Business context and reporting period
The Charles Schwab Corporation is a financial services holding company serving individual investors, businesses and independent investment advisers through its Investor Services and Advisor Services segments. This unaudited Form 10-Q covers the quarter and six months ended June 30, 2019; comparisons are with the corresponding 2018 periods unless stated otherwise. Amounts below are in U.S. dollars.
Financial and operating performance
| Metric | Q2 2019 | Change | Six months 2019 | Change |
|---|---|---|---|---|
| Total net revenue | $2.681 billion | +8% | $5.404 billion | +11% |
| Net interest revenue | $1.609 billion | +14% | $3.290 billion | +23% |
| Expenses excluding interest | $1.445 billion | +7% | $2.904 billion | +6% |
| Income before taxes | $1.236 billion | +9% | $2.500 billion | +17% |
| Net income | $937 million | +8% | $1.901 billion | +15% |
| Net income attributable to common stockholders | $887 million | +9% | $1.812 billion | +16% |
| Diluted EPS | $0.66 | +10% | $1.35 | +18% |
| Pre-tax profit margin | 46.1% | 45.5% prior year | 46.3% | 43.7% prior year |
| Net interest margin | 2.40% | 2.30% prior year | 2.43% | 2.21% prior year |
Revenue mix and drivers: Higher net interest revenue was the main growth driver, reflecting increased interest-earning assets, including bank deposits from sweep transfers, and the benefit of 2018 Federal Reserve rate increases. Asset management and administration fees fell 3% in Q2 and 7% in the first half, principally due to lower sweep money-market fund revenue and reduced Mutual Fund OneSource balances. Trading revenue fell 3% and 6%, respectively, mainly as revenue per trade declined. Other revenue rose 32% in Q2 and 27% in the first half, including gains from a Q2 sale of advisor software and a Q1 lease-space assignment; the filing does not specify the individual gain amounts.
Client and segment measures: Client assets were $3.702 trillion at quarter-end, up 9% year over year; active brokerage accounts were 11.967 million, up 7%. Core net new client assets were $37.2 billion in Q2 and $88.9 billion in the first half, an annualized first-half organic growth rate of 5%. Investor Services Q2 revenue increased 4% to $1.891 billion, while Advisor Services revenue increased 17% to $790 million; pre-tax income was $834 million and $402 million, respectively.
Balance sheet, cash flow, debt and liquidity
- Total assets were $276.3 billion at June 30, 2019, down from $296.5 billion at December 31, 2018. Management attributed the quarterly balance-sheet decline in part to tax-season disbursements and client cash allocation changes after completion of the sweep-fund transfer program.
- Cash and cash equivalents on the balance sheet were $24.2 billion. Bank deposits were $208.4 billion, down from $231.4 billion at year-end 2018. Total liabilities were $255.0 billion and stockholders’ equity was $21.3 billion.
- Long-term debt was $7.424 billion, versus $6.878 billion at year-end. The Company issued $600 million of 3.25% senior notes due 2029 during Q2. No FHLB advances were outstanding at quarter-end; available FHLB capacity was $35.2 billion.
- For the six months, operating cash flow was negative $381 million, versus positive $3.380 billion in 2018; investing cash flow was positive $20.448 billion, versus negative $19.654 billion; and financing cash flow was negative $24.112 billion, versus positive $16.032 billion. Cash, cash equivalents and restricted amounts decreased $4.045 billion. These flows were materially affected by securities transactions and changes in bank deposits and client-related balances.
- The average Q2 liquidity coverage ratio was 111%, and the Company reported compliance with the LCR rule. The consolidated Tier 1 Leverage Ratio was 7.3%; management reported CSC and CSB as well capitalized.
Material changes, outlook, risks and unusual items
- Expenses increased with staffing and investment in technology, efficiency and scale. Capital expenditures were $354 million in the first half; management expected full-year 2019 capital expenditures to be approximately 7–9% of total net revenue.
- The Company repurchased 29 million shares for approximately $1.2 billion in Q2, leaving $2.8 billion under its $4.0 billion authorization. The quarterly common dividend was increased 31% to $0.17 per share in January 2019.
- On July 25, 2019, after quarter-end, Schwab announced an agreement to acquire USAA-IMCO assets, including more than one million accounts and approximately $90 billion of client assets, for $1.8 billion in cash. A long-term referral agreement would make Schwab the exclusive wealth-management and brokerage provider for USAA members. Closing was expected in 2020, subject to approvals and other conditions.
- Management described a challenging geopolitical, economic and market environment and noted lower interest rates than at year-end 2018. Simulations estimated that a gradual 100-basis-point rate increase would raise next-12-month net interest revenue by 4.7%, while a 100-basis-point decrease would reduce it by 4.1%, assuming no balance-sheet changes. Actual outcomes may differ; management began shifting some investment securities toward fixed-rate, longer-duration assets to reduce sensitivity to further rate declines.
- Key risks include market and interest-rate changes, client asset and cash levels, competitive pricing and deposit rates, expense control, execution of technology and growth initiatives, liquidity and capital needs, and regulatory or litigation developments. The Company was preparing for LIBOR’s expected discontinuation and said the financial-statement impact could not yet be estimated. It expected an immaterial incremental allowance on adoption of CECL in 2020, subject to economic and portfolio conditions.
- Schwab disclosed a pending class action alleging deficient order-routing practices related to orders routed to UBS during 2011–2014. Defendants deny the allegations and intend to contest the case; the filing provides no reasonable estimate of potential liability. Management said it had strong defenses and that other pending matters were not currently expected to be material.
- The effective tax rate rose to 24.2% in Q2 and 24.0% for the first half, primarily due to lower equity-compensation tax benefits. Lease accounting adoption added $596 million of right-of-use assets and $662 million of lease liabilities at January 1, 2019.
Important facts for investors to verify
- Whether net interest revenue and margins remain resilient if market rates decline, and how deposit pricing and client cash allocations affect funding costs.
- Whether client asset inflows, account growth and advisory balances continue to offset declines in certain fee categories and lower revenue per trade.
- How much reported growth depended on the disclosed software-sale and lease-assignment gains, and the continuing cost of staffing, technology and campus investment.
- The funding, regulatory approvals, conversion costs and expected economics of the proposed USAA-IMCO acquisition and referral agreement.
- Capital return capacity alongside liquidity and capital requirements, including the effects of repurchases, dividends, deposit movements and the pending CECL transition.
- Developments in the order-routing litigation, LIBOR transition and other regulatory or legal matters.