Business context and reporting period
The Charles Schwab Corporation is a savings and loan holding company operating brokerage, banking, asset-management, and related financial-services businesses through its Investor Services and Institutional Services segments. This unaudited Form 10-Q covers the quarter and nine months ended September 30, 2011; amounts are in millions unless stated otherwise.
Financial performance and position
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Net revenues | $1,181 | $1,063 | $3,578 | $3,121 |
| Income before taxes | $360 | $199 | $1,140 | $550 |
| Net income | $220 | $124 | $701 | $335 |
| Diluted EPS | $0.18 | $0.10 | $0.57 | $0.28 |
| Pre-tax profit margin | 30.5% | 18.7% | 31.9% | 17.6% |
- Revenue drivers: Q3 net interest revenue rose 14% to $443 and trading revenue rose 36% to $248; asset-management and administration fees were nearly unchanged at $466. For the first nine months, net interest revenue increased 20% to $1,330, trading revenue 11% to $694, and fees 11% to $1,470.
- Expenses excluding interest were $821 in Q3, down 5%, and $2,438 year to date, down 5%. Compensation and benefits increased 11% in Q3 and 10% year to date.
- Cash and cash equivalents were $6.376 billion at September 30, versus $4.931 billion at year-end 2010. Nine-month operating cash flow was $2.012 billion, investing cash flow was negative $3.821 billion, and financing cash flow was positive $3.254 billion.
- Total assets were $102.906 billion, liabilities $95.251 billion, and stockholders’ equity $7.655 billion. Long-term debt was $2.002 billion, approximately 21% of total financial capital; deposits from banking clients were $54.078 billion. Management reported a loan-to-deposit ratio of 18%.
- Schwab Bank was reported as well capitalized, with a 23.0% Tier 1 risk-based capital ratio and a 7.6% Tier 1 core capital ratio. CSC’s Tier 1 leverage ratio was 6.5%, against a stated target of at least 6%.
Material changes versus comparable periods
- Net income increased 77% in Q3 and 109% for the first nine months. Higher average interest-earning asset balances and increased trading activity supported revenue growth.
- Comparisons benefited from prior-year charges: Q3 2010 included $132 million of money-market-fund losses and a $21 million credit-card-program termination charge; the first nine months of 2010 also included a $196 million YieldPlus litigation reserve. These items contributed to lower reported expenses in 2011.
- Client assets reached $1.576 trillion, up 7% year over year. Q3 net new client assets were $86.0 billion, including $60.9 billion from mutual-fund clearing clients and $7.5 billion related to optionsXpress. Excluding those inflows, net new assets were $17.6 billion, up 21% year over year. Daily average client trades increased 35% to 475,400.
- On September 1, Schwab completed its $714 million, stock-based acquisition of optionsXpress, issuing 59 million shares. The acquired business contributed $17 million in revenue and a $2 million net loss from the acquisition date through quarter-end. Preliminary goodwill of $507 million was recorded.
Outlook, commentary, risks and contingencies
- The filing provides no specific earnings or revenue guidance. Management said persistently low short-term rates constrain net interest revenue and require fee waivers on certain money-market funds; waivers could increase if fund yields remain low or decline.
- Management expected full-year 2011 capital expenditures to be approximately 55% above 2010, compared with its prior expectation of 35% growth, mainly because of increased internal-use software development spending.
- The company recorded securities impairment charges of $13 million in Q3 and $22 million year to date, primarily related to non-agency residential mortgage-backed securities. Management warned that further deterioration in underlying loans could cause additional charges. It said it did not intend, and was not expected to be required, to sell these securities before anticipated recovery.
- Market risks include volatile equity markets, low interest rates, asset-price movements, credit deterioration, and liquidity or valuation changes in investment securities. A modeled 100-basis-point rate increase would raise 12-month net interest revenue by 20.1%; a 100-basis-point decrease would reduce it by 6.4%. These are simulations, not forecasts.
- Contingencies include litigation and regulatory matters. The New York Attorney General’s auction-rate-securities complaint was dismissed on October 24, 2011. The Schwab Total Bond Market Fund case had been dismissed with prejudice, but an appeal remained pending. The optionsXpress merger litigation settlement was subject to court approval. The filing states that outcomes and potential losses in some matters cannot yet be reasonably estimated.
- Dodd-Frank implementation changed the company’s primary regulators in July 2011; management was continuing to assess the law’s effects. Management also cautioned that actual results may differ from forward-looking statements. It reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether low interest rates and money-market fee waivers continue to pressure fee revenue and net interest margins.
- Whether trading activity and client-asset inflows persist, particularly excluding acquisition and clearing-client-related flows.
- OptionsXpress integration, final purchase-price allocation, and the contribution of the acquisition to earnings and expenses.
- Performance of non-agency mortgage-backed securities, additional impairment exposure, and the concentration of mortgage lending in California.
- Developments and potential costs in pending litigation, regulatory proceedings, and Dodd-Frank rulemaking.
- Capital spending against the higher 2011 outlook, liquidity needs, and the company’s capital and debt targets.