UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2008 |
Commission file number 1-9700 |
THE CHARLES SCHWAB CORPORATION
(Exact name of registrant as specified in its charter)
Delaware | 94-3025021 | |
(State or other jurisdiction of incorporation or organization) |
(I.R.S. Employer Identification Number) |
120 Kearny Street, San Francisco, CA 94108
(Address of principal executive offices and zip code)
Registrants telephone number, including area code: (415) 636-7000
Securities registered pursuant to Section 12(b) of the Act:
Title of each class | Name of each exchange on which registered | |
Common Stock - $.01 par value per share | The Nasdaq Stock Market |
Securities registered pursuant to Section 12(g) of the Act: Common Stock - None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes x No ¨
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes ¨ No x
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 x No ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨
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 | x | Accelerated filer | ¨ | |||
Non-accelerated filer | ¨ (Do not check if a smaller reporting company) | 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 x
As of June 30, 2008, the aggregate market value of the voting stock held by non-affiliates of the registrant was $19.6 billion. For purposes of this information, the outstanding shares of Common Stock owned by directors and executive officers of the registrant, and certain investment companies managed by Charles Schwab Investment Management, Inc. were deemed to be shares of the voting stock held by affiliates.
The number of shares of Common Stock outstanding as of January 30, 2009, was 1,157,306,315.
DOCUMENTS INCORPORATED BY REFERENCE
Part III of this Form 10-K incorporates certain information contained in the registrants definitive proxy statement for its annual meeting of stockholders, to be held May 14, 2009, by reference to that document.
THE CHARLES SCHWAB CORPORATION
Annual Report On Form 10-K
For Fiscal Year Ended December 31, 2008
TABLE OF CONTENTS
THE CHARLES SCHWAB CORPORATION
Item 1. | Business |
The Charles Schwab Corporation (CSC), headquartered in San Francisco, California, was incorporated in 1986 and engages, through its subsidiaries (collectively referred to as the Company, and primarily located in San Francisco except as indicated), in securities brokerage, banking, and related financial services. At December 31, 2008, the Company had $1.137 trillion in client assets, 7.4 million active brokerage accounts(a), 1.4 million corporate retirement plan participants, and 447,000 banking accounts. Significant subsidiaries of CSC include: Charles Schwab & Co., Inc. (Schwab), which was incorporated in 1971, is a securities broker-dealer with 306 domestic branch offices in 45 states, as well as a branch in each of the Commonwealth of Puerto Rico and London, U.K., and serves clients in Hong Kong through one of CSCs subsidiaries; Charles Schwab Bank (Schwab Bank), which commenced operations in 2003, is a federal savings bank located in Reno, Nevada; and Charles Schwab Investment Management, Inc. (CSIM) is the investment advisor for Schwabs proprietary mutual funds, which are referred to as the Schwab Funds®.
The Company provides financial services to individuals and institutional clients through three segments Investor Services (formerly called Schwab Investor Services), Advisor Services (formerly called Schwab Institutional®), and Corporate and Retirement Services (formerly called Schwab Corporate and Retirement Services). The Investor Services segment includes the Companys retail brokerage and banking operations. The Advisor Services segment provides custodial, trading and support services to independent investment advisors (IAs). The Corporate and Retirement Services segment provides retirement plan services for employers and employees, as well as support services for plan administrators. For financial information by segment for the three years ended December 31, 2008, see Item 8 Financial Statements and Supplementary Data Notes to Consolidated Financial Statements 21. Segment Information.
As of December 31, 2008, the Company had full-time, part-time and temporary employees, and persons employed on a contract basis that represented the equivalent of about 13,400 full-time employees.
On July 1, 2007, the Company completed the sale of all of the outstanding stock of U.S. Trust Corporation (USTC, and with its subsidiaries collectively referred to as U.S. Trust). U.S. Trust was a subsidiary that provided wealth management services. U.S. Trust is presented as a discontinued operation for all periods prior to the completion of the sale. All other information contained in this Annual Report on Form 10-K is presented on a continuing operations basis unless otherwise noted.
On March 31, 2007, the Company completed its acquisition of The 401(k) Company, which offers retirement plan services. The acquisition enhanced the Companys ability to meet the needs of retirement plans of all sizes. The acquisition also provided the opportunity to capture rollover accounts from individuals participating in retirement plans served by The 401(k) Company and to cross-sell the Companys other investment and banking services to plan participants.
In 2004, the Company sold its capital markets business, consisting of partnership interests of Schwab Capital Markets L.P. and all of the outstanding capital stock of SoundView Technology Group, Inc. (collectively referred to as Schwab Soundview Capital Markets, or SSCM).
Business Strategy and Competitive Environment
The Companys purpose is to help everyone become financially fit. The Companys strategy is to meet the financial services needs of individual investors both directly and indirectly through its three segments. The Company provides clients with a compelling combination of personalized relationships, superior service, and great value, delivered through a blend of people and technology. People provide the client focus and personal touch that are essential in serving investors, while technology
(a) | Accounts with balances or activity within the preceding eight months. |
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THE CHARLES SCHWAB CORPORATION
helps create services that are scalable and consistent. This combination helps the Company address a wide range of client needs from tools and information for self-directed or active investors, to advice services, to retirement and equity-based incentive plans, to support services for independent IAs while enabling each client to easily utilize some or all of these capabilities according to each clients unique circumstances.
The Companys competition in serving individual investors includes a wide range of brokerage, wealth management, asset management firms, banks, and trust companies. In serving these investors and competing for a growing percentage of the investable wealth in the U.S., the Company offers a multi-channel service delivery model which includes branch, telephonic, and online capabilities. Under this model, the Company can offer personalized service at competitive prices while giving clients the choice of where, when, and how they do business with the Company. Schwabs branches and regional telephone service centers are staffed with trained and experienced financial consultants (FCs) focused on building and sustaining client relationships. The Company offers the ability to meet client investing needs through a single ongoing point of contact, even as those needs change over time. In particular, management believes that the Companys ability to provide those clients seeking help, guidance, or advice with an integrated, individually tailored solution ranging from occasional consultations to an ongoing relationship with a Schwab FC or an IA is a competitive strength compared to the more fragmented offerings of other firms.
The Companys online and telephonic channels provide quick and efficient access to an extensive array of information, research, tools, trade execution, and administrative services, which clients can access according to their needs. For example, as clients trade more actively, they can use these channels to access highly competitive pricing, expert tools, and extensive service capabilities including experienced, knowledgeable teams of trading specialists and integrated product offerings.
Individuals investing for retirement through 401(k) plans can take advantage of the Companys bundled offering of multiple investment choices, education, and third-party advice. Management also believes the Company is able to compete with the wide variety of financial services firms striving to attract individual client relationships by complementing these capabilities with the extensive array of investment, banking, and lending products and services described in the following section.
In the IA arena, the Company competes with institutional custodians, traditional and discount brokers, banks, and trust companies. Management believes that its Advisor Services segment can maintain its market leadership position primarily through the efforts of its expanded sales and support teams, which are dedicated to helping IAs grow, compete, and succeed in serving their clients. In addition to focusing on superior service, Advisor Services competes by utilizing technology to provide IAs with a highly-developed, scalable platform for administering their clients assets easily and efficiently. Advisor Services sponsors a variety of national, regional, and local events designed to help IAs identify and implement better ways to grow and manage their practices efficiently.
Another important aspect of the Companys ability to compete is its ongoing focus on efficiency and productivity, as lower costs give the Company greater flexibility in its approach to pricing and investing for growth. Management believes that this flexibility remains important in light of the current competitive environment, in which a number of competitors offer reduced online trading commission rates and account fees, as well as lower expense ratios on certain classes of mutual funds. Additionally, the Companys nationwide marketing effort is an important competitive tool because it reinforces the attributes of the Schwab® brand.
The Company offers a broad range of products to address individuals varying investment and financial needs. Examples of these product offerings include:
| Brokerage various asset management accounts including some with check-writing features, debit card, and billpay; individual retirement accounts; retirement plans for small to large businesses; 529 college savings accounts; separately managed accounts; designated brokerage accounts; equity incentive plan accounts; and margin loans, as well as access to fixed income securities and equity and debt offerings; |
| Banking first mortgages, home equity lines of credit, pledged-asset loans, certificates of deposit, demand deposit accounts, high-yield investor checking accounts linked to brokerage accounts, and credit cards; |
| Trust trust custody services, personal trust reporting services, and administrative trustee services; and |
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THE CHARLES SCHWAB CORPORATION
|
Mutual funds third-party mutual funds through Mutual Fund Marketplace®, including no-load mutual funds through the Mutual Fund OneSource® service, proprietary mutual funds from two fund families Schwab Funds® and Laudus Funds®, other third-party mutual funds, and mutual fund trading and clearing services to broker-dealers. |
These products, and the Companys full array of investing services, are made available through its three segments Investor Services, Advisor Services, and Corporate and Retirement Services.
Investor Services
Through the Investor Services segment, the Company provides retail brokerage and banking services to individual investors. Most clients with assets totaling $250,000 or more at Schwab have a specific FC designated as their primary point of contact for utilizing Schwabs services.
The Company offers research, analytic tools, performance reports, market analysis, and educational material to all clients. Clients looking for more guidance have access to online portfolio planning tools, as well as professional advice from Schwabs portfolio consultants who can help develop an investment strategy and carry out investment and portfolio management decisions.
Schwab strives to demystify investing by educating and assisting clients in the development of investment plans. Educational tools include workshops, interactive courses, and online information about investing. Additionally, Schwab provides various internet-based research and analysis tools which are designed to help clients achieve better investment outcomes. As an example of such tools, Schwab Equity Ratings® is a quantitative model-based stock rating system which provides all clients with ratings on approximately 3,000 stocks, assigning each equity a single grade: A, B, C, D, or F. Stocks are rated based on specific factors relating to fundamentals, valuation, momentum, and risk and ranked so that the number of buy consideration ratings As and Bs equals the number of sell consideration ratings Ds and Fs.
Clients may need specific investment recommendations either from time to time or on an ongoing basis. The Company seeks to provide clients seeking advice with customized solutions. The Companys approach to advice is based on long-term investment strategies and guidance on portfolio diversification and asset allocation. This approach is designed to be offered consistently across all of Schwabs delivery channels.
Schwab Private ClientTM features a personal advice relationship with a designated FC, supported by a team of investment professionals who provide individualized service, a customized investment strategy developed in collaboration with the client, and ongoing guidance and execution.
For clients seeking a relationship in which investment decisions are fully delegated to a financial professional, the Company offers several alternatives. The Company provides investors access to professional investment management in a diversified account that is invested exclusively in mutual funds through the Schwab Managed PortfolioTM program. The Company also refers investors who want to utilize a specific third-party money manager to direct a portion of their investment assets to the Schwab Managed Account program. In addition, clients who want the assistance of an independent professional in managing their financial affairs may be referred to IAs in the Schwab Advisor Network®. These IAs provide personalized portfolio management, financial planning, and wealth management solutions.
The Company strives to deliver information, education, technology, service, and pricing which meet the specific needs of clients who trade actively. Schwab offers integrated Web- and software-based trading platforms, which incorporate intelligent order routing technology, real-time market data, options trading, premium stock research, and multi-channel access, as well as sophisticated account and trade management features, risk management tools, decision support tools, and dedicated personal support.
The Company serves both foreign investors and non-English-speaking U.S. clients who wish to trade or invest in U.S. dollar-based securities. The Company has a physical presence in the United Kingdom and Hong Kong. In the U.S., the Company serves Chinese-, Korean-, Spanish-, and Vietnamese-speaking clients through a combination of its branch offices and Web-based and telephonic services.
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THE CHARLES SCHWAB CORPORATION
Advisor Services
Through the Advisor Services segment, Schwab provides custodial, trading, technology, practice management, trust asset, and other support services to IAs. To attract and serve IAs, Advisor Services has a dedicated sales force and service teams assigned to meet their needs.
IAs who custody client accounts at Schwab may use proprietary software that provides them with up-to-date client account information, as well as trading capabilities. The Advisor Services website is the core platform for IAs to conduct daily business activities online with Schwab, including submitting client account information and retrieving news and market information. This platform provides IAs with a comprehensive suite of electronic and paper-based reporting capabilities. Advisor Services offers online cashiering services, as well as internet-based eDocuments sites for both IAs and their clients that provide multi-year archiving of online statements, trade confirms and tax reports, along with document search capabilities.
To help IAs grow and manage their practices, Advisor Services offers a variety of services, including marketing and business development, business strategy and planning, and transition support. Regulatory compliance consulting and support services are available, as well as website design and development capabilities. Advisor Services maintains a website that provides interactive tools, educational content, and research reports to assist advisors thinking about establishing their own independent practices.
In addition, Advisor Services offers an array of services to help advisors establish their own independent practices through the Business Start-up Solutions package. This includes access to dedicated service teams and outsourcing of back-office operations, as well as third-party firms who provide assistance with real estate, errors and omissions insurance, and company benefits.
The Company offers a variety of educational materials and events to IAs seeking to expand their knowledge of industry issues and trends, as well as sharpen their individual expertise and practice management skills. Advisor Services updates and shares market research on an ongoing basis, and it holds a series of events and conferences every year to discuss topics of interest to IAs, including business strategies and best practices. The Company sponsors the annual IMPACT® conference, which provides a national forum for the Company, IAs, and other industry participants to gather and share information and insights.
IAs and their clients have access to a broad range of the Companys products and services, including managed accounts and cash products.
Corporate and Retirement Services
Through the Corporate and Retirement Services segment, the Company provides retirement plan services, plan administrator services, advice services, education, stock plan services, and mutual fund clearing services, and supports the availability of Schwab proprietary mutual funds on third-party platforms. The Company serves all aspects of employer sponsored plans: equity compensation, defined contribution plans, defined benefit plans, and other investment related benefits plans.
The Companys bundled 401(k) retirement plan product offers plan sponsors a wide array of investment options, trustee services, and participant-level recordkeeping. Plan design features which increase plan efficiency and achieve employer goals are also offered, such as automatic enrollment, automatic fund mapping at conversion, and automatic contribution increases. Services such as Roth 401(k) and designated brokerage accounts are also offered. The Company provides a robust suite of tools to plan sponsors to manage their plans including plan-specific reports, studies and research, access to legislative updates and benchmarking reports that provide perspective of their plans features compared with overall industry and segment-specific plans. Participants in bundled 401(k) plans receive targeted education materials, have access to electronic tools and resources, may attend onsite and virtual seminars, and can receive customized advice provided by a third party.
Participants in 401(k) plans administered by Corporate and Retirement Services have access to personalized advice online, by phone, or in person, including recommendations specific to the core investment fund choices in their retirement plan and specific recommended savings rates. Advice services include the automatic rebalancing of participant accounts to maintain proper asset allocations.
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THE CHARLES SCHWAB CORPORATION
The Companys equity compensation product offers plan sponsors full-service recordkeeping for stock plans: stock options, restricted stock, performance shares and stock appreciation rights. Specialized services for executive transactions and reporting, grant acceptance tracking and other services are offered to employers to meet the needs of administering the reporting and compliance aspects of an equity compensation plan.
In the Companys Plan Administrator Services business, the Company and third-party administrators work together to serve plan sponsors, combining the consulting and administrative expertise of the administrator with the Companys investment, technology, participant education and trustee services.
Schwab also offers its proprietary mutual funds on third party retirement platforms, allowing plan sponsors outside of the Companys bundled platform access to the Schwab Managed Retirement Trust Fund family. These target-date retirement collective trusts have independent sub-managers and leverage both active and passive management, which offer institutional structure and pricing.
CSC is a savings and loan holding company and Schwab Bank, CSCs depository institution subsidiary, is a federal savings bank. CSC and Schwab Bank are both subject to supervision and regulation by the Office of Thrift Supervision (OTS). As a savings and loan holding company, CSC is not subject to specific statutory capital requirements. However, CSC is required to maintain capital that is sufficient to support the holding company and its subsidiaries business activities, and the risks inherent in those activities.
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 govern transactions with CSC and its non-depository institution subsidiaries, including loans and other extensions of credit, investments or asset purchases, dividends, and investments. 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. Schwab Bank is required to maintain a capital level that at least equals minimum capital levels specified in federal banking laws and regulations. Failure to meet the minimum levels will 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 securities industry in the United States is subject to extensive regulation under both federal and state laws. Schwab and 401(k) Investment Services, Inc. (a subsidiary of The 401(k) Companies, Inc.) are registered as broker-dealers with the Securities and Exchange Commission (SEC), the fifty states, and the District of Columbia and Puerto Rico. Schwab and CSIM are registered as investment advisors with the SEC. Additionally, Schwab is regulated by the Commodities Futures Trading Commission (CFTC) with respect to the futures and commodities trading activities it conducts as an introducing broker.
Much of the regulation of broker-dealers has been delegated to self-regulatory organizations (SROs), namely the Financial Industry Regulatory Authority, Inc. (FINRA), and the Municipal Securities Rulemaking Board (MSRB). Schwab is a member of the Nasdaq Stock Market and the Chicago Board Options Exchange and is consequently subject to their rules and regulations. The primary regulators of Schwab and 401(k) Investment Services, Inc. are FINRA and, for municipal securities, the MSRB. The CFTC has designated the National Futures Association (NFA) as Schwabs primary regulator for futures and commodities trading activities. The Companys business is also subject to oversight by regulatory bodies in other countries in which the Company operates.
The principal purpose of regulating broker-dealers and investment advisors is the protection of clients and the securities markets. The regulations to which broker-dealers and investment advisors are subject cover all aspects of the securities business, including, among other things, sales and trading practices, publication of research, margin lending, uses and safekeeping of clients funds and securities, capital adequacy, recordkeeping and reporting, fee arrangements, disclosure to clients, fiduciary duties owed to advisory clients, and the conduct of directors, officers and employees.
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THE CHARLES SCHWAB CORPORATION
As registered broker-dealers, Schwab and 401(k) Investment Services, Inc. are subject to SEC Rule 15c3-1 (the Uniform Net Capital Rule) and related SRO requirements. The CFTC and NFA also impose net capital requirements. The Uniform Net Capital Rule specifies minimum capital requirements that are intended to ensure the general financial soundness and liquidity of broker-dealers. Because CSC itself is not a registered broker-dealer, it is not subject to the Uniform Net Capital Rule. However, if Schwab failed to maintain specified levels of net capital, such failure would constitute a default by CSC under certain debt covenants.
The Uniform Net Capital Rule limits broker-dealers ability to transfer capital to parent companies and other affiliates. Compliance with the Net Capital Rule could limit Schwabs operations and its ability to repay subordinated debt to CSC, which in turn could limit CSCs ability to repay debt, pay cash dividends, and purchase shares of its outstanding stock.
The Companys major sources of net revenues are asset management and administration fees, net interest revenue, and trading revenue. The Company generates asset management and administration fees through its proprietary and third-party mutual fund offerings, as well as fee-based investment management and advisory services. Net interest revenue is the difference between interest earned on interest-earning assets (such as cash, short- and long-term investments, and mortgage and margin loans) and interest paid on funding sources (including deposits in banking and brokerage accounts, short-term borrowings, and long-term debt). The Company generates trading revenues through commissions earned for executing trades for clients and principal transaction revenues from trading activity in fixed income securities.
For revenue information by source for the three years ended December 31, 2008, see Item 7 Managements Discussion and Analysis of Financial Condition and Results of Operations Results of Operations Net Revenues.
The Company files annual, quarterly, and current reports, proxy statements, and other information with the SEC. You may read and copy any document we file with the SEC at the SECs public reference room at 100 F Street, NE, Room 1580, Washington, DC 20549. Please call the SEC at 1-800-SEC-0330 for information on the public reference room. The SEC maintains an Internet website that contains annual, quarterly, and current reports, proxy and information statements, and other information that issuers (including the Company) file electronically with the SEC. The SECs Internet website is www.sec.gov.
On the Companys Internet website, www.aboutschwab.com, the Company posts the following recent filings as soon as reasonably practicable after they are electronically filed with or furnished to the SEC: the Companys annual reports on Form 10-K, the Companys quarterly reports on Form 10-Q, the Companys current reports on Form 8-K, and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934. All such filings are available free of charge either on the Companys website or by request via email (investor.relations@schwab.com), telephone (415-636-2787), or mail (Charles Schwab Investor Relations at 101 Montgomery Street, San Francisco, CA 94104).
Item 1A. | Risk Factors |
The Company faces a variety of risks that may affect its operations or financial results, and many of those risks are driven by factors that the Company cannot control or predict. The following discussion addresses those risks that management believes are the most significant, although there may be other risks that could arise, or may prove to be more significant than expected, that may affect the Companys operations or financial results.
For a discussion of the Companys risk management, including technology and operating risk, credit risk, concentration risk, market risk, fiduciary risk, and legal and regulatory risk, see Item 7 Managements Discussion and Analysis of Financial Condition and Results of Operations Risk Management.
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Developments in the business, economic, and geopolitical environment could negatively impact the Companys business.
The Companys business can be adversely affected by the general environment economic, corporate, securities market, regulatory, and geopolitical developments all play a role in client asset valuations, trading activity, interest rates and overall investor engagement, and are outside of the Companys control. Deterioration in the housing and credit markets, reductions in short-term interest rates, and decreases in securities valuations are negatively impacting the Companys net interest revenue, asset management and administration fees, and capital resources.
A significant decrease in the Companys liquidity could negatively affect the Companys business and financial management as well as reduce client confidence in the Company.
Maintaining adequate liquidity is crucial to the business operations of the Company, including margin lending, mortgage lending, and transaction settlement, among other liquidity needs. The Company meets its liquidity needs primarily through cash generated by client activity and operating earnings, as well as cash provided by external financing. Fluctuations in client cash or deposit balances, as well as changes in market conditions, may affect the Companys ability to meet its liquidity needs. A reduction in the Companys liquidity position could reduce client confidence in the Company, which could result in the loss of client accounts. In addition, if the Companys broker-dealer or depository institution subsidiaries fail to meet regulatory capital guidelines, regulators could limit the subsidiaries operations or their ability to upstream funds to CSC, which could reduce CSCs liquidity and adversely affect its ability to repay debt and pay cash dividends.
Factors which may adversely affect the Companys liquidity position include a reduction in cash held in banking or brokerage client accounts and/or a dramatic increase in the Companys client lending activities (including margin and personal lending). The Company also experiences liquidity demands as a result of brokerage client asset flows. In the ordinary course of business, clients asset flows between cash balances and investment products and timing differences between when amounts are segregated for regulatory purposes and when amounts are required to fund settlement of client transactions can create significant daily changes in the Companys cash position. The unpredictability of such timing differences and liquidity demands has increased with recent market conditions as client asset flows have become more volatile.
When cash generated by client activity and operating earnings is not sufficient for the Companys liquidity needs, the Company must seek external financing. Due to significant disruptions in the credit and capital markets, potential sources of external financing have been reduced for many firms, and borrowing costs have increased. Although CSC and Schwab maintain uncommitted, unsecured bank credit lines and CSC has a commercial paper issuance program, as well as a universal shelf registration statement filed with the SEC, financing may not be available on acceptable terms or at all due to market conditions and disruptions in the credit markets. In addition, a significant downgrade in the Companys credit ratings could increase its borrowing costs and limit its access to the capital markets.
The Company may suffer significant losses from its credit exposures.
The Companys businesses are subject to the risk that a client or counterparty will fail to perform its contractual obligations, or that the value of collateral held to secure obligations will prove to be inadequate. While the Company has policies and procedures designed to manage this risk, the policies and procedures may not be fully effective. The Companys exposure mainly results from margin lending activities, securities lending activities, mortgage lending activities, its role as a counterparty in financial contracts and investing activities, and indirectly from the investing activities of certain of the proprietary funds that the Company sponsors.
The Company has exposure to credit risk associated with its securities available for sale portfolio, which includes U.S. agency and non-agency collateralized mortgage obligations and corporate debt securities among other investments. The Companys loans to banking clients primarily consist of first-lien mortgage loans and home equity lines of credit. Housing price declines, increases in the unemployment rate, increases in delinquency and default rates, changes in the interest rate environment and other economic factors can result in write-downs on such loans and the loss of value of securities available for sale and securities held to maturity.
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THE CHARLES SCHWAB CORPORATION
Loss of value of securities available for sale and securities held to maturity can result in charges if management determines that the impairments are other than temporary. The evaluation of whether other-than-temporary impairment exists is a matter of judgment which includes the assessment of several factors. See Item 7 Managements Discussion and Analysis of Financial Condition and Results of Operations Critical Accounting Estimates. If management determines that a security is other-than-temporarily impaired, the cost basis of the security must be adjusted to the then-current fair value and a corresponding loss must be recognized in current earnings. Certain securities available for sale experienced deteriorating credit characteristics in 2008. Further deterioration in the performance of securities available for sale could result in the recognition of future impairment charges.
Heightened credit exposures to specific counterparties or instruments (concentration risk) can increase the Companys risk of loss. Examples of the Companys credit concentration risk include:
| large investment positions in financial instruments collateralized by assets with similar economic characteristics or in securities of a single issuer or industry; |
| mortgage loans and home equity lines of credit to banking clients which are secured by properties in the same geographic region; and |
| margin and securities lending activities collateralized by securities of a single issuer or industry. |
The Company may also be subject to concentration risk when lending to a particular counterparty, borrower or issuer.
The Company sponsors a number of proprietary money market funds. Although the Company has no obligation to do so, the Company may decide for competitive reasons to provide credit, liquidity or other support to its funds in the event of significant declines in valuation of fund holdings or significant redemption activity that exceeds available liquidity. Such support could cause the Company to take significant charges and could reduce the Companys liquidity. If the Company chose not to provide credit, liquidity or other support in such a situation, the Company could suffer reputational damage and its business could be adversely affected.
Significant interest rate changes could affect the Companys profitability and financial condition.
The Company is exposed to interest rate risk primarily from changes in the interest rates on its interest-earning assets (such as cash, short- and long-term investments, and mortgage and margin loans) relative to changes in the costs of its funding sources (including deposits in banking and brokerage accounts, short-term borrowings, and long-term debt). Changes in interest rates generally affect the interest earned on interest-earning assets differently than the interest the Company pays on its interest-bearing liabilities. In addition, certain funding sources do not bear interest and their cost therefore does not vary. Overall, the Company is positioned to benefit from a rising interest rate environment; the Company could be adversely affected by a decline in interest rates if the rates that the Company earns on interest-earning assets decline more than the rates that the Company pays on its funding sources, or if prepayment rates increase on the mortgages and mortgage-backed securities that the Company holds. With the recent decline in interest rates, the Companys revenue from interest-earning assets has been declining more than the rates that the Company pays on its funding sources. The Company may also be limited in the amount it can reduce interest rates on deposit accounts and still offer a competitive return.
To the extent certain money market mutual funds replace maturing securities with lower yielding securities and the overall yield on such funds falls to a level at or below the management fees on those funds, the Company may waive a portion of its fee in order to continue providing some return to clients. Such fee waivers negatively impact the Companys asset management and administration fees.
The Company is subject to litigation and regulatory investigations and proceedings and may not always be successful in defending itself against such claims or proceedings.
The financial services industry faces substantial litigation and regulatory risks. The Company is subject to arbitration claims and lawsuits in the ordinary course of its business, as well as class actions and other significant litigation. The Company is also the subject of inquiries, investigations, and proceedings by regulatory and other governmental agencies. Actions brought against the Company may result in settlements, awards, injunctions, fines, penalties or other results adverse to the Company. Predicting the outcome of matters is inherently difficult, particularly where claims are brought on behalf of various classes of claimants, claimants seek substantial or unspecified damages, or when investigations or legal proceedings are at an early
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stage. A substantial judgment, settlement, fine, or penalty could be material to the Companys operating results or cash flows for a particular future period, depending on the Companys results for that period. In market downturns, the volume of legal claims and amount of damages sought in litigation and regulatory proceedings against financial services companies have historically increased. See Item 3 Legal Proceedings.
From time to time, the Company is subject to litigation claims from third parties alleging infringement of their intellectual property rights (e.g., patents). Such litigation can require the expenditure of significant Company resources. If the Company was found to have infringed a third-party patent, or other intellectual property rights, it could incur substantial liability, and in some circumstances could be enjoined from using certain technology, or providing certain products or services.
Extensive regulation of the Companys businesses limits the Companys activities and may subject it to significant penalties.
As a participant in the securities, banking and financial services industries, the Company is subject to extensive regulation under both federal and state laws by governmental agencies, supervisory authorities, and SROs. Such regulation is expected to become more extensive and complex in response to the recent market disruptions. The requirements imposed by the Companys regulators are designed to ensure the integrity of the financial markets, the safety and soundness of financial institutions, and the protection of clients. These regulations often serve to limit the Companys activities by way of capital, customer protection and market conduct requirements, and restrictions on the businesses in which the Company may operate. Despite the Companys efforts to comply with applicable regulations, there are a number of risks, particularly in areas where applicable regulations may be unclear or where regulators revise their previous guidance. Any enforcement actions or other proceedings brought by the Companys regulators against the Company or its affiliates, officers or employees could result in fines, penalties, cease and desist orders, enforcement actions, or suspension or expulsion, any of which could harm the Companys reputation and adversely affect the Companys results of operations and financial condition.
Legislation or changes in rules and regulations could negatively impact the Companys business and financial results.
New legislation, rule changes, or changes in the interpretation or enforcement of existing federal, state and SRO rules and regulations may directly affect the operation and profitability of the Company or its specific business lines. The profitability of the Company could also be affected by rules and regulations which impact the business and financial communities generally, including changes to the laws governing taxation, electronic commerce, client privacy and security of client data.
The Companys industry is characterized by aggressive price competition.
The Company continually monitors its pricing in relation to competitors and periodically adjusts trade commission rates, interest rates on deposits and loans, fees for advisory services, and other fee structures to enhance its competitive position. Increased price competition from other financial services firms, such as reduced commissions to attract trading volume or higher deposit rates to attract client cash balances, could impact the Companys results of operations and financial condition.
The industry in which the Company competes has undergone a period of consolidation.
The Company faces intense competition for the clients that it serves and the products and services it offers. There has been significant consolidation as financial institutions with which the Company competes have been acquired by or merged into or acquired other firms. This consolidation may continue. Competition is based on many factors, including the range of products and services offered, pricing, customer service, brand recognition, reputation, and perceived financial strength. Consolidations may enable other firms to offer a broader range of products and services than the Company does, or offer such products at more competitive prices.
The Company faces competition in hiring and retaining qualified employees, especially for employees who are key to the Companys ability to build and enhance client relationships.
The market for quality professionals and other personnel in the Companys business is highly competitive. Competition is particularly strong for financial consultants who build and sustain the Companys client relationships. The Companys ability
- 9 -
THE CHARLES SCHWAB CORPORATION
to continue to compete effectively will depend upon its ability to attract new employees and retain existing employees while managing compensation costs.
Technology and operational failures could subject the Company to losses, litigation, and regulatory actions.
The Company faces technology and operating risk which is the potential for loss due to deficiencies in control processes or technology systems of the Company or its vendors that constrain the Companys ability to gather, process, and communicate information and process client transactions efficiently and securely, without interruptions. This risk also includes the risk of human error, employee misconduct, external fraud, computer viruses, terrorist attacks, and natural disaster. The Companys business and operations could be negatively impacted by any significant technology and operational failures. Moreover, instances of fraud or other misconduct, including improper use or disclosure of confidential client, employee, or company information, might also negatively impact the Companys reputation and client confidence in the Company, in addition to any direct losses that might result from such instances. Despite the Companys efforts to identify areas of risk, oversee operational areas involving risk, and implement policies and procedures designed to manage risk, there can be no assurance that the Company will not suffer unexpected losses, reputational damage or regulatory action due to technology or other operational failures, including those of its vendors.
The Company also faces risk related to its security guarantee which covers client losses from unauthorized account activity, such as those caused by external fraud involving the compromise of clients login and password information. Losses reimbursed under the guarantee could have a negative impact on the Companys results of operations.
The Company relies on outsourced service providers to perform key functions.
The Company relies on service providers to perform certain key technology, processing, and support functions. These service providers also face technology and operating risk and any significant failures by them, including the improper use or disclosure of the Companys confidential client, employee, or company information, could cause the Company to incur losses and could harm the Companys reputation. The Company also faces the risk that a service provider could, without adequate notice, cease to provide services, which could disrupt the Companys operations. Switching to an alternative service provider may also require a transition period and result in less efficient operations.
Potential strategic transactions could have a negative impact on the Companys financial position.
The Company evaluates potential strategic transactions, including business combinations, acquisitions, and dispositions. Any such transaction could have a material impact on the Companys financial position, results of operations, or cash flows. The process of evaluating, negotiating, and effecting any such strategic transaction may divert managements attention from other business concerns, and might cause the loss of key clients, employees, and business partners. Moreover, integrating businesses and systems may result in unforeseen expenditures as well as numerous risks and uncertainties, including the need to integrate operational, financial, and management information systems and management controls, integrate relationships with clients and business partners, and manage facilities and employees in different geographic areas. In addition, an acquisition may cause the Company to assume liabilities or become subject to litigation. Further, the Company may not realize the anticipated benefits from an acquisition, and any future acquisition could be dilutive to the Companys current stockholders percentage ownership or to earnings per share (EPS).
The Companys acquisitions and dispositions are typically subject to closing conditions, including regulatory approvals and the absence of material adverse changes in the business, operations or financial condition of the entity being acquired or sold. To the extent the Company enters into an agreement to buy or sell an entity, there can be no guarantee that the transaction will close when expected, or at all. If a material transaction does not close, the Companys stock price could decline.
The Companys stock price has fluctuated historically, and may continue to fluctuate.
The Companys stock price can be volatile. Among the factors that may affect the Companys stock price are the following:
| speculation in the investment community or the press about, or actual changes in, the Companys competitive position, organizational structure, executive team, operations, financial condition, financial reporting and results, effectiveness of cost reduction initiatives, or strategic transactions; |
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THE CHARLES SCHWAB CORPORATION
| the announcement of new products, services, acquisitions, or dispositions by the Company or its competitors; |
| increases or decreases in revenue or earnings, changes in earnings estimates by the investment community, and variations between estimated financial results and actual financial results. |
Changes in the stock market generally or as it concerns the Companys industry, as well as geopolitical, economic, and business factors unrelated to the Company, may also affect the Companys stock price.
Item 1B. | Unresolved Securities and Exchange Commission Staff Comments |
None.
Item 2. | Properties |
A summary of the Companys significant locations at December 31, 2008 is presented in the following table. Locations are leased or owned as noted below. The square footage amounts are presented net of space that has been subleased to third parties.
Square Footage | ||||
(amounts in thousands) | Leased |
Owned | ||
Location |
||||
Corporate office space: |
||||
San Francisco, CA (1) |
1,273 | | ||
Service centers: |
||||
Phoenix, AZ (2, 3) |
154 | 709 | ||
Denver, CO (2) |
274 | | ||
Austin, TX (2) |
146 | | ||
Indianapolis, IN (2) |
| 113 | ||
Orlando, FL (2) |
106 | | ||
Other: |
||||
Richfield, OH (4) |
| 117 |
(1) |
Includes Schwab headquarters. |
(2) |
Includes a regional telephone service center. |
(3) |
Includes two data centers and an administrative support center. |
(4) |
Includes the Corporate and Retirement Services division headquarters. |
Substantially all of the Companys branch offices are located in leased premises. The corporate headquarters, data centers, offices, and service centers generally support all of the Companys segments.
Item 3. | Legal Proceedings |
For a discussion of legal proceedings, see Item 8 Financial Statements and Supplementary Data Notes to Consolidated Financial Statements 13. Commitments and Contingent Liabilities.
Item 4. | Submission of Matters to a Vote of Security Holders |
During the fourth quarter of 2008, no matters were submitted to a vote of CSCs security holders.
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THE CHARLES SCHWAB CORPORATION
Item 5. | Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities |
CSCs common stock is listed on The Nasdaq Stock Market under the ticker symbol SCHW. The number of common stockholders of record as of January 30, 2009 was 9,115. The closing market price per share on that date was $13.59.
The other information required to be furnished pursuant to this item is included in Item 8 Financial Statements and Supplementary Data Notes to Consolidated Financial Statements 17. Employee Incentive, Deferred Compensation, and Retirement Plans and 27. Quarterly Financial Information (Unaudited).
The following graph shows a five-year comparison of cumulative total returns for CSCs common stock, the Dow Jones U.S. Investment Services Index, and the Standard & Poors 500 Index, each of which assumes an initial investment of $100 and reinvestment of dividends.
December 31, |
2003 | 2004 | 2005 | 2006 | 2007 | 2008 | ||||||||||||
The Charles Schwab Corporation |
$ | 100 | $ | 102 | $ | 126 | $ | 167 | $ | 234 | $ | 150 | ||||||
Dow Jones U.S. Investment Services Index |
$ | 100 | $ | 108 | $ | 132 | $ | 178 | $ | 161 | $ | 53 | ||||||
Standard & Poors 500 Index |
$ | 100 | $ | 111 | $ | 116 | $ | 135 | $ | 142 | $ | 90 |
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THE CHARLES SCHWAB CORPORATION
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 fourth quarter of 2008.
Month |
Total Number of Shares Purchased (in thousands) |
Average Price Paid per Share |
Total Number of Shares Purchased as Part of Publicly Announced Program (1) (in thousands) |
Approximate Dollar Value of Shares that May Yet be Purchased under the Program (in millions) | ||||||
October: |
||||||||||
Share Repurchase Program (1) |
| $ | | | $ | 596 | ||||
Employee transactions (2) |
217 | $ | 18.66 | N/A | N/A | |||||
November: |
||||||||||
Share Repurchase Program (1) |
| $ | | | $ | 596 | ||||
Employee transactions (2) |
117 | $ | 19.19 | N/A | N/A | |||||
December: |
||||||||||
Share Repurchase Program (1) |
| $ | | | $ | 596 | ||||
Employee transactions (2) |
165 | $ | 16.46 | N/A | N/A | |||||
Total: |
||||||||||
Share Repurchase Program (1) |
| $ | | | $ | 596 | ||||
Employee transactions (2) |
499 | $ | 18.06 | N/A | N/A | |||||
N/A Not applicable.
(1) |
There were no share repurchases under the Share Repurchase Program during the fourth quarter. Repurchases under this program are under authorizations by CSCs Board of Directors covering up to $500 million and $500 million of common stock publicly announced by the Company on April 25, 2007 and March 13, 2008, respectively. 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 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. |
- 13 -
THE CHARLES SCHWAB CORPORATION
Item 6. | Selected Financial Data |
Selected Financial and Operating Data
(In Millions, Except Per Share Amounts, Ratios, or as Noted)
Growth Rates | ||||||||||||||||||||||||||
Compounded | Annual | |||||||||||||||||||||||||
4-Year 2004-2008 |
1-Year 2007-2008 |
2008 | 2007 | 2006 | 2005 | 2004 | ||||||||||||||||||||
Results of Operations |
||||||||||||||||||||||||||
Net revenues |
11 | % | 3 | % | $ | 5,150 | $ | 4,994 | $ | 4,309 | $ | 3,619 | $ | 3,416 | ||||||||||||
Expenses excluding interest |
2 | % | (1 | %) | $ | 3,122 | $ | 3,141 | $ | 2,833 | $ | 2,592 | $ | 2,869 | ||||||||||||
Income from continuing operations |
37 | % | 10 | % | $ | 1,230 | $ | 1,120 | $ | 891 | $ | 634 | $ | 350 | ||||||||||||
Net income (1) |
43 | % | N/M | $ | 1,212 | $ | 2,407 | $ | 1,227 | $ | 725 | $ | 286 | |||||||||||||
Income from continuing operations per share basic |
42 | % | 15 | % | $ | 1.07 | $ | .93 | $ | .70 | $ | .49 | $ | .26 | ||||||||||||
Income from continuing operations per share diluted |
42 | % | 15 | % | $ | 1.06 | $ | .92 | $ | .69 | $ | .48 | $ | .26 | ||||||||||||
Basic earnings per share (1,2) |
50 | % | N/M | $ | 1.06 | $ | 1.99 | $ | .97 | $ | .56 | $ | .21 | |||||||||||||
Diluted earnings per share (1,2) |
50 | % | N/M | $ | 1.05 | $ | 1.97 | $ | .95 | $ | .55 | $ | .21 | |||||||||||||
Dividends declared per common share |
31 | % | 10 | % | $ | .220 | $ | .200 | $ | .135 | $ | .089 | $ | .074 | ||||||||||||
Special dividend declared per common share |
N/M | N/M | $ | | $ | 1.00 | $ | | $ | | $ | | ||||||||||||||
Weighted-average common shares outstanding diluted |
(4 | %) | (5 | %) | 1,157 | 1,222 | 1,286 | 1,308 | 1,365 | |||||||||||||||||
Asset management and administration fees as a percentage of net revenues |
46 | % | 47 | % | 45 | % | 46 | % | 45 | % | ||||||||||||||||
Net interest revenue as a percentage of net revenues |
32 | % | 33 | % | 33 | % | 28 | % | 21 | % | ||||||||||||||||
Trading revenue as a percentage of net revenues (3) |
21 | % | 17 | % | 18 | % | 21 | % | 30 | % | ||||||||||||||||
Effective income tax rate on income from continuing operations |
39.3 | % | 39.6 | % | 39.6 | % | 38.3 | % | 36.0 | % | ||||||||||||||||
Capital expenditures purchases of equipment, office facilities, and property, net (4) |
2 | % | 15 | % | $ | 194 | $ | 168 | $ | 59 | $ | 78 | $ | 177 | ||||||||||||
Capital expenditures, net, as a percentage of net revenues |
4 | % | 3 | % | 1 | % | 2 | % | 5 | % | ||||||||||||||||
Performance Measures |
||||||||||||||||||||||||||
Net revenue growth |
3 | % | 16 | % | 19 | % | 6 | % | 5 | % | ||||||||||||||||
Pre-tax profit margin from continuing operations |
39.4 | % | 37.1 | % | 34.3 | % | 28.4 | % | 16.0 | % | ||||||||||||||||
Return on stockholders equity |
31 | % | 55 | % | 26 | % | 16 | % | 6 | % | ||||||||||||||||
Financial Condition (at year end) |
||||||||||||||||||||||||||
Total assets |
2 | % | 22 | % | $ | 51,675 | $ | 42,286 | $ | 48,992 | $ | 47,351 | $ | 47,133 | ||||||||||||
Long-term debt |
13 | % | (2 | %) | $ | 883 | $ | 899 | $ | 388 | $ | 462 | $ | 533 | ||||||||||||
Stockholders equity |
(2 | %) | 9 | % | $ | 4,061 | $ | 3,732 | $ | 5,008 | $ | 4,450 | $ | 4,386 | ||||||||||||
Assets to stockholders equity ratio |
13 | 11 | 10 | 11 | 11 | |||||||||||||||||||||
Long-term debt to total financial capital (long-term debt plus stockholders equity) |
18 | % | 19 | % | 7 | % | 9 | % | 11 | % | ||||||||||||||||
Employee Information |
||||||||||||||||||||||||||
Full-time equivalent employees (5) (at year end, in thousands) |
3 | % | 1 | % | 13.4 | 13.3 | 12.4 | 11.6 | 11.8 | |||||||||||||||||
Net revenues per average full-time equivalent employee (in thousands) |
10 | % | (1 | %) | $ | 383 | $ | 387 | $ | 362 | $ | 319 | $ | 260 |
Note: All information contained in this Annual Report on Form 10-K is presented on a continuing basis unless otherwise noted.
(1) |
Net income in 2007 includes a gain of $1.2 billion, after tax, on the sale of U.S. Trust. |
(2) |
Both basic and diluted earnings per share include discontinued operations. |
(3) |
Trading revenue includes commission and principal transaction revenues. |
(4) |
Capital expenditures in 2006 are presented net of proceeds of $63 million primarily from the sale of a data center and in 2005 are presented net of proceeds of $20 million from the sale of equipment. |
(5) |
Full-time equivalent employees in 2007 includes 365 employees related to the acquisition of The 401(k) Company on March 31, 2007. |
N/M | Not meaningful. |
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THE CHARLES SCHWAB CORPORATION
Managements Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Millions, Except Ratios, or as Noted)
Item 7. | Managements Discussion and Analysis of Financial Condition and Results of Operations |
Management of the Company focuses on several key financial and non-financial metrics in evaluating the Companys financial position and operating performance. All information contained in this Annual Report on Form 10-K is presented on a continuing operations basis unless otherwise noted. Results for the years ended December 31, 2008, 2007, and 2006 are shown in the following table:
Growth Rate 1-year 2007-2008 |
2008 | 2007 | 2006 | ||||||||||||
Client Activity Metrics: |
|||||||||||||||
Net new client assets (in billions) (1, 2) |
(29 | %) | $ | 113.4 | $ | 160.2 | $ | 83.3 | |||||||
Client assets (in billions, at year end) |
(21 | %) | $ | 1,137.0 | $ | 1,445.5 | $ | 1,239.2 | |||||||
Clients daily average trades (in thousands) |
22 | % | 346.6 | 284.9 | 270.0 | ||||||||||
Company Financial Metrics: |
|||||||||||||||
Net revenues |
3 | % | $ | 5,150 | $ | 4,994 | $ | 4,309 | |||||||
Expenses excluding interest |
(1 | %) | 3,122 | 3,141 | 2,833 | ||||||||||
Income from continuing operations before taxes on income |
9 | % | 2,028 | 1,853 | 1,476 | ||||||||||
Taxes on income |
9 | % | (798 | ) | (733 | ) | (585 | ) | |||||||
Income from continuing operations |
10 | % | 1,230 | 1,120 | 891 | ||||||||||
(Loss) income from discontinued operations, net of tax |
N/M | (18 | ) | 1,287 | 336 | ||||||||||
Net income |
N/M | $ | 1,212 | $ | 2,407 | $ | 1,227 | ||||||||
Earnings per share from continuing operations diluted |
15 | % | $ | 1.06 | $ | .92 | $ | .69 | |||||||
Earnings per share diluted |
N/M | $ | 1.05 | $ | 1.97 | $ | .95 | ||||||||
Net revenue growth from prior year |
3 | % | 16 | % | 19 | % | |||||||||
Pre-tax profit margin from continuing operations |
39.4 | % | 37.1 | % | 34.3 | % | |||||||||
Return on stockholders equity |
31 | % | 55 | % | 26 | % | |||||||||
Net revenue per average full-time equivalent employee (in thousands) |
(1 | %) | $ | 383 | $ | 387 | $ | 362 |
(1) |
Net new client assets in 2007 includes $23.0 billion related to the acquisition of The 401(k) Company and $3.3 billion related to a mutual fund clearing services client. |
(2) |
Effective in 2007, amounts include the Companys mutual fund clearing services business daily net settlements. All prior period amounts have been recast to reflect this change. |
N/M Not meaningful.
| 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 depicts how well the Companys products and services appeal to new and existing clients. |
| Client assets is the market value of all client assets housed at the Company. Management considers client assets to be indicative of the Companys appeal in the marketplace. Additionally, fluctuations in certain components of client assets (e.g., Mutual Fund OneSource funds) directly impacts asset management and administration fee revenues. |
| Clients daily average trades is an indicator of client engagement with securities markets and the most prominent driver of trading revenues. |
| Management believes that net revenue growth, pre-tax profit margin from continuing operations, and return on stockholders equity provide broad indicators of the Companys overall financial health, operating efficiency, and ability to generate acceptable returns. |
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THE CHARLES SCHWAB CORPORATION
Managements Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Millions, Except Ratios, or as Noted)
| Net revenue per average full-time equivalent employee is considered by management to be the Companys broadest measure of productivity. |
The Companys major sources of net revenues are asset management and administration fees, net interest revenue, and trading revenue. The Company generates asset management and administration fees through its proprietary and third-party mutual fund offerings, as well as fee-based investment management and advisory services. Net interest revenue is the difference between interest earned on interest-earning assets and interest paid on funding sources. Asset management and administration fees and net interest revenue are impacted by securities valuations, interest rates, the Companys ability to attract new clients, and client activity levels. The Company generates trading revenues through commissions earned for executing trades for clients and principal transaction revenues from trading activity in fixed income securities. Trading revenues are impacted by trading volumes, the volatility of equity prices in the securities markets and commission rates.
2008 Compared to 2007
2008 was marked by extraordinary market conditions, including continued downward pressure on home prices, tighter credit markets, liquidity concerns, significant volatility and sharp declines in the equity markets, and continued slowing of general economic activity. The Nasdaq Composite Index, Standard and Poors 500 Index, and the Dow Jones Industrial Average decreased during the year by 41%, 38%, and 34%, respectively, with a significant portion of these decreases occurring in the fourth quarter. In addition, the federal funds rate decreased during the year by 4.25% to a range of zero to 0.25% at December 31, 2008.
Even with this unprecedented market environment, clients remained actively engaged with the Company in managing their investments and made heavy use of all of the Companys service channels branch, phone, and internet. Net new client assets totaled $113.4 billion for the year, down 29% from a year ago, reflecting continued deterioration in the equity markets and lower asset valuations. Total client assets were $1.137 trillion at December 31, 2008, down 21% from December 31, 2007. Additionally, clients daily average trades increased 22% to 346,600 in 2008 from 2007.
Net revenues grew by 3% in 2008 from the prior year primarily due to an increase in trading revenue partially offset by a decrease in other revenue. Trading revenue increased in 2008 primarily due to higher trading volume as a result of significant volatility in the equity markets during the year. The decrease in other revenue in 2008 related to losses of $75 million on investments in the Companys securities available for sale portfolio. Asset management and administration fees remained relatively flat in 2008 reflecting the Companys ability to attract and retain clients. Net interest revenue increased by 1% in 2008 due to higher levels of interest-earning assets offset by the impact of a decrease in the average net yield earned on these assets. Although expenses excluding interest remained relatively flat in 2008, compensation and benefits expense decreased reflecting lower incentive compensation, while other expense and occupancy and equipment expense increased. The loss from discontinued operations of $18 million in 2008 relates to the adjustment to finalize the income tax gain related to the sale of U.S. Trust. As a result of the Companys sustained expense discipline in 2008, the Company achieved a pre-tax profit margin from continuing operations of 39.4% and return on stockholders equity of 31% in 2008. Return on stockholders equity in 2007 included a $1.2 billion after-tax gain on the sale of U.S. Trust, as well as incremental interest revenue generated from temporarily investing the proceeds from the sale. Net revenue per average full-time equivalent employee was $383,000 in 2008, down 1% from 2007 as net revenue growth was lower than the increase in average full-time equivalent employees.
2007 Compared to 2006
Overall equity market returns for 2007 showed gains for the three major indices the Nasdaq Composite Index increased by 10%, the Dow Jones Industrial Average increased 6%, and the Standard and Poors 500 Index increased 4%.
Net new client assets totaled $160.2 billion for 2007, up 92% from 2006, which included $23.0 billion related to the acquisition of The 401(k) Company in 2007. Total client assets were $1.446 trillion at December 31, 2007, up 17% from December 31, 2006. Clients daily average trades increased 6% to 284,900 in 2007 from 2006.
- 16 -
THE CHARLES SCHWAB CORPORATION
Managements Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Millions, Except Ratios, or as Noted)
Net revenues grew by 16% in 2007 as compared to 2006 primarily due to an increase in asset management and administration fees driven by growth in client assets, as well as an increase in net interest revenue due to higher interest rate spreads. Expenses excluding interest increased in 2007 as compared to 2006 primarily due to higher compensation and benefits expense, advertising and market development expense, and professional services expense. The Companys pre-tax profit margin from continuing operations was 37.1% in 2007 as compared to 34.3% in 2006 due to revenue growth and disciplined expense management during the year. Return on stockholders equity increased to 55% in 2007 as compared to 26% in 2006, reflecting the sale of U.S. Trust, earnings growth, and the Companys active management of its capital base. Net revenue per average full-time equivalent employee was $387,000 in 2007, up 7% from 2006 due to revenue growth partially offset by the increase in average full-time equivalent employees as a result of the acquisition of The 401(k) Company.
Certain reclassifications have been made to prior year amounts to conform to the current presentation. All references to EPS information in this Managements Discussion and Analysis of Financial Condition and Results of Operations reflect diluted earnings per share unless otherwise noted.
The adverse market conditions in 2008 discussed above continue to negatively impact the Companys revenues.
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. Continued depressed equity valuations in 2009 will negatively impact asset management and administration fees on a year-over-year basis. Additionally, mutual fund service fees may be further reduced if the current interest rate environment persists. To the extent certain money market mutual funds replace maturing securities with lower yielding securities and the overall yield on such funds falls to a level at or below the management fees on those funds, the Company may waive a portion of its fee in order to continue providing some return to clients.
With the recent decline in interest rates, the Companys revenue from interest-earning assets such as securities held and loans to clients has been declining more than the rates that the Company pays on funding sources such as customer deposits. The Companys ability to reduce those rates has been limited as short term rates have approached zero. If the current interest rate environment persists through 2009, it will negatively impact net interest revenue on a year-over-year basis.
The level at which clients utilize margin loans will also impact net interest revenue. While the average balance of margin loans was $10.3 billion for all of 2008, by month-end December the balance had declined to $6.2 billion.
The Company recorded pre-tax losses of $75 million related to two corporate debt securities in its securities available for sale portfolio in 2008. Certain securities available for sale experienced deteriorating credit characteristics in 2008. Further deterioration in the performance of these securities, including non-agency mortgage-backed securities, could result in the recognition of future impairment charges.
The following discussion presents an analysis of the Companys results of operations for the years ended December 31, 2008, 2007, and 2006.
- 17 -
THE CHARLES SCHWAB CORPORATION
Managements Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Millions, Except Ratios, or as Noted)
Net Revenues
The Companys major sources of net revenues are asset management and administration fees, net interest revenue, and trading revenue. Asset management and administration fees were relatively flat, while net interest revenue and trading revenue increased in 2008 as compared to 2007. Asset management and administration fees, net interest revenue, and trading revenue increased in 2007 as compared to 2006.
Year Ended December 31, | 2008 | 2007 | 2006 | |||||||||||||||||||||
Growth Rate 2007-2008 |
Amount | % of Total Net Revenues |
Amount | % of Total Net Revenues |
Amount | % of Total Net Revenues |
||||||||||||||||||
Asset management and administration fees |
||||||||||||||||||||||||
Mutual fund service fees: (1) |
||||||||||||||||||||||||
Proprietary funds (Schwab Funds® and Laudus Funds®) |
8 | % | $ | 1,265 | 24 | % | $ | 1,167 | 23 | % | $ | 963 | 22 | % | ||||||||||
Mutual Fund OneSource® |
(12 | %) | 544 | 11 | % | 621 | 13 | % | 526 | 12 | % | |||||||||||||
Clearing and other |
4 | % | 108 | 2 | % | 104 | 2 | % | 74 | 2 | % | |||||||||||||
Investment management and trust fees |
(10 | %) | 340 | 7 | % | 378 | 8 | % | 310 | 7 | % | |||||||||||||
Other |
11 | % | 98 | 2 | % | 88 | 1 | % | 72 | 2 | % | |||||||||||||
Asset management and administration fees |
| 2,355 | 46 | % | 2,358 | 47 | % | 1,945 | 45 | % | ||||||||||||||
Net interest revenue |
||||||||||||||||||||||||
Interest revenue |
(16 | %) | 1,908 | 37 | % | 2,270 | 46 | % | 2,113 | 49 | % | |||||||||||||
Interest expense |
(61 | %) | (243 | ) | (5 | %) | (623 | ) | (13 | %) | (679 | ) | (16 | %) | ||||||||||
Net interest revenue |
1 | % | 1,665 | 32 | % | 1,647 | 33 | % | 1,434 | 33 | % | |||||||||||||
Trading revenue |
||||||||||||||||||||||||
Commissions |
21 | % | 915 | 18 | % | 755 | 15 | % | 703 | 16 | % | |||||||||||||
Principal transactions |
57 | % | 165 | 3 | % | 105 | 2 | % | 82 | 2 | % | |||||||||||||
Trading revenue |
26 | % | 1,080 | 21 | % | 860 | 17 | % | 785 | 18 | % | |||||||||||||
Other |
(61 | %) | 50 | 1 | % | 129 | 3 | % | 145 | 4 | % | |||||||||||||
Total net revenues |
3 | % | $ | 5,150 | 100 | % | $ | 4,994 | 100 | % | $ | 4,309 | 100 | % | ||||||||||
(1) |
Certain prior-year amounts have been reclassified to conform to the 2008 presentation. |
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 transfer agent services, 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 third-party funds and the Companys proprietary funds. The Company also earns asset management fees for advisory and managed account services, which are based on the daily balances of client assets subject to the specific fee for service. The fair values of client assets, which include proprietary and third-party mutual funds, are based on quoted market prices and other observable market data. Asset management and administration fees may vary with changes in the balances of client assets due to market fluctuations and levels of net new client assets. For discussion of the impact of current market conditions on asset management and administration fees, see Current Market Environment.
Asset management and administration fees remained relatively flat in 2008 from 2007, primarily due to lower third-party mutual fund and advisory service fees, partially offset by higher proprietary fund fees. Mutual Fund OneSource service fees decreased by $77 million, or 12%, in 2008 from 2007 primarily due to a 39% decline in Schwabs Mutual Fund OneSource asset balances. The Companys proprietary mutual fund service fees increased $98 million, or 8%, in 2008 from 2007 primarily due to a 15% increase in money market mutual fund asset balances. Investment management and trust fees decreased by $38 million, or 10%, in 2008 from 2007 due to lower balances of client assets participating in advisory and managed account services programs.
Asset management and administration fees increased by $413 million, or 21%, in 2007 from 2006 primarily due to higher mutual fund, advisory, and managed account asset balances. Mutual fund service fees increased $329 million, or 21% in 2007
- 18 -
THE CHARLES SCHWAB CORPORATION
Managements Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Millions, Except Ratios, or as Noted)
from 2006 primarily due to a 26% rise in the Companys proprietary mutual fund asset balances and an 11% increase in asset balances in Schwabs Mutual Fund OneSource service. Investment management and trust fees increased by $68 million, or 22%, in 2007 from 2006 primarily due to higher balances of client assets participating in advisory and managed account services programs.
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 Company is positioned so that the consolidated balance sheet produces an increase in net interest revenue when interest rates rise and, conversely, a decrease in net interest revenue when interest rates fall (i.e., interest-earning assets generally reprice more quickly than interest-bearing liabilities). In the event of falling interest rates, the Company might attempt to mitigate some of this negative impact by extending the maturities of assets in investment portfolios to lock-in asset yields as well as 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. For discussion of the impact of current market conditions on net interest revenue, see Current Market Environment.
In clearing its clients trades, Schwab holds cash balances payable to clients. In most cases, Schwab pays its clients interest on cash balances awaiting investment, and may invest these funds and earn interest revenue. Receivables from brokerage clients consist primarily of margin loans to brokerage clients. Margin loans are loans made by Schwab to clients on a secured basis to purchase securities. Pursuant to SEC 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.
When investing segregated client cash balances, Schwab must adhere to SEC regulations that restrict investments to securities guaranteed by the full faith and credit of the U.S. government, participation certificates, mortgage-backed securities guaranteed by the Government National Mortgage Association, certificates of deposit issued by U.S. banks and thrifts, and resale agreements collateralized by qualified securities. Additionally, Schwab has established policies for the minimum credit quality and maximum maturity of these investments. Schwab Bank also maintains investment portfolios for liquidity as well as to invest funding from deposits raised in excess of loans to banking clients. Schwab Banks securities available for sale include mortgage-backed securities, corporate debt securities, certificates of deposit, asset-backed securities, and U.S. agency notes. Schwab Banks securities held to maturity include asset-backed securities. Schwab Bank lends funds to banking clients primarily in the form of mortgage loans. These loans are largely funded by interest-bearing deposits from banking clients.
The Companys interest-earning assets are financed primarily by brokerage client cash balances and deposits from banking clients. Other funding sources include noninterest-bearing brokerage client cash balances and proceeds from stock-lending activities, as well as stockholders equity.
The amount of excess cash held in certain Schwab brokerage client accounts that is swept into money market deposit accounts at Schwab Bank and (through May 2007) at U.S. Trust has increased significantly since the programs inception in 2003. Average interest-bearing banking deposits increased $7.2 billion, or 59%, to $19.2 billion in 2008 from 2007, and $2.9 billion, or 32%, to $12.0 billion in 2007 from 2006. As a result, the average securities available for sale balances increased $4.4 billion, or 60%, to $11.8 billion in 2008 from 2007, and $1.2 billion, or 20%, to $7.3 billion in 2007 from 2006, while the average balance of loans to banking clients increased $2.0 billion, or 73%, to $4.8 billion in 2008 from 2007, and $629 million, or 29%, to $2.8 billion in 2007 from 2006.
- 19 -
THE CHARLES SCHWAB CORPORATION
Managements 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 consolidated balance sheet:
Year Ended December 31, | 2008 | 2007 | 2006 | ||||||||||||||||||||||||
Average Balance |
Interest Revenue/ Expense |
Average Yield/ Rate |
Average Balance |
Interest Revenue/ Expense |
Average Yield/ Rate |
Average Balance |
Interest Revenue/ Expense |
Average Yield/ Rate |
|||||||||||||||||||
Interest-earning assets: |
|||||||||||||||||||||||||||
Cash and cash equivalents |
$ | 5,217 | $ | 129 | 2.47 | % | $ | 4,290 | $ | 223 | 5.20 | % | $ | 2,450 | $ | 125 | 5.10 | % | |||||||||
Cash and investments segregated |
11,223 | 280 | 2.49 | % | 9,991 | 511 | 5.11 | % | 12,758 | 602 | 4.72 | % | |||||||||||||||
Broker-related receivables (1) |
428 | 8 | 1.87 | % | 595 | 27 | 4.54 | % | 533 | 25 | 4.69 | % | |||||||||||||||
Receivables from brokerage clients |
10,278 | 612 | 5.95 | % | 10,736 | 859 | 8.00 | % | 10,252 | 837 | 8.16 | % | |||||||||||||||
Securities available for sale (2) |
11,772 | 517 | 4.39 | % | 7,335 | 399 | 5.44 | % | 6,125 | 319 | 5.21 | % | |||||||||||||||
Securities held to maturity |
22 | 1 | 5.86 | % | | | | | | | |||||||||||||||||
Loans to banking clients |
4,831 | 227 | 4.70 | % | 2,786 | 169 | 6.07 | % | 2,157 | 128 | 5.93 | % | |||||||||||||||
Total interest-earning assets |
43,771 | 1,774 | 4.05 | % | 35,733 | 2,188 | 6.12 | % | 34,275 | 2,036 | 5.94 | % | |||||||||||||||
Other interest revenue |
134 | 82 | 77 | ||||||||||||||||||||||||
Total interest-earning assets |
$ | 43,771 | $ | 1,908 | 4.36 | % | $ | 35,733 | $ | 2,270 | 6.35 | % | $ | 34,275 | $ | 2,113 | 6.16 | % | |||||||||
Funding sources: |
|||||||||||||||||||||||||||
Deposits from banking clients |
$ | 19,203 | $ | 104 | 0.54 | % | $ | 12,046 | $ | 238 | 1.98 | % | $ | 9,135 | $ | 200 | 2.19 | % | |||||||||
Payables to brokerage clients |
15,220 | 55 | 0.36 | % | 14,768 | 329 | 2.23 | % | 17,865 | 426 | 2.38 | % | |||||||||||||||
Short-term borrowings |
40 | 1 | 2.54 | % | | | | | | | |||||||||||||||||
Long-term debt |
890 | 59 | 6.63 | % | 531 | 38 | 7.16 | % | 419 | 29 | 6.92 | % | |||||||||||||||
Total interest-bearing liabilities |
35,353 | 219 | 0.62 | % | 27,345 | 605 | 2.21 | % | 27,419 | 655 | 2.39 | % | |||||||||||||||
Non-interest bearing funding sources |
8,418 | 8,388 | 6,856 | ||||||||||||||||||||||||
Other interest expense |
24 | 18 | 24 | ||||||||||||||||||||||||
Total funding sources |
$ | 43,771 | $ | 243 | 0.56 | % | $ | 35,733 | $ | 623 | 1.74 | % | $ | 34,275 | $ | 679 | 1.98 | % | |||||||||
Net interest revenue |
$ | 1,665 | 3.80 | % | $ | 1,647 | 4.61 | % | $ | 1,434 | 4.18 | % | |||||||||||||||
(1) |
Includes receivables from brokers, dealers, and clearing organizations. |
(2) |
Amounts have been calculated based on amortized cost. |
The increases in net interest revenue in the last two years were primarily due to higher average interest-earning assets, including increases in securities available for sale, and loans to banking clients, partially offset by higher average balances on deposits from banking clients. In addition, the increase in net interest revenue in 2008 was also partially offset by a decrease in receivables from brokerage clients, as well as generally lower yields on interest-earning assets. Net interest revenue in 2007 included incremental interest revenue generated from temporarily investing the proceeds from the sale of U.S. Trust. Consistent with declines in general market interest rates prevalent in 2008, the Company experienced declines in the yields of all interest-earning assets during 2008 as compared to 2007 and 2006. Accordingly, the average interest rates on deposits from banking clients and payables to brokerage clients also decreased during 2008 compared to 2007 and 2006. The decline in the average interest rate on long-term debt was due to the additional debt issued at lower interest rates as part of the Companys capital restructuring in 2007.
Certain interest-bearing assets and liabilities of U.S. Trust retained by the Company in 2007 and 2006: The excess cash held in certain Schwab brokerage client accounts was previously swept into a money market deposit account at U.S. Trust. In May 2007, Schwab terminated this arrangement and moved all of these balances to a similar existing arrangement with Schwab Bank. The interest expense related to these client deposit balances maintained at U.S. Trust is included in interest expense from continuing operations on the Companys consolidated statements of income for 2007 and 2006. The interest expense was $4 million and $11 million for 2007 and 2006, respectively. The corresponding interest revenue on the invested cash balances related to these deposits is included in interest revenue from continuing operations on the Companys consolidated statements of income for 2007 and 2006. The interest revenue was $14 million and $38 million for 2007 and 2006, respectively. The interest revenue amount was calculated using the Companys funds transfer pricing methodology.
Trading Revenue
Trading revenue includes commission and principal transaction revenues. Commission revenues are affected by the number of revenue trades executed and the average revenue earned per revenue trade. Principal transaction revenues are primarily
- 20 -
THE CHARLES SCHWAB CORPORATION
Managements Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Millions, Except Ratios, or as Noted)
comprised of revenues from client fixed income securities trading activity. Factors that influence principal transaction revenues include the volume of client trades, market price volatility, and competitive pressures.
Trading revenue increased by $220 million, or 26%, in 2008 from 2007 and $75 million, or 10%, in 2007 from 2006 due to higher daily average revenue trades and higher average revenue earned per revenue trade.
As shown in the following table, daily average revenue trades executed by the Company increased 19% in 2008. The increase in daily average revenue trades was due to higher volumes of equity, mutual fund, option, and principal transaction trades. Average revenue earned per revenue trade increased 4% in 2008 from 2007 primarily due to higher average revenue earned per revenue trade for fixed income securities, partially offset by lower average revenue earned per revenue trade for option securities. Average revenue earned per revenue trade increased 4% in 2007 from 2006 primarily due to a higher proportion of equity trading volume outside the Companys active investor programs.
Growth Rate 2007-2008 |
2008 | 2007 | 2006 | |||||||||
Daily average revenue trades (in thousands) (1) |
19 | % | 292.6 | 245.3 | 234.4 | |||||||
Number of trading days |
1 | % | 251.5 | 249.5 | 250.0 | |||||||
Average revenue earned per revenue trade |
4 | % | $ | 14.53 | $ | 13.99 | $ | 13.39 |
(1) |
Includes all client trades that generate trading revenue (i.e., commission revenue or revenue from fixed income securities trading). |
Other Revenue
Other revenue includes realized gains and losses on sales of securities available for sale, service fees, and software maintenance fees. Other revenue decreased by $79 million, or 61%, in 2008 from 2007 primarily due to losses of $75 million related to two corporate debt securities in the Companys securities available for sale portfolio in 2008. On September 15, 2008, Lehman Brothers Holdings, Inc. (Lehman) filed a Chapter 11 bankruptcy petition and on September 25, 2008, the Federal Deposit Insurance Corporation (FDIC) seized Washington Mutual Bank. As a result of these events, the Company sold these debt securities in 2008.
Expenses Excluding Interest
As shown in the table below, expenses excluding interest were relatively flat in 2008 as compared to 2007 primarily due to a decrease in compensation and benefits expense, partially offset by increases in other expense and occupancy and equipment expense. Expenses excluding interest increased in 2007 as compared to 2006 primarily due to higher compensation and benefits expense, advertising and market development expense, and professional services expense.
Growth Rate 2007-2008 |
2008 | 2007 | 2006 | ||||||||||||
Compensation and benefits |
(6 | %) | $ | 1,667 | $ | 1,781 | $ | 1,619 | |||||||
Professional services |
3 | % | 334 | 324 | 285 | ||||||||||
Occupancy and equipment |
6 | % | 299 | 282 | 260 | ||||||||||
Advertising and market development |
6 | % | 243 | 230 | 189 | ||||||||||
Communications |
6 | % | 211 | 200 | 180 | ||||||||||
Depreciation and amortization |
(3 | %) | 152 | 156 | 157 | ||||||||||
Other |
29 | % | 216 | 168 | 143 | ||||||||||
Total expenses excluding interest |
(1 | %) | $ | 3,122 | $ | 3,141 | $ | 2,833 | |||||||
Expenses as a percentage of total net revenues: |
|||||||||||||||
Total expenses excluding interest |
61 | % | 63 | % | 66 | % | |||||||||
Advertising and market development |
5 | % | 5 | % | 4 | % |
- 21 -
THE CHARLES SCHWAB CORPORATION
Managements Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Millions, Except Ratios, or as Noted)
Compensation and Benefits
Compensation and benefits expense includes salaries and wages, incentive compensation, and related employee benefits and taxes. Incentive compensation is based on the achievement of specified performance objectives, including revenue growth, profit margin, and EPS, and therefore will fluctuate with these measures.
Compensation and benefits expense decreased by $114 million, or 6%, in 2008 from 2007 due to decreases in incentive compensation and employee benefits and other expense, offset by an increase in salaries and wages. Compensation and benefits expense increased by $162 million, or 10%, in 2007 from 2006 due to increases in salaries and wages, incentive compensation, and employee benefits and other expense. The following table shows a comparison of certain compensation and benefits components and employee data:
Growth Rate 2007-2008 |
2008 | 2007 | 2006 | ||||||||||||
Salaries and wages |
7 | % | $ | 1,020 | $ | 955 | $ | 872 | |||||||
Incentive compensation (1) |
(27 | %) | 402 | 552 | 504 | ||||||||||
Employee benefits and other |
(11 | %) | 245 | 274 | 243 | ||||||||||
Total compensation and benefits expense |
(6 | %) | $ | 1,667 | $ | 1,781 | $ | 1,619 | |||||||
Compensation and benefits expense as a percentage of total net revenues: |
|||||||||||||||
Salaries and wages |
20 | % | 19 | % | 20 | % | |||||||||
Incentive compensation |
8 | % | 11 | % | 12 | % | |||||||||
Employee benefits and other |
4 | % | 6 | % | 6 | % | |||||||||
Total compensation and benefits expense |
32 | % | 36 | % | 38 | % | |||||||||
Full-time equivalent employees (in thousands) (2) |
|||||||||||||||
At year end |
1 | % | 13.4 | 13.3 | 12.4 | ||||||||||
Average |
5 | % | 13.5 | 12.9 | 11.9 |
(1) |
Includes incentives, discretionary bonus costs, long-term incentive plan, stock-based compensation, and employee stock purchase plan expense. |
(2) |
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 2008 from 2007 due to higher severance expense. Incentive compensation decreased in 2008 from 2007 primarily due to lower long-term incentive plan compensation, discretionary bonus costs, and variable compensation. Discretionary bonus costs and variable compensation decreased in 2008 from 2007 based on actual performance in 2008. Long-term incentive plan compensation decreased in 2008 from 2007 primarily due to the maturity of certain plan units that matured in 2007. Employee benefits and other expense decreased in 2008 from 2007 primarily due to a decrease in deferred compensation.
Salaries and wages and employee benefit and other expense increased in 2007 from 2006 due to an increase in full-time employees. Incentive compensation increased in 2007 from 2006 primarily due to the increased cost of performance-based incentive plans as a result of the Companys improved financial results in 2007 and stock-based compensation.
Expenses Excluding Compensation and Benefits
Occupancy and equipment expense increased in 2008 from 2007 primarily due to increases in data processing equipment and maintenance expense of $12 million and occupancy expense of $5 million. Advertising and market development expense increased in 2008 from 2007 due to an increase in media spending related to the Companys Talk to Chuck national advertising campaign. Communications expense increased in 2008 from 2007 primarily due to higher levels of postage and printing costs of $8 million. Other expense increased in 2008 from 2007 primarily due to charges of $29 million for individual client complaints and arbitration claims relating to Schwab YieldPlus Fund® investments.
- 22 -
THE CHARLES SCHWAB CORPORATION
Managements Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Millions, Except Ratios, or as Noted)
Professional services expense increased in 2007 from 2006 primarily due to higher levels of fees paid to outsourced service providers and consultants. Occupancy and equipment expense increased in 2007 from 2006 due to increases in data processing equipment and maintenance expense of $17 million and occupancy expense of $5 million. Advertising and market development expense increased in 2007 from 2006 primarily due to the Companys media and marketing spending related to its Talk to Chuck national advertising campaign. Communications expense increased in 2007 from 2006 due to higher levels of postage and printing costs of $15 million and news and quotes services of $5 million. Other expense increased in 2007 from 2006 primarily due to increases in regulatory fees of $7 million, bank service charges of $7 million, and charitable contributions of $4 million.
Taxes on Income
The Companys effective income tax rate on income from continuing operations was 39.3% in 2008 and 39.6% in both 2007 and 2006.
Segment Information
The Company provides financial services to individuals, and institutional and corporate clients through three segments Investor Services (formerly called Schwab Investor Services), Advisor Services (formerly called Schwab Institutional®), and Corporate and Retirement Services (formerly called Schwab Corporate and Retirement Services). The Investor Services segment includes the Companys retail brokerage and banking operations. The Advisor Services segment provides custodial, trading, and support services to independent investment advisors. The Corporate and Retirement Services segment provides retirement plan services, plan administrator services, stock plan services, and mutual fund clearing services and supports the availability of Schwab proprietary mutual funds on third-party platforms. The Company evaluates the performance of its segments on a pre-tax basis excluding items such as restructuring charges, impairment charges on non-financial assets, discontinued operations, and extraordinary items. Segment assets are not disclosed because the balances are not used for evaluating segment performance and deciding how to allocate resources to segments.
- 23 -
THE CHARLES SCHWAB CORPORATION
Managements Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Millions, Except Ratios, or as Noted)
Financial information for the Companys reportable segments is presented in the following table:
For the year ended December 31, |
Growth Rate 2007-2008 |
2008 | 2007 | 2006 | |||||||||||
Investor Services: |
|||||||||||||||
Net revenues |
1 | % | $ | 3,385 | $ | 3,352 | $ | 2,940 | |||||||
Expenses excluding interest |
| (2,107 | ) | (2,115 | ) | (1,982 | ) | ||||||||
Contribution margin |
3 | % | $ | 1,278 | $ | 1,237 | $ | 958 | |||||||
Advisor Services: |
|||||||||||||||
Net revenues |
12 | % | $ | 1,250 | $ | 1,121 | $ | 966 | |||||||
Expenses excluding interest |
(4 | %) | (612 | ) | (639 | ) | (562 | ) | |||||||
Contribution margin |
32 | % | $ | 638 | $ | 482 | $ | 404 | |||||||
Corporate and Retirement Services: |
|||||||||||||||
Net revenues |
| $ | 504 | $ | 506 | $ | 373 | ||||||||
Expenses excluding interest |
6 | % | (389 | ) | (367 | ) | (268 | ) | |||||||
Contribution margin |
(17 | %) | $ | 115 | $ | 139 | $ | 105 | |||||||
Unallocated and other: |
|||||||||||||||
Net revenues |
N/M | $ | 11 | $ | 15 | $ | 30 | ||||||||
Expenses excluding interest |
N/M | (14 | ) | (20 | ) | (21 | ) | ||||||||
Contribution margin |
N/M | $ | (3 | ) | $ | (5 | ) | $ | 9 | ||||||
Total: |
|||||||||||||||
Net revenues |
3 | % | $ | 5,150 | $ | 4,994 | $ | 4,309 | |||||||
Expenses excluding interest |
(1 | %) | (3,122 | ) | (3,141 | ) | (2,833 | ) | |||||||
Contribution margin |
9 | % | $ | 2,028 | $ | 1,853 | $ | 1,476 | |||||||
N/M Not meaningful.
Investor Services
Net revenues increased in 2008 by $33 million, or 1%, from 2007 primarily due to increases in trading revenue and net interest revenue, partially offset by the decrease in other revenue. Trading revenue increased due to higher daily average revenue trades. Net interest revenue increased due to higher levels of interest-earning assets, partially offset by the impact of a decrease in the average net yield earned on these assets. The decrease in other revenue was primarily due to losses on investments in the Companys securities available for sale portfolio. Expenses excluding interest were relatively flat in 2008 as compared to 2007 as a result of lower incentive compensation expense, offset by a charge for individual client complaints and arbitration claims related to Schwab YieldPlus Fund investments in 2008.
Net revenues increased in 2007 by $412 million, or 14%, from 2006 due to increases in net interest revenue and asset management and administration fees. Net interest revenue increased due to higher levels of market interest rates and changes in the composition of interest-earning assets, including increases in securities available for sale and loans to banking clients. Asset management and administration fees increased as a result of higher balances of client assets in the Companys proprietary mutual funds and Mutual Fund OneSource® service, as well as balances participating in advisory and managed account service programs. Expenses excluding interest increased in 2007 by $133 million, or 7%, from 2006 primarily due to higher client servicing and other related expenses, as well as higher market development expense.
Advisor Services
Net revenues increased in 2008 by $129 million, or 12%, from 2007 due to increases in trading revenue and asset management and administration fees, offset by the decrease in net interest revenue. Trading revenue increased due to higher daily average revenue trades. Asset management and administration fees increased as a result of higher balances of client assets in the Companys proprietary funds. Net interest revenue decreased due to the impact of a decrease in the average net yield earned on interest-earning assets. Expenses excluding interest decreased in 2008 by $27 million, or 4%, from 2007 primarily due to lower incentive compensation expense.
- 24 -
THE CHARLES SCHWAB CORPORATION
Managements Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Millions, Except Ratios, or as Noted)
Net revenues increased in 2007 by $155 million, or 16%, from 2006 due to increases in asset management and administration fees and net interest revenue. Asset management and administration fees increased as a result of higher balances of client assets in the Companys proprietary mutual funds and Mutual Fund OneSource® service, as well as balances participating in managed account service programs. Net interest revenue increased due to higher levels of market interest rates and changes in the composition of interest-earning assets, including increases in securities available for sale. Expenses excluding interest increased in 2007 by $77 million, or 14%, from 2006 primarily due to higher business development, marketing and account servicing related expenses, as well as increased infrastructure investment.
Corporate and Retirement Services
Net revenues were flat in 2008 as compared to 2007 as a result of an increase in trading revenue offset by a decrease in net interest revenue. Trading revenue increased due to higher daily average revenue trades. Net interest revenue decreased due to the impact of a decrease in the average net yield earned on interest-earning assets. Expenses excluding interest increased in 2008 by $22 million, or 6%, from 2007 due to increased costs to service additional corporate retirement plan participants resulting from the acquisition of the 401(k) Company, offset by lower incentive compensation expense.
Net revenues increased in 2007 by $133 million, or 36%, from 2006 due to increases in asset management and administration fees and net interest revenue, as well as the acquisition of the 401(k) Company in March 2007. Asset management and administration fees increased as a result of higher balances of client assets in the Companys mutual funds and advisory and managed account service programs. Net interest revenue increased due to higher levels of market interest rates and changes in the composition of interest-earning assets. Expenses excluding interest increased in 2007 by $99 million, or 37%, from 2006 primarily due to costs to service additional corporate retirement plan participants as a result of the acquisition of the 401(k) Company.
Capital Restructuring
In 2007, CSC completed a capital restructuring that returned approximately $3.3 billion in capital to stockholders to create a more efficient and cost-effective capital structure. The capital restructuring included the following components:
| CSC paid a special cash dividend of $1.00 per common share, which returned $1.2 billion to stockholders. The special dividend was paid on August 24, 2007, to stockholders of record on July 24, 2007. |
| CSC repurchased 84 million shares of its common stock through a modified Dutch Auction tender offer in August 2007. The tender offer period closed on July 31, 2007, and CSC accepted for purchase 84 million shares of its common stock, at a purchase price of $20.50 per share, for a total purchase price of $1.7 billion. |
| CSC executed a separate Stock Purchase Agreement with Chairman and former CEO Charles R. Schwab, CSCs largest stockholder, and with certain additional stockholders whose shares Mr. Schwab was deemed to beneficially own. Under the Stock Purchase Agreement, Mr. Schwab and the other stockholders who are parties to the agreement did not participate in the tender offer, but instead, sold, and CSC purchased, 18 million shares, at a purchase price ($20.50 per share), which is the same as was determined and paid in the tender offer, for a total purchase price of $369 million. The number of shares repurchased resulted in Mr. Schwab maintaining the same beneficial percentage interest in CSCs outstanding common stock that he had prior to the tender offer and sale of shares pursuant to the Stock Purchase Agreement (approximately 18 percent, which does not take into consideration Mr. Schwabs outstanding options to acquire stock). The shares under this agreement were repurchased on August 15, 2007. |
| CSC issued $250 million of 6.375% Senior Medium-Term Notes due in 2017 in September 2007 and $300 million of junior subordinated notes in October 2007. For further discussion of the issuance of the junior subordinated notes, see Item 8 Financial Statements and Supplementary Data Notes to Consolidated Financial Statements 12. Borrowings. |
Discontinued Operations
On July 1, 2007, the Company completed the sale of all of the outstanding common stock of U.S. Trust for $3.3 billion in cash. CSC recognized a gain on the sale of $1.9 billion, or $1.2 billion after tax, in third quarter of 2007. In connection with the determination of the final income tax gain on the sale of U.S. Trust, the Company recorded additional tax expense of
- 25 -
THE CHARLES SCHWAB CORPORATION
Managements Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Millions, Except Ratios, or as Noted)
$18 million in the second quarter of 2008. U.S. Trust is presented as a discontinued operation for all periods prior to the completion of the sale.
Business Acquisition
On March 31, 2007, the Company completed its acquisition of The 401(k) Company, which offers retirement plan services, for $115 million in cash. As a result of a purchase price allocation, the Company recorded goodwill of $106 million and intangible assets of $8 million. The intangible assets are being amortized over 16 years.
LIQUIDITY AND CAPITAL RESOURCES
CSC conducts substantially all of its business through its wholly-owned subsidiaries. The capital structure among CSC and its subsidiaries is designed to provide each entity with capital and liquidity to meet its operational needs and regulatory requirements.
CSC is a savings and loan holding company and Schwab Bank, CSCs depository institution, is a federal savings bank. CSC and Schwab Bank are both subject to supervision and regulation by the Office of Thrift Supervision.
Liquidity
CSC
As a savings and loan holding company, CSC is not subject to specific statutory capital requirements. However, CSC is required to maintain capital that is sufficient to support the holding company and its subsidiaries business activities, and the risks inherent in those activities. To manage capital adequacy, CSC currently utilizes a target Tier 1 Leverage Ratio, as defined by the Board of Governors of the Federal Reserve Board, of at least 6%. At December 31, 2008, CSCs Tier 1 Leverage Ratio was 8.6%.
CSCs liquidity needs are generally met through cash generated by its subsidiaries, as well as cash provided by external financing. CSC maintains excess liquidity in the form of overnight cash deposits to cover daily funding needs and to support growth in the Companys 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 and Schwab Bank are subject to regulatory requirements that may restrict them from certain transactions with CSC. Management believes that funds generated by the operations of CSCs subsidiaries will continue to be the primary funding source in meeting CSCs liquidity needs, providing adequate liquidity to meet Schwab Banks capital guidelines, and maintaining Schwabs net capital.
CSC has liquidity needs that arise from its Senior Medium-Term Notes, Series A (Medium-Term Notes), and junior subordinated notes, as well as from the funding of cash dividends, acquisitions, and other investments. The Medium-Term Notes, of which $458 million was outstanding at December 31, 2008, have maturities ranging from 2009 to 2017 and fixed interest rates ranging from 6.375% to 8.05% with interest payable semiannually. The Medium-Term Notes are rated A2 by Moodys Investors Service (Moodys), A by Standard & Poors Ratings Group (S&P), and A by Fitch IBCA, Inc. (Fitch). At December 31, 2008, $300 million of junior subordinated notes were outstanding and have a fixed interest rate of 7.50% until 2017 and a floating rate thereafter. The junior subordinated notes are not rated, however the trust preferred securities related to these notes are rated A3 by Moodys, BBB+ by S&P, and A- by Fitch. For further discussion of the issuance of the junior subordinated notes, see Item 8 Financial Statements and Supplementary Data Notes to Consolidated Financial Statements 12. Borrowings.
CSC has a universal automatic shelf registration statement on file with the SEC which enables CSC to issue debt, equity and other securities. This registration statement was filed in December 2008. CSCs prior shelf registration statement/prospectus supplement for issuing Medium-Term Notes and universal shelf registration statement both expired in November 2008.
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THE CHARLES SCHWAB CORPORATION
Managements Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Millions, Except Ratios, or as Noted)
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 is not subject to voluntary prepayment. The proceeds of the commercial paper program are to be used for general corporate purposes. CSC commenced issuing Commercial Paper Notes in April 2008. Average borrowings for the year ended December 31, 2008 were $40 million. There were no Commercial Paper Notes outstanding at December 31, 2008. CSCs ratings for these short-term borrowings are P-1 by Moodys, A-1 by S&P, and F1 by Fitch.
CSC maintains an $800 million committed, unsecured credit facility with a group of fourteen banks which is scheduled to expire in June 2009. CSC plans to establish a similar facility to replace this one when it expires. This facility was unused in 2008. Any issuances under CSCs commercial paper program will reduce the amount available under this facility. The funds under this facility are available for general corporate purposes, including repayment of the Commercial Paper Notes discussed above. 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 December 31, 2008, the minimum level of stockholders equity required under this facility was $2.6 billion. Management believes that these restrictions will not have a material effect on its ability to meet foreseeable dividend or funding requirements.
CSC also has direct access to $1.0 billion of the $1.1 billion uncommitted, unsecured bank credit lines discussed below, that are primarily utilized by Schwab to manage short-term liquidity. The amount available to CSC under these lines is lower than the amount available to Schwab because the credit line provided by one of these banks is only available to Schwab. These lines were not used by CSC in 2008.
In addition, Schwab provides CSC with a $1.0 billion credit facility maturing in 2009. No funds were drawn under this facility at December 31, 2008.
Schwab
Schwab is subject to regulatory requirements that are intended to ensure the general financial soundness and liquidity of broker-dealers. These regulations prohibit Schwab from repaying subordinated borrowings to CSC, paying cash dividends, or making unsecured advances or loans to its parent or employees if such payment would result in net capital of less than 5% of aggregate debit balances or less than 120% of its minimum dollar requirement of $250,000. At December 31, 2008, Schwabs net capital was $1.2 billion (16% of aggregate debit balances), which was $1.1 billion in excess of its minimum required net capital and $840 million in excess of 5% of aggregate debit balances.
Most of Schwabs assets are readily convertible to cash, consisting primarily of short-term (i.e., less than 150 days) 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.
Liquidity needs relating to client trading and margin borrowing activities are met primarily through cash balances in brokerage client accounts, which were $19.2 billion, $19.5 billion, and $19.9 billion at December 31, 2008, 2007, and 2006, respectively. Management believes that brokerage client cash balances and operating earnings will continue to be the primary sources of liquidity for Schwab in the future.
The Company has a finance lease obligation related to an office building and land under a 20-year lease. The remaining finance lease obligation of $116 million at December 31, 2008 is being reduced by a portion of the lease payments over the remaining lease term of approximately 16 years.
To manage short-term liquidity, Schwab maintains uncommitted, unsecured bank credit lines with a group of six banks totaling $1.1 billion at December 31, 2008. The need for short-term borrowings arises primarily from timing differences
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THE CHARLES SCHWAB CORPORATION
Managements Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Millions, Except Ratios, or as Noted)
between cash flow requirements, scheduled liquidation of interest-bearing investments, and movements of cash to meet segregation requirements. Schwab used such borrowings for eighteen days in 2008, with daily amounts borrowed averaging $117 million. There were no borrowings outstanding under these lines at December 31, 2008.
To satisfy the margin requirement of client option transactions with the Options Clearing Corporation (OCC), Schwab has unsecured standby letter of credit (LOCs) agreements with seven banks in favor of the OCC aggregating $550 million at December 31, 2008. In connection with its securities lending activities, Schwab is required to provide collateral to certain brokerage clients. Schwab satisfies the collateral requirements by arranging LOCs, in favor of these brokerage clients, which are issued by multiple banks. At December 31, 2008, the aggregate face amount of these LOCs totaled $100 million. No funds were drawn under any of these LOCs during 2008.
To manage Schwabs regulatory capital requirement, CSC provides Schwab with a $1.4 billion subordinated revolving credit facility which is scheduled to expire in March 2010. The amount outstanding under this facility at December 31, 2008 was $220 million. Borrowings under this subordinated lending arrangement qualify as regulatory capital for Schwab.
In addition, CSC provides Schwab with a $1.5 billion credit facility which is scheduled to expire in 2011. Borrowings under this facility do not qualify as regulatory capital for Schwab. At December 31, 2008, $153 million was outstanding under this facility, which was subsequently repaid on January 2, 2009.
Schwab Bank
Schwab Bank is required to maintain a capital level that at least equals minimum capital levels specified in federal banking laws and regulations. Failure to meet the minimum levels will result in certain mandatory, and possibly additional discretionary, actions by the regulators that, if undertaken, could have a direct effect on Schwab Bank. Based on its regulatory capital ratios at December 31, 2008, Schwab Bank is considered well capitalized. Schwab Banks regulatory capital and ratios are as follows:
Actual | Minimum Capital Requirement |
Minimum to be Well Capitalized |
|||||||||||||
December 31, 2008 |
Amount | Ratio | Amount | Ratio | Amount | Ratio | |||||||||
Tier 1 Capital |
$ 1,650 | 15.3 | % | $ 432 | 4.0 | % | $ 647 | 6.0 | % | ||||||
Total Capital |
$ 1,671 | 15.5 | % | $ 863 | 8.0 | % | $ 1,079 | 10.0 | % | ||||||
Leverage |
$ 1,650 | 6.4 | % | $ 1,037 | 4.0 | % | $ 1,296 | 5.0 | % | ||||||
Tangible Equity |
$ 1,650 | 6.4 | % | $ 518 | 2.0 | % | N/A |
N/A Not applicable.
Schwab Banks current liquidity needs are generally met through deposits from banking clients and equity capital.
The excess cash held in certain Schwab brokerage client accounts is swept into a money market deposit account at Schwab Bank. At December 31, 2008, these balances totaled $18.4 billion.
Additionally, Schwab Bank has access to traditional funding sources such as deposits, federal funds purchased, and repurchase agreements. 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 amount of Schwab Banks mortgage-backed securities available for sale that are pledged as collateral. At December 31, 2008, $187 million was available under this arrangement. There were no funds drawn under this arrangement during 2008.
Schwab Bank maintains a credit facility with the Federal Home Loan Bank System (FHLB). Amounts available under this facility are dependent on the amount of Schwab Banks home equity lines of credit that are pledged as collateral. At December 31, 2008, $415 million was available under this facility. There were no funds drawn under this facility during 2008.
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THE CHARLES SCHWAB CORPORATION
Managements Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Millions, Except Ratios, or as Noted)
CSC provides Schwab Bank with a $100 million short-term credit facility which is scheduled to expire in December 2009. Borrowings under this facility do not qualify as regulatory capital for Schwab Bank. No funds were drawn under this facility during 2008.
Capital Resources
The Company monitors both the relative composition and absolute level of its capital structure. Management is focused on limiting the Companys use of capital and currently targets a long-term debt to total financial capital ratio of less than 30%. The Companys total financial capital (long-term debt plus stockholders equity) at December 31, 2008 was $4.9 billion, up $313 million, or 7%, from December 31, 2007.
At December 31, 2008, the Company had long-term debt of $883 million, or 18% of total financial capital, that bears interest at a weighted-average rate of 7.03%. At December 31, 2007, the Company had long-term debt of $899 million, or 19% of total financial capital. The Company repaid $20 million and $43 million of long-term debt in 2008 and 2007, respectively.
The Companys cash position (reported as cash and cash equivalents on the Companys consolidated balance sheet) 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 Companys cash position and cash flows include investment activity in securities, 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 of CSCs common stock. The combination of these factors can cause significant fluctuations in the levels of cash and cash equivalents during specific time periods.
Capital Expenditures
The Companys capital expenditures were $196 million in 2008 and $168 million in 2007. Capital expenditures as a percentage of net revenues were 4% and 3% in 2008 and 2007, respectively. Capital expenditures in 2008 included software and equipment relating to the Companys information technology systems, buildings, and leasehold improvements. Capital expenditures in 2007 were primarily for software and equipment relating to the Companys information technology systems. Capital expenditures include capitalized costs for developing internal-use software of $46 million in 2008 and $57 million in 2007.
Management currently anticipates that 2009 capital expenditures will be approximately 25% lower than 2008 spending, primarily due to decreased spending on software relating to the Companys information technology systems, as well as decreased spending on buildings. As has been the case in recent years, the Company may adjust its capital expenditures from period to period as business conditions change. Management believes that funds generated by its operations will continue to be the primary funding source of its capital expenditures.
Dividends
CSC paid common stock cash dividends of $253 million in 2008. CSC paid common stock cash dividends of $1.5 billion in 2007, which included a special cash dividend of $1.2 billion. Since the initial dividend in 1989, CSC has paid 79 consecutive quarterly dividends and has increased the quarterly dividend 19 times, including a 20% increase in the third quarter of 2008. Since 1989, dividends have increased by a 28% compounded annual growth rate, excluding the special cash dividend of $1.00 per common share in 2007. CSC paid common stock dividends of $.220, $1.200, and $.135 per share in 2008, 2007, and 2006, respectively. While the payment and amount of dividends are at the discretion of the Board, subject to certain regulatory and other restrictions, the Company currently targets its cash dividend at approximately 20% to 30% of net income.
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THE CHARLES SCHWAB CORPORATION
Managements Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Millions, Except Ratios, or as Noted)
Share Repurchases
CSC repurchased 17 million shares of its common stock for $350 million in 2008. CSC repurchased 135 million shares of its common stock, including shares repurchased under the tender offer and the Stock Purchase Agreement described below for $2.7 billion in 2007. As of December 31, 2008, CSC had remaining authority from the Board of Directors to repurchase up to $596 million of its common stock.
On July 31, 2007, CSC completed a share repurchase through a tender offer. CSC accepted for purchase 84 million shares of its common stock at a price of $20.50 per share, for a total purchase price of $1.7 billion. Pursuant to the tender offer rules, CSC was prohibited from making open market repurchases of its common stock during the tender offer period and until August 15, 2007.
Under the Stock Purchase Agreement executed on July 2, 2007 with Chairman and former CEO Charles R. Schwab, CSCs largest stockholder, and with certain additional stockholders whose shares Mr. Schwab is deemed to beneficially own, CSC purchased 18 million shares at a price of $20.50 per share for a total of $369 million on August 15, 2007.
Acquisition and Divestiture
On July 1, 2007, the Company completed the sale of U.S. Trust and received proceeds of $3.3 billion. On March 31, 2007, the Company completed its acquisition of The 401(k) Company for $115 million in cash.
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 information on each of these arrangements, see Item 8 Financial Statements and Supplementary Data Notes to Consolidated Financial Statements 13. Commitments and Contingent Liabilities.
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THE CHARLES SCHWAB CORPORATION
Managements Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Millions, Except Ratios, or as Noted)
Contractual Obligations
A summary of the Companys principal contractual obligations as of December 31, 2008, is shown in the following table. Excluded from this table are liabilities recorded on the consolidated balance sheet that are generally short-term in nature (e.g., drafts payable) or without contractual payment terms (e.g., deposits from banking clients, payables to brokerage clients, and deferred compensation). Management believes that funds generated by its continuing operations, as well as cash provided by external financing, will continue to be the primary funding sources in meeting these obligations.
Less than 1 Year |
1-3 Years |
3-5 Years |
More than 5 Years |
Total | |||||||||||
Credit-related financial instruments (1) |
$ | 711 | $ | 8 | $ | 352 | $ | 3,885 | $ | 4,956 | |||||
Long-term debt (2) |
63 | 285 | 77 | 705 | 1,130 | ||||||||||
Leases (3) |
129 | 234 | 125 | 237 | 725 | ||||||||||
Purchase obligations (4) |
214 | 106 | 3 | | 323 | ||||||||||
Long-term incentive plan |
90 | | | | 90 | ||||||||||
Total |
$ | 1,207 | $ | 633 | $ | 557 | $ | 4,827 | $ | 7,224 | |||||
(1) |
Represents Schwab Banks firm commitments to extend credit to banking clients. |
(2) |
Includes estimated future interest payments through 2017. The junior subordinated notes have a fixed interest rate of 7.50% until 2017 and a floating rate from 2018 to 2067. Based on the current interest rate of 7.50% and no repayments of principal, the estimated future interest payments on the junior subordinated notes in 2018 to 2067 would be $22 million per year. Amounts exclude maturities under a finance lease obligation, unamortized discounts, and the effect of interest rate swaps. |
(3) |
Represents minimum rental commitments, net of sublease commitments, and includes facilities under the Companys past restructuring initiatives and rental commitments under a finance lease obligation. |
(4) |
Consists of purchase obligations for services such as advertising and marketing, telecommunications, professional services, and hardware- and software-related agreements. Includes purchase obligations which can be canceled by the Company without penalty. |
Overview
The Companys business activities expose it to a variety of risks including technology and operations risk, credit, market and liquidity risks, and legal and reputational risk. Identification and management of these risks are essential to the success and financial soundness of the Company.
Senior management takes an active role in the Companys risk management process and has developed policies and procedures under which specific business and control units are responsible for identifying, measuring, and controlling various risks. Oversight of risk management has been delegated to the Global Risk Committee, which is comprised of senior managers of major business and control functions. The Global Risk Committee is responsible for reviewing and monitoring the Companys risk exposures, and leading the continued development of the Companys risk management policies and practices.
Functional risk sub-committees focusing on specific areas of risk report into the Global Risk Committee. These sub-committees include:
| Corporate Asset-Liability Management and Pricing Committee, which focuses on the Companys liquidity, capital resources, interest rate risk, and investments; |
| Credit and Market Risk Oversight Committee, which focuses on the credit exposures resulting from client activity (e.g., margin lending activities and loans to banking clients), the investing activities of certain of the Companys proprietary funds, corporate credit activities (e.g., counterparty and corporate investing activities), and market risk resulting from the Company taking positions in certain securities to facilitate client trading activity; |
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THE CHARLES SCHWAB CORPORATION
Managements Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Millions, Except Ratios, or as Noted)
| Technology and Operations Risk Committee, which focuses on the integrity of controls and operating capacity of the Companys systems and operations processes; |
| Fiduciary Risk Committee, which oversees activities of the Company with a fiduciary component; |
| New Products Committee, which addresses risks associated with new products and services; and |
| Information Security and Privacy Steering Committee, which oversees information security and privacy programs and policies. |
The Global Risk Committee reports regularly to the Audit Committee of the Board of Directors (Audit Committee), which reviews major risk exposures and the steps management has taken to monitor and control such exposures.
The Companys Disclosure Committee is responsible for the monitoring and evaluation of the effectiveness of the Companys (a) disclosure controls and procedures and (b) internal control over financial reporting as of the end of each fiscal quarter. The Disclosure Committee reports on this evaluation to the CEO and CFO prior to their certification required by Sections 302 and 906 of the Sarbanes Oxley Act of 2002.
Additionally, the Companys compliance, finance, internal audit, legal, and risk and credit management departments assist management and the various risk committees in evaluating, testing, and monitoring the Companys risk management.
Risk is inherent in the Companys business. Consequently, despite the Companys efforts to identify areas of risk, oversee operational areas involving risk, and implement policies and procedures designed to manage risk, there can be no assurance that the Company will not suffer unexpected losses due to operating or other risks. The following discussion highlights the Companys policies and procedures for identification, assessment, and management of the principal areas of risk in its operations.
Technology and Operating Risk
Technology and operating risk is the potential for loss due to deficiencies in control processes or technology systems that constrain the Companys ability to gather, process and communicate information and process client transactions efficiently and securely, without interruptions. The Companys operations are highly dependent on the integrity of its technology systems and the Companys success depends, in part, on its ability to make timely enhancements and additions to its technology in anticipation of evolving client needs. To the extent the Company experiences system interruptions, errors or downtime (which could result from a variety of causes, including changes in client use patterns, technological failure, changes to its systems, linkages with third-party systems, and power failures), the Companys business and operations could be significantly negatively impacted. Additionally, rapid increases in client demand may strain the Companys ability to enhance its technology and expand its operating capacity. To minimize business interruptions, Schwab has two data centers intended, in part, to further improve the recovery of business processing in the event of an emergency. The Company is committed to an ongoing process of upgrading, enhancing, and testing its technology systems. This effort is focused on meeting client needs, meeting market and regulatory changes, and deploying standardized technology platforms.
Technology and operating risk also includes the risk of human error, employee misconduct, external fraud, computer viruses, terrorist attack, and natural disaster. Employee misconduct could include fraud and misappropriation of client or Company assets, improper use or disclosure of confidential client or Company information, and unauthorized activities, such as transactions exceeding acceptable risks or authorized limits. External fraud includes misappropriation of client or Company assets by third parties, including through unauthorized access to Company systems and data and client accounts. The frequency and sophistication of such fraud attempts continue to increase.
The Company has specific policies and procedures to identify and manage operational risk, and uses periodic risk self-assessments and internal audit reviews to evaluate the effectiveness of these internal controls. The Company maintains backup and recovery functions, including facilities for backup and communications, and conducts periodic testing of disaster recovery plans. The Company also maintains policies and procedures and technology to protect against fraud and unauthorized access to systems and data.
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THE CHARLES SCHWAB CORPORATION
Managements Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Millions, Except Ratios, or as Noted)
Despite the Companys risk management efforts, it is not always possible to deter or prevent technological or operational failure, or fraud or other misconduct, and the precautions taken by the Company may not be effective in all cases. The Company may be subject to litigation, losses, and regulatory actions in such cases, and may be required to expend significant additional resources to remediate vulnerabilities or other exposures.
The Company also faces technology and operating risk when it employs the services of various external vendors, including domestic and international outsourcing of certain technology, processing, and support functions. The Company manages its exposure to such outsourcing risks through contractual provisions, control standards, and ongoing monitoring of vendor performance. The Company maintains policies and procedures regarding the standard of care expected with Company data, whether the data is internal company information, employee information, or non-public client information. The Company clearly defines for employees, contractors, and vendors the Companys expected standards of care for confidential data. Regular training is provided by the Company in regard to data security.
The Company is actively engaged in the research and development of new technologies, services, and products. The Company endeavors to protect its research and development efforts, and its brands, through the use of copyrights, patents, trade secrets, and contracts.
Credit Risk
Credit risk is the potential for loss due to a client or counterparty failing to perform its contractual obligations, or the value of collateral held to secure obligations proving to be inadequate. The Companys direct exposure to credit risk mainly results from margin lending activities, securities lending activities, mortgage lending activities, its role as a counterparty in financial contracts and investing activities, and indirectly from the investing activities of certain of the proprietary funds that the Company sponsors. To manage the risks of such losses, the Company has established policies and procedures which include: establishing and reviewing credit limits, monitoring of credit limits and quality of counterparties, and adjusting margin requirements for certain securities. In addition, most of the Companys credit extensions, such as margin loans to clients, securities lending agreements, and resale agreements, are supported by collateral arrangements. These arrangements are subject to requirements to provide additional collateral in the event that market fluctuations result in declines in the value of collateral received.
The Companys credit 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, non-performing loans, losses, and recoveries. All are factors in the determination of an appropriate allowance for credit losses, which is reviewed quarterly by senior management.
The Companys loan portfolios primarily include first lien 3-, 5- and 7-year adjustable rate mortgage loans (First Mortgage portfolio) of $3.2 billion and home equity lines of credit (HELOC portfolio) of $2.7 billion at December 31, 2008. The Company does not offer loans that allow for negative amortization. The Company maintains credit underwriting standards that have limited the exposure to the types of loans that experienced high foreclosures and loss rates elsewhere in the industry during 2008. The Company does not originate or purchase subprime loans (generally defined as extensions of credit to borrowers with a Fair Isaac & Company (FICO) credit score of less than 620 at origination), unless the borrower has compensating credit factors. At December 31, 2008, approximately 1% of both the First Mortgage and HELOC portfolios consisted of loans to borrowers with FICO credit scores of less than 620.
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THE CHARLES SCHWAB CORPORATION
Managements Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Millions, Except Ratios, or as Noted)
The following table presents certain of the Companys loan quality metrics as a percentage of total outstanding loans:
December 31, |
2008 | 2007 | ||||
Loan delinquencies (1) |
0.54 | % | 0.80 | % | ||
Nonaccrual loans |
0.13 | % | 0.12 | % | ||
Allowance for credit losses |
0.33 | % | 0.20 | % |
(1) |
Loan delinquencies are defined as loans that are 30 days or more past due. |
The Company has exposure to credit risk associated with its securities available for sale portfolio, which totaled $14.4 billion at December 31, 2008. This portfolio includes U.S. agency and non-agency mortgage-backed securities, corporate debt securities, long term certificates of deposit, asset-backed securities and U.S. agency notes. 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. agencies. Included in non-agency mortgage-backed securities are securities collateralized by loans that are considered to be Prime (defined by the Company as loans to borrowers with a FICO credit score of 620 or higher at origination), and Alt-A (defined by the Company as Prime loans with reduced documentation at origination).
The table below presents the credit ratings for U.S. agency and non-agency mortgage-backed securities, including prime and Alt-A mortgage-backed securities by year of origination. In some instances securities have divergent ratings from Moodys, Fitch Ratings or Standard and Poors. In these instances the Company has used the lowest rating as of December 31, 2008 for purposes of presenting the table below. Mortgage-backed securities, particularly Alt-A securities, experienced deteriorating credit characteristics, including increased delinquencies, and valuation pressure in 2008. For a discussion of the impact of current market conditions on mortgage-backed securities available for sale, see Current Market Environment.
AAA | AA to A | BBB | BB or Lower | Total | ||||||||||||||||||||||||||||||||||||
Amortized Cost |
Net Unrealized Gain (Loss) |
Amortized Cost |
Net Unrealized Gain (Loss) |
Amortized Cost |
Net Unrealized Gain (Loss) |
Amortized Cost |
Net Unrealized Gain (Loss) |
Amortized Cost |
Net Unrealized Gain (Loss) |
|||||||||||||||||||||||||||||||
U.S. agency mortgage-backed securities: |
||||||||||||||||||||||||||||||||||||||||
2005 |
$ | 813 | $ | (11 | ) | $ | | $ | | $ | | $ | | $ | | $ | | $ | 813 | $ | (11 | ) | ||||||||||||||||||
2006 |
509 | (13 | ) | | | | | | | 509 | (13 | ) | ||||||||||||||||||||||||||||
2007 |
1,053 | 20 | | | | | | | 1,053 | 20 | ||||||||||||||||||||||||||||||
2008 |
5,828 | 30 | | | | | | | 5,828 | 30 | ||||||||||||||||||||||||||||||
Total |
8,203 | 26 | | | | | | | 8,203 | 26 | ||||||||||||||||||||||||||||||
Non-agency mortgage-backed securities: |
||||||||||||||||||||||||||||||||||||||||
2003 |
130 | (16 | ) | | | | | | | 130 | (16 | ) | ||||||||||||||||||||||||||||
2004 |
337 | (68 | ) | | | | | | | 337 | (68 | ) | ||||||||||||||||||||||||||||
2005 |
987 | (226 | ) | 62 | (29 | ) | | | 15 | (7 | ) | 1,064 | (262 | ) | ||||||||||||||||||||||||||
2006 |
260 | (90 | ) | 202 | (63 | ) | 126 | (35 | ) | 309 | (181 | ) | 897 | (369 | ) | |||||||||||||||||||||||||
2007 |
347 | (54 | ) | 121 | (32 | ) | 42 | (10 | ) | 147 | (51 | ) | 657 | (147 | ) | |||||||||||||||||||||||||
Total |
2,061 | (454 | ) | 385 | (124 | ) | 168 | (45 | ) | 471 | (239 | ) | 3,085 | (862 | ) | |||||||||||||||||||||||||
Total mortgage-backed securities |
$ | 10,264 | $ | (428 | ) | $ | 385 | $ | (124 | ) | $ | 168 | $ | (45 | ) | $ | 471 | $ | (239 | ) | $ | 11,288 | $ | (836 | ) | |||||||||||||||
% of Total mortgage-backed securities |
91 | % | 3 | % | 2 | % | 4 | % | 100 | % | ||||||||||||||||||||||||||||||
At December 31, 2008, the corporate debt securities and non-mortgage asset-backed securities were rated investment grade (defined as a rating equivalent to a Moodys rating of Baa or higher, or a Standard and Poors rating of BBB- or higher).
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THE CHARLES SCHWAB CORPORATION
Managements Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Millions, Except Ratios, or as Noted)
Schwab performs clearing services for all securities transactions in its client accounts. Schwab has exposure to credit risk due to its obligation to settle transactions with clearing corporations, mutual funds, and other financial institutions even if Schwabs client or a counterparty fails to meet its obligations to Schwab.
Concentration Risk
The Company is subject to concentration risk when holding large positions of financial instruments collateralized by assets with similar economic characteristics or in securities of a single issuer or industry.
The Companys investments in mortgage-backed securities totaled $10.4 billion at December 31, 2008. Of these, $8.2 billion were U.S. agency securities and $2.2 billion were non-agency securities. Included in non-agency mortgage-backed securities are securities collateralized by Alt-A loans. At December 31, 2008, the amortized cost and fair value of Alt-A mortgage-backed securities were $798 million and $429 million, respectively.
The Companys investments in corporate debt securities and commercial paper totaled $3.5 billion at December 31, 2008, with the majority issued by institutions in the financial services industry. Included in corporate debt securities and commercial paper at December 31, 2008, were $2.6 billion of securities issued by financial institutions and guaranteed under the FDIC Temporary Liquidity Guarantee Program. These corporate debt securities and commercial paper are included in securities available for sale and cash and investments segregated and on deposit for regulatory purposes in the Companys consolidated balance sheets.
The Companys loans to banking clients includes $3.2 billion of first lien residential real estate mortgage loans at December 31, 2008. Approximately 80% of these mortgages consisted of loans with interest-only payment terms. The interest rates on approximately 80% of these interest-only loans are not scheduled to reset for three or more years. All interest-only loans are underwritten based on underwriting standards that do not include interest terms described as temporary introductory rates below current market rates. At December 31, 2008, 33% of the residential real estate mortgages and 46% of the home equity lines of credit balances were secured by properties which are located in California. The Company is also subject to concentration risk from its margin and securities lending activities collateralized by securities of a single issuer or industry.
The Company is subject to indirect exposure to U.S. Government and agency securities held as collateral to secure its resale agreements. The Companys 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 counterpartys default on the resale agreements. U.S. Government and agency securities held as collateral for resale agreements, at December 31, 2008, totaled $6.8 billion.
Market Risk
Market risk is the potential for changes in revenue or the value of financial instruments held by the Company as a result of fluctuations in interest rates, equity prices or market conditions. For discussion of the Companys market risk, see Item 7A Quantitative and Qualitative Disclosures About Market Risk.
Fiduciary Risk
Fiduciary risk is the potential for financial or reputational loss through breach of fiduciary duties to a client. Fiduciary activities include, but are not limited to, individual and institutional trust, investment management, custody, and cash and securities processing. The Company attempts to manage this risk by establishing procedures to ensure that obligations to clients are discharged faithfully and in compliance with applicable legal and regulatory requirements. Business units have the primary responsibility for adherence to the procedures applicable to their business. Guidance and control are provided through the creation, approval, and ongoing review of applicable policies by business units and various fiduciary risk committees.
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THE CHARLES SCHWAB CORPORATION
Managements Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Millions, Except Ratios, or as Noted)
Legal and Regulatory Risk
The Company faces significant legal and compliance risk in its business, and the volume of litigation and regulatory proceedings against financial services firms and the amount of damages claimed have been increasing. Among other things, these risks relate to the suitability of client investments, conflicts of interest, disclosure obligations and performance expectations for Company products and services, supervision of employees, and the adequacy of the Companys controls. Claims against the Company may increase due to a variety of factors, such as if clients suffer losses during a period of deteriorating equity market conditions, as the Company increases the level of advice it provides to clients, and as the Company enhances the services it provides to IAs. In addition, the Company and its affiliates are subject to extensive regulation by federal, state and foreign regulatory authorities, and SROs, and such regulation is becoming increasingly extensive and complex.
The Company attempts to manage legal and compliance risk through policies and procedures reasonably designed to avoid litigation claims and prevent or detect violations of applicable legal and regulatory requirements. These procedures address issues such as business conduct and ethics, sales and trading practices, marketing and communications, extension of credit, client funds and securities, books and records, anti-money laundering, client privacy, employment policies, and contracts management. Despite the Companys efforts to maintain an effective compliance program and internal controls, legal breaches and rule violations could result in reputational harm, significant losses and disciplinary sanctions, including limitations on the Companys business activities.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company uses fair value measurements to record certain financial assets and liabilities at fair value in accordance with SFAS No. 157 Fair Value Measurements (SFAS No. 157), and to determine fair value disclosures. At December 31, 2008, 42% of total assets ($21.9 billion) were recorded at fair value. All of these assets were measured at fair value using quoted prices or market-based information and accordingly were classified as Level 1 or Level 2 measurements in accordance with SFAS No. 157. Liabilities recorded at fair value were not material at December 31, 2008. See note 15 Fair Value of Assets and Liabilities for more information on the Companys assets and liabilities accounted for at fair value.
The Company uses prices obtained from an independent third-party pricing service to measure the fair value of certain investment securities. The Company validates prices received from the pricing service using various methods including, comparison to prices received from additional pricing services, comparison to available quoted market prices, internal valuation models, and review of other relevant market data including implied yields of major categories of securities. The Company does not adjust the prices received from the independent third-party pricing service unless such prices are inconsistent with SFAS No. 157 and result in a material difference in the recorded amounts. At December 31, 2008, the Company did not adjust prices received from the independent third-party pricing service. For certificates of deposits and treasury securities included in investments segregated and on deposit for regulatory purposes, the Company uses discounted cash-flow models to measure the fair value that utilize market-based inputs including observable market interest rates that correspond to the remaining maturities or next interest reset dates.
The consolidated financial statements of the Company have been prepared in accordance with accounting principles generally accepted in the U.S. While the majority of the Companys revenues, expenses, assets and liabilities are not based on estimates, there are certain accounting principles that require management to make estimates regarding matters that are uncertain and susceptible to change where such change may result in a material adverse impact on the Companys financial position and reported financial results. These critical accounting estimates are described below. Management regularly reviews the estimates and assumptions used in the preparation of the Companys financial statements for reasonableness and adequacy.
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THE CHARLES SCHWAB CORPORATION
Managements Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Millions, Except Ratios, or as Noted)
Other- than-Temporary Impairment of Securities Available for Sale and Securities Held to Maturity: Management evaluates securities available for sale and securities held to maturity for other-than-temporary impairment on a quarterly basis. For debt securities, other-than-temporary impairment exists if management determines it is probable that the Company will not collect all amounts due under the contractual terms of the security. Other-than-temporary impairment also exists if management no longer has the ability or intent to hold a security with an unrealized loss for a period of time sufficient to allow for any anticipated recovery. If management determines other-than temporary impairment exists, the cost basis of the security is adjusted to the then-current fair value, with a corresponding loss recognized in current earnings. If future evaluations conclude that an impairment now considered to be temporary is other-than-temporary, the Company would recognize a realized loss through earnings at that time.
The evaluation of whether other-than-temporary impairment exists is a matter of judgment. The evaluation includes the assessment of several factors including: 1) whether the unrealized loss is solely due to changes in interest rates, 2) the length of time and the extent to which the fair value has been less than amortized cost, 3) the financial condition of the issuer, if applicable, 4) the credit ratings of the issuer or security, 5) the credit characteristics of the collateral underlying the security, including the credit default experience, delinquency rates, cumulative losses to date and the ratio of credit enhancement available under the terms of the security to expected losses for non-agency mortgage-backed securities, and 6) the Companys intent and ability to hold the investment for a period of time sufficient to allow for any anticipated recovery. Additionally, management utilizes cash flow models for securities that exhibit deteriorating credit characteristics to estimate the expected cash flow from the securities in order to assess whether it is probable that the Company will not collect all amounts due under the contractual terms of the security. These cash flow models require management to estimate future principal prepayments, default rates, and default loss severities based on underlying collateral, and future housing price changes. Further deterioration of these characteristics could result in the recognition of other-than-temporary impairment.
Valuation of Goodwill: Under the provisions of Statement of Financial Accounting Standards (SFAS) No. 142 Goodwill and Other Intangible Assets, goodwill is required to be tested for impairment at least annually, or whenever indications of impairment exist. An impairment exists when the carrying amount of goodwill exceeds its implied fair value, resulting in an impairment charge for this excess.
The Company has elected April 1 st as its annual goodwill impairment testing date. In testing for a potential impairment of goodwill on April 1, 2008, management estimated the fair value of each of the Companys reporting units (generally defined as the Companys businesses for which financial information is available and reviewed regularly by management) and compared this value to the carrying value of the reporting unit. The estimated fair value of each reporting unit was greater than its carrying value, and therefore management concluded that no amount of goodwill was impaired. The estimated fair value of the reporting units was established using a discounted cash flow model that includes significant assumptions about the future operating results and cash flows of each reporting unit. Adverse changes in the Companys planned business operations such as unanticipated competition, a loss of key personnel, the sale of a reporting unit or a significant portion of a reporting unit, or other unforeseen developments could result in an impairment of the Companys recorded goodwill.
Allowance for Credit Losses: The Company regularly evaluates its portfolio of loans to banking clients and provides allowances for the portion management believes may be uncollectible. Several factors are taken into consideration in this evaluation including current economic conditions, the composition of the loan portfolio, past loss experience, and risks inherent in the loan portfolio. For Schwab Banks portfolio, which primarily consists of mortgage loans and home equity lines of credit, a risk-based methodology is used to determine the allowance for credit losses. Loans are categorized into portfolios by loan type and risk characteristics. A probable loss rate, based on company and industry experience, is used to determine the credit allowance.
Legal Reserve: Reserves for legal and regulatory claims and proceedings reflect an estimate of probable losses for each matter, after considering, among other factors, the progress of the case, prior experience and the experience of others in similar cases, available defenses, insurance coverage and indemnification, and the opinions and views of legal counsel. In many cases, including most class action lawsuits, it is not possible to determine whether a loss will be incurred, or to estimate the range of that loss, until the matter is close to resolution, in which case no accrual is made until that time. Reserves are
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THE CHARLES SCHWAB CORPORATION
Managements Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Millions, Except Ratios, or as Noted)
adjusted as more information becomes available or when an event occurs requiring a change. Significant judgment is required in making these estimates, and the actual cost of resolving a matter may ultimately differ materially from the amount reserved.
The Companys management has discussed the development and selection of these critical accounting estimates with the Audit Committee. Additionally, management has reviewed with the Audit Committee the Companys significant estimates discussed in this Managements Discussion and Analysis of Financial Condition and Results of Operations.
In addition to historical information, this Annual Report on Form 10-K 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, aim, target, 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 managements beliefs, objectives, and expectations as of the date hereof, are necessarily estimates based on the best judgment of the Companys senior management. These statements relate to, among other things:
| the Companys ability to pursue its business strategy (see Item 1 Business Business Strategy and Competitive Environment); |
| the impact of legal proceedings and regulatory matters (see Item 3 Legal Proceedings and Item 8 Financial Statements and Supplementary Data Notes to Consolidated Financial Statements 13. Commitments and Contingent Liabilities Legal Contingencies); |
| the impact of current market conditions on the Companys results of operations (see Current Market Environment); |
| target capital ratios (see Liquidity and Capital Resources); |
| sources of liquidity, capital, and level of dividends (see Liquidity and Capital Resources and Contractual Obligations); |
| capital expenditures (see Liquidity and Capital Resources Capital Resources); |
| the impact of changes in managements estimates on the Companys results of operations (see Critical Accounting Estimates); |
| the impact on the Companys results of operations of recording stock option expense (see Item 8 Financial Statements and Supplementary Data Notes to Consolidated Financial Statements 17. Employee Incentive, Deferred Compensation, and Retirement Plans); |
| the impact of changes in estimated costs related to past restructuring initiatives on the Companys results of operations (see Item 8 Financial Statements and Supplementary Data Notes to Consolidated Financial Statements 25. Restructuring Reserve); and |
| the impact of changes in the likelihood of indemnification and guarantee payment obligations on the Companys results of operations (see Item 8 Financial Statements and Supplementary Data Notes to Consolidated Financial Statements 13. Commitments and Contingent Liabilities). |
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 Annual Report on Form 10-K 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; |
| unanticipated adverse developments in litigation or regulatory matters; |
| fluctuations in client asset values due to changes in equity valuations; |
| the performance of securities available for sale; |
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THE CHARLES SCHWAB CORPORATION
Managements Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Millions, Except Ratios, or as Noted)
| the amount of loans to the Companys brokerage and banking clients; |
| the level of brokerage client cash balances and deposits from banking clients; |
| the availability and terms of external financing; |
| the level of the Companys stock repurchase activity; |
| the timing and impact of changes in the Companys level of investments in technology and buildings; |
| the Companys ability to sublease certain properties; and |
| potential breaches of contractual terms for which the Company has indemnification obligations. |
Certain of these factors, as well as general risk factors affecting the Company, are discussed in greater detail in this Annual Report on Form 10-K, including Item 1A Risk Factors.
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THE CHARLES SCHWAB CORPORATION
Item 7A. | Quantitative and Qualitative Disclosures About Market Risk |
Market risk is the potential for changes in revenue or the value of financial instruments held by the Company as a result of fluctuations in interest rates, equity prices or market conditions.
For the Companys market risk related to interest rates, a sensitivity analysis, referred to as a net interest revenue simulation model, is shown below. The Company is exposed to interest rate risk primarily from changes in the interest rates on its interest-earning assets relative to changes in the costs of its funding sources which finance these assets.
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 re-price 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, which tend to increase in a declining rate environment.
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 its investment portfolios. Because the Company establishes the rates paid on certain brokerage client cash balances and deposits from banking clients, the rates charged on margin loans, 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.
The Company is also subject to market risk as a result of fluctuations in equity prices. The Companys direct holdings of equity securities and its associated exposure to equity prices are not material. The Company is indirectly exposed to equity market fluctuations in connection with securities collateralizing margin loans to brokerage customers, and customer securities loaned out as part of the Companys 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 instruments underlying cash flows.
Financial instruments held by the Company are also subject to valuation risk as a result of changes in valuations of the underlying collateral, such as housing prices in the case of residential real estate loans and mortgage-backed securities.
For discussion of the impact of current market conditions on asset management and administration fees, net interest, and securities available for sale, see Item 7 Managements Discussion and Analysis of Financial Condition and Results of Operations Current Market Environment.
The Companys market risk related to financial instruments held for trading, interest rate swaps related to a portion of its fixed interest rate medium-term notes, and forward sale and interest rate lock commitments related to its loans held for sale portfolio is not material.
Net Interest Revenue Simulation
The Company uses net interest revenue simulation modeling techniques to evaluate and manage the effect of changing interest rates. The simulation model (the model) includes all interest-sensitive assets and liabilities, as well as interest rate swap agreements utilized by the Company to hedge its interest rate risk. Key variables in the model include the repricing of financial instruments, prepayment and reinvestment assumptions, and product pricing assumptions. The Company uses
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THE CHARLES SCHWAB CORPORATION
constant balances and market rates in the model 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 precisely predict the impact of changes in interest rates on 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.
As represented by the simulations presented below, the Company is positioned so that the consolidated balance sheet produces an increase in net interest revenue when interest rates rise and, conversely, a decrease in net interest revenue when interest rates fall (i.e., interest-earning assets generally reprice more quickly than interest-bearing liabilities).
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 Companys current market rates forecast on simulated net interest revenue over the next 12 months at December 31, 2008 and 2007. While the Company typically uses a gradual 200 basis point change, it revised the methodology at March 31, 2008 due to the current low levels of interest rates. The Company will use a gradual 100 basis point change until such time as the level of interest rates justifies a return to the previous methodology.
December 31, |
2008 | 2007 | ||||
Increase of 100 basis points |
6.4 | % | 4.4 | % | ||
Decrease of 100 basis points |
(6.8 | %) | (3.1 | %) |
The sensitivity shown in the 100 basis point decrease scenario reflects the fact that the rates paid on brokerage client cash balances and banking deposits had reached minimal levels by year-end 2008. With liability costs essentially fixed, lower rates earned on interest-bearing assets would have a direct impact on net interest income. The Company remains positioned to experience increases in net interest revenue as rates rise and decreases as rates fall.
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THE CHARLES SCHWAB CORPORATION
Item 8. | Financial Statements and Supplementary Data |
TABLE OF CONTENTS
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THE CHARLES SCHWAB CORPORATION
Consolidated Statements of Income
(In Millions, Except Per Share Amounts)
Year Ended December 31, |
2008 | 2007 | 2006 | |||||||||
Net Revenues |
||||||||||||
Asset management and administration fees |
$ | 2,355 | $ | 2,358 | $ | 1,945 | ||||||
Interest revenue |
1,908 | 2,270 | 2,113 | |||||||||
Interest expense |
(243 | ) | (623 | ) | (679 | ) | ||||||
Net interest revenue |
1,665 | 1,647 | 1,434 | |||||||||
Trading revenue |
1,080 | 860 | 785 | |||||||||
Other |
50 | 129 | 145 | |||||||||
Total net revenues |
5,150 | 4,994 | 4,309 | |||||||||
Expenses Excluding Interest |
||||||||||||
Compensation and benefits |
1,667 | 1,781 | 1,619 | |||||||||
Professional services |
334 | 324 | 285 | |||||||||
Occupancy and equipment |
299 | 282 | 260 | |||||||||
Advertising and market development |
243 | 230 | 189 | |||||||||
Communications |
211 | 200 | 180 | |||||||||
Depreciation and amortization |
152 | 156 | 157 | |||||||||
Other |
216 | 168 | 143 | |||||||||
Total expenses excluding interest |
3,122 | 3,141 | 2,833 | |||||||||
Income from continuing operations before taxes on income |
2,028 | 1,853 | 1,476 | |||||||||
Taxes on income |
(798 | ) | (733 | ) | (585 | ) | ||||||
Income from continuing operations |
1,230 | 1,120 | 891 | |||||||||
(Loss) income from discontinued operations, net of tax |
(18 | ) | 1,287 | 336 | ||||||||
Net Income |
$ | 1,212 | $ | 2,407 | $ | 1,227 | ||||||
Weighted-Average Common Shares Outstanding Diluted |
1,157 | 1,222 | 1,286 | |||||||||
Earnings Per Share Basic |
||||||||||||
Income from continuing operations |
$ | 1.07 | $ | .93 | $ | .70 | ||||||
(Loss) income from discontinued operations, net of tax |
$ | (.01 | ) | $ | 1.06 | $ | .27 | |||||
Net income |
$ | 1.06 | $ | 1.99 | $ | .97 | ||||||
Earnings Per Share Diluted |
||||||||||||
Income from continuing operations |
$ | 1.06 | $ | .92 | $ | .69 | ||||||
(Loss) income from discontinued operations, net of tax |
$ | (.01 | ) | $ | 1.05 | $ | .26 | |||||
Net income |
$ | 1.05 | $ | 1.97 | $ | .95 | ||||||
Dividends Declared Per Common Share |
$ | .220 | $ | 1.200 | $ | .135 | ||||||
See Notes to Consolidated Financial Statements.
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THE CHARLES SCHWAB CORPORATION
Consolidated Balance Sheets
(In Millions, Except Share and Per Share Amounts)
December 31, |
2008 | 2007 | ||||
Assets |
||||||
Cash and cash equivalents |
$ 5,442 | $ 6,764 | ||||
Cash and investments segregated and on deposit for regulatory purposes (including resale agreements of $6,701 in 2008 and $2,722 in 2007) |
14,685 | 8,803 | ||||
Receivables from brokers, dealers, and clearing organizations |
759 | 725 | ||||
Receivables from brokerage clients net |
7,129 | 12,314 | ||||
Other securities owned at fair value |
626 | 675 | ||||
Securities available for sale |
14,446 | 7,526 | ||||
Securities held to maturity (fair value $244 at December 31, 2008) |
243 | | ||||
Loans to banking clients net |
6,044 | 3,443 | ||||
Loans held for sale |
41 | 44 | ||||
Equipment, office facilities, and property net |
661 | 617 | ||||
Goodwill |
528 | 525 | ||||
Other assets |
1,071 | 850 | ||||
Total |
$ 51,675 | $ 42,286 | ||||
Liabilities and Stockholders Equity |
||||||
Deposits from banking clients |
$ 23,841 | $ 13,822 | ||||
Payables to brokers, dealers, and clearing organizations |
1,100 | 1,922 | ||||
Payables to brokerage clients |
20,256 | 20,290 | ||||
Accrued expenses and other liabilities |
1,534 | 1,621 | ||||
Long-term debt |
883 | 899 | ||||
Total Liabilities |
47,614 | 38,554 | ||||
Stockholders equity: |
||||||
Preferred stock 9,940,000 shares authorized; $.01 par value per share; none issued |
| | ||||
Common stock 3 billion shares authorized; $.01 par value per share; 1,392,091,544 shares issued |
14 | 14 | ||||
Additional paid-in capital |
2,214 | 2,107 | ||||
Retained earnings |
6,735 | 5,776 | ||||
Treasury stock 234,991,565 and 231,274,906 shares in 2008 and 2007, respectively, at cost |
(4,349 | ) | (4,148 | ) | ||
Accumulated other comprehensive loss |
(553 | ) | (17 | ) | ||
Total stockholders equity |
4,061 | 3,732 | ||||
Total |
$ 51,675 | $ 42,286 | ||||
See Notes to Consolidated Financial Statements.
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THE CHARLES SCHWAB CORPORATION
Consolidated Statements of Cash Flows
(In Millions)
Year Ended December 31, |
2008 | 2007 | 2006 | |||||||||
Cash Flows from Operating Activities |
||||||||||||
Net income |
$ | 1,212 | $ | 2,407 | $ | 1,227 | ||||||
Adjustments to reconcile net income to net cash provided by operating activities: |
||||||||||||
Loss (income) from discontinued operations, net of tax |
18 | (1,287 | ) | (336 | ) | |||||||
Depreciation and amortization expense |
152 | 156 | 157 | |||||||||
Stock-based compensation expense |
69 | 58 | 39 | |||||||||
Excess tax benefits from stock-based compensation |
(50 | ) | (108 | ) | (64 | ) | ||||||
Provision for deferred income taxes |
97 | 175 | (31 | ) | ||||||||
Other |
114 | 16 | (2 | ) | ||||||||
Originations of loans held for sale |
(1,526 | ) | (863 | ) | (638 | ) | ||||||
Proceeds from sales of loans held for sale |
1,522 | 849 | 626 | |||||||||
Net change in: |
||||||||||||
Cash and investments segregated and on deposit for regulatory purposes |
(5,882 | ) | 2,059 | 4,331 | ||||||||
Other securities owned |
48 | (277 | ) | 73 | ||||||||
Receivables from brokers, dealers, and clearing organizations |
(32 | ) | (75 | ) | 170 | |||||||
Receivables from brokerage clients |
5,171 | (1,394 | ) | (151 | ) | |||||||
Other assets |
51 | (33 | ) | (6 | ) | |||||||
Payables to brokers, dealers, and clearing organizations |
(822 | ) | 424 | 204 | ||||||||
Payables to brokerage clients |
(34 | ) | (331 | ) | (4,079 | ) | ||||||
Accrued expenses and other liabilities |
(106 | ) | (419 | ) | 164 | |||||||
Net cash provided by discontinued operations |
| 389 | 76 | |||||||||
Net cash provided by operating activities |
2 | 1,746 | 1,760 | |||||||||
Cash Flows from Investing Activities |
||||||||||||
Purchases of securities available for sale |
(9,839 | ) | (3,554 | ) | (3,224 | ) | ||||||
Proceeds from sales of securities available for sale |
14 | | 81 | |||||||||
Principal payments on securities available for sale |
2,003 | 2,034 | 854 | |||||||||
Purchases of securities held to maturity |
(245 | ) | | | ||||||||
Principal payments on securities held to maturity |
2 | | | |||||||||
Net increase in loans to banking clients |
(2,642 | ) | (1,129 | ) | (442 | ) | ||||||
Purchase of equipment, office facilities, and property |
(188 | ) | (168 | ) | (122 | ) | ||||||
Proceeds from sales of equipment, office facilities, and property |
2 | | 63 | |||||||||
Proceeds from sale of U.S. Trust, net of transaction costs |
| 3,237 | | |||||||||
Cash payments for business combinations, net of cash acquired |
(5 | ) | (119 | ) | | |||||||
Other investing activities |
(3 | ) | (1 | ) | 6 | |||||||
Net cash provided by (used for) discontinued operations |
| 67 | (456 | ) | ||||||||
Net cash (used for) provided by investing activities |
(10,901 | ) | 367 | (3,240 | ) | |||||||
Cash Flows from Financing Activities |
||||||||||||
Net change in deposits from banking clients |
10,019 | 2,802 | 4,051 | |||||||||
Issuance of long-term debt |
| 549 | | |||||||||
Repayment of long-term debt |
(20 | ) | (43 | ) | (68 | ) | ||||||
Excess tax benefits from stock-based compensation |
50 | 108 | 64 | |||||||||
Dividends paid |
(253 | ) | (1,500 | ) | (173 | ) | ||||||
Purchase of treasury stock |
(350 | ) | (2,742 | ) | (868 | ) | ||||||
Proceeds from stock options exercised and other |
131 | 414 | 253 | |||||||||
Other financing activities |
| (7 | ) | 1 | ||||||||
Net cash provided by discontinued operations |
| 563 | 822 | |||||||||
Net cash provided by financing activities |
9,577 | 144 | 4,082 | |||||||||
(Decrease) increase in Cash and Cash Equivalents |
(1,322 | ) | 2,257 | 2,602 | ||||||||
Cash and Cash Equivalents at Beginning of Year |
6,764 | 4,507 | 1,905 | |||||||||
Cash and Cash Equivalents at End of Year |
$ | 5,442 | $ | 6,764 | $ | 4,507 | ||||||
Supplemental Cash Flow Information |
||||||||||||
Cash paid during the year for: |
||||||||||||
Interest |
$ | 232 | $ | 616 | $ | 666 | ||||||
Income taxes (amounts include discontinued operations) |
$ | 767 | $ | 1,071 | $ | 618 |
See Notes to Consolidated Financial Statements.
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THE CHARLES SCHWAB CORPORATION
Consolidated Statements of Stockholders Equity
(In Millions)
Additional |
Retained |
Treasury Stock, |
Unamortized |
Accumulated Comprehensive |
|||||||||||||||||||||||||
Common Stock | |||||||||||||||||||||||||||||
Shares | Amount | Capital | Earnings | at cost | Compensation | Loss | Total | ||||||||||||||||||||||
Balance at December 31, 2005 |
1,392 | $ | 14 | $ | 1,827 | $ | 3,847 | $ | (1,124 | ) | $ | (81 | ) | $ | (33 | ) | $ | 4,450 | |||||||||||
Comprehensive income: |
|||||||||||||||||||||||||||||
Net income |
| | | 1,227 | | | | 1,227 | |||||||||||||||||||||
Net unrealized loss on cash flow hedging instruments, net of reclassification adjustment |
| | | | | | (6 | ) | (6 | ) | |||||||||||||||||||
Net unrealized gain on securities available for sale, net of tax |
| | | | | | 7 | 7 | |||||||||||||||||||||
Foreign currency translation adjustment |
| | | | | | 1 | 1 | |||||||||||||||||||||
Total comprehensive income |
1,229 | ||||||||||||||||||||||||||||
Adjustment to initially apply SFAS No. 158, net of tax |
| | | | | | (5 | ) | (5 | ) | |||||||||||||||||||
Dividends declared on common stock |
| | | (173 | ) | | | | (173 | ) | |||||||||||||||||||
Purchase of treasury stock |
| | | | (859 | ) | | | (859 | ) | |||||||||||||||||||
Stock option exercises and other |
| | 6 | | 249 | | | 255 | |||||||||||||||||||||
Stock-based compensation expense |
| | 52 | | | | | 52 | |||||||||||||||||||||
Excess tax benefits from stock-based compensation |
| | 64 | | | | | 64 | |||||||||||||||||||||
Restricted shares withheld for tax |
| | | | (5 | ) | | | (5 | ) | |||||||||||||||||||
Adoption of SFAS No. 123R |
| | (81 | ) | | | 81 | | | ||||||||||||||||||||
Balance at December 31, 2006 |
1,392 | 14 | 1,868 | 4,901 | (1,739 | ) | | (36 | ) | 5,008 | |||||||||||||||||||
Comprehensive income: |
|||||||||||||||||||||||||||||
Net income |
| | | 2,407 | | | | 2,407 | |||||||||||||||||||||
Net unrealized loss on cash flow hedging instruments, net of reclassification adjustment |
| | | | | | (3 | ) | (3 | ) | |||||||||||||||||||
Net unrealized gain on securities available for sale, net of tax |
| | | | | | 17 | 17 | |||||||||||||||||||||
Minimum pension liability adjustment, net of tax |
| | | | | | 5 | 5 | |||||||||||||||||||||
Total comprehensive income |
2,426 | ||||||||||||||||||||||||||||
Dividends declared on common stock |
| | | (1,498 | ) | | | | (1,498 | ) | |||||||||||||||||||
Purchase of treasury stock |
| | | | (2,742 | ) | | | (2,742 | ) | |||||||||||||||||||
Stock option exercises and other |
| | 53 | | 362 | | | 415 | |||||||||||||||||||||
Stock-based compensation expense |
| | 78 | | | | | 78 | |||||||||||||||||||||
Excess tax benefits from stock-based compensation |
| | 108 | | | | | 108 | |||||||||||||||||||||
Adoption of EITF 06-02 |
| | | (17 | ) | | | | (17 | ) | |||||||||||||||||||
Adoption of FIN 48 |
| | | (17 | ) | | | | (17 | ) | |||||||||||||||||||
Restricted shares withheld for tax |
| | | | (29 | ) | | | (29 | ) | |||||||||||||||||||
Balance at December 31, 2007 |
1,392 | 14 | 2,107 | 5,776 | (4,148 | ) | | (17 | ) | 3,732 | |||||||||||||||||||
Comprehensive income: |
|||||||||||||||||||||||||||||
Net income |
| | | 1,212 | | | | 1,212 | |||||||||||||||||||||
Net unrealized loss on securities available for sale, net of tax |
| | | | | | (535 | ) | (535 | ) | |||||||||||||||||||
Foreign currency translation adjustment |
| | | | | | (1 | ) | (1 | ) | |||||||||||||||||||
Total comprehensive income |
676 | ||||||||||||||||||||||||||||
Dividends declared on common stock |
| | | (253 | ) | | | | (253 | ) | |||||||||||||||||||
Purchase of treasury stock |
| | | | (350 | ) | | | (350 | ) | |||||||||||||||||||
Stock option exercises and other |
| | (20 | ) | | 149 | | | 129 | ||||||||||||||||||||
Stock-based compensation expense |
| | 65 | | | | | 65 | |||||||||||||||||||||
Excess tax benefits from stock-based compensation |
| | 50 | | | | | 50 | |||||||||||||||||||||
Restricted shares withheld for tax |
| | | | (11 | ) | | | (11 | ) | |||||||||||||||||||
Employee stock purchase plan purchases |
| | 12 | | 11 | | | 23 | |||||||||||||||||||||
Balance at December 31, 2008 |
1,392 | $ | 14 | $ | 2,214 | $ | 6,735 | $ | (4,349 | ) | | $ | (553 | ) | $ | 4,061 | |||||||||||||
See Notes to Consolidated Financial Statements.
- 46 -
THE CHARLES SCHWAB CORPORATION
Notes to Consolidated Financial Statements
(Tabular Amounts in Millions, Except Per Share Data, Option Price Amounts, Ratios, or as Noted)
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, and related financial services. Charles Schwab & Co., Inc. (Schwab) is a securities broker-dealer with 306 domestic branch offices in 45 states, as well as a branch in each of the Commonwealth of Puerto Rico and London, U.K. In addition, Schwab serves clients in Hong Kong through one of CSCs subsidiaries. Other subsidiaries include Charles Schwab Bank (Schwab Bank), a federal savings bank, and Charles Schwab Investment Management, Inc. (CSIM), the investment advisor for Schwabs proprietary mutual funds, which are referred to as the Schwab Funds®.
The consolidated financial statements include CSC and its majority-owned subsidiaries (collectively referred to as the Company). All material intercompany balances and transactions have been eliminated. These consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the U.S. (GAAP), which require management to make certain estimates and assumptions that affect the reported amounts in the accompanying financial statements. Certain estimates include other-than-temporary impairment of securities available for sale and securities held to maturity, the valuation of goodwill, the allowance for credit losses, and legal reserves. Actual results could differ from those estimates. Certain prior-year amounts have been reclassified to conform to the 2008 presentation.
On July 1, 2007, the Company completed the sale of all of the outstanding stock of U.S. Trust Corporation (USTC, and with its subsidiaries collectively referred to as U.S. Trust). U.S. Trust was a subsidiary that provided wealth management services. U.S. Trust is presented as a discontinued operation for all periods prior to the completion of the sale. All other information contained in this Annual Report on Form 10-K is presented on a continuing operations basis unless otherwise noted.
2. | Summary of Significant Accounting Policies |
Asset management and administration fees: Asset management and administration fees, which include mutual fund service fees and fees for other asset-based financial services provided to individual and institutional clients, are recognized as revenue over the period that the related service is provided, based upon average net asset balances. The Company earns mutual fund service fees for transfer agent services, shareholder services, administration, and investment management provided to its proprietary funds, and recordkeeping and shareholder services provided to third-party funds. Mutual fund service fees are based upon the daily balances of client assets invested in third-party funds and the Companys proprietary funds. These daily asset balances are based upon quoted market prices and other observable market data. The Company also earns asset management fees for advisory and managed account services, which are based on the daily balances of client assets subject to the specific fee for service.
Interest revenue: Interest revenue represents interest earned on certain assets, which include cash and cash equivalents, cash and investments segregated, receivables from brokerage clients, securities available for sale, securities held to maturity, and loans to banking clients. Interest revenue is recognized in the period earned based upon average daily asset balances and respective interest rates.
Securities transactions: Trading revenue includes commission revenues and revenues from principal transactions. Clients securities transactions are recorded on the date that they settle, while the related commission revenues and expenses are recorded on the date that the trade occurs. Principal transactions are recorded on a trade date basis.
Cash and cash equivalents: The Company considers all highly liquid investments with original maturities of three months or less that are not segregated and on deposit for regulatory purposes to be cash equivalents. Cash and cash equivalents include money market funds, deposits with banks, certificates of deposit, federal funds sold, commercial paper, and treasury securities. Cash and cash equivalents also include balances that Schwab Bank maintains at the Federal Reserve Bank.
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. Resale agreements are collateralized investing transactions that are recorded at their contractual amounts plus accrued interest. The Company obtains
-47-
THE CHARLES SCHWAB CORPORATION
Notes to Consolidated Financial Statements
(Tabular Amounts in Millions, Except Per Share Data, Option Price Amounts, Ratios, or as Noted)
control of collateral with a market value equal to or in excess of the principal amount loaned and accrued interest under resale agreements. Collateral is valued daily by the Company, with additional collateral obtained when necessary. Cash and investments segregated also include certificates of deposit and U.S. Treasury securities, as well as corporate debt securities and commercial paper guaranteed by the Federal Deposit Insurance Corporation (FDIC) under the Temporary Liquidity Guarantee Program. Certificates of deposit, U.S. Treasury securities, corporate debt securities, and commercial paper are recorded at fair value.
Receivables from brokerage clients include margin loans to clients and are stated net of allowance for doubtful accounts. Cash receivables from brokerage clients that remain unsecured or partially secured for more than 30 days are fully reserved.
Other securities owned include Schwab Funds® money market funds, fixed income securities, equity and other securities, and equity and bond mutual funds recorded at fair value based on quoted market prices. Unrealized gains and losses are included in trading revenue.
Securities available for sale are recorded at fair value based on quoted prices for similar securities in active markets and other observable market data. Securities available for sale include U.S. agency and non-agency mortgage-backed securities, corporate debt securities, asset-backed securities, certificates of deposit, and U.S. agency notes. The Company evaluates these securities for other-than-temporary impairment on a quarterly basis. If the Company determines other-than-temporary impairment exists, the cost basis of the security is adjusted to the then-current fair value, with a corresponding loss recognized in current earnings. Unrealized gains and losses are reported, net of taxes, in accumulated other comprehensive income (loss) included in stockholders equity. Realized gains and losses from sales of securities available for sale are determined on a specific identification basis and are included in other revenue.
Securities held to maturity are recorded at amortized cost based on the Companys positive intent and ability to hold these securities to maturity. The Company evaluates these securities for other-than-temporary impairment on a quarterly basis. If the Company determines other-than-temporary impairment exists, the cost basis of the security is adjusted to the then-current fair value, with a corresponding loss recognized in current earnings.
Securities borrowed and securities loaned: Securities borrowed require the Company to deliver cash to the lender in exchange for securities and are included in receivables from brokers, dealers, and clearing organizations. For securities loaned, the Company receives collateral in the form of cash in an amount equal to the market value of securities loaned. Securities loaned are included in payables to brokers, dealers, and clearing organizations. The Company monitors the market value of securities borrowed and loaned, with additional collateral obtained or refunded when necessary. Fees received or paid are recorded in interest revenue or interest expense.
Loans to banking clients are stated net of allowance for credit losses. The allowance is established through charges to income based on managements evaluation of the existing portfolio. The adequacy of the allowance is reviewed regularly by management, taking into consideration current economic conditions, the existing loan portfolio composition, past loss experience, and risks inherent in the portfolio, as more fully described below.
The Company performs a quarterly analysis to estimate the allowance for credit losses. This process utilizes loan-level statistical models that estimate prepayments, defaults, and lifetime contractual losses for our loan portfolios based on predicted behavior of individual loans within the portfolios. The models consider effects of borrower behavior and a variety of factors including, but not limited to, interest rate fluctuations, housing price movements, current economic conditions, estimated defaults and foreclosures, delinquencies, the loan portfolio composition (including concentrations of credit risk), past loss experience, estimates of loss severity, and credit scores. The more significant variables within the models are interest rates and housing prices. Predicted housing price scenarios are primarily based on 20 years of historical prices at the metropolitan statistical area level. Interest rate projections are based on the current term structure of interest rates and historical volatilities to project various possible future interest rate paths. Other variables in the model, such as probability of default, are derived from historical data. This quarterly analysis results in a loss factor that is applied to the outstanding balances to determine the allowance for credit loss for each loan category.
- 48 -
THE CHARLES SCHWAB CORPORATION
Notes to Consolidated Financial Statements
(Tabular Amounts in Millions, Except Per Share Data, Option Price Amounts, Ratios, or as Noted)
Nonaccrual loans: Loans are placed on nonaccrual status upon becoming 90 days past due as to interest or principal (unless the loans are both well-secured and in the process of collection), or when the full timely collection of interest or principal becomes uncertain. When a loan is placed on nonaccrual status, the accrued and unpaid interest receivable is reversed and the loan is accounted for on the cash or cost recovery method thereafter, until qualifying for return to accrual status. Generally, a loan may be returned to accrual status when all delinquent interest and principal become current in accordance with the terms of the loan agreement, or when the loan is both well-secured and in the process of collection and collectability is no longer doubtful.
Loans held for sale consist of fixed-rate and adjustable-rate residential real estate mortgage loans intended for sale. Loans held for sale are stated at lower of cost or market value. Fair value is estimated using quoted market prices for securities backed by similar types of loans.
Equipment, office facilities, and property: Equipment and office facilities are depreciated on a straight-line basis over the estimated useful life of the asset of three to ten years. Buildings are depreciated on a straight-line basis over forty years. Leasehold improvements are amortized on a straight-line basis over the lesser of the estimated useful life of the asset or the term of the lease. Software and certain costs incurred for purchasing or developing software for internal use are amortized on a straight-line basis over an estimated useful life of three or five years. Equipment, office facilities, and property are stated at cost net of accumulated depreciation and amortization, except for land, which is stated at cost. Equipment, office facilities, and property are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable.
Goodwill represents the cost of acquired businesses in excess of the fair value of the related net assets acquired. Goodwill is tested for impairment annually and whenever indications of impairment exist. In testing for a potential impairment of goodwill, management estimates the fair value of each of the Companys reporting units (defined as the Companys businesses for which financial information is available and reviewed regularly by management), and compares it to their carrying value. If the estimated fair value of a reporting unit is less than its carrying value, management is required to estimate the fair value of all assets and liabilities of the reporting unit, including goodwill. If the carrying value of the reporting units goodwill is greater than the estimated fair value, an impairment charge is recognized for the excess. The Company has elected April 1st as its annual impairment testing date.
Intangible assets: The Company has non-amortizing intangible assets related to contracts acquired to manage investments of mutual funds that totaled $14 million at December 31, 2008 and 2007. Non-amortizing intangible assets are subject to impairment testing annually and whenever events or changes in circumstances indicate that their carrying amount may not be recoverable. The Company has amortizing intangible assets, primarily related to purchased client accounts, that totaled $10 million at December 31, 2008. These intangible assets have finite lives and are amortized over their estimated useful lives and are subject to impairment testing whenever events or changes in circumstances indicate that their carrying amount may not be recoverable. These amortizing intangible assets have a remaining weighted-average useful life of 12 years. All intangible assets are recorded in other assets.
Derivative financial instruments are recorded on the balance sheet in other assets and other liabilities at fair value. As part of its consolidated asset and liability management process, the Company utilizes interest rate swap agreements (Swaps) to effectively convert the interest rate characteristics of a portion of its Medium-Term Notes from fixed to variable. These Swaps have been designated as fair value hedges and therefore, changes in fair value of the Swaps are offset by changes in the fair value of the hedged Medium-Term Notes.
Schwab Banks loans held for sale portfolio consists of fixed-rate and adjustable-rate mortgages, which are subject to a loss in value when market interest rates rise. Schwab Bank uses forward sale commitments to manage this risk. These forward sale commitments have been designated as cash flow hedging instruments with respect to the loans held for sale. Accordingly, the fair values of these forward sale commitments are recorded on the Companys consolidated balance sheet, with gains or losses recorded in other comprehensive income (loss).
- 49 -
THE CHARLES SCHWAB CORPORATION
Notes to Consolidated Financial Statements
(Tabular Amounts in Millions, Except Per Share Data, Option Price Amounts, Ratios, or as Noted)
Additionally, Schwab Bank uses forward sale commitments to hedge interest rate lock commitments issued on mortgage loans that will be held for sale. Schwab Bank considers the fair value of these commitments to be zero at the commitment date, with subsequent changes in fair value determined solely based on changes in market interest rates. Any changes in fair value of the interest rate lock commitments are completely offset by changes in fair value of the related forward sale commitments.
Income taxes: The Company provides for income taxes on all transactions that have been recognized in the consolidated financial statements in accordance with Statement of Financial Accounting Standards No. 109 Accounting for Income Taxes (SFAS No. 109). Accordingly, deferred tax assets are adjusted to reflect the tax rates at which future taxable amounts will likely be settled or realized. The effects of tax rate changes on future deferred tax assets and deferred tax liabilities, as well as other changes in income tax laws, are recorded in earnings in the period during which such changes are enacted. The Company records uncertain tax positions in accordance with Financial Accounting Standards Board (FASB) Interpretation (FIN) No. 48, Accounting for Uncertainty in Income Taxes.
Stock-based compensation: The Company measures and recognizes compensation expense based on estimated fair values for all share-based payment arrangements including employee and director stock option and restricted stock awards, in accordance with Statement of Financial Accounting Standards No. 123 (revised 2004) Share Based Payment (SFAS No. 123R).
Stock-based compensation expense is based on awards expected to vest and therefore is reduced for estimated forfeitures. Forfeitures are estimated at the time of grant based on the Companys historical forfeiture experience and revised in subsequent periods if actual forfeitures differ from those estimates.
Long-term incentive compensation: Eligible officers received long-term incentive plan units under a long-term incentive plan (LTIP). These awards are restricted from transfer or sale and vest annually over a three- to four-year performance period. Each award provides for a one-time cash payment for an amount that varies based upon the Companys cumulative earnings per share (EPS) over the respective performance period of each grant. The Company accrues the estimated total cost for each grant on a straight-line basis over each LTIPs vesting period with periodic cumulative adjustments to expense as estimates of the total grant cost are revised. The last performance period on existing grants under this incentive plan ended on December 31, 2008.
New accounting standards: SFAS No. 157 Fair Value Measurements was effective beginning January 1, 2008. This statement defines fair value, establishes a framework for measuring fair value in GAAP, and expands disclosures about fair value measurements. SFAS No. 157 does not require any new fair value measurements. The adoption of SFAS No. 157 did not have a material impact on the Companys financial position, results of operations, EPS, or cash flows, but expanded the disclosures in the Companys consolidated financial statements. See note 15 Fair Values of Assets and Liabilities, for disclosures pursuant to SFAS No. 157.
SFAS No. 159 The Fair Value Option for Financial Assets and Financial Liabilities was effective beginning January 1, 2008. This statement permits entities to elect to measure eligible financial instruments, commitments, and certain other arrangements at fair value at specified election dates with changes in fair value recognized in earnings at each subsequent reporting period. The Company made no such election on January 1, 2008, or during 2008. The adoption of SFAS No. 159 did not have any impact on the Companys financial position, results of operations, EPS, or cash flows.
SFAS No. 141R Business Combinations was issued in December 2007. This statement generally requires an acquirer to recognize the assets acquired, the liabilities assumed, contingent purchase consideration, and any noncontrolling interest in the acquiree, at fair value on the date of acquisition. SFAS No. 141R also requires an acquirer to expense most transaction and restructuring costs as incurred, and not include such items in the cost of the acquired entity. The adoption of SFAS No. 141R will not have an impact on the Companys financial position, results of operations, EPS, or cash flows, as SFAS No. 141R applies prospectively for all business acquisitions with an acquisition date on or after January 1, 2009. Early adoption is prohibited.
- 50 -
THE CHARLES SCHWAB CORPORATION
Notes to Consolidated Financial Statements
(Tabular Amounts in Millions, Except Per Share Data, Option Price Amounts, Ratios, or as Noted)
SFAS No. 160 Noncontrolling Interests in Consolidated Financial Statements, was issued in December 2007 and is effective beginning January 1, 2009. This statement amends Accounting Research Bulletin No. 51 Consolidated Financial Statements by establishing financial statement presentation and disclosure requirements for reporting noncontrolling ownership interests. SFAS No. 160 also establishes consistent accounting methods for changes in ownership interest and for the valuation of retained noncontrolling investments upon deconsolidation. The adoption of SFAS No. 160 is not expected to have a material impact on the Companys financial position, results of operations, EPS, or cash flows.
SFAS No. 161 Disclosures about Derivative Instruments and Hedging Activities, was issued in March 2008 and is effective beginning January 1, 2009. This statement amends the disclosure requirements of SFAS No. 133 Accounting for Derivative Instruments and Hedging Activities by requiring qualitative disclosures about objectives and strategies for using derivatives, quantitative disclosures about fair values and gains and losses on derivative instruments, and disclosures about credit-risk related contingent features in derivative agreements. SFAS No. 161 does not require any new derivative or hedging measurements. The adoption of SFAS No. 161 will not impact the Companys financial position, results of operations, EPS, or cash flows, but will expand the disclosures in the Companys condensed consolidated financial statements.
FASB Staff Position (FSP) on EITF Issue 03-6-1 (FSP EITF 03-6-1) Determining Whether Instruments Granted in Share-Based Payment Transactions are Participating Securities, was issued in June 2008 and is effective beginning January 1, 2009. This statement requires the inclusion of unvested share-based payment awards with non-forfeitable rights to dividends or dividend equivalents as participating securities in the computation of EPS under the two-class method described in SFAS No. 128 Earnings per Share. The requirements of this statement require retrospective adjustment to all prior-period EPS data presented. Early adoption is prohibited. The Company is currently evaluating the impact of the adoption of FSP EITF 03-6-1 on its disclosures of EPS. The adoption of FSP EITF 03-6-1 will not impact the Companys financial position, results of operations, or cash flows.
3. | Receivables from Brokerage Clients |
Receivables from brokerage clients are stated net of allowance for doubtful accounts of $4 million and $1 million at December 31, 2008 and 2007, respectively. Receivables from brokerage clients consist primarily of margin loans to brokerage clients of $6.2 billion and $11.6 billion at December 31, 2008 and 2007, respectively. Securities owned by brokerage clients are held as collateral for margin loans. Such collateral is not reflected in the consolidated financial statements. Charge-offs related to margin loans were not material in 2008, 2007 and 2006. The average yield earned on margin loans was 5.95% and 8.00% in 2008 and 2007, respectively.
4. | Other Securities Owned |
A summary of other securities owned is as follows:
December 31, |
2008 |
2007 | ||
Schwab Funds® money market funds |
$ 440 | $ 413 | ||
Fixed income, equity, and other securities |
124 | 175 | ||
Equity and bond mutual funds |
62 | 87 | ||
Total other securities owned (1) |
$ 626 | $ 675 | ||
(1) |
Amounts include securities pledged of $7 million in 2008 and $6 million in 2007. |
The Companys positions in Schwab Funds® money market funds arise from certain overnight funding of clients redemption, check-writing, and debit card activities. Fixed income, equity, and other securities include investments made by the Company relating to its deferred compensation plan and fixed income securities held to meet clients trading activities. Equity and bond mutual funds include mutual fund investments held at CSC and inventory maintained to facilitate certain Schwab Funds and third-party mutual fund clients transactions.
- 51 -
THE CHARLES SCHWAB CORPORATION
Notes to Consolidated Financial Statements
(Tabular Amounts in Millions, Except Per Share Data, Option Price Amounts, Ratios, or as Noted)
Securities sold, but not yet purchased of $2 million at December 31, 2008 and $6 million at December 31, 2007, consisted primarily of mutual fund shares that are distributed to clients to satisfy their dividend reinvestment requests. These securities are recorded at fair value in accrued expenses and other liabilities.
5. | 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:
December 31, 2008 |
Amortized Cost |
Gross Unrealized Gains |
Gross Unrealized Losses |
Fair Value | ||||||||
Securities available for sale: |
||||||||||||
U.S. agency mortgage-backed securities |
$ | 8,203 | $ | 108 | $ | 82 | $ | 8,229 | ||||
Non-agency mortgage-backed securities |
3,085 | | 862 | 2,223 | ||||||||
Corporate debt securities |
1,762 | 2 | 31 | 1,733 | ||||||||
Certificates of deposit |
925 | | 3 | 922 | ||||||||
Asset-backed securities |
866 | | 44 | 822 | ||||||||
U.S. agency notes |
515 | 2 | | 517 | ||||||||
Total securities available for sale |
$ | 15,356 | $ | 112 | $ | 1,022 | $ | 14,446 | ||||
Securities held to maturity: |
||||||||||||
Asset-backed securities |
$ | 243 | $ | 1 | $ | | $ | 244 | ||||
Total securities held to maturity |
$ | 243 | $ | 1 | $ | | $ | 244 | ||||
December 31, 2007 |
Amortized Cost |
Gross Unrealized Gains |
Gross Unrealized Losses |
Fair Value | ||||||||
Securities available for sale: |
||||||||||||
U.S. agency mortgage-backed securities |
$ | 2,889 | $ | 25 | $ | 6 | $ | 2,908 | ||||
Non-agency mortgage-backed securities |
3,503 | 4 | 33 | 3,474 | ||||||||
Corporate debt securities |
804 | 1 | 21 | 784 | ||||||||
Certificates of deposit |
345 | | | 345 | ||||||||
U.S. agency notes |
15 | | | 15 | ||||||||
Total securities available for sale |
$ | 7,556 | $ | 30 | $ | 60 | $ | 7,526 | ||||
There were no securities classified as held to maturity at December 31, 2007.
- 52 -
THE CHARLES SCHWAB CORPORATION
Notes to Consolidated Financial Statements
(Tabular Amounts in Millions, Except Per Share Data, Option Price Amounts, Ratios, or as Noted)
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 | ||||||||||||||||
December 31, 2008 |
Fair Value |
Unrealized Losses |
Fair Value |
Unrealized Losses |
Fair Value |
Unrealized Losses | ||||||||||||
Securities available for sale: |
||||||||||||||||||
U.S. agency mortgage-backed securities |
$ | 2,231 | $ | 63 | $ | 381 | $ | 19 | $ | 2,612 | $ | 82 | ||||||
Non-agency mortgage-backed securities |
1,704 | 512 | 513 | 350 | < |