EXHIBIT 13.1
The Charles Schwab Corporation
2000 Annual Report to Stockholders
(Only those portions specifically incorporated by reference into
The Charles Schwab Corporation 2000 Annual Report on Form 10-K)
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Selected Financial and Operating Data The Charles Schwab Corporation
(In Millions, Except Per Share Amounts, Ratios,
Number of Offices, Average Commission and as Noted)
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Growth Rates
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Compounded Annual
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5-Year 1-Year
1995-2000 1999-2000 2000 1999 1998 1997 1996
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Operating Results
Revenues 26% 29% $ 5,788 $ 4,486 $ 3,178 $ 2,672 $ 2,174
Expenses excluding interest 23% 34% $ 4,556 $ 3,388 $ 2,500 $ 2,141 $ 1,710
Operating income(1) 32% 27% $ 849 $ 666 $ 410 $ 345 $ 275
Net income(2) 43% 8% $ 718 $ 666 $ 410 $ 321 $ 275
Basic earnings per share(3) 40% 4% $ .53 $ .51 $ .32 $ .25 $ .22
Diluted earnings per share(3) 41% 4% $ .51 $ .49 $ .31 $ .24 $ .21
Dividends declared per common share(3, 4) 14% 9% $ .0407 $ .0373 $ .0360 $ .0311 $ .0267
Weighted-average common shares outstanding - diluted(3) 1,404 1,373 1,343 1,338 1,320
Trading revenues as a percentage of revenues(5) 49% 53% 51% 54% 56%
Non-trading revenues as a percentage of revenues(5) 51% 47% 49% 46% 44%
Effective income tax rate 41.7% 39.4% 39.5% 39.5% 40.7%
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Performance Measures
Revenue growth 29% 41% 19% 23% 20%
Pre-tax profit margin 21.3% 24.5% 21.3% 19.9% 21.3%
After-tax profit margin - reported 12.4% 14.9% 12.9% 12.0% 12.6%
After-tax profit margin - operating(1) 14.7% 14.9% 12.9% 12.9% 12.6%
Return on stockholders' equity 21% 31% 27% 26% 29%
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Financial Condition (at year end)
Total assets 24% 11% $ 38,154 $34,322 $26,407 $20,297 $17,256
Long-term debt 23% 49% $ 770 $ 518 $ 419 $ 433 $ 310
Stockholders' equity 39% 64% $ 4,230 $ 2,576 $ 1,673 $ 1,376 $ 1,069
Assets to stockholders' equity ratio 9 13 16 15 16
Long-term debt to total financial capital
(long-term debt plus stockholders' equity) 15% 17% 20% 24% 22%
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Client Information (at year end)
Active client accounts(6) 17% 14% 7.5 6.6 5.6 4.8 4.1
Client assets (in billions) 29% 3% $ 871.7 $ 846.0 $ 594.3 $ 437.2 $ 324.1
Proprietary funds (SchwabFunds and Excelsior)
(in billions) 32% 19% $ 139.5 $ 117.4 $ 89.0 $ 61.7 $ 47.8
Mutual Fund OneSource assets (in billions)(7) 33% (3%) $ 98.3 $ 101.0 $ 69.3 $ 56.6 $ 39.2
Total Mutual Fund Marketplace assets (in billions)(7) 31% 8% $ 190.8 $ 176.6 $ 129.1 $ 104.6 $ 74.6
Active independent investment managers (in thousands) (2%) 5.7 5.8 5.4 5.3 4.8
Independent investment manager client accounts
(in thousands) 21% 19% 1,009.7 848.3 689.9 547.2 442.2
Independent investment manager client assets
(in billions) 36% 10% $ 234.1 $ 213.1 $ 146.4 $ 105.8 $ 72.9
Number of Schwab domestic branch offices 11% 13% 384 340 291 272 235
Number of U.S. Trust offices 17% 11% 31 28 24 19 18
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Employee Information
Full-time equivalent employees (at year end,
in thousands) 20% 31% 26.3 20.1 15.1 14.3 11.9
Revenues per average full-time equivalent employee
(in thousands) 6% (4%) $ 239 $ 249 $ 214 $ 204 $ 195
Compensation and benefits expense as a percentage
of revenues 41.7% 42.1% 43.3% 42.5% 42.1%
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Selected Cash Flow Highlights
Capital expenditures - cash purchases of equipment,
office facilities, property and internal-use
software development costs, net 31% 91% $ 705 $ 370 $ 199 $ 150 $ 173
Capital expenditures as a percentage of revenues 12.2% 8.3% 6.3% 5.6% 8.0%
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Clients' Daily Average Trading Volume (in thousands)(8)
Daily average revenue trades 43% 48% 242.0 163.1 97.2 71.8 54.0
Mutual Fund OneSource trades 27% 27% 58.1 45.6 40.3 34.2 27.2
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Daily average trades 39% 44% 300.1 208.7 137.5 106.0 81.2
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Average Commission Per Revenue Trade (13%) (18%) $ 37.38 $ 45.55 $ 53.44 $ 64.27 $ 69.08
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All periods have been restated to reflect the merger of The Charles Schwab Corporation with U.S. Trust Corporation
(USTC) except as noted.
(1) Represents an adjusted operating income measure which in 2000 excludes goodwill and intangible asset amortization,
acquisition-related compensation expense and other merger-related costs totaling $131 million after-tax. In 1997,
excludes charges for a litigation settlement of $24 million after-tax.
(2) 2000 and 1999 include an accounting change, for certain internal-use software development costs to conform with
Statement of Position 98-1, totaling $55 million after-tax and $41 million after-tax, respectively. Excluding this
accounting change, net income would have been $663 million in 2000 and $625 million in 1999.
(3) All periods have been restated for the May 2000 three-for-two common stock split.
(4) Dividends declared per common share do not include dividends declared by USTC prior to the completion of the
merger.
(5) Trading revenues include commission and principal transaction revenues. Non-trading revenues include asset
management and administration fees, net interest revenue and other revenues.
(6) Effective in 1998, active accounts are defined as accounts with balances or activity within the preceding eight
months instead of twelve months as previously defined. This change in definition had the effect of decreasing the
number of active accounts in 1998 by approximately 200,000. Prior years have not been restated.
(7) Excludes money market funds and all of Schwab's proprietary money market, equity and bond funds. Mutual Fund
OneSource assets are included in Total Mutual Fund Marketplace assets.
(8) Effective in 1997, revenue trades have been restated for all years presented to include all client trades (both
domestic and international) that generate either commission revenue or revenue from principal markups. This data is
reported on a trade date basis.
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The Charles Schwab Corporation
Management's Discussion and Analysis
of Results of Operations and Financial Condition
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 7.5 million active client accounts(a). Client assets in these
accounts totaled $871.7 billion at December 31, 2000. Charles Schwab & Co., Inc.
(Schwab) is a securities broker-dealer with 384 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, 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), an
electronic trading technology and brokerage firm providing Internet-based
services to highly active, online investors.
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(a) Accounts with balances or activity within the preceding eight months.
(CHART OMITTED)
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,
support services for independent investment managers, 401(k) defined
contribution plans, equity securities market-making, mutual funds, 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 leveraging 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 intends to continue to selectively expand its
international presence.
Brands: The Company's worldwide advertising and marketing programs support
its strategy by continually reinforcing the strengths and key attributes of
Schwab's full-service offering, CyBerCorp's trading technology and U.S. Trust's
wealth management services. By maintaining a consistent level of visibility in
the marketplace, the Company seeks to establish Schwab, CyBerCorp and U.S. Trust
as leading financial services brands in a focused and cost-effective manner. The
Company primarily uses a combination of network, cable and local television,
print media, athletic event sponsorship, and online channels in its advertising
to clients and potential clients.
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.
Schwab 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, financial planners and
certified public accountants through the Schwab AdvisorSource service. Schwab
also provides investors with investment education, research and analysis tools
which include WebShops(TM) - a series of workshops designed to help investors
increase their skills in using Schwab's online services, and The Analyst Center
- - an Internet-based tool which connects clients to proprietary and third-party
investment research, guidance and decision-making tools.
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Additionally, Schwab provides custodial, trading and support services to
approximately 5,700 independent investment managers. As of December 31, 2000,
these managers were guiding the investments of 1 million Schwab client accounts
containing $234.1 billion in assets. Further, the Company provides 401(k)
recordkeeping and other retirement plan services directly through a dedicated
sales force, as well as indirectly through alliances with third-party
administrators. In the direct channel, SchwabPlan is the Company's 401(k)
retirement plan, which offers plan sponsors a wide array of investment options,
participant education and servicing, trustee services, and participant-level
recordkeeping. The Company also provides its clients with quick and efficient
access to the securities markets by offering trade execution services in Nasdaq,
exchange-listed and other securities through its market maker and specialist
operations; access to extended-hours trading through its participation in the
REDIBook ECN LLC, an electronic communication network; and the ability to
analyze and trade a variety of fixed income securities through Schwab's
multi-channel delivery systems.
Schwab's Mutual Fund Marketplace provides clients with the ability to invest
in over 2,000 mutual funds from 341 fund families, including 1,280 Mutual Fund
OneSource funds. Schwab's share of the industry's net inflows to direct-marketed
mutual funds was 22% in 2000, up from 14% in 1999(b). Schwab's share of the
industry's direct-marketed mutual fund assets was 13% at December 31, 2000, up
from 11% at December 31, 1999(b).
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(b) Source: Strategic Insight Mutual Fund Research and Consulting, LLC.
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, which also provide investors with
access to the Internet, were expanded by 44 during 2000 to 384 at December 31,
2000. U.S. Trust's total offices were expanded by 3 during 2000 to 31 at
December 31, 2000. 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 during 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, Schwab's touch-tone telephone quote and trading service, and Schwab
by Phone, Schwab's voice recognition quote and trading service. Schwab's
automated telephonic channels handled over 70% of client calls received in each
of 2000 and 1999. Schwab handled approximately 110 million automated and live
calls received in each of 2000 and 1999. Online channels include the Charles
Schwab Web Site, an information and trading service on the Internet at
www.schwab.com; the CyBerCorp Web site, an Internet service for highly active
investors at www.cybercorp.com; PocketBroker, a wireless information and trading
service; 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. The Company's online channels handled 80% of
total trades during 2000, up from 68% of total trades in 1999. Schwab's share of
the industry's online assets was 38% at September 30, 2000, down from 39% at
December 31, 1999(c). Schwab's share of the industry's online trades was 22% in
2000, down from 24% in 1999(c). Schwab provides every retail client access to
all delivery channels.
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(c) Source: U.S. Bancorp Piper Jaffray. Effective March 2000, includes CyBerCorp
trades. Online trade data for 2000 is based on information for the first three
quarters of 2000.
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.
In 2000, all trading and order entry systems were remediated and tested for
industry decimalization requirements. Additionally in 2000, further enhancements
to trading and backup systems improved overall systems availability.
International: The Company's international business serves both foreign
investors and non-English-speaking U.S. clients. The Company has established a
presence in the United Kingdom, Canada, Hong Kong, Japan, Australia, the Cayman
Islands and Brazil. In the U.S., the Company serves Chinese-, Korean-,
Vietnamese- and Spanish-speaking clients through a combination of designated
branch offices
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and Web-based and telephonic services. As of December 31, 2000, client assets in
the Company's international business totaled $23.7 billion.
Business Combinations
On May 31, 2000, CSC completed its merger (the Merger) with USTC. Under the
terms of the merger agreement, USTC became a wholly owned subsidiary of CSC and
USTC shareholders received 5.1405 shares of CSC's common stock for each common
share of USTC. The Merger was treated as a non-taxable stock-for-stock exchange
and USTC's shareholders received approximately 112,000,000 shares of CSC's
common stock. Upon completion of the Merger, CSC became a financial holding
company, which is a type of 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 (the Act).
The consolidated financial statements and financial information in this Annual
Report 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 Annual 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.
On March 1, 2000, the Company acquired CyBerCorp in a non-taxable
stock-for-stock exchange. Pursuant to the acquisition, CyBerCorp became a wholly
owned subsidiary of CSC which resulted in 17,570,000 shares of CSC's common
stock and 3,077,000 options to purchase CSC common stock being exchanged for all
of the outstanding shares, options and equity rights of CyBerCorp. Because the
acquisition was accounted for using the purchase method, the operating results
of CyBerCorp are included in the consolidated results of the Company since the
acquisition date. The historical results of CyBerCorp are not included in
periods prior to the acquisition.
On November 14, 2000, the Company acquired Chicago Investment Analytics,
Inc., a private research firm, to help expand Schwab's research offerings. The
acquisition was treated as a non-taxable stock-for-stock exchange and accounted
for using the purchase method.
New Developments During 2000
The Company responds to changing client needs with continued product,
technology and service innovations. During 2000:
o Schwab launched the Schwab Portfolio Consultation, a package of analytical
services and individual consultations with Schwab investment specialists
designed to assist clients in evaluating their asset allocations.
o Schwab entered into a global financial services alliance with AOL Time Warner
Inc. (AOL) to provide investment information, tools and assistance to AOL's
users and to enable Schwab to reach potential clients. Under the alliance,
Schwab and AOL are expected to engage in a series of marketing and
promotional programs and both companies are expected to incorporate
co-branded initiatives into their ongoing marketing efforts.
o Schwab introduced PocketBroker, a wireless investing service that enables
U.S. clients to access their account information or place an equity order via
PalmPilot, RIM Wireless Handheld pager and Internet-ready cellular phones.
o Schwab began offering clients and potential clients referrals to U.S. Trust's
investment management, trust and private banking capabilities as part of the
AdvisorSource referral services program. Schwab created a special version of
the Schwab Signature Services(TM) offering for U.S. Trust clients who want to
utilize Schwab's products and services.
o Schwab introduced Administrative Trustee Services, a program enabling
independent investment managers, through U.S. Trust, to offer trust
administration services to their clients.
o Schwab invested in and formed an alliance with E-LOAN, Inc., to provide
Schwab clients with online access to E-LOAN's broad choice of mortgage
products, as well as online rate search and loan comparison, selection,
application and tracking services, all supported by trained client
representatives.
o 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.
o The Company's joint venture in Japan, Charles Schwab Tokio Marine Securities
Co., Ltd., commenced business and opened two branch offices in Tokyo, Japan.
o Through a joint venture with ecorp Limited, the Company formed Charles Schwab
Australia Pty Ltd. to provide financial services to investors in Australia
and New Zealand.
o Schwab launched a Spanish-language Web site that serves Hispanic clients in
the U.S., the Caribbean, and Central and South America. Additionally, Schwab
introduced a Korean-language Web site and enhanced its Chinese-language Web
site, both of which provide information about the U.S. financial markets and
Schwab products and services.
FORWARD-LOOKING STATEMENTS
In addition to historical information, this Annual Report contains
forward-looking statements that reflect management's beliefs, objectives and
expectations as of the
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date hereof. These statements relate to, among other things, the impact on the
Company's results of operations of reduced pricing on certain equity trades (see
Revenues - Commissions), the impact on the Company's results of operations of
decimalization (see Revenues - Principal Transactions), sources of liquidity and
capital (see Liquidity and Capital Resources - Liquidity), development spending
(see Liquidity and Capital Resources - Development Spending and Looking Ahead),
capital expenditures and capital structure (see Liquidity and Capital Resources
- - Cash Flows and Capital Resources and Looking Ahead), revenue growth, after-tax
operating profit margin and return on stockholders' equity (see Results of
Operations and Looking Ahead), the Company's ability to pursue its strategy of
attracting and retaining client assets (see Description of Business and Looking
Ahead), and contingent liabilities (see note "19 - Commitments and Contingent
Liabilities" in the Notes to Consolidated Financial Statements). 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 objectives and expectations. Important
factors that may cause such differences include, but are not limited to: the
effect of client trading patterns on Company revenues and earnings; changes in
revenues and profit margin due to cyclical securities markets and fluctuations
in 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; the Company's inability to
attract and retain key personnel; the timing and impact of changes in the
Company's level of investments in personnel, technology, or 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; a significant decline in the real estate market; and risks associated
with international expansion and operations. Certain of these factors are
discussed in greater detail in this Annual Report and in the Company's Annual
Report on Form 10-K.
RESULTS OF OPERATIONS
Financial Overview
During 2000, the securities markets experienced significant volatility -
record volumes and valuations early in the year shifted to a slowdown in the
second half of the year. The Nasdaq Composite Index reached a record high in
March, but closed the year down 39% - the largest one-year decrease in Nasdaq's
history. The Standard & Poor's 500 Index also reached a record high in March,
but closed the year down 9%.
Throughout 2000, the Company remained focused on improving client service
levels and expanding its full-service capabilities. The Company achieved record
revenues for the eleventh consecutive year and record earnings in 2000. Assets
in client accounts rose $25.7 billion, or 3%, to $871.7 billion. This increase
resulted from net new client assets of $171.3 billion, partially offset by net
market losses of $145.6 billion.
(CHART OMITTED)
Trading activity reached record levels as shown in the following table (in
thousands):
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Daily Average Trades 2000 1999 1998
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Revenue Trades
Online 204.1 119.1 56.3
TeleBroker and Schwab by Phone 8.2 8.5 8.2
Regional client telephone
service centers, branch offices
and other 29.7 35.5 32.7
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Total 242.0 163.1 97.2
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Mutual Fund OneSource Trades
Online 36.8 23.3 18.0
TeleBroker and Schwab by Phone 1.0 1.0 1.0
Regional client telephone
service centers, branch offices
and other 20.3 21.3 21.3
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Total 58.1 45.6 40.3
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Total Daily Average Trades
Online 240.9 142.4 74.3
TeleBroker and Schwab by Phone 9.2 9.5 9.2
Regional client telephone
service centers, branch offices
and other 50.0 56.8 54.0
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Total 300.1 208.7 137.5
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Revenues increased mainly due to higher client trading volume and an increase
in client assets. Revenues of $5.8 billion in 2000 grew $1.3 billion, or 29%,
from 1999 due to increases in revenues of $883 million, or 32%, in the
Individual Investor segment, $229 million, or 36%, in the Institutional Investor
segment, $101 million, or 19%, in the U.S. Trust segment, and $88 million, or
16%, in the Capital Markets segment. See note "21 - Segment Information" in the
Notes to Consolidated Financial Statements for financial information by segment
for the last three years.
Total expenses increased 34% during 2000 to $4.6 billion, primarily due to a
28% increase in compensation and benefits, a 35% increase in occupancy and
equipment expenses, and a 50% increase in depreciation and
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amortization. The increase in total expenses was also due to costs of $157
million, or $131 million after-tax, 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.
The Company's income before taxes on income for 2000 was $1.2 billion, up
$133 million, or 12% from 1999. The Company's 2000 net income rose 8% to $718
million, or $.51 per share, up from $666 million, or $.49 per share, in 1999.
The Company's after-tax profit margin for 2000 was 12.4%, which was lower than
the 14.9% margin in 1999. The Company's 2000 results include charges totaling
$131 million after-tax 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. In evaluating the
Company's financial performance, management now uses an adjusted operating
income measure, which excludes the aforementioned charges. On that basis, the
Company's operating income was $849 million, up 27% from 1999, and its after-tax
operating profit margin for 2000 was 14.7%.
The Company's operating income before taxes for 2000 was $1.4 billion, up
$289 million, or 26%, from 1999 due to increases of $147 million, or 21%, in the
Individual Investor segment, $122 million, or 70%, in the Institutional Investor
segment and $30 million, or 23%, in the U.S. Trust segment, partially offset by
a decrease of $10 million, or 10%, in the Capital Markets segment. The decrease
in income in the Capital Markets segment was primarily due to continued growth
in employees and higher trading volume-related expenses while revenues were
adversely impacted by securities market conditions and volatility.
In light of more difficult market conditions and the Company's continued
investments in personnel, technology and advertising, the after-tax operating
profit margin for the second half of 2000 was 12.3%, just above the Company's
minimum long-term objective of 12%. Beginning in November 2000, the Company
implemented a number of expense containment measures, including hiring
restrictions.
Return on stockholders' equity was 21% in 2000, which was lower than the 31%
return on stockholders' equity in 1999, but just above the Company's annual
long-term objective of 20%. The decrease was primarily due to a 64% increase in
average stockholders' equity from 1999, partially offset by an increase in
earnings as discussed above.
Certain reclassifications have been made to prior year amounts to conform to
the current presentation. Share and per share information throughout this Annual
Report has been restated to reflect the May 2000 three-for-two common stock
split, effected in the form of a 50% stock dividend. All references to earnings
per share information in this Annual Report reflect diluted earnings per share
unless otherwise noted.
REVENUES
Revenues grew $1.3 billion, or 29%, in 2000, exceeding management's annual
long-term objective of 20%, mainly due to a 22% increase in commission revenues,
a 30% increase in asset management and administration fees, a 51% increase in
interest revenue, net of interest expense (referred to as net interest revenue)
and a 14% increase in principal transaction revenues. Non-trading revenues
represented 51% of total revenues for 2000, up from 47% for 1999 and 49% for
1998 as shown in the table below. While revenues in the Individual Investor and
Institutional Investor segments are comprised of both trading and non-trading,
revenues in the Capital Markets segment are primarily trading and revenues in
the U.S. Trust segment are primarily non-trading.
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Composition of Revenues 2000 1999 1998
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Commissions 39% 42% 41%
Principal transactions 10 11 10
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Total trading revenues 49 53 51
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Asset management and administration fees 27 27 29
Net interest revenue 21 18 18
Other 3 2 2
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Total non-trading revenues 51 47 49
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Total 100% 100% 100%
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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 were $2.3 billion in 2000, compared to $1.9
billion in 1999 and $1.3 billion in 1998.
As illustrated in the table below, from 1998 to 2000, the total number of
client revenue trades executed by the Company increased 149% as the average
number of trades per account increased and the Company's client base grew. From
1998 to 2000, average commission per revenue trade decreased 30%. The 18%
decrease from 1999 to 2000 was mainly due to reduced equity online pricing for
more actively trading investors and the impact of CyBerCorp's lower equity
online pricing. The 15% decrease from 1998 to 1999 was mainly due to an increase
in the proportion of trades placed through online channels, which have lower
commission rates than the Company's other channels. However, in both 2000 and
1999 the increases in trading activity more than offset the effect of lower
average commissions per revenue trade.
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The Company continually evaluates its commission pricing structure for its
client groups and investment products. In February 2000, Schwab reduced the
equity online pricing for more actively trading investors. In October 2000,
Schwab also reduced the price of equity trades made through the automated
telephone channels to align with the price of equity trades made through online
channels. These price reductions will only affect the Individual Investor and
Institutional Investor segments and, based on management's expectations, will
not have a material impact on these segments' revenues. Any similar pricing
actions in the future would be expected to cause further declines in average
commission per revenue trade.
- --------------------------------------------------------------------------------
Commissions Earned on
Client Revenue Trades 2000 1999 1998
- --------------------------------------------------------------------------------
Client accounts that traded
during the year (in thousands) 3,787 3,349 2,783
Average client revenue
trades per account 16.1 12.3 8.8
Total revenue trades (in thousands) 60,972 41,116 24,508
Average commission per revenue trade $ 37.38 $ 45.55 $ 53.44
Commissions earned on client
revenue trades (in millions)(1) $ 2,279 $ 1,873 $ 1,309
================================================================================
(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 the Company'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 $1.6 billion in 2000, compared
to $1.2 billion in 1999 and $937 million in 1998, as shown in the following
table (in millions):
- --------------------------------------------------------------------------------
Asset Management and Administration Fees 2000 1999 1998
- --------------------------------------------------------------------------------
Mutual fund service fees:
Proprietary funds (SchwabFunds
and Excelsior) $ 673 $ 542 $401
Mutual Fund OneSource 334 229 175
Other 32 17 13
Asset management and related services 544 432 348
- --------------------------------------------------------------------------------
Total $1,583 $1,220 $937
================================================================================
The increases from 1998 to 2000 were primarily due to significant increases
in client assets in Schwab's proprietary funds, referred to as the SchwabFunds,
increases in client assets in funds purchased through Schwab's Mutual Fund
OneSource service and increases in U.S. Trust's client assets.
The Company's proprietary funds include money market funds, equity index
funds, bond funds, asset allocation funds, funds that primarily invest in stock,
bond and money market funds, and actively-managed equity funds. Schwab clients
may elect to have cash balances in their brokerage accounts automatically
invested in certain SchwabFunds money market funds. Client assets invested in
the SchwabFunds were $127.2 billion, $107.9 billion and $81.5 billion at the end
of 2000, 1999 and 1998, respectively.
At December 31, 2000, Schwab's Mutual Fund OneSource service enabled clients
to trade 1,280 mutual funds in 237 fund families without incurring transaction
fees. The service allows investors to access multiple mutual fund companies,
avoid brokerage transaction fees, and achieve investment diversity among fund
families. In addition, investors' recordkeeping and investment monitoring are
simplified through one consolidated statement. Client assets invested in
third-party funds that have been purchased through the Mutual Fund OneSource
service were $98.3 billion, $101.0 billion and $69.3 billion at the end of 2000,
1999 and 1998, respectively.
Further, U.S. Trust's client assets were $130.4 billion, $120.8 billion and
$103.2 billion at the end of 2000, 1999 and 1998, respectively. In addition,
U.S. Trust provides administrative services for corporations, municipalities,
and financial and other institutions through its corporate trust division. U.S.
Trust's client assets do not include these assets under administration, which
were $338.0 billion, $330.7 billion and $300.5 billion at the end of 2000, 1999
and 1998, respectively.
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
- 7 -
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. In clearing its clients' trades, Schwab
holds cash balances payable to clients. In most cases, Schwab pays its clients
interest on cash balances awaiting investment, and may invest these funds and
earn interest revenue. Schwab also may lend funds to clients on a secured basis
to purchase qualified securities - a practice commonly known as "margin
lending." Pursuant to Securities and Exchange Commission (SEC) regulations,
client cash balances that are not used for margin lending are segregated into an
investment account that is maintained for the exclusive benefit of clients. U.S.
Trust lends funds primarily to its private banking clients.
When investing segregated client cash balances, Schwab must adhere to SEC
regulations that restrict investments to U.S. government securities,
participation certificates and mortgage-backed securities guaranteed by the
Government National Mortgage Association, certificates of deposit issued by U.S.
banks and thrifts, and resale agreements collateralized by qualified securities.
Schwab's policies for credit quality and maximum maturity requirements are more
restrictive than these SEC regulations. In each of the last three years, resale
agreements accounted for approximately 70% of Schwab's investments of segregated
client cash balances. The annual average maturities of Schwab's total
investments of segregated client cash balances were 59 days in 2000, 62 days in
1999 and 66 days in 1998.
Net interest revenue was $1.2 billion in 2000, compared to $820 million in
1999 and $578 million in 1998, as shown in the following table (in millions):
- --------------------------------------------------------------------------------
2000 1999 1998
- --------------------------------------------------------------------------------
Interest Revenue:
Margin loans to clients $1,772 $ 983 $ 671
Investments, client-related 338 404 400
Private banking loans 219 175 149
Securities available for sale 69 57 60
Other 191 99 72
- --------------------------------------------------------------------------------
Total 2,589 1,718 1,352
- --------------------------------------------------------------------------------
Interest Expense:
Brokerage client cash balances 1,076 701 580
Deposits from banking clients 155 117 108
Long-term debt 55 33 30
Stock-lending activities 40 32 37
Short-term borrowings 20 8 9
Other 6 7 10
- --------------------------------------------------------------------------------
Total 1,352 898 774
- --------------------------------------------------------------------------------
Net interest revenue $1,237 $ 820 $ 578
================================================================================
The Company's interest-earning assets are financed primarily by
interest-bearing brokerage client cash balances and banking deposits. Other
funding sources include noninterest-bearing brokerage client cash balances,
proceeds from stock-lending activities, short-term borrowings and long-term
debt, and stockholders' equity. Client-related daily average balances, interest
rates, and average net interest spread are summarized as follows (dollars in
millions):
- --------------------------------------------------------------------------------
2000 1999 1998
- --------------------------------------------------------------------------------
Interest-Earning Assets (client-related and other):
Margin loans to clients:
Average balance outstanding $19,764 $13,172 $ 8,772
Average interest rate 8.96% 7.46% 7.65%
Investments (client-related):
Average balance outstanding $ 6,170 $ 8,555 $ 7,687
Average interest rate 5.48% 4.72% 5.21%
Private banking loans:
Average balance outstanding $ 2,867 $ 2,404 $ 1,973
Average interest rate 7.65% 7.26% 7.58%
Securities available for sale:
Average balance outstanding $ 1,133 $ 997 $ 995
Average interest rate 6.08% 5.75% 5.99%
Average yield on interest-earning assets 8.01% 6.44% 6.59%
Funding Sources (client-related and other):
Interest-bearing brokerage client cash balances:
Average balance outstanding $20,961 $17,344 $13,278
Average interest rate 5.14% 4.04% 4.37%
Interest-bearing banking deposits:
Average balance outstanding $ 3,071 $ 2,779 $ 2,351
Average interest rate 5.05% 4.23% 4.59%
Other interest-bearing sources:
Average balance outstanding $ 1,831 $ 1,510 $ 1,299
Average interest rate 4.53% 3.85% 4.23%
Average noninterest-bearing portion $ 4,071 $ 3,495 $ 2,499
Average interest rate on funding sources 4.39% 3.49% 3.82%
Summary:
Average yield on interest-earning assets 8.01% 6.44% 6.59%
Average interest rate on funding sources 4.39% 3.49% 3.82%
- --------------------------------------------------------------------------------
Average net interest spread 3.62% 2.95% 2.77%
================================================================================
The increases in net interest revenue from 1998 to 2000 were primarily due to
higher levels of margin loans to clients, partially offset by higher average
brokerage client cash balances. After increasing from 1998 to 1999 and reaching
a peak of $22.3 billion in April 2000, margin loans to clients declined to $15.8
billion at December 31, 2000 along with the decline in equity valuations in the
securities markets. The increase in net interest revenue from 1999 to 2000 was
also due to an increase in the average rate on margin loans to clients, which
was partially offset by an increase in the average rate on brokerage client cash
balances.
- 8 -
Since the Company establishes the rates paid on brokerage client cash
balances and certain banking deposits and the rates charged on margin and
private banking loans, a substantial portion of its net interest spread is
managed by the Company. However, the spread is highly influenced by external
factors such as the interest rate environment and competition. The Company's
average net interest spread increased from 1999 to 2000 as the average yield on
interest-earning assets, primarily margin loans to clients, increased more than
the increase in average interest rate on funding sources. The Company's average
net interest spread increased from 1998 to 1999 as the average interest rate on
funding sources declined more than the decline in the average yield on
interest-earning assets.
Principal Transactions
Principal transaction revenues are primarily comprised of net gains from
market-making activities in Nasdaq and other securities 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. As a market
maker in Nasdaq and other securities, SCM generally executes client trades as
principal. While substantially all Nasdaq security trades originated by the
clients of Schwab are directed to SCM, a substantial portion of SCM's trading
volume comes from parties other than Schwab. Orders handled by SCM represented
approximately 8% of the total shares traded on Nasdaq in both 2000 and 1999(d).
- --------
(d) Source: The Nasdaq Stock Market, Inc.
Principal transaction revenues were $570 million in 2000, compared to $500
million in 1999 and $287 million in 1998. The increases from 1998 to 2000 were
primarily due to significant increases in share volume handled by SCM. The
increase from 1999 to 2000 was partially offset by lower average revenue per
share traded. SCM's average revenue per share traded increased from 2.5(cent) in
1998 to 2.8(cent) in 1999 partially due to an increase in the market price
volatility of technology stocks in 1999. However, SCM's average revenue per
share traded decreased from 2.8(cent) in 1999 to 1.8(cent) in 2000 primarily due
to market conditions.
The SEC ordered the exchanges and Nasdaq to submit a plan to phase in
decimal pricing, which pricing began for certain listed stocks and options on
September 5, 2000, and which pricing begins for certain Nasdaq securities on
March 12, 2001, and for all remaining equity securities and options by April 9,
2001. This change, which will only affect the Capital Markets segment, is likely
to cause decreases in average revenue per share traded, and therefore management
considers it likely that decimalization will adversely impact this segment's
revenues. Applicable laws and regulations also limit SCM's ability to engage in
principal transactions with certain accounts where U.S. Trust acts as a
fiduciary.
See note "19 - Commitments and Contingent Liabilities" in the Notes to
Consolidated Financial Statements regarding certain civil litigation relating to
principal transaction activities.
Principal transaction revenues also include revenues relating to Schwab's
specialist operations and to client trading of fixed income securities. These
amounts totaled $84 million in 2000, $67 million in 1999 and $50 million in
1998.
Other Revenues
Other revenues include fees for services, such as payments received by Schwab
for order flow, software maintenance and account service fees. Other revenues
are earned primarily through the Individual Investor, Institutional Investor and
U.S. Trust segments. These revenues were $103 million in 2000, compared to $71
million in 1999 and $59 million in 1998. The increases from 1998 to 2000 were
due to higher levels of client activity-related revenues and financial services
fees. The increase from 1999 to 2000 was also due to higher volumes of payment
for order flow.
EXPENSES EXCLUDING INTEREST
- --------------------------------------------------------------------------------
Expenses Excluding Interest as a Percentage
of Revenues 2000 1999 1998
- --------------------------------------------------------------------------------
Compensation and benefits 42% 42% 43%
Other compensation - merger retention programs 1
Occupancy and equipment 7 7 7
Communications 6 6 7
Advertising and market development 6 6 5
Depreciation and amortization 5 4 5
Professional services 4 4 4
Commissions, clearance and floor brokerage 2 2 3
Merger-related 1
Goodwill amortization 1
Other 4 5 5
- --------------------------------------------------------------------------------
Total 79% 76% 79%
================================================================================
Compensation and Benefits
Compensation and benefits expense includes salaries and wages, variable
compensation, and related employee benefits and taxes. Employees receive
variable compensation that is tied to the achievement of specified objectives
relating primarily to revenue growth, profit margin and growth in client assets.
Therefore, a significant portion of compensation and benefits expense will
fluctuate with these measures.
Compensation and benefits expense was $2.4 billion in 2000, compared to $1.9
billion in 1999 and $1.4 billion in 1998. The increase from 1999 to 2000 was
primarily due to a
- 9 -
greater number of employees. The increase from 1998 to 1999 was generally due to
a greater number of employees and 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):
- --------------------------------------------------------------------------------
2000 1999 1998
- --------------------------------------------------------------------------------
Variable compensation as a
% of compensation and benefits expense 28% 30% 24%
Compensation for temporary employees,
contractors and overtime hours as a
% of compensation and benefits expense 9% 11% 12%
Full-time equivalent employees(1)
(at end of year) 26.3 20.1 15.1
Revenues per average full-time equivalent
employee $239 $249 $214
================================================================================
(1) Includes full-time, part-time and temporary employees, and persons employed
on a contract basis.
The Company encourages and provides for employee ownership of the Company's
common stock through its profit sharing and employee stock ownership plan, its
stock incentive plans and its automatic investment plan. The Company's overall
compensation structure is intended to attract, retain and reward highly
qualified employees, and to align the interests of employees with those of
stockholders. To further this alignment and in recognition of the Company's
financial performance, the Company granted to all non-officer employees
11,339,000, 5,675,000 and 5,217,000 stock options in 2000, 1999 and 1998,
respectively. (Stock options granted in 1999 and 1998 were granted prior to the
Merger, and therefore did not include U.S. Trust employees.)
Other Compensation - Merger Retention Programs
Other compensation - merger retention programs consists of retention programs
established for U.S. Trust and CyBerCorp employees, under which the employees
will receive cash compensation, contingent upon continued employment for the
two-year periods ending May 31, 2002 and March 1, 2002, respectively. The costs
of the U.S. Trust and CyBerCorp retention programs are approximately $125
million and $8 million, respectively, and are being amortized over the two-year
periods. These amounts could be reduced if employees leave U.S. Trust and
CyBerCorp prior to the end of the respective two-year periods. The combined
expense for the programs was $39 million in 2000.
Occupancy and Equipment
Occupancy and equipment expense includes the costs of leasing and maintaining
the Company's office space, five regional client telephone service centers, two
online client support centers, two primary data centers, 384 Schwab domestic
branch offices and 31 U.S. Trust offices. It also includes lease and rental
expenses for computer and other equipment. Occupancy and equipment expense was
$415 million in 2000, compared to $307 million in 1999 and $236 million in 1998.
This trend reflects the Company's continued growth and expansion, and its
commitment to client service and investment in technology. The Company expanded
its office space in 2000, 1999 and 1998, and opened its fifth regional client
telephone service center in 2000 and its second data center in 1998. Schwab
opened 44 new branch offices in 2000, 49 in 1999 and 19 in 1998. U.S. Trust
opened 3 new offices in 2000, 4 in 1999 and 5 in 1998. The increases in
occupancy and equipment expense from 1998 to 2000 also reflect higher lease and
maintenance expenses for information technology equipment.
Communications
Communications expense includes telephone, postage and printing, and news and
quotation costs. This expense was $353 million in 2000, compared to $279 million
in 1999 and $216 million in 1998. The increases from 1998 to 2000 primarily
resulted from higher client trading volumes, higher postage and printing costs
in connection with the growth in client accounts, increased client use of
automated telephonic and online channel news, quotation and information
services, and additional telephone lines related to new branch offices and a
greater number of employees.
Advertising and Market Development
Advertising and market development expense includes media, print and direct
mail advertising expenses, and related production, printing and postage costs.
This expense was $332 million in 2000, compared to $248 million in 1999 and $160
million in 1998. The increases from 1998 to 2000 were primarily a result of the
Company's increased brand-focused television and print media spending.
Depreciation and Amortization
Depreciation and amortization includes expenses relating to equipment and
office facilities, capitalized software, leasehold improvements, property and
other intangibles. This expense was $262 million in 2000, compared to $175
million in 1999 and $152 million in 1998. The increases from 1998 to 2000 were
primarily due to newly acquired information technology equipment that increased
the Company's client service capacity, as well as increased amortization of
leasehold improvements for new branches and expanded office space. The increase
from 1999 to 2000 was also due to the amortization of internally-developed
software. Amortization expense related to intangible assets was $17 million in
2000, compared to $8 million in 1999 and $9 million in 1998. The increase from
1999 to 2000 was primarily due to intangible assets (excluding goodwill) related
to the acquisition of CyBerCorp. Amortization
- 10 -
expense decreased from 1998 to 1999 due to certain intangible assets becoming
fully amortized.
Professional Services
Professional services expense includes fees paid to consultants engaged to
support product, service and information technology projects, as well as legal
and accounting fees, but excludes all merger-related professional fees. This
expense was $255 million in 2000, compared to $184 million in 1999 and $114
million in 1998. The increases from 1998 to 2000 were primarily due to higher
levels of consulting fees in several areas, including new and expanded products
and services, information technology projects, and capacity expansion.
Commissions, Clearance and Floor Brokerage
Commissions, clearance and floor brokerage expense includes fees paid to
stock and option exchanges for trade executions, fees paid by SCM to
broker-dealers for orders received for execution, and fees paid to clearing
entities for trade processing. This expense was $138 million in 2000, compared
to $100 million in 1999 and $87 million in 1998. The increases from 1998 to 2000
were primarily due to an increase in trading volume processed by SCM and Schwab.
Merger-related
Merger-related expense includes professional fees, change in control related
compensation expense and other expenses relating to the merger with USTC. This
expense was $69 million in 2000.
Goodwill Amortization
Goodwill represents the cost of acquired businesses in excess of fair value
of the related net assets at acquisition and is amortized on a straight-line
basis. Goodwill amortization expense was $46 million in 2000 and $6 million in
both 1999 and 1998. The increase from 1999 to 2000 was primarily due to goodwill
related to the acquisition of CyBerCorp.
Other Expenses
Other expenses include travel and entertainment, trade-related errors,
regulatory fees and dues, and other miscellaneous expenses. These other expenses
were $233 million in 2000, compared to $200 million in 1999 and $153 million in
1998. The increases from 1998 to 2000 were primarily due to higher levels of
travel and related costs and volume-related regulatory fees and dues. The
increase from 1998 to 1999 was also due to an increase in reserves for
uncollectible accounts and contingent liabilities, and increased trade-related
errors resulting from system downtime.
Taxes on Income
The Company's effective income tax rate was 41.7% in 2000, 39.4% in 1999 and
39.5% in 1998. The increase from 1999 to 2000 was primarily due to charges,
which are non-deductible for tax purposes, for certain professional costs
related to the merger with USTC and goodwill amortization related to the
acquisition of CyBerCorp.
New Accounting Standard
In 1999, the Company adopted a new accounting standard related to
internal-use software development costs (see "Accounting Change" in note "2 -
Significant Accounting Policies" in the Notes to Consolidated Financial
Statements). As required by the standard, in 2000 and 1999 certain of the
Company's costs, primarily compensation and benefits, were capitalized and will
be amortized over the software's estimated useful life of three years. In prior
years, these costs were expensed as incurred. Adoption of this standard resulted
in the capitalization, net of amortization, of $93 million and $68 million of
internal-use software development costs during 2000 and 1999, respectively,
which increased net income by $55 million and $41 million, or $.04 and $.03
diluted earnings per share, respectively.
LIQUIDITY AND CAPITAL RESOURCES
Upon completion of the merger with USTC, CSC became a financial holding
company, which is a type of bank holding company subject to supervision and
regulation by the Federal Reserve Board under the Act. 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 "18 - Regulatory
Requirements" in the Notes to Consolidated Financial Statements.
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 depository institution subsidiaries, and SCM 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 depository institution subsidiaries' capital
guidelines and maintaining Schwab's and SCM's net capital. Based on their
respective regulatory capital ratios at December 31, 2000 and 1999, the Company
and its depository institution subsidiaries are considered well capitalized.
- 11 -
CSC has liquidity needs that arise from its issued and outstanding $718
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 2001 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, A by Standard &
Poor's Ratings Group and A+ by Fitch IBCA, Inc.
In May 2000, the SEC declared effective CSC's Registration Statement covering
the issuance of $750 million in Senior or Senior Subordinated Medium-Term Notes,
Series A. At December 31, 2000, all of these notes remained unissued.
In October 2000, the Company's Board of Directors authorized a $1.2 billion
commercial paper program for CSC. At December 31, 2000, no commercial paper has
been issued. CSC's short-term ratings are P-1 by Moody's Investors Service and
A-1 by Standard & Poor's Ratings Group.
CSC maintains a $1.2 billion committed, unsecured credit facility with a
group of twenty-seven banks which is scheduled to expire in June 2001. CSC plans
to establish a similar facility to replace this one when it expires. 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 a minimum level of tangible net worth,
and Schwab and SCM to maintain specified levels of net capital, as defined.
Management believes that these restrictions will not have a material effect on
its ability to meet foreseeable dividend or funding requirements. This facility
was unused in 2000.
CSC also has direct access to $740 million of the $880 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 in 2000.
Schwab
Most of Schwab's assets are liquid, consisting primarily of receivables from
brokerage clients, short-term (i.e., less than 90 days) investment-grade,
interest-earning investments (the majority of which are segregated for the
exclusive benefit of clients pursuant to regulatory requirements), 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.
Liquidity needs relating to client trading and margin borrowing activities
are met primarily through cash balances in brokerage client accounts, which were
$25.2 billion, $23.0 billion and $17.5 billion at December 31, 2000, 1999 and
1998, 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 December 31, 2000, Schwab's net capital was $1.7 billion (11% of
aggregate debit balances), which was $1.4 billion in excess of its minimum
required net capital and $913 million 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 $520 million was outstanding at December 31, 2000. At year 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 $880 million at December 31, 2000 ($740 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 twenty-six days in both 2000 and 1999 and six days in 1998, with
the daily amounts borrowed averaging $80 million, $125 million and $87 million,
respectively. These lines were unused at December 31, 2000.
To satisfy the margin requirement of client option transactions with the
Options Clearing Corporation (OCC), Schwab has unsecured letter of credit
agreements with twelve banks in favor of the OCC aggregating $855 million at
December 31, 2000. Schwab pays a fee to maintain these letters of credit. No
funds were drawn under these letters of credit at December 31, 2000.
- 12 -
U.S. Trust
U.S. Trust's liquidity needs are generally met through earnings generated by
its operations.
U.S. Trust is subject to the Federal Reserve Board's risk-based and leverage
capital guidelines. These regulations require banks and bank holding companies
to maintain minimum levels of capital. In addition, CSC's depository institution
subsidiaries are subject to limitations on the amount of dividends they can pay.
In addition to traditional funding sources such as deposits, federal funds
purchased and repurchase agreements, CSC's depository institution subsidiaries
have established their own external funding sources. At December 31, 2000, U.S.
Trust had $50 million in Trust Preferred Capital Securities outstanding with a
fixed interest rate of 8.41%. Certain of CSC's depository institution
subsidiaries have established credit facilities with the Federal Home Loan Bank
System (FHLB) totaling approximately $498 million. At December 31, 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 receivables from brokers, dealers and
clearing organizations.
SCM's liquidity is affected by the same net capital regulatory requirements
as Schwab (see discussion above). At December 31, 2000, SCM's net capital was
$36 million, which was $35 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
December 31, 2000.
Development Spending
A significant portion of the Company's liquidity needs arises from ongoing
investments to support future growth. These investments, which the Company
refers to as development spending, are comprised of two categories: media
spending (including media and production expenses) and project spending. Project
spending is generally targeted towards enhancing future revenue growth, such as
improvements to the Company's Web site or branch expansion; enhancing the
Company's infrastructure, such as investments to improve client statements or
its systems integration; and improving the firm's productivity, such as
enhancements to its telecommunications systems or operations processes. This
spending is imbedded throughout certain categories of the Company's non-interest
expenses.
Development spending in 2000 was approximately $530 million, up 18% from
1999. Given the prevailing market conditions and the Company's financial
performance, the Company reduced its development spending in the second half of
2000 below the level originally anticipated. Management currently anticipates
2001 development spending to stay at approximately the 2000 level, reflecting
management's focus on expense containment in light of prevailing market
conditions.
As has been the case in recent years, the Company may adjust its development
spending from period to period as business conditions change. In general, the
level of future spending will be influenced by the rate of growth in client
assets and trading activities, the opportunities to invest in technology that
improve capacity, productivity or the client experience, and the expected return
on these investments as compared to the Company's financial objectives and cost
of capital. While development spending is discretionary and can be altered in
response to business conditions, the Company views its development spending as
essential for future growth and therefore prefers to avoid major adjustments in
such spending unless faced with what it believes is a sustained slowdown in
revenue growth.
(CHART OMITTED)
Cash Flows and Capital Resources
Net income plus depreciation and amortization including goodwill amortization
was $1.0 billion in 2000, up 21% from $848 million in 1999, allowing the Company
to finance the majority of its growth with internally generated funds.
Depreciation and amortization expense related to equipment, office facilities
and property was $245 million in 2000 and $167 million in 1999. Amortization
expense related to intangible assets was $17 million in 2000 and $8 million in
1999. Goodwill amortization expense was $46 million in 2000 and $6 million in
1999. This increase was primarily due to goodwill amortization related to the
acquisition of CyBerCorp.
(CHART OMITTED)
The Company's capital expenditures were $705 million in 2000 and $373 million
($370 million net of proceeds) in 1999, or 12% and 8% of revenues, respectively.
In 2000, 58% of capital expenditures were for information technology and 42% for
facilities expansion and improvements. The $332 million, or 89%, increase in
capital expenditures in 2000 was primarily due to facilities and leasehold
improvements to support the Company's growth in employees, increased systems
capacity and enhanced
- 13 -
systems availability. Capital expenditures as described above include the
capitalized costs for developing internal-use software of $109 million in 2000
and $68 million in 1999. Schwab opened 44 new branch offices during 2000,
compared to 49 in 1999. U.S. Trust opened 3 new offices in 2000, compared to 4
in 1999. The Company continues to view its office network as important to
pursuing its strategy of attracting client assets.
Management currently anticipates that 2001 capital expenditures will be
approximately 35% to 45% lower than 2000 spending. As has been the case in
recent years, the Company may adjust its capital expenditures from period to
period as business conditions change.
During 2000, the Company:
o Issued $311 million and repaid $59 million of long-term debt and
o Paid common stock dividends of $62 million.
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 December 31, 2000 was $5.0 billion, up $1.9 billion, or
62%, from a year ago. At December 31, 2000, the Company had long-term debt of
$770 million, or 15% of total financial capital, bearing interest at a
weighted-average rate of 7.33%. At December 31, 2000, the Company's
stockholders' equity was $4.2 billion, or 85% of total financial capital.
Management currently anticipates that long-term debt will remain below 30% of
total financial capital.
Share Repurchases
CSC did not repurchase any common stock in 2000. CSC repurchased 3,371,100
shares of its common stock in 1999 for $54 million and 23,219,700 shares in 1998
for $208 million. At December 31, 2000, there was no authorization for share
repurchases.
Dividend Policy
Since the initial dividend in 1989, CSC has paid 47 consecutive quarterly
dividends and has increased the dividend 12 times. Since 1989, dividends have
increased by a 32% compounded annual growth rate. CSC paid common stock
dividends of $.0407 per share in 2000, $.0373 per share in 1999 and $.0360 per
share in 1998. Dividends declared per common share do not include dividends
declared by USTC prior to the completion of the merger. While the payment and
amount of dividends are at the discretion of the Company's Board of Directors,
the Company targets its cash dividend at approximately 5% to 10% of net income
plus depreciation and amortization.
RISK MANAGEMENT
Overview
The Company's business and activities expose it to different types of risks
including, but not limited to, those discussed below. Proper identification,
assessment and management of these risks are essential to the success and
financial soundness of the Company. Managing risk at the Company begins with the
expertise and experience of management at the business unit level. To supplement
risk management at the business unit level, the Company has formed a Global Risk
Steering Committee, and various other functional risk committees consisting of
members of senior management. The Global Risk Steering Committee takes an active
role in the oversight of the various risk committees by reviewing risk
exposures, leading in the continued development of the Company's risk management
practices, discussing changes in regulations and other risk-related
developments, and reporting regularly to the Audit Committee of the Company's
Board of Directors. Other risk committees include the Technology and Operations
Risk Committee, which focuses on the integrity and operating capacity of the
Company's technology systems; the Credit Oversight Committee, which focuses on
client activity (i.e., margin lending activities and private banking loans), the
investing activities of certain of the Company's proprietary funds, and
corporate credit activities (i.e., counterparty and corporate investing
activities); the Fiduciary Risk Committee, which focuses on financial or
reputational risk caused by a potential breach of fiduciary duties to a client;
and the Financial Risk Management Committee, which focuses on liquidity and
capital resources, interest rate risk, and securities positioning activities.
Further, the U.S. Trust Risk Policy Committee, which has broad responsibilities
for the oversight of risk management at U.S. Trust, reports to the Company's
Global Risk Steering Committee, as well as to the Board of Directors of U.S.
Trust. Additionally, the Finance, Compliance, and Internal Audit Departments and
the Office of Corporate Counsel assist management and the various risk
committees in evaluating and monitoring the Company's risk profile.
The following discussion highlights the Company's principal risks and some of
the policies and procedures for risk identification, assessment and mitigation.
See Liquidity and Capital Resources for a discussion on liquidity risk and note
"20 - Financial Instruments with Off-Balance-Sheet and Credit Risk" in the Notes
to Consolidated Financial Statements for additional discussion on credit 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 a period are not
necessarily indicative of results for any future period. Risk is inherent in the
Company's business. Consequently,
- 14 -
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.
Competition
The Company faces significant competition from companies seeking to attract
client financial assets, including traditional brokerage firms (particularly
firms that have started providing online trading services), discount brokerage
firms, online brokerage firms, mutual fund companies, banks, and asset
management companies. Certain of these competitors have greater financial
resources than the Company. The consolidation trend in the financial services
industry is likely to increase in light of the new financial modernization
legislation that became effective in March 2000. This new legislation allows
banks, securities firms and insurance companies more flexibility to affiliate
under one holding company. These holding companies can engage in activities and
acquire companies engaged in activities that are financial in nature. The
expansion and client acceptance of conducting financial transactions online, as
well as through wireless applications, have also attracted competition from
providers of online services, software development companies and other providers
of financial services. Finally, the growth of online trading has led to the
creation of new ECNs and new exchanges, and is causing major existing markets to
consider converting to for-profit status, all of which may intensify
competition. Increased competition may have a negative impact on the Company's
business and operations.
Business Environment
The Company's business, like that of other securities brokerage and related
financial services firms, is directly affected by the fluctuations in securities
trading volumes and price levels that occur in fundamentally cyclical financial
markets, as well as by changes in government monetary policies that impact the
growth of bank loans and investments and the level of interest charged for loans
and paid on deposits and other funding sources. While the Company's non-trading
revenues have grown, transaction-based revenues continue to represent
approximately half of the Company's revenues and the Company may experience
significant variations in revenues from period to period. The Company's
non-trading revenues are less cyclical than its trading revenues, but would be
impacted by a sustained downturn in the securities markets. The Company adjusts
its expenses in anticipation of and in response to changes in financial market
conditions and client trading patterns. Certain of the Company's expenses
(including variable compensation, portions of communications, and commissions,
clearance and floor brokerage) vary directly with changes in financial
performance or client trading activity. Expenses relating to the level of
contractors, temporary employees, overtime hours, advertising and market
development, and professional services are adjustable over the short term to
help the Company achieve its financial objectives. Additionally, development
spending is discretionary and can be altered in response to market conditions.
However, a significant portion of the Company's expenses such as salaries and
wages, occupancy and equipment, and depreciation and amortization do not vary
directly, at least in the short term, with fluctuations in revenues or
securities trading volumes. Also, the Company views its development spending as
essential for future growth and therefore prefers to avoid major adjustments in
such spending unless faced with a sustained slowdown in revenue growth.
Technology and Operating Risk
Technology and operating risk is the potential for loss due to deficiencies
in control processes or technology systems that constrain the Company's ability
to gather, process and communicate information efficiently and securely, without
interruptions. The Company's operations are highly dependent on the integrity of
its technology systems and the Company's success depends, in part, on its
ability to make timely enhancements and additions to its technology in
anticipation of client demands. To the extent the Company experiences system
interruptions, errors or downtime (which could result from a variety of causes,
including changes in client use patterns, technological failure, changes to its
systems, linkages with third-party systems, and power failures), the Company's
business and operations could be significantly negatively impacted.
Additionally, rapid increases in client demand may strain the Company's ability
to enhance its technology and expand its operating capacity. To minimize
business interruptions, Schwab has two data centers intended, in part, to
further improve the recovery of business processing in the event of an
emergency. Technology and operating risk also includes human error, fraud and
natural disaster. The Company attempts to mitigate technology and operating risk
by maintaining a comprehensive internal control system and by employing
experienced personnel. Also, the Company maintains backup and recovery
functions, including facilities for backup and communications, and conducts
periodic testing of a disaster recovery plan. Each functional area deemed to be
potentially of medium to high risk by management performs a risk self-assessment
on an annual basis to evaluate the appropriateness of these internal controls
and recovery plans. The Company is committed to an ongoing process of upgrading,
enhancing and testing its technology systems. This effort is focused on meeting
client demands, meeting market and regulatory changes, and deploying
standardized technology platforms.
- 15 -
In addition, USTC has an outsourcing agreement with a third party that
provides data processing, security processing, custodial and other operational
support services. Under the terms of the outsourcing agreement, the third-party
provider has the right to terminate the contract upon the change in control that
resulted from the merger of CSC with USTC. The Company plans to repatriate to
the Company's systems substantially all of the service functions provided by
this third party, and the Company and U.S. Trust expect to be able to provide
for an orderly repatriation of such functions. The transition is expected to be
completed before the end of the third quarter of 2001. While management believes
that there will be a successful transition, there is a possibility that the
transition could result in a significant disruption to U.S. Trust's ability to
service its clients and as a consequence could result in lost business and a
deterioration in U.S. Trust's fee revenues.
The Company is engaged in the research and development of new technologies,
services and products. The Company endeavors to protect its research and
development efforts, and its brands, through the use of copyrights, patents,
trade secrets and contracts. From time to time, third parties indicate that they
believe the Company may be infringing on their intellectual property rights. The
Company's efforts to assess the merits of third-party claims of infringement of
intellectual property, and its efforts to protect its own intellectual property,
require an investment of time and resources. In certain circumstances, the
Company attempts to obtain licenses under third-party intellectual property
rights. In some circumstances, a license may not be available from a third party
under acceptable terms. Similarly, the Company from time to time licenses its
intellectual property to third parties. Under some circumstances, litigation may
result from questions regarding infringement, ownership, validity, and scope of
intellectual property. Such litigation can require the expenditure of
significant Company resources. If the Company were found to have infringed a
third-party patent, or other intellectual property rights, it could incur
substantial liability, and in some circumstances could be enjoined from using
certain technology, or providing certain products or services.
Credit Risk
Credit risk is the potential for loss due to a client or counterparty failing
to perform its contractual obligations, or the value of collateral held to
secure obligations proving to be inadequate. The Company's direct exposure to
credit risk mainly results from its margin lending activities, securities
lending activities, role as a counterparty in financial contracts, and investing
activities, and indirectly from the investing activities of certain of the
Company's proprietary funds. To mitigate the risks of such losses, the Company
has established policies and procedures which include: establishing and
reviewing credit limits, monitoring of credit limits and quality of
counterparties, and increasing margin requirements for certain securities. In
addition, most of the Company's credit extensions, such as margin loans to
clients, securities lending agreements, and resale agreements, are supported by
collateral arrangements. These arrangements are subject to requirements to
provide additional collateral in the event that market fluctuations result in
declines in the value of collateral received.
Additionally, the Company has exposure to credit risk associated with the
Company's private banking loan portfolio held at U.S. Trust. This counterparty
credit exposure is actively managed through individual and portfolio reviews
performed by account officers and senior line management. Periodic assessment of
the validity of credit ratings, credit quality and the credit management process
is conducted by a risk review department which is separate from the loan
origination and monitoring department. Management regularly reviews asset
quality including concentrations, delinquencies, non-performing private banking
loans, losses and recoveries. All are factors in the determination of an
appropriate allowance for credit losses, which is reviewed quarterly by senior
management. See notes "6 - Loans to Banking Clients and Related Allowance for
Credit Losses" and "20 - Financial Instruments with Off-Balance-Sheet and Credit
Risk" in the Notes to Consolidated Financial Statements for an analysis of the
Company's loan portfolio and allowance for credit losses, and for an additional
discussion on credit risk, respectively.
There were no troubled debt restructurings at December 31, 2000 and 1999. As
of December 31, 2000, management is not aware of any significant potential
problem loans other than the amounts disclosed in the table in note "6 - Loans
to Banking Clients and Related Allowance for Credit Losses" in the Notes to
Consolidated Financial Statements.
Fiduciary Risk
Fiduciary risk is the potential for financial or reputational loss through
the breaching of fiduciary duties to a client. Fiduciary activities include, but
are not limited to, individual and corporate trust, investment management,
custody and cash and securities processing. The Company attempts to mitigate
this risk by establishing procedures to ensure that obligations to clients are
discharged faithfully and in compliance with applicable legal and regulatory
requirements. Business units have the primary responsibility for adherence to
the procedures applicable to their business. Guidance and control is provided
through the creation, approval and ongoing review of applicable policies by
business units and the Fiduciary Risk Committee.
- 16 -
Market Risk
Market risk is the potential for loss due to a change in the value of a
financial instrument held by the Company as a result of fluctuations in interest
rates, currency exchange rates, or equity prices.
The Company is exposed to interest rate risk primarily from changes in the
interest rates on its interest-earning assets (mainly margin loans to clients,
investments, private banking loans, mortgage-backed securities and other
fixed-rate investments) and its funding sources (including brokerage client cash
balances, banking deposits, proceeds from stock-lending activities, long-term
debt, and stockholders' equity) which finance these assets. The Company attempts
to mitigate this risk by monitoring the net interest margin and average maturity
of its interest-earning assets and funding sources. The Company also has the
ability to adjust the rates paid on certain brokerage client cash balances and
certain banking deposits and the rates charged on margin loans. Additionally,
the Company uses interest rate swaps (Swaps) to mitigate interest rate exposure
associated with short-term floating interest-rate deposits.
The Company is exposed to equity price risk through its role as a financial
intermediary in client-related transactions, and by holding financial
instruments mainly in its capacity as a market maker and relating to its
specialists' operations. To mitigate the risk of losses, these financial
instruments are marked to market daily and are monitored by management to assure
compliance with limits established by the Company. Additionally, the Company
purchases from time to time exchange-traded option contracts to reduce market
risk on these inventories. The Company may also purchase futures contracts to
reduce this risk. The Company may enter into foreign currency contracts to
reduce currency exchange rate risk. However, the Company's exposure to currency
exchange risks through its international operations is not material.
Additional qualitative and quantitative disclosures about market risk are
summarized as follows. See note "20 - Financial Instruments with
Off-Balance-Sheet and Credit Risk" in the Notes to Consolidated Financial
Statements for an additional discussion on credit risk.
Financial Instruments Held For Trading Purposes
The Company held government securities and certificates of deposit with a
fair value of approximately $32 million and $22 million at December 31, 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 December 31, 2000 was $69 million in long positions
and $30 million in short positions. The fair value of these securities at
December 31, 1999 was $107 million in long positions and $60 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 $4 million
and $5 million at December 31, 2000 and 1999, respectively, due to the offset of
the 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
December 31, 2000 and 1999 would not be material to the Company's financial
position, results of operations or cash flows. The notional amount of option
contracts was approximately $66 million and $103 million at December 31, 2000
and 1999, respectively. The fair value of such option contracts was not material
to the Company's consolidated balance sheets at December 31, 2000 and 1999.
Financial Instruments Held For Purposes Other Than Trading
The Company maintains investments primarily in mutual funds to fund the
majority of the obligations under its deferred compensation plan, which is
available to certain employees. These investments were approximately $70 million
and $60 million at December 31, 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 December 31, 2000, CSC had $718 million aggregate principal amount of
Medium-Term Notes outstanding, with fixed interest rates ranging from 5.96% to
8.05%. At December 31, 1999, CSC had $455 million aggregate principal amount of
Medium-Term Notes outstanding, with fixed interest rates ranging from 5.96% to
7.50%. At December 31, 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 December 31, 2000 and 1999, U.S. Trust had $2 million and $13
million of FHLB borrowings outstanding, respectively. The FHLB borrowings had
fixed interest rates ranging from 6.69% to 6.76% at December 31, 2000 and from
6.59% to 6.76% at December 31, 1999.
The Company has fixed cash flow requirements regarding these long-term debt
obligations due to the fixed rate of interest. The estimated fair value of these
obligations at December 31, 2000 and 1999, based on estimates of market rates
for debt with similar terms and remaining maturities, was $785 million and $498
million, respectively, which
- 17 -
approximated their carrying amounts of $770 million and $518 million,
respectively.
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. During the second
quarter of 2000, the Company revised the interest rate scenarios for the model
to more closely reflect the risks inherent in the balance sheet resulting from
the merger with USTC. The interest rate scenarios were changed from an immediate
100 basis point change to a gradual 200 basis point change in equal monthly
increments over twelve months. 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 December 31, 2000
and 1999. The change in simulated net interest revenue sensitivity from 1999 to
2000 was primarily due to a decrease in margin loan balances as a percentage of
assets and an increase in equity as a source of funding.
- --------------------------------------------------------------------------------
Impact on Net Interest Revenue
Percentage Increase (Decrease)
December 31, 2000 1999
- --------------------------------------------------------------------------------
Increase of 200 basis points 6.9% 9.2%
Decrease of 200 basis points (7.1%) (9.2%)
================================================================================
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 years ended December 31, 2000, 1999 and 1998 was immaterial to the Company's
results of operations.
Legal and Compliance Risk
Legal and compliance risk refers to the possibility that the Company will be
found, by a court, arbitration panel or regulatory authority, not to have
complied with an applicable legal or regulatory requirement. The Company may be
subject to lawsuits or arbitration claims by clients, employees or other third
parties in the different jurisdictions in which it conducts business. In
addition, the Company is subject to extensive regulation by the SEC, the
National Association of Securities Dealers, Inc., the NYSE, the Board of
Governors of the Federal Reserve System, the Federal Deposit Insurance
Corporation, the Superintendent of Banks of the State of New York, and other
federal, state and market regulators, as well as certain foreign regulatory
authorities. New rules and changes in application of current rules could affect
the Company's manner of operations and profitability. The Company attempts to
mitigate legal and compliance risk through policies and procedures that it
believes are reasonably designed to prevent or detect violations of applicable
statutory and regulatory requirements (see note "19 - Commitments and Contingent
Liabilities" in the Notes to Consolidated Financial Statements). However,
violations of applicable statutory and regulatory requirements could subject the
Company and/or its directors, officers or employees to disciplinary proceedings
or civil or criminal liability. Any such proceeding could cause a significant
negative impact on the Company's business and operations.
BANK HOLDING COMPANY ACT REQUIREMENTS
Upon completion of the Merger, CSC became a financial holding company, which
is a type of bank holding company subject to supervision and regulation by the
Federal Reserve Board under 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.
- 18 -
The Federal Reserve Board may impose limitations, restrictions, or prohibitions
on the activities or acquisitions of a financial holding company if the Federal
Reserve Board believes that the company does not have the appropriate financial
and managerial resources to commence or conduct an activity, make an
acquisition, or retain ownership of a company and the Federal Reserve Board may
take actions as appropriate to enforce applicable federal law.
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 depository institution subsidiaries.
CSC's primary depository institution subsidiary is United States Trust
Company of New York. The operations and financial condition of CSC's depository
institution 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 non-depository institution
subsidiaries, including 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. CSC, 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.
To remain a financial holding company, each of CSC's depository institution
subsidiaries must be well capitalized and well managed. In addition, each of
CSC's insured depository institution subsidiaries must be rated "satisfactory"
or better on the institutions' records of meeting the credit needs of their
communities under the Community Reinvestment Act of 1977 in order for CSC to
engage in new financial activities or, with certain limited exceptions, acquire
a company engaged in financial activities. If CSC ceases to qualify as a
financial holding company it will be subject to substantial additional
restrictions on its activities.
The Federal Reserve Board has not published consolidated capital requirements
specific to financial holding companies. In January 2001, the federal bank
agencies requested comment on a new Capital Accord proposed by the Basel
Committee on Banking Supervision. Among other issues, the bank agencies have not
determined the category of banks that would be subject to the Capital Accord and
have requested comment generally on this question and on whether the Capital
Accord should cover bank holding companies. The Company is evaluating how the
Capital Accord will affect CSC at this time.
Subject to limited exceptions, the privacy provisions of the GLB Act prohibit
financial institutions from disclosing to unaffiliated third parties nonpublic
personal information regarding consumers and require financial institutions to
disclose consumer privacy policies. Federal law does not preempt state financial
privacy laws that are stricter than the federal provisions. Schwab and U.S.
Trust are amending their privacy policies and consumer disclosures to comply
with the GLB Act and its implementing regulations. See note "18 - Regulatory
Requirements" in the Notes to Consolidated Financial Statements.
LOOKING AHEAD
During 2000, competition in financial services remained intense - a number of
traditional and discount brokerage firms spent aggressively on their advertising
and marketing programs, and many firms added new products and services. In
addition, the trend of industry consolidation continued, particularly in retail
brokerage and Nasdaq market making. Further, firms offering wealth management
services continued to expand their marketing efforts. While this pattern of
intensified competition is expected to continue in 2001, management believes
that the Company's competitive advantages will enable the firm to pursue its
strategy of attracting and retaining client assets. As described more fully in
the Description of Business section above, these competitive advantages include:
nationally recognized brands, a broad line of products and services offered at
prices that management believes represent superior value, multi-channel delivery
systems, and the commitment and skills necessary to invest in technology
intended to empower clients and reduce costs. Additionally, the Company's
significant level of employee ownership aligns the interests of management with
those of stockholders.
Management continues to believe that the key to sustaining the Company's
competitive advantages will be its ability to combine people and technology in
ways that provide investors with the access, information, guidance, advice and
control they expect - as well as superior service - all at a lower cost than
traditional providers of financial services. Accordingly, the Company expects to
remain in direct competition with traditional, online and discount brokerage
firms, investment management companies, banks and other providers of financial
products and services.
During 2001, the Company expects to sustain its
- 19 -
competitive advantages by providing its clients with expanded and enhanced
services driven by evolving client needs. As clients continue to accumulate
wealth, many will need more guidance in managing their financial affairs and the
Company therefore expects to continue developing an enhanced help and advice
offering for all clients, including more affluent investors. The Company intends
to leverage U.S. Trust's highly personalized service model, research
capabilities, trust and estate services, investment track record and reputation
in wealth management services to help provide affluent investors, as well as
independent investment managers and their clients, with access to a broad array
of wealth management services. The Company also intends to leverage CyBerCorp's
technological skills to provide actively trading investors with access to
advanced order entry, routing and management technology, as well as to support
the Company's ongoing role as a leader in the evolution of client access to the
capital markets. The Company also expects to continue its process of selective
international expansion.
Capitalizing on and strengthening the Company's competitive advantages
requires significant development spending and capital expenditures. While such
outlays are expected to moderate in 2001 in light of prevailing market
conditions and a substantial buildup in service capacity during the prior year,
management continues to believe that these ongoing investments are critical to
increasing the Company's market share and achieving its long-term financial
objectives, which include annual growth in revenues of 20%, an after-tax
operating profit margin of at least 12%, and a return on stockholders' equity of
20%.
- 20 -
- ------------------------------------------------------------------------------------------------------------------------------
Consolidated Statement of Income The Charles Schwab Corporation
(In Thousands, Except Per Share Amounts)
Year Ended December 31, 2000 1999 1998
- ------------------------------------------------------------------------------------------------------------------------------
Revenues
Commissions $2,294,145 $1,874,594 $1,318,103
Asset management and administration fees 1,583,098 1,220,346 936,796
Interest revenue, net of interest expense of $1,351,776 in 2000,
$898,219 in 1999 and $773,998 in 1998 1,237,100 819,790 577,643
Principal transactions 570,207 500,496 286,754
Other 103,101 71,193 58,574
- ------------------------------------------------------------------------------------------------------------------------------
Total 5,787,651 4,486,419 3,177,870
- ------------------------------------------------------------------------------------------------------------------------------
Expenses Excluding Interest
Compensation and benefits 2,414,480 1,888,414 1,374,436
Other compensation - merger retention programs 38,703
Occupancy and equipment 415,356 306,900 236,232
Communications 353,044 278,509 216,389
Advertising and market development 332,311 247,808 159,784
Depreciation and amortization 261,732 174,651 152,107
Professional services 254,549 184,470 114,097
Commissions, clearance and floor brokerage 138,038 100,132 87,273
Merger-related (1) 68,986
Goodwill amortization 45,544 6,419 6,443
Other 233,435 200,201 153,471
- ------------------------------------------------------------------------------------------------------------------------------
Total 4,556,178 3,387,504 2,500,232
- ------------------------------------------------------------------------------------------------------------------------------
Income before taxes on income 1,231,473 1,098,915 677,638
Taxes on income 513,336 432,469 267,509
- ------------------------------------------------------------------------------------------------------------------------------
Net Income $ 718,137 $ 666,446 $ 410,129
==============================================================================================================================
Weighted-Average Common Shares Outstanding - Diluted (2) 1,403,763 1,373,030 1,342,895
==============================================================================================================================
Earnings Per Share (2)
Basic $ .53 $ .51 $ .32
Diluted $ .51 $ .49 $ .31
==============================================================================================================================
Dividends Declared Per Common Share (2, 3) $ .0407 $ .0373 $ .0360
==============================================================================================================================
All periods have been restated to reflect the merger of The Charles Schwab Corporation (CSC) with U.S. Trust Corporation
(USTC) except as noted.
(1) Merger-related costs include professional fees, change in control related compensation expense and other expenses
relating to the merger of CSC with USTC.
(2) All periods have been restated for the May 2000 three-for-two common stock split.
(3) Dividends declared per common share do not include dividends declared by USTC prior to the completion of the merger.
See Notes to Consolidated Financial Statements.
- 21 -
- --------------------------------------------------------------------------------------------------------------------------
Consolidated Balance Sheet The Charles Schwab Corporation
(In Thousands, Except Per Share Amounts)
December 31, 2000 1999
- --------------------------------------------------------------------------------------------------------------------------
Assets
Cash and cash equivalents $ 3,302,255 $ 2,612,451
Cash and investments required to be segregated under federal or other regulations
(including resale agreements of $7,002,252 in 2000 and $6,165,043 in 1999) 10,998,368 8,826,121
Securities owned - at market value 1,602,942 1,333,220
Receivables from brokers, dealers and clearing organizations 348,199 484,247
Receivables from brokerage clients - net 16,332,113 17,060,222
Loans to banking clients - net 3,147,435 2,689,205
Equipment, office facilities and property - net 1,132,602 678,208
Goodwill - net 508,511 53,723
Other assets 781,544 584,715
- --------------------------------------------------------------------------------------------------------------------------
Total $38,153,969 $34,322,112
==========================================================================================================================
Liabilities and Stockholders' Equity
Deposits from banking clients $ 4,209,415 $ 4,204,943
Drafts payable 543,539 467,758
Payables to brokers, dealers and clearing organizations 1,070,322 1,748,765
Payables to brokerage clients 25,714,691 23,422,592
Accrued expenses and other liabilities 1,277,030 1,243,121
Short-term borrowings 339,031 141,157
Long-term debt 770,229 518,000
- --------------------------------------------------------------------------------------------------------------------------
Total liabilities 33,924,257 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;
1,385,625 shares issued and outstanding in 2000 and 1,336,636 shares
issued in 1999* 13,856 13,366
Additional paid-in capital 1,588,298 595,282
Retained earnings* 2,713,094 2,144,683
Treasury stock - 7,336 shares in 1999, at cost* (96,742)
Employee stock ownership plans (967)
Unamortized stock-based compensation (71,026) (70,926)
Accumulated other comprehensive loss (14,510) (8,920)
- --------------------------------------------------------------------------------------------------------------------------
Total stockholders' equity 4,229,712 2,575,776
- --------------------------------------------------------------------------------------------------------------------------
Total $38,153,969 $34,322,112
==========================================================================================================================
All periods have been restated to reflect the merger of The Charles Schwab Corporation with U.S. Trust Corporation.
* All periods have been restated for the May 2000 three-for-two common stock split.
See Notes to Consolidated Financial Statements.
- 22 -
- ----------------------------------------------------------------------------------------------------------------------------------
Consolidated Statement of Cash Flows The Charles Schwab Corporation
(In Thousands)
Year Ended December 31, 2000 1999 1998
- ----------------------------------------------------------------------------------------------------------------------------------
Cash Flows from Operating Activities
Net income $ 718,137 $ 666,446 $ 410,129
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization 261,732 174,651 152,107
Goodwill amortization 45,544 6,419 6,443
Net amortization of premium on securities available for sale 3,627 4,677 3,384
Compensation payable in common stock 81,578 34,977 30,891
Deferred income taxes (26,724) (3,218) (9,498)
Tax benefits from stock options exercised and other stock-based
compensation 329,858 215,480 70,589
Other 4,656 6,814 7,020
Net change in:
Cash and investments required to be segregated under federal
or other regulations (2,218,395) 1,475,017 (3,500,320)
Securities owned (excluding securities available for sale) (38,340) (97,519) 40,454
Receivables from brokers, dealers and clearing organizations 130,863 (153,877) (65,978)
Receivables from brokerage clients 727,251 (7,419,482) (1,893,821)
Other assets (109,586) (29,133) 3,578
Drafts payable 75,060 144,006 56,028
Payables to brokers, dealers and clearing organizations (662,028) 329,423 298,411
Payables to brokerage clients 2,328,866 5,317,093 5,010,081
Accrued expenses and other liabilities (12,713) 333,028 155,060
- ----------------------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 1,639,386 1,004,802 774,558
- ----------------------------------------------------------------------------------------------------------------------------------
Cash Flows from Investing Activities
Purchases of securities available for sale (545,436) (465,789) (367,762)
Proceeds from sales of securities available for sale 93,456 10,019
Proceeds from maturities, calls and mandatory redemptions of securities
available for sale 227,016 413,454 429,929
Net increase in loans to banking clients (458,350) (517,865) (251,463)
Purchase of equipment, office facilities and property - net (704,558) (370,191) (199,168)
Cash payments for business combinations and investments,
net of cash received (34,989) (25,568) (23,584)
- ----------------------------------------------------------------------------------------------------------------------------------
Net cash used for investing activities (1,422,861) (955,940) (412,048)
- ----------------------------------------------------------------------------------------------------------------------------------
Cash Flows from Financing Activities
Net increase in deposits from banking clients 4,472 790,152 340,889
Net change in short-term borrowings 197,874 232 (38,662)
Proceeds from long-term debt 311,000 144,000 30,000
Repayment of long-term debt (58,903) (44,853) (44,531)
Dividends paid (62,366) (61,107) (56,041)
Purchase of treasury stock (53,924) (208,353)
Proceeds from stock options exercised and other 84,891 65,799 36,015
- ----------------------------------------------------------------------------------------------------------------------------------
Net cash provided by financing activities 476,968 840,299 59,317
- ----------------------------------------------------------------------------------------------------------------------------------
Effect of exchange rate changes on cash and cash equivalents (3,689) 2,382 (160)
- ----------------------------------------------------------------------------------------------------------------------------------
Increase in Cash and Cash Equivalents 689,804 891,543 421,667
Cash and Cash Equivalents at Beginning of Year 2,612,451 1,720,908 1,299,241
- ----------------------------------------------------------------------------------------------------------------------------------
Cash and Cash Equivalents at End of Year $ 3,302,255 $ 2,612,451 $ 1,720,908
==================================================================================================================================
All periods have been restated to reflect the merger of The Charles Schwab Corporation with U.S. Trust Corporation.
See Notes to Consolidated Financial Statements.
- 23 -
- ----------------------------------------------------------------------------------------------------------------------------------
Consolidated Statement of Stockholders' Equity The Charles Schwab Corporation
(In Thousands)
Common
Stock Accumu-
Deferred Issued lated
Compen- Unamortized to Other
sation Employee Stock- Deferred Compre-
Additional Stock Stock based Compen- hensive
Common Paid-In Retained Trust Treasury Ownership Compen- sation Income
Stock(1) Capital Earnings(1) (2) Stock Plans sation Trust(2) (Loss) Total
- -----------------------------------------------------------------------------------------------------------------------------------
Balance at
December 31, 1997 $13,073 $ 272,619 $1,191,103 $ (78,028) $(10,023) $(17,228) $ 4,747 $1,376,263
Comprehensive income:
Net income 410,129 410,129
Foreign currency
translation adjustment 388 388
Change in net unrealized
gain (loss) on securities
available for sale,
net of tax 187 187
-----------
Total comprehensive
income 410,704
Dividends declared on
common stock (56,519) (56,519)
Purchase of treasury
stock (208,353) (208,353)
Stock options exercised,
and shares and stock
options issued under
stock-based
compensation plans 10 (37,140) (4,284) 189,075 (42,153) 105,508
Issuance of shares for
acquisitions 2,917 9,538 12,455
Cash paid in lieu of
fractional shares as
a result of the stock
split (364) (364)
Amortization of stock-based
compensation awards 15,499 15,499
Principal payment by U.S.
Trust Corporation ESOP 3,481 3,481
ESOP shares released for
allocation 12,762 140 1,681 14,583
- -----------------------------------------------------------------------------------------------------------------------------------
Balance at
December 31, 1998 13,083 251,158 1,540,205 (87,768) (4,861) (43,882) 5,322 1,673,257
- -----------------------------------------------------------------------------------------------------------------------------------
Comprehensive income:
Net income 666,446 666,446
Foreign currency
translation adjustment 2,606 2,606
Change in net unrealized
gain (loss) on securities
available for sale,
net of tax (16,848) (16,848)
-----------
Total comprehensive
income 652,204
Dividends declared on
common stock (61,868) (61,868)
Purchase of treasury
stock (53,924) (53,924)
Deferred compensation
liability settled by
issuing common stock 1 2,404 $2,405 $(2,405) 2,405
Stock options exercised,
and shares and stock
options issued under
stock-based
compensation plans 282 325,279 (140) 12,769 (54,072) 284,118
Issuance of shares for
acquisitions 13,278 32,181 45,459
Amortization of stock-based
compensation awards 27,028 27,028
Principal payment by U.S.
Trust Corporation ESOP 3,773 3,773
ESOP shares released for
allocation 3,163 40 121 3,324
- -----------------------------------------------------------------------------------------------------------------------------------
Balance at
December 31, 1999 13,366 595,282 2,144,683 2,405 (96,742) (967) (70,926) (2,405) (8,920) 2,575,776
- -----------------------------------------------------------------------------------------------------------------------------------
Comprehensive income:
Net income 718,137 718,137
Foreign currency
translation adjustment (15,213) (15,213)
Change in net unrealized
gain (loss) on securities
available for sale,
net of tax 9,623 9,623
-----------
Total comprehensive
income 712,547
Dividends declared on
common stock (57,746) (57,746)
Deferred compensation
payable in common stock 5 5 (5) 5
Stock options exercised,
and shares and stock
options issued under
stock-based
compensation plans 376 440,301 (50) 135 (37,020) 403,742
Cash paid in lieu of
fractional shares as
a result of the stock
split (469) (469)
Issuance of shares for
acquisitions 184 528,602 (59) 88 528,815
Retirement of treasury
stock (70) (5,009) (91,440) 96,519
Amortization of stock-based
compensation awards 36,920 36,920
ESOP shares released for
allocation 29,117 38 967 30,122
- -----------------------------------------------------------------------------------------------------------------------------------
Balance at
December 31, 2000 $13,856 $1,588,298 $2,713,094 $2,410 $(71,026) $(2,410) $(14,510) $4,229,712
===================================================================================================================================
All periods have been restated to reflect the merger of The Charles Schwab Corporation with U.S. Trust Corporation.
(1) All periods have been restated for the May 2000 three-for-two common stock split.
(2) Deferred compensation stock trust amounts are presented net on the Consolidated Balance Sheet.
See Notes to Consolidated Financial Statements.
- 24 -
The Charles Schwab Corporation
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Per Share and Option Price Amounts)
1. Basis of Presentation
The Company
The consolidated financial statements include The Charles Schwab Corporation
(CSC) and its majority-owned 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 384 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), an
electronic trading technology and brokerage firm providing Internet-based
services to highly active, online investors.
Investments in which the Company has significant influence, but owns less
than a majority of the voting stock, are generally accounted for by the equity
method. Certain items in prior years' financial statements have been
reclassified to conform to the 2000 presentation. All material intercompany
balances and transactions have been eliminated.
Merger with U.S. Trust Corporation
On May 31, 2000, CSC completed its merger (the Merger) with USTC. Under the
terms of the merger agreement, U.S. Trust became a wholly owned subsidiary of
CSC and USTC shareholders received 5.1405 shares of CSC's common stock for each
common share of USTC. The Merger was treated as a non-taxable stock-for-stock
exchange and USTC's shareholders received approximately 112,000,000 shares of
CSC's common stock. Upon completion of the Merger, CSC became a financial
holding company, which is a type of 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. The
consolidated financial statements, included in this Annual Report, 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. For the years ended December 31, 2000, 1999
and 1998, stockholders' equity and other per share information reflects the
accounts of CSC and its subsidiaries as if the common stock issued to USTC
shareholders had been issued 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 consolidated statement of income are as follows:
- --------------------------------------------------------------------------------
(Unaudited)
Three Months Year Ended
Ended December 31,
March 31, 2000 1999 1998
- --------------------------------------------------------------------------------
Revenues:
Company (excluding
U.S. Trust) $1,571,876 $3,944,822 $2,736,221
U.S. Trust 153,752 541,597 441,649
- --------------------------------------------------------------------------------
Combined $1,725,628 $4,486,419 $3,177,870
================================================================================
Net Income:
Company (excluding
U.S. Trust) $ 284,247 $ 588,877 $ 348,462
U.S. Trust 15,711 77,569 61,667
- --------------------------------------------------------------------------------
Combined $ 299,958 $ 666,446 $ 410,129
================================================================================
2. Significant Accounting Policies
Securities transactions: Clients' securities transactions are recorded on the
date that they settle, while the related commission revenues and expenses are
recorded on the date that the trade occurs. Principal transactions are recorded
on a trade date basis.
Use of estimates: The preparation of the consolidated financial statements in
conformity with accounting principles generally accepted in the U.S. requires
management to make certain estimates and assumptions that affect the reported
amounts in the accompanying financial statements. Such estimates relate to
useful lives of equipment, office facilities, buildings, goodwill and other
intangible assets, capitalized internal-use software development costs, fair
value of
- 25 -
financial instruments, allowance for credit losses on banking loans, allowance
for doubtful accounts of brokerage clients, retirement and postretirement
benefits, future tax benefits and legal reserves. Actual results could differ
from such estimates.
Cash and cash equivalents: The Company considers all highly liquid investments
(including securities purchased under agreements to resell (resale agreements),
money market funds, interest-bearing deposits with banks and federal funds sold)
with maturities of three months or less that are not required to be segregated
under federal or other regulations to be cash equivalents.
Cash and investments required to be segregated under federal or other
regulations consist primarily of resale agreements and certificates of deposit.
Certificates of deposit are stated at cost, which approximates market.
Securities financing activities: Resale agreements are accounted for as
collateralized financing transactions and are recorded at their contractual
amounts plus accrued interest. The Company obtains possession of collateral with
a market value equal to or in excess of the principal amount loaned and accrued
interest under resale agreements. Collateral is valued daily by the Company,
with additional collateral obtained or refunded when necessary.
Securities borrowed and securities loaned are reported as collateralized
financing transactions. Securities borrowed require the Company to deposit cash
with the lender and are included in receivables from brokers, dealers and
clearing organizations. For securities loaned, the Company receives collateral
in the form of cash in an amount generally equal to the market value of
securities loaned. Securities loaned are included in payables to brokers,
dealers and clearing organizations. The Company monitors the market value of
securities borrowed and loaned on a daily basis, with additional collateral
obtained or refunded when necessary.
Securities owned include securities available for sale that are recorded at
estimated fair value with unrealized gains and losses reported, net of taxes, in
accumulated other comprehensive income (loss) included in stockholders' equity.
Realized gains and losses from sales of securities available for sale are
determined on a specific identification basis and are included in other
revenues.
Securities owned also include equity, fixed income and other securities,
SchwabFunds money market funds and equity and bond mutual funds. These
securities are recorded at estimated fair value with unrealized gains and losses
included in principal transaction revenues.
Receivables from brokerage clients that remain unsecured for more than 30 days
or partially secured for more than 90 days are fully reserved for, and are
stated net of allowance for doubtful accounts.
Nonperforming assets included in the loan portfolio consist of financial
instruments and other real estate owned where the Company has stopped accruing
interest (non-accrual financial instruments). Interest accruals are discontinued
when principal or interest is contractually past due ninety days or more unless
collectibility of the loan is reasonably assured. In addition, interest accruals
may be discontinued when principal or interest is contractually past due less
than ninety days if, in the opinion of management, the amount due is not likely
to be paid in accordance with the terms of the contractual agreement, even
though the financial instruments are currently performing. Any accrued but
unpaid interest previously recorded on a non-accrual financial instrument is
reversed and recorded as a reduction of interest income. Interest received on
non-accrual financial instruments is applied either to the outstanding principal
balance or recorded as interest income, depending on management's assessment of
the ultimate collectibility of principal. Non-accrual financial instruments are
generally returned to accrual status only when all delinquent principal and
interest payments become current and the collectibility of future principal and
interest on a timely basis is reasonably assured.
Allowance for credit losses on banking loans is established through charges to
income based on management's evaluation of the adequacy of the allowance for
credit losses in the existing credit portfolio.
The adequacy of the allowance is reviewed regularly by management, taking
into consideration current economic conditions, the present loan portfolio
composition, past loss experience and risks inherent in the credit portfolio,
including the value of impaired loans.
Equipment, office facilities and property: Equipment and office facilities are
depreciated on a straight-line basis over the estimated useful life of the asset
of two to fifteen years. Buildings are depreciated on a straight-line basis over
twenty years. Leasehold improvements are amortized on a straight-line basis over
the lesser of the estimated useful life of the asset or the life of the lease.
Software is amortized on a straight-line basis over an estimated useful life of
three years. Equipment, office facilities, property and capitalized internal-use
software development costs are stated at cost net of accumulated depreciation
and amortization.
Goodwill, which represents the cost of acquired businesses in excess of the fair
value of the related net assets acquired, is amortized on a straight-line basis
over a period generally not to exceed fifteen years. Goodwill is reviewed for
impairment whenever events or changes in circumstances indicate that the
carrying amount of goodwill may not be recoverable. Goodwill is stated at cost
net of accumulated amortization of $79 million and $31 million at December 31,
2000 and 1999, respectively.
- 26 -
Estimated fair value of financial instruments: Substantially all of the
Company's financial instruments are recorded at estimated fair value or amounts
that approximate fair value.
The fair value of securities, loans and long-term debt are estimated using
quoted market prices, third-party pricing services, discounted cash flow
analyses utilizing discount rates currently available for similar instruments,
or other valuation techniques. Other equity securities where quoted market
prices are not available are initially recorded at cost. The carrying value of
such securities is adjusted when changes in the underlying fair values are
readily ascertainable, generally as evidenced by listed market prices or
transactions which directly affect the value of such securities.
Derivative financial instruments: As part of its asset and liability management
activities, the Company uses interest rate swaps (Swaps) to mitigate the
interest rate risk associated with nontrading-related balance sheet financial
instruments. The Company utilizes Swaps solely as hedging instruments.
Swaps that qualify as hedges are accounted for under the accrual method,
whereby the interest component associated with Swaps is recognized over the life
of the contract in net interest revenue and there is no recognition of
unrealized gains and losses on Swaps in the consolidated balance sheet.
Other derivative activities primarily consist of exchange-traded option
contracts to reduce market risk on inventories in Nasdaq and exchange-listed
securities. Options are recorded at market value in securities owned on the
consolidated balance sheet, and gains and losses are included in principal
transaction revenues.
The Company plans to adopt Statement of Financial Accounting Standards (SFAS)
No. 133 by January 1, 2001 which will impact the accounting for Swaps (see
discussion below).
Foreign currency translation: Assets and liabilities denominated in foreign
currencies are translated at the exchange rate on the balance sheet date, while
revenues and expenses are translated at average rates of exchange prevailing
during the year. Translation adjustments are included in other comprehensive
income (loss).
Income taxes: The Company files a consolidated U.S. federal income tax return
and uses the asset and liability method in recording income tax expense. Under
this method, deferred tax assets and liabilities are recorded for temporary
differences between the tax basis of assets and liabilities and their recorded
amounts for financial reporting purposes, using currently enacted tax law.
Common stock split: Share and per share information presented in the financial
statements and related notes have been restated to reflect the May 2000
three-for-two common stock split, effected in the form of a 50% stock dividend.
Accounting change: Statement of Position 98-1 - Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use, was adopted by the
Company effective January 1, 1999. This statement requires that certain costs
incurred for purchasing or developing software for internal use be capitalized
and amortized over the software's estimated useful life of three years. In prior
years, the Company capitalized costs incurred for purchasing internal-use
software, but expensed costs incurred for developing internal-use software. In
accordance with this statement, prior years' financial statements were not
adjusted to reflect this accounting change. Adoption of this statement resulted
in the capitalization, net of amortization, of $93 million and $68 million of
internal-use software development costs during 2000 and 1999, respectively,
which increased net income by $55 million and $41 million, or $.04 and $.03
diluted earnings per share, respectively.
New 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 plans 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 be recognized currently in earnings unless specific
hedge accounting criteria are met and such hedge accounting treatment is
elected. On January 1, 2001, the Company will designate its Swaps as cash flow
hedges of the interest rate risk associated with nontrading-related balance
sheet financial instruments. Changes in the fair value of the Swaps will be
initially recorded in accumulated other comprehensive income and will be
reclassified into earnings when realized. The Company will record the transition
adjustment to adopt this statement on January 1, 2001. The effect of this change
in accounting principle as of the transition date will not have a material
impact on the Company's financial position, results of operations, earnings per
share or cash flows and also is not expected to have a material impact in the
future.
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 adopted SFAS No. 140 in the fourth quarter of 2000 for recognition
and reclassification of collateral and for disclosures relating to
securitization transactions and collateral and plans to adopt SFAS No. 140 by
the second quarter of 2001 for transfers and servicing of financial assets and
extinguishments of liabilities.
- 27 -
In December 1999, the Securities and Exchange Commission (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 adopted SAB 101 in the
fourth quarter of 2000.
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
(EITF No. 00-16), 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 EITF No. 00-16 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 "in the money" vested stock options outstanding
at the end of each period. At December 31, 2000, the remaining accrued liability
balance was $30 million. This liability balance will be reduced to zero over
time as employer payroll taxes become payable on employee stock option
exercises.
The adoptions of SFAS No. 140, SAB 101 and EITF No. 00-16 did not have, and
are 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 Combinations
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 2000, merger-related costs totaled $69 million pre-tax, or $63 million
after-tax. Merger-related costs are recorded separately on the 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 ending May 31,
2002. The cost of this program is recorded separately on the consolidated
statement of income as other compensation expense - merger retention programs.
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.
On March 1, 2000, the Company acquired CyBerCorp for $517 million in a
non-taxable stock-for-stock exchange. Pursuant to the acquisition, CyBerCorp
became a wholly owned subsidiary of CSC which resulted in 17,570,000 shares of
CSC's common stock and 3,077,000 options to purchase CSC common stock being
exchanged for all of the outstanding shares, options and equity rights of
CyBerCorp. Because the acquisition is accounted for using the purchase method,
the operating results of CyBerCorp are included in the consolidated results of
the Company since the acquisition date. The historical results of CyBerCorp are
not included in periods prior to the acquisition. The net assets acquired are
recorded at fair value and the excess of the purchase price over the fair value
of net assets acquired is recorded as goodwill. The Company recorded intangible
assets acquired of $512 million, including $482 million of goodwill. The
goodwill is amortized on a straight-line basis over a period of ten years. Other
intangible assets acquired, which consist primarily of purchased technology and
total $30 million, are amortized on a straight-line basis over a period of three
years.
4. Securities Owned
A summary of securities owned is as follows:
- --------------------------------------------------------------------------------
December 31, 2000 1999
- --------------------------------------------------------------------------------
Securities available for sale $1,222,460 $ 993,586
Equity and bond mutual funds 140,430 92,515
SchwabFunds money market funds 138,521 117,289
Equity, fixed income and other securities 101,531 129,830
- --------------------------------------------------------------------------------
Total $1,602,942 $1,333,220
================================================================================
The amortized cost, estimated fair value and gross unrealized gains and
losses on securities available for sale are as follows:
- 28 -
- --------------------------------------------------------------------------------
December 31, 2000 1999
- --------------------------------------------------------------------------------
U.S. treasury securities:
Amortized cost $ 156,791 $ 178,068
Aggregate fair value $ 156,893 $ 176,816
Gross unrealized gains $ 245 $ 24
Gross unrealized losses $ 143 $ 1,276
U.S. government sponsored agencies
and corporations:
Amortized cost 774,236 690,450
Aggregate fair value 776,273 672,103
Gross unrealized gains 6,391 2,507
Gross unrealized losses 4,354 20,854
State and municipal obligations:
Amortized cost 134,330 119,633
Aggregate fair value 135,410 117,936
Gross unrealized gains 1,392 185
Gross unrealized losses 312 1,882
Collateralized mortgage obligations(1):
Amortized cost 129,459 5,185
Aggregate fair value 129,408 5,209
Gross unrealized gains 309 24
Gross unrealized losses 360
Other securities:
Amortized cost 32,988 22,086
Aggregate fair value 24,476 21,522
Gross unrealized gains 510 370
Gross unrealized losses 9,022 934
- --------------------------------------------------------------------------------
Total securities available for sale:
Amortized cost $1,227,804 $1,015,422
Aggregate fair value $1,222,460 $ 993,586
Gross unrealized gains $ 8,847 $ 3,110
Gross unrealized losses $ 14,191 $ 24,946
================================================================================
(1) Collateralized by either GNMA, FNMA or FHLC obligations.
The maturities of debt securities available for sale at December 31, 2000,
and the related weighted-average yield on such debt securities are as follows:
- --------------------------------------------------------------------------------
Within 1 - 5 5 - 10 Over 10
1 Year Years Years Years Total
- --------------------------------------------------------------------------------
U.S. treasury securities $151,276 $ 5,515 $ 156,791
U.S. government sponsored
agencies and corporations 73,902 517,940 $166,814 $15,580 774,236
State and municipal obligations 16,962 80,703 36,665 134,330
Collateralized mortgage
obligations(1) 5,636 58,893 37,445 27,485 129,459
Other debt securities 2,027 20,942 19 22,988
- --------------------------------------------------------------------------------
Total at amortized cost 249,803 683,993 240,924 43,084 1,217,804
Estimated fair value 250,972 683,083 243,814 43,257 1,221,126
- --------------------------------------------------------------------------------
Net unrealized gains (losses) $ 1,169 $ (910)$ 2,890 $ 173 $ 3,322
================================================================================
Weighted-average yield(2) 6.10% 6.61% 7.41% 7.34% 6.69%
================================================================================
(1) Collateralized mortgage obligations have been allocated over maturity
groupings based on contractual maturities. Expected maturities may differ
from contractual maturities because borrowers have the right to prepay
obligations with or without prepayment penalties.
(2) Yields have been computed by dividing annualized interest revenue, on a
taxable equivalent basis, by the amortized cost of the respective
securities at December 31, 2000.
The components of net realized securities gains related to securities
available for sale are as follows:
- --------------------------------------------------------------------------------
December 31, 2000 1999 1998
- --------------------------------------------------------------------------------
Gross realized gains from sales, calls
and mandatory redemptions $ 988 $17 $4
Gross realized losses from sales, calls
and mandatory redemptions (105)
- --------------------------------------------------------------------------------
Securities gains, net $ 883 $17 $4
================================================================================
Equity, fixed income and other securities include SCM's inventories in Nasdaq
and other securities and Schwab's inventories in securities relating to its
specialist and fixed income operations. The Company's positions in SchwabFunds
money market funds arise from certain overnight funding of clients' redemption,
check-writing and debit card activities. Equity and bond mutual funds include
investments made by the Company for funding obligations under its deferred
compensation plan and for overnight funding of certain SchwabFunds clients'
transactions.
Securities sold, but not yet purchased, of $30 million and $60 million at
December 31, 2000 and 1999, respectively, consist of equity and other
securities, and are recorded at market value in accrued expenses and other
liabilities.
5. Receivables from Brokerage Clients
Receivables from brokerage clients consist primarily of margin loans to
brokerage clients. Securities owned by brokerage clients are held as collateral
for margin loans. Such collateral is not reflected in the consolidated financial
statements. Receivables from brokerage clients are stated net of allowance for
doubtful accounts of $11 million at both December 31, 2000 and 1999.
- 29 -
6. Loans to Banking Clients and Related Allowance for Credit Losses
An analysis of the composition of the loan portfolio is as follows:
- --------------------------------------------------------------------------------
December 31, 2000 1999
- --------------------------------------------------------------------------------
Private banking:
Residential real estate mortgages $2,248,566 $1,984,732
Other 849,505 663,977
- --------------------------------------------------------------------------------
Total private banking loans 3,098,071 2,648,709
- --------------------------------------------------------------------------------
Loans to financial institutions for purchasing
and carrying securities 60,552 57,686
All other 9,101 2,979
- --------------------------------------------------------------------------------
Total $3,167,724 $2,709,374
================================================================================
Nonperforming assets consist of non-accrual loans of $1 million and $2
million at December 31, 2000 and 1999, respectively. The Company considers all
non-accrual loans impaired. For 2000 and 1999, the impact of interest revenue
which would have been earned on non-accrual loans versus interest revenue
recognized on these loans was not material to the Company's results of
operations.
The amount of loans accruing interest that were contractually 90 days or more
past due was less than $1 million at both December 31, 2000 and 1999.
An analysis of the allowance for credit losses on the loan portfolio is as
follows:
- --------------------------------------------------------------------------------
2000 1999 1998
- --------------------------------------------------------------------------------
Balance at beginning of year $20,169 $19,414 $18,294
- --------------------------------------------------------------------------------
Private banking charge-offs (28) (292) (327)
- --------------------------------------------------------------------------------
Recoveries:
Private banking 148 1,047 800
Other 47
- --------------------------------------------------------------------------------
Total recoveries 148 1,047 847
- --------------------------------------------------------------------------------
Net recoveries 120 755 520
Provision charged to income 600
- --------------------------------------------------------------------------------
Balance at end of year $20,289 $20,169 $19,414
================================================================================
The estimated fair value of the loan portfolio was $3.1 billion and $2.6
billion at December 31, 2000 and 1999, respectively.
7. Equipment, Office Facilities and Property
Equipment, office facilities and property are detailed below:
- --------------------------------------------------------------------------------
December 31, 2000 1999
- --------------------------------------------------------------------------------
Land $ 18,646 $ 16,348
Buildings 234,786 109,788
Leasehold improvements 378,247 281,669
Furniture and equipment 228,099 170,928
Telecommunications equipment 165,645 126,778
Information technology equipment and software 800,871 552,067
Construction and software development
in progress 181,358 56,932
- --------------------------------------------------------------------------------
Subtotal 2,007,652 1,314,510
Accumulated depreciation and amortization 875,050 636,302
- --------------------------------------------------------------------------------
Total $1,132,602 $ 678,208
================================================================================
8. Deposits from Banking Clients
Deposits from banking clients consist of money market and other savings
deposits, noninterest-bearing deposits and certificates of deposit. Deposits
from banking clients are as follows:
- --------------------------------------------------------------------------------
December 31, 2000 1999
- --------------------------------------------------------------------------------
Interest-bearing deposits $3,331,365 $2,957,691
Noninterest-bearing deposits 878,050 1,247,252
- --------------------------------------------------------------------------------
Total $4,209,415 $4,204,943
================================================================================
9. Payables to Brokers, Dealers and Clearing Organizations
Payables to brokers, dealers and clearing organizations consist primarily of
securities loaned of $900 million and $1.4 billion at December 31, 2000 and
1999, respectively. The cash collateral received from counterparties under
securities lending transactions approximated the market value of the securities
loaned.
10. Payables to Brokerage Clients
The principal source of funding for Schwab's margin lending is cash balances
in brokerage client accounts. At December 31, 2000, Schwab was paying interest
at 5.4% on $22.0 billion of cash balances in brokerage client accounts, which
were included in payables to brokerage clients. At December 31, 1999, Schwab was
paying interest at 4.5% on $19.6 billion of such cash balances.
- 30 -
11. Short-term Borrowings
CSC may borrow under its $1.2 billion committed, unsecured credit facility
with a group of twenty-seven banks which is scheduled to expire in June 2001.
CSC plans to establish a similar facility to replace this one when it expires.
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 a minimum level of tangible
net worth, and Schwab and SCM to maintain specified levels of net capital, as
defined. This facility was unused in 2000 and 1999.
To manage short-term liquidity, Schwab maintains uncommitted, unsecured bank
credit lines totaling $880 million at December 31, 2000 ($740 million of these
lines are also available for CSC to use). 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. There were no borrowings outstanding under these lines at
December 31, 2000 and 1999.
To satisfy the margin requirement of client option transactions with the
Options Clearing Corporation (OCC), Schwab has unsecured letter of credit
agreements with twelve banks in favor of the OCC aggregating $855 million at
December 31, 2000. Schwab pays a fee to maintain these letters of credit. No
funds were drawn under these letters of credit at December 31, 2000 and 1999.
Other short-term borrowings include federal funds purchased, securities sold
under agreements to repurchase and other borrowed funds. At December 31, 2000
and 1999, these other short-term borrowings totaled $339 million and $106
million, respectively, with weighted-average interest rates ranging from 5.81%
to 6.76% and 4.50% to 6.62%, respectively.
Included in other short-term borrowings at December 31, 1999 was the
utilization of $35 million of U.S. Trust's $80 million unsecured revolving
credit facilities with a weighted-average interest rate of 6.62%. Upon
completion of the merger of CSC with USTC, these facilities were terminated.
12. Long-term Debt
Long-term debt consists of the following:
December 31, 2000 1999
- --------------------------------------------------------------------------------
Senior Medium-Term Notes, Series A $718,000 $455,000
8.414% Trust Preferred Capital Securities 50,000 50,000
Other 2,229 13,000
- --------------------------------------------------------------------------------
Total $770,229 $518,000
================================================================================
The $718 million aggregate principal amount of Senior Medium-Term Notes,
Series A (Medium-Term Notes) outstanding at December 31, 2000 have maturities
ranging from 2001 to 2010 and fixed interest rates ranging from 5.96% to 8.05%.
The Medium-Term Notes carry a weighted-average interest rate of 7.26%.
The Trust Preferred Capital Securities qualify as tier 1 capital under
guidelines of the Federal Reserve Board and have no voting rights. Holders of
the Trust Preferred Capital Securities are entitled to receive cumulative cash
distributions semi-annually. The Company has the right to redeem the Trust
Preferred Capital Securities prior to their stated maturity of February 1, 2027,
on or after February 1, 2007, upon approval (if then required) of the Federal
Reserve Board.
The estimated fair value of long-term debt was $785 million and $498 million
at December 31, 2000 and 1999, respectively.
Annual maturities on long-term debt outstanding at December 31, 2000 are as
follows:
- --------------------------------------------------------------------------------
2001 $ 40,156
2002 114,027
2003 100,027
2004 80,519
2005 56,000
Thereafter 379,500
- --------------------------------------------------------------------------------
Total $770,229
================================================================================
- 31 -
13. Taxes on Income
Income tax expense is as follows:
- --------------------------------------------------------------------------------
Year Ended December 31, 2000 1999 1998
- --------------------------------------------------------------------------------
Current:
Federal $475,483 $375,934 $241,420
State 64,577 59,753 35,587
- --------------------------------------------------------------------------------
Total current 540,060 435,687 277,007
- --------------------------------------------------------------------------------
Deferred:
Federal (23,647) (2,187) (8,969)
State (3,077) (1,031) (529)
- --------------------------------------------------------------------------------
Total deferred (26,724) (3,218) (9,498)
- --------------------------------------------------------------------------------
Total taxes on income $513,336 $432,469 $267,509
================================================================================
The above amounts do not include tax benefits from the exercise of stock
options and the vesting of restricted stock awards, which for accounting
purposes are credited directly to additional paid-in capital. Such tax benefits
reduced income taxes paid by $190 million in 2000, $215 million in 1999 and $71
million in 1998. The above amounts also do not include a tax benefit of $140
million in 2000 from the conversion of unexercised USTC stock options into
shares of CSC's common stock. Additionally, the above deferred amounts do not
include tax expenses or benefits related to intangible assets recorded in
connection with the acquisition of CyBerCorp, and other comprehensive income
(loss).
The temporary differences that created deferred tax assets and liabilities,
included in other assets, and accrued expenses and other liabilities, are
detailed below:
- --------------------------------------------------------------------------------
December 31, 2000 1999
- --------------------------------------------------------------------------------
Deferred tax assets:
Deferred compensation and employee benefits $147,238 $108,968
Reserves and allowances 46,937 39,150
Trust and fiduciary activities 7,826 10,698
Property and equipment leasing 6,432 7,007
Asset valuation 6,315 3,248
Net unrealized losses on securities
available for sale 2,133 9,002
Other 7,376
- --------------------------------------------------------------------------------
Total deferred assets 224,257 178,073
- --------------------------------------------------------------------------------
Deferred tax liabilities:
Capitalized internal-use software development
costs (62,284) (25,136)
Depreciation and amortization (10,126) (3,769)
State and local taxes (1,979) (2,469)
Other (5,256)
- --------------------------------------------------------------------------------
Total deferred liabilities (74,389) (36,630)
- --------------------------------------------------------------------------------
Net deferred tax asset $149,868 $141,443
================================================================================
The Company determined that no valuation allowance against deferred tax
assets at December 31, 2000 and 1999 was necessary.
The effective income tax rate differs from the amount computed by applying
the federal statutory income tax rate as follows:
- --------------------------------------------------------------------------------
Year Ended December 31, 2000 1999 1998
- --------------------------------------------------------------------------------
Federal statutory income tax rate 35.0% 35.0% 35.0%
State income taxes, net of
federal tax benefit 3.4 3.5 3.4
Goodwill amortization 1.3 .2 .2
Merger-related costs 1.3
Other .7 .7 .9
- --------------------------------------------------------------------------------
Effective income tax rate 41.7% 39.4% 39.5%
================================================================================
14. Employee Incentive and Deferred Compensation Plans
The Company's employee incentive and deferred compensation plans consist of
CSC's and U.S. Trust's plans that were in effect prior to the merger with USTC.
The following summarizes such plans.
Stock Option Plans
The Company's stock incentive plans provide for granting options to
employees, officers and directors. Options are granted for the purchase of
shares of common stock at an exercise price not less than market value on the
date of grant, and expire within either eight or ten years from the date of
grant. Options generally vest over a four-year period from the date of grant.
- 32 -
The Company granted to all non-officer employees 11,339,000 options in 2000,
5,675,000 in 1999 and 5,217,000 in 1998(a).
A summary of option activity follows:
- ------------------------------------------------------------------------------------------------------------------------------------
2000 1999 (a) 1998 (a)
------------------------ ------------------------ ------------------------
Weighted- Weighted- Weighted-
Average Average Average
Number Exercise Number Exercise Number Exercise
of Options Price of Options Price of Options Price
- ------------------------------------------------------------------------------------------------------------------------------------
Outstanding at
beginning of year 90,388 $10.31 100,105 $ 5.10 97,726 $ 2.71
Granted(1) 29,352 $26.27 18,805 $27.10 30,212 $10.03
Exercised (20,225) $ 2.74 (25,882) $ 2.15 (23,878) $ 1.33
Canceled (2,649) $20.15 (2,640) $12.26 (3,955) $ 6.41
- ------------------------------------------------------------------------------------------------------------------------------------
Outstanding at
end of year 96,866 $16.46 90,388 $10.31 100,105 $ 5.10
====================================================================================================================================
Exercisable at
end of year 37,914 $ 7.02 40,064 $ 3.71 51,802 $ 2.16
====================================================================================================================================
Available for
future grant at
end of year 22,472 37,128 52,142
====================================================================================================================================
Weighted-average
fair value of
options granted
during the year(1) $ 15.44 $ 12.34 $ 3.65
- ------------------------------------------------------------------------------------------------------------------------------------
(1) In 2000, 3,077,000 options were granted and exchanged for outstanding options of CyBerCorp. The exercise prices for
individual options granted retained the excess of the market value over the exercise price on each CyBerCorp option
canceled. The weighted-average exercise price of these options is $1.04 and the weighted-average fair value is
$28.27. The remaining 26,275,000 options were granted with an exercise price equal to the fair market value of the
Company's common stock on the date of grant. The weighted-average exercise price of these options is $29.23 and the
weighted-average fair value is $13.93.
In 1998, 5,400,000 options were granted with an exercise price greater than the fair market value of the Company's
common stock on the date of grant. The weighted-average exercise price of these options is $16.67 and the
weighted-average fair value is $2.84. The remaining 24,812,000 options were granted with an exercise price equal to
the fair market value of the Company's common stock on the date of grant. The weighted-average exercise price of
these options is $8.59 and the weighted-average fair value is $3.83.
- --------
(a) 1999 and 1998 stock options were granted prior to the merger with USTC, and
therefore did not include U.S. Trust employees.
Options outstanding and exercisable are as follows:
- ------------------------------------------------------------------------------------------------------------------------------------
December 31, 2000
- ------------------------------------------------------------------------------------------------------------------------------------
Options Outstanding Options Exercisable
--------------------------------------------- --------------------------------
Weighted-
Average Weighted- Weighted-
Remaining Average Average
Range of Number Contractual Exercise Number Exercise
Exercise Prices of Options Life (in years) Price of Options Price
- ------------------------------------------------------------------------------------------------------------------------------------
$ 1.00 to $ 5.00 18,494 4.4 $ 2.89 18,406 $ 2.88
$ 5.01 to $ 8.00 17,220 6.8 $ 7.05 10,180 $ 6.96
$ 8.01 to $12.00 13,458 7.2 $ 9.07 5,934 $ 9.27
$12.01 to $24.00 11,072 7.8 $20.46 1,648 $21.67
$24.01 to $30.00 24,122 9.4 $27.54 1,148 $26.73
$30.01 to $40.00 12,500 9.2 $32.53 598 $34.78
- ------------------------------------------------------------------------------------------------------------------------------------
$ 1.00 to $40.00 96,866 7.4 $16.46 37,914 $ 7.02
====================================================================================================================================
The following tables summarize U.S. Trust's option activities. On the closing
date of the merger with USTC, 8,461,000 USTC stock options were converted into
shares of CSC's common stock based upon the excess of the market value over the
exercise price of the unexercised stock options as of that date, net of the
number of shares required to satisfy the participant's payroll tax withholding
obligation.
- ------------------------------------------------------------------------------------------------------------------------------------
2000 1999 1998
------------------------- ------------------------ -----------------------
Weighted- Weighted- Weighted-
Average Average Average
Number Exercise Number Exercise Number Exercise
of Options Price of Options Price of Options Price
- ------------------------------------------------------------------------------------------------------------------------------------
Outstanding at
beginning of year 13,327 $ 8.39 11,694 $ 6.96 10,202 $ 5.84
Granted 2,341 $14.86 1,983 $12.42
Exercised (4,800) $ 7.06 (601) $ 5.37 (391) $ 4.98
Canceled (66) $ 7.32 (107) $10.44 (100) $ 8.78
Converted
into CSC's
common stock (8,461) $ 9.15
- ------------------------------------------------------------------------------------------------------------------------------------
Outstanding at
end of year 13,327 $ 8.39 11,694 $ 6.96
====================================================================================================================================
Exercisable at
end of year 5,382 $ 6.19 3,562 $ 5.23
====================================================================================================================================
Available for
future grant at
end of year 2,576 4,484
====================================================================================================================================
Weighted-average
fair value of
options granted
during the year $ 4.53 $ 3.01
====================================================================================================================================
The fair value of each option granted is estimated as of the grant date using
the Black-Scholes option-pricing model with the following assumptions:
- --------------------------------------------------------------------------------
Company(b) USTC
------------------- -------------
2000 1999 1998 1999 1998
- --------------------------------------------------------------------------------
Dividend yield .40% .50% .65% 1.10% 2.60%
Expected volatility 48% 46% 45% 29% 25%
Risk-free interest rate 6.0% 5.5% 5.6% 4.6% 5.6%
Expected life (in years) 5 5 5 - 8 5 5
- --------------------------------------------------------------------------------
- --------
(b) The assumptions for 1999 and 1998 relate to options granted prior to the
merger with USTC which did not include U.S. Trust employees.
The Company applies Accounting Principles Board Opinion No. 25 - Accounting
for Stock Issued to Employees, and related Interpretations in accounting for its
stock option plans. Accordingly, no compensation expense has been recognized for
the Company's options. Had compensation expense for the Company's options been
determined based on the fair value at the grant dates for awards under those
plans consistent with the fair value method of SFAS No. 123 - Accounting for
Stock-Based Compensation, the Company's net income and earnings per
- 33 -
share would have been reduced to the pro forma amounts presented below:
- --------------------------------------------------------------------------------
Year Ended December 31, 2000 1999 1998
- --------------------------------------------------------------------------------
Net Income: As reported $718,137 $666,446 $410,129
Pro forma $606,084 $604,605 $379,035
================================================================================
Basic Earnings
Per Share: As reported $ .53 $ .51 $ .32
Pro forma $ .45 $ .46 $ .29
Diluted Earnings
Per Share: As reported $ .51 $ .49 $ .31
Pro forma $ .43 $ .44 $ .28
================================================================================
Restricted Stock Plans
The Company
The Company's stock incentive plans provide for granting restricted stock
awards to employees and officers. Restricted stock awards are restricted from
sale and generally vest over a four-year period, but some vest based upon the
Company achieving certain financial or other measures. The fair market value of
shares associated with the restricted stock awards is recorded as unamortized
stock-based compensation in stockholders' equity and is amortized to
compensation expense over the vesting periods.
Restricted stock information is as follows(c):
- --------------------------------------------------------------------------------
2000 1999 1998
- --------------------------------------------------------------------------------
Restricted stock awards 1,278 2,173 4,597
Average market price of awarded shares $ 27.73 $ 24.99 $ 9.17
Restricted stock cancellations 328 483 603
Restricted shares outstanding (at year end) 8,240 8,774 7,918
Restricted stock expense and amortization $31,614 $24,617 $19,765
================================================================================
- --------
(c) 1999 and 1998 restricted stock awards were granted prior to the merger with
USTC, and therefore did not include U.S. Trust employees.
U.S. Trust
Under the U.S. Trust Restricted Stock Unit Plan, the Company issues
restricted stock units (RSUs). RSUs accrue dividend equivalent credits and
generally cliff vest (the entire award typically vests at the end of a five-year
vesting period) at which time they may be converted into common stock. The fair
market value of the grant is amortized to compensation expense and recorded to
additional paid in capital ratably over the vesting period.
Upon completion of the merger with USTC, substantially all of USTC's RSUs
were converted into CSC's common stock pursuant to the exchange ratio, net of
the number of shares required to satisfy the participant's payroll tax
withholding obligation.
Restricted stock unit information is as follows:
- --------------------------------------------------------------------------------
2000 1999 1998
- --------------------------------------------------------------------------------
Restricted stock unit grants 462 646 488
Average market price of granted units $ 24.38 $15.22 $12.57
Restricted stock unit cancellations 18 102 11
Restricted stock units outstanding
(at year end) 692 1,768 1,209
Restricted stock unit amortization (1) $18,590 $4,190 $2,560
================================================================================
(1) 2000 includes $14 million of accelerated amortization expense recognized
upon completion of the merger with USTC and recorded on the consolidated
statement of income as merger-related expense.
Other Deferred Compensation Plans
The Company sponsors deferred compensation plans for both officers and
non-employee directors. The Company's unfunded deferred compensation plan for
officers permits participants to defer the payment of certain cash compensation.
The deferred compensation liability was $119 million and $106 million at
December 31, 2000 and 1999, respectively. The Company's unfunded deferred
compensation plan for non-employee directors permits participants to defer
receipt of all or a portion of their directors' fees and to receive either a
grant of stock options, or upon ceasing to serve as a director, the number of
shares of CSC's common stock that would have resulted from investing the
deferred fee amount into CSC's common stock.
In 1999, the Company issued 111,000 shares of CSC's common stock and placed
such shares into a trust to settle the directors' deferred compensation
liability. In accordance with EITF No. 97-14 - Accounting for Deferred
Compensation Arrangements Where Amounts Earned are Held in a Rabbi Trust and
Invested, assets of the trust are consolidated with those of the Company and the
value of CSC's common stock held in the stock trust is classified in
stockholders' equity in a manner similar to treasury stock. The shares and the
corresponding obligation to directors are shown as separate components of
stockholders' equity in the Company's consolidated statement of stockholders'
equity.
- 34 -
15. Retirement and Other Employee Benefit Plans
The Company's retirement and other employee benefit plans consist of CSC's
and U.S. Trust's plans that were in effect prior to the merger with USTC. The
following summarizes such plans.
Employee Stock Ownership Plans
The Company has a profit sharing and employee stock ownership plan (Profit
Sharing Plan), including a 401(k) salary deferral component, for eligible
employees who have met certain service requirements. The Company matches certain
employee contributions; additional contributions to this plan are at the
discretion of the Company. Total Company contribution expense was $78 million in
2000, $74 million in 1999 and $46 million in 1998.
In 1993, the Profit Sharing Plan borrowed $15 million from the Company to
purchase approximately 15 million shares of CSC's common stock. In 2000, the
final payment on the note receivable from the Profit Sharing Plan was received
and all remaining shares were allocated to eligible participants. The note
receivable had a balance of $1 million at December 31, 1999, bearing interest at
7.9%. Shares are released for allocation to eligible employees' accounts based
on the proportion of principal and interest payments made during the year as
compared to the total of these payments and the remaining principal and
interest. In accordance with Statement of Position No. 93-6 - Employers'
Accounting for Employee Stock Ownership Plans (the Statement), the fair value of
shares released for allocation to employees through the employee stock ownership
plan (ESOP) is recognized by the Company as compensation and benefits expense -
$31 million in 2000, $3 million in 1999 and $15 million in 1998. At December 31,
1999, a $25 million accrued liability was recorded for 1999 retirement benefits
and was contributed to the ESOP during the first half of 2000 for the purchase
from CSC of newly issued shares of CSC's common stock. Only released ESOP shares
are considered outstanding for basic and diluted earnings per share
computations. Dividends on allocated shares and unallocated shares are charged
to retained earnings and are used to make principal and interest payments on the
ESOP note receivable, respectively. The unallocated shares are recorded as
unearned ESOP shares included in employee stock ownership plans on the
consolidated balance sheet. Under the "grandfather" provisions of the Statement,
the Company did not apply the Statement to shares purchased by the ESOP prior to
1993.
The ESOP(d) share information is as follows:
- --------------------------------------------------------------------------------
December 31, 2000 1999
- --------------------------------------------------------------------------------
Allocated shares:
Purchased prior to 1993 22,708 28,826
Purchased in 1993 and after 18,293 18,150
Shares released for allocation:
Purchased in 1993 and after 1,003 143
Unreleased shares:
Purchased in 1993 and after 951
- --------------------------------------------------------------------------------
Total ESOP shares 42,004 48,070
================================================================================
Fair value of unreleased shares $24,239
================================================================================
- --------
(d) The profit sharing plan and the ESOP were in place prior to the merger with
USTC, and therefore did not include U.S. Trust employees.
U.S. Trust sponsors a 401(k) Plan and ESOP covering all U.S. Trust employees
who have met the specified service requirement. Effective January 1, 1999, U.S.
Trust began matching certain employees' U.S. Trust 401(k) plan contributions in
the form of common stock. Total contribution expense under the U.S. Trust 401(k)
Plan was $4 million in 2000 and $3 million in 1999.
In 1989 and 1988, the U.S. Trust ESOP borrowed a total of $27 million to
purchase 7 million shares of common stock. The Company accounts for the U.S.
Trust ESOP shares in accordance with Statement of Position No. 76-3 -
Accounting Practices for Certain Employee Stock Ownership Plans. Accordingly,
the loan to the U.S. Trust ESOP is recorded as a reduction to stockholders'
equity included in employee stock ownership plans on the consolidated balance
sheet. On February 1, 1999 the final payment on the U.S. Trust ESOP loan was
made, and all remaining shares were allocated to eligible participants. ESOP
compensation expense is based on the costs of the U.S. Trust ESOP shares and is
recorded as shares are released and allocated to participants' accounts. ESOP
compensation expense was $3 million in 1998. There was no ESOP compensation
expense in 2000 and 1999. Dividends on allocated and unallocated U.S. Trust ESOP
shares are used to make principal and interest payments on the U.S. Trust ESOP
loans and are recorded as a reduction to retained earnings. U.S. Trust ESOP
shares are allocated to participants' accounts ratably over the term of the
loans. The Company receives a tax benefit for dividends paid on U.S. Trust ESOP
shares. This tax benefit is recorded in the consolidated statement of income as
a reduction to income tax expense. All shares held by the U.S. Trust ESOP are
considered outstanding for basic and diluted earnings per share computations.
At December 31, 2000 and 1999 the U.S. Trust ESOP held a total of 7,569,000
shares and 7,802,000 shares of common stock, respectively. Dividends on U.S.
Trust ESOP shares used for debt repayment were less than $1 million in 1999 and
$1 million in 1998.
- 35 -
The U.S. Trust ESOP share information is as follows:
- --------------------------------------------------------------------------------
December 31, 2000 1999
- --------------------------------------------------------------------------------
Allocated shares 7,569 6,649
Shares released for allocation 1,153
- --------------------------------------------------------------------------------
Total U.S. Trust ESOP shares 7,569 7,802
================================================================================
Other Benefit Plans
The Company is the beneficiary of a life insurance program covering some of
its employees. Under the program, the cash surrender value of insurance policies
is recorded net of policy loans in other assets. During 1999, the Company repaid
$65 million on the policy loans and received $65 million cash surrender value on
the insurance policies. At both December 31, 2000 and 1999, policy loans totaled
$15 million with interest rates of 8.4% and 8.2%, respectively.
Pension and Other Postretirement Benefits
U.S. Trust provides a trusteed, noncontributory, qualified defined benefit
pension plan to substantially all U.S. Trust employees. Benefits are based upon
years of service, average compensation over the final years of service and the
social security covered compensation. U.S. Trust uses the projected unit credit
cost method to compute the vested benefit obligation, where the vested benefit
obligation is the actuarial present value of the vested benefits to which the
employee is entitled based on the employee's expected date of separation or
retirement.
In addition, U.S. Trust provides certain health care and life insurance
benefits for all employees, certain qualifying retired employees and their
dependents. Postretirement medical and life insurance benefits are accrued
during the years that the employee renders service to reflect the expected cost
of providing health care and life insurance and other benefits to an employee
upon retirement.
The following table summarizes the components of retirement and
postretirement benefit expenses (credits), the funded status of U.S. Trust's
qualified retirement plan, changes in the benefit obligations related to these
plans and the major assumptions used to determine these amounts.
- 36 -
- ------------------------------------------------------------------------------------------------------------------------------------
2000 1999 1998
---------------------------------- --------------------------------- ---------------------------------
Pension Health & Pension Health & Pension Health &
Plan Life Total Plan Life Total Plan Life Total
- ------------------------------------------------------------------------------------------------------------------------------------
Components of expense
(credit):
Service cost and
expenses $ 8,161 $ 178 $ 8,339 $ 9,119 $ 238 $ 9,357 $ 6,617 $ 278 $ 6,895
Interest cost 15,621 1,515 17,136 14,601 1,394 15,995 14,077 1,779 15,856
Amortization of prior
service cost 87 (391) (304) 87 (391) (304) 177 (391) (214)
Actual return on plan
assets (9,267) (9,267) (84,668) (84,668) (46,341) (46,341)
Other net amortizations
and deferrals (24,962) (24,962) 58,987 34 59,021 30,541 (6,759) 23,782
Special termination
benefits charge 193 193
- ------------------------------------------------------------------------------------------------------------------------------------
Net expense
(credit)(1) $ (10,360) $ 1,302 $ (9,058) $ (1,681) $ 1,275 $ (406) $ 5,071 $ (5,093) $ (22)
- ------------------------------------------------------------------------------------------------------------------------------------
Change in plan assets:
Fair value of plan
assets at
beginning of year $ 366,788 $ 291,128 $253,442
Actual return on plan
assets 9,267 84,668 46,341
Employer
contribution $ 967 $ 1,630 $ 1,666
Benefits and expenses
paid (6,934) (967) (9,008) (1,630) (8,655) (1,666)
- ------------------------------------------------------------------------------------------------------------------------------------
Fair value of plan
assets at end of year $ 369,121 $ 366,788 $291,128
- ------------------------------------------------------------------------------------------------------------------------------------
Change in benefit
obligation:
Benefit obligation at
beginning of year $ 200,387 $ 19,001 $ 220,715 $ 20,821 $192,352 $ 31,940
Service cost 7,961 178 8,919 238 6,417 278
Interest cost 15,621 1,515 14,601 1,394 14,077 1,779
Actuarial (gain) loss (5,877) 58 (34,850) (1,822) 16,327 (11,510)
Benefits paid (6,782) (967) (8,717) (1,630) (8,458) (1,666)
Amendments (474)
Special termination
benefits charge 193
- ------------------------------------------------------------------------------------------------------------------------------------
Benefit obligation at
end of year $ 211,310 $ 19,785 $ 200,387 $ 19,001 $220,715 $ 20,821
- -----------------------------------------------------------------------------------------------------------------------------------
Prepaid (accrued) cost:
Excess of plan assets
over benefit
obligation $ 157,811 $(19,785) $ 166,401 $(19,001) $ 70,413 $(20,821)
Amount contributed
10/1 through 12/31 258
Unrecognized cumulative
net (gains) losses (119,753) (1,203) (136,391) (1,261) (40,246) 595
Unrecognized prior
service cost 892 (1,191) 978 (1,582) 1,539 (1,973)
Unrecognized net
liability (asset) at
date of initial
application (2,399) (4,797) (7,196)
- -----------------------------------------------------------------------------------------------------------------------------------
Prepaid (accrued)
cost $ 36,551 $(21,921) $ 26,191 $(21,844) $ 24,510 $(22,199)
- -----------------------------------------------------------------------------------------------------------------------------------
Discount rate 8.00% 8.00% 8.00% 8.00% 6.75% 6.75%
Rate of increase
in salary (2) 6.10% 6.10% 6.00% 6.00% 6.00% 6.00%
Health care cost
trend rate N/A 8.00% N/A 8.50% N/A 9.00%
Expected rate of return
on plan assets 9.00% N/A 9.00% N/A 9.00% N/A
- ------------------------------------------------------------------------------------------------------------------------------------
(1) The pension expense (credit) and postretirement benefit expense (credit) are determined using the assumptions as of
the beginning of the year. The benefit obligations and the funded status are determined using the assumptions as of
the end of the year.
(2) The rate of increase in compensation is based on an age-related table with assumed rates of increase in
compensation ranging from 9.0% to 3.5%. The amount shown is the average assumed rate of increase for the given plan
year.
N/A Not applicable.
- 37 -
The assumed rate of future increases in per capita cost of health care
benefits (the health care cost trend rate) is 8.0% in 2000, decreasing gradually
to 5.5% in the year 2005. A one percentage point change in the assumed health
care cost trend rates would have the following effects:
- --------------------------------------------------------------------------------
2000 1999 1998
- --------------------------------------------------------------------------------
Effect on total of service and
interest cost components:
1% increase $ 10 $ 17 $ 26
1% decrease $ (9) $ (16) $ (26)
Effect on postretirement benefit obligation:
1% increase $ 133 $ 208 $ 317
1% decrease $(122) $(217) $(333)
- --------------------------------------------------------------------------------
16. Accumulated Other Comprehensive Income (Loss)
Accumulated other comprehensive income (loss) represents cumulative gains and
losses that are not reflected in earnings. The components of accumulated other
comprehensive income (loss) are as follows:
- --------------------------------------------------------------------------------
2000 1999 1998
- --------------------------------------------------------------------------------
Foreign currency translation
adjustment:
Beginning balance $ 3,914 $ 1,308 $ 920
Change during the year (15,213) 2,606 388
- --------------------------------------------------------------------------------
Ending balance $(11,299) $ 3,914 $1,308
================================================================================
Net unrealized gain (loss) on
securities available for sale,
net of tax:
Beginning balance $(12,834) $ 4,014 $3,827
Change during the year 9,623 (16,848) 187
- --------------------------------------------------------------------------------
Ending balance $ (3,211) $(12,834) $4,014
================================================================================
Total accumulated other comprehensive
income (loss), net of tax:
Beginning balance $ (8,920) $ 5,322 $4,747
Change during the year (5,590) (14,242) 575
- --------------------------------------------------------------------------------
Ending balance $(14,510) $ (8,920) $5,322
================================================================================
17. Earnings Per Share
Basic earnings per share (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:
- --------------------------------------------------------------------------------
Year Ended December 31, 2000 1999 1998
- --------------------------------------------------------------------------------
Net income $ 718,137 $ 666,446 $ 410,129
================================================================================
Weighted-average common
shares outstanding - basic 1,359,433 1,310,444 1,287,460
Common stock equivalent shares
related to stock incentive plans 44,330 62,586 55,435
- --------------------------------------------------------------------------------
Weighted-average common
shares outstanding - diluted 1,403,763 1,373,030 1,342,895
================================================================================
Basic earnings per share $ .53 $ .51 $ .32
================================================================================
Diluted earnings per share $ .51 $ .49 $ .31
================================================================================
The computation of diluted EPS for the years ended December 31, 2000, 1999
and 1998, respectively, excludes outstanding stock options to purchase
12,510,000, 8,069,000 and 30,340,000 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.
18. Regulatory Requirements
Upon completion of the merger with USTC, CSC became a financial holding
company, which is a type of 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
impose limitations, restrictions, or prohibitions on the activities or
acquisitions of a financial holding company if the Federal Reserve Board
believes that the company does not have the appropriate financial and managerial
resources to commence or conduct an activity, make an acquisition, or retain
ownership of a company and the Federal Reserve Board may take actions as
appropriate to enforce applicable federal law.
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 depository institution subsidiaries.
CSC's primary depository institution subsidiary is United States Trust
Company of New York (U.S. Trust NY). The operations and financial condition of
CSC's depository institution subsidiaries are subject to regulation and
- 38 -
supervision and to various requirements and restrictions under federal and state
law, including requirements governing: transactions with CSC and its
non-depository institution 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. CSC, U.S. Trust
and their U.S.-based insured depository institution subsidiaries must meet
regulatory capital guidelines adopted by the federal banking agencies. 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.
Under the Act, the Federal Reserve Board has established consolidated capital
requirements for bank holding companies. CSC is subject to those guidelines. The
GLB Act prohibits the Federal Reserve Board from imposing capital requirements
on functionally regulated non-depository institution subsidiaries of a financial
holding company, such as broker-dealers and investment advisors.
The Company's, U.S. Trust's and U.S. Trust NY's regulatory capital and ratios
are as follows:
- --------------------------------------------------------------------------------
2000 1999
------------------ -----------------
December 31, Amount Ratio(1) Amount Ratio(1)
- --------------------------------------------------------------------------------
Tier 1 Capital:
Company $3,677,974 14.6% $2,500,831 11.0%
U.S. Trust $ 556,471 20.3% $ 272,044 11.8%
U.S. Trust NY $ 370,180 16.7% $ 186,360 9.7%
Total Capital:
Company $3,709,756 14.7% $2,532,352 11.2%
U.S. Trust $ 576,760 21.0% $ 292,213 12.7%
U.S. Trust NY $ 387,995 17.5% $ 204,153 10.7%
Leverage:
Company $3,677,974 10.4% $2,500,831 7.3%
U.S. Trust $ 556,471 11.1% $ 272,044 6.2%
U.S. Trust NY $ 370,180 9.4% $ 186,360 5.4%
- --------------------------------------------------------------------------------
(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 depository institution subsidiaries exceed the well-capitalized
standards set forth by the banking regulatory authorities.
Based on their respective regulatory capital ratios at December 31, 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 December 31, 2000.
To remain a financial holding company, each of CSC's depository institution
subsidiaries must be well capitalized and well managed. In addition, each of
CSC's insured depository institution subsidiaries must be rated "satisfactory"
or better on the institutions' records of meeting the credit needs of their
communities under the Community Reinvestment Act of 1977 in order for CSC to
engage in new financial activities or, with certain limited exceptions, acquire
a company engaged in financial activities.
CSC's depository institution subsidiaries are required, under federal
regulations, to maintain reserve balances at the Federal Reserve Bank based on
deposit levels. These amounts are included in cash and investments required to
be segregated under federal or other regulations. The average balances were $55
million in 2000 and $39 million in 1999.
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. This method requires the
maintenance of minimum net capital, as defined, of the greater of 2% of
aggregate debit balances arising from client transactions or a minimum dollar
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 December 31, 2000, Schwab's net capital was $1.7 billion (11% of
aggregate debit balances), which was $1.4 billion in excess of its minimum
required net capital and $913 million in excess of 5% of aggregate debit
balances. At December 31, 2000, SCM's net capital was $36 million, which was $35
million in excess of its minimum required net capital.
Schwab, SCM and CSE had portions of their cash and investments segregated for
the exclusive benefit of clients at December 31, 2000, in accordance with
applicable regulations. The amount held on deposit in the reserve bank account
at December 31, 1999 exceeded cash and investments required to be segregated
under federal or other regulations by approximately $200 million. This excess is
included in cash and cash equivalents.
- 39 -
19. Commitments and Contingent Liabilities
The Company has noncancelable operating leases for office space and
equipment. Future minimum rental commitments, including guaranteed residual
values under these leases, at December 31, 2000 are as follows:
- --------------------------------------------------------------------------------
2001 $ 249,963
2002 225,424
2003 177,046
2004 171,546
2005 338,603
Thereafter 654,546
- --------------------------------------------------------------------------------
Total $1,817,128
================================================================================
Certain leases contain provisions for renewal options, purchase options and
rent escalations based on increases in certain costs incurred by the lessor. The
Company has provided a residual value guarantee of approximately $200 million to
one of its lessors in the event the leased property is sold and the proceeds on
the sale are below the guarantee. Rent expense was $298 million in 2000, $218
million in 1999 and $164 million in 1998.
The Company may, under certain circumstances, be required to make additional
capital contributions pursuant to joint venture agreements with The Tokio Marine
Fire Insurance Co., Limited and certain of its related companies, including
contributions to assure that Charles Schwab Tokio Marine Securities Co., Ltd. is
in compliance with regulatory requirements regarding capital adequacy.
On November 9, 2000, a federal district court in New Orleans, Louisiana
entered a Final Order and Judgment dismissing two payment for order flow and
best execution class action lawsuits against Schwab that have been pending since
1995. The judgment precludes members of the class from asserting any other
claims against Schwab on payment for order flow or best execution issues for the
period 1985 through July 1999. The judgment of dismissal was entered into after
the court approved a settlement of the two cases following a fairness hearing
that was held in May 2000. The lawsuits, which were filed on behalf of a class
consisting of all individuals nationwide who purchased or sold securities
through Schwab from 1985 until July 1999, alleged that Schwab improperly
retained monetary payments for routing orders to market makers and other third
parties, and did not provide best execution to client orders. Prior to the
settlement, Schwab vigorously contested the allegations. However, in the
interests of avoiding the expense of further litigation, in June 1999 Schwab
agreed to settle the cases for certain non-monetary relief. In addition, Schwab
agreed, and the court approved, the payment of up to $900,000 in plaintiffs'
attorneys' fees and costs. In response to the entry of judgment, four similar
payment for order flow and best execution class action lawsuits against Schwab,
which had been consolidated in federal court in the Northern District of
California, were voluntarily dismissed. The plaintiffs' attorneys in those
cases, who had objected to the settlement of the Louisiana cases, have filed a
notice of appeal of the judgment of dismissal that was entered by the federal
court in Louisiana on November 9, 2000.
In December 1998, a class action complaint was filed against U.S. Trust
Company, N.A. (USTC, N.A.) in the U.S. District Court for the Southern District
of Texas. The suit alleged that USTC, N.A., in its capacity as trustee, breached
its fiduciary duty to the MidCon Corp.'s Employee Stock Ownership Plan (MidCon
ESOP) in connection with Occidental Petroleum Corporation's (Occidental) sale of
its subsidiary, MidCon Corp., to KN Energy, Inc., in December 1997. The
complaint sought damages exceeding $200 million. The court certified a class
consisting of the participants in the MidCon ESOP. On December 12, 2000, the
parties agreed, in writing, to settle the case. Under the terms of the
settlement, Occidental agreed to make certain payments to plaintiffs and their
attorneys, but USTC, N.A., which under certain circumstances is indemnified by
Occidental, will not make any payment. On December 18, 2000, the court entered
an order preliminarily approving settlement and authorized the sending of notice
to the class members. The final hearing to approve the settlement is scheduled
for March 2001.
In March 2000, three purported class action complaints were filed against
USTC, N.A., all of which are now pending in the U.S. District Court for the
Middle District of Louisiana. All three suits are brought on behalf of
participants in an employee stock ownership plan (the Plan) sponsored by United
Companies Financial Corporation (United Companies), which is currently in
chapter 11 bankruptcy proceedings in Delaware. Plaintiffs allege that USTC,
N.A., which acted as directed trustee of the Plan, breached its fiduciary duties
under the Employee Retirement Income Security Act of 1974 by failing to
diversify the assets of the Plan. Damages have not yet been specified. In
October 2000, the court declined to grant a motion to dismiss the case at that
time, and ordered that the three purported class action complaints be
consolidated. In November 2000, the plaintiffs filed a consolidated complaint
which USTC, N.A. has answered, denying all liability. USTC, N.A. intends to
vigorously defend against these claims.
The nature of the Company's business subjects it to claims, lawsuits,
regulatory examinations and other proceedings in the ordinary course of
business. The ultimate outcome of the legal proceedings described above and the
various other lawsuits, arbitration proceedings, and claims pending against the
Company cannot be determined at this time, and the results of these legal
proceedings cannot be predicted with certainty. There can be no assurance that
these legal proceedings will not have a material adverse effect on the Company's
results of operations in any future period,
- 40 -
depending partly on the results for that period, and a substantial judgment
could have a material adverse impact on the Company's financial condition and
results of operations. However, it is the opinion of management, after
consultation with outside legal counsel, that the ultimate outcome of these
actions will not have a material adverse impact on the financial condition or
operating results of the Company.
20. Financial Instruments with Off-Balance-Sheet and Credit Risk
Through Schwab and SCM, the Company loans client securities temporarily to
other brokers in connection with its securities lending activities. The Company
receives cash as collateral for the securities loaned. Increases in security
prices may cause the market value of the securities loaned to exceed the amount
of cash received as collateral. In the event the counterparty to these
transactions does not return the loaned securities or provide additional cash
collateral, the Company may be exposed to the risk of acquiring the securities
at prevailing market prices in order to satisfy its client obligations. The
Company mitigates this risk by requiring credit approvals for counterparties, by
monitoring the market value of securities loaned on a daily basis and by
requiring additional cash as collateral when necessary.
The Company is obligated to settle transactions with brokers and other
financial institutions even if its clients fail to meet their obligations to the
Company. Clients are required to complete their transactions on settlement date,
generally three business days after trade date. If clients do not fulfill their
contractual obligations, the Company may incur losses. The Company has
established procedures to reduce this risk by requiring deposits from clients in
excess of amounts prescribed by regulatory requirements for certain types of
trades.
Schwab provides margin loans to its clients which are collateralized by
securities in their brokerage accounts. These clients have agreed to allow
Schwab to sell or repledge those securities in accordance with federal
regulations. At December 31, 2000, Schwab was allowed, under such regulations,
to sell or repledge securities with a fair market value of $22.3 billion. At
December 31, 2000, the fair market value of Schwab's client securities pledged
in securities lending transactions to other broker-dealers was $864 million and
the fair market value of Schwab's client securities pledged to fulfill the short
sales of its clients was $477 million. At December 31, 2000, the fair market
value of Schwab's client securities pledged to fulfill Schwab's and SCM's
proprietary short sales was $27 million. Schwab has pledged a portion of its
securities owned in order to fulfill the short sales of clients and in
connection with securities lending transactions to other broker-dealers. At
December 31, 2000, the fair market value of these pledged securities was not
material to the Company's consolidated balance sheet.
In the normal course of its margin lending activities, Schwab may be liable
for the margin requirement of client margin securities transactions. As clients
write option contracts or sell securities short, the Company may incur losses if
the clients do not fulfill their obligations and the collateral in client
accounts is not sufficient to fully cover losses which clients may incur from
these strategies. To mitigate this risk, the Company monitors required margin
levels daily and clients are required to deposit additional collateral, or
reduce positions, when necessary.
In its capacity as market maker, SCM maintains inventories in Nasdaq
securities on both a long and short basis. While long inventory positions
represent SCM's ownership of securities, short inventory positions represent
SCM's obligations to deliver specified securities at a contracted price, which
may differ from market prices prevailing at the time of completion of the
transaction. Accordingly, both long and short inventory positions may result in
losses or gains to SCM as market values of securities fluctuate. Also, Schwab
maintains inventories in exchange-listed securities on both a long and short
basis relating to its specialist and fixed income operations and could incur
losses or gains as a result of changes in the market value of these securities.
To mitigate the risk of losses, long and short positions are marked to market
daily and are monitored by management to assure compliance with limits
established by the Company. Additionally, the Company may purchase
exchange-traded option contracts to reduce market risk on these inventories. The
notional amount of such derivatives was $66 million and $103 million at December
31, 2000 and 1999, respectively. The estimated fair value of such derivatives
was not material to the Company's consolidated balance sheets at December 31,
2000 and 1999.
Schwab and U.S. Trust enter into collateralized resale agreements principally
with other broker-dealers, which could result in losses in the event the
counterparty to the transaction does not purchase the securities held as
collateral for the cash advanced and the market value of these securities
declines. To mitigate this risk, Schwab requires that the counterparty deliver
securities to a custodian, to be held as collateral, with a market value in
excess of the resale price. Schwab also sets standards for the credit quality of
the counterparty, monitors the market value of the underlying securities as
compared to the related receivable, including accrued interest, and requires
additional collateral where deemed appropriate. At December 31, 2000, the fair
value of collateral received in connection with resale agreements that is
available to be repledged or sold is $7.3 billion.
At December 31, 2000 and 1999, financial instruments in the amount of $421
million and $208 million, respectively,
- 41 -
were pledged to secure public deposits, to qualify for fiduciary powers and for
other purposes or as collateral for borrowings. Included in the above amount at
December 31, 2000, the fair value of collateral pledged under repurchase
agreements that is available to be repledged or sold by the counterparties is
$101 million.
In the normal course of business, U.S. Trust enters into various transactions
involving off-balance sheet financial instruments to meet the needs of its
clients and to reduce its own exposure to interest rate risk. The credit risk
associated with these instruments varies depending on the creditworthiness of
the client and the value of any collateral held. Collateral requirements vary by
type of instrument. The contractual amounts of these instruments represent the
amounts at risk should the contract be fully drawn upon, the client default, and
the value of any existing collateral become worthless.
Credit-related financial instruments include firm commitments to extend
credit (firm commitments) and standby letters of credit. Firm commitments are
legally binding agreements to lend to a client that generally have fixed
expiration dates or other termination clauses, may require payment of a fee and
are not secured by collateral until funds are advanced. Collateral held includes
marketable securities, real estate mortgages or other assets. The majority of
U.S. Trust's firm commitments are related to mortgage lending to private banking
clients. Firm commitments totaled $429 million and $307 million at December 31,
2000 and 1999, respectively. Standby letters of credit are conditional
commitments issued by U.S. Trust to guarantee the performance of a client to a
third party. Standby letters of credit outstanding at December 31, 2000 and 1999
amounted to $78 million and $80 million, respectively. Standby letters of credit
are generally partially or fully collateralized by cash, marketable equity
securities, marketable debt securities (including corporate and U.S. Treasury
debt securities) and other assets.
As part of its overall asset and liability management process, U.S. Trust
utilizes Swaps as hedges of the interest rate risk associated with
nontrading-related balance sheet financial instruments. The market values of
Swaps can vary depending on movements in interest rates. The amounts at risk
upon default are generally limited to the unrealized market value gains of the
Swaps, if any. The risk of default depends on the creditworthiness of the
counterparty. U.S. Trust evaluates the creditworthiness of its counterparties as
part of its normal credit review procedures. At December 31, 2000 and 1999, the
Company was a counterparty to Swaps with a total notional principal amount of
$1.0 billion and $1.1 billion, respectively. Outstanding Swaps had a
weighted-average maturity of approximately 3.3 years at both December 31, 2000
and 1999. The estimated fair value of the Swaps was not material to the
Company's consolidated balance sheets at December 31, 2000 and 1999.
21. Segment Information
Segments are defined as components of a company in which separate financial
information is evaluated regularly by the chief operating decision maker, or
decision-making group, in deciding how to allocate resources and in assessing
performance. 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. The Individual Investor segment includes Schwab'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 Company's mutual fund services are considered a product and
not a segment. Mutual fund service fees are included in both the Individual
Investor and Institutional Investor segments.) 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 accounting policies of the segments are the same as those described in
note "2 - Significant Accounting Policies." The Company evaluates the
performance of its segments based on an adjusted operating income before taxes
measure, which excludes merger- and acquisition-related charges. Segment assets
are not disclosed because they are not used for evaluating segment performance
and deciding how to allocate resources to segments. However, capital
expenditures are used in evaluating segment performance and are therefore
disclosed. Intersegment revenues, defined as revenues from transactions with
other segments within the Company, are not material and are therefore not
disclosed. Except for the U.S. Trust segment, for which expenses are directly
incurred, technology, corporate and general administrative expenses are
allocated to the remaining segments generally in proportion to either their
respective revenues or average full-time equivalent employees.
Financial information for the Company's reportable segments is presented in
the table below, and the totals are equal to the Company's consolidated amounts
as reported in the consolidated financial statements. Capital expenditures are
reported in total, as opposed to net of proceeds from the sale of fixed assets.
- 42 -
- --------------------------------------------------------------------------------
Year Ended December 31, 2000 1999 1998
- --------------------------------------------------------------------------------
Revenues
Individual investor $ 3,644,672 $ 2,761,585 $1,936,494
Institutional investor 860,902 631,945 461,056
Capital markets 639,467 551,292 338,671
U.S. Trust 642,610 541,597 441,649
- --------------------------------------------------------------------------------
Total $ 5,787,651 $ 4,486,419 $3,177,870
================================================================================
Interest Revenue, Net of
Interest Expense
Individual investor $ 939,841 $ 591,967 $ 393,242
Institutional investor 165,365 106,351 69,897
Capital markets 5,710 4,359 12,478
U.S. Trust 126,184 117,113 102,026
- --------------------------------------------------------------------------------
Total $1,237,100 $ 819,790 $ 577,643
================================================================================
Operating Income
Individual investor $ 837,345 $ 689,694 $ 388,580
Institutional investor 296,888 175,000 109,534
Capital markets 96,409 106,545 78,430
U.S. Trust 157,336 127,676 101,094
- --------------------------------------------------------------------------------
Operating income 1,387,978 1,098,915 677,638
Merger- and acquisition-
related charges (1) 156,505
- --------------------------------------------------------------------------------
Total income before taxes
on income $1,231,473 $1,098,915 $ 677,638
================================================================================
Capital Expenditures
Individual investor $ 482,699 $ 264,039 $ 145,394
Institutional investor 95,298 51,762 24,944
Capital markets 82,730 37,793 19,905
U.S. Trust 44,008 19,216 13,673
- --------------------------------------------------------------------------------
Total $ 704,735 $ 372,810 $ 203,916
================================================================================
Depreciation and Amortization (2)
Individual investor $ 228,173 $ 115,602 $ 101,350
Institutional investor 31,060 23,433 22,438
Capital markets 22,834 17,641 14,689
U.S. Trust 25,209 24,394 20,073
- --------------------------------------------------------------------------------
Total $ 307,276 $ 181,070 $ 158,550
================================================================================
(1) Includes 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.
(2) Includes goodwill amortization.
During the fourth quarter of 2000, the Company reallocated certain shared
revenues and technology expenses among the Individual Investor, Institutional
Investor and Capital Markets segments. Additionally, the Company conformed its
financial presentation with management's focus on an adjusted operating income
measure that excludes merger- and acquisition-related charges as discussed in
the Results of Operations section in Management's Discussion and Analysis of
Results of Operations and Financial Condition. Previously, the Company's segment
information disclosure focused on income before taxes on income. None of these
changes had any impact on the Company's consolidated income statement, balance
sheet, statement of cash flows or earnings per share. The following table
provides unaudited quarterly restated segment information for operating income
before taxes, which changes information previously reported in the Company's
2000 Quarterly Reports filed with the Securities and Exchange Commission on
Forms 10-Q to conform with the revised presentation.
- --------------------------------------------------------------------------------
(Unaudited)
Three Months Ended March 31, 2000 1999
- --------------------------------------------------------------------------------
Individual investor $339,429 $166,513
Institutional investor 78,148 33,823
Capital markets 75,492 35,756
U.S. Trust 42,427 30,324
- --------------------------------------------------------------------------------
Operating income before taxes on
operating income 535,496 266,416
Merger- and acquisition-related charges (1) 23,941
- --------------------------------------------------------------------------------
Total income before taxes on income $511,555 $266,416
================================================================================
- --------------------------------------------------------------------------------
(Unaudited)
Three Months Ended June 30, 2000 1999
- --------------------------------------------------------------------------------
Individual investor $199,741 $169,104
Institutional investor 74,197 44,678
Capital markets 10,984 35,797
U.S. Trust 39,346 32,299
- --------------------------------------------------------------------------------
Operating income before taxes on
operating income 324,268 281,878
Merger- and acquisition-related charges (1) 70,731
- --------------------------------------------------------------------------------
Total income before taxes on income $253,537 $281,878
================================================================================
- --------------------------------------------------------------------------------
(Unaudited)
Three Months Ended September 30, 2000 1999
- --------------------------------------------------------------------------------
Individual investor $162,791 $146,424
Institutional investor 68,503 37,541
Capital markets (753) 19,883
U.S. Trust 41,267 32,015
- --------------------------------------------------------------------------------
Operating income before taxes on
operating income 271,808 235,863
Merger- and acquisition-related charges (1) 31,337
- --------------------------------------------------------------------------------
Total income before taxes on income $240,471 $235,863
================================================================================
- 43 -
- --------------------------------------------------------------------------------
(Unaudited)
Three Months Ended December 31, 2000 1999
- --------------------------------------------------------------------------------
Individual investor $135,384 $207,653
Institutional investor 76,040 58,958
Capital markets 10,686 15,109
U.S. Trust 34,296 33,038
- --------------------------------------------------------------------------------
Operating income before taxes on
operating income 256,406 314,758
Merger- and acquisition-related charges (1) 30,496
- --------------------------------------------------------------------------------
Total income before taxes on income $225,910 $314,758
================================================================================
(1) Includes 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.
Fees received from Schwab's proprietary mutual funds represented
approximately 11% of the Company's consolidated revenues in both 2000 and 1999
and 12% in 1998. Except for Schwab's proprietary mutual funds, which are
considered a single client for purposes of this computation, no single client
accounted for more than 10% of the Company's consolidated revenues in 2000, 1999
and 1998. Substantially all of the Company's revenues and assets are attributed
to or located in the U.S. The percentage of Schwab's total client accounts
located in California was approximately 27% at December 31, 2000 and 25% at both
December 31, 1999 and 1998.
22. Supplemental Cash Flow Information
- --------------------------------------------------------------------------------
Year Ended December 31, 2000 1999 1998
- --------------------------------------------------------------------------------
Income taxes paid $ 240,113 $182,019 $172,420
================================================================================
Interest paid:
Brokerage clients cash balances $1,068,283 $700,518 $579,477
Deposits from banking clients 154,963 116,251 107,834
Long-term debt 46,799 29,773 29,274
Stock-lending activities 41,937 30,905 38,118
Short-term borrowings 18,550 7,267 11,159
Other 3,099 7,385 11,236
- --------------------------------------------------------------------------------
Total interest paid $1,333,631 $892,099 $777,098
================================================================================
Non-cash investing and financing
activities:
Common stock and options issued
for purchases of businesses $ 528,815 $ 45,459 $ 12,455
================================================================================
- 44 -
Management's Report
To Our Stockholders:
Management of the Company is responsible for the preparation, integrity and
objectivity of the consolidated financial statements and the other financial
information presented in this annual report. To meet these responsibilities we
maintain a system of internal control that is designed to provide reasonable
assurance as to the integrity and reliability of the financial statements, the
protection of Company and client assets from unauthorized use, and the execution
and recording of transactions in accordance with management's authorization. The
system is augmented by careful selection of our managers, by organizational
arrangements that provide an appropriate division of responsibility and by
communications programs aimed at assuring that employees adhere to the highest
standards of personal and professional integrity. The Company's internal audit
function monitors and reports on the adequacy of and compliance with our
internal controls, policies and procedures. Although no cost-effective internal
control system will preclude all errors and irregularities, we believe the
Company's system of internal control is adequate to accomplish the objectives
set forth above.
The consolidated financial statements have been prepared in conformity with
accounting principles generally accepted in the United States of America and
necessarily include some amounts that are based on estimates and our best
judgments. The financial statements have been audited by the independent
accounting firm of Deloitte & Touche LLP, who were given unrestricted access to
all the Company's financial records and related data. We believe that all
representations made to Deloitte & Touche LLP during their audit were valid and
appropriate.
The Board of Directors through its Audit Committee, which is comprised
entirely of nonmanagement directors, has an oversight role in the area of
financial reporting and internal control. The Audit Committee periodically meets
with Deloitte & Touche LLP, our internal auditors and Company management to
discuss accounting, auditing, internal controls over financial reporting and
other matters.
/s/Charles R. Schwab
- ---------------------------
Charles R. Schwab
Chairman of the Board and Co-Chief Executive Officer
/s/David S. Pottruck
- ---------------------------
David S. Pottruck
President and Co-Chief Executive Officer
/s/Christopher V. Dodds
- ---------------------------
Christopher V. Dodds
Executive Vice President and Chief Financial Officer
- 45 -
Independent Auditors' Report
To the Stockholders and Board of Directors of The Charles Schwab Corporation:
We have audited the accompanying consolidated balance sheets of The Charles
Schwab Corporation and subsidiaries (the Company) as of December 31, 2000 and
1999, and the related consolidated statements of income, stockholders' equity
and cash flows for each of the three years in the period ended December 31,
2000. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in
all material respects, the financial position of The Charles Schwab Corporation
and subsidiaries at December 31, 2000 and 1999, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2000 in conformity with accounting principles generally accepted in
the United States of America.
As discussed in Note 2 to the consolidated financial statements, in 1999
the Company changed its method of accounting for certain internal-use software
development costs to conform with Statement of Position 98-1.
/s/DELOITTE & TOUCHE LLP
- ---------------------------
DELOITTE & TOUCHE LLP
San Francisco, California
February 22, 2001
- 46 -
- -----------------------------------------------------------------------------------------------------------------------------------
The Charles Schwab Corporation
Quarterly Financial Information (Unaudited)
(In Millions, Except Per Share Data and Ratios)
- -----------------------------------------------------------------------------------------------------------------------------------
Weighted- Dividends
Average Basic Diluted Declared Range Range
Expenses Common Earnings Earnings Per of Common of Price/
Excluding Net Shares- Per Per Common Stock Price Earnings
Revenues(1) Interest Income(2) Diluted Share(2) Share(2) Share(3) Per Share Ratio(4)
- ------------------------------------------------------------------------------------------------------------------------------------
2000 by Quarter (5)
Fourth $1,335.0 $1,109.1 $138.7 1,414.0 $.10 $.10 $.0110 $35.88 - 25.69 70 - 50
Third dividend increase 1,322.5 1,082.1 142.3 1,414.9 .10 .10 .0110 40.50 - 30.00 74 - 55
Second stock split 1,404.6 1,151.1 137.1 1,407.4 .10 .09 .0094 40.58 - 24.00 72 - 43
First 1,725.6 1,214.0 300.0 1,390.0 .23 .22 .0093 44.75 - 22.46 76 - 38
- ------------------------------------------------------------------------------------------------------------------------------------
1999 by Quarter
Fourth $1,274.0 $ 959.3 $190.5 1,374.2 $.15 $.14 $.0094 $31.17 - 17.96 64 - 37
Third stock split 1,015.7 779.8 144.2 1,375.7 .11 .11 .0093 37.67 - 21.33 84 - 47
Second 1,116.2 834.3 170.5 1,377.0 .13 .12 .0093 51.67 - 26.67 123 - 64
First 1,080.5 814.1 161.2 1,365.6 .12 .12 .0093 32.67 - 16.96 88 - 46
- ------------------------------------------------------------------------------------------------------------------------------------
1998 by Quarter
Fourth dividend increase/stock split $ 904.7 $ 703.0 $122.1 1,349.0 $.10 $.10 $.0093 $22.83 - 7.03 74 - 23
Third 818.9 630.4 113.7 1,339.2 .08 .08 .0089 10.22 - 6.17 38 - 23
Second 745.9 594.9 91.6 1,337.9 .08 .07 .0089 8.89 - 6.58 36 - 26
First 708.4 572.0 82.7 1,345.5 .06 .06 .0089 9.32 - 7.58 39 - 32
- ------------------------------------------------------------------------------------------------------------------------------------
1997 by Quarter (6)
Fourth dividend increase $ 720.8 $ 594.2 $ 76.7 1,345.9 $.06 $.06 $.0089 $ 9.83 - 6.50 41 - 27
Third stock split 705.8 557.5 89.6 1,339.4 .07 .06 .0074 8.13 - 5.93 34 - 25
Second 620.8 494.6 76.4 1,333.3 .06 .06 .0074 6.35 - 4.50 28 - 20
First 624.2 494.3 78.6 1,332.4 .06 .06 .0074 6.22 - 4.50 27 - 20
- ------------------------------------------------------------------------------------------------------------------------------------
1996 by Quarter
Fourth $ 566.5 $ 448.9 $ 70.9 1,324.5 $.06 $.06 $.0074 $ 4.87 - 3.33 23 - 16
Third dividend increase 511.7 397.7 67.3 1,321.2 .05 .05 .0074 3.98 - 2.94 21 - 15
Second 571.2 435.6 80.0 1,318.9 .07 .06 .0060 3.93 - 3.24 33 - 27
First 524.2 428.1 56.5 1,315.5 .04 .04 .0059 4.06 - 2.76 45 - 31
- ------------------------------------------------------------------------------------------------------------------------------------
All periods have been restated to reflect the merger of The Charles Schwab Corporation with U.S. Trust Corporation
(USTC) except as noted. Additionally, all share and per share data have been restated for the May 2000 three-for-two
common stock split.
(1) Revenues are presented net of interest expense.
(2) 2000 and 1999 include an accounting change, for certain internal-use software development costs to conform with
Statement of Position 98-1, totaling $55 million after-tax and $41 million after-tax, respectively. Excluding this
accounting change, net income would have been $663 million in 2000 and $625 million in 1999.
(3) Dividends declared per common share do not include dividends declared by USTC prior to the completion of the
merger.
(4) Price/earnings ratio is computed by dividing the high and low market prices by diluted earnings per share for the
12-month period ended on the last day of the quarter presented.
(5) 2000 includes goodwill and intangible asset amortization, acquisition-related compensation expense and other
merger-related costs totaling $131 million after-tax. Excluding this amount, net income would have been $849
million and the after-tax profit margin would have been 14.7%.
(6) 1997 includes charges for a litigation settlement of $24 million after-tax ($.02 per share for both basic and
diluted earnings per share).
- 47 -
THE CHARLES SCHWAB CORPORATION
Chart Appendix List
In this appendix, the following descriptions of certain charts in portions of
the Company's 2000 Annual Report to Stockholders that are omitted from the EDGAR
Version are more specific with respect to the actual numbers, amounts and
percentages than is determinable from the charts themselves. The Company submits
such more specific descriptions only for the purpose of complying with the
requirements for transmitting portions of this Annual Report on Form 10-K
electronically via EDGAR; such more specific descriptions are not intended in
any way to provide information that is additional to the information otherwise
provided in portions of the Company's 2000 Annual Report to Stockholders.
EDGAR
Version
Page Number Chart Description
2 Bar chart titled "Assets in Client Accounts" representing total
assets in client accounts at year end 2000, 1999, 1998, 1997 and
1996 (years shown on the bottom axis) as follows (billions of
dollars) (bar labeled): $871.7, $846.0, $594.3, $437.2 and
$324.1, respectively; and annual growth rate for 2000, 1999, 1998
and 1997 (percentages shown in shaded area between bars) as
follows: 3%, 42%, 36% and 35%, respectively.
5 Stacked bar chart titled "Revenues by Segment" representing the
composition of revenues by segment for the years ended December
31, 2000, 1999 and 1998 (years shown on the bottom axis) as
follows (billions of dollars): Individual Investor $3.7, $2.8 and
$1.9, respectively; Institutional Investor $.9, $.6 and $.5,
respectively; Capital Markets $.6, $.6 and $.4, respectively;
U.S. Trust $.6, $.5 and $.4, respectively; Revenues by Segment
(bar labeled) $5.8, $4.5 and $3.2, respectively.
13 Pie chart titled "Development Spending for 2001" representing the
composition of estimated development spending for the year ended
December 31, 2001 as follows (percentage of total): (pie pieces
labeled) Project Spending 54% and Media Spending 46%.
13 Bar chart titled "Net Income Plus Depreciation and Amortization,
and Goodwill Amortization" representing the net income plus
depreciation and amortization, and goodwill amortization for the
years ended December 31, 2000, 1999 and 1998 (years shown on the
bottom axis) as follows (millions of dollars) (bar labeled):
$1,025, $848 and $569, respectively.
- 48 -