Charles Schwab Corporation — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018. Amounts are in U.S. dollars; financial statement figures are in millions unless noted. Schwab provides brokerage, banking, wealth management, asset management, custody, and advisory services through Investor Services and Advisor Services.
Financial and operating results
| Metric | Q1 2018 | Q1 2017 | Change |
|---|---|---|---|
| Total net revenue | $2,398 | $2,081 | +15% |
| Net interest revenue | $1,263 | $1,000 | +26% |
| Asset management and administration fees | $851 | $823 | +3% |
| Trading revenue | $201 | $192 | +5% |
| Expenses excluding interest | $1,396 | $1,238 | +13% |
| Income before taxes | $1,002 | $843 | +19% |
| Net income | $783 | $564 | +39% |
| Net income available to common stockholders | $746 | $525 | +42% |
| Diluted EPS | $0.55 | $0.39 | +41% |
| Pre-tax profit margin | 41.8% | 40.5% | +1.3 percentage points |
| Effective tax rate | 21.9% | 33.1% | Lower, mainly due to Tax Act |
- Net interest margin was 2.12%, versus 1.87% a year earlier. Management attributed higher net interest revenue to higher rates and growth in interest-earning assets; interest expense also rose as deposit and borrowing costs increased.
- Trading activity strengthened: daily average revenue trades rose 46% to 462,000, while trading revenue grew 5%. Revenue per revenue trade fell 26% to $7.24, reflecting pricing reductions and the mix of activity.
- Expense growth reflected higher staffing and technology-related spending and a $15 million charge for unsecured client margin losses in volatility-related products during early February.
- Return on average common stockholders’ equity was 18%, compared with 15% in Q1 2017. Expenses excluding interest were 0.17% of average client assets, compared with 0.18%.
Client activity, cash flow, and balance sheet
- Quarter-end client assets were $3.305 trillion, up 13% year over year; average client assets were $3.382 trillion, up 18%. Active brokerage accounts reached 11.005 million, up 7%, and clients opened 443,000 new accounts.
- Reported net new client assets were negative $18.8 billion, including $84.4 billion of outflows from certain mutual fund clearing clients. Core net new client assets, excluding those planned outflows, were $65.6 billion, up from $38.9 billion.
- Client cash was 11.0% of client assets at quarter-end, down from 12.4% a year earlier. Schwab transferred about $25 billion from sweep money market funds to bank sweep deposits during the quarter.
- Operating cash flow was $248 million, versus a use of $1.577 billion in Q1 2017. Investing activities used $6.539 billion and financing activities provided $4.756 billion. Cash and cash equivalents, including restricted amounts, decreased $1.535 billion to $17.625 billion.
- Total assets were $248.320 billion at March 31, 2018, versus $243.274 billion at December 31, 2017. Bank deposits were $190.184 billion, up from $169.656 billion.
- Long-term debt was $4.128 billion, down from $4.753 billion at year-end. Short-term borrowings were zero, versus $15 billion at December 31, 2017; Schwab reported paying off $15 billion of Federal Home Loan Bank borrowings. The filing lists $4.106 billion principal outstanding on senior notes, plus finance lease and accounting adjustments.
- Stockholders’ equity was $19.330 billion. CSC’s Tier 1 leverage ratio was 7.5%; CSC and its bank subsidiary were reported well capitalized. Schwab was in compliance with the modified liquidity coverage ratio rule.
Outlook, risks, and notable items
- Management expected full-year 2018 capital expenditures to rise to approximately 6%–7% of net revenue, above its typical 3%–5% range, for geographic expansion, office campus work, and technology investment. Q1 capital expenditures were $135 million, versus $67 million a year earlier.
- Management’s stated strategy emphasizes client growth, trusted relationships, affordable products, and expense discipline; the filing does not provide a numerical earnings or revenue forecast.
- The Tax Act reduced the federal corporate tax rate to 21% effective in 2018 and was a principal reason for the lower Q1 effective tax rate. The company said its accounting for certain Tax Act effects remained subject to further analysis; it recorded no material measurement-period adjustments in Q1.
- Interest-rate sensitivity modeling estimated that a gradual 100-basis-point increase would raise net interest revenue by 3.5% over the next 12 months, while a 100-basis-point decrease would reduce it by 5.2%. Management cautioned that actual results may differ and depend on rates, balance changes, and management actions.
- Key risks cited include market and interest-rate conditions, competition and deposit pricing, client asset and cash movements, expenses, liquidity and capital needs, regulatory matters, litigation, and execution of new products and technology. The company reported no material change to its 2017 Form 10-K risk factors during the quarter.
- Legal matters include the Total Bond Market Fund litigation and Crago order-routing litigation. Schwab said it intends to contest the claims; for the described matters, it generally could not reasonably estimate potential liability at this stage. It also disclosed $10.932 billion in commitments to extend credit or purchase mortgages and $225 million in standby letters of credit; certain clearing-house guarantee exposures are not quantifiable, though management considered payment remote.
- Unrealized losses on investment securities increased: at March 31, 2018, securities with unrealized losses totaled $2.689 billion, primarily in held-to-maturity mortgage-backed securities. Management reported that substantially all portfolio securities were investment grade and that no other-than-temporary impairment was recognized in Q1.
Most important facts for investors to verify
- Whether core asset gathering continues to offset the reported mutual fund clearing outflows, and how client cash levels and sweep transfers evolve.
- Whether rising rates continue to support net interest margin after higher deposit and borrowing costs and any changes in client cash behavior.
- Whether revenue growth outpaces expense growth as staffing, technology, regulatory, and planned capital spending increase.
- The extent and duration of securities valuation losses, and the effect of any credit deterioration or interest-rate changes on the investment portfolio.
- Developments in the disclosed litigation and contingencies, including whether potential losses become estimable or require additional reserves.
- The effect of remaining Tax Act accounting estimates and the 2019 lease and 2020 credit-loss accounting standards on reported results and balance-sheet presentation.