20160630 Q2 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 June 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.



 1,323,003,955 shares of $.01 par value Common Stock

Outstanding on July 27, 2016





 


 

THE CHARLES SCHWAB CORPORATION

 

Quarterly Report on Form 10-Q

For the Quarter Ended June 30, 2016

 

Index

 







 

 

 

 

 

 

Part I - Financial Information

 

Page



 

 



 

 

 

 



Item 1.

Condensed Consolidated Financial Statements (Unaudited):

 

 



 

 

 

 



 

Statements of Income

 

27



 

Statements of Comprehensive Income

 

28



 

Balance Sheets

 

29



 

Statements of Cash Flows

 

30



 

Notes

 

31-55



 

 

 

 



Item 2.

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

 

1-24



 

 

 

 



Item 3.

Quantitative and Qualitative Disclosures About Market Risk

 

25-26



 

 

 

 



Item 4.

Controls and Procedures

 

56



 

 

 

 

Part II - Other Information

 

 



 

 

 

 



Item 1.

Legal Proceedings

 

57



 

 

 

 



Item 1A.

Risk Factors

 

57



 

 

 

 



Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

 

57



 

 

 

 



Item 3.

Defaults Upon Senior Securities

 

58



 

 

 

 



Item 4.

Mine Safety Disclosures

 

58



 

 

 

 



Item 5.

Other Information

 

58



 

 

 

 



Item 6.

Exhibits

 

59



 

 

 

 

Signature

 

60



 

 







 


 

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.





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 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”);

·

management’s ability to adjust spending plans to maintain the balance between profitability and investing for growth (see “Part I, Item 2. – Management’s Discussion and Analysis of Financial Condition and Results of Operations – Overview”);

·

the expected impact of the final Department of Labor fiduciary rule, the final Federal Deposit Insurance Corporation (FDIC) assessment 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”);

·

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”);

-  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 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

·

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:

·

changes in general economic and financial market conditions;

·

changes in revenues and profit margin due to changes in interest rates;

·

the level of interest rates, including yields available on money market mutual fund eligible instruments;

·

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 Company’s ability to develop and launch new products, services and capabilities in a timely and successful manner;

·

fluctuations in client asset values due to changes in equity valuations;

·

the performance or valuation of securities available for sale and securities held to maturity;

·

trading activity;

·

competitive pressures on rates and fees;

·

the Company’s ability to manage expenses;

·

the timing and impact of changes in the Company’s level of investments in land, leasehold improvements, information technology equipment and software;

·

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

·

the timing of when the FDIC’s Deposit Insurance Fund reserve ratio reaches a set threshold of insured deposits;

·

the adverse impact of financial reform legislation and related regulations;

·

the level of client assets, including cash balances;

·

the amount of loans to the Company’s brokerage and banking clients;

·

the level of the Company’s stock repurchase activity;

·

the availability and terms of external financing;

·

capital needs and management;

·

client sensitivity to interest rates;

·

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

·

regulatory guidance;

·

potential breaches of contractual terms for which the Company has indemnification or guarantee obligations;

·

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

·

amounts recovered on insurance policies.



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 Company’s Annual Report on Form 10-K for the year ended December 31, 2015, 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: Potential for loss due to inadequate or failed internal processes, systems, and firms or exchanges handling client orders, or loss from external events and relationships impacting the Company and/or any of its key business partners and vendors.



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 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 key 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 second quarters and first halves of 2016 and 2015 are:





 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

Three Months Ended

 

 

 

 

Six Months Ended

 

 

 



 

June 30,

 

Percent

 

June 30,

 

Percent



 

2016

 

 

2015

 

Change

 

2016

 

 

2015

 

Change

Client Metrics:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net new client assets (in billions)

 

$

26.6 

  

 

$

37.0 

 

(28)

%

 

$

58.6 

  

 

$

65.7 

  

(11)

%

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

 

$

26.6 

 

 

$

37.0 

 

(28)

%

 

$

58.6 

 

 

$

71.2 

 

(18)

%

Client assets (in billions, at quarter end)

 

$

2,622.0 

  

 

$

2,543.3 

 

%

 

 

 

 

 

 

 

 

 

 

Average client assets (in billions)

 

$

2,585.4 

 

 

$

2,576.2 

 

-

 

 

$

2,515.4 

 

 

$

2,542.3 

 

(1)

%

New brokerage accounts (in thousands)

 

 

271 

 

 

 

280 

 

(3)

%

 

 

536 

 

 

 

554 

 

(3)

%

Active brokerage accounts (in thousands,

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

at quarter end)

 

 

9,977 

 

 

 

9,605 

 

%

 

 

 

 

 

 

 

 

 

 

Assets receiving ongoing advisory services

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(in billions, at quarter end)

 

$

1,315.5 

 

 

$

1,258.1 

 

%

 

 

 

 

 

 

 

 

 

 

Client cash as a percentage of client assets 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(at quarter end)

 

 

12.6 

%

 

 

11.7 

%

 

 

 

 

 

 

 

 

 

 

 

 

Company Financial Metrics:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net revenues

 

$

1,828 

  

 

$

1,566 

 

17 

%

 

$

3,592 

  

 

$

3,092 

  

16 

%

Expenses excluding interest

 

 

1,108 

  

 

 

999 

 

11 

%

 

 

2,217 

  

 

 

2,041 

  

%

Income before taxes on income

 

 

720 

  

 

 

567 

 

27 

%

 

 

1,375 

  

 

 

1,051 

  

31 

%

Taxes on income

 

 

268 

  

 

 

214 

 

25 

%

 

 

511 

  

 

 

396 

  

29 

%

Net income

 

 

452 

  

 

 

353 

 

28 

%

 

 

864 

  

 

 

655 

  

32 

%

Preferred stock dividends and other

 

 

46 

 

 

 

23 

 

100 

%

 

 

66 

 

 

 

34 

 

94 

%

Net income available to common stockholders

 

$

406 

 

 

$

330 

 

23 

%

 

$

798 

 

 

$

621 

 

29 

%

Earnings per common share – diluted

 

$

.30

  

 

$

.25

 

20 

%

 

$

.60

  

 

$

.47

  

28 

%

Net revenue growth from prior year

 

 

17 

 

 

%

 

 

 

 

16 

 

 

 

 

Pre-tax profit margin

 

 

39.4 

 

 

36.2 

%

 

 

 

 

38.3 

 

 

34.0 

 

 

Return on average common stockholders’ equity

 

 

13 

 

 

12 

%

 

 

 

 

13 

%

 

 

11 

%

 

 

Expenses excluding interest as a percentage of

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

average client assets (annualized)

 

 

0.17 

 

 

0.16 

%

 

 

 

 

0.18 

%

 

 

0.16 

%

 

 



(1)

The six months ended June 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 second quarter of 2016, the Company continued to grow, steadily building clients and assets with a combination of financial products, service and value. The number of accounts enrolled in one of our retail advisory solutions reached 581,000, up 8%, through June 30, 2016, compared to the same period in 2015. At June 30, 2016, there were 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.



Core net new assets were $26.6 billion and $58.6 billion, respectively, for the second quarter and first half of 2016, continuing a pattern of solid organic asset growth. Total client assets ended the second quarter of 2016 at $2.62 trillion, up 3% from the second quarter of 2015.



-  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 by 17% and 16% in the second quarter and first half of 2016 compared to the same periods in 2015, respectively, primarily due to a combination of sustained success in growing our client base and the effects of the Federal Reserve’s initial rate increase in December 2015.



On the expense side, spending increased 11% and 9% in the second quarter and first half of 2016 compared to the same periods in 2015, respectively, in keeping with expectations of reinvesting a portion of improved revenues to support growth. This approach yielded a spread of 580 basis points between the pace of growth in net revenue and expense growth during the second quarter of 2016.



The pre-tax profit margin for the second quarter and first half of 2016 was 39.4% and 38.3%, respectively, compared to 36.2% and 34.0% for the same periods in 2015. Net income grew by 28% and 32%, respectively, for the second quarter and first half 2016 compared to the same periods in 2015.



At the end of the second quarter of 2016, market concerns regarding economic growth, interest rates and equity valuations escalated. While many of the concerns have abated somewhat, the Company recognizes the importance of remaining flexible in order to make the most of the environment as it evolves. The Company’s management is experienced in monitoring conditions and adjusting spending plans as necessary to maintain a balance between near-term profitability and investing for long-term growth.



Current Regulatory Environment and Other Developments



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 ends 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 March 2016, the FDIC issued a final rule that will impose a surcharge on insured depository institutions with total consolidated assets of $10 billion or more in order to increase the reserve ratio of the FDIC’s Deposit Insurance Fund (DIF). Based on expected reductions in the Company’s regular FDIC insurance assessments combined with the surcharge, the Company anticipates that its overall FDIC assessment, relative to its regular assessment base, will increase by a net of approximately 2 to 2.5 basis points annually, beginning in the third quarter of 2016 and likely running through the end of 2018.



In December 2015, the OCC issued proposed guidelines to establish standards for recovery planning by national banks and federal savings banks with total consolidated assets of $50 billion or more. The proposed guidelines would require each bank to develop and maintain a recovery plan that sets forth the bank’s plan for how it will remain a going concern when it is experiencing considerable financial or operational stress. The comment period for the proposed guidelines ended on February 16, 2016 and the guidelines are subject to further modification. The Company will continue to evaluate the impact of the proposed guidelines.



In October 2015, the Federal Reserve issued a notice of proposed rulemaking that 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 second quarter and first half of 2016 compared to the same periods in 2015.



Net Revenues





 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended June 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)

 

23 

 

$

461 

 

25 

 

$

375 

  

24 

Advice solutions

 

(1)

 

 

226 

 

12 

 

 

228 

  

15 

Other (1)

 

 

 

70 

 

 

 

67 

  

Asset management and administration fees

 

13 

 

 

757 

 

41 

 

 

670 

  

43 

Net interest revenue

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest revenue

 

30 

%

 

 

840 

 

46 

 

 

645 

  

41 

Interest expense

 

27 

%

 

 

(42)

 

(2)

%

 

 

(33)

 

(2)

%

Net interest revenue

 

30 

%

 

 

798 

 

44 

 

 

612 

  

39 

Trading revenue

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commissions

 

(1)

%

 

 

190 

 

10 

 

 

191 

  

12 

Principal transactions

 

(8)

%

 

 

11 

 

 

 

12 

  

Trading revenue

 

(1)

%

 

 

201 

 

11 

 

 

203 

  

13 

Other

 

(11)

%

 

 

70 

 

 

 

79 

  

Provision for loan losses

 

 -

 

 

 

 

 -

 

 

 

 

 -

 

Total net revenues

 

17 

 

$

1,828 

 

100 

 

$

1,566 

  

100 



 





 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Six Months Ended June 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)

 

20 

%

 

$

876 

 

24 

 

$

733 

  

24 

Advice solutions

 

(2)

 

 

441 

 

12 

 

 

448 

  

14 

Other (1)

 

 

 

139 

 

 

 

133 

  

Asset management and administration fees

 

11 

 

 

1,456 

 

40 

 

 

1,314 

  

42 

Net interest revenue

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest revenue

 

31 

 

 

1,650 

 

46 

 

 

1,262 

  

41 

Interest expense

 

29 

 

 

(80)

 

(2)

%

 

 

(62)

 

(2)

%

Net interest revenue

 

31 

%

 

 

1,570 

 

44 

 

 

1,200 

  

39 

Trading revenue

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commissions

 

(1)

 

 

405 

 

11 

 

 

409 

  

13 

Principal transactions

 

33 

%

 

 

28 

 

 

 

21 

  

Trading revenue

 

%

 

 

433 

 

12 

 

 

430 

  

14 

Other

 

(6)

 

 

133 

 

 

 

142 

  

Provision for loan losses

 

(100)

 

 

 -

 

 -

 

 

 

 

 -

 

Total net revenues

 

16 

 

$

3,592 

 

100 

 

$

3,092 

  

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.



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. For a discussion of the impact of current market conditions on asset management and administration fees, see “Item 3 – Quantitative and Qualitative Disclosures About Market Risk.”



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 June 30,

 

2016

 

 

2015

 

 

2016

 

 

2015

 

 

2016

 

 

2015

Balance at beginning of period

$

167,427 

 

$

162,473 

 

$

104,953 

 

$

95,161 

 

$

203,759 

 

$

237,317 

Net inflows (outflows)

 

(6,495)

 

 

(6,906)

 

 

3,572 

 

 

3,498 

 

 

(4,437)

 

 

(6,282)

Net market gains (losses) and other

 

19 

 

 

10 

 

 

2,197 

 

 

(260)

 

 

4,030 

 

 

212 

Balance at end of period

$

160,951 

 

$

155,577 

 

$

110,722 

 

$

98,399 

 

$

203,352 

 

$

231,247 







 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

Schwab Money

 

 

Schwab Equity and

 

 

Mutual Fund



 

Market Funds

 

 

Bond Funds and ETFs

 

 

OneSource®

Six Months Ended June 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)

 

(5,243)

 

 

(12,506)

 

 

5,654 

 

 

8,296 

 

 

(9,179)

 

 

(8,875)

Net market gains (losses) and other

 

46 

 

 

174 

 

 

2,956 

 

 

1,653 

 

 

4,877 

 

 

5,741 

Balance at end of period

$

160,951 

 

$

155,577 

 

$

110,722 

 

$

98,399 

 

$

203,352 

 

$

231,247 



-  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 June 30,

 

2016

 

 

 

2015



Average
Client
Assets

 

Revenue

 

Average
Fee

 

 

Average
Client
Assets

 

Revenue

 

Average
Fee

Schwab money market funds before fee waivers

$

163,929 

 

$

239 

 

0.59% 

 

 

$

157,418 

 

$

230 

 

0.59% 

Fee waivers

 

 

 

 

(55)

 

 

 

 

 

 

 

 

(168)

 

 

Schwab money market funds

 

163,929 

 

 

184 

 

0.45% 

 

 

 

157,418 

 

 

62 

 

0.16% 

Schwab equity and bond funds and ETFs

 

112,814 

 

 

52 

 

0.19% 

 

 

 

103,986 

 

 

56 

 

0.22% 

Mutual Fund OneSource®

 

201,034 

 

 

169 

 

0.34% 

 

 

 

235,433 

 

 

199 

 

0.34% 

Other third-party mutual funds and ETFs (1)

 

252,405 

 

 

56 

 

0.09% 

 

 

 

257,516 

 

 

58 

 

0.09% 

Total mutual funds and ETFs (2)

$

730,182 

 

 

461 

 

0.25% 

 

 

$

754,353 

 

 

375 

 

0.20% 

Advice solutions (2):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fee-based

$

175,973 

 

 

226 

 

0.52% 

 

 

$

174,657 

 

 

228 

 

0.52% 

Intelligent Portfolios

 

6,620 

 

 

 -

 

 -

 

 

 

2,159 

 

 

 -

 

 -

Legacy Non-Fee

 

17,015 

 

 

 -

 

 -

 

 

 

16,783 

 

 

 -

 

 -

Total advice solutions

$

199,608 

 

 

226 

 

0.46% 

 

 

$

193,599 

 

 

228 

 

0.47% 

Other balance-based fees (3)

 

338,529 

 

 

58 

 

0.07% 

 

 

 

327,569 

 

 

57 

 

0.07% 

Other (4)

 

 

 

 

12 

 

 

 

 

 

 

 

 

10 

 

 

Total asset management and administration fees

 

 

 

$

757 

 

 

 

 

 

 

 

$

670 

 

 







 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Six Months Ended June 30,

 

2016

 

 

 

2015



Average
Client
Assets

 

Revenue

 

Average
Fee

 

 

Average
Client
Assets

 

Revenue

 

Average
Fee

Schwab money market funds before fee waivers

$

166,184 

 

$

485 

 

0.59% 

 

 

$

161,411 

 

$

469 

 

0.59% 

Fee waivers

 

 

 

 

(152)

 

 

 

 

 

 

 

 

(353)

 

 

Schwab money market funds

 

166,184 

 

 

333 

 

0.40% 

 

 

 

161,411 

 

 

116 

 

0.14% 

Schwab equity and bond funds and ETFs

 

108,103 

 

 

103 

 

0.19% 

 

 

 

100,556 

 

 

108 

 

0.22% 

Mutual Fund OneSource®

 

197,839 

 

 

333 

 

0.34% 

 

 

 

234,342 

 

 

395 

 

0.34% 

Other third-party mutual funds and ETFs (1)

 

244,820 

 

 

107 

 

0.09% 

 

 

 

253,031 

 

 

114 

 

0.09% 

Total mutual funds and ETFs (2)

$

716,946 

 

 

876 

 

0.25% 

 

 

$

749,340 

 

 

733 

 

0.20% 

Advice solutions (2):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fee-based

$

171,146 

 

 

441 

 

0.52% 

 

 

$

172,405 

 

 

448 

 

0.52% 

Intelligent Portfolios

 

5,868 

 

 

 -

 

 -

 

 

 

1,725 

 

 

 -

 

 -

Legacy Non-Fee

 

16,712 

 

 

 -

 

 -

 

 

 

16,815 

 

 

 -

 

 -

Total advice solutions

$

193,726 

 

 

441 

 

0.46% 

 

 

$

190,945 

 

 

448 

 

0.47% 

Other balance-based fees (3)

 

328,278 

 

 

114 

 

0.07% 

 

 

 

320,699 

 

 

112 

 

0.07% 

Other (4)

 

 

 

 

25 

 

 

 

 

 

 

 

 

21 

 

 

Total asset management and administration fees

 

 

 

$

1,456 

 

 

 

 

 

 

 

$

1,314 

 

 



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 $87 million, or 13%, and $142 million, or 11%, in the second quarter and first half of 2016 compared to the same periods in 2015. The increase in mutual fund and ETF service fees is primarily due to higher net yields on money market fund assets, 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 brokerage client 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 borrowed and loaned 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 non-interest bearing 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 June 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

 

$

10,888 

  

$

14 

  

0.52 

 

$

8,540 

  

$

  

0.28 

Cash and investments segregated

 

 

19,155 

  

 

22 

  

0.46 

 

 

18,265 

  

 

  

0.15 

Broker-related receivables (1)

 

 

685 

  

 

 -

  

0.20 

 

 

261 

  

 

 -

  

0.02 

Receivables from brokerage clients

 

 

15,027 

  

 

124 

  

3.32 

 

 

15,105 

  

 

125 

  

3.32 

Securities available for sale (2)

 

 

71,431 

  

 

211 

  

1.19 

 

 

61,194 

  

 

153 

  

1.00 

Securities held to maturity

 

 

53,404 

  

 

335 

  

2.52 

 

 

36,458 

  

 

227 

  

2.50 

Bank loans

 

 

14,569 

  

 

98 

  

2.71 

 

 

13,866 

  

 

91 

  

2.63 

Total interest-earning assets

 

 

185,159 

  

 

804 

  

1.75 

 

 

153,689 

  

 

609 

  

1.59 

Other interest revenue

 

 

 

 

 

36 

  

 

 

 

 

 

 

 

36 

  

 

 

Total interest-earning assets

 

$

185,159 

  

$

840 

  

1.82 

 

$

153,689 

  

$

645 

  

1.68 

Funding sources:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Bank deposits

 

$

136,009 

  

$

  

0.02 

 

$

110,159 

  

$

  

0.02 

Payables to brokerage clients (1)

 

 

25,302 

  

 

  

0.01 

 

 

25,138 

  

 

 -

  

0.01 

Short-term borrowings (1,4)

 

 

2,038 

  

 

  

0.39 

 

 

24 

  

 

 -

  

0.15 

Long-term debt (5)

 

 

2,876 

  

 

26 

  

3.64 

 

 

2,889 

  

 

24 

  

3.33 

Total interest-bearing liabilities (5)

 

 

166,225 

  

 

37 

  

0.09 

 

 

138,210 

  

 

30 

  

0.09 

Non-interest-bearing funding sources (4)

 

 

18,934 

  

 

 

 

 

 

 

 

15,479 

  

 

 

 

 

 

Other interest expense (3)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total funding sources

 

$

185,159 

  

$

42 

  

0.09 

 

$

153,689 

  

$

33 

  

0.08 

Net interest revenue

 

 

 

 

$

798 

  

1.73 

 

 

 

 

$

612 

  

1.60 





 

(1)

Interest revenue or expense was less than $500,000 in the period or periods presented.

(2)

Amounts have been calculated based on amortized cost.

(3)

Includes the impact of capitalizing interest on building construction and software development.

(4)

Certain prior period amounts have been reclassified to conform to the 2016 presentation.

(5)

Adjusted for the retrospective adoption of Accounting Standards Update (ASU) 2015-03. See “Item 1 – Notes to Condensed Consolidated Financial Statements (Unaudited) – 2. New Accounting Standards” for additional information.







-  12  -


 

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)

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Six Months Ended June 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

 

$

10,820 

  

$

27 

  

0.50 

 

$

8,959 

  

$

11 

  

0.25 

Cash and investments segregated

 

 

19,710 

  

 

41 

  

0.42 

 

 

18,884 

  

 

13 

  

0.14 

Broker-related receivables (1)

 

 

535 

  

 

 -

  

0.15 

 

 

271 

  

 

 -

  

0.06 

Receivables from brokerage clients

 

 

14,959 

  

 

249 

  

3.35 

 

 

14,763 

  

 

244 

  

3.33 

Securities available for sale (2)

 

 

69,797 

  

 

409 

  

1.18 

 

 

59,315 

  

 

295 

  

1.00 

Securities held to maturity

 

 

51,830 

  

 

657 

  

2.55 

 

 

35,673 

  

 

445 

  

2.52 

Bank loans

 

 

14,487 

  

 

197 

  

2.73 

 

 

13,701 

  

 

181 

  

2.66 

Total interest-earning assets

 

 

182,138 

  

 

1,580 

  

1.74 

 

 

151,566 

  

 

1,189 

  

1.58 

Other interest revenue

 

 

 

 

 

70 

  

 

 

 

 

 

 

 

73 

  

 

 

Total interest-earning assets

 

$

182,138 

  

$

1,650 

  

1.82 

 

$

151,566 

  

$

1,262 

  

1.68 

Funding sources:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Bank deposits

 

$

133,814 

  

$

16 

  

0.02 

 

$

108,008 

  

$

14 

  

0.03 

Payables to brokerage clients

 

 

26,015 

  

 

  

0.01 

 

 

25,602 

  

 

  

0.01 

Short-term borrowings (1,4)

 

 

1,029 

 

 

 

0.39 

%

 

 

16 

 

 

 -

 

0.15 

%

Long-term debt (5)

 

 

2,877 

  

 

52 

  

3.63 

 

 

2,517 

  

 

43 

  

3.45 

Total interest-bearing liabilities (5)

 

 

163,735 

  

 

71 

  

0.09 

 

 

136,143 

  

 

58 

  

0.09 

Non-interest-bearing funding sources (4)

 

 

18,403 

  

 

 

 

 

 

 

 

15,423 

  

 

 

 

 

 

Other interest expense (3)

 

 

 

 

 

  

 

 

 

 

 

 

 

  

 

 

Total funding sources

 

$

182,138 

  

$

80 

  

0.09 

 

$

151,566 

  

$

62 

  

0.08 

Net interest revenue

 

 

 

 

$

1,570 

 

1.73 

 

 

 

 

$

1,200 

 

1.60 





 

(1)

Interest revenue or expense was less than $500,000 in the period or periods presented.

(2)

Amounts have been calculated based on amortized cost.

(3)

Includes the impact of capitalizing interest on building construction and software development.

(4)

Certain prior period amounts have been reclassified to conform to the 2016 presentation.

(5)

Adjusted for the retrospective adoption of ASU 2015-03. See “Item 1 – Notes to Condensed Consolidated Financial Statements (Unaudited) – 2. New Accounting Standards” for additional information.



Net interest revenue increased $186 million, or 30%, and $370 million, or 31% in the second quarter and first half of 2016 compared to the same periods in 2015, primarily due to higher average balances of held to maturity and available for sale securities, and higher average interest rates on securities available for sale and cash and investments segregated. The growth in average balances in bank deposits resulted from an increase in amounts swept to Schwab Bank of uninvested cash balances in certain client brokerage accounts. Starting in June 2016, the Schwab Bank sweep feature became the default investment option for uninvested cash balances within all new brokerage accounts. 



Trading Revenue



Trading revenue includes commission and principal transaction revenues. Commission revenue is affected by the number of revenue trades executed and the average revenue earned per revenue trade. Principal transaction revenue is primarily comprised of revenue from trading activity in fixed income securities with clients. To accommodate clients’ fixed income trading activity, the Company maintains positions in fixed income securities, including U.S. state and municipal debt obligations, U.S. Government and corporate debt, and other securities. The difference between the price at which the Company buys and sells securities to and from its clients and other broker-dealers is recognized as principal transaction revenue. Principal transaction revenue also includes adjustments to the fair value of these securities positions.  









-  13  -


 

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 table presents trading revenue and the related drivers:





 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

Three Months Ended

 

 

 

 

Six Months Ended

 

 

 



 

June 30,

 

Percent

 

June 30,

 

Percent



 

2016

 

 

2015

 

Change

 

2016

 

 

2015

 

Change

Daily average revenue trades (in thousands)

 

 

279 

  

 

 

267 

  

%

 

 

303 

 

  

 

290 

 

%

Clients’ daily average trades (in thousands)

 

 

518 

 

 

 

494 

 

%

 

 

566 

 

 

 

537 

 

%

Number of trading days

 

 

64.0 

  

 

 

63.0 

  

%

 

 

125.0 

 

  

 

124.0 

 

%

Average revenue per revenue trade

 

$

11.27 

    

 

$

11.97 

    

(6)

%

 

$

11.36 

 

    

$

11.97 

 

(5)

%

Trading revenue

 

$

201 

 

 

$

203 

    

(1)

%

 

$

433 

 

 

$

430 

 

%





Other Revenue



Other revenue includes order flow revenue, nonrecurring gains, software fees from the Company’s portfolio management services, exchange processing fees, and other service fees. 



Other revenue decreased by $9 million, or 11%, and $9 million, or 6%, in the second quarter and first half of 2016 compared to the same periods in 2015, respectively, primarily due to higher litigation proceeds in the second quarter of 2015 relating to the Company’s non-agency residential mortgage-backed securities portfolio, partially offset by higher gains on sales of securities available for sale. 



Order flow revenue was $25 million and $52 million during the second quarters and first halves of both 2016 and 2015, respectively.



Expenses Excluding Interest



The following table shows a comparison of expenses excluding interest:





 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



  

Three Months Ended

 

 

 

Six Months Ended

 

 



 

June 30,

Percent

 

June 30,

Percent



  

2016

 

 

2015

 

Change

 

2016

 

 

2015

 

Change

Compensation and benefits

  

$

602 

  

 

$

540 

  

11 

 

$

1,228 

  

 

$

1,121 

  

10 

Professional services

  

 

125 

  

 

 

112 

  

12 

 

 

241 

  

 

 

226 

  

%

Occupancy and equipment

  

 

101 

  

 

 

85 

  

19 

%

 

 

199 

  

 

 

168 

  

18 

Advertising and market development

  

 

70 

  

 

 

62 

  

13 

 

 

140 

  

 

 

131 

  

Communications

  

 

62 

  

 

 

59 

  

 

 

122 

  

 

 

117 

  

%

Depreciation and amortization

  

 

57 

  

 

 

55 

  

 

 

113 

  

 

 

109 

  

Other

  

 

91 

  

 

 

86 

  

 

 

174 

  

 

 

169 

  

Total expenses excluding interest

  

$

1,108 

  

 

$

999 

  

11 

 

$

2,217 

  

 

$

2,041 

  

Expenses as a percentage of total net revenues:

  

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Compensation and benefits

  

 

33 

 

 

34 

 

 

 

 

34 

 

 

36 

 

 

Advertising and market development

  

 

 

 

 

 

 

 

 

 

 

 







Compensation and Benefits



Compensation and benefits expense includes salaries and wages, incentive compensation, and related employee benefits. Incentive compensation includes variable compensation, discretionary bonuses, and stock-based compensation. Variable compensation includes payments to certain individuals based on their sales performance. Discretionary bonuses are based on the Company’s overall performance as measured by EPS. Stock-based compensation primarily includes employee and board of director stock options and restricted stock.



-  14  -


 

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 table shows a comparison of certain compensation and benefits components and employee data:





 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

Three Months Ended

 

 

 

 

Six Months Ended

 

 

 



 

June 30,

 

Percent

 

June 30,

 

Percent



 

2016

 

 

2015

 

Change

 

2016

 

 

2015

 

Change

Salaries and wages

 

$

339 

  

 

$

313 

  

 

$

675 

  

 

$

630 

  

Incentive compensation

 

 

166 

  

 

 

144 

  

15 

 

 

339 

  

 

 

301 

  

13 

Employee benefits and other

 

 

97 

  

 

 

83 

  

17 

 

 

214 

  

 

 

190 

  

13 

Total compensation and benefits expense

 

$

602 

  

 

$

540 

  

11 

 

$

1,228 

  

 

$

1,121 

  

10 

Full-time equivalent employees (in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

At quarter end

 

 

16.1 

  

 

 

15.0 

  

 

 

 

 

 

 

 

 

 

 

Average

 

 

15.9 

  

 

 

15.0 

  

 

 

15.7 

  

 

 

14.9 

  



Salaries and wages increased in the second quarter and first half of 2016 compared to the same periods in 2015 primarily due to higher employee headcount to support the growth in the business and annual salary increases.



Incentive compensation increased in the second quarter and first half of 2016 compared to the same periods in 2015 primarily due to higher discretionary bonus expenses, long-term incentive plan costs, and field incentive plan costs relating to increased net client asset flows. The increase in incentive compensation in the first half of 2016 was also due to higher stock compensation expense.



Employee benefits and other expenses increased in the second quarter and first half of 2016 compared to the same periods in 2015 due to increases in healthcare costs and higher employee headcount.



Expenses Excluding Compensation and Benefits



Professional services expense increased in the second quarter and first half of 2016 compared to the same periods in 2015, primarily due to higher spending on technology services and an increase in fees paid to outsourced service providers and consultants as the Company continued to invest in the business.



Occupancy and equipment expense increased in the second quarter and first half of 2016 compared to the same periods in 2015, primarily due to an increase in software maintenance expense relating to the Company’s information technology systems and increases in property taxes and rent attributable to the changes in the Company’s geographic footprint.



Advertising and market development expense increased in the second quarter and first half of 2016 compared to the same periods in 2015, primarily due to an increase in media advertising.



Taxes on Income



The Company’s effective income tax rate on income before taxes was 37.2% and 37.7% for the second quarters and first halves of 2016 and 2015, respectively. The effective income tax rate decreases in the second quarter and first half of 2016 from the same periods in the prior year were primarily due to increases in tax exempt income from U.S. state and municipal securities.





Segment Information



The Company provides financial services to individuals and institutional clients through two 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. Revenues and expenses are allocated to the Company’s two segments based on which segment services the client. The Company evaluates the performance of its segments on a pre-tax basis, excluding items such as restructuring and other charges. Segment assets and liabilities are not used for evaluating segment performance or in deciding how to allocate resources to segments.



-  15  -


 

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)

 

 

Financial information for the Company’s reportable segments is presented in the following tables:





 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

Investor Services (1)

 

Advisor Services (1)

 

Total



 

Percent

 

 

 

 

 

 

 

Percent

 

 

 

 

 

 

 

Percent

 

 

 

 

 

 

Three Months Ended June 30,

 

Change

 

2016

 

2015

 

Change

 

2016

 

2015

 

Change

 

2016

 

2015

Net Revenues:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Asset management and

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

administration fees

 

11 

%

 

$

514 

 

$

465 

  

19 

%

 

$

243 

  

$

205 

 

13 

%

 

$

757 

  

$

670 

Net interest revenue

 

20 

%

 

 

628 

 

 

524 

  

93 

%

 

 

170 

  

 

88 

 

30 

%

 

 

798 

  

 

612 

Trading revenue

 

(3)

%

 

 

129 

 

 

133 

  

%

 

 

72 

  

 

70 

 

(1)

%

 

 

201 

  

 

203 

Other

 

(11)

%

 

 

51 

 

 

57 

  

(14)

%

 

 

19 

  

 

22 

 

(11)

%

 

 

70 

  

 

79 

Provision for loan losses

 

 -

 

 

 

 

 

 

 -

 

 

 

 -

 

 

 -

 

 -

 

 

 

 

 

Total net revenues

 

12 

%

 

 

1,324 

 

 

1,181 

  

31 

%

 

 

504 

  

 

385 

 

17 

 

 

1,828 

  

 

1,566 

Expenses Excluding Interest

 

10 

%

 

 

834 

 

 

760 

  

15 

%

 

 

274 

  

 

239 

 

11 

 

 

1,108 

  

 

999 

Income before taxes on income

 

16 

%

 

$

490 

 

$

421 

  

58 

%

 

$

230 

  

$

146 

 

27 

 

$

720 

  

$

567 





 









 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

Investor Services (1)

 

Advisor Services (1)

 

Total



 

Percent

 

 

 

 

 

 

 

Percent

 

 

 

 

 

 

 

Percent

 

 

 

 

 

 

Six Months Ended June 30,

 

Change

 

2016

 

2015

 

Change

 

2016

 

2015

 

Change

 

2016

 

2015

Net Revenues:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Asset management and

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

administration fees

 

 

$

986 

 

$

911 

  

17 

 

$

470 

  

$

403 

  

11 

 

$

1,456 

  

$

1,314 

Net interest revenue

 

20 

 

 

1,241 

 

 

1,034 

  

98 

 

 

329 

  

 

166 

  

31 

 

 

1,570 

  

 

1,200 

Trading revenue

 

(3)

 

 

272 

 

 

280 

  

 

 

161 

  

 

150 

  

 

 

433 

  

 

430 

Other

 

(4)

 

 

97 

 

 

101 

  

(12)

 

 

36 

  

 

41 

  

(6)

 

 

133 

  

 

142 

Provision for loan losses

 

(100)

 

 

 -

 

 

 

 -

 

 

 

 -

 

 

 -

  

(100)

 

 

 -

 

 

Total net revenues

 

11 

 

 

2,596 

 

 

2,332 

  

31 

 

 

996 

  

 

760 

  

16 

 

 

3,592 

  

 

3,092 

Expenses Excluding Interest

 

 

 

1,671 

 

 

1,546 

  

10 

 

 

546 

  

 

495 

 

 

 

2,217 

  

 

2,041 

Income before taxes on income

 

18 

%

 

$

925 

 

$

786 

  

70 

 

$

450 

  

$

265 

  

31 

 

$

1,375 

  

$

1,051 





 

(1)

The Corporate Brokerage Retirement Services business was transferred from the Investor Services segment to the Advisor Services segment in the fourth quarter of 2015. Prior period information has been recast to reflect these changes.



Investor Services

Net revenues increased by $143 million, or 12%, and $264 million, or 11%, in the second quarter and first half of 2016 compared to the same periods in 2015 primarily due to increases in net interest revenue and asset management and administration fees. Net interest revenue increased primarily due to higher balances of interest-earning assets, and higher interest rates on securities available for sale and cash and investments segregated.  Asset management and administration fees increased primarily due to higher net yields on money market fund assets, partially offset by a reduction in client assets in Mutual Fund OneSource®.



Expenses excluding interest increased by $74 million, or 10%,  and $125 million, or 8%, in the second quarter and first half of 2016 compared to the same periods in 2015, primarily due to increases in compensation and benefits and occupancy and equipment expenses. Compensation and benefits expenses are higher as a result of higher headcount in client-facing positions and higher incentive compensation associated with growth in net client asset flows.



-  16  -


 

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)

 

 

Advisor Services

Net revenues increased by $119 million, or 31%,  and $236 million, or 31%, in the second quarter and first half of 2016 compared to the same periods in 2015 primarily due to increases in net interest revenue, asset management and administration fees and trading revenue. Net interest revenue increased primarily due to higher balances of interest-earning assets. This growth was bolstered by the decision to migrate more uninvested client cash balances in the segment to the Schwab Bank sweep feature. Net interest revenue also improved due to higher interest rates on securities available for sale and cash and investments segregated. Asset management and administration fees increased primarily due to higher net yields on money market fund assets. Trading revenue increased due to higher daily average revenue trades, partially offset by lower commissions per revenue trade.



Expenses excluding interest increased by $35 million, or 15%,  and $51 million, or 10%, in the second quarter and first half of 2016 compared to the same periods in 2015, primarily due to increases in compensation and benefits and occupancy and equipment expenses.





Risk Management



The Company’s business activities expose it to a variety of risks, including operational, credit, market, liquidity, compliance and legal risk. The Company has a comprehensive risk management program to identify and manage these risks and their associated potential for financial and reputational impact. Despite the Company’s efforts to identify areas of risk and implement risk management policies and procedures, there can be no assurance that the Company will not suffer unexpected losses due to these risks.



For a discussion on risks that the Company faces and the Company’s process of risk identification and assessment, risk measurement, risk monitoring and reporting and risk mitigation, see “Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations – Risk Management” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015. For updated information on the Company’s credit risk and concentration risk exposures, see below. See “Item 3 – Quantitative and Qualitative Disclosures About Market Risk” for additional information relating to market risk.



Credit Risk Exposures



The Company’s exposure to credit risk mainly results from margin lending and client option and futures activities, securities lending activities, mortgage lending activities, pledged asset lending, its role as a counterparty in financial contracts and other investing activities. To manage the risks of such losses, the Company has established policies and procedures which include: establishing and reviewing credit limits, monitoring of credit limits and quality of counterparties, and adjusting margin, PAL, option, and futures requirements for certain securities. Collateral arrangements relating to margin loans, PALs, option positions, securities lending agreements, and resale agreements include provisions that require additional collateral in the event market fluctuations result in declines in the value of collateral received. Additionally, for margin loan, PAL and securities lending agreements, collateral arrangements require that the fair value of such collateral exceeds the amounts loaned.



Schwab performs clearing services for all securities transactions in its client accounts. Schwab has exposure to credit risk due to its obligation to settle transactions with clearing corporations, mutual funds, and other financial institutions even if Schwab’s clients or a counterparty fail to meet their obligations to Schwab.



The Company’s bank loan portfolio includes First Mortgages, HELOCs, PALs and other loans. The credit risk exposure related to loans is actively managed through individual and portfolio reviews. Management regularly reviews asset quality, including concentrations, delinquencies, nonaccrual loans, charge-offs, and recoveries. All are factors in the determination of an appropriate allowance for loan losses.



The Company’s residential loan underwriting guidelines include maximum loan-to-value (LTV) ratios, cash out limits, and minimum Fair Isaac Corporation (FICO) credit scores. The specific guidelines are dependent on the individual characteristics of a loan (for example, whether the property is a primary or secondary residence, whether the loan is for investment property,

-  17  -


 

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)

 

 

whether the loan is for an initial purchase of a home or refinance of an existing home, and whether the loan size is conforming or jumbo).



The Company does not originate or purchase residential loans that allow for negative amortization and does not purchase subprime loans (generally defined as extensions of credit to borrowers with a FICO score of less than 620 at origination), unless the borrower has compensating credit factors.



Among other items, the Company monitors the following information in evaluating the First Mortgage and HELOC portfolios and in the determination of an appropriate allowance for loan losses:





 

 

 

 

 

 

 

 

 



First

 

 

June 30, 2016

Mortgages

 

HELOCs

Percentage of loans to borrowers with updated FICO scores <620

 

%

 

 

 

%

 

Weighted-average origination FICO scores

 

771 

 

 

 

 

769 

 

 

Weighted-average updated FICO scores

 

774 

 

 

 

 

770 

 

 

Weighted-average origination LTV ratios

 

58 

%

 

 

 

58 

%

 

Weighted-average current LTV ratios

 

47 

%

 

 

 

49 

%

 



A portion of the Company’s HELOC portfolio is secured by second liens on the associated properties. Second lien mortgage loans possess a higher degree of credit risk given the subordination to the first lien holder in the event of default. At June 30, 2016, $2.0 billion, or 79%, of the HELOC portfolio was in a second lien position. In addition to the credit monitoring activities described above, the Company also monitors credit risk on second lien HELOC loans by reviewing the delinquency status of the first lien loan on the associated property. At June 30, 2016, approximately 30% of the HELOC borrowers that had a balance only paid the minimum amount of interest due.



The following table presents certain of the Company’s bank loan quality metrics as a percentage of total outstanding bank loans:





 

 

 

 

 

 

 

 

 



June 30,

 

December 31,



2016

 

2015

Loan delinquencies (1)

 

0.23 

%

 

 

 

0.25 

%

 

Nonaccrual loans (2)

 

0.18 

%

 

 

 

0.19 

%

 

Allowance for loan losses

 

0.21 

%

 

 

 

0.22 

%

 





 

(1)

Loan delinquencies include loans that are 30 days or more past due.

(2)

Nonaccrual loans include loans past due more than 90 days and other nonaccrual loans.



For more information on the Company’s credit quality indicators relating to its First Mortgage and HELOC portfolios, including delinquency characteristics, borrower FICO scores at origination (Origination FICO), updated borrower FICO scores (Updated FICO), LTV ratios at origination (Origination LTV), and estimated current LTV ratios (Estimated Current LTV), see “Item 1 – Notes to Condensed Consolidated Financial Statements (Unaudited) – 4. Bank Loans and Related Allowance for Loan Losses.”



The Company has exposure to credit risk associated with its available for sale and securities held to maturity securities which include U.S. agency and non-agency mortgage-backed securities, asset-backed securities, corporate debt securities, U.S. agency notes, U.S. Treasury securities, certificates of deposit, U.S. state and municipal securities, and commercial paper.  



At June 30, 2016, all securities in the available for sale and held to maturity portfolios were rated investment grade. U.S. agency mortgage-backed securities do not have explicit credit ratings; however, management considers these to be of the highest credit quality and rating given the guarantee of principal and interest by the U.S. government-sponsored enterprises.



-  18  -


 

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)

 

 

Concentration Risk Exposures



The Company has exposure to concentration risk when holding large positions in financial instruments collateralized by assets with similar economic characteristics or in securities of a single issuer or within a particular industry or geographical area.



The fair value of the Company’s investments in mortgage-backed securities totaled $88.3 billion at June 30, 2016. Of these, $87.1 billion were issued by U.S. agencies and $1.2 billion were issued by private entities (non-agency securities). These U.S. agency and non-agency securities are included in securities available for sale and securities held to maturity.



The fair value of the Company’s investments in asset-backed securities totaled $21.8 billion at June 30, 2016. The Company holds $10.6 billion floating rate Federal Family Education Loan Program Asset-Backed Securities (FFELP ABS). Two Nationally Recognized Statistical Rating Organizations have placed a portion of FFELP ABS on review for downgrade. Both agencies have indicated that some classes could be downgraded below investment grade due to the risk that some remainder of the securities could be outstanding after their legal final maturity dates. The timing of FFELP ABS principal payment is inherently uncertain given the variety of payment options available to student loan borrowers. Loans collateralizing these securities continue to be covered by a guarantee from the Department of Education of at least 97% of principal and interest. The Company holds only senior class notes that have additional credit enhancement of 3% or more that, together with the Department of Education guarantee, provide 100% or more credit enhancement. The Company has an independent credit assessment function and it does not rely on rating agencies. The Company does not consider these securities to be impaired because it expects full payment of principal and interest. Therefore, the Company continues to assign them the highest internal credit rating.



The fair value of the Company’s investments in corporate debt securities and commercial paper totaled $11.0 billion at June 30, 2016, with the majority issued by institutions in the financial services industry. These securities are included in securities available for sale, cash and cash equivalents, and other securities owned in the Company’s condensed consolidated balance sheets. Issuer, geographic, and sector concentrations are controlled by established credit policy limits to each concentration type.



The Company’s bank loans include $7.6 billion of adjustable rate First Mortgage loans at June 30, 2016. The Company’s adjustable rate mortgages have initial fixed interest rates for three to ten years and interest rates that adjust annually thereafter. Approximately 38% of these mortgages consisted of loans with interest-only payment terms. The interest rates on approximately 55% of these interest-only loans are not scheduled to reset for three or more years. The Company’s mortgage loans do not include interest terms described as temporary introductory rates below current market rates.



The Company’s HELOC product has a 30-year loan term with a revolving period of ten years from the date of origination. After the revolving period, the balance outstanding at such time is converted to a 20-year amortizing loan. The interest rate during the revolving period and the 20-year amortizing period is a floating rate based on the prime rate plus a margin. HELOCs that convert to an amortizing loan may experience higher delinquencies and higher loss rates than those in the revolving period. The Company’s allowance for loan loss methodology takes this increased inherent risk into consideration. The following table presents when current outstanding HELOCs will convert to amortizing loans:





 

 

 

 

June 30, 2016

  

Balance

 

Converted to amortizing loan by period end

 

$

482 

 

Within 1 year

  

 

139 

 

> 1 year – 3 years

  

 

950 

 

> 3 years – 5 years

  

 

258 

 

> 5 years

  

 

753 

 

Total

  

$

2,582 

 



The Company also has exposure to concentration risk from its margin and securities lending, PAL, and client option and futures activities collateralized by or referencing securities of a single issuer, an index, or within a single industry. This concentration risk is mitigated by collateral arrangements that require the fair value of such collateral exceed the amounts loaned.

-  19  -


 

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 Company has indirect exposure to U.S. Government and agency securities held as collateral to secure its resale agreements. The Company’s primary credit exposure on these resale transactions is with its counterparty. The Company would have exposure to the U.S. Government and agency securities only in the event of the counterparty’s default on the resale agreements. The fair value of U.S. Government and agency securities held as collateral for resale agreements totaled $7.4 billion at June 30, 2016.



Foreign Holdings



At June 30, 2016, the Company had exposure to non-sovereign financial and non-financial institutions in foreign countries of $6.8 billion, with the fair value of the top three exposures being to issuers and counterparties domiciled in Sweden at $1.4 billion, Canada at $1.4 billion and Australia at $1.3 billion. The Company has no direct exposure to sovereign foreign governments. The Company does not have unfunded commitments to counterparties in foreign countries, nor does it have exposure as a result of credit default protection purchased or sold separately as of June 30, 2016. In addition to the direct holdings in foreign companies, the Company has indirect exposure to foreign countries through its investments in Schwab sponsored money market funds (collectively, the Funds) resulting from brokerage clearing activities. At June 30, 2016, the Company had $162 million in investments in these Funds. Certain of the Funds’ positions include certificates of deposits, time deposits, commercial paper and corporate debt securities issued by counterparties in foreign countries. Additionally, at June 30, 2016, the Company had outstanding margin loans to foreign residents of $434 million, which are fully collateralized.





LIQUIDITY



CSC’s liquidity needs are primarily driven by the capital needs of Schwab Bank and liquidity and capital needs of Schwab, the amount of dividend payments on CSC’s common and preferred stock and principal and interest due on corporate debt. The liquidity needs of its brokerage subsidiaries are primarily driven by client activity including trading and margin borrowing activities and capital expenditures; and the capital needs of its bank subsidiary are primarily driven by client deposits.



The Company has established liquidity policies to support the successful execution of its business strategies, while ensuring ongoing and sufficient liquidity to meet its operational needs and satisfy applicable regulatory requirements under both normal and stress conditions. For additional information on the policies and methodologies used to monitor and manage liquidity, see “Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015.



Beginning on January 1, 2016, the Company became subject to the modified liquidity coverage ratio (LCR) rule which, when fully phased in, will require CSC to hold high-quality liquid assets equal to at least 70% of projected net cash outflows over a 30-day period, as defined by the rule. At June 30, 2016, the Company was in compliance with the fully phased-in modified LCR rule. For additional information on the LCR rule, see “Item 1 – Business – Regulation” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015.



The Company’s primary source of funds is cash generated by client activity: bank deposits and cash balances in brokerage client accounts. Bank deposits swept from brokerage accounts were $116.0 billion at June 30, 2016 compared to $108.1 billion at December 31, 2015. These funds were used to invest in interest earning assets, thereby funding a significant portion of the 8% growth in the Company’s balance sheet.



Other sources of funds may include cash flows from operations, maturities and sales of investment securities, repayments on loans, securities lending, and cash provided by external financing or equity offerings.



To meet daily funding needs, the Company maintains liquidity in the form of overnight cash deposits and short-term investments. For unanticipated liquidity needs, the Company maintains a buffer of highly liquid investments, currently comprised of U.S. Treasury notes.



-  20  -


 

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)

 

 

In addition to internal sources of liquidity, the Company has sources of external funding. CSC maintains a $750 million committed, unsecured credit facility with a group of banks that is scheduled to expire in June 2017.  This facility replaced a similar facility that expired in June 2016, and both facilities  were unused during the first half of 2016. The funds under this facility are available for general corporate purposes. The financial covenants require Schwab to maintain a minimum net capital ratio, Schwab Bank to be well capitalized, and CSC to maintain a minimum level of stockholders’ equity, adjusted to exclude AOCI.  At June 30, 2016, the minimum level of stockholders’ equity required under this facility was $9.7 billion (CSC’s stockholders’ equity, excluding AOCI, at June 30, 2016 was $15.0 billion). Management believes these restrictions will not have a material effect on CSC’s ability to meet foreseeable dividend or funding requirements.



CSC and Schwab also have access to uncommitted, unsecured bank credit lines with several banks. The need for short-term borrowings from these sources arises primarily from timing differences between cash flow requirements, scheduled liquidation of interest-earning investments, and movements of cash to meet regulatory brokerage client cash segregation requirements. These lines were not used by CSC during the first half of 2016. Schwab used such borrowings for one day during the first half of 2016 for $15 million, and there were no borrowings outstanding under these lines at June 30, 2016.



To partially satisfy the margin requirement of client option transactions with the Options Clearing Corporation, the broker-dealer subsidiaries have unsecured standby letter of credit agreements (LOCs) with several banks in favor of the Options Clearing Corporation aggregating $310 million at June 30, 2016. There were no funds drawn under any of these LOCs during the first half of 2016. In connection with its securities lending activities, the Company is required to provide collateral to certain brokerage clients. The collateral requirements were satisfied by providing cash as collateral.



Schwab Bank has access to short-term secured funding through the Federal Reserve’s discount window. Amounts available under the Federal Reserve discount window are dependent on the fair value of certain of Schwab Bank’s securities available for sale and/or securities held to maturity that are pledged as collateral. Schwab Bank maintains policies and procedures necessary to access this funding and tests discount window borrowing procedures on a periodic basis. At June 30, 2016, $1.8 billion was available under this arrangement. There were no funds drawn under this arrangement during the first half of 2016.



Schwab Bank also maintains a secured credit facility with the Federal Home Loan Bank of San Francisco. Amounts available under this facility are dependent on the amount of Schwab Bank’s First Mortgages, HELOCs, and the fair value of certain of Schwab’s securities available for sale and/or securities held to maturity that are pledged as collateral. Schwab Bank maintains policies and procedures necessary to access this funding and tests borrowing procedures on a periodic basis. At June 30, 2016, $5.0 billion was outstanding under this facility with an additional $3.9 billion available based on the loans currently pledged there. This funding source is being used to temporarily support recent investment purchases until later in 2016 when management expects to complete planned bulk transfers of uninvested client brokerage cash to Schwab Bank.



CSC has authorization from its Board of Directors to issue unsecured commercial paper notes (Commercial Paper Notes) not to exceed $1.5 billion. Management has set a current limit for the commercial paper program not to exceed the amount of the committed, unsecured credit facility, which was $750 million at June 30, 2016. The maturities of the Commercial Paper Notes may vary, but are not to exceed 270 days from the date of issue. The commercial paper is not redeemable prior to maturity and cannot be voluntarily prepaid. The proceeds of the commercial paper program are to be used for general corporate purposes. CSC’s ratings for these short-term borrowings are P1 by Moody’s, A1 by Standard & Poor’s, and F1 by Fitch. CSC had no Commercial Paper Notes outstanding as of June 30, 2016.



CSC had long-term debt of $2.9 billion  at  June 30, 2016 and December 31, 2015, bearing a weighted-average interest rate of 3.38%. CSC has a universal automatic shelf registration statement on file with the Securities and Exchange Commission (SEC) which enables it to issue debt, equity, and other securities.



-  21  -


 

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 are details of CSC’s long-term debt:





 

 

 

 

 

 

 

 

 

 

 

 

 

 



Par

 

 

  

Weighted Average

  

 

  

Standard

  

 

June 30, 2016

Outstanding

 

Maturity

 

Interest Rate

 

Moody’s

 

& Poor’s

 

Fitch

Senior Notes

 

$

2,581 

 

 

2018 – 2026

 

3.03% fixed

 

A2

  

A

  

A

Medium-Term Notes

 

$

250 

 

 

2017

 

6.375% fixed

 

A2

  

A

  

A



On March 7, 2016, CSC completed an equity offering of 30 million depositary shares, each representing a 1/40th ownership interest in a share of 5.95% non-cumulative perpetual preferred stock (Series D Preferred Stock). The net proceeds from the sale were $725 million. CSC’s preferred stock is rated Baa2 by Moody’s, BBB by Standard & Poor’s, and BB+ by Fitch.



For further discussion of CSC’s long-term debt and information on the equity offering, see “Item 1 – Notes to Condensed Consolidated Financial Statements (Unaudited) – 7. Borrowings and 11. Stockholders’ Equity.”





CAPITAL MANAGEMENT



The Company seeks to manage capital to a level and composition sufficient to support execution of its business strategy, including anticipated balance sheet growth, providing financial support to its subsidiaries, and sustained access to the capital markets, while at the same time meeting its regulatory capital requirements and serving as a source of financial strength to Schwab Bank. The Company’s primary sources of capital are funds generated by the operations of its subsidiaries and securities issuances by CSC in the capital markets. To ensure that it has a sufficient amount of capital to absorb unanticipated losses or declines in asset values, the Company has adopted a policy to remain well capitalized even in stressed scenarios.



Internal guidelines are set, for both the Company and its regulated subsidiaries, to ensure capital levels are in line with the Company’s strategy and regulatory requirements, and capital forecasts are reviewed monthly at Capital Planning and Asset-Liability Management and Pricing Committee meetings. A number of early warning indicators are monitored to help identify potential problems that could impact capital. In addition, the Company monitors its subsidiaries’ capital levels and requirements. Subject to regulatory capital requirements and any required approvals, any excess capital held by subsidiaries is transferred to CSC in the form of dividends and returns of capital. When subsidiaries have need of additional capital, funds are provided by CSC as equity investments and also as subordinated loans (in a form approved as regulatory capital by regulators) for Schwab. The details and method used for each cash infusion are based on an analysis of the particular entity’s needs and financing alternatives. The amounts and structure of infusions must take into consideration maintenance of regulatory capital requirements, debt/equity ratios, and equity double leverage ratios.



The Company conducts regular capital stress testing to assess the potential financial impacts of various adverse macroeconomic and company-specific events to which the Company could be subjected. The objective of the Company’s capital stress testing is (1) to explore various potential outcomes including rare and extreme events and (2) to assess impacts of potential stressful outcomes on both capital and liquidity. Additionally, the Company has a comprehensive Capital Contingency Plan to provide action plans for certain low probability/high impact capital events that the Company might face. The Capital Contingency Plan is issued under the authority of the Asset-Liability Management and Pricing Committee and provides guidelines for sustained capital events. It does not specifically address every contingency, but is designed to provide a framework for responding to any capital stress. The Capital Contingency Plan is reviewed annually and updated as appropriate.



For additional information, see “Part I  Item 1 – Business – Regulation” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015.



Regulatory Capital Requirements



CSC is subject to capital requirements set by the Federal Reserve and is required to serve as a source of strength for Schwab Bank and to provide financial assistance if Schwab Bank experiences financial distress. To manage capital adequacy, the Company currently utilizes a target Tier 1 Leverage Ratio for CSC of at least 6%. Due to the relatively low risk of the

-  22  -


 

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)

 

 

Company’s balance sheet assets and risk-based capital ratios at CSC and Schwab Bank that are well in excess of regulatory requirements, the Tier 1 Leverage Ratio is the most restrictive capital constraint on CSC’s asset growth.



Schwab Bank is subject to capital requirements set by the OCC that are substantially similar to those imposed on CSC by the Federal Reserve. Schwab Bank’s failure to remain well capitalized could result in certain mandatory and possibly additional discretionary actions by the regulators that, if undertaken, could have a direct material effect on the bank. The Company currently utilizes a target Tier 1 Leverage Ratio for Schwab Bank of at least  6.25%. Based on its regulatory capital ratios at June 30, 2016, Schwab Bank is considered well capitalized.



The following table details CSC’s and Schwab Bank’s capital ratios:





 

 

 

 

 

 

 

 

 

June 30, 2016

 

CSC

 

 

 

Schwab Bank

 

Total stockholders’ equity

$

14,990 

 

 

 

$

10,546 

 

 

Less:

 

 

 

 

 

 

 

 

 

Preferred Stock

 

2,189 

 

 

 

 

 -

 

 

Common Equity Tier 1 Capital before regulatory adjustments

$

12,801 

 

 

 

$

10,546 

 

 

Less:

 

 

 

 

 

 

 

 

 

Goodwill, net of associated deferred tax liabilities

$

1,180 

 

 

 

$

11 

 

 

Other intangible assets, net of associated deferred tax liabilities

 

56 

 

 

 

 

 -

 

 

Deferred tax assets, net of valuation allowances and deferred tax liabilities

 

 

 

 

 

 -

 

 

AOCI adjustment (1)

 

(17)

 

 

 

 

(29)

 

 

Common Equity Tier 1 Capital 

$

11,581 

 

 

 

$

10,564 

 

 

Tier 1 Capital

$

13,770 

 

 

 

$

10,564 

 

 

Total Capital

 

13,802 

 

 

 

 

10,595 

 

 

Risk-Weighted Assets

 

64,615 

 

 

 

 

55,963 

 

 

Common Equity Tier 1 Capital/Risk-Weighted Assets

 

17.9 

%

 

 

 

18.9 

%

 

Tier 1 Capital/Risk-Weighted Assets

 

21.3 

 

 

 

18.9 

 

Total Capital/Risk-Weighted Assets

 

21.4 

%

 

 

 

18.9 

%

 

Tier 1 Leverage Ratio

 

7.2 

 

 

 

7.1 

 





 

(1)

CSC and Schwab Bank have elected to opt-out of the requirement to include most components of AOCI in CET1 Capital.



Schwab Bank is also subject to regulatory requirements that restrict and govern the terms of affiliate transactions. In addition, Schwab Bank is required to provide notice to, and may be required to obtain approval from, the OCC and the Federal Reserve to declare dividends to CSC.



The Company’s broker-dealer subsidiaries (Schwab and optionsXpress, Inc.) are subject to regulatory requirements of the Uniform Net Capital Rule. The rule is intended to ensure the general financial soundness and liquidity of broker-dealers. These regulations prohibit the broker-dealer subsidiaries from paying cash dividends, making unsecured advances and loans to their parent company and employees, and from repaying subordinated borrowings from CSC if such payment would result in a net capital amount of less than 5% of aggregate debit balances or less than 120% of its minimum dollar requirement of $250,000. As such, the broker-dealer subsidiaries are required to maintain, at all times, at least the minimum level of net capital required under Rule 15c3-1. At June 30, 2016, Schwab and optionsXpress, Inc. met and exceeded their net capital requirements.



In addition to the capital requirements above, the Company’s subsidiaries are subject to various regulatory requirements that are intended to ensure financial soundness and liquidity. See “Item 1 – Condensed Consolidated Balance Sheets and Notes to Condensed Consolidated Financial Statements (Unaudited) – 14. Regulatory Requirements” for additional information on the components of stockholders equity and information on the capital requirements of each of the subsidiaries.





-  23  -


 

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)

 

 

Dividends



On April 21, 2016, the Board of Directors of the Company declared a one cent, or 17%, increase in the quarterly cash dividend to $0.07 per common share. The following table details the CSC cash dividends paid and per share amounts for the first halves of 2016 and 2015:





 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Six Months Ended June 30,

  

2016

  

2015



 

 

 

 

 

 

Per Share

 

 

 

 

 

 

 

Per Share

 



  

Cash Paid

 

 

Amount

 

  

Cash Paid

 

 

Amount

 

Common Stock

  

$

173 

  

 

$

0.13 

  

  

$

159 

  

 

$

0.12 

  

Series A Preferred Stock

  

 

14 

  

 

 

35.00 

  

  

 

14 

  

 

 

35.00 

  

Series B Preferred Stock

  

 

15 

  

 

 

30.00 

  

  

 

15 

  

 

 

30.00 

  

Series C Preferred Stock

 

 

18 

 

 

 

30.00 

 

 

 

 -

 

 

 

 -

 

Series D Preferred Stock (1)

  

 

10 

  

 

 

13.89 

  

  

 

 -

  

 

 

 -

  





 

(1)

Series D Preferred Stock was issued on March 7, 2016.







Off-Balance Sheet Arrangements



The Company enters into various off-balance sheet arrangements in the ordinary course of business, primarily to meet the needs of its clients. These arrangements include firm commitments to extend credit. Additionally, the Company enters into guarantees and other similar arrangements as part of transactions in the ordinary course of business. For discussion on the Company’s off-balance sheet arrangements, see “Part II – Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity – Off-Balance Sheet Arrangements” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015, and “Item 1 – Notes to Condensed Consolidated Financial Statements (Unaudited) – 8. Commitments and Contingencies.”





Critical Accounting ESTIMATES



Certain of the Company’s accounting policies that involve a higher degree of judgment and complexity are discussed in “Part II – Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Estimates” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015. There have been no changes to these critical accounting estimates during the first half of 2016.



 

-  24  -


 

THE CHARLES SCHWAB CORPORATION

 

 

 

 

Item 3.Quantitative and Qualitative Disclosures About Market Risk



The Company is exposed to interest rate risk primarily from changes in market interest rates on its interest-earning assets relative to changes in the costs of its funding sources that finance these assets. The majority of the Company’s interest-earning assets and interest-bearing liabilities are sensitive to changes in short-term interest rates. To a lesser degree, a portion of the Company’s investment portfolios is sensitive to changes in long-term interest rates. To manage the Company’s interest rate risk, management utilizes simulation models, which include the net interest revenue sensitivity analysis described below.



Net interest revenue is affected by various factors, such as the distribution and composition of interest-earning assets and interest-bearing liabilities, the spread between yields earned on interest-earning assets and rates paid on interest-bearing liabilities, which may reprice at different times or by different amounts, and the spread between short and long-term interest rates. Interest-earning assets primarily include investment securities, margin loans and bank loans. These assets are sensitive to changes in interest rates and changes in prepayment levels that tend to increase in a declining rate environment and decrease in a rising rate environment. Because the Company establishes the rates paid on certain brokerage client cash balances and bank deposits and the rates charged on certain margin loans and bank loans, and controls the composition of its investment securities, it has some ability to manage its net interest spread, depending on competitive factors and market conditions.



To mitigate the risk of declining revenue, the Company has established policies and procedures which include setting guidelines on the amount of net interest revenue at risk, and monitoring the net interest margin and average maturity of its interest-earning assets and funding sources. To remain within these guidelines, the Company manages the maturity, repricing, and cash flow characteristics of the investment portfolios.



Financial instruments held by the Company are also subject to the risk that valuations will be negatively affected by changes in demand and the underlying market for a financial instrument. The Company is also subject to market risk as a result of fluctuations in option and equity prices. The Company’s direct holdings of option and equity securities and its associated exposure to option and equity prices are not material. The Company is indirectly exposed to option, futures, and equity market fluctuations in connection with client option and futures accounts, securities collateralizing margin loans to brokerage customers, and client securities loaned out as part of the Company’s securities lending activities. Equity market valuations may also affect the level of brokerage client trading activity, margin borrowing, and overall client engagement with the Company. Additionally, the Company earns mutual fund and ETF service fees and asset management fees based upon daily balances of certain client assets. Fluctuations in these client asset balances caused by changes in equity valuations directly impact the amount of fee revenue earned by the Company.



The Company’s market risk related to financial instruments held for trading is not material.



Net Interest Revenue Simulation



For the Company’s net interest revenue sensitivity analysis, the Company uses net interest revenue simulation modeling techniques to evaluate and manage the effect of changing interest rates. The simulation includes all interest-sensitive assets and liabilities. Key variables in the simulation include the repricing of financial instruments, prepayment, reinvestment, and product pricing assumptions. The Company uses constant balances and market rates in the simulation assumptions in order to minimize the number of variables and to better isolate risks. The simulations involve assumptions that are inherently uncertain and, as a result, cannot precisely estimate net interest revenue or predict the impact of changes in interest rates on net interest revenue. Actual results may differ from simulated results due to balance growth or decline and the timing, magnitude, and frequency of interest rate changes, as well as changes in market conditions and management strategies, including changes in asset and liability mix.



If the Company’s guidelines for its net interest revenue sensitivity are breached, management must report the breach to the Company’s Corporate Asset-Liability Management and Pricing Committee and establish a plan to address the interest rate risk. This plan could include, but is not limited to, rebalancing certain investment portfolios or using derivative instruments to mitigate the interest rate risk. Depending on the severity and expected duration of the breach, as well as the then current interest rate environment, the plan could also be to take no action. Any plan that recommends taking action is required to be approved by the Company’s Corporate Asset-Liability Management and Pricing Committee. There were no breaches of the Company’s net interest revenue sensitivity guidelines during the first half of 2016 or year ended December 31, 2015.



-  25  -


 

THE CHARLES SCHWAB CORPORATION

 

 

 

 

As represented by the simulations presented below, the Company’s investment strategy is structured to produce an increase in net interest revenue when interest rates rise and, conversely, a decrease in net interest revenue when interest rates fall.



The simulations in the following table assume that the asset and liability structure of the consolidated balance sheet would not be changed as a result of the simulated changes in interest rates. As the Company actively manages its consolidated balance sheet and interest rate exposure, in all likelihood the Company would take steps to manage additional interest rate exposure that could result from changes in the interest rate environment. The following table shows the simulated net interest revenue change over the next 12 months beginning June 30, 2016 and December 31, 2015 of a gradual 100 basis point increase or decrease in market interest rates relative to prevailing market rates at the end of each reporting period.





 

 

 

 

 

 



 

June 30,

 

December 31,



 

2016

 

2015

Increase of 100 basis points

 

9.1 

 

8.2 

Decrease of 100 basis points

 

(10.7)

 

(9.5)

%



The sensitivities shown in the simulation reflect the fact that short-term interest rates in the first half of 2016 remained at low levels despite the increase in federal funds target range to .25% to .50% as directed by the Federal Open Markets Committee in December 2015. The current low interest rate environment limits the extent to which the Company can reduce interest expense paid on funding sources. A decline in interest rates could negatively impact the yield on the Company’s investment portfolio to a greater degree than any offsetting reduction in interest expense, further compressing net interest margin. Any increases in short-term interest rates result in a greater impact as yields on interest-earning assets are expected to rise faster than the cost of funding sources.



 

-  26  -


 

Part I – FINANCIAL INFORMATION

Item 1.  Condensed Consolidated Financial Statements

 

THE CHARLES SCHWAB CORPORATION

Condensed Consolidated Statements of Income

(In Millions, Except Per Share Amounts)

(Unaudited)

 

 







 

 

 

 

 

 

 

 

 

 

 

 



  

Three Months Ended

 

Six Months Ended



 

June 30,

 

June 30,



  

2016

 

2015

 

2016

 

2015

Net Revenues

  

 

 

 

 

 

 

 

 

 

 

 

Asset management and administration fees (1)

  

$

757 

 

$

670 

  

$

1,456 

 

$

1,314 

Interest revenue

  

 

840 

 

 

645 

  

 

1,650 

 

 

1,262 

Interest expense

  

 

(42)

 

 

(33)

 

 

(80)

 

 

(62)

Net interest revenue

  

 

798 

 

 

612 

 

 

1,570 

 

 

1,200 

Trading revenue

  

 

201 

 

 

203 

 

 

433 

 

 

430 

Other

  

 

70 

 

 

79 

 

 

133 

 

 

142 

Provision for loan losses

  

 

 

 

 

 

-

 

 

Total net revenues

  

 

1,828 

 

 

1,566 

 

 

3,592 

 

 

3,092 

Expenses Excluding Interest

  

 

 

 

 

 

 

 

 

 

 

 

Compensation and benefits

  

 

602 

 

 

540 

  

 

1,228 

 

 

1,121 

Professional services

  

 

125 

 

 

112 

  

 

241 

 

 

226 

Occupancy and equipment

  

 

101 

 

 

85 

  

 

199 

 

 

168 

Advertising and market development

  

 

70 

 

 

62 

  

 

140 

 

 

131 

Communications

  

 

62 

 

 

59 

  

 

122 

 

 

117 

Depreciation and amortization

  

 

57 

 

 

55 

  

 

113 

 

 

109 

Other

  

 

91 

 

 

86 

  

 

174 

 

 

169 

Total expenses excluding interest

  

 

1,108 

 

 

999 

  

 

2,217 

 

 

2,041 

Income before taxes on income

  

 

720 

 

 

567 

  

 

1,375 

 

 

1,051 

Taxes on income

  

 

268 

 

 

214 

  

 

511 

 

 

396 

Net Income

  

 

452 

 

 

353 

  

 

864 

 

 

655 

Preferred stock dividends and other (2)

  

 

46 

 

 

23 

  

 

66 

 

 

34 

Net Income Available to Common Stockholders

  

$

406 

 

$

330 

  

$

798 

 

$

621 

Weighted-Average Common Shares Outstanding:

  

 

 

 

 

 

  

 

 

 

 

 

Basic

 

 

1,322 

 

 

1,314 

 

 

1,322 

 

 

1,313 

Diluted

 

 

1,333 

 

 

1,326 

 

 

1,331 

 

 

1,325 

Earnings Per Common Share:

 

 

 

 

 

 

 

 

 

 

 

 

Basic

  

$

.31

 

$

.25

  

$

.60

 

$

.47

Diluted

  

$

.30

 

$

.25

  

$

.60

 

$

.47

Dividends Declared Per Common Share

 

$

.07

 

$

.06

 

 

.13

 

 

.12





 

(1)

Includes fee waivers of $55 and $168 during the second quarters of 2016 and 2015, respectively and $152 and $353 during the first halves of 2016 and 2015, respectively, relating to Schwab-sponsored money market funds.

(2)

Includes preferred stock dividends and undistributed earnings and dividends allocated to non-vested restricted stock units.



See Notes to Condensed Consolidated Financial Statements.



 

-  27  -


 

THE CHARLES SCHWAB CORPORATION

Condensed Consolidated Statements of Comprehensive Income

(In Millions)

(Unaudited)

 

 

 





 

 

 

 

 

 

 

 

 

 

 

 



 

Three Months Ended

 

Six Months Ended



  

June 30,

 

June 30,



  

2016

 

2015

 

2016

 

2015

Net Income

  

$

452 

 

$

353 

  

$

864 

 

$

655 

Other comprehensive income (loss), before tax:

  

 

 

 

 

 

 

 

 

 

 

 

Change in net unrealized gain on securities available for sale:

  

 

 

 

 

 

 

 

 

 

 

 

Net unrealized gain (loss)

  

 

168 

 

 

(91)

  

 

189 

 

 

16 

Other reclassifications included in other revenue

 

 

(3)

 

 

 -

 

 

(3)

 

 

 -

Other

 

 

 -

 

 

 -

 

 

 

 

 -

Other comprehensive income (loss), before tax

  

 

165 

 

 

(91)

 

 

187 

 

 

16 

Income tax effect

 

 

(62)

 

 

34 

 

 

(70)

 

 

(7)

Other comprehensive income (loss), net of tax

  

 

103 

 

 

(57)

  

 

117 

 

 

Comprehensive Income

  

$

555 

 

$

296 

  

$

981 

 

$

664 



See Notes to Condensed Consolidated Financial Statements.



 

-  28  -


 

THE CHARLES SCHWAB CORPORATION

Condensed Consolidated Balance Sheets

(In Millions, Except Per Share and Share Amounts)

(Unaudited)

 

 

 







 

 

 

 

 

 



 

June 30,

 

December 31,



  

2016

 

2015 (1)

Assets

  

 

 

 

 

 

Cash and cash equivalents

  

$

12,976 

 

$

11,978 

Cash and investments segregated and on deposit for regulatory purposes

  

 

 

 

 

 

(including resale agreements of $7,270 at June 30, 2016 and $8,088

 

 

 

 

 

 

at December 31, 2015)

 

 

18,593 

 

 

19,598 

Receivables from brokers, dealers, and clearing organizations

  

 

1,008 

 

 

582 

Receivables from brokerage clients — net

  

 

16,822 

 

 

17,313 

Other securities owned — at fair value

  

 

525 

 

 

533 

Securities available for sale

  

 

74,228 

 

 

65,646 

Securities held to maturity (fair value — $57,195 at June 30, 2016 and

  

 

 

 

 

 

$50,088 at December 31, 2015)

 

 

55,307 

 

 

50,007 

Bank loans — net

  

 

14,670 

 

 

14,334 

Equipment, office facilities, and property — net

  

 

1,242 

 

 

1,145 

Goodwill

  

 

1,227 

 

 

1,227 

Intangible assets — net

  

 

163 

 

 

181 

Other assets

  

 

1,291 

 

 

1,161 

Total assets

  

$

198,052 

 

$

183,705 

Liabilities and Stockholders’ Equity

  

 

 

 

 

 

Bank deposits

  

$

137,295 

 

$

129,502 

Payables to brokers, dealers, and clearing organizations

  

 

3,392 

 

 

2,588 

Payables to brokerage clients

  

 

32,679 

 

 

33,185 

Accrued expenses and other liabilities

  

 

1,820 

 

 

2,151 

Short-term borrowings

 

 

5,000 

 

 

 -

Long-term debt

  

 

2,876 

 

 

2,877 

Total liabilities

  

 

183,062 

 

 

170,303 

Stockholders’ equity:

  

 

 

 

 

 

Preferred stock — $.01 par value per share; aggregate liquidation preference

  

 

 

 

 

 

of $2,235 at June 30, 2016 and $1,485 at December 31, 2015

 

 

2,189 

 

 

1,459 

Common stock — 3 billion shares authorized; $.01 par value per share;

  

 

 

 

 

 

1,487,543,446 shares issued

 

 

15 

 

 

15 

Additional paid-in capital

  

 

4,223 

 

 

4,152 

Retained earnings

  

 

11,882 

 

 

11,253 

Treasury stock, at cost — 164,670,326 shares at June 30, 2016 and

  

 

 

 

 

 

167,205,881 shares at December 31, 2015

 

 

(3,302)

 

 

(3,343)

Accumulated other comprehensive income

  

 

(17)

 

 

(134)

Total stockholders’ equity

  

 

14,990 

 

 

13,402 

Total liabilities and stockholders’ equity

  

$

198,052 

 

$

183,705 





 

(1)

Adjusted for the retrospective adoption of ASU 2015-03. See “Notes – 2. New Accounting Standards” for additional information.



See Notes to Condensed Consolidated Financial Statements.



 

-  29  -


 

THE CHARLES SCHWAB CORPORATION

Condensed Consolidated Statements of Cash Flows

(In Millions)

(Unaudited)

 









 

 

 

 

 

 



 

Six Months Ended



 

June 30,



 

2016

 

2015

Cash Flows from Operating Activities

 

 

 

 

 

 

Net income

 

$

864 

 

$

655 

Adjustments to reconcile net income to net cash provided by (used for) operating activities:

 

 

 

 

 

 

Provision for loan losses

 

 

 -

 

 

(6)

Stock-based compensation

 

 

75 

 

 

69 

Depreciation and amortization

 

 

113 

 

 

109 

Premium amortization, net, on securities available for sale and securities held to maturity

 

 

107 

 

 

77 

Other

 

 

17 

 

 

Net change in:

 

 

 

 

 

 

Cash and investments segregated and on deposit for regulatory purposes

 

 

1,005 

 

 

2,897 

Receivables from brokers, dealers, and clearing organizations

 

 

(431)

 

 

(445)

Receivables from brokerage clients

 

 

486 

 

 

(954)

Other securities owned

 

 

 

 

(95)

Other assets

 

 

(37)

 

 

(33)

Payables to brokers, dealers, and clearing organizations

 

 

153 

 

 

269 

Payables to brokerage clients

 

 

(506)

 

 

(2,825)

Accrued expenses and other liabilities

 

 

(331)

 

 

(458)

Net cash provided by (used for) operating activities

 

 

1,523 

 

 

(737)

Cash Flows from Investing Activities

 

 

 

 

 

 

Purchases of securities available for sale

 

 

(16,598)

 

 

(12,423)

Proceeds from sales of securities available for sale

 

 

4,074 

 

 

594 

Principal payments on securities available for sale

 

 

4,763 

 

 

3,404 

Purchases of securities held to maturity

 

 

(7,582)

 

 

(5,070)

Principal payments on securities held to maturity

 

 

2,198 

 

 

1,688 

Net increase in bank loans

 

 

(362)

 

 

(632)

Purchases of equipment, office facilities, and property

 

 

(195)

 

 

(125)

Other investing activities

 

 

(132)

 

 

(4)

Net cash used for investing activities

 

 

(13,834)

 

 

(12,568)

Cash Flows from Financing Activities

 

 

 

 

 

 

Net change in bank deposits

 

 

7,793 

 

 

10,096 

Proceeds from short-term borrowings

 

 

5,000 

 

 

 -

Issuance of long-term debt

 

 

 -

 

 

998 

Repayment of long-term debt

 

 

(3)

 

 

(4)

Net proceeds from preferred stock offering

 

 

725 

 

 

 -

Dividends paid

 

 

(230)

 

 

(188)

Proceeds from stock options exercised and other

 

 

19 

 

 

50 

Other financing activities

 

 

 

 

Net cash provided by financing activities

 

 

13,309 

 

 

10,959 

Increase (Decrease) in Cash and Cash Equivalents

 

 

998 

 

 

(2,346)

Cash and Cash Equivalents at Beginning of Period

 

 

11,978 

 

 

11,363 

Cash and Cash Equivalents at End of Period

 

$

12,976 

 

$

9,017 

Supplemental Cash Flow Information

 

 

 

 

 

 

Cash paid during the period for:

 

 

 

 

 

 

Interest

 

$

74 

 

$

53 

Income taxes

 

$

505 

 

$

386 

Non-cash investing activity:

 

 

 

 

 

 

Securities purchased during the period but settled after period end

 

$

651 

 

$

245 



See Notes to Condensed Consolidated Financial Statements.





 

-  30  -


 

THE CHARLES SCHWAB CORPORATION

Notes to Condensed Consolidated Financial Statements

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

(Unaudited)

 

1.Introduction and Basis of Presentation



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. 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 Schwab Bank, a federal savings bank, and 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, which are referred to as the Schwab ETFs™.



The accompanying unaudited condensed consolidated financial statements include CSC and its majority-owned subsidiaries (collectively referred to as the Company). Intercompany balances and transactions have been eliminated. These condensed consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the U.S., which require management to make certain estimates and assumptions that affect the reported amounts in the accompanying financial statements. Certain estimates relate to other-than-temporary impairment (OTTI) of securities available for sale and securities held to maturity, valuation of goodwill, allowance for loan losses, and legal and regulatory reserves. Actual results may differ from those estimates.



These condensed consolidated financial statements reflect all adjustments that are, in the opinion of management, necessary for a fair presentation of the results for the periods presented. These adjustments are of a normal recurring nature. The Company’s results for any interim period are not necessarily indicative of results for a full year or any other interim period. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015.



The Company’s significant accounting policies are included in “Notes – 2. Summary of Significant Accounting Policies” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015. There have been no significant changes to these accounting policies during the first half of 2016.



Principles of Consolidation



The Company evaluates for consolidation all entities in which it has financial interests, except for money market funds which are specifically excluded from consolidation guidance. For an entity subject to consolidation, the Company evaluates whether the Company’s interest in the entity constitutes a controlling financial interest under either the variable interest entity (VIE) model or a voting interest entity (VOE) model. Based upon the Company’s assessments, the Company is not deemed to have a controlling financial interest in and, therefore, is not required to consolidate any VIEs. See “Notes – 5. Variable Interest Entities” for further information about VIEs. The Company consolidates all VOEs in which it has majority voting interests.



For investments in entities in which the Company does not have a controlling financial interest, the Company accounts for those investments under the equity method of accounting when the Company has the ability to exercise significant influence over operating and financing decisions of the entity. Investments in entities for which the Company does not have the ability to exercise significant influence are generally carried at cost. Both equity method and cost method investments are included in other assets on the condensed consolidated balance sheets.





2.New Accounting Standards



Adoption of New Accounting Standards



On January 1, 2016, the Company adopted ASU 2015-02, “Consolidation (Topic 810),” which amends the analysis a reporting entity must perform to determine whether it should consolidate certain types of legal entities. The new guidance is applicable to all entities but provides an exception for reporting entities with interests in legal entities that are required to comply with or operate in accordance with requirements that are similar to those in Rule 2a-7 of the Investment Company Act of 1940 for registered money market funds. The adoption of ASU 2015-02 did not have an impact on the Company’s consolidated financial statements or EPS as the new guidance did not change any existing consolidation conclusions reached in accordance with the previous guidance.



On January 1, 2016, the Company adopted ASU 2015-03, “Interest – Imputation of Interest (Subtopic 835-30).” ASU 2015-03 requires debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction

-  31  -


 

THE CHARLES SCHWAB CORPORATION

Notes to Condensed Consolidated Financial Statements

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

(Unaudited)

 

from the carrying amount of that debt liability, consistent with debt discounts. Previously, debt issuance costs were presented as a separate asset on the balance sheet. The guidance in ASU 2015-03 has been applied on a retrospective basis which requires the adjustment of all prior period consolidated balance sheets. The effect of the adoption on the Company’s December 31, 2015 consolidated balance sheet was to decrease other assets and total assets by $13 million and to decrease long-term debt and total liabilities by $13 million. A similar amount was also reclassified in the prior year. The Company considers the reclassifications immaterial.



On January 1, 2016, the Company also adopted ASU 2015-05, “Intangibles – Goodwill and Other – Internal-Use Software (Subtopic 350-40),” which provides new guidance that clarifies customer’s accounting for fees paid in a cloud computing arrangement. Under the new guidance, if a cloud computing arrangement includes a software license, the customer shall account for the software license element of the arrangement consistent with the acquisition of other software licenses. If the cloud computing arrangement does not include a software license, the customer shall account for the arrangement as a service contract. The guidance applies to all new arrangements entered into after January 1, 2016. The adoption of ASU 2015-05 did not have an impact on the Company’s financial statements or EPS.



New Accounting Standards Not Yet Adopted



In May 2014, the Financial Accounting Standards Board (FASB) issued ASU 2014-09, “Revenue from Contracts with Customers (Topic 606),” which provides new guidance on revenue recognition. The guidance clarifies that revenue from contracts with customers should be recognized in a manner that depicts the timing of the related transfer of goods or performance of services at an amount that reflects the expected consideration. The new guidance will become effective January 1, 2018, with early adoption permitted as of January 1, 2017. Entities may elect either full or modified retrospective transition. Full retrospective transition will require a cumulative effect adjustment to retained earnings as of the earliest comparative period presented. Modified retrospective transition will require a cumulative effect adjustment to retained earnings as of the beginning of the reporting period in which the entity first applies the new guidance. The Company is currently evaluating the impact of this new guidance on its financial statements and EPS.



In January 2016, the FASB issued ASU 2016-01, “Financial Instruments – Overall (Subtopic 825-10),” which will become effective January 1, 2018. This new guidance addresses certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. The main provisions of the guidance include (i) most equity investments are to be measured at fair value with changes in fair value recognized in net income, except for those accounted for under the equity method or those that do not have readily determinable fair values for which a practical expedient can be elected, (ii) requires the use of an exit price notion when measuring the fair value of financial instruments for disclosure purposes, and (iii) requires separate presentation of financial assets and financial liabilities by measurement category and form of financial instrument on the balance sheet or in the accompanying notes. The Company is currently evaluating the impact of this new guidance on its financial statements and EPS.



In February 2016, the FASB issued ASU 2016-02, “Leases (Topic 842)” which amends the accounting for leases by lessees and lessors. The primary change as a result of the new standard is the recognition of lease assets and lease liabilities by lessees for those leases classified as operating leases. Additional changes include accounting for lease origination and executory costs, required lessee reassessments during the lease term due to changes in circumstances and expanded lease disclosures. ASU 2016-02 will become effective January 1, 2019, with early adoption permitted, and requires entities to apply the new guidance using a modified retrospective transition. Modified retrospective transition requires entities to apply the new guidance as of the beginning of the earliest comparative period presented in the financial statements in which the entity first applies the new standard. Certain transition reliefs are permitted if elected by the entity. The Company is currently evaluating the impact of this new guidance on its financial statements and EPS.



In March 2016, the FASB issued ASU 2016-09, “Stock Compensation – Improvements to Employee Share-Based Payment Accounting (Topic 718)” which amends certain aspects of how an entity accounts for share-based payments to employees. The new guidance requires entities to recognize the income tax effects of share-based awards in the income statement when the awards vest or are settled, rather than recording such effects in additional paid-in capital. Entities will also be permitted to elect to account for forfeitures of share-based payments as they occur or continue with current practice which requires estimating the number of awards expected to be forfeited and adjusting the estimate when it is likely to change. ASU 2016-09 will become effective January 1, 2017, with early adoption permitted. The change in recognition of income tax effects of share-based awards will be applied prospectively. If an entity elects to account for forfeitures of share-based payments as they occur, such change will be applied using a modified retrospective transition method, with a cumulative-effect adjustment to retained earnings. The Company is currently evaluating the impact of this new guidance on its financial statements and EPS.



-  32  -


 

THE CHARLES SCHWAB CORPORATION

Notes to Condensed Consolidated Financial Statements

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

(Unaudited)

 

In June 2016, the FASB issued ASU 2016-13, “Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments” which provides new guidance for recognizing impairment of most debt instruments measured at amortized cost, including loans and held to maturity debt securities. The new guidance will require estimating expected credit losses (ECL) over the remaining life of an instrument or a portfolio of instruments with similar risk characteristics based on relevant information about past events, current conditions and reasonable forecasts. The initial estimate of and the subsequent changes in ECL will be recognized as credit loss expense through current earnings and will be reflected as an allowance for credit losses offsetting the carrying value of the financial instrument(s) on the balance sheet. The new guidance also amends the OTTI model for available for sale debt securities by requiring the use of an allowance, rather than directly reducing the carrying value of the security, and eliminating consideration of the length of time such security has been in an unrealized loss position as a factor in concluding whether a credit loss exists. ASU 2016-13 will become effective January 1, 2020, with early adoption permitted as of January 1, 2019. The new guidance will be applied through a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the entity applies the new guidance except that a prospective transition is required for available for sale debt securities for which an OTTI had been recognized before the effective date. The Company is currently evaluating the impact of this new guidance on its financial statements and EPS.





-  33  -


 

THE CHARLES SCHWAB CORPORATION

Notes to Condensed Consolidated Financial Statements

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

(Unaudited)

 

3.Securities Available for Sale and Securities Held to Maturity



The amortized cost, gross unrealized gains and losses, and fair value of securities available for sale and securities held to maturity are as follows:





 

 

 

 

 

 

 

 

 

 

 

 



  

 

 

  

Gross

  

Gross

 

 

 



 

Amortized

 

Unrealized

 

Unrealized

 

Fair

June 30, 2016

 

Cost

 

Gains

 

Losses

 

Value

Securities available for sale:

  

 

 

  

 

 

  

 

 

 

 

 

U.S. agency mortgage-backed securities

  

$

30,942 

  

$

251 

  

$

60 

  

$

31,133 

Asset-backed securities

  

 

22,117 

  

 

11 

  

 

372 

  

 

21,756 

Corporate debt securities

  

 

10,095 

  

 

60 

  

 

  

 

10,147 

U.S. Treasury securities

  

 

4,966 

  

 

52 

  

 

 -

  

 

5,018 

U.S. agency notes

  

 

2,972 

  

 

  

 

 -

  

 

2,973 

Certificates of deposit

  

 

2,180 

  

 

  

 

  

 

2,178 

U.S. state and municipal securities

 

 

613 

 

 

38 

 

 

 -

 

 

651 

Commercial paper

 

 

213 

 

 

 -

 

 

 -

 

 

213 

Non-agency commercial mortgage-backed securities

 

 

158 

 

 

 

 

 -

 

 

159 

Total securities available for sale

  

$

74,256 

  

$

415 

  

$

443 

  

$

74,228 

Securities held to maturity:

  

 

 

  

 

 

  

 

 

 

 

 

U.S. agency mortgage-backed securities

  

$

54,087 

 

$

1,829 

 

$

 -

 

$

55,916 

Non-agency commercial mortgage-backed securities

 

 

998 

 

 

46 

 

 

 -

 

 

1,044 

U.S. Treasury securities

  

 

222 

 

 

13 

 

 

 -

 

 

235 

Total securities held to maturity

  

$

55,307 

 

$

1,888 

 

$

 -

 

$

57,195 





 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2015

 

 

 

 

 

 

 

 

Securities available for sale:

  

 

 

 

  

 

 

 

  

 

 

 

U.S. agency mortgage-backed securities

  

$

22,014 

  

$

183 

 

$

48 

 

$

22,149 

Asset-backed securities

  

 

21,784 

  

 

 

 

306 

 

 

21,485 

Corporate debt securities

  

 

10,764 

  

 

14 

 

 

31 

 

 

10,747 

U.S. Treasury securities

 

 

5,719 

 

 

 

 

17 

 

 

5,704 

U.S. agency notes

  

 

3,177 

  

 

 -

 

 

27 

 

 

3,150 

Certificates of deposit

  

 

1,685 

  

 

 

 

 

 

1,683 

U.S. state and municipal securities

 

 

414 

 

 

10 

 

 

 -

 

 

424 

Non-agency commercial mortgage-backed securities

 

 

298 

 

 

 

 

 -

 

 

299 

Other securities

  

 

  

 

 -

 

 

 -

 

 

Total securities available for sale

  

$

65,860 

  

$

218 

 

$

432 

 

$

65,646 

Securities held to maturity:

  

 

 

 

 

 

 

 

 

 

 

 

U.S. agency mortgage-backed securities

  

$

48,785 

  

$

391 

 

$

293 

 

$

48,883 

Non-agency commercial mortgage-backed securities

 

 

999 

 

 

 

 

20 

 

 

985 

U.S. Treasury securities

  

 

223 

  

 

 -

 

 

 

 

220 

Total securities held to maturity

  

$

50,007 

  

$

397 

 

$

316 

 

$

50,088 



Schwab Bank pledges securities issued by federal agencies to secure certain trust deposits. The fair value of these pledged securities was $170 million at June 30, 2016.



-  34  -


 

THE CHARLES SCHWAB CORPORATION

Notes to Condensed Consolidated Financial Statements

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

(Unaudited)

 

A summary of securities with unrealized losses, aggregated by category and period of continuous unrealized loss, is as follows:





 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



  

Less than

 

12 months

  

 

 

 

 

 



 

12 months

 

or longer

 

Total



  

Fair

  

Unrealized

 

Fair

  

Unrealized

  

Fair

  

Unrealized

June 30, 2016

 

Value

 

Losses

 

Value

 

Losses

 

Value

 

Losses

Securities available for sale:

  

 

 

  

 

 

 

 

 

  

 

 

  

 

 

  

 

 

U.S. agency mortgage-backed securities

 

$

8,613 

 

$

52 

 

$

1,420 

 

$

 

$

10,033 

 

$

60 

Asset-backed securities

  

 

10,733 

  

 

261 

  

 

3,789 

  

 

111 

  

 

14,522 

  

 

372 

Corporate debt securities

  

 

1,452 

  

 

  

 

1,471 

  

 

  

 

2,923 

  

 

Certificates of deposit

 

 

843 

 

 

 

 

299 

 

 

 -

 

 

1,142 

 

 

Total securities with unrealized losses (1)

  

$

21,641 

  

$

319 

  

$

6,979 

  

$

124 

  

$

28,620 

  

$

443 





 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2015

 

 

 

 

 

 

 

 

 

 

 

 

Securities available for sale:

  

 

 

 

  

 

 

 

  

 

 

 

  

 

 

 

  

 

U.S. agency mortgage-backed securities

 

$

8,541 

 

$

47 

 

$

813 

 

$

 

$

9,354 

 

$

48 

Asset-backed securities

  

 

17,127 

  

 

240 

 

 

2,743 

 

 

66 

  

 

19,870 

  

 

306 

Corporate debt securities

  

 

5,433 

  

 

25 

 

 

942 

 

 

  

 

6,375 

  

 

31 

U.S. Treasury securities

 

 

5,010 

 

 

17 

 

 

 -

 

 

 -

 

 

5,010 

 

 

17 

U.S. agency notes

  

 

1,281 

  

 

10 

 

 

1,547 

 

 

17 

  

 

2,828 

  

 

27 

Certificates of deposit

 

 

773 

 

 

 

 

599 

 

 

 

 

1,372 

 

 

Total

  

$

38,165 

  

$

341 

 

$

6,644 

 

$

91 

  

$

44,809 

  

$

432 

Securities held to maturity:

  

 

 

 

 

 

 

 

 

 

 

 

  

 

 

 

 

 

U.S. agency mortgage-backed securities

 

$

24,219 

 

$

253 

 

$

1,842 

 

$

40 

 

$

26,061 

 

$

293 

Non-agency commercial mortgage-backed

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

securities

  

 

729 

  

 

20 

 

 

 -

 

 

 -

  

 

729 

  

 

20 

U.S. Treasury securities

 

 

220 

 

 

 

 

 -

 

 

 -

 

 

220 

 

 

Total

  

$

25,168 

  

$

276 

 

$

1,842 

 

$

40 

  

$

27,010 

  

$

316 

Total securities with unrealized losses (2)

  

$

63,333 

  

$

617 

 

$

8,486 

 

$

131 

  

$

71,819 

  

$

748 





 

(1)

The number of investment positions with unrealized losses totaled 322 for securities available for sale.

(2)

The number of investment positions with unrealized losses totaled 409 for securities available for sale and 286 for securities held to maturity.



Management evaluates whether securities available for sale and securities held to maturity are OTTI on a quarterly basis as described in “Notes – 2. Summary of Significant Accounting Policies” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015.



-  35  -


 

THE CHARLES SCHWAB CORPORATION

Notes to Condensed Consolidated Financial Statements

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

(Unaudited)

 

The maturities of securities available for sale and securities held to maturity are as follows:





 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

  

After 1 year

  

After 5 years

  

 

 

  

 

 



 

Within

 

through

 

through

 

After

 

 

 

June 30, 2016

 

1 year

 

5 years

 

10 years

 

10 years

 

Total

Securities available for sale:

 

 

 

  

 

 

  

 

 

  

 

 

  

 

 

U.S. agency mortgage-backed securities (1)

 

$

  

$

3,072 

  

$

15,661 

  

$

12,397 

  

$

31,133 

Asset-backed securities

 

 

 -

  

 

8,787 

  

 

4,176 

  

 

8,793 

  

 

21,756 

Corporate debt securities

 

 

2,601 

  

 

7,546 

  

 

 -

  

 

 -

  

 

10,147 

U.S. Treasury securities

 

 

 -

  

 

4,809 

  

 

209 

  

 

 -

  

 

5,018 

U.S. agency notes

 

 

 -

  

 

2,973 

  

 

 -

  

 

 -

  

 

2,973 

Certificates of deposit

 

 

786 

  

 

1,392 

  

 

 -

  

 

 -

  

 

2,178 

U.S. state and municipal securities

 

 

 -

 

 

 -

 

 

29 

 

 

622 

 

 

651 

Commercial paper

 

 

213 

 

 

 -

 

 

 -

 

 

 -

 

 

213 

Non-agency commercial mortgage-backed

 

 

 

  

 

 

  

 

 

  

 

 

  

 

 

securities

 

 

 -

 

 

 -

 

 

 -

 

 

159 

 

 

159 

Total fair value

 

$

3,603 

  

$

28,579 

  

$

20,075 

  

$

21,971 

  

$

74,228 

Total amortized cost

 

$

3,596 

  

$

28,417 

  

$

20,106 

  

$

22,137 

  

$

74,256 

Securities held to maturity:

 

 

 

  

 

 

  

 

 

  

 

 

  

 

 

U.S. agency mortgage-backed securities (1)

 

$

 -

  

$

3,399 

  

$

21,564 

  

$

30,953 

  

$

55,916 

Non-agency commercial mortgage-backed

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

securities (1)

 

 

 -

 

 

 -

 

 

378 

 

 

666 

 

 

1,044 

U.S. Treasury securities

 

 

 -

  

 

 -

  

 

235 

  

 

 -

  

 

235 

Total fair value

 

$

 -

  

$

3,399 

  

$

22,177 

  

$

31,619 

  

$

57,195 

Total amortized cost

 

$

 -

  

$

3,232 

  

$

21,116 

  

$

30,959 

  

$

55,307 





 

(1)

Mortgage-backed securities have been allocated to maturity groupings based on final contractual maturities. Actual maturities will differ from final contractual maturities because borrowers on a certain portion of loans underlying these securities have the right to prepay their obligations.



Proceeds and gross realized gains and losses from sales of securities available for sale are as follows:





 

 

 

 

 

 

 

 

 

 

 

 



 

Three Months Ended

 

Six Months Ended



 

June 30,

 

June 30,



 

2016

 

2015

 

2016

 

2015

Proceeds

 

$

3,774 

  

$

444 

  

$

4,074 

  

$

594 

Gross realized gains

 

 

 

 

 

 

 

 

Gross realized losses

 

 

 -

  

 

  

 

 -

  

 







-  36  -


 

THE CHARLES SCHWAB CORPORATION

Notes to Condensed Consolidated Financial Statements

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

(Unaudited)

 

4.Bank Loans and Related Allowance for Loan Losses



The composition of bank loans and delinquency analysis by loan segment is as follows:





 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

>90 days past

 

Total past due

 

 

 

Allowance

 

Total



 

 

 

30-59 days

 

60-89 days

 

due and other

 

and other

 

Total

 

for loan

 

bank

June 30, 2016

Current

 

past due

 

past due

 

nonaccrual loans

 

nonaccrual loans

 

loans

 

losses

 

loans - net

Residential real estate mortgages

$

8,472 

  

 

$

13 

 

 

  

$

 

 

 

$

16 

 

 

 

$

30 

  

 

$

8,502 

 

$

20 

 

 

$

8,482 

 

Home equity loans and lines of credit

 

2,564 

  

 

 

 

 

  

 

 

 

 

 

12 

 

 

 

 

18 

  

 

 

2,582 

 

 

10 

 

 

 

2,572 

 

Pledged asset lines

 

3,530 

  

 

 

 -

 

 

  

 

 

 

 

 

 -

 

 

 

 

  

 

 

3,531 

 

 

 -

 

 

 

3,531 

 

Other

 

86 

  

 

 

 -

 

 

  

 

 -

 

 

 

 

 -

 

 

 

 

 -

  

 

 

86 

 

 

 

 

 

85 

 

Total bank loans

$

14,652 

  

 

$

18 

 

 

  

$

 

 

 

$

28 

 

 

 

$

49 

  

 

$

14,701 

 

$

31 

 

 

$

14,670 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2015

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential real estate mortgages

$

8,304 

  

 

$

11 

 

 

  

$

 

 

 

$

18 

 

 

 

$

30 

  

 

$

8,334 

 

$

20 

 

 

$

8,314 

 

Home equity loans and lines of credit

 

2,720 

  

 

 

 

 

  

 

 

 

 

 

10 

 

 

 

 

15 

  

 

 

2,735 

 

 

11 

 

 

 

2,724 

 

Pledged asset lines

 

3,228 

  

 

 

 

 

  

 

 

 

 

 

 -

 

 

 

 

  

 

 

3,232 

 

 

 -

 

 

 

3,232 

 

Other

 

64 

  

 

 

 -

 

 

  

 

 -

 

 

 

 

 -

 

 

 

 

 -

  

 

 

64 

 

 

 -

 

 

 

64 

 

Total bank loans

$

14,316 

  

 

$

18 

 

 

  

$

 

 

 

$

28 

 

 

 

$

49 

  

 

$

14,365 

 

$

31 

 

 

$

14,334 

 

 

First Mortgages and HELOCs include unamortized premiums and discounts and direct origination costs of $79 million and $80 million at June 30, 2016 and December 31, 2015, respectively. The Company had commitments to extend credit related to unused HELOCs, PALs, and other lines of credit, which totaled $7.8 billion and $7.4 billion at June 30, 2016 and December 31, 2015, respectively. The Company had commitments to purchase First Mortgage loans of $569 million and $260 million at June 30, 2016 and December 31, 2015, respectively. All PALs were fully collateralized by securities with fair values in excess of borrowings at June 30, 2016 and December 31, 2015.



Schwab Bank provides a co-branded loan origination program for Schwab Bank clients (the Program) with Quicken Loans, Inc. (Quicken Loans®). Pursuant to the Program, Quicken Loans originates and services First Mortgages and HELOCs for Schwab Bank clients. Under the Program, Schwab Bank purchases certain First Mortgages and HELOCs that are originated by Quicken Loans. Schwab Bank purchased First Mortgages of $691 million and $542 million during the second quarters of 2016 and 2015, respectively, and $1.2 billion and $982 million during the first halves of 2016 and 2015, respectively. Schwab purchased HELOCs with commitments of $112 million and $165 million during the second quarters of 2016 and 2015, respectively, and $222 million and $282 million during the first halves of 2016 and 2015, respectively.



-  37  -


 

THE CHARLES SCHWAB CORPORATION

Notes to Condensed Consolidated Financial Statements

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

(Unaudited)

 

Credit Quality



Changes in the allowance for loan losses were as follows:





 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

June 30, 2016

 

 

June 30, 2015



Residential

 

Home equity

 

 

 

 

 

 

 

 

Residential

 

Home equity

 

 

 



real estate

 

loans and

 

 

 

 

 

 

 

 

real estate

 

loans and

 

 

 



mortgages

 

lines of credit

 

Other

 

Total

 

 

mortgages

 

lines of credit

 

Total

Balance at beginning of period

$

21 

  

 

$

11 

 

 

$

 

$

33 

  

 

$

26 

  

 

$

12 

 

  

$

38 

Charge-offs

 

 -

 

 

 

 -

 

 

 

 -

 

 

 -

 

 

 

 -

 

 

 

(1)

 

 

 

(1)

Recoveries

 

 -

  

 

 

 -

 

 

 

 -

 

 

 -

  

 

 

 -

  

 

 

 

  

 

Provision for loan losses

 

(1)

  

 

 

(1)

 

 

 

 -

 

 

(2)

  

 

 

(3)

  

 

 

 

  

 

(2)

Balance at end of period

$

20 

  

 

$

10 

 

 

$

 

$

31 

  

 

$

23 

  

 

$

13 

 

  

$

36 





 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Six Months Ended

June 30, 2016

 

 

June 30, 2015



Residential

 

Home equity

 

 

 

 

 

 

 

 

Residential

 

Home equity

 

 

 



real estate

 

loans and

 

 

 

 

 

 

 

 

real estate

 

loans and

 

 

 



mortgages

 

lines of credit

 

Other

 

Total

 

 

mortgages

 

lines of credit

 

 

Total

Balance at beginning of period

$

20 

  

 

$

11 

 

 

$

 -

 

$

31 

  

 

$

29 

  

 

$

13 

 

  

$

42 

Charge-offs

 

(1)

 

 

 

 -

 

 

 

 -

 

 

(1)

 

 

 

 -

 

 

 

(2)

 

 

 

(2)

Recoveries

 

  

 

 

 -

 

 

 

 -

 

 

  

 

 

 -

  

 

 

 

  

 

Provision for loan losses

 

 -

  

 

 

(1)

 

 

 

 

 

 -

  

 

 

(6)

  

 

 

 -

 

  

 

(6)

Balance at end of period

$

20 

  

 

$

10 

 

 

$

 

$

31 

  

 

$

23 

  

 

$

13 

 

  

$

36 



Substantially all of the bank loans were collectively evaluated for impairment at June 30, 2016 and December 31, 2015. There were no loans accruing interest that were contractually 90 days or more past due at June 30, 2016 or December 31, 2015. Nonperforming assets, which include nonaccrual loans and other real estate owned, totaled $35 million and $36 million at June 30, 2016 and December 31, 2015, respectively. Impaired assets, which include nonaccrual loans, other real estate owned and troubled debt restructurings, totaled $48 million and $50 million at June 30, 2016 and December 31, 2015, respectively. Troubled debt restructurings were not material at June 30, 2016 or December 31, 2015.



In addition to monitoring delinquency, the Company monitors the credit quality of First Mortgages and HELOCs by stratifying the portfolios by the year of origination, borrower Origination FICO, Updated FICO, Origination LTV, and Estimated Current LTV. Borrowers’ FICO scores are provided by an independent third-party credit reporting service and were last updated in June 2016. The Origination LTV and Estimated Current LTV for a HELOC include any first lien mortgage outstanding on the same property at the time of the HELOC’s origination. The Estimated Current LTV for each loan is estimated by reference to a home price appreciation index.



As of June 30, 2016 and December 31, 2015, 48% of the Company’s HELOC and First Mortgage portfolio was concentrated in California. These loans have performed in a manner consistent with the portfolio as a whole.

-  38  -


 

THE CHARLES SCHWAB CORPORATION

Notes to Condensed Consolidated Financial Statements

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

(Unaudited)

 





 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

Weighted

 

 

 

 

Percent of



 

 

 

 

 

Average

 

Utilization

 

Loans on

June 30, 2016

 

Balance

 

 

Updated FICO

 

Rate(1)  

 

Nonaccrual Status

Residential real estate mortgages:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Estimated Current LTV

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

<70%

 

$

7,740 

  

 

 

776 

 

 

  

N/A

  

 

 

0.03 

 

>70% – <90%

 

 

703 

  

 

 

766 

 

 

  

N/A

  

 

 

0.23 

 

>90% – <100%

 

 

35 

  

 

 

743 

 

 

  

N/A

  

 

 

1.40 

 

>100%

 

 

24 

  

 

 

708 

 

 

  

N/A

  

 

 

12.44 

 

Total

 

$

8,502 

  

 

 

774 

 

 

  

N/A

  

 

 

0.08 

 

Home equity loans and lines of credit:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Estimated Current LTV

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

<70%

 

$

2,187 

  

 

 

773 

 

 

  

36 

 

 

0.13 

 

>70% – <90%

 

 

318 

  

 

 

759 

 

 

  

49 

 

 

0.30 

 

>90% – <100%

 

 

44 

  

 

 

753 

 

 

  

57 

 

 

1.01 

 

>100%

 

 

33 

  

 

 

738 

 

 

  

68 

 

 

2.01 

 

Total

 

$

2,582 

  

 

 

770 

 

 

  

38 

 

 

0.19 

 

Pledged asset lines:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted-Average LTV

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 =70%

 

$

3,531 

 

 

 

762 

 

 

 

48 

%

 

 

 -

 

 





 

(1)

The Utilization Rate is calculated using the outstanding balance divided by the associated total line of credit.

N/A Not applicable.







 

 

 

 

 

 

 

 

 



 

Residential

 

Home equity



 

real estate

 

loans and

June 30, 2016

 

mortgages

 

lines of credit

Year of origination

 

 

 

 

 

 

 

 

 

Pre-2012

 

$

1,171 

 

 

$

1,875 

 

 

2012

 

 

1,385 

 

 

 

114 

 

 

2013

 

 

2,126 

 

 

 

212 

 

 

2014

 

 

874 

 

 

 

174 

 

 

2015

 

 

1,744 

 

 

 

159 

 

 

2016

 

 

1,202 

 

 

 

48 

 

 

Total

 

$

8,502 

 

 

$

2,582 

 

 

Origination FICO

 

 

 

 

 

 

 

 

 

<620

 

$

 

 

$

 

 

620 – 679

 

 

84 

 

 

 

14 

 

 

680 – 739

 

 

1,391 

 

 

 

470 

 

 

>740

 

 

7,018 

 

 

 

2,097 

 

 

Total

 

$

8,502 

 

 

$

2,582 

 

 

Origination LTV

 

 

 

 

 

 

 

 

 

<70%

 

$

6,178 

 

 

$

1,771 

 

 

>70% – <90%

 

 

2,312 

 

 

 

796 

 

 

>90% – <100%

 

 

12 

 

 

 

15 

 

 

Total

 

$

8,502 

 

 

$

2,582 

 

 





-  39  -


 

THE CHARLES SCHWAB CORPORATION

Notes to Condensed Consolidated Financial Statements

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

(Unaudited)

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

Weighted

 

 

 

 

Percent of



 

 

 

 

 

Average

 

Utilization

 

Loans on

December 31, 2015

 

Balance

 

 

Updated FICO

 

Rate(1)  

 

Nonaccrual Status

Residential real estate mortgages:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Estimated Current LTV

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

<70%

 

$

7,508 

 

 

 

774 

 

 

 

N/A 

 

 

 

0.03 

 

>70% – <90%

 

 

759 

 

 

 

764 

 

 

 

N/A 

 

 

 

0.31 

 

>90% – <100%

 

 

37 

 

 

 

736 

 

 

 

N/A 

 

 

 

5.54 

 

>100%

 

 

30 

 

 

 

713 

 

 

 

N/A 

 

 

 

7.72 

 

Total

 

$

8,334 

 

 

 

773 

 

 

 

N/A 

 

 

 

0.11 

 

Home equity loans and lines of credit:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Estimated Current LTV

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

<70%

 

$

2,277 

 

 

 

772 

 

 

 

37 

 

 

0.09 

 

>70% – <90%

 

 

373 

 

 

 

760 

 

 

 

50 

 

 

0.48 

 

>90% – <100%

 

 

48 

 

 

 

748 

 

 

 

63 

 

 

1.02 

 

>100%

 

 

37 

 

 

 

739 

 

 

 

67 

 

 

1.79 

 

Total

 

$

2,735 

 

 

 

770 

 

 

 

39 

 

 

0.18 

 

Pledged asset lines:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted-Average LTV

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 =70%

 

$

3,232 

 

 

 

764 

 

 

 

49 

%

 

 

 -

 

 





 

(1)

The Utilization Rate is calculated using the outstanding balance divided by the associated total line of credit.

N/A Not applicable.







 

 

 

 

 

 

 

 

 



 

Residential

 

Home equity



 

real estate

 

loans and

December 31, 2015

 

mortgages

 

lines of credit

Year of origination

 

 

 

 

 

 

 

 

 

Pre-2012

 

$

1,306 

 

 

$

2,048 

 

 

2012

 

 

1,644 

 

 

 

125 

 

 

2013

 

 

2,450 

 

 

 

232 

 

 

2014

 

 

1,021 

 

 

 

188 

 

 

2015

 

 

1,913 

 

 

 

142 

 

 

Total

 

$

8,334 

 

 

$

2,735 

 

 

Origination FICO

 

 

 

 

 

 

 

 

 

<620

 

$

10 

 

 

$

 -

 

 

620 – 679

 

 

88 

 

 

 

16 

 

 

680 – 739

 

 

1,381 

 

 

 

498 

 

 

>740

 

 

6,855 

 

 

 

2,221 

 

 

Total

 

$

8,334 

 

 

$

2,735 

 

 

Origination LTV

 

 

 

 

 

 

 

 

 

<70%

 

$

5,913 

 

 

$

1,858 

 

 

>70% – <90%

 

 

2,408 

 

 

 

860 

 

 

>90% – <100%

 

 

13 

 

 

 

17 

 

 

Total

 

$

8,334 

 

 

$

2,735 

 

 









5.Variable Interest Entities



A VIE requires consolidation by the entity’s primary beneficiary. The Company evaluates all entities in which it has a financial interest to determine if the entity is a VIE and if so, whether the Company is the primary beneficiary. See the “Principles of Consolidation” section of “Notes – 1. Introduction and Basis of Presentation” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015, for discussion of the Company’s evaluations of VIEs and whether it is

-  40  -


 

THE CHARLES SCHWAB CORPORATION

Notes to Condensed Consolidated Financial Statements

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

(Unaudited)

 

deemed to be the primary beneficiary of any VIEs in which it holds an interest. The Company was not the primary beneficiary of, and therefore, not required to consolidate any VIEs at June 30, 2016 and December 31, 2015.



Community Reinvestment Act investments



Schwab Bank is subject to the Community Reinvestment Act (CRA). The CRA is intended to encourage banks to help meet the credit needs of the communities in which they operate, including low and moderate income neighborhoods, consistent with safe and sound banking operations. As part of Schwab Bank’s community reinvestment initiatives, Schwab Bank invests with other institutional investors in funds that make equity investments in multifamily affordable housing properties. Schwab Bank receives tax credits and other tax benefits for these investments. Schwab Bank’s Low-Income Housing Tax Credit (LIHTC) investments are accounted for using the proportional amortization method. Amortization, tax credits, and other tax benefits recognized in relation to LIHTC investments are included in taxes on income on the condensed consolidated statements of income. As of June 30, 2016 and December 31, 2015, the majority of the Company’s VIEs related to Schwab Bank’s LIHTC investments.



The carrying value of the LIHTC investments was $138 million and $104 million as of June 30, 2016 and December 31, 2015, respectively, which is included in other assets on the condensed consolidated balance sheets. Schwab Bank recorded liabilities of $106 million and $84 million for unfunded commitments related to LIHTC investments at June 30, 2016 and December 31, 2015, respectively, which are included in accrued expenses and other liabilities on the condensed consolidated balance sheets. Schwab Bank’s funding of these remaining commitments is dependent upon the occurrence of certain conditions and Schwab Bank expects to pay substantially all of these commitments between 2016 and 2019.



Aggregate assets, liabilities and maximum exposure to loss



The aggregate assets, liabilities, and maximum exposure to loss from those VIEs in which the Company holds a variable interest, but as to which the Company has concluded it is not the primary beneficiary, are summarized in the table below:







 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

June 30, 2016

 

 

 

December 31, 2015



 

 

 

 

 

 

 

 

 

 

Maximum

 

 

 

 

 

 

 

 

 

 

 

Maximum



 

 

Aggregate

 

 

 

Aggregate

 

 

 

exposure

 

 

 

Aggregate

 

 

 

Aggregate

 

 

 

exposure



 

 

assets

 

 

 

liabilities

 

 

 

to loss

 

 

 

assets

 

 

 

liabilities

 

 

 

to loss

LIHTC investments (1)

 

$

138 

 

 

$

106 

 

 

$

138 

 

 

$

104 

 

 

$

84 

 

 

$

104 

Other CRA investments (2)

 

 

57 

 

 

 

-  

 

 

 

65 

 

 

 

57 

 

 

 

-  

 

 

 

66 

Total

 

$

195 

 

 

$

106 

 

 

$

203 

 

 

$

161 

 

 

$

84 

 

 

$

170 





 

(1)

LIHTC investments are recorded using the proportional amortization method.

(2)

Other CRA investments are recorded using either the cost method or the equity method. Aggregate assets are included in either other assets or bank loans – net on the condensed consolidated balance sheets.



The Company’s maximum exposure to loss would result from the loss of the investments, including any committed amounts. During the six months ended June 30, 2016 and 2015, the Company did not provide or intend to provide financial or other support to the VIEs that it was not contractually required to provide.









-  41  -


 

THE CHARLES SCHWAB CORPORATION

Notes to Condensed Consolidated Financial Statements

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

(Unaudited)

 

6.Bank Deposits



Bank deposits consist of interest-bearing and non-interest-bearing deposits as follows:





 

 

 

 

 

 

 

 



 

June 30,

 

December 31,



 

2016

 

2015

Interest-bearing deposits:

 

 

 

 

 

 

 

 

Deposits swept from brokerage accounts

 

$

116,024 

  

 

$

108,137 

  

Checking

 

 

12,685 

  

 

 

12,822 

  

Savings and other

 

 

8,052 

  

 

 

7,896 

  

Total interest-bearing deposits

 

 

136,761 

  

 

 

128,855 

  

Non-interest-bearing deposits

 

 

534 

  

 

 

647 

  

Total bank deposits

 

$

137,295 

  

 

$

129,502 

  







7.Borrowings



Long-term debt, including unamortized debt discounts and premiums, and debt issuance costs, where applicable, consists of the following:





 

 

 

 

 

 

 

 



 

June 30,

 

December 31,



 

2016

 

2015

Senior Notes (1)

 

$

2,555 

 

 

$

2,553 

 

Senior Medium-Term Notes (1)

 

 

249 

 

 

 

249 

 

Finance lease obligation

 

 

72 

 

 

 

75 

 

Total long-term debt

 

$

2,876 

 

 

$

2,877 

 



(1)

Balances as of December 31, 2015 have been recast as a result of the adoption of ASU 2015-03, to present debt issuance costs of $13 million as a direct deduction from the carrying amount of the associated debt liability, consistent with the recording of debt discounts.



Annual maturities on long-term debt outstanding at June 30, 2016 are as follows:





 

 

 

 

 

 

2016

 

 

 

 

$

2017

 

 

 

 

 

258 

2018

 

 

 

 

 

908 

2019

 

 

 

 

 

2020

 

 

 

 

 

709 

Thereafter

 

 

 

 

 

1,016 

Total maturities

 

 

 

 

 

2,903 

Unamortized discount, net

 

 

 

 

 

(15)

Debt issuance costs

 

 

 

 

 

(12)

Total long-term debt

 

 

 

 

$

2,876 



Short-term borrowings: Schwab Bank maintains a secured credit facility with the Federal Home Loan Bank of San Francisco. At June 30, 2016, $5.0 billion was outstanding under this facility with an additional $3.9 billion available based on the loans currently pledged there. As a condition of the borrowings, Schwab Bank purchased $118 million of FHLB stock, recorded at par, in the first half of 2016, with the investment recorded in other assets on the condensed consolidated balance sheets. No funds were drawn under this facility as of December 31, 2015. Amounts outstanding under this facility are included in short-term borrowings on the condensed consolidated balance sheets.



CSC has authorization from its Board of Directors to issue Commercial Paper Notes not to exceed $1.5 billion. Management has set a current limit for the commercial paper program not to exceed the amount of the committed, unsecured credit facility, which was $750 million at June 30, 2016. The maturities of the Commercial Paper Notes may vary, but are not to exceed

-  42  -


 

THE CHARLES SCHWAB CORPORATION

Notes to Condensed Consolidated Financial Statements

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

(Unaudited)

 

270 days from the date of issue. The commercial paper is not redeemable prior to maturity and cannot be voluntarily prepaid. The proceeds of the commercial paper program are to be used for general corporate purposes. CSC had no borrowings of Commercial Paper Notes outstanding at June 30, 2016 and December 31, 2015.







8.Commitments and Contingencies



Guarantees and indemnifications: The Company has clients that sell (i.e., write) listed option contracts that are cleared by the Options Clearing Corporation – a clearing house that establishes margin requirements on these transactions. The Company partially satisfies the margin requirements by arranging unsecured standby LOCs, in favor of the Options Clearing Corporation, which are issued by several banks. At June 30, 2016, the aggregate face amount of these LOCs totaled $310 million. There were no funds drawn under any of these LOCs at June 30, 2016. In connection with its securities lending activities, the Company is required to provide collateral to certain brokerage clients. The Company satisfies the collateral requirements by providing cash as collateral.



The Company also provides guarantees to securities clearing houses and exchanges under standard membership agreements, which require members to guarantee the performance of other members. Under the agreements, if another member becomes unable to satisfy its obligations to the clearing houses and exchanges, other members would be required to meet shortfalls. The Company’s liability under these arrangements is not quantifiable and may exceed the cash and securities it has posted as collateral. However, the potential requirement for the Company to make payments under these arrangements is remote. Accordingly, no liability has been recognized for these guarantees.



Legal contingencies: The Company is subject to claims and lawsuits in the ordinary course of business, including arbitrations, class actions and other litigation, some of which include claims for substantial or unspecified damages. The Company is also the subject of inquiries, investigations, and proceedings by regulatory and other governmental agencies.



The Company believes it has strong defenses in all significant matters currently pending and is contesting liability and any damages claimed. Nevertheless, some of these matters may result in adverse judgments or awards, including penalties, injunctions or other relief, and the Company may also determine to settle a matter because of the uncertainty and risks of litigation. Described below are certain matters in which there is a reasonable possibility that a material loss could be incurred or where the matter may otherwise be of significant interest to stockholders. Unless otherwise noted, the Company is unable to provide a reasonable estimate of any potential liability given the stage of proceedings in the matter.



With respect to all other pending matters, based on current information and consultation with counsel, it does not appear reasonably possible that the outcome of any such matter would be material to the financial condition, operating results or cash flows of the Company. However, predicting the outcome of a litigation or regulatory matter is inherently difficult, requiring significant judgment and evaluation of various factors, including the procedural status of the matter and any recent developments; prior experience and the experience of others in similar cases; available defenses, including potential opportunities to dispose of a case on the merits or procedural grounds before trial (e.g., motions to dismiss or for summary judgment); the progress of fact discovery; the opinions of counsel and experts regarding potential damages; potential opportunities for settlement and the status of any settlement discussions; and potential insurance coverage and indemnification. It may not be possible to reasonably estimate potential liability, if any, or a range of potential liability until the matter is closer to resolution – pending, for example, further proceedings, the outcome of key motions or appeals, or discussions among the parties. Numerous issues may have to be developed, such as discovery of important factual matters and determination of threshold legal issues, which may include novel or unsettled questions of law. Reserves are established or adjusted or further disclosure and estimates of potential loss are provided as the matter progresses and more information becomes available.



Total Bond Market Fund Litigation: On August 28, 2008, a class action lawsuit was filed in the U.S. District Court for the Northern District of California on behalf of investors in the Schwab Total Bond Market Fund™. The lawsuit, which alleged violations of state law and federal securities law in connection with the fund’s investment policy, named CSIM, Schwab Investments (registrant and issuer of the fund’s shares) and certain current and former fund trustees as defendants. Allegations include that the fund improperly deviated from its stated investment objectives by investing in collateralized mortgage obligations (CMOs) and investing more than 25% of fund assets in CMOs and mortgage-backed securities without obtaining a shareholder vote. Plaintiff seeks unspecified compensatory and rescission damages, unspecified equitable and

-  43  -


 

THE CHARLES SCHWAB CORPORATION

Notes to Condensed Consolidated Financial Statements

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

(Unaudited)

 

injunctive relief, costs and attorneys’ fees. Plaintiff’s federal securities law claim and certain of plaintiff’s state law claims were dismissed. On August 8, 2011, the court dismissed plaintiff’s remaining claims with prejudice. Plaintiff appealed to the Ninth Circuit, which issued a ruling on March 9, 2015 reversing the district court’s dismissal of the case and remanding the case for further proceedings. Plaintiff filed a fourth amended complaint on June 25, 2015, and in decisions issued October 6, 2015 and February 23, 2016, the court dismissed all claims with prejudice. Plaintiff has appealed to the Ninth Circuit, where the case is again pending.



Regulatory Matters: On April 16, 2012, optionsXpress, Inc. was charged by the SEC in an administrative proceeding alleging violations of the firm’s close-out obligations under Regulation SHO (short sale delivery rules) in connection with certain customer trading activity. Following trial, in a decision issued June 7, 2013, the judge held that the firm had violated Regulation SHO and aided and abetted fraudulent trading activity by its customer, and ordered the firm and the customer to pay disgorgement and penalties in an amount that would not be material. The Company continues to dispute the allegations and is appealing the decision.





9.Offsetting Assets and Liabilities



Resale and repurchase agreements: Schwab enters into collateralized resale agreements principally with other broker-dealers, which could result in losses in the event the counterparty fails to purchase the securities held as collateral for the cash advanced and the fair value of the securities declines. To mitigate this risk, Schwab requires that the counterparty deliver securities to a custodian, to be held as collateral, with a fair value at or in excess of 102% of the resale price. Schwab also sets standards for the credit quality of the counterparty, monitors the fair value of the underlying securities as compared to the related receivable, including accrued interest, and requires additional collateral where deemed appropriate. At June 30, 2016 and December 31, 2015, the fair value of collateral received in connection with resale agreements that are available to be repledged or sold was $7.4 billion and $8.2 billion, respectively. Schwab utilizes the collateral provided under these resale agreements to meet obligations under broker-dealer client protection rules, which place limitations on its ability to access such segregated securities. For Schwab to repledge or sell this collateral, it would be required to deposit cash and/or securities of an equal amount into its segregated reserve bank accounts in order to meet its segregated cash and investment requirement. The Company’s resale agreements are not subject to master netting arrangements.



Securities lending: The Company loans client securities temporarily to other brokers in connection with its securities lending activities and receives cash as collateral for the securities loaned. Increases in security prices may cause the fair value of the securities loaned to exceed the amount of cash received as collateral. In the event the counterparty to these transactions does not return the loaned securities or provide additional cash collateral, the Company may be exposed to the risk of acquiring the securities at prevailing market prices in order to satisfy its client obligations. The Company mitigates this risk by requiring credit approvals for counterparties, monitoring the fair value of securities loaned, and requiring additional cash as collateral when necessary. The fair value of client securities pledged in securities lending transactions to other broker-dealers was $2.1 billion at June 30, 2016 and $1.9 billion at December 31, 2015. The Company has also pledged a portion of its securities owned in connection with securities lending transactions to other broker-dealers. Additionally, the Company borrows securities from other broker-dealers to fulfill short sales by clients and delivers cash to the lender in exchange for the securities. The fair value of these borrowed securities was $442 million at June 30, 2016 and $72 million at December 31, 2015. All of the Company’s securities lending transactions are subject to enforceable master netting arrangements with other broker-dealers. However, the Company does not net securities lending transactions and therefore, the Company’s securities loaned and securities borrowed are presented gross in the condensed consolidated balance sheets.



-  44  -


 

THE CHARLES SCHWAB CORPORATION

Notes to Condensed Consolidated Financial Statements

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

(Unaudited)

 

The following table presents information about the Company’s resale agreements and securities lending activity to enable the users of the Company’s financial statements to evaluate the potential effect of rights of setoff between these recognized assets and recognized liabilities at June 30, 2016 and December 31, 2015.





 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

Gross Amounts

 

Net Amounts

 

Gross Amounts Not Offset in the

 

 

 



 

 

 

 

 

Offset in the

 

Presented in the

 

Condensed Consolidated

 

 

 



 

 

Gross

 

 

 

Condensed

 

 

 

Condensed

 

 

Balance Sheets

 

 

 



 

 

Assets/

 

 

Consolidated

 

Consolidated

 

Counterparty

 

 

 

 

Net



 

 

Liabilities

 

 

Balance Sheets

 

Balance Sheets

 

Offsetting

 

Collateral

 

 

Amount

June 30, 2016

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Resale agreements (1)

 

$

7,270 

 

 

$

 -

 

 

$

7,270 

 

 

$

 -

 

 

$

(7,270)

(2)

 

$

 -

Securities borrowed (3)

 

 

643 

 

 

 

 -

 

 

 

643 

 

 

 

(436)

 

 

 

(206)

 

 

 

Total

 

$

7,913 

 

 

$

 -

 

 

$

7,913 

 

 

$

(436)

 

 

$

(7,476)

 

 

$

Liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Securities loaned (4,5)

 

$

2,461 

 

 

$

 -

 

 

$

2,461 

 

 

$

(436)

 

 

$

(1,890)

 

 

$

135 

Total

 

$

2,461 

 

 

$

 -

 

 

$

2,461 

 

 

$

(436)

 

 

$

(1,890)

 

 

$

135 

December 31, 2015

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Resale agreements (1)

 

$

8,088 

 

 

$

 -

 

 

$

8,088 

 

 

$

 -

 

 

$

(8,088)

(2)

 

$

 -

Securities borrowed (3)

 

 

198 

 

 

 

 -

 

 

 

198 

 

 

 

(70)

 

 

 

(127)

 

 

 

Total

 

$

8,286 

 

 

$

 -

 

 

$

8,286 

 

 

$

(70)

 

 

$

(8,215)

 

 

$

Liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Securities loaned (4,5)

 

$

2,233 

 

 

$

 -

 

 

$

2,233 

 

 

$

(70)

 

 

$

(1,990)

 

 

$

173 

Total

 

$

2,233 

 

 

$

 -

 

 

$

2,233 

 

 

$

(70)

 

 

$

(1,990)

 

 

$

173 





 

(1)

Included in cash and investments segregated and on deposit for regulatory purposes in the Company’s condensed consolidated balance sheets.

(2)

Actual collateral was greater than or equal to 102% of the related assets.

(3)

Included in receivables from brokers, dealers, and clearing organizations in the Company’s condensed consolidated balance sheets.

(4)

Included in payables to brokers, dealers, and clearing organizations in the Company’s condensed consolidated balance sheets.

(5)

Securities loaned are predominantly comprised of equity securities with overnight and continuous remaining contractual maturities.







10.Fair Values of Assets and Liabilities



Assets and liabilities measured at fair value on a recurring basis



The Company’s assets and liabilities measured at fair value on a recurring basis include certain cash equivalents, certain investments segregated and on deposit for regulatory purposes, other securities owned, and securities available for sale. The Company uses the market approach to determine the fair value of assets and liabilities. When available, the Company uses quoted prices in active markets to measure the fair value of assets and liabilities. When utilizing market data and bid-ask spread, the Company uses the price within the bid-ask spread that best represents fair value. When quoted prices do not exist, the Company uses prices obtained from independent third-party pricing services to measure the fair value of investment assets. The Company generally obtains prices from at least three independent pricing sources for assets recorded at fair value.



The Company’s primary independent pricing service provides prices based on observable trades and discounted cash flows that incorporate observable information such as yields for similar types of securities (a benchmark interest rate plus observable spreads) and weighted-average maturity for the same or similar “to-be-issued” securities. The Company compares the prices obtained from its primary independent pricing service to the prices obtained from the additional independent pricing services to determine if the price obtained from the primary independent pricing service is reasonable. The Company

-  45  -


 

THE CHARLES SCHWAB CORPORATION

Notes to Condensed Consolidated Financial Statements

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

(Unaudited)

 

does not adjust the prices received from independent third-party pricing services unless such prices are inconsistent with the definition of fair value and result in a material difference in the recorded amounts.



Fair value of other financial instruments



Descriptions of the valuation methodologies and assumptions used to estimate the fair value of other financial instruments are described below. The Company’s financial instruments not recorded at fair value but for which fair value can be approximated and disclosed include:



·

Cash and cash equivalents are short-term in nature and accordingly are recorded at amounts that approximate fair value.



·

Cash and investments segregated and on deposit for regulatory purposes include cash and securities purchased under resale agreements. Securities purchased under resale agreements are short-term in nature and are backed by collateral that both exceeds the carrying value of the resale agreement and is highly liquid in nature. Accordingly, the carrying values of these financial instruments approximate their fair values.



·

Receivables from/payables to brokers, dealers, and clearing organizations are short-term in nature, recorded at contractual amounts and historically have been settled at those values. Accordingly, the carrying values of these financial instruments approximate their fair values.



·

Receivables from/payables to brokerage clientsnet are short-term in nature, recorded at contractual amounts and historically have been settled at those values. Accordingly, the carrying values of these financial instruments approximate their fair values.



·

Securities held to maturity – The fair values of securities held to maturity are obtained using an independent third-party pricing service similar to investment assets recorded at fair value as discussed above.



·

Bank loans – The fair values of the Company’s First Mortgages and HELOCs are estimated based on prices of mortgage-backed securities collateralized by similar types of loans. PALs are non-purpose revolving lines of credit secured by eligible assets; accordingly, the carrying values of these loans approximate their fair values.



·

Financial instruments included in other assets primarily consist of LIHTC investments, cost method investments and Federal Home Loan Bank (FHLB) stock, whose carrying values approximate their fair values. FHLB stock is recorded at par, which approximates fair value.



·

Bank deposits have no stated maturity and are recorded at the amount payable on demand as of the balance sheet date. The Company considers the carrying values of these deposits to approximate their fair values.



·

Financial instruments included in accrued expenses and other liabilities consist of drafts payable and certain amounts due under contractual obligations, including unfunded LIHTC commitments. The carrying values of these instruments approximate their fair values.



·

Short-term borrowings consist of commercial paper and funds drawn on Schwab Bank’s secured credit facility with the Federal Home Loan Bank of San Francisco. Due to the short-term nature of these borrowings, carrying value approximates fair value.



·

Long-term debt – Except for the finance lease obligation, the fair values of long-term debt are estimated using indicative, non-binding quotes from independent brokers. The Company validates indicative prices for its debt through comparison to other independent non-binding quotes. The finance lease obligation is recorded at carrying value, which approximates fair value.



-  46  -


 

THE CHARLES SCHWAB CORPORATION

Notes to Condensed Consolidated Financial Statements

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

(Unaudited)

 

·

Firm commitments to extend credit – The Company extends credit to banking clients through HELOCs and PALs. The Company considers the fair value of these unused commitments to not be material because the interest rates earned on these balances are based on floating interest rates that reset monthly.



For a description of the fair value hierarchy, see “Notes – 2. Summary of Significant Accounting Policies” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015. There were no significant changes in these policies and methodologies during the first six months of 2016. The Company did not transfer any assets or liabilities between Level 1, Level 2, or Level 3 during the six months ended June 30, 2016, or the year ended December 31, 2015. In addition, the Company did not adjust prices received from the primary independent third-party pricing service at June 30, 2016 or December 31, 2015.



Assets and Liabilities Measured at Fair Value on a Recurring Basis



The following tables present the fair value hierarchy for assets measured at fair value on a recurring basis. Liabilities recorded at fair value were not material, and therefore are not included in the following tables:





 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



Quoted Prices

 

 

 

  

 

 



in Active Markets

 

Significant

 

Significant

 

 



for Identical

 

Other Observable

 

Unobservable

 

 



Assets

 

Inputs

 

Inputs

 

Balance at

June 30, 2016

(Level 1)

 

(Level 2)

 

(Level 3)

 

Fair Value

Cash equivalents:

 

 

 

  

 

 

 

 

 

 

  

 

 

 

 

 

 

 

 

Money market funds

 

$

2,350 

 

 

 

$

 -

 

 

 

$

 -

 

 

 

$

2,350 

 

Commercial paper

 

 

 -

 

 

 

 

567 

 

 

 

 

 -

 

 

 

 

567 

 

Total cash equivalents

 

 

2,350 

 

 

 

 

567 

 

 

 

 

 -

 

 

 

 

2,917 

 

Investments segregated and on deposit for regulatory

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

purposes:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Certificates of deposit

 

 

 -

 

 

 

 

3,151 

 

 

 

 

 -

 

 

 

 

3,151 

 

U.S. Government securities

 

 

 -

 

 

 

 

4,150 

 

 

 

 

 -

 

 

 

 

4,150 

 

Total investments segregated and on deposit for

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

regulatory purposes

 

 

 -

 

 

 

 

7,301 

 

 

 

 

 -

 

 

 

 

7,301 

 

Other securities owned:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Schwab Funds® money market funds

 

 

162 

 

 

 

 

 -

 

 

 

 

 -

 

 

 

 

162 

 

Equity and bond mutual funds

 

 

241 

 

 

 

 

10 

 

 

 

 

 -

 

 

 

 

251 

 

State and municipal debt obligations

 

 

 -

 

 

 

 

64 

 

 

 

 

 -

 

 

 

 

64 

 

Equity, U.S. Government and corporate debt, and

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

other securities

 

 

 

 

 

 

46 

 

 

 

 

 -

 

 

 

 

48 

 

Total other securities owned

 

 

405 

 

 

 

 

120 

 

 

 

 

 -

 

 

 

 

525 

 

Securities available for sale:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. agency mortgage-backed securities

 

 

 -

 

 

 

 

31,133 

 

 

 

 

 -

 

 

 

 

31,133 

 

Asset-backed securities

 

 

 -

 

 

 

 

21,756 

 

 

 

 

 -

 

 

 

 

21,756 

 

Corporate debt securities

 

 

 -

 

 

 

 

10,147 

 

 

 

 

 -

 

 

 

 

10,147 

 

U.S. Treasury securities

 

 

 -

 

 

 

 

5,018 

 

 

 

 

 -

 

 

 

 

5,018 

 

U.S. agency notes

 

 

 -

 

 

 

 

2,973 

 

 

 

 

 -

 

 

 

 

2,973 

 

Certificates of deposit

 

 

 -

 

 

 

 

2,178 

 

 

 

 

 -

 

 

 

 

2,178 

 

U.S. state and municipal securities

 

 

 -

 

 

 

 

651 

 

 

 

 

 -

 

 

 

 

651 

 

Commercial paper

 

 

 -

 

 

 

 

213 

 

 

 

 

 -

 

 

 

 

213 

 

Non-agency commercial mortgage-backed securities

 

 

 -

 

 

 

 

159 

 

 

 

 

 -

 

 

 

 

159 

 

Total securities available for sale

 

 

 -

 

 

 

 

74,228 

 

 

 

 

 -

 

 

 

 

74,228 

 

Total

 

$

2,755 

 

 

 

$

82,216 

 

 

 

$

 -

 

 

 

$

84,971 

 





-  47  -


 

THE CHARLES SCHWAB CORPORATION

Notes to Condensed Consolidated Financial Statements

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

(Unaudited)

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



Quoted Prices

 

 

 

  

 

 



in Active Markets

 

Significant

 

Significant

 

 



for Identical

 

Other Observable

 

    Unobservable    

 

 



Assets

 

Inputs

 

Inputs

 

Balance at

December 31, 2015

(Level 1)

 

(Level 2)

 

(Level 3)

 

Fair Value

Cash equivalents:

 

 

 

  

 

 

 

 

 

 

  

 

 

 

 

 

 

 

 

Money market funds

 

$

1,968 

 

 

 

$

 -

 

 

 

$

 -

 

 

 

$

1,968 

 

Commercial paper

 

 

 -

 

 

 

 

360 

 

 

 

 

 -

 

 

 

 

360 

 

Total cash equivalents

 

 

1,968 

 

 

 

 

360 

 

 

 

 

 -

 

 

 

 

2,328 

 

Investments segregated and on deposit for regulatory

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

purposes:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Certificates of deposit

 

 

 -

 

 

 

 

3,430 

 

 

 

 

 -

 

 

 

 

3,430 

 

U.S. Government securities

 

 

 -

 

 

 

 

4,517 

 

 

 

 

 -

 

 

 

 

4,517 

 

Total investments segregated and on deposit for

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

regulatory purposes

 

 

 -

 

 

 

 

7,947 

 

 

 

 

 -

 

 

 

 

7,947 

 

Other securities owned:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Schwab Funds® money market funds

 

 

261 

 

 

 

 

 -

 

 

 

 

 -

 

 

 

 

261 

 

Equity and bond mutual funds

 

 

205 

 

 

 

 

 -

 

 

 

 

 -

 

 

 

 

205 

 

State and municipal debt obligations

 

 

 -

 

 

 

 

50 

 

 

 

 

 -

 

 

 

 

50 

 

Equity, U.S. Government and corporate debt, and

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

other securities

 

 

 

 

 

 

16 

 

 

 

 

 -

 

 

 

 

17 

 

Total other securities owned

 

 

467 

 

 

 

 

66 

 

 

 

 

 -

 

 

 

 

533 

 

Securities available for sale:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. agency mortgage-backed securities

 

 

 -

 

 

 

 

22,149 

 

 

 

 

 -

 

 

 

 

22,149 

 

Asset-backed securities

 

 

 -

 

 

 

 

21,485 

 

 

 

 

 -

 

 

 

 

21,485 

 

Corporate debt securities

 

 

 -

 

 

 

 

10,747 

 

 

 

 

 -

 

 

 

 

10,747 

 

U.S. Treasury securities

 

 

 -

 

 

 

 

5,704 

 

 

 

 

 -

 

 

 

 

5,704 

 

U.S. agency notes

 

 

 -

 

 

 

 

3,150 

 

 

 

 

 -

 

 

 

 

3,150 

 

Certificates of deposit

 

 

 -

 

 

 

 

1,683 

 

 

 

 

 -

 

 

 

 

1,683 

 

U.S. state and municipal securities

 

 

 -

 

 

 

 

424 

 

 

 

 

 -

 

 

 

 

424 

 

Non-agency commercial mortgage-backed securities

 

 

 -

 

 

 

 

299 

 

 

 

 

 -

 

 

 

 

299 

 

Other securities

 

 

 -

 

 

 

 

 

 

 

 

 -

 

 

 

 

 

Total securities available for sale

 

 

 -

 

 

 

 

65,646 

 

 

 

 

 -

 

 

 

 

65,646 

 

Total

 

$

2,435 

 

 

 

$

74,019 

 

 

 

$

 -

 

 

 

$

76,454 

 



-  48  -


 

THE CHARLES SCHWAB CORPORATION

Notes to Condensed Consolidated Financial Statements

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

(Unaudited)

 

Fair Value of Other Financial Instruments



The following tables present the fair value hierarchy for other financial instruments:





 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

  

 

 

 

 

Quoted Prices

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 in Active Markets 

 

Significant

 

Significant

 

 

 

 



 

 

 

 

for Identical

 

Other Observable

 

Unobservable

 

 

 

 



 

Carrying

 

Assets

 

Inputs

 

Inputs

 

Balance at

 

June 30, 2016

 

Amount

 

(Level 1)

 

(Level 2)

 

(Level 3)

 

Fair Value

 

Assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

10,059 

 

 

$

 -

 

 

  

$

10,059 

 

 

  

$

 -

 

 

$

10,059 

  

Cash and investments segregated and

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

  

on deposit for regulatory purposes

 

 

11,287 

 

 

 

 -

 

 

  

 

11,287 

 

 

  

 

 -

 

 

 

11,287 

 

Receivables from brokers, dealers, and

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

  

clearing organizations

 

 

1,008 

 

 

 

 -

 

 

  

 

1,008 

 

 

  

 

 -

 

 

 

1,008 

 

Receivables from brokerage clients – net

 

 

16,819 

 

 

 

 -

 

 

  

 

16,819 

 

 

  

 

 -

 

 

 

16,819 

  

Securities held to maturity:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. agency mortgage-backed securities

 

 

54,087 

 

 

 

 -

 

 

  

 

55,916 

 

 

  

 

 -

 

 

 

55,916 

  

Non-agency commercial mortgage-backed

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

  securities

 

 

998 

 

 

 

 -

 

 

  

 

1,044 

 

 

  

 

 -

 

 

 

1,044 

  

U.S. Treasury securities

 

 

222 

 

 

 

 -

 

 

 

 

235 

 

 

 

 

 -

 

 

 

235 

 

Total securities held to maturity

 

 

55,307 

 

 

 

 -

 

 

  

 

57,195 

 

 

  

 

 -

 

 

 

57,195 

  

Bank loans: (1)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential real estate mortgages

 

 

8,502 

 

 

 

 -

 

 

  

 

8,632 

 

 

  

 

 -

 

 

 

8,632 

  

Home equity loans and lines of credit

 

 

2,582 

 

 

 

 -

 

 

  

 

2,718 

 

 

  

 

 -

 

 

 

2,718 

  

Pledged asset lines

 

 

3,531 

 

 

 

 -

 

 

  

 

3,531 

 

 

  

 

 -

 

 

 

3,531 

  

Other

 

 

86 

 

 

 

 -

 

 

  

 

86 

 

 

  

 

 -

 

 

 

86 

  

Total bank loans

 

 

14,701 

 

 

 

 -

 

 

  

 

14,967 

 

 

  

 

 -

 

 

 

14,967 

  

Other assets

 

 

333 

 

 

 

 -

 

 

  

 

333 

 

 

  

 

 -

 

 

 

333 

  

Total

 

$

109,514 

 

 

$

 -

 

 

  

$

111,668 

 

 

  

$

 -

 

 

$

111,668 

  

Liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Bank deposits

 

$

137,295 

 

 

$

 -

 

 

  

$

137,295 

 

 

  

$

 -

 

 

$

137,295 

  

Payables to brokers, dealers, and clearing

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

  

organizations

 

 

3,392 

 

 

 

 -

 

 

  

 

3,392 

 

 

  

 

 -

 

 

 

3,392 

 

Payables to brokerage clients

 

 

32,679 

 

 

 

 -

 

 

  

 

32,679 

 

 

  

 

 -

 

 

 

32,679 

  

Accrued expenses and other liabilities

 

 

835 

 

 

 

 -

 

 

  

 

835 

 

 

  

 

 -

 

 

 

835 

  

Short-term borrowings

 

 

5,000 

 

 

 

 -

 

 

 

 

5,000 

 

 

 

 

 -

 

 

 

5,000 

 

Long-term debt

 

 

2,876 

 

 

 

 -

 

 

  

 

3,033 

 

 

  

 

 -

 

 

 

3,033 

  

Total

 

$

182,077 

 

 

$

 -

 

 

  

$

182,234 

 

 

  

$

 -

 

 

$

182,234 

  





 

(1)

The carrying value of bank loans excludes the allowance for loan losses of $31 million at June 30, 2016.





-  49  -


 

THE CHARLES SCHWAB CORPORATION

Notes to Condensed Consolidated Financial Statements

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

(Unaudited)

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

  

 

 

 

 

Quoted Prices

 

 

 

 

 

 

 

 



 

 

 

 

 in Active Markets 

 

Significant

 

Significant

 

 

 

 



 

 

 

 

for Identical

 

Other Observable

 

Unobservable

 

 

 



 

Carrying

 

Assets

 

Inputs

 

Inputs

 

Balance at

 

December 31, 2015

 

Amount

 

(Level 1)

 

(Level 2)

 

(Level 3)

 

Fair Value

 

Assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

9,650 

 

 

$

 -

 

 

  

$

9,650 

 

 

  

$

 -

 

 

$

9,650 

  

Cash and investments segregated and

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

  

on deposit for regulatory purposes

 

 

11,647 

 

 

 

 -

 

 

  

 

11,647 

 

 

  

 

 -

 

 

 

11,647 

 

Receivables from brokers, dealers, and

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

  

clearing organizations

 

 

582 

 

 

 

 -

 

 

  

 

582 

 

 

  

 

 -

 

 

 

582 

 

Receivables from brokerage clients – net

 

 

17,310 

 

 

 

 -

 

 

  

 

17,310 

 

 

  

 

 -

 

 

 

17,310 

  

Securities held to maturity:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. agency mortgage-backed securities

 

 

48,785 

 

 

 

 -

 

 

  

 

48,883 

 

 

  

 

 -

 

 

 

48,883 

  

Non-agency commercial mortgage-backed

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

securities

 

 

999 

 

 

 

 -

 

 

 

 

985 

 

 

 

 

 -

 

 

 

985 

 

U.S. Treasury securities

 

 

223 

 

 

 

 -

 

 

  

 

220 

 

 

  

 

 -

 

 

 

220 

  

Total securities held to maturity

 

 

50,007 

 

 

 

 -

 

 

  

 

50,088 

 

 

  

 

 -

 

 

 

50,088 

  

Bank loans: (1)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential real estate mortgages

 

 

8,334 

 

 

 

 -

 

 

  

 

8,347 

 

 

  

 

 -

 

 

 

8,347 

  

Home equity loans and lines of credit

 

 

2,735 

 

 

 

 -

 

 

  

 

2,857 

 

 

  

 

 -

 

 

 

2,857 

  

Pledged asset lines

 

 

3,232 

 

 

 

 -

 

 

  

 

3,232 

 

 

  

 

 -

 

 

 

3,232 

  

Other

 

 

64 

 

 

 

 -

 

 

  

 

64 

 

 

  

 

 -

 

 

 

64 

  

Total bank loans

 

 

14,365 

 

 

 

 -

 

 

  

 

14,500 

 

 

  

 

 -

 

 

 

14,500 

  

Other assets

 

 

184 

 

 

 

 -

 

 

  

 

184 

 

 

  

 

 -

 

 

 

184 

  

Total

 

$

103,745 

 

 

$

 -

 

 

 

$

103,961 

 

 

 

$

 -

 

 

$

103,961 

  

Liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Bank deposits

 

$

129,502 

 

 

$

 -

 

 

  

$

129,502 

 

 

  

$

 -

 

 

$

129,502 

  

Payables to brokers, dealers, and clearing

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

  

organizations

 

 

2,588 

 

 

 

 -

 

 

  

 

2,588 

 

 

  

 

 -

 

 

 

2,588 

 

Payables to brokerage clients

 

 

33,185 

 

 

 

 -

 

 

  

 

33,185 

 

 

  

 

 -

 

 

 

33,185 

  

Accrued expenses and other liabilities

 

 

1,115 

 

 

 

 -

 

 

  

 

1,115 

 

 

  

 

 -

 

 

 

1,115 

  

Long-term debt (2)

 

 

2,877 

 

 

 

 -

 

 

  

 

2,967 

 

 

  

 

 -

 

 

 

2,967 

  

Total

 

$

169,267 

 

 

$

 -

 

 

  

$

169,357 

 

 

  

$

 -

 

 

$

169,357 

  





 

(1)

The carrying value of bank loans excludes the allowance for loan losses of $31 million at December 31, 2015.

(2)

The amounts as of December 31, 2015 have been recast as a result of the adoption of ASU 2015-03, to present debt issuance costs of $13 million as a direct deduction from the carrying amount of the associated debt liability, consistent with the recording of debt discounts.









11.Stockholders’ Equity



There have been no significant changes to the Company’s stockholders’ equity with the exception of the issuance disclosed below. The Company did not issue any shares of common stock during the six months ended June 30, 2016, or the year ended December 31, 2015.



On March 7, 2016, the Company issued and sold 30 million depositary shares, each representing a 1/40th ownership interest in a share of 5.95% non-cumulative perpetual preferred stock, Series D, $0.01 par value, with a liquidation preference of $1,000 per share (equivalent to $25 per depositary share). The Series D Preferred Stock has a fixed dividend rate of 5.95%.



-  50  -


 

THE CHARLES SCHWAB CORPORATION

Notes to Condensed Consolidated Financial Statements

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

(Unaudited)

 

Including the Series D issuance discussed above, the Company’s preferred stock issued and outstanding is as follows:





 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



June 30, 2016

 

 

December 31, 2015



Shares

 

 

 

 

 

 

 

 

 

 

Shares

 

 

 

 

 

 

 

 



Issued and

 

Liquidation

 

 

 

 

 

 

 

 

Issued and

 

Liquidation

 

 

 

 

 

 



Outstanding

 

Preference

 

Liquidation

 

Carrying

 

 

Outstanding

 

Preference

 

Liquidation

 

Carrying



(In thousands)

 

Per Share

 

Preference

 

Value

 

 

(In thousands)

 

Per Share

 

Preference

 

Value

Series A

400 

 

 

 

$

1,000 

 

$

400 

 

$

397 

 

 

400 

 

 

 

$

1,000 

 

$

400 

 

$

396 

Series B

485 

 

 

 

 

1,000 

 

 

485 

 

 

482 

 

 

485 

 

 

 

 

1,000 

 

 

485 

 

 

480 

Series C

600 

 

 

 

 

1,000 

 

 

600 

 

 

584 

 

 

600 

 

 

 

 

1,000 

 

 

600 

 

 

583 

Series D

750 

 

 

 

 

1,000 

 

 

750 

 

 

726 

 

 

 -

 

 

 

 

 -

 

 

 -

 

 

 -

Total Preferred Stock

2,235 

 

 

 

 

 

 

$

2,235 

 

$

2,189 

 

 

1,485 

 

 

 

 

 

 

$

1,485 

 

$

1,459 







12.Accumulated Other Comprehensive Income



Accumulated other comprehensive income represents cumulative gains and losses that are not reflected in earnings. The components of other comprehensive income are as follows:





 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended June 30,

 

 

 

 

2016

 

 

 

 

 

 

 

 

2015

 

 

 

 



 

Before

 

Tax

 

 

Net of

 

Before

 

Tax

 

 

Net of



 

Tax

 

Effect

 

 

Tax

 

Tax

 

Effect

 

 

Tax

Change in net unrealized gain on

 

 

 

  

 

 

 

  

 

 

 

 

 

  

 

 

 

  

 

 

securities available for sale:

 

 

 

  

 

 

 

  

 

 

 

 

 

  

 

 

 

  

 

 

Net unrealized gain (loss)

 

$

168 

  

$

(63)

 

$

105 

 

 

$

(91)

  

$

34 

 

$

(57)

 

Other reclassifications included in

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

other revenue

 

 

(3)

 

 

 

 

(2)

 

 

 

 -

 

 

 -

 

 

 -

 

Change in net unrealized gain (loss) on

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

  

 

 

securities available for sale

 

 

165 

 

 

(62)

 

 

103 

 

 

 

(91)

 

 

34 

 

 

(57)

 

Other comprehensive income (loss)

 

$

165 

 

$

(62)

 

$

103 

 

 

$

(91)

 

$

34 

 

$

(57)

 







 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Six Months Ended June 30,

 

 

 

 

2016

 

 

 

 

 

 

 

 

2015

 

 

 

 



 

Before

 

Tax

 

 

Net of

 

Before

 

Tax

 

 

Net of



 

Tax

 

Effect

 

 

Tax

 

Tax

 

Effect

 

 

Tax

Change in net unrealized gain on

 

 

 

  

 

 

 

  

 

 

 

 

 

  

 

 

 

  

 

 

securities available for sale:

 

 

 

  

 

 

 

  

 

 

 

 

 

  

 

 

 

  

 

 

Net unrealized gain (loss)

 

$

189 

  

$

(71)

 

$

118 

 

 

$

16 

  

$

(7)

 

$

 

Other reclassifications included in

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

other revenue

 

 

(3)

 

 

 

 

(2)

 

 

 

 -

 

 

 -

 

 

 -

 

Change in net unrealized gain (loss) on

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

  

 

 

securities available for sale

 

 

186 

 

 

(70)

 

 

116 

 

 

 

16 

 

 

(7)

 

 

 

Other

 

 

  

 

 -

 

  

 

 

 

 -

  

 

 -

 

  

 -

 

Other comprehensive income (loss)

 

$

187 

 

$

(70)

 

$

117 

 

 

$

16 

 

$

(7)

 

$

 



-  51  -


 

THE CHARLES SCHWAB CORPORATION

Notes to Condensed Consolidated Financial Statements

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

(Unaudited)

 

Accumulated other comprehensive income balances are as follows:





 

 

 

 

 

 

 

 

 

 

 

  

 

 

 

 

Total



 

 

 

 

Accumulated Other



 

 

 

 

Comprehensive Income

Balance at December 31, 2014

 

 

 

 

 

 

 

 

$

165 

 

Net unrealized gain on securities available for sale

 

 

 

 

 

 

 

 

 

 

Balance at June 30, 2015

 

 

 

 

 

 

 

 

$

174 

 



 

 

 

 

 

 

 

 

 

 

 

Balance at December 31, 2015

 

 

 

 

 

 

 

 

$

(134)

 

Net unrealized gain on securities available for sale

 

 

 

 

 

 

 

 

 

116 

 

Other

 

 

 

 

 

 

 

 

 

 

Balance at June 30, 2016

 

 

 

 

 

 

 

 

$

(17)

 







13.Earnings Per Common Share



EPS is computed using the two-class method. Preferred stock dividends, and undistributed earnings and dividends allocated to participating securities are subtracted from net income in determining net income available to common stockholders. Basic EPS is computed by dividing net income available to common stockholders by the weighted-average number of common shares outstanding during the period. The computation of diluted EPS is similar to the computation of basic EPS except that the denominator is increased to include the number of additional common shares that would have been outstanding if dilutive potential common shares had been issued. Dilutive potential common shares include, if dilutive, the effect of outstanding stock options and non-vested restricted stock awards and units. EPS under the basic and diluted computations is as follows:





 

 

 

 

 

 

 

 

 

 

 

 



 

Three Months Ended

 

Six Months Ended



 

June 30,

 

June 30,



 

2016

 

2015

 

2016

 

2015

Net income

 

$

452 

  

$

353 

  

$

864 

 

$

655 

Preferred stock dividends and other (1)

 

 

(46)

 

 

(23)

  

 

(66)

 

 

(34)

Net income available to common stockholders

 

$

406 

  

$

330 

  

$

798 

 

$

621 

Weighted-average common shares outstanding — basic

 

 

1,322 

  

 

1,314 

  

 

1,322 

 

 

1,313 

Common stock equivalent shares related to stock incentive plans

 

 

11 

  

 

12 

  

 

 

 

12 

Weighted-average common shares outstanding — diluted (2)

 

 

1,333 

  

 

1,326 

  

 

1,331 

 

 

1,325 

Basic EPS

 

$

 .31

  

$

 .25

  

$

 .60

 

$

 .47

Diluted EPS

 

$

 .30

  

$

 .25

  

$

 .60

 

$

 .47





 

(1)

Includes preferred stock dividends and undistributed earnings and dividends allocated to non-vested restricted stock units.

(2)

Antidilutive stock options and restricted stock awards excluded from the calculation of diluted EPS totaled 19 million and 15 million shares for the second quarters of 2016 and 2015, respectively, and 22 million and 16 million shares for the first halves of 2016 and 2015, respectively.









14.Regulatory Requirements



CSC is a savings and loan holding company and Schwab Bank, CSC’s depository institution subsidiary, is a federal savings bank. CSC is subject to examination, supervision, and regulation by the Federal Reserve. Schwab Bank is subject to examination, supervision, and regulation by the OCC, as its primary regulator, the FDIC, as its deposit insurer, and the CFPB. CSC is required to serve as a source of strength for Schwab Bank. On January 1, 2015, CSC became subject to regulatory capital requirements adopted by the Federal Reserve.



Schwab Bank is subject to various requirements and restrictions under federal and state laws, including regulatory capital requirements and requirements that restrict and govern the terms of affiliate transactions, such as extensions of credit to, or

-  52  -


 

THE CHARLES SCHWAB CORPORATION

Notes to Condensed Consolidated Financial Statements

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

(Unaudited)

 

asset purchases from CSC or its other subsidiaries by Schwab Bank. In addition, Schwab Bank is required to provide notice to and may be required to obtain approval of the OCC and the Federal Reserve to declare dividends to CSC. The federal banking agencies have broad powers to enforce these regulations, including the power to terminate deposit insurance, impose substantial fines and other civil and criminal penalties, and appoint a conservator or receiver. Under the Federal Deposit Insurance Act, Schwab Bank could be subject to restrictive actions if it were to fall within one of the lowest three of five capital categories. CSC and Schwab Bank are required to maintain minimum capital levels as specified in federal banking regulations. Failure to meet the minimum levels could result in certain mandatory, and possibly additional discretionary actions by the regulators that, if undertaken, could have a direct material effect on CSC and Schwab Bank. At June 30, 2016, both CSC and Schwab Bank met all of their respective capital requirements. Certain events, such as growth in bank deposits and regulatory discretion, could adversely affect CSC’s or Schwab Bank’s ability to meet future capital requirements.



The regulatory capital and ratios for CSC and Schwab Bank are as follows:





 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

Minimum to be

 

Minimum Capital



 

Actual

 

Well Capitalized

 

Requirement

June 30, 2016

 

Amount

 

Ratio

 

Amount

 

Ratio

 

Amount

  

Ratio

CSC

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Common Equity Tier 1 Risk-Based Capital

 

$

11,581 

 

17.9 

 

 

N/A

 

 

 

 

$

2,908 

 

4.5 

Tier 1 Risk-Based Capital

 

 

13,770 

 

21.3 

 

 

N/A

 

 

 

 

 

3,877 

  

6.0 

Total Risk-Based Capital

 

 

13,802 

 

21.4 

 

 

N/A

 

 

 

 

 

5,169 

  

8.0 

Tier 1 Leverage

 

 

13,770 

 

7.2 

 

 

N/A

 

 

 

 

 

7,620 

  

4.0 

Schwab Bank

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Common Equity Tier 1 Risk-Based Capital

 

$

10,564 

 

18.9 

 

$

3,638 

 

6.5 

 

$

2,518 

 

4.5 

Tier 1 Risk-Based Capital

 

 

10,564 

 

18.9 

 

 

4,477 

 

8.0 

 

 

3,358 

 

6.0 

Total Risk-Based Capital

 

 

10,595 

 

18.9 

 

 

5,596 

 

10.0 

 

 

4,477 

 

8.0 

Tier 1 Leverage

 

 

10,564 

 

7.1 

 

 

7,462 

 

5.0 

 

 

5,970 

 

4.0 

December 31, 2015

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

CSC

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Common Equity Tier 1 Risk-Based Capital

 

$

10,851 

 

18.2 

 

 

N/A

 

 

 

 

$

2,681 

 

4.5 

Tier 1 Risk-Based Capital

 

 

12,310 

 

20.7 

 

 

N/A

 

 

 

 

 

3,575 

  

6.0 

Total Risk-Based Capital

 

 

12,342 

 

20.7 

 

 

N/A

 

 

 

 

 

4,766 

  

8.0 

Tier 1 Leverage

 

 

12,310 

 

7.1 

 

 

N/A

 

 

 

 

 

6,912 

  

4.0 

Schwab Bank

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Common Equity Tier 1 Risk-Based Capital

 

$

9,314 

 

18.1 

 

$

3,349 

 

6.5 

 

$

2,318 

 

4.5 

Tier 1 Risk-Based Capital

 

 

9,314 

 

18.1 

 

 

4,121 

  

8.0 

 

 

3,091 

 

6.0 

Total Risk-Based Capital

 

 

9,345 

 

18.1 

 

 

5,152 

  

10.0 

 

 

4,121 

 

8.0 

Tier 1 Leverage

 

 

9,314 

 

7.1 

 

 

6,594 

  

5.0 

 

 

5,275 

 

4.0 



N/A Not applicable.



Based on its regulatory capital ratios at June 30, 2016, Schwab Bank is considered well capitalized (the highest category) under their respective regulatory capital rules. There are no conditions or events since June 30, 2016 that management believes have changed Schwab Bank’s capital category.



Beginning on January 1, 2016, CSC and Schwab Bank became subject to a new capital conservation buffer requirement of .625% of risk-weighted assets, increasing each year by .625% until fully implemented at 2.5% of risk-weighted assets in January 2019. The capital conservation buffer is in addition to the minimum risk-based capital requirements described above. Failure to maintain the capital conservation buffer would limit an entity’s ability to make capital distributions and discretionary bonus payments to executive officers. At June 30, 2016, both CSC’s and Schwab Bank’s capital levels exceeded the fully implemented capital conservation buffer requirement.



CSC’s principal broker-dealers are Schwab and optionsXpress, Inc. Schwab and optionsXpress, Inc. are both subject to Rule 15c3-1 under the Securities Exchange Act of 1934 (the Uniform Net Capital Rule). Schwab and optionsXpress, Inc. compute net capital under the alternative method permitted by the Uniform Net Capital Rule. This method requires the

-  53  -


 

THE CHARLES SCHWAB CORPORATION

Notes to Condensed Consolidated Financial Statements

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

(Unaudited)

 

maintenance of minimum net capital, as defined, of the greater of 2% of aggregate debit balances arising from client transactions or a minimum dollar requirement ($250,000), which is based on the type of business conducted by the broker-dealer. Under the alternative method, a broker-dealer may not repay subordinated borrowings, pay cash dividends, or make any unsecured advances or loans to its parent company or employees if such payment would result in a net capital amount of less than 5% of aggregate debit balances or less than 120% of its minimum dollar requirement.



optionsXpress, Inc. is also subject to Commodity Futures Trading Commission Regulation 1.17 (Reg. 1.17) under the Commodity Exchange Act, which also requires the maintenance of minimum net capital. optionsXpress, Inc., as a futures commission merchant, is required to maintain minimum net capital equal to the greater of its net capital requirement under Reg. 1.17 ($1 million), or the sum of 8% of the total risk margin requirements for all positions carried in client accounts and 8% of the total risk margin requirements for all positions carried in non-client accounts (as defined in Reg. 1.17).



Net capital and net capital requirements for Schwab and optionsXpress, Inc. are as follows:





 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

Net Capital

 



 

 

Minimum

 

2% of

 

in Excess of

 



 

 

Net Capital

 

Aggregate

 

Required

 

June 30, 2016

 

Net Capital

 

Required

 

Debit Balances

 

Net Capital

 

Schwab

 

$

1,820 

 

 

$

0.250 

 

 

$

360 

 

 

$

1,460 

 

 

optionsXpress, Inc.

 

 

260 

 

 

 

 

 

 

 

 

 

253 

 

 

December 31, 2015

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Schwab

 

$

1,746 

 

 

$

0.250 

 

 

$

358 

 

 

$

1,388 

 

 

optionsXpress, Inc.

 

 

244 

 

 

 

 

 

 

 

 

 

237 

 

 







15.Segment Information



The Company’s two reportable segments are Investor Services and Advisor Services. The Company structures its operating segments according to its clients and the services provided to those clients. 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. Revenues and expenses are allocated to the Company’s two segments based on which segment services the client.



The Company evaluates the performance of its segments on a pre-tax basis, excluding items such as restructuring and other charges. Segment assets and liabilities are not used for evaluating segment performance or in deciding how to allocate resources to segments. There are no revenues from transactions between the segments.



-  54  -


 

THE CHARLES SCHWAB CORPORATION

Notes to Condensed Consolidated Financial Statements

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

(Unaudited)

 

Financial information for the Company’s reportable segments is presented in the following tables:





 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

  

Investor Services (1)

 

Advisor Services (1)

 

Total

Three Months Ended June 30,

2016

 

2015

 

2016

 

2015

 

2016

 

2015

Net Revenues:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Asset management and administration fees

$

514 

  

$

465 

  

$

243 

  

$

205 

  

$

757 

  

$

670 

Net interest revenue

 

628 

  

 

524 

  

 

170 

  

 

88 

  

 

798 

  

 

612 

Trading revenue

 

129 

  

 

133 

  

 

72 

  

 

70 

  

 

201 

  

 

203 

Other

 

51 

  

 

57 

  

 

19 

  

 

22 

  

 

70 

  

 

79 

Provision for loan losses

 

 

 

 

 

 -

 

 

 -

 

 

 

 

Total net revenues

 

1,324 

  

 

1,181 

  

 

504 

  

 

385 

  

 

1,828 

  

 

1,566 

Expenses Excluding Interest

 

834 

  

 

760 

  

 

274 

  

 

239 

  

 

1,108 

  

 

999 

Income before taxes on income

$

490 

  

$

421 

  

$

230 

  

$

146 

  

$

720 

  

$

567 





 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

  

Investor Services (1)

 

Advisor Services (1)

 

Total

Six Months Ended June 30,

2016

 

2015

 

2016

 

2015

 

2016

 

2015

Net Revenues:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Asset management and administration fees

$

986 

  

$

911 

  

$

470 

  

$

403 

  

$

1,456 

  

$

1,314 

Net interest revenue

 

1,241 

  

 

1,034 

  

 

329 

  

 

166 

  

 

1,570 

  

 

1,200 

Trading revenue

 

272 

  

 

280 

  

 

161 

  

 

150 

  

 

433 

  

 

430 

Other

 

97 

  

 

101 

  

 

36 

  

 

41 

  

 

133 

  

 

142 

Provision for loan losses

 

 -

 

 

 

 

 -

 

 

 -

 

 

 -

 

 

Total net revenues

 

2,596 

  

 

2,332 

  

 

996 

  

 

760 

  

 

3,592 

  

 

3,092 

Expenses Excluding Interest

 

1,671 

  

 

1,546 

  

 

546 

  

 

495 

  

 

2,217 

  

 

2,041 

Income before taxes on income

$

925 

  

$

786 

  

$

450 

  

$

265 

  

$

1,375 

  

$

1,051 



(1)

The Corporate Brokerage Retirement Services business was transferred from the Investor Services segment to the Advisor Services segment in the fourth quarter of 2015. Prior period information has been recast to reflect these changes.















 

-  55  -


 

THE CHARLES SCHWAB CORPORATION

 

 

 

Item 4.Controls and Procedures



Evaluation of disclosure controls and procedures: The management of the Company, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934) as of June 30, 2016. Based on this evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures were effective as of June 30, 2016.



Changes in internal control over financial reporting: No change in the Company’s internal control over financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934) was identified during the quarter ended June 30, 2016, that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.





-  56  -


 

THE CHARLES SCHWAB CORPORATION

 

 

 

PART  II  -  OTHER  INFORMATION





Item 1.Legal Proceedings



For a discussion of legal proceedings, see “Part I – Financial Information – Item 1 – Notes to Condensed Consolidated Financial Statements (Unaudited) –  8. Commitments and Contingencies.”





Item 1A.Risk Factors



During the first half of 2016, there have been no material changes to the risk factors in “Part I – Item 1A – Risk Factors” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015.





Item 2.Unregistered Sales of Equity Securities and Use of Proceeds



Issuer Purchases of Equity Securities



At June 30, 2016, approximately $596 million of future share repurchases are authorized under the Share Repurchase Program. There were no share repurchases during the second quarter of 2016. There were two authorizations under this program by CSC’s Board of Directors, each covering up to $500 million of common stock that were publicly announced by the Company on April 25, 2007, and March 13, 2008. The remaining authorizations do not have an expiration date.



The following table summarizes purchases made by or on behalf of CSC of its common stock for each calendar month in the second quarter of 2016:





 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 



 

Total Number of

 

Average

 



 

Shares Purchased

 

Price Paid

 

Month

 

(in thousands)

 

per Share

 

April:

 

 

 

 

 

 

 

 

Employee transactions (1)

 

 

 

  

$

28.62 

  

May:

 

 

 

 

 

 

 

 

Employee transactions (1)

 

 

 

  

$

28.32 

  

June:

 

 

 

 

 

 

 

 

Employee transactions (1)

 

 

 

  

$

30.06 

  

Total:

 

 

 

 

 

 

 

 

Employee transactions (1)

 

 

21 

 

  

$

28.85 

 





 

(1)

Includes restricted shares withheld (under the terms of grants under employee stock incentive plans) to offset tax withholding obligations that occur upon vesting and release of restricted shares. The Company may receive shares delivered or attested to pay the exercise price and/or to satisfy tax withholding obligations by employees who exercise stock options granted under employee stock incentive plans, which are commonly referred to as stock swap exercises.







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THE CHARLES SCHWAB CORPORATION

 

 

 

Item 3.Defaults Upon Senior Securities



None.





Item 4.Mine Safety Disclosures



Not applicable.





Item 5.Other Information



None.





-  58  -


 

THE CHARLES SCHWAB CORPORATION

 

 

 

Item 6.Exhibits



The following exhibits are filed as part of this Quarterly Report on Form 10-Q:





 

 

Exhibit
Number


Exhibit

 



 

 



 

 

10.338

The Charles Schwab Corporation 2004 Stock Incentive Plan.

(1)



 

 

10.368

Credit Agreement (364 – Day Commitment) dated as of June 3, 2016, between the Registrant and financial institutions therein (supersedes Exhibit 10.366).

 



 

 

12.1

Computations of Ratio of Earnings to Fixed Charges and Ratio of Earnings to Fixed Charges and Preferred Stock Dividends.

 



 

 

31.1

Certification Pursuant to Rule 13a-14(a)/15d-14(a), As Adopted Pursuant to Section 302 of The Sarbanes-Oxley Act of 2002.

 



 

 

31.2

Certification Pursuant to Rule 13a-14(a)/15d-14(a), As Adopted Pursuant to Section 302 of The Sarbanes-Oxley Act of 2002.

 



 

 

32.1

Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of The Sarbanes-Oxley Act of 2002.

(2)



 

 

32.2

Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of The Sarbanes-Oxley Act of 2002.

(2)



 

 

101.INS

XBRL Instance Document

(3)



 

 

101.SCH

XBRL Taxonomy Extension Schema

(3)



 

 

101.CAL

XBRL Taxonomy Extension Calculation

(3)



 

 

101.DEF

XBRL Extension Definition

(3)



 

 

101.LAB

XBRL Taxonomy Extension Label

(3)



 

 

101.PRE

XBRL Taxonomy Extension Presentation

(3)



 

 

(1)

Management contract or compensatory plan.

 



 

 

(2)

Furnished as an exhibit to this Quarterly Report on Form 10-Q.

 



 

(3)

Attached as Exhibit 101 to this Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2016 are the following materials formatted in XBRL (Extensible Business Reporting Language) (i) the Condensed Consolidated Statements of Income, (ii) the Condensed Consolidated Statements of Comprehensive Income, (iii) the Condensed Consolidated Balance Sheets, (iv) the Condensed Consolidated Statements of Cash Flows, and (v) Notes to Condensed Consolidated Financial Statements.

 



 



-  59  -


 

THE CHARLES SCHWAB CORPORATION

 

 

 

SIGNATURE







Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.



 

 

THE CHARLES SCHWAB CORPORATION



 

 

(Registrant)



 

 

 



 

 

 



 

 

 



 

 

 

Date:

August 5, 2016

 

/s/ Joseph R. Martinetto



 

 

Joseph R. Martinetto



 

 

Senior Executive Vice President and



 

 

Chief Financial Officer







-  60  -