Periodically, our Chief Financial Officer will use this forum to provide insight and commentary regarding Schwab's financial picture. For any questions, please contact Investor Relations via email or call:
Richard G. Fowler, Senior Vice President: (415) 667-1841
The commentary in this section speaks only as of the date specified below. The company makes no commitment to update any of this information.
August 14, 2018
As we announced in our second quarter earnings release, we crossed the $250 billion asset threshold1 for heightened regulatory requirements, ending the period at $262 billion in consolidated assets. While we don't believe the consequences will be disruptive to our business model or our strategy, I wanted to share a brief overview of what crossing this threshold means to Schwab and how we have been preparing over the last few years.
Beginning in 2016, we engaged consultants to review our readiness and help create a roadmap for the increased regulatory requirements. Below is a timeline of the anticipated milestones.
We have grouped the implications into three main work streams: the inclusion of accumulated other comprehensive income (AOCI) in our capital ratios, the increased requirements for the liquidity coverage ratio, and other regulatory requirements and expectations. Assuming we stay above $250 billion in consolidated assets for the remainder of the year, the first significant deadlines for these requirements are in 2019.
AOCI in Capital
Historically, we have elected to exclude AOCI, or the net unrealized gains or losses on available-for-sale (AFS) securities, from our calculation of regulatory capital. Starting in 2019, this exclusion is no longer available to us and we are required to include AOCI in our regulatory capital. This means that as the market price of our AFS securities fluctuates, unrealized gains or losses will impact AOCI, and therefore our regulatory capital and ratios. To mitigate this impact, during the first quarter of 2017 we transferred $25 billion of AFS securities to held-to-maturity (HTM), where market fluctuations do not affect AOCI. Furthermore, as we purchase new securities, we are designating more of them as HTM. We intend to bring the size of our AFS portfolio closer to a floor of 20% of total bank assets, thereby balancing liquidity needs with the AOCI impact. Note that we have not made any changes to the composition of the consolidated investment portfolio or interest rate and credit risk profiles. We believe our efforts will keep our current Asset / Liability Management strategy intact while minimizing capital volatility.
Liquidity Coverage Ratio
In April 2019, we will also be required to adhere to higher standards for our liquidity coverage ratio. This ratio measures our amount of high-quality liquidity assets (HQLA) divided by the amount of our prescribed outflows, an indication of our ability to withstand a short-term liquidity event. Currently, we are required to measure 70% of prescribed outflows in the denominator. By crossing $250B in consolidated assets, we will soon be required to measure 100% of prescribed outflows. We are strategically adding more Level 1 securities (Ginnie Mae mortgage-backed securities, U.S. Treasuries, and Excess Reserves) in our investment portfolios to increase our HQLA to meet the increased liquidity coverage ratio requirements. As we seek the optimal mix of Level 1 securities, near-term improvement in our net interest margin (NIM) may be impacted, yet we still believe the long-term effect of these purchases will be small — about one basis point of NIM. We’ll also be required to calculate this ratio on a daily basis, but we are already prepared to do so.
Other Regulatory Requirements and Expectations
Lastly, we will be held to a range of higher regulatory standards and expectations, including:
Additional governance, risk management, reporting, and capital requirements
Funds Transfer Pricing
Liquidity Monitoring Reporting
Implementation Plan for internally-developed risk-weighted asset calculations
In preparation, we’ve hired staff in the risk management and regulatory areas. We also continue to invest in enhancing our automation and systems to improve efficiency and meet reporting requirements. These costs are largely in our run rate and we do not anticipate a significant step-up in expenses going forward.
As Schwab continues to grow, maintaining a healthy balance sheet is essential. By proactively addressing these heightened regulatory requirements, we will be ready to respond to the evolving landscape while continuing to serve clients seamlessly into the future.
1 The $250 billion consolidated asset threshold is triggered when assets are greater than $250 billion at year-end.
This commentary contains forward-looking statements relating to: the consequences of crossing and remaining above the $250 billion consolidated asset threshold; deadlines; size of our AFS portfolio; our asset/liability management strategy; capital volatility; adding Level 1 securities to meet increased liquidity coverage ratio requirements and the related near-term and long-term impact on our net interest margin; investing in automation and systems to improve efficiency and meet reporting requirements; and expenses.
Important factors that may cause such differences include, but are not limited to, regulatory guidance; general market conditions, including the level of interest rates and securities valuations; competitive pressures on pricing, including deposit rates; the company’s ability to enhance automation and systems in a timely and effective manner; the level of client assets, including cash balances; the company’s ability to monetize client assets; capital and liquidity needs and management; the company’s ability to manage expenses; client sensitivity to rates; and the timing and amount of transfers to bank sweep.
In our January SMART report released today, we noted a $7.2 billion outflow from a mutual fund clearing services (“clearing”) client. Since we expect several additional large clearing outflows in early 2018, I wanted to share some context on the business and discuss the potential effect on our reported client asset flows (noticeable) and revenues (immaterial).
Today, President Trump signed significant tax reform legislation into law and I wanted to spend a moment focusing on the potential impacts to Schwab’s effective tax rate. As you may know, we have historically paid close to the full statutory federal corporate income tax rate, so the benefits are likely to be significant – though the new law does include the disallowance of some Schwab-relevant deductions.
Today we announced another reduction in our online equity, ETF, and option trade commission rates, following moves we announced just a few weeks ago on February 2nd. With this second action coming right on the heels of the first, I thought it might be useful to share some context regarding how they both fit within our financial planning for 2017.
Those of you who follow The Charles Schwab Corporation closely may receive our quarterly financial results through a wire service/email, a market data aggregator, or simply by checking our corporate website. This morning, we began making our results available via another widely-used platform: Twitter. You can find our page on www.Twitter.com with the handle @CharlesSchwab. Today’s activity includes a Tweet noting the availability of fourth quarter 2015 results with a link to our press release, and follow-ups sharing the headlines from this morning’s announcement.
Today we released our November Monthly Activity Report. While we produced another month of solid client metrics, we have no illusions about another press release stealing the show later this week. As you know, the Federal Reserve is widely anticipated to begin raising interest rates on December 16th. We have seen economic and employment reports meet expectations, FOMC minutes evolve, and member speeches show increasing conviction.
We issued our SMART report for the month of August today, and between the client metrics shown there and the trading data that we’ve already posted it’s clear we’ve been busy. With the elevated market volatility late in the month, our clients made extensive use of our branches, phone-based service centers and online capabilities to help keep their investing on track. Many of them engaged with our financial consultants and subject matter experts to ask questions about how their assets enrolled in our advisory solutions are positioned, as well as assess their holdings and determine what, if any, action should be taken.
By now, you may have noticed that we recently made a few changes to our disclosures, and I’d like to make sure everyone is aware of these developments as well as provide context for how they help tell our story. As a large savings and loan holding company, our required reporting has expanded significantly in recent years. In addition, as Schwab evolves, we revisit our reporting and strive to keep it closely aligned with the everyday workings of the business. In the second quarter of 2015, we added a new Other Regulatory Disclosures tab to our corporate website, made changes to the Asset Management and Administration Fees (AMAF) table in our earnings release package, and included some new information in our 10-Q filing.
As we announced in our earnings release today, our Q4 ’14 financial results included two nonrecurring items related to the company’s non-agency residential mortgage-backed securities (RMBS) portfolio: net litigation proceeds of approximately $28 million and net losses of $8 million from selling securities totaling approximately $500 million. Taken together, these items increased pre-tax income by approximately $20 million, or $.01 per share. With the financial crisis well behind us, it’s been a while since we’ve needed to discuss these securities, so I wanted to walk through some history and share a perspective on these recent developments.
Concurrent with our Earnings Release today, we are inaugurating a new approach to reporting on our clients’ trading activity intra-quarter. We have retired the inclusion of trade reporting in our Monthly Market Activity Report (“SMART”) and are now providing a weekly look at trading activity, including revenue, asset-based and other trades, which is posted on the Investor Relations landing page on aboutschwab.com. Here’s a link to our initial report: http://www.aboutschwab.com/investor-relations.
As you look through today’s earnings release, you might notice that the size of our balance sheet (shown in the Financial and Operating Highlights table on page 5) hasn’t changed much since year-end 2013, continuing to hover around $144 billion. That’s unusual for us – for example, the company’s balance sheet grew by approximately $8 billion during the second half of 2013. Given the factors influencing this situation, I wanted to share some perspective on current client behavior and ramifications for our capital management going forward.
As I mentioned in my last post, here are a few more thoughts on the evolution of client behavior during the market recovery, which is now a full five years along: With the S&P 500 up over 170% from its lowest point in the first quarter of 2009 and setting new records, it’s not really surprising to see investors put cash back to work in the markets. There are, however, some interesting aspects to the way our clients have reallocated their holdings across products and asset classes during the recovery thus far.
The S&P 500 Index bottomed at 676.53 on March 9, 2009, so we are now a full five years into the market recovery. As the recovery has strengthened in recent months, we have been asked more often about individual investor engagement, with the questioner usually equating engagement with trading activity.
This is my inaugural CFO Commentary. I expect to use this site regularly to provide perspectives on Schwab's financial picture, including color on our performance and details on topical issues. Over time, I can see sharing more significant financial information that might be better discussed in a forum like this, versus press releases or other forms of communication.
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