Business context and reporting period
The Charles Schwab Corporation is a savings and loan holding company operating securities brokerage, banking, investment management, and related financial services businesses. This unaudited Form 10-Q covers the three months ended March 31, 2010; comparisons are with the first quarter of 2009 unless otherwise noted. Amounts are in millions of dollars except per-share data and client metrics.
Financial and operating performance
| Metric | Q1 2010 | Q1 2009 |
|---|---|---|
| Net revenues | $978 | $1,111 |
| Expenses excluding interest | $965 | $756 |
| Income before taxes | $13 | $355 |
| Net income | $6 | $218 |
| Diluted EPS | Reported as “—” | $0.19 |
| Operating cash flow | $(589) | $159 |
| Investing cash flow | $(4,435) | $(1,767) |
| Financing cash flow | $3,077 | $2,701 |
- Net revenue fell 12%; pre-tax margin was 1.3%, versus 32.0%. The $196 million YieldPlus litigation reserve was the principal reason expenses rose 28%.
- Asset management and administration fees were $420 million, down 16%, including $125 million of money market fund fee waivers versus $6 million a year earlier. Net interest revenue rose 7% to $326 million; trading revenue declined 19% to $209 million.
- Investor Services revenue was $641 million and pre-tax contribution $112 million; Institutional Services revenue was $337 million and contribution $95 million. Both segments’ revenue and contribution declined year over year.
- Client assets reached a reported record $1.491 trillion, up 36% year over year. Net new client assets were $23.3 billion, down 8%; clients’ daily average trades were 415,500, down 6% year over year.
- Total assets were $78.337 billion at quarter-end, versus $75.431 billion at December 31, 2009. Stockholders’ equity was $5.671 billion, up from $5.073 billion.
- Cash and cash equivalents were $6.294 billion, down from $8.241 billion at year-end. Banking-client deposits were $42.055 billion, up from $38.820 billion. The company reported an 18% loan-to-deposit ratio.
- Long-term debt was $1.309 billion, down from $1.512 billion; debt was 19% of total financial capital, versus 23% at year-end. The company repaid $201 million of debt during the quarter.
- Schwab Bank was reported well capitalized, with Tier 1 capital of 24.3%, total capital of 24.6%, and Tier 1 leverage of 7.6%. CSC’s Tier 1 leverage ratio was 7.3%; Schwab’s net capital was $1.1 billion, 11% of aggregate debit balances.
Material changes, outlook, and risks
- Lower fee and trading revenue reflected money-market fee waivers, lower daily average revenue trades and revenue per trade, and the absence of a $26 million debt-repurchase gain recognized in Q1 2009. Higher average interest-earning balances partly offset these declines.
- Management said historically low interest rates continued to constrain net interest revenue and necessitate money-market fee waivers. A gradual 100-basis-point rate increase was modeled to raise 12-month net interest revenue by 17.5%; a 100-basis-point decrease was modeled to reduce it by 6.7%. These are simulations, not guidance.
- The company recorded $8 million of impairment losses on securities, chiefly reflecting credit deterioration in non-agency mortgage-backed securities. It reported $430 million of unrealized losses on available-for-sale securities, concentrated in non-agency mortgage-backed securities; further collateral deterioration could cause additional impairment.
- YieldPlus litigation: a $196 million reserve was recorded for Q1, reflecting a preliminary settlement of federal and state class claims and expected insurance coverage. After quarter-end, the company agreed to a $200 million settlement of federal claims and an additional $35 million to include state claims, without admitting liability; court approval remained outstanding. The actual liability could differ from the reserve. Regulatory investigations and 194 individual arbitration claims seeking $34 million remained disclosed; the company had not reserved for potential regulatory settlements because it could not determine whether loss was probable or estimate a range.
- Other legal matters included New York State and FINRA proceedings relating to auction-rate securities. The filing describes potential adverse judgments, penalties, or other relief; outcomes and losses were uncertain.
- Management described liquidity as adequate, citing $6.3 billion cash and equivalents, access to borrowing facilities, and capital ratios above required well-capitalized levels. An $800 million committed CSC credit facility was scheduled to expire in June 2010; CSC said it planned to replace it. An equity offering generated $543 million net proceeds to support balance-sheet growth, including deposit growth and migration of client balances into Schwab Bank.
- Credit and concentration risks included $22.1 billion of residential mortgage-backed securities, $1.9 billion of non-agency holdings, and California exposure representing 39% of residential mortgages and 48% of home-equity lines. About 75% of first-mortgage balances were interest-only loans. Management reported no material change to the company’s stated risk factors.
Investor facts to verify
- Review the final court approval, insurance recoveries, and ultimate cost of the YieldPlus settlement, including any regulatory resolution and arbitration outcomes.
- Track money-market fee waivers, interest-rate sensitivity, trading activity, and revenue per trade for signs of improvement or further pressure.
- Monitor mortgage-backed securities credit performance, unrealized losses, and any subsequent impairment charges.
- Confirm replacement of CSC’s expiring committed credit facility and continued deposit, liquidity, and capital trends.
- Check the reported “—” diluted EPS presentation against the full financial statements; the filing text does not provide a clear positive per-share amount for Q1 2010.