Edgar Filing: SCHWAB CHARLES CORP

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, 2018

Commission File Number: 1-9700

THE CHARLES SCHWAB CORPORATION

(Exact name of registrant as specified in its charter)



Delaware (State or other jurisdiction of incorporation or organization)	94-3025021 (I.R.S. Employer Identification No.)

211 Main Street, San Francisco, CA 94105

(Address of principal executive offices and zip code)

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

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

Yes ☒ No ☐

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

Yes ☒ No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, 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.



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.

1,351,062,783 shares of $.01 par value Common Stock Outstanding on July 31, 2018

THE CHARLES SCHWAB CORPORATION

Quarterly Report on Form 10-Q

For the Quarter Ended June 30, 2018

Index



Part I - Financial Information


	Item 1.	Condensed Consolidated Financial Statements (Unaudited):

		Statements of Income	18
		Statements of Comprehensive Income	19
		Balance Sheets	20
		Statements of Stockholders’ Equity	21
		Statements of Cash Flows	22-23
		Notes	24-54

	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	1-16

	Item 3.	Quantitative and Qualitative Disclosures About Market Risk	17

	Item 4.	Controls and Procedures	55

Part II - Other Information

	Item 1.	Legal Proceedings	56

	Item 1A.	Risk Factors	56

	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	56

	Item 3.	Defaults Upon Senior Securities	56

	Item 4.	Mine Safety Disclosures	56

	Item 5.	Other Information	56

	Item 6.	Exhibits	57

Signature			58

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 “Schwab” or the “Company”), in wealth management, securities brokerage, banking, asset management, custody, and financial advisory services.

Significant business subsidiaries of CSC include the following:


•	Charles Schwab & Co., Inc. (CS&Co), a securities broker-dealer;


•	Charles Schwab Bank (CSB), a federal savings bank; and


•	Charles Schwab Investment Management, Inc. (CSIM), the investment advisor for Schwab’s proprietary mutual funds (Schwab Funds^®) and Schwab’s exchange-traded funds (Schwab ETFs™).

Unless otherwise indicated, the terms “Schwab,” “the Company,” “we,” “us,” or “our” mean CSC together with its consolidated subsidiaries.

Schwab provides financial services to individuals and institutional clients through two segments – Investor Services and Advisor Services. The Investor Services segment provides retail brokerage and banking services to individual investors, and retirement plan services, as well as other corporate brokerage services, to businesses and their employees. The Advisor Services segment provides custodial, trading, banking, and support services, as well as retirement business services, to independent registered investment advisors (RIAs), independent retirement advisors, and recordkeepers.

Schwab was founded on the belief that all Americans deserve access to a better investing experience. Although much has changed in the intervening years, our 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.”

This strategy emphasizes placing clients’ perspectives, needs, and desires at the forefront. Because investing plays a fundamental role in building financial security, we strive to deliver a better investing experience for our clients – individual investors and the people and institutions who serve them – by disrupting longstanding industry practices on their behalf and providing superior service. We also aim to offer a broad range of products and solutions to meet client needs with a focus on transparency, value, and trust. In addition, management works to couple Schwab’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. In combination, these are the key elements of our “no trade-offs” approach to serving investors. We believe that following this strategy is the best way to maximize our market valuation and stockholder returns over time.

Management estimates that investable wealth in the United States (consisting of assets in defined contribution, retail wealth management and brokerage, and registered investment advisor channels, along with bank deposits) currently exceeds $45 trillion, which means the Company’s $3.40 trillion in client assets leaves substantial opportunity for growth. Our 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, will generate earnings growth and build long-term stockholder value.

This Management’s Discussion and Analysis should be read in conjunction with our Annual Report on Form 10-K for the fiscal year ended December 31, 2017 (2017 Form 10-K).

On our website, www.aboutschwab.com, we post the following filings after they are electronically filed with or furnished to the Securities and Exchange Commission (SEC): annual reports on Form 10-K, quarterly reports on Form 10-Q, 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

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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)

Act of 1934. The SEC maintains a website at www.sec.gov that contains reports, proxy, and other information that we file electronically with the SEC.

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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,” “could,” “would,” 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 estimates based on the best judgment of Schwab’s senior management. These statements relate to, among other things:


•	Maximizing our market valuation and stockholder returns over time; our belief that developing trusted relationships will translate into more client assets which drives revenue and, along with expense discipline, generates earnings growth and builds stockholder value (see Introduction in Part I, Item 2);


•	Ongoing investments to fuel growth (see Overview);


•	Capital expenditures in 2018 (see Results of Operations);


•	Consolidated balance sheet assets remaining above $250 billion (see Risk Management and Capital Management);


•	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);


•	The likelihood of indemnification and guarantee payment obligations (see Commitments and Contingencies in Item 1 – Note 9); and


•	The impact of legal proceedings and regulatory matters (see Commitments and Contingencies in Item 1 – Note 9 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:


•	General market conditions, including the level of interest rates, equity valuations, and trading activity;


•	Our ability to attract and retain clients, develop trusted relationships, and grow client assets;


•	Client use of our advice solutions and other products and services;


•	The level of client assets, including cash balances;


•	Competitive pressure on pricing, including deposit rates;


•	Client sensitivity to interest rates;


•	Regulatory guidance;


•	Timing and amount of transfers of certain balances from sweep money market funds into bank sweep deposits;


•	Capital and liquidity needs and management;


•	Our ability to manage expenses;


•	Our ability to develop and launch new products, services, infrastructure, and capabilities in a timely and successful manner;


•	The effect of adverse developments in litigation or regulatory matters and the extent of any related charges; and


•	Potential breaches of contractual terms for which we have 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 2017 Form 10-K.

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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 Schwab’s financial position and operating performance. Results for the second quarters and first six months of 2018 and 2017 are:



	Three Months Ended June 30,						Percent Change		Six Months Ended June 30,						Percent Change
	2018			2017			Percent Change		2018			2017			Percent Change
Client Metrics:
Net new client assets (in billions) ⁽¹⁾	$	43.9		$	64.5		(32	)%	$	25.1		$	103.4		(76	)%
Core net new client assets (in billions)	$	53.4		$	46.2		16	%	$	119.0		$	85.1		40	%
Client assets (in billions, at quarter end)	$	3,397.0		$	3,040.6		12	%
Average client assets (in billions)	$	3,370.4		$	2,979.2		13	%	$	3,376.2		$	2,925.5		15	%
New brokerage accounts (in thousands)	384			357			8	%	827			719			15	%
Active brokerage accounts (in thousands, at quarter end)	11,202			10,487			7	%
Assets receiving ongoing advisory services (in billions, at quarter end)	$	1,768.7		$	1,539.8		15	%
Client cash as a percentage of client assets (at quarter end)	10.7		%	11.5		%
Company Financial Metrics:
Total net revenues	$	2,486		$	2,130		17	%	$	4,884		$	4,211		16	%
Total expenses excluding interest	1,355			1,221			11	%	2,751			2,459			12	%
Income before taxes on income	1,131			909			24	%	2,133			1,752			22	%
Taxes on income	265			334			(21	)%	484			613			(21	)%
Net income	866			575			51	%	1,649			1,139			45	%
Preferred stock dividends and other	53			45			18	%	90			84			7	%
Net income available to common stockholders	$	813		$	530		53	%	$	1,559		$	1,055		48	%
Earnings per common share — diluted	$	.60		$	.39		54	%	$	1.14		$	.78		46	%
Net revenue growth from prior year	17		%	17		%			16		%	17		%
Pre-tax profit margin	45.5		%	42.7		%			43.7		%	41.6		%
Return on average common stockholders’ equity	19		%	15		%			19		%	15		%
Expenses excluding interest as a percentage of average client assets (annualized)	0.16		%	0.16		%			0.16		%	0.17		%
Consolidated Tier 1 Leverage Ratio (at quarter end)	7.6		%	7.4		%

⁽¹⁾Includes outflows of $9.5 billion and $93.9 billion in the second quarter and first six months of 2018, respectively, from certain mutual fund clearing services clients.

Net income grew 51% and 45% for the second quarter and first six months of 2018, respectively, compared to the same periods in 2017, driven primarily by sustained business momentum, higher interest rates, and lower corporate income taxes. Total net revenues rose 17% and 16% in the second quarter and first six months of 2018, respectively, compared to the same periods in 2017, primarily due to higher net interest revenue as a result of higher interest rates and larger client cash sweep balances. Total expenses excluding interest grew 11% and 12% during the second quarter and first six months of 2018, respectively, compared to the same periods in 2017, reflecting higher spending to support the expanding client base and ongoing investments to fuel growth. Altogether, we achieved a 570 basis point gap between revenue and expense growth, which resulted in a 45.5% and 43.7% pre-tax profit margin for the second quarter and first six months of 2018, respectively, compared to the same periods in 2017.

Taxes on income decreased 21% for both the second quarter and first six months of 2018 resulting in effective tax rates of 23.4% and 22.7% for the second quarter and first six months of 2018, respectively. The reduction in taxes on income was due to the Tax Act of 2017, which lowered the federal corporate income tax rate from 35% to 21% effective January 1, 2018.

We delivered net income of $866 million and $1.6 billion for the second quarter and first six months of 2018, respectively, up $291 million and $510 million from a year ago, lifting our return on equity to 19% for the second quarter and first six months of 2018 compared to 15% for the same periods in 2017.

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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)

During the second quarter of 2018, clients opened 384,000 new brokerage accounts, helping to bring active brokerage accounts to 11.2 million at June 30, 2018. Excluding planned mutual funding clearing outflows of $9.5 billion, core net new assets gathered during the second quarter of 2018 were $53.4 billion, compared to $46.2 billion for the same period a year ago. Client engagement remained strong during the second quarter of 2018, with daily average revenue trades rising 21% from the same period in 2017.

Effective balance sheet management remains an essential element of our financial discipline. In the second quarter, we issued $1.95 billion of Senior Notes, which we used to redeem $275 million of maturing debt and maintain appropriate liquidity given the growth we’re achieving. We also transferred an additional $20 billion in the second quarter of 2018 from sweep money market funds to bank sweep deposits, bringing the total year-to-date transferred amount to $45 billion. As anticipated, we crossed the $250 billion asset threshold for heightened regulatory requirements during the second quarter of 2018, ending with $262 billion in total consolidated assets at June 30, 2018.

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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

Total Net Revenues

The following tables present a comparison of revenue by category:



			2018					2017
Three Months Ended June 30,	Percent Change		Amount			% of Total Net Revenues		Amount			% of Total Net Revenues
Net interest revenue
Interest revenue	41	%	$	1,590		64	%	$	1,127		52	%
Interest expense	147	%	(183		)	(7	)%	(74		)	(3	)%
Net interest revenue	34	%	1,407			57	%	1,053			49	%
Asset management and administration fees
Mutual funds and ETF service fees	(11	)%	458			19	%	513			24	%
Advice solutions	11	%	283			11	%	256			12	%
Other	(4	)%	73			3	%	76			4	%
Asset management and administration fees	(4	)%	814			33	%	845			40	%
Trading revenue
Commissions	11	%	157			6	%	142			6	%
Principal transactions	53	%	23			1	%	15			1	%
Trading revenue	15	%	180			7	%	157			7	%
Other	13	%	85			3	%	75			4	%
Total net revenues	17	%	$	2,486		100	%	$	2,130		100	%



			2018					2017
Six Months Ended June 30,	Percent Change		Amount			% of Total Net Revenues		Amount			% of Total Net Revenues
Net interest revenue
Interest revenue	38	%	$	3,011		62	%	$	2,182		52	%
Interest expense	164	%	(341		)	(7	)%	(129		)	(3	)%
Net interest revenue	30	%	2,670			55	%	2,053			49	%
Asset management and administration fees
Mutual funds and ETF service fees	(7	)%	951			19	%	1,019			24	%
Advice solutions	13	%	565			12	%	500			12	%
Other	—		149			3	%	149			4	%
Asset management and administration fees	—		1,665			34	%	1,668			40	%
Trading revenue
Commissions	8	%	346			7	%	320			7	%
Principal transactions	21	%	35			1	%	29			1	%
Trading revenue	9	%	381			8	%	349			8	%
Other	19	%	168			3	%	141			3	%
Total net revenues	16	%	$	4,884		100	%	$	4,211		100	%

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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:



	2018						2017
Three Months Ended June 30,	Average Balance		Interest Revenue/ Expense		Average Yield/ Rate		Average Balance		Interest Revenue/ Expense		Average Yield/ Rate
Interest-earning assets:
Cash and cash equivalents	$	12,764	$	57	1.80	%	$	8,562	$	22	1.03	%
Cash and investments segregated	11,825		50		1.68	%	19,703		41		0.83	%
Broker-related receivables	378		2		1.58	%	435		1		0.68	%
Receivables from brokerage clients	19,775		204		4.09	%	15,827		138		3.50	%
Available for sale securities⁽¹⁾	52,682		291		2.19	%	48,154		177		1.47	%
Held to maturity securities	129,825		812		2.49	%	107,378		600		2.24	%
Bank loans	16,530		138		3.32	%	15,701		115		2.94	%
Total interest-earning assets	243,779		1,554		2.54	%	215,760		1,094		2.03	%
Other interest revenue			36						33
Total interest-earning assets	$	243,779	$	1,590	2.60	%	$	215,760	$	1,127	2.10	%
Funding sources:
Bank deposits	$	193,029	$	117	0.24	%	$	163,711	$	30	0.07	%
Payables to brokerage clients	21,729		14		0.26	%	26,125		3		0.05	%
Short-term borrowings	1,429		7		1.94	%	1,393		3		0.86	%
Long-term debt	4,961		43		3.47	%	3,518		31		3.53	%
Total interest-bearing liabilities	221,148		181		0.33	%	194,747		67		0.14	%
Non-interest-bearing funding sources	22,631						21,013
Other interest expense			2						7
Total funding sources	$	243,779	$	183	0.30	%	$	215,760	$	74	0.14	%
Net interest revenue			$	1,407	2.30	%			$	1,053	1.96	%



	2018						2017
Six Months Ended June 30,	Average Balance		Interest Revenue/ Expense		Average Yield/ Rate		Average Balance		Interest Revenue/ Expense		Average Yield/ Rate
Interest-earning assets:
Cash and cash equivalents	$	14,912	$	123	1.65	%	$	8,803	$	39	0.89	%
Cash and investments segregated	12,891		98		1.51	%	20,755		76		0.74	%
Broker-related receivables	333		3		1.47	%	412		1		0.62	%
Receivables from brokerage clients	19,326		383		3.95	%	15,537		264		3.43	%
Available for sale securities⁽¹⁾	51,533		531		2.06	%	59,728		428		1.45	%
Held to maturity securities	125,641		1,533		2.44	%	95,439		1,085		2.29	%
Bank loans	16,493		268		3.25	%	15,615		225		2.91	%
Total interest-earning assets	241,129		2,939		2.43	%	216,289		2,118		1.97	%
Other interest revenue			72						64
Total interest-earning assets	$	241,129	$	3,011	2.49	%	$	216,289	$	2,182	2.03	%
Funding sources:
Bank deposits	$	185,052	$	181	0.20	%	$	163,696	$	49	0.06	%
Payables to brokerage clients	22,097		21		0.20	%	26,892		5		0.04	%
Short-term borrowings	6,770		54		1.59	%	1,363		5		0.74	%
Long-term debt	4,678		80		3.42	%	3,305		59		3.60	%
Total interest-bearing liabilities	218,597		336		0.31	%	195,256		118		0.12	%
Non-interest-bearing funding sources	22,532						21,033
Other interest expense			5						11
Total funding sources	$	241,129	$	341	0.28	%	$	216,289	$	129	0.12	%
Net interest revenue			$	2,670	2.21	%			$	2,053	1.91	%

⁽¹⁾Amounts have been calculated based on amortized cost.

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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 $354 million, or 34%, and $617 million, or 30%, in the second quarter and first six months of 2018, respectively, compared to the same periods in 2017, primarily due to higher interest rates and growth in interest-earning assets.

Our net interest margin improved to 2.30% and 2.21% during the second quarter and first six months of 2018, respectively, up from 1.96% and 1.91% during the same periods in 2017, primarily as a result of the Federal Reserve System’s (Federal Reserve) 2017 and March and June 2018 interest rate hikes, partially offset by higher interest rates paid on bank deposits and other interest-bearing liabilities.

During the second quarter and the first six months of 2018, average interest earning assets grew 13% and 11%, respectively, compared to the same periods in 2017. These increases reflect higher bank deposits due to transfers from sweep money market funds to bank sweep balances, as well as other client-related deposit inflows and higher borrowings, partially offset by client purchases of other assets.

In addition to issuing the Senior Notes, we utilized Federal Home Loan Bank (FHLB) advances during the first half of 2018 to provide temporary funding for additional investments ahead of deposit growth. The FHLB advances matured by June 30, 2018.

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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 asset management and administration fees, average client assets, and average fee yields:



Three Months Ended June 30,	2018						2017
Three Months Ended June 30,	Average Client Assets		Revenue		Average Fee		Average Client Assets		Revenue			Average Fee
Schwab money market funds before fee waivers	$	139,968	$	147	0.42	%	$	158,974	$	224		0.57	%
Fee waivers			—						(1		)
Schwab money market funds	139,968		147		0.42	%	158,974		223			0.56	%
Schwab equity and bond funds and ETFs	203,179		65		0.13	%	151,825		52			0.14	%
Mutual Fund OneSource^®and other non-transaction fee funds	217,867		175		0.32	%	220,680		179			0.33	%
Other third-party mutual funds and ETFs ⁽¹⁾	325,061		71		0.09	%	271,503		59			0.09	%
Total mutual funds and ETFs⁽²⁾	$	886,075	458		0.21	%	$	802,982	513			0.26	%
Advice solutions ⁽²⁾:
Fee-based	$	225,879	283		0.50	%	$	199,879	256			0.51	%
Non-fee-based	62,109		—		—		46,882		—			—
Total advice solutions	$	287,988	283		0.39	%	$	246,761	256			0.41	%
Other balance-based fees⁽³⁾	387,727		62		0.06	%	406,307		64			0.06	%
Other⁽⁴⁾			11						12
Total asset management and administration fees			$	814					$	845



	2018						2017
Six Months Ended June 30,	Average Client Assets		Revenue		Average Fee		Average Client Assets		Revenue			Average Fee
Schwab money market funds before fee waivers	$	148,165	$	329	0.45	%	$	160,881	$	455		0.57	%
Fee waivers			—						(9		)
Schwab money market funds	148,165		329		0.45	%	160,881		446			0.56	%
Schwab equity and bond funds and ETFs	199,519		128		0.13	%	145,363		107			0.15	%
Mutual Fund OneSource^®and other non-transaction fee funds	220,268		353		0.32	%	211,548		349			0.33	%
Other third-party mutual funds and ETFs⁽¹⁾	322,391		141		0.09	%	272,065		117			0.09	%
Total mutual funds and ETFs⁽²⁾	$	890,343	951		0.22	%	$	789,857	1,019			0.26	%
Advice solutions ⁽²⁾ :
Fee-based	$	225,320	565		0.51	%	$	195,823	500			0.51	%
Non-fee-based	60,964		—		—		44,801		—			—
Total advice solutions	$	286,284	565		0.40	%	$	240,624	500			0.42	%
Other balance-based fees⁽³⁾	406,869		128		0.06	%	397,523		125			0.06	%
Other⁽⁴⁾			21						24
Total asset management and administration fees			$	1,665					$	1,668

⁽¹⁾ Includes Schwab ETF OneSource™.

⁽²⁾ Beginning in the fourth quarter of 2017, a change was made to add non-fee-based average assets from managed portfolios. Average client assets for advice solutions may also include the asset balances contained in the mutual fund and/or ETF categories listed above. Prior periods have been adjusted to accommodate this change.

⁽³⁾ Includes various asset-related fees, such as trust fees, 401(k) recordkeeping fees, and mutual fund clearing fees and other service fees.

⁽⁴⁾ Includes miscellaneous service and transaction fees relating to mutual funds and ETFs that are not balance-based.

Asset management and administration fees decreased by $31 million, or 4%, and $3 million, or 0.2%, in the second quarter and first six months of 2018, respectively, compared to the same periods in 2017. The decreases were due to lower money market fund revenue as a result of transfers to bank sweep, client asset allocation choices, and our 2017 fee reductions. Part of the declines were offset by revenue from growing asset balances in advice solutions, equity and bond funds, and ETFs.

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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 present a roll forward of client assets for the Schwab money market funds, Schwab equity and bond funds and exchange-traded funds (ETFs), and Mutual Fund OneSource^®and other non-transaction fee (NTF) funds. These funds generated 48% and 49% of the asset management and administration fees earned during the second quarter and first six months of 2018, respectively, compared to 54% for the same periods in 2017:



	Schwab Money Market Funds						Schwab Equity and Bond Funds and ETFs				Mutual Fund OneSource^®and Other NTF funds
Three Months Ended June 30,	2018			2017			2018		2017		2018			2017
Balance at beginning of period	$	144,995		$	162,887		$	187,930	$	139,412	$	221,614		$	204,887
Net inflows (outflows)	(11,319		)	(6,861		)	9,625		8,086		(13,348		)	(5,648		)
Net market gains (losses) and other ⁽¹⁾	490			160			3,806		3,838		4,247			25,510
Balance at end of period	$	134,166		$	156,186		$	201,361	$	151,336	$	212,513		$	224,749



	Schwab Money Market Funds						Schwab Equity and Bond Funds and ETFs				Mutual Fund OneSource^®and Other NTF funds
Six Months Ended June 30,	2018			2017			2018		2017		2018			2017
Balance at beginning of period	$	163,650		$	163,495		$	181,608	$	125,813	$	225,202		$	198,924
Net inflows (outflows)	(30,441		)	(7,585		)	18,271		15,261		(18,277		)	(10,239		)
Net market gains (losses) and other ⁽¹⁾	957			276			1,482		10,262		5,588			36,064
Balance at end of period	$	134,166		$	156,186		$	201,361	$	151,336	$	212,513		$	224,749

⁽¹⁾ Includes net inflows from other third-party mutual funds to Mutual Fund OneSource^®in the second quarter of 2017.

Trading Revenue

The following table presents trading revenue and the related drivers:



	Three Months Ended June 30,				Percent Change		Six Months Ended June 30,				Percent Change
	2018		2017		Percent Change		2018		2017		Percent Change
Daily average revenue trades (DARTs) (in thousands)	376		311		21	%	418		314		33	%
Clients’ daily average trades (in thousands)	704		589		20	%	757		587		29	%
Number of trading days	64.0		63.0		2	%	125.0		125.0		—
Daily average revenue per revenue trade	$	7.30	$	7.96	(8	)%	$	7.27	$	8.91	(18	)%
Trading revenue	$	180	$	157	15	%	$	381	$	349	9	%

DART volumes increased 21% and 33% in the second quarter and first six months of 2018, respectively, compared to the prior year. This led to an increase in trading revenue of $23 million, or 15%, and $32 million, or 9%, in the second quarter and first six months of 2018, respectively, compared to the same periods in 2017, as the volume growth more than offset Schwab’s commission pricing reductions implemented in the first quarter of 2017. During that time, Schwab 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.

Other Revenue

Other revenue includes order flow revenue, other service fees, software fees from our portfolio management solutions, exchange processing fees, and non-recurring gains. Order flow revenue was $33 million and $26 million during the second quarters of 2018 and 2017, respectively, and $71 million and $53 million during the first six months of 2018 and 2017, respectively. These increases were primarily due to higher rates on certain types of orders and higher volume of trades.

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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)

Total Expenses Excluding Interest

The following table shows a comparison of expenses excluding interest:



	Three Months Ended June 30,						Percent Change		Six Months Ended June 30,						Percent Change
	2018			2017			Percent Change		2018			2017			Percent Change
Compensation and benefits
Salaries and wages	$	419		$	371		13	%	$	830		$	738		12	%
Incentive compensation	210			191			10	%	422			393			7	%
Employee benefits and other	116			101			15	%	263			233			13	%
Total compensation and benefits	$	745		$	663		12	%	$	1,515		$	1,364		11	%
Professional services	156			144			8	%	312			277			13	%
Occupancy and equipment	122			107			14	%	244			212			15	%
Advertising and market development	77			71			8	%	150			142			6	%
Communications	58			58			—		120			115			4	%
Depreciation and amortization	75			66			14	%	148			131			13	%
Regulatory fees and assessments	50			46			9	%	101			90			12	%
Other	72			66			9	%	161			128			26	%
Total expenses excluding interest	$	1,355		$	1,221		11	%	$	2,751		$	2,459		12	%
Expenses as a percentage of total net revenues:
Compensation and benefits	30		%	31		%			31		%	32		%
Advertising and market development	3		%	3		%			3		%	3		%
Full-time equivalent employees (in thousands):
At quarter end	18.7			16.9			11	%
Average	18.4			16.7			10	%	18.2			16.6			10	%

Total compensation and benefits increased in the second quarter and first six months of 2018 compared to the same periods in 2017, primarily due to an increase in employee headcount to support our expanding client base.

Professional services expense increased in the second quarter and first six months of 2018 compared to the same periods in 2017, primarily due to an increase in asset management and administration-related expenses resulting from growth in the Schwab Funds^® and Schwab ETFs™ and higher spending on technology projects.

Occupancy and equipment expense increased in the second quarter and first six months of 2018 compared to the same periods in 2017, primarily due to an increase in software maintenance expenses and additional licenses to support growth in the business.

Depreciation and amortization expenses grew in the second quarter and first six months of 2018 compared to the same periods in 2017, primarily due to higher amortization of internally developed software associated with continued investments in software and technology enhancements.

Regulatory fees and assessments increased in the second quarter and first six months of 2018 compared to the same periods in 2017, primarily due to an increase in Federal Deposit Insurance Corporation (FDIC) insurance assessments, which rose as a result of higher average assets.

Other expenses increased in the first six months of 2018 compared to the same period in 2017, primarily due to a $15 million charge in the first quarter of 2018 associated with unsecured client margin losses in volatility-related products and other miscellaneous expense growth related to the expanding client base.

Capital expenditures were $126 million and $261 million in the second quarter and first six months of 2018, respectively, compared with $86 million and $153 million in the second quarter and first six months of 2017, respectively. The increases in the second quarter and year-to-date capital expenditures from the same periods in 2017 were due primarily to our office campus

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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)

expansion in the U.S. and investments in technology projects. As we continue to pursue our geographic strategy, we anticipate increasing capital expenditures for full-year 2018 from our typical range of 3-5% of total net revenues to approximately 6-7%.

Taxes on Income

Taxes on income were $265 million and $334 million for the second quarters of 2018 and 2017, respectively, resulting in effective income tax rates on income before taxes of 23.4% and 36.7%, respectively. Taxes on income were $484 million and $613 million for the first six months of 2018 and 2017, respectively, resulting in effective income tax rates on income before taxes of 22.7% and 35.0%, respectively. The decrease in the effective tax rate was primarily due to the Tax Act which was signed into law on December 22, 2017. Among other things, the Tax Act lowered the federal corporate income tax rate from 35% to 21%, effective for tax years including or commencing January 1, 2018.

Segment Information

Financial information for our segments is presented in the following tables:



	Investor Services						Advisor Services						Total
Three Months Ended June 30,	Percent Change		2018		2017		Percent Change		2018		2017		Percent Change		2018		2017
Net Revenues:
Net interest revenue	34	%	$	1,063	$	795	33	%	$	344	$	258	34	%	$	1,407	$	1,053
Asset management and administration fees	(2	)%	569		582		(7	)%	245		263		(4	)%	814		845
Trading revenue	17	%	115		98		10	%	65		59		15	%	180		157
Other	18	%	65		55		—		20		20		13	%	85		75
Total net revenues	18	%	1,812		1,530		12	%	674		600		17	%	2,486		2,130
Expenses Excluding Interest	11	%	1,012		914		12	%	343		307		11	%	1,355		1,221
Income before taxes on income	30	%	$	800	$	616	13	%	$	331	$	293	24	%	$	1,131	$	909



	Investor Services						Advisor Services						Total
Six Months Ended June 30,	Percent Change		2018		2017		Percent Change		2018		2017		Percent Change		2018		2017
Net Revenues:
Net interest revenue	30	%	$	2,020	$	1,548	29	%	$	650	$	505	30	%	$	2,670	$	2,053
Asset management and administration fees	1	%	1,162		1,148		(3	)%	503		520		—		1,665		1,668
Trading revenue	12	%	242		217		5	%	139		132		9	%	381		349
Other	23	%	129		105		8	%	39		36		19	%	168		141
Total net revenues	18	%	3,553		3,018		12	%	1,331		1,193		16	%	4,884		4,211
Expenses Excluding Interest	11	%	2,054		1,844		13	%	697		615		12	%	2,751		2,459
Income before taxes on income	28	%	$	1,499	$	1,174	10	%	$	634	$	578	22	%	$	2,133	$	1,752

Investor Services

Total net revenues rose by 18% in both the second quarter and first six months of 2018 compared to the same periods in 2017, primarily due to an increase in net interest revenue. Net interest revenue increased due to higher net interest margins and higher interest-earning assets.

Expenses excluding interest increased by 11% in both the second quarter and first six months of 2018 compared to the same periods in 2017, primarily due to higher compensation and benefits, technology project spend, and asset management and administration-related expenses to support our expanding client base.

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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

Total net revenues rose by 12% in both the second quarter and first six months of 2018 compared to the same periods in 2017, primarily due to an increase in net interest revenue, partially offset by lower asset management and administration fees. Net interest revenue increased due to higher net interest margins and higher interest-earning assets. Asset management and administration fees decreased primarily due to lower money market fund revenue as a result of transfers to bank sweep, client asset allocation choices, and our 2017 fee reductions.

Expenses excluding interest increased by 12% and 13% in the second quarter and first six months of 2018, respectively, compared to the same periods in 2017, primarily due to higher compensation and benefits, technology project spend, and asset management and administration-related expenses to support our expanding client base.

RISK MANAGEMENT

Schwab’s business activities expose us 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 our risk management programs, see Item 7 – Risk Management in the 2017 Form 10-K.

Net Interest Revenue Simulation

For Schwab’s net interest revenue sensitivity analysis, we use 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 simulations involve assumptions that are inherently uncertain and, as a result, cannot precisely estimate 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 our guidelines for net interest revenue sensitivity are breached, management must report the breach to the Financial Risk Oversight Committee and establish a plan to address the interest rate risk. There were no breaches of Schwab’s net interest revenue sensitivity risk limits during the six months ended June 30, 2018, or year ended December 31, 2017.

As represented by the simulations presented below, our 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 sheets would not be changed as a result of the simulated changes in interest rates. As we actively manage the consolidated balance sheets and interest rate exposure, in all likelihood we would take steps to manage additional interest rate exposure that could result from changes in the interest rate environment. The following table shows the simulated net interest revenue change over the next 12 months beginning June 30, 2018 and December 31, 2017 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, 2018		December 31, 2017
Increase of 100 basis points	3.1	%	3.3	%
Decrease of 100 basis points	(4.8	)%	(6.2	)%

The change in net interest revenue sensitivities as of June 30, 2018 reflects the increase in interest rates across all maturities.

- 13 -

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)

Liquidity Risk

Schwab’s primary source of funds is cash generated by client activity: bank deposits and cash balances in client brokerage accounts. These funds are used to purchase investment securities and extend loans to clients.

Other sources of funds may include cash flows from operations, maturities and sales of investment securities, repayments on loans, securities lending of assets held in client brokerage accounts, and cash provided by external debt or equity financing.

To meet daily funding needs, we maintain liquidity in the form of overnight cash deposits and short-term investments. For unanticipated liquidity needs, a buffer of highly liquid investments, currently comprised of U.S. Treasury notes, is also maintained.

In addition to internal sources of liquidity, Schwab has access to external funding. The following table describes external debt facilities available at June 30, 2018:



Description	Borrower	Outstanding		Available
Committed, unsecured credit facility with various external banks	CSC	$	—	$	750
Uncommitted, unsecured lines of credit with various external banks	CSC, CS&Co	—		1,432
Federal Reserve Bank discount window ⁽¹⁾	CSB	—		2,455
Federal Home Loan Bank secured credit facility ⁽²⁾	CSB	—		30,323
Unsecured commercial paper ⁽³⁾	CSC	—		750

⁽¹⁾Amounts available are dependent on the fair value of certain investment securities that are pledged as collateral.

⁽²⁾ Amounts available are dependent on the amount of first lien residential real estate mortgage loans (First Mortgages), home equity lines of credit (HELOCs), and the fair value of certain investment securities that are pledged as collateral.

⁽³⁾CSC has authorization from its Board of Directors to issue Commercial Paper Notes to not exceed $1.5 billion. Management has set a current limit not to exceed the amount of the committed, unsecured credit facility.

CSC’s ratings for Commercial Paper Notes are P1 by Moody’s Investor Service (Moody’s), A1 by Standard & Poor’s Rating Group (Standard & Poor’s), and F1 by Fitch Ratings, Ltd (Fitch).

Borrowings

The following are details of the Senior Notes and short-term borrowings:



June 30, 2018	Par Outstanding		Maturity	Weighted Average Interest Rate	Moody’s	Standard & Poor’s	Fitch
Senior Notes ⁽¹⁾	$	5,781	2020 - 2028	3.31%	A2	A	A
Short-term borrowings	$	—	N/A	N/A	N/A	N/A	N/A

⁽¹⁾Amounts include $600 million Senior Notes with a quarterly variable interest rate equal to the three-month LIBOR plus 0.32%.

N/A Not applicable.

New Debt Issuances

All debt issuances in 2018 were senior unsecured obligations with interest payable quarterly or semi-annually. Additional details are as follows:



Issuance Date	Issuance Amount		Maturity Date	Interest Rate	Interest Payable
May 22, 2018	$	600	5/21/2021	Three-month LIBOR + 0.32%	Quarterly
May 22, 2018	$	600	5/21/2021	3.25%	Semi-annually
May 22, 2018	$	750	5/21/2025	3.85%	Semi-annually

Schwab is subject to, and was in compliance with, the modified liquidity coverage ratio (LCR) rule at June 30, 2018. Schwab expects consolidated balance sheet assets to remain above $250 billion in 2018, and as a result, would become subject to the full LCR rule in 2019.

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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)

CAPITAL MANAGEMENT

Schwab seeks to manage capital to a level and composition sufficient to support execution of our business strategy, including anticipated balance sheet growth, providing financial support to our subsidiaries, and sustained access to the capital markets, while at the same time meeting our regulatory capital requirements, and serving as a source of financial strength to our banking subsidiaries. Schwab’s primary sources of capital are funds generated by the operations of subsidiaries and securities issuances by CSC in the capital markets. To ensure that Schwab has sufficient capital to absorb unanticipated losses or declines in asset values, we have adopted a policy to remain well capitalized even in stressed scenarios.

Regulatory Capital Requirements

CSC and CSB are subject to various capital requirements set by regulatory agencies as discussed in further detail in the 2017 Form 10-K and in Item 1 – Note 16. As of June 30, 2018, CSC and CSB are considered well capitalized.

The following table details CSC’s consolidated and CSB’s capital ratios as of June 30, 2018 and December 31, 2017:



	June 30, 2018				December 31, 2017
	CSC		CSB		CSC		CSB
Total stockholders’ equity	$	20,097	$	14,352	$	18,525	$	13,224
Less:
Preferred stock	2,793		—		2,793		—
Common Equity Tier 1 Capital before regulatory adjustments	$	17,304	$	14,352	$	15,732