Edgar Filing: SCHWAB CHARLES CORP

0788285acd984bb

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, 2013

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 T 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 T 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 T

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 T

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

1,284,909,433 shares of $.01 par value Common Stock
Outstanding on July 24, 2013

THE CHARLES SCHWAB CORPORATION

Quarterly Report on Form 10-Q

For the Quarter Ended June 30, 2013

Index


			Page
Part I - Financial Information

	Item 1.	Condensed Consolidated Financial Statements (Unaudited):

		Statements of Income	1
		Statements of Comprehensive (Loss) Income	2
		Balance Sheets	3
		Statements of Cash Flows	4
		Notes	5 – 22

	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	23 – 44

	Item 3.	Quantitative and Qualitative Disclosures About Market Risk	45 – 46

	Item 4.	Controls and Procedures	46

Part II - Other Information

	Item 1.	Legal Proceedings	47

	Item 1A.	Risk Factors	47

	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	47

	Item 3.	Defaults Upon Senior Securities	48

	Item 4.	Mine Safety Disclosures	48

	Item 5.	Other Information	48

	Item 6.	Exhibits	49

Signature			50

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,
	2013		2012		2013		2012
Net Revenues
Asset management and administration fees	$	572	$	496	$	1,124	$	980
Interest revenue		499		497		996		969
Interest expense		(26)		(39)		(54)		(77)
Net interest revenue		473		458		942		892
Trading revenue		235		219		458		462
Other		59		121		115		167
Provision for loan losses		1		(4)		(5)		(4)
Net impairment losses on securities⁽¹⁾		(3)		(7)		(7)		(25)
Total net revenues		1,337		1,283		2,627		2,472
Expenses Excluding Interest
Compensation and benefits		494		446		1,030		911
Professional services		106		93		205		189
Occupancy and equipment		77		80		154		156
Advertising and market development		67		57		141		124
Communications		56		55		110		113
Depreciation and amortization		51		48		102		96
Other		74		72		142		138
Total expenses excluding interest		925		851		1,884		1,727
Income before taxes on income		412		432		743		745
Taxes on income		156		157		281		275
Net Income		256		275		462		470
Preferred stock dividends		23		14		31		14
Net Income Available to Common Stockholders	$	233	$	261	$	431	$	456
Weighted-Average Common Shares Outstanding — Diluted		1,288		1,274		1,285		1,273
Earnings Per Common Share — Basic	$	.18	$	.20	$	.33	$	.36
Earnings Per Common Share — Diluted	$	.18	$	.20	$	.33	$	.36

⁽¹⁾

Net impairment losses on securities include total other-than-temporary impairment losses of $2 million and $12 million, net of $(1) million and $5 million reclassified from or recognized in other comprehensive income, for the three months ended June 30, 2013 and 2012, respectively. Net impairment losses on securities include total other-than-temporary impairment losses of $2 million and $14 million, net of $(5) million and $(11) million reclassified from other comprehensive income, for the six months ended June 30, 2013 and 2012, respectively.

See Notes to Condensed Consolidated Financial Statements.

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THE CHARLES SCHWAB CORPORATION

Condensed Consolidated Statements of Comprehensive (Loss) Income

(In millions)

(Unaudited)



	Three Months Ended				Six Months Ended
	June 30,				June 30,
	2013		2012		2013		2012
Net Income	$	256	$	275	$	462	$	470
Other comprehensive (loss) income, before tax:
Change in net unrealized gain on securities available for sale:
Net unrealized (loss) gain		(477)		119		(480)		208
Reclassification of impairment charges included in net
impairment losses on securities		3		7		7		25
Other reclassifications included in other revenue		(3)		(1)		(3)		(1)
Other		-		-		1		-
Other comprehensive (loss) income, before tax		(477)		125		(475)		232
Income tax effect		180		(47)		180		(86)
Other comprehensive (loss) income, net of tax		(297)		78		(295)		146
Comprehensive (Loss) Income	$	(41)	$	353	$	167	$	616

See Notes to Condensed Consolidated Financial Statements.

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THE CHARLES SCHWAB CORPORATION

Condensed Consolidated Balance Sheets

(In millions, except per share and share amounts)

(Unaudited)


	June 30,		December 31,
	2013		2012
Assets
Cash and cash equivalents	$	6,234	$	12,663
Cash and investments segregated and on deposit for regulatory purposes
(including resale agreements of $18,214 at June 30, 2013 and $19,325
at December 31, 2012)		27,011		28,469
Receivables from brokers, dealers, and clearing organizations		395		333
Receivables from brokerage clients — net		12,825		13,458
Other securities owned — at fair value		488		636
Securities available for sale		48,414		46,123
Securities held to maturity (fair value — $25,288 at June 30, 2013 and
$18,732 at December 31, 2012)		25,818		18,194
Loans to banking clients — net		11,732		10,726
Equipment, office facilities, and property — net		711		675
Goodwill		1,231		1,228
Intangible assets — net		290		319
Other assets		758		813
Total assets	$	135,907	$	133,637
Liabilities and Stockholders’ Equity
Deposits from banking clients	$	84,345	$	79,377
Payables to brokers, dealers, and clearing organizations		2,150		1,068
Payables to brokerage clients		36,852		40,330
Accrued expenses and other liabilities		1,210		1,641
Long-term debt		1,630		1,632
Total liabilities		126,187		124,048
Stockholders’ equity:
Preferred stock — $.01 par value per share; aggregated liquidation
preference of $885 at both June 30, 2013 and December 31, 2012		867		865
Common stock — 3 billion shares authorized; $.01 par value per share;
1,487,543,446 shares issued		15		15
Additional paid-in capital		3,932		3,881
Retained earnings		8,830		8,554
Treasury stock, at cost — 203,545,769 shares at June 30, 2013 and
210,014,305 shares at December 31, 2012		(3,927)		(4,024)
Accumulated other comprehensive income		3		298
Total stockholders’ equity		9,720		9,589
Total liabilities and stockholders’ equity	$	135,907	$	133,637

See Notes to Condensed Consolidated Financial Statements.

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THE CHARLES SCHWAB CORPORATION

Condensed Consolidated Statement of Cash Flows

(In millions)

(Unaudited)


	Six Months Ended
	June 30,
	2013		2012
Cash Flows from Operating Activities
Net income	$	462	$	470
Adjustments to reconcile net income to net cash provided by (used for) operating activities:
Provision for loan losses		5		4
Net impairment losses on securities		7		25
Stock-based compensation		59		54
Depreciation and amortization		102		96
Premium amortization, net, on securities available for sale and securities held to maturity		92		98
Other		20		1
Originations of loans held for sale		-		(435)
Proceeds from sales of loans held for sale		-		505
Net change in:
Cash and investments segregated and on deposit for regulatory purposes		1,458		3,311
Receivables from brokers, dealers, and clearing organizations		(62)		(86)
Receivables from brokerage clients		631		(885)
Other securities owned		148		168
Other assets		16		49
Payables to brokers, dealers, and clearing organizations		662		212
Payables to brokerage clients		(3,478)		(3,656)
Accrued expenses and other liabilities		42		(163)
Net cash provided by (used for) operating activities		164		(232)
Cash Flows from Investing Activities
Purchases of securities available for sale		(12,587)		(14,114)
Proceeds from sales of securities available for sale		3,004		1,323
Principal payments on securities available for sale		7,017		6,904
Purchases of securities held to maturity		(9,914)		(3,029)
Principal payments on securities held to maturity		2,413		2,566
Net increase in loans to banking clients		(976)		(62)
Purchase of equipment, office facilities, and property		(111)		(76)
Other investing activities		2		-
Net cash used for investing activities		(11,152)		(6,488)
Cash Flows from Financing Activities
Net change in deposits from banking clients		4,968		5,403
Repayment of commercial paper		(300)		-
Repayment of long-term debt		(3)		(3)
Net proceeds from preferred stock offerings		-		864
Dividends paid		(184)		(154)
Proceeds from stock options exercised and other		81		20
Other financing activities		(3)		-
Net cash provided by financing activities		4,559		6,130
Decrease in Cash and Cash Equivalents		(6,429)		(590)
Cash and Cash Equivalents at Beginning of Period		12,663		8,679
Cash and Cash Equivalents at End of Period	$	6,234	$	8,089
Supplemental Cash Flow Information
Cash paid during the period for:
Interest	$	51	$	74
Income taxes	$	277	$	221
Non-cash investing activities:
Securities purchased during the period but settled after period end	$	420	$	22

See Notes to Condensed Consolidated Financial Statements.

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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

The Charles Schwab Corporation (CSC) is a savings and loan holding company engaged, through its subsidiaries, in securities brokerage, banking, money management, and financial advisory services. Charles Schwab & Co., Inc. (Schwab) is a securities broker-dealer with over 300 domestic branch offices in 45 states, as well as a branch in each of the Commonwealth of Puerto Rico and London, U.K. 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, 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 United States (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 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. Certain prior period amounts have been reclassified to conform to the 2013 presentation. 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, 2012, as updated by the Company’s Current Report on Form 8-K filed on June 24, 2013, relating to the realignment of the Company’s reportable segments.

The Company’s significant accounting policies are included in note “2 – Summary of Significant Accounting Policies” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012, as updated by its Current Report on Form 8-K filed on June 24, 2013. There have been no significant changes to these accounting policies during the first half of 2013.

2. 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, 2013	Cost		Gains		Losses		Value
Securities available for sale:
U.S. agency mortgage-backed securities	$	18,422	$	202	$	16	$	18,608
Asset-backed securities		11,895		21		77		11,839
Corporate debt securities		8,306		39		26		8,319
Certificates of deposit		4,915		7		1		4,921
U.S. agency notes		3,740		-		105		3,635
Non-agency residential mortgage-backed securities		700		5		54		651
Commercial paper		160		-		-		160
Other securities		272		9		-		281
Total securities available for sale	$	48,410	$	283	$	279	$	48,414
Securities held to maturity:
U.S. agency mortgage-backed securities	$	24,887	$	184	$	643	$	24,428
Other securities		931		-		71		860
Total securities held to maturity	$	25,818	$	184	$	714	$	25,288

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THE CHARLES SCHWAB CORPORATION

Notes to Condensed Consolidated Financial Statements

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

(Unaudited)


			Gross		Gross
	Amortized		Unrealized		Unrealized		Fair
December 31, 2012	Cost		Gains		Losses		Value
Securities available for sale:
U.S. agency mortgage-backed securities	$	20,080	$	396	$	-	$	20,476
Asset-backed securities		8,104		62		2		8,164
Corporate debt securities		6,197		61		2		6,256
Certificates of deposit		6,150		12		1		6,161
U.S. agency notes		3,465		2		3		3,464
Non-agency residential mortgage-backed securities		796		2		65		733
Commercial paper		574		-		-		574
Other securities		278		17		-		295
Total securities available for sale	$	45,644	$	552	$	73	$	46,123
Securities held to maturity:
U.S. agency mortgage-backed securities	$	17,750	$	558	$	19	$	18,289
Other securities		444		-		1		443
Total securities held to maturity	$	18,194	$	558	$	20	$	18,732

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, 2013	Value		Losses		Value		Losses		Value		Losses
Securities available for sale:
U.S agency mortgage-backed securities	$	2,416	$	16	$	-	$	-	$	2,416	$	16
Asset-backed securities		8,704		70		481		7		9,185		77
Corporate debt securities		2,555		25		250		1		2,805		26
Certificates of deposit		774		1		-		-		774		1
U.S. agency notes		3,635		105		-		-		3,635		105
Non-agency residential mortgage-backed
securities		181		5		401		49		582		54
Total	$	18,265	$	222	$	1,132	$	57	$	19,397	$	279
Securities held to maturity:
U.S. agency mortgage-backed securities	$	16,315	$	643	$	-	$	-	$	16,315	$	643
Other securities		760		71		-		-		760		71
Total	$	17,075	$	714	$	-	$	-	$	17,075	$	714
Total securities with unrealized losses ⁽¹⁾	$	35,340	$	936	$	1,132	$	57	$	36,472	$	993

⁽¹⁾	The number of investment positions with unrealized losses totaled 238 for securities available for sale and 135 for securities held to maturity.

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THE CHARLES SCHWAB CORPORATION

Notes to Condensed Consolidated Financial Statements

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

(Unaudited)


	Less than				12 months
	12 months				or longer				Total
	Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
December 31, 2012	Value		Losses		Value		Losses		Value		Losses
Securities available for sale:
Asset-backed securities	$	-	$	-	$	801	$	2	$	801	$	2
Corporate debt securities		878		2		-		-		878		2
Certificates of deposit		599		1		-		-		599		1
U.S. agency notes		2,102		3		-		-		2,102		3
Non-agency residential mortgage-backed
securities		46		1		549		64		595		65
Total	$	3,625	$	7	$	1,350	$	66	$	4,975	$	73
Securities held to maturity:
U.S. agency mortgage-backed
securities	$	2,680	$	19	$	-	$	-	$	2,680	$	19
Other securities		240		1		-		-		240		1
Total	$	2,920	$	20	$	-	$	-	$	2,920	$	20
Total securities with unrealized losses ⁽¹⁾	$	6,545	$	27	$	1,350	$	66	$	7,895	$	93

⁽¹⁾	The number of investment positions with unrealized losses totaled 139 for securities available for sale and 24 for securities held to maturity.

Non-agency residential mortgage-backed securities include securities collateralized by loans that are considered to be “Prime” (defined as loans to borrowers with a Fair Isaac Corporation (FICO) credit score of 620 or higher at origination), and “Alt-A” (defined as Prime loans with reduced documentation at origination). Based on the Company’s cash flow projections, management determined that it does not expect to recover all of the amortized cost of certain of its Alt-A and Prime residential mortgage-backed securities and therefore determined that these securities were other-than-temporarily impaired (OTTI). Because the Company does not intend to sell these securities and it is not “more likely than not” that the Company will be required to sell these securities, the Company recognized an impairment charge equal to the securities’ expected credit losses of $3 million and $7 million during the second quarter and first half of 2013, respectively. The expected credit losses were measured as the difference between the present value of expected cash flows and the amortized cost of the securities. Further deterioration in the performance of the underlying loans in the Company’s non-agency residential mortgage-backed securities portfolio could result in the recognition of additional impairment losses.

The following table is a rollforward of the amount of credit losses recognized in earnings for OTTI securities held by the Company during the period for which a portion of the impairment was recognized in or reclassified from other comprehensive (loss) income:


	Three Months Ended				Six Months Ended
	June 30,				June 30,
	2013		2012		2013		2012
Balance at beginning of period	$	163	$	145	$	159	$	127
Credit losses recognized into current period earnings on debt securities for
which an other-than-temporary impairment was not previously recognized		1		4		1		5
Credit losses recognized into current period earnings on debt securities for
which an other-than-temporary impairment was previously recognized		2		3		6		20
Balance at end of period	$	166	$	152	$	166	$	152

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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 at June 30, 2013, are as follows:


			After 1 year		After 5 years
	Within		through		through		After
	1 year		5 years		10 years		10 years		Total
Securities available for sale:
U.S. agency mortgage-backed securities ⁽¹⁾	$	-	$	122	$	3,974	$	14,512	$	18,608
Asset-backed securities		-		856		1,060		9,923		11,839
Corporate debt securities		2,234		6,085		-		-		8,319
Certificates of deposit		3,028		1,893		-		-		4,921
U.S. agency notes		-		1,781		1,854		-		3,635
Non-agency residential mortgage-backed
securities ⁽¹⁾		-		2		3		646		651
Commercial paper		160		-		-		-		160
Other securities		-		-		-		281		281
Total fair value	$	5,422	$	10,739	$	6,891	$	25,362	$