Charles Schwab Corporation — Q2 2015 Form 10-Q
Reporting period: Three and six months ended June 30, 2015; unaudited. Schwab provides wealth management, brokerage, banking, money management, and advisory services through Investor Services and Advisor Services.
Financial and operating performance
Amounts are in millions except per-share data, ratios, and client metrics.
| Metric | Q2 2015 | Q2 2014 | H1 2015 | H1 2014 |
|---|---|---|---|---|
| Net revenues | $1,566 | $1,478 | $3,092 | $2,956 |
| Net interest revenue | $612 | $562 | $1,200 | $1,115 |
| Asset management and administration fees | $670 | $632 | $1,314 | $1,243 |
| Trading revenue | $203 | $212 | $430 | $459 |
| Expenses excluding interest | $999 | $957 | $2,041 | $1,913 |
| Income before taxes | $567 | $521 | $1,051 | $1,043 |
| Net income | $353 | $324 | $655 | $650 |
| Diluted EPS | $0.25 | $0.23 | $0.47 | $0.47 |
| Pre-tax profit margin | 36.2% | 35.3% | 34.0% | 35.3% |
| Return on average common equity, annualized | 12% | 12% | 11% | 13% |
- Q2 revenue grew 6% and net income grew 9% year over year; H1 revenue grew 5%, while net income increased 1% and diluted EPS was unchanged.
- Client assets were $2.543 trillion at quarter-end, up 6% year over year. Q2 net new client assets were $37.0 billion, including an $11.6 billion one-time outflow excluded from core flows; core net new assets were also $37.0 billion. H1 net new assets were $65.7 billion and core net new assets were $71.2 billion.
- Schwab added 280,000 brokerage accounts in Q2; active brokerage accounts reached 9.605 million. Assets receiving ongoing advisory services were $1.258 trillion.
- Q2 segment results: Investor Services revenue of $1.193 billion and pre-tax income of $423 million; Advisor Services revenue of $373 million and pre-tax income of $144 million. Advisor Services revenue grew 11% year over year, compared with 4% for Investor Services.
Balance sheet, cash flow, and liquidity
- At June 30, total assets were $163.627 billion, total liabilities $151.204 billion, and stockholders’ equity $12.423 billion. Cash and cash equivalents were $9.017 billion; an additional $17.884 billion was segregated or on deposit for regulatory purposes and is not generally available for corporate liquidity.
- Bank deposits were $112.911 billion, up from $102.815 billion at December 31, 2014. Long-term debt was $2.894 billion, up from $1.899 billion; debt represented 19% of total financial capital versus 14% at year-end. Management’s long-term debt target is no more than 30% of financial capital.
- For H1, operating cash flow was negative $737 million, investing cash flow was negative $12.568 billion, and financing cash flow was positive $10.959 billion. Financing included a $10.096 billion increase in bank deposits and $998 million of debt issuance. Cash declined $2.346 billion to $9.017 billion.
- On March 10, the company issued $625 million of 1.50% senior notes due 2018 and $375 million of 3.00% notes due 2025. No commercial paper or committed corporate credit facility borrowings were outstanding at quarter-end. Schwab Bank had $2.2 billion available at the Federal Reserve discount window and $9.2 billion available through the Federal Home Loan Bank facility; neither was drawn in H1.
- Regulatory capital ratios were above stated minimums. Schwab Bank was classified as well capitalized, with a 17.7% Common Equity Tier 1 ratio and 7.0% Tier 1 leverage ratio. Schwab broker-dealer net capital was $1.650 billion, or 9% of aggregate debit balances.
Material changes and management commentary
- Revenue growth reflected higher net interest revenue and asset-management fees, partly offset by lower trading revenue. Net interest revenue benefited from larger interest-earning asset balances, while lower average rates compressed net interest margin. Q2 average net interest margin was 1.60%, versus 1.65% a year earlier.
- Trading revenue fell 4% in Q2 and 6% in H1. Q2 daily average revenue trades declined 3% year over year; average revenue per revenue trade declined 2%.
- Expenses excluding interest rose 4% in Q2 and 7% in H1, driven in part by compensation, employee headcount, depreciation and amortization, and other costs. The H1 pre-tax margin declined 1.3 percentage points.
- Management said persistently low short-term rates constrain net interest revenue and can require fee waivers on certain money market funds. Its 12-month simulation indicated net interest revenue would rise 10.6% with a gradual 100-basis-point rate increase and fall 5.9% with a 100-basis-point decrease, assuming the balance sheet remains unchanged.
- Capital expenditures were $139 million in H1. Management revised its full-year 2015 estimate to approximately 5% below 2014, compared with its prior expectation of approximately 15% below 2014.
Outlook, risks, and unusual items
- No specific revenue or earnings guidance is provided. The company expected to comply with the modified liquidity coverage ratio by January 1, 2016 and did not expect a material business or financial impact. The rule’s minimum requirement phases in at 90% in 2016 and 100% in 2017.
- A proposed Department of Labor fiduciary rule could broaden obligations for broker-dealers advising retirement accounts; the proposal remained subject to modification, and the company was evaluating its impact.
- Q2 other revenue included $17 million of proceeds from litigation concerning non-agency residential mortgage-backed securities. Cumulative net settlement proceeds were $45 million; a trial involving remaining defendants was scheduled for February 2016.
- In a subsequent event, on August 3 the company issued 24 million depositary shares representing Series C perpetual preferred stock with a 6.00% fixed dividend. Net proceeds were $581 million, intended to support balance-sheet growth, including migration of certain client balances into Schwab Bank.
- Credit risks include a $14.014 billion net bank-loan portfolio, with 48% of first-mortgage and HELOC balances concentrated in California; 79% of HELOC balances were in second-lien positions. Loan delinquencies were 0.20% of loans, nonaccrual loans 0.22%, and the allowance for loan losses 0.26% at June 30.
- Significant legal matters include the Total Bond Market Fund litigation, remanded for further proceedings after an appellate reversal, and an SEC administrative proceeding involving optionsXpress that the company is appealing. The filing says potential liability estimates are generally unavailable at this stage. Guarantees to clearing houses carry unquantifiable exposure, though payment was considered remote.
- Interest-rate, market, liquidity, credit, operational, legal, and regulatory risks remain relevant. The filing reported no material changes to the company’s previously disclosed risk factors and no material change in internal control over financial reporting.
Investor verification priorities
- Confirm the composition and durability of revenue growth, particularly the balance between net interest revenue, asset-based fees, and declining trading revenue.
- Assess sensitivity to interest rates, including the effects of low rates on net interest margins and money-market-fund fee waivers.
- Review the negative H1 operating cash flow in the context of client cash movements, regulatory segregation, and the substantial investment-portfolio purchases.
- Track debt growth, capital ratios, the Series C preferred issuance and dividend cost, and compliance with upcoming liquidity and capital rules.
- Monitor California mortgage and second-lien HELOC concentrations, loan performance, litigation developments, and any impact from the proposed fiduciary rule.