The Charles Schwab Corporation — 2010 Form 10-K
Reporting period: Fiscal year ended December 31, 2010. This is an annual filing; fourth-quarter figures are noted separately. Amounts are in U.S. dollars unless stated otherwise.
Business context
Schwab provides brokerage, banking, asset management and related services through Investor Services and Institutional Services. At year-end, it reported $1.57 trillion in client assets, 8.0 million active brokerage accounts, 1.5 million corporate retirement plan participants and 690,000 banking accounts. In November 2010, it acquired substantially all assets of investment adviser Windward for $106 million in stock and $44 million in cash.
Financial performance and key metrics
| Metric | 2010 | 2009 |
|---|---|---|
| Net revenues | $4.248 billion | $4.193 billion |
| Expenses excluding interest | $3.469 billion | $2.917 billion |
| Income from continuing operations | $454 million | $787 million |
| Net income | $454 million | $787 million |
| Diluted EPS | $0.38 | $0.68 |
| Pre-tax margin from continuing operations | 18.3% | 30.4% |
| Operating cash flow | $(9) million | $1.437 billion |
| Capital expenditures | $127 million | $139 million |
Revenue mix shifted: net interest revenue rose 22% to $1.524 billion, while asset management and administration fees fell 3% to $1.822 billion and trading revenue declined 17% to $830 million. Other revenue was $135 million, down from $175 million; 2009 included a $31 million gain on debt repurchases. The effective tax rate was 41.7%, compared with 38.3%.
Expenses included $320 million of YieldPlus-related litigation and regulatory reserves and a $132 million charge for the company’s decision to cover remaining losses in money market funds tied to a structured investment vehicle that defaulted in 2008. Money market mutual fund fee waivers totaled $433 million, versus $224 million in 2009.
Year-end balance sheet: Total assets were $92.568 billion, up from $75.431 billion; stockholders’ equity was $6.226 billion, up from $5.073 billion. Long-term debt increased to $2.006 billion from $1.512 billion. Cash and cash equivalents were $4.931 billion, down from $8.241 billion. Banking-client deposits rose to $50.590 billion from $38.820 billion.
CSC’s Tier 1 leverage ratio was 6.5%. Schwab Bank was classified as well capitalized, with a 7.6% Tier 1 core capital ratio; Schwab broker-dealer net capital was $1.2 billion. The company reported a 24% long-term-debt-to-total-financial-capital ratio.
Consolidated operating cash flow was $(9) million, investing cash flow $(15.410) billion and financing cash flow $12.109 billion. Cash flows were substantially affected by client balances, securities purchases and banking activity. The operating cash-flow figure should therefore be read alongside the balance-sheet and client-funding movements.
Changes versus 2009 and fourth quarter
- Net revenue increased 1%, but net income fell 42% and diluted EPS fell 44%, mainly reflecting the unusual 2010 charges and lower trading and asset-management revenue.
- Expenses excluding interest rose 19%; excluding the disclosed significant charges, management said aggregate growth in other expense categories was 3%.
- Year-end client assets increased 11% to a record $1.5745 trillion. Net new client assets were $26.6 billion as reported, including $51.5 billion of planned mutual-fund-clearing client outflows; excluding those outflows, the company reported $78.1 billion.
- Daily average client trades declined 4% to 399,700. Daily average revenue trades fell 5%, while average revenue per revenue trade fell 11%, reflecting lower online commissions introduced in January 2010.
- Fourth quarter 2010: Net revenue was $1.127 billion, expenses excluding interest $898 million, net income $119 million and diluted EPS $0.10. Fourth-quarter 2009 net income was $164 million on revenue of $986 million.
Outlook, commentary and principal risks
- Management said historically low short-term rates continued to constrain net interest revenue and contributed to money-market fee waivers; further waivers could reduce asset-management fees. The filing provides no earnings or revenue guidance.
- Management anticipated 2011 capital expenditures approximately 35% above 2010, primarily for information technology, furniture and equipment, subject to adjustment as conditions change.
- The company’s interest-rate simulation estimated that a gradual 100-basis-point increase would raise next-12-month net interest revenue by 13.5%, while a 100-basis-point decrease would reduce it by 4.8%. These are model estimates, not forecasts, and assume the balance sheet remains unchanged.
- Non-agency mortgage-backed securities remained exposed to credit deterioration. The company recorded $36 million of 2010 impairment losses and warned that further deterioration could produce additional charges. Its mortgage and HELOC portfolios were also exposed to housing-market and geographic concentration risks, including substantial California exposure.
- YieldPlus matters remained material: the company accrued $199 million, net of $39 million in insurance proceeds, for class-action settlements and a further $121 million for regulatory settlements. Additional individual arbitration claims and Total Bond Market Fund litigation were disclosed; management said some legal outcomes could not yet be estimated reliably.
- Dodd-Frank was expected to bring significant rulemaking and regulatory changes. The filing stated that the Office of Thrift Supervision’s functions were scheduled to transfer in 2011, with the Federal Reserve becoming CSC’s primary regulator and the OCC Schwab Bank’s primary regulator.
- Other principal risks include interest-rate and market sensitivity, competition and pricing pressure, client-asset and cash-balance fluctuations, credit losses, liquidity and funding access, regulatory capital restrictions, litigation, and technology, cybersecurity, vendor and operational failures.
Important facts for investors to verify
- Track the resolution, payment and any further consequences of YieldPlus settlements, remaining arbitrations and Total Bond Market Fund litigation.
- Assess the sustainability of earnings after the 2010 unusual charges and the effect of ongoing money-market fee waivers and low interest rates.
- Review credit performance, impairment assumptions and concentration in non-agency mortgage securities, mortgages and HELOCs.
- Reconcile reported net new client assets with the planned $51.5 billion client transfer and monitor subsequent asset flows and trading activity.
- Monitor capital, liquidity, deposit and client-cash trends, debt maturities, and the impact of regulatory changes.