Charles Schwab Corporation — Q1 2016 Form 10-Q
Reporting period: Three months ended March 31, 2016. Comparisons are with Q1 2015 unless otherwise stated. Financial amounts are in millions of dollars, except per-share data and client metrics.
Business context
Schwab provides wealth management, brokerage, banking, money management, custody, and advisory services through its Investor Services and Advisor Services segments. In a quarter of sharp market swings, client assets ended at $2.56 trillion, up 1% year over year; average client assets were $2.45 trillion, down 3%.
Financial results and key metrics
| Metric | Q1 2016 | Q1 2015 | Change |
|---|---|---|---|
| Total net revenue | $1,764 | $1,526 | +16% |
| Net interest revenue | $772 | $588 | +31% |
| Asset management and administration fees | $699 | $644 | +9% |
| Trading revenue | $232 | $227 | +2% |
| Expenses excluding interest | $1,109 | $1,042 | +6% |
| Income before taxes | $655 | $484 | +35% |
| Net income | $412 | $302 | +36% |
| Net income available to common stockholders | $392 | $291 | +35% |
| Diluted EPS | $0.29 | $0.22 | +32% |
Pre-tax margin improved to 37.1% from 31.7%; return on average common equity was 13% versus 10%. Net interest margin rose to 1.73% from 1.60%. The effective tax rate was 37.1%, compared with 37.6%.
- Net interest revenue growth reflected larger average interest-earning balances and higher yields, including the benefit of the December 2015 federal funds rate increase.
- Fee growth primarily reflected reduced money-market fund fee waivers, partly offset by lower average Mutual Fund OneSource assets. Waivers were $97 million versus $184 million.
- Trading revenue included commissions of $215 million, down 1%, and principal transactions of $17 million, up 89%. Daily average revenue trades increased 5%, while average revenue per trade fell 5% to $11.44.
- Expenses rose with higher headcount, compensation, software maintenance, rent, and property taxes. Full-time equivalent employees increased 5% to 15,600.
Client activity and segments
- Net new client assets were $32.0 billion, up 11%; core net new assets were $32.0 billion, down 6% from $34.2 billion.
- Active brokerage accounts increased 4% to 9.9 million. Assets receiving ongoing advisory services increased 2% to $1.28 trillion.
- Investor Services revenue was $1.272 billion, up 10%, and pre-tax income was $436 million, up 19%.
- Advisor Services revenue was $492 million, up 32%, and pre-tax income was $219 million, up 87%. Growth was led by net interest revenue, including migration of more client cash to bank sweep deposits.
Cash flow, balance sheet, debt, and capital
- Total assets were $191.0 billion at March 31, up from $183.7 billion at year-end. Stockholders’ equity was $14.5 billion.
- Cash and cash equivalents were $10.5 billion, down from $12.0 billion at year-end. Operating cash flow was negative $369 million; investing cash flow was negative $8.762 billion; financing cash flow was positive $7.610 billion. The quarter-end cash decrease was $1.521 billion.
- Bank deposits were $135.7 billion, including $113.9 billion swept from brokerage accounts, versus $129.5 billion and $108.1 billion, respectively, at year-end.
- Long-term debt was $2.877 billion. Short-term borrowings were $800 million, comprising $500 million drawn under a Federal Home Loan Bank facility and $300 million of commercial paper. The company reported a 3.38% weighted-average rate on long-term debt.
- On March 7, Schwab issued $750 million of 5.95% non-cumulative perpetual preferred stock, receiving $725 million net proceeds. Management said proceeds would support bank growth and transfers of money-market sweep balances to Schwab Bank.
- CSC and Schwab Bank reported Tier 1 leverage ratios of 7.3% and 7.1%, respectively; Schwab Bank was categorized as well capitalized. The company said it complied with the fully phased-in modified liquidity coverage ratio at quarter-end.
- Schwab paid a common dividend of $0.06 per share during the quarter. On April 21, the board declared an increase to $0.07 per share. No share repurchases occurred in the quarter.
Outlook, risks, contingencies, and unusual items
- Management expects net interest revenue to generally rise if short-term rates increase and fall if rates decline. Its simulation estimated that a gradual 100-basis-point rate rise would increase next-12-month net interest revenue by 8.7%; a 100-basis-point decline would reduce it by 10.4%. These are model estimates, not guidance, and actual results may differ.
- The company cited market and interest-rate conditions, client asset values and cash balances, trading activity, competition, expense management, regulatory changes, and litigation as factors that could affect results. No specific earnings or revenue guidance was provided.
- The Department of Labor’s final fiduciary rule was not expected by management to have a material impact, based on its evaluation to date. A new FDIC surcharge was expected to increase the company’s overall assessment by a net 2 to 2.5 basis points annually, potentially beginning in Q3 2016 and likely through 2018.
- The company was evaluating proposed rules concerning a net stable funding ratio, bank recovery planning, and regulatory capital treatment for certain bank holding company debt investments.
- Legal matters included an appeal in the Schwab Total Bond Market Fund litigation and an appeal of an SEC administrative decision involving optionsXpress and Regulation SHO. The filing did not provide a clear estimate of potential losses for the described matters.
- Credit indicators included loan delinquencies of 0.21% of bank loans and nonaccrual loans of 0.20% at March 31. The mortgage and HELOC portfolio was concentrated in California (48%); 79% of HELOC balances were in second-lien positions. Some FFELP asset-backed securities were under rating-agency review for downgrade, though management said guarantees and credit enhancements supported expected full repayment.
- Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Most important facts for investors to verify
- Whether net interest revenue growth persists as rates, interest-earning balances, and client sweep deposits change.
- Whether cash migration to Schwab Bank and the new default sweep feature affect funding costs, capital needs, and liquidity.
- Whether client asset growth and advisory enrollment can offset market-driven pressure on average assets and fee revenue.
- The actual cost and implementation impact of the FDIC surcharge, fiduciary rule, and other proposed regulatory requirements.
- Developments in the pending legal and regulatory matters, mortgage/HELOC credit quality, and reviewed FFELP securities.
- The assumptions behind the interest-rate sensitivity estimates and the company’s ability to maintain capital and liquidity as deposits and assets grow.