Document
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2017
Commission File Number: 1-9700
THE CHARLES SCHWAB CORPORATION
(Exact name of registrant as specified in its charter)
|
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Delaware (State or other jurisdiction of incorporation or organization) | 94-3025021 (I.R.S. Employer Identification No.) |
211 Main Street, San Francisco, CA 94105
(Address of principal executive offices and zip code)
Registrant’s telephone number, including area code: (415) 667-7000
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
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Large accelerated filer ☒ | Accelerated filer ☐ |
Non-accelerated filer ☐ (Do not check if a smaller reporting company) | Smaller reporting company ☐ |
Emerging growth company ☐ | |
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the
Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes ☐ No ☒
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
1,339,119,476 shares of $.01 par value Common Stock Outstanding on July 31, 2017
THE CHARLES SCHWAB CORPORATION
Quarterly Report on Form 10-Q
For the Quarter Ended June 30, 2017
Index
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| Item 1. | | | |
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| | | | 18 |
| | | | 19 |
| | | | 20 |
| | | | 21 |
| | | | 22 |
| | | | 23-48 |
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| Item 2. | | | 1-17 |
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| Item 3. | | | 17 |
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| Item 4. | | | 48 |
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| Item 1. | | | 49 |
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| Item 1A. | | | 49 |
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| Item 2. | | | 49 |
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| Item 3. | | | 50 |
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| Item 4. | | | 50 |
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| Item 5. | | | 50 |
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| Item 6. | | | 51 |
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| | 52 |
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Part I – FINANCIAL INFORMATION
THE CHARLES SCHWAB CORPORATION
Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Millions, Except Ratios, or as Noted)
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
INTRODUCTION
The Charles Schwab Corporation (CSC) is a savings and loan holding company engaged, through its subsidiaries (collectively referred to as the Company), in wealth management, securities brokerage, banking, asset management, custody, and financial advisory services.
Significant business subsidiaries of CSC include the following:
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• | Charles Schwab & Co., Inc. (Schwab), a securities broker-dealer; |
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• | Charles Schwab Bank (Schwab Bank), a federal savings bank; and |
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• | Charles Schwab Investment Management, Inc. (CSIM), the investment advisor for Schwab’s proprietary mutual funds, which are referred to as the Schwab Funds®, and for Schwab’s exchange-traded funds (ETFs), which are referred to as the Schwab ETFs™. |
The Company provides financial services to individuals and institutional clients through two segments – Investor Services and Advisor Services. The Investor Services segment provides retail brokerage and banking services, retirement plan services, and other corporate brokerage services. The Advisor Services segment provides custodial, trading, banking, and support services as well as retirement business services.
Schwab was founded on the belief that average Americans deserve access to a better investing experience. Although much has changed in the intervening years, the Company’s purpose remains clear – to champion every client’s goals with passion and integrity. Guided by this purpose and the aspiration of creating the most trusted leader in investment services, management has adopted a strategy described as “Through Clients’ Eyes.”
Under this approach, the Company’s strategic goals are focused on putting clients’ perspectives, needs, and desires at the forefront. Because investing plays a fundamental role in building financial security, the Company strives to deliver a better investing experience for its clients – individual investors and the people and institutions who serve them – by disrupting longstanding industry practices on their behalf and providing superior service. The Company aims to offer a broad range of products and solutions to meet client needs with a focus on transparency and value. In addition, management works to couple the Company’s scale and resources with ongoing expense discipline to keep costs low and ensure that products and solutions are affordable as well as responsive to client needs. Finally, the Company aims to maximize its market valuation and stockholder returns over time.
Management estimates that investable wealth in the United States (U.S.) is currently well in excess of $30 trillion, which means the Company’s $3.04 trillion in client assets represents a market share of less than ten percent, leaving substantial opportunity for growth. The Company’s strategy is based on the principle that developing trusted relationships will translate into more assets from both new and existing clients, ultimately driving more revenue and, along with expense discipline, generating earnings growth and building long-term stockholder value.
This Form 10-Q is intended to provide an update on the activity and results of operations for the three and six months ended June 30, 2017 and should be read in conjunction with the 2016 Form 10-K. More information on the Company’s business operations, descriptions of revenue and expense categories, policies and procedures including the Company’s governance and monitoring programs is available in the 2016 Form 10-K. The Company’s recent annual reports on Form 10-K, quarterly reports on Form 10-Q, proxy statements, as well as other filings with the Securities and Exchange Commission (SEC), are available free of charge on the Company’s website, https://www.aboutschwab.com or by request via email (investor.relations@schwab.com), telephone (415-667-7000) or mail (Charles Schwab Investor Relations at 211 Main Street, San Francisco, CA 94105).
THE CHARLES SCHWAB CORPORATION
Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Millions, Except Ratios, or as Noted)
FORWARD-LOOKING STATEMENTS
In addition to historical information, this Quarterly Report on Form 10-Q contains “forward-looking statements” within the meaning of Section 27A of the Securities Act, and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements are identified by words such as “believe,” “anticipate,” “expect,” “intend,” “plan,” “will,” “may,” “estimate,” “appear,” “aim,” “target,” “could,” “would,” “continue,” and other similar expressions. In addition, any statements that refer to expectations, projections, or other characterizations of future events or circumstances are forward-looking statements.
These forward-looking statements, which reflect management’s beliefs, objectives, and expectations as of the date hereof, are necessarily estimates based on the best judgment of the Company’s senior management. These statements relate to, among other things, the following sections of this Form 10-Q:
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• | The Company’s aim to maximize its market valuation and stockholder returns over time; and the Company’s belief that developing trusted relationships will translate into more client assets which drives revenue and, along with expense discipline, earnings growth and stockholder value (see Introduction in Part I, Item 2); |
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• | The expected impact of new accounting standards not yet adopted (see New Accounting Standards in Part I, Item 1, Financial Information - Notes to Condensed Consolidated Financial Statements (Item 1) – Note 2); |
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• | The likelihood of indemnification and guarantee payment obligations (see Commitments and Contingencies in Item 1 – Note 8); and |
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• | The impact of legal proceedings and regulatory matters (see Commitments and Contingencies in Item 1 – Note 8 and Legal Proceedings in Part II, Item 1). |
Achievement of the expressed beliefs, objectives, and expectations described in these statements is subject to certain risks and uncertainties that could cause actual results to differ materially from the expressed beliefs, objectives, and expectations. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this Quarterly Report on Form 10-Q or, in the case of documents incorporated by reference, as of the date of those documents.
Important factors that may cause actual results to differ include, but are not limited to:
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• | General market conditions, including the level of interest rates, equity valuations and trading activity; |
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• | The Company’s ability to attract and retain clients, develop trusted relationships, and grow client assets; |
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• | Client use of the Company’s investment advisory services and other products and services; |
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• | The level of client assets including cash balances; |
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• | Competitive pressure on pricing; |
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• | Client sensitivity to rates; |
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• | Timing, amount, and impact of migration of certain balances from brokerage accounts and sweep money market funds into Schwab Bank; |
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• | Capital and liquidity needs and management; |
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• | The Company’s ability to manage expenses; |
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• | The Company’s ability to develop and launch new products, services and capabilities in a timely and successful manner; |
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• | The effect of adverse developments in litigation or regulatory matters and the extent of any related charges; and |
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• | Potential breaches of contractual terms for which the Company has indemnification and guarantee obligations. |
Certain of these factors, as well as general risk factors affecting the Company, are discussed in greater detail in Part I – Item 1A – Risk Factors in the 2016 Form 10-K.
THE CHARLES SCHWAB CORPORATION
Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Millions, Except Ratios, or as Noted)
OVERVIEW
Management focuses on several client activity and financial metrics in evaluating the Company’s financial position and operating performance. For a discussion of the key metrics and a glossary of terms, refer to the Company’s 2016 Form 10-K. Results for the second quarters and first halves of 2017 and 2016 are:
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| | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended June 30, | | | | Six Months Ended June 30, | | |
| 2017 | | 2016 | | Percent
Change | | 2017 | | 2016 | | Percent
Change |
Client Metrics: | | | | | | | | | | | |
Net new client assets (in billions) | $ | 64.5 |
| | $ | 26.6 |
| | 142 | % | | $ | 103.4 |
| | $ | 58.6 |
| | 76 | % |
Core net new client assets (in billions) | $ | 46.2 |
| | $ | 26.6 |
| | 74 | % | | $ | 85.1 |
| | $ | 58.6 |
| | 45 | % |
Client assets (in billions, at quarter end) | $ | 3,040.6 |
| | $ | 2,622.0 |
| | 16 | % | | | | | | |
Average client assets (in billions) | $ | 2,979.2 |
| | $ | 2,585.4 |
| | 15 | % | | $ | 2,925.5 |
| | $ | 2,515.4 |
| | 16 | % |
New brokerage accounts (in thousands) | 357 |
| | 271 |
| | 32 | % | | 719 |
| | 536 |
| | 34 | % |
Active brokerage accounts (in thousands, at quarter end) | 10,487 |
| | 9,977 |
| | 5 | % | | | | | | |
Assets receiving ongoing advisory services | | | | | | | | | | | |
(in billions, at quarter end) | $ | 1,539.8 |
| | $ | 1,315.5 |
| | 17 | % | | | | | | |
Client cash as a percentage of client assets (at quarter end) | 11.5 | % | | 12.6 | % | | |
| | | | | | |
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Company Financial Metrics: | |
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| | |
| | | | | | |
Net revenues | $ | 2,130 |
| | $ | 1,828 |
| | 17 | % | | $ | 4,211 |
| | $ | 3,592 |
| | 17 | % |
Expenses excluding interest | 1,221 |
| | 1,108 |
| | 10 | % | | 2,459 |
| | 2,217 |
| | 11 | % |
Income before taxes on income | 909 |
| | 720 |
| | 26 | % | | 1,752 |
| | 1,375 |
| | 27 | % |
Taxes on income | 334 |
| | 268 |
| | 25 | % | | 613 |
| | 511 |
| | 20 | % |
Net income | 575 |
| | 452 |
| | 27 | % | | 1,139 |
| | 864 |
| | 32 | % |
Preferred stock dividends and other | 45 |
| | 46 |
| | (2 | )% | | 84 |
| | 66 |
| | 27 | % |
Net income available to common stockholders | $ | 530 |
| | $ | 406 |
| | 31 | % | | $ | 1,055 |
| | $ | 798 |
| | 32 | % |
Earnings per common share – diluted | $ | .39 |
| | $ | .30 |
| | 30 | % | | $ | .78 |
| | $ | .60 |
| | 30 | % |
Net revenue growth from prior year | 17 | % | | 17 | % | | |
| | 17 | % | | 16 | % | | |
Pre-tax profit margin | 42.7 | % | | 39.4 | % | | |
| | 41.6 | % | | 38.3 | % | | |
Return on average common stockholders’ equity | 15 | % | | 13 | % | | |
| | 15 | % | | 13 | % | | |
Expenses excluding interest as a percentage of average client | | | | | | | | | | | |
assets (annualized) | 0.16 | % | | 0.17 | % | | | | 0.17 | % | | 0.18 | % | | |
Consolidated Tier 1 Leverage Ratio (at quarter end) | 7.4 | % | | 7.2 | % | | | | | | | | |
The Company experienced strong client engagement and demand for its contemporary approach to wealth management during the second quarter of 2017. Equity markets rose and volatility remained largely contained. While short-term interest rates increased, reflecting the Federal Reserve’s March and June 2017 interest rate hikes, the longer end of the yield curve softened. Against this backdrop, clients opened more than 350,000 new brokerage accounts during the second quarter, bringing year-to-date new accounts to 719,000 – up 34% from a year ago. Heightened client engagement resulted in core net new asset growth of $46.2 billion in the second quarter of 2017, up 74% year-over-year, bringing total client assets to $3.04 trillion at June 30, 2017. Assets enrolled in some form of ongoing advisory service totaled $1.54 trillion at quarter-end, up 17% from a year ago.
The Company’s financial model, with multiple revenue streams, operating leverage, and balance sheet strength resulted in a 27% increase in net income to $575 million in the second quarter of 2017, compared to the same period in 2016. Net income for the six months ended June 30, 2017 was $1.1 billion – an increase of 32% from the prior year. The pre-tax profit margins for the second quarter and first half of 2017 were over 40%, leading to a return on average common stockholders’ equity of 15% for the second quarter and first half of 2017 compared to 13% for the same periods in 2016.
THE CHARLES SCHWAB CORPORATION
Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Millions, Except Ratios, or as Noted)
RESULTS OF OPERATIONS
Net Revenues
Net revenues of $2.1 billion and $4.2 billion for the second quarter and first half of 2017, respectively, grew 17% from the prior year periods, reflecting significant improvements in both net interest revenue and asset management and administration fees. The following tables and sections present a comparison of the Company’s major sources of net revenues:
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| | | | | | | | | | | | | | | | | |
Three Months Ended June 30, | | | | 2017 | | 2016 |
| | Percent
Change | | Amount | | % of
Total Net
Revenues | | Amount | | % of
Total Net
Revenues |
Asset management and administration fees | | | | | | | | | | |
Mutual funds and ETF service fees | | 11 | % | | $ | 513 |
| | 24 | % | | $ | 461 |
| | 25 | % |
Advice Solutions | | 13 | % | | 256 |
| | 12 | % | | 226 |
| | 12 | % |
Other | | 9 | % | | 76 |
| | 4 | % | | 70 |
| | 4 | % |
Asset management and administration fees | | 12 | % | | 845 |
| | 40 | % | | 757 |
| | 41 | % |
Net interest revenue | | | | | | | | | | |
|
Interest revenue | | 34 | % | | 1,127 |
| | 52 | % | | 840 |
| | 46 | % |
Interest expense | | 76 | % | | (74 | ) | | (3 | )% | | (42 | ) | | (2 | )% |
Net interest revenue | | 32 | % | | 1,053 |
| | 49 | % | | 798 |
| | 44 | % |
Trading revenue | | | | | | | | | | |
Commissions | | (25 | )% | | 142 |
| | 6 | % | | 190 |
| | 10 | % |
Principal transactions | | 36 | % | | 15 |
| | 1 | % | | 11 |
| | 1 | % |
Trading revenue | | (22 | )% | | 157 |
| | 7 | % | | 201 |
| | 11 | % |
Other | | 7 | % | | 75 |
| | 4 | % | | 70 |
| | 4 | % |
Provision for loan losses | | (100 | )% | | — |
| | — |
| | 2 |
| | — |
|
Total net revenues | | 17 | % | | $ | 2,130 |
| | 100 | % | | $ | 1,828 |
| | 100 | % |
|
| | | | | | | | | | | | | | | | | |
Six Months Ended June 30, | | | | 2017 | | 2016 |
| | Percent
Change | | Amount | | % of
Total Net
Revenues | | Amount | | % of
Total Net
Revenues |
Asset management and administration fees | | | | | | | | | | |
Mutual funds and ETF service fees | | 16 | % | | $ | 1,019 |
| | 24 | % | | $ | 876 |
| | 24 | % |
Advice solutions | | 13 | % | | 500 |
| | 12 | % | | 441 |
| | 12 | % |
Other | | 7 | % | | 149 |
| | 4 | % | | 139 |
| | 4 | % |
Asset management and administration fees | | 15 | % | | 1,668 |
| | 40 | % | | 1,456 |
| | 40 | % |
Net interest revenue | | | | | | | | | | |
|
Interest revenue | | 32 | % | | 2,182 |
| | 52 | % | | 1,650 |
| | 46 | % |
Interest expense | | 61 | % | | (129 | ) | | (3 | )% | | (80 | ) | | (2 | )% |
Net interest revenue | | 31 | % | | 2,053 |
| | 49 | % | | 1,570 |
| | 44 | % |
Trading revenue | | | | | | | | | | |
Commissions | | (21 | )% | | 320 |
| | 7 | % | | 405 |
| | 11 | % |
Principal transactions | | 4 | % | | 29 |
| | 1 | % | | 28 |
| | 1 | % |
Trading revenue | | (19 | )% | | 349 |
| | 8 | % | | 433 |
| | 12 | % |
Other | | 6 | % | | 141 |
| | 3 | % | | 133 |
| | 4 | % |
Provision for loan losses | | — |
| | — |
| | — |
| | — |
| | — |
|
Total net revenues | | 17 | % | | $ | 4,211 |
| | 100 | % | | $ | 3,592 |
| | 100 | % |
THE CHARLES SCHWAB CORPORATION
Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Millions, Except Ratios, or as Noted)
Asset Management and Administration Fees
The following tables present a roll forward of client assets for the Schwab money market funds, Schwab equity and bond funds and ETFs, and Mutual Fund OneSource®. The following funds generated 54% of the asset management and administration fees earned during the second quarter and first half of 2017, compared to 54% and 53% in the same periods in 2016: |
| | | | | | | | | | | | | | | | | | | | | | | | |
| | Schwab Money Market Funds | | Schwab Equity and Bond Funds and ETFs | | Mutual Fund OneSource® |
Three Months Ended June 30, | | 2017 | | 2016 | | 2017 | | 2016 | | 2017 | | 2016 |
Balance at beginning of period | | $ | 162,887 |
| | $ | 167,427 |
| | $ | 139,412 |
| | $ | 104,953 |
| | $ | 204,887 |
| | $ | 203,759 |
|
Net inflows (outflows) | | (6,861 | ) | | (6,495 | ) | | 8,086 |
| | 3,572 |
| | (5,648 | ) | | (4,437 | ) |
Net market gains (losses) and other (1) | | 160 |
| | 19 |
| | 3,838 |
| | 2,197 |
| | 25,510 |
| | 4,030 |
|
Balance at end of period | | $ | 156,186 |
| | $ | 160,951 |
| | $ | 151,336 |
| | $ | 110,722 |
| | $ | 224,749 |
| | $ | 203,352 |
|
|
| | | | | | | | | | | | | | | | | | | | | | | | |
| | Schwab Money
Market Funds | | Schwab Equity and
Bond Funds and ETFs | | Mutual Fund
OneSource® |
Six Months Ended June 30, | | 2017 | | 2016 | | 2017 | | 2016 | | 2017 | | 2016 |
Balance at beginning of period | | $ | 163,495 |
| | $ | 166,148 |
| | $ | 125,813 |
| | $ | 102,112 |
| | $ | 198,924 |
| | $ | 207,654 |
|
Net inflows (outflows) | | (7,585 | ) | | (5,243 | ) | | 15,261 |
| | 5,654 |
| | (10,239 | ) | | (9,179 | ) |
Net market gains (losses) and other (1) | | 276 |
| | 46 |
| | 10,262 |
| | 2,956 |
| | 36,064 |
| | 4,877 |
|
Balance at end of period | | $ | 156,186 |
| | $ | 160,951 |
| | $ | 151,336 |
| | $ | 110,722 |
| | $ | 224,749 |
| | $ | 203,352 |
|
(1) Includes transfers from other third-party mutual funds to Mutual Fund OneSource® in the second quarter of 2017.
THE CHARLES SCHWAB CORPORATION
Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Millions, Except Ratios, or as Noted)
The following tables categorize asset management and administration fees, average client assets, and average fee yields by funds or revenue source:
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| | | | | | | | | | | | | | | | | | | | | |
Three Months Ended June 30, | 2017 | | 2016 |
| Average Client Assets | | Revenue | | Average Fee | | Average
Client
Assets | | Revenue | | Average
Fee |
Schwab money market funds before fee waivers | $ | 158,974 |
| | $ | 224 |
| | 0.57 | % | | $ | 163,929 |
| | $ | 239 |
| | 0.59 | % |
Fee waivers | | | (1 | ) | | | | | | (55 | ) | | |
Schwab money market funds | 158,974 |
| | 223 |
| | 0.56 | % | | 163,929 |
| | 184 |
| | 0.45 | % |
Schwab equity and bond funds and ETFs | 151,825 |
| | 52 |
| | 0.14 | % | | 112,814 |
| | 52 |
| | 0.19 | % |
Mutual Fund OneSource® | 220,680 |
| | 179 |
| | 0.33 | % | | 201,034 |
| | 169 |
| | 0.34 | % |
Other third-party mutual funds and ETFs (1) | 271,503 |
| | 59 |
| | 0.09 | % | | 252,405 |
| | 56 |
| | 0.09 | % |
Total mutual funds and ETFs (2) | $ | 802,982 |
| | 513 |
| | 0.26 | % | | $ | 730,182 |
| | 461 |
| | 0.25 | % |
Advice solutions (2): | | | | | | | | | | | |
Fee-based | $ | 199,823 |
| | 256 |
| | 0.51 | % | | $ | 175,973 |
| | 226 |
| | 0.52 | % |
Intelligent Portfolios | 17,796 |
| | — |
| | — |
| | 6,620 |
| | — |
| | — |
|
Legacy Non-Fee | 18,340 |
| | — |
| | — |
| | 17,015 |
| | — |
| | — |
|
Total advice solutions | $ | 235,959 |
| | 256 |
| | 0.44 | % | | $ | 199,608 |
| | 226 |
| | 0.46 | % |
Other balance-based fees (3) | 406,307 |
| | 64 |
| | 0.06 | % | | 338,529 |
| | 58 |
| | 0.07 | % |
Other (4) | | | 12 |
| | | | | | 12 |
| | |
Total asset management and administration fees | | | $ | 845 |
| | | | | | $ | 757 |
| | |
|
| | | | | | | | | | | | | | | | | | | | | |
Six Months Ended June 30, | 2017 | | 2016 |
| Average
Client
Assets | | Revenue | | Average
Fee | | Average
Client
Assets | | Revenue | | Average
Fee |
Schwab money market funds before fee waivers | $ | 160,881 |
| | $ | 455 |
| | 0.57 | % | | $ | 166,184 |
| | $ | 485 |
| | 0.59 | % |
Fee waivers |
| | (9 | ) | |
| |
| | (152 | ) | |
|
Schwab money market funds | 160,881 |
| | 446 |
| | 0.56 | % | | 166,184 |
| | 333 |
| | 0.40 | % |
Schwab equity and bond funds and ETFs | 145,363 |
| | 107 |
| | 0.15 | % | | 108,103 |
| | 103 |
| | 0.19 | % |
Mutual Fund OneSource ® | 211,548 |
| | 349 |
| | 0.33 | % | | 197,839 |
| | 333 |
| | 0.34 | % |
Other third-party mutual funds and ETFs (1) | 272,065 |
| | 117 |
| | 0.09 | % | | 244,820 |
| | 107 |
| | 0.09 | % |
Total mutual funds and ETFs (2) | $ | 789,857 |
| | 1,019 |
| | 0.26 | % | | $ | 716,946 |
| | 876 |
| | 0.25 | % |
Advice solutions (2) : |
| |
| |
| |
| |
| |
|
Fee-based | $ | 195,791 |
| | 500 |
| | 0.51 | % | | $ | 171,146 |
| | 441 |
| | 0.52 | % |
Intelligent Portfolios | 16,020 |
| | — |
| | — |
| | 5,868 |
| | — |
| | — |
|
Legacy Non-Fee | 17,890 |
| | — |
| | — |
| | 16,712 |
| | — |
| | — |
|
Total advice solutions | $ | 229,701 |
| | 500 |
| | 0.44 | % | | $ | 193,726 |
| | 441 |
| | 0.46 | % |
Other balance-based fees (3) | 397,523 |
| | 125 |
| | 0.06 | % | | 328,278 |
| | 114 |
| | 0.07 | % |
Other (4) |
| | 24 |
| |
|
| |
| | 25 |
| |
|
|
Total asset management and administration fees |
| | $ | 1,668 |
| |
| |
| | $ | 1,456 |
| |
|
(1) Includes Schwab ETF OneSource™.
(2) Average client assets for advice solutions may also include the asset balances contained in the mutual fund and/or ETF categories listed above.
(3) Includes various asset-related fees, such as trust fees, 401(k) recordkeeping fees, and mutual fund clearing fees and other service fees. Beginning in the first quarter of 2017, a prospective methodology change was made to average client assets relating to 401(k) recordkeeping fees to provide improved insight into the associated fee driver, which resulted in an increase of approximately $25 billion. There was no impact to revenue or the average fee.
(4) Includes miscellaneous service and transaction fees relating to mutual funds and ETFs that are not balance-based.
THE CHARLES SCHWAB CORPORATION
Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Millions, Except Ratios, or as Noted)
Asset management and administration fees increased by $88 million, or 12%, and $212 million, or 15% in the second quarter and first half of 2017 compared to the same periods in 2016, as a result of further improvement in net money fund revenue from rising rates and growing balances in advised solutions, equity and bond funds, and ETFs. By quarter-end, the yields on all proprietary money fund portfolios were at or above their respective operating expense ratios fully eliminating yield-related fee waivers for the first time since 2008.
THE CHARLES SCHWAB CORPORATION
Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Millions, Except Ratios, or as Noted)
Net Interest Revenue
The following tables present net interest revenue information corresponding to interest-earning assets and funding sources on the condensed consolidated balance sheets:
|
| | | | | | | | | | | | | | | | | | | | | | |
Three Months Ended June 30, | | 2017 | | 2016 |
| | Average Balance | | Interest Revenue/ Expense | | Average Yield/ Rate | | Average
Balance | | Interest
Revenue/
Expense | | Average
Yield/
Rate |
Interest-earning assets: | | | | | | | | | | | | |
Cash and cash equivalents | | $ | 8,562 |
| | $ | 22 |
| | 1.03 | % | | $ | 10,888 |
| | $ | 14 |
| | 0.52 | % |
Cash and investments segregated | | 19,703 |
| | 41 |
| | 0.83 | % | | 19,155 |
| | 22 |
| | 0.46 | % |
Broker-related receivables (1) | | 435 |
| | 1 |
| | 0.68 | % | | 685 |
| | — |
| | 0.20 | % |
Receivables from brokerage clients | | 15,827 |
| | 138 |
| | 3.50 | % | | 15,027 |
| | 124 |
| | 3.32 | % |
Available for sale securities (2) | | 48,154 |
| | 177 |
| | 1.47 | % | | 71,431 |
| | 211 |
| | 1.19 | % |
Held to maturity securities | | 107,378 |
| | 600 |
| | 2.24 | % | | 53,404 |
| | 335 |
| | 2.52 | % |
Bank loans | | 15,701 |
| | 115 |
| | 2.94 | % | | 14,569 |
| | 98 |
| | 2.71 | % |
Total interest-earning assets | | 215,760 |
| | 1,094 |
| | 2.03 | % | | 185,159 |
| | 804 |
| | 1.75 | % |
Other interest revenue | | | | 33 |
| | | | | | 36 |
| | |
Total interest-earning assets | | $ | 215,760 |
| | $ | 1,127 |
| | 2.10 | % | | $ | 185,159 |
| | $ | 840 |
| | 1.82 | % |
Funding sources: | | | | | | | | | | | | |
Bank deposits | | $ | 163,711 |
| | $ | 30 |
| | 0.07 | % | | $ | 136,009 |
| | $ | 8 |
| | 0.02 | % |
Payables to brokerage clients | | 26,125 |
| | 3 |
| | 0.05 | % | | 25,302 |
| | 1 |
| | 0.01 | % |
Short-term borrowings | | 1,393 |
| | 3 |
| | 0.86 | % | | 2,038 |
| | 2 |
| | 0.39 | % |
Long-term debt | | 3,518 |
| | 31 |
| | 3.53 | % | | 2,876 |
| | 26 |
| | 3.64 | % |
Total interest-bearing liabilities | | 194,747 |
| | 67 |
| | 0.14 | % | | 166,225 |
| | 37 |
| | 0.09 | % |
Non-interest-bearing funding sources | | 21,013 |
| | | | | | 18,934 |
| | | | |
Other interest expense | | | | 7 |
| | | | | | 5 |
| | |
Total funding sources | | $ | 215,760 |
| | $ | 74 |
| | 0.14 | % | | $ | 185,159 |
| | $ | 42 |
| | 0.09 | % |
Net interest revenue | | | | $ | 1,053 |
| | 1.96 | % | | | | $ | 798 |
| | 1.73 | % |
|
| | | | | | | | | | | | | | | | | | | | | | |
Six Months Ended June 30, | | 2017 | | 2016 |
| | Average
Balance | | Interest
Revenue/
Expense | | Average
Yield/
Rate | | Average
Balance | | Interest
Revenue/
Expense | | Average
Yield/
Rate |
Interest-earning assets: | | | | | | | | | | | | |
Cash and cash equivalents | | $ | 8,803 |
| | $ | 39 |
| | 0.89 | % | | $ | 10,820 |
| | $ | 27 |
| | 0.50 | % |
Cash and investments segregated | | 20,755 |
| | 76 |
| | 0.74 | % | | 19,710 |
| | 41 |
| | 0.42 | % |
Broker-related receivables (1) | | 412 |
| | 1 |
| | 0.62 | % | | 535 |
| | — |
| | 0.15 | % |
Receivables from brokerage clients | | 15,537 |
| | 264 |
| | 3.43 | % | | 14,959 |
| | 249 |
| | 3.35 | % |
Available for sale securities (2) | | 59,728 |
| | 428 |
| | 1.45 | % | | 69,797 |
| | 409 |
| | 1.18 | % |
Held to maturity securities | | 95,439 |
| | 1,085 |
| | 2.29 | % | | 51,830 |
| | 657 |
| | 2.55 | % |
Bank loans | | 15,615 |
| | 225 |
| | 2.91 | % | | 14,487 |
| | 197 |
| | 2.73 | % |
Total interest-earning assets | | 216,289 |
| | 2,118 |
| | 1.97 | % | | 182,138 |
| | 1,580 |
| | 1.74 | % |
Other interest revenue | | | | 64 |
| | | | | | 70 |
| | |
Total interest-earning assets | | $ | 216,289 |
| | $ | 2,182 |
| | 2.03 | % | | $ | 182,138 |
| | $ | 1,650 |
| | 1.82 | % |
Funding sources: | | | | | | | | | | | | |
Bank deposits | | $ | 163,696 |
| | $ | 49 |
| | 0.06 | % | | $ | 133,814 |
| | $ | 16 |
| | 0.02 | % |
Payables to brokerage clients | | 26,892 |
| | 5 |
| | 0.04 | % | | 26,015 |
| | 1 |
| | 0.01 | % |
Short-term borrowings | | 1,363 |
| | 5 |
| | 0.74 | % | | 1,029 |
| | 2 |
| | 0.39 | % |
Long-term debt | | 3,305 |
| | 59 |
| | 3.60 | % | | 2,877 |
| | 52 |
| | 3.63 | % |
Total interest-bearing liabilities | | 195,256 |
| | 118 |
| | 0.12 | % | | 163,735 |
| | 71 |
| | 0.09 | % |
Non-interest-bearing funding sources | | 21,033 |
| | | | | | 18,403 |
| | | | |
Other interest expense | | | | 11 |
| | | | | | 9 |
| | |
Total funding sources | | $ | 216,289 |
| | $ | 129 |
| | 0.12 | % | | $ | 182,138 |
| | $ | 80 |
| | 0.09 | % |
Net interest revenue | | | | $ | 2,053 |
| | 1.91 | % | | | | $ | 1,570 |
| | 1.73 | % |
(1) Interest revenue or expense was less than $500,000 in the period or periods presented.
(2) Amounts have been calculated based on amortized cost.
THE CHARLES SCHWAB CORPORATION
Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Millions, Except Ratios, or as Noted)
Net interest revenue increased $255 million, or 32%, and $483 million, or 31%, in the second quarter and first half of 2017 compared to the same periods in 2016 due to higher interest margins and interest-earning assets driven by growth in bank deposits. As of June 30, 2017 net interest revenue represented 49% of total net revenues, growing from 44% in the same period in the prior year.
Higher short-term interest rates reflecting the Federal Reserve’s March and June 2017 interest rate hikes, coupled with growth in interest-earning assets, have resulted in a 23 and 18 basis point improvement in net interest margins to 1.96% and 1.91% during the second quarter and first half of 2017, respectively, compared to the same periods in 2016.
Compared to the prior year, the Company has grown bank deposits through a combination of:
| |
• | Gathering additional assets from new and current clients; |
| |
• | Transferring uninvested cash balances in certain client brokerage accounts to Schwab Bank; and |
| |
• | Establishing the Schwab Bank sweep feature as the default investment option for uninvested cash balances within all new brokerage accounts as of June 2016. |
While there has been significant growth in bank deposits and average interest-earning assets compared to the prior year periods, balances declined from the first quarter due to clients investing more of their cash into the markets.
In March 2017, the Company transferred $24.7 billion of debt securities from the available for sale (AFS) category to the held to maturity (HTM) category. The transfer had no effect on the overall net interest margin. For additional information on the transfer, see Item 1 – Note 3.
Trading Revenue
The following table presents trading revenue and the related drivers: |
| | | | | | | | | | | | | | | | | | | | | | |
| | Three Months Ended
June 30, | | Six Months Ended
June 30, |
| | 2017 | | 2016 | | Percent
Change | | 2017 | | 2016 | | Percent
Change |
Daily average revenue trades (in thousands) | | 311 |
| | 279 |
| | 11 | % | | 314 |
| | 303 |
| | 4 | % |
Clients’ daily average trades (in thousands) | | 589 |
| | 518 |
| | 14 | % | | 587 |
| | 566 |
| | 4 | % |
Number of trading days | | 63.0 |
| | 64.0 |
| | (2 | )% | | 125.0 |
| | 125.0 |
| | — |
|
Average revenue per revenue trade | | $ | 7.96 |
| | $ | 11.27 |
| | (29 | )% | | $ | 8.91 |
| | $ | 11.36 |
| | (22 | )% |
Trading revenue | | $ | 157 |
| | $ | 201 |
| | (22 | )% | | $ | 349 |
| | $ | 433 |
| | (19 | )% |
During the first quarter of 2017, the Company announced two trading price reductions which lowered standard equity, ETF, and option trade commissions from $8.95 to $4.95 and lowered the per contract option fee from $.75 to $.65. Trading revenue decreased by $44 million, or 22%, and $84 million, or 19%, in the second quarter and first half of 2017, respectively, compared to the same periods in 2016, primarily due to these pricing reductions. These reductions in commission rates reflect both the Company’s belief that trade pricing should never be an obstacle for choosing Schwab and the Company’s commitment to share the benefits of its scale with clients. With these changes, trading revenue represented 8% of total net revenues through the first half of 2017 compared to 12% for the same period in 2016.
Other Revenue
Other revenue increased by $5 million, or 7%, in the second quarter of 2017 compared to the second quarter of 2016 largely due to an increase in realized gains on available for sale securities. Other revenue increased $8 million, or 6%, in the first half of 2017 compared to the same period in 2016, primarily due to the sublease of office space in San Francisco, a gain on the sale of a building in Indianapolis, and an increase in realized gains on available for sale securities.
Order flow revenue was $26 million and $25 million during the second quarters of 2017 and 2016 and $53 million and $52 million during the first halves of 2017 and 2016, respectively.
THE CHARLES SCHWAB CORPORATION
Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Millions, Except Ratios, or as Noted)
Expenses Excluding Interest
The following table shows a comparison of expenses excluding interest: |
| | | | | | | | | | | | | | | | | | | | | | |
| | Three Months Ended June 30, | | | | Six Months Ended June 30, | | |
| | 2017 | | 2016 | | Percent
Change | | 2017 | | 2016 | | Percent
Change |
Compensation and benefits | | | | | | | | | | | | |
Salaries and wages | | $ | 371 |
| | $ | 339 |
| | 9 | % | | $ | 738 |
| | $ | 675 |
| | 9 | % |
Incentive compensation | | 191 |
| | 166 |
| | 15 | % | | 393 |
| | 339 |
| | 16 | % |
Employee benefits and other | | 101 |
| | 97 |
| | 4 | % | | 233 |
| | 214 |
| | 9 | % |
Total compensation and benefits | | $ | 663 |
| | $ | 602 |
| | 10 | % | | $ | 1,364 |
| | $ | 1,228 |
| | 11 | % |
Professional services | | 144 |
| | 125 |
| | 15 | % | | 277 |
| | 241 |
| | 15 | % |
Occupancy and equipment | | 107 |
| | 101 |
| | 6 | % | | 212 |
| | 199 |
| | 7 | % |
Advertising and market development | | 71 |
| | 70 |
| | 1 | % | | 142 |
| | 140 |
| | 1 | % |
Communications | | 58 |
| | 62 |
| | (6 | )% | | 115 |
| | 122 |
| | (6 | )% |
Depreciation and amortization | | 66 |
| | 57 |
| | 16 | % | | 131 |
| | 113 |
| | 16 | % |
Other | | 112 |
| | 91 |
| | 23 | % | | 218 |
| | 174 |
| | 25 | % |
Total expenses excluding interest | | $ | 1,221 |
| | $ | 1,108 |
| | 10 | % | | $ | 2,459 |
| | $ | 2,217 |
| | 11 | % |
Expenses as a percentage of total net revenues: | | | | | | | | | | | | |
Compensation and benefits | | 31 | % | | 33 | % | |
| | 32 | % | | 34 | % | |
|
Advertising and market development | | 3 | % | | 4 | % | |
| | 3 | % | | 4 | % | |
|
Full-time equivalent employees (in thousands): | | | | | | | | | | | | |
At quarter end | | 16.9 |
| | 16.1 |
| | 5 | % | |
|
| |
|
| |
|
Average | | 16.7 |
| | 15.9 |
| | 5 | % | | 16.6 |
| | 15.7 |
| | 6 | % |
Salaries and wages increased in the second quarter and first half of 2017 compared to the same periods in 2016 primarily due to an increase in employee headcount to support the growth in the business and annual salary increases.
Incentive compensation increased in the second quarter and first half of 2017 compared to the same periods in 2016 primarily due to higher field incentive plan costs relating to increased net client asset flows and increased employee headcount.
Employee benefits and other expenses increased in the second quarter and first half of 2017 compared to the same periods in 2016 primarily due to higher payroll taxes and employer 401(k) matching contributions, which resulted from increased salaries and wages and incentive compensation.
Professional services expense increased in the second quarter and first half of 2017 compared to the same periods in 2016 primarily due to higher spending on technology services and an increase in fees paid to outsourced service providers and consultants as the Company continued to invest in the ongoing growth of the business.
Depreciation and amortization expenses grew in the second quarter and first half of 2017 compared to the same periods in 2016 as a result of higher amortization of internally developed software as projects were completed and placed into production.
Other expenses increased in the second quarter and first half of 2017 compared to the same periods in 2016 primarily due to an increase in the Company’s Federal Deposit Insurance Corporation (FDIC) assessments. The FDIC assessments rose as a result of higher bank deposits and the effect of a new surcharge that commenced in the third quarter of 2016.
Taxes on Income
Effective January 1, 2017, the Company adopted Accounting Standards Update (ASU) 2016-09, which prospectively changes the accounting treatment of a portion of the tax deductions relating to equity compensation. These deductions were previously reflected directly in additional paid-in capital, a component of stockholders’ equity, and are now included in tax expense, a component of net income. As a result of this change, the Company’s tax expense was reduced by approximately $5 million and
THE CHARLES SCHWAB CORPORATION
Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Millions, Except Ratios, or as Noted)
$36 million in the second quarter and first half of 2017. Future effects will depend on the Company’s share price, restricted stock vesting, and the volume of equity incentive options exercised.
The Company’s effective income tax rate on income before taxes was 36.7% and 37.2% for the second quarters of 2017 and 2016, respectively, and 35.0% and 37.2% for the first halves of 2017 and 2016, respectively, which reflects the benefit in the first half of 2017 as discussed above.
Segment Information
Financial information for the Company’s reportable segments is presented in the following tables: |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Investor Services | | Advisor Services | | Total |
Three Months Ended June 30, | | Percent Change | | 2017 | | 2016 | | Percent
Change | | 2017 | | 2016 | | Percent
Change | | 2017 | | 2016 |
Net Revenues: | | | | | | | | | | | | | | | | | | |
Asset management and administration fees | | 13 | % | | $ | 582 |
| | $ | 514 |
| | 8 | % | | $ | 263 |
| | $ | 243 |
| | 12 | % | | $ | 845 |
| | $ | 757 |
|
Net interest revenue | | 27 | % | | 795 |
| | 628 |
| | 52 | % | | 258 |
| | 170 |
| | 32 | % | | 1,053 |
| | 798 |
|
Trading revenue | | (24 | )% | | 98 |
| | 129 |
| | (18 | )% | | 59 |
| | 72 |
| | (22 | )% | | 157 |
| | 201 |
|
Other | | 8 | % | | 55 |
| | 51 |
| | 5 | % | | 20 |
| | 19 |
| | 7 | % | | 75 |
| | 70 |
|
Provision for loan losses | | (100 | )% | | — |
| | 2 |
| | — |
| | — |
| | — |
| | (100 | )% | | — |
| | 2 |
|
Total net revenues | | 16 | % | | 1,530 |
| | 1,324 |
| | 19 | % | | 600 |
| | 504 |
| | 17 | % | | 2,130 |
| | 1,828 |
|
Expenses Excluding Interest | | 10 | % | | 914 |
| | 834 |
| | 12 | % | | 307 |
| | 274 |
| | 10 | % | | 1,221 |
| | 1,108 |
|
Income before taxes on income | | 26 | % | | $ | 616 |
| | $ | 490 |
| | 27 | % | | $ | 293 |
| | $ | 230 |
| | 26 | % | | $ | 909 |
| | $ | 720 |
|
|
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Investor Services | | Advisor Services | | Total |
Six Months Ended June 30, | | Percent Change | | 2017 | | 2016 | | Percent Change | | 2017 | | 2016 | | Percent Change | | 2017 | | 2016 |
Net Revenues: | | | | | | | | | | | | | | | | | | |
Asset management and administration fees | | 16 | % | | $ | 1,148 |
| | $ | 986 |
| | 11 | % | | $ | 520 |
| | $ | 470 |
| | 15 | % | | $ | 1,668 |
| | $ | 1,456 |
|
Net interest revenue | | 25 | % | | 1,548 |
| | 1,241 |
| | 53 | % | | 505 |
| | 329 |
| | 31 | % | | 2,053 |
| | 1,570 |
|
Trading revenue | | (20 | )% | | 217 |
| | 272 |
| | (18 | )% | | 132 |
| | 161 |
| | (19 | )% | | 349 |
| | 433 |
|
Other | | 8 | % | | 105 |
| | 97 |
| | — |
| | 36 |
| | 36 |
| | 6 | % | | 141 |
| | 133 |
|
Provision for loan losses | | — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | — |
|
Total net revenues | | 16 | % | | 3,018 |
| | 2,596 |
| | 20 | % | | 1,193 |
| | 996 |
| | 17 | % | | 4,211 |
| | 3,592 |
|
Expenses Excluding Interest | | 10 | % | | 1,844 |
| | 1,671 |
| | 13 | % | | 615 |
| | 546 |
| | 11 | % | | 2,459 |
| | 2,217 |
|
Income before taxes on income | | 27 | % | | $ | 1,174 |
| | $ | 925 |
| | 28 | % | | $ | 578 |
| | $ | 450 |
| | 27 | % | | $ | 1,752 |
| | $ | 1,375 |
|
Investor Services
Net revenues rose by 16% in the second quarter and first half of 2017 compared to the same periods in 2016 primarily due to increases in net interest revenue and asset management and administration fees, partially offset by a decrease in trading revenue. Net interest revenue increased primarily due to higher net interest margins and higher balances of interest-earning assets. Asset management and administration fees increased primarily due to higher net yields on money market fund assets and growth in client assets invested in equity and bond funds, ETFs and advisory solutions. Trading revenue decreased primarily due to the reductions in commissions rates announced earlier in the year.
Expenses excluding interest increased by 10% in the second quarter and first half of 2017 compared to the same periods in 2016 primarily due to higher compensation and benefits and other expenses. Incentive compensation increased as a result of growth in net client asset flows, while salaries and benefits grew, reflecting higher staffing levels to support growth in the business. Other expenses rose due to higher FDIC regulatory assessments and occupancy and equipment costs.
THE CHARLES SCHWAB CORPORATION
Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Millions, Except Ratios, or as Noted)
Advisor Services
Net revenues rose by 19% and 20%, in the second quarter and first half of 2017 compared to the same periods in 2016 primarily due to increases in net interest revenue and asset management and administration fees, partially offset by a decrease in trading revenue. Net interest revenue increased primarily due to higher balances of interest-earning assets and higher net interest margins. This growth in interest-earning assets was aided by the migration of more uninvested client cash balances in the segment to Schwab Bank. Asset management and administration fees increased primarily due to higher net yields on money market fund assets and growth in client assets invested in equity and bond funds and ETFs. Trading revenue decreased primarily due to the reductions in commissions rates announced earlier in the year.
Expenses excluding interest increased by 12% and 13%, in the second quarter and first half of 2017 compared to the same periods in 2016 primarily due to higher compensation and benefits and other expenses. Incentive compensation increased as a result of growth in net client asset flows, while salaries and benefits grew, reflecting higher staffing levels to support growth in the business. Other expenses rose due to higher FDIC regulatory assessments and occupancy and equipment costs.
RISK MANAGEMENT
The Company’s business activities expose it to a variety of risks, including operational, credit, market, liquidity, and compliance risk. The Company has a comprehensive risk management program to identify and manage these risks and their associated potential for financial and reputational impact. For a discussion of the Company’s risk management programs, see Item 7 – Risk Management in the 2016 Form 10-K.
Credit Risk
Credit risk is the potential for loss due to a borrower, counterparty, or issuer failing to perform on its contractual obligations. The Company’s exposure to credit risk mainly results from margin lending and client option and futures activities, securities lending, mortgage lending, pledged asset lending, its role as a counterparty in financial contracts, and other investing activities. Client investing activities often include the use of leverage through margin, options, and futures positions. The Company manages collateral concentrations at the account level and across client portfolios.
The credit risk exposure related to the Company’s bank loans is actively managed through individual loan and portfolio reviews. Management regularly reviews asset quality, including concentrations, delinquencies, nonaccrual loans, charge-offs, and recoveries. All are factors in the determination of an appropriate allowance for loan losses. For more information on the Company’s credit quality indicators relating to its bank loans, see Item 1 – Note 4.
The Company also has exposure to concentration risk when holding large positions in financial instruments collateralized by assets with similar economic characteristics or in securities of a single issuer or within a particular industry or geographical area. The fair value of the Company’s investments in corporate debt securities and commercial paper totaled $10.1 billion at June 30, 2017, with 46% issued by institutions in the financial services industry. For more information on the Company’s investment portfolios, see Item 1 – Note 3.
Market Risk
Market risk is the potential for changes in earnings or the value of financial instruments held by the Company as a result of fluctuations in interest rates, equity prices, or market conditions.
The Company is exposed to interest rate risk primarily from changes in market interest rates on its interest-earning assets relative to changes in the costs of its funding sources that finance these assets. The majority of the Company’s interest-earning assets and interest-bearing liabilities are sensitive to changes in short-term interest rates. A portion of the Company’s investment portfolio is sensitive to changes in long-term interest rates.
Net Interest Revenue Simulation
THE CHARLES SCHWAB CORPORATION
Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Millions, Except Ratios, or as Noted)
For the Company’s net interest revenue sensitivity analysis, the Company uses net interest revenue simulation modeling techniques to evaluate and manage the effect of changing interest rates. The simulation includes all interest-sensitive assets and liabilities. Key variables in the simulation include the repricing of financial instruments, prepayment, reinvestment, and product pricing assumptions. The Company uses constant balances and prevailing market rates in the simulation assumptions in order to minimize the number of variables and to better isolate risks. The simulations involve assumptions that are inherently uncertain and, as a result, cannot precisely estimate net interest revenue or predict the impact of changes in interest rates on net interest revenue. Actual results may differ from simulated results due to balance growth or decline and the timing, magnitude, and frequency of interest rate changes, as well as changes in market conditions and management strategies, including changes in asset and liability mix.
If the Company’s guidelines for its net interest revenue sensitivity are breached, management must report the breach to the Company’s Corporate Asset-Liability Management and Pricing Committee and establish a plan to address the interest rate risk. There were no breaches of the Company’s net interest revenue sensitivity risk limits during the second quarter of 2017 or year ended December 31, 2016.
As represented by the simulations presented below, the Company’s investment strategy is structured to produce an increase in net interest revenue when interest rates rise and, conversely, a decrease in net interest revenue when interest rates fall.
The simulations in the following table assume that the asset and liability structure of the consolidated balance sheet would not be changed as a result of the simulated changes in interest rates. As the Company actively manages its consolidated balance sheet and interest rate exposure, in all likelihood the Company would take steps to manage additional interest rate exposure that could result from changes in the interest rate environment. The following table displays the simulated net interest revenue change over the next 12 months beginning June 30, 2017 and December 31, 2016 of a gradual 100 basis point increase or decrease in market interest rates relative to prevailing market rates at the end of each reporting period:
|
| | | | | | |
| | June 30, 2017 | | December 31, 2016 |
Increase of 100 basis points | | 5.3 | % | | 6.5 | % |
Decrease of 100 basis points | | (8.1 | )% | | (9.8 | )% |
The change in net interest revenue sensitivities as of June 30, 2017 reflects the increase in short-term interest rates. The increase of short-term interest rates positively impacts net interest revenue as yields on interest-earning assets rise faster than the cost of funding sources. A decline in interest rates could negatively impact the yield on the Company’s investment and loan portfolio to a greater degree than any offsetting reduction in interest expense from funding sources, compressing net interest margin.
Liquidity Risk
Liquidity risk is the potential that the Company will be unable to sell assets or meet cash flow obligations when they come due without incurring unacceptable losses. The Company’s primary source of funds is cash generated by client activity: bank deposits and cash balances in client brokerage accounts. Other sources of funds may include cash flows from operations, maturities and sales of investment securities, repayments on loans, lending securities held in client brokerage accounts, and cash provided by external financing.
To meet daily funding needs, the Company maintains liquidity in the form of overnight cash deposits and short-term investments. For unanticipated liquidity needs, the Company maintains a buffer of highly liquid investments, currently comprised of U.S. Treasury notes.
THE CHARLES SCHWAB CORPORATION
Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Millions, Except Ratios, or as Noted)
In addition to internal sources of liquidity, the Company has sources of external funding. The following table describes debt facilities available to the Company: |
| | | | |
| | Available at |
Description | Borrower | June 30, 2017 (1) |
Committed, unsecured credit facility with various external banks (2) | CSC | $ | 750 |
|
Uncommitted, unsecured lines of credit with various external banks | CSC, Schwab | 829 |
|
Federal Reserve Bank discount window | Schwab Bank | 3,488 |
|
Federal Home Loan Bank secured credit facility | Schwab Bank | 17,507 |
|
Unsecured commercial paper | CSC | 750 |
|
(1) See Item 1 – Note 7 for information on amounts outstanding. For additional information on the Company’s borrowing facilities, including financial covenants and other conditions of borrowing, see Item 7 – Liquidity Risk in the 2016 Form 10-K.
(2) In June 2017, CSC entered into this facility, which is set to expire in June 2018. This facility replaced a similar facility that expired in June 2017. The funds under this facility are available for general corporate purposes.
CSC has a universal automatic shelf registration statement on file with the SEC, which enables it to issue debt, equity, and other securities.
On March 2, 2017, CSC issued $650 million aggregate principal amount of Senior Notes that mature in 2027. The Senior Notes have a fixed interest rate of 3.200% with interest payable semi-annually. CSC intends to use the net proceeds from the sale of the Senior Notes for general corporate purposes, including, but not limited to, the repayment of $250 million aggregate principal amount of its 6.375% Senior Notes due September 1, 2017.
CSC’s ratings for commercial paper notes are P1 by Moody’s, A1 by Standard & Poor’s, and F1 by Fitch. CSC’s Senior Notes and Medium-Term Notes are rated A2 by Moody’s, A by Standard & Poor’s, and A by Fitch. CSC’s preferred stock is rated Baa2 by Moody’s, BBB by Standard & Poor’s, and BB+ by Fitch. For further discussion of CSC’s debt and equity, see Item 1 – Note 7 and Note 11.
Beginning on January 1, 2016, the Company became subject to the modified liquidity coverage ratio (LCR) rule which was fully phased in on January 1, 2017 and requires CSC to hold High Quality Liquid Assets equal to at least 70% of projected net cash outflows over a 30-day period, as defined by the rule. At June 30, 2017, the Company was in compliance with the fully phased-in modified LCR rule. For additional information on the LCR rule, see Item 1 – Business – Regulation in the 2016 Form 10‑K.
CAPITAL MANAGEMENT
The Company seeks to manage capital to a level and composition sufficient to support execution of its business strategy, including anticipated balance sheet growth, providing financial support to its subsidiaries, and sustained access to the capital markets, while at the same time meeting its regulatory capital requirements and serving as a source of financial strength to Schwab Bank.
The Company’s primary sources of capital are funds generated by the operations of its subsidiaries and securities issuances by CSC in the capital markets. To ensure that it has a sufficient amount of capital to absorb unanticipated losses or declines in asset values, the Company has adopted a policy to remain well capitalized even in stressed scenarios. For a description of the Company’s internal guidelines, monitoring and governance processes, see Item 7 – Capital Management in the 2016 Form 10‑K.
THE CHARLES SCHWAB CORPORATION
Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Millions, Except Ratios, or as Noted)
Regulatory Capital Requirements
CSC and Schwab Bank are subject to various capital requirements set by regulatory agencies as discussed in further detail in the 2016 Form 10-K and in Item 1 – Note 14. As of June 30, 2017, CSC and Schwab Bank are considered well capitalized.
The following table details CSC’s and Schwab Bank’s capital ratios as of June 30, 2017 and December 31, 2016:
|
| | | | | | | | | | | | | | | |
| June 30, 2017 | | December 31, 2016 |
| CSC | | Schwab Bank | | CSC | | Schwab Bank |
Total stockholders’ equity | $ | 17,489 |
| | $ | 12,888 |
| | $ | 16,421 |
| |