Charles Schwab Corporation — Q3 2014 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2014. Financial statement amounts are in millions of dollars unless noted. Schwab provides brokerage, banking, asset management, and financial advisory services.
Financial performance and key metrics
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Total net revenues | $1,551 (+13%) | $1,373 | $4,507 (+13%) | $4,000 |
| Net interest revenue | $573 (+13%) | $506 | $1,688 (+17%) | $1,448 |
| Asset management and administration fees | $649 (+11%) | $583 | $1,892 (+11%) | $1,707 |
| Trading revenue | $209 (-7%) | $224 | $668 (-2%) | $682 |
| Expenses excluding interest | $1,033 (+14%) | $909 | $2,946 (+5%) | $2,793 |
| Income before taxes | $518 (+12%) | $464 | $1,561 (+29%) | $1,207 |
| Net income | $321 (+11%) | $290 | $971 (+29%) | $752 |
| Net income available to common stockholders | $312 | $282 | $932 | $713 |
| Diluted EPS | $0.24 (+9%) | $0.22 | $0.70 (+27%) | $0.55 |
| Pre-tax profit margin | 33.4% | 33.8% | 34.6% | 30.2% |
Q3 net interest revenue benefited from higher interest-earning asset balances and improved yields on held-to-maturity securities. Fee growth reflected higher advisory and fund assets. Trading revenue declined with lower daily average revenue trades. Q3 other revenue rose to $120, including a $45 net insurance settlement and $12 in realized securities-sale gains.
Expenses increased notably in Q3, including a $68 charge for estimated severance benefits related to changes in the company’s geographic footprint. Compensation and benefits rose 23% in Q3 and 9% year to date. The annualized return on average common equity was 12% for both the quarter and nine-month period.
Client activity and balance sheet
- Quarter-end client assets were $2.404 trillion, up 12% year over year; assets receiving ongoing advisory services were $1.193 trillion, up 15%.
- Q3 net new client assets were $34.7 billion versus $18.1 billion a year earlier. Nine-month inflows were $91.6 billion versus $39.8 billion. The company reported no significant one-time flows in 2014.
- Active brokerage accounts reached 9.309 million, up 3% year over year; 229,000 new brokerage accounts were added in Q3.
- At September 30, total assets were $147.444 billion and stockholders’ equity was $11.473 billion. Banking-client deposits were $97.345 billion; long-term debt was $1.900 billion.
- Cash and cash equivalents were $8.588 billion. A further $19.890 billion of cash and investments was segregated or on deposit for regulatory purposes and is not generally available for company liquidity needs.
- Banking-client loans, net, were $13.080 billion, with a $40 million allowance for loan losses. Nonperforming assets were $46 million, down from $53 million at year-end 2013.
Cash flow, capital, and liquidity
For the first nine months of 2014, operating cash flow was $1.488 billion, investing cash flow was negative $4.856 billion, and financing cash flow was positive $4.228 billion. Cash and cash equivalents increased $860 million to $8.588 billion. Financing inflows included a $4.373 billion increase in banking-client deposits; dividends paid totaled $286 million.
Schwab Bank was categorized as well capitalized, with a 21.7% Tier 1 risk-based capital ratio, 21.8% total risk-based capital ratio, and 7.1% Tier 1 leverage ratio. CSC reported a 6.9% Tier 1 leverage ratio. Company long-term debt was 14% of total financial capital, within management’s stated target of no more than 30%. No commercial paper borrowings were outstanding; an $800 million committed credit facility was unused at quarter-end.
Outlook, risks, and unusual items
- Management gave no quantified earnings or revenue guidance in the supplied filing text. It revised its 2014 capital-expenditure estimate to approximately 50% above 2013, primarily due to revised timing of planned facilities and land purchases.
- Management said persistently low short-term rates constrain net interest revenue and have led to money-market fund fee waivers. A gradual 100-basis-point rate increase was estimated to raise modeled 12-month net interest revenue by 11.1%; a 100-basis-point decrease was estimated to reduce it by 4.2%. These are simulations, not forecasts.
- New Basel III-related capital rules begin phasing in during 2015. A modified liquidity coverage requirement applies to the company, with full compliance required by January 2017; management did not expect either rule to have a material impact but was evaluating the liquidity rule.
- Mortgage-credit exposures include $8.1 billion of first mortgages and $3.0 billion of HELOCs. About 78% of HELOC balances were in second-lien positions; 46% of residential mortgages and 52% of HELOC balances were secured by California properties. The company identified interest-rate, prepayment, market-liquidity, client-asset, and credit risks.
- Contingencies include the New York Attorney General’s auction-rate securities case, litigation concerning the Schwab Total Bond Market Fund, and an appealed SEC decision involving optionsXpress and Regulation SHO. The filing says the optionsXpress contingent liability was not material; potential loss estimates for certain other matters were not reasonably estimable.
- The company recognized a $1 million securities credit impairment charge in the quarter and nine-month period. Management said goodwill was not impaired in its April 2014 annual test. Disclosure controls were deemed effective, and no material change in internal control was reported.
Important facts for investors to verify
- Whether the $45 million insurance settlement and $68 million severance charge recur or distort comparisons of underlying revenue and expenses.
- Whether net interest revenue can continue growing if rates stay low, and the effect of eventual rate changes on asset yields and funding costs.
- How much of reported cash is unrestricted, given substantial regulatory segregation, and how deposit and client-cash movements affect liquidity.
- Trends in trading activity, fee waivers, client asset flows, and the revised capital-expenditure plan.
- Developments in the cited legal and regulatory matters, mortgage credit quality, and implementation of capital and liquidity rules.