Charles Schwab Corporation — 2018 Form 10-K Summary
Business context and reporting period
The filing covers the fiscal year ended December 31, 2018; quarterly figures are also reported for Q4. Schwab provides brokerage, banking, asset management, custody, retirement, and advisory services through Investor Services and Advisor Services. At year-end, it reported $3.25 trillion in client assets, 11.6 million active brokerage accounts, and approximately 19,500 full-time-equivalent employees.
Financial and operating results
| Metric | 2018 | 2017 | Change |
|---|---|---|---|
| Total net revenues | $10.132 billion | $8.618 billion | +18% |
| Net interest revenue | $5.823 billion | $4.282 billion | +36% |
| Asset management and administration fees | $3.229 billion | $3.392 billion | -5% |
| Trading revenue | $763 million | $654 million | +17% |
| Expenses excluding interest | $5.570 billion | $4.968 billion | +12% |
| Income before taxes | $4.562 billion | $3.650 billion | +25% |
| Net income | $3.507 billion | $2.354 billion | +49% |
| Net income available to common stockholders | $3.329 billion | $2.180 billion | +53% |
| Diluted EPS | $2.45 | $1.61 | +52% |
Pre-tax margin rose to 45.0% from 42.4%; return on average common equity was 19%, versus 15%. Net interest margin increased to 2.29% from 1.97%. The effective tax rate fell to 23.1% from 35.5%, primarily reflecting the 2017 Tax Act and its lower federal corporate tax rate.
Q4 2018 revenue was $2.669 billion, net income was $935 million, and diluted EPS was $0.65. Q4 2017 figures were $2.242 billion, $597 million, and $0.41, respectively.
Operating cash flow was $12.456 billion, compared with negative $839 million in 2017. Investing cash flow was negative $40.555 billion and financing cash flow was positive $47.166 billion. Cash flows were materially affected by client-related balance movements and security purchases. Capital expenditures were $576 million, up from $412 million.
Total assets increased 22% to $296.482 billion. Long-term debt was $6.878 billion, up from $4.753 billion; short-term borrowings were zero at year-end, versus $15.0 billion in 2017. Stockholders’ equity was $20.670 billion. Bank deposits reached $231.423 billion, including $212.311 billion swept from brokerage accounts. The average modified liquidity coverage ratio for Q4 was 111%; Schwab was compliant with the modified LCR and expected to become subject to the full LCR in Q2 2019. The consolidated Tier 1 leverage ratio was 7.1%, down from 7.6%.
Material changes versus 2017
- Net interest revenue drove most revenue growth, reflecting higher rates, growth in interest-earning assets, and $72 billion transferred from sweep money market funds to bank and broker-dealer sweep. The Federal Reserve raised rates four times in 2018.
- Asset management fees declined as cash moved out of money market funds and as prior fee reductions took effect; growth in advice solutions and other funds partly offset the decline.
- Record trading activity lifted trading revenue despite lower average revenue per revenue trade. Daily average revenue trades rose 31%, while average revenue per trade fell 12%.
- Expenses rose with increased staffing, technology and professional-services spending, marketing, and a $36 million special stock award. Expenses as a percentage of average client assets remained 0.16%.
- Core net new client assets grew 15% to $227.8 billion, but reported net new client assets fell to $133.9 billion from $233.1 billion, including $93.9 billion of outflows from certain mutual fund clearing clients. Year-end client assets fell 3%, reflecting lower market valuations; client cash as a percentage of client assets rose to 12.8% from 10.8%.
Outlook, risks, contingencies, and unusual items
- Management expected 2019 capital expenditures of approximately 7–9% of net revenues, due to campus expansion and technology investment; longer-term expectations remained 3–5%. No specific earnings or revenue guidance is provided.
- Management said the balance sheet was positioned to benefit from rising rates, but warned that higher deposit costs or client cash moving to higher-yield alternatives could reduce net interest revenue. Its sensitivity analysis estimated that a gradual 100-basis-point increase would raise next-12-month net interest revenue 4.4%, while a 100-basis-point decrease would reduce it 4.9%, assuming no balance-sheet changes.
- Key risks include interest-rate and market exposure, competition and pricing pressure, changes in client cash allocations, cybersecurity and technology disruptions, credit losses, liquidity or capital constraints, regulatory changes, reliance on third parties, and litigation. Schwab also identified LIBOR transition risk after 2021.
- Crossing $250 billion in consolidated assets in 2018 brought additional regulatory requirements. Schwab became subject to the supplementary leverage ratio and AOCI inclusion requirements; it expected full LCR requirements to apply beginning in Q2 2019. Proposed regulatory changes could alter stress-testing, capital, and liquidity requirements; their effect was not yet assessable.
- Legal matters include the Crago order-routing class action, for which the company denied allegations and said it would contest the case; management could not reasonably estimate potential liability. A separate Total Bond Market Fund lawsuit concluded in December 2018 after dismissal of the claims.
- Capital returns included completion of $1.0 billion in share repurchases during Q4 and an increase in the quarterly dividend to $0.13 per share. On January 30, 2019, Schwab authorized up to $4.0 billion in additional repurchases and raised the quarterly dividend to $0.17.
- The 2017 tax reform produced a $46 million one-time, non-cash tax charge in Q4 2017. The 2018 net income also benefited from the lower tax rate. The 2018 financial statements were audited, and the auditor reported effective internal control over financial reporting.
Important facts for investors to verify
- Whether higher rates and growth in interest-earning assets continue to outweigh rising deposit costs and potential client cash migration.
- The sustainability and composition of client asset growth, especially the gap between core and reported net new assets and the effect of market valuations.
- Investment portfolio exposures, including the $2.301 billion of unrealized losses on held-to-maturity securities at year-end, and how interest rates or liquidity needs could affect outcomes.
- Capital and liquidity position following the full LCR transition and any final changes to enhanced prudential standards.
- Progress, cost, and returns from the planned 2019 campus and technology spending, and the effect of higher operating expenses on margins.
- Developments in the Crago litigation, tax examinations and unrecognized tax benefits, and adoption of the expected-credit-loss accounting standard in 2020.