10-Q 1 schw-20140331x10q.htm 10-Q 6f39dca81d724ab

UNITED STATES

SECURITIES  AND  EXCHANGE  COMMISSION

Washington, D.C.  20549

 

FORM 10-Q

 

QUARTERLY  REPORT  PURSUANT  TO  SECTION  13  OR  15(d)
OF  THE  SECURITIES  EXCHANGE  ACT  OF  1934

 

For the quarterly period ended March 31, 2014

 

Commission File Number: 1-9700

 

THE  CHARLES  SCHWAB  CORPORATION

(Exact name of registrant as specified in its charter)

 

 

 

Delaware

(State or other jurisdiction

of incorporation or organization)

94-3025021

(I.R.S. Employer Identification No.)

 

211 Main Street, San Francisco, CA  94105

(Address of principal executive offices and zip code)

 

Registrant’s telephone number, including area code:  (415) 667-7000

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes   No 

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes    No 

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer 

Non-accelerated filer  (Do not check if a smaller reporting company)

Accelerated filer 

Smaller reporting company 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes  No 

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

1,301,140,339 shares of $.01 par value Common Stock

Outstanding on April 24, 2014

 

 

 


 

THE CHARLES SCHWAB CORPORATION

 

Quarterly Report on Form 10-Q

For the Quarter Ended March 31, 2014

 

Index

 

 

 

 

 

 

 

 

 

 

 

 

Page

Part I - Financial Information 

 

 

 

 

 

 

 

 

Item 1.

Condensed Consolidated Financial Statements (Unaudited):

 

 

 

 

 

 

 

 

 

Statements of Income

 

1

 

 

Statements of Comprehensive Income

 

2

 

 

Balance Sheets

 

3

 

 

Statements of Cash Flows

 

4

 

 

Notes

 

522

 

 

 

 

 

 

Item 2.

Management’s Discussion and Analysis of Financial
Condition and Results of Operations

 

2341

 

 

 

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

 

42  43

 

 

 

 

 

 

Item 4.

Controls and Procedures

 

43

 

 

 

 

 

Part II - Other Information 

 

 

 

 

 

 

 

 

Item 1.

Legal Proceedings

 

44

 

 

 

 

 

 

Item 1A.

Risk Factors

 

44

 

 

 

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

 

44

 

 

 

 

 

 

Item 3.

Defaults Upon Senior Securities

 

45

 

 

 

 

 

 

Item 4.

Mine Safety Disclosures

 

45

 

 

 

 

 

 

Item 5.

Other Information

 

45

 

 

 

 

 

 

Item 6.

Exhibits

 

45

 

 

 

 

 

Signature 

 

46

 

 

 

 

 

 

 


 

Part I – FINANCIAL INFORMATION

Item 1.  Condensed Consolidated Financial Statements

 

THE CHARLES SCHWAB CORPORATION

Condensed Consolidated Statements of Income

(In Millions, Except Per Share Amounts)

(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

  

Three Months Ended

 

 

March 31,

 

  

2014

 

2013

Net Revenues

  

 

 

 

 

 

Asset management and administration fees

  

$

611 

 

$

552 

Interest revenue

  

 

579 

 

 

497 

Interest expense

  

 

(26)

 

 

(28)

Net interest revenue

  

 

553 

 

 

469 

Trading revenue

  

 

247 

 

 

223 

Other

  

 

68 

 

 

56 

Provision for loan losses

  

 

(1)

 

 

(6)

Net impairment losses on securities (1)

  

 

 -

 

 

(4)

Total net revenues

  

 

1,478 

 

 

1,290 

Expenses Excluding Interest

  

 

 

 

 

 

Compensation and benefits

  

 

528 

 

 

536 

Professional services

  

 

106 

 

 

99 

Occupancy and equipment

  

 

80 

 

 

77 

Advertising and market development

  

 

63 

 

 

74 

Communications

  

 

56 

 

 

54 

Depreciation and amortization

  

 

48 

 

 

51 

Other

  

 

75 

 

 

68 

Total expenses excluding interest

  

 

956 

 

 

959 

Income before taxes on income

  

 

522 

 

 

331 

Taxes on income

  

 

196 

 

 

125 

Net Income

  

 

326 

 

 

206 

Preferred stock dividends

  

 

 

 

Net Income Available to Common Stockholders

  

$

318 

 

$

198 

Weighted-Average Common Shares Outstanding — Diluted

  

 

1,311 

 

 

1,282 

Earnings Per Common Share — Basic

  

$

.24

 

$

.15

Earnings Per Common Share — Diluted

  

$

.24

 

$

.15

 

 

 

(1)

There were no net impairment losses on securities for the three months ended March 31, 2014. Net impairment losses on securities include total other-than-temporary impairment losses of $0 million recognized in other comprehensive income, net of $(4) million reclassified from other comprehensive income, for the three months ended March 31, 2013.

 

See Notes to Condensed Consolidated Financial Statements.

 

 

1 


 

THE CHARLES SCHWAB CORPORATION

Condensed Consolidated Statements of Comprehensive Income

(In Millions)

(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

  

March 31,

 

  

2014

 

2013

Net Income

  

$

326 

 

$

206 

Other comprehensive income, before tax:

  

 

 

 

 

 

Change in net unrealized gain on securities available for sale:

  

 

 

 

 

 

Net unrealized gain (loss)

  

 

159 

 

 

(3)

Reclassification of impairment charges included in net

  

 

 

 

 

 

impairment losses on securities

 

 

 -

 

 

Other reclassifications included in other revenue

 

 

(1)

 

 

 -

Other

 

 

 -

 

 

Other comprehensive income, before tax

  

 

158 

 

 

Income tax effect

 

 

(59)

 

 

 -

Other comprehensive income, net of tax

  

 

99 

 

 

Comprehensive Income

  

$

425 

 

$

208 

 

See Notes to Condensed Consolidated Financial Statements.

 

 

2 


 

THE CHARLES SCHWAB CORPORATION

Condensed Consolidated Balance Sheets

(In Millions, Except Per Share and Share Amounts)

(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

March 31,

 

December 31,

 

  

2014

 

2013

Assets

  

 

 

 

 

 

Cash and cash equivalents

  

$

7,173 

 

$

7,728 

Cash and investments segregated and on deposit for regulatory purposes

  

 

 

 

 

 

(including resale agreements of $11,776 at March 31, 2014 and $14,016

 

 

 

 

 

 

at December 31, 2013)

 

 

20,548 

 

 

23,553 

Receivables from brokers, dealers, and clearing organizations

  

 

482 

 

 

509 

Receivables from brokerage clients — net

  

 

14,571 

 

 

13,951 

Other securities owned — at fair value

  

 

456 

 

 

517 

Securities available for sale

  

 

53,080 

 

 

51,618 

Securities held to maturity (fair value — $31,669 at March 31, 2014 and

  

 

 

 

 

 

$29,490 at December 31, 2013)

 

 

32,123 

 

 

30,318 

Loans to banking clients — net

  

 

12,591 

 

 

12,419 

Equipment, office facilities, and property — net

  

 

820 

 

 

790 

Goodwill

  

 

1,227 

 

 

1,227 

Intangible assets — net

  

 

255 

 

 

266 

Other assets

  

 

740 

 

 

746 

Total assets

  

$

144,066 

 

$

143,642 

Liabilities and Stockholders’ Equity

  

 

 

 

 

 

Deposits from banking clients

  

$

95,591 

 

$

92,972 

Payables to brokers, dealers, and clearing organizations

  

 

1,918 

 

 

1,467 

Payables to brokerage clients

  

 

32,308 

 

 

35,333 

Accrued expenses and other liabilities

  

 

1,532 

 

 

1,586 

Long-term debt

  

 

1,902 

 

 

1,903 

Total liabilities

  

 

133,251 

 

 

133,261 

Stockholders’ equity:

  

 

 

 

 

 

Preferred stock — $.01 par value per share; aggregate liquidation

  

 

 

 

 

 

preference of $885

 

 

870 

 

 

869 

Common stock — 3 billion shares authorized; $.01 par value per share;

  

 

 

 

 

 

1,487,543,446 shares issued

 

 

15 

 

 

15 

Additional paid-in capital

  

 

3,982 

 

 

3,951 

Retained earnings

  

 

9,492 

 

 

9,253 

Treasury stock, at cost — 186,648,711 shares at March 31, 2014 and

  

 

 

 

 

 

190,657,263 shares at December 31, 2013

 

 

(3,652)

 

 

(3,716)

Accumulated other comprehensive income

  

 

108 

 

 

Total stockholders’ equity

  

 

10,815 

 

 

10,381 

Total liabilities and stockholders’ equity

  

$

144,066 

 

$

143,642 

 

See Notes to Condensed Consolidated Financial Statements.

 

 

3 


 

THE CHARLES SCHWAB CORPORATION

Condensed Consolidated Statements of Cash Flows

(In Millions)

(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

 

March 31,

 

 

2014

 

2013

Cash Flows from Operating Activities

 

 

 

 

 

 

Net income

 

$

326 

 

$

206 

Adjustments to reconcile net income to net cash provided by (used for) operating activities:

 

 

 

 

 

 

Provision for loan losses

 

 

 

 

Net impairment losses on securities

 

 

 -

 

 

Stock-based compensation

 

 

29 

 

 

37 

Depreciation and amortization

 

 

48 

 

 

51 

Premium amortization, net, on securities available for sale and securities held to maturity

 

 

27 

 

 

44 

Other

 

 

 

 

Net change in:

 

 

 

 

 

 

Cash and investments segregated and on deposit for regulatory purposes

 

 

3,005 

 

 

1,572 

Receivables from brokers, dealers, and clearing organizations

 

 

29 

 

 

(134)

Receivables from brokerage clients

 

 

(622)

 

 

1,003 

Other securities owned

 

 

61 

 

 

91 

Other assets

 

 

(24)

 

 

(29)

Payables to brokers, dealers, and clearing organizations

 

 

293 

 

 

84 

Payables to brokerage clients

 

 

(3,025)

 

 

(3,442)

Accrued expenses and other liabilities

 

 

(81)

 

 

132 

Net cash provided by (used for) operating activities

 

 

69 

 

 

(368)

Cash Flows from Investing Activities

 

 

 

 

 

 

Purchases of securities available for sale

 

 

(4,250)

 

 

(6,703)

Proceeds from sales of securities available for sale

 

 

1,285 

 

 

 -

Principal payments on securities available for sale

 

 

1,738 

 

 

3,997 

Purchases of securities held to maturity

 

 

(2,271)

 

 

(6,031)

Principal payments on securities held to maturity

 

 

520 

 

 

1,279 

Net increase in loans to banking clients

 

 

(171)

 

 

(530)

Purchase of equipment, office facilities, and property

 

 

(53)

 

 

(49)

Other investing activities

 

 

(8)

 

 

Net cash used for investing activities

 

 

(3,210)

 

 

(8,035)

Cash Flows from Financing Activities

 

 

 

 

 

 

Net change in deposits from banking clients

 

 

2,619 

 

 

3,047 

Repayment of commercial paper

 

 

 -

 

 

(300)

Repayment of long-term debt

 

 

(2)

 

 

(2)

Dividends paid

 

 

(100)

 

 

(98)

Proceeds from stock options exercised and other

 

 

65 

 

 

25 

Other financing activities

 

 

 

 

(1)

Net cash provided by financing activities

 

 

2,586 

 

 

2,671 

Decrease in Cash and Cash Equivalents

 

 

(555)

 

 

(5,732)

Cash and Cash Equivalents at Beginning of Period

 

 

7,728 

 

 

12,663 

Cash and Cash Equivalents at End of Period

 

$

7,173 

 

$

6,931 

Supplemental Cash Flow Information

 

 

 

 

 

 

Cash paid during the period for:

 

 

 

 

 

 

Interest

 

$

40 

 

$

40 

Income taxes

 

$

51 

 

$

35 

Non-cash investing activity:

 

 

 

 

 

 

Securities purchased during the period but settled after period end

 

$

158 

 

$

 -

 

See Notes to Condensed Consolidated Financial Statements.

 

4 


 

THE CHARLES SCHWAB CORPORATION

Notes to Condensed Consolidated Financial Statements

(Tabular Amounts in Millions, Except Per Share Data, Ratios, or as Noted)

(Unaudited)

 

1.Introduction and Basis of Presentation

 

The Charles Schwab Corporation (CSC) is a savings and loan holding company engaged, through its subsidiaries, in securities brokerage, banking, money management, and financial advisory services. Charles Schwab & Co., Inc. (Schwab) is a securities broker-dealer with over 300 domestic branch offices in 45 states, as well as a branch in each of the Commonwealth of Puerto Rico and London, England. In addition, Schwab serves clients in Hong Kong through one of CSC’s subsidiaries. Other subsidiaries include Charles Schwab Bank (Schwab Bank), a federal savings bank, and Charles Schwab Investment Management, Inc. (CSIM), the investment advisor for Schwab’s proprietary mutual funds, which are referred to as the Schwab Funds®, and for Schwab’s exchange-traded funds, which are referred to as the Schwab ETFs™.

 

The accompanying unaudited condensed consolidated financial statements include CSC and its majority-owned subsidiaries (collectively referred to as the Company). Intercompany balances and transactions have been eliminated. These condensed consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States (U.S.), which require management to make certain estimates and assumptions that affect the reported amounts in the accompanying financial statements. Certain estimates relate to other-than-temporary impairment of securities available for sale and securities held to maturity, valuation of goodwill, allowance for loan losses, and legal and regulatory reserves. Actual results may differ from those estimates. These condensed consolidated financial statements reflect all adjustments that are, in the opinion of management, necessary for a fair presentation of the results for the periods presented. These adjustments are of a normal recurring nature. The Company’s results for any interim period are not necessarily indicative of results for a full year or any other interim period. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013.

 

The Company’s significant accounting policies are included in note “2 – Summary of Significant Accounting Policies” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013. There have been no significant changes to these accounting policies during the first quarter of 2014. 

 

 

2.New Accounting Standard

 

New Accounting Standard Not Yet Adopted

 

In January 2014, the Financial Accounting Standards Board issued new guidance for creditors of consumer mortgage loans, which is effective January 1, 2015. The guidance clarifies when physical possession of a property underlying a consumer mortgage loan transfers to the creditor, and therefore when a loan receivable should be derecognized and the real estate property underlying the loan should be recognized. The adoption of this new guidance is not expected to have a material impact on the Company’s financial position, results of operations, earnings per common share (EPS), or cash flows.

 

 

5 


 

THE CHARLES SCHWAB CORPORATION

Notes to Condensed Consolidated Financial Statements

(Tabular Amounts in Millions, Except Per Share Data, Ratios, or as Noted)

(Unaudited)

 

3.Securities Available for Sale and Securities Held to Maturity

 

The amortized cost, gross unrealized gains and losses, and fair value of securities available for sale and securities held to maturity are as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

  

 

 

  

Gross

  

Gross

 

 

 

 

 

Amortized

 

Unrealized

 

Unrealized

 

Fair

March 31, 2014

 

Cost

 

Gains

 

Losses

 

Value

Securities available for sale:

  

 

 

  

 

 

  

 

 

 

 

 

U.S. agency mortgage-backed securities

  

$

18,404 

  

$

168 

  

$

38 

  

$

18,534 

Asset-backed securities

  

 

16,642 

  

 

91 

  

 

  

 

16,725 

Corporate debt securities

  

 

9,043 

  

 

53 

  

 

  

 

9,087 

U.S. agency notes

  

 

4,490 

  

 

  

 

81 

  

 

4,410 

Certificates of deposit

  

 

3,424 

  

 

  

 

  

 

3,426 

Non-agency residential mortgage-backed securities

  

 

593 

  

 

13 

  

 

28 

  

 

578 

Non-agency commercial mortgage-backed securities

 

 

312 

 

 

 

 

 -

 

 

320 

Total securities available for sale

  

$

52,908 

  

$

338 

  

$

166 

  

$

53,080 

Securities held to maturity:

  

 

 

  

 

 

  

 

 

 

 

 

U.S. agency mortgage-backed securities

  

$

31,066 

 

$

219 

 

$

627 

 

$

30,658 

Non-agency commercial mortgage-backed securities

 

 

957 

 

 

 

 

47 

 

 

911 

Other securities

  

 

100 

 

 

 -

 

 

 -

 

 

100 

Total securities held to maturity

  

$

32,123 

 

$

220 

 

$

674 

 

$

31,669 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

  

 

 

 

Gross

 

Gross

 

 

 

 

 

Amortized

 

Unrealized

 

Unrealized

 

Fair

December 31, 2013

 

Cost

 

Gains

 

Losses

 

Value

Securities available for sale:

  

 

 

 

  

 

 

 

  

 

 

 

U.S. agency mortgage-backed securities

  

$

18,554 

  

$

140 

 

$

49 

 

$

18,645 

Asset-backed securities

  

 

15,201 

  

 

42 

 

 

37 

 

 

15,206 

Corporate debt securities

  

 

8,973 

  

 

49 

 

 

15 

 

 

9,007 

U.S. agency notes

  

 

4,239 

  

 

 

 

104 

 

 

4,136 

Certificates of deposit

  

 

3,650 

  

 

 

 

 

 

3,652 

Non-agency residential mortgage-backed securities

  

 

616 

  

 

11 

 

 

34 

 

 

593 

Non-agency commercial mortgage-backed securities

 

 

271 

 

 

 

 

 -

 

 

279 

Other securities

  

 

100 

  

 

 -

 

 

 -

 

 

100 

Total securities available for sale

  

$

51,604 

  

$

255 

 

$

241 

 

$

51,618 

Securities held to maturity:

  

 

 

 

 

 

 

 

 

 

 

 

U.S. agency mortgage-backed securities

  

$

29,260 

  

$

161 

 

$

921 

 

$

28,500 

Non-agency commercial mortgage-backed securities

 

 

958 

 

 

 -

 

 

68 

 

 

890 

Other securities

  

 

100 

  

 

 -

 

 

 -

 

 

100 

Total securities held to maturity

  

$

30,318 

  

$

161 

 

$

989 

 

$

29,490 

 

Schwab Bank pledges securities issued by federal agencies to secure certain trust deposits. The fair value of these pledged securities was $131 million at March 31, 2014.

6 


 

THE CHARLES SCHWAB CORPORATION

Notes to Condensed Consolidated Financial Statements

(Tabular Amounts in Millions, Except Per Share Data, Ratios, or as Noted)

(Unaudited)

 

A summary of securities with unrealized losses, aggregated by category and period of continuous unrealized loss, is as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

  

Less than

 

12 months

  

 

 

 

 

 

 

 

12 months

 

or longer

 

Total

 

  

Fair

  

Unrealized

 

Fair

  

Unrealized

  

Fair

  

Unrealized

March 31, 2014

 

Value

 

Losses

 

Value

 

Losses

 

Value

 

Losses

Securities available for sale:

  

 

 

  

 

 

 

 

 

  

 

 

  

 

 

  

 

 

U.S agency mortgage-backed securities

  

$

6,119 

  

$

37 

  

$

176 

  

$

  

$

6,295 

  

$

38 

Asset-backed securities

 

 

1,887 

 

 

 

 

769 

 

 

 

 

2,656 

 

 

Corporate debt securities

  

 

1,180 

  

 

  

 

400 

  

 

  

 

1,580 

  

 

U.S. agency notes

  

 

3,909 

  

 

81 

  

 

 -

  

 

 -

  

 

3,909 

  

 

81 

Certificates of deposit

  

 

1,050 

  

 

 -

  

 

98 

  

 

  

 

1,148 

  

 

Non-agency residential mortgage-backed

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

securities

  

 

59 

  

 

  

 

352 

  

 

27 

  

 

411 

  

 

28 

Total

  

$

14,204 

  

$

132 

  

$

1,795 

  

$

34 

  

$

15,999 

  

$

166 

Securities held to maturity:

  

 

 

  

 

 

 

 

 

  

 

 

  

 

 

  

 

 

U.S. agency mortgage-backed securities

  

$

15,147 

  

$

438 

  

$

2,591 

  

$

189 

  

$

17,738 

  

$

627 

Non-agency commercial mortgage-backed

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

securities

 

 

444 

 

 

23 

 

 

338 

 

 

24 

 

 

782 

 

 

47 

Total

  

$

15,591 

  

$

461 

  

$

2,929 

  

$

213 

  

$

18,520 

  

$

674 

Total securities with unrealized losses (1)

  

$

29,795 

  

$

593 

  

$

4,724 

  

$

247 

  

$

34,519 

  

$

840 

 

(1)

The number of investment positions with unrealized losses totaled 264 for securities available for sale and 154 for securities held to maturity.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

  

Less than

 

12 months

 

 

 

 

  

 

 

 

12 months

 

or longer

 

Total

 

  

Fair

 

Unrealized

 

Fair

 

Unrealized

 

Fair

 

Unrealized

December 31, 2013

 

Value

 

Losses

 

Value

 

Losses

 

Value

 

Losses

Securities available for sale:

  

 

 

 

  

 

 

 

  

 

 

 

  

 

 

 

  

 

U.S. agency mortgage-backed securities

 

$

5,044 

 

$

47 

 

$

93 

 

$

 

$

5,137 

 

$

49 

Asset-backed securities

  

 

6,391 

  

 

33 

 

 

591 

 

 

  

 

6,982 

  

 

37 

Corporate debt securities

  

 

1,802 

  

 

14 

 

 

499 

 

 

  

 

2,301 

  

 

15 

U.S. agency notes

  

 

3,636 

  

 

104 

 

 

 -

 

 

 -

  

 

3,636 

  

 

104 

Certificates of deposit

  

 

 -

  

 

 -

 

 

299 

 

 

  

 

299 

  

 

Non-agency residential mortgage-backed

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

securities

  

 

89 

  

 

 

 

374 

 

 

32 

  

 

463 

  

 

34 

Total

  

$

16,962 

  

$

200 

 

$

1,856 

 

$

41 

  

$

18,818 

  

$

241 

Securities held to maturity:

  

 

 

 

 

 

 

 

 

 

 

 

  

 

 

 

 

 

U.S. agency mortgage-backed securities

 

$

19,175 

 

$

698 

 

$

2,345 

 

$

223 

 

$

21,520 

 

$

921 

Non-agency commercial mortgage-backed

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

securities

  

 

630 

  

 

43 

 

 

260 

 

 

25 

  

 

890 

  

 

68 

Total

  

$

19,805 

  

$

741 

 

$

2,605 

 

$

248 

  

$

22,410 

  

$

989 

Total securities with unrealized losses (1)

  

$

36,767 

  

$

941 

 

$

4,461 

 

$

289 

  

$

41,228 

  

$

1,230 

 

(1)

The number of investment positions with unrealized losses totaled 273 for securities available for sale and 193 for securities held to maturity.

 

Non-agency residential mortgage-backed securities include securities collateralized by loans that are considered to be “Prime” (defined as loans to borrowers with a Fair Isaac Corporation (FICO) credit score of 620 or higher at origination), and “Alt-A” (defined as Prime loans with reduced documentation at origination). Management determined that it does not expect to recover all of the amortized cost of certain of its Alt-A and Prime residential mortgage-backed securities and therefore determined that these securities were other-than-temporarily impaired (OTTI). The Company does not intend to sell these

7 


 

THE CHARLES SCHWAB CORPORATION

Notes to Condensed Consolidated Financial Statements

(Tabular Amounts in Millions, Except Per Share Data, Ratios, or as Noted)

(Unaudited)

 

securities and it is not “more likely than not” that the Company will be required to sell these securities before anticipated recovery of the unrealized losses on these securities. The Company may recognize an impairment charge equal to the securities’ expected credit losses based on the Company’s cash flow projections for these securities. The expected credit losses are measured as the difference between the present value of expected cash flows and the amortized cost of the securities. There were no impairment charges recognized during the first quarter of 2014. Further deterioration in the performance of the underlying loans in the Company’s non-agency residential mortgage-backed securities portfolio could result in the recognition of impairment losses.

 

The following table is a rollforward of the amount of credit losses recognized in earnings for OTTI securities held by the Company during the period for which a portion of the impairment was recognized in or reclassified from other comprehensive income:

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

 

March 31,

 

 

2014

  

2013

Balance at beginning of period

 

$

169 

  

$

159 

Credit losses recognized into current period earnings on debt securities for

 

 

 

 

 

 

which an other-than-temporary impairment was not previously recognized

 

 

 -

  

 

 -

Credit losses recognized into current period earnings on debt securities for

 

 

 

 

 

 

which an other-than-temporary impairment was previously recognized

 

 

 -

  

 

Balance at end of period

 

$

169 

  

$

163 

 

The maturities of securities available for sale and securities held to maturity at March 31, 2014, are as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

  

After 1 year

  

After 5 years

  

 

 

  

 

 

 

 

Within

 

through

 

through

 

After

 

 

 

 

 

1 year

 

5 years

 

10 years

 

10 years

 

Total

Securities available for sale:

 

 

 

  

 

 

  

 

 

  

 

 

  

 

 

U.S. agency mortgage-backed securities (1)

 

$

 -

  

$

1,005 

  

$

4,015 

  

$

13,514 

  

$

18,534 

Asset-backed securities

 

 

 -

  

 

1,513 

  

 

4,109 

  

 

11,103 

  

 

16,725 

Corporate debt securities

 

 

1,065 

  

 

8,022 

  

 

 -

  

 

 -

  

 

9,087 

U.S. agency notes

 

 

 -

  

 

4,410 

  

 

 -

  

 

 -

  

 

4,410 

Certificates of deposit

 

 

1,502 

  

 

1,924 

  

 

 -

  

 

 -

  

 

3,426 

Non-agency residential mortgage-backed

 

 

 

  

 

 

  

 

 

  

 

 

  

 

 

securities (1)

 

 

 -

 

 

 

 

 -

 

 

575 

 

 

578 

Non-agency commercial mortgage-backed

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

securities (1)

 

 

 -

 

 

 -

 

 

 -

 

 

320 

 

 

320 

Total fair value

 

$

2,567 

  

$

16,877 

  

$

8,124 

  

$

25,512 

  

$

53,080 

Total amortized cost

 

$

2,560 

  

$

16,907 

  

$

8,047 

  

$

25,394 

  

$

52,908 

Securities held to maturity:

 

 

 

  

 

 

  

 

 

  

 

 

  

 

 

U.S. agency mortgage-backed securities (1)

 

$

 -

  

$

609 

  

$

13,036 

  

$

17,013 

  

$

30,658 

Non-agency commercial mortgage-backed

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

securities (1)

 

 

 -

 

 

 -

 

 

344 

 

 

567 

 

 

911 

Other securities

 

 

100 

  

 

 -

  

 

 -

  

 

 -

  

 

100 

Total fair value

 

$

100 

  

$

609 

  

$

13,380 

  

$

17,580 

  

$

31,669 

Total amortized cost

 

$

100 

  

$

601 

  

$

13,717 

  

$

17,705 

  

$

32,123 

 

(1)

Mortgage-backed securities have been allocated to maturity groupings based on final contractual maturities. Actual maturities will differ from final contractual maturities because borrowers on a certain portion of loans underlying these securities have the right to prepay their obligations.

 

8 


 

THE CHARLES SCHWAB CORPORATION

Notes to Condensed Consolidated Financial Statements

(Tabular Amounts in Millions, Except Per Share Data, Ratios, or as Noted)

(Unaudited)

 

Proceeds and gross realized gains from sales of securities available for sale are as follows:

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

 

March 31,

 

 

2014

 

2013

Proceeds

 

$

1,285 

  

$

 -

Gross realized gains

 

$

 

$

 -

 

 

 

4.Loans to Banking Clients and Related Allowance for Loan Losses

 

The composition of loans to banking clients by loan segment is as follows:

 

 

 

 

 

 

 

 

 

 

March 31,

 

December 31,

 

 

2014

 

2013

Residential real estate mortgages

 

$

8,050 

  

$

8,006 

Home equity lines of credit

 

 

3,018 

  

 

3,041 

Personal loans secured by securities

 

 

1,536 

  

 

1,384 

Other

 

 

35 

  

 

36 

Total loans to banking clients (1)

 

 

12,639 

  

 

12,467 

Allowance for loan losses

 

 

(48)

 

 

(48)

Total loans to banking clients – net

 

$

12,591 

  

$

12,419 

 

(1)

All loans are evaluated for impairment by loan segment.

 

The Company has commitments to extend credit related to unused home equity lines of credit (HELOCs), personal loans secured by securities, and other lines of credit, which totaled $5.9 billion and $5.7 billion at March 31, 2014 and December 31, 2013, respectively. All of the personal loans were fully collateralized by securities with fair values in excess of borrowings at March 31, 2014 and December 31, 2013.

 

Changes in the allowance for loan losses were as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

March 31, 2014

 

 

March 31, 2013

 

Residential

 

 

 

 

 

 

 

 

 

 

Residential

 

 

 

 

 

 

 

 

 

real estate

 

Home equity

 

 

 

 

 

real estate

 

Home equity

 

 

 

 

mortgages

 

lines of credit

 

Total

 

 

mortgages

 

lines of credit

 

Total

Balance at beginning of period

$

34 

  

 

$

14 

 

  

$

48 

  

 

$

36 

  

 

$

20 

 

  

$

56 

Charge-offs

 

(1)

 

 

 

(1)

 

 

 

(2)

 

 

 

(2)

 

 

 

(2)

 

 

 

(4)

Recoveries

 

 -

  

 

 

 

  

 

  

 

 

  

 

 

 -

 

  

 

Provision for loan losses

 

 -

  

 

 

 

  

 

  

 

 

  

 

 

 

  

 

Balance at end of period

$

33 

  

 

$

15 

 

  

$

48 

  

 

$

40 

  

 

$

19 

 

  

$

59 

 

Included in the loan portfolio are nonaccrual loans totaling $40 million and $48 million at March 31, 2014 and December 31, 2013, respectively. There were no loans accruing interest that were contractually 90 days or more past due at March 31, 2014 or December 31, 2013. Nonperforming assets, which include nonaccrual loans and other real estate owned, totaled $46 million and $53 million at March 31, 2014 and December 31, 2013, respectively. Troubled debt restructurings were not material at March 31, 2014 or December 31, 2013.

 

Schwab Bank provides a co-branded loan origination program for Schwab Bank clients (the Program) with Quicken Loans, Inc. (Quicken® Loans®). Pursuant to the Program, Quicken Loans originates and services first lien residential real estate mortgage loans (First Mortgages) and HELOCs for Schwab Bank clients. Under the Program, Schwab Bank purchases certain First Mortgages and HELOCs that are originated by Quicken Loans. Schwab Bank sets the underwriting guidelines and pricing for all loans it intends to purchase for its portfolio. Schwab Bank purchased First Mortgages of $286 million and $1.3 billion during the first quarters of 2014 and 2013, respectively. Schwab Bank purchased HELOCs with commitments of

9 


 

THE CHARLES SCHWAB CORPORATION

Notes to Condensed Consolidated Financial Statements

(Tabular Amounts in Millions, Except Per Share Data, Ratios, or as Noted)

(Unaudited)

 

$172 million and $218 million during the first quarters of 2014 and 2013, respectively. The First Mortgages purchased under the Program are included in the First mortgages loan class in the tables below.

 

The delinquency analysis by loan class is as follows: 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

  

 

 

  

 

 

 

 

 

>90 days past

 

 

 

  

 

 

 

 

 

 

30-59 days

 

 

60-89 days

 

 

due and other

 

Total

 

Total

March 31, 2014

Current

 

past due

 

 

past due

 

 

nonaccrual loans

 

past due

 

loans

Residential real estate mortgages:

 

 

  

 

 

  

 

 

 

 

 

 

 

 

  

 

 

 

  

 

 

First mortgages

$

7,856 

  

$

  

 

$

 

 

 

$

25 

  

 

$

33 

  

$

7,889 

Purchased first mortgages

 

155 

  

 

  

 

 

 -

 

 

 

 

  

 

 

  

 

161 

Home equity lines of credit

 

3,004 

  

 

  

 

 

 

 

 

 

10 

  

 

 

14 

  

 

3,018 

Personal loans secured by securities

 

1,533 

  

 

  

 

 

 -

 

 

 

 

 -

  

 

 

  

 

1,536 

Other

 

35 

  

 

 -

  

 

 

 -

 

 

 

 

 -

  

 

 

 -

  

 

35 

Total loans to banking clients

$

12,583 

  

$

13 

  

 

$

 

 

 

$

40 

  

 

$

56 

  

$

12,639 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

  

 

 

 

 

 

 

 

 

>90 days past

 

 

 

  

 

 

 

 

 

 

30-59 days

  

 

60-89 days

 

 

due and other

 

Total

 

Total

December 31, 2013

Current

 

past due

 

 

past due

 

 

nonaccrual loans

 

past due

 

loans

Residential real estate mortgages:

 

 

  

 

 

  

 

 

 

 

 

 

 

 

  

 

 

 

  

 

 

First mortgages

$

7,808 

  

$

  

 

$

 

 

 

$

30 

  

 

$

37 

  

$

7,845 

Purchased first mortgages

 

154 

  

 

  

 

 

 -

 

 

 

 

  

 

 

  

 

161 

Home equity lines of credit

 

3,025 

  

 

  

 

 

 

 

 

 

12 

  

 

 

16 

  

 

3,041 

Personal loans secured by securities

 

1,384 

  

 

 -

  

 

 

 -

 

 

 

 

 -

  

 

 

 -

  

 

1,384 

Other

 

36 

  

 

 -

  

 

 

 -

 

 

 

 

 -

  

 

 

 -

  

 

36 

Total loans to banking clients

$

12,407 

  

$

  

 

$

 

 

 

$

48 

  

 

$

60 

  

$

12,467 

 

In addition to monitoring delinquency, the Company monitors the credit quality of residential real estate mortgages and HELOCs by stratifying the portfolios by the year of origination, borrower FICO scores at origination (Origination FICO), updated borrower FICO scores (Updated FICO), loan-to-value (LTV) ratios at origination (Origination LTV), and estimated current LTV ratios (Estimated Current LTV), as presented in the following tables. Borrowers’ FICO scores are provided by an independent third party credit reporting service and were last updated in March 2014. The Origination LTV and Estimated Current LTV ratios for a HELOC include any first lien mortgage outstanding on the same property at the time of the HELOC’s origination. The Estimated Current LTV for each loan is estimated by reference to a home price appreciation index.

 

10 


 

THE CHARLES SCHWAB CORPORATION

Notes to Condensed Consolidated Financial Statements

(Tabular Amounts in Millions, Except Per Share Data, Ratios, or as Noted)

(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential real estate mortgages

 

 

 

 

 

 

 

First

Purchased

 

 

 

 

Home equity

 

March 31, 2014

mortgages

first mortgages

 

Total

 

lines of credit

 

Year of origination

 

 

 

 

 

 

 

  

 

 

 

 

 

 

 

 

 

Pre-2010

 

$

818 

 

 

$

53 

  

 

$

871 

 

 

$

2,246 

 

 

2010

 

 

479 

 

 

 

  

 

 

486 

 

 

 

189 

 

 

2011

 

 

694 

 

 

 

36 

  

 

 

730 

 

 

 

151 

 

 

2012

 

 

2,333 

 

 

 

26 

  

 

 

2,359 

 

 

 

157 

 

 

2013

 

 

3,304 

 

 

 

36 

 

 

 

3,340 

 

 

 

239 

 

 

2014

 

 

261 

 

 

 

 

 

 

264 

 

 

 

36 

 

 

Total

 

$

7,889 

 

 

$

161 

  

 

$

8,050 

 

 

$

3,018 

 

 

Origination FICO

 

 

 

 

 

 

 

  

 

 

 

 

 

 

 

 

 

<620

 

$

10 

 

 

$

  

 

$

11 

 

 

$

 

 

620 – 679

 

 

94 

 

 

 

13 

  

 

 

107 

 

 

 

19 

 

 

680 – 739

 

 

1,361 

 

 

 

32 

  

 

 

1,393 

 

 

 

571 

 

 

>740

 

 

6,424 

 

 

 

115 

  

 

 

6,539 

 

 

 

2,427 

 

 

Total

 

$

7,889 

 

 

$

161 

  

 

$

8,050 

 

 

$

3,018 

 

 

Updated FICO

 

 

 

 

 

 

 

  

 

 

 

 

 

 

 

 

 

<620

 

$

54 

 

 

$

  

 

$

59 

 

 

$

38 

 

 

620 – 679

 

 

188 

 

 

 

  

 

 

196 

 

 

 

111 

 

 

680 – 739

 

 

1,017 

 

 

 

27 

  

 

 

1,044 

 

 

 

447 

 

 

>740

 

 

6,630 

 

 

 

121 

  

 

 

6,751 

 

 

 

2,422 

 

 

Total

 

$

7,889 

 

 

$

161 

  

 

$

8,050 

 

 

$

3,018 

 

 

Origination LTV

 

 

 

 

 

 

 

  

 

 

 

 

 

 

 

 

 

<70%

 

$

5,352 

 

 

$

111 

  

 

$

5,463 

 

 

$

2,017 

 

 

>70% – <90%

 

 

2,521 

 

 

 

45 

  

 

 

2,566 

 

 

 

977 

 

 

>90% – <100%

 

 

16 

 

 

 

  

 

 

21 

 

 

 

24 

 

 

Total

 

$

7,889 

 

 

$

161 

  

 

$

8,050 

 

 

$

3,018 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted

 

 

 

 

Percent of Loans

 

 

 

 

 

 

Average

 

Utilization

 

that are on

March 31, 2014

 

Balance

 

 

Updated FICO

 

Rate (1)  

 

Nonaccrual Status

Residential real estate mortgages:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Estimated Current LTV

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

<70%

 

$

6,742 

  

 

 

776 

 

 

  

N/A 

  

 

 

0.06 

 

>70% – <90%

 

 

1,140 

  

 

 

765 

 

 

  

N/A 

  

 

 

0.28 

 

>90% – <100%

 

 

77 

  

 

 

739 

 

 

  

N/A 

  

 

 

2.53 

 

>100%

 

 

91 

  

 

 

728 

 

 

  

N/A 

  

 

 

11.43 

 

Total

 

$

8,050 

  

 

 

774 

 

 

  

N/A 

  

 

 

0.24 

 

Home equity lines of credit:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Estimated Current LTV

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

<70%

 

$

2,146 

  

 

 

774 

 

 

  

36 

 

 

0.06 

 

>70% – <90%

 

 

651 

  

 

 

764 

 

 

  

47 

 

 

0.28 

 

>90% – <100%

 

 

116 

  

 

 

754 

 

 

  

59 

 

 

0.47 

 

>100%

 

 

105 

  

 

 

743 

 

 

  

61 

 

 

2.23 

 

Total

 

$

3,018 

  

 

 

770 

 

 

  

39 

 

 

0.20 

 

 

(1)

The Utilization Rate is calculated using the outstanding HELOC balance divided by the associated total line of credit.

N/A Not applicable.

11 


 

THE CHARLES SCHWAB CORPORATION

Notes to Condensed Consolidated Financial Statements

(Tabular Amounts in Millions, Except Per Share Data, Ratios, or as Noted)

(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential real estate mortgages

 

 

 

 

 

 

 

First

Purchased

 

 

 

 

Home equity

 

December 31, 2013

mortgages

first mortgages

 

Total

 

lines of credit

 

Year of origination

 

 

 

 

 

 

 

  

 

 

 

 

 

 

 

 

 

Pre-2010

 

$

859 

 

 

$

55 

 

 

$

914 

 

 

$

2,304 

 

 

2010

 

 

503 

 

 

 

 

 

 

510 

 

 

 

191 

 

 

2011

 

 

733 

 

 

 

38 

 

 

 

771 

 

 

 

155 

 

 

2012

 

 

2,403 

 

 

 

26 

 

 

 

2,429 

 

 

 

162 

 

 

2013

 

 

3,347 

 

 

 

35 

 

 

 

3,382 

 

 

 

229 

 

 

Total

 

$

7,845 

 

 

$

161 

 

 

$

8,006 

 

 

$

3,041 

 

 

Origination FICO

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

<620

 

$

10 

 

 

$

 

 

$

11 

 

 

$

 -

 

 

620 – 679

 

 

96 

 

 

 

14 

 

 

 

110 

 

 

 

20 

 

 

680 – 739

 

 

1,352 

 

 

 

32 

 

 

 

1,384 

 

 

 

576 

 

 

>740

 

 

6,387 

 

 

 

114 

 

 

 

6,501 

 

 

 

2,445 

 

 

Total

 

$

7,845 

 

 

$

161 

 

 

$

8,006 

 

 

$

3,041 

 

 

Updated FICO

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

<620

 

$

50 

 

 

$

 

 

$

55 

 

 

$

42 

 

 

620 – 679

 

 

209 

 

 

 

10 

 

 

 

219 

 

 

 

106 

 

 

680 – 739

 

 

1,012 

 

 

 

29 

 

 

 

1,041 

 

 

 

453 

 

 

>740

 

 

6,574 

 

 

 

117 

 

 

 

6,691 

 

 

 

2,440 

 

 

Total

 

$

7,845 

 

 

$

161 

 

 

$

8,006 

 

 

$

3,041 

 

 

Origination LTV

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

<70%

 

$

5,306 

 

 

$

110 

 

 

$

5,416 

 

 

$

2,040 

 

 

>70% – <90%

 

 

2,523 

 

 

 

45 

 

 

 

2,568 

 

 

 

977 

 

 

>90% – <100%

 

 

16 

 

 

 

 

 

 

22 

 

 

 

24 

 

 

Total

 

$

7,845 

 

 

$

161 

 

 

$

8,006 

 

 

$

3,041 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted

 

 

 

 

 

Percent of Loans

 

 

 

 

 

Average

 

 

Utilization

 

that are on

December 31, 2013

 

Balance

 

Updated FICO

 

 

Rate (1)  

 

Nonaccrual Status

Residential real estate mortgages:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Estimated Current LTV

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

<70%

 

$

6,649 

 

 

 

775 

 

 

 

N/A 

 

 

 

0.05 

 

>70% – <90%

 

 

1,181 

 

 

 

763 

 

 

 

N/A 

 

 

 

0.34 

 

>90% – <100%

 

 

86 

 

 

 

732 

 

 

 

N/A 

 

 

 

4.77 

 

>100%

 

 

90 

 

 

 

730 

 

 

 

N/A 

 

 

 

10.50 

 

Total

 

$

8,006 

 

 

 

772 

 

 

 

N/A 

 

 

 

0.26 

 

Home equity lines of credit:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Estimated Current LTV

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

<70%

 

$

2,127 

 

 

 

773 

 

 

 

36 

 

 

0.13 

 

>70% – <90%

 

 

664 

 

 

 

762 

 

 

 

48 

 

 

0.22 

 

>90% – <100%

 

 

127 

 

 

 

752 

 

 

 

59 

 

 

1.22 

 

>100%

 

 

123 

 

 

 

743 

 

 

 

63 

 

 

1.34 

 

Total

 

$

3,041 

 

 

 

769 

 

 

 

39 

 

 

0.24 

 

 

(1)

The Utilization Rate is calculated using the outstanding HELOC balance divided by the associated total line of credit.

N/A Not applicable.

 

 

12 


 

THE CHARLES SCHWAB CORPORATION

Notes to Condensed Consolidated Financial Statements

(Tabular Amounts in Millions, Except Per Share Data, Ratios, or as Noted)

(Unaudited)

 

5.Commitments and Contingencies

 

The Company has clients that sell (i.e., write) listed option contracts that are cleared by the Options Clearing Corporation – a clearing house that establishes margin requirements on these transactions. The Company partially satisfies the margin requirements by arranging unsecured standby letter of credit agreements (LOCs), in favor of the Options Clearing Corporation, which are issued by multiple banks. At March 31, 2014, the aggregate face amount of these LOCs totaled $240 million. There were no funds drawn under any of these LOCs at March 31, 2014. In connection with its securities lending activities, the Company is required to provide collateral to certain brokerage clients. The Company satisfies the collateral requirements by providing cash as collateral. 

 

The Company also provides guarantees to securities clearing houses and exchanges under standard membership agreements, which require members to guarantee the performance of other members. Under the agreements, if another member becomes unable to satisfy its obligations to the clearing houses and exchanges, other members would be required to meet shortfalls. The Company’s liability under these arrangements is not quantifiable and may exceed the cash and securities it has posted as collateral. However, the potential requirement for the Company to make payments under these arrangements is remote. Accordingly, no liability has been recognized for these guarantees.

 

Legal contingencies: The Company is subject to claims and lawsuits in the ordinary course of business, including arbitrations, class actions and other litigation, some of which include claims for substantial or unspecified damages. The Company is also the subject of inquiries, investigations, and proceedings by regulatory and other governmental agencies.

 

The Company believes it has strong defenses in all significant matters currently pending and is contesting liability and any damages claimed. Nevertheless, some of these matters may result in adverse judgments or awards, including penalties, injunctions or other relief, and the Company may also determine to settle a matter because of the uncertainty and risks of litigation. Described below are certain matters in which there is a reasonable possibility that a material loss could be incurred or where the matter may otherwise be of significant interest to stockholders. With respect to all other pending matters, based on current information and consultation with counsel, it does not appear that the outcome of any such matter could be material to the financial condition, operating results or cash flows of the Company. However, predicting the outcome of a litigation or regulatory matter is inherently difficult, requiring significant judgment and evaluation of various factors, including the procedural status of the matter and any recent developments; prior experience and the experience of others in similar cases; available defenses, including potential opportunities to dispose of a case on the merits or procedural grounds before trial (e.g., motions to dismiss or for summary judgment); the progress of fact discovery; the opinions of counsel and experts regarding potential damages; potential opportunities for settlement and the status of any settlement discussions; and potential insurance coverage and indemnification. Often, as in the case of the Auction Rate Securities Regulatory Inquiries and Total Bond Market Fund Litigation matters described below, it is not possible to reasonably estimate potential liability, if any, or a range of potential liability until the matter is closer to resolution – pending, for example, further proceedings, the outcome of key motions or appeals, or discussions among the parties. Numerous issues may have to be developed, such as discovery of important factual matters and determination of threshold legal issues, which may include novel or unsettled questions of law. Reserves are established or adjusted or further disclosure and estimates of potential loss are provided as the matter progresses and more information becomes available.

 

Auction Rate Securities Regulatory Inquiries: Schwab has been responding to industry wide inquiries from federal and state regulators regarding sales of auction rate securities to clients who were unable to sell their holdings when the normal auction process for those securities froze unexpectedly in February 2008. On August 17, 2009, a civil complaint was filed against Schwab in New York state court by the Attorney General of the State of New York (NYAG) alleging material misrepresentations and omissions by Schwab regarding the risks of auction rate securities, and seeking restitution, disgorgement, penalties and other relief, including repurchase of securities held in client accounts. As reflected in a statement issued August 17, 2009, Schwab has responded that the allegations are without merit, and has been contesting all charges. By order dated October 24, 2011, the court granted Schwab’s motion to dismiss the complaint with prejudice. The NYAG appealed, and in a decision issued August 29, 2013, the Appellate Division reinstated two of the NYAG’s four causes of action. A petition by the NYAG for reconsideration of part of the Appellate Division’s decision was denied, and the NYAG has now filed notice with the trial court of its intention to proceed on the remaining two causes of action.

 

Total Bond Market Fund Litigation: On August 28, 2008, a class action lawsuit was filed in the U.S. District Court for the Northern District of California on behalf of investors in the Schwab Total Bond Market Fund™ (Northstar lawsuit). The lawsuit, which alleges violations of state law and federal securities law in connection with the fund’s investment policy,

13 


 

THE CHARLES SCHWAB CORPORATION

Notes to Condensed Consolidated Financial Statements

(Tabular Amounts in Millions, Except Per Share Data, Ratios, or as Noted)

(Unaudited)

 

names Schwab Investments (registrant and issuer of the fund’s shares) and CSIM as defendants. Allegations include that the fund improperly deviated from its stated investment objectives by investing in collateralized mortgage obligations (CMOs) and investing more than 25% of fund assets in CMOs and mortgage-backed securities without obtaining a shareholder vote. Plaintiffs seek unspecified compensatory and rescission damages, unspecified equitable and injunctive relief, costs and attorneys’ fees. Plaintiffs’ federal securities law claim and certain of plaintiffs’ state law claims were dismissed in proceedings before the court and following a successful petition by defendants to the Ninth Circuit Court of Appeals. On August 8, 2011, the court dismissed plaintiffs’ remaining claims with prejudice. Plaintiffs have again appealed to the Ninth Circuit, where the case is currently pending.

 

Other Regulatory Matters:  A subsidiary of optionsXpress Holdings, Inc. (optionsXpress) and an individual employee are respondents in a pending regulatory matter which predates the Company’s acquisition of optionsXpress. On April 16, 2012, optionsXpress, Inc., a securities broker-dealer and wholly-owned subsidiary of optionsXpress, was charged by the SEC in an administrative proceeding alleging violations of the firm’s close-out obligations under Regulation SHO (short sale delivery rules) in connection with certain customer trading activity. Following trial, in a decision issued June 7, 2013, the judge held that optionsXpress, Inc. violated Regulation SHO and aided and abetted fraudulent trading activity by its customer, and ordered the firm to pay disgorgement and penalties. The Company continues to dispute the allegations and is appealing the decision.  The Company has a contingent liability associated with this matter, which was not material at March 31, 2014.

 

 

6.Fair Values of Assets and Liabilities

 

For a description of the fair value hierarchy and the Company’s fair value methodologies, including the use of independent third-party pricing services, see note “2 – Summary of Significant Accounting Policies” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013. There were no significant changes in these methodologies during the quarter ended March 31, 2014. The Company did not transfer any assets or liabilities between Level 1 and Level 2 during the quarter ended March 31, 2014, or the year ended December 31, 2013. In addition, the Company did not adjust prices received from the primary independent third-party pricing service at March 31, 2014 or December 31, 2013.

 

14 


 

THE CHARLES SCHWAB CORPORATION

Notes to Condensed Consolidated Financial Statements

(Tabular Amounts in Millions, Except Per Share Data, Ratios, or as Noted)

(Unaudited)

 

Financial Instruments Recorded at Fair Value

 

The following tables present the fair value hierarchy for assets measured at fair value. Liabilities recorded at fair value were not material, and therefore are not included in the following tables:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Quoted Prices

 

 

 

  

 

 

 

in Active Markets

 

Significant

 

Significant

 

 

 

for Identical

 

Other Observable

 

Unobservable

 

 

 

Assets

 

Inputs

 

Inputs

 

Balance at

March 31, 2014

(Level 1)

 

(Level 2)

 

(Level 3)

 

Fair Value

Cash equivalents:

 

 

 

  

 

 

 

 

 

 

  

 

 

 

 

 

 

Money market funds

 

$

1,037 

  

 

 

$

 -

 

 

  

$

 -

 

 

$

1,037 

Commercial paper

 

 

 -

  

 

 

 

14 

 

 

  

 

 -

 

 

 

14 

Total cash equivalents

 

 

1,037 

  

 

 

 

14 

 

 

  

 

 -

 

 

 

1,051 

Investments segregated and on deposit for regulatory purposes:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Certificates of deposit

 

 

 -

  

 

 

 

3,493 

 

 

  

 

 -

 

 

 

3,493 

U.S. Government securities

 

 

 -

  

 

 

 

925 

 

 

  

 

 -

 

 

 

925 

Total investments segregated and on deposit for regulatory

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

purposes

 

 

 -

  

 

 

 

4,418 

 

 

  

 

 -

 

 

 

4,418 

Other securities owned:

 

 

 

  

 

 

 

 

 

 

  

 

 

 

 

 

 

Schwab Funds® money market funds

 

 

208 

  

 

 

 

 -

 

 

  

 

 -

 

 

 

208 

Equity and bond mutual funds

 

 

200 

  

 

 

 

 -

 

 

  

 

 -

 

 

 

200 

State and municipal debt obligations

 

 

 -

  

 

 

 

33 

 

 

  

 

 -

 

 

 

33 

Equity, U.S. Government and corporate debt, and other

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

securities

 

 

  

 

 

 

14 

 

 

  

 

 -

 

 

 

15 

Total other securities owned

 

 

409 

  

 

 

 

47 

 

 

  

 

 -

 

 

 

456 

Securities available for sale:

 

 

 

  

 

 

 

 

 

 

  

 

 

 

 

 

 

U.S. agency mortgage-backed securities

 

 

 -

  

 

 

 

18,534 

 

 

  

 

 -

 

 

 

18,534 

Asset-backed securities

 

 

 -

  

 

 

 

16,725 

 

 

  

 

 -

 

 

 

16,725 

Corporate debt securities

 

 

 -

  

 

 

 

9,087 

 

 

  

 

 -

 

 

 

9,087 

U.S. agency notes

 

 

 -

  

 

 

 

4,410 

 

 

  

 

 -

 

 

 

4,410 

Certificates of deposit

 

 

 -

  

 

 

 

3,426 

 

 

  

 

 -

 

 

 

3,426 

Non-agency residential mortgage-backed securities

 

 

 -

  

 

 

 

578 

 

 

  

 

 -

 

 

 

578 

Non-agency commercial mortgage-backed securities

 

 

 -

 

 

 

 

320 

 

 

 

 

 -

 

 

 

320 

Other securities

 

 

 -

  

 

 

 

 -

 

 

  

 

 -

 

 

 

 -

Total securities available for sale

 

 

 -

  

 

 

 

53,080 

 

 

  

 

 -

 

 

 

53,080 

Total

 

$

1,446 

  

 

 

$

57,559 

 

 

  

$

 -

 

 

$

59,005 

 

15 


 

THE CHARLES SCHWAB CORPORATION

Notes to Condensed Consolidated Financial Statements

(Tabular Amounts in Millions, Except Per Share Data, Ratios, or as Noted)

(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Quoted Prices

 

 

 

  

 

 

 

in Active Markets

 

Significant

 

Significant

 

 

 

for Identical

 

Other Observable

 

    Unobservable    

 

 

 

Assets

 

Inputs

 

Inputs

 

Balance at

December 31, 2013

(Level 1)

 

(Level 2)

 

(Level 3)

 

Fair Value

Cash equivalents:

 

 

 

  

 

 

 

 

 

 

  

 

 

 

 

 

 

Money market funds

 

$

1,141 

  

 

 

$

 -

 

 

  

$

 -

 

 

$

1,141 

Commercial paper

 

 

 -

  

 

 

 

22 

 

 

  

 

 -

 

 

 

22 

Total cash equivalents

 

 

1,141 

  

 

 

 

22 

 

 

  

 

 -

 

 

 

1,163 

Investments segregated and on deposit for regulatory purposes:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Certificates of deposit

 

 

 -

  

 

 

 

2,737 

 

 

  

 

 -

 

 

 

2,737 

U.S. Government securities

 

 

 -

  

 

 

 

2,539 

 

 

  

 

 -

 

 

 

2,539 

Total investments segregated and on deposit for regulatory

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

purposes

 

 

 -

  

 

 

 

5,276 

 

 

  

 

 -

 

 

 

5,276 

Other securities owned:

 

 

 

  

 

 

 

 

 

 

  

 

 

 

 

 

 

Schwab Funds® money market funds

 

 

261 

  

 

 

 

 -

 

 

  

 

 -

 

 

 

261 

Equity and bond mutual funds

 

 

208 

  

 

 

 

 -

 

 

  

 

 -

 

 

 

208 

State and municipal debt obligations

 

 

 -

  

 

 

 

32 

 

 

  

 

 -

 

 

 

32 

Equity, U.S. Government and corporate debt, and other

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

securities

 

 

  

 

 

 

15 

 

 

  

 

 -

 

 

 

16 

Total other securities owned

 

 

470 

  

 

 

 

47 

 

 

  

 

 -

 

 

 

517 

Securities available for sale:

 

 

 

  

 

 

 

 

 

 

  

 

 

 

 

 

 

U.S. agency mortgage-backed securities

 

 

 -

  

 

 

 

18,645 

 

 

  

 

 -

 

 

 

18,645 

Asset-backed securities

 

 

 -

  

 

 

 

15,206 

 

 

  

 

 -

 

 

 

15,206 

Corporate debt securities

 

 

 -

  

 

 

 

9,007 

 

 

  

 

 -

 

 

 

9,007 

U.S. agency notes

 

 

 -

  

 

 

 

4,136 

 

 

  

 

 -

 

 

 

4,136 

Certificates of deposit

 

 

 -

  

 

 

 

3,652 

 

 

  

 

 -

 

 

 

3,652 

Non-agency residential mortgage-backed securities

 

 

 -

  

 

 

 

593 

 

 

  

 

 -

 

 

 

593 

Non-agency commercial mortgage-backed securities

 

 

 -

 

 

 

 

279 

 

 

 

 

 -

 

 

 

279 

Other securities

 

 

 -

  

 

 

 

100 

 

 

  

 

 -

 

 

 

100 

Total securities available for sale

 

 

 -

  

 

 

 

51,618 

 

 

  

 

 -

 

 

 

51,618 

Total

 

$

1,611 

  

 

 

$

56,963 

 

 

  

$

 -

 

 

$

58,574 

 

16 


 

THE CHARLES SCHWAB CORPORATION

Notes to Condensed Consolidated Financial Statements

(Tabular Amounts in Millions, Except Per Share Data, Ratios, or as Noted)

(Unaudited)

 

Financial Instruments Not Recorded at Fair Value

 

Descriptions of the valuation methodologies and assumptions used to estimate the fair value of financial instruments not recorded at fair value are also described in note “2 – Summary of Significant Accounting Policies” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013. There were no significant changes in these methodologies or assumptions during the quarter ended March 31, 2014.  The following tables present the fair value hierarchy for financial instruments not recorded at fair value:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

  

 

 

 

 

Quoted Prices

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 in Active Markets 

 

Significant

 

Significant

 

 

 

 

 

 

 

 

 

for Identical

 

Other Observable

 

Unobservable

 

 

 

 

 

 

Carrying

 

Assets

 

Inputs

 

Inputs

 

Balance at

 

March 31, 2014

 

Amount

 

(Level 1)

 

(Level 2)

 

(Level 3)

 

Fair Value

 

Assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

6,122 

 

 

$

 -

 

 

  

$

6,122 

 

 

  

$

 -

 

 

$

6,122 

  

Cash and investments segregated and

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

  

on deposit for regulatory purposes

 

 

16,127 

 

 

 

 -

 

 

  

 

16,127 

 

 

  

 

 -

 

 

 

16,127 

 

Receivables from brokers, dealers, and

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

  

clearing organizations

 

 

482 

 

 

 

 -

 

 

  

 

482 

 

 

  

 

 -

 

 

 

482 

 

Receivables from brokerage clients – net

 

 

14,566 

 

 

 

 -

 

 

  

 

14,566 

 

 

  

 

 -

 

 

 

14,566 

  

Securities held to maturity:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. agency mortgage-backed securities

 

 

31,066 

 

 

 

 -

 

 

  

 

30,658 

 

 

  

 

 -

 

 

 

30,658 

  

Non-agency commercial mortgage-backed

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

securities

 

 

957 

 

 

 

 -

 

 

  

 

911 

 

 

  

 

 -

 

 

 

911 

 

Other securities

 

 

100 

 

 

 

 -

 

 

  

 

100 

 

 

  

 

 -

 

 

 

100 

  

Total securities held to maturity

 

 

32,123 

 

 

 

 -

 

 

  

 

31,669 

 

 

  

 

 -

 

 

 

31,669 

  

Loans to banking clients: (1)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential real estate mortgages

 

 

8,050 

 

 

 

 -

 

 

  

 

7,900 

 

 

  

 

 -

 

 

 

7,900 

  

Home equity lines of credit

 

 

3,018 

 

 

 

 -

 

 

  

 

3,180 

 

 

  

 

 -

 

 

 

3,180 

  

Personal loans secured by securities

 

 

1,536 

 

 

 

 -

 

 

  

 

1,536 

 

 

  

 

 -

 

 

 

1,536 

  

Other

 

 

35 

 

 

 

 -

 

 

  

 

34 

 

 

  

 

 -

 

 

 

34 

  

Total loans to banking clients

 

 

12,639 

 

 

 

 -

 

 

  

 

12,650 

 

 

  

 

 -

 

 

 

12,650 

  

Other assets

 

 

71 

 

 

 

 -

 

 

  

 

71 

 

 

  

 

 -

 

 

 

71 

  

Total

 

$

82,130 

 

 

$

 -

 

 

  

$

81,687 

 

 

  

$

 -

 

 

$

81,687 

  

Liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Deposits from banking clients

 

$

95,591 

 

 

$

 -

 

 

  

$

95,591 

 

 

  

$

 -

 

 

$

95,591 

  

Payables to brokers, dealers, and clearing

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

  

organizations

 

 

1,918 

 

 

 

 -

 

 

  

 

1,918 

 

 

  

 

 -

 

 

 

1,918 

 

Payables to brokerage clients

 

 

32,308 

 

 

 

 -

 

 

  

 

32,308 

 

 

  

 

 -

 

 

 

32,308 

  

Accrued expenses and other liabilities

 

 

607 

 

 

 

 -

 

 

  

 

607 

 

 

  

 

 -

 

 

 

607 

  

Long-term debt

 

 

1,902 

 

 

 

 -

 

 

  

 

1,995 

 

 

  

 

 -

 

 

 

1,995 

  

Total

 

$

132,326 

 

 

$

 -

 

 

  

$

132,419 

 

 

  

$

 -

 

 

$

132,419 

  

 

(1)

The carrying value of loans to banking clients excludes the allowance for loan losses of $48 million at March 31, 2014.

 

17 


 

THE CHARLES SCHWAB CORPORATION

Notes to Condensed Consolidated Financial Statements

(Tabular Amounts in Millions, Except Per Share Data, Ratios, or as Noted)

(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

  

 

 

 

 

Quoted Prices

 

 

 

 

 

 

 

 

 

 

 

 

 

 in Active Markets 

 

Significant

 

Significant

 

 

 

 

 

 

 

 

 

for Identical

 

Other Observable

 

Unobservable

 

 

 

 

 

Carrying

 

Assets

 

Inputs

 

Inputs

 

Balance at

 

December 31, 2013

 

Amount

 

(Level 1)

 

(Level 2)

 

(Level 3)

 

Fair Value

 

Assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

6,565 

 

 

$

 -

 

 

  

$

6,565 

 

 

  

$

 -

 

 

$

6,565 

  

Cash and investments segregated and

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

  

on deposit for regulatory purposes

 

 

18,273 

 

 

 

 -

 

 

  

 

18,273 

 

 

  

 

 -

 

 

 

18,273 

 

Receivables from brokers, dealers, and

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

  

clearing organizations

 

 

509 

 

 

 

 -

 

 

  

 

509 

 

 

  

 

 -

 

 

 

509 

 

Receivables from brokerage clients – net

 

 

13,949 

 

 

 

 -

 

 

  

 

13,949 

 

 

  

 

 -

 

 

 

13,949 

  

Securities held to maturity:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. agency mortgage-backed securities

 

 

29,260 

 

 

 

 -

 

 

  

 

28,500 

 

 

  

 

 -

 

 

 

28,500 

  

Non-agency commercial mortgage-backed

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

securities

 

 

958 

 

 

 

 -

 

 

 

 

890 

 

 

 

 

 -

 

 

 

890 

 

Other securities

 

 

100 

 

 

 

 -

 

 

  

 

100 

 

 

  

 

 -

 

 

 

100 

  

Total securities held to maturity

 

 

30,318 

 

 

 

 -

 

 

  

 

29,490 

 

 

  

 

 -

 

 

 

29,490 

  

Loans to banking clients: (1)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential real estate mortgages

 

 

8,006 

 

 

 

 -

 

 

  

 

7,930 

 

 

  

 

 -

 

 

 

7,930 

  

Home equity lines of credit

 

 

3,041 

 

 

 

 -

 

 

  

 

3,043 

 

 

  

 

 -

 

 

 

3,043 

  

Personal loans secured by securities

 

 

1,384 

 

 

 

 -

 

 

  

 

1,384 

 

 

  

 

 -

 

 

 

1,384 

  

Other

 

 

36 

 

 

 

 -

 

 

  

 

35 

 

 

  

 

 -

 

 

 

35 

  

Total loans to banking clients

 

 

12,467 

 

 

 

 -

 

 

  

 

12,392 

 

 

  

 

 -

 

 

 

12,392 

  

Other assets

 

 

64 

 

 

 

 -

 

 

  

 

64 

 

 

  

 

 -

 

 

 

64 

  

Total

 

$

82,145 

 

 

$

 -

 

 

 

$

81,242 

 

 

 

$

 -

 

 

$

81,242 

  

Liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Deposits from banking clients

 

$

92,972 

 

 

$

 -

 

 

  

$

92,972 

 

 

  

$

 -

 

 

$

92,972 

  

Payables to brokers, dealers, and clearing

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

  

organizations

 

 

1,467 

 

 

 

 -

 

 

  

 

1,467 

 

 

  

 

 -

 

 

 

1,467 

 

Payables to brokerage clients

 

 

35,333 

 

 

 

 -

 

 

  

 

35,333 

 

 

  

 

 -

 

 

 

35,333 

  

Accrued expenses and other liabilities

 

 

680 

 

 

 

 -

 

 

  

 

680 

 

 

  

 

 -

 

 

 

680 

  

Long-term debt

 

 

1,903 

 

 

 

 -

 

 

  

 

1,989 

 

 

  

 

 -

 

 

 

1,989 

  

Total

 

$

132,355 

 

 

$

 -

 

 

  

$

132,441 

 

 

  

$

 -

 

 

$

132,441 

  

 

(1)

The carrying value of loans to banking clients excludes the allowance for loan losses of $48 million at December 31, 2013.

 

Securities lending: Payables from brokers, dealers, and clearing organizations include securities loaned. The Company loans client securities temporarily to other brokers in connection with its securities lending activities and receives cash as collateral for the securities loaned. The fair value of client securities pledged in securities lending transactions to other broker-dealers was $1.4 billion at March 31, 2014 and $1.1 billion at December 31, 2013.  The Company has also pledged a portion of its securities owned in connection with securities lending transactions to other broker-dealers. Additionally, the Company borrows securities from other broker-dealers to fulfill short sales by clients, which are included in receivables from brokers, dealers, and clearing organizations. The fair value of these borrowed securities was $142 million at March 31, 2014 and $276 million at December 31, 2013. All of the Company’s securities lending transactions are subject to enforceable master netting arrangements with other broker-dealers. However, the Company does not net securities lending transactions and therefore, the Company’s securities loaned and securities borrowed are presented gross in the condensed consolidated balance sheets.

 

Resale agreements: Cash and investments segregated and on deposit for regulatory purposes include securities purchased under agreements to resell (resale agreements), which are collateralized by U.S. Government and agency securities. Schwab enters into collateralized resale agreements principally with other broker-dealers, which could result in losses in the event the counterparty fails to purchase the securities held as collateral for the cash advanced and the fair value of the securities declines. Schwab utilizes the collateral provided under these resale agreements to meet obligations under broker-dealer client

18 


 

THE CHARLES SCHWAB CORPORATION

Notes to Condensed Consolidated Financial Statements

(Tabular Amounts in Millions, Except Per Share Data, Ratios, or as Noted)

(Unaudited)

 

protection rules, which place limitations on its ability to access such segregated securities. The Company’s resale agreements are not subject to master netting arrangements.

 

 

7.Accumulated Other Comprehensive Income

 

Accumulated other comprehensive income represents cumulative gains and losses that are not reflected in earnings. The components of other comprehensive income are as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended March 31,

 

 

 

 

2014

 

 

 

 

 

 

 

 

2013

 

 

 

 

 

 

Before

 

Tax

 

 

Net of

 

Before

 

Tax

 

 

Net of

 

 

tax

 

effect

 

 

tax

 

tax

 

effect

 

 

tax

Change in net unrealized gain on

 

 

 

  

 

 

 

  

 

 

 

 

 

  

 

 

 

  

 

 

securities available for sale:

 

 

 

  

 

 

 

  

 

 

 

 

 

  

 

 

 

  

 

 

Net unrealized gain (loss)

 

$

159 

  

$

(59)

 

$

100 

 

 

$

(3)

  

$

 

$

(1)

 

Reclassification of impairment charges

 

 

 

  

 

 

 

  

 

 

 

 

 

  

 

 

 

  

 

 

included in net impairment losses

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

on securities

 

 

 -

  

 

 -

 

  

 -

 

 

 

  

 

(2)

 

  

 

Other reclassifications included in

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

other revenue

 

 

(1)

 

 

 -

 

 

(1)

 

 

 

 -

 

 

 -

 

 

 -

 

Change in net unrealized gain on

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

  

 

 

securities available for sale

 

 

158 

 

 

(59)

 

 

99 

 

 

 

 

 

 -

 

 

 

Other

 

 

 -

 

 

 -

 

 

 -

 

 

 

 

 

 -

 

 

 

Other comprehensive income

 

$

158 

 

$

(59)

 

$

99 

 

 

$

 

$

 -

 

$

 

 

Accumulated other comprehensive income balances are as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

  

Net unrealized

 

 

 

 

 

 

Total

 

gain on securities

 

 

 

 

 

 

accumulated other

 

available for sale

 

Other

 

comprehensive income

Balance at December 31, 2012

 

$

299 

 

 

  

$

(1)

 

 

 

$

298 

 

Other net changes

 

 

 

 

  

 

 

 

 

 

 

Balance at March 31, 2013

 

$

300 

 

 

  

$

 -

 

 

 

$

300 

 

Balance at December 31, 2013

 

$

 

 

  

$

 -

 

 

 

$

 

Other net changes

 

 

99 

 

 

 

 

 -

 

 

 

 

99 

 

Balance at March 31, 2014

 

$

108 

 

 

 

$

 -

 

 

 

$

108 

 

 

 

 

19 


 

THE CHARLES SCHWAB CORPORATION

Notes to Condensed Consolidated Financial Statements

(Tabular Amounts in Millions, Except Per Share Data, Ratios, or as Noted)

(Unaudited)

 

8.Earnings Per Common Share

 

Basic EPS is computed by dividing net income available to common stockholders by the weighted-average number of common shares outstanding during the period. The computation of diluted EPS is similar to the computation of basic EPS except that the denominator is increased to include the number of additional common shares that would have been outstanding if dilutive potential common shares had been issued. Dilutive potential common shares include, if dilutive, the effect of outstanding stock options and unvested restricted stock awards and units. EPS under the basic and diluted computations is as follows: 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

 

March 31,

 

 

2014

 

2013

Net income

 

$

326 

  

$

206 

Preferred stock dividends

 

 

(8)

 

 

(8)

Net income available to common stockholders

 

$

318 

  

$

198 

Weighted-average common shares outstanding — basic

 

 

1,299 

  

 

1,279 

Common stock equivalent shares related to stock incentive plans

 

 

12 

  

 

Weighted-average common shares outstanding — diluted (1)

 

 

1,311 

  

 

1,282 

Basic EPS

 

$

  .24

  

$

  .15

Diluted EPS

 

$

  .24

  

$

  .15

 

(1)

Antidilutive stock options and restricted stock awards excluded from the calculation of diluted EPS totaled 17 million and 45 million shares for the first quarters of 2014 and 2013, respectively.

 

 

 

9.Regulatory Requirements

 

CSC is a savings and loan holding company and Schwab Bank, CSC’s depository institution subsidiary, is a federal savings bank. CSC is subject to supervision and regulation by the Board of Governors of the Federal Reserve System (Federal Reserve) and Schwab Bank is subject to supervision and regulation by the Office of the Comptroller of the Currency (OCC). CSC is currently not subject to specific statutory capital requirements, however, CSC is required to serve as a source of strength for Schwab Bank. CSC will be subject to new capital requirements set by the Federal Reserve that will be phased in beginning January 1, 2015. 

 

Schwab Bank is subject to regulation and supervision and to various requirements and restrictions under federal and state laws, including regulatory capital guidelines. Among other things, these requirements also restrict and govern the terms of affiliate transactions, such as extensions of credit and repayment of loans between Schwab Bank and CSC or CSC’s other subsidiaries. In addition, Schwab Bank is required to provide notice to and may be required to obtain approval of the OCC and the Federal Reserve to declare dividends to CSC. The federal banking agencies have broad powers to enforce these regulations, including the power to terminate deposit insurance, impose substantial fines and other civil and criminal penalties, and appoint a conservator or receiver. Under the Federal Deposit Insurance Act, Schwab Bank could be subject to restrictive actions if it were to fall within one of the lowest three of five capital categories. Schwab Bank is required to maintain minimum capital levels as specified in federal banking laws and regulations. Failure to meet the minimum levels could result in certain mandatory, and possibly additional discretionary actions, by the regulators that, if undertaken, could have a direct material effect on Schwab Bank. At March 31, 2014, CSC and Schwab Bank met the capital level requirements.

 

20 


 

THE CHARLES SCHWAB CORPORATION

Notes to Condensed Consolidated Financial Statements

(Tabular Amounts in Millions, Except Per Share Data, Ratios, or as Noted)

(Unaudited)

 

The regulatory capital and ratios for Schwab Bank at March 31, 2014 are as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Minimum to be

 

Minimum Capital

 

 

Actual

 

Well Capitalized

 

Requirement

 

 

Amount

 

Ratio

 

Amount

 

Ratio

 

Amount

  

Ratio

Tier 1 Risk-Based Capital

 

$

7,026 

 

20.1 

 

$

2,094 

 

6.0 

 

$

1,396 

  

4.0 

Total Risk-Based Capital

 

$

7,074 

 

20.3 

 

$

3,490 

 

10.0 

 

$

2,792 

  

8.0 

Tier 1 Leverage

 

$

7,026 

 

6.8 

 

$

5,157 

 

5.0 

 

$

4,126 

  

4.0 

Tangible Equity

 

$

7,026 

 

6.8 

 

 

N/A 

 

 

 

 

$

2,063 

  

2.0 

 

N/A Not applicable.

 

Based on its regulatory capital ratios at March 31, 2014, Schwab Bank is considered well capitalized (the highest category) pursuant to banking regulatory guidelines. There are no conditions or events since March 31, 2014, that management believes have changed Schwab Bank’s capital category.

 

CSC’s principal U.S. broker-dealers are Schwab and optionsXpress, Inc. Schwab and optionsXpress, Inc. are both subject to Rule 15c3-1 under the Securities Exchange Act of 1934 (the Uniform Net Capital Rule). Schwab and optionsXpress, Inc. compute net capital under the alternative method permitted by the Uniform Net Capital Rule. This method requires the maintenance of minimum net capital, as defined, of the greater of 2% of aggregate debit balances arising from client transactions or a minimum dollar requirement ($250,000 for Schwab), which is based on the type of business conducted by the broker-dealer. Under the alternative method, a broker-dealer may not repay subordinated borrowings, pay cash dividends, or make any unsecured advances or loans to its parent company or employees if such payment would result in a net capital amount of less than 5% of aggregate debit balances or less than 120% of its minimum dollar requirement.

 

optionsXpress, Inc. is also subject to Commodity Futures Trading Commission Regulation 1.17 (Reg. 1.17) under the Commodity Exchange Act, which also requires the maintenance of minimum net capital. optionsXpress, Inc., as a futures commission merchant, is required to maintain minimum net capital equal to the greater of its net capital requirement under Reg. 1.17 ($1 million), or the sum of 8% of the total risk margin requirements for all positions carried in client accounts and 8% of the total risk margin requirements for all positions carried in non-client accounts (as defined in Reg. 1.17).

 

Net capital and net capital requirements for Schwab and optionsXpress, Inc. at March 31, 2014 are as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net Capital

 

Net Capital

 

 

 

 

 

% of

 

Minimum

 

2% of

 

in Excess of

 

in Excess of 5%

 

 

 

 

 

Aggregate

 

Net Capital

 

Aggregate

 

Required

 

of Aggregate

 

 

Net Capital

 

Debit Balances

 

Required

 

Debit Balances

 

Net Capital

 

Debit Balances

Schwab

 

$

1,548 

  

 

10 

 

 

$

0.250 

  

 

$

305 

 

  

$

1,243 

  

 

$

786 

  

optionsXpress, Inc.

 

$

112 

  

 

32 

 

 

$

  

 

$

 

  

$

105 

  

 

$

94 

  

 

 

 

10.Segment Information

 

The Company’s two reportable segments are Investor Services and Advisor Services. The Company structures its operating segments according to its clients and the services provided to those clients. The Investor Services segment provides retail brokerage and banking services to individual investors, retirement plan services, and corporate brokerage services. The Advisor Services segment provides custodial, trading, and support services to independent investment advisors, and retirement business services to independent retirement plan advisors and recordkeepers whose plan assets are held at Schwab Bank. Revenues and expenses are allocated to the Company’s two segments based on which segment services the client.

 

The Company evaluates the performance of its segments on a pre-tax basis, excluding extraordinary or significant non-recurring items and results of discontinued operations. Segment assets and liabilities are not used for evaluating segment performance or in deciding how to allocate resources to segments. There are no revenues from transactions between the segments.

 

21 


 

THE CHARLES SCHWAB CORPORATION

Notes to Condensed Consolidated Financial Statements

(Tabular Amounts in Millions, Except Per Share Data, Ratios, or as Noted)

(Unaudited)

 

Financial information for the Company’s reportable segments is presented in the following table:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

  

Investor Services

 

Advisor Services

 

Unallocated

 

Total

Three Months Ended March 31,

2014

 

2013

 

2014

 

2013

 

2014

 

2013

 

2014

 

2013

Net Revenues:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Asset management and administration fees

$

428 

  

$

387 

  

$

183 

  

$

165 

  

$

 -

  

$

 -

  

$

611 

  

$

552 

Net interest revenue

 

495 

  

 

413 

  

 

58 

  

 

56 

  

 

 -

  

 

 -

  

 

553 

  

 

469 

Trading revenue

 

171 

  

 

149 

  

 

76 

  

 

74 

  

 

 -

 

 

 -

  

 

247 

  

 

223 

Other

 

51 

  

 

42 

  

 

17 

  

 

14 

  

 

 -

  

 

 -

  

 

68 

  

 

56 

Provision for loan losses

 

(1)

 

 

(5)

 

 

 -

 

 

(1)

 

 

 -

  

 

 -

  

 

(1)

 

 

(6)

Net impairment losses on securities

 

 -

 

 

(4)

 

 

 -

 

 

 -

 

 

 -

  

 

 -

  

 

 -

 

 

(4)

Total net revenues

 

1,144 

  

 

982 

  

 

334 

  

 

308 

  

 

 -

  

 

 -

  

 

1,478 

  

 

1,290 

Expenses Excluding Interest

 

738 

  

 

751 

  

 

218 

  

 

208 

  

 

 -

  

 

 -

 

 

956 

  

 

959 

Income before taxes on income

$

406 

  

$

231 

  

$

116 

  

$

100 

  

$

 -

  

$

 -

  

$

522 

  

$

331 

Taxes on income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

196 

  

 

125 

Net Income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

$

326 

 

$

206 

 

 

 

11.Subsequent Events

 

The Company has evaluated the impact of events that have occurred subsequent to March 31, 2014, through the date the condensed consolidated financial statements were filed with the SEC. Based on this evaluation, other than as recorded or disclosed within these condensed consolidated financial statements and related notes, the Company has determined none of these events were required to be recognized or disclosed. 

 

 

 

22 


 

THE CHARLES SCHWAB CORPORATION

Management’s Discussion and Analysis of Financial Condition and Results of Operations

(Tabular Amounts in Millions, Except Ratios, or as Noted)

 

 

Item 2.Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

OVERVIEW

 

Management of The Charles Schwab Corporation (CSC) and its subsidiaries (collectively referred to as the Company) focuses on several key client activity and financial metrics in evaluating the Company’s financial position and operating performance. Management believes that earnings per common share (EPS), net revenue growth, pre-tax profit margin, and return on average common stockholders’ equity provide broad indicators of the Company’s overall financial health, operating efficiency, and ability to generate acceptable returns within the context of a given operating environment. Expenses excluding interest as a percentage of average client assets is considered by management to be another measure of operating efficiency. Results for the first quarters of 2014 and 2013 are:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

 

 

 

 

March 31,

 

Percent

 

 

2014

 

 

2013

 

 

Change

Client Activity Metrics:

 

 

 

 

 

 

 

 

 

 

 

Net new client assets (1) (in billions)

 

$

34.2 

  

 

$

43.4 

 

 

(21)

%

Client assets (2) (in billions, at quarter end)

 

$

2,308.0 

  

 

$

2,084.9 

 

 

11 

%

New brokerage accounts (3) (in thousands)

 

 

258 

 

 

 

244 

 

 

%

Active brokerage accounts (4) (in thousands, at quarter end)

 

 

9,178 

  

 

 

8,865 

 

 

%

Company Financial Metrics:

 

 

 

 

 

 

 

 

 

 

 

Net revenues

 

$

1,478 

  

 

$

1,290 

 

 

15 

%

Expenses excluding interest

 

 

956 

  

 

 

959 

 

 

 -

 

Income before taxes on income

 

 

522 

  

 

 

331 

 

 

58 

%

Taxes on income

 

 

196 

  

 

 

125 

 

 

57 

%

Net income

 

$

326 

  

 

$

206 

 

 

58 

%

Preferred stock dividends

 

$

 

 

$

 

 

 -

 

Net income available to common stockholders

 

$

318 

 

 

$

198 

 

 

61 

%

Earnings per common share – diluted

 

$

.24

  

 

$

.15

 

 

60 

%

Net revenue growth from prior year

 

 

15 

 

 

%

 

 

 

Pre-tax profit margin

 

 

35.3 

 

 

25.7 

%

 

 

 

Return on average common stockholders’

 

 

 

 

 

 

 

 

 

 

 

equity (annualized) (5)

 

 

13 

 

 

%

 

 

 

Expenses excluding interest as a percentage of

 

 

 

 

 

 

 

 

 

 

 

average client assets (annualized)

 

 

0.17 

 

 

0.19 

%

 

 

 

 

(1)

Net new client assets is defined as the total inflows of client cash and securities to the firm less client outflows. Management believes that this metric, along with core net new assets, depicts how well the Company’s products and services appeal to new and existing clients in a given operating environment. Core net new assets is defined as net new client assets before significant one-time flows. There were no significant one-time flows during the first quarters of 2014 and 2013.

(2)

Client assets is the market value of all client assets custodied at the Company. Management considers client assets to be indicative of the Company’s appeal in the marketplace. Additionally, fluctuations in certain components of client assets (e.g., Mutual Fund OneSource® funds) directly impact asset management and administration fees.

(3)

New brokerage accounts include all brokerage accounts opened during the period, as well as any accounts added via acquisition. This metric measures the Company’s effectiveness in attracting new clients and building stronger relationships with existing clients.

(4)

Active brokerage accounts include accounts with balances or activity within the preceding eight months. This metric is an indicator of the Company’s success in both attracting and retaining clients.

(5)

Calculated as net income available to common stockholders divided by average common stockholders’ equity.

 

The Company continued to operate in an environment that contained mixed market drivers of performance during the first quarter of 2014. The Nasdaq Composite Index, Standard & Poor’s 500 Index, and Dow Jones Industrial Average increased 29%, 19%, and 13% from the first quarter of 2013, respectively. Short-term interest rates continued to be constrained as the

23 


 

THE CHARLES SCHWAB CORPORATION

Management’s Discussion and Analysis of Financial Condition and Results of Operations

(Tabular Amounts in Millions, Except Ratios, or as Noted)

 

 

federal funds target rate remained unchanged at a range of zero to 0.25% and the average three-month Treasury Bill yield decreased by 4 basis points to 0.04% compared to the first quarter of 2013. In addition, long-term interest rates increased compared to the first quarter of 2013, including the average 10-year Treasury yield, which increased by 83 basis points to 2.76%.

 

The Company continued to strengthen its earnings power during the first quarter of 2014. Core net new assets, defined as net new client assets before significant one-time flows, were the same as net new client assets in the first quarter of 2014. Net new client assets of  $34.2 billion were up 7% from core net new assets sequentially, and decreased 21% from the first quarter of 2013 due to lower mutual fund clearing inflows. Total client assets ended the first quarter of 2014 at $2.31 trillion, up 11% from the first quarter of 2013.  The Company also added 258,000 new brokerage accounts to its client base during the first quarter of 2014, up 6%, and active brokerage accounts were 9.2 million, up 4% on a year-over-year basis.

 

In addition to growth in its client base, higher levels of client trading activity, balances in fee-based products and services, and cash held at the Company as part of investing relationships all contributed to the Company achieving increases in all three major revenue lines in the first quarter of 2014 compared to the first quarter of 2013.  Overall, net revenues increased by 15% in the first quarter of 2014 compared to the first quarter of 2013, primarily due to increases in net interest revenue, asset management and administration fees, and trading revenue. Net interest revenue increased primarily due to higher balances of interest-earning assets combined with the effect higher average interest rates on securities held to maturity had on the Company’s average net interest margin. Asset management and administration fees increased primarily due to increases in advice solutions fees and other asset management and administration fees. Trading revenue increased primarily due to higher daily average revenue trades.

 

Expenses excluding interest remained relatively flat in the first quarter of 2014 compared to the first quarter of 2013, primarily due to decreases in advertising and market development and compensation and benefits, partially offset by increases in professional services and other expense. Compensation and benefits expense decreased in the first quarter of 2014 compared to the first quarter of 2013, primarily due to a decrease in incentive compensation relating to the transition to a new payout schedule for field incentive plans in the first quarter of 2013 and equity incentive plan changes to vesting for retirement-eligible employees in the first quarter of 2013. Advertising and market development expense decreased in the first quarter of 2014 compared to the first quarter of 2013, primarily due to production costs incurred in the first quarter of 2013 relating to the development of the Company’s advertising and branding initiative, Own your tomorrow™, and lower spending on customer promotions.  

 

As a result of the Company’s strong key client activity metrics, the Company achieved a pre-tax profit margin of 35.3% in the first quarter of 2014. Overall, net income increased by 58% in the first quarter of 2014 compared to the first quarter of 2013. The return on average common stockholders’ equity was 13% in the first quarter of 2014.

 

 

CURRENT MARKET AND REGULATORY ENVIRONMENT AND OTHER DEVELOPMENTS

 

To the extent short-term interest rates remain at current low levels, the Company’s net interest revenue will continue to be constrained, even as growth in average balances helps to increase such revenue. The low short-term interest rate environment also affects asset management and administration fees. The Company continues to waive a portion of its management fees, as the overall yields on certain Schwab-sponsored money market mutual funds have remained at levels at or below the management fees on those funds. These and certain other Schwab-sponsored money market mutual funds may not be able to replace maturing securities with securities of equal or higher yields. As a result, the yields on such funds may remain around or decline from their current levels, and therefore below the stated management fees on those funds. To the extent this occurs, asset management and administration fees may be negatively affected.

 

In July 2013, the U.S. banking agencies issued regulatory capital rules that implemented Basel III and relevant provisions of the “Dodd-Frank Wall Street Reform and Consumer Protection Act” (the Dodd-Frank Act) (Final Regulatory Capital Rules), which are applicable to savings and loan holding companies, such as CSC, and federal savings banks, such as Schwab Bank. The rules will be phased in beginning on January 1, 2015. The Company does not expect the Final Regulatory Capital Rules to have a material impact on the Company’s business, financial condition, and results of operations.

 

24 


 

THE CHARLES SCHWAB CORPORATION

Management’s Discussion and Analysis of Financial Condition and Results of Operations

(Tabular Amounts in Millions, Except Ratios, or as Noted)

 

 

On October 24, 2013, the Board of Governors of the Federal Reserve System (Federal Reserve), in collaboration with the Office of the Comptroller of the Currency (OCC) and the Federal Deposit Insurance Corporation, issued a joint notice of proposed rulemaking that would implement a quantitative liquidity requirement generally consistent with the liquidity coverage ratio (LCR) standard established by Basel III. The LCR would apply to all internationally active banking organizations. The Federal Reserve also proposed a modified LCR standard, which would apply to the Company. Under the modified LCR, a depository institution holding company would be required to maintain high-quality liquid assets in an amount related to its total net cash outflows over a prospective period. The proposed transition period for the rule would begin on January 1, 2015, and institutions would be required to be fully compliant by January 1, 2017. This proposed rule was open for comment until January 31, 2014 and the impact to Schwab cannot be assessed until the final rule is released.

 

The Company is pursuing lawsuits in state court in San Francisco for rescission and damages against issuers, underwriters, and dealers of individual non-agency residential mortgage-backed securities on which the Company has experienced realized and unrealized losses. The lawsuits allege that offering documents for the securities contained material untrue and misleading statements about the securities and the underwriting standards and credit quality of the underlying loans. On January 27, 2012 and July 24, 2012, the court denied defendants’ motions to dismiss the claims with respect to all but 3 of the 51 securities, and discovery is proceeding. A trial date for claims relating to an initial group of these securities is set for July 2015.

 

 

25 


 

THE CHARLES SCHWAB CORPORATION

Management’s Discussion and Analysis of Financial Condition and Results of Operations

(Tabular Amounts in Millions, Except Ratios, or as Noted)

 

 

Results of Operations

 

The following discussion presents an analysis of the Company’s results of operations for the first quarter of 2014 compared to the first quarter of 2013.

 

Net Revenues

 

The Company’s major sources of net revenues are asset management and administration fees, net interest revenue, and trading revenue, all of which increased in the first quarter of 2014 compared to the first quarter of 2013.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended March 31,

 

 

 

 

2014

 

2013

 

 

 

 

 

 

 

 

% of

 

 

 

 

% of

 

 

Percent

 

 

 

 

Total Net

 

 

 

 

Total Net

 

 

Change

 

Amount

 

Revenues

 

Amount

 

Revenues

Asset management and administration fees

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Schwab money market funds before fee waivers

 

%

 

$

239 

 

 

 

 

$

230 

  

 

 

Fee waivers

 

19 

%

 

 

(185)

 

 

 

 

 

(155)

 

 

 

Schwab money market funds after fee waivers

 

(28)

 

 

54 

 

 

 

75 

  

Equity and bond funds

 

29 

 

 

45 

 

 

 

35 

  

Mutual Fund OneSource®

 

11 

 

 

204 

 

14 

 

 

184 

  

14 

Total mutual funds

 

 

 

303 

 

21 

 

 

294 

  

23 

Advice solutions

 

22 

 

 

199 

 

13 

 

 

163 

  

13 

Other

 

15 

 

 

109 

 

 

 

95 

  

Asset management and administration fees

 

11 

 

 

611 

 

41 

 

 

552 

  

43 

Net interest revenue

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest revenue

 

16 

%

 

 

579 

 

39 

 

 

497 

  

38 

Interest expense

 

(7)

%

 

 

(26)

 

(2)

%

 

 

(28)

 

(2)

%

Net interest revenue

 

18 

%

 

 

553 

 

37 

 

 

469 

  

36 

Trading revenue

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commissions

 

11 

%

 

 

234 

 

16 

 

 

211 

  

16 

Principal transactions

 

%

 

 

13 

 

 

 

12 

  

Trading revenue

 

11 

%

 

 

247 

 

17 

 

 

223 

  

17 

Other

 

21 

%

 

 

68 

 

 

 

56 

  

Provision for loan losses

 

(83)

%

 

 

(1)

 

 -

 

 

 

(6)

 

 -

 

Net impairment losses on securities

 

(100)

%

 

 

 -

 

 -

 

 

 

(4)

 

 -

 

Total net revenues

 

15 

 

$

1,478 

 

100 

 

$

1,290 

  

100 

 

 

Asset Management and Administration Fees

 

Asset management and administration fees include mutual fund service fees and fees for other asset-based financial services provided to individual and institutional clients. The Company earns mutual fund service fees for shareholder services, administration, and investment management provided to its proprietary funds, and recordkeeping and shareholder services provided to third-party funds. These fees are based upon the daily balances of client assets invested in these funds. The Company also earns asset management fees for advice solutions, which include advisory and managed account services that are based on the daily balances of client assets subject to the specific fee for service. The fair values of client assets included in proprietary and third-party mutual funds are based on quoted market prices and other observable market data. Other asset management and administration fees include various asset based fees, such as third-party mutual fund service fees, trust fees, 401(k) record keeping fees, and mutual fund clearing and other service fees. Asset management and administration fees vary with changes in the balances of client assets due to market fluctuations and client activity. For a discussion of the impact of current market conditions on asset management and administration fees, see “Current Market and Regulatory Environment and Other Developments.”

 

26 


 

THE CHARLES SCHWAB CORPORATION

Management’s Discussion and Analysis of Financial Condition and Results of Operations

(Tabular Amounts in Millions, Except Ratios, or as Noted)

 

 

Asset management and administration fees increased by $59 million, or 11%, in the first quarter of 2014 compared to the first quarter of 2013, due to increases in mutual fund service fees, advice solutions fees and other asset management and administration fees.

 

Mutual fund service fees increased by $9 million, or 3%, in the first quarter of 2014 compared to the first quarter of 2013, primarily due to growth in client assets invested in the Company’s Mutual Fund OneSource funds and equity and bond funds, partially offset by a decrease in net money market mutual fund fees as a result of lower yields on fund assets.

 

Advice solutions fees increased by $36 million, or 22%, in the first quarter of 2014 compared to the first quarter of 2013, primarily due to growth in client assets enrolled in advisory offers, including Schwab Private Client, Windhaven®, and ThomasPartners®.

 

Other asset management and administration fees increased by $14 million, or 15%, in the first quarter of 2014 compared to the first quarter of 2013, primarily due to an increase in third-party mutual fund service fees as a result of an increase in client asset balances invested in other third-party mutual funds.

 

Net Interest Revenue

 

Net interest revenue is the difference between interest earned on interest-earning assets and interest paid on funding sources. Net interest revenue is affected by changes in the volume and mix of these assets and liabilities, as well as by fluctuations in interest rates and portfolio management strategies. The majority of the Company’s interest-earning assets and interest-bearing liabilities are sensitive to changes in short-term interest rates. The Company’s investment strategy is structured to produce an increase in net interest revenue when interest rates rise and, conversely, a decrease in net interest revenue when interest rates fall, from current levels. When interest rates fall, the Company may attempt to mitigate some of this negative impact by extending the maturities of assets in investment portfolios to lock in asset yields, and by lowering rates paid to clients on interest-bearing liabilities. Since the Company establishes the rates paid on certain brokerage client cash balances and deposits from banking clients, as well as the rates charged on receivables from brokerage clients, and also controls the composition of its investment securities, it has some ability to manage its net interest spread. However, the spread is influenced by external factors such as the interest rate environment and competition. The current low interest rate environment limits the extent to which the Company can reduce interest expense paid on funding sources. To a lesser degree, the Company is sensitive to changes in long-term interest rates through some of its investment portfolios. To mitigate the related risk, the Company may alter the types of investments purchased. For discussion of the impact of current market conditions on net interest revenue, see “Current Market and Regulatory Environment and Other Developments.”

 

The Company’s interest-earning assets are financed primarily by brokerage client cash balances and deposits from banking clients. Non-interest-bearing funding sources include non-interest-bearing brokerage client cash balances, stockholders’ equity, and proceeds from stock-lending activities. Revenue from stock-lending activities is included in other interest revenue.

 

Schwab Bank maintains available for sale and held to maturity investment portfolios for liquidity as well as to earn interest by investing funds from deposits that are in excess of loans to banking clients and liquidity requirements. Schwab Bank lends funds to banking clients primarily in the form of mortgage loans, HELOCs, and personal loans secured by securities. These loans are largely funded by interest-bearing deposits from banking clients.

 

In clearing their clients’ trades, Charles Schwab & Co., Inc. (Schwab) and optionsXpress, Inc., a securities broker-dealer and wholly-owned subsidiary of optionsXpress Holdings, Inc. (optionsXpress), hold cash balances payable to clients. In most cases, Schwab and optionsXpress, Inc. pay their clients interest on cash balances awaiting investment, and in turn invest these funds and earn interest revenue. Receivables from brokerage clients consist primarily of margin loans to brokerage clients. Margin loans are loans made to clients on a secured basis to purchase securities. Pursuant to applicable regulations, client cash balances that are not used for margin lending are generally segregated into investment accounts that are maintained for the exclusive benefit of clients, which are recorded in cash and investments segregated on the Company’s condensed consolidated balance sheets.

 

27 


 

THE CHARLES SCHWAB CORPORATION

Management’s Discussion and Analysis of Financial Condition and Results of Operations

(Tabular Amounts in Millions, Except Ratios, or as Noted)

 

 

The following table presents net interest revenue information corresponding to interest-earning assets and funding sources on the condensed consolidated balance sheet:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended March 31,

 

2014

 

2013

 

 

 

 

 

Interest

 

Average

 

 

 

 

Interest

 

Average

 

 

Average

 

Revenue/

 

Yield/

 

Average

 

Revenue/

 

Yield/

 

 

Balance

 

Expense

 

Rate

 

Balance

 

Expense

 

Rate

Interest-earning assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

6,701 

  

$

  

0.24 

 

$

7,907 

  

$

  

0.26 

Cash and investments segregated

 

 

21,619 

  

 

  

0.11 

 

 

27,590 

  

 

12 

  

0.18 

Broker-related receivables (1)

 

 

294 

  

 

 -

  

0.35 

 

 

361 

  

 

 -

  

0.13 

Receivables from brokerage clients

 

 

13,158 

  

 

116 

  

3.58 

 

 

11,342 

  

 

106 

  

3.79 

Securities available for sale (2)

 

 

51,971 

  

 

140 

  

1.09 

 

 

46,908 

  

 

138 

  

1.19 

Securities held to maturity

 

 

30,846 

  

 

199 

  

2.62 

 

 

21,063 

  

 

131 

  

2.52 

Loans to banking clients

 

 

12,546 

  

 

87 

  

2.81 

 

 

11,091 

  

 

80 

  

2.93 

Total interest-earning assets

 

 

137,135 

  

 

552 

  

1.63 

 

 

126,262 

  

 

472 

  

1.52 

Other interest revenue

 

 

 

 

 

27 

  

 

 

 

 

 

 

 

25 

  

 

 

Total interest-earning assets

 

$

137,135 

  

$

579 

  

1.71 

 

$

126,262 

  

$

497 

  

1.60 

Funding sources:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Deposits from banking clients

 

$

93,776 

  

$

  

0.03 

 

$

80,341 

  

$

10 

  

0.05 

Payables to brokerage clients

 

 

27,210 

  

 

  

0.01 

 

 

32,096 

  

 

  

0.01 

Long-term debt

 

 

1,902 

  

 

18 

  

3.84 

 

 

1,632 

  

 

17 

  

4.22 

Total interest-bearing liabilities

 

 

122,888 

  

 

26 

  

0.09 

 

 

114,069 

  

 

28 

  

0.10 

Non-interest-bearing funding sources

 

 

14,247 

  

 

 

 

 

 

 

 

12,193 

  

 

 

 

 

 

Total funding sources

 

$

137,135 

  

$

26 

  

0.07 

 

$

126,262 

  

$

28 

  

0.09 

Net interest revenue

 

 

 

 

$

553 

  

1.64 

 

 

 

 

$

469 

  

1.51 

 

 

 

(1)

Interest revenue was less than $500,000 in the periods presented.

(2)

Amounts have been calculated based on amortized cost.

 

Net interest revenue increased in the first quarter of 2014 compared to the first quarter of 2013, primarily due to higher balances of interest-earning assets, including securities held to maturity and securities available for sale, combined with the effect higher average interest rates on securities held to maturity had on the Company’s average net interest margin. The growth in the average balance of deposits from banking clients funded the increase in the balances of securities held to maturity and securities available for sale.

 

Trading Revenue

 

Trading revenue includes commission and principal transaction revenues. Commission revenue is affected by the number of revenue trades executed and the average revenue earned per revenue trade. Principal transaction revenue is primarily comprised of revenue from trading activity in client fixed income securities. To accommodate clients’ fixed income trading activity, the Company maintains positions in fixed income securities, including state and municipal debt obligations, U.S. Government, corporate debt, and other securities. The difference between the price at which the Company buys and sells securities to and from its clients and other broker-dealers is recognized as principal transaction revenue. Principal transaction revenue also includes adjustments to the fair value of these securities positions. Factors that influence principal transaction revenue include the volume of client trades and market price volatility.

 

28 


 

THE CHARLES SCHWAB CORPORATION

Management’s Discussion and Analysis of Financial Condition and Results of Operations

(Tabular Amounts in Millions, Except Ratios, or as Noted)

 

 

Trading revenue increased by $24 million, or 11%, in the first quarter of 2014 compared to the first quarter of 2013, due to higher daily average revenue trades. Daily average revenue trades increased in the first quarter of 2014, primarily due to a higher volume of equity, future, and option trades. Average revenue per revenue trade decreased in the first quarter of 2014 compared to the first quarter of 2013, primarily due to lower revenue per trade for futures and options.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

 

 

 

 

March 31,

 

Percent

 

 

2014

 

 

2013

 

Change

Daily average revenue trades (1) (in thousands)

 

 

337.3 

  

 

 

298.7 

  

13 

%

Clients’ daily average trades (2) (in thousands)

 

 

553.6 

 

 

 

498.9 

 

11 

%

Number of trading days

 

 

61.0 

  

 

 

60.0 

  

%

Average revenue per revenue trade

 

$

12.03 

    

 

$

12.34 

    

(3)

%

 

(1)

Includes all client trades that generate trading revenue (i.e., commission revenue or principal transaction revenue).

(2)

Includes daily average revenue trades, trades by clients in asset-based pricing relationships, and all commission-free trades, including the Company’s Mutual Fund OneSource funds and exchange-traded funds (ETFs), and other proprietary products. Clients’ daily average trades is an indicator of client engagement with securities markets.

 

Other Revenue

 

Other revenue includes revenue from order flow,  software fees from the Company’s portfolio management services, exchange processing fees, realized gains or losses on sales of securities available for sale, and other service fees. Other revenue increased by $12 million, or 21%, in the first quarter of 2014 compared to the first quarter of 2013, primarily due to an increase in revenue from order flow. 

 

Expenses Excluding Interest

 

As shown in the table below, expenses excluding interest remained relatively flat in the first quarter of 2014 compared to the first quarter of 2013. Decreases in advertising and market development and compensation and benefits were offset by increases in professional services and other expense.

 

 

 

 

 

 

 

 

 

 

 

 

 

  

Three Months Ended

 

 

 

 

March 31,

Percent

 

  

2014

 

 

2013

 

Change

Compensation and benefits

  

$

528 

  

 

$

536 

  

(1)

Professional services

  

 

106 

  

 

 

99 

  

%

Occupancy and equipment

  

 

80 

  

 

 

77 

  

%

Advertising and market development

  

 

63 

  

 

 

74 

  

(15)

Communications

  

 

56 

  

 

 

54 

  

%

Depreciation and amortization

  

 

48 

  

 

 

51 

  

(6)

Other

  

 

75 

  

 

 

68 

  

10 

%

Total expenses excluding interest

  

$

956 

  

 

$

959 

  

 -

 

Expenses as a percentage of total net revenues:

  

 

 

 

 

 

 

 

 

 

Total expenses excluding interest

  

 

65 

 

 

74 

 

 

Advertising and market development

  

 

 

 

 

 

 

 

Compensation and Benefits

 

Compensation and benefits expense includes salaries and wages, incentive compensation, and related employee benefits and taxes. Incentive compensation includes variable compensation, discretionary bonuses, and stock-based compensation. Variable compensation includes payments to certain individuals based on their sales performance. Discretionary bonuses are based on the Company’s overall performance as measured by EPS, and therefore will fluctuate with this measure. Stock-based compensation primarily includes employee and board of director stock options, restricted stock units, and restricted stock awards. 

 

29 


 

THE CHARLES SCHWAB CORPORATION

Management’s Discussion and Analysis of Financial Condition and Results of Operations

(Tabular Amounts in Millions, Except Ratios, or as Noted)

 

 

Compensation and benefits expense remained relatively flat in the first quarter of 2014 compared to the first quarter of 2013. A decrease in incentive compensation was offset by an increase in salaries and wages. The following table shows a comparison of certain compensation and benefits components and employee data: 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

 

 

 

March 31,

Percent

 

 

2014

 

 

2013

 

Change

Salaries and wages

 

$

295 

  

 

$

284 

  

Incentive compensation

 

 

147 

  

 

 

163 

  

(10)

Employee benefits and other

 

 

86 

  

 

 

89 

  

(3)

Total compensation and benefits expense

 

$

528 

  

 

$

536 

  

(1)

Compensation and benefits expense as a percentage of total net revenues:

 

 

 

 

 

 

 

 

 

 

Salaries and wages

 

 

20 

 

 

22 

 

 

Incentive compensation

 

 

10 

 

 

13 

 

 

Employee benefits and other

 

 

 

 

 

 

Total compensation and benefits expense

 

 

36 

 

 

42 

 

 

Full-time equivalent employees (1) (in thousands)

 

 

 

 

 

 

 

 

 

 

At quarter end

 

 

14.0 

  

 

 

14.0 

  

 -

 

Average

 

 

14.0 

  

 

 

14.0 

  

 -

 

 

 

 

(1)

Includes full-time, part-time and temporary employees, and persons employed on a contract basis, and excludes employees of outsourced service providers.

 

Salaries and wages increased in the first quarter of 2014 compared to the first quarter of 2013, primarily due to annual salary increases.

 

Incentive compensation decreased in the first quarter of 2014 compared to the first quarter of 2013, primarily due to the transition to a new payout schedule for field incentive plans in the first quarter of 2013 and equity incentive plan changes to vesting for retirement-eligible employees in the first quarter of 2013. 

 

Expenses Excluding Compensation and Benefits

 

Professional services expense increased in the first quarter of 2014 compared to the first quarter of 2013, primarily due to an increase in fees paid to outsourced service providers and consultants, and higher spending on technology services and enhancements.

 

Advertising and market development expense decreased in the first quarter of 2014 compared to the first quarter of 2013, primarily due to production costs incurred in the first quarter of 2013 relating to the development of the Company’s advertising and branding initiative, Own your tomorrow™, and lower spending on customer promotions.

 

Other expense increased in the first quarter of 2014 compared to the first quarter of 2013, primarily due to an increase in regulatory assessments.

 

Taxes on Income

 

The Company’s effective income tax rate on income before taxes was 37.5% and 37.8% for the first quarters of 2014 and 2013, respectively. The slight decrease was primarily due to a lower effective state income tax rate in the first quarter of 2014.

 

Segment Information

 

The Company provides financial services to individuals and institutional clients through two segments – Investor Services and Advisor Services. The Investor Services segment provides retail brokerage and banking services to individual investors, retirement plan services, and corporate brokerage services. The Advisor Services segment provides custodial, trading, and support services to independent investment advisors, and retirement business services to independent retirement plan advisors

30 


 

THE CHARLES SCHWAB CORPORATION

Management’s Discussion and Analysis of Financial Condition and Results of Operations

(Tabular Amounts in Millions, Except Ratios, or as Noted)

 

 

and recordkeepers whose plan assets are held at Schwab Bank. Banking revenues and expenses are allocated to the Company’s two segments based on which segment services the client. The Company evaluates the performance of its segments on a pre-tax basis, excluding items such as significant nonrecurring gains, impairment charges on non-financial assets, discontinued operations, extraordinary items, and significant restructuring and other charges. Segment assets and liabilities are not used for evaluating segment performance or in deciding how to allocate resources to segments.

 

Financial information for the Company’s reportable segments is presented in the following tables:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Investor Services

 

Advisor Services

 

 

Percent

 

 

 

 

 

 

 

Percent

 

 

 

 

 

 

Three Months Ended March 31,

 

Change

 

2014 

 

2013 

 

Change

 

2014 

 

2013 

Net Revenues:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Asset management and administration fees

 

11 

 

$

428 

 

$

387 

  

11 

 

$

183 

  

$

165 

Net interest revenue

 

20 

%

 

 

495 

 

 

413 

  

 

 

58 

  

 

56 

Trading revenue

 

15 

%

 

 

171 

 

 

149 

  

%

 

 

76 

  

 

74 

Other

 

21 

%

 

 

51 

 

 

42 

  

21 

 

 

17 

  

 

14 

Provision for loan losses

 

(80)

%

 

 

(1)

 

 

(5)

 

(100)

 

 

 -

 

 

(1)

Net impairment losses on securities

 

(100)

%

 

 

 -

 

 

(4)

 

 -

 

 

 

 -

 

 

 -

Total net revenues

 

16 

%

 

 

1,144 

 

 

982 

  

 

 

334 

  

 

308 

Expenses Excluding Interest

 

(2)

 

 

738 

 

 

751 

  

 

 

218 

  

 

208 

Income before taxes on income

 

76 

%

 

$

406 

 

$

231 

  

16 

 

$

116 

  

$

100 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unallocated

 

Total

 

 

Percent

 

 

 

 

 

 

 

Percent

 

 

 

 

 

 

Three Months Ended March 31,

 

Change

 

2014 

 

2013 

 

Change

 

2014 

 

2013 

Net Revenues:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Asset management and administration fees

 

 -

 

 

$

 -

 

$

 -

  

11 

 

$

611 

  

$

552 

Net interest revenue

 

 -

 

 

 

 -

 

 

 -

  

18 

%

 

 

553 

  

 

469 

Trading revenue

 

 -

 

 

 

 -

 

 

 -

  

11 

%

 

 

247 

  

 

223 

Other

 

 -

 

 

 

 -

 

 

 -

  

21 

%

 

 

68 

  

 

56 

Provision for loan losses

 

 -

 

 

 

 -

 

 

 -

  

(83)

%

 

 

(1)

 

 

(6)

Net impairment losses on securities

 

 -

 

 

 

 -

 

 

 -

  

(100)

%

 

 

 -

 

 

(4)

Total net revenues

 

 -

 

 

 

 -

 

 

 -

  

15 

 

 

1,478 

  

 

1,290 

Expenses Excluding Interest

 

 -

 

 

 

 -

 

 

 -

  

 -

 

 

 

956 

  

 

959 

Income before taxes on income

 

 -

 

 

$

 -

 

$

 -

  

58 

%

 

$

522 

  

$

331 

Taxes on income

 

 

 

 

 

 

 

 

 

 

57 

%

 

 

196 

  

 

125 

Net Income

 

 

 

 

 

 

 

 

 

 

58 

 

$

326 

  

$

206 

 

Investor Services

Net revenues increased by $162 million, or 16%, in the first quarter of 2014 compared to the first quarter of 2013 primarily due to increases in net interest revenue, asset management and administration fees, trading revenue, and other revenue. Net interest revenue increased primarily due to higher balances of interest-earning assets combined with the effect higher average interest rates on securities held to maturity had on the Company’s average net interest margin. Asset management and administration fees increased primarily due to increases in advice solutions fees and mutual fund service fees. Advice solutions fees increased primarily due to growth in client assets enrolled in advisory offers. Mutual fund service fees increased primarily due to growth in client assets invested in the Company’s Mutual Fund OneSource funds and equity and bond funds, partially offset by a decrease in net money market mutual fund fees as a result of lower yields on fund assets. Trading revenue increased primarily due to higher daily average revenue trades. Other revenue increased primarily due to an increase in revenue from order flow.

 

Expenses excluding interest decreased by $13 million, or 2%, in the first quarter of 2014 compared to the first quarter of 2013 primarily due to decreases in compensation and benefits and advertising and market development expenses, partially offset by an increase in other expense.

31 


 

THE CHARLES SCHWAB CORPORATION

Management’s Discussion and Analysis of Financial Condition and Results of Operations

(Tabular Amounts in Millions, Except Ratios, or as Noted)

 

 

 

Advisor Services

Net revenues increased by $26 million, or 8%, in the first quarter of 2014 compared to the first quarter of 2013 primarily due to increases in asset management and administration fees and other revenue. Asset management and administration fees increased due to increases in advice solutions fees, mutual fund service fees, and other asset management and administration fees. Advice solutions fees increased due to growth in client assets enrolled in advisory offers. Mutual fund service fees increased primarily due to growth in client assets invested in the Company’s Mutual Fund OneSource funds and equity and bond funds, partially offset by a decrease in net money market mutual fund fees as a result of lower yields on fund assets. Other asset management and administration fees increased primarily due to an increase in third-party mutual fund service fees as a result of an increase in client asset balances invested in other third-party mutual funds. Other revenue increased primarily due to an increase in revenue from order flow.

 

Expenses excluding interest increased by $10 million, or 5%, in the first quarter of 2014 compared to the first quarter of 2013 primarily due to increases in compensation and benefits and professional services expenses.

 

 

Liquidity and Capital Resources

 

CSC conducts substantially all of its business through its wholly-owned subsidiaries. The Company’s capital structure is designed to provide each subsidiary with capital and liquidity to meet its operational needs and regulatory requirements.

 

CSC is a savings and loan holding company and Schwab Bank, CSC’s depository institution, is a federal savings bank. CSC is subject to supervision and regulation by the Federal Reserve and Schwab Bank is subject to supervision and regulation by the OCC.

 

Liquidity

 

CSC

 

CSC’s liquidity needs arise from funding its subsidiaries’ operations, including margin and mortgage lending, and transaction settlement, in addition to funding cash dividends, acquisitions, investments, short- and long-term debt, and managing statutory capital requirements.

 

CSC’s liquidity needs are generally met through cash generated by its subsidiaries, as well as cash provided by external financing. CSC has a universal automatic shelf registration statement on file with the SEC which enables CSC to issue debt, equity and other securities. CSC maintains excess liquidity in the form of overnight cash deposits and short-term investments to cover daily funding needs and to support growth in the Company’s business. Generally, CSC does not hold liquidity at its subsidiaries in excess of amounts deemed sufficient to support the subsidiaries’ operations, including any regulatory capital requirements. Schwab, Schwab Bank, and optionsXpress, Inc. are subject to regulatory requirements that may restrict them from certain transactions with CSC, as further discussed below. Management believes that funds generated by the operations of CSC’s subsidiaries will continue to be the primary funding source in meeting CSC’s liquidity needs, providing adequate liquidity to meet Schwab Bank’s capital guidelines, and maintaining Schwab and optionsXpress, Inc.’s net capital.

 

While CSC is not currently subject to specific statutory capital requirements, CSC is required to serve as a source of strength for Schwab Bank and must have the ability to provide financial assistance if Schwab Bank experiences financial distress. To manage capital adequacy, the Company currently utilizes a target Tier 1 Leverage Ratio for CSC, as currently defined by the Federal Reserve, of at least 6%. At March 31, 2014, CSC’s Tier 1 Leverage Ratio was 6.6%, Tier 1 Capital Ratio was 17.1%, and Total Capital Ratio was 17.2%. Beginning in 2015, CSC will be subject to new capital requirements set by the Federal Reserve.

 

32 


 

THE CHARLES SCHWAB CORPORATION

Management’s Discussion and Analysis of Financial Condition and Results of Operations

(Tabular Amounts in Millions, Except Ratios, or as Noted)

 

 

The following are details of CSC’s long-term debt:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Par

 

 

  

 

  

 

  

Standard

  

 

March 31, 2014

Outstanding

 

Maturity

 

Interest Rate

 

Moody’s

 

& Poor’s

 

Fitch

Senior Notes

 

$

1,581 

 

 

2015 – 2022

 

0.850% to 4.45% fixed

 

A2

  

A

  

A

Medium-Term Notes

 

$

250 

 

 

2017

 

6.375% fixed

 

A2

  

A

  

A

 

CSC has authorization from its Board of Directors to issue unsecured commercial paper notes (Commercial Paper Notes) not to exceed $1.5 billion. Management has set a current limit for the commercial paper program of $800 million. The maturities of the Commercial Paper Notes may vary, but are not to exceed 270 days from the date of issue. The commercial paper is not redeemable prior to maturity and cannot be voluntarily prepaid. The proceeds of the commercial paper program are to be used for general corporate purposes. There were no borrowings of Commercial Paper Notes outstanding at March 31, 2014. CSC’s ratings for these short-term borrowings are P1 by Moody’s, A1 by Standard & Poor’s, and F1 by Fitch.

 

CSC maintains an $800 million committed, unsecured credit facility with a group of 12 banks, which is scheduled to expire in June 2014. This facility was unused during the first quarter of 2014. The funds under this facility are available for general corporate purposes. The financial covenants under this facility require Schwab to maintain a minimum net capital ratio, as defined, Schwab Bank to be well capitalized, as defined, and CSC to maintain a minimum level of stockholders’ equity. At March 31, 2014, the minimum level of stockholders’ equity required under this facility was $7.3 billion (CSC’s stockholders’ equity at March 31, 2014 was $10.8 billion). Management believes that these restrictions will not have a material effect on CSC’s ability to meet foreseeable dividend or funding requirements.

 

CSC also has direct access to $647 million of the $942 million uncommitted, unsecured bank credit lines discussed below, that are primarily utilized by Schwab to manage short-term liquidity. These lines were not used by CSC during the first quarter of 2014.

 

In addition, Schwab provides CSC with a $1.0 billion credit facility, which is scheduled to expire in December 2014. There were no funds drawn under this facility at March 31, 2014.

 

Schwab

 

Schwab’s liquidity needs relating to client trading and margin borrowing activities are met primarily through cash balances in brokerage client accounts, which were $30.2 billion and $33.2 billion at March 31, 2014 and December 31, 2013, respectively. Management believes that brokerage client cash balances and operating earnings will continue to be the primary sources of liquidity for Schwab.

 

Schwab is subject to regulatory requirements of Rule 15c3-1 under the Securities Exchange Act of 1934 (the Uniform Net Capital Rule) that are intended to ensure the general financial soundness and liquidity of broker-dealers. These regulations prohibit Schwab from repaying subordinated borrowings from CSC, paying cash dividends, or making unsecured advances or loans to its parent company or employees if such payment would result in a net capital amount of less than 5% of aggregate debit balances or less than 120% of its minimum dollar requirement of $250,000. At March 31, 2014, Schwab’s net capital was $1.5 billion (10% of aggregate debit balances), which was $1.2 billion in excess of its minimum required net capital and $786 million in excess of 5% of aggregate debit balances. 

 

Schwab is also subject to Rule 15c3-3 under the Securities Exchange Act of 1934 and other applicable regulations that require it to maintain cash or qualified securities in a segregated reserve account for the exclusive benefit of clients. These funds are included in cash and investments segregated and on deposit for regulatory purposes in the Company’s condensed consolidated balance sheets and are not available as a general source of liquidity.

 

Most of Schwab’s assets are readily convertible to cash, consisting primarily of short-term investment-grade, interest-earning investments (the majority of which are segregated for the exclusive benefit of clients pursuant to regulatory requirements), receivables from brokerage clients, and receivables from brokers, dealers, and clearing organizations. Client margin loans are demand loan obligations secured by readily marketable securities. Receivables from and payables to brokers, dealers, and clearing organizations primarily represent current open transactions, which usually settle, or can be closed out, within a few business days.

33 


 

THE CHARLES SCHWAB CORPORATION

Management’s Discussion and Analysis of Financial Condition and Results of Operations

(Tabular Amounts in Millions, Except Ratios, or as Noted)

 

 

 

Schwab has a finance lease obligation related to an office building and land under a 20-year lease. The remaining finance lease obligation of $87 million at March 31, 2014 is being reduced by a portion of the lease payments over the remaining lease term of 11 years.

 

To manage short-term liquidity, Schwab maintains uncommitted, unsecured bank credit lines with a group of six banks totaling $942 million at March 31, 2014. The need for short-term borrowings arises primarily from timing differences between cash flow requirements, scheduled liquidation of interest-earning investments, and movements of cash to meet regulatory brokerage client cash segregation requirements. These lines were not used by Schwab during the first quarter of 2014.

 

To partially satisfy the margin requirement of client option transactions with the Options Clearing Corporation, Schwab has unsecured standby letter of credit agreements (LOCs) with five banks in favor of the Options Clearing Corporation aggregating $225 million at March 31, 2014. There were no funds drawn under any of these LOCs during the first quarter of 2014. In connection with its securities lending activities, Schwab is required to provide collateral to certain brokerage clients. Schwab satisfies the collateral requirements by providing cash as collateral.

 

To manage Schwab’s regulatory capital requirement, CSC provides Schwab with a $1.4 billion subordinated revolving credit facility, which is scheduled to expire in March 2016. The amount outstanding under this facility at March 31, 2014 was $315 million. Borrowings under this subordinated lending arrangement qualify as regulatory capital for Schwab.

 

In addition, CSC provides Schwab with a $2.5 billion credit facility, which is scheduled to expire in December 2014. Borrowings under this facility do not qualify as regulatory capital for Schwab. The amount outstanding under this facility at March 31, 2014 was $125 million.

 

Schwab Bank

 

Schwab Bank’s liquidity needs are met through deposits from banking clients and equity capital.

 

Deposits from banking clients at March 31, 2014 were $95.6 billion, which includes the excess cash held in certain Schwab and optionsXpress, Inc. brokerage client accounts that is swept into deposit accounts at Schwab Bank. At March 31, 2014, these balances totaled $74.5 billion.

 

Schwab Bank is subject to regulatory requirements that restrict and govern the terms of affiliate transactions, such as extensions of credit and repayment of loans between Schwab Bank and CSC or CSC’s other subsidiaries. In addition, Schwab Bank is required to provide notice to and may be required to obtain approval of the OCC and the Federal Reserve to declare dividends to CSC.

 

Schwab Bank is required to maintain capital levels as specified in federal banking laws and regulations. Failure to meet the minimum levels could result in certain mandatory, and possibly additional discretionary actions, by the regulators that, if undertaken, could have a direct material effect on Schwab Bank. The Company currently utilizes a target Tier 1 Leverage Ratio for Schwab Bank of at least 6.25%. Beginning in 2015, Schwab Bank will be subject to new capital requirements set by the OCC. Based on its regulatory capital ratios at March 31, 2014, Schwab Bank is considered well capitalized. Schwab Bank’s regulatory capital and ratios are as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Minimum to be

 

Minimum Capital

 

 

Actual

 

Well Capitalized

 

Requirement

March 31, 2014

 

Amount

 

Ratio

 

Amount

 

Ratio

 

Amount

 

Ratio

Tier 1 Risk-Based Capital

 

$

7,026 

  

20.1 

 

$

2,094 

  

6.0 

 

$

1,396 

  

4.0 

Total Risk-Based Capital

 

$

7,074 

  

20.3 

 

$

3,490 

  

10.0 

 

$

2,792 

  

8.0 

Tier 1 Leverage

 

$

7,026 

  

6.8 

 

$

5,157 

  

5.0 

 

$

4,126 

  

4.0 

Tangible Equity

 

$

7,026 

  

6.8 

 

 

N/A 

  

 

 

 

$

2,063 

  

2.0 

 

N/A Not applicable.

 

34 


 

THE CHARLES SCHWAB CORPORATION

Management’s Discussion and Analysis of Financial Condition and Results of Operations

(Tabular Amounts in Millions, Except Ratios, or as Noted)

 

 

Schwab Bank has access to traditional funding sources such as deposits, federal funds purchased, and repurchase agreements. Additionally, Schwab Bank has access to short-term funding through the Federal Reserve Bank (FRB) discount window. Amounts available under the FRB discount window are dependent on the fair value of certain of Schwab Bank’s securities available for sale and/or securities held to maturity that are pledged as collateral to the FRB. Schwab Bank maintains policies and procedures necessary to access this funding and tests discount window borrowing procedures annually. At March 31, 2014, $2.6 billion was available under this arrangement. There were no funds drawn under this arrangement during the first quarter of 2014. 

 

Schwab Bank maintains a credit facility with the Federal Home Loan Bank System. Amounts available under this facility are dependent on the amount of Schwab Bank’s residential real estate mortgages and HELOCs that are pledged as collateral. Schwab Bank maintains policies and procedures necessary to access this funding and tests borrowing procedures annually. At March 31, 2014, $7.0 billion was available under this facility. There were no funds drawn under this facility during the first quarter of 2014.

 

optionsXpress, Inc.

 

optionsXpress, Inc.’s liquidity needs relating to client trading and margin borrowing activities are met primarily through cash balances in brokerage client accounts, which were $1.1 billion at both March 31, 2014 and December 31, 2013. Management believes that brokerage client cash balances and operating earnings will continue to be the primary sources of liquidity for optionsXpress, Inc.

 

optionsXpress, Inc. is subject to regulatory requirements of the Uniform Net Capital Rule that are intended to ensure the general financial soundness and liquidity of broker-dealers. These regulations prohibit optionsXpress, Inc. from paying cash dividends or making unsecured advances or loans to its parent company or employees if such payment would result in a net capital amount of less than 5% of aggregate debit balances or less than 120% of its minimum dollar requirement of $250,000. At March 31, 2014, optionsXpress, Inc.’s net capital was $112 million (32% of aggregate debit balances), which was $105 million in excess of its minimum required net capital and $94 million in excess of 5% of aggregate debit balances.

 

optionsXpress, Inc. is also subject to Commodity Futures Trading Commission Regulation 1.17 (Reg. 1.17) under the Commodity Exchange Act, which also requires the maintenance of minimum net capital. optionsXpress, Inc. as a futures commission merchant, is required to maintain minimum net capital equal to the greater of its net capital requirement under Reg. 1.17 ($1 million), or the sum of 8% of the total risk margin requirements for all positions carried in customer accounts and 8% of the total risk margin requirements for all positions carried in non-customer accounts (as defined in Reg. 1.17). At March 31, 2014, optionsXpress, Inc. met the requirements of Reg. 1.17.

 

Additionally, optionsXpress, Inc. is subject to Rule 15c3-3 under the Securities Exchange Act of 1934 and other applicable regulations that require it to maintain cash or qualified securities in a segregated reserve account for the exclusive benefit of clients. These funds are included in cash and investments segregated and on deposit for regulatory purposes in the Company’s condensed consolidated balance sheets and are not available as a general source of liquidity.

 

To partially satisfy the margin requirement of client option transactions with the Options Clearing Corporation, optionsXpress, Inc. has an unsecured standby LOC with one bank in favor of the Options Clearing Corporation in the amount of $15 million at March 31, 2014. There were no funds drawn under this LOC during the first quarter of 2014.

 

CSC provides optionsXpress, Inc. with a $200 million credit facility, which is scheduled to expire in December 2014. Borrowings under this facility do not qualify as regulatory capital for optionsXpress, Inc. There were no borrowings outstanding under this facility at March 31, 2014.

 

optionsXpress has a term loan with CSC, of which $31 million was outstanding at March 31, 2014, and it matures in December 2017.  

 

Capital Resources

 

The Company monitors both the relative composition and absolute level of its capital structure. Management is focused on optimizing the Company’s use of capital and currently targets a long-term debt to total financial capital ratio not to exceed

35 


 

THE CHARLES SCHWAB CORPORATION

Management’s Discussion and Analysis of Financial Condition and Results of Operations

(Tabular Amounts in Millions, Except Ratios, or as Noted)

 

 

30%. The Company’s total financial capital (long-term debt plus stockholders’ equity) at March 31, 2014 was $12.7 billion, up $433 million, or 4%, from December 31, 2013.

 

The Company’s cash position (reported as cash and cash equivalents on its condensed consolidated balance sheets) and cash flows are affected by changes in brokerage client cash balances and the associated amounts required to be segregated under regulatory guidelines. Timing differences between cash and investments actually segregated on a given date and the amount required to be segregated for that date may arise in the ordinary course of business, and are addressed by the Company in accordance with applicable regulations. Other factors which affect the Company’s cash position and cash flows include investment activity in security portfolios, levels of capital expenditures, acquisition and divestiture activity, banking client deposit activity, brokerage and banking client loan activity, financing activity in long-term debt, payments of dividends, and repurchases and issuances of CSC’s preferred and common stock. The combination of these factors can cause significant fluctuations in the cash position during specific time periods.

 

Long-term Debt

 

At both March 31, 2014, and December 31, 2013, the Company had long-term debt of $1.9 billion, or 15% of total financial capital. At March 31, 2014, the Company had long term debt that bears interest at a weighted-average rate of 3.60%. The Company repaid $2 million of long-term debt in the first quarter of 2014.

 

Capital Expenditures

 

The Company’s capital expenditures were $67 million and $46 million in the first quarters of 2014 and 2013, respectively. Capital expenditures in the first quarter of 2014 were primarily for buildings, developing internal-use software, and software and equipment relating to the Company’s information technology systems. Capital expenditures for the first quarter of 2013 were primarily for developing internal-use software, software and equipment relating to the Company’s information technology systems, and land. Capitalized costs for developing internal-use software were $18 million and $17 million in the first quarters of 2014 and 2013, respectively.

 

As discussed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013, management anticipated that 2014 capital expenditures would be approximately 20% higher than 2013. However, during the current quarter management revised the Company’s estimated full-year 2014 capital expenditures to approximately 50% higher than 2013 levels primarily due to the decision to acquire additional facilities to support future growth and expansion.

 

Dividends

 

CSC paid common stock cash dividends of $79 million ($0.06 per share) and $77 million ($0.06 per share) in the first quarters of 2014 and 2013, respectively.

 

CSC paid Series A Preferred Stock cash dividends of $14 million ($35.00 per share) in both the first quarters of 2014 and 2013. CSC paid Series B Preferred Stock cash dividends of $7 million ($15.00 per share) in both the first quarters of 2014 and 2013.

 

Share Repurchases

 

There were no repurchases of CSC’s common stock in the first quarters of 2014 and 2013. As of March 31, 2014, CSC had remaining authority from the Board of Directors to repurchase up to $596 million of its common stock, which is not  subject to expiration.

 

Off-Balance Sheet Arrangements

 

The Company enters into various off-balance sheet arrangements in the ordinary course of business, primarily to meet the needs of its clients. These arrangements include firm commitments to extend credit. Additionally, the Company enters into guarantees and other similar arrangements as part of transactions in the ordinary course of business. For discussion on the Company’s off-balance sheet arrangements, see “Part II – Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources  Off-Balance Sheet Arrangements” in the

36 


 

THE CHARLES SCHWAB CORPORATION

Management’s Discussion and Analysis of Financial Condition and Results of Operations

(Tabular Amounts in Millions, Except Ratios, or as Noted)

 

 

Company’s Annual Report on Form 10-K for the year ended December 31, 2013, and “Item 1 – Condensed Consolidated Financial Statements (Unaudited) – Notes – 5. Commitments and Contingencies.”

 

 

Risk Management

 

The Company’s business activities expose it to a variety of risks, including operational, credit, market, liquidity, compliance and legal risk. The Company has a comprehensive risk management program to identify and manage these risks and their associated potential for financial and reputational impact. Despite the Company’s efforts to identify areas of risk and implement risk management policies and procedures, there can be no assurance that the Company will not suffer unexpected losses due to these risks.  

 

For a discussion on risks that the Company faces and the Company’s process of risk identification and assessment, risk measurement, risk monitoring and reporting and risk mitigation, see “Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations – Risk Management” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013. For updated information on the Company’s credit risk and concentration risk exposures, see below. See “Item 3 – Quantitative and Qualitative Disclosures About Market Risk” for additional information relating to market risk.

 

Credit Risk Exposures

 

The Company’s credit risk exposure related to loans to banking clients is actively managed through individual and portfolio reviews performed by management. Management regularly reviews asset quality, including concentrations, delinquencies, nonaccrual loans, charge-offs, and recoveries. All are factors in the determination of an appropriate allowance for loan losses. The Company’s mortgage loan portfolios primarily include first lien residential real estate mortgage loans (First Mortgages) of $8.1 billion and HELOCs of $3.0 billion at March 31, 2014.

 

The Company’s underwriting guidelines include maximum loan-to-value (LTV) ratios, cash out limits, and minimum Fair Isaac Corporation (FICO) credit scores. The specific guidelines are dependent on the individual characteristics of a loan (for example, whether the property is a primary or secondary residence, whether the loan is for investment property, whether the loan is for an initial purchase of a home or refinance of an existing home, and whether the loan is conforming or jumbo). These credit underwriting standards have limited the exposure to the types of loans that experienced high foreclosures and loss rates elsewhere in the industry in recent years. In January 2014, the Company revised its First Mortgage underwriting criteria in conformance with the Consumer Financial Protection Bureau’s new guidance on Qualified Mortgage lending and a borrower’s ability to repay. Revisions were made to requirements affecting debt to income ratio, loan to value ratio, and liquid asset holdings. These revised underwriting criteria are not expected to have a material impact on the credit quality of the Company’s First Mortgage or HELOC portfolios. The Company does not purchase loans that allow for negative amortization and does not purchase subprime loans (generally defined as extensions of credit to borrowers with a FICO score of less than 620 at origination), unless the borrower has compensating credit factors. At March 31, 2014, approximately 1% of both the First Mortgage and HELOC portfolios consisted of loans to borrowers with updated FICO scores of less than 620.

 

At March 31, 2014, the weighted-average originated LTV ratio was 59% for both the First Mortgage and HELOC portfolios. The computation of the origination LTV ratio for a HELOC includes any first lien mortgage outstanding on the same property at the time of origination. At March 31, 2014,  22% of HELOCs ($672 million of the HELOC portfolio) were in a first lien position. The weighted-average originated FICO score was 769 and 768 for the First Mortgage and HELOC portfolios, respectively.  

 

The Company monitors the estimated current LTV ratios of its First Mortgage and HELOC portfolios on an ongoing basis. At March 31, 2014, the weighted-average estimated current LTV ratios were 52% and 58% for the First Mortgage and HELOC portfolios, respectively. The computation of the estimated current LTV ratio for a HELOC includes any first lien mortgage outstanding on the same property at the time of the HELOC’s origination. The Company estimates the current LTV ratio for each loan by reference to a home price appreciation index. The Company also monitors updated borrower FICO scores, delinquency trends, and verified liquid assets held by individual borrowers. At March 31, 2014, the weighted-average updated FICO scores were 774 and 770 for the First Mortgage and HELOC portfolios, respectively.

 

37 


 

THE CHARLES SCHWAB CORPORATION

Management’s Discussion and Analysis of Financial Condition and Results of Operations

(Tabular Amounts in Millions, Except Ratios, or as Noted)

 

 

A portion of the Company’s HELOC portfolio is secured by second liens on the associated properties. Second lien mortgage loans possess a higher degree of credit risk given the subordination to the first lien holder in the event of default. At March 31, 2014, $2.3 billion, or 78%, of the HELOC portfolio was in a second lien position. In addition to the credit monitoring activities described above, the Company also monitors credit risk on second lien HELOC loans by reviewing the delinquency status of the first lien loan on the associated property. Additionally, at March 31, 2014, approximately 30% of the HELOC borrowers that had a balance only paid the minimum amount due.

 

For more information on the Company’s credit quality indicators relating to its First Mortgage and HELOC portfolios, including delinquency characteristics, borrower FICO scores at origination, updated borrower FICO scores, LTV ratios at origination, and estimated current LTV ratios, see “Item 1 – Condensed Consolidated Financial Statements (Unaudited) – Notes – 4. Loans to Banking Clients and Related Allowance for Loan Losses.”

 

The following table presents certain of the Company’s loan quality metrics as a percentage of total outstanding loans:

 

 

 

 

 

 

 

 

 

 

March 31,

 

December 31,

 

 

2014

 

2013

Loan delinquencies (1)

 

0.44% 

 

 

0.48% 

 

Nonaccrual loans

 

0.32% 

 

 

0.39% 

 

Allowance for loan losses

 

0.38% 

 

 

0.39% 

 

 

(1)

Loan delinquencies include loans that are 30 days or more past due and other nonaccrual loans.

 

The Company has exposure to credit risk associated with its securities available for sale and securities held to maturity portfolios, whose fair values totaled $53.1 billion and $31.7 billion at March 31, 2014, respectively. These portfolios include U.S. agency and non-agency mortgage-backed securities, asset-backed securities, corporate debt securities, U.S. agency notes, and certificates of deposit. U.S. agency mortgage-backed securities do not have explicit credit ratings; however, management considers these to be of the highest credit quality and rating given the guarantee of principal and interest by the U.S. government-sponsored enterprises.

 

At March 31, 2014, all securities in the available for sale and held to maturity portfolios were rated investment grade (defined as a rating equivalent to a Moody’s rating of “Baa” or higher, or a Standard & Poor’s rating of “BBB-” or higher). Although the Company has recognized net impairment losses on certain non-agency residential mortgage-backed securities in prior quarters, at March 31, 2014, the amortized cost of all non-agency residential mortgage-backed securities represented less than 1% of the securities available for sale and securities held to maturity portfolios.

 

Concentration Risk Exposures

 

The Company has exposure to concentration risk when holding large positions in financial instruments collateralized by assets with similar economic characteristics or in securities of a single issuer or within a particular industry.

 

The fair value of the Company’s investments in mortgage-backed securities totaled $51.0 billion at March 31, 2014. Of these, $49.2 billion were issued by U.S. agencies and $1.8 billion were issued by private entities (non-agency securities). These U.S. agency and non-agency securities are included in securities available for sale and securities held to maturity.

 

The fair value of the Company’s investments in corporate debt securities and commercial paper totaled $9.2 billion at March 31,  2014, with the majority issued by institutions in the financial services industry. These securities are included in securities available for sale, securities held to maturity, cash and cash equivalents, and other securities owned in the Company’s condensed consolidated balance sheets. Issuer, geographic, and sector concentrations are controlled by established credit policy limits to each concentration type.

 

The Company’s loans to banking clients include $7.3 billion of adjustable rate first lien residential real estate mortgage loans at March 31, 2014. The Company’s adjustable rate mortgages have initial fixed interest rates for three to ten years and interest rates that adjust annually thereafter. Approximately 40% of these mortgages consisted of loans with interest-only payment terms. The interest rates on approximately 65% of these interest-only loans are not scheduled to reset for three or more years. The Company’s mortgage loans do not include interest terms described as temporary introductory rates below

38 


 

THE CHARLES SCHWAB CORPORATION

Management’s Discussion and Analysis of Financial Condition and Results of Operations

(Tabular Amounts in Millions, Except Ratios, or as Noted)

 

 

current market rates. At March 31, 2014,  46% of the residential real estate mortgages and 51% of the HELOC balances were secured by properties which are located in California.

 

The Company’s HELOC product has a 30-year loan term with an initial draw period of ten years from the date of origination. After the initial draw period, the balance outstanding at such time is converted to a 20-year amortizing loan. The interest rate during the initial draw period and the 20-year amortizing period is a floating rate based on the prime rate plus a margin. The following table presents when current outstanding HELOCs will convert to amortizing loans:

 

 

 

 

 

 

March 31, 2014

  

Balance

 

Converted to amortizing loan by period end

 

$

184 

 

Within 1 year

  

 

221 

  

> 1 year – 3 years

  

 

477 

  

> 3 years – 5 years

  

 

1,203 

  

> 5 years

  

 

933 

  

Total

  

$

3,018 

  

 

The Company also has exposure to concentration risk from its margin and securities lending activities collateralized by securities of a single issuer or within a single industry. This concentration risk is mitigated by collateral arrangements that require the fair value of such collateral exceeds the amounts loaned.

 

The Company has indirect exposure to U.S. Government and agency securities held as collateral to secure its resale agreements. The Company’s primary credit exposure on these resale transactions is with its counterparty. The Company would have exposure to the U.S. Government and agency securities only in the event of the counterparty’s default on the resale agreements. The fair value of U.S. Government and agency securities held as collateral for resale agreements totaled $12.0 billion at March 31, 2014.

 

European Holdings

 

The Company has exposure to non-sovereign financial and non-financial institutions in Europe. The following table shows the balances of this exposure by each country in Europe in which the issuer or counterparty is domiciled. The Company has no direct exposure to sovereign governments in Europe. The Company does not have unfunded commitments to counterparties in Europe, nor does it have exposure as a result of credit default protection purchased or sold separately as of March 31, 2014.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fair Value as of March 31, 2014

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

United

 

 

 

 

France

Germany

Italy

Netherlands

Norway

Sweden

Switzerland

Kingdom

Total

Cash equivalents

 

$

400 

 

$

 -

 

$

 -

 

$

 -

 

$

 -

 

$

 -

 

$

 -

 

$

200 

 

$

600 

Cash and investments

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

segregated and on deposit

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

for regulatory purposes

 

 

 -

  

 

400 

 

 

 -

 

 

 -

  

 

 -

  

 

 -

  

 

 -

 

 

 -

 

 

400 

Securities available for sale

 

 

356 

 

 

150 

 

 

200 

 

 

236 

 

 

75 

 

 

1,298 

 

 

650 

 

 

846 

 

 

3,811 

Securities held to maturity

 

 

 -

  

 

 -

 

 

 -

 

 

 -

  

 

 -

  

 

 -

  

 

100 

 

 

 -

 

 

100 

Total fair value

 

$

756 

  

$

550 

 

$

200 

 

$

236 

  

$

75 

  

$

1,298 

  

$

750 

 

$

1,046 

 

$

4,911 

Total amortized cost

 

$

755 

  

$

550 

 

$

200 

 

$

235 

  

$

75 

  

$

1,295 

  

$

750 

 

$

1,045 

 

$

4,905 

Maturities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Overnight

 

$

400 

  

$

400 

 

$

 -

 

$

 -

  

$

 -

  

$

 -

  

$

 -

 

$

200 

 

$

1,000 

1 day – < 6 months

 

 

 -

  

 

 -

 

 

 -

 

 

100 

  

 

 -

  

 

100 

  

 

 -

 

 

159 

 

 

359 

6 months – < 1 year

 

 

200 

  

 

150 

 

 

100 

 

 

 -

  

 

 -

  

 

526 

  

 

100 

 

 

152 

 

 

1,228 

1 year – 2 years

 

 

70 

  

 

 -

 

 

100 

 

 

101 

  

 

 -

  

 

201 

  

 

500 

 

 

485 

 

 

1,457 

> 2 years

 

 

86 

  

 

 -

 

 

 -

 

 

35 

  

 

75 

  

 

471 

  

 

150 

 

 

50 

 

 

867 

Total fair value

 

$

756 

  

$

550 

 

$

200 

 

$

236 

  

$

75 

  

$

1,298 

  

$

750 

 

$

1,046 

 

$

4,911 

 

In addition to the direct holdings of European companies listed above, the Company also has indirect exposure to Europe through its investments in Schwab sponsored money market funds (collectively, the Funds) resulting from clearing activities.

39 


 

THE CHARLES SCHWAB CORPORATION

Management’s Discussion and Analysis of Financial Condition and Results of Operations

(Tabular Amounts in Millions, Except Ratios, or as Noted)

 

 

At March 31, 2014, the Company had $208 million in investments in these Funds. Certain of the Funds’ positions include certificates of deposits, time deposits, commercial paper and corporate debt securities issued by counterparties in Europe.

 

 

Critical Accounting ESTIMATES

 

Certain of the Company’s accounting policies that involve a higher degree of judgment and complexity are discussed in “Part II – Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Estimates” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013. There have been no changes to these critical accounting estimates during the first quarter of 2014.

 

 

Forward-Looking Statements

 

In addition to historical information, this Quarterly Report on Form 10-Q contains “forward-looking statements” within the meaning of Section 27A of the Securities Act, and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements are identified by words such as “believe,” “anticipate,” “expect,” “intend,” “plan,” “will,” “may,” “estimate,” “appear,” “aim,” “target,” “could,” and other similar expressions. In addition, any statements that refer to expectations, projections, or other characterizations of future events or circumstances are forward-looking statements.

 

These forward-looking statements, which reflect management’s beliefs, objectives, and expectations as of the date hereof, are necessarily estimates based on the best judgment of the Company’s senior management. These statements relate to, among other things:

·

the impact of current market conditions on the Company’s results of operations (see “Item 1 – Condensed Consolidated Financial Statements (Unaudited) – Notes – 3. Securities Available for Sale and Securities Held to Maturity, “Current Market and Regulatory Environment and Other Developments, and “Results of Operations – Net Interest Revenue”);

·

the expected impact of the final regulatory capital rules, which implemented Basel III and relevant provisions of the Dodd-Frank Act, and the Federal Reserve notice of proposed rulemaking regarding quantitative liquidity requirements (see “Current Market and Regulatory Environment and Other Developments”);

·

the impact of changes in the likelihood of indemnification and guarantee payment obligations on the Company’s results of operations (see “Item 1 – Condensed Consolidated Financial Statements (Unaudited) – Notes – 5. Commitments and Contingencies”);

·

the impact of legal proceedings and regulatory matters (see “Item 1 – Condensed Consolidated Financial Statements (Unaudited) – Notes – 5. Commitments and Contingencies  Legal contingencies” and “Part II – Other Information – Item 1 – Legal Proceedings”);

·

target capital and debt ratios (see “Item 1 – Condensed Consolidated Financial Statements (Unaudited) – Notes – 9. Regulatory Requirements” and “Liquidity and Capital Resources”);

·

sources of liquidity, capital, and level of dividends (see “Item 1 Condensed Consolidated Financial Statements (Unaudited) Notes 9. Regulatory Requirements” and “Liquidity and Capital Resources”);

·

capital expenditures (see “Liquidity and Capital Resources – Capital Resources  Capital Expenditures”); and

·

the impact of the revised underwriting criteria on the credit quality of the Company’s mortgage portfolio (see “Risk Management – Credit Risk Exposures”).

 

Achievement of the expressed beliefs, objectives, and expectations described in these statements is subject to certain risks and uncertainties that could cause actual results to differ materially from the expressed beliefs, objectives, and expectations. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this Quarterly Report on Form 10-Q or, in the case of documents incorporated by reference, as of the date of those documents.

 

Important factors that may cause actual results to differ include, but are not limited to:

·

changes in general economic and financial market conditions;

·

changes in revenues and profit margin due to changes in interest rates;

·

the Company’s ability to attract and retain clients and grow client assets and relationships;

40 


 

THE CHARLES SCHWAB CORPORATION

Management’s Discussion and Analysis of Financial Condition and Results of Operations

(Tabular Amounts in Millions, Except Ratios, or as Noted)

 

 

·

the Company’s ability to develop and launch new products, services and capabilities in a timely and successful manner;

·

fluctuations in client asset values due to changes in equity valuations;

·

the Company’s ability to monetize client assets;

·

the performance or valuation of securities available for sale and securities held to maturity;

·

trading activity;

·

the level of interest rates, including yields available on money market mutual fund eligible instruments;

·

the adverse impact of financial reform legislation and related regulations;

·

adverse developments in litigation or regulatory matters;

·

amounts recovered on insurance policies;

·

the extent of any charges associated with litigation and regulatory matters;

·

the amount of loans to the Company’s brokerage and banking clients;

·

the level of the Company’s stock repurchase activity;

·

the level of brokerage client cash balances and deposits from banking clients;

·

the availability and terms of external financing;

·

capital needs and management;

·

the level of field sales volume and related incentive compensation;

·

level of expenses;

·

the Company’s ability to manage expenses;

·

regulatory guidance;

·

the level of client assets, including cash balances;

·

competitive pressures on rates and fees;

·

acquisition integration costs;

·

the timing and impact of changes in the Company’s level of investments in buildings, land, and leasehold improvements;

·

potential breaches of contractual terms for which the Company has indemnification and guarantee obligations; and

·

the extent to which past performance of the Company’s mortgage portfolio is indicative of future performance.

 

Certain of these factors, as well as general risk factors affecting the Company, are discussed in greater detail in “Part I –Item 1A – Risk Factors” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013, and “Part II – Other Information – Item 1A – Risk Factors.

 

41 


 

THE CHARLES SCHWAB CORPORATION

 

 

 

 

Item 3.Quantitative and Qualitative Disclosures About Market Risk

 

Market risk is the potential for changes in earnings or the value of financial instruments held by the Company as a result of fluctuations in interest rates, equity prices or market conditions.

 

The Company is exposed to interest rate risk primarily from changes in market interest rates on its interest-earning assets relative to changes in the costs of its funding sources that finance these assets. The majority of the Company’s interest-earning assets and interest-bearing liabilities are sensitive to changes in short-term interest rates. To a lesser degree, the Company is sensitive to changes in long-term interest rates through some of its investment portfolios. To manage the Company’s market risk related to interest rates, management utilizes simulation models, which include the net interest revenue sensitivity analysis described below.

 

Net interest revenue is affected by various factors, such as the distribution and composition of interest-earning assets and interest-bearing liabilities, the spread between yields earned on interest-earning assets and rates paid on interest-bearing liabilities, which may reprice at different times or by different amounts, and the spread between short and long-term interest rates. Interest-earning assets include residential real estate loans and mortgage-backed securities. These assets are sensitive to changes in interest rates and to changes to prepayment levels that tend to increase in a declining rate environment and decrease in a rising rate environment. Because the Company establishes the rates paid on certain brokerage client cash balances and deposits from banking clients and the rates charged on margin loans and loans to banking clients, and controls the composition of its investment securities, it has some ability to manage its net interest spread, depending on competitive factors and market conditions.

 

To mitigate the risk of loss, the Company has established policies and procedures which include setting guidelines on the amount of net interest revenue at risk, and monitoring the net interest margin and average maturity of its interest-earning assets and funding sources. To remain within these guidelines, the Company manages the maturity, repricing, and cash flow characteristics of the investment portfolios.

 

The Company is also subject to market risk as a result of fluctuations in option and equity prices. The Company’s direct holdings of option and equity securities and its associated exposure to option and equity prices are not material. The Company is indirectly exposed to option and equity market fluctuations in connection with client option accounts, securities collateralizing margin loans to brokerage customers, and customer securities loaned out as part of the Company’s securities lending activities. Equity market valuations may also affect the level of brokerage client trading activity, margin borrowing, and overall client engagement with the Company. Additionally, the Company earns mutual fund service fees and asset management fees based upon daily balances of certain client assets. Fluctuations in these client asset balances caused by changes in equity valuations directly impact the amount of fee revenue earned by the Company.

 

Financial instruments held by the Company are also subject to liquidity risk – that is, the risk that valuations will be negatively affected by changes in demand and the underlying market for a financial instrument. Recent conditions in the credit markets have significantly reduced market liquidity in a wide range of financial instruments, including the types of instruments held by the Company, and fair value can differ significantly from the value implied by the credit quality and actual performance of the instrument’s underlying cash flows.

 

For discussion of the impact of current market conditions on asset management and administration fees and net interest revenue, see “Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations – Current Market and Regulatory Environment and Other Developments.”

 

The Company’s market risk related to financial instruments held for trading is not material.

 

Net Interest Revenue Simulation

 

For the Company’s net interest revenue sensitivity analysis, the Company uses net interest revenue simulation modeling techniques to evaluate and manage the effect of changing interest rates. The simulation includes all interest-sensitive assets and liabilities. Key variables in the simulation include the repricing of financial instruments, prepayment, reinvestment, and product pricing assumptions. The Company uses constant balances and market rates in the simulation assumptions in order to minimize the number of variables and to better isolate risks. The simulations involve assumptions that are inherently uncertain and, as a result, cannot precisely estimate net interest revenue or predict the impact of changes in interest rates on

42 


 

THE CHARLES SCHWAB CORPORATION

 

 

 

 

net interest revenue. Actual results may differ from simulated results due to balance growth or decline and the timing, magnitude, and frequency of interest rate changes, as well as changes in market conditions and management strategies, including changes in asset and liability mix.

 

If the Company’s guidelines for its net interest revenue sensitivity are breached, management must report the breach to the Company’s Corporate Asset-Liability Management and Pricing Committee (Corporate ALCO) and establish a plan to address the interest rate risk. This plan could include, but is not limited to, rebalancing certain investment portfolios or using derivative instruments to mitigate the interest rate risk. Depending on the severity and expected duration of the breach, as well as the then current interest rate environment, the plan could also be to take no action. Any plan that recommends taking action is required to be approved by the Company’s Corporate ALCO. There were no breaches of the Company’s net interest revenue sensitivity guidelines during the first quarter of 2014 or year-ending December 31, 2013.

 

As represented by the simulations presented below, the Company’s investment strategy is structured to produce an increase in net interest revenue when interest rates rise and, conversely, a decrease in net interest revenue when interest rates fall.

 

The simulations in the following table assume that the asset and liability structure of the consolidated balance sheet would not be changed as a result of the simulated changes in interest rates. As the Company actively manages its consolidated balance sheet and interest rate exposure, in all likelihood the Company would take steps to manage any additional interest rate exposure that could result from changes in the interest rate environment. The following table shows the results of a gradual 100 basis point increase or decrease in market interest rates relative to the Company’s current market rates forecast on simulated net interest revenue over the next 12 months beginning March 31, 2014 and December 31, 2013.

 

 

 

 

 

 

 

 

 

 

March 31,

 

December 31,

 

 

2014

 

2013

Increase of 100 basis points

 

10.2 

 

11.0 

Decrease of 100 basis points

 

(4.4)

 

(4.5)

%

 

The sensitivities shown in the simulation reflect the fact that short-term interest rates in the first quarter of 2014 remained at historically low levels, including the federal funds target rate, which was unchanged at a range of zero to 0.25%. The current low interest rate environment limits the extent to which the Company can reduce interest expense paid on funding sources. A decline in interest rates could negatively impact the yield on the Company’s investment portfolio to a greater degree than any offsetting reduction in interest expense, further compressing net interest margin. Any increases in short-term interest rates result in a greater impact as yields on interest-earning assets are expected to rise faster than the cost of funding sources. 

 

 

Item 4.Controls and Procedures

 

Evaluation of disclosure controls and procedures: The management of the Company, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934) as of March 31, 2014. Based on this evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures were effective as of March 31, 2014.

 

Changes in internal control over financial reporting: No change in the Company’s internal control over financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934) was identified during the quarter ended March 31, 2014, that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

 

43 


 

THE CHARLES SCHWAB CORPORATION

 

 

 

 

PART  II  -  OTHER  INFORMATION

 

 

Item 1.Legal Proceedings

 

For a discussion of legal proceedings, see “Part I – Financial Information – Item 1 – Condensed Consolidated Financial Statements (Unaudited) – Notes – 5Commitments and Contingencies.”

 

 

Item 1A.Risk Factors

 

During the first quarter of 2014, there have been no material changes to the risk factors in “Part I – Item 1A – Risk Factors” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013.

 

 

Item 2.Unregistered Sales of Equity Securities and Use of Proceeds

 

Issuer Purchases of Equity Securities

 

The following table summarizes purchases made by or on behalf of CSC of its common stock for each calendar month in the first quarter of 2014:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total Number

 

Approximate

 

 

 

 

 

 

 

 

of Shares Purchased

 

Dollar Value of

 

 

Total Number

 

 

 

 

as Part of Publicly

 

Shares that May

 

 

of Shares

 

Average

 

Announced

 

Yet be Purchased

 

 

Purchased

 

Price Paid

 

Program (1) 

 

Under the Program

Month

 

(in thousands)

 

per Share

 

(in thousands)

 

(in millions)

January:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Share repurchase program (1)

 

 -

 

  

$

 -

  

 -

 

  

 

$

596 

 

Employee transactions (2)

 

 

  

$

25.84 

  

N/A

 

  

 

 

N/A

 

February:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Share repurchase program (1)

 

 -

 

  

$

 -

  

 -

 

  

 

$

596 

 

Employee transactions (2)

 

 

  

$

24.98 

  

N/A

 

  

 

 

N/A

 

March:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Share repurchase program (1)

 

 -

 

  

$

 -

  

 -

 

  

 

$

596 

 

Employee transactions (2)

 

219 

 

  

$

25.99 

  

N/A

 

  

 

 

N/A

 

Total:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Share repurchase program (1)

 

 -

 

  

$

 -

  

 -

 

  

 

$

596 

 

Employee transactions (2)

 

233 

 

  

$

25.95 

  

N/A

 

  

 

 

N/A

 

 

 

 

(1)

There were no share repurchases under the Share Repurchase Program during the first quarter. Repurchases under this program would occur under two authorizations by CSC’s Board of Directors, each covering up to $500 million of common stock that were publicly announced by the Company on April 25, 2007 and March 13, 2008. The remaining authorizations do not have an expiration date.

(2)

Includes restricted shares withheld (under the terms of grants under employee stock incentive plans) to offset tax withholding obligations that occur upon vesting and release of restricted shares. The Company may receive shares delivered or attested to pay the exercise price and/or to satisfy tax withholding obligations by employees who exercise stock options (granted under employee stock incentive plans), which are commonly referred to as stock swap exercises.

N/A Not applicable.

 

 

44 


 

THE CHARLES SCHWAB CORPORATION

 

 

 

 

Item 3.Defaults Upon Senior Securities

 

None.

 

 

Item 4.Mine Safety Disclosures

 

Not applicable.

 

 

Item 5.Other Information

 

None.

 

 

Item 6.Exhibits

 

The following exhibits are filed as part of this Quarterly Report on Form 10-Q.

 

 

 

 

Exhibit
Number


Exhibit

 

 

 

 

12.1

Computation of Ratio of Earnings to Fixed Charges and Ratio of Earnings to Fixed Charges and Preferred Stock Dividends.

 

 

 

 

31.1

Certification Pursuant to Rule 13a-14(a)/15d-14(a), As Adopted Pursuant to Section 302 of The Sarbanes-Oxley Act of 2002.

 

 

 

 

31.2

Certification Pursuant to Rule 13a-14(a)/15d-14(a), As Adopted Pursuant to Section 302 of The Sarbanes-Oxley Act of 2002.

 

 

 

 

32.1

Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of The Sarbanes-Oxley Act of 2002.

(1)

 

 

 

32.2

Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of The Sarbanes-Oxley Act of 2002.

(1)

 

 

 

101.INS

XBRL Instance Document

(2)

 

 

 

101.SCH

XBRL Taxonomy Extension Schema

(2)

 

 

 

101.CAL

XBRL Taxonomy Extension Calculation

(2)

 

 

 

101.DEF

XBRL Extension Definition

(2)

 

 

 

101.LAB

XBRL Taxonomy Extension Label

(2)

 

 

 

101.PRE

XBRL Taxonomy Extension Presentation

(2)

 

 

 

(1)

Furnished as an exhibit to this Quarterly Report on Form 10-Q.

 

 

 

(2)

Attached as Exhibit 101 to this Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2014 are the following materials formatted in XBRL (Extensible Business Reporting Language) (i) the Condensed Consolidated Statements of Income, (ii) the Condensed Consolidated Statements of Comprehensive Income, (iii) the Condensed Consolidated Balance Sheets, (iv) the Condensed Consolidated Statements of Cash Flows, and (v) Notes to Condensed Consolidated Financial Statements.

 

 

 

 

45 


 

THE CHARLES SCHWAB CORPORATION

 

 

 

 

SIGNATURE

 

 

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

 

THE CHARLES SCHWAB CORPORATION

 

 

 

(Registrant)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Date:

May 7, 2014

 

/s/ Joseph R. Martinetto

 

 

 

Joseph R. Martinetto

 

 

 

Executive Vice President and

 

 

 

Chief Financial Officer

 

 

46