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 June 30, 2015

 

Commission File Number: 1-9700

 

THE  CHARLES  SCHWAB  CORPORATION

(Exact name of registrant as specified in its charter)

 

 

211 Main Street, San Francisco, CA  94105

(Address of principal executive offices and zip code)

 

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

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes ⌧  No ☐

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes ⌧   No ☐

 

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

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes ☐ No ⌧

 

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

 

1,315,623,956 shares of $.01 par value Common Stock

Outstanding on July 27, 2015

 

 

 

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

 

INTRODUCTION

 

The Charles Schwab Corporation (CSC) is a savings and loan holding company engaged, through its subsidiaries, in wealth management, securities brokerage, banking, money management, and financial advisory services. Charles Schwab & Co., Inc. (Schwab) is a securities broker-dealer with over 325 domestic branch offices in 45 states, as well as a branch in each of the Commonwealth of Puerto Rico and London, England. In addition, Schwab serves clients in Hong Kong through one of CSC’s subsidiaries. Other subsidiaries include Charles Schwab Bank (Schwab Bank), a federal savings bank, and Charles Schwab Investment Management, Inc. (CSIM), the investment advisor for Schwab’s proprietary mutual funds, which are referred to as the Schwab Funds®, and for Schwab’s exchange-traded funds, which are referred to as the Schwab ETFs™.

 

CSC and its subsidiaries (collectively referred to as the Company) operate through two reportable segments – Investor Services and Advisor Services. The Investor Services segment provides retail brokerage and banking services to individual investors, retirement plan services, and corporate brokerage services. The Advisor Services segment provides custodial, trading, and support services to independent investment advisors, and retirement business services to independent retirement plan advisors and recordkeepers whose plan assets are held at Schwab Bank.

 

 

Forward-Looking Statements

 

In addition to historical information, this Quarterly Report on Form 10-Q contains “forward-looking statements” within the meaning of Section 27A of the Securities Act, and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements are identified by words such as “believe,” “anticipate,” “expect,” “intend,” “plan,” “will,” “may,” “estimate,” “appear,” “aim,” “target,” “could,” and other similar expressions. In addition, any statements that refer to expectations, projections, or other characterizations of future events or circumstances are forward-looking statements.

 

These forward-looking statements, which reflect management’s beliefs, objectives, and expectations as of the date hereof, are necessarily estimates based on the best judgment of the Company’s senior management. These statements relate to, among other things:

 

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

 

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

 

Certain of these factors, as well as general risk factors affecting the Company, are discussed in greater detail in “Part I –Item 1A – Risk Factors” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2014, and “Part II – Other Information – Item 1A – Risk Factors.”

 

 

 

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OVERVIEW

 

Management of the Company focuses on several key client activity and financial metrics in evaluating the Company’s financial position and operating performance. Management believes that net revenue growth, pre-tax profit margin, earnings per common share (EPS), and return on average common stockholders’ equity provide broad indicators of the Company’s overall financial health, operating efficiency, and ability to generate acceptable returns. Expenses excluding interest as a percentage of average client assets is considered by management to be a measure of operating efficiency. Results for the second quarters and first halves of 2015 and 2014 are:

 

 

 

Core net new client assets is defined as net new client assets before significant one-time flows. Management considers this to be a useful metric when comparing period-to-period client asset flows. The following one-time flows were excluded from core net new assets.

 

The Company’s operating environment included variable equity market performance during the second quarter of 2015; however, the markets ended the quarter largely unchanged from March 31, 2015.  Compared to the second quarter of 2014, the Nasdaq Composite Index, Standard & Poor’s 500 Index, and Dow Jones Industrial Average improved 13%,  5%, and 5%, respectively, at the end of the second quarter of 2015. Meanwhile, short-term interest rates continued to be constrained as the federal funds target rate remained unchanged at a range of zero to 0.25% and the average 3-month Treasury Bill yield decreased by 1 basis point to 0.01% compared to the second quarter of 2014. In addition, long-term interest rates decreased in the second quarter of 2015 compared to the same period in 2014. The average 10-year yield during the second quarter of 2015 was 2.16% which was 45 basis points lower than the average yield during the second quarter of 2014.

 

Strong client momentum continued as the Company’s innovative, full-service model continued to resonate with clients and drive growth during the second quarter of 2015. Core net new assets totaled $37.0 billion in the second quarter of 2015, which were up $14.3 billion compared to core net new client assets in the second quarter of 2014. Total client assets ended the second quarter of 2015 at $2.54 trillion, up 6% from the second quarter of 2014. The Company added 280,000 new brokerage accounts to its client base during the second quarter of 2015, up 16% compared to the second quarter of 2014. Active brokerage accounts ended the second quarter at 9.6 million, also up 4% on a year-over-year basis.

 

For the second quarter and first half of 2015, the Company’s net revenues increased 6% and 5% compared to the second quarter and first half of 2014, respectively, primarily due to increases in net interest revenue and asset management and administration fees, partially offset by a decrease in trading revenue. Net interest revenue increased primarily due to higher balances of interest-earning assets, including margin loans and the Company’s investment portfolio (securities available for sale and securities held to maturity), partially offset by the effect lower average interest rates had on the Company’s average net interest margin. Asset management and administration fees increased due to higher client asset balances in mutual fund services, advice solutions, and other asset management and administration services and improved rates earned on money market funds. Trading revenue decreased primarily due to a decrease in commission revenue as a result of lower daily average revenue trades. Other revenue increased primarily due to litigation proceeds of $17 million in the second quarter of 2015 relating to the Company’s non-agency residential mortgage-backed securities portfolio, offset by decreases in order flow revenue.

 

Expenses excluding interest increased 4% and 7% in the second quarter and first half of 2015 compared to the same periods in 2014, respectively, primarily due to increases in compensation and benefits, professional services, and other expense.

 

The combined effect of the environment, strong business growth, and the Company’s overall spending resulted in a pre-tax profit margin of 36.2% and 34.0% in the second quarter and first half of 2015, respectively. Overall, net income increased by 9%  and 1% in the second quarter and first half of 2015, compared to the same periods in 2014, respectively. The return on average common stockholders’ equity was 12% and 11% in the second quarter and first half of 2015, respectively.

 

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Subsequent Event

 

On August 3, 2015, the Company issued and sold 24 million depositary shares, each representing a 1/40th ownership interest in a share of 6.00% non-cumulative perpetual preferred stock, Series C, $0.01 par value, with a liquidation preference of $1,000 per share (equivalent to $25 per depositary share) (Series C Preferred Stock). The Series C Preferred Stock has a fixed dividend rate of 6.00%. Net proceeds received from the sale were $581 million and are being used to support balance sheet growth, including the migration of certain client balances from sweep money market funds into Schwab Bank.

 

 

CURRENT MARKET AND REGULATORY ENVIRONMENT AND OTHER DEVELOPMENTS

 

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

 

In July 2013, the United States (U.S.) banking agencies issued regulatory capital rules that implemented BASEL III and relevant provisions of the “Dodd-Frank Wall Street Reform and Consumer Protection Act” (the Dodd-Frank Act) (Final Regulatory Capital Rules), which are applicable to savings and loan holding companies, such as CSC, and federal savings banks, such as Schwab Bank. The implementation of the rules began on January 1, 2015.

 

The Final Regulatory Capital Rules, among other things:

 

The application of the revised risk-weighting of assets resulted in a decrease in the Company’s Common Equity Tier 1 Risk-Based Capital, Tier 1 Risk-Based Capital, and Total Risk-Based Capital ratios of approximately 3.5% in 2015. The required minimum capital conservation buffer will be phased in incrementally, starting at 0.625% on January 1, 2016 and increasing to 1.25% on January 1, 2017, 1.875% on January 1, 2018 and 2.5% on January 1, 2019.

 

The Final Regulatory Capital Rules provide that the failure to maintain the minimum capital conservation buffer will result in restrictions on capital distributions and discretionary cash bonus payments to executive officers.

 

In September 2014, the Board of Governors of the Federal Reserve System (Federal Reserve), in collaboration with the Office of the Comptroller of the Currency (OCC) and the Federal Deposit Insurance Corporation, issued a rule implementing a quantitative liquidity requirement generally consistent with the LCR standard established by Basel III. The LCR applies to all internationally active banking organizations. The Federal Reserve also issued a modified LCR that applies to the Company. Under the modified LCR, a depository institution holding company is required to maintain high-quality liquid assets in an amount related to its total estimated net cash outflows over a prospective period. The modified LCR will be phased in beginning on January 1, 2016, with a minimum requirement of 90%, increasing to 100% at January 1, 2017. The Company expects to be compliant with the modified LCR by January 1, 2016 and does not expect a material impact to the Company’s business, financial condition, and results of operations.

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In April 2015, the Department of Labor published notice of a rule proposal to significantly broaden the definition of “fiduciary” under the Employee Retirement Income Security Act of 1974. If adopted, among other things, the new rule would subject broker-dealers who provide non-discretionary investment advice to retirement plans and accounts to a “best interest” standard, as well as other conditions and requirements. The comment period for the rule proposal ended on July 21, 2015 and the rule proposal is subject to further modification. The Company will continue to evaluate the impact of the proposed rule.

 

The Company is pursuing lawsuits in state court in San Francisco for rescission and damages against issuers, underwriters, and dealers of individual non-agency residential mortgage-backed securities on which the Company experienced losses. The lawsuits allege that offering documents for the securities contained material untrue and misleading statements about the securities and the underwriting standards and credit quality of the underlying loans. On January 27, 2012, and July 24, 2012, the court denied defendants’ motions to dismiss the claims and discovery is proceeding. As of June 30, 2015, the Company has realized $45 million in net settlement proceeds on such claims, and an initial trial relating to certain of the defendants who remain in the case is set for February 2016.

 

 

 

Results of Operations

 

The following discussion presents an analysis of the Company’s results of operations for the second quarter and first half of 2015 compared to the same periods in 2014.

 

Net Revenues

 

The Company’s major sources of net revenues are asset management and administration fees, net interest revenue, and trading revenue. Asset management and administration fees and net interest revenue increased, while trading revenue decreased in the second quarter and first half of 2015 compared to the same periods in 2014. Other revenue in the second quarter and first six months of 2015 includes litigation proceeds of $17 million relating to the Company’s non-agency residential mortgage-backed securities.

 

 

 

 

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Asset Management and Administration Fees

 

Asset management and administration fees include mutual fund service fees and fees for other asset-based financial services provided to individual and institutional clients. The Company earns mutual fund service fees for shareholder services, administration, and investment management provided to its proprietary funds, and recordkeeping and shareholder services provided to third-party funds. These fees are based upon the daily balances of client assets invested in these funds. The Company also earns asset management fees for advice solutions, which include advisory and managed account services that are based on the daily balances of client assets subject to the specific fee for service. The fair values of client assets included in proprietary and third-party mutual funds are based on quoted market prices and other observable market data. Other asset management and administration fees include various asset-based fees, such as third-party mutual fund service fees, trust fees, 401(k) recordkeeping fees, and mutual fund clearing and other service fees. Asset management and administration fees vary with changes in the balances of client assets due to market fluctuations and client activity. For a discussion of the impact of current market conditions on asset management and administration fees, see “Current Market and Regulatory Environment and Other Developments.”

 

The following tables present a roll forward of client assets for the Schwab money market funds, Schwab equity and bond funds and Mutual Fund OneSource:

 

 

 

 

 

 

The following tables present asset management and administration fees, average client assets, and average fee rate:

 

 

N/A Not applicable.

 

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N/A Not applicable.

 

Asset management and administration fees increased by $38 million, or 6%, and $71 million, or 6% in the second quarter and first half of 2015 compared to the same periods in 2014, due to the following items.

 

 

Net Interest Revenue

 

Net interest revenue is the difference between interest earned on interest-earning assets and interest paid on funding sources. Net interest revenue is affected by changes in the volume and mix of these assets and liabilities, as well as by fluctuations in interest rates and portfolio management strategies.

 

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Schwab Bank maintains available for sale and held to maturity investment portfolios for liquidity as well as to earn interest by investing funds from deposits that are in excess of bank loans and liquidity requirements. Schwab Bank lends funds to banking clients primarily in the form of mortgage loans, home equity lines of credit (HELOCs), and personal loans secured by securities. These loans are largely funded by interest-bearing bank deposits.

 

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

 

The Company’s interest-earning assets are primarily funded through brokerage client cash balances and bank deposits. These interest-bearing liabilities are primarily sensitive to short-term rates, and the Company establishes the rates paid on most of these liabilities. The Company expects that the rate paid on these liabilities will generally adjust at some fraction of the movement in short-term market rates. The rates on the majority of the firm’s investment securities and loans re-price or reset based on short-term market rates. A smaller portion is invested in fixed-rate loans and securities. As such, the Company expects that net interest revenue will increase as short-term market rates increase, and decline as rates fall from current levels. When interest rates fall, the Company may attempt to mitigate some of this negative impact by lowering rates paid to clients on interest-bearing liabilities. The current low interest rate environment limits the extent to which the Company can reduce interest expense on funding sources. The Company may also alter the amount and type of fixed-rate loans and securities that are added to the portfolio. Generally, increases in the percentage of fixed-rate assets relative to total interest-bearing liabilities will reduce the rate at which net interest revenue changes if rates move.

 

Non-interest-bearing funding sources include non-interest-bearing brokerage client cash balances, stockholders’ equity, and proceeds from stock-lending activities. Revenue from stock-lending activities is included in other interest revenue.

 

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The following tables present net interest revenue information corresponding to interest-earning assets and funding sources on the condensed consolidated balance sheet:

 

 

 

 

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Net interest revenue increased in the second quarter and first half of 2015 compared to the same periods in 2014, primarily due to higher balances of interest-earning assets, including the Company’s investment portfolio, partially offset by the effect lower average interest rates had on the Company’s average net interest margin. The growth in the average balances in bank deposits resulted from an increase in the excess cash held in certain brokerage client accounts swept to Schwab Bank. The growth in bank deposits contributed to the increase in interest-earning assets.

 

Trading Revenue

 

Trading revenue includes commission and principal transaction revenues. Commission revenue is affected by the number of revenue trades executed and the average revenue earned per revenue trade. Principal transaction revenue is primarily comprised of revenue from trading activity in client fixed income securities. To accommodate clients’ fixed income trading activity, the Company maintains positions in fixed income securities, including state and municipal debt obligations, U.S. Government, corporate debt, and other securities. The difference between the price at which the Company buys and sells securities to and from its clients and other broker-dealers is recognized as principal transaction revenue. Principal transaction revenue also includes adjustments to the fair value of these securities positions. Factors that influence principal transaction revenue include the volume of client trades and market price volatility.

 

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Trading revenue decreased by $9 million, or 4%, in the second quarter of 2015 compared to the second quarter of 2014, primarily due to a decrease in commission revenue as a result of lower commissions per revenue trade and lower daily average revenue trades. Trading revenue decreased by $29 million or 6% in the first half of 2015 compared to the first half of 2014 primarily due to a decrease in commission revenue as a result of lower daily average revenue trades and commissions per revenue trades. Daily average revenue trades decreased in the second quarter and first half of 2015 compared to the same periods in 2014, primarily due to a lower volume of equity and option trades, offset by a higher volume of mutual fund trades. Average revenue per revenue trade decreased 2% and 1%, respectively, in the second quarter and first half of 2015 compared to the same periods in 2014.

 

Other Revenue

 

Other revenue includes order flow revenue, nonrecurring gains, software fees from the Company’s portfolio management services, exchange processing fees, and other service fees.

 

Other revenue increased by $14 million, or 22%, and $9 million, or 7%, in the second quarter and first half of 2015 compared to the same periods in 2014, respectively, primarily due to litigation proceeds of $17 million in the second quarter of 2015 relating to the Company’s non-agency residential mortgage-backed securities portfolio, partially offset by a decrease in order flow revenue.

 

Order flow revenue was $25 million and $52 million during the second quarter and first half of 2015, respectively, compared to $27 million and $59 million during the second quarter and first half of 2014, respectively. The decrease in order flow revenue in both periods was primarily due to changes in the composition and volume of different types of orders and the fees and rebates for such orders.

 

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Expenses Excluding Interest

 

As shown in the table below, expenses excluding interest increased in the second quarter and first half of 2015 compared to the same periods in 2014, primarily due to increases in compensation and benefits, depreciation and amortization, and other expense.

 

 

 

Compensation and Benefits

 

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

 

The following table shows a comparison of certain compensation and benefits components and employee data:

 

 

 

Salaries and wages increased in the second quarter and first half of 2015 compared to the same periods in 2014, primarily due to higher employee headcount and annual salary increases.

 

Incentive compensation decreased in the second quarter of 2015 compared to the second quarter of 2014, due to lower discretionary bonuses, partially offset by increases in equity-based incentives. Incentive compensation increased in the first half of 2015 compared to the first half of 2014, primarily due to the earlier recognition of certain equity-based incentives due to plan changes and higher field incentive plan costs relating to increased net client asset flows.

 

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Employee benefits and other expense increased in the second quarter and first half of 2015 compared to the same periods in 2014, due to increases in payroll taxes as a result of higher employee headcount. The increase in employee benefits in the first half of 2015 was also due to the Company matching 401(k) contributions by pay period in 2015 instead of annually and more employees choosing to fund their 401(k) contributions from annual bonuses.

 

Expenses Excluding Compensation and Benefits

 

Professional services expense was flat in the second quarter of 2015 compared to the second quarter of 2014. Professional services increased in the first half of 2015 compared to the first half of 2014, primarily due to an increase in fees paid to outsourced service providers and consultants.

 

Occupancy and equipment expense increased in the second quarter and first half of 2015 compared to the same periods in 2014, primarily due to an increase in software maintenance expense relating to the Company’s information technology systems.

 

Depreciation and amortization expense increased in the second quarter and first half of 2015 compared to the same periods in 2014, primarily due to increased amortization of internally-developed software.

 

Other expense increased in the second quarter of 2015 compared to the second quarter of 2014, primarily due to increases in regulatory assessments, reserves for margin loss estimates, and travel costs.

 

Taxes on Income

 

The Company’s effective income tax rate on income before taxes was 37.7% and 37.8% for the second quarters of 2015 and 2014, respectively. The Company’s effective income tax rate on income before taxes was 37.7% for both first halves of 2015 and 2014, respectively.

 

Segment Information

 

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

 

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

 

 

 

 

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Investor Services

Net revenues increased by $50 million, or 4%, and $70 million, or 3%, in the second quarter and first half of 2015 compared to the same periods in 2014 primarily due to increases in asset management and administration fees, net interest revenue, and other revenue, partially offset by a decrease in trading revenue. Asset management and administration fees increased primarily due to fees from advice solutions. Advice solutions fees increased primarily due to growth in client assets enrolled in advisory offers. Net interest revenue increased primarily due to higher balances of interest-earning assets, including the Company’s investment portfolio, partially offset by the effect lower average interest rates had on the Company’s average net interest margin. Other revenue increased primarily due to litigation proceeds relating to the Company’s non-agency residential mortgage-backed securities portfolio, partially offset by a decrease in order flow revenue. Trading revenue decreased primarily due to a decrease in commission revenue as a result of lower commissions per revenue trades and lower daily average revenue trades.

 

Expenses excluding interest increased by $36 million, or 5%, and $92 million, or 6%, in the second quarter and first half of 2015 compared to the same periods in 2014, primarily due to increases in compensation and benefits, occupancy and equipment, and depreciation and amortization expense.

 

Advisor Services

Net revenues increased by $38 million, or 11%, and $66 million, or 10%, in the second quarter and first half of 2015 compared to the same periods in 2014 primarily due to increases in net interest revenue and asset management and administration fees. Net interest revenue increased primarily due to higher balances of interest-earning assets, including the Company’s investment portfolio, partially offset by the effect lower average interest rates had on the Company’s average net interest margin. Asset management and administration fees increased due to fees from mutual fund services and other asset management and administration services. Mutual fund service fees increased primarily due to growth in client assets invested in equity and bond funds. Other asset management and administration service fees increased primarily due to third-party mutual fund service fees on higher client asset balances invested in other third-party mutual funds.

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Expenses excluding interest increased by $6 million, or 3%, and $36 million, or 8%, in the second quarter and first half of 2015 compared to the same periods in 2014, primarily due to increases in compensation and benefits and other expense.

 

 

Liquidity and Capital Resources

 

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

 

The Company monitors both the relative composition and absolute level of its capital structure. Management is focused on optimizing the Company’s use of capital and currently targets a long-term debt to total financial capital ratio not to exceed 30%. The Company’s total financial capital (long-term debt plus stockholders’ equity) at June 30, 2015 was $15.3 billion, up $1.6 billion, or 12%, from December 31, 2014.

 

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

 

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

 

CSC

 

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

 

CSC’s liquidity needs are generally met through cash generated by its subsidiaries, as well as cash provided by external financing. CSC has a universal shelf registration statement on file with the Securities and Exchange Commission (SEC) which enables CSC to issue debt, equity and other securities. CSC maintains excess liquidity in the form of overnight cash deposits, short-term investments to cover daily funding needs and to support growth in the Company’s business, and long-term investments to support contingent funding needs. Generally, CSC does not hold liquidity at its subsidiaries in excess of amounts deemed sufficient to support the subsidiaries’ operations, including any regulatory capital requirements. Schwab, Schwab Bank, and optionsXpress, Inc. are subject to regulatory requirements that may restrict them from certain transactions with CSC, as further discussed below.

 

On March 10, 2015, CSC issued $625 million aggregate principal amount of Senior Notes that mature in 2018 and $375 million aggregate principal amount of Senior Notes that mature in 2025 under its universal shelf registration statement on file with the SEC. The Senior Notes due 2018 have a fixed interest rate of 1.50% with interest payable semi-annually. The Senior Notes due 2025 have a fixed interest rate of 3.00% with interest payable semi-annually.

 

In connection with the above Senior Note issuances, CSC purchased $575 million of 3-year Treasury securities and $225 million of 10-year Treasury securities that are held at CSC to augment its liquidity position.

 

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

 

 

CSC has authorization from its Board of Directors to issue unsecured commercial paper notes (Commercial Paper Notes) not to exceed $1.5 billion. Management has set a current limit for the commercial paper program of $800 million. The maturities of the Commercial Paper Notes may vary, but are not to exceed 270 days from the date of issue. The commercial paper is not redeemable prior to maturity and cannot be voluntarily prepaid. The proceeds of the commercial paper program are to be used for general corporate purposes. There were no borrowings of Commercial Paper Notes outstanding at June 30, 2015. CSC’s ratings for these short-term borrowings are P1 by Moody’s, A1 by Standard & Poor’s, and F1 by Fitch.

 

CSC maintains a $750 million committed, unsecured credit facility with a group of 11 banks, which is scheduled to expire in June 2016. This facility replaced a similar facility that expired in June 2015 and both facilities were unused during the first half of 2015. The funds under this facility are available for general corporate purposes. The financial covenants under this facility require Schwab to maintain a minimum net capital ratio, as defined, Schwab Bank to be well capitalized, as defined, and CSC to maintain a minimum level of stockholders’ equity, excluding accumulated other comprehensive income. At June 30, 2015, the minimum level of stockholders’ equity required under this facility was $8.5 billion (CSC’s stockholders’ equity, excluding accumulated other comprehensive income, at June 30, 2015 was $12.2 billion). Management believes that these restrictions will not have a material effect on CSC’s ability to meet foreseeable dividend or funding requirements.

 

CSC also has direct access to certain of the uncommitted, unsecured bank credit lines discussed below, that are primarily utilized by Schwab to manage short-term liquidity. These lines were not used by CSC during the first half of 2015.

 

CSC is required to serve as a source of strength for Schwab Bank and must have the ability to provide financial assistance if Schwab Bank experiences financial distress. To manage capital adequacy, the Company currently utilizes a target Tier 1 Leverage Ratio for CSC, as currently defined by the Federal Reserve, of at least 6%. Beginning on January 1, 2015, CSC became subject to new capital requirements set by the Federal Reserve. Based on its regulatory capital ratios at June 30, 2015, CSC exceeded minimum capital requirements. See “Item 1 – Condensed Consolidated Financial Statements (Unaudited) – Notes – 11. Regulatory Requirements” for CSC’s regulatory capital and ratios.

 

Schwab

 

Schwab’s liquidity needs relating to client trading and margin borrowing activities are met primarily through cash balances in brokerage client accounts, which were $29.2 billion and $32.0 billion at June 30, 2015 and December 31, 2014, respectively. Management believes that brokerage client cash balances and operating earnings will continue to be the primary sources of liquidity for Schwab.

 

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

 

Schwab has a finance lease obligation related to an office building and land under a 20-year lease. The remaining finance lease obligation of $79 million at June 30, 2015 is being reduced by a portion of the lease payments over the remaining lease term of nine years.

 

To manage short-term liquidity, Schwab maintains uncommitted, unsecured bank credit lines with a group of banks. The need for short-term borrowings arises primarily from timing differences between cash flow requirements, scheduled liquidation of interest-earning investments, and movements of cash to meet regulatory brokerage client cash segregation

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requirements. Schwab used such borrowings for six days during the first half of 2015, with average daily amounts borrowed of $137 million. There were no borrowings outstanding under these lines at June 30, 2015.

 

To partially satisfy the margin requirement of client option transactions with the Options Clearing Corporation, Schwab has unsecured standby letter of credit agreements (LOCs) with five banks in favor of the Options Clearing Corporation aggregating $225 million at June 30, 2015. There were no funds drawn under any of these LOCs during the first half of 2015. In connection with its securities lending activities, Schwab is required to provide collateral to certain brokerage clients. Schwab satisfies the collateral requirements by providing cash as collateral.

 

Schwab is subject to regulatory requirements of Rule 15c3-1 under the Securities Exchange Act of 1934 (the Uniform Net Capital Rule) that are intended to ensure the general financial soundness and liquidity of broker-dealers. These regulations prohibit Schwab from repaying subordinated borrowings from CSC, paying cash dividends, or making unsecured advances or loans to its parent company or employees if such payment would result in a net capital amount of less than 5% of aggregate debit balances or less than 120% of its minimum dollar requirement of $250,000. At June 30, 2015, Schwab’s net capital was $1.7 billion (9% of aggregate debit balances), which was $1.3 billion in excess of its minimum required net capital and $767 million in excess of 5% of aggregate debit balances. 

 

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

 

To manage Schwab’s regulatory capital requirement, CSC provides Schwab with a $1.4 billion subordinated revolving credit facility, which is scheduled to expire in March 2016. The amount outstanding under this facility at June 30, 2015 was $465 million. Borrowings under this subordinated lending arrangement qualify as regulatory capital for Schwab.

 

In addition, CSC provides Schwab with a $2.5 billion credit facility, which is scheduled to expire in December 2017. Borrowings under this facility do not qualify as regulatory capital for Schwab. There were no funds drawn under this facility at June 30, 2015.

 

Schwab Bank

 

Schwab Bank’s liquidity needs are met through bank deposits and equity capital.

 

Bank deposits at June 30, 2015 were $112.9 billion, which includes the excess cash held in certain Schwab and optionsXpress, Inc. brokerage client accounts that is swept into deposit accounts at Schwab Bank. At June 30, 2015, these balances totaled $92.2 billion.

 

Schwab Bank has access to traditional funding sources such as deposits, federal funds purchased, and repurchase agreements. Additionally, Schwab Bank has access to short-term funding through the Federal Reserve Bank (FRB) discount window. Amounts available under the FRB discount window are dependent on the fair value of certain of Schwab Bank’s securities available for sale and/or securities held to maturity that are pledged as collateral to the FRB. Schwab Bank maintains policies and procedures necessary to access this funding and tests discount window borrowing procedures annually. At June 30, 2015, $2.2 billion was available under this arrangement. There were no funds drawn under this arrangement during the first half of 2015.

 

Schwab Bank maintains a credit facility with the Federal Home Loan Bank System. Amounts available under this facility are dependent on the amount of Schwab Bank’s residential real estate mortgages and HELOCs that are pledged as collateral. Schwab Bank maintains policies and procedures necessary to access this funding and tests borrowing procedures annually. At June 30, 2015, $9.2 billion was available under this facility. There were no funds drawn under this facility during the first half of 2015.

 

Schwab Bank is subject to regulatory requirements that restrict and govern the terms of affiliate transactions, such as extensions of credit and repayment of loans between Schwab Bank and CSC or CSC’s other subsidiaries. In addition, Schwab

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Bank is required to provide notice to and may be required to obtain approval of the OCC and the Federal Reserve to declare dividends to CSC.

 

Schwab Bank is required to maintain capital levels as specified in federal banking laws and regulations. Failure to meet the minimum levels could result in certain mandatory and possibly additional discretionary actions by the regulators that, if undertaken, could have a direct material effect on Schwab Bank. The Company currently utilizes a target Tier 1 Leverage Ratio for Schwab Bank of at least 6.25%. Beginning on January 1, 2015, Schwab Bank is subject to new capital requirements set by the OCC. Based on its regulatory capital ratios at June 30, 2015, Schwab Bank is considered well capitalized. See “Item 1 – Condensed Consolidated Financial Statements (Unaudited) – Notes – 11. Regulatory Requirements” for Schwab Bank’s regulatory capital and ratios.

 

optionsXpress, Inc.

 

optionsXpress, Inc.’s liquidity needs relating to client trading and margin borrowing activities are met primarily through cash balances in brokerage client accounts, which were $1.1 billion and $942 million at June 30, 2015 and December 31, 2014, respectively. Management believes that brokerage client cash balances and operating earnings will continue to be the primary sources of liquidity for optionsXpress, Inc.

 

optionsXpress, Inc. is subject to regulatory requirements of the Uniform Net Capital Rule that are intended to ensure the general financial soundness and liquidity of broker-dealers. These regulations prohibit optionsXpress, Inc. from paying cash dividends or making unsecured advances or loans to its parent company or employees if such payment would result in a net capital amount of less than 5% of aggregate debit balances or less than 120% of its minimum dollar requirement of $250,000. At June 30, 2015, optionsXpress, Inc.’s net capital was $131 million (31% of aggregate debit balances), which was $123 million in excess of its minimum required net capital and $110 million in excess of 5% of aggregate debit balances.

 

optionsXpress, Inc. is also subject to Commodity Futures Trading Commission Regulation 1.17 (Reg. 1.17) under the Commodity Exchange Act, which also requires the maintenance of minimum net capital. optionsXpress, Inc. as a futures commission merchant, is required to maintain minimum net capital equal to the greater of its net capital requirement under Reg. 1.17 ($1 million), or the sum of 8% of the total risk margin requirements for all positions carried in customer accounts and 8% of the total risk margin requirements for all positions carried in non-customer accounts (as defined in Reg. 1.17). At June 30, 2015, optionsXpress, Inc. met the requirements of Reg. 1.17.

 

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

 

To partially satisfy the margin requirement of client option transactions with the Options Clearing Corporation, optionsXpress, Inc. has an unsecured standby LOC with one bank in favor of the Options Clearing Corporation in the amount of $15 million at June 30, 2015. There were no funds drawn under this LOC during the first half of 2015.

 

CSC provides optionsXpress, Inc. with a $200 million credit facility, which is scheduled to expire in December 2016. Borrowings under this facility do not qualify as regulatory capital for optionsXpress, Inc. There was $20 million of borrowings outstanding under this facility at June 30, 2015.

 

optionsXpress has a term loan with CSC, of which $3 million was outstanding at June 30, 2015, and it matures in December 2017.

 

Long-term Debt

 

At June 30, 2015, the Company had long-term debt of $2.9 billion, or 19% of total financial capital, that bears interest at a weighted-average rate of 3.07%. At December 31, 2014, the Company had long term debt of $1.9 billion, or 14% of total financial capital. The Company repaid $4 million of long-term debt in the first half of 2015.

 

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On March 10, 2015, CSC issued $625 million aggregate principal amount of Senior Notes that mature in 2018 and $375 million aggregate principal amount of Senior Notes that mature in 2025 under its universal shelf registration statement on file with the SEC. The Senior Notes due 2018 have a fixed interest rate of 1.50% with interest payable semi-annually. The Senior Notes due 2025 have a fixed interest rate of 3.00% with interest payable semi-annually.

 

Capital Expenditures

 

The Company’s capital expenditures were $139 million and $168 million in the first halves of 2015 and 2014, respectively. The Company’s capital expenditures include $14 million and $3 million of accrued but unpaid capital expenditures at June 30, 2015 and 2014, respectively. Capital expenditures in the first half of 2015 were primarily for developing internal-use software, buildings, and software and equipment relating to the Company’s information technology systems. Capital expenditures for the first half of 2014 were primarily for buildings, developing internal-use software, and software and equipment relating to the Company’s information technology systems. Capitalized costs for developing internal-use software were $49 million and $36 million in the first halves of 2015 and 2014, respectively.

 

As discussed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2014, management anticipated that the 2015 capital expenditures would be approximately 15% lower than 2014. However, management has revised the Company’s estimated full year 2015 capital expenditures to be approximately 5% less than 2014 levels primarily due to capitalized costs for developing internal-use software, and equipment relating to the Company’s information technology systems.

 

Dividends

 

CSC paid common stock cash dividends of $159 million ($0.12 per share) and $157 million ($0.12 per share) in the first halves of 2015 and 2014, respectively.

 

CSC paid Series A Preferred Stock cash dividends of $14 million ($35.00 per share) in both the first halves of 2015 and 2014. CSC paid Series B Preferred Stock cash dividends of $15 million ($30.00 per share) in both the first halves of 2015 and 2014, respectively.

 

Share Repurchases

 

There were no repurchases of CSC’s common stock in the first halves of 2015 and 2014. As of June 30, 2015, CSC had remaining authority from the Board of Directors to repurchase up to $596 million of its common stock, which is not subject to expiration.

 

Off-Balance Sheet Arrangements

 

The Company enters into various off-balance sheet arrangements in the ordinary course of business, primarily to meet the needs of its clients. These arrangements include firm commitments to extend credit. Additionally, the Company enters into guarantees and other similar arrangements as part of transactions in the ordinary course of business. For discussion on the Company’s off-balance sheet arrangements, see “Part II – Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources – Off-Balance Sheet Arrangements” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2014, and “Item 1 – Condensed Consolidated Financial Statements (Unaudited) – Notes – 6. Commitments and Contingencies.”

 

 

Risk Management

 

The Company’s business activities expose it to a variety of risks, including operational, credit, market, liquidity, compliance and legal risk. The Company has a comprehensive risk management program to identify and manage these risks and their associated potential for financial and reputational impact. Despite the Company’s efforts to identify areas of risk and implement risk management policies and procedures, there can be no assurance that the Company will not suffer unexpected losses due to these risks.  

 

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For a discussion on risks that the Company faces and the Company’s process of risk identification and assessment, risk measurement, risk monitoring and reporting and risk mitigation, see “Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations – Risk Management” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2014. For updated information on the Company’s credit risk and concentration risk exposures, see below. See “Item 3 – Quantitative and Qualitative Disclosures About Market Risk” for additional information relating to market risk.

 

Credit Risk Exposures

 

The Company’s credit risk exposure related to bank loans is actively managed through individual and portfolio reviews performed by management. Management regularly reviews asset quality, including concentrations, delinquencies, nonaccrual loans, charge-offs, and recoveries. All are factors in the determination of an appropriate allowance for loan losses. The Company’s mortgage loan portfolios primarily include first lien residential real estate mortgage loans (First Mortgages) of $8.2 billion and HELOCs of $2.8 billion at June 30, 2015.

 

The Company’s underwriting guidelines include maximum loan-to-value (LTV) ratios, cash out limits, and minimum Fair Isaac Corporation (FICO) credit scores. The specific guidelines are dependent on the individual characteristics of a loan (for example, whether the property is a primary or secondary residence, whether the loan is for investment property, whether the loan is for an initial purchase of a home or refinance of an existing home, and whether the loan is conforming or jumbo). These credit underwriting standards have limited the exposure to the types of loans that experienced high foreclosures and loss rates elsewhere in the industry in recent years. In January 2014, the Company revised its First Mortgage underwriting criteria in conformance with the Consumer Financial Protection Bureau’s new guidance on Qualified Mortgage lending and a borrower’s ability to repay. Revisions were made to requirements affecting debt to income ratio, LTV ratio, and liquid asset holdings. These revised underwriting criteria have not and are not expected to have a material impact on the credit quality of the Company’s First Mortgage or HELOC portfolios. The Company does not purchase loans that allow for negative amortization and does not purchase subprime loans (generally defined as extensions of credit to borrowers with a FICO score of less than 620 at origination), unless the borrower has compensating credit factors. At June 30, 2015, approximately 1% of both the First Mortgage and HELOC portfolios consisted of loans to borrowers with updated FICO scores of less than 620.

 

At June 30, 2015, the weighted-average originated LTV ratio was 59% for both the First Mortgage and HELOC portfolios. The computation of the origination LTV ratio for a HELOC includes any first lien mortgage outstanding on the same property at the time of origination. At June 30, 2015,  21% of HELOCs ($609 million of the HELOC portfolio) were in a first lien position. The weighted-average originated FICO score was 770 and 769 for the First Mortgage and HELOC portfolios, respectively.  

 

The Company monitors the estimated current LTV ratios of its First Mortgage and HELOC portfolios on an ongoing basis. At June 30, 2015, the weighted-average estimated current LTV ratios were 48% and 52% for the First Mortgage and HELOC portfolios, respectively. The computation of the estimated current LTV ratio for a HELOC includes any first lien mortgage outstanding on the same property at the time of the HELOC’s origination. The Company estimates the current LTV ratio for each loan by reference to a home price appreciation index. The Company also monitors updated borrower FICO scores, delinquency trends, and verified liquid assets held by individual borrowers. At June 30, 2015, the weighted-average updated FICO scores were 773 and 770 for the First Mortgage and HELOC portfolios, respectively.

 

The majority of the Company’s HELOC portfolio is secured by second liens on the associated properties. Second lien mortgage loans possess a higher degree of credit risk given the subordination to the first lien holder in the event of default. At June 30, 2015, $2.2 billion, or 79%, of the HELOC portfolio was in a second lien position. In addition to the credit monitoring activities described above, the Company also monitors credit risk on second lien HELOC loans by reviewing the delinquency status of the first lien loan on the associated property. Additionally, at June 30, 2015, approximately 30% of the HELOC borrowers that had a balance only paid the minimum amount due.

 

For more information on the Company’s credit quality indicators relating to its First Mortgage and HELOC portfolios, including delinquency characteristics, borrower FICO scores at origination, updated borrower FICO scores, LTV ratios at origination, and estimated current LTV ratios, see “Item 1 – Condensed Consolidated Financial Statements (Unaudited) – Notes – 4. Bank Loans and Related Allowance for Loan Losses.”

 

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

 

 

 

The Company has exposure to credit risk associated with its securities available for sale and securities held to maturity portfolios, whose fair values totaled $63.4 billion and $38.0 billion at June 30, 2015, respectively. These portfolios include U.S. agency and non-agency mortgage-backed securities, asset-backed securities, corporate debt securities, U.S. agency notes, treasury securities, and certificates of deposit. U.S. agency mortgage-backed securities do not have explicit credit ratings; however, management considers these to be of the highest credit quality and rating given the guarantee of principal and interest by the U.S. government-sponsored enterprises.

 

At June 30, 2015,  with the exception of certain non-agency residential mortgage-backed securities, all securities in the available for sale and held to maturity portfolios were rated investment grade (defined as a rating equivalent to a Moody’s rating of “Baa” or higher, or a Standard & Poor’s rating of “BBB-” or higher).

 

Concentration Risk Exposures

 

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

 

The fair value of the Company’s investments in mortgage-backed securities totaled $58.9 billion at June 30, 2015. Of these, $57.6 billion were issued by U.S. agencies and $1.3 billion were issued by private entities (non-agency securities). These U.S. agency and non-agency securities are included in securities available for sale and securities held to maturity.

 

The fair value of the Company’s investments in asset-backed securities totaled $21.7 billion at June 30, 2015. Of these, $12.5 billion were securities backed by student loans, the majority of which are guaranteed by the U.S. federal government. These asset-backed securities are included in securities available for sale.

 

The fair value of the Company’s investments in corporate debt securities and commercial paper totaled $10.0 billion at June 30, 2015, with the majority issued by institutions in the financial services industry. These securities are included in securities available for sale, cash and cash equivalents, and other securities owned in the Company’s condensed consolidated balance sheets. Issuer, geographic, and sector concentrations are controlled by established credit policy limits to each concentration type.

 

The Company’s bank loans include $7.4 billion of adjustable rate First Mortgage loans at June 30, 2015. The Company’s adjustable rate mortgages have initial fixed interest rates for three to ten years and interest rates that adjust annually thereafter. Approximately 40% of these mortgages consisted of loans with interest-only payment terms. The interest rates on approximately 55% of these interest-only loans are not scheduled to reset for three or more years. The Company’s mortgage loans do not include interest terms described as temporary introductory rates below current market rates.

 

As of June 30, 2015, 48% of the Company’s HELOC and First Mortgage portfolio was concentrated in California. These loans have performed in a manner consistent with the portfolio as a whole.

 

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The Company’s HELOC product has a 30-year loan term with an initial draw period of ten years from the date of origination. After the initial draw period, the balance outstanding at such time is converted to a 20-year amortizing loan. The interest rate during the initial draw period and the 20-year amortizing period is a floating rate based on the prime rate plus a margin. HELOCs that convert to an amortizing loan may experience higher delinquencies and higher loss rates than those in the initial draw period. The Company’s allowance for loan loss methodology takes this increased inherent risk into consideration. The following table presents when current outstanding HELOCs will convert to amortizing loans:

 

 

The Company also has exposure to concentration risk from its margin and securities lending and client option and futures activities collateralized by or referencing securities of a single issuer, an index, or within a single industry. This concentration risk is mitigated by collateral arrangements that require the fair value of such collateral exceed the amounts loaned.

 

The Company has indirect exposure to U.S. Government and agency securities held as collateral to secure its resale agreements. The Company’s primary credit exposure on these resale transactions is with its counterparty. The Company would have exposure to the U.S. Government and agency securities only in the event of the counterparty’s default on the resale agreements. The fair value of U.S. Government and agency securities held as collateral for resale agreements totaled $8.6 billion at June 30, 2015.

 

European Holdings

 

The Company has exposure to non-sovereign financial and non-financial institutions in Europe. The following table shows the balances of this exposure by each country in Europe in which the issuer or counterparty is domiciled. The Company has no direct exposure to sovereign governments in Europe. The Company does not have unfunded commitments to counterparties in Europe, nor does it have exposure as a result of credit default protection purchased or sold separately as of June 30, 2015.

 

 

In addition to the direct holdings of European companies listed above, the Company also has indirect exposure to Europe through its investments in Schwab sponsored money market funds (collectively, the Funds) resulting from clearing activities. At June 30, 2015, the Company had $248 million in investments in these Funds. Certain of the Funds’ positions include certificates of deposits, time deposits, commercial paper and corporate debt securities issued by counterparties in Europe.

 

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Critical Accounting ESTIMATES

 

Certain of the Company’s accounting policies that involve a higher degree of judgment and complexity are discussed in “Part II – Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Estimates” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2014. There have been no changes to these critical accounting estimates during the first half of 2015.