CHARLES SCHWAB Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
INTRODUCTIONThe Charles Schwab Corporation (CSC) is a savings and loan holding company and engages, through its subsidiaries, in wealth management, securities brokerage, banking, asset management, custody, and financial advisory services.
Principal business subsidiaries of CSC include the following:
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•
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for Schwab's proprietary mutual funds (Schwab Funds®) and for Schwab's
exchange-traded funds (Schwab ETFs™).
Unless otherwise indicated, the terms "Schwab," "the Company," "we," "us," or "our" mean CSC together with its consolidated subsidiaries.
Schwab 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 to individual investors, and retirement plan services, as well as other corporate brokerage services, to businesses and their employees. The Advisor Services segment provides custodial, trading, banking, and support services, as well as retirement business services, to independent registered investment advisors (RIAs), independent retirement advisors, and recordkeepers. Schwab was founded on the belief that all Americans deserve access to a better investing experience. Although much has changed in the intervening years, our purpose remains clear - to champion every client's goals with passion and integrity. Guided by this purpose and our vision of creating the most trusted leader in investment services, management has adopted a strategy described as "Through Clients' Eyes." This strategy emphasizes placing clients' perspectives, needs, and desires at the forefront. Because investing plays a fundamental role in building financial security, we strive to deliver a better investing experience for our clients - individual investors and the people and institutions who serve them - by disrupting longstanding industry practices on their behalf and providing superior service. We also aim to offer a broad range of products and solutions to meet client needs with a focus on transparency, value, and trust. In addition, management works to couple Schwab's scale and resources with ongoing expense discipline to keep costs low and ensure that products and solutions are affordable as well as responsive to client needs. In combination, these are the key elements of our "no trade-offs" approach to serving investors. We believe that following this strategy is the best way to maximize our market valuation and stockholder returns over time. Management estimates that investable wealth inthe United States (U.S. ) (consisting of assets in defined contribution, retail wealth management and brokerage, and registered investment advisor channels, along with bank deposits) currently exceeds$45 trillion , which means the Company's$3.50 trillion in client assets leaves substantial opportunity for growth. Our strategy is based on the principle that developing trusted relationships will translate into more assets from both new and existing clients, ultimately driving more revenue, and along with expense discipline and thoughtful capital management, will generate earnings growth and build long-term stockholder value. This Management's Discussion and Analysis should be read in conjunction with our Annual Report on Form 10-K for the fiscal year endedDecember 31, 2019 (2019 Form 10-K). On our website, https://www.aboutschwab.com, we post the following filings after they are electronically filed with or furnished to theSecurities and Exchange Commission (SEC): annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934. In addition, the website also includes the Dodd-Frank stress test results, our regulatory capital disclosures based on Basel III, and our quarterly average liquidity coverage ratio (LCR). TheSEC maintains a website at https://www.sec.gov that contains reports, proxy statements, and other information that we file electronically with them. - 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) 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," "could," "would," "expand," "aim," "maintain," 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 estimates based on the best judgment of Schwab's senior management. These statements relate to, among other things: • Maximizing our market valuation and stockholder returns over time; our
belief that developing trusted relationships will translate into more
client assets which drives revenue and, along with expense discipline and
thoughtful capital management, generates earnings growth and builds
stockholder value (see Introduction in Part I, Item 2);
• Impacts related to the coronavirus (COVID-19) pandemic (see Overview);
• Focus on scale and efficiency and balancing near-term profitability with
continued reinvestment for long-term growth (see Overview);
• Balance sheet management and Tier 1 Leverage Ratio operating objective
(see Overview and Risk Management - Capital Management);
• Pending transactions involving TD Ameritrade,
Company (USAA-IMCO), and
Schroeder), including anticipated closing, status and acquisition-related
expenses; the funding for the USAA-IMCO transaction and entering into a
referral agreement (see Overview, Risk Management - Liquidity Risk,
Capital Management, and Commitments and Contingencies in Part I, Item 1,
Financial Information - Notes to Condensed Consolidated Financial
Statements (Item 1) - Note 9);
• Timing and ability to invest amounts currently held in excess reserves
into higher yielding investments (see Results of Operations);
• Net interest margin compression and net interest revenue (see Results of
Operations);
• 2020 capital expenditures (see Results of Operations);
• The phase-out of the use of LIBOR (see Risk Management);
• Sources of capital (see Risk Management - Capital Management);
• The expected impact of new accounting standards not yet adopted (see
Summary of Significant Accounting Policies in Item 1 - Note 2);
• The likelihood of indemnification and guarantee payment obligations (see
Commitments and Contingencies in Item 1 - Note 9); and
• The impact of legal proceedings and regulatory matters (see Commitments
and Contingencies in Item 1 - Note 9 and Legal Proceedings in Part II,
Item 1).
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:
• General market conditions, including the level of interest rates, equity
valuations, and trading activity;
• Our ability to attract and retain clients, develop trusted relationships,
and grow client assets;
• Client use of our advisory solutions and other products and services;
• The level of client assets, including cash balances;
• Competitive pressure on pricing, including deposit rates;
• Client sensitivity to interest rates;
• Regulatory guidance;
• Capital and liquidity needs and management;
• Our ability to manage expenses;
• Our ability to develop and launch new and enhanced products, services, and
capabilities, as well as enhance our infrastructure, in a timely and
successful manner;
• Our ability to monetize client assets;
• The scope and duration of the COVID-19 pandemic and actions taken by
governmental authorities to contain the spread of the virus and the
economic impact;
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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 ability of our platform to handle increased client volume;
• Failure of the parties to satisfy the closing conditions in the agreements
for the pending acquisitions of TD Ameritrade, USAA-IMCO and Wasmer
Schroeder in a timely manner or at all, including stockholder and
regulatory approvals, and the implementation of conversion or integration
plans;
• Disruptions to the parties' businesses as a result of the announcement and
pendency of the acquisitions;
• The risk that expected revenue, expense and other synergies and benefits
from the acquisitions may not be fully realized or may take longer to
realize than expected;
• Client cash allocations and cash sorting;
• LIBOR trends;
• Spreads on securities;
• Mix of excess reserves to AFS securities;
• The availability and terms of external financing;
• The timing of campus expansion work and technology projects;
• Adverse developments in litigation or regulatory matters and any related
charges; and
• Potential breaches of contractual terms for which we have indemnification
and guarantee obligations.
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 2019
Form 10-K.
- 3 -
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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)
OVERVIEWManagement focuses on several client activity and financial metrics in evaluating Schwab's financial position and operating performance. Results for the first quarter of 2020 and 2019 are:
Three Months Ended
March 31, Percent
2020 2019 Change
Client Metrics
Net new client assets (in billions) $ 73.2 $ 51.7 42 %
Core net new client assets (in billions) $ 73.2 $ 51.7 42 %
Client assets (in billions, at quarter end) $ 3,496.9 $ 3,585.4 (2 )%
Average client assets (in billions) $ 3,918.8 $ 3,465.7 13 %
New brokerage accounts (in thousands) 609 386 58 %
Active brokerage accounts (in thousands, at quarter end) 12,736 11,787 8 % Assets receiving ongoing advisory services (in billions, at quarter end)
$ 1,822.8 $ 1,871.2 (3 )% Client cash as a percentage of client assets (at quarter end) 15.1 % 11.3 % Company Financial Metrics Total net revenues$ 2,617 $ 2,723 (4 )% Total expenses excluding interest 1,570 1,459 8 % Income before taxes on income 1,047 1,264 (17 )% Taxes on income 252 300 (16 )% Net income 795 964 (18 )% Preferred stock dividends and other 38 39 (3 )% Net income available to common stockholders$ 757 $ 925 (18 )% Earnings per common share - diluted$ .58 $ .69 (16 )% Net revenue growth from prior year (4 )% 14 % Pre-tax profit margin 40.0 % 46.4 % Return on average common stockholders' equity (annualized) 14 %
20 % Expenses excluding interest as a percentage of average client assets (annualized)
0.16 % 0.17 %
Consolidated Tier 1 Leverage Ratio (at quarter end) 6.9 % 7.2 %
The first quarter of 2020 saw an unprecedented environment as the COVID-19 pandemic upended daily life both world-wide and here in theU.S. Throughout this challenging time, the Company operated without significant client disruption. Schwab's unwavering focus on continuing to earn our clients' trust is made possible by the significant contributions of our employees, and the Company remains committed to serving our clients while protecting our employees' wellbeing. In response to the pandemic, we have enabled approximately 95% of our employees to work remotely, and, in addition to other measures, we made a$1,000 payment to all non-officer employees to help them cover costs incurred due to the COVID-19 pandemic. Core net new assets during the first quarter totaled$73.2 billion , up 42% from the first quarter of 2019. Clients opened 609,000 new brokerage accounts, bringing total active brokerage accounts to 12.7 million at quarter end, up 8% fromMarch 2019 . The first quarter saw record trading activity, as daily average trades for the period reached 1.5 million, a 98% increase from the first quarter of 2019. Our ongoing and multi-year investments in our technology systems helped ensure we efficiently processed the quarter's record trading activity and client interactions across our various communication channels. Schwab's first quarter financial results were shaped by this very challenging economic environment in which the decade-long bull market ended - with the S&P falling 20% during the period and theFederal Reserve cutting the target overnight rate 150 basis points to near zero in an emergency effort to help shield the economy amid pandemic concerns. Schwab's first quarter net income totaled$795 million , a decrease of$169 million , or 18%, from the first quarter of 2019. Diluted earnings per common share in the first quarter of$0.58 represented a decrease of 16% from the first quarter of 2019. - 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) Total net revenues in the quarter were$2.6 billion , a decrease of 4% from the first quarter of 2019. Net interest revenue declined 6% year-over-year to$1.6 billion , due to declines in interest rates across maturities in the quarter, which offset the impact of significantly higher levels of client cash balances held at our bank and broker-dealer subsidiaries. Asset management and administration fees of$827 million represented a 10% increase from the first quarter of 2019, largely due to our clients' sustained utilization of advice solutions along with increased balances in purchased money market funds, helping offset sharp declines in equity market valuations. Trading revenue declined 13% year-over-year to$188 million due to ourOctober 2019 pricing actions, partially offset by the significant increase in trading volume. Total expenses excluding interest were$1.6 billion in the quarter, representing an increase of 8% from the first quarter of 2019. This total included approximately$27 million for the$1,000 payments to employees and other compensation and business continuity expenses relating to our pandemic response. Our first quarter expenses also included$37 million relating to our pending acquisitions described below. Our longstanding focus on scale and efficiency has helped us begin the year with a first quarter pre-tax profit margin of 40.0% and remains an important strength as we balance near-term profitability with continued reinvestment for long-term growth. Regardless of the environment, our priorities for balance sheet management remain intact, including supporting our ongoing growth while also maintaining appropriate levels of liquidity and capital. With first quarter market volatility and lower interest rates driving a significant influx of client cash, total balance sheet assets increased by$77 billion during the quarter to$371 billion atMarch 31st . Consistent with optimizing liquidity management during heightened volatility, we issued 5- and 10-year senior notes totaling$1.1 billion in March. We finished the first quarter with a Tier 1 Leverage Ratio of 6.9%, consistent with our operating objective of 6.75%-7.00%. Return on average common stockholders' equity was 14% for the first quarter of 2020, down from 20% in the first quarter of 2019, due to lower net income as well as a$3.9 billion increase in accumulated other comprehensive income (AOCI) due to unrealized gains in our available for sale (AFS) investment securities portfolio. Our pending acquisitions of TD Ameritrade and assets of USAA-IMCO remain on track, with anticipated closing of USAA-IMCO expected in mid-2020, and TD Ameritrade in the second half of 2020. In late February, we entered into a definitive agreement to acquire Wasmer Schroeder, which will add established strategies and new separately managed account offerings to our existing fixed income lineup. Our purchase of Wasmer Schroeder is also expected to close mid-2020, subject to satisfaction of customary closing conditions.
Subsequent Event
OnApril 30, 2020 , the Company issued and sold 2,500,000 depositary shares, each representing a 1/100th ownership interest in a share of 5.375% fixed-rate reset non-cumulative perpetual preferred stock, Series G,$0.01 par value per share, with a liquidation preference of$100,000 per share (equivalent of$1,000 per depositary share). The net proceeds of the offering were approximately$2.47 billion , after deducting the underwriting discount and estimated offering expenses.
Current Regulatory Environment and Other Developments
EffectiveMarch 20, 2020 ,CSB andCharles Schwab Premier Bank (CSPB) converted toTexas -chartered state savings banks. CSB and CSPB became members of theFederal Reserve and are subject to regulation, supervision and examination by theFederal Reserve and theTexas Department of Savings and Mortgage Lending . - 5 -
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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
Total Net Revenues
The following tables present a comparison of revenue by category:
2020 2019
% of % of
Percent Total Net Total Net
Three Months Ended March 31, Change Amount Revenues Amount Revenues
Net interest revenue
Interest revenue (15 )% $ 1,708 65 % $ 1,998 73 %
Interest expense (57 )% (136 ) (5 )% (317 ) (11 )%
Net interest revenue (6 )% 1,572 60 % 1,681 62 %
Asset management and administration fees
Mutual funds, ETFs, and collective trust
funds (CTFs) 9 % 452 17 % 414 16 %
Advice solutions 12 % 312 12 % 278 10 %
Other - 63 3 % 63 2 %
Asset management and administration fees 10 % 827 32 % 755 28 %
Trading revenue
Commissions (31 )% 113 4 % 163 6 %
Principal transactions (9 )% 20 1 % 22 1 %
Order flow revenue (1) 72 % 55 2 % 32 1 %
Trading revenue (1) (13 )% 188 7 % 217 8 %
Other (1) (57 )% 30 1 % 70 2 %
Total net revenues (4 )% $ 2,617 100 % $ 2,723 100 %
(1) In the first quarter of 2020, order flow revenue was reclassified from other revenue to trading revenue. Prior period amounts have been reclassified to reflect this change.
Net Interest Revenue
Revenue on interest-earning assets is affected by various factors, such as the composition of assets, prevailing interest rates and spreads at the time of origination or purchase, changes in interest rates on floating rate securities and loans, and changes in prepayment levels for mortgage-backed and other asset-backed securities and loans. Interest rates across maturities declined during the first three months of 2020 relative to the end of 2019. During the first quarter of 2020, theFederal Reserve cut the federal funds target overnight rate twice, for a total of 150 basis points to near zero; on the longer-end of the curve, the 10-yearTreasury rate declined by over 120 basis points. The changes in the economic environment in the first quarter of 2020 resulting from the COVID-19 pandemic drove significantly higher levels of client cash sweep balances. Given the rapid accumulation of these balances, the Company initially placed a substantial amount in excess reserves at theFederal Reserve , which totaled$58.7 billion atMarch 31, 2020 , up from$18.8 billion at the end of 2019. Similarly, fromDecember 31, 2019 toMarch 31, 2020 , payables to brokerage clients increased$10.0 billion while margin loan balances decreased$2.3 billion , contributing to growth in cash and investments segregated. Consistent with our existing asset-liability-management approach, we expect to invest the majority of the amounts currently held in excess reserves into higher yielding investments over the next several quarters. - 6 -
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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:
2020 2019
Interest Interest
Average Revenue/ Average Average Revenue/ Average
Three Months Ended March 31, Balance Expense Yield/Rate Balance Expense Yield/Rate
Interest-earning assets
Cash and cash equivalents $ 32,134 $ 85
1.04 %
87 1.45 % 13,533 83 2.44 %
Broker-related receivables 730 2 1.35 % 257 2 2.75 %
Receivables from brokerage clients 19,151 168 3.47 % 18,972 214 4.52 %
Available for sale securities (1, 2) 197,745 1,185 2.39 % 66,853 451 2.70 %
Held to maturity securities (2) - - - 132,427 916 2.77 %
Bank loans 18,897 144 3.06 % 16,578 149 3.61 %
Total interest-earning assets 292,373 1,671 2.28 % 273,603 1,966 2.88 %
Other interest revenue 37 32
Total interest-earning assets $ 292,373 $ 1,708 2.33 % $ 273,603 $ 1,998 2.92 %
Funding sources
Bank deposits $ 227,523 $ 57 0.10 % $ 219,987 $ 226 0.42 %
Payables to brokerage clients 30,287 8 0.10 % 22,184 23 0.43 %
Short-term borrowings (3) 3 - 1.07 % 30 - 2.48 %
Long-term debt 7,527 66 3.53 % 6,845 62 3.61 %
Total interest-bearing liabilities 265,340 131 0.20 % 249,046 311 0.51 %
Non-interest-bearing funding sources 27,033 24,557
Other interest expense 5 6
Total funding sources $ 292,373 $ 136 0.19 % $ 273,603 $ 317 0.46 %
Net interest revenue $ 1,572 2.14 % $ 1,681 2.46 %
(1) Amounts have been calculated based on amortized cost.
(2) On January 1, 2020 , the Company transferred all of its investment securities
designated as held to maturity (HTM) to the AFS category, as described in Note
4.
(3) Interest revenue or expense was less than $500,000 in the period or periods
presented.
Net interest revenue decreased $109 million , or 6%, in the first quarter of 2020
compared to the same period in 2019, due primarily to lower average investment
yields, partially offset by growth in interest-earning assets.
Average interest-earning assets for the first quarter of 2020 were higher by 7%
compared to the same period in 2019. The increase in average interest-earning
assets for the first quarter of 2020 was primarily driven by higher client cash
balances in bank deposits and payables to brokerage clients.
Our net interest margin was 2.14% during the first quarter of 2020, down from
2.46% a year earlier. This decrease was driven primarily by lower yields
received on interest-earning assets due largely to the Federal Reserve's 2019
and 2020 interest rate decreases. We expect some net interest margin compression
in coming quarters largely due to the impact of lower interest rates across
maturities; at the same time, higher balances of cash and other interest-earning
assets can be additive to net interest revenue. The amount of net interest
margin compression and resulting net interest revenue is dependent on a number
of factors, including the timing of investing cash into higher yielding assets,
changes to LIBOR, and the level of client cash balances.
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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
The following tables present asset management and administration fees, average client assets, and average fee yields:
2020 2019
Average Average
Client Average Client Average
Three Months Ended March 31, Assets Revenue Fee Assets Revenue Fee
Schwab money market funds $ 203,772 $ 152 0.30 % $ 158,268 $ 122 0.31 %
Schwab equity and bond funds, ETFs,
and CTFs 290,808 76 0.11 % 244,314 70 0.12 %
Mutual Fund OneSource® and other
non-transaction fee funds 188,583 147 0.31 % 187,223 147 0.32 %
Other third-party mutual funds and
ETFs (1) 451,959 77 0.07 % 452,461 75 0.07 %
Total mutual funds, ETFs, and CTFs
(2) $ 1,135,122 452 0.16 % $ 1,042,266 414 0.16 %
Advice solutions (2)
Fee-based $ 263,256 312 0.48 % $ 230,394 278 0.49 %
Non-fee-based 71,229 - - 66,756 - -
Total advice solutions $ 334,485 312 0.38 % $ 297,150 278 0.38 %
Other balance-based fees (3) 432,847 54 0.05 % 392,191 52 0.05 %
Other (4) 9 11
Total asset management and
administration fees $ 827 $ 755
(1) Beginning in the fourth quarter of 2019, Schwab ETF OneSource™ was
discontinued as a result of the elimination of online trading commissions for
U.S. and Canadian-listed ETFs.
(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-related 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 $72 million , or 10%, in
the first quarter of 2020 compared to the same period in 2019. This increase was
primarily driven by higher revenue from increased balances in purchased money
market funds and advice solutions in the first quarter of 2020 relative to the
first quarter of 2019, helping offset declines in equity market valuations in
the first quarter of 2020.
The following table presents a roll forward of client assets for the Schwab
money market funds, Schwab equity and bond funds, ETFs, and CTFs, and Mutual
Fund OneSource® and other non-transaction fee (NTF) funds. These funds generated
45% of the asset management and administration fees earned during the first
quarters of 2020 and 2019:
Schwab Money Schwab Equity and Mutual Fund OneSource®
Market Funds Bond Funds, ETFs, and CTFs and Other NTF funds
Three Months Ended March 31, 2020 2019 2020 2019 2020 2019
Balance at beginning of
period $ 200,826 $ 153,472 $ 286,275 $ 209,471 $ 202,068 $ 180,532
Net inflows (outflows) 1,989 5,152 6,531 7,248 (10,565 ) (6,206 )
Net market gains (losses)
and other 913 1,045 (57,183 ) 24,168 (29,864 ) 20,790
Balance at end of period $ 203,728 $ 159,669 $ 235,623 $ 240,887 $ 161,639 $ 195,116
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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)
Trading Revenue
The following table presents trading revenue and related information:
Three Months Ended
March 31, Percent
2020 2019 Change
Trading revenue (1) $ 188 $ 217 (13 )%
Clients' daily average trades (DATs) (in thousands) 1,540 777 98 %
Number of trading days 62.0 61.0 2 %
Revenue per trade (2) $ 1.97 $ 4.58 (57 )%
Note: Effective
options.
(1) In the first quarter of 2020, order flow revenue was reclassified from other
revenue to trading revenue. Prior period amounts have been reclassified to
reflect this change.
(2) Revenue per trade is calculated as trading revenue divided by DATs multiplied
by the number of trading days.
Trading revenue decreased$29 million , or 13%, in the first quarter of 2020 compared to the same period in 2019, due primarily to our 2019 pricing actions, which more than offset a significant increase in clients' daily average trades and higher order flow revenue amid heightened market volatility. Order flow revenue was$55 million and$32 million during the first quarters of 2020 and 2019, respectively. The increase in order flow revenue during the first quarter of 2020 was due to a higher volume of trades.
Other Revenue
Other revenue includes certain service fees, software fees, exchange processing fees, and non-recurring gains. Other revenue decreased$40 million , or 57%, in the first quarter of 2020 compared to the same period in 2019. This decrease was primarily driven by a gain recognized in the first quarter of 2019 from the assignment of leased office space, as well as an increase in the allowance for credit losses on bank loans in the first quarter of 2020. - 9 - -------------------------------------------------------------------------------- THE CHARLES SCHWAB CORPORATION Management's Discussion and Analysis of Financial Condition and Results of Operations (Tabular Amounts in Millions, Except Ratios, or as Noted) Total Expenses Excluding Interest The following table shows a comparison of expenses excluding interest: Three Months Ended March 31, Percent 2020 2019 Change Compensation and benefits Salaries and wages$ 502 $ 476 5 % Incentive compensation 227 216 5 % Employee benefits and other 168 158 6 % Total compensation and benefits$ 897 $ 850 6 % Professional services 182 170 7 % Occupancy and equipment 142 131 8 % Advertising and market development 67 69 (3 )% Communications 75 62 21 % Depreciation and amortization 96 83 16 % Regulatory fees and assessments 34 32 6 % Other 77 62 24 % Total expenses excluding interest$ 1,570 $ 1,459 8 % Expenses as a percentage of total net revenues Compensation and benefits 34 % 31 % Advertising and market development 3 % 3 % Full-time equivalent employees (in thousands) At quarter end 20.2 20.0 1 % Average 20.0 19.9 1 % Total compensation and benefits increased in the first quarter of 2020 compared to the same period in 2019, reflecting annual merit increases and an increase in employee headcount to support our expanding client base. The increase was also due to the Company's payment of$1,000 to all non-officer employees inMarch 2020 to help them cover costs incurred due to the COVID-19 pandemic. Professional services expense increased in the first quarter of 2020 compared to the same period in 2019, primarily due to expenses relating to pending acquisitions and overall growth in the business. Occupancy and equipment expense increased in the first quarter of 2020 compared to the same period in 2019, primarily due to an increase in technology equipment costs associated with higher customer trade volumes. Communications expense increased in the first quarter of 2020 compared to the same period in 2019, primarily due to higher customer trade volumes as well as overall growth in our business and client base. Depreciation and amortization expenses grew in the first quarter of 2020 compared to the same period in 2019, primarily due to higher depreciation of buildings and equipment related to expansion of our campuses in theU.S. in 2019 and 2020, as well as higher amortization of purchased and internally developed software associated with continued investments in software and technology enhancements. Other expenses increased in the first quarter of 2020 compared to the same period in 2019, primarily resulting from increases in processing fees and related expenses due to higher customer trade volumes and market volatility, as well as expenses relating to pending acquisitions. These increases were partially offset by lower travel and entertainment expense. Capital expenditures were$250 million and$181 million in the first quarter of 2020 and 2019, respectively. The increase in capital expenditures from the prior year was primarily due to higher capitalized software costs, partially offset by lower building expansion in 2020 relative to the first quarter of 2019. Excluding any potential impact of the pending acquisition of TD Ameritrade, we anticipate capital expenditures for full-year 2020 to be approximately 5-6% of total net revenues. - 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)
Taxes on Income
Taxes on income were$252 million and$300 million for the first quarters of 2020 and 2019, respectively, resulting in effective income tax rates on income before taxes of 24.1% and 23.7%, respectively. The increase in the effective tax rate in the first quarter of 2020 compared to the same period in the prior year was due to a decrease in equity compensation tax deduction benefits and an increase in nondeductible acquisition costs, partially offset by state-related tax benefits recognized during the first quarter of 2020.
Segment Information
Financial information for our segments is presented in the following tables:
Investor Services Advisor Services Total
Three Months Ended
March 31, Percent Change 2020 2019 Percent
Change 2020 2019 Percent Change 2020 2019
Net Revenues
Net interest revenue (6 )%
(9 )% $ 444 $ 486 (6 )% $ 1,572 $ 1,681
Asset management and
administration fees 13 % 600 533 2 % 227 222 10 % 827 755
Trading revenue (1) (16 )% 119 141 (9 )% 69 76 (13 )% 188 217
Other (1) (52 )% 20 42 (64 )% 10 28 (57 )% 30 70
Total net revenues (2 )% 1,867 1,911 (8 )% 750 812 (4 )% 2,617 2,723
Expenses Excluding
Interest 9 % 1,154 1,062 5 % 416 397 8 % 1,570 1,459
Income before taxes on
income (16 )% $ 713 $ 849 (20 )% $ 334 $ 415 (17 )% $ 1,047 $ 1,264
Net New Client Assets
(in billions) 21 % $ 35.3 $ 29.2 68 % $ 37.9 $ 22.5 42 % $ 73.2 $ 51.7 (1) In the first quarter of 2020, order flow revenue was reclassified from other revenue to trading revenue. Prior period amounts have been reclassified to reflect this change.
Investor Services
Total net revenues decreased by 2% in the first quarter of 2020 compared to the same period in 2019, primarily due to decreases in net interest revenue, trading revenue and other revenue, partially offset by an increase in asset management and administration fees. Net interest revenue decreased primarily due to lower average investment yields, partially offset by growth in interest-earning assets. Trading revenue decreased primarily as a result of the Company's 2019 pricing actions, partially offset by higher trading volume. The decrease in other revenue was primarily driven by a gain recognized in the first quarter of 2019 from the assignment of leased office space, as well as an increase in the allowance for credit losses on bank loans in the first quarter of 2020. Asset management and administration fees increased primarily due to increased balances in purchased money market funds and advice solutions. Expenses excluding interest increased by 9% in the first quarter of 2020 compared to the same period in 2019, primarily due to higher compensation and benefits, professional services, depreciation and amortization, and other expenses. Compensation and benefits increased in the first quarter or 2020 due to annual merit increases and increased headcount to support our expanding client base, as well as the Company's payment of$1,000 to all non-officer employees inMarch 2020 to help them cover costs incurred due to the COVID-19 pandemic. Professional services also increased, driven by expenses related to pending acquisitions and overall growth in the business. Depreciation and amortization increased due to higher depreciation of buildings and equipment related to our campus expansion, as well as higher amortization of purchased and internally developed software associated with continued investments in software and technology enhancements. Other expenses increased due to increased processing fees associated with higher customer trade volumes and expenses related to pending acquisitions, partially offset by lower travel and entertainment expenses. - 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)
Advisor Services
Total net revenues decreased by 8% in the first quarter of 2020 compared to the same period in 2019, primarily due to decreases in net interest revenue, trading revenue, and other revenue, partially offset by an increase in asset management and administration fees. Net interest revenue decreased primarily due to lower average investment yields, partially offset by growth in interest-earning assets. Trading revenue decreased primarily as a result of the Company's 2019 pricing actions, partially offset by higher trading volume. The decrease in other revenue was primarily driven by a gain recognized in the first quarter of 2019 from the assignment of leased office space. Asset management and administration fees increased primarily due to increased balances in purchased money market funds. Expenses excluding interest increased by 5% in the first quarter of 2020 compared to the same period in 2019, primarily due to higher compensation and benefits expense as well as higher depreciation and amortization expense. Compensation and benefits increased in the first quarter of 2020 due to annual merit increases and increased headcount to support our expanding client base, as well as the Company's payment of$1,000 to all non-officer employees inMarch 2020 to help them cover costs incurred due to the COVID-19 pandemic. Depreciation and amortization expense increased primarily due to higher depreciation of buildings and equipment related to our campus expansion, as well as higher amortization of internally developed software associated with continued investments in software and technology enhancements.
RISK MANAGEMENT
Schwab's business activities expose us to a variety of risks, including operational, credit, market, liquidity, and compliance risks. The Company has a comprehensive risk management program to identify and manage these risks and their associated potential for financial and reputational impact. For a discussion of our risk management programs, see Item 7 - Risk Management in the 2019 Form 10-K.
Net Interest Revenue Simulation
For our net interest revenue sensitivity analysis, we use net interest revenue simulation modeling techniques to evaluate and manage the effect of changing interest rates. The simulations include all interest rate-sensitive assets and liabilities. Key assumptions include the projection of interest rate scenarios with rate floors, prepayment speeds of mortgage-related investments, repricing of financial instruments, and reinvestment of matured or paid-down securities and loans. 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 we establish the rates paid on certain brokerage client cash balances and bank deposits and the rates charged on certain margin and bank loans, and control the composition of our investment securities, we have some ability to manage our net interest spread, depending on competitive factors and market conditions. Net interest revenue sensitivity analysis assumes 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 we actively manage the consolidated balance sheet and interest rate exposure, in all likelihood we 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 beginningMarch 31, 2020 andDecember 31, 2019 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: March 31, 2020 December 31, 2019 Increase of 100 basis points 15.8 % 4.8 % Decrease of 100 basis points (7.8 )% (7.4 )% The change in net interest revenue sensitivities as ofMarch 31, 2020 reflects a significantly lower interest rate curve from the fourth quarter of 2019 due to the global economic impact from the COVID-19 pandemic. Higher short-term interest rates would - 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) positively impact net interest revenue as yields on interest earning assets are expected to rise faster than the cost of funding sources. A decline in interest rates could negatively impact the yield on the Company's investment and loan portfolio to a greater degree than any offsetting reduction in interest expense from funding sources, compressing net interest margin.
In addition to measuring the effect of a gradual 100 basis point parallel increase or decrease in current interest rates, we regularly simulate the effects of larger parallel- and non-parallel shifts in interest rates on net interest revenue.
Economic Value of Equity Simulation
Management also uses economic value of equity (EVE) simulations to measure interest rate risk. EVE sensitivity measures the long-term impact of interest rate changes on the net present value of assets and liabilities. EVE is calculated by subjecting the balance sheet to hypothetical instantaneous shifts in the level of interest rates. This analysis is highly dependent upon asset and liability assumptions based on historical behaviors as well as our expectations of the economic environment. Key assumptions in our EVE calculation include projection of interest rate scenarios with rate floors, prepayment speeds of mortgage-related investments, term structure models of interest rates, non-maturity deposit behavior, and pricing assumptions. As a result of the low interest rate environment in the first quarter of 2020, the downward assessments of our net interest revenue and EVE simulations as ofMarch 31, 2020 reflected the assumption of non-negative investment yields.
Expected Phase-out of LIBOR
The Company has established a firm-wide team to address the likely discontinuation of LIBOR. As part of our efforts, we have inventoried our LIBOR exposures, the largest of which are certain investment securities and loans. In purchasing new investment securities, we ensure that appropriate fall-back language is in the security's prospectus in the event that LIBOR is unavailable or deemed unreliable. We are updating loan agreements to ensure new LIBOR-based loans adequately provide for an alternative to LIBOR. Furthermore, we plan to phase-out the use of LIBOR as a reference rate in our new lending products beforeDecember 2021 . Consistent with our "Through Clients' Eyes" strategy, our focus throughout the LIBOR transition process is to ensure clients are treated fairly and consistently as this major change is occurring in the financial markets. The market transition process has not yet progressed to a point at which the impact to the Company's consolidated financial statements of LIBOR's discontinuation can be estimated.
Liquidity Risk
Funding Sources
Schwab's primary source of funds is cash generated by client activity which includes bank deposits and cash balances in client brokerage accounts. These funds are used to purchase investment securities and extend loans to clients.
Other sources of funds may include cash flows from operations, maturities and sales of investment securities, repayments on loans, securities lending of assets held in client brokerage accounts, repurchase agreements, and cash provided by external financing.
To meet daily funding needs, we maintain liquidity in the form of overnight cash deposits and short-term investments. For unanticipated liquidity needs, we also maintain a buffer of highly liquid investments, includingU.S. Treasury securities. - 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) In addition to internal sources of liquidity, Schwab has access to external funding. The following table describes external debt facilities available atMarch 31, 2020 : Description Borrower
Outstanding
subsidiaries $
-
Banking
Federal Reserve discount window (2) subsidiaries - 8,169
Uncommitted, unsecured lines of credit with
various external banks CSC, CS&Co - 1,642
Unsecured commercial paper (3) CSC - 750
Committed, unsecured credit facility with
various external banks CSC - 750
(1) Amounts available are dependent on the amount of first lien residential real
estate mortgage loans (First Mortgages), home equity lines of credit (HELOCs),
and the fair value of certain investment securities that are pledged as
collateral.
(2) Amounts available are dependent on the fair value of certain investment
securities that are pledged as collateral.
(3) CSC has authorization from its Board of Directors to issue Commercial Paper
Notes to not exceed $1.5 billion . Management has set a current limit not to
exceed the amount of the committed, unsecured credit facility.
CSC's ratings for Commercial Paper Notes are P1 by Moody's Investor Service
(Moody's), A1 by Standard & Poor's Rating Group (Standard & Poor's ), and F1 by
Fitch Ratings, Ltd (Fitch) at March 31, 2020 and December 31, 2019 .
CSC also has a universal automatic shelf registration statement on file with the
SEC , which enables it to issue debt, equity, and other securities.
Liquidity Coverage Ratio
Pursuant to the 2019 interagency regulatory capital and liquidity rules, beginning in the first quarter of 2020, Schwab became subject to a reduced LCR rule requiring the Company to hold high quality liquid assets (HQLA) in an amount equal to at least 85% of the Company's projected net cash outflows over a prospective 30-calendar-day period of acute liquidity stress, calculated on each business day. See Part I - Item 1 - Regulation in the 2019 Form 10-K for additional information. The Company was in compliance with the reduced LCR rule atMarch 31, 2020 . The table below presents information about our average daily LCR: Average for the Three Months Ended March 31, 2020 Total eligible high quality liquid assets $ 49,234 Net cash outflows $ 43,212 LCR 114 % Borrowings
The following are details of the Senior Notes:
Par Weighted Average Standard
A
New Debt Issuances
The new debt issuances in 2020 were senior unsecured obligations with interest
payable semi-annually. Additional details are as follows:
Issuance Date Issuance Amount Maturity Date Interest Rate
600 3/24/2025 4.200 %
3/24/2020 $ 500 3/22/2030 4.625 %
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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)
Acquisition of USAA-IMCO
We expect to utilize cash generated from operations to fund the$1.8 billion purchase of assets from USAA-IMCO. The transaction is expected to close in mid-2020, subject to satisfaction of closing conditions, including regulatory approvals and the implementation of conversion plans.
CAPITAL MANAGEMENT
Schwab seeks to manage capital to a level and composition sufficient to support execution of our business strategy, including anticipated balance sheet growth, providing financial support to our subsidiaries, and sustained access to the capital markets, while at the same time meeting our regulatory capital requirements and serving as a source of financial strength to our banking subsidiaries. Schwab's primary sources of capital are funds generated by the operations of subsidiaries and securities issuances by CSC in the capital markets. To ensure that Schwab has sufficient capital to absorb unanticipated losses or declines in asset values, we have adopted a policy to remain well capitalized even in stressed scenarios. In addition, our near-term capital management incorporates preparations for closing the USAA-IMCO transaction, including the allocation of capital to support client cash that will be added to our balance sheet. As a result of the significant inflow of client cash in the first quarter of 2020, our consolidated Tier 1 Leverage Ratio declined from 7.3% at year-end 2019 to 6.9% atMarch 31, 2020 . While we continue to maintain our long-term operating objective of 6.75%-7.00%, our Tier 1 Leverage Ratio is likely to decline further into the buffer we maintain between our long-term operating objective and our regulatory requirement. Moreover, our Tier 1 Leverage Ratio may remain below the level seen atMarch 31, 2020 in coming quarters before returning to our operating objective over time. We expect to continue managing our capital position in accordance with our policy and strategy described above and in further detail in the 2019 Form 10-K.
Regulatory Capital Requirements
CSC and CSB are subject to various capital requirements set by regulatory
agencies as discussed in further detail in the 2019 Form 10-K and in Item 1 -
Note 14. As of
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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 details CSC's consolidated and CSB's capital ratios as of
March 31, 2020 (1) December 31, 2019 (1)
CSC CSB CSC CSB
Total stockholders' equity $ 26,270 $ 18,862 $ 21,745 $ 14,832
Less:
Preferred stock 2,793 - 2,793 -
Common Equity Tier 1 Capital before
regulatory adjustments $ 23,477 $ 18,862 $ 18,952 $ 14,832
Less:
Goodwill , net of associated deferred tax
liabilities $ 1,184 $ 13 $ 1,184 $ 13
Other intangible assets, net of associated
deferred tax liabilities 97 - 104 -
Deferred tax assets, net of valuation
allowances and deferred tax liabilities 4 - 4 -
Accumulated other comprehensive income (AOCI)
adjustment (1) 3,995 3,436 - -
Common Equity Tier 1 Capital $ 18,197 $ 15,413 $ 17,660 $ 14,819
Tier 1 Capital $ 20,990 $ 15,413 $ 20,453 $ 14,819
Total Capital 21,023 15,445 20,472 14,837
Risk-Weighted Assets 99,039 78,082 90,512 71,521
Total Leverage Exposure 310,299 228,916 286,813 216,582
Common Equity Tier 1 Capital/Risk-Weighted
Assets 18.4 % 19.7 % 19.5 % 20.7 %
Tier 1 Capital/Risk-Weighted Assets 21.2 % 19.7 % 22.6 % 20.7 %
Total Capital/Risk-Weighted Assets 21.2 % 19.8 % 22.6 % 20.7 %
Tier 1 Leverage Ratio 6.9 % 6.9 % 7.3 % 7.1 %
Supplementary Leverage Ratio 6.8 % 6.7 % 7.1 % 6.8 %
(1) In the interagency regulatory capital and liquidity rules adopted in October
2019 , Category III banking organizations such as CSC were given the ability to
opt-out of the inclusion of AOCI in regulatory capital, and CSC made this
opt-out election as of January 1, 2020 . Therefore, AOCI is excluded from the
amounts and ratios presented as of March 31, 2020 . In 2019, CSC and CSB were
required to include all components of AOCI in regulatory capital; the amounts
and ratios for December 31, 2019 are presented on this basis.
CSB is also subject to regulatory requirements that restrict and govern the
terms of affiliate transactions. In addition, CSB is required to provide notice
to, and may be required to obtain approval from, the Federal Reserve to declare
dividends to CSC.
As a broker-dealer, CS&Co is subject to regulatory requirements of the Uniform
Net Capital Rule. At
In addition to the capital requirements above, Schwab's subsidiaries are subject
to other regulatory requirements intended to ensure financial soundness and
liquidity. See Item 1 - Note 14 for additional information on the components of
stockholders' equity and information on the capital requirements of significant
subsidiaries.
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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
Cash dividends paid and per share amounts for the first three months of 2020 and
2019 are as follows:
2020 2019
Per Share Per Share
Three Months Ended March 31, Cash Paid Amount Cash Paid Amount
Common Stock $ 233 $ 0.18 $ 228 $ 0.17
Series A Preferred Stock (1) 14 35.00 14 35.00
Series C Preferred Stock (2) 9 15.00 9 15.00
Series D Preferred Stock (2) 11 14.88 11 14.88
Series E Preferred Stock (3) 14 2,312.50 14 2,312.50
Series F Preferred Stock (4) - - - -
(1) Dividends paid semi-annually until February 1, 2022 and quarterly
thereafter.
(2) Dividends paid quarterly.
(3) Dividends paid semi-annually until March 1, 2022 and quarterly thereafter.
(4) Dividends paid semi-annually beginning on June 1, 2018 until December 1,
2027 , and quarterly thereafter.
Share Repurchases
OnJanuary 30, 2019 , CSC publicly announced that its Board of Directors authorized the repurchase of up to$4.0 billion of common stock. The authorization does not have an expiration date. There were no repurchases of CSC's common stock under this authorization during the first quarter of 2020, leaving$1.8 billion remaining on our existing authorization as ofMarch 31, 2020 . OTHER Foreign Exposure AtMarch 31, 2020 , Schwab had exposure to non-sovereign financial and non-financial institutions in foreign countries, as well as agencies of foreign governments. AtMarch 31, 2020 , the fair value of these holdings totaled$8.5 billion , with the top three exposures being to issuers and counterparties domiciled inFrance at$5.6 billion ,the Netherlands at$834 million , andSweden at$675 million . In addition, Schwab had outstanding margin loans to foreign residents of$909 million atMarch 31, 2020 . Off-Balance Sheet Arrangements Schwab enters into various off-balance sheet arrangements in the ordinary course of business, primarily to meet the needs of our clients. These arrangements include firm commitments to extend credit. Additionally, Schwab enters into guarantees and other similar arrangements in the ordinary course of business. For information on each of these arrangements, see Item 1 - Note 5, Note 6, Note 8, Note 9, and Note 10, and Item 8 - Note 14 in the 2019 Form 10-K.
CRITICAL ACCOUNTING ESTIMATES
Certain of our 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 2019 Form 10-K. There have been no changes to critical
accounting estimates during the first three months of 2020.
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THE CHARLES SCHWAB CORPORATION © Edgar Online, source
