CHARLES SCHWAB 
FORWARD-LOOKING STATEMENTS
In addition to historical information, this Annual Report on Form 10-K contains "forward-looking statements" within the meaning of Section 27A of the Securities Act, and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements are identified by words such as "believe," "anticipate," "expect," "intend," "plan," "will," "may," "estimate," "appear," "could," "would," "expand", "maintain," and other similar expressions. In addition, any statements that refer to expectations, projections, or other characterizations of future events or circumstances are forward-looking statements. These forward-looking statements, which reflect management's beliefs, objectives, and expectations as of the date hereof, are estimates based on the best judgment of Schwab's senior management. These statements relate to, among other things:
• The acquisition of TD Ameritrade; the acquisition of assets of USAA-IMCO,
the related funding, and entering into a referral agreement; and the
expected closing dates of the acquisitions (see Business Acquisitions in
Part I, Item 1; Overview and Capital Management in Part II, Item 7;
Commitments and Contingencies in Part II, Item 8 - Notes to Consolidated
Financial Statements (Item 8) - Note 14);
• Maximizing our market valuation and stockholder returns over time; our
belief that developing trusted relationships will translate into moreclient assets which drives revenue and, along with expense discipline and
thoughtful capital management, generates earnings growth and builds
stockholder value; and maintaining our market position (see Business
Strategy and Competitive Environment and Products and Services in Part I,
Item 1);
• The impact of pricing reductions on our value proposition, competitive
positioning and long-term growth in client assets and accounts (see
Sources of Net Revenues in Part I, Item I; Overview in Part II, Item 7);
• The impact of legal proceedings and regulatory matters (see Legal
Proceedings in Part I, Item 3 and Commitments and Contingencies in Part
II, Item 8 - Note 14);
• Commitment to balancing long-term profitability with reinvesting forgrowth; business growth; meaningful capital returns; and intent to return
excess capital above our long-term operating objective of 6.75% - 7.00%
(see Overview in Part II, Item 7);
• The adjustment of rates paid on client-related liabilities; client cash
sorting; reducing exposure to lower rates; and the duration difference
between liabilities and assets (see Net Interest Revenue in Part II, Item
7);
• Capital expenditures (see Total Expenses Excluding Interest in Part II,
Item 7);
• The phase-out of the use of LIBOR (see Expected Phase-out of LIBOR in Part
II, Item 7);
• Sources of liquidity, capital, and level of dividends (see Liquidity Risk
in Part II, Item 7);
• Capital ratios (see Regulatory Capital Requirements in Part II, Item 7);
• The expected impact of new accounting standards not yet adopted (see
Summary of Significant Accounting Policies in Part II, Item 8 - Note 2);
and
• The likelihood of indemnification and guarantee payment obligations (see
Commitments and Contingencies in Part II, Item 8 - Note 14).
Achievement of the expressed beliefs, objectives and expectations described in these statements is subject to certain risks and uncertainties that could cause actual results to differ materially from the expressed beliefs, objectives, and expectations. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this Annual Report on Form 10-K or, in the case of documents incorporated by reference, as of the date of those documents. Important factors that may cause actual results to differ include, but are not limited to: • The timing and the ability of us and TD Ameritrade to satisfy the closing
conditions in the merger agreement, including stockholder and regulatory
approvals;
• The timing and the ability of us and USAA-IMCO to satisfy the closing
conditions in the purchase agreement, including regulatory approvals and
the implementation of conversion plans;
• The timing and extent to which we realize expected revenue, expense and
other synergies from our acquisitions;
• General market conditions, including the level of interest rates, equity
valuations, and trading activity;
• Our ability to attract and retain clients, develop trusted
relationships, and grow client assets;
• Client use of our advisory solutions and other products and services;
• The level of client assets, including cash balances;
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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)
• Competitive pressure on pricing, including deposit rates;
• Client sensitivity to rates;
• Regulatory guidance;
• Capital and liquidity needs and management;
• Our ability to manage expenses;
• Our ability to develop and launch new and enhanced products, services, and
capabilities, as well as implement infrastructure, in a timely and
successful manner;
• The effect of pricing reductions on client acquisition, retention and
asset levels, including cash balances;
• The Company's ability to monetize client assets;
• The timing of campus expansion work and technology projects;
• Adverse developments in litigation or regulatory matters and any related
charges;
• Potential breaches of contractual terms for which we have indemnification
and guarantee obligations; and
• Client cash sorting and net equity sales.
Certain of these factors, as well as general risk factors affecting the Company, are discussed in greater detail in Risk Factors in Part I, Item 1A.
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THE CHARLES SCHWAB CORPORATION
Management's Discussion and Analysis of Financial Condition and Results of
Operations
(Tabular Amounts in Millions, Except Ratios, or as Noted)
GLOSSARY OF TERMS
Active brokerage accounts: Brokerage accounts with activity within the preceding 270 days.
Accumulated Other Comprehensive Income (AOCI): A component of stockholders' equity which includes unrealized gains and losses on available for sale (AFS) securities and net gains or losses associated with pension obligations.
Asset-backed securities: Debt securities backed by financial assets such as loans or receivables.
Assets receiving ongoing advisory services: Market value of all client assets custodied at the Company under the guidance of an independent advisor or enrolled in one of Schwab's advice solutions at the end of the reporting period.
Basel III: Global regulatory standards on bank capital adequacy and liquidity
issued by the
Basis point: One basis point equals 1/100th of 1%, or 0.01%.
Client assets: The market value, as of the end of the reporting period, of all client assets in our custody and proprietary products, which includes both cash and securities. Average client assets are the daily average client asset balance for the reporting period. Client cash as a percentage of client assets: Calculated as the value, at the end of the reporting period, of all proprietary money market fund balances, bank deposits, Schwab One® balances, and certain cash equivalents divided by client assets. Common Equity Tier 1 (CET1) Capital: The sum of common stock and related surplus net of treasury stock, retained earnings, AOCI and qualifying minority interests, less applicable regulatory adjustments and deductions. See Current Regulatory Environment and Other Developments for information on recently issued rules that will impact Schwab's regulatory capital requirements.
Common Equity Tier 1 Risk-Based Capital Ratio: The ratio of
Core net new client assets: Net new client assets before significant one-time inflows or outflows, such as acquisitions/divestitures or extraordinary flows (generally greater than$10 billion ) relating to a specific client. These flows may span multiple reporting periods.
Customer Protection Rule: Refers to Rule 15c3-3 of the Securities Exchange Act of 1934.
Daily Average Revenue Trades (DARTs): Total revenue trades during a certain period, divided by the number of trading days in that period. Revenue trades include all client trades that generate trading revenue (i.e., commission revenue or principal transaction revenue).
Daily Average Trades (DATs): Includes daily average revenue trades by clients, trades by clients in asset-based pricing relationships, and all commission-free trades.
Debt to total capital ratio: Calculated as total debt divided by stockholders' equity and total debt.
Delinquency roll rates: The rates at which loans transition through delinquency stages, ultimately resulting in a loss. Schwab considers a loan to be delinquent if it is 30 days or more past due.
Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank): Regulatory reform legislation containing numerous provisions which expanded prudential regulation of large financial services companies.
Duration: Duration is typically used to measure the expected change in value of a financial instrument for a 1% change in interest rates, expressed in years.
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THE CHARLES SCHWAB CORPORATION
Management's Discussion and Analysis of Financial Condition and Results of
Operations
(Tabular Amounts in Millions, Except Ratios, or as Noted)
Final Regulatory Capital Rules: Refers to the regulatory capital rules issued by
U.S. banking agencies which implemented Basel III and relevant provisions of
Dodd-Frank, which apply to savings and loan holding companies, as well as
federal savings banks.
First mortgages: Refers to first lien residential real estate mortgage loans.
Full-time equivalent employees: Represents the total number of hours worked divided by a 40-hour work week for the following categories: full-time, part-time and temporary employees and persons employed on a contract basis.
High Quality Liquid Assets (HQLA): HQLA is defined by theFederal Reserve , but includes assets with low market- and credit risk that are actively traded and readily convertible to cash in times of stress.
Interest-bearing liabilities: Includes bank deposits, payables to brokerage clients, short-term borrowings, and long-term debt on which Schwab pays interest.
Interest-earning assets: Includes cash and cash equivalents, cash and investments segregated, broker-related receivables, receivables from brokerage clients, investment securities, and bank loans on which Schwab earns interest.
Investment grade: Defined as a rating equivalent to a Moody's Investors Service
(Moody's) rating of "Baa" or higher, or a Standard & Poor's
Liquidity Coverage Ratio (LCR): The ratio of HQLA to projected net cash outflows during a 30-day stress scenario.
Loan-To-Value (LTV) ratio: Calculated as the principal amount of a loan divided by the value of the collateral securing the loan.
Margin loans: Advances made to brokerage clients on a secured basis to purchase or carry securities reflected in receivables from brokerage clients on the consolidated balance sheets.
Master netting arrangement: An agreement between two counterparties that have multiple contracts with each other that provides for net settlement of all contracts through a single cash payment in the event of default or termination of any one contract.
Mortgage-backed securities: A type of asset-backed security that is secured by a mortgage or group of mortgages.
Net interest margin: Net interest revenue (annualized for interim periods) divided by average interest-earning assets.
Net new client assets: Total inflows of client cash and securities to Schwab less client outflows. Inflows include dividends and interest; outflows include commissions and fees. Capital gains distributions are excluded. Net Stable Funding Ratio (NSFR): Measures an organization's "available" amount of stable funding relative to its "required" amount of stable funding over a one-year time horizon.
New brokerage accounts: All brokerage accounts opened during the period, as well as any accounts added via acquisition.
Nonperforming assets: The total of nonaccrual loans and other real estate owned.
Order flow revenue: Net compensation received from markets and firms to which CS&Co sends equity and options orders. The amount reflects rebates received for certain types of orders, less fees paid for orders where exchange fees or other charges apply.
Pledged Asset Line® (PAL): A non-purpose revolving line of credit from CSB secured by eligible assets held in a separate pledged brokerage account maintained at CS&Co.
Return on average common stockholders' equity: Calculated as net income available to common stockholders (annualized for interim periods) divided by average common stockholders' equity.
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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)
Risk-weighted assets: Computed by assigning specific risk-weightings to assets and off-balance sheet instruments for capital adequacy calculations.
Tier 1 Capital: The sum of
Tier 1 Leverage Ratio: End-of-period Tier 1 Capital divided by adjusted average total consolidated assets for the quarter.
Trading days: Days in which the markets/exchanges are open for the buying and selling of securities. Early market closures are counted as half-days.
Uniform Net Capital Rule: Refers to Rule 15c3-1 under the Securities Exchange
Act of 1934, which specifies minimum capital requirements that are intended to
ensure the general financial soundness and liquidity of broker-dealers at all
times.
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THE CHARLES SCHWAB CORPORATION
Management's Discussion and Analysis of Financial Condition and Results of
Operations
(Tabular Amounts in Millions, Except Ratios, or as Noted)
OVERVIEW
Management focuses on several client activity and financial metrics in
evaluating Schwab's financial position and operating performance. We believe
that metrics relating to net new and total client assets, as well as client cash
levels and utilization of advisory services, offer perspective on our business
momentum and client engagement. Data on new and total client brokerage accounts
provides additional perspective on our ability to attract and retain new
business. Total net revenue growth, pre-tax profit margin, EPS, return on
average common stockholders' equity, and the Consolidated Tier 1 Leverage Ratio
provide broad indicators of Schwab's overall financial health, operating
efficiency, and ability to generate acceptable returns. Total expenses,
excluding interest, as a percentage of average client assets, is a measure of
operating efficiency. Results for the years ended December 31, 2019 , 2018, and
2017 are as follows:
Growth
Rate
1-Year
2018-2019 2019 2018 2017
Client Metrics
Net new client assets (in billions) (1) 66% $ 222.8 $ 133.9 $ 233.1
Core net new client assets (in billions) (7)% $ 211.7 $ 227.8 $ 198.6
Client assets (in billions, at year end) 24% $ 4,038.8 $ 3,252.2 $ 3,361.8
Average client assets (in billions) 8% $ 3,682.0 $ 3,409.6 $ 3,060.2
New brokerage accounts (in thousands) (1)% 1,568 1,576 1,441
Active brokerage accounts (in thousands, at
year end) 6% 12,333 11,593 10,755
Assets receiving ongoing advisory services
(in billions, at year end) 23% $ 2,106.8 $ 1,708.5 $ 1,699.8
Client cash as a percentage of client assets
(at year end) 11.3 % 12.8 % 10.8 %
Company Financial Metrics
Total net revenues 6% $ 10,721 $ 10,132 $ 8,618
Total expenses excluding interest 5% 5,873 5,570 4,968
Income before taxes on income 6% 4,848 4,562 3,650
Taxes on income 8% 1,144 1,055 1,296
Net income 6% $ 3,704 $ 3,507 $ 2,354
Preferred stock dividends and other - 178 178 174
Net income available to common stockholders 6%
9% $ 2.67 $ 2.45 $ 1.61
Net revenue growth from prior year 6 % 18 % 15 %
Pre-tax profit margin 45.2 % 45.0 % 42.4 %
Return on average common stockholders'
equity 19 % 19 % 15 %
Expenses excluding interest as a percentage
of average client assets 0.16 % 0.16 % 0.16 %
Consolidated Tier 1 Leverage Ratio (at year
end) 7.3 % 7.1 % 7.6 %
(1) 2019 and 2017 include inflows of
2019 Compared to 2018
Schwab delivered solid financial results in 2019 while taking significant steps to further enhance our offer to clients and help position the Company to build value for our stakeholders over the long-term. Throughout the year, investor sentiment reflected a complex market environment that included global trade negotiations and an uncertain domestic economic outlook. TheFederal Reserve ended up cutting the federal funds target interest rate three times, in a reversal of the increases seen in 2018. At the same time, stocks continued to rise, with the S&P 500 increasing 29% during the year. Core net new assets totaled$211.7 billion for the year, representing an organic growth rate of 7% and our second consecutive year over$200 billion . Clients opened 1.6 million new brokerage accounts in 2019, while active brokerage accounts grew 6% to 12.3 million. Our success in asset gathering combined with strong market returns drove total client assets to reach$4.04 trillion atDecember 31, 2019 , closing the year up 24%. - 30 -
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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)
Company actions to benefit clients and build long-term value during 2019
included the elimination of online trading commissions for U.S. and
Canadian-listed stocks and ETFs, as well as the base charge on options, which
became effective October 7th . The Company also announced two significant
acquisitions during the year. In July, the Company agreed to acquire assets of
USAA-IMCO and agreed to enter into a long-term referral agreement. In late
November, we entered into a definitive agreement to acquire TD Ameritrade.
Against the backdrop of the more challenging than expected macroeconomic
environment and our own pricing decisions, Schwab's net income totaled
Total net revenues reached$10.7 billion , up 6% in 2019. Net interest revenue increased 12% in 2019 to$6.5 billion , driven by higher average investment yields and also by an increase in client cash balances held at our bank and broker-dealer subsidiaries. While trading revenue declined 19% to$617 million due to our pricing actions, asset management and administration fees remained essentially flat with 2018 at$3.2 billion , decreasing 1%. Growing enrollment in advice solutions, along with rising balances in other third-party mutual funds, helped to largely offset declines in Mutual Fund OneSource® and lower sweep money market fund revenue due to transfers of sweep money market funds to our balance sheet in 2018 and early 2019. Total expenses excluding interest increased 5% in 2019 to$5.9 billion , which included$62 million in severance charges associated with a 3% reduction in our workforce and$25 million in costs relating to the announced acquisitions of assets of USAA-IMCO and TD Ameritrade. Our ongoing focus on driving efficiency while managing our spending in a disciplined manner helped us maintain a ratio of expenses to client assets of 16 bps for 2019. Reflecting our commitment to balancing long-term profitability with reinvesting for growth, we achieved a 45.2% pre-tax profit margin and a 19% return on equity in 2019, representing our second consecutive year of at least 45% and 19%, respectively. Disciplined balance sheet management remains core to our strategy as we continue to support business growth and meaningful capital returns across a range of conditions. In early 2019, the Board of Directors raised the quarterly cash dividend 31% to$0.17 per share and authorized the repurchase of up to$4.0 billion of common stock; during 2019 we repurchased 55 million shares for$2.2 billion under this authorization. As ofDecember 31, 2019 , our balance sheet assets were$294 billion , down 1% from a year ago; our Tier 1 Leverage Ratio was 7.3% at year-end. As the Company continues to grow both organically and through our pending acquisitions, our intent to return excess capital above our long-term operating objective of 6.75%-7.00% remains in place.
Planned Acquisitions
TD Ameritrade: OnNovember 25, 2019 , CSC announced a definitive agreement to acquire TD Ameritrade in an all-stock transaction. At the time of announcement, TD Ameritrade had approximately twelve million brokerage accounts and$1.3 trillion in total client assets. Under the agreement, TD Ameritrade stockholders will receive 1.0837 CSC shares for each TD Ameritrade share. Based on the closing price of CSC common stock onNovember 20, 2019 , the merger consideration represented approximately$26 billion . The Company anticipates this transaction will add scale to help support the Company's ongoing efforts to enhance the client experience, provide deeper resources for RIAs, and continue to improve our operating efficiency. The transaction is expected to close in the second half of 2020, subject to satisfaction of closing conditions. Under certain circumstances, CSC or TD Ameritrade could be required to pay the other party a termination fee of$950 million or reimburse the other party's fees up to$50 million . Assets of USAA-IMCO: OnJuly 25, 2019 , the Company announced a definitive agreement to acquire assets of USAA-IMCO, including over one million brokerage and managed portfolio accounts with approximately$90 billion in client assets at the time of announcement, for$1.8 billion in cash. The companies have also agreed to enter into a long-term referral agreement, effective at closing of the acquisition, which would make Schwab the exclusive wealth management and brokerage provider forUSAA members. The transaction is expected to close in mid-2020, subject to satisfaction of closing conditions, including regulatory approvals and the implementation of conversion plans.
The Company expects to recognize significant amounts of goodwill and amortizable intangible assets as part of the planned acquisitions.
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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)
2018 Compared to 2017
Net income increased by$1.2 billion , or 49%, in 2018, driven primarily by business momentum, a supportive economic environment for much of the year, and lower corporate tax rates. Continued execution of our 'Through Clients' Eyes' strategy helped us succeed with clients. In 2018, clients opened 1.6 million new brokerage accounts, helping bring active brokerage accounts to 11.6 million at the end of the year, and core net new assets totaled$227.8 billion , up 15% from the 2017 total. Our strong net new assets largely offset lower market valuations, and we ended 2018 at$3.25 trillion in total client assets. Total net revenue grew by$1.5 billion , or 18%, in 2018 primarily due to an increase of$1.5 billion , or 36%, in net interest revenue.The Fed raised the federal funds target interest rate four times in 2018 for a total of 100 basis points. The growth of total net revenue resulted from higher interest rates due to the Fed's rate increases, and also from higher interest-earning assets, which reflect both client cash allocations and the transfer of sweep money market funds to bank and broker-dealer sweep. As we progressed with these transfers, the corresponding money market fund asset management and administration fee revenue naturally declined, yet positive inflows in advice solutions, Schwab equity and bond funds and ETFs, and other third-party mutual funds and ETFs kept asset management fees at$3.2 billion , limiting the decrease to 5% from 2017. Record trading activity from our clients resulted in trading revenue reaching$763 million , an increase of 17% from the prior year. Our increase in total expenses excluding interest of$602 million , or 12%, reflected our 2018 investments to support and fuel our business growth, including hiring additional client-facing and other employees and technology project spending, as well as an increase in marketing and a special stock award of$36 million to our employees. Even with these increases, expenses as a percentage of client assets remained consistent at 16 basis points, and pre-tax income increased 25% to$4.6 billion in 2018, resulting in a pre-tax profit margin of 45.0%. As a result of the Tax Cuts and Jobs Act of 2017 (the Tax Act), taxes on income decreased 19% in 2018, resulting in an effective tax rate of 23.1%. Overall, we generated a 19% return on equity and diluted EPS of$2.45 for the year. During 2018, the Board of Directors raised the quarterly cash dividend 63% to$0.13 per share and authorized a$1.0 billion Share Repurchase Program, which we completed during the fourth quarter of 2018. These actions reflected the Company's strong financial performance and our confidence in its long-term success; they also demonstrated that effective capital management at Schwab can support both healthy business growth and more meaningful capital returns to stockholders.
Subsequent Events
InOctober 2019 , theFederal Reserve issued a final enhanced prudential standards rule, and theFederal Reserve , OCC, and theFDIC jointly issued a final regulatory capital and liquidity rule. With total consolidated assets of$294.0 billion atDecember 31, 2019 , CSC is designated as a Category III firm pursuant to the framework established by the final rules. Accordingly, the Company opted to exclude AOCI from its regulatory capital as permitted by the regulatory capital and liquidity rule beginningJanuary 1, 2020 . In accordance with ASC 320, Investments - Debt and Equity Securities (ASC 320) and as ofJanuary 1, 2020 , the Company transferred all of its investment securities designated as held to maturity (HTM) to the AFS category without tainting our intent to hold other debt securities to maturity. At the date of transfer, these securities had a total amortized cost of$134.7 billion and a total net unrealized gain of$1.4 billion .
CURRENT REGULATORY ENVIRONMENT AND OTHER DEVELOPMENTS
InDecember 2019 , theFDIC issued a proposed rule that would modernize its brokered deposits regulations. Among other things, the proposed rule would clarify the "primary purpose" exception from the definition of a deposit broker for securities broker-dealers such as CS&Co that place deposits through brokerage sweep arrangements under certain conditions. In addition, the proposed rule would create a streamlined application process for obtaining a primary purpose exception where less than 25 percent of a broker-dealer's customer assets are placed with a depository institution. Schwab is currently evaluating the impact of the proposed rule on its bank sweep program. InJanuary 2020 , the OCC and theFDIC published their jointly proposed revisions to the regulations implementing the CRA. The proposed regulations (i) clarify and expand what qualifies for CRA credit; (ii) expand where CRA activity counts; (iii) provide an objective method to measure CRA activity; and (iv) revise data collection, recordkeeping, and reporting. The - 32 - -------------------------------------------------------------------------------- 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)Federal Reserve did not join the OCC and theFDIC in the proposed regulations. The comment period for the proposed regulations ends onMarch 9, 2020 . Schwab is currently evaluating the impact of the proposed regulations. InMay 2016 , theFederal Reserve , the OCC and theFDIC jointly issued a notice of proposed rulemaking that would impose a minimum NSFR on certain banking organizations, including CSC. The comment period for the proposed rule ended onAugust 5, 2016 and the impact to the Company cannot be assessed until the final rule is released. The agencies indicated in theOctober 2019 interagency regulatory capital and liquidity rule their intention to utilize the four category tiering framework when the NSFR rule is adopted. RESULTS OF OPERATIONS Total Net Revenues Total net revenues of$10.7 billion and$10.1 billion for the years endedDecember 31, 2019 and 2018, respectively, represented growth of 6% and 18% from the prior periods, primarily due to increases in net interest revenue. Year Ended December 31, 2019 2018 2017 % of % of % of Growth Rate Total Net Total Net Total Net 2018-2019 Amount Revenues Amount Revenues Amount Revenues Net interest revenue Interest revenue 13 %$ 7,580 71 %$ 6,680 66 %$ 4,624 54 % Interest expense 24 % (1,064 ) (10 )% (857 ) (9 )% (342 ) (4 )% Net interest revenue 12 % 6,516 61 % 5,823 57 % 4,282 50 % Asset management and administration fees Mutual funds, ETFs, and collective trust funds (CTFs) (1) (5 )% 1,747 16 % 1,837 18 % 2,088 24 % Advice solutions 5 % 1,198 11 % 1,139 11 % 1,043 12 % Other (1) 5 % 266 3 % 253 3 % 261 3 % Asset management and administration fees (1 )% 3,211 30 % 3,229 32 % 3,392 39 % Trading revenue Commissions (20 )% 549 5 % 685 7 % 600 7 % Principal transactions (13 )% 68 1 % 78 1 % 54 1 % Trading revenue (19 )% 617 6 % 763 8 % 654 8 % Other 19 % 377 3 % 317 3 % 290 3 % Total net revenues 6 %$ 10,721 100 %$ 10,132 100 %$ 8,618 100 %
(1) Beginning in 2019, a change was made to move CTFs from other asset management and administration fees. Prior periods have been recast to reflect this change.
Net Interest Revenue Schwab's primary interest-earning assets include cash and cash equivalents; cash and investments segregated; margin loans, which constitute the majority of receivables from brokerage clients; investment securities; and bank loans. Revenue on interest-earning assets is affected by various factors, such as the composition of assets, prevailing interest rates and spreads at the time of origination or purchase, changes in interest rates on floating rate securities and loans, and changes in prepayment levels for mortgage-backed and other asset-backed securities and loans. Fees earned on securities borrowing and lending activities, which are conducted by CS&Co using assets held in client brokerage accounts, are primarily included in other interest revenue and expense.
Schwab's interest-bearing liabilities include bank deposits, payables to
brokerage clients, short-term borrowings (e.g.,
We establish the rates paid on client-related liabilities, and management
expects that it will generally adjust the rates paid on these liabilities at
some fraction of any movement in short-term rates. Schwab deploys the funds from
these sources into the
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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)
assets outlined above. We do not use short-term, wholesale borrowings to support our long-term investment activity, but may use such funding, including FHLB advances, for short-term liquidity purposes or to provide temporary funding (e.g., for investment purchases) ahead of anticipated balance sheet deposit growth.
In order to keep interest-rate sensitivity within established limits, management actively monitors and adjusts interest-rate sensitivity through changes in the balance sheet, primarily by adjusting the composition of our banking subsidiaries' investment portfolios. As Schwab builds its client base, we attract new client sweep cash, which is a primary driver of funding balance sheet growth. Towards the end of 2018, the federal funds target interest rate increased to levels not seen in over a decade, leading us to expect some clients would shift more of their cash holdings from brokerage deposits swept to our banking subsidiaries to higher-yielding alternatives like purchased money market funds. We therefore expected brokerage deposits swept to our banking subsidiaries, excluding organic growth, to decline during the first part of 2019. As a result, we held a higher amount of short-term liquidity at our banking subsidiaries at the end of 2018 to accommodate this potential client cash sorting. While average interest rates throughout the year in 2019 were higher than average rates in 2018, interest rates across maturities declined fromDecember 2018 toDecember 2019 . Lower interest rates typically result in longer durations on our client-related liabilities and shorter durations on our investment securities, especially mortgage-related securities with options to prepay without penalty. During 2019, to maintain our overall targeted interest rate risk profile, we began positioning our banking entities' investment portfolios to include a higher percentage of fixed-rate, longer duration investments to reduce our interest rate sensitivities which would naturally increase as market rates declined. We did, however, once again hold a higher level of short-term liquidity at the end of 2019 to accommodate a typical seasonal buildup of client cash, much of which then generally moves to other assets within a few months. We believe that the process of clients sorting between transactional cash and cash held for investment is subsiding. Aligned with market consensus, we do not expect to see a significant increase in market rates in the near term. Over the course of 2020, we expect to further reduce our exposure to lower rates primarily by adding a larger percentage of fixed-rate securities with relatively longer duration to our ongoing purchases as a result of maturities, prepayments, organic deposit growth, on-boarding of USAA-IMCO client cash to our balance sheet, and any potential asset-liability-management-driven investment portfolio re-balancing. As such, we expect the duration difference between our liabilities and assets to decline over the course of 2020. - 34 - -------------------------------------------------------------------------------- THE CHARLES SCHWAB CORPORATION Management's Discussion and Analysis of Financial Condition and Results of Operations (Tabular Amounts in Millions, Except Ratios, or as Noted) The following table presents net interest revenue information corresponding to interest-earning assets and funding sources on the consolidated balance sheets: Year Ended December 31, 2019 2018 2017 Interest Average Interest Average Interest Average Average Revenue/ Yield/ Average Revenue/ Yield/ Average Revenue/ Yield/ Balance Expense Rate Balance
Expense Rate Balance Expense Rate
Interest-earning assets
Cash and cash equivalents
$ 348 1.93 %$ 9,931 $ 109 1.10 % Cash and investments segregated 15,694 345 2.17 % 11,461 206 1.78 % 18,525 166 0.90 % Broker-related receivables 376 7 1.87 % 303 6 2.09 % 430 3 0.70 % Receivables from brokerage clients 19,270 821 4.20 % 19,870 830 4.12 % 16,269 575 3.53 % Available for sale securities (1) 58,181 1,560 2.67 % 54,542 1,241 2.26 % 53,040 815 1.54 % Held to maturity securities 134,708 3,591 2.65 % 131,794 3,348 2.53 % 103,599 2,354 2.27 % Bank loans 16,832 584 3.47 % 16,554 559 3.37 % 15,919 472 2.97 % Total interest-earning assets 268,573 7,426 2.75 % 252,307 6,538 2.57 % 217,713 4,494 2.06 % Other interest revenue 154 142 130 Total interest-earning assets$ 268,573 $ 7,580 2.80 %$ 252,307 $ 6,680 2.63 %$ 217,713 $ 4,624 2.12 % Funding sources Bank deposits$ 212,605 $ 700 0.33 %$ 199,139
24,353 79 0.33 % 21,178 56 0.27 % 25,403 16 0.06 %
Short-term borrowings (2) 17 - 2.36 % 3,359 54 1.59 % 3,503 41 1.17 %
Long-term debt 7,199 258 3.58 % 5,423 190 3.50 % 3,431 119 3.47 %
Total interest-bearing
liabilities 244,174 1,037 0.42 % 229,099 845 0.37 % 196,335 324 0.17 %
Non-interest-bearing
funding sources 24,399 23,208 21,378
Other interest expense 27 12 18
Total funding sources $ 268,573 $ 1,064 0.39 % $ 252,307 $ 857 0.34 %$ 217,713 $ 342 0.15 % Net interest revenue$ 6,516 2.41 %$ 5,823 2.29 %$ 4,282 1.97 %
(1) Amounts have been calculated based on amortized cost.
(2) Interest revenue or expense was less than
Net interest revenue increased$693 million or 12%, in 2019 from 2018, and$1.5 billion , or 36%, in 2018 from 2017, due to higher average investment yields and growth in interest earning assets. Our net interest margin improved 12 basis points to 2.41% in 2019, driven primarily by higher average yields received on interest-earning assets in 2019 due largely to the net impact of theFederal Reserve's interest rate increases in 2018 and decreases in the third and fourth quarters of 2019. The increase in average yields on interest-earning assets was partially offset by higher average interest rates paid on bank deposits and other interest-bearing liabilities. The portfolio adjustments made in 2019 as described above helped to moderate the impact of the declining rate environment on our net interest margin.
Average interest-earning assets grew 6% from 2018 to 2019, primarily driven by higher bank deposits due to transfers from sweep money market funds to bank sweep, as well as higher client cash balances.
Our net interest margin improved 32 basis points to 2.29% in 2018, primarily as a result of theFederal Reserve's 2017 and 2018 interest rate increases, partially offset by higher interest rates paid on bank deposits and other interest-bearing liabilities. Average interest earning assets grew 16% from 2017 to 2018, primarily reflecting higher bank deposits due to transfers from sweep money market funds to bank sweep, as well as changes in client cash allocations, partially offset by client purchases of other assets. InMarch 2017 , the Company transferred$24.7 billion of debt securities from the AFS category to the HTM category. The transfer had no effect on the overall net interest margin. Short-term borrowings in 2018 and 2017 primarily included FHLB advances, which were used to provide temporary funding for investments ahead of deposit growth. - 35 - --------------------------------------------------------------------------------THE CHARLES SCHWAB CORPORATION Management's Discussion and Analysis of Financial Condition and Results of Operations (Tabular Amounts in Millions, Except Ratios, or as Noted)
Asset Management and Administration Fees
Asset management and administration fees include mutual fund, ETF, and CTF service fees and fees for other asset-based financial services provided to individual and institutional clients. Schwab earns mutual fund, ETF, and CTF service fees for shareholder services, administration, and investment management provided to its proprietary funds, and recordkeeping and shareholder services provided to third-party funds. Asset management and administration fees are based upon the daily balances of client assets invested in these funds and do not include securities lending revenues earned by proprietary mutual funds, ETFs, and CTFs, as those amounts, net of program fees, are credited to the fund shareholders. Proprietary CTFs may, but generally do not, directly participate in securities lending. The fair values of client assets included in proprietary and third-party mutual funds, ETFs, and CTFs are based on quoted market prices and other observable market data. We also earn asset management fees for advice solutions, which include managed portfolios, specialized strategies, and customized investment advice. Other asset management and administration fees include various asset-based fees such as trust fees, 401(k) recordkeeping fees, mutual fund clearing fees, and non-balance based service and transaction fees.
Asset management and administration fees vary with changes in the balances of client assets due to market fluctuations and client activity.
The following table presents asset management and administration fees, average
client assets, and average fee yields:
Year Ended December 2019 2018 2017
31,
Average Average Average
Client Average Client Average Client Average
Assets Revenue Fee Assets Revenue Fee Assets Revenue Fee
Schwab money market
funds before fee
waivers $ 173,558 $ 525 0.30 % $ 141,018
- - (10 )
Schwab money market
funds 173,558 525 0.30 % 141,018 568 0.40 % 160,735 865 0.54 % Schwab equity and bond funds, ETFs, and
CTFs (1) 267,213 298 0.11 % 222,830 302 0.14 % 172,809 266 0.15 %Mutual Fund OneSource® and other non-
transaction fee funds 191,552 606 0.32 % 210,429
680 0.32 % 215,333 706 0.33 %
Other third-party
mutual funds and ETFs
(2) 478,037 318 0.07 % 328,150
287 0.09 % 286,111 251 0.09 %
Total mutual funds,
ETFs, and CTFs (1,3)
1,837 0.20 %
$ 246,888 1,198 0.49 %$ 227,790
1,139 0.50 %
70,191 - - 62,813 - - 48,936 - -
Total advice solutions
1,139 0.39 %
432,613 216 0.05 % 383,050 206 0.05 % 403,474 215 0.05 %
Other (5) 50 47 46
Total asset management
and administration
fees $ 3,211 $ 3,229 $ 3,392
(1) Beginning in the first quarter of 2019, a change was made to move CTFs from
other balance-based fees. Prior periods have been recast to reflect this change.
(2) Beginning in the fourth quarter of 2019, Schwab ETF OneSourceTM was
discontinued as a result of the elimination of online trading commissions for
U.S. and Canadian-listed ETFs.
(3) Average client assets for advice solutions may also include the asset
balances contained in the mutual fund and/or ETF categories listed above.
(4) Includes various asset-related fees, such as trust fees, 401(k)
recordkeeping fees, and mutual fund clearing fees and other service fees.
(5) Includes miscellaneous service and transaction fees relating to mutual funds
and ETFs that are not balance-based.
Asset management and administration fees decreased by $18 million , or 1%, in
2019 from 2018, primarily due to lower sweep money market fund revenue as a
result of transfers to bank and broker-dealer sweep in 2018 and early 2019, as
well as client asset allocation choices including continued reduced usage of
Mutual Fund OneSource®. Part of the decline was offset by revenue from growing
asset balances in purchased money market funds, other third-party mutual funds
and ETFs, and in advice solutions.
Asset management and administration fees decreased by $163 million , or 5%, in
2018 from 2017, primarily due to lower money market fund revenue as a result of
transfers to bank sweep, client asset allocation choices, and lower fee rates on
- 36 -
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THE CHARLES SCHWAB CORPORATION
Management's Discussion and Analysis of Financial Condition and Results of
Operations
(Tabular Amounts in Millions, Except Ratios, or as Noted)
proprietary money funds and other indexed mutual funds and ETFs due to fee
reductions implemented by the Company in 2017. Part of the decline was offset by
revenue from growing asset balances in advice solutions, Schwab equity and bond
funds, ETFs, and CTFs, and other third-party mutual funds and ETFs.
The following table presents a roll forward of client assets for the Schwab
money market funds, Schwab equity and bond funds, ETFs, and CTFs, and Mutual
Fund OneSource® and other non-transaction fee (NTF) funds. The following funds
generated 45%, 48%, and 54% of the asset management and administration fees
earned during 2019, 2018, and 2017, respectively:
Schwab Money Schwab Equity and Mutual Fund OneSource®
Market Funds Bond Funds, ETFs, and CTFs (1) and Other NTF Funds
Year Ended
2019 2018 2017 2019 2018
2017
Balance at beginning of period$ 153,472 $ 163,650 $ 163,495 $
209,471
44,077 (11,641 ) (486 ) 26,039 31,169 31,127 (19,930 ) (37,513 ) (27,485 )
Net market gains (losses)
and other (2) 3,277 1,463 641
50,765 (18,482 ) 27,133 41,466 (7,157 ) 53,763
Balance at end of period
(1) Beginning in the first quarter of 2019, CTFs are included in these balances. Prior periods have been recast to reflect this change. (2) Includes net inflows from other third-party mutual funds to Mutual Fund OneSource® in the second quarter of 2017.
Trading Revenue
Trading revenue includes commission and principal transaction revenues. Commission revenue is affected by the number of revenue trades executed and the average revenue earned per revenue trade. Principal transaction revenue is primarily comprised of revenue from trading activity in fixed income securities with clients. To accommodate clients' fixed income trading activity, Schwab maintains positions in fixed income securities, includingU.S. state and municipal debt obligations,U.S. Government and corporate debt, and other securities. The difference between the price at which the Company buys and sells securities to and from its clients and other broker-dealers is recognized as principal transaction revenue. Principal transaction revenue also includes adjustments to the fair value of these securities positions.
The following table presents trading revenue and the related drivers:
Growth Rate
Year Ended December 31, 2018-2019 2019 2018 2017
DARTs (in thousands) (20 )% 338.4 420.9 321.3
Daily average trades (in thousands) (2 )% 748.9 765.4 608.8
Number of trading days - 250.5 249.5
250.0
Daily average revenue per revenue trade -$ 7.26 $ 7.23 $ 8.20 Trading revenue (19 )%$ 617 $ 763 $ 654 Trading revenue decreased by$146 million , or 19%, in 2019 compared to 2018. The decrease was primarily due to a 20% decrease in DART volumes in 2019 as a result of the elimination of online trading commissions forU.S. and Canadian-listed stocks and ETFs, as well as the base charge on options effectiveOctober 7, 2019 . Trading revenue increased by$109 million , or 17%, in 2018 compared to 2017. This increase was due primarily to a 31% increase in DART volumes in 2018, which more than offset Schwab's 2017 commission pricing reductions to lower standard equity, ETF, and option trade commissions from$8.95 to$4.95 and lower the per contract option fee from$.75 to$.65 .
Other Revenue
Other revenue includes order flow revenue, other service fees, software fees from our portfolio management solutions, exchange processing fees, and non-recurring gains. Other revenue increased$60 million , or 19%, in 2019 compared to 2018 due primarily to a gain from the sale of a portfolio management and reporting software solution for advisors toTamarac Inc. in the second quarter of 2019 and a gain from the assignment of leased office space in the first quarter of 2019. Order flow revenue was$135 million during 2019,$139 million for 2018, and$114 million in 2017. The increase in 2018 from 2017 was primarily due to higher rebate rates received on certain types of orders and higher volume of trades. - 37 - --------------------------------------------------------------------------------THE CHARLES SCHWAB CORPORATION Management's Discussion and Analysis of Financial Condition and Results of Operations (Tabular Amounts in Millions, Except Ratios, or as Noted)
Total Expenses Excluding Interest
The following table shows a comparison of total expenses excluding interest:
Growth Rate
2018-2019 2019 2018 2017
Compensation and benefits
Salaries and wages 16 % $ 1,958 $ 1,692 $ 1,496
Incentive compensation (6 )% 804 855 797
Employee benefits and other 9 % 558 510 444
Total compensation and benefits 9 % $ 3,320 $ 3,057 $ 2,737
Professional services 7 % 702 654 580
Occupancy and equipment 13 % 559 496 436
Advertising and market development (2 )% 307 313 268
Communications 5 % 253 242 231
Depreciation and amortization 14 % 349 306 269
Regulatory fees and assessments (35 )% 122 189 179
Other (17 )% 261 313 268
Total expenses excluding interest 5 % $ 5,873 $ 5,570 $ 4,968
Expenses as a percentage of total net revenues
Compensation and benefits 31 % 30 % 32 %
Advertising and market development 3 % 3 % 3 %
Full-time equivalent employees (in thousands)
At year end 1 % 19.7 19.5 17.6
Average 7 % 20.0 18.7 16.9
?
Expenses excluding interest increased in 2019 and 2018 from the prior years by
5% and 12%, respectively. The largest driver of the increase in both years was
compensation and benefits costs.
Total compensation and benefits increased in 2019 from 2018, primarily due to
both an overall increase in employee headcount to support our expanding client
base and higher severance costs, which included $62 million associated with a 3%
reduction in our workforce in the third quarter of 2019. The increase in 2018
from 2017 was primarily due to increases in employee headcount; additionally,
special stock awards were issued in 2018 to non-officer employees, totaling $36
million .
Professional services expense increased in 2019 from 2018, primarily due to
overall growth in the business, investments in projects to further drive
efficiency and scale, and certain costs relating to pending acquisitions. The
increase in 2018 from 2017 was primarily due to higher spending on technology
projects as well as an increase in asset management and administration related
expenses resulting from growth in the Schwab Funds® and Schwab ETFs™.
Occupancy and equipment expense increased in 2019 and 2018 from the prior years, primarily due to increases in software maintenance expenses and additional licenses to support growth in the business.
Advertising and market development expense increased in 2018 from 2017, primarily reflecting management's decision to increase television advertising and digital media spending in the fourth quarter of 2018.
Depreciation and amortization expenses grew in 2019 and 2018 from the prior years, primarily due to higher amortization of internally developed software associated with continued investments in software and technology enhancements.
Regulatory fees and assessments decreased in 2019 from 2018, primarily due to a decrease inFDIC insurance assessments resulting from the elimination of theFDIC surcharge in the fourth quarter of 2018. Regulatory fees and assessments - 38 - --------------------------------------------------------------------------------THE CHARLES SCHWAB CORPORATION Management's Discussion and Analysis of Financial Condition and Results of Operations (Tabular Amounts in Millions, Except Ratios, or as Noted) increased in 2018 from 2017, due to an increase inFDIC insurance assessments which rose as a result of higher average assets in deposit balances, partially offset by the elimination of theFDIC surcharge. Other expenses decreased in 2019 from 2018, primarily due to lower travel and entertainment expense and bad debt expense. Other expenses increased in 2018 from 2017 due to travel and entertainment and miscellaneous items due to overall growth in the business. Capital expenditures were$753 million ,$576 million , and$412 million in 2019, 2018, and 2017, respectively. The increases in capital expenditures in 2019 and 2018 from the prior years were primarily due to the expansion of our campuses in theU.S. , with investments in buildings totaling$397 million and$253 million in 2019 and 2018, respectively. Capitalized costs for developing internal-use software totaled$165 million ,$167 million , and$157 million in 2019, 2018, and 2017, respectively. Our capital expenditures for 2019 equaled 7% of total net revenues, within our estimated range for the year. Along with continued campus expansion, we will continue to invest further in technology projects in 2020. Excluding any potential impact of the pending acquisition of TD Ameritrade, we anticipate capital expenditures in 2020 to be approximately 5-6% of total net revenues, while our longer term expectation for capital expenditures remains in the range of 3-5% of total net revenues.
Taxes on Income
OnDecember 22, 2017 , P.L.115-97, the Tax Act, was signed into law, and became effective onJanuary 1, 2018 . Among other things, the Tax Act lowered the federal corporate income tax rate from 35% to 21% beginning in 2018. As a result of the Tax Act, Schwab recognized a$46 million one-time non-cash charge to taxes on income in the fourth quarter of 2017 associated with the remeasurement of net deferred tax assets and other tax adjustments related to the Tax Act. Schwab's effective income tax rate on income before taxes was 23.6% in 2019, 23.1% in 2018, and 35.5% in 2017. The change in rates in 2019 from 2018 was primarily due to a decrease in equity compensation tax deduction benefits which reduced our tax expense by approximately$23 million and$46 million in 2019 and 2018, respectively. The change in rates in 2018 from 2017 was primarily due to impacts of the Tax Act and a decrease in equity compensation tax deduction benefits, which totaled$87 million in 2017.
Segment Information
Schwab provides financial services to individuals and institutional clients
through two segments - Investor Services and Advisor Services. The Investor
Services segment provides retail brokerage and banking services to individual
investors, and retirement plan services, as well as other corporate brokerage
services to businesses and their employees. The Advisor Services segment
provides custodial, trading, banking, and support services, as well as
retirement business services, to independent RIAs, independent retirement
advisors, and recordkeepers. Revenues and expenses are attributed to the two
segments based on which segment services the client. Management evaluates the
performance of the segments on a pre-tax basis. Segment assets and liabilities
are not used for evaluating segment performance or in deciding how to allocate
resources to segments. Net revenues in both segments are generated from the
underlying client assets and trading activity; differences in the composition of
net revenues between the segments are based on the composition of client assets,
client trading frequency, and pricing unique to each. While both segments
leverage the scale and efficiency of our platforms, segment expenses reflect the
dynamics of serving millions of clients in Investor Services versus the
thousands of RIAs on the advisor platform.
- 39 -
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THE CHARLES SCHWAB CORPORATION
Management's Discussion and Analysis of Financial Condition and Results of
Operations
(Tabular Amounts in Millions, Except Ratios, or as Noted)
Financial information for our segments is presented in the following table:
Investor Services Advisor Services Total
Year Ended Growth Rate Growth Rate Growth Rate
December 31, 2018-2019 2019 2018 2017 2018-2019 2019 2018 2017 2018-2019 2019 2018 2017
Net Revenues
Net interest
revenue 8 % $ 4,685 $ 4,341 $ 3,231 24 % $ 1,831 $ 1,482 $ 1,051 12 % $ 6,516 $ 5,823 $ 4,282
Asset
management and
administration
fees 1 % 2,289 2,260 2,344 (5 )% 922 969 1,048 (1 )% 3,211 3,229 3,392
Trading
revenue (20 )% 378 475 408 (17 )% 239 288 246 (19 )% 617 763 654
Other 11 % 271 245 217 47 % 106 72 73 19 % 377 317 290
Total net
revenues 4 % 7,623 7,321 6,200 10 % 3,098 2,811 2,418 6 % 10,721 10,132 8,618
Expenses
Excluding
Interest 3 % 4,284 4,145 3,725 12 % 1,589 1,425 1,243 5 % 5,873 5,570 4,968
Income before
taxes
on income 5 % $ 3,339 $ 3,176 $ 2,475 9 % $ 1,509 $ 1,386 $ 1,175 6 % $ 4,848 $ 4,562 $ 3,650
Net new client
assets
(in billions)
(1) N/M $ 115.6 $ 19.4 $ 123.7 (6 )% $ 107.2 $ 114.5 $ 109.4 66 % $ 222.8 $ 133.9 $ 233.1
(1) Investor Services includes inflows of $11.1 billion and $34.5 billion in
2019 and 2017, respectively, and outflows of $93.9 billion in 2018 from certain
mutual fund clearing services clients.
N/M Not meaningful.
Investor Services
Total net revenues increased by 4% in 2019 from 2018 primarily due to an increase in net interest revenue and higher asset management and administrations fees, partially offset by lower trading revenue. Net interest revenue increased primarily due to higher average investment yields and higher interest-earning assets. Asset management and administration fees increased primarily due to growing asset balances in advice solutions, partially offset by lower mutual fund and ETF service fee revenue as a result of client cash allocation choices, including reduced usage of Mutual Fund OneSource®. Trading revenue decreased as a result of the elimination of online trading commissions forU.S. and Canadian-listed stocks and ETFs, as well as the base charge on options in the fourth quarter of 2019. Expenses excluding interest increased by 3% in 2019 compared to 2018, primarily as a result of higher compensation and benefits due to increased headcount in 2019 and severance charges in the third quarter of 2019, higher occupancy and equipment expenses due to an increase in software maintenance expenses and additional licenses to support growth in the business, and higher amortization of internally developed software associated with continued investments in software and technology enhancements. These increases were partially offset by a decrease inFDIC insurance assessments due to the elimination of theFDIC surcharge in the fourth quarter of 2018 and lower travel and entertainment expenses. Total net revenues increased by$1.1 billion , or 18%, in 2018 from 2017 primarily due to an increase in net interest revenue, partially offset by lower asset management and administration fees. Net interest revenue increased primarily due to higher net interest margins and higher balances of interest-earning assets. Asset management and administration fees decreased primarily due to lower money market fund revenue as a result of transfers to bank sweep, client asset allocation choices, and our 2017 fee reductions. Expenses excluding interest increased by$420 million , or 11%, in 2018 from 2017 primarily due to higher compensation and benefits, technology project spend, and asset management and administration related expenses to support the Company's expanding client base. Advisor Services Total net revenues increased by 10%, in 2019 from 2018 primarily due to an increase in net interest revenue and other revenue, partially offset by lower asset management and administration fees and lower trading revenue. Net interest revenue increased primarily due to higher average investment yields and higher interest-earning assets. Other revenue increased primarily due to a gain from the sale of a portfolio management and reporting software solution for advisors toTamarac Inc. in the second quarter of 2019. Asset management and administration fees decreased primarily due to lower sweep money market fund revenue as a result of transfers to bank and broker-dealer sweep, as well as client asset allocation choices, including reduced usage ofMutual Fund OneSource®, partially offset by increased revenue from growing asset balances in purchased money market funds and in other third-party mutual funds and ETFs. Trading revenue decreased as a result of the - 40 - --------------------------------------------------------------------------------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)
elimination of online trading commissions for
Expenses excluding interest increased by 12% of 2019 compared to 2018, primarily due to higher compensation and benefits due to increased headcount in 2019 and severance charges in the third quarter of 2019, higher professional services expense due to overall growth in the business and investments in projects to further drive efficiency and scale, and higher occupancy and equipment expense due to an increase in software maintenance expenses and additional licenses to support growth in the business. These increases were partially offset by a decrease inFDIC insurance assessments due to the elimination of theFDIC surcharge in the fourth quarter of 2018, lower bad debt expenses, and lower travel and entertainment expenses. Total net revenues increased by$393 million or 16%, in 2018 from 2017 primarily due to an increase in net interest revenue, partially offset by lower asset management and administration fees. Net interest revenue increased primarily due to higher net interest margins and higher balances of interest-earning assets. Asset management and administration fees decreased primarily due to lower money market fund revenue as a result of transfers to bank sweep, client asset allocation choices, and our 2017 fee reductions. Expenses excluding interest increased by$182 million , or 15%, in 2018 from 2017 primarily due to higher compensation and benefits, technology project spend, and asset management and administration related expenses to support the Company's expanding client base. RISK MANAGEMENT Schwab's business activities expose it to a variety of risks, including operational, credit, market, liquidity, and compliance risks. The Company has a comprehensive risk management program to identify and manage these risks and their associated potential for financial and reputational impact. Despite our efforts to identify areas of risk and implement risk management policies and procedures, there can be no assurance that Schwab will not suffer unexpected losses due to these risks. Our risk management process is comprised of risk identification and assessment, risk measurement, risk monitoring and reporting, and risk mitigation controls; we use periodic risk and control self-assessments, control testing programs, and internal audit reviews to evaluate the effectiveness of these internal controls. The activities and governance that comprise the risk management process are described below.
Culture
The Board of Directors has approved an Enterprise Risk Management (ERM) framework that incorporates our purpose, vision, and values, which form the bedrock of our corporate culture and set the tone for the organization.
We designed the ERM Framework to enable a comprehensive approach to managing risks encountered by Schwab in its business activities. The framework incorporates key concepts commensurate with the size, risk profile, complexity, and continuing growth of the Company. Risk appetite, which is defined as the amount of risk the Company is willing to accept in pursuit of its corporate strategy, is developed by executive management and approved by the Board of Directors.
Risk Governance
Senior management takes an active role in the risk management process and has developed policies and procedures under which specific business and control units are responsible for identifying, measuring, and controlling risks.
The Global Risk Committee, which is comprised of senior executives from each
major business and control function, is responsible for the oversight of risk
management. This includes identifying emerging risks, assessing risk management
practices and the control environment, reinforcing business accountability for
risk management, supervisory controls and regulatory compliance, supporting
resource prioritization across the organization, and escalating significant
issues to the Board of Directors.
We have established risk metrics and reporting that enable measurement of the
impact of strategy execution against risk appetite. The risk metrics, with risk
limits and tolerance levels, are established for key risk categories by the
Global Risk Committee and its functional risk sub-committees.
- 41 -
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THE CHARLES SCHWAB CORPORATION
Management's Discussion and Analysis of Financial Condition and Results of
Operations
(Tabular Amounts in Millions, Except Ratios, or as Noted)
The Chief Risk Officer regularly reports activities of the Global Risk Committee
to the Risk Committee of the Board of Directors. The Board Risk Committee in
turn assists the Board of Directors in fulfilling its oversight responsibilities
with respect to our risk management program, including approving risk appetite
statements and related key risk appetite metrics and reviewing reports relating
to risk issues from functional areas of corporate risk management, legal,
compliance, and internal audit.
Functional risk sub-committees focusing on specific areas of risk report to the Global Risk Committee. These sub-committees include the:
•
operational risk management policies, risk tolerance levels, and
operational risk governance processes, and includes sub-committees
covering Information Security, Fraud, Third-Party Risk, Data, and Model
Governance;
• Compliance Risk Committee - provides oversight of compliance riskmanagement programs and policies providing an aggregate view of compliance
risk exposure and employee conduct, including subcommittees covering
Fiduciary and Conflicts of Interest Risk and International Compliance
Risk;
•
credit, market, liquidity, and capital risk policies, limits, and
exposures; and
•
of, and approves corporate policy and procedures relating to, the risk
governance of new products and services.
Senior management has also created an
The Company's compliance, finance, internal audit, legal, and corporate risk management departments assist management and the various risk committees in evaluating, testing, and monitoring risk management.
In addition, the Disclosure Committee is responsible for monitoring and
evaluating the effectiveness of our disclosure controls and procedures and
internal control over financial reporting as of the end of each fiscal quarter.
The Disclosure Committee reports on this evaluation to the CEO and CFO prior to
their certification required by Sections 302 and 906 of the Sarbanes Oxley Act
of 2002.
Operational Risk
Operational risk arises due to potential inadequacies or failures related to
people, internal processes, and systems, or from external events or
relationships impacting the Company and/or any of its key business partners and
third parties. While operational risk is inherent in all business activities, we
rely on a system of internal controls and risk management practices designed to
keep operational risk and operational losses within the Company's risk appetite.
We have specific policies and procedures to identify and manage operational
risk, and use control testing programs, and internal audit reviews to evaluate
the effectiveness of these internal controls. Where appropriate, we manage the
impact of operational loss and litigation expense through the purchase of
insurance. The insurance program is specifically designed to address our key
operational risks and to maintain compliance with local laws and regulation.
Schwab's operations are highly dependent on the integrity and resilience of our
critical business functions and technology systems. To the extent Schwab
experiences business or system interruptions, errors or downtime (which could
result from a variety of causes, including natural disasters, terrorist attacks,
technological failure, cyber attacks, changes to systems, linkages with
third-party systems, and power failures), our business and operations could be
negatively impacted. To minimize business interruptions and ensure the capacity
to continue operations during an incident regardless of duration, Schwab
maintains a backup and recovery infrastructure which includes facilities for
backup and communications, a geographically dispersed workforce, and routine
testing of business continuity and disaster recovery plans and a
well-established incident management program.
Information Security risk is the risk of unauthorized access, use, disclosure,
disruption, modification, recording or destruction of the firm's information or
systems. We have designed and implemented an information security program that
knits together complementary tools, controls and technologies to protect
systems, client accounts and data. We continuously
- 42 -
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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)
monitor the systems and work collaboratively with government agencies, law
enforcement and other financial institutions to address potential threats. We
use advanced monitoring systems to identify suspicious activity and deter
unauthorized access by internal or external actors. We limit the number of
employees who have access to clients' personal information and internal
authentication measures are enforced to protect against the potential for social
engineering. All employees who handle sensitive information are trained in
privacy and security. Schwab's conduct and cybersecurity teams monitor activity
looking for suspicious behavior. These capabilities allow us to identify and
quickly act on any attempted intrusions.
Fraud risk arises from attempted or actual theft of financial assets or other
property of any client or the Company. Schwab is committed to protecting the
Company's and its clients' assets from fraud, and complying with all applicable
laws and regulations to prevent, detect and report fraudulent activity. Schwab
manages fraud risk through policies, procedures and controls. We also take
affirmative steps to prevent and detect fraud and report, to appropriate
authorities, any known or suspected acts of fraud in accordance with existing
laws and requirements.
Schwab also faces operational risk when we employ the services of various third
parties, including domestic and international outsourcing of certain technology,
processing, servicing, and support functions. We manage the exposure to third
party risk and promote a culture of resiliency through contractual provisions,
control standards, ongoing monitoring of third party performance, and
appropriate testing. We also maintain policies and procedures regarding the
standard of care expected with all data, whether the data is internal company
information, employee information, or non-public client information. We clearly
define for employees, contractors, and third parties the expected standards of
care for critical and confidential data. We also provide regular training on
data security.
Model risk is the potential for adverse consequences from decisions based on
incorrect or misused model outputs and reports. Models are owned by several
business units throughout the organization, and are used for a variety of
purposes. Model use includes, but is not limited to, calculating capital
requirements for hypothetical stressful environments, estimating interest and
credit risk for loans and other balance sheet assets, and providing guidance in
the management of client portfolios. We have established a policy to describe
the roles and responsibilities of all key stakeholders in model development,
management, and use. All models are registered in a centralized database and
classified into different risk ratings depending on their potential financial,
reputational, or regulatory impact to the Company. The model risk rating
determines the scope of model governance activities.
Incentive Compensation risk is the potential for adverse consequences resulting
from compensation plans that do not balance the execution of our strategy with
risk and financial rewards, potentially encouraging imprudent risk-taking by
employees. We have implemented risk management processes, including a policy, to
identify, evaluate, assess, and manage risks associated with incentive
compensation plans and the activities of certain employees, defined as Covered
Employees, who have the authority to expose the Company to material amounts of
risk.
Compliance Risk
Schwab faces compliance risk which is the potential exposure to legal or
regulatory sanctions, fines or penalties, financial loss, or damage to
reputation resulting from the failure to comply with laws, regulations, rules,
or other regulatory requirements. Among other things, compliance risks relate to
the suitability of client investments, conflicts of interest, disclosure
obligations and performance expectations for products and services, supervision
of employees, and the adequacy of our controls. The Company and its affiliates
are subject to extensive regulation by federal, state and foreign regulatory
authorities, including SROs.
We manage compliance risk through policies, procedures and controls reasonably
designed to achieve and/or monitor compliance with applicable legal and
regulatory requirements. These procedures address issues such as conduct and
ethics, sales and trading practices, marketing and communications, extension of
credit, client funds and securities, books and records, anti-money laundering,
client privacy, and employment policies.
Conduct risk arises from inappropriate, unethical, or unlawful behavior of the
Company, its employees or third parties acting on the Company's behalf that may
result in detriment to the Company's clients, financial markets, the Company,
and/or the Company's employees. We manage this risk through a policy,
procedures, a system of internal controls, including personnel monitoring and
surveillance. Conduct-related matters are escalated through appropriate channels
by the Corporate Responsibility Officer.
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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)
Fiduciary risk is the potential for financial or reputational loss through
breach of fiduciary duties to a client. Fiduciary activities include, but are
not limited to, individual and institutional trust, investment management,
custody, and cash and securities processing. We manage this risk by establishing
policy and procedures to ensure that obligations to clients are discharged
faithfully and in compliance with applicable legal and regulatory requirements.
Business units have the primary responsibility for adherence to the policy and
procedures applicable to their business. Guidance and control are provided
through the creation, approval, and ongoing review of applicable policies by
business units and various risk committees.
Credit Risk
Credit risk is the potential for loss due to a borrower, counterparty, or issuer failing to perform its contractual obligations. Our exposure to credit risk mainly results from investing activities in our liquidity and investment portfolios, mortgage lending, margin lending and client option and futures activities, pledged asset lending, securities lending activities, and our role as a counterparty in other financial contracts. To manage the risks of such losses, we have established policies and procedures, which include setting and reviewing credit limits, monitoring of credit limits and quality of counterparties, and adjusting margin, PAL, option, and futures requirements for certain securities and instruments.
Liquidity and Investment Portfolios
Schwab has exposure to credit risk associated with its investment portfolios,
which include
AtDecember 31, 2019 , substantially all securities in the investment portfolios were rated investment grade.U.S. agency mortgage-backed securities do not have explicit credit ratings; however, management considers these to be of the highest credit quality and rating given the guarantee of principal and interest by theU.S. government orU.S. government-sponsored enterprises.
Mortgage Lending Portfolio
The bank loan portfolio includes First Mortgages, HELOCs, and other loans. The credit risk exposure related to loans is actively managed through individual loan and portfolio reviews. Management regularly reviews asset quality, including concentrations, delinquencies, nonaccrual loans, charge-offs, and recoveries. All are factors in the determination of an appropriate allowance for loan losses. Our residential loan underwriting guidelines include maximum LTV ratios, cash out limits, and minimum Fair Isaac Corporation (FICO) credit scores. The specific guidelines are dependent on the individual characteristics of a loan (for example, whether the property is a primary or secondary residence, whether the loan is for investment property, whether the loan is for an initial purchase of a home or refinance of an existing home, and whether the loan size is conforming or jumbo). Schwab does not originate or purchase residential loans that allow for negative amortization and does not originate or purchase subprime loans (generally defined as extensions of credit to borrowers with a FICO score of less than 620 at origination), unless the borrower has compensating credit factors. For more information on credit quality indicators relating to Schwab's bank loans, see Item 8 - Note 6.
Securities and Instrument-Based Lending Portfolios
Collateral arrangements relating to margin loans, PALs, option and futures
positions, securities lending agreements, and securities purchased under
agreements to resell (resale agreements) include provisions that require
additional collateral in the event of market fluctuations. Additionally, for
margin loans, PALs, options and futures positions, and securities lending
agreements, collateral arrangements require that the fair value of such
collateral sufficiently exceeds the credit exposure in order to maintain a fully
secured position.
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THE CHARLES SCHWAB CORPORATION
Management's Discussion and Analysis of Financial Condition and Results of
Operations
(Tabular Amounts in Millions, Except Ratios, or as Noted)
Other Counterparty Exposures
Schwab performs clearing services for all securities transactions in its client accounts. Schwab has exposure to credit risk due to its obligation to settle transactions with clearing corporations, mutual funds, and other financial institutions even if Schwab's clients or a counterparty fail to meet their obligations to Schwab.
Market Risk
Market risk is the potential for changes in earnings or the value of financial instruments held by Schwab as a result of fluctuations in interest rates, equity prices, or market conditions. Schwab is exposed to interest rate risk primarily from changes in market interest rates on our interest-earning assets relative to changes in the costs of funding sources that finance these assets. To manage interest rate risk, we have established policies and procedures, which include setting limits on net interest revenue risk and economic value of equity risk. To remain within these limits, we manage the maturity, repricing, and cash flow characteristics of the investment portfolios. Management monitors established guidelines to stay within the Company's risk appetite. Our measurement of interest rate risk involves assumptions that are inherently uncertain and, as a result, cannot precisely estimate the impact of changes in interest rates on net interest revenue or economic value of equity. Actual results may differ from simulated results due to balance growth or decline and the timing, magnitude, and frequency of interest rate changes, as well as changes in market conditions and management strategies, including changes in asset and liability mix. Financial instruments are also subject to the risk that valuations will be negatively affected by changes in demand and the underlying market for a financial instrument. We are indirectly exposed to option, futures, and equity market fluctuations in connection with client option and futures accounts, securities collateralizing margin loans to brokerage customers, and client securities loaned out as part of the brokerage securities lending activities. Equity market valuations may also affect the level of brokerage client trading activity, margin borrowing, and overall client engagement with Schwab. Additionally, we earn mutual fund and ETF service fees and asset management fees based upon daily balances of certain client assets. Fluctuations in these client asset balances caused by changes in equity valuations directly impact the amount of fee revenue we earn.
Our market risk related to financial instruments held for trading is not material.
Net Interest Revenue Simulation
For our net interest revenue sensitivity analysis, we use net interest revenue
simulation modeling techniques to evaluate and manage the effect of changing
interest rates. The simulations include all interest rate-sensitive assets and
liabilities. Key assumptions include the projection of interest rate scenarios
with rate floors, prepayment speeds of mortgage-related investments, repricing
of financial instruments, and reinvestment of matured or paid-down securities
and loans.
Net interest revenue is affected by various factors, such as the distribution
and composition of interest-earning assets and interest-bearing liabilities, the
spread between yields earned on interest-earning assets and rates paid on
interest-bearing liabilities, which may reprice at different times or by
different amounts, and the spread between short and long-term interest rates.
Interest-earning assets primarily include investment securities, margin loans
and bank loans. These assets are sensitive to changes in interest rates and
changes in prepayment levels that tend to increase in a declining rate
environment and decrease in a rising rate environment. Because we establish the
rates paid on certain brokerage client cash balances and bank deposits and the
rates charged on certain margin and bank loans, and control the composition of
our investment securities, we have some ability to manage our net interest
spread, depending on competitive factors and market conditions.
- 45 -
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THE CHARLES SCHWAB CORPORATION
Management's Discussion and Analysis of Financial Condition and Results of
Operations
(Tabular Amounts in Millions, Except Ratios, or as Noted)
Net interest revenue sensitivity analysis assumes the asset and liability
structure of the consolidated balance sheet would not be changed as a result of
the simulated changes in interest rates. As we actively manage the consolidated
balance sheet and interest rate exposure, in all likelihood we would take steps
to manage additional interest rate exposure that could result from changes in
the interest rate environment. The following table shows the simulated net
interest revenue change over the next 12 months beginning December 31, 2019 and
2018 of a gradual 100 basis point increase or decrease in market interest rates
relative to prevailing market rates at the end of each reporting period:
December 31, 2019 2018
Increase of 100 basis points 4.8 % 4.4 %
Decrease of 100 basis points (7.4 )% (4.9 )%
The year-over-year change in net interest revenue sensitivities reflects lower
interest rates across the yield curve, producing higher adverse sensitivity to
lower rates as funding costs more rapidly reach rate floor assumptions.
In addition to measuring the effect of a gradual 100 basis point parallel increase or decrease in current interest rates, we regularly simulate the effects of larger parallel- and non-parallel shifts in interest rates on net interest revenue.
Economic Value of Equity Simulation
Management also uses economic value of equity (EVE) simulations to measure interest rate risk. EVE sensitivity measures the long-term impact of interest rate changes on the net present value of assets and liabilities. EVE is calculated by subjecting the balance sheet to hypothetical instantaneous shifts in the level of interest rates. This analysis is highly dependent upon asset and liability assumptions based on historical behaviors as well as our expectations of the economic environment. Key assumptions in our EVE calculation include projection of interest rate scenarios with rate floors, prepayment speeds of mortgage-related investments, term structure models of interest rates, non-maturity deposit behavior, and pricing assumptions.
Expected Phase-out of LIBOR
The Company has established a firm-wide team to address the likely discontinuation of LIBOR. As part of our efforts, we have inventoried our LIBOR exposures, the largest of which are certain investment securities and loans. In purchasing new investment securities, we ensure that appropriate fall-back language is in the security's prospectus in the event that LIBOR is unavailable or deemed unreliable. We are updating loan agreements to ensure new LIBOR-based loans adequately provide for an alternative to LIBOR. Furthermore, we plan to phase-out the use of LIBOR as a reference rate in our new lending products beforeDecember 2021 . Consistent with our "Through Clients' Eyes" strategy, our focus throughout the LIBOR transition process is to ensure clients are treated fairly and consistently as this major change is occurring in the financial markets. The market transition process has not yet progressed to a point at which the impact to the Company's consolidated financial statements of LIBOR's discontinuation can be estimated.
Liquidity Risk
Liquidity risk is the potential that Schwab will be unable to sell assets or
meet cash flow obligations when they come due without incurring unacceptable
losses.
Due to its role as a source of financial strength, CSC's liquidity needs are
primarily driven by the liquidity and capital needs of CS&Co, the capital needs
of the banking subsidiaries, principal and interest due on corporate debt,
dividend payments on CSC's preferred stock, and returns of capital to common
stockholders. The liquidity needs of CS&Co are primarily driven by client
activity including trading and margin borrowing activities and capital
expenditures. The capital needs of the banking subsidiaries are primarily driven
by client deposits. We have established liquidity policies to support the
successful execution of business strategies, while ensuring ongoing and
sufficient liquidity to meet operational needs and satisfy applicable regulatory
requirements under both normal and stressed conditions. We seek to maintain
client confidence in the balance sheet and the safety of client assets by
maintaining liquidity and diversity of funding sources to allow the Company to
meet its obligations. To this end, we have established limits and contingency
funding scenarios to support liquidity levels during both business as usual and
stressed conditions.
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THE CHARLES SCHWAB CORPORATION
Management's Discussion and Analysis of Financial Condition and Results of
Operations
(Tabular Amounts in Millions, Except Ratios, or as Noted)
We employ a variety of methodologies to monitor and manage liquidity. We conduct
regular liquidity stress testing to develop a consolidated view of liquidity
risk exposures and to ensure our ability to maintain sufficient liquidity during
market-related or company-specific liquidity stress events. Liquidity is also
tested at key subsidiaries and results are reported to the Financial Risk
Oversight Committee . A number of early warning indicators are monitored to help
identify emerging liquidity stresses in the market or within the organization
and are reviewed with management as appropriate.
Primary Funding Sources
Schwab's primary source of funds is cash generated by client activity which includes bank deposits and cash balances in client brokerage accounts. These funds are used to purchase investment securities and extend loans to clients.
Other sources of funds may include cash flows from operations, maturities and sales of investment securities, repayments on loans, securities lending of assets held in client brokerage accounts, repurchase agreements, and cash provided by external financing.
To meet daily funding needs, we maintain liquidity in the form of overnight cash deposits and short-term investments. For unanticipated liquidity needs, we also maintain a buffer of highly liquid investments, includingU.S. Treasury securities.
Additional Funding Sources
In addition to internal sources of liquidity, Schwab has access to external funding. The need for short-term borrowings from external debt facilities arises primarily from timing differences between cash flow requirements, scheduled liquidation of interest-earning investments, movements of cash to meet regulatory brokerage client cash segregation requirements and general corporate purposes. We maintain policies and procedures necessary to access funding and test discount window borrowing procedures on a periodic basis. The following table describes external debt facilities available atDecember 31, 2019 : Description Borrower
Outstanding
subsidiaries $
-
Banking
Federal Reserve discount window (2) subsidiaries - 8,536
Uncommitted, unsecured lines of credit with
various external banks CSC, CS&Co - 1,642
Unsecured commercial paper (3) CSC - 750
Committed, unsecured credit facility with various
external banks (4) CSC - 750
(1) Amounts available are dependent on the amount of First Mortgages, HELOCs,
and the fair value of certain investment securities that are pledged as
collateral.
(2) Amounts available are dependent on the fair value of certain investment
securities that are pledged as collateral.
(3) CSC has authorization from its Board of Directors to issue Commercial Paper
Notes not to exceed $1.5 billion . Management has set a current limit not to
exceed the amount of the committed, unsecured credit facility.
(4) Other than an overnight borrowing to test availability, this facility was
unused during 2019.
Our banking subsidiaries maintain secured credit facilities with the FHLB.
Amounts available under these facilities are dependent on the value of our First
Mortgages, HELOCs, and the fair value of certain of our investment securities
that are pledged as collateral. These credit facilities are also available as
backup financing in the event the outflow of client cash from the banking
subsidiaries' respective balance sheets is greater than maturities and paydowns
on investment securities and bank loans.
Our banking subsidiaries also have access to short-term secured funding through
the Federal Reserve discount window. Amounts available under the Federal Reserve
discount window are dependent on the fair value of certain investment securities
that are pledged as collateral.
CSC has a commercial paper program of which proceeds are used for general
corporate purposes. The maturities of the Commercial Paper Notes may vary, but
are not to exceed 270 days from the date of issue. CSC's ratings for these
short-term borrowings were P1 by Moody's, A1 by Standard & Poor's , and F1 by
Fitch at December 31, 2019 and 2018, and CSC had no Commercial Paper Notes
outstanding at December 31, 2019 or 2018.
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THE CHARLES SCHWAB CORPORATION
Management's Discussion and Analysis of Financial Condition and Results of
Operations
(Tabular Amounts in Millions, Except Ratios, or as Noted)
The financial covenants for the $750 million committed credit facility require
CS&Co to maintain a minimum net capital ratio, all bank subsidiaries to be well
capitalized, and CSC to maintain a minimum level of stockholders' equity,
adjusted to exclude AOCI. At December 31, 2019 , the minimum level of
stockholders' equity required under this facility was $16.0 billion (CSC's
stockholders' equity, excluding AOCI, at December 31, 2019 was $21.7 billion ).
Management believes these restrictions will not have a material effect on CSC's
ability to meet foreseeable dividend or funding requirements.
To partially satisfy the margin requirement of client option transactions with
the Options Clearing Corporation , CS&Co has unsecured standby letter of credit
agreements (LOCs) with several banks in favor of the Options Clearing
Corporation aggregating $20 million at December 31, 2019 . There were no funds
drawn under any of these LOCs during 2019 or 2018. In connection with its
securities lending activities, the Company is required to provide collateral to
certain brokerage clients. The collateral requirements were satisfied by
providing cash as collateral.
CSC has a universal automatic shelf registration statement on file with the
Liquidity Coverage Ratio
As Schwab's consolidated balance sheet assets were above$250 billion atDecember 31, 2018 , Schwab became subject to the non-modified LCR rule onApril 1, 2019 . The Company was in compliance with the LCR rule atDecember 31, 2019 . See Business - Regulation in Part I, Item 1 for information on recently issued rules that impact Schwab's LCR requirements.
The table below presents information about our average LCR:
Average for the
Three Months Ended December 31, 2019
Total eligible HQLA $ 54,494
Net cash outflows $ 48,135
LCR 113 %
Borrowings
The Company had no short-term borrowings outstanding as of
The following are details of the Senior Notes:
Weighted-Average Standard
December 31, 2019 Par Outstanding Maturity Interest Rate Moody's & Poor's Fitch
Senior Notes $ 7,481 2020 - 2029 3.34% A2 A A
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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)
New Debt Issuances
All debt issuances in 2019, 2018, and 2017 were senior unsecured obligations.
Additional details are as follows:
Issuance Date Issuance Amount Maturity Date Interest Rate Interest Payable
March 2, 2017 $ 650 3/2/2027 3.200% Semi-annually
December 7, 2017 $ 700 1/25/2028 3.200% Semi-annually
December 7, 2017 $ 800 1/25/2023 2.650% Semi-annually
Three-month LIBOR
May 22, 2018 $ 600 5/21/2021 + 0.32% Quarterly
May 22, 2018 $ 600 5/21/2021 3.250% Semi-annually
May 22, 2018 $ 750 5/21/2025 3.850% Semi-annually
October 31, 2018 $ 500 2/1/2024 3.550% Semi-annually
October 31, 2018 $ 600 2/1/2029 4.000% Semi-annually
May 22, 2019 $ 600 5/22/2029 3.250% Semi-annually
Equity Issuances and Redemptions
CSC did not issue any equity through external offerings during 2019 or 2018. CSC's preferred stock issued and net proceeds for 2017 are as follows:
Date Issued and Sold Net Proceeds
Series F October 31, 2017 $ 492
On December 1, 2017 , CSC redeemed all of the 485,000 outstanding shares of its
6.00% Non-Cumulative Perpetual Preferred Stock, Series B (Series B Preferred
Stock), and the corresponding 19,400,000 depositary shares, each representing a
1/40th interest in a share of the Series B Preferred Stock.
For further discussion of CSC's long-term debt and information on the equity offerings, see Item 8 - Note 12 and Note 17.
Acquisition of USAA-IMCO
We expect to utilize cash generated from operations to fund the$1.8 billion purchase of assets from USAA-IMCO. The transaction is expected to close in mid-2020, subject to satisfaction of closing conditions, including regulatory approvals and the implementation of conversion plans.
Off-Balance Sheet Arrangements
Schwab enters into various off-balance sheet arrangements in the ordinary course
of business, primarily to meet the needs of our clients. These arrangements
include firm commitments to extend credit. Additionally, Schwab enters into
guarantees and other similar arrangements in the ordinary course of business.
For information on each of these arrangements, see Item 8 - Note 6, Note 10,
Note 12, Note 14, and Note 15.
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THE CHARLES SCHWAB CORPORATION
Management's Discussion and Analysis of Financial Condition and Results of
Operations
(Tabular Amounts in Millions, Except Ratios, or as Noted)
Contractual Obligations
Schwab's principal contractual obligations as ofDecember 31, 2019 are shown in the following table. Excluded from this table are liabilities recorded on the consolidated balance sheets that are generally short-term in nature or without contractual payment terms (e.g., bank deposits, payables to brokerage clients, and deferred compensation). The below table also excludes the planned all-stock acquisition of TD Ameritrade and any expenses related to the acquisition. Less than 1-3 3-5 More than 1 Year Years Years 5 Years Total Credit-related financial instruments (1)$ 3,033 $ 3,495 $ 4,549 $ 1,501 $ 12,578 Long-term debt (2) 947 1,842 1,615 4,389 8,793 Purchase obligations (3) 2,061 225 46 44 2,376 Leases (4) 141 236 173 268 818 Total$ 6,182 $ 5,798 $ 6,383 $ 6,202 $ 24,565 (1) Represents CSB's commitments to extend credit to banking clients, purchase mortgage loans, and commitments to fund CRA investments. (2) Includes estimated future interest payments through 2029 for Senior Notes. Amounts exclude unamortized discounts and premiums. (3) Consists of purchase obligations for services such as advertising and marketing, telecommunications, professional services, and hardware- and software-related agreements. Also includes$1.8 billion for the planned acquisition of USAA-IMCO assets; other costs related to the USAA-IMCO acquisition are excluded. (See Item 8 - Note 14). (4) Represents operating lease payments including legally-binding minimum lease payments for leases signed but not yet commenced.
CAPITAL MANAGEMENT
Schwab seeks to manage capital to a level and composition sufficient to support execution of our business strategy, including anticipated balance sheet growth, providing financial support to our subsidiaries, and sustained access to the capital markets, while at the same time meeting our regulatory capital requirements and serving as a source of financial strength to our banking subsidiaries. Schwab's primary sources of capital are funds generated by the operations of subsidiaries and securities issuances by CSC in the capital markets. To ensure that Schwab has sufficient capital to absorb unanticipated losses or declines in asset values, we have adopted a policy to remain well capitalized even in stressed scenarios. Our capital management in coming quarters will incorporate preparations for closing the USAA-IMCO transaction, including the allocation of capital to support client cash that will be added to our balance sheet. Internal guidelines are set, for both CSC and its regulated subsidiaries, to ensure capital levels are in line with our strategy and regulatory requirements. Capital forecasts are reviewed monthly atAsset-Liability Management andPricing Committee andFinancial Risk Oversight Committee meetings. A number of early warning indicators are monitored to help identify potential problems that could impact capital. In addition, we monitor the subsidiaries' capital levels and requirements. Subject to regulatory capital requirements and any required approvals, any excess capital held by subsidiaries is transferred to CSC in the form of dividends and returns of capital. When subsidiaries have need of additional capital, funds are provided by CSC as equity investments and also as subordinated loans (in a form approved as regulatory capital by regulators) for CS&Co. The details and method used for each cash infusion are based on an analysis of the particular entity's needs and financing alternatives. The amounts and structure of infusions must take into consideration maintenance of regulatory capital requirements, debt/equity ratios, and equity double leverage ratios. Schwab conducts regular capital stress testing to assess the potential financial impacts of various adverse macroeconomic and company-specific events to which the Company could be subjected. The objective of the capital stress testing is (1) to explore various potential outcomes - including rare and extreme events and (2) to assess impacts of potential stressful outcomes on both capital and liquidity. Additionally, we have a comprehensive Capital Contingency Plan to provide action plans for certain low probability/high impact capital events that the Company might face. The Capital Contingency Plan is issued under the authority of theFinancial Risk Oversight Committee and provides guidelines for sustained capital events. It does not specifically address every contingency, but is designed to provide a framework for responding to any capital stress. The results of the stress testing indicate there are two scenarios which could stress the Company's capital: (1) inflows of balance sheet cash during a period of very low interest rates and (2) outflows of balance sheet cash when other sources of financing are not available and the Company is required to sell assets to fund the flows at a loss. The Capital Contingency Plan is reviewed annually and updated as appropriate. - 50 - --------------------------------------------------------------------------------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)
For additional information, see Business - Regulation in Part I, Item 1.
Regulatory Capital Requirements
CSC is subject to capital requirements set by theFederal Reserve and is required to serve as a source of strength for our banking subsidiaries and to provide financial assistance if our banking subsidiaries experience financial distress. Schwab is required to maintain a Tier 1 Leverage Ratio for CSC of at least 4%; however, management seeks to maintain a ratio of at least 6%. Due to the relatively low risk of our balance sheet assets and risk-based capital ratios at CSC and CSB that are well in excess of regulatory requirements, the Tier 1 Leverage Ratio is the most restrictive capital constraint on CSC's asset growth. Our banking subsidiaries are subject to capital requirements set by their regulators that are substantially similar to those imposed on CSC by theFederal Reserve . Our banking subsidiaries' failure to remain well capitalized could result in certain mandatory and possibly additional discretionary actions by the regulators that could have a direct material effect on the banks. Schwab's principal banking subsidiary, CSB, is required to maintain a Tier 1 Leverage Ratio of at least 5% to be well capitalized, but seeks to maintain a ratio of at least 6.25%. Based on its regulatory capital ratios atDecember 31, 2019 , CSB is considered well capitalized. The following table details the capital ratios for CSC consolidated and CSB: December 31, 2019 (1) 2018 CSC CSB CSC CSB Total stockholders' equity$ 21,745 $ 14,832 $ 20,670 $ 15,615 Less: Preferred Stock 2,793 - 2,793 - Common Equity Tier 1 Capital before regulatory adjustments$ 18,952 $ 14,832 $ 17,877 $ 15,615 Less:Goodwill , net of associated deferred tax liabilities$ 1,184 $ 13 $ 1,188 $ 13 Other intangible assets, net of associated deferred tax liabilities 104 - 125 - Deferred tax assets, net of valuation allowances and deferred tax liabilities 4 - 3 1 AOCI adjustment (1) - - (252 ) (231 ) Common Equity Tier 1 Capital$ 17,660 $ 14,819 $ 16,813 $ 15,832 Tier 1 Capital$ 20,453 $ 14,819 $ 19,606 $ 15,832 Total Capital 20,472 14,837 19,628 15,853 Risk-Weighted Assets 90,512 71,521 95,441 80,513 Total Leverage Exposure (1) 286,813 216,582 N/A N/A Common Equity Tier 1 Capital/Risk-Weighted Assets 19.5 % 20.7 % 17.6 % 19.7 % Tier 1 Capital/Risk-Weighted Assets 22.6 % 20.7 % 20.5 % 19.7 % Total Capital/Risk-Weighted Assets 22.6 % 20.7 % 20.6 % 19.7 % Tier 1 Leverage Ratio 7.3 % 7.1 % 7.1 % 7.2 % Supplementary Leverage Ratio (1) 7.1 % 6.8 %
N/A N/A
(1) Beginning in 2019, CSC and CSB were required to include all components of AOCI in regulatory capital and report our supplementary leverage ratio, which is calculated as Tier 1 capital divided by total leverage exposure. Total leverage exposure includes all on-balance sheet assets and certain off-balance sheet exposures, including unused commitments. Prior to 2019, CSC and CSB elected to opt-out of the requirement to include most components of AOCI in Common Equity Tier 1 Capital; the amounts and ratios forDecember 31, 2018 are presented on this basis. In the interagency regulatory capital and liquidity rules adopted inOctober 2019 , Category III banking organizations such as CSC were given the ability to opt-out of the inclusion of AOCI in regulatory capital, and CSC made this opt-out election effective as ofJanuary 1, 2020 . See Business - Regulation in Part I, Item 1 for additional information on recently issued rules that impact Schwab's regulatory capital requirements. N/A Not applicable. CSB is also subject to regulatory requirements that restrict and govern the terms of affiliate transactions. In addition, CSB is required to provide notice to, and may be required to obtain approval from, the OCC and theFederal Reserve to declare dividends to CSC. - 51 -
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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)
As a broker-dealer, CS&Co is subject to regulatory requirements of the Uniform
Net Capital Rule, which is intended to ensure the general financial soundness
and liquidity of broker-dealers. These regulations prohibit CS&Co from paying
cash dividends, making unsecured advances and loans to the parent company and
employees, and repaying subordinated borrowings from CSC if such payment would
result in a net capital amount below prescribed thresholds. At December 31,
2019 , CS&Co was in compliance with its net capital requirements.
In addition to the capital requirements above, Schwab's subsidiaries are subject
to other regulatory requirements intended to ensure financial soundness and
liquidity. See Item 8 - Note 21 for additional information on the components of
stockholders' equity and information on the capital requirements of significant
subsidiaries.
Dividends
Since the initial dividend in 1989, CSC has paid 123 consecutive quarterly
dividends and has increased the quarterly dividend rate 24 times, resulting in a
21% compounded annual growth rate, excluding the special cash dividend of
$1.00 per common share in 2007. While the payment and amount of dividends are at
the discretion of the Board of Directors, subject to certain regulatory and
other restrictions, CSC currently targets its common stock cash dividend at
approximately 20% to 30% of net income.
The Board of Directors of the Company declared quarterly cash dividend increases per common share during 2018 and 2019 as shown below:
Quarterly Cash New Quarterly
Increase Per Dividend Per
Date of Declaration Common Share % Increase Common Share
January 25, 2018 $ 0.02 25 % $ 0.10
July 25, 2018 0.03 30 % 0.13
January 30, 2019 0.04 31 % 0.17
In addition, on January 30, 2020 , the Board of Directors of the Company declared
a one cent , or 6%, increase in the quarterly cash dividend to $0.18 per common
share.
The following table details the CSC cash dividends paid and per share amounts:
Year Ended December 31, 2019 2018
Per Share Per Share
Cash Paid Amount Cash Paid Amount
Common Stock $ 898 $ 0.68 $ 623 $ 0.46
Series A Preferred Stock (1) 28 70.00 28 70.00
Series C Preferred Stock (2) 36 60.00 36
60.00
Series D Preferred Stock (2) 45 59.52 45
59.52
Series E Preferred Stock (3) 28 4,625.00 28
4,625.00
Series F Preferred Stock (4) 25 5,000.00 27
5,430.56
(1) Dividends paid semi-annually untilFebruary 1, 2022 and quarterly thereafter. (2) Dividends paid quarterly. (3) Dividends paid semi-annually untilMarch 1, 2022 and quarterly thereafter. (4) Dividends paid semi-annually beginning onJune 1, 2018 untilDecember 1, 2027 , and quarterly thereafter.
Share Repurchases
On
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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)
On October 25, 2018 , CSC publicly announced that its Board of Directors
terminated the existing two share repurchase authorizations and replaced them
with a new authorization to repurchase up to $1.0 billion of common stock. CSC
repurchased 22 million shares of its common stock for $1.0 billion in 2018,
completing all repurchases under this authorization.
FOREIGN EXPOSURE
AtDecember 31, 2019 , Schwab had exposure to non-sovereign financial and non-financial institutions in foreign countries, as well as agencies of foreign governments. AtDecember 31, 2019 , the fair value of these holdings totaled$6.4 billion , with the top three exposures being to issuers and counterparties domiciled inFrance at$3.1 billion ,the Netherlands at$845 million , andSweden at$684 million .
In addition to the direct holdings in foreign companies and securities issued by
foreign government agencies, Schwab had outstanding margin loans to foreign
residents of
FAIR VALUE OF FINANCIAL INSTRUMENTS
Schwab uses the market approach to determine the fair value of certain financial assets and liabilities recorded at fair value, and to determine fair value disclosures. See Item 8 - Notes 2 and 16 for more information on our assets and liabilities recorded at fair value. When available, Schwab uses quoted prices in active markets to measure the fair value of assets and liabilities. Quoted prices for investments in exchange-traded securities represent end-of-day close prices published by exchanges. Quoted prices for money market funds and other mutual funds represent reported net asset values. When utilizing market data and bid-ask spread, we use the price within the bid-ask spread that best represents fair value. When quoted prices in active markets do not exist, prices are obtained from independent third-party pricing services to measure the fair value of investment assets. We generally obtain prices from three independent pricing sources for assets recorded at fair value. Our primary third-party pricing service provides prices for our fixed income investments such as commercial paper; certificates of deposits;U.S. government and agency securities; state and municipal securities; corporate debt securities; asset-backed securities; foreign government agency securities; and non-agency commercial mortgage-backed securities. Such prices are based on observable trades, broker/dealer quotes, and discounted cash flows that incorporate observable information such as yields for similar types of securities (a benchmark interest rate plus observable spreads) and weighted-average maturity for the same or similar "to-be-issued" securities. We compare the prices obtained from the primary independent pricing service to the prices obtained from the additional independent pricing services to determine if the price obtained from the primary independent pricing service is reasonable. Schwab does not adjust the prices received from independent third-party pricing services unless such prices are inconsistent with the definition of fair value and result in material differences in the amounts recorded. AtDecember 31, 2019 and 2018, we did not adjust prices received from the primary independent third-party pricing service. CRITICAL ACCOUNTING ESTIMATES The consolidated financial statements of Schwab have been prepared in accordance with GAAP. Item 8 - Note 2 contains more information on our significant accounting policies made in connection with its application of these accounting principles. While the majority of the revenues, expenses, assets and liabilities are not based on estimates, there are certain accounting principles that require management to make estimates regarding matters that are uncertain and susceptible to change where such change may result in a material adverse impact on Schwab's financial position and reported financial results. These critical accounting estimates are described below. Management regularly reviews the estimates and assumptions used in the preparation of the financial statements for reasonableness and adequacy. - 53 - --------------------------------------------------------------------------------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) Management has discussed the development and selection of these critical accounting estimates with the Audit Committee of the Board of Directors. Additionally, management has reviewed with the Audit Committee the Company's significant estimates discussed in this Management's Discussion and Analysis of Financial Condition and Results of Operations.
Income Taxes
Schwab estimates income tax expense based on amounts expected to be owed to the various tax jurisdictions in which we operate, including federal, state and local domestic jurisdictions, and immaterial amounts owed to several foreign jurisdictions. The estimated income tax expense is reported in the consolidated statements of income in taxes on income. Accrued taxes are reported in other assets or accrued expenses and other liabilities on the consolidated balance sheets and represent the net estimated amount due to or to be received from taxing jurisdictions either currently or deferred to future periods. Deferred taxes arise from differences between assets and liabilities measured for financial reporting purposes versus income tax reporting purposes. Deferred tax assets are recognized if, in management's judgment, their realizability is determined to be more likely than not. Uncertain tax positions that meet the more likely than not recognition threshold are measured to determine the amount of benefit to recognize. An uncertain tax position is measured at the largest amount of benefit management believes is more likely than not to be realized upon settlement. In estimating accrued taxes, we assess the relative merits and risks of the appropriate tax treatment considering statutory, judicial and regulatory guidance in the context of the tax position. Because of the complexity of tax laws and regulations, interpretation can be difficult and subject to legal judgment given specific facts and circumstances. Changes in the estimate of accrued taxes occur periodically due to changes in tax rates, interpretations of tax laws, the status of examinations being conducted by various taxing authorities, and newly enacted statutory, judicial and regulatory guidance that impacts the relative merits and risks of tax positions. These changes, when they occur, affect accrued taxes and can be significant to the operating results of the Company. See Item 8 - Note 20 for more information on the Company's income taxes.
Legal and Regulatory Reserves
Reserves for legal and regulatory claims and proceedings reflect an estimate of
probable losses for each matter, after considering, among other factors, the
progress of the case, prior experience and the experience of others in similar
cases, available defenses, and the opinions and views of legal counsel. In many
cases, including most class action lawsuits, it is not possible to determine
whether a loss will be incurred, or to estimate the range of that loss, until
the matter is close to resolution, in which case no accrual is made until that
time. Reserves are adjusted as more information becomes available. Significant
judgment is required in making these estimates, and the actual cost of resolving
a matter may ultimately differ materially from the amount reserved. See Item 8 -
Note 14 for more information on the Company's contingencies related to legal and
regulatory reserves.
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THE CHARLES SCHWAB CORPORATION Item 7A. Quantitative and Qualitative Disclosures About Market Risk
For a discussion of the quantitative and qualitative disclosures about market
risk, see Risk Management in Part II, Item 7.
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THE CHARLES SCHWAB CORPORATION © Edgar Online, source
