Charles Schwab Corporation — Q3 2009 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2009. Unaudited consolidated results compare with the corresponding 2008 periods. Schwab provides brokerage, banking, investment management and related financial services.
Financial performance
Amounts are in millions, except per-share data and ratios.
| Metric | Q3 2009 | Q3 2008 | Nine months 2009 | Nine months 2008 |
|---|---|---|---|---|
| Total net revenues | $1,011 | $1,251 | $3,207 | $3,866 |
| Net interest revenue | $294 | $447 | $902 | $1,293 |
| Asset management and administration fees | $451 | $596 | $1,439 | $1,827 |
| Trading revenue | $241 | $252 | $772 | $728 |
| Expenses excluding interest | $691 | $752 | $2,197 | $2,345 |
| Pre-tax income from continuing operations | $320 | $499 | $1,010 | $1,521 |
| Net income | $200 | $304 | $623 | $904 |
| Diluted EPS | $0.17 | $0.26 | $0.54 | $0.78 |
- Q3 net revenue fell 19% year over year and nine-month revenue fell 17%. Net income declined 34% and 31%, respectively.
- Pre-tax margin was 31.7% in Q3 versus 39.9% a year earlier, and 31.5% for the nine-month period versus 39.3%.
- Q3 net interest revenue declined 34%; nine-month net interest revenue declined 30%. Management attributed the pressure mainly to very low rates and a less favorable asset mix, partly offset by growth in average interest-earning assets.
- Money-market mutual fund fee waivers were $78 million in Q3 and $114 million for the first nine months; none were reported in 2008. Q3 trading revenue decreased 4%, while nine-month trading revenue increased 6%.
Balance sheet, cash flow and capital
- At September 30, 2009, total assets were $67.984 billion, compared with $51.675 billion at December 31, 2008; stockholders’ equity was $4.903 billion versus $4.061 billion. Banking-client deposits rose to $35.500 billion from $23.841 billion.
- Cash and cash equivalents were $8.116 billion, up from $5.442 billion at year-end 2008. The filing reports a 19% loan-to-deposit ratio and describes liquidity as adequate.
- For the first nine months, operating cash flow was positive $700 million, compared with negative $712 million in 2008; investing cash flow was negative $10.188 billion and financing cash flow was positive $12.162 billion. The increase in deposits was a major financing source.
- Long-term debt was $1.516 billion versus $883 million at year-end. Schwab issued $750 million of 4.95% senior notes due 2014 and repurchased $98 million of trust preferred securities for $67 million, recognizing a $31 million gain. Long-term debt represented 24% of financial capital, below management’s stated long-term target ceiling of 30%.
- Schwab Bank was classified as well capitalized: Tier 1 capital ratio 17.0%, total capital ratio 17.3%, and leverage ratio 6.4%. CSC’s Tier 1 leverage ratio was 7.4%. Schwab’s net capital was $1.1 billion, $897 million above its minimum requirement.
- The company declared dividends of $0.06 per share in Q3 and $0.18 per share for the nine months. It made no company share repurchases in the first nine months of 2009; $596 million remained authorized.
Material changes and management commentary
- Net new client assets were $19.9 billion in Q3, down 18% year over year; nine-month net inflows were $62.5 billion, down 32%. Quarter-end client assets were $1.364 trillion, up 5% year over year. Daily average trades were 318,500 in Q3, down 5% year over year.
- Expenses excluding interest fell 8% in Q3 and 6% for the nine months, reflecting lower compensation, professional services and advertising. Nine-month expenses included $99 million in facilities and severance charges and a $16 million FDIC special assessment; insurance recoveries produced a net $13 million credit for certain YieldPlus-related costs.
- Management said low rates, market valuations, client activity and mortgage-credit conditions continued to affect results. It warned that further low rates may increase money-market fee waivers and constrain net interest revenue; declining client asset values may reduce asset-based fees.
- The company recorded $11 million of net impairment losses on non-agency residential mortgage-backed securities in Q3 and $38 million for the nine months. It reported $643 million of unrealized losses on available-for-sale securities, concentrated in non-agency mortgage-backed securities, and said further deterioration could require additional impairment charges.
- No specific earnings or revenue guidance was provided in the filing. The filing states that interim results are not necessarily indicative of full-year results.
Risks, contingencies and unusual items
- Mortgage and credit exposure: The company held $21.3 billion of available-for-sale securities and $3.0 billion of held-to-maturity securities. Non-agency mortgage securities had $585 million of unrealized losses; Alt-A mortgage-backed securities had $672 million amortized cost and $393 million fair value. Banking-client nonaccrual loans rose to $26 million from $8 million at year-end, and the loan-loss allowance rose to $44 million from $20 million.
- Legal and regulatory matters: The New York Attorney General sued Schwab over auction-rate securities, seeking remedies that include restitution and potential repurchases. YieldPlus Fund class actions were certified as classes; the company received SEC and FINRA Wells notices concerning possible enforcement actions. The SEC notice also addressed the Total Bond Market Fund. The company said it intends to contest the matters and could not estimate potential liability; it warned that a possible YieldPlus liability could exceed applicable insurance limits.
- Other commitments: Standby letters of credit totaled $445 million for listed options clearing and $31 million for securities-lending collateral; none were drawn. The company also described clearing-house guarantees whose potential liability is not quantifiable, though payment was considered remote.
- Market sensitivity: The company’s interest-rate simulation estimated that a gradual 100-basis-point increase would raise next-12-month net interest revenue by 19.4%, while a 100-basis-point decrease would reduce it by 3.8%, based on the modeled balance sheet and assumptions. Actual results may differ.
Important facts for investors to verify
- Whether further low rates, market changes or higher fee waivers continue to pressure net interest revenue and asset-based fees.
- Mortgage-backed securities valuations, underlying loan performance, impairment assumptions and future credit-loss provisions.
- Developments, potential liabilities and insurance coverage in the auction-rate securities, YieldPlus and Total Bond Market matters.
- Deposit growth, liquidity, capital ratios and debt levels, including the refinancing and maturity profile of outstanding notes.
- Whether client asset inflows, trading activity and expense reductions can offset the revenue declines reported for 2009.