Edgar Filing: SCHWAB CHARLES CORP

Form 10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2012

Commission File Number: 1-9700

THE CHARLES SCHWAB CORPORATION

(Exact name of registrant as specified in its charter)

Delaware

94-3025021

(State or other jurisdiction

of incorporation or organization)

(I.R.S. Employer Identification No.)

211 Main Street, San Francisco, CA 94105

(Address of principal executive offices and zip code)

Registrant’s telephone number, including area code: (415) 667-7000

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.


Large accelerated filer	x	Accelerated filer	¨

Non-accelerated filer	¨ (Do not check if a smaller reporting company)	Smaller reporting company	¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x

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

1,275,098,321 shares of $.01 par value Common Stock

Outstanding on October 24, 2012

THE CHARLES SCHWAB CORPORATION

Quarterly Report on Form 10-Q

For the Quarter Ended September 30, 2012

Index


		Page

Part I - Financial Information

Item 1.	Condensed Consolidated Financial Statements (Unaudited):

	Statements of Income		1

	Statements of Comprehensive Income		2

	Balance Sheets		3

	Statements of Cash Flows		4

	Notes		5 – 26

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		27 – 51

Item 3.	Quantitative and Qualitative Disclosures About Market Risk		52 – 53

Item 4.	Controls and Procedures		53

Part II - Other Information

Item 1.	Legal Proceedings		54

Item 1A.	Risk Factors		54

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		54

Item 3.	Defaults Upon Senior Securities		54

Item 4.	Mine Safety Disclosures		55

Item 5.	Other Information		55

Item 6.	Exhibits		56

Signature			58

Part I – FINANCIAL INFORMATION

Item 1. Condensed Consolidated Financial Statements

THE CHARLES SCHWAB CORPORATION

Condensed Consolidated Statements of Income

(In millions, except per share amounts)

(Unaudited)


	Three Months Ended September 30,						Nine Months Ended September 30,
	2012			2011			2012			2011
Net Revenues
Asset management and administration fees	$	524		$	466		$	1,504		$	1,470

Interest revenue		478			487			1,447			1,464
Interest expense		(39	)		(44	)		(116	)		(134	)

Net interest revenue		439			443			1,331			1,330

Trading revenue		204			248			666			694
Other		42			45			209			119
Provision for loan losses		(10	)		(8	)		(14	)		(13	)
Net impairment losses on securities⁽¹⁾		(3	)		(13	)		(28	)		(22	)


Total net revenues		1,196			1,181			3,668			3,578

Expenses Excluding Interest
Compensation and benefits		442			423			1,353			1,290
Professional services		98			104			287			288
Occupancy and equipment		77			78			233			222
Advertising and market development		49			48			173			159
Communications		53			56			166			166
Depreciation and amortization		50			39			146			107
Class action litigation and regulatory reserve		—			—			—			7
Other		66			73			204			199

Total expenses excluding interest		835			821			2,562			2,438

Income before taxes on income		361			360			1,106			1,140
Taxes on income		114			140			389			439

Net Income		247			220			717			701

Preferred stock dividends		9			—			23			—

Net Income Available to Common Stockholders	$	238		$	220		$	694		$	701


Weighted-Average Common Shares Outstanding — Diluted		1,275			1,229			1,274			1,216


Earnings Per Common Share — Basic	$	.19		$	.18		$	.54		$	.58
Earnings Per Common Share — Diluted	$	.19		$	.18		$	.54		$	.57

⁽¹⁾

Net impairment losses on securities include total other-than-temporary impairment losses of $1 million and $2 million, net of $(2) million and $(11) million recognized in other comprehensive income, for the three months ended September 30, 2012 and 2011, respectively. Net impairment losses on securities include total other-than-temporary impairment losses of $15 million and $13 million, net of $(13) million and $(9) million recognized in other comprehensive income, for the nine months ended September 30, 2012 and 2011, respectively.

See Notes to Condensed Consolidated Financial Statements.

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THE CHARLES SCHWAB CORPORATION

Condensed Consolidated Statements of Comprehensive Income

(In millions)

(Unaudited)


	Three Months Ended September 30,						Nine Months Ended September 30,
	2012			2011			2012			2011
Net Income	$	247		$	220		$	717		$	701
Other comprehensive income:
Change in net unrealized gain on securities available for sale:
Net unrealized gain		250			4			458			41
Reclassification of impairment charges included in earnings		3			13			28			22
Other reclassifications included in earnings		—			—			(1	)		1
Income tax effect		(95	)		(6	)		(181	)		(24	)

Total other comprehensive income		158			11			304			40

Comprehensive Income	$	405		$	231		$	1,021		$	741

See Notes to Condensed Consolidated Financial Statements.

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THE CHARLES SCHWAB CORPORATION

Condensed Consolidated Balance Sheets

(In millions, except per share and share amounts)

(Unaudited)


	September 30, 2012			December 31, 2011
Assets
Cash and cash equivalents	$	8,523		$	8,679
Cash and investments segregated and on deposit for regulatory purposes (including resale agreements of $17,843 at September 30, 2012 and $17,899 at December 31, 2011)		25,041			26,034
Receivables from brokers, dealers, and clearing organizations		607			230
Receivables from brokerage clients — net		11,914			11,072
Other securities owned — at fair value		513			593
Securities available for sale		42,448			33,965
Securities held to maturity (fair value — $16,229 at September 30, 2012 and $15,539 at December 31, 2011)		15,612			15,108
Loans to banking clients — net		10,102			9,812
Loans held for sale		—			70
Equipment, office facilities, and property — net		672			685
Goodwill		1,159			1,161
Intangible assets — net		292			326
Other assets		775			818

Total assets	$	117,658		$	108,553

Liabilities and Stockholders’ Equity
Deposits from banking clients	$	68,756		$	60,854
Payables to brokers, dealers, and clearing organizations		1,445			1,098
Payables to brokerage clients		34,761			35,489
Accrued expenses and other liabilities		1,455			1,397
Long-term debt		1,776			2,001

Total liabilities		108,193			100,839

Stockholders’ equity:
Preferred stock — $.01 par value per share; aggregate liquidation preference of $885 at September 30, 2012 and $0 at December 31, 2011		864			—
Common stock — 3 billion shares authorized; $.01 par value per share; 1,487,543,446 shares issued		15			15
Additional paid-in capital		3,890			3,826
Retained earnings		8,442			7,978
Treasury stock, at cost — 212,554,662 shares at September 30, 2012 and 216,378,623 shares at December 31, 2011		(4,058	)		(4,113	)
Accumulated other comprehensive income		312			8

Total stockholders’ equity		9,465			7,714

Total liabilities and stockholders’ equity	$	117,658		$	108,553

See Notes to Condensed Consolidated Financial Statements.

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THE CHARLES SCHWAB CORPORATION

Condensed Consolidated Statements of Cash Flows

(In millions)

(Unaudited)


	Nine Months Ended September 30,
	2012			2011
Cash Flows from Operating Activities
Net income	$	717		$	701
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses		14			13
Net impairment losses on securities		28			22
Stock-based compensation		79			73
Depreciation and amortization		146			107
Premium amortization, net, on securities available for sale and securities held to maturity		163			62
Other		4			(3	)
Originations of loans held for sale		(441	)		(1,139	)
Proceeds from sales of loans held for sale		513			1,251
Net change in:
Cash and investments segregated and on deposit for regulatory purposes		880			(3,187	)
Receivables from brokers, dealers, and clearing organizations		(376	)		(111	)
Receivables from brokerage clients		(844	)		333
Other securities owned		80			(86	)
Other assets		19			32
Payables to brokers, dealers, and clearing organizations		84			(242	)
Payables to brokerage clients		(619	)		4,513
Accrued expenses and other liabilities		(74	)		(327	)

Net cash provided by operating activities		373			2,012

Cash Flows from Investing Activities
Purchases of securities available for sale		(19,889	)		(10,800	)
Proceeds from sales of securities available for sale		1,524			450
Principal payments on securities available for sale		10,546			5,639
Purchases of securities held to maturity		(4,620	)		(866	)
Principal payments on securities held to maturity		4,012			2,795
Net increase in loans to banking clients		(318	)		(997	)
Purchase of equipment, office facilities, and property		(107	)		(137	)
Cash acquired in business acquisition, net of cash paid		—			84
Other investing activities		10			11

Net cash used for investing activities		(8,842	)		(3,821	)

Cash Flows from Financing Activities
Net change in deposits from banking clients		7,902			3,488
Repayment of long-term debt		(207	)		(115	)
Premium paid on debt exchange		(19	)		—
Net proceeds from preferred stock offerings		863			—
Dividends paid		(252	)		(218	)
Proceeds from stock options exercised and other		26			89
Other financing activities		—			10

Net cash provided by financing activities		8,313			3,254

(Decrease) Increase in Cash and Cash Equivalents		(156	)		1,445
Cash and Cash Equivalents at Beginning of Period		8,679			4,931

Cash and Cash Equivalents at End of Period	$	8,523		$	6,376


Supplemental Cash Flow Information
Cash paid during the period for:
Interest	$	118		$	127
Income taxes	$	379		$	416
Non-cash investing activities:
Common stock issued and equity awards assumed for business acquisition (See note “3 - Business Acquisition” for acquisition of optionsXpress Holdings, Inc.)	$	—		$	714
Securities purchased during the period but settled after period end	$	263		$	203
Non-cash financing activity:
Exchange of Senior Notes (See note “6 - Borrowings”)	$	256		$	—

See Notes to Condensed Consolidated Financial Statements.

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THE CHARLES SCHWAB CORPORATION

Notes to Condensed Consolidated Financial Statements

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

(Unaudited)

Introduction and Basis of Presentation

The Charles Schwab Corporation (CSC) is a savings and loan holding company engaged, through its subsidiaries, in securities brokerage, banking, and related financial services. Charles Schwab & Co., Inc. (Schwab) is a securities broker-dealer with over 300 domestic branch offices in 45 states, as well as a branch in each of the Commonwealth of Puerto Rico and London, U.K. In addition, Schwab serves clients in Hong Kong through one of CSC’s subsidiaries. Other subsidiaries include Charles Schwab Bank (Schwab Bank), a federal savings bank, and Charles Schwab Investment Management, Inc. (CSIM), the investment advisor for Schwab’s proprietary mutual funds, which are referred to as the Schwab Funds^®, and for Schwab’s exchange-traded funds, which are referred to as the Schwab ETFs™.

The accompanying unaudited condensed consolidated financial statements include CSC and its majority-owned subsidiaries (collectively referred to as the Company). Intercompany balances and transactions have been eliminated. These condensed consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States, which require management to make certain estimates and assumptions that affect the reported amounts in the accompanying financial statements. Certain estimates relate to other-than-temporary impairment of securities available for sale and securities held to maturity, valuation of goodwill, allowance for loan losses, and legal reserves. Actual results may differ from those estimates. These condensed consolidated financial statements reflect all adjustments that are, in the opinion of management, necessary for a fair presentation of the results for the periods presented. These adjustments are of a normal recurring nature. Certain prior period amounts have been reclassified to conform to the 2012 presentation. The Company’s results for any interim period are not necessarily indicative of results for a full year or any other interim period. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011.

New Accounting Standard

Adoption of New Accounting Standard

Testing Goodwill for Impairment: In September 2011, the Financial Accounting Standards Board issued new guidance allowing companies to consider qualitative factors before performing a quantitative assessment when determining whether goodwill is impaired, which was effective for goodwill impairment tests performed after January 1, 2012. Specifically, there is no longer a requirement to perform the two-step goodwill impairment test unless the entity determines that based on qualitative factors, it is more likely than not that the fair value of a reporting unit is less than its carrying amount. The adoption of this new guidance did not have a material impact on the Company’s financial position, results of operations, earnings per common share (EPS), or cash flows.

Business Acquisition

On September 1, 2011, the Company completed its acquisition of all of the outstanding common shares of optionsXpress Holdings, Inc. (optionsXpress) for total consideration of $714 million. optionsXpress is an online brokerage firm primarily focused on equity option securities and futures. The optionsXpress^® brokerage platform provides active investors and traders trading tools, analytics and education to execute a variety of investment strategies. The combination of optionsXpress and Schwab offers active investors an additional level of service and platform capabilities.

Under the terms of the merger agreement, optionsXpress stockholders received 1.02 shares of the Company’s common stock for each share of optionsXpress stock. As a result, the Company issued 59 million shares of the Company’s common stock valued at $710 million, based on the closing price of the Company’s common stock on September 1, 2011. The Company also assumed optionsXpress’ stock-based compensation awards valued at $4 million. In allocating the purchase price based on estimated fair values of assets and liabilities assumed as of the acquisition date, the Company recorded $511 million of goodwill and $285 million of intangible assets. The results of optionsXpress’ operations have been included in the Company’s condensed consolidated statements of income from the date of acquisition. optionsXpress’ net revenues were

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THE CHARLES SCHWAB CORPORATION

Notes to Condensed Consolidated Financial Statements

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

(Unaudited)

$42 million and its net loss was not material for the third quarter of 2012. optionsXpress’ net revenues were $143 million and its net income was $7 million for the first nine months of 2012.

The following table presents pro forma financial information as if optionsXpress had been acquired prior to January 1, 2011. Pro forma net income for the third quarter and first nine months of 2011 were adjusted to exclude $10 million and $12 million, after tax, respectively, of acquisition related costs incurred by the Company in 2011. Additionally, pro forma net income below excludes $15 million, before tax, of acquisition related costs because these costs were incurred by optionsXpress prior to the acquisition date. Pro forma net income also reflects the impact of amortizing purchase accounting adjustments relating to intangible assets, net of tax, of $6 million and $17 million in the third quarter and first nine months of 2011, respectively.


	Three Months Ended September 30, 2011		Nine Months Ended September 30, 2011
Net revenues	$	1,222	$	3,744
Net income	$	231	$	726
Basic EPS	$	.18	$	.57
Diluted EPS	$	.18	$	.57

The pro forma financial information above is presented for illustrative purposes only and is not necessarily indicative of the results that actually would have occurred had the acquisition been completed prior to January 1, 2011, nor is it indicative of the results of operations for future periods.

Securities Available for Sale and Securities Held to Maturity

The amortized cost, gross unrealized gains and losses, and fair value of securities available for sale and securities held to maturity are as follows:


September 30, 2012	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
Securities available for sale:
U.S. agency residential mortgage-backed securities	$	23,298	$	480	$	6	$	23,772
Non-agency residential mortgage-backed securities		856		3		77		782
Corporate debt securities		5,555		56		1		5,610
Certificates of deposit		5,524		14		2		5,536
Commercial paper		449		—		—		449
U.S. agency notes		350		—		—		350
Asset-backed and other securities		5,916		35		2		5,949

Total securities available for sale	$	41,948	$	588	$	88	$	42,448

Securities held to maturity:
U.S. agency residential mortgage-backed securities	$	15,450	$	618	$	1	$	16,067
Other securities		162		—		—		162

Total securities held to maturity	$	15,612	$	618	$	1	$	16,229

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THE CHARLES SCHWAB CORPORATION

Notes to Condensed Consolidated Financial Statements

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

(Unaudited)


December 31, 2011	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
Securities available for sale:
U.S. agency residential mortgage-backed securities	$	20,666	$	269	$	14	$	20,921
Non-agency residential mortgage-backed securities		1,130		—		223		907
Corporate debt securities		3,592		5		26		3,571
Certificates of deposit		3,623		2		3		3,622
Commercial paper		225		—		—		225
U.S. agency notes		1,795		5		—		1,800
Asset-backed and other securities		2,919		7		7		2,919

Total securities available for sale	$	33,950	$	288	$	273	$	33,965

Securities held to maturity:
U.S. agency residential mortgage-backed securities	$	14,770	$	430	$	2	$	15,198
Other securities		338		3		—		341

Total securities held to maturity	$	15,108	$	433	$	2	$	15,539

A summary of securities with unrealized losses, aggregated by category and period of continuous unrealized loss, is as follows:


	Less than 12 months				12 months or longer				Total
September 30, 2012	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
Securities available for sale:
U.S. agency residential mortgage-backed securities	$	—	$	—	$	346	$	6	$	346	$	6
Non-agency residential mortgage-backed securities		—		—		606		77		606		77
Corporate debt securities		776		1		—		—		776		1
Certificates of deposit		698		2		—		—		698		2
Asset-backed and other securities		—		—		923		2		923		2

Total	$	1,474	$	3	$	1,875	$	85	$	3,349	$	88

Securities held to maturity:
U.S. agency residential mortgage-backed securities	$	249	$	1	$	—	$	—	$	249	$	1

Total	$	249	$	1	$	—	$	—	$	249	$	1

Total securities with unrealized losses ⁽¹⁾	$	1,723	$	4	$	1,875	$	85	$	3,598	$	89

⁽¹⁾	The number of investment positions with unrealized losses totaled 128 for securities available for sale and 7 for securities held to maturity.

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THE CHARLES SCHWAB CORPORATION

Notes to Condensed Consolidated Financial Statements

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

(Unaudited)


	Less than 12 months				12 months or longer				Total
December 31, 2011	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
Securities available for sale:
U.S. agency residential mortgage-backed securities	$	5,551	$	14	$	—	$	—	$	5,551	$	14
Non-agency residential mortgage-backed securities		121		8		746		215		867		223
Corporate debt securities		1,888		26		—		—		1,888		26
Certificates of deposit		2,158		3		—		—		2,158		3
Asset-backed and other securities		1,376		6		152		1		1,528		7

Total	$	11,094	$	57	$	898	$	216	$	11,992	$	273

Securities held to maturity:
U.S. agency residential mortgage-backed securities	$	384	$	2	$	—	$	—	$	384	$	2

Total	$	384	$	2	$	—	$	—	$	384	$	2

Total securities with unrealized losses ⁽¹⁾	$	11,478	$	59	$	898	$	216	$	12,376	$	275

⁽¹⁾	The number of investment positions with unrealized losses totaled 296 for securities available for sale and 3 for securities held to maturity.

Unrealized losses in securities available for sale of $88 million as of September 30, 2012, were concentrated in non-agency residential mortgage-backed securities. Included in non-agency residential mortgage-backed securities are securities collateralized by loans that are considered to be “Prime” (defined as loans to borrowers with a Fair Isaac Corporation credit score of 620 or higher at origination), and “Alt-A” (defined as Prime loans with reduced documentation at origination). At September 30, 2012, the amortized cost and fair value of Alt-A residential mortgage-backed securities were $326 million and $280 million, respectively.

Certain Alt-A and Prime residential mortgage-backed securities experienced continued credit deterioration in the first nine months of 2012, including increased payment delinquency rates and losses on foreclosures of underlying mortgages. In addition, the Company increased the projected default rates for modified loans in the first quarter of 2012. Based on the Company’s cash flow projections, management determined that it does not expect to recover all of the amortized cost of these securities and therefore determined that these securities were other-than-temporarily impaired (OTTI). The Company employs a buy and hold strategy relative to its mortgage-related securities, and does not intend to sell these securities and will not be required to sell these securities before anticipated recovery of the unrealized losses on these securities. Further, the Company has adequate liquidity at September 30, 2012, with cash and cash equivalents totaling $8.5 billion, a loan-to-deposit ratio of 15%, adequate access to short-term borrowing facilities and regulatory capital ratios in excess of “well capitalized” levels. Because the Company does not intend to sell these securities and it is not “more likely than not” that the Company will be required to sell these securities, the Company recognized an impairment charge equal to the securities’ expected credit losses of $3 million and $28 million during the third quarter and first nine months of 2012, respectively. The expected credit losses were measured as the difference between the present value of expected cash flows and the amortized cost of the securities. Further deterioration in the performance of the underlying loans in the Company’s residential mortgage-backed securities portfolio could result in the recognition of additional impairment charges.

Actual credit losses on the Company’s residential mortgage-backed securities were not material during the third quarters or first nine months of 2012 or 2011.

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THE CHARLES SCHWAB CORPORATION

Notes to Condensed Consolidated Financial Statements

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

(Unaudited)

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


	Three Months Ended September 30,				Nine Months Ended September 30,
	2012		2011		2012		2011
Balance at beginning of period	$	152	$	105	$	127	$	96
Credit losses recognized into current period earnings on debt securities for which an other-than-temporary impairment was not previously recognized		1		2		6		4
Credit losses recognized into current period earnings on debt securities for which an other-than-temporary impairment was previously recognized		2		11		22		18

Balance at end of period	$	155	$	118	$	155	$	118

The maturities of securities available for sale and securities held to maturity at September 30, 2012, are as follows:


	Within 1 year		After 1 year through 5 years		After 5 years through 10 years		After 10 years		Total
Securities available for sale:
U.S. agency residential mortgage-backed securities ⁽¹⁾	$	—	$	2	$	4,031	$	19,739	$	23,772
Non-agency residential mortgage-backed securities ⁽¹⁾		—		—		8		774		782
Corporate debt securities		1,015		4,595		—		—		5,610
Certificates of deposit		4,030		1,506		—		—		5,536
Commercial paper		449		—		—		—		449
U.S. agency notes		—		100		250		—		350
Asset-backed and other securities		—		474		440		5,035		5,949

Total fair value	$	5,494	$	6,677	$	4,729	$	25,548	$	42,448
Total amortized cost	$	5,484	$	6,617	$	4,565	$	25,282	$	41,948

Securities held to maturity:
U.S. agency residential mortgage-backed securities ⁽¹⁾	$	—	$	—	$	7,049	$	9,018	$	16,067
Other securities		—		162		—		—		162

Total fair value	$	—	$	162	$	7,049	$	9,018	$	16,229
Total amortized cost	$	—	$	162	$	6,678	$	8,772	$	15,612

⁽¹⁾

Residential mortgage-backed securities have been allocated over maturity groupings based on final contractual maturities. Actual maturities will differ from final contractual maturities because borrowers on a certain portion of loans underlying these securities have the right to prepay their obligations.

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


	Three Months Ended September 30,				Nine Months Ended September 30,
	2012		2011		2012		2011
Proceeds	$	201	$	—	$	1,524	$	450
Gross realized gains	$	—	$	—	$	2	$	1
Gross realized losses	$	—	$	—	$	—	$	—

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THE CHARLES SCHWAB CORPORATION

Notes to Condensed Consolidated Financial Statements

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

(Unaudited)

Loans to Banking Clients and Related Allowance for Loan Losses

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


	September 30, 2012			December 31, 2011
Residential real estate mortgages	$	5,982		$	5,596
Home equity lines of credit		3,346			3,509
Personal loans secured by securities		807			742
Other		24			19

Total loans to banking clients ⁽¹⁾		10,159			9,866
Allowance for loan losses		(57	)		(54	)

Total loans to banking clients – net	$	10,102		$	9,812

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

The Company records an allowance for loan losses through a charge to earnings based on management’s evaluation of probable losses in the existing portfolio. Management reviews the allowance for loan losses quarterly, taking into consideration current economic conditions, the composition of the existing loan portfolio, past loss experience, and risks inherent in the portfolio to ensure that the allowance for loan losses is maintained at an appropriate level.

The methodology to establish an allowance for loan losses utilizes statistical models that estimate prepayments, defaults, and probable losses for the loan segments based on predicted behavior of individual loans within the segments. The methodology considers the effects of borrower behavior and a variety of factors including, but not limited to, interest rates, housing price movements as measured by a housing price index, economic conditions, estimated defaults and foreclosures measured by historical and expected delinquencies, changes in prepayment speeds, loan-to-value (LTV) ratios, past loss experience, estimates of future loss severities, borrower credit risk measured by Fair Isaac Corporation (FICO) scores, and the adequacy of collateral. The methodology also evaluates concentrations in the loan segments, including loan products, year of origination, geographical distribution of collateral, and the portion of borrowers who have other client relationships with the Company.

Probable losses are forecast using a loan-level simulation of the delinquency status of the loans over the term of the loans. The simulation starts with the current relevant risk indicators, including the current delinquent status of each loan, the estimated current LTV ratio of each loan, the term and structure of each loan, current key interest rates including U.S. Treasury and LIBOR rates, and borrower FICO scores. The more significant variables included in the simulation include delinquency roll rates, loss severity, housing prices, and interest rates. Delinquency roll rates (i.e., the rates at which loans transition through delinquency stages and ultimately result in a loss) are estimated from the Company’s historical loss experience adjusted for current trends and market information. Further, the delinquency roll rates within the loan-level simulation discussed above are calibrated to match a moving average of the delinquency roll rates actually experienced in the respective first lien residential real estate mortgage loan (First Mortgage) and home equity line of credit (HELOC) portfolios. Loss severity estimates are based on the Company’s historical loss experience and market trends. Housing price trends are derived from historical home price indices and econometric forecasts of future home values. Factors affecting the home price index include: housing inventory, unemployment, interest rates, and inflation expectations. Interest rate projections are based on the current term structure of interest rates and historical volatilities to project various possible future interest rate paths. As a result, the current state of house prices, including the decrease in general house prices experienced over the last several years, as well as the current state of delinquencies unique to the Company’s First Mortgage and HELOC portfolios, are considered in the allowance for loan loss methodology.

This methodology results in a loss factor that is applied to the outstanding balances to determine the allowance for loan loss for each loan segment.

- 10 -

THE CHARLES SCHWAB CORPORATION

Notes to Condensed Consolidated Financial Statements

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

(Unaudited)

Changes in the allowance for loan losses were as follows:


Three Months Ended	September 30, 2012									September 30, 2011
	Residential real estate mortgages			Home equity lines of credit			Total			Residential real estate mortgages			Home equity lines of credit			Total
Balance at beginning of period	$	34		$	17		$	51		$	34		$	16		$	50
Charge-offs		(2	)		(3	)		(5	)		(2	)		(3	)		(5	)
Recoveries		1			—			1			—			—			—
Provision for loan losses		2			8			10			6			2			8

Balance at end of period	$	35		$	22		$	57		$	38		$	15		$	53


Nine Months Ended	September 30, 2012									September 30, 2011
	Residential real estate mortgages			Home equity lines of credit			Total			Residential real estate mortgages			Home equity lines of credit			Total
Balance at beginning of period	$	40		$	14		$	54		$	38		$	15		$	53
Charge-offs		(6	)		(7	)		(13	)		(8	)		(6	)		(14	)
Recoveries		2			—			2			—			1			1
Provision for loan losses		(1	)		15			14			8			5			13

Balance at end of period	$	35		$	22		$	57		$	38		$	15		$	53

Included in the loan portfolio are nonaccrual loans totaling $46 million and $52 million at September 30, 2012 and December 31, 2011, respectively. There were no loans accruing interest that were contractually 90 days or more past due at September 30, 2012 or December 31, 2011. The amount of interest revenue that would have been earned on nonaccrual loans, versus actual interest revenue recognized on these loans, was not material to the Company’s results of operations in the first nine months of 2012 or 2011. Nonperforming assets, which include nonaccrual loans and other real estate owned, totaled $50 million and $56 million at September 30, 2012 and December 31, 2011, respectively. The Company considers loan modifications in which it makes an economic concession to a borrower experiencing financial difficulty to be a troubled debt restructuring. Troubled debt restructurings were not material at September 30, 2012 or December 31, 2011.

In the first quarter of 2012, Schwab Bank launched a co-branded loan origination program for Schwab Bank clients (the Program) with Quicken Loans, Inc. (Quicken^® Loans^®). Pursuant to the Program, Quicken Loans originates and services loans for Schwab Bank clients and Schwab Bank sets the underwriting standards and pricing for those loans it intends to purchase for its portfolio. These underwriting standards are the same standards that Schwab Bank applied previously to its originated loans. The First Mortgage portion of the Program launched in March 2012 and is included in the originated and purchased first mortgages loan class as of September 30, 2012, in the tables below. The HELOC portion of the Program was launched in May 2012. Under the Program, Schwab Bank purchases all HELOC loans to Schwab Bank clients that are originated by Quicken Loans.

- 11 -

THE CHARLES SCHWAB CORPORATION

Notes to Condensed Consolidated Financial Statements

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

(Unaudited)

The delinquency aging analysis by loan class is as follows:


September 30, 2012	Current		30-59 days past due		60-89 days past due		Greater than 90 days		Total past due		Total loans
Residential real estate mortgages:
Originated and purchased first mortgages	$	5,751	$	30	$	3	$	33	$	66	$	5,817
Other purchased first mortgages		160		1		—		4		5		165
Home equity lines of credit		3,326		8		3		9		20		3,346
Personal loans secured by securities		807		—		—		—		—		807
Other		24		—		—		—		—		24

Total loans to banking clients	$	10,068	$	39	$	6	$	46	$	91	$	10,159


December 31, 2011
Residential real estate mortgages:
Originated first mortgages	$	5,380	$	16	$	2	$	39	$	57	$	5,437
Purchased first mortgages		152		2		—		5		7		159
Home equity lines of credit		3,494		5		2		8		15		3,509
Personal loans secured by securities		741		1		—		—		1		742
Other		19		—		—		—		—		19

Total loans to banking clients	$	9,786	$	24	$	4	$	52	$	80	$	9,866

In addition to monitoring delinquency characteristics, the Company monitors the credit quality of residential real estate mortgages and HELOCs by stratifying the portfolios by the year of origination, borrower FICO scores at origination (Origination FICO), updated borrower FICO scores (Updated FICO), LTV ratios at origination (Origination LTV), and estimated current LTV ratios (Estimated Current LTV), as presented in the following tables. Borrowers’ FICO scores are provided by an independent third party credit reporting service and were last updated in September 2012. The Origination LTV and Estimated Current LTV ratios for a HELOC include any first lien mortgage outstanding on the same property at the time of the HELOC’s origination. The Estimated Current LTV for each loan is estimated by reference to a home price appreciation index.

- 12 -

THE CHARLES SCHWAB CORPORATION

Notes to Condensed Consolidated Financial Statements

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

(Unaudited)


	Residential real estate mortgages
September 30, 2012	Originated and purchased first mortgages		Other purchased first mortgages		Total		Home equity lines of credit
Year of origination
Pre-2008	$	489	$	57	$	546	$	1,220
2008		430		6		436		1,180
2009		354		6		360		362
2010		1,128		14		1,142		270
2011		1,606		62		1,668		214
2012		1,810		20		1,830		100

Total	$	5,817	$	165	$	5,982	$	3,346

Origination FICO
< 620	$	10	$	1	$	11	$	—
620 - 679		96		18		114		24
680 - 739		1,061		40		1,101		643
³740		4,650		106		4,756		2,679

Total	$	5,817	$	165	$	5,982	$	3,346

Updated FICO
< 620	$	56	$	6	$	62	$	47
620 - 679		163		11		174		111
680 - 739		862		39		901		505
³740		4,736		109		4,845		2,683

Total	$	5,817	$	165	$	5,982	$	3,346

Origination LTV
£70%	$	3,807	$	103	$	3,910	$	2,263
>70% - £90%		1,994		55		2,049		1,056
>90% - £100%		16		7		23		27

Total	$	5,817	$	165	$	5,982	$	3,346

- 13 -

THE CHARLES SCHWAB CORPORATION

Notes to Condensed Consolidated Financial Statements

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

(Unaudited)


September 30, 2012	Balance		Weighted Average Updated FICO		Utilization Rate ⁽¹⁾			Percent of Loans that are 90+ Days Past Due and Less than 90 Days Past Due but on Nonaccrual Status
Residential real estate mortgages:
Estimated Current LTV
£70%	$	4,024		774		N/A			0.26	%
>70% - £90%		1,557		764		N/A			0.41	%
>90% - £100%		171		748		N/A			1.31	%
>100%		230		748		N/A			1.96	%

Total	$	5,982		769		N/A			0.39	%

Home equity lines of credit:
Estimated Current LTV
£70%	$	1,704		775		37	%		0.07	%
>70% - £90%		1,013		767		47	%		0.33	%
>90% - £100%		265		762		54	%		0.40	%
>100%		364		754		61	%		0.83	%

Total	$	3,346		769		42	%		0.26	%

⁽¹⁾	The Utilization Rate is calculated using the outstanding HELOC balance divided by the associated total line of credit.

N/A Not applicable.


	Residential real estate mortgages						Home equity lines of credit
December 31, 2011	Originated first mortgages		Purchased first mortgages		Total		Home equity lines of credit
Year of origination
Pre-2008	$	569	$	60	$	629	$	1,306
2008		538		8		546		1,262
2009		553		10		563		412
2010		1,757		17		1,774		311
2011		2,020		64		2,084		218

Total	$	5,437	$	159	$	5,596	$	3,509

Origination FICO
<620	$	9	$	2	$	11	$	—
620 - 679		108		19		127		24
680 - 739		1,030		43		1,073		667
³740		4,290		95		4,385		2,818

Total	$	5,437	$	159	$	5,596	$	3,509

Updated FICO
<620	$	55	$	7	$	62	$	49
620 - 679		162		11		173		112
680 - 739		831		44		875		520
³740		4,389		97		4,486		2,828

Total	$	5,437	$	159	$	5,596	$	3,509

Origination LTV
£70%	$	3,507	$	91	$	3,598	$	2,378
>70% - £90%		1,904		60		1,964		1,091
>90% - £100%		26		8		34		40

Total	$	5,437	$	159	$	5,596	$	3,509

- 14 -

THE CHARLES SCHWAB CORPORATION

Notes to Condensed Consolidated Financial Statements

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

(Unaudited)


December 31, 2011	Balance		Weighted Average Updated FICO		Utilization Rate ⁽¹⁾			Percent of Loans that are 90+ Days Past Due and Less than 90 Days Past Due but on Nonaccrual Status
Residential real estate mortgages:
Estimated Current LTV
£70%	$	3,200		773		N/A			0.27	%
>70% - £90%		1,764		766		N/A			0.41	%
>90% - £100%		241		758		N/A			1.33	%
>100%		391		748		N/A			2.34	%

Total	$	5,596		768		N/A			0.50	%

Home equity lines of credit:
Estimated Current LTV
£70%	$	1,561		774		37	%		0.09	%
>70% - £90%		1,099		769		46	%		0.26	%
>90% - £100%		328		765		54	%		0.16	%
>100%		521		755		58	%		0.75	%

Total	$	3,509		769		43	%		0.25	%

⁽¹⁾	The Utilization Rate is calculated using the outstanding HELOC balance divided by the associated total line of credit.

N/A Not applicable.

The Company monitors the credit quality of personal loans secured by securities by reviewing the fair value of collateral to ensure adequate collateralization of at least 100% of the principal amount of the loans. All of these personal loans were fully collateralized by securities with fair values in excess of borrowings at September 30, 2012 and December 31, 2011.

Borrowings

Long-term debt including unamortized debt discounts and premiums, where applicable, consists of the following:


	September 30, 2012		December 31, 2011
Senior Notes	$	1,432	$	1,450
Senior Medium-Term Notes, Series A		249		249
Finance lease obligation		95		100
Junior Subordinated Notes		—		202

Total long-term debt	$	1,776	$	2,001

In August 2012, CSC completed an exchange offer with certain eligible holders of its 4.950% Senior Notes due 2014 (Old Senior Notes), whereby Old Senior Notes in an aggregate principal amount of $256 million were exchanged for the same aggregate principal amount of 3.225% Senior Notes due 2022 (New Senior Notes) and cash consideration of $19 million. The New Senior Notes have a fixed interest rate of 3.225% with interest payable semiannually. Pursuant to an exchange and registration rights agreement (Registration Rights Agreement), on October 30, 2012, CSC filed an exchange registration statement with the SEC to allow the holders of the New Senior Notes to exchange such New Senior Notes for an equal principal amount of notes with substantially identical terms, except that they will generally be freely transferable under the Securities Act of 1933. In addition, CSC has agreed pursuant to the Registration Rights Agreement, under certain circumstances, to file a shelf registration statement with the SEC to cover resales of the New Senior Notes.

CSC and Schwab Capital Trust I, a statutory trust formed under the laws of the State of Delaware (Trust), previously closed a public offering of $300 million of the Trust’s fixed-to-floating rate trust preferred securities. The proceeds from the sale of

- 15 -

THE CHARLES SCHWAB CORPORATION

Notes to Condensed Consolidated Financial Statements

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

(Unaudited)

the trust preferred securities were invested by the Trust in fixed-to-floating rate Junior Subordinated Notes issued by CSC, of which $202 million remained outstanding at August 30, 2012. On August 31, 2012, CSC redeemed all of the outstanding fixed-to-floating rate trust preferred securities issued by the Trust for $207 million. The trust preferred securities were redeemed, along with the common securities issued by the Trust and held by CSC, as a result of the concurrent redemption in whole by CSC of the Junior Subordinated Notes held by the Trust which underlay the trust preferred securities. The redemption price represented 100% of the liquidation amount of each trust preferred security, plus accumulated and unpaid distributions up to and including the redemption date.

Annual maturities on long-term debt outstanding at September 30, 2012, are as follows:


2012	$	1
2013		6
2014		500
2015		7
2016		7
Thereafter		1,275

Total maturities		1,796
Unamortized discount, net		(20	)

Total long-term debt	$	1,776

Commitments and Contingencies

The Company has clients that sell (i.e., write) listed option contracts that are cleared by various clearing houses. The clearing houses establish margin requirements on these transactions. The Company partially satisfies the margin requirements by arranging unsecured standby letter of credit agreements (LOCs), in favor of the clearing houses, which are issued by multiple banks. At September 30, 2012, the aggregate face amount of these LOCs totaled $325 million. In connection with its securities lending activities, Schwab is required to provide collateral to certain brokerage clients. Schwab satisfies the collateral requirements by arranging LOCs in favor of these brokerage clients, which are issued by multiple banks. At September 30, 2012, the aggregate face amount of these LOCs totaled $99 million. There were no funds drawn under any of these LOCs at September 30, 2012.

The Company also provides guarantees to securities clearing houses and exchanges under standard membership agreements, which require members to guarantee the performance of other members. Under the agreements, if another member becomes unable to satisfy its obligations to the clearing houses and exchanges, other members would be required to meet shortfalls. The Company’s liability under these arrangements is not quantifiable and may exceed the cash and securities it has posted as collateral. However, the potential requirement for the Company to make payments under these arrangements is remote. Accordingly, no liability has been recognized for these guarantees.

Legal contingencies: The Company is subject to claims and lawsuits in the ordinary course of business, including arbitrations, class actions and other litigation, some of which include claims for substantial or unspecified damages. The Company is also the subject of inquiries, investigations, and proceedings by regulatory and other governmental agencies. In addition, the Company is responding to certain litigation claims brought against former subsidiaries pursuant to indemnities it has provided to purchasers of those entities.

The Company believes it has strong defenses in all significant matters currently pending and is contesting liability and any damages claimed. Nevertheless, some of these matters may result in adverse judgments or awards, including penalties, injunctions or other relief, and the Company may also determine to settle a matter because of the uncertainty and risks of litigation. Described below are certain matters in which there is a reasonable possibility that a material loss could be incurred or where the matter may otherwise be of significant interest to stockholders. With respect to all other pending matters, based on current information and consultation with counsel, it does not appear that the outcome of any such matter could be material to the financial condition, operating results or cash flows of the Company. However, predicting the outcome of a litigation or regulatory matter is inherently difficult, requiring significant judgment and evaluation of various factors,

- 16 -

THE CHARLES SCHWAB CORPORATION

Notes to Condensed Consolidated Financial Statements

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

(Unaudited)

including the procedural status of the matter and any recent developments; prior experience and the experience of others in similar cases; available defenses, including potential opportunities to dispose of a case on the merits or procedural grounds before trial (e.g., motions to dismiss or for summary judgment); the progress of fact discovery; the opinions of counsel and experts regarding potential damages; potential opportunities for settlement and the status of any settlement discussions; and potential insurance coverage and indemnification. Often, as in the case of the Auction Rate Securities Regulatory Inquiries and Total Bond Market Fund Litigation matters described below, it is not possible to reasonably estimate potential liability, if any, or a range of potential liability until the matter is closer to resolution - pending, for example, further proceedings, the outcome of key motions or appeals, or discussions among the parties. Numerous issues may have to be developed, such as discovery of important factual matters and determination of threshold legal issues, which may include novel or unsettled questions of law. Reserves are established or adjusted or further disclosure and estimates of potential loss are provided as the matter progresses and more information becomes available.

Auction Rate Securities Regulatory Inquiries: Schwab has been responding to industry wide inquiries from federal and state regulators regarding sales of auction rate securities to clients who were unable to sell their holdings when the normal auction process for those securities froze unexpectedly in February 2008. On August 17, 2009, a civil complaint was filed against Schwab in New York state court by the Attorney General of the State of New York (NYAG) alleging material misrepresentations and omissions by Schwab regarding the risks of auction rate securities, and seeking restitution, disgorgement, penalties and other relief, including repurchase of securities held in client accounts. As reflected in a statement issued August 17, 2009, Schwab has responded that the allegations are without merit, and has been contesting all charges. By order dated October 24, 2011, the court granted Schwab’s motion to dismiss the complaint with prejudice. The NYAG has appealed to the Appellate Division, where the case is currently pending.

Total Bond Market Fund Litigation: On August 28, 2008, a class action lawsuit was filed in the U.S. District Court for the Northern District of California on behalf of investors in the Schwab Total Bond Market Fund™ (Northstar lawsuit). The lawsuit, which alleges violations of state law and federal securities law in connection with the fund’s investment policy, names Schwab Investments (registrant and issuer of the fund’s shares) and CSIM as defendants. Allegations include that the fund improperly deviated from its stated investment objectives by investing in collateralized mortgage obligations (CMOs) and investing more than 25% of fund assets in CMOs and mortgage-backed securities without obtaining a shareholder vote. Plaintiffs seek unspecified compensatory and rescission damages, unspecified equitable and injunctive relief, costs and attorneys’ fees. Plaintiffs’ federal securities law claim and certain of plaintiffs’ state law claims were dismissed in proceedings before the court and following a successful petition by defendants to the Ninth Circuit Court of Appeals. On August 8, 2011, the court dismissed plaintiffs’ remaining claims with prejudice. Plaintiffs have again appealed to the Ninth Circuit, where the case is currently pending.

optionsXpress Regulatory Matters: optionsXpress entities and individual employees have been responding to certain pending regulatory matters which predate the Company’s acquisition of optionsXpress. On April 16, 2012, optionsXpress, Inc. was charged by the Securities and Exchange Commission (SEC) in an administrative proceeding alleging violations of the firm’s close-out obligations under SEC Regulation SHO (short sale delivery rules) in connection with certain customer trading activity. Trial in the administrative proceeding commenced September 5, 2012. The Company disputes the allegations and is contesting the charges. Separately, on April 19, 2012, the SEC instituted an administrative proceeding alleging violations of the broker-dealer registration requirements by an unregistered optionsXpress entity. On September 5, 2012, the administrative law judge hearing the case ruled on summary disposition that applicable registration requirements were violated. Certain other issues, including relief, remain to be determined at trial. The Company continues to dispute the allegations and is contesting the charges. The Company recorded a contingent liability associated with the two separate matters, which was not material at September 30, 2012.

Fair Values of Assets and Liabilities

Fair value is defined as the price that would be received to sell an asset or the price paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value measurement accounting guidance describes the fair value hierarchy for disclosing assets and liabilities measured at fair value based on the inputs used to value them. The fair value hierarchy maximizes the use of observable inputs and minimizes the use of unobservable inputs. Observable inputs

- 17 -

THE CHARLES SCHWAB CORPORATION

Notes to Condensed Consolidated Financial Statements

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

(Unaudited)

are based on market pricing data obtained from sources independent of the Company. A quoted price in an active market provides the most reliable evidence of fair value and is generally used to measure fair value whenever available. Unobservable inputs reflect management’s judgment about the assumptions market participants would use in pricing the asset or liability. Where inputs used to measure fair value of an asset or liability are from different levels of the hierarchy, the asset or liability is categorized based on the lowest level input that is significant to the fair value measurement in its entirety. Assessing the significance of a particular input requires judgment. The fair value hierarchy includes three levels based on the objectivity of the inputs as follows:

•

Level 1 inputs are quoted prices in active markets as of the measurement date for identical assets or liabilities that the Company has the ability to access. The Company did not transfer any assets or liabilities between Level 1 and Level 2 during the first nine months of 2012, or the year ended December 31, 2011.

•

Level 2 inputs are inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. Level 2 inputs include quoted prices for similar assets and liabilities in active markets, and inputs other than quoted prices that are observable for the asset or liability, such as interest rates, benchmark yields, issuer spreads, new issue data, and collateral performance.

•

Level 3 inputs are unobservable inputs for the asset or liability, and include situations where there is little, if any, market activity for the asset or liability. The Company did not have any financial assets or liabilities utilizing Level 3 inputs as of September 30, 2012 or December 31, 2011.

Assets and Liabilities Recorded at Fair Value

The Company’s assets recorded at fair value include certain cash equivalents, investments segregated and on deposit for regulatory purposes, other securities owned, and securities available for sale. The Company uses the market and income approaches to determine the fair value of assets and liabilities. When available, the Company uses quoted prices in active markets to measure the fair value of assets. When utilizing market data with a bid-ask spread, the Company uses the price within the bid-ask spread that best represents fair value. When quoted prices do not exist, the Company uses prices obtained from independent third-party pricing services to measure the fair value of investment assets. The Company generally obtains prices from at least three independent pricing sources for assets recorded at fair value and may obtain up to five prices on assets with higher risk of limited observable information, such as non-agency residential mortgage-backed securities. The Company’s primary independent pricing service provides prices based on observable trades 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. The Company compares the prices obtained from its 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. The Company 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 a material difference in the recorded amounts. At September 30, 2012 and December 31, 2011, the Company did not adjust prices received from the primary independent third-party pricing service. Liabilities recorded at fair value were not material, and therefore are not included in the following tables.

- 18 -

THE CHARLES SCHWAB CORPORATION

Notes to Condensed Consolidated Financial Statements

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

(Unaudited)

The following tables present the fair value hierarchy for assets measured at fair value:


September 30, 2012	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Balance at Fair Value
Cash equivalents:
Money market funds	$	218	$	—	$	—	$	218
Commercial paper		—		866		—		866

Total cash equivalents		218		866		—		1,084
Investments segregated and on deposit for regulatory purposes:
Certificates of deposit		—		2,675		—		2,675
Corporate debt securities		—		535		—		535

Total investments segregated and on deposit for regulatory purposes		—		3,210		—		3,210
Other securities owned:
Schwab Funds^® money market funds		244		—		—		244
Equity and bond mutual funds		183		—		—		183
State and municipal debt obligations		—		55		—		55
Equity, U.S. Government and corporate debt, and other securities		1		30		—		31

Total other securities owned		428		85		—		513
Securities available for sale:
U.S. agency residential mortgage-backed securities		—		23,772		—		23,772
Non-agency residential mortgage-backed securities		—		782		—		782
Corporate debt securities		—		5,610		—		5,610
Certificates of deposit		—		5,536		—		5,536
Commercial paper		—		449		—		449
U.S. agency notes		—		350		—		350
Asset-backed and other securities		—		5,949		—		5,949

Total securities available for sale		—		42,448		—		42,448

Total	$	646	$	46,609	$	—	$	47,255

- 19 -

THE CHARLES SCHWAB CORPORATION

Notes to Condensed Consolidated Financial Statements

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

(Unaudited)


December 31, 2011	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Balance at Fair Value
Cash equivalents:
Money market funds	$	8	$	—	$	—	$	8
Commercial paper		—		814		—		814

Total cash equivalents		8		814		—		822
Investments segregated and on deposit for regulatory purposes:
Certificates of deposit		—		2,374		—		2,374
Corporate debt securities		—		767		—		767
U.S. Government securities		—		650		—		650

Total investments segregated and on deposit for regulatory purposes		—		3,791		—		3,791
Other securities owned:
Schwab Funds^® money market funds		332		—		—		332
Equity and bond mutual funds		183		—		—		183
State and municipal debt obligations		—		46		—		46
Equity, U.S. Government and corporate debt, and other securities		12		20		—		32

Total other securities owned		527		66		—		593
Securities available for sale:
U.S. agency residential mortgage-backed securities		—		20,921		—		20,921
Non-agency residential mortgage-backed securities		—		907		—		907
Corporate debt securities		—		3,571		—		3,571
Certificates of deposit		—		3,622		—		3,622
Commercial paper		—		225		—		225
U.S. agency notes		—		1,800		—		1,800
Asset-backed and other securities		—		2,919		—		2,919

Total securities available for sale		—		33,965		—		33,965

Total	$	535	$	38,636	$	—	$	39,171

Financial Instruments Not Recorded at Fair Value

Descriptions of the valuation methodologies and assumptions used to estimate the fair value of financial instruments not recorded at fair value are described below. There were no significant changes in these methodologies or assumptions during the first nine months of 2012.

Cash and cash equivalents, receivables from/payables to brokers, dealers, and clearing organizations, and receivables from/payables to brokerage clients are short-term in nature and accordingly are recorded at amounts that approximate fair value. Cash and cash equivalents include cash and highly liquid investments with original maturities of three months or less. Receivables from/payables to brokers, dealers, and clearing organizations, and receivables from/payables to brokerage clients are recorded at or near transaction price and historically have been settled or converted to cash at approximately that value.

Cash and investments segregated and on deposit for regulatory purposes include cash and securities purchased under resale agreements. Securities purchased under resale agreements are recorded at par value plus accrued interest. Securities purchased under resale agreements are short-term in nature and are backed by collateral that both exceeds the carrying value of the resale agreement and is highly liquid in nature. Accordingly, the carrying value approximates fair value.

Securities held to maturity include U.S. agency residential mortgage-backed securities and other securities. Securities held to maturity are recorded at amortized cost. The fair value of these securities is obtained using an independent third-party pricing service similar to investment assets recorded at fair value as discussed above.

- 20 -

THE CHARLES SCHWAB CORPORATION

Notes to Condensed Consolidated Financial Statements

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

(Unaudited)

Loans to banking clients primarily include adjustable rate residential first-mortgage and HELOC loans. Loans to banking clients are recorded at carrying value net of an allowance for loan losses. The fair value of the Company’s loans to banking clients is estimated based on prices obtained from independent third-party pricing services for mortgage-backed securities collateralized by similar types of loans. The Company may adjust the independent third-party prices to account for differences between comparable mortgage-backed securities and loans to banking clients.

Loans held for sale at December 31, 2011, included fixed-rate and adjustable-rate residential first-mortgage loans intended for sale. Loans held for sale were recorded at the lower of cost or fair value. The fair value of the Company’s loans held for sale was estimated using quoted market prices for securities backed by similar types of loans.

Other assets – Financial instruments included in other assets primarily consist of cost method investments and Federal Home Loan Bank (FHLB) stock, whose carrying values approximate their fair values. FHLB stock is recorded at par, which approximates fair value.

Deposits from banking clients – The Company considers the fair value of deposits with no stated maturity, such as deposits from banking clients, to be equal to the amount payable on demand as of the balance sheet date.

Accrued expenses and other liabilities – Financial instruments included in accrued expenses and other liabilities consist of drafts payable and certain amounts due under contractual obligations which are short-term in nature and accordingly are recorded at amounts that approximate fair value.

Long-term debt includes Senior Notes, Senior Medium-Term Notes, Series A, and a finance lease obligation. The fair values of the Senior Notes and Senior Medium-Term Notes, Series A, are estimated using indicative non-binding quotes from independent brokers. The Company validates indicative prices for its debt through comparison to other independent non-binding quotes. The finance lease obligation is recorded at carrying value, which approximates fair value. Long-term debt at December 31, 2011, included Junior Subordinated Notes, which were estimated using indicative non-binding quotes from independent brokers.

Firm commitments to extend credit – The Company extends credit to banking clients through HELOC and personal loans secured by securities. The Company considers the fair value of these unused commitments to be not material because the interest rates earned on these balances are based on market interest rate indices and reset monthly. Future utilization of HELOC and personal loan commitments will earn a then-current market interest rate. The Company does not charge a fee to maintain a HELOC or personal loan.

- 21 -

THE CHARLES SCHWAB CORPORATION

Notes to Condensed Consolidated Financial Statements

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

(Unaudited)

The following table presents the fair value hierarchy for financial instruments not recorded at fair value at September 30, 2012:


	Carrying Amount		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Balance at Fair Value
Assets:
Cash and cash equivalents	$	7,439	$	—	$	7,439	$	—	$	7,439
Cash and investments segregated and on deposit for regulatory purposes		21,824		—		21,824		—		21,824
Receivables from brokers, dealers, and clearing organizations		607		—		607		—		607
Receivables from brokerage clients – net		11,909		—		11,909		—		11,909
Securities held to maturity:
U.S. agency residential mortgage-backed securities		15,450		—		16,067		—		16,067
Other securities		162		—		162		—		162

Total securities held to maturity		15,612		—		16,229		—		16,229
Loans to banking clients – net:
Residential real estate mortgages		5,947		—		6,028		—		6,028
Home equity lines of credit		3,324		—		3,315		—		3,315
Personal loans secured by securities		807		—		807		—		807
Other		24		—		24		—		24

Total loans to banking clients – net		10,102		—		10,174		—		10,174
Other assets		64		—		64		—		64

Total	$	67,557	$	—	$	68,246	$	—	$	68,246

Liabilities:
Deposits from banking clients	$	68,756	$	—	$	68,756	$	—	$	68,756
Payables to brokers, dealers, and clearing organizations		1,445		—		1,445		—		1,445
Payables to brokerage clients		34,761		—		34,761		—		34,761
Accrued expenses and other liabilities		546		—		546		—		546
Long-term debt		1,776		—		1,717		—		1,717

Total	$	107,284	$	—	$	107,225	$	—	$	107,225

The following table presents the Company’s fair value estimates for financial instruments not recorded at fair value at December 31, 2011. The table excludes short-term financial assets and liabilities, for which carrying amounts approximate fair value, and financial instruments recorded at fair value.


	Carrying Amount		Fair Value
Financial Assets:
Securities held to maturity	$	15,108	$	15,539
Loans to banking clients – net	$	9,812	$	9,671
Loans held for sale	$	70	$	73
Financial Liabilities:
Long-term debt	$	2,001	$	2,159

- 22 -

THE CHARLES SCHWAB CORPORATION

Notes to Condensed Consolidated Financial Statements

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

(Unaudited)

Preferred Stock

The Company was authorized to issue 9,940,000 shares of preferred stock, $0.01 par value, at both September 30, 2012 and December 31, 2011. There were no shares of preferred stock issued and outstanding at December 31, 2011. The Company’s preferred stock issued and outstanding as of September 30, 2012, are as follows:


	Shares Issued and Outstanding (In thousands)		Liquidation Preference Per Share		Liquidation Preference		Carrying Value
Series A		400	$	1,000	$	400	$	394
Series B		485	$	1,000		485		470

Total Preferred Stock		885			$	885	$	864

In June 2012, the Company issued and sold 19,400,000 depositary shares, each representing a 1/40^th ownership interest in a share of 6.00% non-cumulative perpetual preferred stock, Series B, equivalent to $25 per depositary share (Series B Preferred Stock). Net proceeds received from the sale were $469 million. The Series B Preferred Stock has no stated maturity and has a fixed dividend rate of 6.00%. Dividends, if declared, will be payable quarterly in arrears. Under the terms of the Series B Preferred Stock, the Company’s ability to pay dividends on, make distributions with respect to, or to repurchase, redeem or acquire its common stock or any preferred stock ranking on parity with or junior to the Series B Preferred Stock, is subject to restrictions in the event that the Company does not declare and either pay or set aside a sum sufficient for payment of dividends on the Series B Preferred Stock for the immediately preceding dividend period. The Series B Preferred Stock is redeemable at the Company’s option, in whole or in part, on any dividend payment date on or after September 1, 2017, or, in whole but not in part, within 90 days following a regulatory capital treatment event as defined in its Certificate of Designations.

In January 2012, the Company issued and sold 400,000 shares of fixed-to-floating rate non-cumulative perpetual preferred stock, Series A (Series A Preferred Stock). Net proceeds received from the sale were $394 million. The Series A Preferred Stock has no stated maturity and has a fixed dividend rate of 7.000% until February 2022 and a floating rate equal to three-month LIBOR plus 4.820% thereafter. During the fixed rate period, dividends, if declared, will be payable semi-annually in arrears. During the floating rate period, dividends, if declared, will be payable quarterly in arrears. Dividends will not be cumulative. Under the terms of the Series A Preferred Stock, the Company’s ability to pay dividends on, make distributions with respect to, or to repurchase, redeem or acquire its common stock or any preferred stock ranking on parity with or junior to the Series A Preferred Stock, is subject to restrictions in the event that the Company does not declare and either pay or set aside a sum sufficient for payment of dividends on the Series A Preferred Stock for the immediately preceding dividend period. The Series A Preferred Stock is redeemable at the Company’s option, in whole or in part, on any dividend payment date on or after February 1, 2022, or, in whole but not in part, within 90 days following a regulatory capital treatment event as defined in its Certificate of Designations.

- 23 -

THE CHARLES SCHWAB CORPORATION

Notes to Condensed Consolidated Financial Statements

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

(Unaudited)

10.

Accumulated Other Comprehensive Income

Accumulated other comprehensive income (loss) represents cumulative gains and losses that are not reflected in earnings. Accumulated other comprehensive income balances were:


	Net unrealized gain on securities available for sale		Other			Total accumulated other comprehensive income
Balance at December 31, 2010	$	17	$	(1	)	$	16
Other net changes		39		1			40

Balance at September 30, 2011	$	56	$	—		$	56

Balance at December 31, 2011	$	10	$	(2	)	$	8
Other net changes		303		1			304

Balance at September 30, 2012	$	313	$	(1	)	$	312

11.

Earnings Per Common Share

Basic EPS is computed by dividing net income available to common stockholders by the weighted-average number of common shares outstanding during the period. The computation of diluted EPS is similar to the computation of basic EPS except that the denominator is increased to include the number of additional common shares that would have been outstanding if dilutive potential common shares had been issued. Dilutive potential common shares include the effect of outstanding stock options and unvested restricted stock awards and units. EPS under the basic and diluted computations is as follows:


	Three Months Ended September 30,					Nine Months Ended September 30,
	2012			2011		2012			2011
Net income	$	247		$	220	$	717		$	701
Preferred stock dividends		(9	)		—		(23	)		—

Net income available to common stockholders ⁽¹⁾	$	238		$	220	$	694		$	701

Weighted-average common shares outstanding — basic		1,274			1,228		1,273			1,213
Common stock equivalent shares related to stock incentive plans		1			1		1			3

Weighted-average common shares outstanding — diluted ⁽²⁾		1,275			1,229		1,274			1,216

Basic EPS	$	.19		$	.18	$	.54		$	.58
Diluted EPS	$	.19		$	.18	$	.54		$	.57

⁽¹⁾	Net income available to participating securities (unvested restricted shares) was not material for the third quarters or first nine months of 2012 or 2011.

⁽²⁾	Antidilutive stock options and restricted stock awards excluded from the calculation of diluted EPS totaled 59 million and 50 million shares for the third quarters of 2012 and 2011, respectively, and 61 million and 48 million shares for the first nine months of 2012 and 2011, respectively.

12.

Regulatory Requirements

CSC is a savings and loan holding company and Schwab Bank, CSC’s depository institution subsidiary, is a federal savings bank. CSC is subject to supervision and regulation by the Board of Governors of the Federal Reserve System (the Federal Reserve) and Schwab Bank is subject to supervision and regulation by the Office of the Comptroller of the Currency. CSC is currently not subject to specific statutory capital requirements, however CSC is required to serve as a source of strength for Schwab Bank. Under the “Dodd-Frank Wall Street Reform and Consumer Protection Act”, CSC will be subject to new

- 24 -

THE CHARLES SCHWAB CORPORATION

Notes to Condensed Consolidated Financial Statements

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

(Unaudited)

minimum leverage and minimum risk-based capital ratio requirements that will be set by the Federal Reserve that are at least as stringent as the requirements generally applicable to insured depository institutions as of July 21, 2011.

Schwab Bank is required to maintain minimum capital levels as specified in federal banking laws and regulations. Failure to meet the minimum levels could result in certain mandatory, and possibly additional discretionary actions by the regulators that, if undertaken, could have a direct material effect on Schwab Bank. At September 30, 2012, CSC and Schwab Bank met the capital level requirements.

The regulatory capital and ratios for Schwab Bank at September 30, 2012, are as follows:


	Actual					Minimum Capital Requirement					Minimum to be Well Capitalized
	Amount		Ratio			Amount		Ratio			Amount		Ratio
Tier 1 Risk-Based Capital	$	5,584		21.7	%	$	1,031		4.0	%	$	1,547		6.0	%
Total Risk-Based Capital	$	5,639		21.9	%	$	2,062		8.0	%	$	2,578		10.0	%
Tier 1 Leverage	$	5,584		7.5	%	$	2,993		4.0	%	$	3,741		5.0	%
Tangible Equity	$	5,584		7.5	%	$	1,496		2.0	%		N/A

N/A Not applicable.

Based on its regulatory capital ratios at September 30, 2012, Schwab Bank is considered well capitalized (the highest category) pursuant to banking regulatory guidelines. There are no conditions or events since September 30, 2012, that management believes have changed Schwab Bank’s capital category.

CSC’s principal U.S. broker-dealers are Schwab and optionsXpress, Inc. optionsXpress, Inc. is a wholly-owned subsidiary of optionsXpress. Schwab and optionsXpress, Inc. are both subject to Rule 15c3-1 under the Securities Exchange Act of 1934 (the Uniform Net Capital Rule). Schwab and optionsXpress, Inc. compute net capital under the alternative method permitted by the Uniform Net Capital Rule. This method requires the maintenance of minimum net capital, as defined, of the greater of 2% of aggregate debit balances arising from client transactions or a minimum dollar requirement ($250,000 for Schwab), which is based on the type of business conducted by the broker-dealer. Under the alternative method, a broker-dealer may not repay subordinated borrowings, pay cash dividends, or make any unsecured advances or loans to its parent company or employees if such payment would result in a net capital amount of less than 5% of aggregate debit balances or less than 120% of its minimum dollar requirement.

optionsXpress, Inc. is also subject to Commodity Futures Trading Commission Regulation 1.17 (Reg. 1.17) under the Commodity Exchange Act, which also requires the maintenance of minimum net capital. optionsXpress, Inc., as a futures commission merchant, is required to maintain minimum net capital equal to the greater of its net capital requirement under Reg. 1.17 ($1 million), or the sum of 8% of the total risk margin requirements for all positions carried in client accounts and 8% of the total risk margin requirements for all positions carried in non-client accounts (as defined in Reg. 1.17).

Net capital and net capital requirements for Schwab and optionsXpress, Inc. at September 30, 2012, are as follows:


	Net Capital		% of Aggregate Debit Balances			Minimum Net Capital Required		2% of Aggregate Debit Balances		Net Capital in Excess of Required Net Capital		Net Capital in Excess of 5% of Aggregate Debit Balances
Schwab	$	1,371		10	%	$	0.250	$	272	$	1,099	$	692
optionsXpress, Inc.	$	78		33	%	$	1	$	5	$	73	$	66

- 25 -

THE CHARLES SCHWAB CORPORATION

Notes to Condensed Consolidated Financial Statements

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

(Unaudited)

13.

Segment Information

The Company structures its operating segments according to its clients and the services provided to those clients. The Company’s two reportable segments are Investor Services and Institutional Services.

The Company evaluates the performance of its segments on a pre-tax basis, excluding items such as significant nonrecurring gains, impairment charges on non-financial assets, discontinued operations, extraordinary items, and significant restructuring and other charges. Segment assets and liabilities are not used for evaluating segment performance or in deciding how to allocate resources to segments. There are no revenues from transactions with other segments within the Company.

Financial information for the Company’s reportable segments is presented in the following table:


	Investor Services						Institutional Services						Unallocated						Total
Three Months Ended September 30,	2012			2011			2012			2011			2012			2011			2012			2011
Net Revenues:
Asset management and administration fees	$	285		$	254		$	238		$	212		$	1		$	—		$	524		$	466
Net interest revenue		367			377			72			66			—			—			439			443
Trading revenue		136			166			69			82			(1	)		—			204			248
Other		22			25			20			19			—			1			42			45
Provision for loan losses		(9	)		(7	)		(1	)		(1	)		—			—			(10	)		(8	)
Net impairment losses on securities		(2	)		(12	)		(1	)		(1	)		—			—			(3	)		(13	)

Total net revenues		799			803			397			377			—			1			1,196			1,181

Expenses Excluding Interest		571			561			264			259			—			1			835			821

Income before taxes on income	$	228		$	242		$	133		$	118		$	—		$	—		$	361		$	360

Taxes on income																				114			140

Net Income																			$	247		$	220


	Investor Services						Institutional Services						Unallocated						Total
Nine Months Ended September 30,	2012			2011			2012			2011			2012			2011			2012			2011
Net Revenues:
Asset management and administration fees	$	816		$	805		$	688		$	665		$	—		$	—		$	1,504		$	1,470
Net interest revenue		1,117			1,137			214			193			—			—			1,331			1,330
Trading revenue		446			462			221			232			(1	)		—			666			694
Other ⁽¹⁾		76			61			61			57			72			1			209			119
Provision for loan losses		(12	)		(11	)		(2	)		(2	)		—			—			(14	)		(13	)
Net impairment losses on securities		(24	)		(20	)		(4	)		(2	)		—			—			(28	)		(22	)

Total net revenues		2,419			2,434			1,178			1,143			71			1			3,668			3,578

Expenses Excluding Interest		1,764			1,662			798			777			—			(1	)		2,562			2,438

Income before taxes on income	$	655		$	772		$	380		$	366		$	71		$	2		$	1,106		$	1,140

Taxes on income																				389			439

Net Income																			$	717		$	701

⁽¹⁾	Unallocated amount includes a pre-tax gain of $70 million relating to a confidential resolution of a vendor dispute in the second quarter of 2012.

- 26 -

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)

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

OVERVIEW

Management of The Charles Schwab Corporation (CSC) and its subsidiaries (collectively referred to as the Company) focuses on several key client activity and financial metrics in evaluating the Company’s financial position and operating performance. Results for the third quarters and first nine months of 2012 and 2011 are:


	Three Months Ended September 30,						Percent Change			Nine Months Ended September 30,						Percent Change
	2012			2011			Percent Change			2012			2011			Percent Change
Client Activity Metrics:
Net new client assets ⁽¹⁾(in billions)	$	20.4		$	86.0			(76	%)	$	75.3		$	124.4			(39	%)
Client assets (in billions, at quarter end)	$	1,890.4		$	1,576.4			20	%
Clients’ daily average trades ⁽²⁾(in thousands)		402.4			475.4			(15	%)		438.0			448.3			(2	%)

Company Financial Metrics:
Net revenues	$	1,196		$	1,181			1	%	$	3,668		$	3,578			3	%
Expenses excluding interest		835			821			2	%		2,562			2,438			5	%

Income before taxes on income		361			360			—			1,106			1,140			(3	%)
Taxes on income		114			140			(19	%)		389			439			(11	%)

Net income	$	247		$	220			12	%	$	717		$	701			2	%

Earnings per common share – diluted	$	.19		$	.18			6	%	$	.54		$	.57			(5	%)
Net revenue growth from prior year		1	%		11	%					3	%		15	%
Pre-tax profit margin		30.2	%		30.5	%					30.2	%		31.9	%
Return on average common stockholders’equity (annualized) ⁽³⁾		11	%		12	%					11	%		13	%
Annualized net revenue per average full-time equivalent employee (in thousands)	$	352		$	350			1	%	$	354		$	361			(2	%)

⁽¹⁾

Includes outflows of $1.3 billion as a result of the closure and/or sale of certain subsidiaries of optionsXpress Holdings, Inc. in the third quarter of 2012. Includes inflows of $12.0 billion from a mutual fund clearing services client in the first quarter of 2012. Includes inflows of $60.9 billion from mutual fund clearing services clients and $7.5 billion from the acquisition of optionsXpress Holdings, Inc. in the third quarter of 2011.

⁽²⁾	Amounts include revenue trades from commissions or principal mark-ups (i.e., fixed income), trades by clients in asset-based pricing relationships, and all commission-free trades, including the Company’s Mutual Fund OneSource^® funds and Exchange-Traded Funds, and other proprietary products.

⁽³⁾	Return on average common stockholders’ equity is calculated using net income available to common stockholders divided by average common stockholders’ equity.

The broad equity markets improved during the third quarter of 2012 compared to the third quarter of 2011, as the Nasdaq Composite Index, Standard & Poor’s 500 Index, and Dow Jones Industrial Average increased 29%, 27%, and 23%, respectively. While the federal funds target rate remained unchanged at a range of zero to 0.25%, the average three-month Treasury Bill yield increased by 8 basis points to 0.09% during the third quarter of 2012 compared to the third quarter of 2011. At the same time, the average 10-year Treasury yield decreased by 78 basis points to 1.62%.

Clients remained engaged in the third quarter of 2012 despite the challenging economic and market environment that continued during the period. Net new client assets before significant one-time flows totaled $21.7 billion in the third quarter of 2012, up 23% from the third quarter of 2011. Total client assets ended the quarter at a record $1.89 trillion, up 20% from the third quarter of 2011. Clients’ daily average trades were 402,400 in the third quarter of 2012, down 15% on a year-over-year basis.

For the third quarter of 2012, net revenues remained relatively flat compared to the third quarter of 2011 as the increase in asset management and administration fees was largely offset by a decrease in trading revenue. Asset management and administration fees increased primarily due to increases in mutual fund service fees and advice solutions fees. Trading

- 27 -

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 decreased primarily due to lower daily average revenue trades. Net interest revenue was relatively flat, reflecting higher balances of interest-earning assets offset by the effect of lower interest rate spreads during the third quarter of 2012 due to the continued low interest rate environment.

For the first nine months of 2012, net revenues increased by 3% compared to the first nine months of 2011 primarily due to increases in asset management and administration fees and other revenue, partially offset by a decrease in trading revenue. Asset management and administration fees increased due to increases in advice solutions fees and other asset management and administration fees, offset by a decrease in mutual fund service fees. Other revenue increased primarily due to a pre-tax gain of $70 million relating to a confidential resolution of a vendor dispute in the second quarter of 2012. Trading revenue decreased primarily due to lower daily average revenue trades, partially offset by the inclusion of optionsXpress’ option, future, and equity trades from its acquisition in September 2011. Net interest revenue was flat as higher average balances of interest-earning assets were offset by lower interest rate spreads during the first nine months of 2012 due to the continued pressure on market interest rates.

Expenses excluding interest increased by 2% and 5% in the third quarter and first nine months of 2012 compared to the same periods in 2011, respectively, primarily due to the inclusion of optionsXpress. Taxes on income in the third quarter of 2012 include a non-recurring state tax benefit of $20 million. Overall, net income increased by 12% and 2% in the third quarter and first nine months of 2012 compared to the same periods in 2011, respectively.

In comparison to the second quarter of 2012, the broad equity markets increased in the third quarter of 2012 as the Nasdaq Composite Index, Standard & Poor’s 500 Index, and Dow Jones Industrial Average increased 6%, 6%, and 4%, respectively, while the average three-month Treasury Bill yield remained relatively flat at 0.09%. The average 10-year Treasury yield decreased by 19 basis points to 1.62% from the second quarter of 2012. Despite the challenging economic environment, the Company’s growing client base and ongoing expense discipline helped maintain a pre-tax profit margin of 30.2% in the third quarter of 2012. Net income in the third quarter and second quarter of 2012 include the non-recurring state tax benefit of $20 million and pre-tax gain of $70 million (after-tax of $44 million), respectively, discussed above.

CURRENT MARKET AND REGULATORY ENVIRONMENT AND OTHER DEVELOPMENTS

The broad equity markets and short-term interest rates showed improvement from 2011, however the low interest rate environment continues to constrain growth in the Company’s net revenues.

As discussed above, interest rates remained at low levels during the third quarter of 2012. To the extent rates remain at these low levels, the Company’s net interest revenue will continue to be constrained, even as growth in average balances helps to increase such revenue. The low interest rate environment also affects asset management and administration fees. While net money market mutual fund fees improved in the third quarter of 2012 from the second quarter of 2012 primarily due to sustained improvement in short-term interest rates, the overall yields on certain Schwab-sponsored money market mutual funds have remained at levels at or below the management fees on those funds. The Company continues to waive a portion of its management fees so that the funds can maintain a positive return to clients. These and other money market mutual funds may not be able to replace maturing securities with securities of equal or higher yields. As a result, the yields on such funds may remain around or decline from their current levels, and therefore below the management fees on those funds. To the extent this occurs, asset management and administration fees may be negatively affected.

The Company recorded net impairment losses of $3 million and $28 million related to certain non-agency residential mortgage-backed securities in the third quarter and first nine months of 2012, respectively, due to further credit deterioration of the securities’ underlying loans. Net impairment losses in the first nine months of 2012 were also due to an increase in projected default rates for modified loans in the first quarter of 2012. Further deterioration in the performance of the underlying loans in the Company’s residential mortgage-backed securities portfolio could result in the recognition of additional impairment charges.

The “Dodd-Frank Wall Street Reform and Consumer Protection Act” (the Dodd-Frank Act) was signed into law in July 2010. Among other things, the legislation transferred the supervision and regulation of CSC from the Office of Thrift Supervision (OTS) to the Board of Governors of the Federal Reserve System (the Federal Reserve) and supervision and

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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)

regulation of Schwab Bank from the OTS to the Office of the Comptroller of the Currency (OCC); both transfers were effective July 21, 2011. The Federal Reserve recently issued notices of proposed rulemaking (NPRs) to meet certain requirements of the Dodd-Frank Act and to align current capital rules with the BASEL III capital standards. The NPRs would subject all savings and loan holding companies, including CSC, to consolidated capital requirements. In addition, the NPRs would establish more restrictive capital definitions, higher risk-weightings for certain asset classes, higher minimum capital ratios and capital buffers. The NPRs would be phased in under an extended timeframe, beginning January 2013. The comment period for the NPRs ended on October 22, 2012 and the NPRs are subject to further modification. CSC is currently evaluating the impact of the NPRs but does not expect them to have a material impact on the Company’s business, financial condition, and results of operations.

The Company is pursuing lawsuits in state court in San Francisco for rescission and damages against issuers, underwriters, and dealers of individual non-agency residential mortgage-backed securities on which the Company has experienced realized and unrealized losses. The lawsuits allege that offering documents for the securities contained material untrue and misleading statements about the securities and the underwriting standards and credit quality of the underlying loans. On January 27, 2012, and July 24, 2012, the court denied defendants’ motions to dismiss the claims with respect to all but 3 of the 51 securities, and discovery is proceeding.

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THE CHARLES SCHWAB CORPORATION

Management’s Discussion and Analysis of Financial Condition and Results of Operations

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

RESULTS OF OPERATIONS

The following discussion presents an analysis of the Company’s results of operations for the third quarter and first nine months of 2012 compared to the same periods in 2011.

Net Revenues

The Company’s major sources of net revenues are asset management and administration fees, net interest revenue, and trading revenue. Asset management and administration fees increased and net interest revenue was relatively flat, while trading revenue decreased in the third quarter and first nine months of 2012 compared to the same periods in 2011, respectively.


Three Months Ended September 30,				2012						2011
	Percent Change			Amount			% of Total Net Revenues			Amount			% of Total Net Revenues
Asset management and administration fees
Schwab money market funds before fee waivers		—		$	221					$	220
Fee waivers		(15	%)		(136	)					(160	)

Schwab money market funds after fee waivers		42	%		85			7	%		60			5	%
Equity and bond funds		10	%		32			3	%		29			2	%
Mutual Fund OneSource

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