20160930 Q3 10Q

UNITED STATES

SECURITIES  AND  EXCHANGE  COMMISSION

Washington, D.C.  20549



FORM 10-Q



QUARTERLY  REPORT  PURSUANT  TO  SECTION  13  OR  15(d)
OF  THE  SECURITIES  EXCHANGE  ACT  OF  1934



For the quarterly period ended September 30, 2016



Commission File Number: 1-9700



THE  CHARLES  SCHWAB  CORPORATION

(Exact name of registrant as specified in its charter)





 

Delaware

(State or other jurisdiction

of incorporation or organization)

94-3025021

(I.R.S. Employer Identification No.)



211 Main Street, San Francisco, CA  94105

(Address of principal executive offices and zip code)



Registrant’s telephone number, including area code:  (415) 667-7000



Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes   No 



Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes    No 



Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.





 

Large accelerated filer 

Non-accelerated filer  (Do not check if a smaller reporting company)

Accelerated filer 

Smaller reporting company 



Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes  No 



Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.



 1,325,672,135 shares of $.01 par value Common Stock

Outstanding on October 26, 2016





 


 

THE CHARLES SCHWAB CORPORATION

 

Quarterly Report on Form 10-Q

For the Quarter Ended September 30, 2016

 

Index

 







 

 

 

 

 

 

Part I - Financial Information

 

Page



 

 



 

 

 

 



Item 1.

Condensed Consolidated Financial Statements (Unaudited):

 

 



 

 

 

 



 

Statements of Income

 

28



 

Statements of Comprehensive Income

 

29



 

Balance Sheets

 

30



 

Statements of Cash Flows

 

31



 

Notes

 

32-56



 

 

 

 



Item 2.

Management’s Discussion and Analysis of Financial
Condition and Results of Operations

 

1-25



 

 

 

 



Item 3.

Quantitative and Qualitative Disclosures About Market Risk

 

26-27



 

 

 

 



Item 4.

Controls and Procedures

 

57



 

 

 

 

Part II - Other Information

 

 



 

 

 

 



Item 1.

Legal Proceedings

 

58



 

 

 

 



Item 1A.

Risk Factors

 

58



 

 

 

 



Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

 

58



 

 

 

 



Item 3.

Defaults Upon Senior Securities

 

59



 

 

 

 



Item 4.

Mine Safety Disclosures

 

59



 

 

 

 



Item 5.

Other Information

 

59



 

 

 

 



Item 6.

Exhibits

 

60-61



 

 

 

 

Signature

 

62



 

 







 


 

Part I – FINANCIAL INFORMATION

 

THE CHARLES SCHWAB CORPORATION

Management’s Discussion and Analysis of Financial Condition and Results of Operations

(Tabular Amounts in Millions, Except Ratios, or as Noted)

 

 

Item 2.Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A)





INTRODUCTION



The Charles Schwab Corporation (CSC) is a savings and loan holding company engaged, through its subsidiaries, in wealth management, securities brokerage, banking, money management, custody, and financial advisory services. Charles Schwab & Co., Inc. (Schwab) is a securities broker-dealer with over 330 domestic branch offices in 46 states, as well as a branch in each of the Commonwealth of Puerto Rico and London, England. In addition, Schwab serves clients in Hong Kong through one of CSC’s subsidiaries. Other subsidiaries include Charles Schwab Bank (Schwab Bank), a federal savings bank, and Charles Schwab Investment Management, Inc. (CSIM), the investment advisor for Schwab’s proprietary mutual funds, which are referred to as the Schwab Funds®, and for Schwab’s exchange-traded funds (ETFs), which are referred to as the Schwab ETFs™.



CSC and its subsidiaries (collectively, referred to as the Company) operate through two reportable segments – Investor Services and Advisor Services. The Investor Services segment provides retail brokerage and banking services, retirement plan services, and other corporate brokerage services. The Advisor Services segment provides custodial, trading, and support services as well as retirement business services.



This quarterly report on Form 10-Q should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2015 (2015 Form 10-K).





Forward-Looking Statements



In addition to historical information, this Quarterly Report on Form 10-Q contains “forward-looking statements” within the meaning of Section 27A of the Securities Act, and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements are identified by words such as “believe,” “anticipate,” “expect,” “intend,” “plan,” “will,” “may,” “estimate,” “appear,” “aim,” “target,” “could,” “would,” “continue,” and other similar expressions. In addition, any statements that refer to expectations, projections, or other characterizations of future events or circumstances are forward-looking statements.



These forward-looking statements, which reflect management’s beliefs, objectives, and expectations as of the date hereof, are necessarily estimates based on the best judgment of the Company’s senior management. These statements relate to, among other things:



·

the expected impact of the final Department of Labor fiduciary rule and the proposed rule relating to a regulatory capital deduction for investments in unsecured debt issued by global systemically important banking organizations (see “Part I, Item 2. – Management’s Discussion and Analysis of Financial Condition and Results of Operations – Overview – Current Regulatory Environment and Other Developments”);

·

the impact of current market conditions and interest rates on the Company’s results of operations (see “Part I, Item 2. – Management’s Discussion and Analysis of Financial Condition and Results of Operations – Overview” and “– Results of Operations – Net Interest Revenue”);

·

sources of liquidity, capital, and level of dividends (see “Part I, Item 2. – Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity”);

·

the timing of bulk transfers (see “Part I, Item 2. – Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity”);

·

target capital ratios (see “Part I, Item 2. – Management’s Discussion and Analysis of Financial Condition and Results of Operations – Capital Management – Regulatory Capital Requirements”);

·

the likelihood of indemnification and guarantee payment obligations (see “Part I, Item 1. – Condensed Consolidated Financial Statements (Unaudited) – Notes – 8. Commitments and Contingencies – Guarantees and indemnifications”); and

-  1  -


 

THE CHARLES SCHWAB CORPORATION

Management’s Discussion and Analysis of Financial Condition and Results of Operations

(Tabular Amounts in Millions, Except Ratios, or as Noted)

 

 

·

the impact of legal proceedings and regulatory matters (see “Part I, Item 1. – Condensed Consolidated Financial Statements (Unaudited) – Notes – 8. Commitments and Contingencies – Legal contingencies” and “Part II, Item 1. – Legal Proceedings”).



Achievement of the expressed beliefs, objectives, and expectations described in these statements is subject to certain risks and uncertainties that could cause actual results to differ materially from the expressed beliefs, objectives, and expectations. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this Quarterly Report on Form 10-Q or, in the case of documents incorporated by reference, as of the date of those documents.



Important factors that may cause actual results to differ include, but are not limited to:

·

the clarification and interpretation of certain provisions in the final Department of Labor rule concerning fiduciary standards; 

·

the adverse impact of financial reform legislation and related regulations;

·

general market conditions, including the level of interest rates, equity valuations and trading activity;

·

the Company’s ability to attract and retain clients and registered investment advisors and grow those relationships and client assets;

·

client use of the Company’s investment advisory services and other products and services;

·

the level of client assets, including cash balances;

·

competitive pressure on rates and fees;

·

client sensitivity to interest rates;

·

regulatory guidance;

·

timing, amount and impact of the migration of certain balances from brokerage accounts and sweep money market funds into Schwab Bank;

·

capital needs and management;

·

the availability and terms of external financing;

·

the company’s ability to manage expenses;

·

the failure of another member of a securities clearing house or exchange to satisfy its obligations for which the Company has a guarantee obligation; and

·

the effect of adverse developments in litigation or regulatory matters and the extent of any related charges.



Certain of these factors, as well as general risk factors affecting the Company, are discussed in greater detail in “Part I –Item 1A – Risk Factors” in the 2015 Form 10-K, and “Part II – Other Information – Item 1A – Risk Factors.



 

-  2  -


 

THE CHARLES SCHWAB CORPORATION

Management’s Discussion and Analysis of Financial Condition and Results of Operations

(Tabular Amounts in Millions, Except Ratios, or as Noted)

 

 

GLOSSARY OF TERMS



Active brokerage accounts: Brokerage accounts with activity within the preceding eight months.



Asset-backed securities: Debt securities backed by financial assets such as loans or receivables.



Assets receiving ongoing advisory services: Client relationships under the guidance of independent advisors and assets enrolled in one of the Company’s retail or other advisory solutions.



Average client assets: The daily average client asset balance for the period.



Basel III: Global regulatory standards on bank capital adequacy and liquidity issued by the Basel Committee on Banking Supervision.



Basis point: One basis point equals 1/100th of 1%, or 0.01%.



Cash and investments segregated and on deposit for regulatory purposes: Client cash or qualified securities balances not used for margin lending are segregated into investment accounts maintained for the exclusive benefit of clients, pursuant to Rule 15c3-3 of the Securities Exchange Act of 1934, by the Company’s broker-dealer subsidiaries.



Client assets: The market value of all client assets custodied at the Company, which includes both cash and securities, at a point in time.  



Client cash as a percentage of client assets: Calculated as money market fund balances, bank deposits, Schwab One® balances, and certain cash equivalents as a percentage of client assets.



Clients’ daily average trades: Includes daily average revenue trades by clients, trades by clients in asset-based pricing relationships, and all commission-free trades.



Commitments to extend credit: Legally binding agreements to extend credit for unused home equity loans and lines of credit (HELOCs), Pledged Asset Lines® (PALs) and other lines of credit.



Common Equity Tier 1 (CET1) Capital: The sum of common stock and related surplus net of treasury stock, retained earnings, accumulated other comprehensive income (AOCI) and qualifying minority interests, less applicable regulatory adjustments and deductions.



Common Equity Tier 1 Risk-Based Capital Ratio: The ratio of CET1 Capital to total risk-weighted assets.



Concentration risk: The potential for loss resulting from holding large positions in financial instruments collateralized by assets with similar economic characteristics or in securities of a single issuer or particular industry or geographical area.



Core net new client assets: Net new client assets before significant one-time inflows or outflows, such as acquisitions/divestitures or extraordinary (generally, greater than $10 billion) mutual fund clearing transfers.



Credit risk: The potential for loss due to a borrower, counterparty, or issuer failing to perform its contractual obligations.



Customer Protection Rule: Refers to Rule 15c3-3 of the Securities Exchange Act of 1934.



Daily average revenue trades: Total revenue trades during a certain period, divided by the number of trading days in that period. Revenue trades include all client trades that generate trading revenue (i.e., commission revenue or principal transaction revenue).



Debt to total capital ratio: Calculated as long-term debt divided by stockholders’ equity and long-term debt.



-  3  -


 

THE CHARLES SCHWAB CORPORATION

Management’s Discussion and Analysis of Financial Condition and Results of Operations

(Tabular Amounts in Millions, Except Ratios, or as Noted)

 

 

Delinquency roll rates: The rates at which loans transition through delinquency stages, ultimately resulting in a loss. The Company considers a loan to be delinquent if it is 30 days or more past due.



Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank): Regulatory reform legislation signed into federal law in 2010 containing numerous provisions which expanded prudential regulation of large financial services companies.



Final Regulatory Capital Rules: Refers to the regulatory capital rules issued by U.S. banking agencies in July 2013 that implemented Basel III and relevant provisions of Dodd-Frank, which apply to savings and loan holding companies, as well as federal savings banks. Implementation began on January 1, 2015.



First Mortgages: Refers to first lien residential real estate mortgage loans, which include two loan classes: first mortgages and purchased first mortgages.



Full-time equivalent employees: Represents the total number of hours worked divided by a 40-hour work week for the following categories: full-time, part-time, and temporary employees and persons employed on a contract basis.



Interest rate risk: The potential for variability in net interest revenue or the fluctuation in the valuation of assets arising from changes in interest rates.



Interest-bearing liabilities: Includes bank deposits, payables to brokerage clients, short-term borrowings, and long-term debt on which the Company pays interest.



Interest-earning assets: Includes cash and cash equivalents, cash and investments segregated, broker-related receivables, receivables from brokerage clients, securities available for sale, securities held to maturity, and bank loans on which the Company earns interest.



Investment grade: Defined as a rating equivalent to a Moody’s Investors Service (Moody’s) rating of “Baa” or higher, or a Standard & Poor’s Ratings Group (Standard & Poor’s) or Fitch Ratings, Ltd (Fitch) rating of “BBB-” or higher.



Liquidity risk: The potential that the Company will be unable to sell assets or meet cash flow obligations when they come due without incurring unacceptable losses.



Loan-to-value ratio: Calculated as the principal amount of a loan divided by the value of the collateral securing the loan.



Margin loans: Advances made to brokerage clients on a secured basis to purchase securities reflected in receivables from brokerage clients on the Company’s balance sheets.



Market risk: The potential for changes in earnings or the value of financial instruments held by the Company as a result of fluctuations in interest rates, equity prices or market conditions.



Master netting arrangement: An agreement between two counterparties that have multiple contracts with each other that provides for net settlement of all contracts through a single cash payment in the event of default or termination of any one contract.



Mortgage-backed security: A type of asset-backed security that is secured by a mortgage or group of mortgages.



Net interest margin: Net interest revenue divided by average interest-earning assets.



Net new client assets: Total inflows of client cash and securities to the Company less client outflows.



New brokerage accounts: All brokerage accounts opened during the period, as well as any accounts added via acquisition.



Nonperforming assets: The total of nonaccrual loans and other real estate owned.



-  4  -


 

THE CHARLES SCHWAB CORPORATION

Management’s Discussion and Analysis of Financial Condition and Results of Operations

(Tabular Amounts in Millions, Except Ratios, or as Noted)

 

 

Operational risk: The risk, including litigation, of inadequate or failed internal processes, people, systems or from external events and relationships impacting the Company and/or any of its key business partners and third parties.



Order flow revenue: Net compensation received from markets and firms to which Schwab and optionsXpress, Inc. send equity and options orders. Reflects rebates received for certain types of orders, minus fees paid for types of orders for which exchange fees or other charges apply.



Pledged Asset Line: A non-purpose revolving line of credit from Schwab Bank secured by eligible assets held in a separate pledged asset account maintained at Schwab.



Return on average common stockholders’ equity: Calculated as net income available to common stockholders annualized divided by average common stockholders’ equity.



Risk-weighted assets: Primarily computed by assigning specific risk-weightings as specified by the regulators to assets and off-balance sheet instruments for capital adequacy calculations.



Tier 1 Capital: The sum of CET1 Capital and additional Tier 1 Capital instruments and related surplus, less applicable adjustments and deductions.



Tier 1 Leverage Ratio: Tier 1 Capital divided by adjusted average total consolidated assets at the end of the quarter.



Trading days: Days in which the markets/exchanges are open for the buying and selling of securities. Early market closures are counted as half-days.



U.S. federal banking agencies: Refers to the Board of Governors of the Federal Reserve System (Federal Reserve), the Office of the Comptroller of the Currency (OCC), the Federal Deposit Insurance Corporation (FDIC), and the Consumer Financial Protection Bureau (CFPB).



Uniform Net Capital Rule: Refers to Rule 15c3-1 under the Securities Exchange Act of 1934 which specifies minimum capital requirements that are intended to ensure the general financial soundness and liquidity of broker-dealers.





 

-  5  -


 

THE CHARLES SCHWAB CORPORATION

Management’s Discussion and Analysis of Financial Condition and Results of Operations

(Tabular Amounts in Millions, Except Ratios, or as Noted)

 

 

OVERVIEW



Management of the Company focuses on several client activity and financial metrics in evaluating the Company’s financial position and operating performance. Management believes that net revenue growth, pre-tax profit margin, earnings per common share (EPS), and return on average common stockholders’ equity provide broad indicators of the Company’s overall financial health, operating efficiency, and ability to generate acceptable returns. Expenses excluding interest as a percentage of average client assets are considered by management to be a measure of operating efficiency. Results for the third quarters and first nine months of 2016 and 2015 are:





 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

Three Months Ended

 

 

 

 

Nine Months Ended

 

 

 



 

September 30,

 

Percent

 

September 30,

 

Percent



 

2016

 

 

2015

 

Change

 

2016

 

 

2015

 

Change

Client Metrics:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net new client assets (in billions)

 

$

30.0 

  

 

$

30.8 

 

(3)

%

 

$

88.6 

  

 

$

96.5 

  

(8)

%

Core net new client assets (in billions) (1)

 

$

30.0 

 

 

$

30.8 

 

(3)

%

 

$

88.6 

 

 

$

102.0 

 

(13)

%

Client assets (in billions, at quarter end)

 

$

2,725.3 

  

 

$

2,415.9 

 

13 

%

 

 

 

 

 

 

 

 

 

 

Average client assets (in billions)

 

$

2,699.5 

 

 

$

2,513.5 

 

%

 

$

2,576.8 

 

 

$

2,532.7 

 

%

New brokerage accounts (in thousands)

 

 

264 

 

 

 

254 

 

%

 

 

800 

 

 

 

808 

 

(1)

%

Active brokerage accounts (in thousands,

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

at quarter end)

 

 

10,046 

 

 

 

9,691 

 

%

 

 

 

 

 

 

 

 

 

 

Assets receiving ongoing advisory services

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(in billions, at quarter end)

 

$

1,368.8 

 

 

$

1,204.8 

 

14 

%

 

 

 

 

 

 

 

 

 

 

Client cash as a percentage of client assets 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(at quarter end)

 

 

12.5 

%

 

 

12.9 

%

 

 

 

 

 

 

 

 

 

 

 

 

Company Financial Metrics:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net revenues

 

$

1,914 

  

 

$

1,597 

 

20 

%

 

$

5,506 

  

 

$

4,689 

  

17 

%

Expenses excluding interest

 

 

1,120 

  

 

 

1,014 

 

10 

%

 

 

3,337 

  

 

 

3,055 

  

%

Income before taxes on income

 

 

794 

  

 

 

583 

 

36 

%

 

 

2,169 

  

 

 

1,634 

  

33 

%

Taxes on income

 

 

291 

  

 

 

207 

 

41 

%

 

 

802 

  

 

 

603 

  

33 

%

Net income

 

 

503 

  

 

 

376 

 

34 

%

 

 

1,367 

  

 

 

1,031 

  

33 

%

Preferred stock dividends and other

 

 

33 

 

 

 

11 

 

200 

%

 

 

99 

 

 

 

45 

 

120 

%

Net income available to common stockholders

 

$

470 

 

 

$

365 

 

29 

%

 

$

1,268 

 

 

$

986 

 

29 

%

Earnings per common share – diluted

 

$

.35

  

 

$

.28

 

25 

%

 

$

.95

  

 

$

.74

  

28 

%

Net revenue growth from prior year

 

 

20 

 

 

%

 

 

 

 

17 

 

 

 

 

Pre-tax profit margin

 

 

41.5 

 

 

36.5 

%

 

 

 

 

39.4 

 

 

34.9 

 

 

Return on average common stockholders’ equity

 

 

14 

 

 

13 

%

 

 

 

 

13 

%

 

 

12 

%

 

 

Expenses excluding interest as a percentage of

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

average client assets (annualized)

 

 

0.17 

 

 

0.16 

%

 

 

 

 

0.17 

%

 

 

0.16 

%

 

 



(1)

The nine months ended September 30, 2015 excludes an inflow of $6.1 billion to reflect the final impact of the consolidation of the Company’s retirement plan recordkeeping platforms and an outflow of $11.6 billion relating to the Company’s planned resignation from an Advisor Services cash management relationship netting to an adjustment of ($5.5) billion.



During the third quarter of 2016, the Company’s range of full-service investment capabilities continued to attract a broad spectrum of investors. Core net new assets totaled $30.0 billion and $88.6 billion for the third quarter and nine months ended September 30, 2016, respectively, sustaining a 5% annualized organic growth rate over year-end 2015 client assets. The Company ended the quarter serving 10.0 million active brokerage accounts, 1.1 million banking accounts and 1.6 million retirement plan participants, up 4%, 6%, and 5%, respectively, from the same period in 2015. Total client assets reached $2.73 trillion at September 30, 2016, up 13% year-over-year, as investors continued to engage with the Company throughout the summer quarter. During the third quarter of 2016, the Company’s financial consultants held planning conversations with 34,000 clients, up 17% from the same quarter in 2015. For the nine months ended September 30, 2016, 101,000 clients have participated in such conversations, up 22% from September 30, 2015. Assets enrolled in some form of ongoing advisory service totaled $1.37 trillion at quarter-end, up 14% from a year ago.

-  6  -


 

THE CHARLES SCHWAB CORPORATION

Management’s Discussion and Analysis of Financial Condition and Results of Operations

(Tabular Amounts in Millions, Except Ratios, or as Noted)

 

 

Net revenues increased 20% and 17% in the third quarter and first nine months of 2016, respectively, compared to the same periods in 2015 primarily due to growth in client assets and higher short-term interest rates.



Expenses increased 10% and 9% in the third quarter and first nine months of 2016, respectively, compared to the same periods in 2015 consistent with management’s expectations for spending to support current and future growth in the business.



The pre-tax profit margin for the third quarter and first nine months of 2016 was 41.5% and 39.4%, respectively, compared to 36.5% and 34.9% for the same periods in 2015. Net income grew by 34% and 33%, respectively, for the third quarter and first nine months 2016 compared to the same periods in 2015.



Subsequent Event



On October 31, 2016, the Company issued and sold 600,000 depositary shares, each representing a 1/100th ownership interest in a share of fixed-to-floating rate non-cumulative perpetual preferred stock, Series E, $0.01 par value, with a liquidation preference of $100,000 per share (equivalent to $1,000 per depositary share) (Series E Preferred Stock). The Series E Preferred Stock has a fixed dividend rate of 4.625% through February 28, 2022, payable semi-annually, and thereafter at a floating rate of three-month LIBOR plus a fixed spread of 3.315%, payable quarterly. Net proceeds received from the sale were $591 million and are being used to support balance sheet growth, including the migration of certain client balances from sweep money market funds into Schwab Bank.



Current Regulatory Environment and Other Developments



In September 2016, the OCC issued final guidelines for recovery planning by national banks and federal savings banks with total consolidated assets of $50 billion or more. The guidelines establish enforceable standards requiring each bank to develop and maintain a recovery plan that describes how the bank will restore itself to financial health and viability in response to a wide range of external and internal financial and operational stress scenarios. The guidelines go into effect on January 1, 2017, and Schwab Bank will have until the end of 2017 to develop and prepare a recovery plan.



Effective July 1, 2016, the FDIC began imposing a surcharge on insured depository institutions with total consolidated assets of $10 billion or more at the same time that a scheduled reduction in the regular FDIC insurance assessment also went into effect. As a result, the Company is now subject to a 3 basis point regular assessment on its total assessment base (down from 5 basis points) and a new 4.5 basis point surcharge on the amount of its assessment base in excess of $10 billion. For the third quarter of 2016, the Company’s combined FDIC assessment rate, measured against its total assessment base, rose by a net of 2.2 basis points.



In May 2016, the Federal Reserve, the OCC and the FDIC jointly issued a notice of proposed rulemaking that would impose a minimum net stable funding ratio (NSFR) on certain banking organizations, including CSC. The NSFR is intended to measure an organization’s “available” amount of stable funding relative to its “required” amount of stable funding over a one-year time horizon. The effective date of the rule would be January 1, 2018. The comment period for the proposed rule ended on August 5, 2016 and the impact to the Company cannot be assessed until the final rule is released.



In April 2016, the Department of Labor published a final rule that significantly broadens the definition of “fiduciary” under the Employee Retirement Income Security Act of 1974. Among other things, the new rule subjects broker-dealers who provide non-discretionary investment advice to retirement plans and accounts to a “best interest” standard, as well as other conditions and requirements. Based on the Company’s evaluation of the final rule to date, the Company does not expect the rule to have a material impact on the Company’s business, financial condition or results of operations.



In October 2015, the Federal Reserve issued a notice of proposed rulemaking that, among other things, would require certain financial institutions that are subject to the Federal Reserve’s capital rules to apply a regulatory capital deduction treatment to their investments in unsecured debt issued by U.S. bank holding companies identified as global systemically important banking organizations. The comment period for the rule proposal ended on February 19, 2016 and the rule proposal is subject to further modification. The proposed effective date of the rule would be January 1, 2019. The Company continues to monitor developments in order to assess the impact of the proposed rule, but does not expect it to have a material impact on the Company’s business, financial condition and results of operations.



-  7  -


 

THE CHARLES SCHWAB CORPORATION

Management’s Discussion and Analysis of Financial Condition and Results of Operations

(Tabular Amounts in Millions, Except Ratios, or as Noted)

 

 



Results of Operations



The following discussion presents an analysis of the Company’s results of operations for the third quarter and first nine months of 2016 compared to the same periods in 2015.



Net Revenues





 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended September 30,

 

 

 

 

2016

 

2015



 

 

 

 

 

 

 

% of

 

 

 

 

% of



 

Percent

 

 

 

 

Total Net

 

 

 

 

Total Net



 

Change

 

Amount

 

Revenues

 

Amount

 

Revenues

Asset management and administration fees

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Mutual funds and ETF service fees (1)

 

32 

 

$

486 

 

25 

 

$

369 

  

23 

Advice solutions

 

 

 

237 

 

12 

 

 

225 

  

14 

Other (1)

 

 

 

75 

 

 

 

69 

  

Asset management and administration fees

 

20 

 

 

798 

 

42 

 

 

663 

  

42 

Net interest revenue

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest revenue

 

33 

%

 

 

891 

 

46 

 

 

669 

  

42 

Interest expense

 

35 

%

 

 

(46)

 

(2)

%

 

 

(34)

 

(2)

%

Net interest revenue

 

33 

%

 

 

845 

 

44 

 

 

635 

  

40 

Trading revenue

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commissions

 

(15)

%

 

 

181 

 

10 

 

 

214 

  

13 

Principal transactions

 

(36)

%

 

 

 

 -

 

 

 

14 

  

Trading revenue

 

(17)

%

 

 

190 

 

10 

 

 

228 

  

14 

Other

 

15 

%

 

 

76 

 

 

 

66 

  

Provision for loan losses

 

 -

 

 

 

 

 -

 

 

 

 

 -

 

Total net revenues

 

20 

 

$

1,914 

 

100 

 

$

1,597 

  

100 





 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Nine Months Ended September 30,

 

 

 

 

2016

 

2015



 

 

 

 

 

 

 

% of

 

 

 

 

% of



 

Percent

 

 

 

 

Total Net

 

 

 

 

Total Net



 

Change

 

Amount

 

Revenues

 

Amount

 

Revenues

Asset management and administration fees

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Mutual funds and ETF service fees (1)

 

24 

%

 

$

1,362 

 

25 

 

$

1,102 

  

24 

Advice solutions

 

 

 

678 

 

12 

 

 

673 

  

14 

Other (1)

 

 

 

214 

 

 

 

202 

  

Asset management and administration fees

 

14 

 

 

2,254 

 

41 

 

 

1,977 

  

42 

Net interest revenue

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest revenue

 

32 

 

 

2,541 

 

46 

 

 

1,931 

  

41 

Interest expense

 

31 

 

 

(126)

 

(2)

%

 

 

(96)

 

(2)

%

Net interest revenue

 

32 

%

 

 

2,415 

 

44 

 

 

1,835 

  

39 

Trading revenue

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commissions

 

(6)

 

 

586 

 

10 

 

 

623 

  

13 

Principal transactions

 

%

 

 

37 

 

 

 

35 

  

Trading revenue

 

(5)

%

 

 

623 

 

11 

 

 

658 

  

14 

Other

 

 -

 

 

 

209 

 

 

 

208 

  

Provision for loan losses

 

(55)

 

 

 

 -

 

 

 

11 

 

 -

 

Total net revenues

 

17 

 

$

5,506 

 

100 

 

$

4,689 

  

100 





 

(1)

Other third-party mutual funds have been reclassified to Mutual funds and ETFs. Related revenues have been reclassified from Other asset management and administration fees. Prior period information has been recast to reflect this change.



-  8  -


 

THE CHARLES SCHWAB CORPORATION

Management’s Discussion and Analysis of Financial Condition and Results of Operations

(Tabular Amounts in Millions, Except Ratios, or as Noted)

 

 



Asset Management and Administration Fees



Asset management and administration fees include mutual fund and ETF service fees and fees for other asset-based financial services provided to individual and institutional clients. The Company earns mutual fund and ETF service fees for shareholder services, administration, and investment management provided to its proprietary funds, and recordkeeping and shareholder services provided to third-party funds. These fees are based upon the daily balances of client assets invested in these funds. Asset management and administration fees do not include securities lending revenues earned by proprietary mutual funds and ETFs as those amounts, net of program fees, are credited to the fund shareholders.



The Company also earns asset management fees for advice solutions, which include managed portfolios, specialized strategies and customized investment advice.  



The fair values of client assets included in proprietary and third-party mutual funds and ETFs are based on quoted market prices and other observable market data.



Other asset management and administration fees include various asset-based fees, such as trust fees, 401(k) recordkeeping fees, mutual fund clearing fees, collective trust fund fees, and non-balance based service and transaction fees.



Asset management and administration fees vary with changes in the balances of client assets due to market fluctuations and client activity.



The following tables present a roll forward of client assets for the Schwab money market funds, Schwab equity and bond funds and ETFs, and Mutual Fund OneSource®:





 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

Schwab Money

 

 

Schwab Equity and

 

 

Mutual Fund



 

Market Funds

 

 

Bond Funds and ETFs

 

 

OneSource®

Three Months Ended September 30,

 

2016

 

 

2015

 

 

2016

 

 

2015

 

 

2016

 

 

2015

Balance at beginning of period

$

160,951 

 

$

155,577 

 

$

110,722 

 

$

98,399 

 

$

203,352 

 

$

231,247 

Net inflows (outflows)

 

(725)

 

 

6,221 

 

 

3,297 

 

 

2,457 

 

 

(5,453)

 

 

(6,289)

Net market gains (losses) and other

 

26 

 

 

 

 

4,435 

 

 

(7,391)

 

 

8,184 

 

 

(14,213)

Balance at end of period

$

160,252 

 

$

161,807 

 

$

118,454 

 

$

93,465 

 

$

206,083 

 

$

210,745 







 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

Schwab Money

 

 

Schwab Equity and

 

 

Mutual Fund



 

Market Funds

 

 

Bond Funds and ETFs

 

 

OneSource®

Nine Months Ended September 30,

 

2016

 

 

2015

 

 

2016

 

 

2015

 

 

2016

 

 

2015

Balance at beginning of period

$

166,148 

 

$

167,909 

 

$

102,112 

 

$

88,450 

 

$

207,654 

 

$

234,381 

Net inflows (outflows)

 

(5,968)

 

 

(6,285)

 

 

8,951 

 

 

10,753 

 

 

(14,632)

 

 

(15,164)

Net market gains (losses) and other

 

72 

 

 

183 

 

 

7,391 

 

 

(5,738)

 

 

13,061 

 

 

(8,472)

Balance at end of period

$

160,252 

 

$

161,807 

 

$

118,454 

 

$

93,465 

 

$

206,083 

 

$

210,745 



-  9  -


 

THE CHARLES SCHWAB CORPORATION

Management’s Discussion and Analysis of Financial Condition and Results of Operations

(Tabular Amounts in Millions, Except Ratios, or as Noted)

 

 

The following tables present asset management and administration fees, average client assets, and average fee yields:





 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended September 30,

2016

 

 

2015



Average

 

 

 

 

 

 

 

Average

 

 

 

 

 



Client

 

 

 

 

Average

 

 

Client

 

 

 

 

Average



Assets

 

Revenue

 

Fee

 

 

Assets

 

Revenue

 

Fee

Schwab money market funds before fee waivers

$

161,904 

 

$

239 

 

0.59% 

 

 

$

160,266 

 

$

237 

 

0.59% 

Fee waivers

 

 

 

 

(41)

 

 

 

 

 

 

 

 

(166)

 

 

Schwab money market funds

 

161,904 

 

 

198 

 

0.49% 

 

 

 

160,266 

 

 

71 

 

0.18% 

Schwab equity and bond funds and ETFs

 

121,378 

 

 

57 

 

0.19% 

 

 

 

102,898 

 

 

55 

 

0.21% 

Mutual Fund OneSource®

 

203,589 

 

 

175 

 

0.34% 

 

 

 

220,419 

 

 

187 

 

0.34% 

Other third-party mutual funds and ETFs (1)

 

263,995 

 

 

56 

 

0.08% 

 

 

 

251,245 

 

 

56 

 

0.09% 

Total mutual funds and ETFs (2)

$

750,866 

 

 

486 

 

0.26% 

 

 

$

734,828 

 

 

369 

 

0.20% 

Advice solutions (2):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fee-based

$

183,191 

 

 

237 

 

0.51% 

 

 

$

170,211 

 

 

225 

 

0.52% 

Intelligent Portfolios

 

8,249 

 

 

 -

 

 -

 

 

 

3,714 

 

 

 -

 

 -

Legacy Non-Fee

 

17,232 

 

 

 -

 

 -

 

 

 

16,372 

 

 

 -

 

 -

Total advice solutions

$

208,672 

 

 

237 

 

0.45% 

 

 

$

190,297 

 

 

225 

 

0.47% 

Other balance-based fees (3)

 

350,117 

 

 

62 

 

0.07% 

 

 

 

328,461 

 

 

57 

 

0.07% 

Other (4)

 

 

 

 

13 

 

 

 

 

 

 

 

 

12 

 

 

Total asset management and administration fees

 

 

 

$

798 

 

 

 

 

 

 

 

$

663 

 

 







 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

Nine Months Ended September 30,

2016

 

 

2015



Average

 

 

 

 

 

 

 

Average

 

 

 

 

 



Client

 

 

 

 

Average

 

 

Client

 

 

 

 

Average



Assets

 

Revenue

 

Fee

 

 

Assets

 

Revenue

 

Fee

Schwab money market funds before fee waivers

$

164,758 

 

$

724 

 

0.59% 

 

 

$

161,029 

 

$

706 

 

0.59% 

Fee waivers

 

 

 

 

(193)

 

 

 

 

 

 

 

 

(519)

 

 

Schwab money market funds

 

164,758 

 

 

531 

 

0.43% 

 

 

 

161,029 

 

 

187 

 

0.16% 

Schwab equity and bond funds and ETFs

 

112,528 

 

 

160 

 

0.19% 

 

 

 

101,337 

 

 

163 

 

0.22% 

Mutual Fund OneSource®

 

199,758 

 

 

508 

 

0.34% 

 

 

 

229,660 

 

 

582 

 

0.34% 

Other third-party mutual funds and ETFs (1)

 

251,211 

 

 

163 

 

0.09% 

 

 

 

252,423 

 

 

170 

 

0.09% 

Total mutual funds and ETFs (2)

$

728,255 

 

 

1,362 

 

0.25% 

 

 

$

744,449 

 

 

1,102 

 

0.20% 

Advice solutions (2):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fee-based

$

175,210 

 

 

678 

 

0.52% 

 

 

$

171,516 

 

 

673 

 

0.52% 

Intelligent Portfolios

 

6,662 

 

 

 -

 

 -

 

 

 

2,578 

 

 

 -

 

 -

Legacy Non-Fee

 

16,901 

 

 

 -

 

 -

 

 

 

16,573 

 

 

 -

 

 -

Total advice solutions

$

198,773 

 

 

678 

 

0.46% 

 

 

$

190,667 

 

 

673 

 

0.47% 

Other balance-based fees (3)

 

335,555 

 

 

176 

 

0.07% 

 

 

 

323,087 

 

 

169 

 

0.07% 

Other (4)

 

 

 

 

38 

 

 

 

 

 

 

 

 

33 

 

 

Total asset management and administration fees

 

 

 

$

2,254 

 

 

 

 

 

 

 

$

1,977 

 

 



Note: Certain changes have been made to the above categorizations. Prior period information has been recast to reflect these changes.



 

(1)

Includes Schwab ETF OneSource™.

(2)

Average client assets for advice solutions may also include the asset balances contained in the mutual fund and/or ETF categories listed above.

(3)

Includes various asset-based fees, such as trust fees, 401(k) recordkeeping fees, and mutual fund clearing fees and other service fees.

(4)

Includes miscellaneous service and transaction fees relating to mutual funds and ETFs that are not balance-based.



Asset management and administration fees increased by $135 million, or 20%, and $277 million, or 14%, in the third quarter and first nine months of 2016 compared to the same periods in 2015. The increase is primarily due to higher net yields on money market fund assets as short-term interest rates have risen in 2016, partially offset by a reduction in average client assets in Mutual Fund OneSource.



-  10  -


 

THE CHARLES SCHWAB CORPORATION

Management’s Discussion and Analysis of Financial Condition and Results of Operations

(Tabular Amounts in Millions, Except Ratios, or as Noted)

 

 

Net Interest Revenue



Net interest revenue is the difference between interest earned on interest-earning assets and interest paid on funding sources. The Company’s interest-earning assets are primarily funded through bank deposits and client brokerage account balances.



Interest-earning assets primarily include cash and cash equivalents, segregated cash and investments, margin loans included in receivables from brokerage clients, investment securities and bank loans on which the Company earns interest. Revenue on interest-earning assets is affected by various factors such as the distribution and composition of assets, prevailing interest rates when purchased, and changes in prepayment levels. Fees earned on securities borrowing and lending activities conducted by the Company’s broker-dealer subsidiaries on assets held in client brokerage accounts are included in other interest revenue and expense. The rates on the majority of the Company’s investment securities and loans re-price or reset based on short-term interest rates and the remainder is invested in fixed-rate loans and securities.



The Company’s interest-bearing liabilities include bank deposits, payables to brokerage clients, short-term borrowings and long-term debt. Interest-bearing liabilities are primarily sensitive to short-term interest rates and the Company establishes the rates paid on most of these liabilities. The Company expects that the rate paid on these liabilities will generally adjust at some fraction of the movement in short-term interest rates.



The Company expects that net interest revenue will increase as short-term interest rates increase and decline should rates fall below current levels. When interest rates fall, the Company may attempt to mitigate some of this negative impact by lowering rates paid to clients on interest-bearing liabilities. The current low interest rate environment limits the extent to which the Company can reduce interest expense on funding sources. The Company may also alter the amount and type of fixed rate loans and securities that are added to the portfolio. Generally, modest increases in the percentage of fixed-rate assets will reduce the rate at which net interest revenue changes if rates move.



Non-interest-bearing funding sources include certain cash balances, stockholders’ equity and other miscellaneous assets and liabilities.



-  11  -


 

THE CHARLES SCHWAB CORPORATION

Management’s Discussion and Analysis of Financial Condition and Results of Operations

(Tabular Amounts in Millions, Except Ratios, or as Noted)

 

 

The following tables present net interest revenue information corresponding to interest-earning assets and funding sources on the condensed consolidated balance sheets:





 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended September 30,

 

2016

 

2015



 

 

 

 

Interest

 

Average

 

 

 

 

Interest

 

Average



 

Average

 

Revenue/

 

Yield/

 

Average

 

Revenue/

 

Yield/



 

Balance

 

Expense

 

Rate

 

Balance

 

Expense

 

Rate

Interest-earning assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

12,875 

  

$

17 

  

0.53 

 

$

9,764 

  

$

  

0.24 

Cash and investments segregated

 

 

19,941 

  

 

24 

  

0.48 

 

 

18,061 

  

 

  

0.18 

Broker-related receivables (1)

 

 

667 

  

 

 -

  

0.31 

 

 

312 

  

 

 -

  

0.09 

Receivables from brokerage clients

 

 

14,940 

  

 

123 

  

3.28 

 

 

15,594 

  

 

130 

  

3.31 

Securities available for sale (2)

 

 

74,064 

  

 

227 

  

1.22 

 

 

63,916 

  

 

159 

  

0.99 

Securities held to maturity

 

 

57,669 

  

 

349 

  

2.41 

 

 

38,533 

  

 

241 

  

2.48 

Bank loans

 

 

14,739 

  

 

100 

  

2.70 

 

 

14,137 

  

 

93 

  

2.61 

Total interest-earning assets

 

 

194,895 

  

 

840 

  

1.71 

 

 

160,317 

  

 

637 

  

1.58 

Other interest revenue

 

 

 

 

 

51 

  

 

 

 

 

 

 

 

32 

  

 

 

Total interest-earning assets

 

$

194,895 

  

$

891 

  

1.82 

 

$

160,317 

  

$

669 

  

1.66 

Funding sources:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Bank deposits

 

$

143,578 

  

$

10 

  

0.03 

 

$

115,606 

  

$

  

0.03