Business context and reporting period
The Charles Schwab Corporation’s unaudited Form 10-Q covers the quarter and six months ended June 30, 2014. The company provides brokerage, banking, money management, and financial advisory services through its Investor Services and Advisor Services segments. Financial figures below are in millions of dollars unless stated otherwise.
Financial and operating metrics
| Metric | Q2 2014 | Q2 2013 | H1 2014 | H1 2013 |
|---|---|---|---|---|
| Net revenues | $1,478 | $1,337 | $2,956 | $2,627 |
| Net interest revenue | $562 | $473 | $1,115 | $942 |
| Asset management and administration fees | $632 | $572 | $1,243 | $1,124 |
| Trading revenue | $212 | $235 | $459 | $458 |
| Expenses excluding interest | $957 | $925 | $1,913 | $1,884 |
| Income before taxes | $521 | $412 | $1,043 | $743 |
| Net income | $324 | $256 | $650 | $462 |
| Net income available to common stockholders | $302 | $233 | $620 | $431 |
| Diluted EPS | $0.23 | $0.18 | $0.47 | $0.33 |
| Pre-tax profit margin | 35.3% | 30.8% | 35.3% | 28.3% |
- Year-over-year revenue rose 11% in Q2 and 13% in H1; net income rose 27% and 41%, respectively. Expenses increased 3% and 2%.
- Annualized return on average common equity was 12% in Q2 and 13% in H1. Expenses excluding interest were 0.16% of average client assets in both periods, versus 0.18% and 0.19% in 2013.
- Client assets were $2.402 trillion at quarter-end, up 17% year over year. Net new client assets were $22.7 billion in Q2 and $56.9 billion in H1; active brokerage accounts totaled 9.252 million.
- Cash flow for H1: operating activities provided $501; investing used $4,010; financing provided $2,613. Cash and cash equivalents declined $896 to $6,832. Regulatory-segregated cash and investments were a further $19,093 and are not generally available for corporate liquidity.
- At June 30, total assets were $143,401, total liabilities $132,231, and stockholders’ equity $11,170. Banking-client deposits were $95,688. Long-term debt was $1,901, essentially unchanged from year-end 2013; it represented 15% of total financial capital.
- Schwab Bank was well capitalized: Tier 1 risk-based capital ratio 20.5%, total risk-based ratio 20.6%, and Tier 1 leverage ratio 7.0%. CSC’s Tier 1 leverage ratio was 6.8%.
Material changes and management commentary
- Higher interest-earning asset balances and improved yields on held-to-maturity securities drove net interest revenue growth. Q2 average net interest margin rose to 1.65% from 1.49%; H1 rose to 1.64% from 1.50%.
- Fee growth reflected higher client assets in advisory solutions, Mutual Fund OneSource, and equity and bond funds. Low money-market yields continued to depress fees: Q2 fee waivers were $183 versus $157 a year earlier; H1 waivers were $368 versus $312.
- Q2 trading revenue fell 10%, primarily from lower daily average revenue trades (274,000 versus 302,000). H1 trading revenue was nearly flat.
- Q2 segment pre-tax income was $409 for Investor Services (up 37%) and $112 for Advisor Services (down 1%). H1 segment pre-tax income was $815 (up 54%) and $228 (up 7%), respectively.
- Management said persistently low short-term rates constrain net interest revenue and may continue to pressure money-market fund fee revenue. Simulations estimated that a gradual 100-basis-point rate increase would lift next-12-month net interest revenue 10.7%, while a 100-basis-point decrease would reduce it 4.5%; actual results may differ.
- Management revised its 2014 capital expenditure estimate to approximately 75% above 2013, versus its prior estimate of approximately 20% above, mainly to acquire facilities and land for growth. First-half capital expenditures were $168.
Outlook, risks, and contingencies
- The filing provides no earnings or revenue guidance. Management expects Basel III-related capital rules, phased in from 2015, not to have a material impact; the impact of a proposed liquidity rule was not yet assessable.
- Key sensitivities include interest rates, market-driven client asset values and activity, client cash and deposit balances, competition on rates and fees, credit and liquidity conditions, and expense management. Management reported no material risk-factor changes from the 2013 Form 10-K.
- Legal matters include the New York Attorney General’s auction-rate securities case (Schwab sought summary judgment in June 2014), an appeal in the Schwab Total Bond Market Fund litigation, and an appeal of an adverse SEC administrative decision involving optionsXpress. The optionsXpress contingent liability was described as immaterial; potential losses in other matters were not clearly estimable.
- No securities impairment charges were recorded in H1 2014. Management cautioned that further deterioration in underlying non-agency mortgage loans could lead to impairment losses.
- Credit quality indicators improved versus December 31, 2013: nonaccrual loans were $37 versus $48, and nonperforming assets were $44 versus $53. However, 78% of HELOC balances were in second-lien positions, and 46% of residential mortgage balances and 52% of HELOC balances were secured by California properties.
- CSC and Schwab Bank met applicable regulatory capital requirements. Disclosure controls were effective at June 30, 2014; management reported no material change in internal control over financial reporting during the quarter.
Most important facts for investors to verify
- Whether net interest revenue can continue growing if short-term rates remain low, and how rate movements affect margins and money-market fee waivers.
- Whether asset and advisory-fee growth, client inflows, and trading activity persist; compare reported 2013 net new assets with core flows because 2013 included a $44.3 billion one-time outflow from a planned client transfer.
- The revised capital expenditure plan, its timing and financing, and whether it delivers the expected capacity for growth.
- Developments in the auction-rate securities, Total Bond Market Fund, and optionsXpress matters, including any change in estimated exposure or reserves.
- Mortgage and HELOC performance, particularly second-lien and California concentrations, and any resulting change in provisions or impairment assessments.
- Regulatory capital and liquidity requirements taking effect from 2015, and the effect of any finalized liquidity rules.