Business context and reporting period
The Charles Schwab Corporation is a savings and loan holding company providing brokerage, banking, asset-management and related services through its subsidiaries. This unaudited Form 10-Q covers the three months ended March 31, 2011, compared with the three months ended March 31, 2010. Amounts are in millions of dollars unless stated otherwise.
Financial and operating performance
| Metric | Q1 2011 | Q1 2010 | Change/comment |
|---|---|---|---|
| Total net revenues | $1,207 | $978 | Up 23% |
| Net interest revenue | $436 | $340 | Up 28%; net interest margin was 1.96% versus 1.91% |
| Asset management and administration fees | $502 | $420 | Up 20%; includes money-market fee waivers of $112 versus $125 |
| Trading revenue | $241 | $209 | Up 15%; daily average revenue trades rose 16%, while average revenue per trade fell 4% |
| Expenses excluding interest | $813 | $965 | Down 16%, principally reflecting the prior-year litigation reserve |
| Income before taxes | $394 | $13 | Pre-tax margin was 32.6% versus 1.3% |
| Net income | $243 | $6 | Diluted EPS was $0.20 versus $0.00 (reported as zero) |
| Cash flow from operations | $1,303 | $(589) | Improved; cash flows include substantial client-balance movements |
Client assets ended the quarter at $1.647 trillion, up 10% year over year; net new client assets were $23.0 billion, compared with $23.3 billion. Clients’ daily average trades increased 14% to 472,500, the highest level in nine quarters. Investor Services revenue rose 28% to $820 million and Institutional Services revenue rose 15% to $386 million.
Balance sheet, debt and liquidity
- Total assets were $94.883 billion at March 31, 2011, compared with $92.568 billion at December 31, 2010. Cash and cash equivalents were $5.548 billion; regulatory-segregated cash and investments were $23.071 billion.
- Banking-client deposits were $51.259 billion; brokerage-client payables were $32.106 billion. Banking-client loans, net, were $9.130 billion, producing a reported loan-to-deposit ratio of 18%.
- Long-term debt was $2.005 billion, essentially unchanged from year-end. Debt was 24% of total financial capital; the weighted-average interest rate was 5.24%. Total stockholders’ equity was $6.487 billion.
- Management reported adequate liquidity, access to borrowing facilities and regulatory capital ratios above “well capitalized” levels. Schwab Bank’s Tier 1 risk-based capital ratio was 23.9%; Schwab’s net capital was $1.2 billion. The company’s Tier 1 leverage ratio was 6.5%.
Material changes versus the prior comparable period
- Revenue growth reflected higher average interest-earning assets, higher client asset valuations and inflows, increased advisory fees, and greater trading activity. A persistently low-rate environment continued to constrain yields and require money-market fund fee waivers.
- The sharp year-over-year expense decline is not solely indicative of recurring cost reductions: Q1 2010 included a $196 million YieldPlus class-action reserve. Q1 2011 compensation and benefits rose 9% and professional services rose 15%.
- The loan-loss provision declined to $4 million from $14 million, reflecting lower expected loss rates and reduced first-mortgage delinquencies. Net securities impairment charges were $7 million versus $8 million.
- Total assets increased by $2.315 billion from December 31, 2010; available-for-sale securities rose to $26.046 billion, while held-to-maturity securities declined to $16.646 billion.
Outlook, management commentary, risks and unusual items
- No formal earnings guidance is provided. Management said low short-term rates may continue to constrain net interest revenue and may sustain or increase money-market fee waivers. The company’s interest-rate simulation indicated that a gradual 100-basis-point rise would increase modeled 12-month net interest revenue by 14.6%, while a 100-basis-point decline would reduce it by 4.7%; actual results may differ.
- Management expects 2011 capital expenditures to be approximately 40% above 2010 levels, versus its earlier estimate of 35% higher, primarily for technology, equipment and leasehold improvements.
- Schwab agreed to acquire optionsXpress in an all-stock transaction valued at approximately $1.0 billion based on Schwab’s March 31 share price. Closing was expected in Q3 2011, subject to shareholder, regulatory and other customary approvals. Stockholder lawsuits challenging the transaction were pending.
- Non-agency mortgage-backed securities remained a key credit and valuation risk. Management recorded $7 million of expected credit-loss impairment in Q1; further deterioration in underlying mortgage performance could lead to additional charges. The company reported $179 million of unrealized losses on available-for-sale securities, concentrated in non-agency residential mortgage-backed securities, and $160 million on held-to-maturity securities.
- Other legal matters include the New York Attorney General’s auction-rate-securities case and the Northstar Total Bond Market Fund litigation. The Smit fund case was dismissed with prejudice on April 19, 2011. Management said pending matters were not expected to materially affect financial condition or cash flows, but could affect results in a particular period; some losses could not yet be estimated.
- Guarantees to clearing organizations could require payments if another member defaults; the potential liability is not quantifiable, though management considered payment remote. Standby letters of credit totaled $499 million, with no amounts drawn at quarter-end.
- Dodd-Frank implementation was ongoing; the filing anticipated a change in primary regulators effective July 21, 2011. Management cited market conditions, interest rates, client asset levels, litigation, regulation, acquisition approvals and financing availability among factors that could cause actual results to differ from expectations.
Important facts for investors to verify
- How much of the profit and margin improvement is sustainable after adjusting for the $196 million prior-year litigation reserve?
- Whether low interest rates, fee waivers and changes in client balances continue to affect net interest revenue and asset-based fees.
- Developments in non-agency mortgage-backed securities performance, impairment estimates and related litigation.
- Completion terms, approvals, timing and potential effects of the optionsXpress acquisition and its related litigation.
- Actual 2011 capital expenditure levels, capital and liquidity positions, and regulatory changes following the Dodd-Frank transition.