Charles Schwab Corporation — Q1 2015 Form 10-Q
Business context and reporting period
Unaudited results cover the three months ended March 31, 2015, compared with the same period in 2014. Schwab provides wealth management, brokerage, banking, money management, and advisory services through Investor Services and Advisor Services.
Financial results and key metrics
| Metric | Q1 2015 | Q1 2014 | Change |
|---|---|---|---|
| Total net revenues | $1,526 million | $1,478 million | +3% |
| Net interest revenue | $588 million | $553 million | +6% |
| Asset management and administration fees | $644 million | $611 million | +5% |
| Trading revenue | $227 million | $247 million | -8% |
| Expenses excluding interest | $1,042 million | $956 million | +9% |
| Income before taxes | $484 million | $522 million | -7% |
| Net income | $302 million | $326 million | -7% |
| Net income available to common stockholders | $291 million | $318 million | -8% |
| Diluted EPS | $0.22 | $0.24 | -8% |
- Pre-tax margin was 31.7%, versus 35.3%; annualized return on average common equity was 10%, versus 13%. Net interest margin was 1.60%, versus 1.64%.
- Revenue growth reflected higher net interest revenue and asset-based fees, partly offset by lower trading revenue. Expenses rose mainly on higher compensation, professional services, and other costs. Compensation and benefits increased 10%; average employee headcount rose 6%.
- At March 31, total assets were $160.2 billion and stockholders’ equity was $12.2 billion. Cash and cash equivalents were $9.0 billion; an additional $19.4 billion was segregated or on deposit for regulatory purposes and is not generally available for corporate liquidity.
- Q1 operating cash flow was a use of $1.3 billion, versus $69 million provided in Q1 2014; investing cash use was $8.7 billion, while financing provided $7.6 billion. The cash decrease was $2.4 billion, leaving $9.0 billion at quarter-end. Cash flows reflect, among other factors, securities purchases and changes in client balances.
- Long-term debt was $2.9 billion, up from $1.9 billion at year-end. The company issued $1.0 billion of senior notes: $625 million due 2018 at 1.50% and $375 million due 2025 at 3.00%. Debt was 19% of total financial capital, compared with 14% at year-end; management’s long-term debt-to-financial-capital target is no more than 30%.
- Bank loans, net, were $13.6 billion; the allowance for loan losses was $38 million, down from $42 million at year-end. Nonperforming assets were $40 million, compared with $44 million.
Material changes and business trends
- Client assets reached $2.524 trillion, up 9% year over year. New brokerage accounts increased 6% to 274,000; active brokerage accounts rose 3% to 9.493 million. Assets receiving ongoing advisory services increased 11% to $1.252 trillion.
- Reported net new client assets were $28.7 billion, down 16% year over year. Management reported core net new assets of $34.2 billion, flat against the prior-year comparison, excluding an $11.6 billion outflow tied to a planned Advisor Services cash-management relationship resignation. Client assets also included a $6.1 billion increase from final retirement-recordkeeping platform consolidation.
- Daily average revenue trades fell 7% to 313,000, contributing to lower commission revenue. Short-term rates remained near zero; management cited low rates as a constraint on net interest revenue and money-market fund fees.
- CSC and Schwab Bank met applicable regulatory capital requirements. CSC’s Common Equity Tier 1 ratio was 14.6% and Tier 1 leverage ratio was 6.8%; Schwab Bank’s corresponding ratios were 17.9% and 7.1%, and the bank was classified as well capitalized.
Outlook, risks, contingencies, and unusual items
- Management said persistently low short-term rates could continue to constrain net interest revenue and require fee waivers on certain Schwab money-market funds. Its simulation estimated that a gradual 100-basis-point rate increase would raise next-12-month net interest revenue 10.9%; a 100-basis-point decrease would lower it 5.4%. These are scenario estimates, not guidance.
- The company expected to comply with the modified liquidity coverage ratio by January 1, 2016 and did not expect a material impact. The new regulatory capital rules began applying to CSC in 2015; capital-conservation-buffer requirements phase in through 2019.
- Management identified market and interest-rate changes, client-asset values and flows, trading activity, competitive pressures, expense management, regulatory developments, and litigation as risks to results. The filing provides no specific earnings or revenue guidance.
- A class action concerning the Schwab Total Bond Market Fund was reinstated by the Ninth Circuit in March 2015 and remanded for further proceedings; the company contests the claims and did not provide a loss estimate. The company also continued appealing an SEC administrative decision involving optionsXpress and Regulation SHO.
- The company disclosed ordinary-course litigation and regulatory matters for which potential losses generally could not be reasonably estimated. Guarantees to clearing houses could require payments if another member defaults, though management considered that possibility remote. Unfunded affordable-housing investment commitments were $37 million.
- A proposed Department of Labor rule would broaden the definition of fiduciary for retirement advice; Schwab was evaluating its potential impact. No material risk-factor changes were reported during the quarter.
Important facts for investors to verify
- Whether client-asset growth and advisory-fee gains can offset weaker trading revenue and pressure from low interest rates.
- Whether expense growth moderates and margins recover after the 9% increase in expenses.
- The composition and availability of cash, especially regulatory-segregated funds, and the drivers of negative operating cash flow.
- Debt levels and capital ratios as new regulatory requirements and liquidity rules take effect.
- Developments, potential exposure, and any eventual estimates or reserves for the fund litigation, optionsXpress matter, and other legal or regulatory proceedings.