Business context and reporting period
The Charles Schwab Corporation’s 10-K covers the fiscal year ended December 31, 2013; the filing also reports unaudited quarterly results. Schwab provides brokerage, banking, asset management and advisory services through Investor Services and Advisor Services. At year-end, it reported $2.25 trillion in client assets, 9.1 million active brokerage accounts and 916,000 banking accounts.
Key financial and operating metrics
| Metric | 2013 | 2012 | Change |
|---|---|---|---|
| Net revenue | $5.435 billion | $4.883 billion | +11% |
| Expenses excluding interest | $3.730 billion | $3.433 billion | +9% |
| Income before taxes | $1.705 billion | $1.450 billion | +18% |
| Net income | $1.071 billion | $928 million | +15% |
| Net income available to common stockholders | $1.010 billion | $883 million | +14% |
| Diluted EPS | $0.78 | $0.69 | +13% |
| Pre-tax profit margin | 31.4% | 29.7% | +1.7 percentage points |
- Revenue mix: asset management and administration fees were $2.315 billion (+13%); net interest revenue was $1.980 billion (+12%); trading revenue was $913 million (+5%). Other revenue was $236 million, down 8%, partly reflecting the absence of a $70 million vendor-dispute settlement gain recorded in 2012.
- Net interest margin was 1.52%, down from 1.62%. Management attributed revenue growth to higher asset balances, market appreciation, advisory enrollment and trading activity, while low short-term rates continued to constrain yields.
- Cash flow: operating activities provided $1.656 billion; investing activities used $20.050 billion, largely reflecting securities purchases and growth in banking loans; financing activities provided $13.459 billion. Cash and cash equivalents decreased $4.935 billion to $7.728 billion.
- Year-end balance sheet: total assets were $143.642 billion, total liabilities $133.261 billion and stockholders’ equity $10.381 billion. Banking-client deposits were $92.972 billion; long-term debt was $1.903 billion, or 15% of total financial capital. The company issued $275 million of 2.20% senior notes due 2018.
- Liquidity and capital: Schwab Bank had a 6.6% Tier 1 leverage ratio and 19.0% Tier 1 risk-based capital ratio and was categorized as well capitalized. CSC reported a 6.4% Tier 1 leverage ratio. Schwab’s broker-dealer net capital was $1.446 billion. Some segregated client cash and securities are not available for general liquidity.
- Common dividends were $0.24 per share for the year. No shares were repurchased under the public repurchase program in 2013; $596 million of authorization remained.
Fourth-quarter results (unaudited)
Q4 2013 net revenue was $1.435 billion versus $1.215 billion in Q4 2012; net income was $319 million versus $211 million; income available to common stockholders was $297 million versus $189 million; and diluted EPS was $0.23 versus $0.15.
Material changes versus the prior comparable period
- Client assets rose 15% to $2.249 trillion and active brokerage accounts increased 3%. Core net new client assets grew 25% to $140.8 billion. Reported net new assets were $41.6 billion, affected by a $74.5 billion planned mutual-fund-clearing client transfer; the company also reduced reported client assets by $24.7 billion following retirement-plan platform consolidation and client resignations.
- Expenses rose 9%, with compensation and benefits up 12% to $2.027 billion. Management cited higher incentive compensation, employee benefits, professional services and advertising, including the “Own your tomorrow” campaign.
- Net impairment losses on securities declined to $10 million from $32 million. The provision for loan losses was a $1 million recovery, compared with a $16 million provision in 2012; management cited improved residential mortgage and HELOC credit quality.
- Other comprehensive income turned to a $289 million loss from $290 million of income, mainly due to a $468 million pre-tax unrealized loss on available-for-sale securities. Accumulated other comprehensive income fell to $9 million from $298 million.
Outlook, management commentary, risks and contingencies
- Management expected 2014 capital expenditures to be approximately 20% higher than 2013’s $270 million, mainly for buildings, equipment and leasehold improvements, including the Denver office campus project. This is an estimate, not earnings guidance.
- Management said continued low short-term rates would constrain net interest revenue and could sustain fee waivers on certain money-market funds. Fee waivers were $674 million in 2013, up from $587 million in 2012. A gradual 100-basis-point rate increase was modeled to raise next-12-month net interest revenue 11.0%; a 100-basis-point decrease was modeled to reduce it 4.5%. These are simulations, not forecasts.
- Basel III/Dodd-Frank capital rules were scheduled to phase in beginning in 2015; management did not expect a material impact. The company was evaluating a proposed liquidity coverage requirement. A clearinghouse special liquidity deposit rule took effect February 1, 2014; management expected no material impact. An additional proposed equities-related requirement had been withdrawn, with alternatives under discussion.
- Material risk factors include sensitivity to interest rates and market valuations, competition on pricing, client cash outflows, credit and securities impairment risk, mortgage concentrations, regulatory change, cyberattacks and operational/vendor failures, and litigation. The investment portfolio included $48.9 billion of mortgage-backed securities, largely agency-issued; 46% of residential mortgages and 51% of HELOC balances were secured by California properties.
- Legal matters include an appeal of an adverse administrative decision against optionsXpress involving Regulation SHO (the company disputed the findings; the contingent liability was not material at year-end), revived claims in a New York auction-rate-securities case, and pending appeal in Total Bond Market Fund litigation. Schwab was also pursuing claims over non-agency mortgage-backed securities. The filing states some potential losses cannot yet be reasonably estimated.
- The company reported effective disclosure controls and internal control over financial reporting; Deloitte & Touche issued unqualified opinions on the financial statements and internal control.
Important facts for investors to verify
- Whether core asset flows remain strong after the planned $74.5 billion client transfer and retirement-plan platform changes, and how those changes affect reported client assets.
- How persistent low rates, money-market fee waivers and repricing of the investment portfolio affect net interest revenue and margins.
- The performance, valuation sensitivity and credit quality of securities portfolios, especially mortgage-backed securities, and the effect of further unrealized losses or impairment.
- Mortgage/HELOC credit trends and geographic concentration, alongside the implications of HELOC second-lien exposure and future payment resets.
- Developments in the disclosed lawsuits and regulatory matters, and any effects from new capital, liquidity or clearinghouse requirements.
- The filing’s selected financial data lists 2012 assets as $133.617 billion, while the audited balance sheet lists $133.637 billion; verify the correct comparative figure in the filed financial statements.