Business context and reporting period
The Charles Schwab Corporation is a savings and loan holding company providing brokerage, banking, wealth management, asset management, custody, and advisory services through Investor Services and Advisor Services. This unaudited Form 10-Q covers the quarter and six months ended June 30, 2018; comparisons are with the corresponding 2017 periods unless noted. Amounts are in U.S. dollars.
Financial and operating performance
| Metric | Q2 2018 | Q2 2017 | First half 2018 | First half 2017 |
|---|---|---|---|---|
| Net revenues | $2.486 billion | $2.130 billion | $4.884 billion | $4.211 billion |
| Net income | $866 million | $575 million | $1.649 billion | $1.139 billion |
| Net income available to common stockholders | $813 million | $530 million | $1.559 billion | $1.055 billion |
| Diluted EPS | $0.60 | $0.39 | $1.14 | $0.78 |
| Expenses excluding interest | $1.355 billion | $1.221 billion | $2.751 billion | $2.459 billion |
| Pre-tax profit margin | 45.5% | 42.7% | 43.7% | 41.6% |
| Net interest revenue | $1.407 billion | $1.053 billion | $2.670 billion | $2.053 billion |
| Net interest margin | 2.30% | 1.96% | 2.21% | 1.91% |
Revenue growth was primarily driven by higher interest rates and growth in interest-earning assets. Asset management and administration fees declined 4% in Q2 to $814 million, while trading revenue rose 15% to $180 million. Expenses excluding interest increased 11% in Q2 and 12% in the first half, reflecting hiring, technology investment, and business growth. Effective tax rates fell to 23.4% for Q2 and 22.7% for the first half, principally reflecting the Tax Act’s reduction of the federal corporate rate.
Client assets were $3.397 trillion at quarter-end, up 12% year over year. Average client assets rose 13% in Q2. Schwab opened 384,000 brokerage accounts; active accounts reached 11.2 million. Core net new client assets were $53.4 billion in Q2 and $119.0 billion for the first half. Reported net new assets were $43.9 billion and $25.1 billion, respectively, including planned outflows from mutual fund clearing clients of $9.5 billion in Q2 and $93.9 billion year to date. Daily average revenue trades increased 21% in Q2.
Balance sheet, cash flow, debt, and capital
At June 30, 2018, total assets were $261.9 billion, up from $243.3 billion at December 31, 2017. Bank deposits were $199.9 billion, versus $169.7 billion; stockholders’ equity was $20.1 billion. Cash and cash equivalents were $13.3 billion. Long-term debt was $5.8 billion and short-term borrowings were zero, compared with $15.0 billion of short-term borrowings at year-end. The company issued approximately $1.95 billion of senior notes during Q2, redeemed $275 million of maturing debt, and repaid first-half FHLB advances that had been used for temporary funding.
For the first six months, operating cash flow was $3.380 billion, investing cash flow was negative $19.654 billion, and financing cash flow was $16.032 billion. Cash and cash equivalents including restricted amounts decreased $242 million to $18.918 billion. Schwab reported $30.266 billion of net deposit inflows and $1.936 billion of long-term debt issuance during the period. Cash flows include restricted cash following retrospective adoption of a new accounting standard.
CSC’s Common Equity Tier 1 ratio was 19.3% and Tier 1 leverage ratio was 7.6%; CSB’s corresponding ratios were 20.1% and 7.2%. The company and bank reported meeting applicable capital requirements and being well capitalized. Available external liquidity included $750 million of committed unsecured credit, $2.455 billion at the Federal Reserve discount window, and $30.323 billion of FHLB capacity, subject to collateral and other conditions.
Material changes, outlook, and risks
- Net income rose 51% in Q2 and 45% in the first half; revenue growth exceeded expense growth, supporting higher margins and return on equity of 19%, versus 15% in the prior-year periods.
- Management transferred $20 billion of sweep balances from money market funds to bank sweep deposits in Q2, bringing year-to-date transfers to $45 billion. Such transfers supported deposit and interest-earning asset growth but contributed to lower money market fund fee revenue.
- Management expected 2018 capital expenditures of approximately 6%–7% of net revenues, above its typical 3%–5% range, for U.S. campus expansion and technology investment. No broader earnings or revenue guidance is provided in the supplied filing text.
- Consolidated assets exceeded $250 billion in Q2. Management expected assets to remain above that level in 2018, triggering the full liquidity coverage ratio rule in 2019 and removal of the AOCI exclusion from regulatory capital beginning in 2019. Schwab reported compliance with the modified LCR rule at quarter-end.
- Interest-rate modeling estimated that a gradual 100-basis-point increase would raise net interest revenue 3.1% over the next 12 months; a 100-basis-point decrease would reduce it 4.8%. Actual outcomes may vary with rates, balance growth, client behavior, and management actions.
- Material risks include market and interest-rate conditions, client asset and cash levels, competitive pressure on pricing and deposit rates, liquidity and capital needs, expense control, execution of technology and product plans, and litigation or regulatory developments. Management reported no material changes to the risk factors in its 2017 Form 10-K.
- The filing describes pending Total Bond Market Fund and order-routing litigation. Schwab is contesting the claims; for matters where a material loss is reasonably possible, the filing says a potential liability estimate is generally not available at this stage. It also reports a $15 million first-quarter charge related to unsecured client margin losses in volatility-related products.
- The July 25, 2018 board declaration increased the quarterly common dividend 30%, from $0.10 to $0.13 per share. Revenue-standard adoption increased reported Q2 net income by $7 million and first-half net income by $15 million versus amounts without adoption; the standard also capitalized client-acquisition commissions.
Important facts for investors to verify
- How much of net interest revenue growth can persist if interest rates, deposit pricing, or sweep balances change.
- Whether core client asset growth continues and how planned mutual fund clearing outflows affect reported net flows and revenue.
- Whether expense growth and elevated capital expenditures translate into sustained operating leverage.
- The effect of the full LCR rule and AOCI treatment on liquidity and regulatory capital in 2019.
- Developments in the cited litigation and any resulting loss estimates, settlements, or charges.
- The continuing effects of the Tax Act and accounting-standard adoption on reported earnings, taxes, and balance-sheet comparisons.