Charles Schwab Corporation — Q1 2017 Form 10-Q
Reporting period: Three months ended March 31, 2017; comparisons are primarily with Q1 2016. Schwab provides wealth management, brokerage, banking, asset management, custody, and advisory services through Investor Services and Advisor Services.
Financial and operating performance
| Metric | Q1 2017 | Q1 2016 / comparison |
|---|---|---|
| Net revenues | $2.081 billion | $1.764 billion; up 18% |
| Net interest revenue | $1.000 billion | $772 million; up 30% |
| Asset management and administration fees | $823 million | $699 million; up 18% |
| Trading revenue | $192 million | $232 million; down 17% |
| Expenses excluding interest | $1.238 billion | $1.109 billion; up 12% |
| Income before taxes | $843 million | $655 million; up 29% |
| Net income | $564 million | $412 million; up 37% |
| Net income available to common stockholders | $525 million | $392 million; up 34% |
| Diluted EPS | $0.39 | $0.29; up 34% |
| Pre-tax margin | 40.5% | 37.1% |
| Return on average common equity | 15% | 13% |
| Net interest margin | 1.87% | 1.73%; up 14 basis points |
Net interest revenue growth reflected higher short-term rates and growth in interest-earning assets, particularly as bank deposits increased. Fee growth reflected higher money-market fund revenue and growth in advisory, mutual fund, and ETF assets. Trading revenue fell as lower commissions per trade and lower trading volumes outweighed a modest increase in trading days. Schwab reduced standard equity, ETF, and option trade commissions from $8.95 to $4.95 and the per-contract option fee from $0.75 to $0.65.
- Client activity: Net new client assets were $38.9 billion, up 22%; quarter-end client assets were $2.923 trillion, up 14%. New brokerage accounts increased 37% to 362,000, and active brokerage accounts rose 5% to 10.32 million.
- Assets receiving ongoing advisory services reached $1.482 trillion, up 16%. Client cash was 12.4% of client assets, versus 13.1% a year earlier.
- Advisor Services revenue increased 21% to $593 million; Investor Services revenue increased 17% to $1.488 billion. Pre-tax income was $285 million and $558 million, respectively.
Cash flow, balance sheet, debt, and capital
- Cash flow: Operating activities used $334 million, investing activities used $5.587 billion, and financing activities provided $4.568 billion. Cash and cash equivalents declined $1.353 billion during the quarter to $9.475 billion. Financing included a $3.435 billion increase in bank deposits and $643 million of net long-term debt issuance proceeds.
- Balance sheet at March 31, 2017: Total assets were $227.061 billion, up from $223.383 billion at year-end 2016; total liabilities were $210.079 billion and stockholders’ equity was $16.982 billion. Bank deposits were $166.889 billion.
- Debt: Long-term debt was $3.518 billion, compared with $2.876 billion at December 31, 2016. Schwab issued $650 million of 3.20% senior notes due 2027. Commercial paper outstanding was $600 million; there were no short-term borrowings at year-end 2016.
- Liquidity and capital: The company reported compliance with the fully phased-in modified liquidity coverage ratio rule. CSC and Schwab Bank were considered well capitalized; the Tier 1 leverage ratios were 7.1% and 7.0%, respectively. The filing lists additional credit and borrowing facilities, including a $750 million committed unsecured facility and an $18.166 billion secured FHLB facility available to Schwab Bank.
- Cash dividends paid on common stock were $0.08 per share, versus $0.06 in Q1 2016. No share repurchases were made during the quarter; approximately $596 million remained authorized.
Changes, outlook, risks, and unusual items
- Management attributed strong results to client growth, a stronger economic environment, higher short-term interest rates, and expense management. Expenses rose 12%, including higher compensation, headcount, professional services, and FDIC assessments; management said spending supported current and future business growth.
- Adoption of ASU 2016-09 reduced Q1 2017 tax expense by approximately $31 million. The reported effective tax rate was 33.1%, compared with 37.1% a year earlier; future effects depend on share price and employee equity activity.
- In March 2017, Schwab transferred $24.7 billion of securities from available-for-sale to held-to-maturity, including $227 million of pre-tax unrealized losses. Management said the transfer was intended to reduce potential regulatory-capital volatility as consolidated assets approach the $250 billion threshold at which AOCI can no longer be excluded from regulatory capital.
- Interest-rate exposure is material: company simulations estimated that a gradual 100-basis-point rate increase would raise next-12-month net interest revenue by 4.7%, while a 100-basis-point decrease would reduce it by 9.6%, assuming the balance-sheet structure remained unchanged. Management cautioned that actual results may differ.
- The filing gives no specific numerical earnings or revenue guidance. Management’s stated strategy is to grow client assets and relationships while maintaining expense discipline. Risks include market and trading conditions, interest rates, competition and pricing pressure, client cash balances, regulation, liquidity and capital needs, expense control, and litigation or regulatory developments.
- Legal matters include the long-running Total Bond Market Fund litigation, pending again before the Ninth Circuit. The company stated it could not reasonably estimate potential liability for described matters; it believes it has strong defenses. Guarantees and indemnifications include $295 million of standby letters of credit for options activity; none had been drawn. Payments under clearinghouse and exchange guarantees were described as remote.
- Credit and concentration exposures include $11.3 billion of corporate debt securities and commercial paper, 43% issued by financial-services institutions; 48% of the mortgage and home-equity portfolio was concentrated in California. Management said substantially all investment securities were investment grade.
Important facts for investors to verify
- How much of the 18% revenue growth and 37% net-income growth is sustainable as rate effects, client-asset growth, and the one-time-in-period tax benefit change?
- Whether lower trading commissions and trading activity continue to pressure trading revenue, and how pricing reductions affect client growth and overall profitability.
- The sensitivity of net interest revenue and margins to changing rates, deposit mix, and transfers of client cash into Schwab Bank.
- The future impact of the $24.7 billion AFS-to-HTM transfer, unrealized securities losses, and the company’s approach to regulatory capital as assets approach $250 billion.
- Developments in the Total Bond Market Fund litigation and other legal or regulatory matters, for which potential losses may not yet be estimable.