Business context and reporting period
The Charles Schwab Corporation is a savings and loan holding company providing securities brokerage, banking, money management, and financial advisory services through its subsidiaries. This unaudited Form 10-Q covers the three months ended March 31, 2014; comparisons are with the first quarter of 2013 unless stated otherwise. Amounts are in millions of dollars except per-share data, ratios, and client metrics.
Financial performance and key metrics
| Metric | Q1 2014 | Q1 2013 | Change |
|---|---|---|---|
| Total net revenues | $1,478 | $1,290 | +15% |
| Net interest revenue | $553 | $469 | +18% |
| Asset management and administration fees | $611 | $552 | +11% |
| Trading revenue | $247 | $223 | +11% |
| Expenses excluding interest | $956 | $959 | Essentially flat |
| Income before taxes | $522 | $331 | +58% |
| Net income | $326 | $206 | +58% |
| Net income available to common stockholders | $318 | $198 | +61% |
| Diluted EPS | $0.24 | $0.15 | +60% |
Pre-tax margin was 35.3%, versus 25.7%; annualized return on average common equity was 13%, versus 9%. The effective tax rate was 37.5%, compared with 37.8%. Other comprehensive income was $99, primarily reflecting after-tax unrealized gains on available-for-sale securities; comprehensive income was $425.
Operating cash flow was $69, compared with a use of $368 in Q1 2013. Investing cash flow was a use of $3,210, versus a use of $8,035; financing cash flow was $2,586, versus $2,671 provided. Cash and cash equivalents decreased $555 to $7,173 during the quarter. These cash-flow figures are affected by brokerage and regulatory-segregation balances and investment activity.
Balance sheet, debt, and liquidity
At March 31, 2014, total assets were $144,066 and total liabilities were $133,251; stockholders’ equity was $10,815. Compared with December 31, 2013, assets increased $424 and equity increased $434. Banking-client deposits rose to $95,591 from $92,972, while brokerage-client payables declined to $32,308 from $35,333. Long-term debt was $1,902, essentially unchanged; it represented 15% of total financial capital, with a weighted-average interest rate of 3.60%.
CSC reported a 6.6% Tier 1 leverage ratio, 17.1% Tier 1 capital ratio, and 17.2% total capital ratio. Schwab Bank was categorized as well capitalized, with a 20.1% Tier 1 risk-based capital ratio, 20.3% total risk-based capital ratio, and 6.8% Tier 1 leverage ratio. Schwab had $1.5 billion of net capital, 10% of aggregate debit balances. The company reported unused liquidity sources including $2.6 billion available through the Federal Reserve discount window and $7.0 billion through the Federal Home Loan Bank facility. Regulatory-segregated cash and investments are not generally available for corporate liquidity needs.
Material changes and management commentary
- Management attributed revenue growth to higher balances of interest-earning assets, higher average rates on held-to-maturity securities, increased client assets in advice and mutual-fund offerings, and more daily revenue trades. Daily average revenue trades rose 13%; average revenue per revenue trade fell 3%.
- Net new client assets were $34.2 billion, down 21% year over year, primarily because of lower mutual-fund clearing inflows. Client assets reached $2.308 trillion, up 11%; new brokerage accounts rose 6% to 258,000, and active accounts rose 4% to 9.178 million.
- Expenses were broadly stable: lower compensation and advertising costs were offset by higher professional services and other costs. Management said compensation comparisons benefited from incentive-plan changes recorded in Q1 2013.
- Management revised its 2014 capital expenditure estimate to approximately 50% above 2013, from a prior expectation of approximately 20% above 2013, mainly because of planned facility acquisitions to support growth.
- No formal earnings or revenue guidance is provided in the filing. Management said persistently low short-term rates constrain net interest revenue and can pressure fees through money-market-fund fee waivers. Its interest-rate simulation estimated that a gradual 100-basis-point increase would raise next-12-month net interest revenue 10.2%, while a 100-basis-point decrease would reduce it 4.4%; actual results may differ.
Risks, contingencies, and unusual items
- Available-for-sale and held-to-maturity securities had fair values of $53.1 billion and $31.7 billion, respectively. Unrealized losses on held-to-maturity securities were $674 million at quarter-end. No impairment charges were recorded in Q1 2014; further deterioration in non-agency mortgage-backed securities could result in future impairment.
- Banking-client loans totaled $12.6 billion, net of a $48 million allowance. Nonaccrual loans were $40 million; nonperforming assets were $46 million. California represented 46% of residential mortgage balances and 51% of HELOC balances; 78% of HELOC balances were in second-lien positions.
- Material legal matters include New York Attorney General claims concerning auction-rate securities, an appeal in litigation involving the Schwab Total Bond Market Fund, and an appeal of an SEC administrative decision involving optionsXpress. The filing states that potential losses for some matters cannot be reasonably estimated; the optionsXpress contingent liability was not material at March 31, 2014.
- The company also disclosed ordinary-course litigation and regulatory inquiries, guarantees to clearing houses and exchanges for which potential liability is not quantifiable, and $5.9 billion of commitments to extend credit. A proposed modified liquidity coverage rule’s impact could not yet be assessed. New regulatory capital rules were scheduled to phase in beginning in 2015; management did not expect them to have a material impact.
- The filing reported no material changes to previously disclosed risk factors, no material change in internal control over financial reporting, and effective disclosure controls as of March 31, 2014.
Important facts for investors to verify
- Whether revenue growth and the improved margin persist if short-term rates remain low or client activity and asset values weaken.
- How much of reported cash and investment balances is restricted or otherwise unavailable for general liquidity, and whether deposit and brokerage cash balances remain stable.
- Credit quality and concentration trends in California mortgages, second-lien HELOCs, and the securities portfolio, including potential impairment exposure.
- Progress, potential financial exposure, and any reserve changes related to the disclosed litigation and regulatory matters.
- Execution and funding of the higher 2014 capital expenditure plan, as well as the effects of forthcoming capital and liquidity rules.