Charles Schwab Corporation (10-Q) — Quarter ended June 30, 2017
Business context: Schwab provides brokerage, banking, asset management, custody, and advisory services through its Investor Services and Advisor Services segments. The filing reports the second quarter and first six months of 2017; comparisons below are with the corresponding 2016 periods unless noted. Amounts are in millions except per-share data, ratios, and client metrics.
Financial and operating performance
| Metric | Q2 2017 | Q2 2016 | Change |
|---|---|---|---|
| Net revenues | $2,130 | $1,828 | +17% |
| Net interest revenue | $1,053 | $798 | +32% |
| Asset management and administration fees | $845 | $757 | +12% |
| Trading revenue | $157 | $201 | -22% |
| Expenses excluding interest | $1,221 | $1,108 | +10% |
| Income before taxes | $909 | $720 | +26% |
| Net income | $575 | $452 | +27% |
| Net income available to common stockholders | $530 | $406 | +31% |
| Diluted EPS | $0.39 | $0.30 | +30% |
| Pre-tax margin | 42.7% | 39.4% | +3.3 pts |
For the first half, revenue was $4.211 billion (+17%), net income was $1.139 billion (+32%), diluted EPS was $0.78 (+30%), and pre-tax margin was 41.6% versus 38.3%. Return on average common equity was 15% for both the quarter and half, up from 13%.
Client activity: Quarter-end client assets were $3.041 trillion (+16% year over year); average client assets were $2.979 trillion (+15%). Q2 net new client assets were $64.5 billion and core net new client assets were $46.2 billion, up 142% and 74%, respectively. Schwab opened 357,000 brokerage accounts in the quarter; active accounts reached 10.487 million. Advisory-service assets were $1.540 trillion (+17%). Client cash was 11.5% of client assets, down from 12.6%.
Revenue drivers and costs: Higher short-term rates, bank deposit growth, and larger interest-earning assets lifted net interest revenue; Q2 net interest margin increased to 1.96% from 1.73%. Fee growth reflected improved money-market yields and growth in advised, equity, and bond fund assets. Money-market fund yield-related fee waivers were fully eliminated by quarter-end for the first time since 2008. Trading revenue declined mainly after the standard equity, ETF, and option commission was reduced from $8.95 to $4.95 and the per-contract option fee from $0.75 to $0.65. Expense growth reflected staffing, incentive compensation, technology and outside services, depreciation, and higher FDIC assessments.
Cash flow, balance sheet, debt, and capital
- Six-month cash flows: Operating cash flow was $509 million, down from $1.523 billion. Investing activities used $1.317 billion versus $13.834 billion in 2016; financing activities used $445 million versus providing $13.309 billion. Cash and cash equivalents ended June at $9.575 billion, down $1.253 billion since year-end. The filing does not provide a separate quarterly cash-flow statement.
- Balance sheet at June 30: Total assets were $220.601 billion, versus $223.383 billion at December 31, 2016. Bank deposits were $162.300 billion, down from $163.454 billion; bank loans, net, were $15.817 billion. Total liabilities were $203.112 billion and stockholders’ equity was $17.489 billion.
- Debt: Long-term debt was $3.518 billion, up from $2.876 billion at year-end; short-term borrowings were $300 million. Schwab issued $650 million of 3.20% senior notes due 2027 in March. It reported $750 million available under its committed unsecured credit facility and was compliant with the fully phased-in modified liquidity coverage ratio requirement.
- Capital: CSC’s Tier 1 leverage ratio was 7.4%, up from 7.2% at year-end. Schwab Bank’s was 7.3%, up from 7.0%; both were described as well capitalized. CSC and Schwab Bank met their regulatory capital requirements.
Material changes, outlook, and risks
- Schwab transferred $24.7 billion of securities from available-for-sale to held-to-maturity in Q1, including a $227 million pre-tax unrealized loss in accumulated other comprehensive income. Management said the transfer was intended to mitigate potential regulatory-capital volatility as consolidated assets approach the $250 billion threshold; it did not affect overall net interest margin.
- Adoption of share-based compensation tax guidance reduced income tax expense by approximately $5 million in Q2 and $36 million in the first half. The company provided no numerical earnings or revenue guidance in this filing.
- Management cited rising short-term rates and client engagement as supportive of results, while noting that client balances declined from Q1 as clients invested more cash in markets. Interest-rate sensitivity simulations estimated that a gradual 100-basis-point rise would increase next-12-month net interest revenue by 5.3%, while a 100-basis-point decline would reduce it by 8.1%; actual outcomes may differ.
- Key exposures include interest-rate and market movements, competitive pricing, client-asset and cash-balance changes, credit and liquidity risk, and operational, regulatory, and legal matters. The company reported $10.1 billion of corporate debt and commercial paper investments, 46% issued by financial-services institutions. About 48% of its first-mortgage and HELOC portfolio was concentrated in California.
- The company disclosed ongoing litigation, including the Schwab Total Bond Market Fund case, which was pending again before the Ninth Circuit. It said it could not reasonably estimate potential liability for described matters. Management stated that risk factors had not materially changed from the 2016 Form 10-K. No share repurchases were made in Q2; approximately $596 million remained authorized.
Important facts for investors to verify
- Whether higher rates and growth in bank deposits continue to support net interest revenue, and how client cash migration affects deposit balances and margins.
- Whether strong net new asset and account growth persists, including the distinction between total and core flows.
- How commission reductions affect trading revenue and whether fee and interest growth can offset that pressure.
- The drivers of lower six-month operating cash flow and the effects of client-balance movements on cash generation.
- The investment portfolio’s interest-rate exposure, unrealized losses, and accounting and capital implications of the AFS-to-HTM transfer.
- Developments in the pending litigation and any changes to the company’s assessment of potential loss or regulatory matters.