UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended
September 30, 2000 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 (I.R.S. Employer Identification No.)
of incorporation or organization)
120 Kearny Street, San Francisco, CA 94108
(Address of principal executive offices and zip code)
Registrant's telephone number, including area code: (415) 627-7000
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 the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
1,383,657,459 shares of $.01 par value Common Stock
Outstanding on October 31, 2000
<PAGE>
THE CHARLES SCHWAB CORPORATION
Quarterly Report on Form 10-Q
For the Quarter Ended September 30, 2000
Index
Page
Part I - Financial Information
Item 1. Condensed Consolidated Financial Statements:
Statement of Income 1
Balance Sheet 2
Statement of Cash Flows 3
Notes 4-8
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 9-21
Item 3. Quantitative and Qualitative Disclosures About
Market Risk 21-23
Part II - Other Information
Item 1. Legal Proceedings 23
Item 2. Changes in Securities and Use of Proceeds 23
Item 3. Defaults Upon Senior Securities 23
Item 4. Submission of Matters to a Vote of Security Holders 23
Item 5. Other Information 23
Item 6. Exhibits and Reports on Form 8-K 24
Signature 25
------------------------------------------------
Forward-Looking Statements - 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" 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 Company's status under the Bank Holding Company Act, the
ability to successfully pursue the Company's strategy to attract and retain
client assets, the decline in average revenue per share traded, sources of
liquidity, capital expenditures and contingent liabilities. Achievement of the
expressed beliefs, objectives and expectations is subject to certain risks and
uncertainties that could cause actual results to differ materially from those
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. See "Forward-Looking Statements" in
Management's Discussion and Analysis of Financial Condition and Results of
Operations in this interim report and in the Company's Current Report on Form
8-K as filed with the Securities and Exchange Commission on July 18, 2000 for a
discussion of important factors that may cause such differences.
<PAGE>
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Part I - FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
THE CHARLES SCHWAB CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF INCOME
(In thousands, except per share amounts)
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
2000 1999 2000 1999
--------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Revenues
Commissions $ 474,935 $ 386,007 $1,804,539 $1,328,514
Asset management and administration fees 410,488 308,854 1,172,111 884,370
Interest revenue, net of interest expense (1) 315,875 210,882 931,423 586,452
Principal transactions 96,599 92,905 469,588 361,053
Other 24,675 17,074 75,067 52,014
--------------------------------------------------------------------------------------------------------------------
Total 1,322,572 1,015,722 4,452,728 3,212,403
--------------------------------------------------------------------------------------------------------------------
Expenses Excluding Interest
Compensation and benefits 596,399 434,533 1,851,716 1,357,216
Other compensation - merger retention programs 16,424 23,025
Occupancy and equipment 106,644 78,552 295,401 218,862
Communications 86,314 63,503 263,489 205,490
Advertising and market development 62,554 59,282 243,362 169,516
Professional services 55,136 47,489 190,506 131,014
Depreciation and amortization 67,973 44,304 185,492 124,217
Commissions, clearance and floor brokerage 29,397 22,277 106,759 73,348
Merger-related (2) 328 68,986
Goodwill amortization 13,527 1,593 32,042 4,865
Other 47,405 28,326 186,387 143,718
--------------------------------------------------------------------------------------------------------------------
Total 1,082,101 779,859 3,447,165 2,428,246
--------------------------------------------------------------------------------------------------------------------
Income before taxes on income 240,471 235,863 1,005,563 784,157
Taxes on income 98,177 91,756 426,131 308,304
--------------------------------------------------------------------------------------------------------------------
Net Income $ 142,294 $ 144,107 $ 579,432 $ 475,853
====================================================================================================================
Weighted-Average Common Shares Outstanding - Diluted 1,414,897 1,375,736 1,401,894 1,372,959
====================================================================================================================
Earnings Per Share
Basic $ .10 $ .11 $ .43 $ .36
Diluted $ .10 $ .11 $ .41 $ .35
====================================================================================================================
Dividends Declared Per Common Share (3) $ .0110 $ .0093 $ .0297 $ .0279
====================================================================================================================
All periods have been restated to reflect the merger of The Charles Schwab Corporation (CSC) with U.S. Trust
Corporation (USTC).
(1) Interest revenue is presented net of interest expense. Interest expense for the three months ended
September 30, 2000 and 1999 was $357,560 and $226,998, respectively. Interest expense for the nine
months ended September 30, 2000 and 1999 was $994,135 and $636,346, respectively.
(2) Merger-related costs include professional fees, change in control related compensation expense and
other expenses relating to the merger of CSC with USTC.
(3) Dividends declared per common share do not include dividends declared by USTC prior to the completion of
the merger.
See Notes to Condensed Consolidated Financial Statements.
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THE CHARLES SCHWAB CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEET
(In thousands, except per share amounts)
(Unaudited)
September 30, December 31,
2000 1999
----------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Assets
Cash and cash equivalents $ 2,792,176 $ 2,612,451
Cash and investments required to be segregated under federal or other
regulations (including resale agreements of $3,705,165 in 2000
and $6,165,043 in 1999) 4,684,747 8,826,121
Securities owned - at market value 1,495,895 1,333,220
Receivable from brokers, dealers and clearing organizations 382,575 482,657
Receivable from brokerage clients - net 20,815,303 17,060,222
Loans to banking clients - net 3,004,996 2,689,205
Equipment, office facilities and property - net 962,372 678,208
Goodwill - net 501,940 53,723
Other assets 867,637 586,305
----------------------------------------------------------------------------------------------------------------------
Total $35,507,641 $34,322,112
======================================================================================================================
Liabilities and Stockholders' Equity
Deposits from banking clients $ 3,790,141 $ 4,204,943
Drafts payable 459,814 467,758
Payable to brokers, dealers and clearing organizations 1,407,826 1,748,765
Payable to brokerage clients 23,414,371 23,422,592
Accrued expenses and other liabilities 1,279,769 1,243,121
Short-term borrowings 320,406 141,157
Long-term debt 793,293 518,000
----------------------------------------------------------------------------------------------------------------------
Total liabilities 31,465,620 31,746,336
----------------------------------------------------------------------------------------------------------------------
Stockholders' equity:
Preferred stock - 9,940 shares authorized; $.01 par value
per share; none issued
Common stock - 2,000,000 shares authorized; $.01 par value per share;
1,383,228 issued and outstanding in 2000 and 1,336,636 shares issued
in 1999 13,835 13,366
Additional paid-in capital 1,530,455 595,282
Retained earnings 2,589,562 2,144,683
Treasury stock - 7,336 shares in 1999, at cost (96,742)
Employee stock ownership plans (414) (967)
Unamortized restricted stock compensation (75,868) (70,926)
Accumulated other comprehensive loss (15,549) (8,920)
----------------------------------------------------------------------------------------------------------------------
Total stockholders' equity 4,042,021 2,575,776
----------------------------------------------------------------------------------------------------------------------
Total $35,507,641 $34,322,112
======================================================================================================================
All periods have been restated to reflect the merger of The Charles Schwab Corporation with U.S. Trust Corporation.
See Notes to Condensed Consolidated Financial Statements.
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THE CHARLES SCHWAB CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(In thousands)
(Unaudited)
Nine Months Ended September 30, 2000 1999
-----------------------------------------------------------------------------------------------------------
<S> <C> <C>
Cash Flows from Operating Activities
Net income $ 579,432 $ 475,853
Noncash items included in net income:
Depreciation and amortization 185,492 124,217
Goodwill amortization 32,042 4,865
Net amortization of premium on securities available for sale 2,768 3,596
Compensation payable in common stock 59,028 24,631
Deferred income taxes (220) 15,145
Other 6,775 7,795
Net change in:
Cash and investments required to be segregated under federal or
other regulations 4,088,662 1,732,458
Securities owned (excluding securities available for sale) (32,422) (61,865)
Receivable from brokers, dealers and clearing organizations 95,187 (76,671)
Receivable from brokerage clients (3,756,978) (3,930,185)
Other assets (41,067) (19,130)
Drafts payable (10,735) (108,183)
Payable to brokers, dealers and clearing organizations (324,998) (161,000)
Payable to brokerage clients 35,078 2,247,163
Accrued expenses and other liabilities 148,993 291,239
-----------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 1,067,037 569,928
-----------------------------------------------------------------------------------------------------------
Cash Flows from Investing Activities
Purchases of securities available for sale (284,622) (333,941)
Proceeds from sales of securities available for sale 10,019
Proceeds from maturities, calls and mandatory redemptions of
securities available for sale 159,230 323,135
Net change in loans to banking clients (315,798) (397,926)
Purchase of equipment, office facilities and property - net (466,737) (252,754)
Cash payments for business combinations and investments, net of
cash received (48,147) (7,863)
-----------------------------------------------------------------------------------------------------------
Net cash used by investing activities (956,074) (659,330)
-----------------------------------------------------------------------------------------------------------
Cash Flows from Financing Activities
Net change in deposits from banking clients (414,802) 231,314
Net change in short-term borrowings 179,249 (59,456)
Proceeds from long-term debt 311,000 144,000
Repayment of long-term debt (35,839) (34,841)
Dividends paid (47,172) (45,536)
Purchase of treasury stock (35,397)
Proceeds from stock options exercised and other 75,799 51,385
-----------------------------------------------------------------------------------------------------------
Net cash provided by financing activities 68,235 251,469
-----------------------------------------------------------------------------------------------------------
Effect of exchange rate changes on cash and cash equivalents 527 (910)
-----------------------------------------------------------------------------------------------------------
Increase in Cash and Cash Equivalents 179,725 161,157
Cash and Cash Equivalents at Beginning of Period 2,612,451 1,720,908
-----------------------------------------------------------------------------------------------------------
Cash and Cash Equivalents at End of Period $ 2,792,176 $ 1,882,065
===========================================================================================================
All periods have been restated to reflect the merger of The Charles Schwab Corporation with
U.S. Trust Corporation.
See Notes to Condensed Consolidated Financial Statements.
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<PAGE>
The Charles Schwab Corporation
Notes to Condensed Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Per Share Amounts and Ratios)
(Unaudited)
1. Basis of Presentation
The Company
The accompanying unaudited condensed consolidated financial statements
include The Charles Schwab Corporation (CSC) and its subsidiaries (collectively
referred to as the Company). CSC is a financial holding company engaged, through
its subsidiaries, in securities brokerage and related financial services.
Charles Schwab & Co., Inc. (Schwab) is a securities broker-dealer with 368
domestic branch offices in 48 states, as well as branches in the Commonwealth of
Puerto Rico and the U.S. Virgin Islands. U.S. Trust Corporation (USTC, and with
its subsidiaries collectively referred to as U.S. Trust) is an investment
management firm that through its subsidiaries also provides fiduciary services
and private banking services with 31 offices in 11 states. Other subsidiaries
include Charles Schwab Europe (CSE), a retail securities brokerage firm located
in the United Kingdom, Charles Schwab Investment Management, Inc., the
investment advisor for Schwab's proprietary mutual funds, Schwab Capital Markets
L.P. (SCM), a market maker in Nasdaq and other securities providing trade
execution services to broker-dealers and institutional clients, and CyBerCorp
Holdings, Inc. (formerly known as CyBerCorp, Inc.), an electronic trading
technology and brokerage firm providing Internet-based services to highly
active, online investors.
These financial statements have been prepared pursuant to the rules and
regulations of the Securities and Exchange Commission (SEC) and, in the opinion
of management, reflect all adjustments necessary to present fairly the financial
position, results of operations and cash flows for the periods presented in
conformity with accounting principles generally accepted in the U.S. All
adjustments were of a normal recurring nature. All material intercompany
balances and transactions have been eliminated. These financial statements
should be read in conjunction with the consolidated financial statements and
notes thereto and the condensed consolidated financial statements and notes
thereto which are filed as Exhibit 99.1 and Exhibit 99.2, respectively, to the
Company's Current Report on Form 8-K, as filed with the SEC on July 18, 2000 and
the Company's Quarterly Report on Form 10-Q for the period ended June 30, 2000.
The Company's results for any interim period are not necessarily indicative of
results for a full year.
Certain items in prior periods' financial statements have been reclassified
to conform to the 2000 presentation.
Merger with U.S. Trust Corporation
On May 31, 2000, CSC completed its merger (the Merger) with USTC. The
condensed consolidated financial statements included in this Quarterly Report on
Form 10-Q give retroactive effect to the Merger, which was accounted for as a
pooling of interests. The pooling of interests method of accounting requires the
restatement of all periods presented as if CSC and USTC had been operating as a
combined entity during such periods. Stockholders' equity and other per share
information as of September 30, 2000 and December 31, 1999 reflects the accounts
of the Company as if the common stock issued in the Merger had been outstanding
during all of the periods presented. Dividends declared per common share do not
include dividends declared by USTC prior to the completion of the Merger.
The separate results of operations for U.S. Trust and the Company
(excluding U.S. Trust) during the periods preceding the Merger that are included
in the Company's condensed consolidated statement of income are as follows:
--------------------------------------------------------------------------------
Three Months Three Months Nine Months
Ended Ended Ended
March 31, 2000 Sep. 30, 1999 Sep. 30, 1999
--------------------------------------------------------------------------------
Revenues:
Company (excluding U.S. Trust) $1,571,876 $ 883,687 $2,817,374
U.S. Trust 153,752 132,035 395,029
--------------------------------------------------------------------------------
Combined $1,725,628 $1,015,722 $3,212,403
================================================================================
Net Income:
Company (excluding U.S. Trust) $ 284,247 $ 124,579 $ 418,437
U.S. Trust 15,711 19,528 57,416
--------------------------------------------------------------------------------
Combined $ 299,958 $ 144,107 $ 475,853
================================================================================
2. New Accounting Standards
Statement of Financial Accounting Standards (SFAS) No. 137, which amended
the effective date of SFAS No. 133 - Accounting for Derivative Instruments and
Hedging Activities, was issued in June 1999. SFAS No. 138, which also amended
SFAS No. 133, was issued in June 2000. The Company is required to adopt SFAS No.
133 by January 1, 2001. This statement establishes accounting and reporting
standards requiring that all derivative instruments are recorded on the balance
sheet as either an asset or a liability, measured at its fair value. The
statement requires that changes in the derivative's fair value are recognized
currently in earnings unless specific hedge accounting criteria are met and such
hedge accounting treatment is elected. The adoption of this statement is not
expected to have a material impact on the Company's financial position, results
of operations, earnings per share or cash flows.
SFAS No. 140 - Accounting for Transfers and Servicing of Financial Assets
and Extinguishments of Liabilities, which replaces SFAS No. 125, was issued in
September 2000. This statement provides accounting and reporting standards for
transfers and servicing of financial assets and extinguishments of liabilities.
The Company is required to adopt SFAS No. 140 by the second quarter of 2001 for
transfers and servicing of financial assets and extinguishments of liabilities
and by the fourth quarter of 2000 for recognition and reclassification of
collateral and for disclosures relating to securitization transactions and
collateral. The adoption of this statement is not expected to have a material
impact on the Company's financial position, results of operations, earnings per
share or cash flows.
In December 1999, the SEC issued Staff Accounting Bulletin 101 (SAB 101) -
Revenue Recognition in Financial Statements, as amended, which summarizes
certain of the SEC staff's views in applying generally accepted accounting
principles to revenue recognition in financial statements. This bulletin
specifies that revenue should not be recognized until it is realized or
realizable and earned. The Company is required to adopt SAB 101 in the fourth
quarter of 2000, and its adoption is not expected to have a material impact on
the Company's financial position, results of operations, earnings per share or
cash flows.
In July 2000, the Emerging Issues Task Force (EITF) of the Financial
Accounting Standards Board issued a consensus in EITF No. 00-16 - Recognition
and Measurement of Employer Payroll Taxes on Employee Stock-Based Compensation,
that requires an employer to recognize a liability and corresponding expense for
employer payroll taxes on employee stock options on the date of exercise of the
stock option. The Company adopted this consensus in the third quarter of 2000 on
a prospective basis. Prior to adoption, the Company recorded an estimated
liability for employer payroll taxes on employee stock options based on the
number of vested stock options outstanding at the end of each period. The
adoption of this consensus did not have, and is not expected to have in the
future, a material impact on the Company's financial position, results of
operations, earnings per share or cash flows.
3. Business Combination
Upon completion of the merger with USTC, the Company incurred
merger-related costs of $50 million pre-tax, or $44 million after-tax, for
change in control related compensation payable to U.S. Trust employees and
professional fees. During the first nine months of 2000, merger-related costs
totaled $69 million pre-tax, or $63 million after-tax. Merger-related costs are
recorded separately on the condensed consolidated statement of income. In
addition, under the terms of the merger agreement, the Company established a
retention program for all U.S. Trust employees, whereby the employees will
receive cash compensation, contingent upon continued employment, at the end of
the two-year period following the completion of the Merger. The Company is
recognizing the $125 million cost of the cash component of the U.S. Trust
retention program over this two-year period. Accordingly, the Company is
recognizing up to $16 million pre-tax, or $9 million after-tax, per quarter for
this other compensation expense - merger retention programs, which is recorded
separately on the condensed consolidated statement of income. In addition, under
the terms of the merger agreement, U.S. Trust employees received an aggregate of
2,718,000 stock options, of which 50% vest at the end of the three-year period
following the completion of the Merger and 50% vest at the end of the four-year
period following the completion of the Merger.
4. Allowance for Credit Losses on Banking Loans and Nonperforming Assets
An analysis of allowance for credit losses is as follows:
--------------------------------------------------------------------------------
Three Nine
Months Ended Months Ended
September 30, September 30,
2000 1999 2000 1999
--------------------------------------------------------------------------------
Balance at beginning of period $20,200 $19,711 $20,169 $19,414
Recoveries 94 311 125 858
Charge-offs (28) (8) (28) (258)
--------------------------------------------------------------------------------
Net recoveries 66 303 97 600
--------------------------------------------------------------------------------
Balance at end of period $20,266 $20,014 $20,266 $20,014
================================================================================
Nonperforming assets, which consist of non-accrual, or impaired, loans are
as follows:
--------------------------------------------------------------------------------
Sep. 30, Jun. 30, Mar. 31, Dec. 31, Sep. 30,
2000 2000 2000 1999 1999
--------------------------------------------------------------------------------
Non-accrual loans $493 $428 $428 $1,673 $435
================================================================================
5. Comprehensive Income
Comprehensive income includes net income and changes in equity except those
resulting from investments by, or distributions to, stockholders. Comprehensive
income is as follows:
--------------------------------------------------------------------------------
Three Nine
Months Ended Months Ended
September 30, September 30,
2000 1999 2000 1999
--------------------------------------------------------------------------------
Net income $142,294 $144,107 $579,432 $475,853
Foreign currency
translation adjustment (5,108) 2,119 (14,208) (233)
Change in net unrealized
gain (loss) on securities
available for sale, net of tax 7,442 (1,025) 7,579 (11,375)
--------------------------------------------------------------------------------
Total comprehensive
income, net of tax $144,628 $145,201 $572,803 $464,245
================================================================================
6. Earnings Per Share
Basic EPS excludes dilution and is computed by dividing net income by the
weighted-average number of common shares outstanding for the period. Diluted EPS
reflects the potential reduction in EPS that could occur if securities or other
contracts to issue common stock were exercised or converted into common stock.
Earnings per share under the basic and diluted computations are as follows:
--------------------------------------------------------------------------------
Three Months Ended Nine Months Ended
September 30, September 30,
2000 1999 2000 1999
--------------------------------------------------------------------------------
Net income $ 142,294 $ 144,107 $ 579,432 $ 475,853
================================================================================
Weighted-average common
shares outstanding - basic 1,372,542 1,313,263 1,353,933 1,308,059
Common stock equivalent
shares related to stock
incentive plans 42,355 62,473 47,961 64,900
--------------------------------------------------------------------------------
Weighted-average common shares
outstanding - diluted 1,414,897 1,375,736 1,401,894 1,372,959
================================================================================
Basic earnings per share $ .10 $ .11 $ .43 $ .36
================================================================================
Diluted earnings per share $ .10 $ .11 $ .41 $ .35
================================================================================
The computation of diluted EPS for the nine months ended September 30, 2000
and 1999, respectively, excludes stock options to purchase 511,000 and 7,625,000
shares, respectively, because the exercise prices for those options were greater
than the average market price of the common shares, and therefore the effect
would be antidilutive.
7. Regulatory Requirements
Upon completion of the merger with USTC, CSC became a financial holding
company and bank holding company subject to supervision and regulation by the
Federal Reserve Board under the Bank Holding Company Act of 1956, as amended
(the Act).
The Gramm-Leach-Bliley Act (the GLB Act), which became effective in March
2000, permits qualifying bank holding companies to become financial holding
companies and thereby affiliate with a far broader range of financial companies
than has previously been permitted for a bank holding company. The GLB Act
identifies several activities as financial in nature, including securities
brokerage, underwriting, dealing in or making a market in securities, investment
management services and insurance activities. The Federal Reserve Board may
prohibit a financial holding company from engaging in new activities or
acquiring additional companies if the Federal Reserve Board concludes that the
financial holding company's capital or managerial resources are not adequate.
Federal Reserve Board regulations under the Act may also limit CSC's business or
impose additional costs or requirements.
Federal Reserve Board policy provides that a bank holding company generally
should not pay cash dividends unless its net income is sufficient to fully fund
the dividends and the Company's prospective retained earnings appear to be
sufficient to meet the capital needs, asset quality and overall financial
condition of the holding company and its bank subsidiaries.
CSC's primary bank subsidiary is United States Trust Company of New York
(U.S. Trust NY). The operations and financial condition of CSC's bank
subsidiaries are subject to regulation and supervision and to various
requirements and restrictions under Federal and state law, including
requirements governing: transactions with CSC and its nonbank subsidiaries,
loans and other extensions of credit, investments or asset purchases, or
otherwise financing or supplying funds to CSC; dividends; investments; and
aspects of CSC's operations. 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. The Company, U.S. Trust and their U.S.-based insured
depository institution subsidiaries must meet regulatory capital guidelines
adopted by the federal banking agencies. The Federal Reserve Board has not
indicated whether the guidelines will be modified with respect to a bank holding
company, such as CSC, that also qualifies as a financial holding company. Under
the Federal Deposit Insurance Act, the banking regulatory agencies are permitted
or, in certain cases, required to take certain substantial restrictive actions
with respect to institutions falling within one of the lowest three of five
capital categories.
The Company's, U.S. Trust's and U.S. Trust NY's regulatory capital and
ratios are as follows:
2000 1999
------------------ ------------------
September 30, Amount Ratio(1) Amount Ratio(1)
--------------------------------------------------------------------------------
Tier 1 Capital:
Company $3,499,586 13.1% $2,274,609 12.2%
U.S. Trust $ 453,915 17.2% $ 264,912 12.1%
U.S. Trust NY $ 286,948 13.3% $ 174,394 9.6%
Total Capital:
Company $3,533,390 13.2% $2,307,682 12.4%
U.S. Trust $ 474,181 18.0% $ 284,926 13.0%
U.S. Trust NY $ 304,741 14.2% $ 192,186 10.6%
Leverage:
Company $3,499,586 10.0% $2,274,609 7.8%
U.S. Trust $ 453,915 9.2% $ 264,912 6.6%
U.S. Trust NY $ 286,948 7.4% $ 174,394 5.5%
--------------------------------------------------------------------------------
(1) Minimum tier 1 capital, total capital and tier 1 leverage ratios are 4%, 8%
and 3%-5%, respectively, for bank holding companies and banks. Each of CSC's
other bank subsidiaries exceed the well-capitalized standards set forth by
the banking regulatory authorities.
Based on their respective regulatory capital ratios at September 30, 2000
and 1999, the Company, U.S. Trust and U.S. Trust NY are well capitalized (the
highest category). There are no conditions or events that management believes
have changed the Company's, U.S. Trust's and U.S. Trust NY's well-capitalized
status. The capital of the Company, U.S. Trust and U.S. Trust NY exceeded
minimum requirements at September 30, 2000.
To remain a financial holding company, each of CSC's bank subsidiaries must
be well capitalized, well managed and meet requirements relating to the
provision of public services to the communities in which CSC's bank subsidiaries
operate. If CSC ceases to qualify as a financial holding company it will be
subject to substantial additional restrictions on its activities.
Schwab and SCM are subject to the Uniform Net Capital Rule under the
Securities Exchange Act of 1934 (the Rule). Schwab and SCM compute net capital
under the alternative method permitted by this Rule, which 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
amount, which is based on the type of business conducted by the broker-dealer.
The minimum dollar amount for both Schwab and SCM is $1 million. 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 or
employees if such payment would result in net capital of less than 5% of
aggregate debit balances or less than 120% of its minimum dollar amount
requirement. At September 30, 2000, Schwab's net capital was $2.1 billion (10%
of aggregate debit balances), which was $1.7 billion in excess of its minimum
required net capital and $1.1 billion in excess of 5% of aggregate debit
balances. At September 30, 2000, SCM's net capital was $30 million, which was
$29 million in excess of its minimum required net capital. Certain other
subsidiaries of CSC are subject to regulatory and other requirements of the
jurisdictions in which they operate. At September 30, 2000, these subsidiaries
were in compliance with their applicable requirements.
Schwab, SCM and CSE had portions of their cash and investments segregated
for the exclusive benefit of clients at September 30, 2000, in accordance with
applicable regulations.
8. Commitments and Contingent Liabilities
For discussion of legal proceedings, see Part II - Other Information, Item
1 - Legal Proceedings.
9. Segment Information
The Company structures its segments according to its various types of
clients and the services provided to those clients. These segments have been
aggregated, based on similarities in economic characteristics, types of clients,
services provided, distribution channels and regulatory environment, into four
reportable segments - Individual Investor, Institutional Investor, Capital
Markets and U.S. Trust.
Financial information for the Company's reportable segments is presented in
the table below. Intersegment revenues are immaterial and are therefore not
disclosed. Total revenues and income before taxes on income are equal to the
Company's consolidated amounts as reported in the condensed consolidated
statement of income.
--------------------------------------------------------------------------------
Three Months Ended Nine Months Ended
September 30, September 30,
2000 1999 2000 1999
--------------------------------------------------------------------------------
Revenues
Individual Investor $ 847,775 $ 627,072 $2,832,904 $1,963,618
Institutional Investor 210,035 151,529 642,376 451,595
Capital Markets 104,579 105,086 501,961 402,161
U.S. Trust 160,183 132,035 475,487 395,029
--------------------------------------------------------------------------------
Total $1,322,572 $1,015,722 $4,452,728 $3,212,403
================================================================================
Income (Loss) Before Taxes
(Benefit) on Income (Loss)
Individual Investor $ 161,667 $ 153,001 $ 685,764 $ 496,376
Institutional Investor 73,024 39,121 229,902 119,444
Capital Markets (20,114) 11,726 35,346 73,699
U.S. Trust (1) 25,894 32,015 54,551 94,638
--------------------------------------------------------------------------------
Total $ 240,471 $ 235,863 $1,005,563 $ 784,157
================================================================================
(1) Includes merger-related costs and merger retention program costs recorded by
U.S. Trust of $15 million pre-tax in the third quarter of 2000 and $68
million pre-tax in the first nine months of 2000. Excluding these costs,
income before taxes on income for this segment would have been $41 million
in the third quarter of 2000 and $123 million in the first nine months of
2000.
10. Supplemental Cash Flow Information
Certain information affecting the cash flows of the Company follows:
--------------------------------------------------------------------------------
Nine Months Ended
September 30,
2000 1999
--------------------------------------------------------------------------------
Income taxes paid $ 236,179 $ 134,117
================================================================================
Interest paid:
Brokerage clients cash balances $ 799,359 $ 494,069
Deposits from banking clients 113,819 83,074
Stock-lending activities 34,649 23,646
Long-term debt 46,487 29,502
Short-term borrowings 14,327 6,570
Other 3,235 3,576
--------------------------------------------------------------------------------
Total interest paid $1,011,876 $ 640,437
================================================================================
Non-cash investing and financing activities:
Common stock and options issued for
purchases of businesses $ 508,815 $ 44,745
================================================================================
11. Subsequent Event
On October 27, 2000, CSC filed a Registration Statement under the
Securities Act of 1933 on Form S-4 relating to the registration of an aggregate
of 15 million shares of CSC's common stock, par value of $.01 per share. CSC may
offer and issue these shares in connection with future acquisitions of other
businesses, properties or securities. On November 8, 2000, this Registration
Statement was declared effective by the SEC. As of the filing date of this
Quarterly Report on Form 10-Q, none of the shares under this Registration
Statement have been issued.
<PAGE>
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations
Description of Business
The Company: The Charles Schwab Corporation (CSC) and its subsidiaries
(collectively referred to as the Company) provide securities brokerage and
related financial services for 7.4 million active client accounts(a). Client
assets in these accounts totaled $961.0 billion at September 30, 2000. Charles
Schwab & Co., Inc. (Schwab), is a securities broker-dealer with 368 domestic
branch offices in 48 states, as well as branches in the Commonwealth of Puerto
Rico and the U.S. Virgin Islands. U.S. Trust Corporation (USTC, and with its
subsidiaries collectively referred to as U.S. Trust) is an investment management
firm that through its subsidiaries also provides fiduciary services and private
banking services with 31 offices in 11 states. Other subsidiaries include
Charles Schwab Europe (CSE), a retail securities brokerage firm located in the
United Kingdom, Charles Schwab Investment Management, Inc., the investment
advisor for Schwab's proprietary mutual funds, Schwab Capital Markets L.P.
(SCM), a market maker in Nasdaq and other securities providing trade execution
services to broker-dealers and institutional clients, and CyBerCorp Holdings,
Inc. (CyBerCorp) (formerly known as CyBerCorp, Inc.), an electronic trading
technology and brokerage firm providing Internet-based services to highly
active, online investors.
------------------------------
(a) Accounts with balances or activity within the preceding eight months.
The Company provides financial services to individuals, institutional
clients and broker-dealers through four segments - Individual Investor,
Institutional Investor, Capital Markets and U.S. Trust. The Individual Investor
segment includes the Company's domestic and international retail operations. The
Institutional Investor segment provides custodial, trading and support services
to independent investment managers, and serves company 401(k) plan sponsors and
third-party administrators. The Capital Markets segment provides trade execution
services in Nasdaq, exchange-listed and other securities primarily to
broker-dealers and institutional clients. The U.S. Trust segment provides
investment management, fiduciary services and private banking services to
individual and institutional clients.
The Company's strategy is to attract and retain client assets by focusing
on a number of areas within the financial services industry - retail brokerage,
mutual funds, support services for independent investment managers, 401(k)
defined contribution plans, equity securities market-making, investment
management, fiduciary services and private banking services.
To pursue its strategy and its objective of long-term profitable growth,
the Company plans to continue to leverage its competitive advantages. These
advantages include nationally recognized brands, a broad range of products and
services, multi-channel delivery systems and an ongoing investment in
technology. While the Company's business continues to be predominantly conducted
in the U.S., the Company continues to selectively expand its international
presence.
Brands: The Company's nationwide advertising and marketing programs support
its strategy by continually reinforcing the strengths and key attributes of
Schwab's full-service offering and U.S. Trust's wealth management services. By
maintaining a consistent level of visibility in the market place, the Company
seeks to establish Schwab and U.S. Trust as leading and lasting financial
service brands in a focused and cost-effective manner. The Company uses a
combination of network, cable and local television, print media, athletic event
sponsorship, and online channels in its advertising to investors.
Products and Services: The Company offers a broad range of value-oriented
products and services to meet clients' varying investment and financial needs,
including help and advice and access to extensive investment research, news and
information. The Company's approach to advice is based on long-term investment
strategies and guidance on portfolio diversification and asset allocation. The
Company strives to demystify investing by educating and assisting clients in the
development of investment plans. This approach is designed to be offered
consistently across all of Schwab's delivery channels and provides clients with
a wide selection of choices for their investment needs. Schwab's registered
representatives can assist investors in developing asset allocation strategies
and evaluating their investment choices, and refer investors who desire
additional guidance to independent investment managers through the Schwab
AdvisorSource(TM) service. Schwab clients and potential clients in need of
personalized wealth-management services can receive referrals to U.S. Trust's
investment management, trust and private banking capabilities as part of the
AdvisorSource referral services program. Schwab's Mutual Fund Marketplace(R)
provides clients with the ability to invest in 2,020 mutual funds from 337 fund
families, including 1,207 Mutual Fund OneSource(R) funds. Schwab also provides
custodial, trading and support services to independent investment managers. As
of September 30, 2000, these managers were guiding the investments of 977,000
Schwab client accounts containing $242.7 billion in assets.
The Company responds to evolving client needs with continued product,
technology and service innovations. During the third quarter of 2000, Schwab
broadened its service offerings by: expanding its PocketBroker(TM) wireless
investing service to provide clients access to Schwab via PalmPilot(TM), RIM
Wireless Handheld(TM) pager and Internet-ready cellular phones; announcing
alliances with Sprint PCS and AT&T Wireless Group to enable clients to access
PocketBroker(TM) through their wireless Web menus; and introducing an electronic
signature capability which allows existing clients to open additional accounts
entirely online. During the same period, Schwab expanded its Web site to include
Smart Investor(TM), an interactive online resource for investor education and
information, as well as SchwabWelcome, which guides prospective clients through
the process of getting started as an investor at Schwab. Additionally, as part
of its participation in the REDIBook ECN LLC, an electronic communication
network, Schwab launched a pre-market trading session, as well as introduced a
series of enhancements to its existing after-hours trading session. These
enhancements include a longer after-hours session, the addition of odd and mixed
lots, the ability to place limit orders for most exchange-listed securities, and
access to after-hours trading via its Velocity(TM) desktop trading software.
U.S. Trust provides an array of financial services for affluent individuals
and their families. These services include investment management, investment
consulting, trust, financial and estate planning and private banking, including
mortgage, personal lending and deposit products. U.S. Trust also provides
investment management, corporate trust and special fiduciary services for
corporations, endowments, foundations, pension plans and other institutional
clients.
Delivery Systems: The Company's multi-channel delivery systems allow
clients to choose how they prefer to do business with the Company. To enable
clients to obtain services in person with a Company representative, the Company
maintains a network of offices. Schwab's branch offices also provide investors
with access to the Internet. Telephonic access to Schwab is provided primarily
through five regional client telephone service centers and two online client
support centers that operate both during and after normal market hours. The
Company's fifth regional client telephone service center, which is located in
Austin, Texas, began handling calls in September 2000. Additionally, clients are
able to obtain financial information on an automated basis through Schwab's
automated telephonic and online channels. Automated telephonic channels include
TeleBroker(R), Schwab's touch-tone telephone quote and trading service, and
VoiceBroker(TM), Schwab's voice recognition quote and trading service. Online
channels include the Charles Schwab Web Site(TM), an information and trading
service on the Internet at www.schwab.com, the CyBerCorp Web site, an Internet
service for professional traders, and PC-based services such as SchwabLink(R), a
service for investment managers. While the online channel is the Company's
fastest-growing channel, the Company continues to stress the importance of
Clicks and Mortar(TM) access - blending the power of the Internet with personal
service to create a full-service client experience. Schwab provides every retail
client access to all delivery channels.
Technology: The Company's ongoing investment in technology is a key element
in expanding its product and service offerings, enhancing its delivery systems,
providing fast and consistent client service, reducing processing costs, and
facilitating the Company's ability to handle significant increases in client
activity without a corresponding rise in staffing levels. The Company uses
technology to empower its clients to manage their financial affairs and is a
leader in driving technological advancements in the financial services industry.
International Expansion: During the third quarter of 2000, Schwab launched
a Spanish-language Web site that serves Hispanic clients in the U.S., the
Caribbean, and Central and South America. During the same period, Charles Schwab
do Brasil, a subsidiary of CSC, opened the Company's first representative office
in Latin America.
Merger with U.S. Trust Corporation: On May 31, 2000, CSC completed its
merger (the Merger) with USTC. The condensed consolidated financial statements
and financial information in this Quarterly Report on Form 10-Q give retroactive
effect to the Merger, which was accounted for as a pooling of interests. The
pooling of interests method of accounting requires the restatement of all
periods presented as if CSC and USTC had been operating as a combined entity
during such periods. Share and per share information presented throughout this
report has been restated to reflect the common shares issued to USTC
shareholders pursuant to the exchange ratio under the terms of the merger
agreement. Certain reclassifications have been made to prior year amounts to
conform to the current presentation.
Risk Management
For discussion on the Company's principal risks and some of the policies
and procedures for risk identification, assessment and mitigation, see
"Management's Discussion and Analysis of Results of Operations and Financial
Condition - Risk Management" which is filed as Exhibit 99.1 to the Company's
Current Report on Form 8-K as filed with the Securities and Exchange Commission
(SEC) on July 18, 2000. See Liquidity and Capital Resources of this report for a
discussion on liquidity risk; and see Item 3 - Quantitative and Qualitative
Disclosures About Market Risk for additional information relating to market
risk.
Given the nature of the Company's revenues, expenses and risk profile, the
Company's earnings and CSC's common stock price may be subject to significant
volatility from period to period. The Company's results for any interim period
are not necessarily indicative of results for a full year. Risk is inherent in
the Company's business. Consequently, despite the Company's attempts to identify
areas of risk, oversee operational areas involving risk and implement policies
and procedures designed to mitigate risk, there can be no assurance that the
Company will not suffer unexpected losses due to operating or other risks.
Forward-Looking Statements
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"
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 Company's
status under the Bank Holding Company Act (see note "7 - Regulatory
Requirements" in the Notes to Condensed Consolidated Financial Statements), the
ability to successfully pursue the Company's strategy to attract and retain
client assets (see Description of Business: The Company), sources of liquidity
(see Liquidity and Capital Resources - Liquidity), capital expenditures (see
Liquidity and Capital Resources - Cash Flows and Capital Resources), and
contingent liabilities (see Part II - Other Information, Item 1 - Legal
Proceedings). Achievement of the expressed expectations is subject to certain
risks and uncertainties that could cause actual results to differ materially
from the expressed expectations described in these statements. Important factors
that may cause such differences are noted in this interim report and the
Company's Current Report on Form 8-K as filed with the SEC on July 18, 2000, and
include, but are not limited to: the effect of client trading patterns on
Company revenues and earnings; the inability to assimilate acquired companies
and to achieve the anticipated benefits; the Company's inability to attract and
retain key personnel; changes in the Company's level of personnel hiring,
investment in new or existing technology, or utilization of public media for
advertising; changes in technology; computer system failures and security
breaches; the effects of competitors' pricing, product and service decisions and
intensified competition; evolving regulation and changing industry practices
adversely affecting the Company; adverse results of litigation; the inability to
obtain external financing; changes in revenues and profit margin due to cyclical
securities markets and interest rates; the level and volatility of equity
prices; a significant downturn in the securities markets over a short period of
time or a sustained decline in securities prices and trading volumes; a
significant decline in the real estate market; and risks associated with
international expansion and operations.
Three Months Ended September 30, 2000 Compared To Three Months Ended
September 30, 1999
Financial Overview
The Company's revenues increased in the third quarter of 2000 mainly due to
higher levels of average balances and rates earned on margin loans to clients,
an increase in client assets, and higher trading volumes. Revenues of $1.3
billion in the third quarter of 2000 grew $307 million, or 30%, from the third
quarter of 1999 due to increases in revenues of $221 million, or 35%, in the
Individual Investor segment, $59 million, or 39%, in the Institutional Investor
segment, and $28 million, or 21%, in the U.S. Trust segment, partially offset by
a decrease in revenues of $1 million in the Capital Markets segment. See note "9
- Segment Information" in the Notes to Condensed Consolidated Financial
Statements for financial information by segment.
Total expenses excluding interest during the third quarter of 2000 were
$1.1 billion, up 39% from $780 million for the third quarter of 1999. This
increase was primarily due to a 31% increase in the Company's full-time
equivalent employees to 25,400 at September 30, 2000 and related costs, higher
occupancy and equipment, communications and depreciation and amortization
expenses.
Net income for the third quarter of 2000 was $142 million, down 1% from
third quarter 1999 net income of $144 million. Income before taxes on income for
the third quarter of 2000 was $240 million, up $5 million, or 2%, from the third
quarter of 1999 due to increases of $9 million, or 6%, in the Individual
Investor segment and $34 million, or 87%, in the Institutional Investor segment,
partially offset by decreases of $32 million in the Capital Markets segment and
$6 million, or 19%, in the U.S. Trust segment. The decrease to a loss in the
Capital Markets segment was primarily due to a substantial increase in expenses
as a result of continued growth in employees and higher trading volume-related
expenses, while revenues remained unchanged. The decrease in income in the U.S.
Trust segment was primarily due to $16 million of other compensation - merger
retention program expense recorded in the third quarter of 2000. Diluted
earnings per share for the third quarters of 2000 and 1999 were $.10 and $.11
per share, respectively. All references to earnings per share information in
this report reflect diluted earnings per share unless otherwise noted.
The after-tax profit margin for the third quarter of 2000 was 10.8%, down
from 14.2% for the third quarter of 1999. The annualized return on stockholders'
equity for the third quarter of 2000 was 15%, down from 25% for the third
quarter of 1999 primarily due to a 73% increase in average stockholders' equity
from the third quarter of 1999 to the third quarter of 2000, as well as the
decline in net income as discussed above.
The Company's third quarter 2000 results include charges for goodwill and
intangible asset amortization related to the acquisition of CyBerCorp and other
compensation - merger retention programs expense related to the merger with USTC
and the acquisition of CyBerCorp. These charges totaled $23 million after-tax.
Excluding these charges, the Company's third quarter 2000 after-tax profit
margin would have been 12.5% and earnings would have been $166 million, up 15%
from the third quarter of 1999.
The Company's client trading activity is shown in the following table (in
thousands):
--------------------------------------------------------------------------------
Three Months
Ended
September 30, Percent
Daily Average Trades 2000 1999 Change
--------------------------------------------------------------------------------
Revenue Trades
Online 174.8 97.7 79%
TeleBroker(R) and VoiceBroker(TM) 5.0 6.5 (23)
Regional client telephone service
centers, branch offices and other 23.7 30.9 (23)
--------------------------------------------------------------------------------
Total 203.5 135.1 51%
================================================================================
Mutual Fund OneSource(R) Trades
Online 32.7 20.1 63%
TeleBroker and VoiceBroker .7 .9 (22)
Regional client telephone service
centers, branch offices and other 17.6 19.3 (9)
--------------------------------------------------------------------------------
Total 51.0 40.3 27%
================================================================================
Total Daily Average Trades
Online 207.5 117.8 76%
TeleBroker and VoiceBroker 5.7 7.4 (23)
Regional client telephone service
centers, branch offices and other 41.3 50.2 (18)
--------------------------------------------------------------------------------
Total 254.5 175.4 45%
================================================================================
Assets in client accounts were $961.0 billion at September 30, 2000, an
increase of $262.2 billion, or 38%, from a year ago as shown in the table below.
This increase from a year ago included net new client assets of $163.8 billion
and net market gains of $98.4 billion related to client accounts.
--------------------------------------------------------------------------------
Growth in Client Assets and Accounts
(In billions, at quarter end, September 30, Percent
except as noted) 2000 1999 Change
--------------------------------------------------------------------------------
Assets in client accounts
Schwab One(R), other cash equivalents
and deposits from banking clients $ 26.4 $ 23.6 12%
Proprietary funds (SchwabFunds(R)
and Excelsior(R)):
Money market funds 103.1 86.1 20
Equity and bond funds 31.1 23.5 32
--------------------------------------------------------------------------------
Total proprietary funds 134.2 109.6 22
--------------------------------------------------------------------------------
Mutual Fund Marketplace(R)(1):
Mutual Fund OneSource
Retail 63.6 41.0 55
Schwab Institutional(TM)(2) 52.7 36.6 44
--------------------------------------------------------------------------------
Total Mutual Fund OneSource 116.3 77.6 50
Mutual fund clearing services 22.8 2.2 n/m
All other 76.5 64.6 18
--------------------------------------------------------------------------------
Total Mutual Fund Marketplace 215.6 144.4 49
--------------------------------------------------------------------------------
Total mutual fund assets 349.8 254.0 38
--------------------------------------------------------------------------------
Equity and other securities (1) 518.7 364.8 42
Fixed income securities 86.6 69.9 24
Margin loans outstanding (20.5) (13.5) 52
--------------------------------------------------------------------------------
Total client assets $961.0 $698.8 38%
================================================================================
Net growth in assets in client accounts (3)
(for the quarter ended)
Net new client assets $ 40.6 $ 24.6
Net market gains (losses) (10.8) (20.5)
------------------------------------------------------------------------
Net growth $ 29.8 $ 4.1
========================================================================
New client accounts
(in thousands, for the quarter ended) 281.0 283.6 (1%)
Active client accounts (in millions) 7.4 6.4 16%
================================================================================
Active online Schwab client
accounts (in millions) (4) 4.2 3.0 40%
Online Schwab client assets $419.7 $263.6 59%
================================================================================
(1) Excludes money market funds and all proprietary money market, equity and
bond funds.
(2) Represents assets invested in Mutual Fund OneSource by independent
investment managers and retirement plans.
(3) Net new client assets in 2000 include U.S. Trust. For 1999, U.S. Trust
net new client assets are included in net market gains.
(4) Active online accounts are defined as all accounts within a household that
has had at least one online session within the past twelve months.
n/m Not meaningful.
REVENUES
Revenues grew $307 million, or 30%, in the third quarter of 2000 compared
to the third quarter of 1999, due to a $105 million, or 50%, increase in
interest revenue, net of interest expense (referred to as net interest revenue),
a $102 million, or 33%, increase in asset management and administration fees,
and an $89 million, or 23%, increase in commission revenues. As the Company's
non-trading revenues grew at a rate that exceeded the growth rate of total
revenues, non-trading revenues represented 57% of total revenues for the third
quarter of 2000, up from 53% for the third quarter of 1999 as shown in the table
below.
--------------------------------------------------------------------------------
Three Months
Ended
September 30,
Composition of Revenues 2000 1999
--------------------------------------------------------------------------------
Commissions 36% 38%
Principal transactions 7 9
--------------------------------------------------------------------------------
Total trading revenues 43 47
--------------------------------------------------------------------------------
Asset management and administration fees 31 30
Net interest revenue 24 21
Other 2 2
--------------------------------------------------------------------------------
Total non-trading revenues 57 53
--------------------------------------------------------------------------------
Total 100% 100%
================================================================================
Commissions
The Company earns commission revenues by executing client trades primarily
through the Individual Investor and Institutional Investor segments. These
revenues are affected by the number of client accounts that trade, the average
number of commission-generating trades per account, and the average commission
per trade.
Commission revenues for the Company were $475 million for the third quarter
of 2000, up $89 million, or 23%, from the third quarter of 1999. As shown in the
table below, the total number of revenue trades executed by the Company has
increased 48% as the Company's client base, as well as client trading activity
per account, has grown. Average commission per revenue trade decreased 19%. This
decline was mainly due to an increase in the proportion of trades placed through
the Company's online channels, which have lower commission rates than the
Company's other channels, and reduced pricing for certain clients who trade
frequently.
--------------------------------------------------------------------------------
Three Months
Ended
Commissions Earned on September 30, Percent
Client Revenue Trades 2000 1999 Change
--------------------------------------------------------------------------------
Client accounts that traded during
the quarter (in thousands) 1,702 1,510 13%
Average client revenue trades per account 7.54 5.73 32
Total revenue trades (in thousands) 12,825 8,648 48
Average commission per revenue trade $ 36.29 $44.72 (19)
Commissions earned on client
revenue trades (in millions) (1) $ 465 $ 387 20
================================================================================
(1) Includes certain non-commission revenues relating to the execution of
client trades. Excludes commissions on trades relating to specialist
operations and U.S. Trust commissions on trades.
Asset Management and Administration Fees
Asset management and administration fees include mutual fund service fees,
as well as fees for other asset-based financial services provided to individual
and institutional clients. The Company earns mutual fund service fees for
recordkeeping and shareholder services provided to third-party funds, and for
transfer agent services, shareholder services, administration and investment
management provided to its proprietary funds. These fees are based upon the
daily balances of client assets invested in third-party funds and upon the
average daily net assets of Schwab's proprietary funds. Mutual fund service fees
are earned primarily through the Individual Investor and Institutional Investor
segments. The Company also earns asset management and administration fees for
financial services, including investment management and consulting, trust and
fiduciary services, financial and estate planning, and private banking services,
provided to individual and institutional clients. These fees are primarily based
on the value and composition of assets under management and are earned primarily
through the U.S. Trust segment, as well as the Individual Investor and
Institutional Investor segments.
Asset management and administration fees were $410 million for the third
quarter of 2000, up $102 million, or 33%, from the third quarter of 1999, as
shown in the following table (in millions):
--------------------------------------------------------------------------------
Three Months
Ended
Asset Management September 30, Percent
and Administration Fees 2000 1999 Change
--------------------------------------------------------------------------------
Mutual fund service fees:
SchwabFunds(R) $159 $131 21%
Mutual Fund OneSource(R) 90 58 55
Excelsior(R) Funds 14 9 56
Other 2 3 (33)
Asset management and related services 145 107 36
--------------------------------------------------------------------------------
Total $410 $308 33%
================================================================================
The increase in asset management and administration fees was primarily due
to an increase in client assets in funds purchased through Schwab's Mutual Fund
OneSource service, an increase in client assets in Schwab's proprietary funds,
collectively referred to as the SchwabFunds, and an increase in U.S. Trust's
client assets.
Net Interest Revenue
Net interest revenue is the difference between interest earned on assets
(mainly margin loans to clients, investments required to be segregated for
clients, securities available for sale, and private banking loans) and interest
paid on liabilities (mainly brokerage client cash balances and banking
deposits). 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
hedging strategies. Most of the Company's net interest revenue is earned by
Schwab through the Individual Investor and Institutional Investor segments, as
well as by U.S. Trust through the U.S. Trust segment.
Net interest revenue was $315 million for the third quarter of 2000, up
$105 million, or 50%, from the third quarter of 1999 as shown in the following
table (in millions):
--------------------------------------------------------------------------------
Three Months
Ended
September 30, Percent
2000 1999 Change
--------------------------------------------------------------------------------
Interest Revenue
Margin loans to clients $469 $254 85%
Investments, client-related 80 99 (19)
Private banking loans 56 45 24
Securities available for sale 18 14 29
Other 50 26 92
--------------------------------------------------------------------------------
Total 673 438 54
--------------------------------------------------------------------------------
Interest Expense
Brokerage client cash balances 284 177 60
Deposits from banking clients 40 30 33
Long-term debt 15 9 67
Stock-lending activities 10 7 43
Short-term borrowings 8 2 300
Other 1 3 (67)
--------------------------------------------------------------------------------
Total 358 228 57
--------------------------------------------------------------------------------
Net interest revenue $315 $210 50%
================================================================================
Client-related and other daily average balances, interest rates and average
net interest spread for the third quarters of 2000 and 1999 are summarized in
the following table (dollars in millions):
--------------------------------------------------------------------------------
Three Months Ended
September 30,
2000 1999
--------------------------------------------------------------------------------
Interest-Earning Assets (client-related and other):
Margin loans to clients:
Average balance outstanding $19,996 $13,405
Average interest rate 9.32% 7.50%
Investments (client-related):
Average balance outstanding $ 5,616 $ 8,262
Average interest rate 5.70% 4.72%
Private banking loans:
Average balance outstanding $ 2,922 $ 2,487
Average interest rate 7.71% 7.23%
Securities available for sale:
Average balance outstanding $ 1,152 $ 962
Average interest rate 6.18% 5.69%
Average yield on interest-earning assets 8.36% 6.49%
Funding Sources (client-related and other):
Interest-bearing brokerage client cash balances:
Average balance outstanding $20,970 $17,596
Average interest rate 5.38% 4.00%
Interest-bearing banking deposits:
Average balance outstanding $ 3,021 $ 2,778
Average interest rate 5.23% 4.30%
Other interest-bearing sources:
Average balance outstanding $ 1,714 $ 1,339
Average interest rate 4.74% 4.23%
Average noninterest-bearing portion $ 3,981 $ 3,403
Average interest rate on funding sources 4.61% 3.51%
Summary:
Average yield on interest-earning assets 8.36% 6.49%
Average interest rate on funding sources 4.61% 3.51%
--------------------------------------------------------------------------------
Average net interest spread 3.75% 2.98%
================================================================================
The increase in net interest revenue from the third quarter of 1999 was
primarily due to higher levels of margin loans to clients, partially offset by
higher average brokerage client cash balances.
Principal Transactions
Principal transaction revenues are primarily comprised of net gains from
market-making activities in Nasdaq and other securities transactions effected
through the Capital Markets segment. Factors that influence principal
transaction revenues include the volume of client trades, market price
volatility, average revenue per share traded and changes in regulations and
industry practices.
Principal transaction revenues were $97 million for the third quarter of
2000, up $4 million, or 4%, from the third quarter of 1999. This increase was
primarily due to greater share volume handled by SCM, substantially offset by
lower average revenue per share traded.
Expenses Excluding Interest
Compensation and benefits expense was $596 million for the third quarter of
2000, up $162 million, or 37%, from the third quarter of 1999 primarily due to a
greater number of employees and higher incentive and variable compensation
expense resulting from the Company's financial performance. The following table
shows a comparison of certain compensation and benefits components and employee
data (in thousands):
--------------------------------------------------------------------------------
Three Months
Ended
September 30,
2000 1999
--------------------------------------------------------------------------------
Compensation and benefits expense as a
% of total revenues 45% 43%
Incentive and variable compensation as a
% of compensation and benefits expense 24% 23%
Compensation for temporary employees, contractors and
overtime hours as a % of compensation and benefits expense 9% 13%
Full-time equivalent employees(1) (at end of quarter) 25.4 19.4
Revenues per average full-time equivalent employee $52.2 $53.5
================================================================================
(1) Includes full-time, part-time and temporary employees, and persons employed
on a contract basis.
Occupancy and equipment expense was $107 million for the third quarter of
2000, up $28 million, or 36%, from the third quarter of 1999. This increase was
primarily due to facilities expansion to support the Company's growth in
employees and enhancements in systems capacity.
Communications expense was $86 million for the third quarter of 2000, up
$23 million, or 36%, from the third quarter of 1999. This increase was primarily
due to higher client trading volumes, increased client use of online news,
quotes and information services, and increased telecommunications expenses
related to the Company's growth in employees.
Depreciation and amortization expense was $68 million for the third quarter
of 2000, up $24 million, or 53%, from the third quarter of 1999. The increase
was primarily due to the purchase of information technology equipment and
software to increase the Company's client service capacity. The increase was
also due to amortization of additional leasehold improvements for new branches
and office space, as well as internally-developed software.
The Company's effective income tax rate was 40.8% for the third quarter of
2000, up from 38.9% for the third quarter of 1999. The increase was primarily
due to goodwill amortization, related to the acquisition of CyBerCorp, which is
non-deductible for tax purposes.
Nine Months Ended September 30, 2000 Compared To Nine Months Ended
September 30, 1999
Financial Overview
The Company's revenues increased in the first nine months of 2000 mainly
due to higher levels of average balances and rates earned on margin loans to
clients, higher client trading volume, and an increase in client assets.
Revenues of $4.5 billion in the first nine months of 2000 grew $1.2 billion, or
39%, from the first nine months of 1999 due to increases in revenues of $869
million, or 44%, in the Individual Investor segment, $191 million, or 42%, in
the Institutional Investor segment, $100 million, or 25%, in the Capital Markets
segment, and $80 million, or 20%, in the U.S. Trust segment. See note "9 -
Segment Information" in the Notes to Condensed Consolidated Financial Statements
for financial information by segment.
Total expenses excluding interest during the first nine months of 2000 were
$3.4 billion, up 42% from $2.4 billion for the first nine months of 1999,
primarily resulting from additional staff and related costs, higher occupancy
and equipment, advertising and market development spending, and professional
fees and compensation related to the merger with USTC.
Net income for the first nine months of 2000 was $579 million, up 22% from
the first nine months of 1999 net income of $476 million. Income before taxes on
income for the first nine months of 2000 was $1.0 billion, up $221 million, or
28%, from the first nine months of 1999 due to increases of $189 million, or
38%, in the Individual Investor segment and $110 million, or 92%, in the
Institutional Investor segment, partially offset by decreases of $40 million, or
42%, in the U.S. Trust segment and $38 million, or 52%, in the Capital Markets
segment. The decrease in income in the U.S. Trust segment was primarily due to
$68 million of merger-related and other compensation - merger retention program
expenses recorded in the first nine months of 2000. The decrease in income in
the Capital Markets segment was primarily due to a higher growth rate in
expenses as compared to revenues as a result of continued growth in employees
and higher trading volume-related expenses. Diluted earnings per share for the
first nine months of 2000 and 1999 were $.41 and $.35 per share, respectively.
The after-tax profit margin for the first nine months of 2000 was 13.0%,
down from 14.8% for the first nine months of 1999. The annualized return on
stockholders' equity for the first nine months of 2000 was 23%, down from 31%
for the first nine months of 1999 primarily due to a 64% increase in average
stockholders' equity from the first nine months of 1999 to the first nine months
of 2000, partially offset by the increase in net income as discussed above.
The Company's results for the first nine months of 2000 include charges for
professional fees, change in control related and retention program compensation
and other expenses related to the merger with USTC, and goodwill and intangible
asset amortization and retention program compensation related to the acquisition
of CyBerCorp. These charges totaled $108 million after-tax. Excluding these
charges, the Company's after-tax profit margin for the first nine months of 2000
would have been 15.4% and earnings would have been $688 million, up 44% from the
first nine months of 1999.
The Company's trading activity is shown in the following table (in
thousands):
--------------------------------------------------------------------------------
Nine Months
Ended
September 30, Percent
Daily Average Trades 2000 1999 Change
--------------------------------------------------------------------------------
Revenue Trades
Online 210.1 108.1 94%
TeleBroker(R) and VoiceBroker(TM) 7.9 8.5 (7)
Regional client telephone service
centers, branch offices and other 31.4 35.9 (13)
--------------------------------------------------------------------------------
Total 249.4 152.5 64%
================================================================================
Mutual Fund OneSource(R) Trades
Online 37.8 22.4 69%
TeleBroker and VoiceBroker 1.2 1.0 20
Regional client telephone service
centers, branch offices and other 21.3 21.1 1
--------------------------------------------------------------------------------
Total 60.3 44.5 36%
================================================================================
Total Daily Average Trades
Online 247.9 130.5 90%
TeleBroker and VoiceBroker 9.1 9.5 (4)
Regional client telephone service
centers, branch offices and other 52.7 57.0 (8)
--------------------------------------------------------------------------------
Total 309.7 197.0 57%
================================================================================
Assets in client accounts were $961.0 billion at September 30, 2000, an
increase of $262.2 billion, or 38%, from a year ago. During the first nine
months of 2000, net new client assets and new accounts increased from the first
nine months of 1999 as shown in the table below.
--------------------------------------------------------------------------------
Nine
Growth in Client Months Ended
Assets and Accounts September 30, Percent
(In billions, except as noted) 2000 1999 Change
--------------------------------------------------------------------------------
Net growth in assets
in client accounts(1)
Net new client assets $130.5 $ 73.6
Net market gains (losses) (15.5) 30.9
-----------------------------------------------------------------
Net growth $115.0 $104.5
=================================================================
New client accounts (in thousands) 1,178.2 1,098.6 7%
================================================================================
(1) Net new client assets in 2000 include U.S. Trust. For 1999, U.S. Trust
net new client assets are included in net market gains.
REVENUES
Revenues grew $1.2 billion, or 39%, in the first nine months of 2000, due
to a $476 million, or 36%, increase in commission revenues, a $345 million, or
59%, increase in net interest revenue and a $288 million, or 33%, increase in
asset management and administration fees, as well as a $109 million, or 30%,
increase in principal transaction revenues. As the Company's non-trading
revenues grew at a rate that exceeded the growth rate of total revenues,
non-trading revenues represented 49% of total revenues for the first nine months
of 2000, up from 47% for the first nine months of 1999 as shown in the table
below.
--------------------------------------------------------------------------------
Nine Months
Ended
September 30,
Composition of Revenues 2000 1999
--------------------------------------------------------------------------------
Commissions 41% 41%
Principal transactions 10 12
--------------------------------------------------------------------------------
Total trading revenues 51 53
--------------------------------------------------------------------------------
Asset management and administration fees 26 28
Net interest revenue 21 18
Other 2 1
--------------------------------------------------------------------------------
Total non-trading revenues 49 47
--------------------------------------------------------------------------------
Total 100% 100%
================================================================================
Commissions
Commission revenues for the Company were $1.8 billion for the first nine
months of 2000, up $476 million, or 36%, from the first nine months of 1999. As
shown in the table below, the total number of revenue trades executed by the
Company has increased 64% as the Company's client base, as well as client
trading activity per account, has grown. Average commission per revenue trade
decreased 18%. This decline was attributable to the factors described in the
comparison between the three-month periods.
--------------------------------------------------------------------------------
Nine Months
Ended
Commissions Earned on September 30, Percent
Client Revenue Trades 2000 1999 Change
--------------------------------------------------------------------------------
Client accounts that traded during
the period (in thousands) 3,417 2,822 21%
Average client revenue trades per account 13.80 10.16 36
Total revenue trades (in thousands) 47,140 28,668 64
Average commission per revenue trade $ 37.99 $ 46.36 (18)
Commissions earned on client
revenue trades (in millions) (1) $ 1,791 $ 1,329 35
================================================================================
(1) Includes certain non-commission revenues relating to the execution of
client trades. Excludes commissions on trades relating to specialist
operations and U.S. Trust commissions on trades.
Asset Management and Administration Fees
Asset management and administration fees were $1.2 billion for the first
nine months of 2000, up $288 million, or 33%, from the first nine months of 1999
as shown in the following table (in millions). This increase was attributable to
the factors described in the comparison between the three-month periods.
--------------------------------------------------------------------------------
Nine Months
Ended
Asset Management September 30, Percent
and Administration Fees 2000 1999 Change
--------------------------------------------------------------------------------
Mutual fund service fees:
SchwabFunds(R) $ 459 $367 25%
Mutual Fund OneSource(R) 254 165 54
Excelsior(R) Funds 38 25 52
Other 14 10 40
Asset management and related services 407 317 28
--------------------------------------------------------------------------------
Total $1,172 $884 33%
================================================================================
Net Interest Revenue
Net interest revenue was $931 million for the first nine months of 2000, up
$345 million, or 59%, from the first nine months of 1999 as shown in the
following table (in millions):
--------------------------------------------------------------------------------
Nine Months
Ended
September 30, Percent
2000 1999 Change
--------------------------------------------------------------------------------
Interest Revenue
Margin loans to clients $1,334 $ 687 94%
Investments, client-related 249 298 (16)
Private banking loans 160 126 27
Securities available for sale 53 44 20
Other 129 68 90
--------------------------------------------------------------------------------
Total 1,925 1,223 57
--------------------------------------------------------------------------------
Interest Expense
Brokerage client cash balances 788 494 60
Deposits from banking clients 113 84 35
Long-term debt 40 24 67
Stock-lending activities 34 23 48
Short-term borrowings 15 6 150
Other 4 6 (33)
--------------------------------------------------------------------------------
Total 994 637 56
--------------------------------------------------------------------------------
Net interest revenue $ 931 $ 586 59%
================================================================================
Client-related and other daily average balances, interest rates and average
net interest spread for the first nine months of 2000 and 1999 are summarized in
the following table (dollars in millions):
--------------------------------------------------------------------------------
Nine Months Ended
September 30,
2000 1999
--------------------------------------------------------------------------------
Interest-Earning Assets (client-related and other):
Margin loans to clients:
Average balance outstanding $20,139 $12,563
Average interest rate 8.85% 7.31%
Investments (client-related):
Average balance outstanding $ 6,202 $ 8,602
Average interest rate 5.37% 4.63%
Private banking loans:
Average balance outstanding $ 2,816 $ 2,331
Average interest rate 7.60% 7.24%
Securities available for sale:
Average balance outstanding $ 1,154 $ 996
Average interest rate 6.08% 5.79%
Average yield on interest-earning assets 7.91% 6.30%
Funding Sources (client-related and other):
Interest-bearing brokerage client cash balances:
Average balance outstanding $20,884 $16,886
Average interest rate 5.04% 3.91%
Interest-bearing banking deposits:
Average balance outstanding $ 3,036 $ 2,701
Average interest rate 4.96% 4.15%
Other interest-bearing sources:
Average balance outstanding $ 1,973 $ 1,516
Average interest rate 4.50% 3.71%
Average noninterest-bearing portion $ 4,418 $ 3,389
Average interest rate on funding sources 4.26% 3.39%
Summary:
Average yield on interest-earning assets 7.91% 6.30%
Average interest rate on funding sources 4.26% 3.39%
--------------------------------------------------------------------------------
Average net interest spread 3.65% 2.91%
================================================================================
The increase in net interest revenue from the first nine months of 1999 was
primarily due to higher levels of margin loans to clients, partially offset by
higher average brokerage client cash balances.
Principal Transactions
Principal transaction revenues were $470 million for the first nine months
of 2000, up $109 million, or 30%, from the first nine months of 1999. This
increase was primarily due to greater share volume handled by SCM, partially
offset by lower average revenue per share traded.
Expenses Excluding Interest
Compensation and benefits expense was $1.9 billion for the first nine
months of 2000, up $495 million, or 36%, from the first nine months of 1999
primarily due to a greater number of employees, as well as higher variable
compensation expense resulting from the Company's financial performance. The
following table shows a comparison of certain compensation and benefits
components and employee data (in thousands):
--------------------------------------------------------------------------------
Nine Months
Ended
September 30,
2000 1999
--------------------------------------------------------------------------------
Compensation and benefits expense as a % of revenues 42% 42%
Incentive and variable compensation as a
% of compensation and benefits expense 30% 30%
Compensation for temporary employees, contractors and
overtime hours as a % of compensation and benefits
expense 10% 12%
Full-time equivalent employees(1) (at end of period) 25.4 19.4
Revenues per average full-time equivalent employee $190.0 $184.3
================================================================================
(1) Includes full-time, part-time and temporary employees, and persons employed
on a contract basis.
Occupancy and equipment expense was $295 million for the first nine months
of 2000, up $77 million, or 35%, from the first nine months of 1999. This
increase was attributable to the factors described in the comparison between the
three-month periods.
Advertising and market development expense was $243 million for the first
nine months of 2000, up $74 million, or 44%, from the first nine months of 1999.
This increase was primarily a result of increased Schwab brand-focused
television and print media spending.
Merger-related expense was $69 million for the first nine months of 2000,
up $69 million from the first nine months of 1999. Merger-related expense
consists of professional fees and change in control related compensation from
the merger with USTC.
The Company's effective income tax rate was 42.4% for the first nine months
of 2000, up from 39.3% for the first nine months of 1999. The increase was
primarily due to charges, which are non-deductible for tax purposes, for certain
professional fees relating to the merger with USTC and goodwill amortization
relating to the acquisition of CyBerCorp.
Liquidity and Capital Resources
Upon completion of the merger with USTC, CSC became a financial holding
company and bank holding company subject to supervision and regulation by the
Board of Governors of the Federal Reserve System (Federal Reserve Board) under
the Bank Holding Company Act of 1956, as amended. CSC conducts virtually all
business through its wholly owned subsidiaries. The capital structure among CSC
and its subsidiaries is designed to provide each entity with capital and
liquidity consistent with its operations. See note "7 - Regulatory Requirements"
in the Notes to Condensed Consolidated Financial Statements. A description of
significant aspects of this structure for CSC and four of its subsidiaries,
Schwab, U.S. Trust, SCM and CSE follows.
Liquidity
CSC
CSC's liquidity needs are generally met through cash generated by its
subsidiaries, as well as cash provided by external financing. As discussed
below, Schwab, CSC's bank subsidiaries, SCM and CSE are subject to regulatory
requirements that may restrict them from certain transactions with CSC.
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,
maintaining CSC's bank subsidiaries' capital guidelines and maintaining Schwab's
and SCM's net capital. Based on their respective regulatory capital ratios at
September 30, 2000 and 1999, the Company and its bank subsidiaries are well
capitalized.
CSC has liquidity needs that arise from its issued and outstanding $741
million Senior Medium-Term Notes, Series A (Medium-Term Notes), as well as from
the funding of cash dividends, acquisitions and other investments. The
Medium-Term Notes have maturities ranging from 2000 to 2010 and fixed interest
rates ranging from 5.96% to 8.05% with interest payable semiannually. The
Medium-Term Notes are rated A2 by Moody's Investors Service and A by Standard &
Poor's Ratings Group. CSC has a prospectus supplement on file with the
Securities and Exchange Commission enabling CSC to issue up to $750 million in
Senior or Senior Subordinated Medium-Term Notes, Series A. At September 30,
2000, all of these notes remained unissued.
CSC maintains a $1.2 billion committed, unsecured credit facility with a
group of banks which is scheduled to expire in June 2001. The funds under this
facility are available for general corporate purposes and CSC pays a commitment
fee on the unused balance of this facility. The financial covenants in this
facility require CSC to maintain minimum levels of stockholders' equity, and
Schwab and SCM to maintain specified levels of net capital, as defined. The
Company believes that these restrictions will not have a material effect on its
ability to meet foreseeable dividend or funding requirements. This facility was
unused during the first nine months of 2000.
CSC also has direct access to $675 million of the $765 million uncommitted,
unsecured bank credit lines, provided by eight banks, that are primarily
utilized by Schwab to manage short-term liquidity. The amount available to CSC
under these lines is lower than the amount available to Schwab because the
credit line provided by one of these banks is only available to Schwab, while
the credit line provided by another one of these banks includes a sub-limit on
credit available to CSC. These lines were not used by CSC during the first nine
months of 2000.
Schwab
Liquidity needs relating to client trading and margin borrowing activities
are met primarily through cash balances in brokerage client accounts, which were
$22.9 billion and $23.0 billion at September 30, 2000 and December 31, 1999,
respectively. Management believes that brokerage client cash balances and
operating earnings will continue to be the primary sources of liquidity for
Schwab in the future.
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 to CSC, paying
cash dividends, or making unsecured advances or loans to its parent or employees
if such payment would result in net capital of less than 5% of aggregate debit
balances or less than 120% of its minimum dollar amount requirement of $1
million. At September 30, 2000, Schwab's net capital was $2.1 billion (10% of
aggregate debit balances), which was $1.7 billion in excess of its minimum
required net capital and $1.1 billion in excess of 5% of aggregate debit
balances. Schwab has historically targeted net capital to be 10% of its
aggregate debit balances, which primarily consist of client margin loans. To
achieve this target, as client margin loans have grown, an increasing amount of
cash flows have been retained to support aggregate debit balances.
To manage Schwab's regulatory capital position, CSC provides Schwab with a
$1.4 billion subordinated revolving credit facility maturing in September 2002,
of which $705 million was outstanding at September 30, 2000. At quarter end,
Schwab also had outstanding $25 million in fixed-rate subordinated term loans
from CSC maturing in 2002. Borrowings under these subordinated lending
arrangements qualify as regulatory capital for Schwab.
To manage short-term liquidity, Schwab maintains uncommitted, unsecured
bank credit lines totaling $765 million at September 30, 2000 ($675 million of
these lines are also available for CSC to use). The need for short-term
borrowings arises primarily from timing differences between cash flow
requirements and the scheduled liquidation of interest-bearing investments.
Schwab used such borrowings for 24 days during the first nine months of 2000,
with the daily amounts borrowed averaging $82 million. These lines were unused
at September 30, 2000.
To satisfy the margin requirement of client option transactions with the
Options Clearing Corporation (OCC), Schwab had unsecured letter of credit
agreements with twelve banks in favor of the OCC aggregating $1.0 billion at
September 30, 2000. Schwab pays a fee to maintain these letters of credit. No
funds were drawn under these letters of credit at September 30, 2000.
U.S. Trust
U.S. Trust's liquidity needs are generally met through earnings generated
by its operations.
U.S. Trust's liquidity is affected by the Federal Reserve Board's
risk-based and leverage capital guidelines. In addition, CSC's bank subsidiaries
are subject to limitations on the amount of dividends they can pay to U.S. Trust
without prior approval of the bank regulatory authorities.
In addition to traditional funding sources such as deposits, federal funds
purchased and repurchase agreements, CSC's bank subsidiaries have established
their own external funding sources. At September 30, 2000, U.S. Trust had $50
million Trust Preferred Capital Securities outstanding with a fixed interest
rate of 8.41%. Certain of CSC's bank subsidiaries have established credit
facilities with the Federal Home Loan Bank System (FHLB) totaling approximately
$499 million. At September 30, 2000, $150 million in short-term borrowings and
$2 million in long-term debt were outstanding under these facilities.
SCM
SCM's liquidity needs are generally met through earnings generated by its
operations. Most of SCM's assets are liquid, consisting primarily of marketable
securities, cash and cash equivalents, and receivable from brokers, dealers and
clearing organizations.
SCM's liquidity is affected by the same net capital regulatory requirements
as Schwab (see discussion above). At September 30, 2000, SCM's net capital was
$30 million, which was $29 million in excess of its minimum required net
capital.
SCM may borrow up to $70 million under a subordinated lending arrangement
with CSC maturing in 2002. Borrowings under this arrangement qualify as
regulatory capital for SCM. In addition, CSC provides SCM with a $25 million
short-term credit facility. Borrowings under this arrangement do not qualify as
regulatory capital for SCM. No funds were drawn under these facilities at
September 30, 2000.
CSE
CSE's liquidity needs are generally met through earnings generated by its
operations. Most of CSE's assets are liquid, consisting primarily of cash and
investments required to be segregated, receivable from brokers, dealers and
clearing organizations, and receivable from brokerage clients and others.
CSE may borrow up to (pound)70 million, equivalent to $103 million at
September 30, 2000, under subordinated lending arrangements with CSC. At
September 30, 2000, CSE had outstanding (pound)18 million under these
arrangements, equivalent to $29 million, with (pound)5 million maturing in 2001
and (pound)13 million maturing in 2003.
Cash Flows and Capital Resources
Net income plus depreciation and amortization, including goodwill
amortization, was $797 million for the first nine months of 2000, up 32% from
$605 million for the first nine months of 1999, allowing the Company to finance
its operations primarily with internally generated funds. Depreciation and
amortization expense related to equipment, office facilities and property was
$173 million for the first nine months of 2000, as compared to $117 million for
the first nine months of 1999, or 4% of revenues for each period. Amortization
expense related to intangible assets was $12 million for the first nine months
of 2000, as compared to $7 million for the first nine months of 1999. Goodwill
amortization expense was $32 million for the first nine months of 2000, as
compared to $5 million for the first nine months of 1999. This increase was
primarily due to goodwill amortization related to the acquisition of CyBerCorp.
The Company's capital expenditures net of proceeds from the sale of fixed
assets were $467 million in the first nine months of 2000 and $253 million in
the first nine months of 1999, or 10% and 8% of revenues for each period,
respectively. Capital expenditures in the first nine months of 2000 were for
facilities expansion, equipment relating to the Company's information technology
systems and software. Capital expenditures as described above include the
capitalized costs for developing internal-use software of $75 million in the
first nine months of 2000 and $46 million in the first nine months of 1999.
Schwab opened 28 new domestic branch offices during the first nine months of
2000 and 1999. Capital expenditures may vary from period to period as business
conditions change.
The Company issued $311 million and repaid $36 million of long-term debt
during the first nine months of 2000.
During the first nine months of 2000, 18,454,300 of the Company's stock
options, with a weighted-average exercise price of $2.55, were exercised with
cash proceeds received by the Company of $47 million and a related tax benefit
of $165 million. (These stock options were granted prior to the merger with
USTC, and therefore did not include U.S. Trust employees). During the first five
months of 2000, 4,800,200 of U.S. Trust's stock options, with a weighted-average
exercise price of $7.06, were exercised with cash proceeds received by the
Company of $27 million and a related tax benefit of $12 million. The cash
proceeds are recorded as an increase in cash and a corresponding increase in
stockholders' equity. The tax benefit is recorded as a reduction in income taxes
payable and a corresponding increase in stockholders' equity.
During the first nine months of 2000, the Company did not repurchase any
common stock. During the first nine months of 1999, the Company repurchased
2,143,500 shares of its common stock for $35 million. There is no current
authorization for share repurchases.
During the first nine months of 2000 and 1999, the Company paid common
stock cash dividends of $47 million and $46 million, respectively.
The Company monitors both the relative composition and absolute level of
its capital structure. The Company's total financial capital (long-term debt
plus stockholders' equity) at September 30, 2000 was $4.8 billion, up $1.7
billion, or 56% from December 31, 1999. At September 30, 2000, the Company had
long-term debt of $793 million, or 16% of total financial capital, that bear
interest at a weighted-average rate of 7.22%. At September 30, 2000, the
Company's stockholders' equity was $4.0 billion, or 84% of total financial
capital.
Item 3. Quantitative and Qualitative Disclosures
About Market Risk
Financial Instruments Held For Trading Purposes
The Company held municipal, other fixed income and government securities
and certificates of deposit with a fair value of approximately $38 million and
$26 million at September 30, 2000 and 1999, respectively. These securities, and
the associated interest rate risk, are not material to the Company's financial
position, results of operations or cash flows.
Through Schwab and SCM, the Company maintains inventories in
exchange-listed, Nasdaq and other equity securities on both a long and short
basis. The fair value of these securities at September 30, 2000 was $84 million
in long positions and $53 million in short positions. The fair value of these
securities at September 30, 1999 was $61 million in long positions and $39
million in short positions. Using a hypothetical 10% increase or decrease in
prices, the potential loss or gain in fair value is estimated to be
approximately $3,100,000 and $2,200,000 at September 30, 2000 and 1999,
respectively, due to the offset of change in fair value in long and short
positions. In addition, the Company generally enters into exchange-traded option
contracts to hedge against potential losses in equity inventory positions, thus
reducing this potential loss exposure. This hypothetical 10% change in fair
value of these securities at September 30, 2000 and 1999 would not be material
to the Company's financial position, results of operations or cash flows. The
notional amount and fair value of option contracts were not material to the
Company's consolidated balance sheets at September 30, 2000 and 1999.
Financial Instruments Held For Purposes Other Than Trading
The Company maintains investments primarily in mutual funds to fund
obligations under its deferred compensation plan, which is available to certain
employees. These investments were approximately $65 million and $55 million at
September 30, 2000 and 1999, respectively. Any decrease in the fair value of
these investments would result in a comparable decrease in the deferred
compensation plan obligation and would not affect the Company's financial
position, results of operations or cash flows.
Debt Issuances
At September 30, 2000, CSC had $741 million aggregate principal amount of
Medium-Term Notes, with fixed interest rates ranging from 5.96% to 8.05%. At
September 30, 1999, CSC had $465 million aggregate principal amount of
Medium-Term Notes, with fixed interest rates ranging from 5.90% to 7.50%. At
September 30, 2000 and 1999, U.S. Trust had $50 million Trust Preferred Capital
Securities outstanding, with a fixed interest rate of 8.41%. In addition at
September 30, 2000 and 1999, U.S. Trust had $2 million and $13 million FHLB
long-term debt outstanding, respectively. The FHLB long-term debt had fixed
interest rates ranging from 6.69% to 6.76% at September 30, 2000 and 6.59% to
6.76% at September 30, 1999.
The Company has fixed cash flow requirements regarding these long-term debt
obligations due to the fixed rate of interest. The fair value of these
obligations at September 30, 2000 and 1999, based on estimates of market rates
for debt with similar terms and remaining maturities, approximated their
carrying amount.
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 and Swaps
utilized by U.S. Trust to hedge its interest rate risk. Key variables in the
model include assumed margin loan and brokerage client cash balance growth,
changes to the level and term structure of interest rates, the repricing of
financial instruments, prepayment and reinvestment assumptions, loan, banking
deposit, and brokerage client cash balance pricing and volume assumptions. The
simulations involve assumptions that are inherently uncertain and as a result,
the simulations cannot precisely estimate net interest revenue or precisely
predict the impact of changes in interest rates on net interest revenue. Actual
results may differ from simulated results due to 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.
The simulations in the table below 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 200 basis point increase or decrease in interest
rates and the effect on simulated net interest revenue over the next twelve
months at September 30, 2000 and 1999 (dollars in millions). The change in
simulated net interest revenue sensitivity from 1999 to 2000 was primarily due
to increases in the overall size of the balance sheet, driven by the growth in
brokerage client cash balances.
--------------------------------------------------------------------------------
Impact on Net Interest Revenue
Increase (Decrease)
2000 1999
------------- -------------
September 30, Amount % Amount %
--------------------------------------------------------------------------------
Increase of 200 basis points $118 8.3% $88 9.5%
Decrease of 200 basis points ($118) (8.3%) ($90) (9.7%)
================================================================================
As demonstrated by the simulations presented, the Company manages the
consolidated balance sheet to produce increases in net interest revenue when
interest rates rise. This position partially offsets the potential for decreases
in trading activity, and therefore commission revenue, that may result during
periods of rising interest rates.
The impact of the Company's hedging activities upon net interest revenue
for the quarters ended September 30, 2000 and 1999 was immaterial to the
Company's results of operations.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
The nature of the Company's business subjects it to numerous regulatory
investigations, claims, lawsuits and other proceedings in the ordinary course of
its business. The results of these legal proceedings cannot be predicted with
certainty. There can be no assurance that these matters will not have a material
adverse effect on the Company's results of operations in any future period,
depending partly on the results for that period, and a substantial judgment
could have a material adverse impact on the Company's financial condition.
However, it is the opinion of management, after consultation with outside legal
counsel, that the ultimate outcome of the current matters will not have a
material adverse impact on the financial condition or operating results of the
Company.
Item 2. Changes in Securities and Use of Proceeds
None.
Item 3. Defaults Upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders
None.
Item 5. Other Information
None.
Item 6. Exhibits and Reports on Form 8-K
(a) The following exhibits are filed as part of this quarterly report on Form
10-Q.
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Exhibit
Number Exhibit
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10.87 Trust Agreement under the Charles Schwab Profit Sharing and Employee
Stock Ownership Plan, effective November 1, 1990, dated October 25,
1990, amended by: the First Amendment, effective January 1, 1992,
dated December 20, 1991 filed as Exhibit 10.101 to the Registrant's
Form 10-K for the year ended December 31, 1996; the Second Amendment,
effective July 1, 1992, dated June 30, 1992 filed as Exhibit 10.116 to
the Registrant's Form 10-Q for the quarter ended June 30, 1997; the
Third Amendment, effective January 1, 1996, dated May 8, 1996 filed as
Exhibit 10.169 to the Registrant's Form 10-Q for the quarter ended
June 30, 1997; the Fourth Amendment, effective January 1, 1998, filed
as Exhibit 10.202 to the Registrant's Form 10-K for the year ended
December 31, 1998; all amendments are incorporated herein by
reference.
12.1 Computation of Ratio of Earnings to Fixed Charges.
27.1 Financial Data Schedule (electronic only).
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(b) Reports on Form 8-K
On July 18, 2000, the Registrant filed a Current Report on Form 8-K which
included a press release announcing its consolidated results of operations for
the three-month and six-month periods ended June 30, 2000. This Current Report
on Form 8-K was filed to present 30 days of combined results of operations of
The Charles Schwab Corporation (CSC) and U.S. Trust Corporation.
On July 18, 2000, the Registrant filed a Current Report on Form 8-K which
included the audited consolidated balance sheets of CSC and its subsidiaries
(collectively referred to as the Company) as of December 31, 1999 and 1998, and
the related consolidated statements of income, stockholders' equity and cash
flows for each of the years ended December 31, 1999, 1998 and 1997, together
with the Independent Auditors' Reports thereon, as well as the Company's
management's discussion and analysis of results of operations and financial
condition, and supplementary financial information. Also included in this
Current Report on Form 8-K are the unaudited condensed consolidated balance
sheets of the Company as of March 31, 2000 and December 31, 1999, and the
related condensed consolidated statements of income and cash flows for each of
the three months ended March 31, 2000 and 1999, together with the Company's
management's discussion and analysis of results of operations and financial
condition, and supplementary financial information.
<PAGE>
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: November 9, 2000 /s/ Christopher V. Dodds
--------------------- ----------------------------------
Christopher V. Dodds
Executive Vice President and
Chief Financial Officer
