Charles Schwab Corporation — Q1 2019 Form 10-Q
Reporting period: Three months ended March 31, 2019; comparative period is Q1 2018 unless noted. Unaudited consolidated results. Amounts are in U.S. dollars.
Business context
Schwab provides brokerage, banking, wealth management, asset management, custody, and advisory services through Investor Services and Advisor Services. Its results are substantially influenced by client assets and activity, interest rates, and the mix of client cash and investments.
Financial and operating results
| Metric | Q1 2019 | Q1 2018 / comparison |
|---|---|---|
| Total net revenues | $2.723 billion | $2.398 billion; up 14% |
| Net interest revenue | $1.681 billion | $1.263 billion; up 33% |
| Asset management and administration fees | $755 million | $851 million; down 11% |
| Trading revenue | $185 million | $201 million; down 8% |
| Expenses excluding interest | $1.459 billion | $1.396 billion; up 5% |
| Income before taxes | $1.264 billion | $1.002 billion; up 26% |
| Net income | $964 million | $783 million; up 23% |
| Net income available to common stockholders | $925 million | $746 million; up 24% |
| Diluted earnings per share | $0.69 | $0.55; up 25% |
| Pre-tax profit margin | 46.4% | 41.8% |
| Net interest margin | 2.46% | 2.12% |
Net interest revenue benefited from higher rates following 2018 Federal Reserve increases and growth in average interest-earning assets, which rose 15% year over year. Higher interest expense partly offset interest revenue growth. Fee revenue declined mainly as sweep money market balances shifted to bank and broker-dealer sweep, and clients used Mutual Fund OneSource less. Trading revenue fell as daily average revenue trades declined 10%; revenue per trade was broadly stable.
Compensation and benefits increased 10%, primarily with higher headcount; professional services, occupancy, and depreciation also rose amid business and technology investments. Lower regulatory assessments and bad-debt expense partly offset those increases. Expenses grew more slowly than revenue, supporting the higher pre-tax margin. Effective tax rate was 23.7%, versus 21.9% in Q1 2018.
Clients, balance sheet, cash flow, and capital
- Quarter-end client assets were $3.585 trillion, up 8% year over year; average client assets were $3.466 trillion, up 2%. Net new client assets were $51.7 billion, compared with net outflows of $18.8 billion in Q1 2018, which included an $84.4 billion outflow from certain mutual fund clearing clients. Core net new assets were $51.7 billion versus $65.6 billion, a 21% decrease.
- Schwab opened 386,000 brokerage accounts, down 13%; active brokerage accounts reached 11.787 million, up 7%. Assets receiving ongoing advisory services were $1.871 trillion, up 9%.
- Total assets were $282.815 billion at March 31, 2019, down from $296.482 billion at December 31, 2018. Cash and cash equivalents were $32.558 billion; bank deposits were $219.454 billion, down from $231.423 billion at year-end. Client cash was 11.3% of client assets, versus 11.0% a year earlier.
- Long-term debt was $6.829 billion, compared with $6.878 billion at year-end. No short-term borrowings were outstanding. The company reported $6.881 billion par value of senior notes, with maturities from 2020 to 2029.
- Operating cash flow was a use of $2.595 billion, versus a source of $248 million in Q1 2018, principally reflecting changes in client-related balances. Investing cash flow was a source of $18.285 billion, including proceeds from securities sales; financing cash flow was a use of $12.229 billion, including a $11.969 billion decrease in bank deposits. These flows produced a $3.461 billion increase in cash and cash equivalents, including restricted cash.
- CSC’s Tier 1 leverage ratio was 7.2%; CSB’s was 7.0%. The company stated CSC and CSB met regulatory capital requirements and were well capitalized. Average liquidity coverage ratio was 111%; Schwab became subject to the full LCR rule on April 1, 2019.
Material changes, outlook, and notable items
- In Q1, Schwab transferred $11.6 billion from sweep money market funds to bank and broker-dealer sweep; it completed all remaining planned transfers in April 2019. The company said these transfers supported balance-sheet management but reduced money market fund revenue.
- Management expected 2019 capital expenditures to be approximately 7%–9% of total net revenues. Q1 capital expenditures were $181 million, versus $135 million a year earlier, mainly due to U.S. campus expansion. No specific earnings or revenue guidance was provided in the filing text.
- In January, the board increased the quarterly common dividend 31% to $0.17 per share and authorized up to $4 billion of common-stock repurchases, with no expiration date. No repurchases were made under the authorization during Q1; management expected to access it in coming quarters to return excess capital.
- Q1 other revenue included a gain from assignment of leased office space. Lease-accounting adoption added right-of-use assets and lease liabilities; at adoption these were $596 million and $662 million, respectively. The filing reported $597 million of lease assets and $663 million of lease liabilities at March 31.
- Schwab expected the January 2020 adoption of the CECL credit-loss standard to increase its allowance, primarily for held-to-maturity corporate debt securities; management expected the incremental allowance at adoption to be immaterial, subject to portfolio and economic conditions.
- Interest-rate risk remains important: simulations estimated that a gradual 100-basis-point rate increase would raise next-12-month net interest revenue 5.1%, while a 100-basis-point decrease would reduce it 5.4%, assuming no balance-sheet changes. Actual results may differ.
- The filing described the Crago order-routing class action alleging failure to seek best execution for certain orders routed to UBS during 2011–2014. Schwab denied the allegations and intended to contest the case; it could not reasonably estimate potential liability. The company said other pending matters were not expected, based on available information, to be material.
- Other risks identified include market conditions and trading activity, client asset and cash levels, pricing and deposit-rate competition, liquidity and capital needs, expense management, operational and compliance risks, and litigation or regulatory developments. Management reported no material change in risk factors from its 2018 Form 10-K.
Important facts for investors to verify
- Whether net interest revenue growth can continue if rates, deposit pricing, or client cash allocations change.
- Whether reduced sweep money market revenue and lower trading activity continue to offset growth in client assets and interest income.
- How planned share repurchases, the higher dividend, capital spending, and balance-sheet growth affect capital and liquidity.
- The eventual impact of CECL adoption and the development of expected credit-loss estimates.
- Developments and potential exposure in the Crago litigation and other regulatory or legal matters.
- That the reported cash-flow movements largely reflect client and deposit activity; operating cash flow alone should not be read as a conventional measure of earnings quality for this financial-services business.