The Charles Schwab Corporation — 2017 Form 10-K
Reporting period: Fiscal year ended December 31, 2017. This annual filing also reports unaudited fourth-quarter results. Schwab provides brokerage, banking, wealth management, asset management, custody, and advisory services through Investor Services and Advisor Services.
Financial performance and position
- Revenue and earnings: Net revenue was $8.618 billion, up 15% from 2016. Net income was $2.354 billion, up 25%; net income available to common shareholders was $2.180 billion. Diluted EPS increased 23% to $1.61.
- Revenue mix: Net interest revenue grew 29% to $4.282 billion; asset management and administration fees rose 11% to $3.392 billion. Trading revenue fell 21% to $654 million, primarily following commission cuts. Net interest revenue represented 50% of revenue, fees 39%, and trading 8%.
- Profitability and costs: Pre-tax margin improved to 42.4% from 40.0%. Expenses excluding interest increased 11% to $4.968 billion, reflecting higher compensation, staffing, technology and professional-services spending, and regulatory assessments. The effective tax rate was 35.5%, versus 36.9%.
- Cash flow and investment: Operating cash flow was $1.263 billion, down from $2.662 billion in 2016; investing activities used $20.473 billion, while financing activities provided $22.599 billion. Capital expenditures were $412 million. Consolidated cash and cash equivalents ended the year at $14.217 billion.
- Balance sheet and debt: Total assets were $243.274 billion, up 9%; stockholders’ equity was $18.525 billion. Long-term debt was $4.753 billion, compared with $2.876 billion a year earlier, and short-term FHLB borrowings were $15.0 billion, versus none in 2016. The debt-to-total-capital ratio rose to 52% from 15%, largely reflecting the short-term borrowing. Bank deposits were $169.656 billion.
- Capital and lending: CSC’s Tier 1 leverage ratio was 7.6%, up from 7.2%; Schwab Bank’s was 7.1%. Both met regulatory capital requirements, and Schwab Bank was classified as well capitalized. Bank loans net of allowance were $16.478 billion; the allowance was $26 million, and nonperforming assets were $31 million.
- Business growth: Year-end client assets reached $3.362 trillion, up 21%; core net new client assets were $198.6 billion, up 58%. New brokerage accounts totaled 1.441 million, and assets receiving ongoing advisory services grew 21% to $1.700 trillion.
Material changes versus 2016
- Revenue growth accelerated earnings: net income rose 25%, while expenses rose 11%, expanding pre-tax margin by 2.4 percentage points.
- Net interest revenue increased $960 million, supported by higher rates and growth in interest-earning assets. Net interest margin improved to 1.97% from 1.73%.
- Trading revenue declined despite higher trading activity: daily average revenue trades rose 10%, but average revenue per revenue trade fell 27%, reflecting lower commission pricing. Standard equity, ETF, and option commissions were reduced in early 2017.
- Client cash as a share of client assets declined to 10.8% from 13.0%, as clients allocated more cash to equity, fixed-income, and other investments.
- In March 2017, Schwab transferred $24.7 billion of securities from available-for-sale to held-to-maturity, citing reduced regulatory-capital volatility as consolidated assets approach $250 billion.
Outlook, risks, and unusual items
- Tax outlook: Management estimated a 2018 effective tax rate of 23%–24%, reflecting the Tax Cuts and Jobs Act’s reduction in the federal corporate rate to 21%. The Act resulted in a $46 million one-time, non-cash tax charge in fourth-quarter 2017; the accounting impact remained subject to further analysis. Adoption of share-based compensation guidance reduced 2017 tax expense by approximately $87 million.
- Interest-rate sensitivity: Management said Schwab was positioned to benefit from rising rates, while noting that higher deposit costs, client cash moving to higher-yielding alternatives, and falling rates could pressure net interest revenue. A modeled gradual 100-basis-point rate increase implied a 3.3% rise in next-12-month net interest revenue; a 100-basis-point decrease implied a 6.2% decline. These are simulations, not forecasts.
- Liquidity and regulation: Schwab reported compliance with the modified Liquidity Coverage Ratio rule at year-end. It had $15.0 billion outstanding under its secured FHLB facility, with additional capacity dependent on eligible collateral. At $250 billion in consolidated assets, it would become subject to more stringent capital and liquidity frameworks.
- Key risks: Market and interest-rate changes, client asset and cash flows, price competition, regulatory requirements, cybersecurity and technology disruptions, third-party service-provider failures, credit exposures, and litigation could adversely affect results or liquidity.
- Contingencies: The filing describes ongoing litigation, including a Schwab Total Bond Market Fund case on appeal and a customer order-routing class action in which a motion to dismiss was denied. For certain matters, the company said it could not reasonably estimate potential liability; it asserted that it had strong defenses.
- Other notable items: Schwab redeemed $485 million of Series B preferred stock in December 2017 and issued $492 million of Series F preferred stock. It redeemed $625 million of 1.500% senior notes on February 8, 2018. The board raised the quarterly common dividend to $0.10 per share in January 2018.
Important facts for investors to verify
- Whether net interest revenue growth can continue as rates, client cash allocations, and deposit pricing change.
- Whether client asset inflows and advisory asset growth remain strong, and how market performance affects fee revenue.
- How the $15.0 billion FHLB borrowing, higher debt-to-capital ratio, and collateral requirements evolve.
- The final tax effects of the Tax Act and the realized 2018 effective tax rate versus management’s estimate.
- Developments and any estimable exposure from the disclosed litigation and regulatory matters.
- Progress toward the $250 billion asset threshold and the resulting regulatory capital and liquidity requirements.