Charles Schwab Corporation (SCHW) — Q3 2022 Form 10-Q
Business context and period. Schwab provides brokerage, wealth management, banking, asset management, custody, and advisory services through Investor Services and Advisor Services. This unaudited report covers the quarter and nine months ended September 30, 2022; comparisons are with the corresponding 2021 periods unless otherwise noted. Amounts below are in U.S. dollars.
Financial and operating results
| Metric | Q3 2022 | Change year over year | Nine months 2022 | Change year over year |
|---|---|---|---|---|
| Total net revenue | $5.50 billion | +20% | $15.27 billion | +11% |
| Net interest revenue | $2.93 billion | +44% | $7.65 billion | +30% |
| Expenses excluding interest | $2.82 billion | +10% | $8.48 billion | +4% |
| Income before tax | $2.68 billion | +33% | $6.79 billion | +19% |
| Net income | $2.02 billion | +32% | $5.22 billion | +22% |
| Diluted EPS | $0.99 | +34% | $2.53 | +23% |
| Pre-tax margin | 48.7% | 44.0% in 2021 | 44.5% | 41.2% in 2021 |
- Revenue mix: Higher interest rates were the principal earnings tailwind. Asset management and administration fees were down 5% in Q3 to $1.05 billion and essentially flat year to date at $3.17 billion. Trading revenue declined 4% in Q3 and 11% year to date. Bank deposit account fees rose 28% in Q3 and 5% year to date.
- Expenses and adjusted results: Compensation, occupancy and technology-related costs increased as Schwab invested in employees, infrastructure, and the TD Ameritrade integration. Adjusted diluted EPS, a non-GAAP measure, was $1.10 in Q3 and $2.83 year to date, versus $0.84 and $2.39. Adjusted expenses exclude integration costs and acquired-intangible amortization.
- Client activity: Quarter-end client assets were $6.64 trillion, down 13% from a year earlier; management cited approximately $1.4 trillion of market-value declines over the 12 months. Q3 net new client assets were $114.6 billion, down 18% year over year. Active brokerage accounts rose 4% to 33.9 million, while new accounts fell 24% to 897,000. Daily average trades were 5.5 million, broadly flat year over year.
- Cash flow: For the first nine months, operating activities provided $4.16 billion, investing activities provided $20.51 billion, and financing activities used $52.76 billion. Cash and cash equivalents, including restricted amounts, decreased $28.09 billion to $65.25 billion. These flows reflect substantial changes in client deposits, securities, and brokerage balances; they should not be read as a conventional industrial-company free-cash-flow measure.
- Balance sheet and capital: Total assets were $577.56 billion, down 13% from December 31, 2021. Bank deposits were $395.72 billion, down from $443.78 billion; brokerage-client payables were $110.01 billion, down from $125.67 billion. Long-term debt was $20.84 billion, up from $18.91 billion; short-term borrowings were $500 million, down from $4.86 billion. The consolidated Tier 1 leverage ratio was 6.8%, above the revised 6.50%–6.75% operating objective; management reported the company and banking subsidiaries met applicable capital requirements.
Material changes, outlook, and management commentary
- Rapid Federal Reserve rate increases lifted asset yields and net interest revenue, but also prompted clients to move cash out of sweep deposits into higher-yielding alternatives. Bank deposits and brokerage-client payables together fell 11% from year-end 2021 through September 30.
- After quarter-end, banking subsidiaries began using supplemental FHLB funding. At October 31, 2022, $9.0 billion was outstanding, with a reported average rate of 4.25% and earliest maturity in June 2023. Schwab said it expects to use temporary funding until primary liquidity sources again exceed cash outflows associated with client cash reallocations.
- Average daily LCR was 118% for Q3, above the 100% regulatory minimum. At September 30, available external facilities included $82.6 billion of FHLB capacity and $8.8 billion of Federal Reserve discount-window capacity, subject to collateral and other conditions.
- Management expects full-year 2022 capital expenditures of approximately 4%–5% of total net revenue. TD Ameritrade conversions are now expected mostly during 2023, with certain client groups in early 2024. Total acquisition and integration costs and capital expenditures are estimated at $2.4–$2.5 billion. Expected annualized cost synergies remain $1.8–$2.0 billion; more than half had been achieved on a run-rate basis by September 30, with most remaining synergies expected by the end of 2024.
- The board raised the quarterly common dividend 10% to $0.22 per share and authorized up to $15 billion of repurchases. Schwab repurchased $1.5 billion under the new authorization in Q3, leaving $13.5 billion authorized at September 30. Series A preferred stock was redeemed November 1; Series E redemption was announced for December 1, 2022.
- Higher interest rates caused substantial unrealized losses in the securities portfolio: AFS securities had $28.3 billion of gross unrealized losses at September 30, versus $4.9 billion at December 31, 2021. AOCI fell to negative $23.15 billion from negative $1.11 billion, contributing to lower reported stockholders’ equity. Schwab transferred $108.8 billion of mortgage-backed securities from AFS to HTM in January and disclosed a further approximately $80 billion transfer after quarter-end, on November 2, with approximately $16 billion of pre-tax unrealized losses at transfer.
- Management cited inflation, monetary tightening, geopolitical uncertainty, declining equity markets, client cash allocation shifts, competitive deposit pricing, and integration complexity as important risks. A 100-basis-point rate increase was modeled to raise next-12-month net interest revenue by 5.3% at September 30; a 100-basis-point decrease was modeled to reduce it by 4.6%. These are simulations based on stated assumptions, not forecasts.
- Legal matters include a newly filed antitrust class action challenging the TD Ameritrade acquisition and ongoing order-routing litigation. Schwab says it is contesting the matters; potential liability estimates are not clear in the filing for the described unresolved cases. The SEC matter concerning Schwab Intelligent Portfolios was settled for $186.5 million, following a previously recorded approximately $200 million charge.
- Other upcoming costs include a 1% federal excise tax on certain net stock repurchases after December 31, 2022, and higher FDIC assessment rates beginning in 2023. Management also noted that the FDIC rate change is expected to increase regulatory fees and reduce bank deposit account fee revenue.
Most important facts for investors to verify
- Whether deposit outflows persist, and the amount, cost, and duration of supplemental FHLB or other funding.
- Subsequent-period net interest revenue and deposit pricing as rates and client cash allocations change.
- Realized versus unrealized securities losses, liquidity implications, and the effects of AFS-to-HTM transfers on reported equity and capital measures.
- Progress, timing, total costs, and realized synergies from TD Ameritrade integration and client conversions.
- Changes in client assets, net new assets, trading activity, and fee revenue amid market weakness.
- Capital and liquidity ratios relative to regulatory requirements and operating objectives, particularly after repurchases, dividends, and preferred-stock redemptions.
- Developments in material litigation and regulatory matters; the filing does not provide a clear loss estimate for certain pending cases.