CHARLES SCHWAB FORWARD-LOOKING STATEMENTS
In addition to historical information, this Annual Report on Form 10-K 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; and
maintaining our market position (see Business Strategy and Competitive
Environment and Products and Services in Part I, Item 1);
•Expected benefits from the TD Ameritrade and other recently completed
acquisitions; and expected timing for the TD Ameritrade integration (see
Business and Asset Acquisitions in Part I, Item 1; Overview - Business and Asset
Acquisitions in Part II, Item 7; Business Acquisitions in Part II, Item 8 - Note
3; and Exit and Other Related Liabilities in Note 16);
•The migration of IDA balances to our balance sheet (see Business and Asset
Acquisitions - Acquisition of TD Ameritrade in Part I, Item 1; Capital
Management - Regulatory Capital Requirements in Part II, Item 7; and Commitments
and Contingencies in Part II, Item 8 - Note 15);
•The impact of legal proceedings and regulatory matters (see Legal Proceedings
in Part I, Item 3; and Commitments and Contingencies in Part II, Item 8 - Note
15);
•Advancing strategic goals to drive scale, monetization and segmentation (see
Overview in Part II, Item 7);
•Cost estimates and timing related to the TD Ameritrade integration, including
acquisition and integration-related costs and capital expenditures, cost
synergies, and exit and other related costs (see Overview - Business and Asset
Acquisitions in Part II, Item 7; Results of Operations - Total Expenses
Excluding Interest; and Exit and Other Related Liabilities in Part II, Item 8 -
Note 16);
•The adjustment of rates paid on client-related liabilities; net interest margin
compression and net interest revenue; and money market fund fee waivers (see
Results of Operations - Net Interest Revenue and Asset Management and
Administration Fees in Part II, Item 7);
•Capital expenditures; and increased spending to improve service levels and
support growth (see Results of Operations - Total Expenses Excluding Interest in
Part II, Item 7);
•The phase-out of the use of LIBOR (see Risk Management - Expected Phase-out of
LIBOR in Part II, Item 7);
•Sources of liquidity, capital, and level of dividends; and Tier 1 Leverage
Ratio operating objective (see Liquidity Risk, Capital Management, Regulatory
Capital Requirements, and Dividends in Part II, Item 7);
•The expected impact of new accounting standards not yet adopted (see Summary of
Significant Accounting Policies in Part II, Item 8 - Note 2); and
•The likelihood of indemnification and guarantee payment obligations and clients
failing to fulfill contractual obligations (see Commitments and Contingencies in
Part II, Item 8 - Note 15 and Financial Instruments Subject to Off-Balance Sheet
Credit Risk - Client Trade Settlement in Note 17).
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 Annual
Report on Form 10-K 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;
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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)
•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 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;
•Our ability to support client activity levels;
•The risk that expected cost synergies and other benefits from the TD Ameritrade
and other recent acquisitions may not be fully realized or may take longer to
realize than expected;
•The ability to successfully implement integration strategies and plans relating
to TD Ameritrade;
•The timing of integration-related and other technology projects;
•Real estate and workforce decisions;
•Migrations of BDA balances;
•Prepayment levels for mortgage-backed securities;
•Client cash allocations;
•LIBOR trends;
•Adverse developments in litigation or regulatory matters and any related
charges;
•Potential breaches of contractual terms for which we have indemnification and
guarantee obligations; and
•Client activity, including daily average trades; margin balances; and balance
sheet cash.
Certain of these factors, as well as general risk factors affecting the Company, are discussed in greater detail in Risk Factors in Part I, Item 1A.
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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)GLOSSARY OF TERMS
Active brokerage accounts: Brokerage accounts with activity within the preceding 270 days.
Accumulated Other Comprehensive Income (AOCI): A component of stockholders' equity which includes unrealized gains and losses on available for sale (AFS) securities and net gains or losses associated with pension obligations.
Asset-backed securities: Debt securities backed by financial assets such as loans or receivables.
Assets receiving ongoing advisory services: Market value of all client assets custodied at the Company under the guidance of an independent advisor or enrolled in one of Schwab's advice solutions at the end of the reporting period.
Bank deposit account balances (BDA balances): Clients' uninvested cash balances held off-balance sheet in deposit accounts at unconsolidated third-party financial institutions, pursuant to the IDA agreement and agreements with other third-party financial institutions. Average BDA balances represent the daily average balance for the reporting period.
Basel III: Global regulatory standards on bank capital adequacy and liquidity
issued by the
Basis point: One basis point equals 1/100th of 1%, or 0.01%.
Client assets: The market value, as of the end of the reporting period, of all client assets in our custody, BDA balances, and proprietary products, which includes both cash and securities. Average client assets are the daily average client asset balance for the reporting period. Client cash as a percentage of client assets: Calculated as the value, at the end of the reporting period, of all money market fund balances, bank deposits, Schwab One® balances, BDA balances, and certain cash equivalents divided by client assets. Common Equity Tier 1 (CET1) Capital: The sum of common stock and related surplus net of treasury stock, retained earnings, AOCI, and qualifying minority interests, less applicable regulatory adjustments and deductions. As permitted by the interagency regulatory capital and liquidity rules adopted inOctober 2019 , CSC, as a Category III banking organization, made an election to exclude AOCI from CET1 capital, beginningJanuary 1, 2020 .
Common Equity Tier 1 Risk-Based Capital Ratio: The ratio of
Core net new client assets: Net new client assets before significant one-time inflows or outflows, such as acquisitions/divestitures or extraordinary flows (generally greater than$10 billion ) relating to a specific client. These flows may span multiple reporting periods.
Customer Protection Rule: Refers to Rule 15c3-3 of the Securities Exchange Act of 1934.
Daily Average Trades (DATs): Includes daily average revenue trades by clients, trades by clients in asset-based pricing relationships, and all commission-free trades.
Debt to total capital ratio: Calculated as total debt divided by stockholders' equity and total debt.
Delinquency roll rates: The rates at which loans transition through delinquency stages, ultimately resulting in a loss. Schwab considers a loan to be delinquent if it is 30 days or more past due.
Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act): Regulatory reform legislation containing numerous provisions which expanded prudential regulation of large financial services companies.
Duration: Duration is typically used to measure the expected change in value of a financial instrument for a 1% change in interest rates, expressed in years.
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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)
Final Regulatory Capital Rules: Refers to the regulatory capital rules issued by
U.S. banking agencies which implemented Basel III and relevant provisions of
Dodd-Frank Act, which apply to savings and loan holding companies, as well as
federal savings banks.
First mortgages: Refers to first lien residential real estate mortgage loans.
Full-time equivalent employees: Represents the total number of hours worked divided by a 40-hour work week for the following categories: full-time, part-time, and temporary employees and persons employed on a contract basis.
High Quality Liquid Assets (HQLA): HQLA is defined by theFederal Reserve , but includes assets with low market- and credit risk that are actively traded and readily convertible to cash in times of stress.
Insured Deposit Account (IDA) Agreement: The IDA agreement with the TD Depository Institutions.
Interest-bearing liabilities: Primarily includes bank deposits, payables to brokerage clients, short-term borrowings, and long-term debt on which Schwab pays interest.
Interest-earning assets: Primarily includes cash and cash equivalents, cash and investments segregated, receivables from brokerage clients, investment securities, and bank loans on which Schwab earns interest.
Investment grade: Defined as a rating equivalent to a Moody's Investors Service
(Moody's) rating of "Baa" or higher, or a Standard & Poor's
Liquidity Coverage Ratio (LCR): The ratio of HQLA to projected net cash outflows during a 30-day stress scenario.
Loan-To-Value (LTV) ratio: Calculated as the principal amount of a loan divided by the value of the collateral securing the loan.
Margin loans: Money borrowed against the value of certain stocks, bonds, and mutual funds in a client portfolio. The borrowed money can be used to purchase additional securities or to meet short-term financial needs. Master netting arrangement: An agreement between two counterparties that have multiple contracts with each other that provides for net settlement of all contracts through a single cash payment in the event of default or termination of any one contract.
Mortgage-backed securities: A type of asset-backed security that is secured by a mortgage or group of mortgages.
Net interest margin: Net interest revenue (annualized for interim periods) divided by average interest-earning assets.
Net new client assets: Total inflows of client cash and securities to Schwab less client outflows. Inflows include dividends and interest; outflows include commissions and fees. Capital gains distributions are excluded.
Net Stable Funding Ratio (NSFR): The ratio of the amount of available stable funding relative to the amount of required stable funding.
New brokerage accounts: All brokerage accounts opened during the period, as well as any accounts added via acquisition.
Nonperforming assets: The total of nonaccrual loans and other real estate owned.
Order flow revenue: Net compensation received from markets and firms to which our broker-dealer subsidiaries send equity and options orders. The amount reflects rebates received for certain types of orders, less fees paid for orders where exchange fees or other charges apply.
Pledged Asset Line® (PAL): A non-purpose revolving line of credit from CSB secured by eligible assets held in a separate pledged brokerage account maintained at CS&Co.
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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)Return on average common stockholders' equity: Calculated as net income available to common stockholders (annualized for interim periods) divided by average common stockholders' equity.
Risk-weighted assets: Computed by assigning specific risk-weightings to assets and off-balance sheet instruments for capital adequacy calculations.
Tier 1 Capital: The sum of
Tier 1 Leverage Ratio: End-of-period Tier 1 Capital divided by adjusted average total consolidated assets for the period.
Trading days: Days in which the markets/exchanges are open for the buying and selling of securities. Early market closures are counted as half-days.
Uniform Net Capital Rule: Refers to Rule 15c3-1 under the Securities Exchange
Act of 1934, which specifies minimum capital requirements that are intended to
ensure the general financial soundness and liquidity of broker-dealers at all
times.
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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)
OVERVIEW
Management focuses on several client activity and financial metrics in
evaluating Schwab's financial position and operating performance. We believe
that metrics relating to net new and total client assets, as well as client cash
levels and utilization of advisory services, offer perspective on our business
momentum and client engagement. Data on new and total client brokerage accounts
provides additional perspective on our ability to attract and retain new
business. Total net revenue growth, pre-tax profit margin, EPS, return on
average common stockholders' equity, and the Consolidated Tier 1 Leverage Ratio
provide broad indicators of Schwab's overall financial health, operating
efficiency, and ability to generate acceptable returns. Total expenses excluding
interest as a percentage of average client assets is a measure of operating
efficiency.
Our consolidated financial statements include the results of operations and
financial condition of TD Ameritrade beginning on
Growth Rate 1-Year
2019-2020 2020 2019 2018
Client Metrics
Net new client assets (in billions) (1) N/M $ 1,952.5 $ 222.8 $ 133.9
Core net new client assets (in billions) 33% $ 281.9 $ 211.7 $ 227.8
Client assets (in billions, at year end) 66% $ 6,691.7 $ 4,038.8 $ 3,252.2
Average client assets (in billions) 24% $ 4,579.0 $ 3,682.0 $ 3,409.6
New brokerage accounts (in thousands) (2) N/M 18,627 1,568 1,576
Active brokerage accounts (in thousands, at year
end) 140% 29,629 12,333 11,593
Assets receiving ongoing advisory services (in
billions, at year end) 57% $ 3,300.1 $ 2,106.8 $ 1,708.5
Client cash as a percentage of client assets (at
year end) 12.3 % 11.3 % 12.8 %
Company Financial Metrics
Total net revenues 9% $ 11,691 $ 10,721 $ 10,132
Total expenses excluding interest 26% 7,391 5,873 5,570
Income before taxes on income (11)% 4,300 4,848 4,562
Taxes on income (13)% 1,001 1,144 1,055
Net income (11)% $ 3,299 $ 3,704 $ 3,507
Preferred stock dividends and other 44% 256 178 178
Net income available to common stockholders (14)% $ 3,043 $ 3,526 $ 3,329
Earnings per common share - diluted (21)% $ 2.12 $ 2.67 $ 2.45
Net revenue growth from prior year 9 % 6 % 18 %
Pre-tax profit margin 36.8 % 45.2 % 45.0 %
Return on average common stockholders' equity 9 % 19 % 19 %
Expenses excluding interest as a percentage of
average client assets 0.16 % 0.16 % 0.16 %
Consolidated Tier 1 Leverage Ratio (at year end) 6.3 % 7.3 % 7.1 %
Non-GAAP Financial Measures (3)
Adjusted total expenses (4) $ 6,759 $ 5,820 $ 5,541
Adjusted diluted EPS $ 2.45 $ 2.70 $ 2.46
Return on tangible common equity 15 % 21 % 21 %
(1) 2020 includes inflows of $1.6 trillion related to the acquisition of TD
Ameritrade, $79.9 billion related to the acquisition of the assets of USAA-IMCO,
$8.5 billion related to the acquisition of Wasmer Schroeder, and an inflow of
$10.9 billion from a mutual fund clearing services client. 2019 includes inflows
of $11.1 billion from certain mutual fund clearing services clients. 2018
includes outflows of $93.9 billion from certain mutual fund clearing services
clients.
(2) 2020 includes 14.5 million new brokerage accounts related to the acquisition
of TD Ameritrade and 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. Percentage changes greater than 200% are presented as not
meaningful.
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THE CHARLES SCHWAB CORPORATIONManagement's Discussion and Analysis of Financial Condition and Results of
Operations
(Tabular Amounts in Millions, Except Ratios, or as Noted)2020 Compared to 2019
Throughout the extraordinary macroeconomic environment that persisted during 2020, Schwab continued to execute on key strategic initiatives, and produced solid financial results. The impact of COVID-19, along with social and political turmoil, created an unprecedented combination of personal and macroeconomic challenges for our clients, employees, and stockholders. While working through these challenges, we progressed in advancing the Company's strategic goals to drive scale, monetization, and segmentation in ways that benefit our clients. Among the Company's key accomplishments in 2020 were the successful completion of the acquisition of TD Ameritrade and three other strategic acquisitions, as discussed below. The COVID-19 pandemic's rapid escalation in early 2020 was accompanied by volatile equity markets and theFederal Reserve's further easing of monetary policy. As the year progressed, government aid packages and vaccine developments helped settle the markets, with the S&P 500® erasing its pandemic-related losses to finish up 16% for the year. Throughout 2020, client engagement with the financial markets greatly increased over the prior year, as client trading activity reached record levels. Core net new assets totaled$281.9 billion in 2020, representing our third consecutive year of over$200 billion . Total client assets reached$6.69 trillion spread across 29.6 million brokerage accounts, up 66% and 140%, respectively, from year-end 2019. Against this backdrop, Schwab's net income totaled$3.3 billion , down$405 million , or 11% from 2019, while the Company produced diluted EPS of$2.12 , representing a decrease of 21% relative to 2019. Adjusted diluted EPS (1), which excludes acquisition and integration-related costs, amortization of acquired intangible assets, and related income tax effects, amounted to$2.45 in 2020, down 9% from$2.70 in 2019. Total net revenues reached$11.7 billion for the year, increasing 9% from 2019. DuringMarch 2020 , theFederal Reserve acted to support the economy by cutting the Fed Funds rate from 1.75% to near zero and announcing significant asset purchase programs. Mortgage refinancing activity subsequently accelerated, and our net interest margin was impacted by both significantly lower interest rates and increased prepayments of mortgage-backed securities held in our investment portfolio. Strong growth in interest-earning assets via client inflows and allocation decisions, as well as our acquisitions of TD Ameritrade and assets of USAA-IMCO, helped limit the decrease in net interest revenue to 6%, resulting in a full-year 2020 total of$6.1 billion . Growing balances in advisory solutions and a rebound in equity markets in 2020 helped drive an 8% increase in asset management and administration fees, which totaled$3.5 billion in 2020. Record client trading activity and the addition of TD Ameritrade in the fourth quarter contributed to an 88% increase in trading revenue, which reached$1.4 billion for the year, more than offsetting a full-year impact of the commission reductions implemented in the fourth quarter of 2019. With the TD Ameritrade acquisition, our fourth quarter 2020 results included bank deposit account fee revenue for the first time, which totaled$355 million for the period fromOctober 6 , throughDecember 31, 2020 . Total expenses excluding interest increased 26% in 2020 to$7.4 billion , which included significant costs related to our acquisitions. With the completion of four acquisitions during the year, acquisition and integration-related costs totaled$442 million in 2020, representing a significant increase from the$26 million incurred in 2019. Amortization of acquired intangible assets also increased, totaling$190 million in 2020 compared with$27 million in 2019. Exclusive of these items (1), adjusted total expenses increased 16% from 2019. Return on average common stockholders' equity was 9% in 2020, down from 19% in 2019. Return on tangible common equity (1) (ROTCE) was 15% in 2020, down from 21% in 2019. The 2020 decreases in both return on average common stockholders' equity and ROTCE are due to lower net income as well as significantly higher balances of common equity due to the TDA acquisition and higher AOCI in 2020, driven by unrealized gains in our AFS investment portfolio. (1) Adjusted diluted EPS, adjusted total expenses, 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. - 33 - --------------------------------------------------------------------------------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)
Throughout 2020, the Company maintained its disciplined approach to capital
management, helping sustain significant balance sheet growth. Schwab's
consolidated total assets ended 2020 at $549 billion , representing growth of
$255 billion , or 87%, from year-end 2019, reflecting both our organic growth as
well as the acquisitions of TD Ameritrade and the assets of USAA-IMCO. Through
offerings in April and December, the Company issued preferred stock totaling
approximately $5 billion in 2020, bringing total preferred stock to
approximately $7.7 billion , or approximately 25% of Tier 1 Capital at December
31, 2020 . The Company's Tier 1 Leverage Ratio was 6.3% at December 31, 2020 .
Business and Asset Acquisitions
TD Ameritrade
EffectiveOctober 6, 2020 , the Company completed its acquisition of TD Ameritrade. TD Ameritrade provides securities brokerage services, including trade execution, clearing services, and margin lending, through its broker-dealer subsidiaries; and futures and foreign exchange trade execution services through its FCM and FDM subsidiary. At the time of closing, TD Ameritrade had approximately$1.6 trillion in client assets and approximately 14.5 million brokerage accounts. In exchange for each share of TD Ameritrade common stock, TD Ameritrade stockholders received 1.0837 shares of CSC common stock, except for TD Bank and its affiliates which received a portion in nonvoting common stock. In connection with the transaction, Schwab issued approximately 586 million common shares to TD Ameritrade stockholders consisting of approximately 509 million shares of common stock and 77 million shares of nonvoting common stock. Upon completion of the acquisition,TDA Holding became a wholly-owned subsidiary of CSC. See Item 8 - Note 3 for more information. For the period ofOctober 6 , throughDecember 31, 2020 , total net revenues and total expenses excluding interest attributable to TD Ameritrade were approximately$1.7 billion and$943 million , respectively. TD Ameritrade's primary sources of revenues include trading revenue, bank deposit account fees, net interest revenue, and asset management and administration fees. Bank deposit account fee revenue is primarily earned through the Company's IDA agreement. TD Ameritrade's assets and liabilities have been revalued and recorded at their provisional estimated fair value as of the date of acquisition. The integration of TD Ameritrade's operations is expected to occur over 18 to 36 months from the date of acquisition, and the Company expects to continue to incur significant acquisition and integration-related costs and integration-related capital expenditures throughout the integration process. Such costs have included and are expected to continue to include professional fees, such as legal, advisory, and accounting fees, and compensation and benefits expenses for employees and contractors involved in the integration work, costs for technology enhancements, as well as exit and other related costs incurred to attain anticipated synergies. Such costs include employee compensation and benefits, including severance pay, other termination benefits and retention costs, as well as costs related to facility closures, including accelerated depreciation or impairments of assets in those locations. The Company currently estimates that total acquisition and integration-related costs and capital expenditures related to the integration of TD Ameritrade will be approximately$1.6 billion . The Company is in the early stages of integration, and our estimates of the nature, amounts, and timing of recognition of acquisition and integration-related costs are subject to change based on a number of factors, including the expected duration and complexity of the integration process and the heightened uncertainty of the current economic environment. More specifically, factors that could cause variability in our expected acquisition and integration-related costs include the level of employee attrition, workforce redeployment from eliminated positions into open roles, changes in the levels of client activity, as well as increased real estate-related exit cost variability due to effects of the COVID-19 pandemic. Acquisition and integration-related costs, which includes related exit costs, for all of our acquisitions completed in 2020 totaled$442 million , and the Company expects to incur a roughly consistent amount in 2021 related primarily to continued work on the integration of TD Ameritrade. While inclusion of TD Ameritrade's operating costs and continued acquisition and integration-related costs will increase the Company's total expenses excluding interest in 2021 and going forward, we expect to realize cost synergies through integration. Over the course of the integration, we expect to realize annualized cost synergies of between$1.8 billion and$2.0 billion , with one-quarter to one-third on an annualized run-rate basis expected by the end of the first year following acquisition. Estimated timing and amounts of synergy realization are subject to change as we progress in the integration. See also Results of Operations - Total Expenses Excluding Interest, Non-GAAP Financial Measures, and Item 8 - Notes 3 and 16. - 34 - --------------------------------------------------------------------------------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)Assets of USAA-IMCO
OnMay 26, 2020 , the Company completed its acquisition of the assets of USAA-IMCO for$1.6 billion in cash. 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 has added 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 8 - Note 3 for more information on the USAA-IMCO acquisition.
Other
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 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 of Wasmer Schroeder, which adds established strategies and new separately managed account offerings to our existing fixed income lineup.
2019 Compared to 2018
Schwab delivered solid financial results in 2019 while taking significant steps to further enhance our offer to clients and help position the Company to build value for our stakeholders over the long-term. Throughout 2019, investor sentiment reflected a complex market environment that included global trade negotiations and an uncertain domestic economic outlook. TheFederal Reserve ended up cutting the federal funds target interest rate three times in 2019, in a reversal of the increases seen in 2018. At the same time, stocks continued to rise, with the S&P 500® increasing 29% during 2019. Core net new assets totaled$211.7 billion for 2019, representing an organic growth rate of 7% and our second consecutive year over$200 billion . Clients opened 1.6 million new brokerage accounts in 2019, while active brokerage accounts grew 6% to 12.3 million. Our success in asset gathering combined with strong market returns drove total client assets to reach$4.04 trillion atDecember 31, 2019 , closing the year up 24%. Company actions to benefit clients and build long-term value during 2019 included the elimination of online trading commissions forU.S. and Canadian-listed stocks and ETFs, as well as the base charge on options, which became effectiveOctober 7, 2019 . The Company also announced two significant acquisitions during 2019. InJuly 2019 , the Company agreed to acquire assets of USAA-IMCO and agreed to enter into a long-term referral agreement. In lateNovember 2019 , we entered into a definitive agreement to acquire TD Ameritrade.
Against the backdrop of the more challenging than expected macroeconomic
environment and our own pricing decisions, Schwab's net income totaled
Total net revenues reached$10.7 billion , up 6% in 2019. Net interest revenue increased 12% in 2019 to$6.5 billion , driven by higher average investment yields and also by an increase in client cash balances held at our bank and broker-dealer subsidiaries. While trading revenue declined 17% to$752 million due to our pricing actions, asset management and administration fees remained essentially flat with 2018 at$3.2 billion , decreasing 1%. Growing enrollment in advice solutions, along with rising balances in other third-party mutual funds, helped to largely offset declines in Mutual Fund OneSource® and lower sweep money market fund revenue due to transfers of sweep money market funds to our balance sheet in 2018 and early 2019. Total expenses excluding interest increased 5% in 2019 to$5.9 billion , which included$62 million in severance charges associated with a 3% reduction in our workforce and$25 million in costs relating to the announced acquisitions of assets of USAA-IMCO and TD Ameritrade. The Company's focus on driving efficiency while managing spending in a disciplined manner helped us maintain a ratio of expenses to client assets of 16 bps for 2019. Balancing long-term profitability with reinvesting for growth, we achieved a 45.2% pre-tax profit margin and a 19% return on equity in 2019, representing our second consecutive year of at least 45% and 19%, respectively. - 35 - --------------------------------------------------------------------------------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)
Disciplined balance sheet management remained core to our strategy as we
continued to support business growth and meaningful capital returns across a
range of conditions. In early 2019, the Board of Directors raised the quarterly
cash dividend 31% to $0.17 per share and authorized the repurchase of up to $4.0
billion of common stock; during 2019 we repurchased 55 million shares for $2.2
billion under this authorization. As of December 31, 2019 , our balance sheet
assets were $294 billion , down 1% from December 31, 2018 ; our Tier 1 Leverage
Ratio was 7.3% at year-end 2019.
RESULTS OF OPERATIONS
Total Net Revenues
Total net revenues of $11.7 billion and $10.7 billion for the years ended
December 31, 2020 and 2019, respectively, represented growth of 9% and 6% from
the prior periods. The 2020 increase was due to our acquisition of TD
Ameritrade, which contributed approximately $1.7 billion of total net revenues
from October 6 , through December 31, 2020 . Total net revenues increased in 2019
primarily due to growth in net interest revenue.
Year Ended December 31, 2020 2019 2018
% of % of % of
Growth Rate Total Net Total Net Total Net
2019-2020 Amount Revenues Amount Revenues Amount Revenues
Net interest revenue
Interest revenue (14) % $ 6,531 56 % $ 7,580 71 % $ 6,680 66 %
Interest expense (61) % (418) (4) % (1,064) (10) % (857) (9) %
Net interest revenue (6) % 6,113 52 % 6,516 61 % 5,823 57 %
Asset management and administration
fees
Mutual funds, ETFs, and collective
trust funds
(CTFs) (1) 1 % 1,770 15 % 1,747 16 % 1,837 18 %
Advice solutions 20 % 1,443 12 % 1,198 11 % 1,139 11 %
Other (1) (2) % 262 3 % 266 3 % 253 3 %
Asset management and administration
fees 8 % 3,475 30 % 3,211 30 % 3,229 32 %
Trading revenue
Commissions 35 % 739 6 % 549 5 % 685 7 %
Order flow revenue (2) N/M 621 6 % 135 1 % 139 1 %
Principal transactions (18) % 56 - 68 1 % 78 1 %
Trading revenue (2) 88 % 1,416 12 % 752 7 % 902 9 %
Bank deposit account fees N/M 355 3 % - - - -
Other (2) 37 % 332 3 % 242 2 % 178 2 %
Total net revenues 9 % $ 11,691 100 % $ 10,721 100 % $ 10,132 100 %
(1) Beginning in the first quarter of 2019, a change was made to move CTFs from
other asset management and administration fees. Prior periods have been recast
to reflect this change.
(2) 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.
N/M Not meaningful. Percentage changes greater than 200% are presented as not
meaningful.
Net Interest Revenue
Schwab's primary interest-earning assets include cash and cash equivalents; cash
and investments segregated; margin loans, which constitute the majority of
receivables from brokerage clients; investment securities; and bank loans.
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. Fees earned and expenses incurred on
securities lending and borrowing activities are conducted by our broker-dealer
subsidiaries using assets held in client brokerage accounts.
Schwab's interest-bearing liabilities include bank deposits, payables to
brokerage clients, short-term borrowings (e.g., Federal Home Loan Bank (FHLB)
advances, commercial paper), and long-term debt. Non-interest-bearing funding
sources include stockholders' equity, certain client cash balances, and other
miscellaneous liabilities.
- 36 -
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THE CHARLES SCHWAB CORPORATIONManagement's Discussion and Analysis of Financial Condition and Results of
Operations
(Tabular Amounts in Millions, Except Ratios, or as Noted)
Schwab establishes the rates paid on client-related liabilities, and management
expects that it will generally adjust the rates paid on these liabilities at
some fraction of any movement in short-term rates. Schwab deploys the funds from
these sources into the assets outlined above. We do not use short-term,
wholesale borrowings to support our long-term investment activity, but may use
such funding, including FHLB advances or commercial paper, for short-term
liquidity purposes or to provide temporary funding (e.g., for investment
purchases) ahead of anticipated balance sheet deposit growth.
In order to keep interest-rate sensitivity within established limits, management
actively monitors and adjusts interest-rate sensitivity through changes in the
balance sheet, primarily by adjusting the composition of our banking
subsidiaries' investment portfolios. As Schwab builds its client base, we
attract new client sweep cash, which is a primary driver of funding balance
sheet growth.
Late in the first quarter of 2020, the Federal Reserve cut the federal funds
target overnight rate from 1.75% to near zero; on the longer-end of the curve,
the 10-year Treasury rate declined by over 120 basis points. Lower interest
rates across maturities persisted from the end of the first quarter through the
end of 2020, while credit spreads also compressed. Moreover, changes in the
economic environment throughout 2020 resulting from the COVID-19 pandemic drove
significantly higher levels of client cash sweep balances. As these balances
rapidly accumulated in the first quarter of 2020, the Company initially placed a
substantial amount in excess reserves held at the Federal Reserve , and
subsequently deployed a significant amount of this cash build-up throughout
2020. AFS securities purchases in 2020 totaled $202.2 billion . These purchases
were made at rates below the average yield on the existing AFS portfolio due to
the current low interest rate environment.
Schwab's acquisition of TD Ameritrade, effective October 6, 2020 , provides
additional interest-earning assets and liabilities. For Schwab's 2020 full-year
averages, TD Ameritrade contributed approximately $12.0 billion of average
interest-earning assets and $9.6 billion of average interest-bearing
liabilities. TD Ameritrade's interest-earning assets consist primarily of
receivables from brokerage clients, cash and investments segregated, cash and
cash equivalents, and AFS securities. TD Ameritrade's interest-bearing
liabilities consist primarily of payables to brokerage clients and long-term
debt. See Item 8 - Note 3 for additional information on the TD Ameritrade
acquisition including the provisional fair values of assets acquired and
liabilities assumed.
- 37 -
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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 presents net interest revenue information corresponding to
interest-earning assets and funding sources on the consolidated balance sheets:
Year Ended December 31, 2020 2019 2018
Interest Average Interest Average Interest Average
Average Revenue/ Yield/ Average Revenue/ Yield/ Average Revenue/ Yield/
Balance Expense Rate Balance Expense Rate Balance Expense Rate
Interest-earning assets
Cash and cash equivalents $ 39,052 $ 120 0.30 % $ 23,512 $ 518 2.17 % $ 17,783 $ 348 1.93 %
Cash and investments segregated 34,100 141 0.41 % 15,694 345 2.17 % 11,461 206 1.78 %
Receivables from brokerage
clients 28,058 848 2.97 % 19,270 821 4.20 % 19,870 830 4.12 %
Available for sale securities
(1,2) 253,555 4,537 1.78 % 58,181 1,560 2.67 % 54,542 1,241 2.26 %
Held to maturity securities (2) - - - 134,708 3,591 2.65 % 131,794 3,348 2.53 %
Bank loans 20,932 545 2.60 % 16,832 584 3.47 % 16,554 559 3.37 %
Total interest-earning assets 375,697 6,191 1.64 % 268,197 7,419 2.75 % 252,004 6,532 2.57 %
Securities lending revenue (3) 334 147 118
Other interest revenue (3) 6 14 30
Total interest-earning assets (4) $ 375,697 $ 6,531 1.73 % $ 268,197 $ 7,580 2.80 % $ 252,004 $ 6,680 2.63 %
Funding sources
Bank deposits $ 291,206 $ 93 0.03 % $ 212,605 $ 700 0.33 % $ 199,139 $ 545 0.27 %
Payables to brokerage clients 46,347 12 0.02 % 24,353 79 0.33 % 21,178 56 0.27 %
Short-term borrowings (5) 89 - 0.20 % 17 - 2.36 % 3,359 54 1.59 %
Long-term debt 8,992 289 3.22 % 7,199 258 3.58 % 5,423 190 3.50 %
Total interest-bearing
liabilities 346,634 394 0.11 % 244,174 1,037 0.42 % 229,099 845 0.37 %
Non-interest-bearing funding
sources (4) 29,063 24,023 22,905
Securities lending expense (3) 33 38 18 Other interest expense (3) (9) (11) (6) Total funding sources (4)$ 375,697 $ 418 0.11 %$ 268,197 $ 1,064 0.39 %$ 252,004 $ 857 0.34 % Net interest revenue$ 6,113 1.62 %$ 6,516 2.41 %$ 5,823 2.29 % (1) Amounts have been calculated based on amortized cost. (2) OnJanuary 1, 2020 , the Company transferred all of its investment securities designated as held to maturity (HTM) to the AFS category, as described in Item 8 - Note 6. (3) Beginning in the fourth quarter of 2020, securities lending revenue has been reclassified from broker-related receivables and other revenue. Securities lending expense has been reclassified from other expense. Prior period amounts have been reclassified to reflect this change. (4) Beginning in the fourth quarter of 2020, broker-related receivables were removed from total interest earning assets and netted against non-interest-bearing funding sources, resulting in an immaterial reduction to total interest-earning assets and total funding sources. Prior period amounts have been reclassified to reflect this change. (5) Interest revenue or expense was less than$500 thousand in the period or periods presented. Net interest revenue decreased$403 million or 6%, in 2020 from 2019, due primarily to lower average investment yields partially offset by growth in interest-earning assets. Accelerated premium amortization on debt securities in 2020 also contributed to the reduction in net interest revenue, as the decline in long-term interest rates in 2020 resulted in higher prepayments of mortgage-related debt securities. TD Ameritrade contributed approximately$443 million of net interest revenue fromOctober 6 , throughDecember 31, 2020 . Average interest-earning assets for 2020 were higher by 40%, compared to 2019. This increase in average interest-earning assets was primarily driven by higher client cash balances in bank deposits and payables to brokerage clients, due to higher client cash allocations and our acquisitions of TD Ameritrade and assets of USAA-IMCO. Our net interest margin decreased to 1.62% in 2020, from 2.41% in 2019. This decrease was driven primarily by lower yields received on interest-earning assets due largely to theFederal Reserve's 2019 and 2020 interest rate reductions as well as higher premium amortization on mortgage-related debt securities. Due to the low interest rate environment, purchases of investment securities in 2020 were made at rates below the average yield on the existing AFS portfolio, which negatively impacted our net interest margin. The amount of any further net interest margin compression and resulting net interest - 38 - -------------------------------------------------------------------------------- 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)revenue is dependent on a number of factors, including changes to LIBOR, premium amortization, reinvestment rates, and growth in client cash balances.
Net interest revenue increased$693 million , or 12%, in 2019 from 2018, due to higher average investment yields and growth in interest earning assets. Our net interest margin improved 12 basis points to 2.41% in 2019 from 2018, driven primarily by higher average yields received on interest-earning assets in 2019 due largely to the net impact of theFederal Reserve's interest rate increases in 2018 and decreases in the third and fourth quarters of 2019. The increase in average yields on interest-earning assets was partially offset by higher average interest rates paid on bank deposits and other interest-bearing liabilities. Portfolio adjustments made in 2019 to hold a higher percentage of fixed-rate, longer duration investments helped to moderate the impact of the declining rate environment on our net interest margin.
Average interest-earning assets grew 6% from 2018 to 2019, primarily driven by higher bank deposits due to transfers from sweep money market funds to bank sweep, as well as higher client cash balances.
Asset Management and Administration Fees
Asset management and administration fees include mutual fund, ETF, and CTF service fees and fees for other asset-based financial services provided to individual and institutional clients. Schwab earns mutual fund, ETF, and CTF service fees for shareholder services, administration, and investment management provided to its proprietary funds, and recordkeeping and shareholder services provided to third-party funds. Asset management and administration fees are based upon the daily balances of client assets invested in these funds and do not include securities lending revenues earned by proprietary mutual funds, ETFs, and CTFs, as those amounts, net of program fees, are credited to the fund shareholders. Proprietary CTFs may, but generally do not, directly participate in securities lending. The fair values of client assets included in proprietary and third-party mutual funds, ETFs, and CTFs are based on quoted market prices and other observable market data. We also earn asset management fees for advice solutions, which include managed portfolios, specialized strategies, and customized investment advice. Other asset management and administration fees include various asset-based fees such as trust fees, 401(k) recordkeeping fees, mutual fund clearing fees, and non-balance based service and transaction fees.
Asset management and administration fees attributable to TD Ameritrade are primarily earned on client assets invested in money market mutual funds and other mutual funds, as well as advice solutions.
Asset management and administration fees vary with changes in the balances of client assets due to market fluctuations and client activity.
- 39 -
--------------------------------------------------------------------------------
THE CHARLES SCHWAB CORPORATION Management's Discussion and Analysis of Financial Condition and Results of
Operations
(Tabular Amounts in Millions, Except Ratios, or as Noted)
The following table presents asset management and administration fees, average
client assets, and average fee yields:
Year Ended December 31, 2020 2019 2018
Average Average Average
Client Average Client Average Client Average
Assets Revenue Fee Assets Revenue Fee Assets Revenue Fee
Schwab money market funds before
fee
waivers $ 200,119 $ 605 0.30 % $ 173,558 $ 525 0.30 % $ 141,018 $ 568 0.40 %
Fee waivers (127) - -
Schwab money market funds 200,119 478 0.24 % 173,558 525 0.30 % 141,018 568 0.40 %
Schwab equity and bond funds,
ETFs, and
CTFs (1) 301,598 300 0.10 % 267,213 298 0.11 % 222,830 302 0.14 %
Mutual Fund OneSource® and other
non-
transaction fee funds 192,464 599 0.31 % 191,552 606 0.32 % 210,429 680 0.32 %
Other third-party mutual funds
and ETFs (2,3) 525,379 393 0.07 % 478,037 318 0.07 % 328,150 287 0.09 %
Total mutual funds, ETFs, and
CTFs (1,4) $ 1,219,560 1,770 0.15 % $ 1,110,360 1,747 0.16 % $ 902,427 1,837 0.20 %
Advice solutions (4)
Fee-based $ 306,010 1,443 0.47 % $ 246,888 1,198 0.49 % $ 227,790 1,139 0.50 %
Non-fee-based 73,161 - - 70,191 - - 62,813 - -
Total advice solutions $ 379,171 1,443 0.38 % $ 317,079 1,198 0.38 % $ 290,603 1,139 0.39 %
Other balance-based fees (1,5) 451,350 208 0.05 % 432,613 216 0.05 % 383,050 206 0.05 %
Other (6) 54 50 47
Total asset management and
administration
fees $ 3,475 $ 3,211 $ 3,229
(1) Beginning in the first quarter of 2019, a change was made to move CTFs from
other balance-based fees. Prior periods have been reclassified to reflect this
change.
(2) Beginning in the fourth quarter of 2019, Schwab ETF OneSourceTM was
discontinued as a result of the elimination of online trading commissions for
U.S. and Canadian-listed ETFs.
(3) Beginning in the fourth quarter of 2020, includes third-party money funds
related to the acquisition of TD Ameritrade.
(4) Average client assets for advice solutions may also include the asset
balances contained in the mutual fund and/or ETF categories listed above.
(5) Includes various asset-related fees, such as trust fees, 401(k)
recordkeeping fees, and mutual fund clearing fees and other service fees.
(6) Includes miscellaneous service and transaction fees relating to mutual funds
and ETFs that are not balance-based.
Asset management and administration fees increased by $264 million , or 8%, in
2020 from 2019, primarily due to higher balances in advice solutions, including
managed account assets from USAA and TD Ameritrade, overall gains in equity
markets, as well as higher purchased money market funds and other third-party
mutual funds and ETFs, in 2020 relative to 2019. These increases were partially
offset by the effect of money market fund fee waivers due to declining portfolio
yields. Asset management and administration fees attributable to TD Ameritrade
were approximately $131 million from October 6 , through December 31, 2020 . The
amount of fee waivers in coming 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.
Asset management and administration fees decreased by $18 million , or 1%, in
2019 from 2018, primarily due to lower sweep money market fund revenue as a
result of transfers to bank and broker-dealer sweep in 2018 and early 2019, as
well as client asset allocation choices including reduced usage of Mutual Fund
OneSource®. Part of the decline was offset by revenue from growing asset
balances in purchased money market funds, other third-party mutual funds and
ETFs, and in advice solutions.
- 40 -
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THE CHARLES SCHWAB CORPORATIONManagement's Discussion and Analysis of Financial Condition and Results of
Operations
(Tabular Amounts in Millions, Except Ratios, or as Noted)
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. The following funds
generated 40%, 45%, and 48% of the asset management and administration fees
earned during 2020, 2019, and 2018, respectively:
Schwab Money Schwab Equity and Mutual Fund OneSource®
Market Funds Bond Funds, ETFs, and CTFs (1) and Other NTF Funds
Year Ended December 31, 2020 2019 2018 2020 2019 2018 2020 2019 2018
Balance at beginning of
period $ 200,826 $ 153,472 $ 163,650 $ 286,275 $ 209,471 $ 196,784 $ 202,068 $ 180,532 $ 225,202
Net inflows (outflows) (25,894) 44,077 (11,641) 17,200 26,039 31,169 (20,246) (19,930) (37,513)
Net market gains (losses)
and other 1,157 3,277 1,463 38,214 50,765 (18,482) 42,035 41,466 (7,157)
Balance at end of period $ 176,089 $ 200,826 $ 153,472 $ 341,689 $ 286,275 $ 209,471 (1) Beginning in the first quarter of 2019, CTFs are included in these balances. Prior periods have been reclassified to reflect this change.
Trading Revenue
Trading revenue includes commissions, order flow revenue, and principal transaction revenues. Commission revenue is affected by volume and mix of trades executed. Order flow revenue is comprised of rebate payments received from trade execution venues to which our broker-dealer subsidiaries send equity and option orders. Order flow revenue is affected by volume and mix of client trades, as well as pricing received from trade execution venues. Principal transaction revenue is primarily comprised of revenue from trading activity in fixed income securities with clients. The difference between the price at which the Company buys and sells securities to and from our clients and other broker-dealers to accommodate clients' fixed income trading activity is recognized as principal transaction revenue. Principal transaction revenue also includes adjustments to the fair value of these securities positions.
The following table presents trading revenue and the related drivers:
Growth Rate
Year Ended December 31, 2019-2020 2020 2019 2018
Trading Revenue (1) 88 % $ 1,416 $ 752 $ 902
Clients' daily average trades (DATs) (in thousands) N/M 2,602.6 748.9 765.4
Number of trading days 1 % 252.0 250.5 249.5
Revenue per trade (2) (46) % Note: EffectiveOctober 7, 2019 , CS&Co eliminated online trade commissions forU.S. and Canadian-listed stocks and ETFs, as well as the base charge on options.TD Ameritrade, Inc. also does not charge for these types of trades and does not have a base charge on 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. N/M Not meaningful. Percentage changes greater than 200% are presented as not meaningful. Trading revenue increased$664 million , or 88% in 2020 compared to 2019, due primarily to the acquisition of TD Ameritrade, which contributed approximately$667 million of trading revenue fromOctober 6, 2020 forward. In addition, the Company saw a significant increase in clients' daily average trades and higher order flow revenue in 2020, which were partially offset by the Company'sOctober 2019 pricing actions. Order flow revenue was$621 million ,$135 million , and$139 million during 2020, 2019, and 2018, respectively. The increase in order flow revenue in 2020 was due to the acquisition of TD Ameritrade and a higher volume of trades throughout 2020 relative to 2019. Trading revenue decreased by$150 million , or 17%, in 2019 compared to 2018. The decrease was primarily due to the elimination of online trading commissions forU.S. and Canadian-listed stocks and ETFs, as well as the base charge on options effectiveOctober 7, 2019 . Bank Deposit Account Fees Beginning in the fourth quarter of 2020, the Company began earning bank deposit account fee revenue pursuant to the IDA agreement and arrangements with other third-party banks. Bank deposit account fees are primarily affected by average BDA balances and the floating- and fixed-rate reference yields that are a key component to derive fees pursuant to the IDA - 41 - --------------------------------------------------------------------------------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)agreement. Fees earned under the IDA agreement are affected by changes in interest rates and the composition of balances designated as fixed- and floating-rate.
Bank deposit account fees totaled$355 million for the period ofOctober 6, 2020 throughDecember 31, 2020 . During this period, the total average BDA balance was approximately$161 billion , of which approximately 80% was designated as fixed-rate obligation amounts and approximately 20% as floating-rate obligation amounts. Other Revenue Other revenue includes exchange processing fees, certain service fees, software fees, and non-recurring gains. Other revenue increased$90 million , or 37%, in 2020 compared to 2019 primarily due to higher exchange processing fees resulting from higher trade volumes and the acquisition of TD Ameritrade. Other revenue increased$64 million , or 36%, in 2019 compared to 2018 due primarily to a gain from the sale of a portfolio management and reporting software solution for advisors toTamarac Inc. in the second quarter of 2019 and a gain from the assignment of leased office space in the first quarter of 2019.
Total Expenses Excluding Interest
The following table shows a comparison of total expenses excluding interest:
Growth Rate
2019-2020 2020 2019 2018
Compensation and benefits
Salaries and wages 23 % $ 2,416 $ 1,958 $ 1,692
Incentive compensation 16 % 932 804 855
Employee benefits and other 9 % 606 558 510
Total compensation and benefits 19 % $ 3,954 $ 3,320 $ 3,057
Professional services 20 % 843 702 654
Occupancy and equipment 26 % 703 559 496
Advertising and market development 6 % 326 307 313
Communications 40 % 353 253 242
Depreciation and amortization (1) 29 % 414 322 277
Amortization of acquired intangible assets (1) N/M 190 27 29
Regulatory fees and assessments 34 % 163 122 189
Other 70 % 445 261 313
Total expenses excluding interest 26 % $ 7,391 $ 5,873 $ 5,570
Expenses as a percentage of total net revenues
Compensation and benefits 34 % 31 % 30 %
Advertising and market development 3 % 3 % 3 %
Full-time equivalent employees (in thousands)
At year end 62 % 32.0 19.7 19.5
Average 20 % 23.9 20.0 18.7
(1) Beginning in the third quarter of 2020, amortization of acquired intangible
assets was reclassified from depreciation and amortization. Prior periods have
been reclassified to reflect this change.
N/M Not meaningful. Percentage changes greater than 200% are presented as not
meaningful.
Total expenses excluding interest increased $1,518 million , or 26%, in 2020 from
2019, and $303 million , or 5%, in 2019 from 2018. In 2020, total expenses
excluding interest included approximately $943 million from TD Ameritrade's
results of operations from October 6 , through December 31, 2020 . Adjusted total
expenses, which excludes acquisition and integration-related costs and
amortization of acquired intangible assets, increased $939 million , or 16%, in
2020 from 2019, and $279 million , or 5%, in 2019 from 2018. See Non-GAAP
Financial Measures for further details and a reconciliation of such measures to
GAAP reported results.
- 42 -
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THE CHARLES SCHWAB CORPORATIONManagement's Discussion and Analysis of Financial Condition and Results of
Operations
(Tabular Amounts in Millions, Except Ratios, or as Noted)
Total compensation and benefits increased in 2020 from 2019, primarily due to an
overall increase in employee headcount due primarily to the addition of
approximately 10,000 TD Ameritrade employees and the hiring of 400 former USAA
employees in connection with our 2020 acquisitions. The increase in 2020 also
reflected 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.
Compensation and benefits in 2020 included $235 million of acquisition and
integration-related costs. The increase in 2019 from 2018 was primarily due to
both an overall increase in employee headcount to support our expanding client
base and higher severance costs, which included $62 million associated with a 3%
reduction in our workforce in the third quarter of 2019.
Professional services expense increased in 2020 from 2019, primarily due to
acquisition and integration-related costs in 2020 of $158 million . The increase
in 2019 from 2018 was primarily due to overall growth in the business,
investments in projects to further drive efficiency and scale, and certain costs
relating to the pending acquisitions completed in 2020.
Occupancy and equipment expense increased in 2020 from 2019, primarily due the
inclusion of TDA's results of operations from October 6, 2020 forward, as well
as an increase in technology equipment costs associated with higher client trade
volumes and overall growth in the business. The increase in 2019 from 2018 was
primarily due to increases in software maintenance expenses and additional
licenses to support growth in the business.
Communications expense increased in 2020 from 2019, primarily due to the
inclusion of TDA's results of operations from
Depreciation and amortization expenses grew in 2020 from 2019, primarily due to higher amortization of purchased and internally developed software, higher depreciation and amortization of equipment, office facilities, and property recognized in the TDA acquisition, as well as higher depreciation of buildings and equipment related to the expansion of ourU.S. campuses in 2019 and 2020. The increase in 2019 from 2018 was primarily due to higher amortization of internally developed software associated with investments in software and technology enhancements.
Amortization of acquired intangible assets increased in 2020 as a result of the acquisitions completed during the year.
Regulatory fees and assessments increased in 2020 from 2019, primarily due to the inclusion of TDA's results of operations fromOctober 6, 2020 forward, and higherFDIC insurance assessments and other regulatory assessments due to growth in assets and overall growth of the business in 2020. Regulatory fees and assessments decreased in 2019 from 2018, primarily due to a decrease inFDIC insurance assessments resulting from the elimination of theFDIC surcharge in the fourth quarter of 2018. Other expenses increased in 2020 from 2019, primarily resulting from the inclusion of TDA's results of operations fromOctober 6, 2020 forward, and increases in processing fees and related expenses due to higher client trade volumes and market volatility. These increases were partially offset by lower travel and entertainment expense in 2020. Other expenses in 2020 included acquisition and integration-related costs of$30 million . Other expenses decreased in 2019 from 2018, primarily due to lower travel and entertainment expense and bad debt expense. Capital expenditures were$741 million ,$753 million , and$576 million in 2020, 2019, and 2018, respectively. Capital expenditures decreased in 2020 compared to 2019 primarily due to lower building expansion in 2020, largely offset by higher capitalized software costs. Capital expenditures increased in 2019 from 2018 primarily due to the expansion of our campuses in theU.S. Investments in buildings were$173 million ,$397 million , and$253 million in 2020, 2019 and 2018, respectively. Capitalized software costs totaled$453 million ,$188 million , and$194 million in 2020, 2019, and 2018, respectively. Our capital expenditures for 2020 equaled 6% of total net revenues, within our estimated range for the year. We will continue to invest in integration-related and other technology projects in 2021, and we anticipate capital expenditures in 2021 to be approximately 6-7% of total net revenues. Our longer term expectation for capital expenditures remains in the range of 3-5% of total net revenues. During 2020, the Company experienced high levels of client engagement and record trading volumes while nearly all employees were in a remote work environment. Client activity rose sharply in the fourth quarter, and the client service and operational challenges created by this environment became more pronounced. Clients experienced longer call wait times - 43 - --------------------------------------------------------------------------------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)along with a limited number of issues in utilizing our website and mobile applications. In 2021, the Company anticipates increased spending to improve service levels and support our expanding client base, including additional technology spending as well as hiring more client service professionals.
Overall in 2021, we expect total expenses excluding interest to reflect the impacts of: continued acquisition and integration-related costs primarily related to our integration of TD Ameritrade; increased spending to improve service levels and support growth; and our progress in achieving incremental cost synergies. The magnitude and timing of these impacts are inherently uncertain and depend on a number of factors, including, but not limited to, the level of client engagement and trading volumes, the pace and levels of employee hiring, onboarding, and attrition, and changes in our needs to exit or maintain office and branch locations.
Taxes on Income
Schwab's effective income tax rate on income before taxes was 23.3% in 2020, 23.6% in 2019, and 23.1% in 2018. The decrease in the effective tax rate in 2020 from 2019 was primarily due to federal and state tax benefits recognized during 2020, including settlement of theIRS examination of tax years 2011-2014, the expiration of the statute of limitations on certain federal and state uncertain tax positions, and tax benefits realized from the filing of state tax returns, as well as an increase in Low-Income Housing Tax Credit (LIHTC) benefits. Offsetting the decrease in the effective tax rate from these items was an increase in nondeductible acquisition costs andFDIC insurance premium disallowance, as well as a decrease in equity compensation tax deduction benefits. The change in rates in 2019 from 2018 was primarily due to a decrease in equity compensation tax deduction benefits which reduced our tax expense by approximately$23 million and$46 million in 2019 and 2018, respectively.
Segment Information
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 RIAs, independent retirement
advisors, and recordkeepers. Revenues and expenses are attributed to the two
segments based on which segment services the client. Management evaluates the
performance of the segments on a pre-tax basis. Segment assets and liabilities
are not used for evaluating segment performance or in deciding how to allocate
resources to segments. Net revenues in both segments are generated from the
underlying client assets and trading activity; differences in the composition of
net revenues between the segments are based on the composition of client assets,
client trading frequency, and pricing unique to each. While both segments
leverage the scale and efficiency of our platforms, segment expenses reflect the
dynamics of serving millions of clients in Investor Services versus the
thousands of RIAs on the Advisor Services platform.
The Company integrated its business and asset acquisitions during 2020 into its
two existing reportable segments. Revenues and expenses from our acquisition of
USAA-IMCO are allocated to Investor Services only; revenues and expenses from TD
Ameritrade and our other 2020 acquisitions are attributed to both Investor
Services and Advisor Services based on which segment services the client. See
Item 8 - Note 3 for more information regarding acquisitions.
- 44 -
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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)Financial information for our segments is presented in the following table:
Investor Services Advisor Services Total
Growth Rate Growth Rate Growth Rate
Year Ended December 31, 2019-2020 2020 2019 2018 2019-2020 2020
2019 2018 2019-2020 2020 2019 2018
Net Revenues
Net interest revenue (6)% $ 4,391 $ 4,685 $ 4,341 (6)% $ 1,722 $ 1,831 $ 1,482 (6)% $ 6,113 $ 6,516 $ 5,823
Asset management and
administration fees 11% 2,544 2,289 2,260 1% 931 922 969 8% 3,475 3,211 3,229
Trading revenue (1) 130% 1,156 503 604 4% 260 249 298 88% 1,416 752 902
Bank deposit account
fees N/M 255 - - N/M 100 - - N/M 355 - -
Other (1) 79% 262 146 116 (27)% 70 96 62 37% 332 242 178
Total net revenues 13% 8,608 7,623 7,321 - 3,083 3,098 2,811 9% 11,691 10,721 10,132
Expenses Excluding
Interest 29% 5,529 4,284 4,145 17% 1,862 1,589 1,425 26% 7,391 5,873 5,570
Income before taxes
on income (8)% $ 3,079 $ 3,339 $ 3,176 (19)% $ 1,221 $ 1,509 $ 1,386 (11)% $ 4,300 $ 4,848 $ 4,562
Net new client assets
(in billions) (2,3) N/M $ 1,106.4 $ 115.6 $ 19.4 N/M $ 846.1 $ 107.2 $ 114.5 N/M $ 1,952.5 $ 222.8 $ 133.9
(1) Beginning in 2020, order flow revenue was reclassified from other revenue to
trading revenue. Prior period amounts have been reclassified to reflect this
change.
(2) In 2020, Investor Services includes inflows of $890.7 billion related to the
acquisition of TD Ameritrade and $79.9 billion related to the acquisition of
assets of USAA-IMCO. Additionally, 2020 and 2019 includes inflows of $10.9
billion and $11.1 billion , respectively, and outflows of $93.9 billion in 2018
from certain mutual fund clearing services clients.
(3) In 2020, Advisor Services includes inflows of $680.6 billion related to the
acquisition of TD Ameritrade and $8.5 billion related to the acquisition of
Wasmer Schroeder.
N/M Not meaningful. Percentage changes greater than 200% are presented as not
meaningful.
Segment Net Revenues
Investor Services total net revenues increased by 13% in 2020 from 2019, while
Advisor Services total net revenues remained relatively consistent
year-over-year. Investor Services' growth was primarily due to an increase in
trading revenue, higher asset management and administration fees, and the
initial recognition of bank deposit account fees in the fourth quarter of 2020,
partially offset by lower net interest revenue. For Advisor Services, bank
deposit account fees largely offset a decrease in net interest revenue, while
trading revenue and asset management and administration fees were consistent
with 2019. Trading revenue increased significantly in the Investor Services
segment primarily due to the TD Ameritrade acquisition and higher trade volumes
in 2020. Asset management and administration fees increased in 2020 for Investor
Services primarily due to higher balances in advice solutions, including managed
account assets from USAA and TD Ameritrade, as well as higher purchased money
market funds and other third-party mutual funds and ETFs, partially offset by
the effect of money fund fee waivers. Net interest revenue decreased for both
segments primarily due to lower average investment yields, partially offset by
growth in interest-earning assets.
Investor Services and Advisor Services total net revenues increased by 4% and
10%, respectively, in 2019 compared to 2018 primarily due to increases in net
interest revenue, which increased as a result of higher average investment
yields and higher interest earning assets. For Investor Services , asset
management and administration fees increased primarily due to growing asset
balances in advice solutions, partially offset by lower mutual fund and ETF
service fee revenue as a result of client cash allocation choices, including
reduced usage of Mutual Fund OneSource®. For Advisor Services, asset management
and administration fees decreased primarily due to lower sweep money market fund
revenue as a result of transfers to bank and broker-dealer sweep, as well as
client asset allocation choices, including reduced usage of Mutual Fund
OneSource®, partially offset by increased revenue from growing asset balances in
purchased money market funds and in other third-party mutual funds and ETFs.
Trading revenue decreased for both segments as a result of the elimination of
online trading commissions for U.S. and Canadian-listed stocks and ETFs, as well
as the base charge on options in the fourth quarter of 2019.
Segment Expenses Excluding Interest
Investor Services and Advisor Services total expenses excluding interest
increased by 29% and 17%, respectively, in 2020 compared to 2019, primarily due
to the inclusion of TD Ameritrade's expenses from
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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 and integration-related costs. Compensation and benefits increased
in both segments primarily due to the acquisition of TDA and overall headcount
growth to support our expanding client base, with Investor Services increasing
more significantly due to greater headcount growth from the TDA acquisition and
the hiring of approximately 400 former USAA employees in connection with the
USAA-IMCO acquisition. Both segments also saw increases in professional
services, depreciation and amortization, amortization of acquired intangible
assets, and other expenses, primarily due to the inclusion of TDA's expenses
from October 6, 2020 forward as well as acquisition and integration-related
costs, with Investor Services' expenses increasing more significantly due to
overall size of the segment's client base and greater client base growth from
TDA.
Investor Services and Advisor Services expenses excluding interest increased 3%
and 12%, respectively, in 2019 compared to 2018 primarily due to higher
compensation and benefits and occupancy and equipment expense. Additionally,
Advisor Services had higher professional services expense due to overall growth
in the business and investments in projects to further drive efficiency and
scale, and Investor Services had higher amortization of internally developed
software due to technology enhancements. For both segments these increases were
partially offset by a decrease in FDIC insurance assessments due to the
elimination of the FDIC surcharge in the fourth quarter of 2018 and lower travel
and entertainment expenses.
RISK MANAGEMENT
Schwab's business activities expose it to a variety of risks, including
operational, compliance, credit, market, and liquidity risks. The Company has a
comprehensive risk management program to identify and manage these risks and
their associated potential for financial and reputational impact. Despite our
efforts to identify areas of risk and implement risk management policies and
procedures, there can be no assurance that Schwab will not suffer unexpected
losses due to these risks.
Our risk management process is comprised of risk identification and assessment,
risk measurement, risk monitoring and reporting, and risk mitigation controls;
we use periodic risk and control self-assessments, control testing programs, and
internal audit reviews to evaluate the effectiveness of these internal controls.
The activities and governance that comprise the risk management process are
described below.
As part of our integration of TD Ameritrade, the Company is aligning TD Ameritrade's historical risk exposures with Schwab's risk appetite. Our integration work includes evaluating new or changed risks impacting the combined company, and may involve modifications to our existing risk management processes. Though integration work continues, the Company's operations, inclusive of TD Ameritrade, remain consistent with our Enterprise Risk Management (ERM) framework.
Culture
The Board of Directors has approved an ERM framework that incorporates our purpose, vision, and values, which form the bedrock of our corporate culture and set the tone for the organization.
We designed the ERM Framework to enable a comprehensive approach to managing risks encountered by Schwab in its business activities. The framework incorporates key concepts commensurate with the size, risk profile, complexity, and continuing growth of the Company. Risk appetite, which is defined as the amount of risk the Company is willing to accept in pursuit of its corporate strategy, is developed by executive management and approved by the Board of Directors.
Risk Governance
Senior management takes an active role in the risk management process and has
developed policies and procedures under which specific business and control
units are responsible for identifying, measuring, and controlling risks.
The Global Risk Committee, which is comprised of senior executives from each
major business and control function, is responsible for the oversight of risk
management. This includes identifying emerging risks, assessing risk management
practices and the control environment, reinforcing business accountability for
risk management, supervisory controls and regulatory compliance, supporting
resource prioritization across the organization, and escalating significant
issues to the Board of Directors.
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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)
We have established risk metrics and reporting that enable measurement of the
impact of strategy execution against risk appetite. The risk metrics, with risk
limits and tolerance levels, are established for key risk categories by the
Global Risk Committee and its functional risk sub-committees.
The Chief Risk Officer regularly reports activities of the Global Risk Committee
to the Risk Committee of the Board of Directors. The Board Risk Committee in
turn assists the Board of Directors in fulfilling its oversight responsibilities
with respect to our risk management program, including approving risk appetite
statements and related key risk appetite metrics and reviewing reports relating
to risk issues from functional areas of corporate risk management, legal,
compliance, and internal audit.
Functional risk sub-committees focusing on specific areas of risk report to the Global Risk Committee. These sub-committees include the:
•Operational Risk Oversight Committee - provides oversight of and approves operational risk management policies, risk tolerance levels, and operational risk governance processes, and includes sub-committees covering Information Security, Fraud, Third-Party Risk, Data, and Model Governance; •Compliance Risk Committee - provides oversight of compliance risk management programs and policies providing an aggregate view of compliance risk exposure and employee conduct, including subcommittees covering Fiduciary and Conflicts of Interest Risk and International Compliance Risk; •Financial Risk Oversight Committee - provides oversight of and approves credit, market, liquidity, and capital risk policies, limits, and exposures; and •New Products andServices Risk Oversight Committee - provides oversight of, and approves corporate policy and procedures relating to, the risk governance of new products and services.
Senior management has also created an
The Company's compliance, finance, internal audit, legal, and corporate risk management departments assist management and the various risk committees in evaluating, testing, and monitoring risk management.
In addition, the Disclosure Committee is responsible for monitoring and
evaluating the effectiveness of our disclosure controls and procedures and
internal control over financial reporting as of the end of each fiscal quarter.
The Disclosure Committee reports on this evaluation to the CEO and CFO prior to
their certification required by Sections 302 and 906 of the Sarbanes Oxley Act
of 2002.
Operational Risk
Operational risk arises due to potential inadequacies or failures related to
people, internal processes, and systems, or from external events or
relationships impacting the Company and/or any of its key business partners and
third parties. While operational risk is inherent in all business activities, we
rely on a system of internal controls and risk management practices designed to
keep operational risk and operational losses within the Company's risk appetite.
We have specific policies and procedures to identify and manage operational
risk, and use control testing programs, and internal audit reviews to evaluate
the effectiveness of these internal controls. Where appropriate, we manage the
impact of operational loss and litigation expense through the purchase of
insurance. The insurance program is specifically designed to address our key
operational risks and to maintain compliance with local laws and regulation.
Schwab's operations are highly dependent on the integrity and resilience of our
critical business functions and technology systems. To the extent Schwab
experiences business or system interruptions, errors or downtime (which could
result from a variety of causes, including natural disasters, terrorist attacks,
technological failure, cyber attacks, changes to systems, linkages with
third-party systems, and power failures), our business and operations could be
negatively impacted. To minimize business interruptions and ensure the capacity
to continue operations during an incident regardless of duration, Schwab
maintains a backup and recovery infrastructure which includes facilities for
backup and communications, a geographically dispersed workforce, and routine
testing of business continuity and disaster recovery plans and a
well-established incident management program.
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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)
Information Security risk is the risk of unauthorized access, use, disclosure,
disruption, modification, recording or destruction of the firm's information or
systems. We have designed and implemented an information security program that
knits together complementary tools, controls and technologies to protect
systems, client accounts and data. We continuously monitor the systems and work
collaboratively with government agencies, law enforcement and other financial
institutions to address potential threats. We use advanced monitoring systems to
identify suspicious activity and deter unauthorized access by internal or
external actors. We limit the number of employees who have access to clients'
personal information and internal authentication measures are enforced to
protect against the potential for social engineering. All employees who handle
sensitive information are trained in privacy and security. Schwab's conduct and
cybersecurity teams monitor activity looking for suspicious behavior. These
capabilities allow us to identify and quickly act on any attempted intrusions.
Fraud risk arises from attempted or actual theft of financial assets or other
property of any client or the Company. Schwab is committed to protecting the
Company's and its clients' assets from fraud, and complying with all applicable
laws and regulations to prevent, detect and report fraudulent activity. Schwab
manages fraud risk through policies, procedures and controls. We also take
affirmative steps to prevent and detect fraud and report, to appropriate
authorities, any known or suspected acts of fraud in accordance with existing
laws and requirements.
Schwab also faces operational risk when we employ the services of various third
parties, including domestic and international outsourcing of certain technology,
processing, servicing, and support functions. We manage the exposure to third
party risk and promote a culture of resiliency through contractual provisions,
control standards, ongoing monitoring of third party performance, and
appropriate testing. We also maintain policies and procedures regarding the
standard of care expected with all data, whether the data is internal company
information, employee information, or non-public client information. We clearly
define for employees, contractors, and third parties the expected standards of
care for critical and confidential data. We also provide regular training on
data security.
Model risk is the potential for adverse consequences from decisions based on
incorrect or misused model outputs and reports. Models are owned by several
business units throughout the organization, and are used for a variety of
purposes. Model use includes, but is not limited to, calculating capital
requirements for hypothetical stressful environments, estimating interest and
credit risk for loans and other balance sheet assets, and providing guidance in
the management of client portfolios. We have established a policy to describe
the roles and responsibilities of all key stakeholders in model development,
management, and use. All models are registered in a centralized database and
classified into different risk ratings depending on their potential financial,
reputational, or regulatory impact to the Company. The model risk rating
determines the scope of model governance activities.
Incentive Compensation risk is the potential for adverse consequences resulting
from compensation plans that do not balance the execution of our strategy with
risk and financial rewards, potentially encouraging imprudent risk-taking by
employees. We have implemented risk management processes, including a policy, to
identify, evaluate, assess, and manage risks associated with incentive
compensation plans and the activities of certain employees, defined as Covered
Employees, who have the authority to expose the Company to material amounts of
risk.
Compliance Risk
Schwab faces compliance risk which is the potential exposure to legal or
regulatory sanctions, fines or penalties, financial loss, or damage to
reputation resulting from the failure to comply with laws, regulations, rules,
or other regulatory requirements. Among other things, compliance risks relate to
the suitability of client investments, conflicts of interest, disclosure
obligations and performance expectations for products and services, supervision
of employees, and the adequacy of our controls. The Company and its affiliates
are subject to extensive regulation by federal, state and foreign regulatory
authorities, including SROs.
We manage compliance risk through policies, procedures and controls reasonably
designed to achieve and/or monitor compliance with applicable legal and
regulatory requirements. These procedures address issues such as conduct and
ethics, sales and trading practices, marketing and communications, extension of
credit, client funds and securities, books and records, anti-money laundering,
client privacy, and employment policies.
Conduct risk arises from inappropriate, unethical, or unlawful behavior of the
Company, its employees or third parties acting on the Company's behalf that may
result in detriment to the Company's clients, financial markets, the Company,
and/or the Company's employees. We manage this risk through a policy,
procedures, a system of internal controls, including personnel
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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)monitoring and surveillance. Conduct-related matters are escalated through appropriate channels by the Corporate Responsibility Officer.
Fiduciary risk is the potential for financial or reputational loss through breach of fiduciary duties to a client. Fiduciary activities include, but are not limited to, individual and institutional trust, investment management, custody, and cash and securities processing. We manage this risk by establishing policy and procedures to ensure that obligations to clients are discharged faithfully and in compliance with applicable legal and regulatory requirements. Business units have the primary responsibility for adherence to the policy and procedures applicable to their business. Guidance and control are provided through the creation, approval, and ongoing review of applicable policies by business units and various risk committees.
Credit Risk
Credit risk is the potential for loss due to a borrower, counterparty, or issuer failing to perform its contractual obligations. Our exposure to credit risk mainly results from investing activities in our liquidity and investment portfolios, mortgage lending, margin lending and client option and futures activities, pledged asset lending, securities lending activities, and our role as a counterparty in other financial contracts. To manage the risks of such losses, we have established policies and procedures, which include setting and reviewing credit limits, monitoring of credit limits and quality of counterparties, and adjusting margin, PAL, option, and futures requirements for certain securities and instruments.
Liquidity and Investment Portfolios
Schwab has exposure to credit risk associated with its investment portfolios,
which include
AtDecember 31, 2020 , substantially all securities in the investment portfolios were rated investment grade.U.S. agency mortgage-backed securities do not have explicit credit ratings; however, management considers these to be of the highest credit quality and rating given the guarantee of principal and interest by theU.S. government orU.S. government-sponsored enterprises.
Mortgage Lending Portfolio
The bank loan portfolio includes First Mortgages, HELOCs, and other loans. The credit risk exposure related to loans is actively managed through individual loan and portfolio reviews. Management regularly reviews asset quality, including concentrations, delinquencies, nonaccrual loans, charge-offs, and recoveries. All are factors in the determination of an appropriate allowance for credit losses. Our residential loan underwriting guidelines include maximum LTV ratios, cash out limits, and minimum Fair Isaac Corporation (FICO) credit scores. The specific guidelines are dependent on the individual characteristics of a loan (for example, whether the property is a primary or secondary residence, whether the loan is for investment property, whether the loan is for an initial purchase of a home or refinance of an existing home, and whether the loan size is conforming or jumbo). Schwab does not originate or purchase residential loans that allow for negative amortization and does not originate or purchase subprime loans (generally defined as extensions of credit to borrowers with a FICO score of less than 620 at origination), unless the borrower has compensating credit factors. For more information on credit quality indicators relating to Schwab's bank loans, see Item 8 - Note 7.
Securities and Instrument-Based Lending Portfolios
Collateral arrangements relating to margin loans, PALs, option and futures
positions, securities lending agreements, and securities purchased under
agreements to resell (resale agreements) include provisions that require
additional collateral in the event of market fluctuations. Additionally, for
margin loans, PALs, options and futures positions, and securities lending
agreements, collateral arrangements require that the fair value of such
collateral sufficiently exceeds the credit exposure in order to maintain a fully
secured position.
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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)Other Counterparty Exposures
Schwab performs clearing services for all securities transactions in its client accounts. Schwab has exposure to credit risk due to its obligation to settle transactions with clearing corporations, mutual funds, and other financial institutions even if Schwab's clients or a counterparty fail to meet their obligations to the Company.
Market Risk
Market risk is the potential for changes in earnings or the value of financial instruments held by Schwab as a result of fluctuations in interest rates, equity prices, or market conditions. Schwab is exposed to interest rate risk primarily from changes in market interest rates on our interest-earning assets relative to changes in the costs of funding sources that finance these assets. To manage interest rate risk, we have established policies and procedures, which include setting limits on net interest revenue risk and economic value of equity risk. To remain within these limits, we manage the maturity, repricing, and cash flow characteristics of the investment portfolios. Management monitors established guidelines to stay within the Company's risk appetite. Our measurement of interest rate risk involves assumptions that are inherently uncertain and, as a result, cannot precisely estimate the impact of changes in interest rates on net interest revenue, bank deposit account fees, or economic value of equity (EVE). Actual results may differ from simulated results due to balance growth or decline and the timing, magnitude, and frequency of interest rate changes, as well as changes in market conditions and management strategies, including changes in asset and liability mix. Financial instruments are also subject to the risk that valuations will be negatively affected by changes in demand and the underlying market for a financial instrument. We are indirectly exposed to option, futures, and equity market fluctuations in connection with client option and futures accounts, securities collateralizing margin loans to brokerage customers, and client securities loaned out as part of the brokerage securities lending activities. Equity market valuations may also affect the level of brokerage client trading activity, margin borrowing, and overall client engagement with Schwab. Additionally, we earn mutual fund and ETF service fees and asset management fees based upon daily balances of certain client assets. Fluctuations in these client asset balances caused by changes in equity valuations directly impact the amount of fee revenue we earn.
Our market risk related to financial instruments held for trading is not material.
Interest Rate Risk Simulations
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 balance sheet 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 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 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.
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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 shows the simulated change to net interest revenue over the
next 12 months beginning December 31, 2020 and 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:
December 31, 2020 2019
Increase of 100 basis points 14.2% 4.8%
Decrease of 100 basis points (4.3)% (7.4)%
The change in sensitivities of net interest revenue as of December 31, 2020
reflects a significantly lower interest rate curve relative to December 31, 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 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. Our net interest revenue and EVE simulations reflect the assumption of non-negative investment yields.
Bank Deposit Account Fees Simulations
Consistent with the presentation on our statement of income, the sensitivity of bank deposit account fee revenue to interest rate changes is assessed separately from the interest rate sensitivity analysis described above. As ofDecember 31, 2020 , the sensitivity of bank deposit account fee revenue to changes in interest rates is limited, as a significant portion of BDA deposit balances are allocated to fixed-rate obligation amounts.
Expected Phase-out of LIBOR
The Company has established a firm-wide team to address the phasing-out of LIBOR byJune 30, 2023 . 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 before the end ofDecember 2021 , per guidance from theFederal Reserve Board . 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.
Liquidity Risk
Liquidity risk is the potential that Schwab will be unable to sell assets or
meet cash flow obligations when they come due without incurring unacceptable
losses.
Due to its role as a source of financial strength, CSC's liquidity needs are
primarily driven by the liquidity and capital needs of: CS&Co, TD Ameritrade,
Inc., and TDAC, our principal broker-dealer subsidiaries; the capital needs of
the banking subsidiaries; principal and interest due on corporate debt; dividend
payments on CSC's preferred stock; and returns 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)
capital to common stockholders. The liquidity needs of our broker-dealer
subsidiaries are primarily driven by client activity including trading and
margin borrowing activities and capital expenditures. The capital needs of the
banking subsidiaries are primarily driven by the amount of client deposits. In
addition, the liquidity needs of our banking subsidiaries can also be met by
excess reserves held at the Federal Reserve , sales of investment securities, or
FHLB borrowings. We have established liquidity policies to support the
successful execution of business strategies, while ensuring ongoing and
sufficient liquidity to meet operational needs and satisfy applicable regulatory
requirements under both normal and stressed conditions. We seek to maintain
client confidence in the balance sheet and the safety of client assets by
maintaining liquidity and diversity of funding sources to allow the Company to
meet its obligations. To this end, we have established limits and contingency
funding scenarios to support liquidity levels during both business as usual and
stressed conditions.
We employ a variety of methodologies to monitor and manage liquidity. We conduct
regular liquidity stress testing to develop a consolidated view of liquidity
risk exposures and to ensure our ability to maintain sufficient liquidity during
market-related or company-specific liquidity stress events. Liquidity is also
tested at certain subsidiaries and results are reported to the Financial Risk
Oversight Committee . A number of early warning indicators are monitored to help
identify emerging liquidity stresses in the market or within the organization
and are reviewed with management as appropriate.
Primary 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, bank deposit account fees earned on client deposits placed in third-party depository programs, 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.
Additional Funding Sources
In addition to internal sources of liquidity, Schwab has access to external
funding. The need for short-term borrowings from external debt facilities arises
primarily from timing differences between cash flow requirements, scheduled
liquidation of interest-earning investments, movements of cash to meet
regulatory brokerage client cash segregation requirements and general corporate
purposes. We maintain policies and procedures necessary to access funding and
test discount window borrowing procedures on a periodic basis.
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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 describes external debt facilities available at December 31,
2020 :
Description Borrower Outstanding Available
Banking subsidiaries - 7,872
Uncommitted, unsecured lines of credit with various external banks
CSC, CS&Co - 1,522
Unsecured commercial paper (3) CSC - 750
Committed, unsecured credit facility with various external banks (4)
CSC - 700
TD Ameritrade Holding Corporation revolving credit facility (5)
TDA Holding - 300
TD Ameritrade Clearing, Inc. committed, unsecured
revolving credit facilities with various external banks TDAC - 1,450
Secured uncommitted lines of credit with various external banks (6)
TDAC - -
(1) Amounts available are dependent on the amount of First Mortgages, 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 not to exceed $1.5 billion . In February 2021 , the Company increased the
amount available to $1.5 billion .
(4) Other than an overnight borrowing to test availability, this facility was
unused during 2020.
(5) Effective October 6, 2020 , Schwab entered into a guaranty supplement to
guarantee the obligations of TD Ameritrade under this credit agreement. The
provision of the guaranty supplement was a condition for certain financial
covenant and reporting obligations being modified in the credit agreement. The
Company terminated this revolving credit facility effective January 28, 2021 .
(6) Secured borrowing is made available based on TDAC's ability to provide
acceptable collateral to the lender as determined by the credit agreement.
Our banking subsidiaries maintain secured credit facilities with the FHLB.
Amounts available under these facilities are dependent on the value of our First
Mortgages, HELOCs, and the fair value of certain of our investment securities
that are pledged as collateral. These credit facilities are also available as
backup financing in the event the outflow of client cash from the banking
subsidiaries' respective balance sheets is greater than maturities and paydowns
on investment securities and bank loans.
Our banking subsidiaries also have access to short-term secured funding through
the Federal Reserve discount window. Amounts available under the Federal Reserve
discount window are dependent on the fair value of certain investment securities
that are pledged as collateral.
CSC has a commercial paper program of which proceeds are used for general
corporate purposes. The maturities of the Commercial Paper Notes may vary, but
are not to exceed 270 days from the date of issue. CSC's ratings for these
short-term borrowings were P1 by Moody's, A1 by Standard & Poor's , and F1 by
Fitch at December 31, 2020 and 2019, and CSC had no Commercial Paper Notes
outstanding at December 31, 2020 or 2019.
The financial covenants for the $700 million committed credit facility require
CS&Co to maintain a minimum net capital ratio, all bank subsidiaries to be well
capitalized, and CSC to maintain a minimum level of stockholders' equity,
adjusted to exclude AOCI. At December 31, 2020 , the minimum level of
stockholders' equity required under this facility was $16.5 billion (CSC's
stockholders' equity, excluding AOCI, at December 31, 2020 was $50.7 billion ).
Management believes these restrictions will not have a material effect on CSC's
ability to meet foreseeable dividend or funding requirements.
The financial covenants for the $300 million TDA Holding revolving credit
facility requires CSC to maintain a minimum level of stockholders' equity,
adjusted to exclude AOCI. At December 31, 2020 , the minimum level of
stockholders' equity required under this facility was $30.9 billion (CSC's
stockholders' equity, excluding AOCI, at December 31, 2020 was $50.7 billion ).
Effective January 28, 2021 , the Company terminated the TDA Holding revolving
credit facility.
To partially satisfy the margin requirement of client option transactions with
the Options Clearing Corporation , CS&Co has unsecured standby letter of credit
agreements (LOCs) with several banks in favor of the Options Clearing
Corporation , which totaled $15 million at December 31, 2020 . There were no funds
drawn under any of these LOCs during 2020 or 2019. In connection with its
securities lending activities, the Company is required to provide collateral to
certain brokerage clients. These collateral requirements are satisfied by
providing cash as collateral.
CSC has a universal automatic shelf registration statement on file with the
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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)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 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 Item 1 - Regulation for additional information. The Company was in compliance with the reduced LCR rule atDecember 31, 2020 . The table below presents information about our average daily LCR: Average for the Three Months Ended December 31, 2020 Total eligible HQLA $ 78,136 Net cash outflows $ 72,005 LCR 109 % Borrowings The Company had no short-term borrowings outstanding as ofDecember 31, 2020 or 2019. Long-term debt outstanding was$13.6 billion and$7.4 billion atDecember 31, 2020 and 2019, respectively. EffectiveOctober 6, 2020 , the Company completed its acquisition of TD Ameritrade.TDA Holding has$3.6 billion of par value unsecured Senior Notes (TDA Senior Notes) outstanding, which were recognized at the date of acquisition at provisional fair value with no change in existing terms.
The following are details of the Senior Notes:
Weighted-Average Standard
December 31, 2020 Par Outstanding Maturity Interest Rate Moody's & Poor's Fitch
CSC Senior Notes $ 9,881 2021 - 2031 2.84% A2 A A
TDA Senior Notes 3,550 2021 - 2029 2.80% A2 A -
New Debt Issuances
All debt issuances in 2020, 2019, and 2018 were senior unsecured obligations. Additional details are as follows:
Issuance
Issuance Date Amount Maturity Date Interest Rate Interest Payable
Three-month LIBOR
May 22, 2018 $ 600 5/21/2021 + 0.32% Quarterly
May 22, 2018 $ 600 5/21/2021 3.250% Semi-annually
May 22, 2018 $ 750 5/21/2025 3.850% Semi-annually
October 31, 2018 $ 500 2/1/2024 3.550% Semi-annually
October 31, 2018 $ 600 2/1/2029 4.000% Semi-annually
May 22, 2019 $ 600 5/22/2029 3.250% Semi-annually
March 24, 2020 $ 600 3/24/2025 4.200% Semi-annually
March 24, 2020 $ 500 3/22/2030 4.625% Semi-annually
December 11, 2020 $ 1,250 3/11/2026 0.900% Semi-annually
December 11, 2020 $ 750 3/11/2031 1.650% Semi-annually
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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)Equity Issuances and Redemptions
CSC did not issue any equity through external offerings during 2019 or 2018. 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
Series H December 11, 2020 $ 2,470 For further discussion of CSC's long-term debt and information on the equity offerings, see Item 8 - Notes 13 and 19.
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 8 - Notes 7, 11, 13, 15, and 17. Concurrent with the closing of the acquisition of TD Ameritrade effectiveOctober 6, 2020 , the IDA agreement with the TD Depository Institutions became effective. Pursuant to the IDA agreement, certain brokerage client deposits are required to be swept off-balance sheet to theTD Depository Institutions. TD Ameritrade also maintains agreements pursuant to which client brokerage cash deposits are swept to other third-party depository institutions. See Item 8 - Notes 3 and 15 for additional information on the IDA agreement.
Contractual Obligations
Schwab's principal contractual obligations as ofDecember 31, 2020 are shown in the following table. Excluded from this table are liabilities recorded on the consolidated balance sheets that are generally short-term in nature or without contractual payment terms (e.g., bank deposits, payables to brokerage clients, and deferred compensation). The below table excludes exit and other related liabilities from the integration of TD Ameritrade (see Item 8 - Note 16), as well as obligations related to the IDA agreement (see Item 8 - Note 15). Less than 1-3 3-5 More than 1 Year Years Years 5 Years Total Credit-related financial instruments (1)$ 3,250 $ 3,856 $ 1,884 $ 1,449 $ 10,439 Long-term debt (2) 2,165 2,466 3,638 7,217 15,486 Purchase obligations (3) 443 303 110 28 884 Leases (4) 184 367 254 351 1,156 Total$ 6,042 $ 6,992 $ 5,886 $ 9,045 $ 27,965 (1) Represents CSB's commitments to extend credit to banking clients, purchase mortgage loans, and fund CRA investments. (2) Includes estimated future interest payments through 2031 for Senior Notes. Amounts exclude unamortized discounts and premiums. (3) Consists of purchase obligations for services such as advertising and marketing, telecommunications, professional services, and hardware- and software-related agreements. (4) Represents operating lease payments including legally-binding minimum lease payments for leases signed but not yet commenced.
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
inclusive of migration of IDA balances (see further discussion below), 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.
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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)
Internal guidelines are set, for both CSC and its regulated subsidiaries, to
ensure capital levels are in line with our strategy and regulatory requirements.
Capital forecasts are reviewed monthly at Asset-Liability Management and Pricing
Committee and Financial Risk Oversight Committee meetings. A number of early
warning indicators are monitored to help identify potential problems that could
impact capital. In addition, we monitor the subsidiaries' capital levels and
requirements. Subject to regulatory capital requirements and any required
approvals, any excess capital held by subsidiaries is transferred to CSC in the
form of dividends and returns of capital. When subsidiaries have need of
additional capital, funds are provided by CSC as equity investments and also as
subordinated loans (in a form approved as regulatory capital by regulators) for
CS&Co. The details and method used for each cash infusion are based on an
analysis of the particular entity's needs and financing alternatives. The
amounts and structure of infusions must take into consideration maintenance of
regulatory capital requirements, debt/equity ratios, and equity double leverage
ratios.
Schwab conducts regular capital stress testing to assess the potential financial
impacts of various adverse macroeconomic and company-specific events to which
the Company could be subjected. The objective of the capital stress testing is
(1) to explore various potential outcomes - including rare and extreme events
and (2) to assess impacts of potential stressful outcomes on both capital and
liquidity. Additionally, we have a comprehensive Capital Contingency Plan to
provide action plans for certain low probability/high impact capital events that
the Company might face. The Capital Contingency Plan is issued under the
authority of the Financial Risk Oversight Committee and provides guidelines for
sustained capital events. It does not specifically address every contingency,
but is designed to provide a framework for responding to any capital stress. The
results of the stress testing indicate there are two scenarios which could
stress the Company's capital: (1) inflows of balance sheet cash during a period
of very low interest rates and (2) outflows of balance sheet cash when other
sources of financing are not available and the Company is required to sell
assets to fund the flows at a loss. The Capital Contingency Plan is reviewed
annually and updated as appropriate.
For additional information, see Business - Regulation in Part I, Item 1.
Regulatory Capital Requirements
CSC is subject to capital requirements set by theFederal Reserve and is required to serve as a source of strength for our banking subsidiaries and to provide financial assistance if our banking subsidiaries experience financial distress. Schwab is required to maintain a Tier 1 Leverage Ratio for CSC of at least 4%, and we have a long-term operating objective of 6.75%-7.00%. Due to the relatively low risk of our balance sheet assets and risk-based capital ratios at CSC and CSB that are well in excess of regulatory requirements, the Tier 1 Leverage Ratio is the most restrictive capital constraint on CSC's asset growth. Our banking subsidiaries are subject to capital requirements set by their regulators that are substantially similar to those imposed on CSC by theFederal Reserve . Our banking subsidiaries' failure to remain well capitalized could result in certain mandatory and possibly additional discretionary actions by the regulators that could have a direct material effect on the banks. Schwab's principal banking subsidiary, CSB, is required to maintain a Tier 1 Leverage Ratio of at least 5% to be well capitalized, but seeks to maintain a ratio of at least 6.25%. Based on its regulatory capital ratios atDecember 31, 2020 , CSB is considered well capitalized. As a result of the significant inflow of client cash in 2020, our Tier 1 Leverage Ratios for CSC and CSB declined from 7.3% and 7.1%, respectively, at year-end 2019 to 6.3% and 5.5%, respectively, atDecember 31, 2020 . Though below our long-term operating objectives, these ratios are well above the regulatory minimum for both CSC and CSB. The pace of our return to the long-term operating objectives over time depends on a number of factors including the overall size of the Company's balance sheet, earnings, and capital issuances and deployment. - 56 - --------------------------------------------------------------------------------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 the capital ratios for CSC consolidated and CSB:
December 31, 2020 (1) 2019 (1)
CSC CSB CSC CSB
Total stockholders' equity $ 56,060 $ 22,223 $ 21,745 $ 14,832
Less:
Preferred Stock 7,733 - 2,793 -
Common Equity Tier 1 Capital before regulatory
adjustments $ 48,327 $ 22,223 $ 18,952 $ 14,832
Less:
Goodwill, net of associated deferred tax liabilities $ 11,897 $ 13 $ 1,184 $ 13
Other intangible assets, net of associated deferred tax
liabilities 8,103 - 104 -
Deferred tax assets, net of valuation allowances and
deferred tax liabilities 17 12 4 -
AOCI adjustment (1) 5,394 4,672 - -
Common Equity Tier 1 Capital $ 22,916 $ 17,526 $ 17,660 $ 14,819
Tier 1 Capital $ 30,649 $ 17,526 $ 20,453 $ 14,819
Total Capital 30,688 17,558 20,472 14,837
Risk-Weighted Assets 123,881 91,062 90,512 71,521
Total Leverage Exposure 491,469 325,437 286,813 216,582
Common Equity Tier 1 Capital/Risk-Weighted Assets 18.5 % 19.2 % 19.5 % 20.7 %
Tier 1 Capital/Risk-Weighted Assets 24.7 % 19.2 % 22.6 % 20.7 %
Total Capital/Risk-Weighted Assets 24.8 % 19.3 % 22.6 % 20.7 %
Tier 1 Leverage Ratio 6.3 % 5.5 % 7.3 % 7.1 %
Supplementary Leverage Ratio 6.2 % 5.4 % 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 December 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. See Business -
Regulation in Part I, Item 1 for additional information.
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 and the
Texas Department of Savings and Mortgage Lending (TDSML) to declare dividends to
CSC. As broker-dealers, CS&Co, TDAC, and TD Ameritrade, Inc. , are subject to
regulatory requirements of the Uniform Net Capital Rule, which is intended to
ensure the general financial soundness and liquidity of broker-dealers. These
regulations prohibit the broker-dealer subsidiaries from paying cash dividends,
making unsecured advances and loans to CSC and employees, and repaying
subordinated borrowings from CSC if such payment would result in a net capital
amount below prescribed thresholds. At December 31, 2020 , CS&Co, TDAC, and TD
Ameritrade, Inc. were in compliance with their respective 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 8 - Note 23 for additional information on the components of
stockholders' equity and information on the capital requirements of significant
subsidiaries.
IDA Agreement
Pursuant to the IDA agreement, Schwab will be required to move all uninsured IDA
balances out of the IDA sweep program on June 30, 2021 . The IDA agreement also
provides that, starting July 1, 2021 , Schwab will have the option to migrate up
to $10 billion of IDA balances every 12 months to Schwab's balance sheet,
subject to certain limitations and adjustments. The Company's overall capital
management strategy includes supporting migration of the uninsured IDA balances
on June 30, 2021 as well as optional IDA balances in future periods as available
pursuant to the terms of the IDA agreement. The Company's ability to migrate
these balances to its balance sheet is dependent upon multiple factors including
having sufficient capital levels to sustain these incremental deposits and the
availability of IDA balances designated as floating-rate obligations. See Item 8
- Note 15 for further information on the IDA agreement.
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THE CHARLES SCHWAB CORPORATIONManagement's Discussion and Analysis of Financial Condition and Results of
Operations
(Tabular Amounts in Millions, Except Ratios, or as Noted)Dividends
Since the initial dividend in 1989, CSC has paid 127 consecutive quarterly dividends and has increased the quarterly dividend rate 25 times, resulting in a 21% compounded annual growth rate, excluding the special cash dividend of$1.00 per common share in 2007. While the payment and amount of dividends are at the discretion of the Board of Directors, subject to certain regulatory and other restrictions, CSC currently targets its common and nonvoting common stock cash dividend at approximately 20% to 30% of net income.
The Board of Directors of the Company declared quarterly cash dividend increases per common share during 2019 and 2020 as shown below:
Quarterly Cash New Quarterly
Increase Per Common Dividend Per Common
Date of Declaration Share % Increase Share
January 30, 2019 $ 0.04 31 % $ 0.17
January 30, 2020 $ 0.01 6 % $ 0.18
The following table details the CSC cash dividends paid and per share amounts:
Year Ended December 31, 2020 2019
Per Share Per Share
Cash Paid Amount Cash Paid Amount
Common and Nonvoting Common Stock
$ 0.68 Series A Preferred Stock (1) 28 70.00 28 70.00 Series C Preferred Stock (2) 36 60.00 36 60.00 Series D Preferred Stock (2) 45 59.52 45 59.52 Series E Preferred Stock (3) 28 4,625.00 28 4,625.00 Series F Preferred Stock (4) 25 5,000.00 25 5,000.00 Series G Preferred Stock (5) 79 3,150.35 N/A N/A Series H Preferred Stock (6) N/A N/A N/A N/A (1) Dividends paid semi-annually untilFebruary 1, 2022 and quarterly thereafter. (2) Dividends paid quarterly. (3) Dividends paid semi-annually untilMarch 1, 2022 and quarterly thereafter. (4) Dividends paid semi-annually beginning onJune 1, 2018 untilDecember 1, 2027 , and quarterly thereafter. (5) Series G Preferred Stock was issued onApril 30, 2020 . Dividends are paid quarterly, and the first dividend was paid onSeptember 1, 2020 . (6) Series H Preferred Stock was issued onDecember 11, 2020 . Dividends are paid quarterly beginning onMarch 1, 2021 . 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 year endedDecember 31, 2020 . During 2019, CSC repurchased 55 million shares of its common stock for$2.2 billion . As ofDecember 31, 2020 ,$1.8 billion remained on our existing authorization. FOREIGN EXPOSURE AtDecember 31, 2020 , Schwab had exposure to non-sovereign financial and non-financial institutions in foreign countries, as well as agencies of foreign governments. AtDecember 31, 2020 , the fair value of these holdings totaled$10.1 billion , with the top three exposures being to issuers and counterparties domiciled inFrance at$6.7 billion ,Germany at$1.2 billion , andCanada at$880 million . AtDecember 31, 2019 , the fair value of these holdings totaled$6.4 billion , with the top three exposures being to issuers and counterparties domiciled inFrance at$3.1 billion ,the Netherlands at$845 million , andSweden at$684 million . In addition, Schwab had outstanding margin loans to foreign residents of$2.2 billion and$437 million atDecember 31, 2020 and 2019, respectively. Outstanding margin loans to foreign residents atDecember 31, 2020 includes$1.2 billion attributable to the inclusion of TDA balances beginning onOctober 6, 2020 . - 58 - --------------------------------------------------------------------------------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)FAIR VALUE OF FINANCIAL INSTRUMENTS
Schwab uses the market approach to determine the fair value of certain financial assets and liabilities recorded at fair value, and to determine fair value disclosures. See Item 8 - Notes 2 and 18 for more information on our assets and liabilities recorded at fair value. When available, Schwab uses quoted prices in active markets to measure the fair value of assets and liabilities. Quoted prices for investments in exchange-traded securities represent end-of-day close prices published by exchanges. Quoted prices for money market funds and other mutual funds represent reported net asset values. When utilizing market data and bid-ask spread, we use the price within the bid-ask spread that best represents fair value. When quoted prices in active markets do not exist, prices are obtained from independent third-party pricing services to measure the fair value of investment assets. We generally obtain prices from three independent pricing sources for assets recorded at fair value. Our primary third-party pricing service provides prices for our fixed income investments such as commercial paper; certificates of deposits;U.S. government and agency securities; state and municipal securities; corporate debt securities; asset-backed securities; foreign government agency securities; and non-agency commercial mortgage-backed securities. Such prices are based on observable trades, broker/dealer quotes, and discounted cash flows that incorporate observable information such as yields for similar types of securities (a benchmark interest rate plus observable spreads) and weighted-average maturity for the same or similar "to-be-issued" securities. We compare the prices obtained from the primary independent pricing service to the prices obtained from the additional independent pricing services to determine if the price obtained from the primary independent pricing service is reasonable. Schwab does not adjust the prices received from independent third-party pricing services unless such prices are inconsistent with the definition of fair value and result in material differences in the amounts recorded. AtDecember 31, 2020 and 2019, we did not adjust prices received from the primary independent third-party pricing service. CRITICAL ACCOUNTING ESTIMATES
The consolidated financial statements of Schwab have been prepared in accordance with GAAP. Item 8 - Note 2 contains more information on our significant accounting policies made in applying these accounting principles.
While the majority of the revenues, expenses, assets and liabilities are not based on estimates, there are certain accounting principles that require management to make estimates regarding matters that are uncertain and susceptible to change where such change may result in a material adverse impact on Schwab's financial position and financial results. These critical accounting estimates are described below. Management regularly reviews the estimates and assumptions used in the preparation of the financial statements for reasonableness and adequacy. Management has discussed the development and selection of these critical accounting estimates with the Audit Committee of the Board of Directors. Additionally, management has reviewed with the Audit Committee the Company's significant estimates discussed in this Management's Discussion and Analysis of Financial Condition and Results of Operations.
Income Taxes
Schwab estimates income tax expense based on amounts expected to be owed to the
various tax jurisdictions in which we operate, including federal, state and
local domestic jurisdictions, and immaterial amounts owed to several foreign
jurisdictions. The estimated income tax expense is reported in the consolidated
statements of income in taxes on income. Accrued taxes are reported in other
assets or accrued expenses and other liabilities on the consolidated balance
sheets and represent the net estimated amount due to or to be received from
taxing jurisdictions either currently or deferred to future periods. Deferred
taxes arise from differences between assets and liabilities measured for
financial reporting purposes versus income tax reporting purposes. Deferred tax
assets are recognized if, in management's judgment, their realizability is
determined to be more likely than not. Uncertain tax positions that meet the
more likely than not recognition threshold are measured to determine the amount
of benefit to recognize. An uncertain tax position is measured at the largest
amount of benefit management believes is more likely than not to be realized
upon settlement. In estimating accrued taxes, we assess the relative merits and
risks of the appropriate tax treatment considering statutory, judicial and
regulatory guidance in the context of the tax position. Because of the
complexity of tax laws and regulations, interpretation can be difficult and
subject to legal judgment given specific facts and circumstances.
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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)
Changes in the estimate of accrued taxes occur periodically due to changes in
tax rates, interpretations of tax laws, the status of examinations being
conducted by various taxing authorities, and newly enacted statutory, judicial
and regulatory guidance that impacts the relative merits and risks of tax
positions. These changes, when they occur, affect accrued taxes and can be
significant to the operating results of the Company. See Item 8 - Note 22 for
more information on the Company's income taxes.
Legal and Regulatory Reserves
Reserves for legal and regulatory claims and proceedings reflect an estimate of
probable losses for each matter, after considering, among other factors, the
progress of the case, prior experience and the experience of others in similar
cases, available defenses, and the opinions and views of legal counsel. In many
cases, including most class action lawsuits, it is not possible to determine
whether a loss will be incurred, or to estimate the range of that loss, until
the matter is close to resolution, in which case no accrual is made until that
time. Reserves are adjusted as more information becomes available. Significant
judgment is required in making these estimates, and the actual cost of resolving
a matter may ultimately differ materially from the amount reserved. See Item 8 -
Note 15 for more information on the Company's contingencies related to legal and
regulatory reserves.
Business Combinations
We have accounted for our acquisitions using the acquisition method of
accounting. The acquisition method requires us to make significant estimates and
assumptions, especially at the acquisition date as we allocate the purchase
price to the estimated fair values of acquired tangible and intangible assets
and the liabilities assumed. We also use our best estimates to determine the
useful lives of the tangible and definite-lived intangible assets, which impact
the periods over which depreciation and amortization of those assets are
recognized. These best estimates and assumptions are inherently uncertain as
they pertain to forward looking views of our businesses, client behavior, and
market conditions. In our acquisitions, we have also recognized goodwill at the
amount by which the purchase price paid exceeds the fair value of the net assets
acquired. See Item 8 - Note 3 for more information on our valuation methods and
the results of applying the acquisition method of accounting, including the
estimated fair values of the assets acquired and liabilities assumed, and, where
relevant, the estimated remaining useful lives.
Our ongoing accounting for goodwill and the tangible and intangible assets
acquired requires us to make significant estimates and assumptions as we
exercise judgement to evaluate these assets for impairment. Our processes and
accounting policies for evaluating impairments are further described in Item 8 -
Note 2. One of our reporting units has an immaterial amount of goodwill. The
results of the 2020 annual goodwill impairment testing for our other two
reporting units indicated that the estimated fair values substantially exceeded
their carrying amounts.
NON-GAAP FINANCIAL MEASURES
In addition to disclosing financial results in accordance with 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.
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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)Schwab's use of non-GAAP measures is reflective of certain adjustments made to GAAP financial measures as described below.
Non-GAAP Adjustment or
Measure Definition Usefulness to Investors and Uses by Management
Acquisition and Schwab adjusts certain GAAP financial We exclude acquisition and integration-related
integration-related costs measures to exclude the impact of costs and amortization of acquired intangible
and amortization of acquisition and integration-related costs assets for the purpose of calculating certain
acquired intangible assets incurred as a result of the Company's non-GAAP measures because we believe doing so
acquisitions, amortization of acquired provides additional transparency of Schwab's
intangible assets, and, where applicable, ongoing operations, and is useful in both
the income tax effect of these expenses. evaluating the operating performance of the
business and facilitating comparison of results
Adjustments made to exclude amortization of with prior and future periods.
acquired intangible assets are reflective of
all acquired intangible assets, which were Acquisition and integration-related costs fluctuate
recorded as part of purchase accounting. based on the timing of acquisitions and integration
These acquired intangible assets contribute activities, thereby limiting comparability of
to the Company's revenue generation. results among periods, and are not representative
Amortization of acquired intangible assets of the costs of running the Company's ongoing
will continue in future periods over their business. Amortization of acquired intangible
remaining useful lives. assets is excluded because management does not
believe it is indicative of the Company's
underlying operating performance. Return on tangible common Return on tangible common equity represents Acquisitions typically result in the recognition of equity
annualized adjusted net income available to significant amounts of goodwill and acquired
common stockholders as a percentage of intangible assets. We believe return on tangible
average tangible common equity. Tangible common equity may be useful to investors as a
common equity represents common equity less supplemental measure to facilitate assessing
goodwill, acquired intangible assets - net, capital efficiency and returns relative to the
and related deferred tax liabilities. composition of Schwab's balance sheet.
Beginning in 2021, the Company also uses adjusted diluted EPS and return on tangible common equity as components of performance criteria for employee bonus and certain executive management incentive compensation arrangements. The Compensation Committee of CSC's Board of Directors maintains discretion in evaluating performance against these criteria.
The following tables present reconciliations of GAAP measures to non-GAAP
measures:
Year Ended December 31,
2020 2019 2018
Total expenses excluding interest (GAAP) $ 7,391 $
5,873
Acquisition and integration-related costs (1) (442) (26) -
Amortization of acquired intangible assets (190) (27) (29)
Adjusted total expenses (non-GAAP) $ 6,759 $
5,820
(1) Acquisition and integration-related costs for 2020 primarily consist 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)
Year Ended December 31,
2020 2019 2018
Amount Diluted EPS Amount Diluted EPS Amount Diluted EPS Net income available to common stockholders (GAAP), Earnings per common share - diluted (GAAP)
$ 3,043 $
2.12
442 .31 26 .02 - -
Amortization of acquired intangible assets 190 .13 27 .02 29 .02
Income tax effects (1) (154) (.11) (13) (.01) (7) (.01)
Adjusted net income available to common stockholders (non-GAAP), Adjusted diluted EPS (non-GAAP)
$ 3,521 $
2.45
(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.
Year
Ended
2020 2019 2018
Return on average common stockholders' equity (GAAP) 9 % 19 % 19 %
Average common stockholders' equity $ 33,640 $ 18,415 $ 17,125
Less: Average goodwill (6,590) (1,227) (1,227)
Less: Average acquired intangible assets - net (5,059) (140) (130)
Plus: Average deferred tax liabilities related to
goodwill and acquired intangible assets - net 1,005 67 68
Average tangible common equity $ 22,996 $ 3,521 $ 3,566 $ 3,351 Return on tangible common equity (non-GAAP) 15 %
21 % 21 %
(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 Item 7A. Quantitative and Qualitative Disclosures About Market Risk
For a discussion of the quantitative and qualitative disclosures about market risk, see Risk Management in Part II, Item 7.
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THE CHARLES SCHWAB CORPORATION © Edgar Online, source
