Edgar Filing: SCHWAB CHARLES CORP

4d4680191421434

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, 2013

Commission File Number: 1-9700

THE CHARLES SCHWAB CORPORATION

(Exact name of registrant as specified in its charter)

Delaware

(State or other jurisdiction

of incorporation or organization)

94-3025021

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

211 Main Street, San Francisco, CA 94105

(Address of principal executive offices and zip code)

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

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes T 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 T 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 T

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

Accelerated filer £

Smaller reporting company £

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes £ No T

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

1,289,217,199 shares of $.01 par value Common Stock

Outstanding on October 23, 2013

THE CHARLES SCHWAB CORPORATION

Quarterly Report on Form 10-Q

For the Quarter Ended September 30, 2013

Index


			Page
Part I - Financial Information

	Item 1.	Condensed Consolidated Financial Statements (Unaudited):

		Statements of Income	1
		Statements of Comprehensive Income	2
		Balance Sheets	3
		Statements of Cash Flows	4
		Notes	5 – 22

	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	23 – 46

	Item 3.	Quantitative and Qualitative Disclosures About Market Risk	47 – 48

	Item 4.	Controls and Procedures	48

Part II - Other Information

	Item 1.	Legal Proceedings	49

	Item 1A.	Risk Factors	49

	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	49

	Item 3.	Defaults Upon Senior Securities	50

	Item 4.	Mine Safety Disclosures	50

	Item 5.	Other Information	50

	Item 6.	Exhibits	51

Signature			52

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				Nine Months Ended
	September 30,				September 30,
	2013		2012		2013		2012
Net Revenues
Asset management and administration fees	$	583	$	524	$	1,707	$	1,504
Interest revenue		531		478		1,527		1,447
Interest expense		(25)		(39)		(79)		(116)
Net interest revenue		506		439		1,448		1,331
Trading revenue		224		204		682		666
Other		57		42		172		209
Provision for loan losses		4		(10)		(1)		(14)
Net impairment losses on securities⁽¹⁾		(1)		(3)		(8)		(28)
Total net revenues		1,373		1,196		4,000		3,668
Expenses Excluding Interest
Compensation and benefits		482		442		1,512		1,353
Professional services		103		98		308		287
Occupancy and equipment		77		77		231		233
Advertising and market development		57		49		198		173
Communications		55		53		165		166
Depreciation and amortization		51		50		153		146
Other		84		66		226		204
Total expenses excluding interest		909		835		2,793		2,562
Income before taxes on income		464		361		1,207		1,106
Taxes on income		174		114		455		389
Net Income		290		247		752		717
Preferred stock dividends		8		9		39		23
Net Income Available to Common Stockholders	$	282	$	238	$	713	$	694
Weighted-Average Common Shares Outstanding — Diluted		1,296		1,275		1,288		1,274
Earnings Per Common Share — Basic	$	.22	$	.19	$	.55	$	.54
Earnings Per Common Share — Diluted	$	.22	$	.19	$	.55	$	.54

(1)

Net impairment losses on securities include total other-than-temporary impairment losses of $0 million and $1 million recognized in other comprehensive income, net of $(1) million and $(2) million reclassified from other comprehensive income, for the three months ended September 30, 2013 and 2012, respectively. Net impairment losses on securities include total other-than-temporary impairment losses of $2 million and $15 million recognized in other comprehensive income, net of $(6) million and $(13) million reclassified from other comprehensive income, for the nine months ended September 30, 2013 and 2012, respectively.

See Notes to Condensed Consolidated Financial Statements.

THE CHARLES SCHWAB CORPORATION

Condensed Consolidated Statements of Comprehensive Income

(In millions)

(Unaudited)


	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2013		2012		2013		2012
Net Income	$	290	$	247	$	752	$	717
Other comprehensive income (loss), before tax:
Change in net unrealized gain on securities available for sale:
Net unrealized gain (loss)		72		250		(408)		458
Reclassification of impairment charges included in net
impairment losses on securities		1		3		8		28
Other reclassifications included in other revenue		(2)		-		(5)		(1)
Other		-		-		1		-
Other comprehensive income (loss), before tax		71		253		(404)		485
Income tax effect		(28)		(95)		152		(181)
Other comprehensive income (loss), net of tax		43		158		(252)		304
Comprehensive Income	$	333	$	405	$	500	$	1,021

See Notes to Condensed Consolidated Financial Statements.

THE CHARLES SCHWAB CORPORATION

Condensed Consolidated Balance Sheets

(In millions, except per share and share amounts)

(Unaudited)


	September 30,		December 31,
	2013		2012
Assets
Cash and cash equivalents	$	7,362	$	12,663
Cash and investments segregated and on deposit for regulatory purposes
(including resale agreements of $13,461 at September 30, 2013 and $19,325
at December 31, 2012)		23,520		28,469
Receivables from brokers, dealers, and clearing organizations		511		333
Receivables from brokerage clients — net		13,124		13,458
Other securities owned — at fair value		482		636
Securities available for sale		51,865		46,123
Securities held to maturity (fair value — $27,717 at September 30, 2013 and
$18,732 at December 31, 2012)		28,219		18,194
Loans to banking clients — net		12,115		10,726
Equipment, office facilities, and property — net		738		675
Goodwill		1,227		1,228
Intangible assets — net		278		319
Other assets		770		813
Total assets	$	140,211	$	133,637
Liabilities and Stockholders’ Equity
Deposits from banking clients	$	91,187	$	79,377
Payables to brokers, dealers, and clearing organizations		1,207		1,068
Payables to brokerage clients		34,532		40,330
Accrued expenses and other liabilities		1,328		1,641
Long-term debt		1,904		1,632
Total liabilities		130,158		124,048
Stockholders’ equity:
Preferred stock — $.01 par value per share; aggregated liquidation
preference of $885 at both September 30, 2013 and December 31, 2012		868		865
Common stock — 3 billion shares authorized; $.01 par value per share;
1,487,543,446 shares issued		15		15
Additional paid-in capital		3,964		3,881
Retained earnings		9,034		8,554
Treasury stock, at cost — 199,823,743 shares at September 30, 2013 and
210,014,305 shares at December 31, 2012		(3,874)		(4,024)
Accumulated other comprehensive income		46		298
Total stockholders’ equity		10,053		9,589
Total liabilities and stockholders’ equity	$	140,211	$	133,637

See Notes to Condensed Consolidated Financial Statements.

THE CHARLES SCHWAB CORPORATION

Condensed Consolidated Statements of Cash Flows

(In millions)

(Unaudited)


	Nine Months Ended
	September 30,
	2013		2012
Cash Flows from Operating Activities
Net income	$	752	$	717
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses		1		14
Net impairment losses on securities		8		28
Stock-based compensation		83		79
Depreciation and amortization		153		146
Premium amortization, net, on securities available for sale and securities held to maturity		129		163
Other		23		4
Originations of loans held for sale		-		(441)
Proceeds from sales of loans held for sale		-		513
Net change in:
Cash and investments segregated and on deposit for regulatory purposes		4,949		880
Receivables from brokers, dealers, and clearing organizations		(177)		(376)
Receivables from brokerage clients		332		(844)
Other securities owned		154		80
Other assets		(48)		19
Payables to brokers, dealers, and clearing organizations		101		84
Payables to brokerage clients		(5,798)		(619)
Accrued expenses and other liabilities		163		(74)
Net cash provided by operating activities		825		373
Cash Flows from Investing Activities
Purchases of securities available for sale		(19,910)		(19,889)
Proceeds from sales of securities available for sale		4,665		1,524
Principal payments on securities available for sale		9,087		10,546
Purchases of securities held to maturity		(13,442)		(4,620)
Principal payments on securities held to maturity		3,332		4,012
Net increase in loans to banking clients		(1,315)		(318)
Purchase of equipment, office facilities, and property		(176)		(107)
Other investing activities		2		10
Net cash used for investing activities		(17,757)		(8,842)
Cash Flows from Financing Activities
Net change in deposits from banking clients		11,810		7,902
Repayment of commercial paper		(300)		-
Issuance of long-term debt		275		-
Repayment of long-term debt		(4)		(207)
Premium paid on debt exchange		-		(19)
Net proceeds from preferred stock offerings		-		863
Dividends paid		(283)		(252)
Proceeds from stock options exercised and other		140		26
Other financing activities		(7)		-
Net cash provided by financing activities		11,631		8,313
Decrease in Cash and Cash Equivalents		(5,301)		(156)
Cash and Cash Equivalents at Beginning of Period		12,663		8,679
Cash and Cash Equivalents at End of Period	$	7,362	$	8,523
Supplemental Cash Flow Information
Cash paid during the period for:
Interest	$	89	$	118
Income taxes	$	448	$	379
Non-cash investing activity:
Securities purchased during the period but settled after period end	$	38	$	263
Non-cash financing activity:
Exchange of Senior Notes	$	-	$	256

See Notes to Condensed Consolidated Financial Statements.

THE CHARLES SCHWAB CORPORATION

Notes to Condensed Consolidated Financial Statements

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

(Unaudited)

1.Introduction and Basis of Presentation

The Charles Schwab Corporation (CSC) is a savings and loan holding company engaged, through its subsidiaries, in securities brokerage, banking, money management, and financial advisory services. Charles Schwab & Co., Inc. (Schwab) is a securities broker-dealer with over 300 domestic branch offices in 45 states, as well as a branch in each of the Commonwealth of Puerto Rico and London, 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 (U.S.), which require management to make certain estimates and assumptions that affect the reported amounts in the accompanying financial statements. Certain estimates relate to other-than-temporary impairment of securities available for sale and securities held to maturity, valuation of goodwill, allowance for loan losses, and legal and regulatory reserves. Actual results may differ from those estimates. These condensed consolidated financial statements reflect all adjustments that are, in the opinion of management, necessary for a fair presentation of the results for the periods presented. These adjustments are of a normal recurring nature. Certain prior period amounts have been reclassified to conform to the 2013 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, 2012, as updated by the Company’s Current Report on Form 8-K filed on June 24, 2013, relating to the realignment of the Company’s reportable segments.

The Company’s significant accounting policies are included in note “2 – Summary of Significant Accounting Policies” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012, as updated by its Current Report on Form 8-K filed on June 24, 2013. There have been no significant changes to these accounting policies during the first nine months of 2013.

2.Securities Available for Sale and Securities Held to Maturity

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


			Gross		Gross
	Amortized		Unrealized		Unrealized		Fair
September 30, 2013	Cost		Gains		Losses		Value
Securities available for sale:
U.S. agency mortgage-backed securities	$	18,498	$	175	$	25	$	18,648
Asset-backed securities		14,519		37		42		14,514
Corporate debt securities		9,335		52		15		9,372
Certificates of deposit		4,275		6		1		4,280
U.S. agency notes		4,240		1		89		4,152
Non-agency residential mortgage-backed securities		653		9		44		618
Other securities		272		9		-		281
Total securities available for sale	$	51,792	$	289	$	216	$	51,865
Securities held to maturity:
U.S. agency mortgage-backed securities	$	27,288	$	249	$	691	$	26,846
Other securities		931		-		60		871
Total securities held to maturity	$	28,219	$	249	$	751	$	27,717

THE CHARLES SCHWAB CORPORATION

Notes to Condensed Consolidated Financial Statements

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

(Unaudited)


			Gross		Gross
	Amortized		Unrealized		Unrealized		Fair
December 31, 2012	Cost		Gains		Losses		Value
Securities available for sale:
U.S. agency mortgage-backed securities	$	20,080	$	396	$	-	$	20,476
Asset-backed securities		8,104		62		2		8,164
Corporate debt securities		6,197		61		2		6,256
Certificates of deposit		6,150		12		1		6,161
U.S. agency notes		3,465		2		3		3,464
Non-agency residential mortgage-backed securities		796		2		65		733
Commercial paper		574		-		-		574
Other securities		278		17		-		295
Total securities available for sale	$	45,644	$	552	$	73	$	46,123
Securities held to maturity:
U.S. agency mortgage-backed securities	$	17,750	$	558	$	19	$	18,289
Other securities		444		-		1		443
Total securities held to maturity	$	18,194	$	558	$	20	$	18,732

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


	Less than				12 months
	12 months				or longer				Total
	Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
September 30, 2013	Value		Losses		Value		Losses		Value		Losses
Securities available for sale:
U.S agency mortgage-backed securities	$	5,105	$	25	$	-	$	-	$	5,105	$	25
Asset-backed securities		7,328		40		469		2		7,797		42
Corporate debt securities		1,685		14		400		1		2,085		15
Certificates of deposit		-		-		299		1		299		1
U.S. agency notes		3,651		89		-		-		3,651		89
Non-agency residential mortgage-backed
securities		112		3		393		41		505		44
Total	$	17,881	$	171	$	1,561	$	45	$	19,442	$	216
Securities held to maturity:
U.S. agency mortgage-backed securities	$	16,051	$	690	$	85	$	1	$	16,136	$	691
Other securities		771		60		-		-		771		60
Total	$	16,822	$	750	$	85	$	1	$	16,907	$	751
Total securities with unrealized losses ⁽¹⁾	$	34,703	$	921	$	1,646	$	46	$	36,349	$	967

(1)	The number of investment positions with unrealized losses totaled 260 for securities available for sale and 135 for securities held to maturity.

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
	Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
December 31, 2012	Value		Losses		Value		Losses		Value		Losses
Securities available for sale:
Asset-backed securities	$	-	$	-	$	801	$	2	$	801	$	2
Corporate debt securities		878		2		-		-		878		2
Certificates of deposit		599		1		-		-		599		1
U.S. agency notes		2,102		3		-		-		2,102		3
Non-agency residential mortgage-backed
securities		46		1		549		64		595		65
Total	$	3,625	$	7	$	1,350	$	66	$	4,975	$	73
Securities held to maturity:
U.S. agency mortgage-backed
securities	$	2,680	$	19	$	-	$	-	$	2,680	$	19
Other securities		240		1		-		-		240		1
Total	$	2,920	$	20	$	-	$	-	$	2,920	$	20
Total securities with unrealized losses ⁽¹⁾	$	6,545	$	27	$	1,350	$	66	$	7,895	$	93

(1)	The number of investment positions with unrealized losses totaled 139 for securities available for sale and 24 for securities held to maturity.

The Company’s non-agency residential mortgage-backed securities portfolio includes securities collateralized by loans that are considered to be “Prime” (defined as loans to borrowers with a Fair Isaac Corporation (FICO) credit score of 620 or higher at origination), and “Alt-A” (defined as Prime loans with reduced documentation at origination). 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. Management determined that it does not expect to recover all of the amortized cost of certain of its Alt-A and Prime residential mortgage-backed securities and therefore determined that these securities were other-than-temporarily impaired (OTTI). The Company recognized an impairment charge equal to the securities’ expected credit losses of $1 million and $8 million during the third quarter and first nine months of 2013, respectively, based on the Company’s cash flow projections for these securities. 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 non-agency residential mortgage-backed securities portfolio could result in the recognition of additional impairment losses.

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


	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2013		2012		2013		2012
Balance at beginning of period	$	166	$	152	$	159	$	127
Credit losses recognized into current period earnings on debt securities for
which an other-than-temporary impairment was not previously recognized		-		1		1		6
Credit losses recognized into current period earnings on debt securities for
which an other-than-temporary impairment was previously recognized		1		2		7		22
Balance at end of period	$	167	$	155	$	167	$	155

THE CHARLES SCHWAB CORPORATION

Notes to Condensed Consolidated Financial Statements

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

(Unaudited)

The maturities of securities available for sale and securities held to maturity at September 30, 2013 are as follows:


			After 1 year		After 5 years
	Within		through		through		After
	1 year		5 years		10 years		10 years		Total
Securities available for sale:
U.S. agency mortgage-backed securities ⁽¹⁾	$	-	$	325	$	4,271	$	14,052	$	18,648
Asset-backed securities		-		1,255		2,598		10,661		14,514
Corporate debt securities		1,902		7,364		106		-		9,372
Certificates of deposit		2,378		1,902		-		-		4,280
U.S. agency notes		-		2,291		1,861		-		4,152
Non-agency residential mortgage-backed
securities ⁽¹⁾		-		3		2		613		618
Other securities		-		-		-		281		281
Total fair value	$	4,280	$	13,140	$	8,838	$	25,607	$	51,865
Total amortized cost	$	4,272	$	13,136	$	8,835	$	25,549	$	51,792
Securities held to maturity:
U.S. agency mortgage-backed securities ⁽¹⁾	$	-	$	371	$	11,555	$	14,920	$	26,846
Other securities		100