Business context and reporting period
The Charles Schwab Corporation provides brokerage, banking, investment management, custody, and retirement services through Investor Services and Institutional Services. This Form 10-K covers the fiscal year ended December 31, 2009; quarterly figures below identify the fourth quarter where relevant. Financial amounts are in U.S. dollars.
At year-end, Schwab reported $1.42 trillion in client assets, 7.7 million active brokerage accounts, 1.5 million corporate retirement plan participants, and 722,000 banking accounts.
Financial results and condition
| Metric | 2009 | 2008 | Change |
|---|---|---|---|
| Net revenues | $4.193 billion | $5.150 billion | Down 19% |
| Income from continuing operations | $787 million | $1.230 billion | Down 36% |
| Net income | $787 million | $1.212 billion | Down 35% |
| Diluted EPS | $0.68 | $1.05 | Down 35% |
| Pre-tax margin from continuing operations | 30.4% | 39.4% | Down 9.0 percentage points |
| Net interest revenue | $1.207 billion | $1.665 billion | Down 28% |
| Asset management and administration fees | $1.875 billion | $2.355 billion | Down 20% |
| Trading revenue | $996 million | $1.080 billion | Down 8% |
- Expenses excluding interest fell 7% to $2.917 billion, reflecting lower compensation, professional services, and advertising costs. They included $101 million of severance and facilities charges related to cost reductions and a $16 million FDIC special assessment.
- Operating cash flow was $1.437 billion, compared with $2 million in 2008. Investing cash flow was negative $14.057 billion, largely reflecting securities purchases and loan growth; financing cash flow was positive $15.419 billion, primarily driven by $14.979 billion of growth in banking-client deposits.
- Total assets rose 46% to $75.431 billion, while stockholders’ equity increased 25% to $5.073 billion. Banking-client deposits grew to $38.820 billion from $23.841 billion. Long-term debt rose to $1.512 billion from $883 million; debt was 23% of total financial capital.
- Cash and cash equivalents were $8.241 billion at year-end. Schwab Bank was classified as well capitalized, with a 6.3% Tier 1 leverage ratio; CSC’s Tier 1 leverage ratio was 7.1% against its 6% target. Schwab broker-dealer net capital was $1.1 billion.
- Fourth-quarter 2009 net revenues were $986 million and net income was $164 million, versus $1.284 billion and $308 million, respectively, in fourth-quarter 2008. Fourth-quarter diluted EPS was $0.14, compared with $0.27.
Material changes versus prior periods
- Low interest rates materially reduced asset yields and net interest revenue. Interest-earning asset yields fell faster than the cost of funding, while average interest-earning balances grew.
- Money market fund fee waivers totaled $224 million in 2009, reducing asset-management fees; there were no such waivers in 2008. Management warned that waivers could increase if fund yields remained at or below management fees.
- Average equity valuations were lower than in 2008, weighing on asset-based fees. Client assets nevertheless rose 25% from year-end 2008, while net new client assets declined 23% to $87.3 billion and daily average client trades declined 4% to 333,600.
- Net impairment charges on securities were $60 million in 2009, versus $44 million in 2008. The 2009 charge reflected expected credit losses on non-agency residential mortgage-backed securities; $218 million of the total impairment was recorded in other comprehensive income rather than earnings under the applicable accounting treatment.
- Other revenue included a $31 million gain from repurchasing $98 million of trust preferred securities for $67 million. The company issued $750 million of 4.95% Senior Notes due 2014 in June 2009.
- Client mortgage credit indicators weakened: delinquencies were 0.87% of loans versus 0.54% in 2008, nonaccrual loans were 0.46% versus 0.13%, and the allowance for credit losses was 0.61% versus 0.33%.
Outlook, commentary, risks, and unusual items
- Management expected 2010 capital expenditures to be approximately 5% below 2009 levels. It stated a long-term debt-to-total-financial-capital target of no more than 30%, and a target cash dividend of approximately 20%–30% of net income, subject to Board discretion and restrictions. The filing does not provide earnings or revenue guidance.
- On January 26, 2010, after year-end, the company sold 29.7 million shares at $19 per share and received $543 million in net proceeds. Proceeds were intended to support balance-sheet growth, including deposit growth and possible migration of client balances from money market funds to Schwab Bank.
- Management identified continued low rates, market and asset-value fluctuations, credit deterioration in mortgage-related securities and loans, volatile client cash flows, and availability and cost of external financing as material risks. The company also cited regulatory, litigation, technology, operational, data-security, and competitive-pricing risks.
- Material legal matters included litigation and regulatory inquiries concerning Schwab YieldPlus Fund, a class action concerning the Total Bond Market Fund, and New York and FINRA matters concerning auction-rate securities. Management could not estimate a possible liability for the YieldPlus litigation and related regulatory matters; it noted that any liability could exceed applicable insurance limits. Management said currently pending matters were not expected to materially affect financial condition or cash flows, but could materially affect results in a particular future period.
- Additional unusual items included $58 million of severance expense and $43 million of facilities charges associated with cost reductions. No shares were repurchased under the company’s repurchase program in 2009.
- The independent auditor gave an unqualified opinion on the financial statements and concluded that internal control over financial reporting was effective as of December 31, 2009.
Important facts for investors to verify
- Whether money market fund fee waivers persist or increase, and how they affect fee revenue and profitability.
- Trends in net interest revenue, client cash and deposit balances, and the sensitivity of earnings to interest-rate changes.
- Mortgage portfolio performance, including delinquency and nonaccrual trends, reserve adequacy, and further impairment risk in non-agency mortgage-backed securities.
- Developments, potential financial exposure, and insurance coverage relating to YieldPlus, Total Bond Market Fund, and auction-rate securities proceedings.
- The impact of the January 2010 equity issuance, deposit growth, and any client-balance migration from money market funds to Schwab Bank.