Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2013

Commission File Number: 1-9700

THE CHARLES SCHWAB CORPORATION

(Exact name of registrant as specified in its charter)

 

Delaware   94-3025021

(State or other jurisdiction

of incorporation or organization)

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

211 Main Street, San Francisco, CA 94105

(Address of principal executive offices and zip code)

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

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

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

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

 

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

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

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

1,279,979,406 shares of $.01 par value Common Stock

Outstanding on April 23, 2013

 

 

 


Table of Contents

THE CHARLES SCHWAB CORPORATION

Quarterly Report on Form 10-Q

For the Quarter Ended March 31, 2013

Index

 

         Page  
Part I - Financial Information   
    Item 1.   Condensed Consolidated Financial Statements (Unaudited):   
  Statements of Income      1   
  Statements of Comprehensive Income      2   
  Balance Sheets      3   
  Statements of Cash Flows      4   
  Notes      5 – 22   
    Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations      23 – 40   
    Item 3.   Quantitative and Qualitative Disclosures About Market Risk      41 – 42   
    Item 4.   Controls and Procedures      42   
Part II - Other Information   
    Item 1.   Legal Proceedings      43   
    Item 1A.   Risk Factors      43   
    Item 2.   Unregistered Sales of Equity Securities and Use of Proceeds      43   
    Item 3.   Defaults Upon Senior Securities      44   
    Item 4.   Mine Safety Disclosures      44   
    Item 5.   Other Information      44   
    Item 6.   Exhibits      45 – 46   
Signature      47   


Table of Contents

Part I – FINANCIAL INFORMATION

Item 1. Condensed Consolidated Financial Statements

T HE C HARLES S CHWAB C ORPORATION

Condensed Consolidated Statements of Income

(In millions, except per share amounts)

(Unaudited)

 

     Three Months Ended
March 31,
 
     2013     2012  

Net Revenues

    

Asset management and administration fees

   $     552      $     484   

Interest revenue

     497        472   

Interest expense

     (28     (38
  

 

 

   

 

 

 

Net interest revenue

     469        434   

Trading revenue

     223        243   

Other

     56        46   

Provision for loan losses

     (6       

Net impairment losses on securities (1)

     (4     (18
  

 

 

   

 

 

 

Total net revenues

     1,290        1,189   
  

 

 

   

 

 

 

Expenses Excluding Interest

    

Compensation and benefits

     536        465   

Professional services

     99        96   

Occupancy and equipment

     77        76   

Advertising and market development

     74        67   

Communications

     54        58   

Depreciation and amortization

     51        48   

Other

     68        66   
  

 

 

   

 

 

 

Total expenses excluding interest

     959        876   
  

 

 

   

 

 

 

Income before taxes on income

     331        313   

Taxes on income

     125        118   
  

 

 

   

 

 

 

Net Income

     206        195   
  

 

 

   

 

 

 

Preferred stock dividends

     8          
  

 

 

   

 

 

 

Net Income Available to Common Stockholders

   $ 198      $ 195   
  

 

 

   

 

 

 

Weighted-Average Common Shares Outstanding — Diluted

     1,282        1,273   
  

 

 

   

 

 

 

Earnings Per Common Share — Basic

   $ .15      $ .15   

Earnings Per Common Share — Diluted

   $ .15      $ .15   
  

 

 

   

 

 

 

  

 

(1)  

Net impairment losses on securities include total other-than-temporary impairment losses of $0 million and $2 million, net of $(4) million and $(16) million reclassified from other comprehensive income, for the three months ended March 31, 2013 and 2012, respectively.

See Notes to Condensed Consolidated Financial Statements.

 

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Table of Contents

T HE C HARLES S CHWAB C ORPORATION

Condensed Consolidated Statements of Comprehensive Income

(In millions)

(Unaudited)

 

     Three Months Ended
March 31,
 
     2013     2012  

Net Income

   $     206      $     195   

Other comprehensive income, before tax:

    

Change in net unrealized gain on securities available for sale:

    

Net unrealized (loss) gain

     (3     89   

Reclassification of impairment charges included in net impairment losses on securities

     4        18   

Other

     1          
  

 

 

   

 

 

 

Other comprehensive income, before tax

     2        107   
  

 

 

   

 

 

 

Income tax effect

            39   
  

 

 

   

 

 

 

Other comprehensive income, net of tax

     2        68   
  

 

 

   

 

 

 

Comprehensive Income

   $ 208      $ 263   
  

 

 

   

 

 

 

See Notes to Condensed Consolidated Financial Statements.

 

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Table of Contents

T HE C HARLES S CHWAB C ORPORATION

Condensed Consolidated Balance Sheets

(In millions, except per share and share amounts)

(Unaudited)

 

     March 31,
2013
    December 31,
2012
 

Assets

    

Cash and cash equivalents

   $         6,931      $         12,663   

Cash and investments segregated and on deposit for regulatory purposes (including resale agreements of $18,387 at March 31, 2013 and $19,325 at December 31, 2012)

     26,897        28,469   

Receivables from brokers, dealers, and clearing organizations

     467        333   

Receivables from brokerage clients — net

     12,454        13,458   

Other securities owned — at fair value

     545        636   

Securities available for sale

     48,809        46,123   

Securities held to maturity (fair value — $23,316 at March 31, 2013 and $18,732 at December 31, 2012)

     22,920        18,194   

Loans to banking clients — net

     11,300        10,726   

Equipment, office facilities, and property — net

     681        675   

Goodwill

     1,231        1,228   

Intangible assets — net

     302        319   

Other assets

     787        813   
  

 

 

   

 

 

 

Total assets

   $ 133,324      $ 133,637   
  

 

 

   

 

 

 

Liabilities and Stockholders’ Equity

    

Deposits from banking clients

   $ 82,424      $ 79,377   

Payables to brokers, dealers, and clearing organizations

     1,152        1,068   

Payables to brokerage clients

     36,888        40,330   

Accrued expenses and other liabilities

     1,453        1,641   

Long-term debt

     1,631        1,632   
  

 

 

   

 

 

 

Total liabilities

     123,548        124,048   
  

 

 

   

 

 

 

Stockholders’ equity:

    

Preferred stock — $.01 par value per share; aggregated liquidation preference of $885 at both March 31, 2013 and December 31, 2012

     866        865   

Common stock — 3 billion shares authorized; $.01 par value per share; 1,487,543,446 shares issued

     15        15   

Additional paid-in capital

     3,911        3,881   

Retained earnings

     8,674        8,554   

Treasury stock, at cost — 207,704,836 shares at March 31, 2013 and 210,014,305 shares at December 31, 2012

     (3,990     (4,024

Accumulated other comprehensive income

     300        298   
  

 

 

   

 

 

 

Total stockholders’ equity

     9,776        9,589   
  

 

 

   

 

 

 

Total liabilities and stockholders’ equity

   $ 133,324      $ 133,637   
  

 

 

   

 

 

 

See Notes to Condensed Consolidated Financial Statements.

 

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Table of Contents

T HE C HARLES S CHWAB C ORPORATION

Condensed Consolidated Statement of Cash Flows

(In millions)

(Unaudited)

 

     Three Months Ended
March 31,
 
     2013     2012  

Cash Flows from Operating Activities

    

Net income

   $ 206     $ 195  

Adjustments to reconcile net income to net cash (used for) provided by operating activities:

    

Provision for loan losses

     6         

Net impairment losses on securities

     4       18  

Stock-based compensation

     37       25  

Depreciation and amortization

     51       48  

Premium amortization, net, on securities available for sale and securities held to maturity

     44       52  

Other

     7         

Originations of loans held for sale

            (335

Proceeds from sales of loans held for sale

            354  

Net change in:

    

Cash and investments segregated and on deposit for regulatory purposes

     1,572       (871

Receivables from brokers, dealers, and clearing organizations

     (134     (360

Receivables from brokerage clients

     1,003       (136

Other securities owned

     91        137  

Other assets

     (29     22  

Payables to brokers, dealers, and clearing organizations

     84       170  

Payables to brokerage clients

     (3,442     868  

Accrued expenses and other liabilities

     132       (89
  

 

 

   

 

 

 

Net cash (used for) provided by operating activities

     (368     98  
  

 

 

   

 

 

 

Cash Flows from Investing Activities

    

Purchases of securities available for sale

     (6,703     (6,836

Proceeds from sales of securities available for sale

            250  

Principal payments on securities available for sale

     3,997       2,759  

Purchases of securities held to maturity

     (6,031     (1,193

Principal payments on securities held to maturity

     1,279       1,308  

Net (increase) decrease in loans to banking clients

     (530     34  

Purchase of equipment, office facilities, and property

     (49     (42

Other investing activities

     2         
  

 

 

   

 

 

 

Net cash used for investing activities

     (8,035     (3,720
  

 

 

   

 

 

 

Cash Flows from Financing Activities

    

Net change in deposits from banking clients

     3,047       1,405  

Repayment of commercial paper

     (300       

Repayment of long-term debt

     (2     (1

Net proceeds from preferred stock offerings

            394  

Dividends paid

     (98     (77

Proceeds from stock options exercised and other

     25       15  

Other financing activities

     (1     1  
  

 

 

   

 

 

 

Net cash provided by financing activities

     2,671       1,737  
  

 

 

   

 

 

 

Decrease in Cash and Cash Equivalents

     (5,732     (1,885

Cash and Cash Equivalents at Beginning of Period

     12,663       8,679  
  

 

 

   

 

 

 

Cash and Cash Equivalents at End of Period

   $       6,931     $       6,794  
  

 

 

   

 

 

 

Supplemental Cash Flow Information

    

Cash paid during the period for:

    

Interest

   $ 40     $ 36  

Income taxes

   $ 35     $ 12  

See Notes to Condensed Consolidated Financial Statements.

 

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Table of Contents

THE CHARLES SCHWAB CORPORATION

Notes to Condensed Consolidated Financial Statements

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

(Unaudited)

 

1.   Introduction and Basis of Presentation

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

The accompanying unaudited condensed consolidated financial statements include CSC and its majority-owned subsidiaries (collectively referred to as the Company). Intercompany balances and transactions have been eliminated. These condensed consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States (U.S.), which require management to make certain estimates and assumptions that affect the reported amounts in the accompanying financial statements. Certain estimates relate to other-than-temporary impairment of securities available for sale and securities held to maturity, valuation of goodwill, allowance for loan losses, and legal and regulatory reserves. Actual results may differ from those estimates. These condensed consolidated financial statements reflect all adjustments that are, in the opinion of management, necessary for a fair presentation of the results for the periods presented. These adjustments are of a normal recurring nature. Certain prior period amounts have been reclassified to conform to the 2013 presentation. The Company’s results for any interim period are not necessarily indicative of results for a full year or any other interim period. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012.

 

2.   Securities Available for Sale and Securities Held to Maturity

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

 

March 31, 2013

   Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
     Fair
Value
 

Securities available for sale:

           

U.S. agency mortgage-backed securities

   $ 19,465       $ 354       $       $ 19,819   

Asset-backed securities

     9,706         81         1         9,786   

Corporate debt securities

     7,554         65         2         7,617   

Certificates of deposit

     5,890         11         1         5,900   

U.S. agency notes

     4,040         2         6         4,036   

Non-agency residential mortgage-backed securities

     747         4         42         709   

Commercial paper

     649                         649   

Other securities

     278         15                 293   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total securities available for sale

   $     48,329       $          532       $            52       $     48,809   
  

 

 

    

 

 

    

 

 

    

 

 

 

Securities held to maturity:

           

U.S. agency mortgage-backed securities

   $ 22,188       $ 470       $ 63       $ 22,595   

Other securities

     732                 11         721   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total securities held to maturity

   $ 22,920       $ 470       $ 74       $ 23,316   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents

THE CHARLES SCHWAB CORPORATION

Notes to Condensed Consolidated Financial Statements

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

(Unaudited)

 

December 31, 2012

   Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
     Fair
Value
 

Securities available for sale:

           

U.S. agency mortgage-backed securities

   $ 20,080       $ 396       $       $ 20,476   

Asset-backed securities

     8,104         62         2         8,164   

Corporate debt securities

     6,197         61         2         6,256   

Certificates of deposit

     6,150         12         1         6,161   

U.S. agency notes

     3,465         2         3         3,464   

Non-agency residential mortgage-backed securities

     796         2         65         733   

Commercial paper

     574                         574   

Other securities

     278         17                 295   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total securities available for sale

   $     45,644       $          552       $            73       $     46,123   
  

 

 

    

 

 

    

 

 

    

 

 

 

Securities held to maturity:

           

U.S. agency mortgage-backed securities

   $ 17,750       $ 558       $ 19       $ 18,289   

Other securities

     444                 1         443   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total securities held to maturity

   $ 18,194       $ 558       $ 20       $ 18,732   
  

 

 

    

 

 

    

 

 

    

 

 

 

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

 

     Less than
12 months
     12 months
or longer
     Total  

March 31, 2013

   Fair
Value
     Unrealized
Losses
     Fair
Value
     Unrealized
Losses
     Fair
Value
     Unrealized
Losses
 

Securities available for sale:

                 

Asset-backed securities

   $       $       $ 768       $ 1       $ 768       $ 1   

Corporate debt securities

     1,232         2                         1,232         2   

Certificates of deposit

     499         1                         499         1   

U.S. agency notes

     2,300         6                         2,300         6   

Non-agency residential mortgage-backed securities

     66         1         494         41         560         42   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 4,097       $ 10       $ 1,262       $ 42       $ 5,359       $ 52   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Securities held to maturity:

                 

U.S. agency mortgage-backed securities

   $ 7,177       $ 63       $       $       $ 7,177       $ 63   

Other securities

     621         11                         621         11   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 7,798       $ 74       $       $       $ 7,798       $ 74   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total securities with unrealized losses  (1)

   $     11,895       $            84       $       1,262       $            42       $     13,157       $          126   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1)  

The number of investment positions with unrealized losses totaled 128 for securities available for sale and 67 for securities held to maturity.

 

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Table of Contents

THE CHARLES SCHWAB CORPORATION

Notes to Condensed Consolidated Financial Statements

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

(Unaudited)

 

                                                                 
     Less than
12 months
     12 months
or longer
     Total  

December 31, 2012

   Fair
Value
     Unrealized
Losses
     Fair
Value
     Unrealized
Losses
     Fair
Value
     Unrealized
Losses
 

Securities available for sale:

                 

Asset-backed securities

   $       $       $ 801       $ 2       $ 801       $ 2   

Corporate debt securities

     878         2                         878         2   

Certificates of deposit

     599         1                         599         1   

U.S. agency notes

     2,102         3                         2,102         3   

Non-agency residential mortgage-backed securities

     46         1         549         64         595         65   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 3,625       $ 7       $ 1,350       $ 66       $ 4,975       $ 73   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Securities held to maturity:

                 

U.S. agency mortgage-backed securities

   $ 2,680       $ 19       $       $       $ 2,680       $ 19   

Other securities

     240         1                         240         1   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $     2,920       $ 20       $       $       $ 2,920       $ 20   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total securities with unrealized losses  (1)

   $ 6,545       $ 27       $     1,350       $ 66       $     7,895       $ 93   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1)  

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

Unrealized losses in securities available for sale of $52 million as of March 31, 2013, were concentrated in non-agency residential mortgage-backed securities. Included in non-agency residential mortgage-backed securities are securities collateralized by loans that are considered to be “Prime” (defined as loans to borrowers with a Fair Isaac Corporation (FICO) credit score of 620 or higher at origination), and “Alt-A” (defined as Prime loans with reduced documentation at origination). At March 31, 2013, the amortized cost and fair value of Alt-A residential mortgage-backed securities were $295 million and $269 million, respectively.

Certain Alt-A and Prime residential mortgage-backed securities experienced continued credit deterioration in the first quarter of 2013. Based on the Company’s cash flow projections, management determined that it does not expect to recover all of the amortized cost of these securities and therefore determined that these securities were other-than-temporarily impaired (OTTI). The Company employs a buy and hold strategy relative to its mortgage-related securities, and does not intend to sell these securities and will not be required to sell these securities before anticipated recovery of the unrealized losses on these securities. Further, the Company has adequate liquidity at March 31, 2013, with cash and cash equivalents totaling $6.9 billion, a loan-to-deposit ratio of 14%, adequate access to short-term borrowing facilities and regulatory capital ratios in excess of “well capitalized” levels. Because the Company does not intend to sell these securities and it is not “more likely than not” that the Company will be required to sell these securities, the Company recognized an impairment charge equal to the securities’ expected credit losses of $4 million during the first quarter of 2013. The expected credit losses were measured as the difference between the present value of expected cash flows and the amortized cost of the securities. Further deterioration in the performance of the underlying loans in the Company’s non-agency residential mortgage-backed securities portfolio could result in the recognition of additional impairment losses.

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

 

     Three Months Ended
March 31,
 
     2013      2012  

Balance at beginning of period

   $ 159       $ 127   

Credit losses recognized into current period earnings on debt securities for which an other-than-temporary impairment was not previously recognized

             1   

Credit losses recognized into current period earnings on debt securities for which an other-than-temporary impairment was previously recognized

     4         17   
  

 

 

    

 

 

 

Balance at end of period

   $ 163       $ 145   
  

 

 

    

 

 

 

 

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Table of Contents

THE CHARLES SCHWAB CORPORATION

Notes to Condensed Consolidated Financial Statements

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

(Unaudited)

 

The maturities of securities available for sale and securities held to maturity at March 31, 2013, are as follows:

 

                                                                
     Within
1 year
     After 1 year
through
5 years
     After 5 years
through
10 years
     After
10 years
     Total  

Securities available for sale:

              

U.S. agency mortgage-backed securities  (1)

   $       $ 126       $ 3,986       $ 15,707       $ 19,819   

Asset-backed securities

     400         589         760         8,037         9,786   

Corporate debt securities

     1,879         5,738                         7,617   

Certificates of deposit

     4,083         1,817                         5,900   

U.S. agency notes

             1,625         2,411                 4,036   

Non-agency residential mortgage-backed securities

                     6         703         709   

Commercial paper

     649                                 649   

Other securities

                             293         293   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total fair value

   $       7,011       $       9,895       $ 7,163       $ 24,740       $ 48,809   

Total amortized cost

   $ 6,995       $ 9,828       $ 7,021       $ 24,485       $ 48,329   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Securities held to maturity:

              

U.S. agency mortgage-backed securities  (1)

   $       $       $ 11,540       $ 11,055       $ 22,595   

Other securities

             100         363         258         721   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total fair value

   $       $ 100       $ 11,903       $ 11,313       $ 23,316   

Total amortized cost

   $       $ 100       $     11,676       $     11,144       $     22,920   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1)  

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

There were no sales of securities available for sale in the first quarter of 2013. Proceeds received from sales of securities available for sale were $250 million in the first quarter of 2012. There were no gross realized gains or losses from sales of securities available for sale in the first quarter of 2012.

 

3.   Loans to Banking Clients and Related Allowance for Loan Losses

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

 

                         
     March 31,
2013
    December 31,
2012
 

Residential real estate mortgages

   $ 7,102      $ 6,507   

Home equity lines of credit

     3,193        3,287   

Personal loans secured by securities

     1,035        963   

Other

     29        25   
  

 

 

   

 

 

 

Total loans to banking clients  (1)

     11,359        10,782   

Allowance for loan losses

     (59     (56
  

 

 

   

 

 

 

Total loans to banking clients – net

   $      11,300      $    10,726   
  

 

 

   

 

 

 

 

(1)  

All loans are evaluated for impairment by loan segment.

The Company has commitments to extend credit related to unused home equity lines of credit (HELOCs), personal loans secured by securities, and other lines of credit, which totaled $5.4 billion at both March 31, 2013, and December 31, 2012, respectively.

 

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Table of Contents

THE CHARLES SCHWAB CORPORATION

Notes to Condensed Consolidated Financial Statements

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

(Unaudited)

 

Changes in the allowance for loan losses were as follows:

 

                                                                                                           
Three Months Ended    March 31, 2013     March 31, 2012  
     Residential
real  estate
mortgages
    Home equity
lines of  credit
    Total     Residential
real estate
mortgages
    Home equity
lines of  credit
    Total  

Balance at beginning of period

   $ 36      $ 20      $ 56      $ 40      $ 14      $ 54   

Charge-offs

     (2     (2     (4     (3     (2     (5

Recoveries

     1               1        1               1   

Provision for loan losses

     5        1        6        (1     1          
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at end of period

   $           40      $     19      $           59      $           37      $     13      $           50   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Included in the loan portfolio are nonaccrual loans totaling $42 million and $48 million at March 31, 2013 and December 31, 2012, respectively. There were no loans accruing interest that were contractually 90 days or more past due at March 31, 2013 or December 31, 2012. Nonperforming assets, which include nonaccrual loans and other real estate owned, totaled $46 million and $54 million at March 31, 2013 and December 31, 2012, respectively.

In 2012, Schwab Bank launched a co-branded loan origination program for Schwab Bank clients (the Program) with Quicken Loans, Inc. (Quicken ® Loans ® ). Pursuant to the Program, Quicken Loans originates and services first lien residential real estate mortgage loans (First Mortgages) and HELOCs for Schwab Bank clients. Under the Program, Schwab Bank purchases certain First Mortgages and HELOCs that are originated by Quicken Loans. Schwab Bank sets the underwriting guidelines and pricing for all loans it intends to purchase for its portfolio. Schwab Bank purchased First Mortgages of $1.3 billion and $71 million during the first quarters of 2013 and 2012, respectively. The First Mortgages purchased under the Program are included in the First mortgages loan class in the tables below.

The delinquency analysis by loan class is as follows:

 

                                                                                                           

March 31, 2013

   Current      30-59 days
past  due
     60-89 days
past  due
     >90 days
past  due
     Total
past  due
     Total
loans
 

Residential real estate mortgages:

                 

First mortgages

   $ 6,906       $ 9       $ 1       $ 29       $ 39       $ 6,945   

Purchased first mortgages

     151         2                 4         6         157   

Home equity lines of credit

     3,175         7         2         9         18         3,193   

Personal loans secured by securities

     1,035                                         1,035   

Other

     29                                         29   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total loans to banking clients

   $ 11,296       $ 18       $ 3       $ 42       $ 63       $ 11,359   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

December 31, 2012

   Current      30-59 days
past due
     60-89 days
past due
     >90 days
past  due
     Total
past  due
     Total
loans
 

Residential real estate mortgages:

                 

First mortgages

   $ 6,291       $ 22       $ 2       $ 33       $ 57       $ 6,348   

Purchased first mortgages

     154         1                 4         5         159   

Home equity lines of credit

     3,269         5         2         11         18         3,287   

Personal loans secured by securities

     963                                         963   

Other

     22         3                         3         25   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total loans to banking clients

   $     10,699       $           31       $             4       $           48       $           83       $     10,782   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

In addition to monitoring delinquency, the Company monitors the credit quality of residential real estate mortgages and HELOCs by stratifying the portfolios by the year of origination, borrower FICO scores at origination (Origination FICO), updated borrower FICO scores (Updated FICO), LTV ratios at origination (Origination LTV), and estimated current LTV ratios (Estimated Current LTV), as presented in the following tables. Borrowers’ FICO scores are provided by an independent third party credit reporting service and were last updated in March 2013. The Origination LTV and Estimated Current LTV ratios for a HELOC include any first lien mortgage outstanding on the same property at the time of the

 

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Table of Contents

THE CHARLES SCHWAB CORPORATION

Notes to Condensed Consolidated Financial Statements

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

(Unaudited)

 

HELOC’s origination. The Estimated Current LTV for each loan is estimated by reference to a home price appreciation index.

 

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Table of Contents

THE CHARLES SCHWAB CORPORATION

Notes to Condensed Consolidated Financial Statements

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

(Unaudited)

 

                                                                                                                   
     Residential real estate mortgages        

March 31, 2013

   First
mortgages
     Purchased
first mortgages
     Total     Home equity
lines of credit
 

Year of origination

          

Pre-2009

   $ 813       $ 59       $ 872      $ 2,248   

2009

     269         5         274        314   

2010

     747         10         757        230   

2011

     1,065         47         1,112        187   

2012

     2,938         29         2,967        170   

2013

     1,113         7         1,120        44   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total

   $ 6,945       $ 157       $ 7,102      $ 3,193   
  

 

 

    

 

 

    

 

 

   

 

 

 

Origination FICO

          

<620

   $ 11       $ 1       $ 12      $   

620 - 679

     99         16         115        22   

680 - 739

     1,236         37         1,273        612   

³ 740

     5,599         103         5,702        2,559   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total

   $ 6,945       $ 157       $ 7,102      $ 3,193   
  

 

 

    

 

 

    

 

 

   

 

 

 

Updated FICO

          

<620

   $ 53       $ 6       $ 59      $ 48   

620 - 679

     194         14         208        113   

680 - 739

     952         29         981        493   

³ 740

     5,746         108         5,854        2,539   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total

   $ 6,945       $ 157       $ 7,102      $ 3,193   
  

 

 

    

 

 

    

 

 

   

 

 

 

Origination LTV

          

£ 70%

   $ 4,626       $ 101       $ 4,727      $ 2,154   

>70% -  £ 90%

     2,302         49         2,351        1,013   

>90% -  £ 100%

     17         7         24        26   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total

   $     6,945       $         157       $     7,102      $     3,193   
  

 

 

    

 

 

    

 

 

   

 

 

 

March 31, 2013

   Balance      Weighted
Average
Updated FICO
     Utilization
Rate (1)
    Percent of Loans
that are 90+ Days
Past Due and
Less than 90 Days
Past Due but on
Nonaccrual Status
 

Residential real estate mortgages:

          

Estimated Current LTV

          

£ 70%

   $ 5,178         774         N/A        0.04

>70% -  £ 90%

     1,579         764         N/A        0.23

>90% -  £ 100%

     133         746         N/A        1.37

>100%

     212         734         N/A        6.71
  

 

 

    

 

 

    

 

 

   

 

 

 

Total

   $ 7,102         770         N/A        0.30
  

 

 

    

 

 

    

 

 

   

 

 

 

Home equity lines of credit:

          

Estimated Current LTV

          

£ 70%

   $ 1,829         773         36     0.09

>70% -  £ 90%

     880         765         47     0.15

>90% -  £ 100%

     218         755         57     0.77

>100%

     266         749         60     0.73
  

 

 

    

 

 

    

 

 

   

 

 

 

Total

   $     3,193                 768                     41                 0.21
  

 

 

    

 

 

    

 

 

   

 

 

 

 

(1)  

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

N/A Not applicable.

 

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Table of Contents

THE CHARLES SCHWAB CORPORATION

Notes to Condensed Consolidated Financial Statements

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

(Unaudited)

 

                                                                                                                   
     Residential real estate mortgages        

December 31, 2012

   First
mortgages
     Purchased
first mortgages
     Total     Home equity
lines of credit
 

Year of origination

          

Pre-2009

   $ 867       $ 62       $ 929      $ 2,338   

2009

     305         6         311        338   

2010

     909         12         921        249   

2011

     1,270         53         1,323        198   

2012

     2,997         26         3,023        164   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total

   $ 6,348       $ 159       $ 6,507      $ 3,287   
  

 

 

    

 

 

    

 

 

   

 

 

 

Origination FICO

          

<620

   $ 10       $ 1       $ 11      $   

620 - 679

     98         16         114        23   

680 - 739

     1,141         40         1,181        633   

³ 740

     5,099         102         5,201        2,631   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total

   $ 6,348       $ 159       $ 6,507      $ 3,287   
  

 

 

    

 

 

    

 

 

   

 

 

 

Updated FICO

          

<620

   $ 54       $ 6       $ 60      $ 49   

620 - 679

     191         13         204        117   

680 - 739

     940         34         974        510   

³ 740

     5,163         106         5,269        2,611   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total

   $ 6,348       $ 159       $ 6,507      $ 3,287   
  

 

 

    

 

 

    

 

 

   

 

 

 

Origination LTV

          

£ 70%

   $ 4,189       $ 97       $ 4,286      $ 2,225   

>70% -  £ 90%

     2,142         54         2,196        1,036   

>90% -  £ 100%

     17         8         25        26   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total

   $ 6,348       $ 159       $ 6,507      $ 3,287   
  

 

 

    

 

 

    

 

 

   

 

 

 

December 31, 2012

   Balance      Weighted
Average
Updated FICO
     Utilization
Rate
(1)  
    Percent of Loans
that are 90+ Days
Past Due and
Less than 90 Days
Past Due but on
Nonaccrual Status
 

Residential real estate mortgages:

          

Estimated Current LTV

          

£ 70%

   $ 4,162         772         N/A        0.05

>70% -  £ 90%

     1,841         764         N/A        0.22

>90% -  £ 100%

     168         750         N/A        0.51

>100%

     336         741         N/A        5.34
  

 

 

    

 

 

    

 

 

   

 

 

 

Total

   $ 6,507         768         N/A        0.38
  

 

 

    

 

 

    

 

 

   

 

 

 

Home equity lines of credit:

          

Estimated Current LTV

          

£ 70%

   $ 1,559         773         36     0.14

>70% -  £ 90%

     1,020         766         46     0.18

>90% -  £ 100%

     267         759         54     0.44

>100%

     441         753         59     1.06
  

 

 

    

 

 

    

 

 

   

 

 

 

Total

   $     3,287                 767                     42                   0.31
  

 

 

    

 

 

    

 

 

   

 

 

 

 

(1)  

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

N/A Not applicable.

 

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Table of Contents

THE CHARLES SCHWAB CORPORATION

Notes to Condensed Consolidated Financial Statements

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

(Unaudited)

 

The Company monitors the credit quality of personal loans secured by securities by reviewing the fair value of collateral to ensure adequate collateralization of at least 100% of the principal amount of the loans. All of these personal loans were fully collateralized by securities with fair values in excess of borrowings at March 31, 2013 and December 31, 2012.

 

4.   Commitments and Contingencies

The Company has clients that sell (i.e., write) listed option contracts that are cleared by the Options Clearing Corporation – a clearing house that establishes margin requirements on these transactions. The Company partially satisfies the margin requirements by arranging unsecured standby letter of credit agreements (LOCs), in favor of the Options Clearing Corporation, which are issued by multiple banks. At March 31, 2013, the aggregate face amount of these LOCs totaled $225 million. In connection with its securities lending activities, the Company is required to provide collateral to certain brokerage clients. The Company satisfies the collateral requirements by arranging LOCs in favor of these brokerage clients, which are issued by multiple banks. At March 31, 2013, the aggregate face amount of these LOCs totaled $104 million. There were no funds drawn under any of these LOCs at March 31, 2013.

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

Legal contingencies: The Company is subject to claims and lawsuits in the ordinary course of business, including arbitrations, class actions and other litigation, some of which include claims for substantial or unspecified damages. The Company is also the subject of inquiries, investigations, and proceedings by regulatory and other governmental agencies.

The Company believes it has strong defenses in all significant matters currently pending and is contesting liability and any damages claimed. Nevertheless, some of these matters may result in adverse judgments or awards, including penalties, injunctions or other relief, and the Company may also determine to settle a matter because of the uncertainty and risks of litigation. Described below are certain matters in which there is a reasonable possibility that a material loss could be incurred or where the matter may otherwise be of significant interest to stockholders. With respect to all other pending matters, based on current information and consultation with counsel, it does not appear that the outcome of any such matter could be material to the financial condition, operating results or cash flows of the Company. However, predicting the outcome of a litigation or regulatory matter is inherently difficult, requiring significant judgment and evaluation of various factors, including the procedural status of the matter and any recent developments; prior experience and the experience of others in similar cases; available defenses, including potential opportunities to dispose of a case on the merits or procedural grounds before trial (e.g., motions to dismiss or for summary judgment); the progress of fact discovery; the opinions of counsel and experts regarding potential damages; potential opportunities for settlement and the status of any settlement discussions; and potential insurance coverage and indemnification. Often, as in the case of the Auction Rate Securities Regulatory Inquiries and Total Bond Market Fund Litigation matters described below, it is not possible to reasonably estimate potential liability, if any, or a range of potential liability until the matter is closer to resolution – pending, for example, further proceedings, the outcome of key motions or appeals, or discussions among the parties. Numerous issues may have to be developed, such as discovery of important factual matters and determination of threshold legal issues, which may include novel or unsettled questions of law. Reserves are established or adjusted or further disclosure and estimates of potential loss are provided as the matter progresses and more information becomes available.

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

 

- 13 -


Table of Contents

THE CHARLES SCHWAB CORPORATION

Notes to Condensed Consolidated Financial Statements

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

(Unaudited)

 

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

optionsXpress Regulatory Matters : optionsXpress entities and individual employees have been responding to certain pending regulatory matters which predate the Company’s acquisition of optionsXpress. On April 16, 2012, optionsXpress, Inc. was charged by the SEC in an administrative proceeding alleging violations of the firm’s close-out obligations under SEC Regulation SHO (short sale delivery rules) in connection with certain customer trading activity. Trial in the administrative proceeding commenced September 5, 2012. The Company disputes the allegations and is contesting the charges. Separately, on April 19, 2012, the SEC instituted an administrative proceeding alleging violations of the broker-dealer registration requirements by an unregistered optionsXpress entity. On September 5, 2012, the administrative law judge hearing the case ruled on summary disposition that applicable registration requirements were violated. Certain other issues, including relief, remain to be determined at trial. The Company continues to dispute the allegations and is contesting the charges. The Company has a contingent liability associated with the two separate matters, which was not material at March 31, 2013.

 

5.   Fair Values of Assets and Liabilities

For a description of the fair value hierarchy and the Company’s fair value methodologies, including the use of independent third-party pricing services, see note “2 – Summary of Significant Accounting Policies” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012. The Company did not transfer any assets or liabilities between Level 1 and Level 2 during the quarter ended March 31, 2013, or the year ended December 31, 2012. In addition, the Company did not adjust prices received from the primary independent third-party pricing service at March 31, 2013, or December 31, 2012.

 

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Table of Contents

THE CHARLES SCHWAB CORPORATION

Notes to Condensed Consolidated Financial Statements

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

(Unaudited)

 

Financial Instruments Recorded at Fair Value

The following tables present the fair value hierarchy for assets measured at fair value. Liabilities recorded at fair value were not material, and therefore are not included in the following tables:

 

                                                   

March 31, 2013

   Quoted Prices
in Active Markets
for Identical
Assets

(Level 1)
     Significant
Other Observable
Inputs

(Level 2)
     Significant
Unobservable

Inputs
(Level 3)
     Balance at
Fair Value
 

Cash equivalents:

           

Money market funds

   $     13      $     —       $     —       $     13  

Commercial paper

             738                738  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total cash equivalents

     13        738                751  

Investments segregated and on deposit for regulatory purposes:

           

Certificates of deposit

             2,626                2,626  

U.S. Government securities

             1,766                1,766  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total investments segregated and on deposit for regulatory purposes

             4,392                4,392  

Other securities owned:

           

Schwab Funds ®  money market funds

     241                        241  

Equity and bond mutual funds

     217        1                218  

State and municipal debt obligations

             48                48  

Equity, U.S. Government and corporate debt, and other securities

     7        31                38  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total other securities owned

     465        80                545  

Securities available for sale:

           

U.S. agency mortgage-backed securities

             19,819                19,819  

Asset-backed securities

             9,786                9,786  

Corporate debt securities

             7,617                7,617  

Certificates of deposit

             5,900                5,900  

U.S. agency notes

             4,036                4,036  

Non-agency residential mortgage-backed securities

             709                709  

Commercial paper

             649                649  

Other securities

             293                293  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total securities available for sale

             48,809                48,809  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $     478      $     54,019      $     —       $     54,497  
  

 

 

    

 

 

    

 

 

    

 

 

 

 

- 15 -


Table of Contents

THE CHARLES SCHWAB CORPORATION

Notes to Condensed Consolidated Financial Statements

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

(Unaudited)

 

                                                   

December 31, 2012

   Quoted Prices
in Active Markets
for Identical
Assets

(Level 1)
     Significant
Other Observable
Inputs

(Level 2)
     Significant
Unobservable

Inputs
(Level 3)
     Balance at
Fair Value
 

Cash equivalents:

           

Money market funds

   $     413      $     —       $     —       $     413  

Commercial paper

             1,076                1,076  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total cash equivalents

     413        1,076                1,489  

Investments segregated and on deposit for regulatory purposes:

           

Certificates of deposit

             2,976                2,976  

U.S. Government securities

             1,767                1,767  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total investments segregated and on deposit for regulatory purposes

             4,743                4,743  

Other securities owned:

           

Schwab Funds ®  money market funds

     329                        329  

Equity and bond mutual funds

     217                        217  

State and municipal debt obligations

             48                48  

Equity, U.S. Government and corporate debt, and other securities

     2        40                42  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total other securities owned

     548        88                636  

Securities available for sale:

           

U.S. agency mortgage-backed securities

             20,476                20,476  

Asset-backed securities

             8,164                8,164  

Corporate debt securities

             6,256                6,256  

Certificates of deposit

             6,161                6,161  

U.S. agency notes

             3,464                3,464  

Non-agency residential mortgage-backed securities

             733                733  

Commercial paper

             574                574  

Other securities

             295                295  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total securities available for sale

             46,123                46,123  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $     961      $     52,030      $     —       $     52,991  
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents

THE CHARLES SCHWAB CORPORATION

Notes to Condensed Consolidated Financial Statements

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

(Unaudited)

 

Financial Instruments Not Recorded at Fair Value

Descriptions of the valuation methodologies and assumptions used to estimate the fair value of financial instruments not recorded at fair value are also described in note “2 – Summary of Significant Accounting Policies” in the Company’s Annual Report on

Form 10-K for the year ended December 31, 2012. There were no significant changes in these methodologies or assumptions during the quarter ended March 31, 2013. The following tables present the fair value hierarchy for financial instruments not recorded at fair value:

 

                                                                          

March 31, 2013

   Carrying
Amount
     Quoted Prices
in Active Markets

for Identical
Assets

(Level 1)
     Significant
Other Observable
Inputs

(Level 2)
     Significant
Unobservable
Inputs

(Level 3)
     Balance at
Fair Value
 

Assets:

              

Cash and cash equivalents

   $     6,180      $     —       $     6,180      $     —       $     6,180  

Cash and investments segregated and on deposit for regulatory purposes

     22,501                22,501                22,501  

Receivables from brokers, dealers, and clearing organizations

     467                467                467  

Receivables from brokerage clients – net

     12,448                12,448                12,448  

Securities held to maturity:

              

U.S. agency mortgage-backed securities

     22,188                22,595                22,595  

Other securities

     732                721                721  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total securities held to maturity

     22,920                23,316                23,316  

Loans to banking clients – net:

              

Residential real estate mortgages

     7,062                7,231                7,231  

Home equity lines of credit

     3,174                3,151                3,151  

Personal loans secured by securities

     1,035                1,035                1,035  

Other

     29                29                29  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total loans to banking clients – net

     11,300                11,446                11,446  

Other assets

     64                64                64  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $     75,880      $     —       $     76,422      $     —       $     76,422  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Liabilities:

              

Deposits from banking clients

   $     82,424      $     —       $     82,424      $     —       $     82,424  

Payables to brokers, dealers, and clearing organizations

     1,152                1,152                1,152  

Payables to brokerage clients

     36,888                36,888                36,888  

Accrued expenses and other liabilities

     528                528                528  

Long-term debt

     1,631                1,794                1,794  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $     122,623      $     —       $     122,786      $     —       $     122,786  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents

THE CHARLES SCHWAB CORPORATION

Notes to Condensed Consolidated Financial Statements

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

(Unaudited)

 

                                                                          

December 31, 2012

   Carrying
Amount
     Quoted Prices
in Active Markets

for Identical
Assets

(Level 1)
     Significant
Other  Observable

Inputs
(Level 2)
     Significant
Unobservable
Inputs

(Level 3)
     Balance at
Fair Value
 

Assets:

              

Cash and cash equivalents

   $     11,174       $     —       $     11,174      $     —       $     11,174  

Cash and investments segregated and on deposit for regulatory purposes

     23,723                 23,723                23,723  

Receivables from brokers, dealers, and clearing organizations

     333                 333                333  

Receivables from brokerage clients – net

     13,453                 13,453                13,453  

Securities held to maturity:

              

U.S. agency mortgage-backed securities

     17,750                 18,289                18,289  

Other securities

     444                 443                443  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total securities held to maturity

     18,194                 18,732                18,732  

Loans to banking clients – net:

              

Residential real estate mortgages

     6,471                 6,687                6,687  

Home equity lines of credit

     3,267                 3,295                3,295  

Personal loans secured by securities

     963                 963                963  

Other

     25                 24                24  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total loans to banking clients – net

     10,726                 10,969                10,969  

Other assets

     64                 64                64  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $     77,667       $     —       $     78,448      $       $     78,448  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Liabilities:

              

Deposits from banking clients

   $     79,377       $     —       $     79,377      $     —       $     79,377  

Payables to brokers, dealers, and clearing organizations

     1,068                 1,068                1,068  

Payables to brokerage clients

     40,330                 40,330                40,330  

Accrued expenses and other liabilities

     353                 353                353  

Long-term debt

     1,632                 1,782                1,782  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $     122,760       $     —       $     122,910      $     —       $ 122,910  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Securities lending: Payables from brokers, dealers, and clearing organizations include securities loaned. The Company loans client securities temporarily to other brokers in connection with its securities lending activities and receives cash as collateral for the securities loaned. Increases in security prices may cause the fair value of the securities loaned to exceed the amount of cash received as collateral. In the event the counterparty to these transactions does not return the loaned securities or provide additional cash collateral, the Company may be exposed to the risk of acquiring the securities at prevailing market prices in order to satisfy its client obligations. The Company mitigates this risk by requiring credit approvals for counterparties, monitoring the fair value of securities loaned, and requiring additional cash as collateral when necessary. The fair value of client securities pledged in securities lending transactions to other broker-dealers was $1.1 billion at March 31, 2013 and $852 million at December 31, 2012. Additionally, the Company borrows securities from other broker-dealers to fulfill short sales by clients, which are included in receivables from brokers, dealers, and clearing organizations. The fair value of these borrowed securities was $279 million at March 31, 2013 and $121 million at December 31, 2012. All of the Company’s securities lending transactions are subject to enforceable master netting arrangements with other broker-dealers. However, the Company does not net securities lending transactions and therefore, the Company’s securities loaned and securities borrowed are presented gross in the condensed consolidated balance sheets.

Resale agreements: Cash and investments segregated and on deposit for regulatory purposes include securities purchased under agreements to resell (resale agreements), which are collateralized by U.S. Government and agency securities. Schwab enters into collateralized resale agreements principally with other broker-dealers, which could result in losses in the event the counterparty fails to purchase the securities held as collateral for the cash advanced and the fair value of the securities declines. To mitigate this risk, Schwab requires that the counterparty deliver securities to a custodian, to be held as collateral, with a fair value in excess of the resale price. Schwab utilizes the collateral provided under these resale agreements to meet

 

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Table of Contents

THE CHARLES SCHWAB CORPORATION

Notes to Condensed Consolidated Financial Statements

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

(Unaudited)

 

obligations under broker-dealer client protection rules, which place limitations on its ability to access such segregated securities. The Company’s resale agreements are not subject to enforceable master netting arrangements.

 

6.   Accumulated Other Comprehensive Income

Accumulated other comprehensive income represents cumulative gains and losses that are not reflected in earnings. The components of other comprehensive income are as follows:

 

Three Months Ended March 31,    2013     2012  
       Before
tax
    Tax
effect
    Net of
tax
    Before
tax
     Tax
effect
     Net of
tax
 

Change in net unrealized gain on securities available for sale:

              

Net unrealized (loss) gain

   $ (3   $ (2   $ (1   $ 89       $ 32       $ 57   

Reclassification of impairment charges included in net impairment losses on securities

     4        2        2        18         7         11   
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

    

 

 

 

Change in net unrealized gain on securities available for sale

     1               1        107         39         68   
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

    

 

 

 

Other

     1               1                          
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

    

 

 

 

Other comprehensive income

   $   2      $   —      $   2      $   107       $   39       $   68   
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

    

 

 

 

Accumulated other comprehensive income balances are as follows:

 

                                                                                                                       
     Net unrealized
gain on securities
available for sale
     Other     Total
accumulated other
comprehensive income
 

Balance at December 31, 2011

   $ 10       $ (2   $ 8   

Other net changes

     68                68   
  

 

 

    

 

 

   

 

 

 

Balance at March 31, 2012

   $ 78       $ (2   $ 76   
  

 

 

    

 

 

   

 

 

 

Balance at December 31, 2012

   $ 299       $ (1   $ 298   

Other net changes

     1         1        2   
  

 

 

    

 

 

   

 

 

 

Balance at March 31, 2013

   $ 300       $      $ 300   
  

 

 

    

 

 

   

 

 

 

 

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Table of Contents

THE CHARLES SCHWAB CORPORATION

Notes to Condensed Consolidated Financial Statements

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

(Unaudited)

 

7.   Earnings Per Common Share

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

 

     Three Months Ended  
     March 31,  
     2013      2012  

Net income

   $ 206       $ 195   

Preferred stock dividends

     8           
  

 

 

    

 

 

 

Net income available to common stockholders

   $ 198       $ 195   
  

 

 

    

 

 

 

Weighted-average common shares outstanding — basic

     1,279         1,272   

Common stock equivalent shares related to stock incentive plans

     3         1   

Weighted-average common shares outstanding — diluted  (1)

     1,282         1,273   
  

 

 

    

 

 

 

Basic EPS

   $ .15       $ .15   

Diluted EPS

   $ .15       $ .15   
  

 

 

    

 

 

 

 

(1)  

Antidilutive stock options and restricted stock awards excluded from the calculation of diluted EPS totaled 45 million and 60 million shares for the first quarters of 2013 and 2012, respectively.

 

8.   Regulatory Requirements

CSC is a savings and loan holding company and Schwab Bank, CSC’s depository institution subsidiary, is a federal savings bank. CSC is subject to supervision and regulation by the Board of Governors of the Federal Reserve System (the Federal Reserve) and Schwab Bank is subject to supervision and regulation by the Office of the Comptroller of the Currency (the OCC). CSC is currently not subject to specific statutory capital requirements, however CSC is required to serve as a source of strength for Schwab Bank. Under the “Dodd-Frank Wall Street Reform and Consumer Protection Act,” CSC will be subject to new minimum leverage and minimum risk-based capital ratio requirements that will be set by the Federal Reserve that are at least as stringent as the current requirements generally applicable to insured depository institutions.

Schwab Bank is subject to regulation and supervision and to various requirements and restrictions under federal and state laws, including regulatory capital guidelines. Among other things, these requirements also restrict and govern the terms of affiliate transactions, such as extensions of credit and repayment of loans between Schwab Bank and CSC or CSC’s other subsidiaries. In addition, Schwab Bank is required to provide notice to and may be required to obtain approval of the OCC and the Federal Reserve to declare dividends to CSC. The federal banking agencies have broad powers to enforce these regulations, including the power to terminate deposit insurance, impose substantial fines and other civil and criminal penalties, and appoint a conservator or receiver. Under the Federal Deposit Insurance Act, Schwab Bank could be subject to restrictive actions if it were to fall within one of the lowest three of five capital categories. Schwab Bank is required to maintain minimum capital levels as specified in federal banking laws and regulations. Failure to meet the minimum levels could result in certain mandatory, and possibly additional discretionary actions by the regulators that, if undertaken, could have a direct material effect on Schwab Bank. At March 31, 2013, CSC and Schwab Bank met the capital level requirements.

 

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Table of Contents

THE CHARLES SCHWAB CORPORATION

Notes to Condensed Consolidated Financial Statements

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

(Unaudited)

 

The regulatory capital and ratios for Schwab Bank at March 31, 2013, are as follows:

 

     Actual     Minimum Capital
Requirement
    Minimum to be
Well Capitalized
 
     Amount          Ratio         Amount          Ratio         Amount          Ratio      

Tier 1 Risk-Based Capital

   $ 5,836         18.5   $ 1,259         4.0   $ 1,889         6.0

Total Risk-Based Capital

   $ 5,896         18.7   $ 2,518         8.0   $ 3,148         10.0

Tier 1 Leverage

   $ 5,836         6.6   $ 3,538         4.0   $     4,423         5.0

Tangible Equity

   $     5,836         6.6   $     1,769         2.0     N/A      

 

N/A Not applicable.

Based on its regulatory capital ratios at March 31, 2013, Schwab Bank is considered well capitalized (the highest category) pursuant to banking regulatory guidelines. There are no conditions or events since March 31, 2013, that management believes have changed Schwab Bank’s capital category.

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

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

Net capital and net capital requirements for Schwab and optionsXpress, Inc. at March 31, 2013, are as follows:

 

                                       Net Capital  
                                Net Capital      in Excess of  
            % of     Minimum      2% of      in Excess of      5% of  
            Aggregate     Net Capital      Aggregate      Required      Aggregate  
     Net Capital      Debit Balances     Required      Debit Balances      Net Capital      Debit Balances  

Schwab

   $     1,386         10   $     0.250       $     275       $     1,111       $     700   

optionsXpress, Inc.

   $ 89         31   $ 1       $ 6       $ 83       $ 75   

 

9.   Segment Information

The Company structures its operating segments according to its clients and the services provided to those clients. The Company’s two reportable segments are Investor Services and Advisor Services. In the first quarter of 2013, the Company realigned its reportable segments as a result of organizational changes. The segment formerly reported as Institutional Services was renamed to Advisor Services. The Retirement Plan Services and Corporate Brokerage Services business units are now part of the Investor Services segment. Prior period segment information has been recast to reflect these organizational changes. The Investor Services segment provides retail brokerage and banking services to individual investors, retirement plan services, and corporate brokerage services. The Advisor Services segment provides custodial, trading, and support services to independent investment advisors, and retirement business services to independent retirement plan advisors and recordkeepers whose plan assets are held at Schwab Bank. Banking revenues and expenses are allocated to the Company’s two segments based on which segment services the client.

 

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Table of Contents

THE CHARLES SCHWAB CORPORATION

Notes to Condensed Consolidated Financial Statements

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

(Unaudited)

 

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

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

 

                                                                                               
     Investor Services     Advisor Services     Unallocated     Total  

Three Months Ended March 31,

   2013     2012     2013     2012     2013      2012     2013     2012  

Net Revenues:

                 

Asset management and administration fees

   $     387     $     341     $     165     $     142     $       $ 1     $ 552     $     484  

Net interest revenue

     413       384       56       50                      469       434  

Trading revenue

     149       174       74       69                      223       243  

Other

     42       32       14       15               (1     56       46  

Provision for loan losses

     (5            (1                           (6       

Net impairment losses on securities

     (4     (17            (1                    (4     (18
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Total net revenues

     982       914       308       275                      1,290       1,189  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Expenses Excluding Interest

     751       690       208       186                      959       876  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Income before taxes on income

   $ 231     $ 224     $ 100     $ 89     $       $     —      $ 331     $ 313  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Taxes on income

                  125       118  
               

 

 

   

 

 

 

Net Income

                $     206     $ 195  
               

 

 

   

 

 

 

 

10.   Subsequent Events

The Company has evaluated the impact of events that have occurred subsequent to March 31, 2013, through the date the condensed consolidated financial statements were filed with the SEC. Based on this evaluation, other than as recorded or disclosed within these condensed consolidated financial statements and related notes, the Company has determined none of these events were required to be recognized or disclosed.

 

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Table of Contents

THE CHARLES SCHWAB CORPORATION

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

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

 

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

OVERVIEW

Management of The Charles Schwab Corporation (CSC) and its subsidiaries (collectively referred to as the Company) focuses on several key client activity and financial metrics in evaluating the Company’s financial position and operating performance. Results for the first quarters of 2013 and 2012 are:

 

     Three Months Ended
March 31,
    Percent
     Change    
 
     2013     2012    

Client Activity Metrics:

      

Net new client assets (1)  (in billions)

   $ 43.4      $ 38.9        12

Client assets (in billions, at quarter end)

   $     2,084.9      $     1,833.5        14

New brokerage accounts (in thousands)

     244        240        2

Active brokerage accounts (in thousands, at quarter end)

     8,865        8,639        3

Company Financial Metrics:

      

Net revenues

   $ 1,290      $ 1,189        8

Expenses excluding interest

     959        876        9
  

 

 

   

 

 

   

 

 

 

Income before taxes on income

     331        313        6

Taxes on income

     125        118        6
  

 

 

   

 

 

   

 

 

 

Net income

   $ 206      $ 195        6
  

 

 

   

 

 

   

 

 

 

Net income available to common stockholders

   $ 198      $ 195        2

Earnings per common share – diluted

   $ .15      $ .15          

Net revenue growth (decline) from prior year

     8     (1 )%   

Pre-tax profit margin

     25.7     26.3  

Return on average common stockholders’ equity (annualized)  (2)

     9     10  

Annualized net revenue per average full-time equivalent employee (in thousands)

     369        340        9

 

(1)  

Includes inflows of $12.0 billion in the first quarter of 2012 from a mutual fund clearing services client.

(2)  

Calculated as net income available to common stockholders divided by average common stockholders’ equity.

The broad equity markets improved during the first quarter of 2013 compared to the first quarter of 2012, as the Standard & Poor’s 500 Index, Dow Jones Industrial Average, and Nasdaq Composite Index increased 11%, 10%, and 6%, respectively. While the federal funds target rate remained unchanged at a range of zero to 0.25%, the average three-month Treasury Bill yield increased by 2 basis points to 0.08% during the first quarter of 2013 compared to the first quarter of 2012. At the same time, the average 10-year Treasury yield decreased by 9 basis points to 1.93%.

The Company’s key client activity metrics demonstrated strong business momentum during the first quarter of 2013 – net new client assets totaled $43.4 billion, up 12% from the first quarter of 2012 and were the highest first quarter core flows since 2000. Total client assets ended the quarter at a record $2.08 trillion, up 14% from the first quarter of 2012. In addition, the Company added 244,000 new brokerage accounts to its client base during the first quarter of 2013, and active brokerage accounts were 8.9 million, up 3% on a year-over-year basis.

For the first quarter of 2013, despite the low interest rate environment and relatively muted trading activity, the Company’s growing client base and continued investments in its clients helped net revenues grow by 8% from the first quarter of 2012. Net revenues increased primarily due to increases in asset management and administration fees and net interest revenue and lower net impairment losses on securities, partially offset by a decrease in trading revenue. Asset management and administration fees increased primarily due to increases in mutual fund service fees and advice solutions fees. Net interest revenue increased primarily due to higher balances of interest-earning assets partially offset by the effect of the continued low interest rate environment. Trading revenue decreased primarily due to lower daily average revenue trades.

Expenses excluding interest increased by 9% in the first quarter of 2013 compared to the first quarter of 2012 primarily due to an increase in compensation and benefits and advertising and market development. Compensation and benefits expense

 

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Table of Contents

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 primarily due to higher incentive compensation and employee benefits, which included expenses relating to the transition to a new payout schedule for field incentive plans, increased and accelerated health savings account (HSA) contributions, and equity incentive plan changes to vesting for retirement-eligible employees in the first quarter of 2013.

As a result of the growth in net revenues, the Company achieved a pre-tax profit margin of 25.7% in the first quarter of 2013. Overall, net income increased by 6% and return on average common stockholders’ equity declined slightly to 9% in the first quarter of 2013 compared to the first quarter of 2012.

CURRENT MARKET AND REGULATORY ENVIRONMENT AND OTHER DEVELOPMENTS

As discussed above, interest rates remained at low levels during the first quarter of 2013. To the extent rates remain at these low levels, the Company’s net interest revenue will continue to be constrained, even as growth in average balances helps to increase such revenue. The low interest rate environment also affects asset management and administration fees. The overall yields on certain Schwab-sponsored money market mutual funds have remained at levels at or below the management fees on those funds. The Company continues to waive a portion of its management fees so that the funds can maintain a positive return to clients. These and other money market mutual funds may not be able to replace maturing securities with securities of equal or higher yields. As a result, the yields on such funds may remain around or decline from their current levels, and therefore below the stated management fees on those funds. To the extent this occurs, asset management and administration fees may be negatively affected.

In 2012, the Board of Governors of the Federal Reserve System (the Federal Reserve) issued notices of proposed rulemaking (NPRs) to meet certain requirements of the “Dodd-Frank Wall Street Reform and Consumer Protection Act” and to align current capital rules with the BASEL III capital standards. The NPRs would subject all savings and loan holding companies, including CSC, to consolidated capital requirements. In addition, the NPRs would establish more restrictive capital definitions, higher risk-weightings for certain asset classes, higher minimum capital ratios and capital buffers. The Company expects the capital standard rules to be phased in under an extended time frame after adoption. The comment period for the NPRs ended on October 22, 2012, and the NPRs are subject to further modification. CSC continues to monitor developments in order to assess the impact of the NPRs but does not expect them to have a material impact on the Company’s business, financial condition, and results of operations.

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

In April 2013, the SEC published notice of a National Securities Clearing Corporation (NSCC) proposed rule change that would impose a supplemental liquidity funding obligation on certain NSCC participants. The stated purpose is to provide the NSCC with sufficient liquidity and financial resources to withstand a default by one of its members. The rule change, as currently proposed, could require the Company to provide a supplemental liquidity deposit. The Company does not have sufficient information to assess the potential impact of the proposed rule change, which is subject to comment and further modification.

 

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Table of Contents

THE CHARLES SCHWAB CORPORATION

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

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

 

RESULTS OF OPERATIONS

The following discussion presents an analysis of the Company’s results of operations for the first quarter of 2013 compared to the first quarter of 2012.

Net Revenues

The Company’s major sources of net revenues are asset management and administration fees, net interest revenue, and trading revenue. Asset management and administration fees and net interest revenue increased, while trading revenue decreased in the first quarter of 2013 compared to the first quarter of 2012.

 

Three Months Ended March 31,          2013     2012  
     Percent
Change
    Amount     % of
Total Net
Revenues
    Amount     % of
Total Net
Revenues
 

Asset management and administration fees

          

Schwab money market funds before fee waivers

     4   $     230        $     222     

Fee waivers

     (5 )%      (155       (163  
  

 

 

   

 

 

     

 

 

   

Schwab money market funds after fee waivers

     27 %     75        6 %     59        5 %

Equity and bond funds

     9 %     35        3 %     32        3 %

Mutual Fund OneSource ®

     11 %     184        14 %     166        14 %
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total mutual funds

     14 %     294        23 %     257        22 %

Advice solutions

     17 %     163        13 %     139        12 %

Other

     8 %     95        7 %     88        7 %
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Asset management and administration fees

     14 %     552        43 %     484        41 %
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net interest revenue

          

Interest revenue

     5     497        38 %     472        40 %

Interest expense

     (26 )%      (28     (2 )%      (38     (3 )% 
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net interest revenue

     8     469        36 %     434        37 %
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Trading revenue

          

Commissions

     (8 )%      211        16 %     229        19 %

Principal transactions

     (14 )%      12        1 %     14        1 %
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Trading revenue

     (8 )%      223        17 %     243        20 %
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Other

     22     56        4 %     46        4 %
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Provision for loan losses

            N/M        (6     —                   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net impairment losses on securities

     (78 )%      (4     —          (18     (2 )% 
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total net revenues

     8 %   $     1,290                100 %   $     1,189                100 %
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

N/M Not meaningful.

Asset Management and Administration Fees

Asset management and administration fees include mutual fund service fees and fees for other asset-based financial services provided to individual and institutional clients. The Company earns mutual fund service fees for shareholder services, administration, and investment management provided to its proprietary funds, and recordkeeping and shareholder services provided to third-party funds. These fees are based upon the daily balances of client assets invested in these funds. The Company also earns asset management fees for advice solutions, which include advisory and managed account services that are based on the daily balances of client assets subject to the specific fee for service. The fair values of client assets included in proprietary and third-party mutual funds are based on quoted market prices and other observable market data. Other asset management and administration fees include various asset based fees, such as third-party mutual fund service fees, trust fees, 401k record keeping fees, and mutual fund clearing and other service fees. Asset management and administration fees vary

 

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Table of Contents

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)

 

with changes in the balances of client assets due to market fluctuations and client activity. For a discussion of the impact of current market conditions on asset management and administration fees, see “Current Market and Regulatory Environment and Other Developments.”

Asset management and administration fees increased by $68 million, or 14%, in the first quarter of 2013 compared to the first quarter of 2012 primarily due to increases in mutual fund service fees and advice solutions fees.

Mutual fund service fees increased by $37 million, or 14%, in the first quarter of 2013 compared to the first quarter of 2012 primarily due to growth in client assets invested in Mutual Fund OneSource funds and an increase in net money market mutual fund fees as a result of improved short-term rates.

Advice solutions fees increased by $24 million, or 17%, in the first quarter of 2013 compared to first quarter of 2012 primarily due to growth in client assets enrolled in retail advisory offers, including Windhaven ® and Schwab Private Client.

Net Interest Revenue

Net interest revenue is the difference between interest earned on interest-earning assets and interest paid on funding sources. Net interest revenue is affected by changes in the volume and mix of these assets and liabilities, as well as by fluctuations in interest rates and portfolio management strategies. The Company’s investment strategy is structured to produce an increase in net interest revenue when interest rates rise and, conversely, a decrease in net interest revenue when interest rates fall (i.e., interest-earning assets generally reprice more quickly than interest-bearing liabilities). When interest rates fall, the Company may attempt to mitigate some of this negative impact by extending the maturities of assets in investment portfolios to lock in asset yields, and by lowering rates paid to clients on interest-bearing liabilities. Since the Company establishes the rates paid on certain brokerage client cash balances and deposits from banking clients, as well as the rates charged on receivables from brokerage clients, and also controls the composition of its investment securities, it has some ability to manage its net interest spread. However, the spread is influenced by external factors such as the interest rate environment and competition. The current low interest rate environment limits the extent to which the Company can reduce interest expense paid on funding sources. For discussion of the impact of current market conditions on net interest revenue, see “Current Market and Regulatory Environment and Other Developments.”

The Company’s interest-earning assets are financed primarily by brokerage client cash balances and deposits from banking clients. Non-interest-bearing funding sources include non-interest-bearing brokerage client cash balances and proceeds from stock-lending activities, as well as stockholders’ equity.

Schwab Bank maintains investment portfolios for liquidity as well as to invest funds from deposits in excess of loans to banking clients and liquidity limits. Schwab Bank’s securities available for sale include mortgage-backed securities, asset-backed securities, corporate debt securities, certificates of deposit, U.S. agency notes, commercial paper, and other securities. Schwab Bank’s securities held to maturity include mortgage-backed and other securities. Schwab Bank lends funds to banking clients primarily in the form of mortgage loans and home equity lines of credit (HELOCs). These loans are largely funded by interest-bearing deposits from banking clients.

In clearing their clients’ trades, Charles Schwab & Co., Inc. (Schwab) and optionsXpress, Inc. hold cash balances payable to clients. In most cases, Schwab and optionsXpress, Inc. pay their clients interest on cash balances awaiting investment, and in turn invest these funds and earn interest revenue. Receivables from brokerage clients consist primarily of margin loans to brokerage clients. Margin loans are loans made to clients on a secured basis to purchase securities. Pursuant to applicable regulations, client cash balances that are not used for margin lending are generally segregated into investment accounts that are maintained for the exclusive benefit of clients, which are recorded in cash and investments segregated on the Company’s condensed consolidated balance sheets.

 

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Table of Contents

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 condensed consolidated balance sheet:

 

                                                                                         
Three Months Ended March 31,    2013     2012  
            Interest      Average            Interest      Average  
     Average      Revenue/      Yield/     Average      Revenue/      Yield/  
     Balance      Expense      Rate     Balance      Expense      Rate  

Interest-earning assets:

                

Cash and cash equivalents

   $ 7,907       $ 5         0.26   $ 6,246       $ 4         0.26

Cash and investments segregated

     27,590         12         0.18     26,847         10         0.15

Broker-related receivables  (1)

     361                 0.13     315                 0.09

Receivables from brokerage clients

     11,342         106         3.79     10,200         106         4.18

Securities available for sale  (2)

     46,908         138         1.19     36,197         145         1.61

Securities held to maturity

     21,063         131         2.52     14,972         99         2.66

Loans to banking clients

     11,091         80         2.93     9,864         79         3.22

Loans held for sale

                            53         1         4.15
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Total interest-earning assets

     126,262         472         1.52     104,694         444         1.71
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Other interest revenue

        25              28      
     

 

 

         

 

 

    

Total interest-earning assets

   $ 126,262       $ 497         1.60   $     104,964       $ 472         1.81
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Funding sources:

                

Deposits from banking clients

   $ 80,341       $ 10         0.05   $ 61,105       $ 10         0.07

Payables to brokerage clients

     32,096         1         0.01     30,560         1         0.01

Long-term debt

     1,632         17         4.22     2,001         27         5.43
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Total interest-bearing liabilities

     114,069         28         0.10     93,666         38         0.16
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Non-interest-bearing funding sources

     12,193              11,028         
  

 

 

         

 

 

       

Total funding sources

   $     126,262       $ 28         0.09   $ 104,964       $ 38         0.14
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Net interest revenue

      $     469         1.51      $     434         1.67
     

 

 

    

 

 

      

 

 

    

 

 

 

 

(1)  

Interest revenue was less than $500,000 in the periods presented.

(2)  

Amounts have been calculated based on amortized cost.

Net interest revenue increased in the first quarter of 2013 compared to the first quarter of 2012, primarily due to higher balances of interest-earning assets, including securities available for sale and securities held to maturity, partially offset by the effect of the continued low interest rate environment. The current low interest rate environment limited the extent to which the Company could reduce interest expense paid on funding sources. The growth in the average balance of deposits from banking clients funded the increase in the balances of securities available for sale and securities held to maturity. The increase in net interest revenue was also attributed to the redemption of higher yielding trust preferred securities and exchange of higher yielding Senior Notes in the third quarter of 2012.

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 client fixed income securities. To accommodate clients’ fixed income trading activity, the Company maintains positions in fixed income securities, including state and municipal debt obligations, U.S. Government, 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 unrealized gains and losses on these securities positions. Factors that influence principal transaction revenue include the volume of client trades and market price volatility.

 

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Table of Contents

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)

 

Trading revenue decreased by $20 million, or 8%, in the first quarter of 2013 compared to the first quarter of 2012 primarily due to lower daily average revenue trades as a result of relatively muted trading activity. Daily average revenue trades decreased in the first quarter of 2013 primarily due to a lower volume of option, future, and equity trades. Average revenue per revenue trade remained relatively flat in the first quarter of 2013 compared to the first quarter of 2012.

 

     Three Months Ended
March 31,
     Percent
 Change 
 
     2013      2012     

Daily average revenue trades (1)  (in thousands)

     298.7         318.4         (6 )% 

Clients’ daily average trades (2) (in thousands)

     498.9         476.2         5

Number of trading days

     60.0         62.0         (3 )% 

Average revenue per revenue trade

   $     12.34       $     12.35           

 

(1)  

Includes all client trades that generate trading revenue (i.e., commission revenue or revenue from fixed income securities trading).

(2)  

Includes daily average revenue trades, trades by clients in asset-based pricing relationships, and all commission-free trades, including the Company’s Mutual Fund OneSource funds and ETFs, and other proprietary products. Clients’ daily average trades is an indicator of client engagement with securities markets.

Other Revenue

Other revenue includes order flow revenue, software fees from the Company’s portfolio management services, exchange processing fees, and other service fees. Other revenue increased by $10 million, or 22%, in the first quarter of 2013 from the first quarter of 2012 primarily due to order flow revenue that Schwab began receiving in November 2012.

Expenses Excluding Interest

As shown in the table below, expenses excluding interest increased in the first quarter of 2013 compared to the first quarter of 2012 primarily due to increases in compensation and benefits and advertising and market development.

 

     Three Months Ended
March 31,
    Percent
Change
 
     2013     2012    

Compensation and benefits

   $     536      $     465        15 %

Professional services

     99        96        3

Occupancy and equipment

     77        76        1

Advertising and market development

     74        67        10 %

Communications

     54        58        (7 )% 

Depreciation and amortization

     51        48        6 %

Other

     68        66        3
  

 

 

   

 

 

   

 

 

 

Total expenses excluding interest

   $ 959      $ 876        9 %
  

 

 

   

 

 

   

 

 

 

Expenses as a percentage of total net revenues:

      

Total expenses excluding interest

     74     74  

Advertising and market development

     6     6  

Compensation and Benefits

Compensation and benefits expense includes salaries and wages, incentive compensation, and related employee benefits and taxes. Incentive compensation includes variable compensation, discretionary bonuses, and stock-based compensation. Variable compensation includes payments to certain individuals based on their sales performance. Discretionary bonuses are based on the Company’s overall performance as measured by earnings per common share, and therefore will fluctuate with this measure. Stock-based compensation primarily includes employee and board of director stock options, restricted stock units, and restricted stock awards.

 

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Table of Contents

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)

 

Compensation and benefits expense increased by $71 million, or 15%, in the first quarter of 2013 compared to the first quarter of 2012 due to increases in salaries and wages, incentive compensation and employee benefits and other expense. The following table shows a comparison of certain compensation and benefits components and employee data:

 

     Three Months Ended        
     March 31,     Percent  
     2013     2012     Change  

Salaries and wages

   $ 284      $ 271                  5

Incentive compensation

     163        116        41

Employee benefits and other

     89        78        14
  

 

 

   

 

 

   

 

 

 

Total compensation and benefits expense

   $     536      $     465        15
  

 

 

   

 

 

   

 

 

 

Compensation and benefits expense as a percentage of total net revenues:

      

Salaries and wages

     22     23  

Incentive compensation

     13     10  

Employee benefits and other

     7     6  
  

 

 

   

 

 

   

Total compensation and benefits expense

     42     39  
  

 

 

   

 

 

   

Full-time equivalent employees  (1) (in thousands)

      

At quarter end

     14.0        14.0          

Average

     14.0        14.0          

 

(1)  

Includes full-time, part-time and temporary employees, and persons employed on a contract basis, and excludes employees of outsourced service providers.

Salaries and wages increased in the first quarter of 2013 compared to the first quarter of 2012 primarily due to annual salary increases.

Incentive compensation increased in the first quarter of 2013 compared to the first quarter of 2012 primarily due to expenses relating to the transition to a new payout schedule for field incentive plans and equity incentive plan changes to vesting for retirement-eligible employees. The increase in incentive compensation was also attributed to higher discretionary bonuses in the first quarter of 2013.

Employee benefits and other expense increased in the first quarter of 2013 compared to the first quarter of 2012 primarily due to increased and accelerated contributions to new employee HSAs. The Company funded its entire annual contribution to employee HSAs in the first quarter of 2013. The Company is converting to HSA-focused healthcare and employee enrollment in these plans has risen significantly in 2013.

Expenses Excluding Compensation and Benefits

Advertising and market development expense increased in the first quarter of 2013 compared to the first quarter of 2012 primarily due to higher spending on customer promotions.

Taxes on Income

The Company’s effective income tax rate on income before taxes was 37.8% and 37.7% for the first quarters of 2013 and 2012, respectively. The slight increase was primarily due to a higher effective state income tax rate in the first quarter of 2013.

Segment Information

The Company provides financial services to individuals and institutional clients through two segments – Investor Services and Advisor Services. In the first quarter of 2013, the Company realigned its reportable segments as a result of organizational changes. The segment formerly reported as Institutional Services was renamed to Advisor Services. The Retirement Plan Services and Corporate Brokerage Services business units are now part of the Investor Services segment. Prior period segment information has been recast to reflect these organizational changes. The Investor Services segment provides retail

 

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Table of Contents

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)

 

brokerage and banking services to individual investors, retirement plan services, and corporate brokerage services. The Advisor Services segment provides custodial, trading, and support services to independent investment advisors, and retirement business services to independent retirement plan advisors and recordkeepers whose plan assets are held at Schwab Bank. Banking revenues and expenses are allocated to the Company’s two segments based on which segment services the client. The Company evaluates the performance of its segments on a pre-tax basis, excluding items such as significant nonrecurring gains, impairment charges on non-financial assets, discontinued operations, extraordinary items, and significant restructuring and other charges. Segment assets and liabilities are not used for evaluating segment performance or in deciding how to allocate resources to segments.

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

 

                                                                                               
Three Months Ended March 31,    Investor Services     Advisor Services  
   Percent                 Percent              
   Change     2013     2012     Change     2013     2012  

Net Revenues:

            

Asset management and administration fees

     13 %   $ 387      $ 341        16 %   $ 165      $ 142   

Net interest revenue

     8     413        384        12 %     56        50   

Trading revenue

     (14 )%      149        174        7     74        69   

Other

     31     42        32        (7 )%     14        15   

Provision for loan losses

     N/M        (5            N/M        (1       

Net impairment losses on securities

     (76 )%      (4     (17     (100 )%             (1
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total net revenues

     7     982        914        12 %     308        275   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Expenses Excluding Interest

     9 %     751        690        12 %     208        186   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income before taxes on income

     3   $ 231      $ 224        12 %   $ 100      $ 89   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
Three Months Ended March 31,    Unallocated     Total  
   Percent                 Percent              
   Change     2013     2012     Change     2013     2012  

Net Revenues:

            

Asset management and administration fees

     N/M      $      $ 1        14 %   $ 552      $ 484   

Net interest revenue

     N/M                      8     469        434   

Trading revenue

     N/M                      (8 )%      223        243   

Other

     N/M               (1     22     56        46   

Provision for loan losses

     N/M                      N/M        (6       

Net impairment losses on securities

     N/M                      (78 )%      (4     (18
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total net revenues

     N/M                      8 %     1,290        1,189   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Expenses Excluding Interest

     N/M                      9 %     959        876   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income before taxes on income

     N/M      $      $        6   $ 331      $ 313   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Taxes on income

           6     125        118   
        

 

 

   

 

 

   

 

 

 

Net Income

           6 %   $ 206      $ 195   
        

 

 

   

 

 

   

 

 

 

 

N/M Not meaningful.

Investor Services

Net revenues increased by $68 million, or 7%, in the first quarter of 2013 compared to the first quarter of 2012 primarily due to increases in asset management and administration fees and net interest revenue and lower net impairment losses on securities, partially offset by a decrease in trading revenue. Asset management and administration fees increased primarily due to increases in mutual fund service fees and advice solution fees as a result of growth in client assets invested in the Company’s Mutual Fund OneSource funds and client assets enrolled in retail advisory offers, respectively. Net interest revenue increased primarily due to higher balances of interest-earning assets, partially offset by the effect of the continued low interest rate environment. Trading revenue decreased primarily due to lower daily average revenue trades. Expenses excluding interest increased by $61 million, or 9%, in the first quarter of 2013 compared to the first quarter of 2012 primarily due to an increase in compensation and benefits expense as a result of higher incentive compensation, which included expenses relating

 

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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)

 

to the transition to a new payout schedule for field incentive plans and equity incentive plan changes to vesting for retirement-eligible employees.

Advisor Services

Net revenues increased by $33 million, or 12%, in the first quarter of 2013 compared to the first quarter of 2012 primarily due to increases in asset management and administration fees and net interest revenue. Asset management and administration fees increased primarily due to an increase in mutual fund service fees as a result of growth in client assets invested in the Company’s Mutual Fund OneSource funds and an increase in net money market mutual fund fees. Net interest revenue increased primarily due to higher balances of interest-earning assets, partially offset by the effect of the continued low interest rate environment. Expenses excluding interest increased by $22 million, or 12%, in the first quarter of 2013 compared to the first quarter 2012 primarily due to an increase in compensation and benefits expense as a result of higher incentive compensation and employee benefits, which included expenses relating to equity incentive plan changes to vesting for retirement-eligible employees and increased and accelerated HSA contributions.

LIQUIDITY AND CAPITAL RESOURCES

CSC conducts substantially all of its business through its wholly-owned subsidiaries. The Company’s capital structure is designed to provide each subsidiary with capital and liquidity to meet its operational needs and regulatory requirements.

CSC is a savings and loan holding company and Schwab Bank, CSC’s depository institution, is a federal savings bank. CSC is subject to supervision and regulation by the Federal Reserve and Schwab Bank is subject to supervision and regulation by the Office of the Comptroller of the Currency (the OCC).

Liquidity

CSC

CSC’s liquidity needs arise from funding its subsidiaries’ operations, including margin and mortgage lending, and transaction settlement, in addition to funding cash dividends, acquisitions, investments, short- and long-term debt, and managing statutory capital requirements.

CSC’s liquidity needs are generally met through cash generated by its subsidiaries, as well as cash provided by external financing. CSC has a universal automatic shelf registration statement (Shelf Registration Statement) on file with the SEC which enables CSC to issue debt, equity and other securities. CSC maintains excess liquidity in the form of overnight cash deposits and short-term investments to cover daily funding needs and to support growth in the Company’s business. Generally, CSC does not hold liquidity at its subsidiaries in excess of amounts deemed sufficient to support the subsidiaries’ operations, including any regulatory capital requirements. Schwab, Schwab Bank, and optionsXpress, Inc. are subject to regulatory requirements that may restrict them from certain transactions with CSC, as further discussed below. Management believes that funds generated by the operations of CSC’s subsidiaries will continue to be the primary funding source in meeting CSC’s liquidity needs, providing adequate liquidity to meet Schwab Bank’s capital guidelines, and maintaining Schwab and optionsXpress, Inc.’s net capital.

While CSC is not currently subject to specific statutory capital requirements, CSC is required to serve as a source of strength for Schwab Bank and must have the ability to provide financial assistance if Schwab Bank experiences financial distress. To manage capital adequacy, the Company currently utilizes a target Tier 1 Leverage Ratio for CSC, as defined by the Federal Reserve, of at least 6%. At March 31, 2013, CSC’s Tier 1 Leverage Ratio was 6.1%, Tier 1 Capital Ratio was 16.8%, and Total Capital Ratio was 16.9%.

The following are details of CSC’s long-term debt:

 

                                                                                                                                               
     Par                     Standard     

March 31, 2013

   Outstanding      Maturity    Interest Rate    Moody’s    & Poor’s    Fitch

Senior Notes

   $     1,306       2015 - 2022    0.850% to 4.45% fixed    A2    A    A

Medium-Term Notes

   $ 250       2017    6.375% fixed    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)

 

CSC has authorization from its Board of Directors to issue unsecured commercial paper notes (Commercial Paper Notes) not to exceed $1.5 billion. Management has set a current limit for the commercial paper program of $800 million. The maturities of the Commercial Paper Notes may vary, but are not to exceed 270 days from the date of issue. The commercial paper is not redeemable prior to maturity and cannot be voluntarily prepaid. The proceeds of the commercial paper program are to be used for general corporate purposes. There were no borrowings of Commercial Paper Notes outstanding at March 31, 2013. CSC’s ratings for these short-term borrowings are P1 by Moody’s, A1 by Standard & Poor’s, and F1 by Fitch.

CSC maintains an $800 million committed, unsecured credit facility with a group of 11 banks, which is scheduled to expire in June 2013. This facility replaced a similar facility that expired in June 2012 and was unused during the first quarter of 2013. The funds under this facility are available for general corporate purposes. The financial covenants under this facility require Schwab to maintain a minimum net capital ratio, as defined, Schwab Bank to be well capitalized, as defined, and CSC to maintain a minimum level of stockholders’ equity. At March 31, 2013, the minimum level of stockholders’ equity required under this facility was $5.9 billion (CSC’s stockholders’ equity at March 31, 2013, was $9.8 billion). Management believes that these restrictions will not have a material effect on CSC’s ability to meet foreseeable dividend or funding requirements.

CSC also has direct access to $641 million of the $941 million uncommitted, unsecured bank credit lines discussed below, that are primarily utilized by Schwab to manage short-term liquidity. These lines were not used by CSC during the first quarter of 2013.

In addition, Schwab provides CSC with a $1.0 billion credit facility, which is scheduled to expire in December 2014. There were no funds drawn under this facility at March 31, 2013.

Schwab

Schwab’s liquidity needs relating to client trading and margin borrowing activities are met primarily through cash balances in brokerage client accounts, which were $34.7 billion and $37.4 billion at March 31, 2013 and December 31, 2012, respectively. Management believes that brokerage client cash balances and operating earnings will continue to be the primary sources of liquidity for Schwab.

Schwab is subject to regulatory requirements that are intended to ensure the general financial soundness and liquidity of broker-dealers. These regulations prohibit Schwab from repaying subordinated borrowings from CSC, paying cash dividends, or making unsecured advances or loans to its parent company or employees if such payment would result in a net capital amount of less than 5% of aggregate debit balances or less than 120% of its minimum dollar requirement of $250,000. At March 31, 2013, Schwab’s net capital was $1.4 billion (10% of aggregate debit balances), which was $1.1 billion in excess of its minimum required net capital and $700 million in excess of 5% of aggregate debit balances.

Schwab is also subject to Rule 15c3-3 under the Securities Exchange Act of 1934 and other applicable regulations that require it to maintain cash or qualified securities in a segregated reserve account for the exclusive benefit of clients. These funds are included in cash and investments segregated and on deposit for regulatory purposes in the Company’s condensed consolidated balance sheets and are not available as a general source of liquidity.

Most of Schwab’s assets are readily convertible to cash, consisting primarily of short-term (i.e., less than 150 days) investment-grade, interest-earning investments (the majority of which are segregated for the exclusive benefit of clients pursuant to regulatory requirements), receivables from brokerage clients, and receivables from brokers, dealers, and clearing organizations. Client margin loans are demand loan obligations secured by readily marketable securities. Receivables from and payables to brokers, dealers, and clearing organizations primarily represent current open transactions, which usually settle, or can be closed out, within a few business days.

Schwab has a finance lease obligation related to an office building and land under a 20-year lease. The remaining finance lease obligation of $93 million at March 31, 2013, is being reduced by a portion of the lease payments over the remaining lease term of 12 years.

To manage short-term liquidity, Schwab maintains uncommitted, unsecured bank credit lines with a group of six banks totaling $941 million at March 31, 2013. The need for short-term borrowings arises primarily from timing differences

 

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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)

 

between cash flow requirements, scheduled liquidation of interest-earning investments, and movements of cash to meet regulatory brokerage client cash segregation requirements. Schwab used such borrowings for four days during the first quarter of 2013, with average daily amounts borrowed of $47 million. There were no borrowings outstanding under these lines at March 31, 2013.

To partially satisfy the margin requirement of client option transactions with the Options Clearing Corporation, Schwab has unsecured standby letter of credit agreements (LOCs) with five banks in favor of the Options Clearing Corporation aggregating $225 million at March 31, 2013. In connection with its securities lending activities, Schwab is required to provide collateral to certain brokerage clients. Schwab satisfies the collateral requirements by arranging LOCs, in favor of these brokerage clients, which are issued by multiple banks. At March 31, 2013, the aggregate face amount of these LOCs totaled $104 million. There were no funds drawn under any of these LOCs during the first quarter of 2013.

To manage Schwab’s regulatory capital requirement, CSC provides Schwab with a $1.4 billion subordinated revolving credit facility, which is scheduled to expire in March 2014. The amount outstanding under this facility at March 31, 2013, was $315 million. Borrowings under this subordinated lending arrangement qualify as regulatory capital for Schwab.

In addition, CSC provides Schwab with a $2.5 billion credit facility, which is scheduled to expire in December 2014. Borrowings under this facility do not qualify as regulatory capital for Schwab. There were no funds drawn under this facility at March 31, 2013.

Schwab Bank

Schwab Bank’s liquidity needs are met through deposits from banking clients and equity capital.

Deposits from banking clients at March 31, 2013, were $82.4 billion, which includes the excess cash held in certain Schwab and optionsXpress, Inc. brokerage client accounts that is swept into deposit accounts at Schwab Bank. At March 31, 2013, these balances totaled $60.9 billion.

Schwab Bank is subject to regulatory requirements that restrict and govern the terms of affiliate transactions, such as extensions of credit and repayment of loans between Schwab Bank and CSC or CSC’s other subsidiaries. In addition, Schwab Bank is required to provide notice to and may be required to obtain approval of the OCC and the Federal Reserve to declare dividends to CSC.

Schwab Bank is required to maintain capital levels as specified in federal banking laws and regulations. Failure to meet the minimum levels could result in certain mandatory, and possibly additional discretionary actions by the regulators that, if undertaken, could have a direct material effect on Schwab Bank. The Company currently utilizes a target Tier 1 Leverage Ratio for Schwab Bank of at least 6.25%. Based on its regulatory capital ratios at March 31, 2013, Schwab Bank is considered well capitalized. Schwab Bank’s regulatory capital and ratios are as follows:

 

     Actual     Minimum Capital
Requirement
    Minimum to be
Well Capitalized
 

March 31, 2013

   Amount      Ratio     Amount      Ratio     Amount      Ratio  

Tier 1 Risk-Based Capital

   $     5,836                 18.5   $     1,259                   4.0   $ 1,889         6.0

Total Risk-Based Capital

   $ 5,896         18.7   $ 2,518         8.0   $     3,418                 10.0

Tier 1 Leverage

   $ 5,836         6.6   $ 3,538         4.0   $ 4,423         5.0

Tangible Equity

   $ 5,836         6.6   $ 1,769         2.0     N/A      

 

N/A Not applicable.

Schwab Bank has access to traditional funding sources such as deposits, federal funds purchased, and repurchase agreements. Additionally, Schwab Bank has access to short-term funding through the Federal Reserve Bank (FRB) discount window. Amounts available under the FRB discount window are dependent on the fair value of Schwab Bank’s securities available for sale and/or securities held to maturity that are pledged as collateral to the FRB. Schwab Bank maintains policies and procedures necessary to access this funding and tests discount window borrowing procedures annually. At March 31, 2013, $2.7 billion was available under this arrangement. There were no funds drawn under this arrangement during the first quarter of 2013.

 

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THE CHARLES SCHWAB CORPORATION

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

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

 

Schwab Bank maintains a credit facility with the Federal Home Loan Bank System. Amounts available under this facility are dependent on the amount of Schwab Bank’s residential real estate mortgages and HELOCs that are pledged as collateral. At March 31, 2013, $5.7 billion was available under this facility. There were no funds drawn under this facility during the first quarter of 2013.

CSC provides Schwab Bank with a $100 million short-term credit facility, which is scheduled to expire in December 2014. Borrowings under this facility do not qualify as regulatory capital for Schwab Bank. There were no funds drawn under this facility during the first quarter of 2013.

optionsXpress, Inc.

optionsXpress, Inc.’s liquidity needs relating to client trading and margin borrowing activities are met primarily through cash balances in brokerage client accounts, which were $1.2 billion at March 31, 2013. Management believes that brokerage client cash balances and operating earnings will continue to be the primary sources of liquidity for optionsXpress, Inc.

optionsXpress, Inc., is subject to regulatory requirements that are intended to ensure the general financial soundness and liquidity of broker-dealers. These regulations prohibit optionsXpress, Inc. from paying cash dividends or making unsecured advances or loans to its parent company or employees if such payment would result in a net capital amount of less than 5% of aggregate debit balances or less than 120% of its minimum dollar requirement of $250,000. At March 31, 2013, optionsXpress, Inc.’s net capital was $89 million (31% of aggregate debit balances), which was $83 million in excess of its minimum required net capital and $75 million in excess of 5% of aggregate debit balances.

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

Additionally, optionsXpress, Inc. is subject to Rule 15c3-3 under the Securities Exchange Act of 1934 and other applicable regulations that require it to maintain cash or qualified securities in a segregated reserve account for the exclusive benefit of clients. These funds are included in cash and investments segregated and on deposit for regulatory purposes in the Company’s condensed consolidated balance sheets and are not available as a general source of liquidity.

CSC provides optionsXpress, Inc. with a $200 million credit facility, which is scheduled to expire in December 2014. Borrowings under this facility do not qualify as regulatory capital for optionsXpress, Inc. There were no borrowings outstanding under this facility at March 31, 2013.

optionsXpress Holdings, Inc., optionsXpress, Inc.’s parent company, has a term loan with CSC, of which $84 million was outstanding at March 31, 2013, and it matures in December 2017.

Capital Resources

The Company monitors both the relative composition and absolute level of its capital structure. Management is focused on limiting the Company’s use of capital and currently targets a long-term debt to total financial capital ratio not to exceed 30%. The Company’s total financial capital (long-term debt plus stockholders’ equity) at March 31, 2013, was $11.4 billion, up $186 million, or 2%, from December 31, 2012.

The Company’s cash position (reported as cash and cash equivalents on its condensed consolidated balance sheets) and cash flows are affected by changes in brokerage client cash balances and the associated amounts required to be segregated under regulatory guidelines. Timing differences between cash and investments actually segregated on a given date and the amount required to be segregated for that date may arise in the ordinary course of business, and are addressed by the Company in accordance with applicable regulations. Other factors which affect the Company’s cash position and cash flows include investment activity in security portfolios, levels of capital expenditures, acquisition and divestiture activity, banking client deposit activity, brokerage and banking client loan activity, financing activity in long-term debt, payments of dividends, and

 

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THE CHARLES SCHWAB CORPORATION

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

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

 

repurchases and issuances of CSC’s preferred and common stock. The combination of these factors can cause significant fluctuations in the cash position during specific time periods.

Long-term Debt

At March 31, 2013, the Company had long-term debt of $1.6 billion, or 14% of total financial capital, that bears interest at a weighted-average rate of 3.84%. At December 31, 2012, the Company had long-term debt of $1.6 billion, or 15% of total financial capital. The Company repaid $2 million of long-term debt in the first quarter of 2013.

Capital Expenditures

The Company’s capital expenditures were $46 million and $34 million in the first quarters of 2013 and 2012, respectively. Capital expenditures in the first quarter of 2013 were primarily for developing internal-use software, software and equipment relating to the Company’s information technology systems, and land. Capital expenditures for the first quarter of 2012 were primarily for developing internal-use software, software and equipment relating to the Company’s information technology systems, and leasehold improvements. Capitalized costs for developing internal-use software were $17 million and $14 million in the first quarters of 2013 and 2012, respectively.

As discussed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012, management anticipated that 2013 capital expenditures would be approximately 85% higher than 2012. Management currently anticipates that full-year 2013 capital expenditures will be approximately 125% higher than 2012 levels primarily due to the accelerated timing of spending on buildings relating to the consolidation and relocation of the Company’s existing office campus in Colorado, which is expected to be completed in 2014.

Dividends

CSC paid common stock cash dividends of $77 million ($0.06 per share) in both the first quarters of 2013 and 2012.

CSC paid Series A Preferred Stock cash dividends of $14 million ($35.00 per share) and Series B Preferred Stock cash dividends of $7 million ($15.00 per share) in the first quarter of 2013.

Share Repurchases

There were no repurchases of CSC’s common stock in the first quarters of 2013 or 2012. As of March 31, 2013, CSC had remaining authority from the Board of Directors to repurchase up to $596 million of its common stock, which does not have an expiration date.

Off-Balance Sheet Arrangements

The Company enters into various off-balance sheet arrangements in the ordinary course of business, primarily to meet the needs of its clients. These arrangements include firm commitments to extend credit. Additionally, the Company enters into guarantees and other similar arrangements as part of transactions in the ordinary course of business. For discussion on the Company’s off-balance sheet arrangements, see “Part II – Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012, and “Item 1 – Condensed Consolidated Financial Statements (Unaudited) – Notes – 4. Commitments and Contingencies.”

RISK MANAGEMENT

The Company’s business activities expose it to a variety of risks, including operational, credit, market, liquidity, and reputational risk. Identification and management of these risks are essential to the success and financial soundness of the Company.

 

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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)

 

For a discussion on risks that the Company faces and the policies and procedures for risk identification, assessment, and management, see “Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations – Risk Management” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012. For updated information on the Company’s credit risk and concentration risk exposures, see below. See “Item 3 – Quantitative and Qualitative Disclosures About Market Risk” for additional information relating to market risk.

Risk is inherent in the Company’s business. Consequently, despite the Company’s efforts to identify areas of risk and implement risk management policies and procedures, there can be no assurance that the Company will not suffer unexpected losses due to operational or other risks.

Credit Risk Exposures

The Company’s credit risk exposure related to loans to banking clients is actively managed through individual and portfolio reviews performed by management. 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, which is reviewed quarterly by management. The Company’s mortgage loan portfolios primarily include first lien residential real estate mortgage loans (First Mortgages) of $7.1 billion and HELOCs of $3.2 billion at March 31, 2013.

The Company’s First Mortgage portfolio underwriting requirements are generally consistent with the underwriting requirements in the secondary market for loan portfolios. The Company’s underwriting guidelines include maximum loan-to-value (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 is conforming or jumbo). These credit underwriting standards have limited the exposure to the types of loans that experienced high foreclosures and loss rates elsewhere in the industry in recent years. There have been no significant changes to the LTV ratio or FICO score underwriting guidelines related to the Company’s First Mortgage or HELOC portfolios during the first quarter of 2013. The Company does not offer 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. At March 31, 2013, approximately 1% of both the First Mortgage and HELOC portfolios consisted of loans to borrowers with updated FICO scores of less than 620.

At March 31, 2013, the weighted-average originated LTV ratio was 59% for both the First Mortgage and HELOC portfolios. The computation of the origination LTV ratio for a HELOC includes any first lien mortgage outstanding on the same property at the time of origination. At March 31, 2013, 22% of HELOCs ($710 million of the HELOC portfolio) were in a first lien position. The weighted-average originated FICO score was 768 for both the First Mortgage and HELOC portfolios.

The Company monitors the estimated current LTV ratios of its First Mortgage and HELOC portfolios on an ongoing basis. At March 31, 2013, the weighted-average estimated current LTV ratios were 58% and 66% for the First Mortgage and HELOC portfolios, respectively. The computation of the estimated current LTV ratio for a HELOC includes any first lien mortgage outstanding on the same property at the time of the HELOC’s origination. The Company estimates the current LTV ratio for each loan by reference to a home price appreciation index. The Company also monitors updated borrower FICO scores, delinquency trends, and verified liquid assets held by individual borrowers. At March 31, 2013, the weighted-average updated FICO scores were 770 and 768 for the First Mortgage and HELOC portfolios, respectively.

A portion of the Company’s HELOC portfolio is secured by second liens on the associated properties. Second lien mortgage loans possess a higher degree of credit risk given the subordination to the first lien holder in the event of default. At March 31, 2013, $2.5 billion, or 78%, of the HELOC portfolio was in a second lien position. In addition to the credit monitoring activities described above, the Company also monitors credit risk on second lien HELOC loans by reviewing the delinquency status of the first lien loan on the associated property. Additionally, at March 31, 2013, approximately 30% of the HELOC borrowers that had a balance only paid the minimum amount due.

For more information on the Company’s credit quality indicators relating to its First Mortgage and HELOC portfolios, including delinquency characteristics, borrower FICO scores at origination, updated borrower FICO scores, LTV ratios at origination, and estimated current LTV ratios, see “Item 1 – Condensed Consolidated Financial Statements (Unaudited) – Notes – 3. Loans to Banking Clients and Related Allowance for Loan Losses.”

 

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THE CHARLES SCHWAB CORPORATION

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

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

 

The following table presents certain of the Company’s loan quality metrics as a percentage of total outstanding loans:

 

     March 31,
2013
    December 31,
2012
 

Loan delinquencies (1)

                   0.55     0.77

Nonaccrual loans

     0.37     0.45

Allowance for loan losses

     0.52     0.52

 

(1)  

Loan delinquencies are defined as loans that are 30 days or more past due.

The Company has exposure to credit risk associated with its securities available for sale and securities held to maturity portfolios, whose fair values totaled $48.8 billion and $23.3 billion at March 31, 2013, respectively. These portfolios include U.S. agency and non-agency mortgage-backed securities, asset-backed securities, corporate debt securities, certificates of deposit, U.S. agency notes, commercial paper, and other securities. 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 the U.S. government-sponsored enterprises. Included in non-agency residential mortgage-backed securities are securities collateralized by loans that are considered to be “Prime” (defined by the Company as loans to borrowers with a FICO score of 620 or higher at origination), and “Alt-A” (defined by the Company as Prime loans with reduced documentation at origination).

Residential mortgage-backed securities, particularly Alt-A securities, experienced continued credit deterioration in the first quarter of 2013, including increased payment delinquency rates and losses on foreclosures of underlying mortgages. At March 31, 2013, the amortized cost of non-agency residential mortgage-backed securities represented 2% of the total mortgage-backed securities portfolio. These securities were originated between 2003 and 2007. At March 31, 2013, all of the corporate debt securities and non-mortgage asset-backed securities were rated investment grade (defined as a rating equivalent to a Moody’s rating of “Baa” or higher, or a Standard & Poor’s rating of “BBB-” or higher).

Concentration Risk Exposures

The Company has exposure to concentration risk when holding large positions in financial instruments collateralized by assets with similar economic characteristics or in securities of a single issuer or industry.

The fair value of the Company’s investments in mortgage-backed securities totaled $43.1 billion at March 31, 2013. Of these, $42.4 billion were issued by U.S. agencies and $709 million were issued by private entities (non-agency securities). The U.S. agency securities are included in securities available for sale and securities held to maturity and the non-agency securities are included in securities available for sale. Included in non-agency residential mortgage-backed securities are securities collateralized by Alt-A loans. At March 31, 2013, the amortized cost and fair value of Alt-A mortgage-backed securities were $295 million and $269 million, respectively.

The Company’s investments in corporate debt securities and commercial paper totaled $9.1 billion at March 31, 2013, with the majority issued by institutions in the financial services industry. These securities are included in securities available for sale, securities held to maturity, cash and cash equivalents, and other securities owned in the Company’s condensed consolidated balance sheets.

The Company’s loans to banking clients include $6.5 billion of adjustable rate first lien residential real estate mortgage loans at March 31, 2013. The Company’s adjustable rate mortgages have initial fixed interest rates for three to ten years and interest rates that adjust annually thereafter. Approximately 45% of these mortgages consisted of loans with interest-only payment terms. The interest rates on approximately 65% of these interest-only loans are not scheduled to reset for three or more years. The Company’s mortgage loans do not include interest terms described as temporary introductory rates below current market rates. At March 31, 2013, 45% of the residential real estate mortgages and 51% of the HELOC balances were secured by properties which are located in California.

 

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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 Company’s HELOC product has a 30-year loan term with an initial draw period of 10 years from the date of origination. After the initial draw period, the balance outstanding at such time is converted to a 20-year amortizing loan. The interest rate during the initial draw period and the 20-year amortizing period is a floating rate based on the prime rate plus a margin. The following table presents when current outstanding HELOCs will convert to amortizing loans:

 

March 31, 2013

   Balance  

Within 1 year

   $ 205   

> 1 year – 3 years

     587   

> 3 years – 5 years

     480   

> 5 years

     1,921   
  

 

 

 

Total

   $     3,193   
  

 

 

 

As of March 31, 2013, all of the Company’s HELOC loans are within the 10-year initial draw period, and as such, none of the HELOCs have converted to an amortizing loan.

The Company also has exposure to concentration risk from its margin and securities lending activities collateralized by securities of a single issuer or industry. This concentration risk is mitigated by collateral arrangements that require the fair value of such collateral exceeds the amounts loaned.

The Company has indirect exposure to U.S. Government and agency securities held as collateral to secure its resale agreements. The Company’s primary credit exposure on these resale transactions is with its counterparty. The Company would have exposure to the U.S. Government and agency securities only in the event of the counterparty’s default on the resale agreements. The fair value of U.S. Government and agency securities held as collateral for resale agreements totaled $18.8 billion at March 31, 2013.

European Holdings

The Company has exposure to non-sovereign financial and non-financial institutions in Europe. The following table shows the balances of this exposure by each country in Europe in which the issuer or counterparty is domiciled. The Company has no direct exposure to sovereign governments in Europe. The Company does not have unfunded commitments to counterparties in Europe, nor does it have exposure as a result of credit default protection purchased or sold separately as of March 31, 2013.

 

    Fair Value as of March 31, 2013  
    Denmark   (1)     France     Germany     Italy     Netherlands     Norway     Sweden     Switzerland     United
Kingdom
    Total  

Cash equivalents

  $      $ 400     $      $ 25     $      $ 247     $      $      $ 500     $ 1,172  

Cash and investments segregated and on deposit for regulatory purposes

                  400                                                 400  

Securities available for sale

    213       170       250       75       323       200       1,527       801       2,058       5,617  

Securities held to maturity

                                                     100              100  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total fair value

  $ 213     $ 570     $ 650     $ 100     $ 323     $ 447     $ 1,527     $ 901     $ 2,558     $ 7,289  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total amortized cost

  $ 212     $ 570     $ 650     $ 100     $ 322     $ 447     $ 1,525     $ 900     $ 2,553     $ 7,279  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Maturities:

                   

Overnight

  $      $ 400     $      $      $      $ 247     $      $      $ 400     $ 1,047  

1 day – < 6 months

    213       100       650       100              100       301       551       1,053       3,068  

6 months – < 1 year

                                123              301       150       802       1,376  

1 year – 2 years

                                100       100       825       100       303       1,428  

> 2 years

           70                     100              100       100              370  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total fair value

  $       213     $       570     $       650     $       100     $       323     $       447     $     1,527     $       901     $     2,558     $     7,289  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1)  

The exposures in Denmark are also backed by the full faith and credit of the Denmark government.

 

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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)

 

In addition to the direct holdings of European companies listed above, the Company also has indirect exposure to Europe through its investments in Schwab sponsored money market funds (collectively, the Funds) resulting from clearing activities. At March 31, 2013, the Company had $241 million in investments in these Funds. Certain of the Funds’ positions include certificates of deposits, time deposits, commercial paper and corporate debt securities issued by counterparties in Europe.

CRITICAL ACCOUNTING ESTIMATES

Certain of the Company’s accounting policies that involve a higher degree of judgment and complexity are discussed in “Part II – Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Estimates” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012. There have been no changes to these critical accounting estimates during the first quarter of 2013.

FORWARD-LOOKING STATEMENTS

In addition to historical information, this Quarterly Report on Form 10-Q contains “forward-looking statements” within the meaning of Section 27A of the Securities Act, and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements are identified by words such as “believe,” “anticipate,” “expect,” “intend,” “plan,” “will,” “may,” “estimate,” “appear,” “aim,” “target,” “could,” 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 necessarily estimates based on the best judgment of the Company’s senior management. These statements relate to, among other things:

 

   

the impact of current market conditions on the Company’s results of operations (see “Item 1 – Condensed Consolidated Financial Statements (Unaudited) – Notes – 2. Securities Available for Sale and Securities Held to Maturity” and “Current Market and Regulatory Environment and Other Developments”);

 

   

the expected impact of the Federal Reserve’s NPRs and NSCC proposed rule change (see “Current Market and Regulatory Environment and Other Developments”);

 

   

the impact of changes in the likelihood of guarantee payment obligations on the Company’s results of operations (see “Item 1 – Condensed Consolidated Financial Statements (Unaudited) – Notes – 4. Commitments and Contingencies”);

 

   

the impact of legal proceedings and regulatory matters (see “Item 1 – Condensed Consolidated Financial Statements (Unaudited) – Notes – 4. Commitments and Contingencies” and “Part II – Other Information – Item 1 – Legal Proceedings”);

 

   

target capital ratios (see “Item 1 – Condensed Consolidated Financial Statements (Unaudited) – Notes – 8. Regulatory Requirements” and “Liquidity and Capital Resources”);

 

   

sources of liquidity, capital, and level of dividends (see “Liquidity and Capital Resources”); and

 

   

capital expenditures (see “Liquidity and Capital Resources – Capital Resources”).

Achievement of the expressed beliefs, objectives, and expectations described in these statements is subject to certain risks and uncertainties that could cause actual results to differ materially from the expressed beliefs, objectives, and expectations. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this Quarterly Report on Form 10-Q or, in the case of documents incorporated by reference, as of the date of those documents.

Important factors that may cause actual results to differ include, but are not limited to:

 

   

changes in general economic and financial market conditions;

 

   

changes in revenues and profit margin due to changes in interest rates;

 

   

the Company’s ability to attract and retain clients and grow client assets and relationships;

 

   

the Company’s ability to develop and launch new products, services and capabilities in a timely and successful manner;

 

   

fluctuations in client asset values due to changes in equity valuations;

 

   

the Company’s ability to monetize client assets;

 

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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 performance or valuation of securities available for sale and securities held to maturity;

 

   

trading activity;

 

   

the level of interest rates, including yields available on money market mutual fund eligible instruments;

 

   

the adverse impact of financial reform legislation and related regulations;

 

   

potential breaches of contractual terms for which the Company has guarantee obligations;

 

   

adverse developments in litigation or regulatory matters;

 

   

amounts recovered on insurance policies;

 

   

the extent of any charges associated with litigation and regulatory matters;

 

   

the amount of loans to the Company’s brokerage and banking clients;

 

   

the level of the Company’s stock repurchase activity;

 

   

capital needs;

 

   

level of expenses;

 

   

competitive pressures on rates and fees;

 

   

acquisition integration costs;

 

   

the level of brokerage client cash balances and deposits from banking clients;

 

   

the availability and terms of external financing; and

 

   

timing and impact of changes in the Company’s level of investments in buildings.

Certain of these factors, as well as general risk factors affecting the Company, are discussed in greater detail in “Part I –Item 1A – Risk Factors” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012, and “Part II – Other Information – Item 1A – Risk Factors.”

 

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THE CHARLES SCHWAB CORPORATION

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Market risk is the potential for changes in revenue or the value of financial instruments held by the Company as a result of fluctuations in interest rates, equity prices or market conditions.

For the Company’s market risk related to interest rates, a sensitivity analysis, referred to as a net interest revenue simulation model, is shown below. The Company is exposed to interest rate risk primarily from changes in market interest rates on its interest-earning assets relative to changes in the costs of its funding sources that finance these assets.

Net interest revenue is affected by various factors, such as the distribution and composition of interest-earning assets and interest-bearing liabilities, the spread between yields earned on interest-earning assets and rates paid on interest-bearing liabilities, which may reprice at different times or by different amounts, and the spread between short and long-term interest rates. Interest-earning assets include residential real estate loans and mortgage-backed securities. These assets are sensitive to changes in interest rates and to changes to prepayment levels, which tend to increase in a declining rate environment.

To mitigate the risk of loss, the Company has established policies and procedures which include setting guidelines on the amount of net interest revenue at risk, and monitoring the net interest margin and average maturity of its interest-earning assets and funding sources. To remain within these guidelines, the Company manages the maturity, repricing, and cash flow characteristics of the investment portfolios. Because the Company establishes the rates paid on certain brokerage client cash balances and deposits from banking clients, and the rates charged on margin loans and loans to banking clients, and controls the composition of its investment securities, it has some ability to manage its net interest spread, depending on competitive factors and market conditions.

The Company is also subject to market risk as a result of fluctuations in equity prices. The Company’s direct holdings of equity securities and its associated exposure to equity prices are not material. The Company is indirectly exposed to equity market fluctuations in connection with securities collateralizing margin loans to brokerage customers, and customer securities loaned out as part of the Company’s securities lending activities. Equity market valuations may also affect the level of brokerage client trading activity, margin borrowing, and overall client engagement with the Company. Additionally, the Company earns mutual fund 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 earned by the Company.

Financial instruments held by the Company are also subject to liquidity risk – that is, the risk that valuations will be negatively affected by changes in demand and the underlying market for a financial instrument. Recent conditions in the credit markets have significantly reduced market liquidity in a wide range of financial instruments, including the types of instruments held by the Company, and fair value can differ significantly from the value implied by the credit quality and actual performance of the instrument’s underlying cash flows.

Financial instruments held by the Company are also subject to valuation risk as a result of changes in valuations of the underlying collateral, such as housing prices in the case of residential real estate loans and mortgage-backed securities.

For discussion of the impact of current market conditions on asset management and administration fees, net interest revenue, and securities available for sale, see “Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations – Current Market and Regulatory Environment and Other Developments.”

The Company’s market risk related to financial instruments held for trading is not material.

Net Interest Revenue Simulation

The Company uses net interest revenue simulation modeling techniques to evaluate and manage the effect of changing interest rates. The simulation model (the model) includes all interest-sensitive assets and liabilities. Key variables in the model include the repricing of financial instruments, prepayment, reinvestment, and product pricing assumptions. The Company uses constant balances and market rates in the model assumptions in order to minimize the number of variables and to better isolate risks. The simulations involve assumptions that are inherently uncertain and, as a result, cannot precisely estimate net interest revenue or predict the impact of changes in interest rates on net interest revenue. Actual results may

 

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THE CHARLES SCHWAB CORPORATION

 

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.

As represented by the simulations presented below, the Company’s investment strategy is structured to produce an increase in net interest revenue when interest rates rise and, conversely, a decrease in net interest revenue when interest rates fall (i.e., interest-earning assets generally reprice more quickly than interest-bearing liabilities).

The simulations in the following table assume that the asset and liability structure of the consolidated balance sheet would not be changed as a result of the simulated changes in interest rates. As the Company actively manages its consolidated balance sheet and interest rate exposure, in all likelihood the Company would take steps to manage any additional interest rate exposure that could result from changes in the interest rate environment. The following table shows the results of a gradual 100 basis point increase or decrease in market interest rates relative to the Company’s current market rates forecast on simulated net interest revenue over the next 12 months beginning March 31, 2013 and December 31, 2012.

 

                 
     March 31,     December 31,  
     2013     2012  

Increase of 100 basis points

                 16.4     19.2 %

Decrease of 100 basis points

     (9.2 )%      (10.0 )% 

The sensitivities shown in the simulation reflect the fact that short-term interest rates in the first quarter of 2013 remained at historically low levels, including the federal funds target rate, which was unchanged at a range of zero to 0.25%. The current low interest rate environment limits the extent to which the Company can reduce interest expense paid on funding sources in a declining interest rate scenario. A decline in interest rates could therefore negatively impact the yield on the Company’s investment portfolio to a greater degree than any offsetting reduction in interest expense, further compressing net interest margin. Any increases in short-term interest rates result in a greater impact as yields on interest-earning assets are expected to rise faster than the cost of funding sources.

 

Item 4. Controls and Procedures

Evaluation of disclosure controls and procedures: The management of the Company, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934) as of March 31, 2013. Based on this evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures were effective as of March 31, 2013.

Changes in internal control over financial reporting: No change in the Company’s internal control over financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934) was identified during the quarter ended March 31, 2013, that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

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THE CHARLES SCHWAB CORPORATION

 

PART II - OTHER INFORMATION

 

Item 1. Legal Proceedings

For a discussion of legal proceedings, see “Part I – Financial Information – Item 1 – Condensed Consolidated Financial Statements (Unaudited) – Notes – 4. Commitments and Contingencies.”

 

Item 1A. Risk Factors

During the first quarter of 2013, there have been no material changes to the risk factors in “Part I – Item 1A – Risk Factors” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012.

 

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

Issuer Purchases of Equity Securities

The following table summarizes purchases made by or on behalf of CSC of its common stock for each calendar month in the first quarter of 2013:

 

                                                                                                                                                       

Month

  Total Number
of Shares
Purchased
(in thousands)
    Average
Price Paid
per Share
    Total Number
of Shares Purchased
as Part of Publicly
Announced
Program 
(1)  
(in thousands)
    Approximate
Dollar Value of
Shares that May
Yet be  Purchased
Under the Program
(in millions)
 

January:

       

Share repurchase program  (1)

         $             $ 596   

Employee transactions  (2)

    5      $ 15.04        N/A        N/A   

February:

       

Share repurchase program  (1)

         $             $ 596   

Employee transactions  (2)

    8      $ 16.65        N/A        N/A   

March:

       

Share repurchase program  (1)

         $             $ 596   

Employee transactions  (2)

    62      $ 16.25        N/A        N/A   
 

 

 

   

 

 

   

 

 

   

 

 

 

Total:

       

Share repurchase program  (1)

         $             $ 596   

Employee transactions  (2)

    75      $ 16.20        N/A        N/A   
 

 

 

   

 

 

   

 

 

   

 

 

 

 

N/A Not applicable.

(1)  

There were no share repurchases under the Share Repurchase Program during the first quarter. Repurchases under this program would occur under two authorizations by CSC’s Board of Directors, each covering up to $500 million of common stock that were publicly announced by the Company on April 25, 2007, and March 13, 2008. The remaining authorizations do not have an expiration date.

 

(2)  

Includes restricted shares withheld (under the terms of grants under employee stock incentive plans) to offset tax withholding obligations that occur upon vesting and release of restricted shares. The Company may receive shares delivered or attested to pay the exercise price and/or to satisfy tax withholding obligations by employees who exercise stock options (granted under employee stock incentive plans), which are commonly referred to as stock swap exercises.

 

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Item 3. Defaults Upon Senior Securities

None.

 

Item 4. Mine Safety Disclosures

Not applicable.

 

Item 5. Other Information

None.

 

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THE CHARLES SCHWAB CORPORATION

 

Item 6. Exhibits

The following exhibits are filed as part of this Quarterly Report on Form 10-Q.

 

Exhibit

Number

  

Exhibit

      
10.314    Employment agreement dated as of March 13, 2008 between the Registrant and Charles R. Schwab      (1
10.352    Form of Performance-Based Cash Long-Term Incentive Award Agreement under The Charles Schwab Corporation 2004 Stock Incentive Plan and successor plans, filed as Exhibit 10.352 to the Registrant’s Form 8-K dated January 24, 2013, and incorporated herein by reference.      (1
10.353    Form of Notice and Performance-Based Restricted Stock Unit Agreement under The Charles Schwab Corporation 2004 Stock Incentive Plan and successor plans (supersedes Exhibit 10.343), filed as Exhibit 10.353 to the Registrant’s Form 8-K dated January 24, 2013, and incorporated herein by reference.      (1
10.354    Form of Notice and Nonqualified Stock Option Agreement under The Charles Schwab Corporation 2004 Stock Incentive Plan and successor plans (supersedes Exhibit 10.345), filed as Exhibit 10.354 to the Registrant’s Form 8-K dated January 24, 2013, and incorporated herein by reference.      (1
10.355    Form of Notice and Restricted Stock Unit Agreement under The Charles Schwab Corporation 2004 Stock Incentive Plan and successor plans (supersedes Exhibit 10.346), filed as Exhibit 10.355 to the Registrant’s Form 8-K dated January 24, 2013, and incorporated herein by reference.      (1
10.356    Form of Notice and Retainer Stock Option Agreement for Non-Employee Directors under The Charles Schwab Corporation 2004 Stock Incentive Plan and successor plans (supersedes Exhibit 10.342), filed as Exhibit 10.356 to the Registrant’s Form 8-K dated January 24, 2013, and incorporated herein by reference.      (1
10.357    Form of Notice and Retainer Restricted Stock Unit Agreement for Non-Employee Directors under The Charles Schwab Corporation 2004 Stock Incentive Plan and successor plans (supersedes Exhibit 10.344), filed as Exhibit 10.357 to the Registrant’s Form 8-K dated January 24, 2013, and incorporated herein by reference.      (1
10.358    Form of Notice and Stock Option Agreement for Non-Employee Directors under The Charles Schwab Corporation Directors’ Deferred Compensation Plan II and The Charles Schwab Corporation 2004 Stock Incentive Plan and successor plans (supersedes Exhibit 10.347), filed as Exhibit 10.358 to the Registrant’s Form 8-K dated January 24, 2013, and incorporated herein by reference.      (1
10.359    Form of Notice and Restricted Stock Unit Agreement for Non-Employee Directors under The Charles Schwab Corporation Directors’ Deferred Compensation Plan II and The Charles Schwab Corporation 2004 Stock Incentive Plan and successor plans (supersedes Exhibit 10.341), filed as Exhibit 10.359 to the Registrant’s Form 8-K dated January 24, 2013, and incorporated herein by reference.      (1
12.1    Computation of Ratio of Earnings to Fixed Charges and Ratio of Earnings to Fixed Charges and Preferred Stock Dividends.   
31.1    Certification Pursuant to Rule 13a-14(a)/15d-14(a), As Adopted Pursuant to Section 302 of The Sarbanes-Oxley Act of 2002.   
31.2    Certification Pursuant to Rule 13a-14(a)/15d-14(a), As Adopted Pursuant to Section 302 of The Sarbanes-Oxley Act of 2002.   
32.1    Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of The Sarbanes-Oxley Act of 2002.      (2
32.2    Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of The Sarbanes-Oxley Act of 2002.      (2

 

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THE CHARLES SCHWAB CORPORATION

 

Exhibit

Number

  

Exhibit

      
101.INS    XBRL Instance Document      (3
101.SCH    XBRL Taxonomy Extension Schema      (3
101.CAL    XBRL Taxonomy Extension Calculation      (3
101.DEF    XBRL Extension Definition      (3
101.LAB    XBRL Taxonomy Extension Label      (3
101.PRE    XBRL Taxonomy Extension Presentation      (3

 

(1) Management contract or compensatory plan.

 

(2) Furnished as an exhibit to this Quarterly Report on Form 10-Q.

 

(3) Attached as Exhibit 101 to this Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2013 are the following materials formatted in XBRL (Extensible Business Reporting Language) (i) the Condensed Consolidated Statements of Income, (ii) the Condensed Consolidated Statements of Comprehensive Income, (iii) the Condensed Consolidated Balance Sheets, (iv) the Condensed Consolidated Statements of Cash Flows, and (v) Notes to Condensed Consolidated Financial Statements.

 

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THE CHARLES SCHWAB CORPORATION

 

SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

    THE CHARLES SCHWAB CORPORATION
            (Registrant)                               
Date:  

May 7, 2013

           

/s/ Joseph R. Martinetto

              Joseph R. Martinetto
              Executive Vice President and Chief Financial Officer

 

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Exhibit 10.314

EMPLOYMENT AGREEMENT

This Agreement, as amended, is made and entered into effective as of March 13, 2008 by and between The Charles Schwab Corporation, a Delaware Corporation (hereinafter referred to as the “Company”), and Charles R. Schwab, an individual (hereinafter referred to as the “Executive”).

WITNESSETH:

WHEREAS, the Company desires to reward the Executive for his continuing contribution to the Company and provide additional security for the Executive and to provide an inducement to the Executive to remain with the Company and not to engage in competition with it.

NOW THEREFORE, in consideration of the mutual obligations herein contained, the parties hereto, intending to be legally bound hereby, covenant and agree as follows:

 

1. EMPLOYMENT

(a) The Company hereby employs the Executive to render services to the Company in the position of Chairman of the Board in the capacity defined in the Bylaws of the Company, as may be amended from time to time. The Executive shall perform such duties commensurate with his position and shall have authority and responsibility in working with the Chief Executive Officer, subject to the control of the Board of Directors, for the overall strategic direction and leadership of the Company.

(b) Throughout the term of this Agreement, the Executive shall devote his full business time and undivided attention to the business and affairs of the Company and its subsidiaries, except for reasonable vacations and except for illness or incapacity, but nothing in the Agreement shall preclude the Executive from devoting reasonable periods required for serving, as appropriate, on Boards of Directors of other companies, and from engaging in charitable and public service activities provided such activities do not materially interfere with the performance of his duties and responsibilities under this Agreement.

 

2. TERM

This Agreement shall commence on March 31, 2003, and shall continue through March 31, 2008, subject to the terms and conditions herein set forth. Beginning on March 31, 2004, and on each subsequent anniversary of this date, one year shall be added to the term of the Agreement, unless, prior to such anniversary, the Company or the Executive has notified the other party hereto that such extension will not become effective.

 

3. COMPENSATION

For services rendered by the Executive during the term of this Agreement, and for his performance of all additional obligations of employment, the Company agrees to pay the Executive and the Executive


agrees to accept the following salary, other compensation, and benefits:

(a) Base Salary. During the term of this Agreement, the Company shall pay the Executive in periodic installments, a base salary at the annual rate of $900,000, such base salary to be reviewed on March 31, 2004, and on each subsequent anniversary the Board may adjust it up or down, taking into account, among other things, individual performance, competitive practice, and general business conditions.

(b) Annual Incentive. In addition to the base salary provided in Section 3(a) above, the Executive shall be eligible to receive an annual incentive award based upon the Company’s attainment of pre-established performance targets relative to specified performance standards. The performance standards upon which annual incentive payments will be earned shall be adopted at the beginning of each year by the Compensation Committee of the Board of Directors (the “Committee”), to be selected by the Committee from among the following: revenue growth, net revenue growth, operating revenue growth, consolidated pretax profit margin, consolidated pretax operating margin, consolidated after-tax profit margin, consolidated after-tax operating profit margin, customer net new asset growth, stockholder return, return on assets, earnings per share, return on equity, and return on investment.

For each fiscal year during the term of this Agreement, the Executive’s incentive opportunity shall be computed as the amount of total cash compensation earned pursuant to the formula-based matrix, which shall be adopted each year by the Compensation Committee of the Board of Directors of the Company, minus the Executive’s actual base salary paid during that year. For the 2003 fiscal year, the target total annual cash compensation amount (including base salary) is $5,400,000; therefore, the incentive target is $4,500,000 for achieving specified objectives (see above).

The formula-based matrix, as amended at the sole discretion of the Committee, shall be the sole basis for determining the Executive’s annual incentive award. The Committee shall annually review and approve the performance standards and targets with respect to the Executive’s incentive opportunity, which review and approval shall be completed no later than the 90th day of the Company’s fiscal year for which such incentive opportunity may be earned.

Notwithstanding anything to the contrary, the Executive’s maximum annual cash compensation (including base salary and annual incentive) may not exceed $8,000,000.

(c) Long-Term Incentive. The Executive will be considered for stock options in accordance with the Company’s 2001 Stock Incentive Plan, as amended, or any successor thereto (“Stock Option Program”) and any other long-term incentives offered to other executives of the Company from time to time during the term of this Agreement.

(d) Benefits. The Executive shall be entitled to participate, as long as he is an employee of the Company, in any and all of the Company’s present or future employee benefit plans, including without limitation pension plans, thrift and savings plans, insurance plans,

 

2


and other benefits that are generally applicable to the Company’s executives; provided, however, that the accrual and/or receipt by the Executive of benefits under and pursuant to any such present or future employee benefit plan shall be determined by the provisions of such plan.

(e) Perquisites. The Executive will be provided such additional perquisites as are customary for senior level executives of the Company provided that each perquisite is approved by the Board of Directors.

(f) Business Expenses. The Executive will be reimbursed for all reasonable expenses incurred in connection with the conduct of the Company’s business upon presentation of evidence of such expenditures, including but not limited to travel expenses incurred by the Executive in the performance of his duties, security for the Executive, his family, and principal residence, professional organization dues, and club initiation fees, dues and expenses.

(g) Any annual incentive award earned by Executive under this Section 3 shall be paid on or after January 1 st and on or before March 15 th of the calendar year immediately following the end of the fiscal year on which the award is based; provided, however, that if any such payment would be nondeductible to the Company under Section 162(m) of the Internal Revenue Code (the “Code”), then any nondeductible amounts shall be deferred from year to year until the payment of such amounts is deductible by the Company.

 

4. TERMINATION OF EMPLOYMENT

(a) Resignation. Notwithstanding Section 2 hereof, this Agreement may be terminated by the Executive at any time upon six (6) months written notice of resignation by the Executive to the Company, and in such event any payments pursuant to Section 3 and 4 of this Agreement shall automatically terminate (except for the Company’s obligations relating to voluntary termination under its compensation and benefit plans, as specified in the various plan documents, and the Executive’s obligations set forth in Section 5). Subsequent payments may be made to the Executive as provided pursuant to Section 6 of this Agreement.

Termination under this Section 4(a) shall continue to be a “Voluntary Termination” for purposes of the Assignment and License Agreement entered into as of March 31, 1987, as amended.

(b) Separation from Service Other Than for Cause. An involuntary Separation from Service (as defined below) other than for Cause, as defined in Section 4(c) below, shall cause the Company to make payments to the Executive hereunder pursuant to the provisions of this Section 4(b). Such involuntary Separation from Service shall require at least sixty (60) business days’ prior notice and must be signed by at least three-fourths (3/4) of all the non-employee members of the Board of Directors.

Notwithstanding anything to the contrary contained in the Stock Option Program or any agreement or document related thereto, the Executive’s total outstanding and unvested shares and/or options under the Stock Option Program shall at the date of Separation from Service

 

3


under this Section 4(b) be 100% vested. No further grants of stock or options shall be made under the Stock Option Program after such termination.

With respect to base salary and annual incentive compensation, the Company’s obligation shall be to pay the Executive, according to the terms of this Agreement and for a period of thirty-six (36) months, an amount equal to the annual salary and incentive paid to the Executive at the bonus level for the year prior to which such Separation from Service occurs unless performance of the Company as defined in the matrix referenced in Section 3(b) is better in the year of Separation from Service, in which event such bonus shall be based on the matrix calculation as described in Section 3(b), such annual amounts to be paid in equal monthly installments commencing on Separation from Service.

If the Executive is a Specified Employee (as defined below), a lump sum representing six (6) of the monthly installment payments under this Section 4(b) shall be paid, and the remaining thirty (30) monthly installments payable under this Section 4(b) shall commence upon the first day of the seventh month following the Executive’s Separation from Service (or on the date of the Executive’s death, if earlier).

If the Board of Directors fails to reelect the Executive to a position comparable to that described in Section 1(a) of this Agreement or, without terminating the Executive’s employment, removes the Executive from his position for reasons other than Cause, substantively reduces the Executive’s duties and responsibilities, reduces his pay and/or benefits without the written consent of the Executive, forces relocation, or requires excessive travel, then the Executive may, by notice to the Company, Separate from Service and treat such Separation from Service as an involuntary Separation from Service pursuant to this Section 4(b).

In the event of the Executive’s death before the completion of the payments pursuant to this Section 4(b), the remaining payments hereunder shall be made to the beneficiary or beneficiaries designated by the Executive to the Company in writing or, absent such a designation, to his estate.

The term “Specified Employee” means an employee treated as a “specified employee” as defined under Code Section 409A as of the date of his Separation from Service. Generally, a specified employee is one of the top 50 most highly compensated officers.

The term “Separation from Service” or “Separate(s) from Service” shall mean a “separation from service” within the meaning of Code Section 409A. Generally, a separation from service occurs when an individual ceases to provide services for the Company and its affiliates.

Termination under this Section 4(b) shall continue to be an “Involuntary Termination” for purposes of the Assignment and License Agreement entered into as of March 31, 1987, as amended.

(i) Post-Employment Benefits. In the event the Executive’s employment terminates under Section 4(b), the Executive

 

4


shall be entitled to all benefits and perquisites as provided for in this Agreement, including office space and secretarial support, comparable to that provided to the Executive during his employment by the Company for a period of thirty-six (36) months following his Separation from Service. All benefits or perquisites that the Executive receives following his Separation from Service that are covered under Code Section 409A (“409A Benefits”) shall be administered consistent with the following requirements as set forth in Treas. Reg. § 1.409A-3(i)(1)(iv): (1) Executive’s eligibility for benefits in one year will not affect Executive’s eligibility for benefits in any other year; (2) any reimbursement of eligible expenses will be made on or before the last day of the year following the year in which the expense was incurred; and (3) Executive’s right to benefits is not subject to liquidation or exchange for another benefit.

If the Executive is a Specified Employee, then the Executive shall pay all applicable costs associated with the provision of 409A Benefits during the first six (6) months following the Executive’s Separation from Service. The Company shall reimburse the Executive for all expenses actually paid by the Executive under this Section 4(b) (i) upon the first day of the seventh month following the Executive’s Separation from Service.

(c) Termination by the Company for Cause. The Company may terminate the Executive’s employment for Cause if the Executive has committed a felonious act, or the Executive, in carrying out his duties hereunder has been willfully and grossly negligent or has committed willful and gross misconduct resulting, in either case, in material harm to the Company. An act or omission shall be deemed “willful” only if done, or omitted to be done, in bad faith and without reasonable belief that it was in the best interest of the Company. In the event of termination of the Executive by the Company for Cause, the Executive shall no longer be entitled to receive any payments or any other rights or benefits under this Agreement.

(d) Disability. In the event the Executive becomes Disabled (as defined below), he will continue to receive the same base salary and benefits which he was receiving prior to such disability for 36 months, offset by payments under the Company’s Long-Term Disability Plan. Such payments shall commence within 90 days of such disability. In addition, he shall receive a pro-rated annual incentive payment for the year in which his employment is terminated, based on the formula described in Section 3(b). Such payment shall be made as soon as practicable following the Executive becoming Disabled, but in no event later than 90 days following the Executive becoming Disabled. The term “Disabled” under this Section 4(d) means disabled within the meaning of Section 409A of the Code and the regulations thereunder. Generally, this means that the Executive is unable to engage in any substantial gainful activity by reason of a medically determinable physical or mental impairment which can be expected to result in death or can be expected to last for a continuous period of not less than 12 months, or is, by reason of a medically determinable physical or mental impairment which can be expected to result in death or can be expected to last for a continuous period of not less than 12 months, receiving income replacement benefits for a period of not less than three months under an accident and health plan covering employees of the Company.

 

5


(e) Death. In the event of the death of the Executive during the term of this Agreement, the rights and benefits under employee benefit plans and programs of the Company, including life insurance, will be determined in accordance with the terms and conditions of such plans and programs as in effect on his date of death. In such event, the Company shall pay in a lump sum to the Executive’s estate an amount equal to five times the then current rate of the Executive’s base salary, and no further payments shall be required pursuant to this Agreement. The lump-sum described in this Section 4(e) shall be paid to the Executive’s estate as soon as practicable following the date of the Executive’s death, but in no event later than 90 days following the Executive’s death.

(f) Change in Control. In the event of a change in control of the Company, as set forth below, the Executive may at any time and in his complete discretion during a 24-month period following a change in control, elect to terminate his employment with the Company. For purposes of this Agreement, a “change in control” shall mean a change in ownership of the Company that would be required to be reported in response to Item 1(a) of a Current Report on Form 8-K pursuant to the Securities and Exchange Act of 1934 (“Exchange Act”), as in effect on the date hereof, except that any merger, consolidation or corporate reorganization in which the owners of the capital stock entitled to vote in the election of directors of the Employer or the Company (“Voting Stock”) prior to said combination, own 75% or more of the resulting entity’s Voting Stock shall not be considered a change in control for the purposes of this Agreement; provided that, without limitation, such a change in control shall be deemed to have occurred if (i) any “person” (as that term is used in Sections 13(d) and 14(d)(2) of the Exchange Act), other than a trustee or other fiduciary holding securities under an employee benefit plan of the Company is or becomes the beneficial owners (as that is used in Section 13(d) of the Exchange Act), directly or indirectly, of 30% or more of the Voting Stock of the Company or its successor; or (ii) during any period of two consecutive years, individuals who at the beginning of such period constitute the Board of Directors of the Company (“Incumbent Board”) cease for any reason to constitute at least a majority thereof; provided, however, that any person becoming a director of the Company after the beginning of the period whose election was approved by a vote of at least three-quarters of the directors comprising the Incumbent Board shall, for the purposes hereof, be considered as though he were a member of the Incumbent Board; or (iii) there shall occur the sale of all or substantially all of the assets of the Company. Notwithstanding anything in the foregoing to the contrary, no change in control of the Company shall be deemed to have occurred for purposes of this Agreement by virtue of any transaction which results in the Executive, or a group of persons which includes the Executive acquiring, directly or indirectly, more than 30 percent of the combined voting power of the Company’s outstanding securities. If any of the events constituting a change in control shall have occurred during the term hereof, the Executive shall be entitled to the privilege provided in subparagraph (f) herein to terminate his employment.

Any termination by the Executive pursuant to this Section shall be communicated by a written “Notice of Termination.”

 

6


If, following a change in control, the Executive shall for any reason voluntarily terminate his employment during the 24-month period following a change in control, then the Company shall pay base salary up to the date of termination and a prorated annual incentive award based on the calculated bonus for the year in which termination occurred, as defined in Section 3(b), in a lump sum on the thirtieth (30th) day following the Date of Termination.

 

5. COVENANT NOT TO COMPETE

(a) As a material inducement to the Company’s entering into this Agreement, the Executive agrees that during the term of this Agreement, he will not become associated with, render service to or engage in any other business competitive with any existing or contemplated business of the Company or its subsidiaries, except that the Executive may serve as a member of the board of directors of other companies or organizations, provided that he provides written notice to the Board of each significant activity, and that he will do nothing inconsistent with his duties and responsibilities to the Company.

(b) If the Executive voluntarily resigns from the employ of the Company prior to the expiration of the term of this Agreement, he specifically agrees that for a period of five (5) years commencing with the date of his voluntary resignation he will not engage in or perform any services either on a full-time or a part-time or on a consulting or advisory basis for any business organization that is in competition with the Company at the time such services are being performed by Executive, with the exception that this Section 5(b) shall not apply in the event the Executive resigns voluntarily following a change in control of the Company as defined in Section 4(f).

(c) The Executive will not at any time, whether while employed by the Company or after voluntary or involuntary termination or after retirement, reveal to any person, firm or entity any trade or business secrets or confidential, secret, or privileged information about the business of the Company or its subsidiaries or affiliates except as shall be required in the proper conduct of the Company’s business.

 

6. CONSULTING ARRANGEMENT

Following the Executive’s Separation from Service pursuant to Section 4(a) or Separation from Service following a change in control under Section 4(f), or an involuntary Separation from Service subsequent to a change in control of the Company, for any reason but during a 24-month period following a change in control as defined in Section 4(f), after the Executive ceases to render services as the Chairman, he may in his sole discretion elect to act as a consultant to the Company for a period of five (5) years. During this period of consulting services, the Executive shall, at reasonable times and places, taking into account any other employment or activities he may then have, hold himself available to consult with and advise the officers, directors, and other representatives of the Company. As compensation therefore, the Executive shall be entitled to receive, and Company shall pay, an annual amount equal to seventy-five percent (75%) of his annual base salary rate in effect immediately prior to his Separation from Service, but in no event an annual amount to exceed

 

7


$1,000,000, for each year of such period, payable in equal monthly installments commencing on Separation from Service.

If the Executive is a Specified Employee, a lump sum representing six (6) of the monthly installment payments under this Section 6 shall be paid, and the remaining monthly installments payable under this Section 6 shall commence upon the first day of the seventh month following the Executive’s Separation from Service.

 

7. WITHHOLDING

All amounts payable hereunder which are or may become subject to withholding under pertinent provisions of law or regulation shall be reduced for applicable income and/or employment taxes required to be withheld.

 

8. MISCELLANEOUS

(a) This Agreement supersedes any prior agreements or understandings, oral or written, with respect to employment of the Executive and constitutes the entire Agreement with respect thereto; provided, however, that nothing contained herein shall supersede that certain Assignment and License Agreement entered into as of March 31, 1987, as amended. This Agreement cannot be altered or terminated orally and may be amended only by a subsequent written agreement executed by both of the parties hereto or their legal representatives, and any material amendment must be approved by a majority of the voting shareholders of the Company.

(b) This Agreement shall be governed by and construed in accordance with the laws of the State of California.

(c) This Agreement shall be binding upon and shall inure to the benefit of the Company and its successors and assigns. In that this constitutes a personal service agreement, it may not be assigned by the Executive and any attempted assignment by the Executive in violation of this covenant shall be null and void.

(d) For the purpose of this Agreement, the phrase “designated beneficiary or beneficiaries” shall include the estates of such beneficiaries in the event of their death before the receipt of all payments under this Agreement and shall also include any alternate or successor beneficiaries designated in writing to the Company by the Executive.

(e) The invalidity or unenforceability of any provision of this Agreement shall not affect the validity or enforceability of any other provisions, which shall remain in full force and effect.

(f) The Section and Paragraph headings contained herein are for reference purposes only and shall not in any way affect the meanings or interpretation of this Agreement.

(g) Any dispute or controversy arising under or in connection with this Agreement shall be settled exclusively by arbitration, conducted before a panel of arbitrators in accordance with the rules of the American Arbitration Association then in effect. Judgment may be

 

8


entered on the arbitrators’ award in any court having jurisdiction. The expense of such arbitration shall be borne by the Company.

(h) Any notices, requests or other communications provided for by this Agreement shall be sufficient if in writing and if sent by registered or certified mail to the Executive at the last address he has filed in writing with the Company or, in the case of the Company, at its principal offices.

 

9. COMPLIANCE WITH CODE SECTION 409A

With respect to any compensation payable or benefits to be provided under this Agreement that are subject to Code Section 409A, this Agreement is intended to comply with the provisions of Code Section 409A. In furtherance of this intent, to the extent that any compensation payable or benefits to be provided under this Agreement are subject to Code Section 409A, this Agreement shall be interpreted, operated, and administered in a manner consistent with these intentions, and the parties agree to amend this Agreement further (if necessary) in order to avoid the adverse tax consequences of Code Section 409A.

IN WITNESS WHEREOF, the parties have executed this Agreement on the day and year first above written.

 

 

ATTEST

   

Company:

THE CHARLES SCHWAB CORPORATION

By:   /s/ Carrie Dwyer     By:   /s/ Jay Allen
 

Carrie Dwyer

Corporate Secretary

     

Jay Allen

Executive Vice President - Human Resources

Executive:   /s/ Charles R. Schwab
  Charles R. Schwab

 

9

THE CHARLES SCHWAB CORPORATION

Exhibit 12.1

Computation of Ratio of Earnings to Fixed Charges and

Ratio of Earnings to Fixed Charges and Preferred Stock Dividends

(Dollar amounts in millions)

(Unaudited)

 

     Three Months Ended
March 31,
 
     2013      2012  

Earnings before taxes on earnings

   $ 331       $ 313   
  

 

 

    

 

 

 

Fixed charges

     

Interest expense:

     

Deposits from banking clients

     10         10   

Payables to brokerage clients

     1         1   

Long-term debt

     17         27   
  

 

 

    

 

 

 

Total

     28         38   

Interest portion of rental expense

     17         17   
  

 

 

    

 

 

 

Total fixed charges (A)

     45         55   
  

 

 

    

 

 

 

Earnings before taxes on earnings and fixed charges (B)

   $ 376       $ 368   
  

 

 

    

 

 

 

Ratio of earnings to fixed charges (B) ÷ (A) (1)

     8.4         6.7   

Ratio of earnings to fixed charges, excluding deposits from banking clients and payables to brokerage clients interest expense (2)

     10.7         8.1   

Total fixed charges

   $ 45       $ 55   

Preferred stock dividends (3)

     13           
  

 

 

    

 

 

 

Total fixed charges and preferred stock dividends (C)

   $ 58       $ 55   
  

 

 

    

 

 

 

Ratio of earnings to fixed charges and preferred stock dividends (B) ÷ (C) (1)

     6.5         6.7   

Ratio of earnings to fixed charges and preferred stock dividends, excluding deposits from banking clients and payables to brokerage clients interest expense (2)

     7.8         8.1   

 

(1)  

The ratios of earnings to fixed charges and earnings to fixed charges and preferred stock dividends are calculated in accordance with SEC requirements. For such purposes, “earnings” consist of earnings before taxes on earnings and fixed charges. “Fixed charges” consist of interest expense as listed above, and one-third of rental expense, which is estimated to be representative of the interest factor.

 

(2)  

Because interest expense incurred in connection with both deposits from banking clients and payables to brokerage clients is completely offset by interest revenue on related investments and loans, the Company considers such interest to be an operating expense. Accordingly, the ratio of earnings to fixed charges, excluding deposits from banking clients and payables to brokerage clients interest expense, and the ratio of earnings to fixed charges and preferred stock dividends, excluding deposits from banking clients and payables to brokerage clients interest expense, reflect the elimination of such interest expense as a fixed charge.

 

(3)  

The preferred stock dividend amounts represent the pre-tax earnings that would be required to pay the dividends on outstanding preferred stock.

THE CHARLES SCHWAB CORPORATION

Exhibit 31.1

CERTIFICATION PURSUANT TO RULE 13a-14(a)/15d-14(a), AS ADOPTED PURSUANT TO

SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002

I, Walter W. Bettinger II, certify that:

 

1. I have reviewed this Quarterly Report on Form 10-Q of The Charles Schwab Corporation;

 

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

 

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

 

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

 

  a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

 

  b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

 

  c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

 

  d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

 

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

 

  a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

 

  b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

 

Date:  

May 7, 2013

     

/s/ Walter W. Bettinger II

        Walter W. Bettinger II
        President and Chief Executive Officer

THE CHARLES SCHWAB CORPORATION

Exhibit 31.2

CERTIFICATION PURSUANT TO RULE 13a-14(a)/15d-14(a), AS ADOPTED PURSUANT TO

SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002

I, Joseph R. Martinetto, certify that:

 

1. I have reviewed this Quarterly Report on Form 10-Q of The Charles Schwab Corporation;

 

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

 

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

 

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

 

  a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

 

  b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

 

  c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

 

  d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

 

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

 

  a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

 

  b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

 

Date:  

May 7, 2013

     

/s/ Joseph R. Martinetto

        Joseph R. Martinetto
        Executive Vice President and Chief Financial Officer

THE CHARLES SCHWAB CORPORATION

Exhibit 32.1

CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350,

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Quarterly Report of The Charles Schwab Corporation (the Company) on Form 10-Q for the quarter ended March 31, 2013 (the Report), I, Walter W. Bettinger II, President and Chief Executive Officer of the Company, hereby certify, pursuant to 18 U.S.C. section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002, that to the best of my knowledge:

 

  (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

 

  (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company for the periods presented therein.

 

/s/ Walter W. Bettinger II

    Date:   May 7, 2013
Walter W. Bettinger II      
President and Chief Executive Officer      

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

A signed original of this written statement required by Section 906 has been provided to The Charles Schwab Corporation and will be retained by The Charles Schwab Corporation and furnished to the Securities and Exchange Commission or its staff upon request.

THE CHARLES SCHWAB CORPORATION

Exhibit 32.2

CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350,

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Quarterly Report of The Charles Schwab Corporation (the Company) on Form 10-Q for the quarter ended March 31, 2013 (the Report), I, Joseph R. Martinetto, Executive Vice President and Chief Financial Officer of the Company, hereby certify, pursuant to 18 U.S.C. section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002, that to the best of my knowledge:

 

  (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

 

  (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company for the periods presented therein.

 

/s/ Joseph R. Martinetto     Date:   May 7, 2013
Joseph R. Martinetto      

Executive Vice President and

Chief Financial Officer

     

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

A signed original of this written statement required by Section 906 has been provided to The Charles Schwab Corporation and will be retained by The Charles Schwab Corporation and furnished to the Securities and Exchange Commission or its staff upon request.