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:
•
•
•
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$4.11 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);
• Pending TD Ameritrade acquisition, including status and anticipated
closing; expected benefits from recently completed transactions (see
Overview, Capital Management, and Commitments and Contingencies in Part I,
Item 1, Financial Information - Notes to Condensed Consolidated Financial
Statements (Item 1) - Note 10);
• Objective for amount of deposits held in excess reserves at the Federal
Reserve (see Results of Operations);
• Net interest margin compression and net interest revenue; money market
fund fee waivers (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; Tier 1 Leverage Ratio operating objective (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);
• Credit quality metrics and performance of the bank loans portfolios (see
Bank Loans and Related Allowance for Credit Losses in Item 1 - Note 6);
• The likelihood of indemnification and guarantee payment obligations (see
Commitments and Contingencies in Item 1 - Note 10); and
• The impact of legal proceedings and regulatory matters (see Commitments
and Contingencies in Item 1 - Note 10 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 equity valuations, trading activity,
the level of interest rates - which can impact money market fund fee
waivers, and credit spreads;
• 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;
• The company's ability to support client activity levels;
• Failure of the parties to satisfy the closing conditions in the agreement
for the pending acquisition of TD Ameritrade in a timely manner or at all,
including regulatory approvals, and the implementation of integration
plans;
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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)
• Disruptions to the parties' businesses as a result of the announcement and
pendency of the TD Ameritrade acquisition;
• The risk that expected revenue, expense and other synergies and benefits
from acquisitions may not be fully realized or may take longer to realize
than expected;
• Timing and ability to invest amounts held in excess reserves at the
Federal Reserve into higher yielding investments in the company's bank
securities portfolio;
• Client cash allocations;
• LIBOR trends;
• 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.
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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 second quarter and first six months of 2020 and 2019 are:
Three Months Ended Six Months Ended
June 30, Percent June 30, Percent
2020 2019 Change 2020 2019 Change
Client Metrics
Net new client assets (in
billions) (1) $ 137.4 $ 37.2 N/M $ 210.6 $ 88.9 137 %
Core net new client assets (in
billions) $ 46.6 $ 37.2 25 % $ 119.8 $ 88.9 35 %
Client assets (in billions, at
quarter end) $ 4,110.1 $ 3,702.4 11 %
Average client assets (in
billions) $ 3,849.7 $ 3,631.1 6 % $ 3,884.2 $ 3,548.4 9 %
New brokerage accounts (in
thousands) (2) 1,652 386 N/M 2,261 772 193 %
Active brokerage accounts (in
thousands, at quarter end) 14,107 11,967 18 %
Assets receiving ongoing advisory
services (in billions,
at quarter end) $ 2,092.7 $ 1,938.2 8 %
Client cash as a percentage of
client assets (at quarter end) 13.6 % 10.9 %
Company Financial Information and
Metrics
Total net revenues $ 2,450 $ 2,681 (9 )% $ 5,067 $ 5,404 (6 )%
Total expenses excluding interest 1,562 1,445 8 % 3,132 2,904 8 %
Income before taxes on income 888 1,236 (28 )% 1,935 2,500 (23 )%
Taxes on income 217 299 (27 )% 469 599 (22 )%
Net income 671 937 (28 )% 1,466 1,901 (23 )%
Preferred stock dividends and
other 50 50 - 88 89 (1 )%
Net income available to common
stockholders $ 621 $ 887 (30 )% $ 1,378 $ 1,812 (24 )%
Earnings per common share -
diluted $ .48 $ .66 (27 )% $ 1.07 $ 1.35 (21 )%
Net revenue growth from prior year (9 )% 8 % (6 )% 11 %
Pre-tax profit margin 36.2 % 46.1 % 38.2 % 46.3 %
Return on average common
stockholders' equity (annualized) 10 % 19 % 12 % 20 %
Expenses excluding interest as a
percentage of average client
assets (annualized) 0.16 % 0.16 % 0.16 % 0.17 %
Consolidated Tier 1 Leverage Ratio
(at quarter end) 5.9 % 7.3 %
Non-GAAP Financial Measures (3)
Adjusted total expenses (4) $ 1,469 $ 1,435 $ 2,996 $ 2,886
Adjusted diluted EPS $ .54 $ .67 $ 1.14 $ 1.36
Return on tangible common equity 12 % 21 % 15 % 22 %
(1) The second quarter and first six months of 2020 include inflows of $79.9
billion related to the acquisition of the assets of USAA's Investment Management
Company (USAA-IMCO) and $10.9 billion from a mutual fund clearing services
client.
(2) The second quarter and first six months of 2020 include 1.1 million new
brokerage accounts related to the acquisition of assets from USAA-IMCO.
(3) See Non-GAAP Financial Measures for further details and a reconciliation of
such measures to GAAP reported results.
(4) Adjusted total expenses is a non-GAAP financial measure adjusting total
expenses excluding interest. See Non-GAAP Financial Measures.
N/M Not meaningful.
During the second quarter and first half of 2020, the ongoing health crisis of
the COVID-19 pandemic and its effects continued to dominate the macroeconomic
environment, resulting in a contracting U.S. economy, and sustained pressures on
interest rates. Throughout this challenging time, the Company continued to
operate without significant client disruption, and we continued to move forward
on important operating initiatives, including multiple acquisitions. Schwab's
focus on clients remains, even as almost 95% of our employees continued to work
remotely throughout the second quarter.
During the second quarter of 2020, we gathered $137.4 billion in net new assets,
with core net new assets totaling $46.6 billion before including the effects of
the USAA-IMCO acquisition and a large mutual fund clearing inflow. Aided by
ongoing client engagement and an extended tax-filing season, our year-to-date
core net new assets reached $119.8 billion , representing a 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)
annualized organic growth rate. Strong client trading activity continued during
the second quarter, as daily average trades were 1.6 million in both the second
quarter and first half of 2020, up 126% and 112%, respectively, from the same
periods in 2019. Active brokerage accounts grew 18% from June 30, 2019 and
totaled 14.1 million at June 30, 2020 , inclusive of 1.1 million USAA accounts
added to our platform upon closing in May of 2020. Growth in equity market
valuations during the second quarter, along with our ongoing asset-gathering and
approximately $80 billion in client assets transferred from USAA, helped push
total client assets to $4.11 trillion at June 30, 2020 , up 11% from June 30,
2019 .
Schwab's net income totaled $671 million and $1.5 billion in the second quarter
and first half of 2020, respectively, representing decreases of 28% and 23% from
the comparable periods in the prior year. Diluted earnings per common share
(EPS) in the second quarter and first half of 2020 were $.48 and $1.07 ,
respectively, declining 27% and 21% from the same periods in 2019. Adjusted
diluted EPS(1), which excludes acquisition and integration-related costs,
amortization of acquired intangible assets, and related income tax effects, were
$.54 and $1.14 for the second quarter and first six months of 2020,
respectively, down from $.67 and $1.36 from the same periods in the prior year.
Total net revenues were $2.5 billion and $5.1 billion in the second quarter and
first half of 2020, declining 9% and 6%, respectively, from the comparable
periods in 2019, due primarily to lower net interest revenue. Lower net
investment yields driven by the Federal Reserve's dramatic monetary easing in
2020 outweighed growth in client cash balances held at our bank and
broker-dealer subsidiaries, which led to declines in net interest revenue of 14%
and 10% in the second quarter and first half of 2020, respectively, compared
with the same periods in 2019. Asset management and administration fees grew to
$801 million and $1.6 billion for the second quarter and first half of 2020,
respectively, representing growth of 2% and 6% relative to the same periods in
2019. These increases were due primarily to clients' higher balances of money
market funds and advice solutions, partially offset by the effect of money
market fund fee waivers due to declining portfolio yields, lower Mutual Fund
OneSource® balances, and lower equity market valuations in the first quarter and
beginning of the second quarter of 2020. Trading revenue declined 7% and 10%
during the second quarter and first half of 2020, respectively, compared with
the same periods in the prior year, as our October 2019 pricing actions more
than offset a significant increase in trading volume in 2020.
Total expenses excluding interest were $1.6 billion and $3.1 billion during the
second quarter and first half of 2020, representing increases of 8% for both
periods relative to the comparable periods in 2019. Our expenses included
acquisition and integration-related costs related to our completed and pending
acquisitions discussed below of $81 million and $118 million during the second
quarter and first six months of 2020, respectively. Adjusted total expenses(1),
which exclude acquisition and integration-related costs as well as amortization
of acquired intangible assets, were $1.5 billion and $3.0 billion during the
second quarter and first six months of 2020, respectively, representing
increases of 2% and 4%, respectively, from the comparable periods in 2019.
During the first six months of 2020, we remained intent on maintaining a balance
sheet with healthy liquidity and capital levels. The sharp pandemic-driven
increase in client cash during the first quarter of 2020 was followed by more
modest balance sheet expansion during the second quarter, and after adding
approximately $10 billion of client cash held at our bank and broker-dealer
subsidiaries from our acquisition of USAA-IMCO, we ended the second quarter with
total assets of $400 billion , up 8% from March 31 and up 36% from December 31,
2019 . During the second quarter, we issued $2.5 billion of preferred stock,
Series G, at an initial fixed rate of 5.375%, bringing total preferred stock to
$5.3 billion , or approximately 24% of Tier 1 Capital at June 30, 2020 , and the
Company ended the second quarter with a Tier 1 Leverage Ratio of 5.9%.
Return on average common stockholders' equity was 10% and 12% for the second
quarter and first six months of 2020, down from 19% and 20% for the comparable
periods in 2019. Return on tangible common equity(1) was 12% and 15% for the
second quarter and first six months of 2020, down from 21% and 22% for the
comparable periods in 2019. The decreases in both return on average common
stockholders' equity and return on tangible common equity were due primarily to
lower net income and an increase in average accumulated other comprehensive
income (AOCI) due to unrealized gains in our available for sale (AFS) investment
securities portfolio. Return on tangible common equity represents annualized
adjusted net income available to common stockholders(1) as a percentage of
average tangible common equity(1). Adjusted net income available to common
stockholders excludes acquisition and integration-related costs, amortization of
acquired intangible assets, and related income tax effects. Tangible common
equity excludes goodwill, acquired intangible assets, and related deferred tax
liabilities.
(1) Adjusted diluted EPS, adjusted total expenses, adjusted net income available
to common stockholders, and return on tangible common equity are non-GAAP
financial measures. Please see Non-GAAP Financial Measures for further details
and a reconciliation of such measures to GAAP reported results.
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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)
Business and Asset Acquisitions
During the second quarter of 2020 we made significant progress towards closing our pending acquisition of TD Ameritrade, with the completion of theDepartment of Justice antitrust review and affirmative votes by both Schwab and TD Ameritrade stockholders. Integration planning efforts are continuing and we remain on track for closing our acquisition of TD Ameritrade during the second half of 2020. OnMay 26, 2020 , the Company completed its acquisition of the assets of USAA-IMCO for$1.6 billion in cash, subject to post-closing adjustments. Along with the asset purchase agreement, the companies entered into a long-term referral agreement that makes Schwab the exclusive provider of wealth management and investment brokerage services for USAA members. The USAA-IMCO acquisition adds scale to the Company's operations through the addition of 1.1 million brokerage and managed portfolio accounts with approximately$80 billion in client assets at the acquisition date. The transaction also provides Schwab the opportunity to further expand our client base by servingUSAA's members through the long-term referral agreement. See Item 1 - Note 3 for more information on the USAA-IMCO acquisition. Additionally, during the second quarter of 2020 the Company completed its acquisition of technology and intellectual property of Motif, a financial technology company. The Motif assets will help us build on our existing capabilities and help accelerate our development of thematic and direct index investing for Schwab's retail investors and RIA clients. OnJuly 1, 2020 , the Company completed its acquisition ofWasmer, Schroeder & Company, LLC , which will add established strategies and new separately managed account offerings to our existing fixed income lineup.
Current Regulatory Environment and Other Developments
EffectiveMarch 20, 2020 ,CSB andCharles Schwab Premier Bank , SSB (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 . - 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)
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 June 30, Change Amount Revenues Amount Revenues
Net interest revenue
Interest revenue (23 )% $ 1,486 61 % $ 1,927 72 %
Interest expense (69 )% (97 ) (4 )% (318 ) (12 )%
Net interest revenue (14 )% 1,389 57 % 1,609 60 %
Asset management and administration fees
Mutual funds, ETFs, and collective trust
funds (CTFs) (1 )% 425 17 % 428 16 %
Advice solutions 6 % 314 13 % 295 11 %
Other (2 )% 62 3 % 63 2 %
Asset management and administration fees 2 % 801 33 % 786 29 %
Trading revenue
Commissions (28 )% 111 5 % 155 5 %
Principal transactions (47 )% 10 - 19 1 %
Order flow revenue (1) 118 % 72 3 % 33 2 %
Trading revenue (1) (7 )% 193 8 % 207 8 %
Other (1) (15 )% 67 2 % 79 3 %
Total net revenues (9 )% $ 2,450 100 % $ 2,681 100 %
2020 2019
% of % of
Percent Total Net Total Net
Six Months Ended June 30, Change Amount Revenues Amount Revenues
Net interest revenue
Interest revenue (19 )% $ 3,194 63 % $ 3,925 73 %
Interest expense (63 )% (233 ) (5 )% (635 ) (12 )%
Net interest revenue (10 )% 2,961 58 % 3,290 61 %
Asset management and administration fees
Mutual funds, ETFs, and collective trust
funds (CTFs) 4 % 877 17 % 842 16 %
Advice solutions 9 % 626 12 % 573 11 %
Other (1 )% 125 3 % 126 2 %
Asset management and administration fees 6 % 1,628 32 % 1,541 29 %
Trading revenue
Commissions (30 )% 224 4 % 318 6 %
Principal transactions (27 )% 30 1 % 41 1 %
Order flow revenue (1) 95 % 127 3 % 65 1 %
Trading revenue (1) (10 )% 381 8 % 424 8 %
Other (1) (35 )% 97 2 % 149 2 %
Total net revenues (6 )% $ 5,067 100 % $ 5,404 100 %
(1) Beginning 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.
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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)
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. Late in 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. Lower interest rates across maturities persisted throughout the second quarter, while credit spreads also compressed. Moreover, changes in the economic environment throughout the first half of 2020 resulting from the COVID-19 pandemic drove significantly higher levels of client cash sweep balances. Given the rapid accumulation of these balances in the first quarter of 2020, the Company initially placed a substantial amount in excess reserves held at theFederal Reserve . The Company deployed a significant amount of this cash build-up during the second quarter, as part of AFS securities purchases totaling$73.9 billion . These purchases were made at rates below the average yield on the existing AFS portfolio due to the current low interest rate environment. The Company held$27.5 billion , or 9% of total deposits, in excess reserves atJune 30, 2020 , versus our longer-term objective of 5-7%. The following tables present net interest revenue information corresponding to interest-earning assets and funding sources on the condensed consolidated balance sheets: 2020 2019 Interest Interest Average Revenue/ Average Average Revenue/ Average Three Months Ended June 30, Balance Expense Yield/Rate Balance Expense Yield/Rate Interest-earning assets Cash and cash equivalents$ 56,553 $ 19
0.13 %
27 0.32 % 14,588 89 2.41 %
Broker-related receivables (1) 429 - 0.30 % 199 - 1.38 %
Receivables from brokerage clients 17,915 111 2.44 % 19,423 217 4.42 %
Available for sale securities (2, 3) 234,346 1,146 1.95 % 56,020 386 2.74 %
Held to maturity securities (3) - - - 132,738 899 2.70 %
Bank loans 20,163 133 2.63 % 16,560 148 3.58 %
Total interest-earning assets 362,927 1,436 1.58 % 265,674 1,897 2.84 %
Other interest revenue 50 30
Total interest-earning assets $ 362,927 $ 1,486 1.63 % $ 265,674 $ 1,927 2.88 %
Funding sources
Bank deposits $ 288,990 $ 12 0.02 % $ 210,811 $ 224 0.43 %
Payables to brokerage clients 37,500 1 0.01 % 23,034 24 0.42 %
Short-term borrowings (1) 39 - 0.24 % 3 - 2.68 %
Long-term debt 8,524 77 3.60 % 7,090 63 3.58 %
Total interest-bearing liabilities 335,053 90 0.11 % 240,938 311 0.52 %
Non-interest-bearing funding sources 27,874 24,736
Other interest expense 7 7
Total funding sources $ 362,927 $ 97 0.10 % $ 265,674 $ 318 0.48 %
Net interest revenue $ 1,389 1.53 % $ 1,609 2.40 %
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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)
2020 2019
Interest Interest
Average Revenue/ Average Average Revenue/ Average
Six Months Ended June 30, Balance Expense Yield/Rate Balance Expense Yield/Rate
Interest-earning assets
Cash and cash equivalents $ 44,343 $ 104
0.46 %
114 0.79 % 14,075 172 2.43 %
Broker-related receivables 580 2 0.96 % 228 2 2.15 %
Receivables from brokerage clients 18,533 279 2.97 % 19,199 431 4.46 %
Available for sale securities (2,3) 216,045 2,331 2.15 % 61,407 837 2.72 %
Held to maturity securities (3) - - - 132,583 1,815 2.73 %
Bank loans 19,530 277 2.84 % 16,569 297 3.59 %
Total interest-earning assets $ 327,650 $ 3,107 1.89 % $ 269,629 $ 3,863 2.86 %
Other interest revenue 87 62
Total interest-earning assets $ 327,650 $ 3,194 1.94 % $ 269,629 $ 3,925 2.90 %
Funding sources
Bank deposits $ 258,256 $ 69 0.05 % $ 215,374 $ 450 0.42 %
Payables to brokerage clients 33,894 9 0.05 % 22,611 47 0.42 %
Short-term borrowings (1) 21 - 0.31 % 17 - 2.50 %
Long-term debt 8,025 143 3.57 % 6,968 125 3.60 %
Total interest-bearing liabilities
24,659
Other interest expense 12 13
Total funding sources $ 327,650 $ 233 0.14 % $ 269,629 $ 635 0.47 %
Net interest revenue $ 2,961 1.80 % $ 3,290 2.43 %
(1) Interest revenue or expense was less than $500,000 in the period or periods
presented.
(2) Amounts have been calculated based on amortized cost.
(3) 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
5.
Net interest revenue decreased $220 million , or 14%, and $329 million , or 10% in
the second quarter and first six months of 2020 compared to the same periods in
2019, due primarily to lower average investment yields partially offset by
growth in interest-earning assets. Accelerated premium amortization on debt
securities in the second quarter and first six months of 2020 also contributed
to the reduction in net interest revenue, as the decline in long-term interest
rates in the first half of 2020 resulted in higher prepayments of
mortgage-related debt securities.
Average interest-earning assets for the second quarter and first six months of
2020 were higher by 37% and 22%, respectively, compared to the same periods in
2019. These increases in average interest-earning assets were primarily driven
by higher client cash balances in bank deposits and payables to brokerage
clients.
Our net interest margin was 1.53% and 1.80% during the second quarter and first
six months of 2020, respectively, down from 2.40% and 2.43%, during the same
periods in 2019. 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. The amount of any further 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 June 30, Assets Revenue Fee Assets Revenue Fee
Schwab money market funds before fee
waivers $ 213,037 $ 164 0.31 % $ 161,998 $ 123 0.30 %
Fee waivers (15 ) -
Schwab money market funds $ 213,037 149 0.28 % $ 161,998 123 0.30 %
Schwab equity and bond funds, ETFs,
and CTFs 274,570 68 0.10 % 261,773 74 0.11 %
Mutual Fund OneSource® and other
non-transaction fee funds 175,067 135 0.31 % 192,227 152 0.32 %
Other third-party mutual funds and
ETFs (1) 416,242 73 0.07 % 471,638 79 0.07 %
Total mutual funds, ETFs, and CTFs
(2) $ 1,078,916 425 0.16 % $ 1,087,636 428 0.16 %
Advice solutions (2)
Fee-based $ 260,653 314 0.48 % $ 243,050 295 0.49 %
Non-fee-based 69,234 - - 69,274 - -
Total advice solutions $ 329,887 314 0.38 % $ 312,324 295 0.38 %
Other balance-based fees (3) 407,796 45 0.04 % 408,929 54 0.05 %
Other (4) 17 9
Total asset management and
administration fees $ 801 $ 786
2020 2019
Average Average
Client Average Client Average
Six Months Ended June 30, Assets Revenue Fee Assets Revenue Fee
Schwab money market funds before fee
waivers $ 208,405 $ 316 0.30 % $ 160,133 $ 245 0.31 %
Fee waivers (15 ) -
Schwab money market funds $ 208,405 $ 301 0.29 % $ 160,133 $ 245 0.31 %
Schwab equity and bond funds, ETFs,
and CTFs 282,689 144 0.10 % 253,048 144 0.11 %
Mutual Fund OneSource ® and other
non-transaction fee funds 181,825 282 0.31 % 189,725 299 0.32 %
Other third-party mutual funds and
ETFs (1) 434,100 150 0.07 % 462,050 154 0.07 %
Total mutual funds, ETFs, and
CTFs (2) $ 1,107,019 877 0.16 % $ 1,064,956 842 0.16 %
Advice solutions (2)
Fee-based $ 261,954 626 0.48 % $ 236,722 573 0.49 %
Non-fee-based 70,232 - - 68,015 - -
Total advice solutions $ 332,186 626 0.38 % $ 304,737 573 0.38 %
Other balance-based fees (3) 420,321 99 0.05 % 400,560 106 0.05 %
Other (4) 26 20
Total asset management and
administration fees $ 1,628 $ 1,541
(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 $15 million , or 2%, and
$87 million , or 6% in the second quarter and first six months of 2020,
respectively, compared to the same periods in 2019. These increases were
primarily driven by higher balances in purchased money market funds and advice
solutions, including managed account assets from USAA, in the second quarter and
first six months of 2020 relative to the same periods in 2019. These increases
were partially offset by the effect of money market fund fee waivers due to
declining portfolio yields, lower Mutual Fund OneSource® balances, and lower
equity market valuations in the first quarter and the beginning of the second
quarter of 2020. The amount of fee waivers in coming
- 10 -
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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)
quarters is dependent on a variety of factors, including the level of short-term interest rates and client preferences across our money market fund line-up.
The following tables present 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
44% and 45% of the asset management and administration fees earned during the
second quarter and first six months, respectively, of both 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 June 30, 2020 2019 2020 2019 2020 2019
Balance at beginning of
period $ 203,728 $ 159,669 $ 235,623 $ 240,887 $ 161,639 $ 195,116
Net inflows (outflows) 7,625 7,539 (1,416 ) 6,133 (4,488 ) (4,937 )
Net market gains (losses)
and other 205 856 39,139 7,440 35,848 7,598
Balance at end of period
$ 254,460 $ 192,999 $ 197,777 Schwab Money Schwab Equity and Mutual Fund OneSource® Market Funds Bond Funds, ETFs, and CTFs and Other NTF funds Six Months Ended June 30, 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) 9,614 12,691 5,115 13,381 (15,053 ) (11,143 ) Net market gains (losses) and other 1,118 1,901 (18,044 ) 31,608 5,984 28,388
Balance at end of period
$ 254,460 $ 192,999 $ 197,777 Trading Revenue The following table presents trading revenue and related information: Six Months Ended Three Months Ended June 30, Percent June 30, Percent 2020 2019 Change 2020 2019 Change Trading revenue (1) $ 193$ 207 (7 )%$ 381 $ 424 (10 )% Clients' daily average trades (DATs) (in thousands) 1,619 716 126 % 1,580 746 112 % Number of trading days 63.0 63.0 - 125.0 124.0 1 % Revenue per trade (2) $ 1.89$ 4.59 (59 )%$ 1.93 $ 4.58 (58 )%
Note: Effective
options.
(1) Beginning 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$14 million , or 7%, and$43 million , or 10%, in the second quarter and first six months of 2020 compared to the same periods 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. Order flow revenue was$72 million and$33 million during the second quarters of 2020 and 2019, and$127 million and$65 million during the first six months of 2020 and 2019, respectively. The increases in order flow revenue during the second quarter and first six months of 2020 compared to the same periods in 2019 were 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$12 million , or 15%, and$52 million , or 35% in the second quarter and first six months of 2020, respectively, - 11 - -------------------------------------------------------------------------------- THE CHARLES SCHWAB CORPORATION Management's Discussion and Analysis of Financial Condition and Results of Operations (Tabular Amounts in Millions, Except Ratios, or as Noted) compared to the same periods in 2019. These decreases were primarily driven by a gain from the sale of a portfolio management and reporting software solution for advisors toTamarac Inc. recognized in the second quarter of 2019, a gain from the assignment of leased office space recognized in the first quarter of 2019, and an increase in the allowance for credit losses on bank loans in the first quarter of 2020. Total Expenses Excluding Interest The following table shows a comparison of expenses excluding interest: Three Months Ended Six Months Ended June 30, Percent June 30, Percent 2020 2019 Change 2020 2019 Change
Compensation and benefits Salaries and wages$ 523 $ 476 10 %$ 1,025 $ 952 8 % Incentive compensation 181 198 (9 )% 408 414 (1 )% Employee benefits and other 115 133 (14 )% 283 291 (3 )% Total compensation and benefits$ 819 $ 807 1 %$ 1,716 $ 1,657 4 % Professional services 198 178 11 % 380 348 9 % Occupancy and equipment 152 133 14 % 294 264 11 % Advertising and market development 70 77 (9 )% 137 146 (6 )% Communications 78 62 26 % 153 124 23 % Depreciation and amortization 109 84 30 % 205 167 23 % Regulatory fees and assessments 36 30 20 % 70 62 13 % Other 100 74 35 % 177 136 30 % Total expenses excluding interest$ 1,562 $ 1,445 8 %$ 3,132 $ 2,904 8 % Expenses as a percentage of total net revenues Compensation and benefits 33 % 30 % 34 % 31 % Advertising and market development 3 % 3 % 3 % 3 % Full-time equivalent employees (in thousands) At quarter end 21.8 20.5 6 % Average 21.3 20.2 5 % 20.6 20.0 3 % Expenses excluding interest increased by 8% in the second quarter and first six months of 2020 compared to the same periods in 2019. Adjusted total expenses, excluding acquisition and integration-related costs, and amortization of acquired intangible assets, increased 2% and 4% in the second quarter and first six months of 2020, respectively. See Non-GAAP Financial Measures for further details and a reconciliation of such measures to GAAP reported results. Total compensation and benefits increased in the second quarter and first six months of 2020 compared to the same periods in 2019, primarily due to an increase in employee headcount to support our expanding client base, including approximately 400 former USAA employees hired in connection with the USAA-IMCO acquisition, partially offset by a lower corporate bonus accrual. The year-to-date increase also reflected 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 second quarter and first six months of 2020 compared to the same periods in 2019, primarily due to expenses relating to our completed and pending acquisitions. Occupancy and equipment expense increased in the second quarter and first six months of 2020 compared to the same periods in 2019, primarily due to an increase in technology equipment costs associated with higher customer trade volumes. Communications expense increased in the second quarter and first six months of 2020 compared to the same periods 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 second quarter and first six months of 2020 compared to the same periods in 2019, primarily due to higher amortization of purchased and internally developed software, higher depreciation of buildings - 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) and equipment related to expansion of our campuses in theU.S. in 2019 and 2020, as well as higher amortization of acquired intangible assets due to acquisitions completed in the second quarter of 2020. Other expenses increased in the second quarter and first six months of 2020 compared to the same periods in 2019, primarily resulting from acquisition and integration-related costs and increases in processing fees and related expenses due to higher customer trade volumes and market volatility. These increases were partially offset by lower travel and entertainment expense. Capital expenditures were$169 million and$419 million in the second quarter and first six months of 2020, respectively compared with$173 million and$354 million in the second quarter of 2019, respectively. The year to date 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 six months 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.
Taxes on Income
Taxes on income were$217 million and$299 million for the second quarters of 2020 and 2019, respectively, resulting in effective income tax rates on income before taxes of 24.4% and 24.2%, respectively. Taxes on income were$469 million and$599 million for the first six months of 2020 and 2019, respectively, resulting in effective income tax rates on income before taxes of 24.2% and 24.0%, respectively. The increase in the effective tax rate in the second quarter and first six months of 2020 compared to the same periods in 2019 was due to an increase in nondeductible acquisition costs andFDIC insurance premium disallowance, as well as a decrease in equity compensation tax deduction benefits. Partially offsetting the increase in the effective tax rate from these items was a lower effective state income tax rate and an increase in Low-Income Housing Tax Credit (LIHTC) benefits in the second quarter and first six months of 2020. - 13 -
--------------------------------------------------------------------------------
THE CHARLES SCHWAB CORPORATION
Management's Discussion and Analysis of Financial Condition and Results of
Operations
(Tabular Amounts in Millions, Except Ratios, or as Noted)
Segment Information
Financial information for our segments is presented in the following tables:
Investor Services Advisor Services Total
Three Months Ended
June 30, Percent Change 2020 2019 PercentChange 2020 2019 Percent Change 2020 2019 Net Revenues Net interest revenue (18 )%$ 952 $ 1,154 (4 )%$ 437 $ 455 (14 )%$ 1,389 $ 1,609 Asset management and administration fees 4 % 583 560 (4 )% 218 226 2 % 801 786 Trading revenue (1) (1 )% 138 140 (18 )% 55 67 (7 )% 193 207 Other (1) 38 % 51 37 (62 )% 16 42 (15 )% 67 79 Total net revenues (9 )% 1,724 1,891 (8 )% 726 790 (9 )% 2,450 2,681 Expenses Excluding Interest 11 % 1,168 1,057 2 % 394 388 8 % 1,562 1,445 Income before taxes on income (33 )%$ 556 $ 834 (17 )%$ 332 $ 402 (28 )%$ 888 $ 1,236 Net New Client Assets (in billions) (2) N/M$ 113.0 $ 17.9 26 %$ 24.4 $ 19.3 N/M$ 137.4 $ 37.2 Investor Services Advisor Services Total Six Months Ended June 30, Percent Change 2020 2019 Percent Change 2020 2019 Percent Change 2020 2019 Net Revenues Net interest revenue (11 )%$ 2,080 $ 2,349 (6 )%$ 881 $ 941 (10 )%$ 2,961 $ 3,290 Asset management and administration fees 8 % 1,183 1,093 (1 )% 445 448 6 % 1,628 1,541 Trading revenue (1) (9 )% 257 281 (13 )% 124 143 (10 )% 381 424 Other (1) (10 )% 71 79 (63 )% 26 70 (35 )% 97 149 Total net revenues (6 )% 3,591 3,802 (8 )% 1,476 1,602 (6 )% 5,067 5,404 Expenses Excluding Interest 10 % 2,322 2,119 3 % 810 785 8 % 3,132 2,904 Income before taxes on income (25 )%$ 1,269 $ 1,683 (18 )%$ 666 $ 817 (23 )%$ 1,935 $ 2,500 Net New Client Assets (in billions) (2) N/M$ 148.3 $ 47.1 49 %$ 62.3 $ 41.8 137 %$ 210.6 $ 88.9 (1) Beginning 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) For the second quarter and first six months of 2020, Investor Services includes inflows of$79.9 billion related to the acquisition of the assets of USAA-IMCO and$10.9 billion from a mutual fund clearing services client. N/M Not meaningful.
Investor Services
Total net revenues decreased by 9% and 6% in the second quarter and first six
months of 2020, respectively, compared to the same periods in 2019, primarily
due to decreases in net interest revenue and trading 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, which more than offset higher
trading volume seen in the first six months of 2020. Asset management and
administration fees increased primarily due to increased balances in purchased
money market funds and advice solutions, partially offset by money market fund
fee waivers due to declining portfolio yields, lower Mutual Fund OneSource®
balances, and lower equity market valuations in the first quarter and beginning
of the second quarter of 2020.
- 14 -
--------------------------------------------------------------------------------
THE CHARLES SCHWAB CORPORATION
Management's Discussion and Analysis of Financial Condition and Results of
Operations
(Tabular Amounts in Millions, Except Ratios, or as Noted)
Expenses excluding interest increased by 11% and 10% in the second quarter and
first six months of 2020, respectively, compared to the same periods in 2019,
primarily due to higher compensation and benefits, professional services,
occupancy and equipment, depreciation and amortization, and other expenses.
Compensation and benefits increased primarily due to increased headcount to
support our expanding client base, including approximately 400 former USAA
employees hired in connection with the USAA-IMCO acquisition, as well as the
Company's payment of $1,000 to all non-officer employees in March 2020 to help
them cover costs incurred due to the COVID-19 pandemic, partially offset by a
lower corporate bonus accrual. The professional services increase was driven
primarily by expenses related to our completed and pending acquisitions and
overall growth in the business. Occupancy and equipment expenses increased
primarily due to technology equipment costs associated with higher customer
trade volumes. Depreciation and amortization increased primarily due to higher
amortization of purchased and internally developed software, higher depreciation
of buildings and equipment related to our campus expansion, as well as higher
amortization of acquired intangible assets due to acquisitions completed in the
second quarter of 2020. Other expenses increased primarily due to increases in
processing fees and related expenses due to higher customer trade volumes and
market volatility, as well as acquisition and integration-related costs,
partially offset by lower travel and entertainment expenses.
Advisor Services
Total net revenues decreased by 8% in both the second quarter and first six months of 2020, compared to the same periods in 2019, due to decreases in net interest revenue, asset management and administration fees, trading revenue, and other revenue. Net interest revenue decreased primarily due to lower average investment yields, partially offset by growth in interest-earning assets. Asset management and administration fees decreased primarily due to lowerMutual Fund OneSource® balances and lower equity market valuations in the first quarter and beginning of the second quarter of 2020, partially offset by increased balances in purchased money market funds. 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 from the sale of a portfolio management and reporting software solution for advisors toTamarac Inc. recognized in the second quarter of 2019, and a gain from the assignment of leased office space recognized in the first quarter of 2019. Expenses excluding interest increased by 2% and 3% in the second quarter and first six months of 2020, respectively, compared to the same periods in 2019, primarily due to higher professional services, occupancy and equipment expenses, and depreciation and amortization. The increase in professional services was driven by expenses related to our acquisitions and overall growth in the business. Occupancy and equipment expenses increased primarily due to technology equipment costs associated with higher customer trade volumes. Depreciation and amortization expense increased primarily due to higher amortization of purchased and internally developed software, and higher depreciation of buildings and equipment related to expansion of our campuses in theU.S. in 2019 and 2020. 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
- 15 -
--------------------------------------------------------------------------------
THE CHARLES SCHWAB CORPORATION
Management's Discussion and Analysis of Financial Condition and Results of
Operations
(Tabular Amounts in Millions, Except Ratios, or as Noted)
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 beginning June 30, 2020 and
December 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:
June 30, 2020 December 31, 2019
Increase of 100 basis points 14.2 % 4.8 %
Decrease of 100 basis points (5.0 )% (7.4 )%
The change in net interest revenue sensitivities as of June 30, 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 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 second quarter and first six months of 2020, the downward assessments of our net interest revenue and EVE simulations as ofJune 30, 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 assessed 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, and we have sold certain securities lacking appropriate fall-back language. 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. - 16 - --------------------------------------------------------------------------------THE CHARLES SCHWAB CORPORATION Management's Discussion and Analysis of Financial Condition and Results of Operations (Tabular Amounts in Millions, Except Ratios, or as Noted) 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. In addition to internal sources of liquidity, Schwab has access to external funding. The following table describes external debt facilities available atJune 30, 2020 : Description Borrower
Outstanding
subsidiaries $
-
Banking
Federal Reserve discount window (2) subsidiaries - 8,814
Uncommitted, unsecured lines of credit with
various external banks CSC, CS&Co - 1,592
Unsecured commercial paper CSC - 750
Committed, unsecured credit facility with
various external banks CSC - 700
(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.
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 June 30, 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 atJune 30, 2020 . The table below presents information about our average daily LCR: Average for the Three Months Ended June 30, 2020 Total eligible high quality liquid assets $ 65,038 Net cash outflows $ 58,351 LCR 112 % - 17 -
--------------------------------------------------------------------------------
THE CHARLES SCHWAB CORPORATION
Management's Discussion and Analysis of Financial Condition and Results of
Operations
(Tabular Amounts in Millions, Except Ratios, or as Noted)
Borrowings
The following are details of the Senior Notes:
Par Weighted Average Standard
June 30, 2020 Outstanding Maturity Interest Rate Moody's & Poor's Fitch
Senior Notes $ 8,581 2020 - 2030 3.37% A2 A A
2020 Debt Issuances
The 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 %
2020 Equity Issuances
CSC's preferred stock issued and net proceeds for 2020 are as follows:
Date Issued and Sold Net Proceeds
Series G April 30, 2020 $ 2,470 For further discussion of CSC's debt and equity, see Item 1 - Notes 9 and 13.
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. As a result of the significant inflow of client cash in the first six months of 2020, our consolidated Tier 1 Leverage Ratio declined from 7.3% at year-end 2019 to 5.9% atJune 30, 2020 , below our long-term operating objective of 6.75%-7.00% but well above the regulatory minimum of 4.00%. The pace of our return to the long-term operating objective over time depends on a number of factors including the overall size of the Company's balance sheet, earnings, and capital issuance and deployment. We continue to manage 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 15. As of
- 18 -
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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
June 30, 2020 (1)
CSC CSB CSC CSB
Total stockholders' equity $ 30,815 $ 20,960 $ 21,745 $ 14,832
Less:
Preferred stock 5,263 - 2,793 -
Common Equity Tier 1 Capital before
regulatory adjustments $ 25,552 $ 20,960 $ 18,952 $ 14,832
Less:
Goodwill , net of associated deferred tax
liabilities $ 1,691 $ 13 $ 1,184 $ 13
Other intangible assets, net of associated
deferred tax liabilities 1,254 - 104 -
Deferred tax assets, net of valuation
allowances and deferred tax liabilities 4 - 4 -
AOCI adjustment (1) 5,611 4,892 - -
Common Equity Tier 1 Capital $ 16,992 $ 16,055 $ 17,660 $ 14,819
Tier 1 Capital $ 22,255 $ 16,055 $ 20,453 $ 14,819
Total Capital 22,288 16,087 20,472 14,837
Risk-Weighted Assets 107,253 85,051 90,512 71,521
Total Leverage Exposure 382,963 283,511 286,813 216,582
Common Equity Tier 1 Capital/Risk-Weighted
Assets 15.8 % 18.9 % 19.5 % 20.7 %
Tier 1 Capital/Risk-Weighted Assets 20.8 % 18.9 % 22.6 % 20.7 %
Total Capital/Risk-Weighted Assets 20.8 % 18.9 % 22.6 % 20.7 %
Tier 1 Leverage Ratio 5.9 % 5.8 % 7.3 % 7.1 %
Supplementary Leverage Ratio 5.8 % 5.7 % 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 June 30, 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 June 30, 2020 , CS&Co was in compliance with its net capital
requirements.
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 15 for additional information on the components of
stockholders' equity and information on the capital requirements of significant
subsidiaries.
- 19 -
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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 six months of 2020 and
2019 are as follows:
2020 2019
Per Share Per Share
Six Months Ended June 30, Cash Paid Amount Cash Paid Amount
Common Stock $ 466 $ .36 $ 456 $ .34
Series A Preferred Stock (1) 14 35.00 14 35.00
Series C Preferred Stock (2) 18 30.00 18 30.00
Series D Preferred Stock (2) 22 29.76 22 29.76
Series E Preferred Stock (3) 14 2,312.50 14 2,312.50
Series F Preferred Stock (4) 13 2,500.00 13 2,500.00
Series G Preferred Stock (5) N/A N/A N/A N/A
(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.
(5) Series G Preferred Stock was issued on April 30, 2020 . Dividends paid
quarterly beginning on September 1, 2020 .
N/A Not applicable.
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 second quarter and first six months of 2020. As ofJune 30, 2020 ,$1.8 billion remained on our existing authorization. OTHER Foreign Exposure AtJune 30, 2020 , Schwab had exposure to non-sovereign financial and non-financial institutions in foreign countries, as well as agencies of foreign governments. AtJune 30, 2020 , the fair value of these holdings totaled$8.2 billion , with the top three exposures being to issuers and counterparties domiciled inFrance at$5.5 billion ,Sweden at$688 million , andCanada at$607 million . In addition, Schwab had outstanding margin loans to foreign residents of$531 million atJune 30, 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 6, Note 7, Note 9, Note 10, and Note 11, 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 six months of 2020.
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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)
NON-GAAP FINANCIAL MEASURES
In addition to disclosing financial results in accordance with generally accepted accounting principles in theU.S. (GAAP), Management's Discussion and Analysis of Financial Condition and Results of Operations contain references to the non-GAAP financial measures described below. We believe these non-GAAP financial measures provide useful supplemental information about the financial performance of the Company, and facilitate meaningful comparison of Schwab's results in the current period to both historic and future results. These non-GAAP measures should not be considered a substitute for, or superior to, financial measures calculated in accordance with GAAP, and may not be comparable to non-GAAP financial measures presented by other companies. Schwab's use of non-GAAP measures is reflective of certain adjustments made to GAAP financial measures as described below. Non-GAAP Adjustment Usefulness to
Management and
or Measure Definition Investors
Acquisition and Schwab adjusts certain GAAP We exclude acquisition and
integration-related financial measures to exclude integration-related costs and
costs and the impact of acquisition and amortization of acquired intangible
amortization of integration-related costs assets for the purpose of
acquired intangible incurred as a result of the calculating certain non-GAAP
assets Company's completed and measures because we believe doing so
pending acquisitions, provides additional transparency of
amortization of acquired Schwab's ongoingoperations, and may
intangible assets, and, where be useful in both evaluating the
applicable, the income tax operating performance of the
effect of these expenses. business and facilitating comparison
of results with prior and future
Adjustments made to exclude periods.
amortization of acquired
intangible assets are Acquisition andintegration-related
reflective of all acquired costs fluctuate based on the timing
intangible assets, which were of acquisitions and integration
recorded as part of purchase activities, thereby limiting
accounting. These acquired comparability of results among
intangible assets contribute periods, and are not representative
to the Company's revenue of the costs of running the
generation. Amortization of Company's ongoing business.
acquired intangible assets Amortization of acquired intangible
will continue in future assets is excluded because
periods over their remaining management does not believe it is
useful lives. indicative of the Company's
underlying operating performance.Return on tangible Return on tangible common Acquisitions typically result in the common equity equity represents annualized recognition of significant amounts
adjusted net income available of goodwill and acquired intangible
to common stockholders as a assets. We believe return on
percentage of average tangible common equity may be useful
tangible common equity. to investors as a supplemental
Tangible common equity measure to facilitate assessing
represents common equity less capital efficiency and returns
goodwill, acquired intangible relative to the composition of
assets - net, and related Schwab's balance sheet.
deferred tax liabilities.
The following tables present reconciliations of GAAP measures to non-GAAP
measures:
Three Months Ended June 30, Six Months Ended June 30,
2020 2019 2020 2019
Total expenses excluding interest
(GAAP) $ 1,562 $ 1,445 $ 3,132 $ 2,904
Acquisition and
integration-related costs (1) (81 ) (3 ) (118 ) (4 )
Amortization of acquired
intangible assets (12 ) (7 ) (18 ) (14 )
Adjusted total expenses (Non-GAAP)
2,996
(1) Acquisition and integration-related expenses are primarily included in Professional services and Other.
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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)
Three Months Ended June 30, Six Months Ended June 30,
2020 2019 2020 2019
Amount Diluted EPS Amount Diluted EPS Amount Diluted EPS Amount Diluted EPS
Net income available to common
stockholders (GAAP),
Earnings per common share -
diluted (GAAP) $ 621 $ .48 $ 887 $ .66 $ 1,378 $ 1.07 $ 1,812 $ 1.35
Acquisition and
integration-related costs 81 .07 3 - 118 .09 4 -
Amortization of acquired
intangible assets 12 .01 7 .01 18 .01 14 .01
Income tax effects (1) (22 ) (.02 ) (2 ) - (33 ) (.03 ) (4 ) -
Adjusted net income available to
common stockholders
(Non-GAAP), Adjusted diluted EPS
(Non-GAAP) $ 692 $ .54 $ 895 $
.67
(1) The income tax effects of the non-GAAP adjustments are determined using an
effective tax rate reflecting the exclusion of non-deductible acquisition costs
and are used to present the acquisition and integration-related costs and
amortization of acquired intangible assets on an after-tax basis.
Three Months Ended June 30 ,
Six Months Ended
2020 2019 2020 2019
Return on average common stockholders'
equity (GAAP) 10 % 19 % 12 % 20 %
Average common stockholders' equity
$ 22,253 $ 18,202 Less: Average goodwill (1,480 ) (1,227 ) (1,480 ) (1,227 ) Less: Average acquired intangible assets - net (700 ) (143 ) (703 ) (146 ) Plus: Average deferred tax liabilities related to goodwill and acquired intangible assets - net 67 67 67 67
Average tangible common equity
$ 20,137 $ 16,896 Adjusted net income available to common stockholders (1) $ 692 $ 895$ 1,481 $ 1,826 Return on tangible common equity (Non-GAAP) 12 % 21 % 15 % 22 %
(1) See table above for the reconciliation of net income available to common stockholders to adjusted net income available to common stockholders (non-GAAP).
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THE CHARLES SCHWAB CORPORATION © Edgar Online, source
