Charles Schwab Corporation — Q3 2013 Form 10-Q
Business context and reporting period. The filing covers the quarter and nine months ended September 30, 2013. Schwab provides brokerage, banking, money management, and financial advisory services through its Investor Services and Advisor Services segments. Financial amounts below are in millions unless stated otherwise.
Financial performance and position
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Total net revenues | $1,373 | $1,196 | $4,000 | $3,668 |
| Expenses excluding interest | $909 | $835 | $2,793 | $2,562 |
| Income before taxes | $464 | $361 | $1,207 | $1,106 |
| Net income | $290 | $247 | $752 | $717 |
| Net income available to common stockholders | $282 | $238 | $713 | $694 |
| Diluted EPS | $0.22 | $0.19 | $0.55 | $0.54 |
| Pre-tax profit margin | 33.8% | 30.2% | 30.2% | 30.2% |
- Quarterly revenue grew 15% year over year; nine-month revenue grew 9%. Net interest revenue rose 15% and 9%, respectively, as larger interest-earning asset balances more than offset pressure on net interest margin from low short-term rates. Asset management and administration fees increased 11% and 13%; trading revenue increased 10% in Q3 but only 2% year to date.
- Quarterly expenses rose 9%, slower than revenue growth. Compensation and benefits increased 9% in Q3 and 12% year to date; advertising and market development increased 16% and 14%. Management cited incentive compensation, the new “Own your tomorrow” campaign, professional services, and other costs.
- Q3 net income rose 17% and nine-month net income rose 5%. Comparability is affected by a $70 million pre-tax vendor-dispute settlement gain in Q2 2012 and a $20 million nonrecurring state tax benefit in Q3 2012.
- Operating cash flow was $825 for the first nine months, versus $373 in 2012. Investing cash flow was negative $17,757 and financing cash flow was positive $11,631. Cash and cash equivalents declined $5,301 to $7,362; the filing describes substantial movements in client balances, regulatory segregation, deposits, and investment portfolios.
- At September 30, total assets were $140,211, total liabilities $130,158, and stockholders’ equity $10,053. Long-term debt was $1,904, up from $1,632 at December 31, 2012. Banking-client deposits increased to $91,187 from $79,377; brokerage-client payables declined to $34,532 from $40,330.
- Client assets were $2.145 trillion, up 13% year over year. Q3 net new client assets were $18.1 billion; management separately reported core net new assets of $42.8 billion, a record for a summer quarter. New brokerage accounts increased 13% to 223,000, and active accounts rose 3% to 9.013 million.
Material changes, outlook, and risks
- Management attributed growth to stronger client assets and activity, higher advice-solutions and mutual-fund fees, higher interest-earning balances, and Q3 trading activity. Low short-term rates continue to constrain net interest revenue and may require continued money-market fund fee waivers, potentially reducing asset-management fees.
- No specific earnings or revenue guidance is provided. Management revised its estimate for 2013 capital expenditures to approximately 90% above 2012, down from its prior estimate of approximately 110% higher, mainly because of revised timing for a Colorado office-campus project; software spending increased.
- Interest-rate sensitivity modeling estimated that a gradual 100-basis-point rate increase would raise 12-month net interest revenue by 11.6%, while a 100-basis-point decrease would reduce it by 5.3%, using the September 30, 2013 balance sheet assumptions. Management cautioned that actual results may differ.
- Schwab Bank was classified as well capitalized. Its Tier 1 leverage ratio was 6.5%, total risk-based capital ratio 18.7%, and Tier 1 risk-based capital ratio 18.5%. CSC reported a Tier 1 leverage ratio of 6.3%. The company said it did not expect the Basel III-related capital rules to materially affect its business or results; a proposed modified liquidity coverage rule and an NSCC supplemental liquidity proposal were still under evaluation.
- Key exposures include low interest rates, market and client-asset fluctuations, mortgage and securities credit/valuation risk, California concentration in residential mortgage and HELOC balances, and regulatory changes. Mortgage securities included $618 million of non-agency holdings; management recognized $8 million of securities impairment losses in the first nine months. Further deterioration in underlying loans could produce additional impairments.
- Legal and regulatory matters include the New York Attorney General’s auction-rate securities case, reinstated in part on appeal; an appeal in Total Bond Market Fund litigation; and optionsXpress Regulation SHO proceedings, for which the company was appealing an adverse decision. The filing states related contingent liabilities were not material at September 30, 2013, but outcomes may be uncertain.
- Other contingencies include $240 million of standby letters of credit for options clearing and guarantees to clearing houses and exchanges. Management considered payment under the clearing-house guarantees remote and recorded no liability. CSC issued $275 million of 2.20% Senior Notes due 2018 in July.
Important facts for investors to verify
- Reconcile reported net new client assets with the $42.8 billion core figure, including the planned $44.3 billion client transfer outflow in Q2 and the $24.7 billion reduction in reported client assets tied to retirement-recordkeeping platform changes.
- Track how sustained low rates, asset growth, client cash balances, and money-market fee waivers affect net interest margins and fee revenue.
- Review the securities portfolio’s unrealized marks: at September 30, available-for-sale securities had $216 million of gross unrealized losses; held-to-maturity securities had $751 million, with fair value of $27,717 million versus $28,219 million amortized cost.
- Monitor mortgage and HELOC credit quality, California concentration, and the performance of non-agency mortgage-backed securities, as well as litigation and regulatory proceedings.
- Confirm actual capital spending against the revised 2013 estimate and assess the effects of proposed liquidity requirements and Basel III implementation beginning in 2015.