feel like that might hold up or has changed over time?
Yes. So we have nothing to suggest that, that won't hold up in the future. It may take us a bit of time to get to that equilibrium state, if you will. But that has been historically the ratio, and I don't think there's anything to suggest that it won't be the same this time around. Great.
Thanks a lot.
Okay. Let's take another question from the webcast. I haven't had a question like this actually for a little while. Interesting. So would we expect our group of core competitors to remain relatively unchanged going forward?
Or what do we think about new entrants potentially moving in over time?
Yes. So I mean time will tell of course, right? But it isn't easy in our industry to move I would say into what we consider that core competitor group because there's a very small number of investment firms that really serve $1,000,000,000,000 or more of client assets. There are certainly large organizations or large institutions that would like to get into that core competitor space that may have a lot of other assets, but to really move into that grouping in investment services is a pretty high hurdle. And so that group of core competitors probably doesn't change very often.
All right. Thank you. Let's go back to the calls.
Thank you. And our next question is from the line of Steven now open.
Hey, good morning. So I wanted to follow-up just on the discussion around organic cash growth. And Peter, given expectations for rates to continue to grind higher from here, the uptick you described in terms of yield seeking behavior, Is there a catalyst that you see that could help spur positive organic cash growth outside of a sustained market correction? And how should we maybe be thinking about the impact of equity market sensitivity on the other parts of your business?
So, I mean, the catalyst for stronger balance sheet growth is growth in our core business. It's growth in our assets. It's bringing on accounts. It's bringing on new assets, bringing on new clients. That over the long term, that is what we believe and history would suggest, that is what drives balance sheet growth.
And those 2 tend to move concurrently. In terms of the near term, how that evolves over the next months, quarters, I think time will tell. As I mentioned, if we see an equity market correction in the past, it's been sort of in the 10% range. That tends to be the thing that moves clients more heavily into cash. I want to make sure I emphasize that the rate increases, Fed increases are still a meaningful positive for us.
There's still meaningful revenue lift associated with each subsequent Fed increase. The lift may be a bit less than what that number we communicated 2, 3 years ago, but it's still quite meaningful. And so we'd certainly view that as a positive.
Okay. And along those same lines, as we start to think about the excess capital that you're building, especially if the balance sheet growth begins to slow, I know you've managed longer term to that 6.75%, 7% target. Now the balance sheet is considerably larger. I'm just wondering in the event that we do see a market correction, do you have to tweak some of those targets to maybe account for additional cushion if significant amounts of cash have to move back on balance sheet?
Yes. So it's a great question and one we get a lot and certainly one I think about quite often. And the short answer is no, we don't have to rethink those targets because those targets themselves build in cushion. I mean, as you know, those are well above the regulatory minimums and they're actually well above our internal limit that we have for our capital levels. Even operating at that 7%, even going down to 6.75% would allow us to obviously to add another what that would work out to be 4 percentage points in balances.
We also have the opportunity to access the preferred market. We target 15% to 20% preferred to total capital. We've been running at the lower end of that range. We could bump that up close to that 20% level in an environment where we needed to have more capital. And then we have a mechanism if we see a significant market correction and a huge flood of cash onto the balance sheet.
We do have kind of a release valve that essentially would allow us to move some of that cash back on into money funds. And again, that's what we only do in an emergency situation, but that allows us to manage that at that 6.75% to 7% level.
That's great. Thanks very much for taking my questions.
Okay. Onward. Next call.
Thank you. Our next question is from the line of Craig Siegenthaler. Your line is now open.
Hey, good morning Walt and Peter. Hi Craig. I just wanted to dig a little deeper on the free funder ETF question. Why wouldn't you launch a new free index fund that is only available on the Schwab platform. I just don't see any big issues with that strategy.
But I think there are obvious issues with a free ETF that can be purchased at your competitors or maybe by cutting fees on your existing products. But launching a new product wouldn't have those issues if it was only available to Schwab clients.
Yes. I didn't say we wouldn't. I just said that that was something that we are studying and looking to understand client reaction to and where it would fit. You accurately identified some of the complexities around it being done in the ETF space. And I think this is one of those things that we're looking at very carefully and we'll make a decision potentially to do so or not over the coming months.
I think the point I just wanted to make is that the delta between 2 or 3 basis points and 0 is really, really small. And so to do a free free mutual free is not the right word to do a 0 operating expense mutual fund or mutual funds is really a differing strategy. It's really sort of a strategy to entice people with something and then hope that you monetize that relationship in other ways. That was the only point I was trying to make.
Got it. Thanks a lot.
Okay. Let's go to the next call.
Thank you. Our next question is from the line of Chris Shutler. Your line is now open.
Hey, good morning. Maybe if we assume stable NIM, assume kind of flat markets going forward, I mean, how do you think about the long term sustainable revenue growth and kind of margin expansion profile, Schwab? Just the just thinking about the long term growth rate of the business, we're increasingly getting that question.
So I do think I think in terms of long term growth rate of the business is going to be dependent on our organic growth rate. We're growing organically at 7% as well as and continuing to find ways to monetize the relationship with our clients. I mean, it's not like net interest revenue is the only way that we monetize those relationships. If you look at that, the graph that was in the business update, the proportion of our revenue that comes from asset management fees ex money funds has actually gone up. There's a lot of opportunity within the advice opportunity as an example.
So we think, believe there's definitely meaningful ways to grow revenue, keep maintain our discipline and grow expenses at a lower level than revenue, which allows us to grow earnings. And through continued ongoing capital return drive very attractive returns for our shareholders over time, even in an environment that might be characterized by flat interest rates and sort of the typical long term equity market appreciation.
Okay, thanks. And then the Peter, the marketing cost, the extra, I think, dollars 25,000,000 or so in the Q4, where is that what's that going to revolve around? What products? Any more detail there?
So it's really around a lot of it basically is around what works. The wonderful thing about marketing is 4 or 5 years ago, if the CMO, Chief Marketing Officer came to me and said he wants another $1,000,000 I'd to sort of take it on faith that, that was actually going to have a good ROI. Nowadays, we have a lot of analytics that show that that is a very positive NPV, high IRR investment. And we're able to very much target the marketing to the channels, the messages and the audience that we want to make sure we maximize that lift, if you will, and maximize that payback for it. So it really is around what works.
There's a lot heavy focus on digital. Since that's worked very, very well, that's an increasing portion of our overall marketing mix. But it's not necessarily a particular product or a particular channel or anything like that. Okay. Thank you.
Thank you. Okay. Operator, I'm going to take one last from the webcast and then we'll probably have time for one last from the callers. The question at hand is, is there anything we're actively doing to prepare the firm for a market downturn? Are we prepared to take advantage of a down cycle to create excess value for customers and stockholders?
I'm going to add on to that questions that we will also get fairly frequently kind of along these lines are, as we think about getting whether or not it's actually happening as we get deeper into a cycle maybe closer to the end of cycles, do we think about changing, we'll call it risk parameters as a as a way of sort of hanging on to that as we again as we say sort of get deeper into the cycle. So your thoughts on that.
So we recognize that when you're in a strongly strong positive environment like you're in now, it lifts all boats. And that's also I think in part why you've seen some of the pricing moves in recent months. But as we know, companies separate themselves from a market share standpoint usually in difficult times. And at Schwab, we have a long history from a risk management standpoint of being very diligent, very careful. We know with our balance sheet, it's OPM as we like to say, it's other people's money.
And so we continue to invest very conservatively with approximately 70% of our balance sheet in U. S. Treasuries and government backed paper. We think we're positioned to withstand a downturn well. And my assumption would be if we go into a downturn, that is when Schwab tends to really shine and we will put our foot on the accelerator at that point in time to take advantage of possible competitor missteps that they may have gotten themselves positioned into during these much stronger environments.
From a client standpoint, it's really all about diversification and helping ensure clients are thoughtful in the way they invest, not just investing in what is the hot thing of the day. We're a long term investment services firm provider. The RIAs we serve take long term views and I think that positions our clients well from their perspective for a potential downturn. Peter, do you have anything you might want to
add to that? Yes. Maybe just to add, Rich asked a little bit about duration and our asset and liability management and whether we change that at all. And what I'd say is we're not in the business of trying to make a market call and time to market around what's happening with interest rates or the expectations around interest rates. What I could see us doing at some point once sort of this whole cash settles out and we get into kind of an equilibrium is taking a look at the duration profile of bank sweep and seeing what that looks like.
And maybe that's an opportunity to extend duration or to adjust our profile a bit on the margin. But in terms of actively managing that through the cycle, I don't think that's something that we're going to be looking too hard at.
All right. Thank you. So let's go to our final call.
Thank you. And our last question is from the line of Bill Katz. Your line is now open.
Okay. Thanks very much for taking the question. So coming back to your sort of preliminary view for expenses for 2019, and thank you for that. I understand you haven't really sort of put together sort of the revenue framework quite yet, but does that infer a little more flexibility even if you have a little bit of moderation in the absolute level of spend? I would assume you have some baseline view for revenue growth to get to that moderation of the elevated expense growth.
So Bill, I wouldn't infer that necessarily. I wouldn't make any statements or any drawing conclusions around what that means from a revenue growth standpoint. We're still working on that. There's still as I mentioned, there's still a lot influx. We tend to set our plan in January and get it approved by the Board in January and then share it with you in February.
And there's a lot that changes between now and then. So we'll be coming back with you in more detail around what that looks like. And I hate to have to tell you to hold tight for a couple of months, but I'm afraid that's where we are.
Okay. I appreciate that. And just the follow-up question is around capital management and thank you for that as well. So you laid out in one of your charts a bunch of things that you're considering. Is that a rank order of priorities?
And the broader question I have is, how do you think about the business mix at this end of the rate cycle sort of come out the other ways? When you look at your slide, we talked about you're getting things from spread has come up a little bit, but also asset management trading. Are you at a point now strategically where you might look to broaden out the asset management revenues through acquisition to maybe counterbalance the flattening of NII from here?
So, yes, so the priorities from a capital management standpoint are to use capital to fund and support the growth, the core business. That is our top priority from a capital standpoint, always has been and will continue to be that way. To the extent that we have capital left over, that's when we look to return that to stockholders. This doesn't suggest any difference from an M and A strategy. It's not like we've got money burning a hole in our pocket and we're saying let's go buy somebody because we have nothing else to do with it.
We are still we'll maintain our discipline, are very, very selective our approach to M and A and think about whether it's a fit strategically, is it fit financially and so forth.
But Peter, I think
it's fair to say we weren't trying to suggest that between regular dividend, a 5th or discretionary type dividend and buybacks, if there was any particular ranking of precedence on that front, is that right?
Yes, sorry. That's correct. I mean, we're looking at all those and taking a look at all those methods of capital return and figure out the exact optimal mix and that's what we talked about with the Board.
Okay. Thank you very much.
All right. Thanks, Phil. All right. So we're going to turn off Q and A and turn it back to Peter for some final thoughts.
Great. Well, thanks everyone for your time today and appreciate your questions and we appreciate you tuning in. And I know there's been certainly a lot of a fair number of questions about the balance sheet and cash and so forth. And rest assured, these are dynamics that we're following and we're quite confident they will sort themselves out over time. And hopefully, what you'll see as they do is that this is a company that has never performed better.
Our strategy is working exactly as intended, producing really strong business momentum and really strong financial results, that our competitive position has never been better as indicated by the transfer of the TOA ratio that Walt talked about and our ability to continue to widen the moat and build on our competitive advantages, that we have a lot of opportunity in front of us. There's still a lot of clients out there that would be a lot better off, a lot of investors, I should say, out there that would be a lot better off working with Schwab. And the capital return will be an increasingly important part of the financial equation and something we'll be talking about soon. So we look forward to seeing you all in person, hopefully in February and sharing more details on 2019. And until then, thanks very much.