Edgar Filing: SCHWAB CHARLES CORP

6f39dca81d724ab

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 March 31, 2014

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.

1,301,140,339 shares of $.01 par value Common Stock

Outstanding on April 24, 2014

THE CHARLES SCHWAB CORPORATION

Quarterly Report on Form 10-Q

For the Quarter Ended March 31, 2014

Index


			Page
Part I - Financial Information

	Item 1.	Condensed Consolidated Financial Statements (Unaudited):

		Statements of Income	1
		Statements of Comprehensive 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 – 41

	Item 3.	Quantitative and Qualitative Disclosures About Market Risk	42 – 43

	Item 4.	Controls and Procedures	43

Part II - Other Information

	Item 1.	Legal Proceedings	44

	Item 1A.	Risk Factors	44

	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	44

	Item 3.	Defaults Upon Senior Securities	45

	Item 4.	Mine Safety Disclosures	45

	Item 5.	Other Information	45

	Item 6.	Exhibits	45

Signature			46

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
	March 31,
	2014		2013
Net Revenues
Asset management and administration fees	$	611	$	552
Interest revenue		579		497
Interest expense		(26)		(28)
Net interest revenue		553		469
Trading revenue		247		223
Other		68		56
Provision for loan losses		(1)		(6)
Net impairment losses on securities (1)		-		(4)
Total net revenues		1,478		1,290
Expenses Excluding Interest
Compensation and benefits		528		536
Professional services		106		99
Occupancy and equipment		80		77
Advertising and market development		63		74
Communications		56		54
Depreciation and amortization		48		51
Other		75		68
Total expenses excluding interest		956		959
Income before taxes on income		522		331
Taxes on income		196		125
Net Income		326		206
Preferred stock dividends		8		8
Net Income Available to Common Stockholders	$	318	$	198
Weighted-Average Common Shares Outstanding — Diluted		1,311		1,282
Earnings Per Common Share — Basic	$	.24	$	.15
Earnings Per Common Share — Diluted	$	.24	$	.15


(1)	There were no net impairment losses on securities for the three months ended March 31, 2014. Net impairment losses on securities include total other-than-temporary impairment losses of $0 million recognized in other comprehensive income, net of $(4) million reclassified from other comprehensive income, for the three months ended March 31, 2013.

See Notes to Condensed Consolidated Financial Statements.

THE CHARLES SCHWAB CORPORATION

Condensed Consolidated Statements of Comprehensive Income

(In Millions)

(Unaudited)


	Three Months Ended
	March 31,
	2014		2013
Net Income	$	326	$	206
Other comprehensive income, before tax:
Change in net unrealized gain on securities available for sale:
Net unrealized gain (loss)		159		(3)
Reclassification of impairment charges included in net
impairment losses on securities		-		4
Other reclassifications included in other revenue		(1)		-
Other		-		1
Other comprehensive income, before tax		158		2
Income tax effect		(59)		-
Other comprehensive income, net of tax		99		2
Comprehensive Income	$	425	$	208

See Notes to Condensed Consolidated Financial Statements.

THE CHARLES SCHWAB CORPORATION

Condensed Consolidated Balance Sheets

(In Millions, Except Per Share and Share Amounts)

(Unaudited)


	March 31,		December 31,
	2014		2013
Assets
Cash and cash equivalents	$	7,173	$	7,728
Cash and investments segregated and on deposit for regulatory purposes
(including resale agreements of $11,776 at March 31, 2014 and $14,016
at December 31, 2013)		20,548		23,553
Receivables from brokers, dealers, and clearing organizations		482		509
Receivables from brokerage clients — net		14,571		13,951
Other securities owned — at fair value		456		517
Securities available for sale		53,080		51,618
Securities held to maturity (fair value — $31,669 at March 31, 2014 and
$29,490 at December 31, 2013)		32,123		30,318
Loans to banking clients — net		12,591		12,419
Equipment, office facilities, and property — net		820		790
Goodwill		1,227		1,227
Intangible assets — net		255		266
Other assets		740		746
Total assets	$	144,066	$	143,642
Liabilities and Stockholders’ Equity
Deposits from banking clients	$	95,591	$	92,972
Payables to brokers, dealers, and clearing organizations		1,918		1,467
Payables to brokerage clients		32,308		35,333
Accrued expenses and other liabilities		1,532		1,586
Long-term debt		1,902		1,903
Total liabilities		133,251		133,261
Stockholders’ equity:
Preferred stock — $.01 par value per share; aggregate liquidation
preference of $885		870		869
Common stock — 3 billion shares authorized; $.01 par value per share;
1,487,543,446 shares issued		15		15
Additional paid-in capital		3,982		3,951
Retained earnings		9,492		9,253
Treasury stock, at cost — 186,648,711 shares at March 31, 2014 and
190,657,263 shares at December 31, 2013		(3,652)		(3,716)
Accumulated other comprehensive income		108		9
Total stockholders’ equity		10,815		10,381
Total liabilities and stockholders’ equity	$	144,066	$	143,642

See Notes to Condensed Consolidated Financial Statements.

THE CHARLES SCHWAB CORPORATION

Condensed Consolidated Statements of Cash Flows

(In Millions)

(Unaudited)


	Three Months Ended
	March 31,
	2014		2013
Cash Flows from Operating Activities
Net income	$	326	$	206
Adjustments to reconcile net income to net cash provided by (used for) operating activities:
Provision for loan losses		1		6
Net impairment losses on securities		-		4
Stock-based compensation		29		37
Depreciation and amortization		48		51
Premium amortization, net, on securities available for sale and securities held to maturity		27		44
Other		2		7
Net change in:
Cash and investments segregated and on deposit for regulatory purposes		3,005		1,572
Receivables from brokers, dealers, and clearing organizations		29		(134)
Receivables from brokerage clients		(622)		1,003
Other securities owned		61		91
Other assets		(24)		(29)
Payables to brokers, dealers, and clearing organizations		293		84
Payables to brokerage clients		(3,025)		(3,442)
Accrued expenses and other liabilities		(81)		132
Net cash provided by (used for) operating activities		69		(368)
Cash Flows from Investing Activities
Purchases of securities available for sale		(4,250)		(6,703)
Proceeds from sales of securities available for sale		1,285		-
Principal payments on securities available for sale		1,738		3,997
Purchases of securities held to maturity		(2,271)		(6,031)
Principal payments on securities held to maturity		520		1,279
Net increase in loans to banking clients		(171)		(530)
Purchase of equipment, office facilities, and property		(53)		(49)
Other investing activities		(8)		2
Net cash used for investing activities		(3,210)		(8,035)
Cash Flows from Financing Activities
Net change in deposits from banking clients		2,619		3,047
Repayment of commercial paper		-		(300)
Repayment of long-term debt		(2)		(2)
Dividends paid		(100)		(98)
Proceeds from stock options exercised and other		65		25
Other financing activities		4		(1)
Net cash provided by financing activities		2,586		2,671
Decrease in Cash and Cash Equivalents		(555)		(5,732)
Cash and Cash Equivalents at Beginning of Period		7,728		12,663
Cash and Cash Equivalents at End of Period	$	7,173	$	6,931
Supplemental Cash Flow Information
Cash paid during the period for:
Interest	$	40	$	40
Income taxes	$	51	$	35
Non-cash investing activity:
Securities purchased during the period but settled after period end	$	158	$	-

See Notes to Condensed Consolidated Financial Statements.

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, 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, 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. 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, 2013.

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, 2013. There have been no significant changes to these accounting policies during the first quarter of 2014.

2.New Accounting Standard

New Accounting Standard Not Yet Adopted

In January 2014, the Financial Accounting Standards Board issued new guidance for creditors of consumer mortgage loans, which is effective January 1, 2015. The guidance clarifies when physical possession of a property underlying a consumer mortgage loan transfers to the creditor, and therefore when a loan receivable should be derecognized and the real estate property underlying the loan should be recognized. The adoption of this new guidance is not expected to have a material impact on the Company’s financial position, results of operations, earnings per common share (EPS), or cash flows.

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
March 31, 2014	Cost		Gains		Losses		Value
Securities available for sale:
U.S. agency mortgage-backed securities	$	18,404	$	168	$	38	$	18,534
Asset-backed securities		16,642		91		8		16,725
Corporate debt securities		9,043		53		9		9,087
U.S. agency notes		4,490		1		81		4,410
Certificates of deposit		3,424		4		2		3,426
Non-agency residential mortgage-backed securities		593		13		28		578
Non-agency commercial mortgage-backed securities		312		8		-		320
Total securities available for sale	$	52,908	$	338	$	166	$	53,080
Securities held to maturity:
U.S. agency mortgage-backed securities	$	31,066	$	219	$	627	$	30,658
Non-agency commercial mortgage-backed securities		957		1		47		911
Other securities		100		-		-		100
Total securities held to maturity	$	32,123	$	220	$	674	$	31,669


			Gross		Gross
	Amortized		Unrealized		Unrealized		Fair
December 31, 2013	Cost		Gains		Losses		Value
Securities available for sale:
U.S. agency mortgage-backed securities	$	18,554	$	140	$	49	$	18,645
Asset-backed securities		15,201		42		37		15,206
Corporate debt securities		8,973		49		15		9,007
U.S. agency notes		4,239		1		104		4,136
Certificates of deposit		3,650		4		2		3,652
Non-agency residential mortgage-backed securities		616		11		34		593
Non-agency commercial mortgage-backed securities		271		8		-		279
Other securities		100		-		-		100
Total securities available for sale	$	51,604	$	255	$	241	$	51,618
Securities held to maturity:
U.S. agency mortgage-backed securities	$	29,260	$	161	$	921	$	28,500
Non-agency commercial mortgage-backed securities		958		-		68		890
Other securities		100		-		-		100
Total securities held to maturity	$	30,318	$	161	$	989	$	29,490

Schwab Bank pledges securities issued by federal agencies to secure certain trust deposits. The fair value of these pledged securities was $131 million at March 31, 2014.

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
March 31, 2014	Value		Losses		Value		Losses		Value		Losses
Securities available for sale:
U.S agency mortgage-backed securities	$	6,119	$	37	$	176	$	1	$	6,295	$	38
Asset-backed securities		1,887		5		769		3		2,656		8
Corporate debt securities		1,180		8		400		1		1,580		9
U.S. agency notes		3,909		81		-		-		3,909		81
Certificates of deposit		1,050		-		98		2		1,148		2
Non-agency residential mortgage-backed
securities		59		1		352		27		411		28
Total	$	14,204	$	132	$	1,795	$	34	$	15,999	$	166
Securities held to maturity:
U.S. agency mortgage-backed securities	$	15,147	$	438	$	2,591	$	189	$	17,738	$	627
Non-agency commercial mortgage-backed
securities		444		23		338		24		782		47
Total	$	15,591	$	461	$	2,929	$	213	$	18,520	$	674
Total securities with unrealized losses (1)	$	29,795	$	593	$	4,724	$	247	$	34,519	$	840

(1)	The number of investment positions with unrealized losses totaled 264 for securities available for sale and 154 for securities held to maturity.


	Less than				12 months
	12 months				or longer				Total
	Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
December 31, 2013	Value		Losses		Value		Losses		Value		Losses
Securities available for sale:
U.S. agency mortgage-backed securities	$	5,044	$	47	$	93	$	2	$	5,137	$	49
Asset-backed securities		6,391		33		591		4		6,982		37
Corporate debt securities		1,802		14		499		1		2,301		15
U.S. agency notes		3,636		104		-		-		3,636		104
Certificates of deposit		-		-		299		2		299		2
Non-agency residential mortgage-backed
securities		89		2		374		32		463		34
Total	$	16,962	$	200	$	1,856	$	41	$	18,818	$	241
Securities held to maturity:
U.S. agency mortgage-backed securities	$	19,175	$	698	$	2,345	$	223	$	21,520	$	921
Non-agency commercial mortgage-backed
securities		630		43		260		25		890		68
Total	$	19,805	$	741	$	2,605	$	248	$	22,410	$	989
Total securities with unrealized losses (1)	$	36,767	$	941	$	4,461	$	289	$	41,228	$	1,230

(1)	The number of investment positions with unrealized losses totaled 273 for securities available for sale and 193 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). 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). The Company does not intend to sell these

THE CHARLES SCHWAB CORPORATION

Notes to Condensed Consolidated Financial Statements

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

(Unaudited)

securities and it is not “more likely than not” that the Company will be required to sell these securities before anticipated recovery of the unrealized losses on these securities. The Company may recognize an impairment charge equal to the securities’ expected credit losses based on the Company’s cash flow projections for these securities. The expected credit losses are measured as the difference between the present value of expected cash flows and the amortized cost of the securities. There were no impairment charges recognized during the first quarter of 2014. 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 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 income:


	Three Months Ended
	March 31,
	2014		2013
Balance at beginning of period	$	169	$	159
Credit losses recognized into current period earnings on debt securities for
which an other-than-temporary impairment was not previously recognized		-		-
Credit losses recognized into current period earnings on debt securities for
which an other-than-temporary impairment was previously recognized		-		4
Balance at end of period	$	169	$	163

The maturities of securities available for sale and securities held to maturity at March 31, 2014, 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)	$	-	$	1,005	$	4,015	$	13,514	$	18,534
Asset-backed securities		-		1,513		4,109		11,103		16,725
Corporate debt securities		1,065		8,022		-		-		9,087
U.S. agency notes		-		4,410		-		-		4,410
Certificates of deposit		1,502		1,924		-		-		3,426
Non-agency residential mortgage-backed
securities (1)		-		3		-		575		578
Non-agency commercial mortgage-backed
securities (1)		-		-		-		320		320
Total fair value	$	2,567	$	16,877	$	8,124	$	25,512	$	53,080
Total amortized cost	$	2,560	$	16,907	$	8,047	$	25,394	$	52,908
Securities held to maturity:
U.S. agency mortgage-backed securities (1)	$	-	$	609	$	13,036	$	17,013	$	30,658
Non-agency commercial mortgage-backed
securities (1)		-		-		344		567		911
Other securities		100		-		-		-		100
Total fair value	$	100	$	609	$	13,380	$	17,580	$	31,669
Total amortized cost	$	100	$	601	$	13,717	$	17,705	$	32,123

(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.

THE CHARLES SCHWAB CORPORATION

Notes to Condensed Consolidated Financial Statements

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

(Unaudited)

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


	Three Months Ended
	March 31,
	2014		2013
Proceeds	$	1,285	$	-
Gross realized gains	$	1	$	-

4.Loans to Banking Clients and Related Allowance for Loan Losses

The composition of loans to banking clients by loan segment is as follows:


	March 31,		December 31,
	2014		2013
Residential real estate mortgages	$	8,050	$	8,006
Home equity lines of credit		3,018		3,041
Personal loans secured by securities		1,536		1,384
Other		35		36
Total loans to banking clients (1)		12,639		12,467
Allowance for loan losses		(48)		(48)
Total loans to banking clients – net	$	12,591	$	12,419

(1)	All loans are evaluated for impairment by loan segment.

The Company has commitments to extend credit related to unused home equity lines of credit (HELOCs), personal loans secured by securities, and other lines of credit, which totaled $5.9 billion and $5.7 billion at March 31, 2014 and December 31, 2013, respectively. All of the personal loans were fully collateralized by securities with fair values in excess of borrowings at March 31, 2014 and December 31, 2013.

Changes in the allowance for loan losses were as follows: