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| SCHW > SEC Filings for SCHW > Form 10-Q on 6-Nov-2008 | All Recent SEC Filings |
6-Nov-2008
Quarterly Report
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 financial and non-financial metrics in evaluating the Company's financial position and operating performance. All information contained in this Form 10-Q is presented on a continuing operations basis unless otherwise noted. Results for the third quarters and first nine months of 2008 and 2007 are shown in the following table:
Three Months Nine Months
Ended Ended
September 30, Percent September 30, Percent
2008 2007 Change 2008 2007 Change
Client Activity Metrics:
Net new client assets (in
billions) (1) $ 24.4 $ 37.3 (35 %) $ 91.7 $ 120.7 (24 %)
Client assets (in billions, at
quarter end) $ 1,304.5 $ 1,440.7 (9 %)
Clients' daily average trades (in
thousands) 334.8 294.3 14 % 320.3 272.8 17 %
Company Financial Metrics:
Net revenue growth from prior
year's period (3 %) 21 % 6 % 14 %
Pre-tax profit margin from
continuing operations 39.9 % 39.7 % 39.3 % 36.4 %
Return on stockholders' equity 31 % 145 % 31 % 67 %
Annualized net revenue per
average full-time equivalent
employee (in thousands) $ 371 $ 400 (7 %) $ 384 $ 379 1 %
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(1) The first nine months of 2007 includes $17.8 billion related to the acquisition of The 401(k) Company. Effective in the second quarter of 2007, amount includes balances covered by 401(k) record-keeping only services, which totaled $5.2 billion at May 31, 2007, related to the March 2007 acquisition of The 401(k) Company.
The third quarter of 2008 was marked by extraordinary market conditions, including continued downward pressure on home prices, tighter credit markets, liquidity concerns, significant volatility and sharp declines in the equity markets, and continued slowing of general economic activity. The S&P 500 Index, Nasdaq Composite Index, and the Dow Jones Industrial Average decreased 9%, 9%, and 4%, respectively, during the third quarter of 2008 and were down 21%, 21%, and 18%, respectively, on a year to date basis. Although the federal funds rate remained unchanged at 2.00% during the quarter, the Federal Reserve reduced the federal funds rate by 2.25% during the first half of 2008.
During this unprecedented market environment in the third quarter of 2008, clients remained actively engaged with the Company in managing their investments and made heavy use of all of the Company's service channels - branch, phone and internet. Net new client assets totaled $24.4 billion in the third quarter of 2008, down 35% on a year-over-year basis, reflecting continued deterioration in the equity markets and lower asset valuations. Total client assets ended the third quarter of 2008 at $1.305 trillion, down 9% from the prior year. Additionally, clients' daily average trades increased 14% on a year-over-year basis to 334,800 in the third quarter of 2008.
Net revenues decreased in the third quarter of 2008 on a year-over-year basis primarily due to the decrease in other revenue relating to losses of $73 million on investments in the Company's securities available for sale portfolio. The decrease in net revenues was partially offset by increases in net interest revenue and trading revenue of 3% and 16%, respectively. Expenses excluding interest in the third quarter of 2008 decreased $27 million, or 3%, compared to the third quarter of 2007, primarily due to a decrease in compensation and benefits expense, partially offset by an increase in other expense. As a result of the Company's diverse revenue mix and ongoing expense discipline, the Company achieved a pre-tax profit margin from continuing operations of 39.9% and return on stockholders' equity of 31% in the third quarter of 2008. Return on stockholders' equity of
Management's Discussion and Analysis of Financial Condition and Results of Operations
145% in the third quarter of 2007 included a $1.2 billion after-tax gain on the sale of U.S. Trust, as well as incremental interest revenue generated from temporarily investing the proceeds from the sale. Annualized net revenue per average full-time equivalent employee was $371,000 in the third quarter of 2008, down 7% from the third quarter of 2007 due to lower revenue in the third quarter of 2008.
Net revenues grew 6% in the first nine months of 2008 as compared to the same period in 2007, as all major sources of revenue (asset management and administration fees, net interest revenue, and trading revenue) increased, offset by the decrease in other revenue due to the losses incurred in the third quarter of 2008 as discussed above. Although expenses excluding interest remained relatively flat in the first nine months of 2008 as compared to the same period in 2007, compensation and benefits expense decreased while other expense, advertising and market development expense, and professional services expense increased. The Company achieved a pre-tax profit margin from continuing operations of 39.3% for the first nine months of 2008, up from 36.4% for the same period in 2007, due to revenue growth and continued expense discipline.
In October 2008, the Federal Reserve lowered the federal funds rate by 1.00% and the S&P 500 Index, Nasdaq Composite Index, and the Dow Jones Industrial Average decreased 17%, 18%, and 14%, respectively. These declines put further pressure on the Company's net interest revenue and asset management and administration fees.
Segment Information
The Company provides financial services to individuals and institutional and corporate clients through three segments - Schwab Investor Services, Schwab Institutional, and Schwab Corporate and Retirement Services. The Schwab Investor Services segment includes the Company's retail brokerage and retail banking operations. The Schwab Institutional segment provides custodial, trading, and support services to independent investment advisors. The Schwab Corporate and Retirement Services segment provides retirement plan services, plan administrator services, stock plan services, and mutual fund clearing services. The Company evaluates the performance of its segments on a pre-tax basis excluding items such as restructuring charges, impairment charges on non-financial assets, discontinued operations, and extraordinary items.
Management's Discussion and Analysis of Financial Condition and Results of Operations
Financial information for the Company's reportable segments is presented in the following table:
Three Months Nine Months
Ended Ended
September 30, Percent September 30, Percent
2008 2007 Change 2008 2007 Change
Schwab Investor Services:
Net revenues $ 820 $ 862 (5 %) $ 2,557 $ 2,450 4 %
Expenses excluding interest 505 519 (3 %) 1,588 1,564 2 %
Contribution margin 315 343 (8 %) 969 886 9 %
Schwab Institutional:
Net revenues 299 287 4 % 911 818 11 %
Expenses excluding interest 149 162 (8 %) 457 476 (4 %)
Contribution margin 150 125 20 % 454 342 33 %
Schwab Corporate and Retirement Services:
Net revenues 129 134 (4 %) 388 371 5 %
Expenses excluding interest 94 94 - 290 267 9 %
Contribution margin 35 40 (13 %) 98 104 (6 %)
Unallocated:
Net revenues 3 8 N/M 10 10 N/M
Expenses excluding interest 4 4 N/M 10 15 N/M
Contribution margin (1 ) 4 N/M - (5 ) N/M
Total:
Net revenues $ 1,251 $ 1,291 (3 %) $ 3,866 $ 3,649 6 %
Expenses excluding interest $ 752 $ 779 (3 %) $ 2,345 $ 2,322 1 %
Contribution margin $ 499 $ 512 (3 %) $ 1,521 $ 1,327 15 %
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N/M Not meaningful.
Schwab Investor Services
Net revenues decreased in the third quarter of 2008 by $42 million, or 5%, from the same period in 2007 due to the decreases in other revenue and asset management and administration fees, partially offset by the increases in net interest revenue and trading revenue. Other revenue decreased primarily due to losses on investments in the Company's securities available for sale portfolio. Asset management and administration fees decreased as a result of lower balances of client assets in the Company's Mutual Fund OneSource® funds. Net interest revenue increased due to higher levels of interest-earning assets, partially offset by the impact of a decrease in the average net yield earned on interest-earning assets. Additionally, net interest revenue in the third quarter of 2007 included incremental interest revenue generated from temporarily investing the proceeds from the sale of U.S. Trust. Trading revenue increased due to higher daily average revenue trades and higher average revenue earned per revenue trade. Expenses excluding interest decreased $14 million, or 3%, from the third quarter of 2007 primarily due to lower incentive compensation expense, partially offset by a charge for individual client complaints and arbitration claims related to Schwab YieldPlus Fund® investments in the third quarter of 2008.
Net revenues increased in the first nine months of 2008 by $107 million, or 4%, from the same period in 2007 due to an increase in all major sources of revenue (asset management and administration fees, net interest revenue, and trading revenue), offset by the decrease in other revenue related to losses on investments in the Company's securities available for sale portfolio. Asset management and administration fees increased as a result of higher balances of client assets in the Company's proprietary funds. Net interest revenue increased due to higher levels of interest-earning assets, partially offset by the impact of a decrease in the average net yield earned on interest-earning assets. Trading revenue increased primarily due to higher daily average revenue trades. Expenses excluding interest increased by $24 million, or 2%, from the first nine months of 2007, primarily due to charges for individual client complaints and arbitration claims relating to Schwab YieldPlus Fund investments in the first nine months of 2008.
Management's Discussion and Analysis of Financial Condition and Results of Operations
Schwab Institutional
Net revenues increased by $12 million, or 4%, and $93 million, or 11%, from the third quarter and first nine months of 2007, respectively, primarily due to increases in asset management and administration fees and trading revenues, partially offset by decreases in net interest revenue and other revenue. Asset management and administration fees increased as a result of higher balances of client assets in the Company's proprietary funds. Trading revenue increased due to higher daily average revenue trades. Net interest revenue decreased primarily due to the incremental interest revenue generated from temporarily investing the proceeds from the sale of U.S. Trust in the third quarter of 2007, as well as the impact of a decrease in the average net yield earned on interest-earning assets in the third quarter and first nine months of 2008. The decrease in other revenue is related to losses on investments in the Company's securities available for sale portfolio. Expenses excluding interest decreased by $13 million, or 8%, and $19 million, or 4%, from the third quarter and first nine months of 2007, respectively, primarily due to lower incentive compensation expense.
Schwab Corporate and Retirement Services
Net revenues decreased in the third quarter of 2008 by $5 million, or 4%, from the same period in 2007 due to decreases in asset management and administration fees and net interest revenue, partially offset by an increase in trading revenue. Asset management and administration fees decreased as a result of lower balances of client assets in the Company's Mutual Fund OneSource funds. Net interest revenue decreased primarily due to the impact of a decrease in the average net yield earned on interest-earning assets. Trading revenue increased due to higher daily average revenue trades.
Net revenues increased in the first nine months of 2008 by $17 million, or 5%, from the same period in 2007 primarily due to higher asset management and administration fees and trading revenues. Asset management and administration fees increased as a result of the acquisition of The 401(k) Company in March 2007, as well as growth in the number of corporate retirement plans and participants. Trading revenue increased due to higher daily average revenue trades. Expenses excluding interest increased by $23 million, or 9%, from the first nine months of 2007, primarily due to increased costs to service additional corporate retirement plan participants resulting from the acquisition of The 401(k) Company.
Management's Discussion and Analysis of Financial Condition and Results of Operations
RESULTS OF OPERATIONS
Three Months Nine Months
Ended Ended
September 30, Percent September 30, Percent
2008 2007 Change 2008 2007 Change
Asset management and administration
fees $ 596 $ 610 (2 %) $ 1,827 $ 1,730 6 %
Net interest revenue 447 433 3 % 1,293 1,206 7 %
Trading revenue 252 218 16 % 728 618 18 %
Other (44 ) 30 N/M 18 95 (81 %)
Total net revenues 1,251 1,291 (3 %) 3,866 3,649 6 %
Expenses excluding interest 752 779 (3 %) 2,345 2,322 1 %
Income from continuing operations
before taxes on income 499 512 (3 %) 1,521 1,327 15 %
Taxes on income (195 ) (189 ) 3 % (599 ) (512 ) 17 %
Income from continuing operations 304 323 (6 %) 922 815 13 %
(Loss) income from discontinued
operations, net of tax - 1,211 N/M (18 ) 1,284 N/M
Net income $ 304 $ 1,534 N/M $ 904 $ 2,099 N/M
Earnings per share from continuing
operations - diluted $ .26 $ .27 (4 %) $ .80 $ .66 21 %
Earnings per share - diluted $ .26 $ 1.28 N/M $ .78 $ 1.69 N/M
Pre-tax profit margin from continuing
operations 39.9 % 39.7 % 39.3 % 36.4 %
Effective income tax rate on income
from continuing operations 39.1 % 36.9 % 39.4 % 38.6 %
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N/M Not meaningful.
Asset management and administration fees decreased from the third quarter of 2007 due to decreases in mutual fund service fees and investment management and trust fees. Net interest revenue increased from the third quarter of 2007 due to higher levels of interest-earning assets, partially offset by the impact of a decrease in the average net yield earned on interest-earning assets in the third quarter of 2008. Net interest revenue in the third quarter of 2007 included incremental interest revenue generated from temporarily investing the proceeds from the sale of U.S. Trust. The increase in trading revenue from the third quarter of 2007 was primarily due to higher daily average revenue trades and higher average revenue earned per revenue trade. The decrease in other revenue from the third quarter of 2007 was primarily due to losses related to two corporate debt securities in the third quarter of 2008. The decrease in expenses excluding interest from the third quarter of 2007 was primarily due to a decrease in compensation and benefits expense, partially offset by an increase in other expense. Income from continuing operations decreased in the third quarter of 2008 by $19 million, or 6%, as compared to the same period for 2007.
Asset management and administration fees increased from the first nine months of 2007 primarily due to an increase in mutual fund service fees. Net interest revenue increased from the first nine months of 2007 due to higher levels of interest-earning assets, partially offset by the impact of a decrease in the average net yield earned on interest-earning assets in the first nine months of 2008. The increase in trading revenue from the first nine months of 2007 was primarily due to higher daily average revenue trades. The decrease in other revenue from the first nine months of 2007 was due to the losses incurred in the third quarter of 2008 as discussed above. Although expenses excluding interest remained relatively flat in the first nine months of 2008 as compared to the same period in 2007, compensation and benefits expense decreased while other expense, advertising and market development expense, and professional services expense increased. Income from continuing operations increased in the first nine months of 2008 by $107 million, or 13%, as compared to the same period in 2007.
Management's Discussion and Analysis of Financial Condition and Results of Operations
Net Revenues
The Company categorizes its major sources of revenue as asset management and administration fees, net interest revenue, or trading revenue. Total asset management and administration fees decreased while net interest revenue and total trading revenue increased in the third quarter of 2008, as compared to the third quarter of 2007. Asset management and administration fees, net interest revenue, and total trading revenue increased in the first nine months of 2008, as compared to the first nine months of 2007.
Three Months Ended September 30, 2008 2007
% of % of
Percent Total Net Total Net
Change Amount Revenues Amount Revenues
Asset management and administration
fees (1)
Mutual fund service fees:
Proprietary funds (Schwab Funds® and
Laudus Funds ® ) 4 % $ 312 25 % $ 301 23 %
Mutual Fund OneSource® (10 %) 143 12 % 159 12 %
Clearing and other (3 %) 28 2 % 29 2 %
Investment management and trust fees (9 %) 88 7 % 97 8 %
Other 4 % 25 2 % 24 2 %
Asset management and administration
fees (2 %) 596 48 % 610 47 %
Net interest revenue
Interest revenue (16 %) 497 40 % 593 46 %
Interest expense (69 %) 50 4 % 160 12 %
Net interest revenue 3 % 447 36 % 433 34 %
Trading revenue
Commissions 19 % 222 18 % 187 15 %
Principal transactions (3 %) 30 2 % 31 2 %
Trading revenue 16 % 252 20 % 218 17 %
Other N/M (44 ) (4 %) 30 2 %
Total net revenues (3 %) $ 1,251 100 % $ 1,291 100 %
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N/M Not meaningful.
(1) Certain prior-year amounts have been reclassified to conform to the 2008 presentation.
THE CHARLES SCHWAB CORPORATION
Management's Discussion and Analysis of Financial Condition and Results of
Operations
(Tabular Amounts in Millions, Except Ratios, and as Noted)
Nine Months Ended September 30, 2008 2007
% of % of
Percent Total Net Total Net
Change Amount Revenues Amount Revenues
Asset management and administration
fees (1)
Mutual fund service fees:
Proprietary funds (Schwab Funds® and
Laudus Funds ® ) 11 % $ 949 25 % $ 854 23 %
Mutual Fund OneSource® (2 %) 446 12 % 456 12 %
Clearing and other 15 % 86 2 % 75 2 %
Investment management and trust fees (3 %) 271 7 % 280 8 %
Other 15 % 75 1 % 65 2 %
Asset management and administration
fees 6 % 1,827 47 % 1,730 47 %
Net interest revenue
Interest revenue (12 %) 1,485 38 % 1,697 47 %
Interest expense (61 %) 192 5 % 491 14 %
Net interest revenue 7 % 1,293 33 % 1,206 33 %
Trading revenue
Commissions 18 % 634 17 % 537 15 %
Principal transactions 16 % 94 2 % 81 2 %
Trading revenue 18 % 728 19 % 618 17 %
Other (81 %) 18 1 % 95 3 %
Total net revenues 6 % $ 3,866 100 % $ 3,649 100 %
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(1) Certain prior-year amounts have been reclassified to conform to the 2008 presentation.
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 transfer agent services, shareholder services, administration, and investment management provided to its proprietary funds, and record-keeping and shareholder services provided to third-party funds. These fees are based upon the daily balances of client assets invested in third-party funds and the Company's proprietary funds. The Company also earns asset management fees for advisory and managed account services, which are based on the daily balances of client assets subject to the specific fee for service. The fair values of client assets, which include proprietary and third-party mutual funds, are based on quoted market prices and other observable market data. Asset management and administration fees may vary with changes in the balances of client assets due to market fluctuations and levels of net new client assets.
Asset management and administration fees decreased in the third quarter of 2008 by $14 million, or 2%, on a year-over-year basis due to decreases in mutual fund service fees and investment management and trust fees. The decrease in mutual fund service fees was primarily due to a 15% decrease in the average asset balance of the Company's Mutual Fund OneSource funds, which was partially offset by a 9% increase in the average asset balance of the Company's proprietary funds. The decrease in investment management and trust fees was primarily due to . . .
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