Charles Schwab Corporation — Q1 2020 Form 10-Q
Reporting period: Three months ended March 31, 2020; unaudited. The filing compares results with Q1 2019 unless otherwise noted. Schwab provides brokerage, banking, asset management, custody, and advisory services through Investor Services and Advisor Services.
Financial and operating performance
- Revenue and earnings: Total net revenue was $2.617 billion, down 4%. Net income was $795 million, down 18%; diluted EPS was $0.58, down 16%. Pre-tax income was $1.047 billion, down 17%, and the pre-tax margin was 40.0%, versus 46.4%.
- Revenue mix: Net interest revenue fell 6% to $1.572 billion; net interest margin declined to 2.14% from 2.46%. Asset management and administration fees rose 10% to $827 million. Trading revenue declined 13% to $188 million despite a 98% increase in daily average trades, reflecting the 2019 commission reductions. Other revenue fell 57% to $30 million, partly because Q1 2019 included a gain on leased office space.
- Expenses and returns: Expenses excluding interest increased 8% to $1.570 billion. Return on average common equity was 14%, compared with 20% in Q1 2019. The effective tax rate was 24.1%, versus 23.7%.
- Client activity: Core net new client assets were $73.2 billion, up 42%; clients opened 609,000 brokerage accounts, up 58%. Active brokerage accounts reached 12.7 million, up 8%. Quarter-end client assets were $3.497 trillion, down 2% year over year, while average client assets increased 13% to $3.919 trillion. Client cash was 15.1% of client assets, compared with 11.3% a year earlier.
- Balance sheet and capital: Total assets increased to $370.8 billion from $294.0 billion at year-end 2019. Bank deposits were $277.5 billion and brokerage-client payables were $49.3 billion. Cash and cash equivalents were $68.5 billion; excess reserves at the Federal Reserve were $58.7 billion, up from $18.8 billion at year-end. Long-term debt was $8.5 billion, including $1.1 billion of senior notes issued in March. The consolidated Tier 1 Leverage Ratio was 6.9%, down from 7.3% at year-end and within the 6.75%–7.00% operating objective at quarter-end.
- Liquidity: The average daily Liquidity Coverage Ratio was 114%, above the applicable 85% minimum. No amounts were drawn on the disclosed credit facilities; available capacity included $43.6 billion from the FHLB facility and $8.2 billion from the Federal Reserve discount window, subject to collateral requirements.
- Cash flow: Operating activities provided $10.1 billion, compared with $2.6 billion used in Q1 2019; financing provided $58.2 billion, while investing activities used $19.2 billion. These movements were substantially influenced by client cash and deposit flows and securities activity, so operating cash flow should not be read as a direct measure of recurring earnings.
Material changes and unusual items
- The Federal Reserve cut its target overnight rate by 150 basis points during the quarter, while the S&P 500 fell 20%. Lower rates pressured investment yields and net interest margin; higher client cash balances partly offset the effect.
- Unrealized gains on available-for-sale securities produced $3.907 billion of after-tax other comprehensive income. AOCI rose to $3.995 billion from $88 million at year-end. The company transferred all securities previously classified as held to maturity to available for sale on January 1, 2020, recognizing a $1.1 billion after-tax increase in AOCI from the transfer. This accounting and market-driven equity movement materially affected reported equity and regulatory capital comparisons.
- Q1 expenses included approximately $27 million for COVID-related employee payments and business continuity measures, and $37 million related to pending acquisitions. Capital expenditures were $250 million, versus $181 million in Q1 2019.
- Schwab adopted the current expected credit losses standard (CECL) on January 1, 2020; the adoption increased the allowance for credit losses immaterially. The company recorded a $10 million provision for bank-loan credit losses in Q1, primarily reflecting deteriorating economic forecasts.
Outlook, management commentary, and risks
- Management expects some net interest margin compression in coming quarters. It expects to invest most of the $58.7 billion in excess reserves into higher-yielding investments over the next several quarters; timing, rates, client cash levels, and LIBOR trends affect the outcome.
- Management estimated full-year 2020 capital expenditures at approximately 5%–6% of net revenue, excluding any potential impact of the TD Ameritrade acquisition.
- Pending transactions were expected to close subject to conditions: USAA-IMCO in mid-2020 for $1.8 billion cash, and TD Ameritrade in the second half of 2020 in an all-stock transaction. The filing also described the planned acquisition of Wasmer Schroeder, expected to close in mid-2020; no purchase price is stated in the provided filing text.
- COVID-19 risks include sustained low interest rates, market declines, pressure on fee revenue, increased client-service demand, operational disruption, and potential deterioration in mortgage, HELOC, and investment-security credit quality. Management reported that approximately 95% of employees were working remotely and that service and processing times had increased in some areas.
- The Tier 1 Leverage Ratio could decline further into the buffer between the operating objective and regulatory requirement before returning to the objective over time. Management said CSC and its banking subsidiaries met applicable capital requirements and were well capitalized at quarter-end.
- The filing describes litigation, including six lawsuits challenging disclosures related to the TD Ameritrade transaction; Schwab considered the complaints without merit. The company stated that it could not reasonably estimate potential liability for certain matters.
- Subsequent event: On April 30, 2020, Schwab issued Series G preferred depositary shares and received approximately $2.47 billion in net proceeds.
Most important facts for investors to verify
- Whether low rates and the timing of investing excess reserves lead to further net interest margin compression or offsetting net interest revenue growth.
- How client cash sorting, market levels, and asset flows affect revenue, the balance sheet, and the Tier 1 Leverage Ratio.
- Whether COVID-related credit deterioration increases loan-loss provisions or reduces the value of securities, particularly asset-backed and commercial mortgage-backed holdings.
- Progress, financing, regulatory approvals, integration costs, and realized benefits for the TD Ameritrade, USAA-IMCO, and Wasmer Schroeder transactions.
- The effect of the securities reclassification and AOCI volatility on reported equity and regulatory capital; note that the company elected to exclude AOCI from regulatory capital beginning in 2020.
- Developments in transaction-related and other litigation, and any changes in the company’s ability to estimate or reserve for potential losses.