Charles Schwab Corporation — Q3 2015 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2015; financial statements are unaudited. Schwab provides brokerage, banking, wealth management, money management, and advisory services through Investor Services and Advisor Services.
Financial performance and key metrics
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Net revenue | $1.597 billion | $1.551 billion | $4.689 billion | $4.507 billion |
| Net interest revenue | $635 million | $573 million | $1.835 billion | $1.688 billion |
| Trading revenue | $228 million | $209 million | $658 million | $668 million |
| Expenses excluding interest | $1.014 billion | $1.033 billion | $3.055 billion | $2.946 billion |
| Income before tax | $583 million | $518 million | $1.634 billion | $1.561 billion |
| Net income | $376 million | $321 million | $1.031 billion | $971 million |
| Diluted EPS | $0.28 | $0.24 | $0.74 | $0.70 |
| Pre-tax profit margin | 36.5% | 33.4% | 34.9% | 34.6% |
- Revenue increased 3% in Q3 and 4% year to date. Higher net interest revenue and asset-management fees supported growth; trading revenue rose in Q3 but declined slightly year to date.
- Q3 net income increased 17%; nine-month net income increased 6%. Q3 expenses fell 2%, partly because the prior-year quarter included a $68 million severance charge. Nine-month expenses rose 4%.
- At September 30, total assets were $170.4 billion, liabilities $157.2 billion, and stockholders’ equity $13.2 billion. Bank deposits were $119.0 billion and long-term debt was $2.893 billion, up from $1.899 billion at December 31, 2014.
- Long-term debt was 18% of total financial capital, below management’s stated long-term target ceiling of 30%. The company issued $1.0 billion of senior notes in March and raised $581 million net from Series C preferred stock in August.
- Cash and cash equivalents were $10.366 billion at quarter-end, down $997 million from year-end 2014. Operating cash flow was $354 million for the first nine months, versus $1.488 billion a year earlier; investing cash outflow was $18.918 billion and financing cash inflow was $17.567 billion, principally reflecting securities investment and growth in bank deposits.
- Client assets were $2.416 trillion, up 1% year over year; net new client assets were $30.8 billion in Q3 and $96.5 billion year to date. Active brokerage accounts increased 4% to 9.691 million.
Material changes and management commentary
- Net interest revenue rose 11% in Q3 and 9% year to date, mainly from higher interest-earning asset balances, including securities and margin loans. Lower average net interest margins partly offset the balance growth.
- Q3 trading revenue rose 9% as daily average revenue trades increased 13%; nine-month trading revenue fell 1%, with lower revenue per trade offsetting higher activity.
- Other revenue declined 45% in Q3 and 18% year to date, reflecting a non-recurring insurance settlement in 2014 and lower gains on securities sales. Nine-month 2015 revenue included $17 million of litigation proceeds.
- Q3 taxes included $14 million of net tax benefits related to revised estimates for tax positions from 2011–2014. Comprehensive income was $221 million in Q3 versus $298 million, reflecting a $155 million after-tax other comprehensive loss, mainly unrealized losses on available-for-sale securities.
Outlook, risks, and contingencies
- Management said persistently low short-term rates constrain net interest revenue and may continue to require fee waivers on certain money market funds. Its interest-rate simulations estimated that a gradual 100-basis-point rate increase would raise next-12-month net interest revenue by 12.2%, while a 100-basis-point decrease would reduce it by 6.7%; actual results may differ.
- Management revised its full-year 2015 capital expenditure estimate to approximately 10% below 2014, versus its earlier estimate of approximately 15% below. Nine-month capital expenditures were $218 million.
- The company expected to comply with the modified liquidity coverage ratio requirement by January 1, 2016 and did not expect a material business or financial impact. Basel III capital rules took effect in 2015; CSC and Schwab Bank exceeded applicable minimum capital requirements at quarter-end. Schwab Bank was categorized as well capitalized.
- A proposed FDIC surcharge on larger insured banks and a proposed Department of Labor fiduciary rule were under evaluation. The filing notes that the proposals could change.
- Schwab is pursuing litigation over losses on non-agency mortgage-backed securities; it had realized $48 million in net settlement proceeds and an initial trial was scheduled for February 2016. Other disclosed matters include Schwab Total Bond Market Fund litigation and an SEC proceeding involving optionsXpress; the company disputes the latter allegations and is appealing.
- Key risks include market and equity-value changes, low or changing interest rates, client cash and asset flows, trading activity, competition and fee pressure, regulatory changes, credit and liquidity risk, and litigation or regulatory outcomes. The filing reports no material changes to previously disclosed risk factors.
Important facts for investors to verify
- Whether client-asset growth and net interest revenue can continue to offset low-rate pressure and weaker trading revenue per trade.
- The effect of continued growth in bank deposits and securities portfolios on net interest margin, liquidity, and interest-rate sensitivity.
- Progress toward the revised capital expenditure estimate and compliance with the modified LCR requirement.
- Developments in the mortgage-backed securities recovery litigation, the Total Bond Market Fund case, and the optionsXpress appeal, including any change in estimated exposure.
- Whether loan quality remains stable, including the California concentration in mortgage and HELOC portfolios and the performance of HELOCs converting to amortizing repayment.