UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2002 Commission file number 1-9700
THE CHARLES SCHWAB CORPORATION
(Exact name of Registrant as specified in its charter)
Delaware 94-3025021
(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation or organization)
120 Kearny Street, San Francisco, CA 94108
(Address of principal executive offices and zip code)
Registrant's telephone number, including area code: (415) 627-7000
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes x No
--- ---
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
1,364,882,212 shares of $.01 par value Common Stock
Outstanding on July 31, 2002
THE CHARLES SCHWAB CORPORATION
Quarterly Report on Form 10-Q
For the Quarter Ended June 30, 2002
Index
Page
----
Part I - Financial Information
Item 1. Condensed Consolidated Financial Statements:
Statement of Income 1
Balance Sheet 2
Statement of Cash Flows 3
Notes 4 - 9
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 10 - 25
Item 3. Quantitative and Qualitative Disclosures About Market Risk 25 - 27
Part II - Other Information
Item 1. Legal Proceedings 27
Item 2. Changes in Securities and Use of Proceeds 27
Item 3. Defaults Upon Senior Securities 27
Item 4. Submission of Matters to a Vote of Security Holders 27 - 28
Item 5. Other Information 28
Item 6. Exhibits and Reports on Form 8-K 28
Signature 29
Part I - FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
THE CHARLES SCHWAB CORPORATION
Condensed Consolidated Statement of Income
(In millions, except per share amounts)
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
2002 2001 2002 2001
- ------------------------------------------------------------------------------------------------------------------------------------
Revenues
Asset management and administration fees $ 447 $ 408 $ 891 $ 819
Commissions 294 341 597 749
Interest revenue, net of interest expense (1) 218 232 439 489
Principal transactions 49 55 100 150
Other 41 35 81 64
- ------------------------------------------------------------------------------------------------------------------------------------
Total 1,049 1,071 2,108 2,271
- ------------------------------------------------------------------------------------------------------------------------------------
Expenses Excluding Interest
Compensation and benefits 470 479 941 972
Other compensation - merger retention programs 8 15 22 30
Occupancy and equipment 117 122 236 245
Communications 66 89 137 185
Depreciation and amortization 81 83 164 167
Advertising and market development 52 50 105 144
Professional services 47 50 96 106
Commissions, clearance and floor brokerage 17 23 35 51
Goodwill amortization 16 32
Restructuring and other charges 3 145 30 145
Other 32 25 56 56
- ------------------------------------------------------------------------------------------------------------------------------------
Total 893 1,097 1,822 2,133
- ------------------------------------------------------------------------------------------------------------------------------------
Income (loss) before taxes on income (loss) and extraordinary gain 156 (26) 286 138
Tax expense (benefit) on income (loss) 58 (7) 106 60
- ------------------------------------------------------------------------------------------------------------------------------------
Income (loss) before extraordinary gain 98 (19) 180 78
Extraordinary gain on sale of corporate trust business, net of tax 121 12 121
- ------------------------------------------------------------------------------------------------------------------------------------
Net Income $ 98 $ 102 $ 192 $ 199
====================================================================================================================================
Weighted-Average Common Shares Outstanding - Diluted 1,385 1,405 1,387 1,407
====================================================================================================================================
Earnings Per Share - Basic
Income (loss) before extraordinary gain $ .07 $ (.01) $ .13 $ .06
Extraordinary gain, net of tax $ .08 $ .01 $ .08
Net income $ .07 $ .07 $ .14 $ .14
Earnings Per Share - Diluted
Income (loss) before extraordinary gain $ .07 $ (.01) $ .13 $ .06
Extraordinary gain, net of tax $ .08 $ .01 $ .08
Net income $ .07 $ .07 $ .14 $ .14
====================================================================================================================================
Dividends Declared Per Common Share $.0110 $.0110 $.0220 $.0220
====================================================================================================================================
(1) Interest revenue is presented net of interest expense. Interest expense for the three months ended June 30, 2002 and 2001 was
$92 million and $257 million, respectively. Interest expense for the six months ended June 30, 2002 and 2001 was $186 million
and $589 million, respectively.
See Notes to Condensed Consolidated Financial Statements.
-1-
THE CHARLES SCHWAB CORPORATION
Condensed Consolidated Balance Sheet
(In millions, except share and per share amounts)
(Unaudited)
June 30, December 31,
2002 2001
- ------------------------------------------------------------------------------------------------------------------------------------
Assets
Cash and cash equivalents $ 2,498 $ 4,407
Cash and investments segregated and on deposit for federal or other
regulatory purposes(1) (including resale agreements of $14,505 in 2002
and $14,811 in 2001) 17,615 17,741
Securities owned - at market value (including securities pledged of $383
in 2002 and $185 in 2001) 2,193 1,700
Receivables from brokers, dealers and clearing organizations 182 446
Receivables from brokerage clients - net 8,468 9,620
Loans to banking clients - net 4,247 4,046
Equipment, office facilities and property - net 961 1,058
Goodwill - net 626 628
Other assets 853 818
- ------------------------------------------------------------------------------------------------------------------------------------
Total $ 37,643 $ 40,464
====================================================================================================================================
Liabilities and Stockholders' Equity
Deposits from banking clients $ 4,357 $ 5,448
Drafts payable 223 396
Payables to brokers, dealers and clearing organizations 880 833
Payables to brokerage clients 24,643 26,989
Accrued expenses and other liabilities 1,170 1,327
Short-term borrowings 1,274 578
Long-term debt 751 730
- ------------------------------------------------------------------------------------------------------------------------------------
Total liabilities 33,298 36,301
- ------------------------------------------------------------------------------------------------------------------------------------
Stockholders' equity:
Preferred stock - 9,940,000 shares authorized; $.01 par value per share;
none issued
Common stock - 3 billion shares authorized; $.01 par value per share;
1,391,919,181 and 1,391,673,494 shares issued in 2002 and 2001, respectively 14 14
Additional paid-in capital 1,736 1,726
Retained earnings 2,914 2,794
Treasury stock - 22,576,142 and 23,110,972 shares in 2002 and 2001,
respectively, at cost (262) (295)
Unamortized stock-based compensation (31) (39)
Accumulated other comprehensive loss (26) (37)
- ------------------------------------------------------------------------------------------------------------------------------------
Total stockholders' equity 4,345 4,163
- ------------------------------------------------------------------------------------------------------------------------------------
Total $ 37,643 $ 40,464
====================================================================================================================================
(1) Amounts included represent actual balances on deposit, whereas cash and investments required to be segregated for federal or
other regulatory purposes were $17,380 million and $18,261 million at June 30, 2002 and December 31, 2001, respectively. On
July 2, 2002, the Company withdrew $19 million of excess segregated cash. As of January 3, 2002, the Company had deposited $710
million to meet its segregated cash requirement.
See Notes to Condensed Consolidated Financial Statements.
-2-
THE CHARLES SCHWAB CORPORATION
Condensed Consolidated Statement of Cash Flows
(In millions)
(Unaudited)
Six Months Ended
June 30,
2002 2001
- ------------------------------------------------------------------------------------------------------------------------------------
Cash Flows from Operating Activities
Net income $ 192 $ 199
Adjustments to reconcile net income to net cash used for operating activities:
Depreciation and amortization 164 167
Goodwill amortization 32
Compensation payable in common stock 13 16
Deferred income taxes 86 (21)
Tax benefits from stock options exercised and other stock-based compensation 4 23
Non-cash restructuring and other charges 3 28
Extraordinary gain on sale of corporate trust business, net of tax (12) (121)
Other (3) 3
Net change in:
Cash and investments segregated and on deposit for federal or other
regulatory purposes 55 (3,972)
Securities owned (excluding securities available for sale) (25) (56)
Receivables from brokers, dealers and clearing organizations 260 (42)
Receivables from brokerage clients 1,123 4,612
Other assets (136) (12)
Drafts payable (173) (260)
Payables to brokers, dealers and clearing organizations 47 (13)
Payables to brokerage clients (2,253) (1,964)
Accrued expenses and other liabilities (63) (153)
- ------------------------------------------------------------------------------------------------------------------------------------
Net cash used for operating activities (718) (1,534)
- ------------------------------------------------------------------------------------------------------------------------------------
Cash Flows from Investing Activities
Purchases of securities available for sale (1,075) (720)
Proceeds from sales of securities available for sale 361 351
Proceeds from maturities, calls and mandatory redemptions of securities
available for sale 185 241
Net increase in loans to banking clients (396) (318)
Proceeds from sale of banking client loans 196
Purchase of equipment, office facilities and property - net (72) (208)
Cash payments for business combinations and investments, net of cash received 2 (23)
Proceeds from sale of Canadian operations 26
Proceeds from sale of corporate trust business 273
- ------------------------------------------------------------------------------------------------------------------------------------
Net cash used for investing activities (773) (404)
- ------------------------------------------------------------------------------------------------------------------------------------
Cash Flows from Financing Activities
Net decrease in deposits from banking clients (1,091) (171)
Net change in short-term borrowings 696 (9)
Proceeds from long-term debt 100
Repayment of long-term debt (82) (24)
Dividends paid (30) (30)
Purchase of treasury stock (31) (144)
Proceeds from stock options exercised 19 14
- ------------------------------------------------------------------------------------------------------------------------------------
Net cash used for financing activities (419) (364)
- ------------------------------------------------------------------------------------------------------------------------------------
Effect of exchange rate changes on cash and cash equivalents 1
- ------------------------------------------------------------------------------------------------------------------------------------
Decrease in Cash and Cash Equivalents (1,909) (2,302)
Cash and Cash Equivalents at Beginning of Period 4,407 4,876
- ------------------------------------------------------------------------------------------------------------------------------------
Cash and Cash Equivalents at End of Period $ 2,498 $ 2,574
====================================================================================================================================
See Notes to Condensed Consolidated Financial Statements.
-3-
THE CHARLES SCHWAB CORPORATION
Notes to Condensed Consolidated Financial Statements
(Tabular Amounts in Millions, Except Per Share Amounts and Ratios)
(Unaudited)
1. Basis of Presentation
The Charles Schwab Corporation (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
394 domestic branch offices in 48 states, as well as a branch in the
Commonwealth of Puerto Rico. U.S. Trust Corporation (USTC, and with its
subsidiaries collectively referred to as U.S. Trust) is a wealth management firm
that through its subsidiaries also provides fiduciary services and private
banking services with 34 offices in 12 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
primarily to broker-dealers and institutional clients, and CyberTrader, Inc.
(CyberTrader), an electronic trading technology and brokerage firm providing
services to highly active, online investors.
The accompanying unaudited condensed consolidated financial statements
include CSC and its majority-owned subsidiaries (collectively referred to as the
Company). These financial statements have been prepared pursuant to the rules
and regulations of the Securities and Exchange Commission (SEC) and, in the
opinion of management, reflect all adjustments necessary to present fairly the
financial position, results of operations, and cash flows for the periods
presented in conformity with accounting principles generally accepted in the
U.S. All adjustments were of a normal recurring nature, except as discussed in
Note "2 - Accounting Change." Certain items in prior periods' financial
statements have been reclassified to conform to the 2002 presentation. All
material intercompany balances and transactions have been eliminated. These
financial statements should be read in conjunction with the consolidated
financial statements and notes thereto included in the Company's 2001 Annual
Report to Stockholders on Form 10-K and the Company's Quarterly Report on Form
10-Q for the period ended March 31, 2002. The Company's results for any interim
period are not necessarily indicative of results for a full year or any other
interim period.
2. Accounting Change
Statement of Financial Standards (SFAS) No. 142 - Goodwill and Other
Intangible Assets, was issued in June 2001. Under the provisions of SFAS No.
142, companies are no longer permitted to amortize goodwill and certain
intangible assets with an indefinite useful life. Instead, these assets must be
reviewed at least annually for possible impairment under new criteria. The
Company adopted SFAS No. 142 and accordingly discontinued the amortization of
goodwill as of January 1, 2002. During the second quarter of 2002, the Company
completed the initial transitional goodwill impairment test as required and did
not record any impairment charges. Except for the cessation of goodwill
amortization, the adoption of SFAS No. 142 did not have a material impact on the
Company's financial position, results of operations, earnings per share (EPS),
or cash flows.
The decrease in goodwill during the first half of 2002 was due to the sale of
the Company's Canadian operations, partially offset by the effects of foreign
currency translation adjustments. The carrying amount of goodwill, net of
accumulated amortization, attributable to each of the Company's reportable
segments is as follows:
- --------------------------------------------------------------------------------
June 30, December 31,
2002 2001
- --------------------------------------------------------------------------------
Individual Investor $ 438 $ 440
Institutional Investor 5 5
Capital Markets 25 25
U.S. Trust 158 158
- --------------------------------------------------------------------------------
Total $ 626 $ 628
================================================================================
The table below compares net income and EPS for the three and six months
ended June 30, 2002, which excludes goodwill amortization, with net income and
EPS for the three and six months ended June 30, 2001, which has been adjusted to
exclude goodwill amortization.
-4-
- --------------------------------------------------------------------------------
Three Months Ended Six Months Ended
June 30, June 30,
2002 2001 2002 2001
(Reported) (Adjusted)(Reported) (Adjusted)
- --------------------------------------------------------------------------------
Net income:
Reported income (loss)
before extraordinary gain $ 98 $ (19) $ 180 $ 78
Add: Goodwill amortization,
net of tax 16 32
- --------------------------------------------------------------------------------
Reported/adjusted
income (loss) before
extraordinary gain 98 (3) 180 110
Extraordinary gain, net of tax 121 12 121
- --------------------------------------------------------------------------------
Reported/adjusted
net income $ 98 $ 118 $ 192 $ 231
================================================================================
Basic and diluted EPS:
Reported earnings (loss)
per share before
extraordinary gain $ .07 $(.01) $ .13 $ .06
Add: Goodwill amortization .01 .02
- --------------------------------------------------------------------------------
Reported/adjusted EPS before
extraordinary gain .07 .13 .08
Extraordinary gain, net of tax .08 .01 .08
- --------------------------------------------------------------------------------
Reported/adjusted EPS $ .07 $ .08 $ .14 $ .16
================================================================================
3. New Accounting Standards
Long-Lived Assets: SFAS No.144 - Accounting for the Impairment or Disposal of
Long-Lived Assets was issued in August 2001 and addresses the financial
accounting and reporting for the impairment or disposal of long-lived assets
(e.g., equipment and office facilities). This statement supersedes SFAS No. 121
- - Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets
to Be Disposed Of, and certain accounting and reporting provisions of Accounting
Principles Board Opinion No. 30 - Reporting the Results of Operations. The
Company adopted this statement on January 1, 2002. The adoption of SFAS No. 144
did not have a material impact on the Company's financial position, results of
operations, EPS, or cash flows.
SFAS No. 146 - Accounting for Costs Associated with Exit or Disposal
Activities was issued in June 2002 and addresses accounting for restructuring
and similar costs. SFAS No. 146 supersedes previous accounting guidance,
principally Emerging Issues Task Force Issue No. 94-3 - Liability Recognition
for Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring). SFAS No. 146 may affect
the timing of recognizing future restructuring costs, as well as the amounts
recognized. The Company is required to adopt this statement effective on January
1, 2003, but early adoption is encouraged by the Financial Accounting Standards
Board.
4. Restructuring
In the second quarter of 2001, the Company initiated a restructuring plan to
reduce operating expenses. The restructuring plan included a workforce
reduction, a reduction in operating facilities, and the removal of certain
systems hardware, software, and equipment from service. Included in these
initiatives are costs associated with the withdrawal from certain international
operations. The Company recorded pre-tax restructuring charges of $3 million and
$30 million for the second quarter of 2002 and the first half of 2002,
respectively.
A summary of the activity in the restructuring liability for the second
quarter of 2002 and the six months ended June 30, 2002 is as follows:
- --------------------------------------------------------------------------------
Three months ended Workforce Facilities Systems
June 30, 2002 Reduction Reduction Removal Total
- --------------------------------------------------------------------------------
Balance at
March 31, 2002 $ 42 $ 94 $ 3 $ 139
Restructuring charges 3 3
Utilization:
Cash payments (13) (15) (2) (30)
Non-cash charges (1) (1) (1)
- --------------------------------------------------------------------------------
Balance at
June 30, 2002 $ 31 (2) $ 79 (3) $ 1 (4) $ 111
================================================================================
- --------------------------------------------------------------------------------
Six months ended Workforce Facilities Systems
June 30, 2002 Reduction Reduction Removal Total
- --------------------------------------------------------------------------------
Balance at
December 31, 2001 $ 74 $ 97 $ 4 $ 175
Restructuring charges 18 11 1 30
Utilization:
Cash payments (58) (29) (4) (91)
Non-cash charges (1) (3) (3)
- --------------------------------------------------------------------------------
Balance at
June 30, 2002 $ 31 (2) $ 79 (3) $ 1 (4) $ 111
================================================================================
(1) Primarily includes charges for officers' stock-based compensation.
(2) The Company expects to substantially utilize the remaining workforce
reduction liability through cash payments for severance pay and benefits
over the respective severance periods through 2003.
(3) The Company expects to utilize the remaining facilities reduction liability
through cash payments for the net lease expense over the respective lease
terms through 2017.
(4) The Company expects to substantially utilize the remaining systems removal
liability in the third quarter of 2002.
-5-
5. Sale of Corporate Trust Business
In June 2001, U.S. Trust sold its Corporate Trust business to The Bank of New
York Company, Inc. The Company recorded an extraordinary gain of $221 million,
or $121 million after tax, on this sale in the second quarter of 2001. During
the first quarter of 2002, the Company recorded an extraordinary gain of $22
million, or $12 million after tax, which represented the remaining proceeds from
this sale that were realized upon satisfaction of certain client retention
requirements.
6. Allowance for Credit Losses on Banking Loans and Nonperforming Assets
Loans to banking clients of $4.2 billion at June 30, 2002 and $4.0 billion at
December 31, 2001 are presented net of the related allowance for credit losses.
The allowance for credit losses on banking loans was $23 million at June 30,
2002 and $21 million at December 31, 2001. Recoveries and charge-offs were not
material for each of the three- and six-month periods ended June 30, 2002 and
2001.
Nonperforming assets consisted of non-accrual loans of $4 million at June
30, 2002 and $5 million at December 31, 2001.
7. Loan Securitization
During the second quarter of 2002, U.S. Trust securitized and sold
residential mortgage loans originated through its private banking business. This
transaction was accounted for as a sale under the requirements of SFAS No. 140 -
Accounting for Transfers and Servicing of Financial Assets and Extinguishments
of Liabilities. U.S. Trust received $196 million in proceeds from the sale and
recognized a gain of $1 million. The senior mortgage pass-through certificates
that were created by the securitization process were sold to third parties. U.S.
Trust retained all other securities created by the process, primarily comprised
of subordinated securities with total par value of $5 million. Any credit losses
on the securitized loans will be assigned to U.S. Trust, as holder of the
subordinated securities, up to the $5 million par value. The estimated fair
value of the retained securities was $6 million at June 30, 2002 and was
included in securities owned on the Company's condensed consolidated balance
sheet. U.S. Trust has not guaranteed the mortgage loans as this transaction was
structured without recourse to U.S. Trust or the Company.
8. Comprehensive Income
Comprehensive income includes net income and changes in equity except those
resulting from investments by, or distributions to, stockholders. Comprehensive
income is as follows:
- --------------------------------------------------------------------------------
Three Six
Months Ended Months Ended
June 30, June 30,
2002 2001 2002 2001
- -------------------------------------------------------------------------------
Net income $ 98 $102 $192 $199
Other comprehensive income (loss):
Cumulative effect of accounting
change for adoption of
SFAS No. 133 (12)
Net gain (loss) on cash flow
hedging instruments (8) 4 (2) (7)
Foreign currency translation
adjustment 6 4 6 (6)
Change in net unrealized gain (loss)
on securities available for sale 14 (5) 7 3
- --------------------------------------------------------------------------------
Total comprehensive income,
net of tax $110 $105 $203 $177
================================================================================
9. Earnings Per Share
Basic EPS excludes dilution and is computed by dividing net income by the
weighted-average number of common shares outstanding for the period. Diluted EPS
reflects the potential reduction in EPS that could occur if securities or other
contracts to issue common stock were exercised or converted into common stock.
EPS under the basic and diluted computations are as follows:
-6-
- --------------------------------------------------------------------------------
Three Six
Months Ended Months Ended
June 30, June 30,
2002 2001 2002 2001
- --------------------------------------------------------------------------------
Net income $ 98 $ 102 $ 192 $ 199
================================================================================
Weighted-average common
shares outstanding - basic 1,367 1,378 1,366 1,378
Common stock equivalent shares
related to stock incentive plans 18 27 21 29
- --------------------------------------------------------------------------------
Weighted-average common
shares outstanding - diluted 1,385 1,405 1,387 1,407
================================================================================
Basic EPS:
Income (loss) before
extraordinary gain $ .07 $(.01) $ .13 $ .06
Extraordinary gain, net of tax $ .08 $ .01 $ .08
Net income $ .07 $ .07 $ .14 $ .14
================================================================================
Diluted EPS:
Income (loss) before
extraordinary gain (1) $ .07 $(.01) $ .13 $ .06
Extraordinary gain, net of tax $ .08 $ .01 $ .08
Net income $ .07 $ .07 $ .14 $ .14
================================================================================
(1) For the three months ended June 30, 2001 this computation excludes common
stock equivalent shares related to stock incentive plans of 27 million
because inclusion of such shares would be antidilutive.
The computation of diluted EPS for the six months ended June 30, 2002 and
2001, respectively, excludes outstanding stock options to purchase 102 million
and 60 million 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.
10. Regulatory Requirements
CSC is 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 (the Federal Reserve Board) under the Bank Holding Company Act of
1956, as amended (the Act).
Under the Act, the Federal Reserve Board has established consolidated capital
requirements for bank holding companies. CSC is subject to those requirements.
The regulatory capital and ratios of the Company, U.S. Trust, and United States
Trust Company of New York (U.S. Trust NY) are as follows:
- --------------------------------------------------------------------------------
2002 2001
---------------- -----------------
June 30, Amount Ratio(1) Amount Ratio(1)
- --------------------------------------------------------------------------------
Tier 1 Capital:
Company $ 3,781 22.7% $ 3,786 19.5%
U.S. Trust(2) $ 606 17.1% $ 657 21.8%
U.S. Trust NY(2) $ 379 13.3% $ 429 18.2%
Total Capital:
Company $ 3,807 22.8% $ 3,813 19.7%
U.S. Trust(2) $ 629 17.7% $ 678 22.5%
U.S. Trust NY(2) $ 399 14.0% $ 447 18.9%
Tier 1 Leverage:
Company $ 3,781 10.2% $ 3,786 10.5%
U.S. Trust(2) $ 606 9.3% $ 657 11.9%
U.S. Trust NY(2) $ 379 7.4% $ 429 10.3%
- -------------------------------------------------------------------------------
(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.
Well-capitalized tier 1 capital, total capital, and tier 1 leverage ratios
are 6%, 10%, and 5%, respectively. Each of CSC's other depository
institution subsidiaries exceed the well-capitalized standards set forth by
the banking regulatory authorities.
(2) The decreases in capital amounts and ratios from 2001 to 2002 were
primarily due to a $100 million dividend payment to CSC during the third
quarter of 2001.
Based on their respective regulatory capital ratios at June 30, 2002 and
2001, the Company, U.S. Trust, and U.S. Trust NY are considered well capitalized
(the highest category). There are no conditions or events that management
believes have changed the Company's, U.S. Trust's, or U.S. Trust NY's
well-capitalized status.
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 the 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
requirement, which is based on the type of business conducted by the
broker-dealer. The minimum dollar requirement 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
requirement. At June 30, 2002, Schwab's net capital was $1.1 billion (13% of
aggregate debit balances), which was $952 million in excess of its minimum
required net capital and $698 million in excess of 5% of aggregate debit
balances. At June 30, 2002, SCM's net capital was $133 million, which was $132
million in excess of its minimum required net capital.
-7-
11. Commitments and Contingent Liabilities
The nature of the Company's business subjects it to claims, lawsuits,
regulatory examinations, and other proceedings in the ordinary course of
business. The results of these matters cannot be predicted with certainty. There
can be no assurance that these matters will not have a material adverse effect
on the Company's results of operations in any future period, depending partly on
the results for that period, and a substantial judgment could have a material
adverse impact on the Company's financial condition and results of operations.
However, it is the opinion of management, after consultation with legal counsel,
that the ultimate outcome of current matters will not have a material adverse
impact on the financial condition or operating results of the Company.
For further discussion of legal proceedings, see Part II - Other Information,
Item 1 - Legal Proceedings.
12. Segment Information
The Company structures its segments according to its various types of clients
and the services provided to those clients. These segments have been aggregated,
based on similarities in economic characteristics, types of clients, services
provided, distribution channels, and regulatory environment, into four
reportable segments - Individual Investor, Institutional Investor, Capital
Markets, and U.S. Trust.
Financial information for the Company's reportable segments is presented in
the following table. The Company periodically reallocates certain revenues and
expenses among the segments to align them with the changes in the Company's
organizational structure. Previously-reported segment information has been
revised to reflect changes during the year in the Company's internal
organization. The Company evaluates the performance of its segments based on
adjusted operating income before taxes, which excludes restructuring and other
charges, merger- and acquisition-related charges, and extraordinary gains.
Intersegment revenues are not material and are therefore not disclosed. Total
revenues, income before taxes on income and extraordinary gain, and net income
are equal to the Company's consolidated amounts as reported in the condensed
consolidated statement of income.
- --------------------------------------------------------------------------------
Three Six
Months Ended Months Ended
June 30, June 30,
2002 2001 2002 2001
- --------------------------------------------------------------------------------
Revenues
Individual Investor $ 598 $ 626 $1,214 $1,318
Institutional Investor 210 203 423 416
Capital Markets 65 78 128 204
U.S. Trust 176 164 343 333
- --------------------------------------------------------------------------------
Total $1,049 $1,071 $2,108 $2,271
================================================================================
Operating income before taxes
Individual Investor $ 66 $ 47 $ 131 $ 112
Institutional Investor 55 68 119 139
Capital Markets 4 9 13 30
U.S. Trust (1) 45 25 80 62
- --------------------------------------------------------------------------------
Operating income before taxes 170 149 343 343
Restructuring and other charges (2) (3) (145) (30) (145)
Merger- and acquisition-related
charges (3) (11) (30) (27) (60)
- --------------------------------------------------------------------------------
Income (loss) before taxes on income
(loss) and extraordinary gain 156 (26) 286 138
Tax expense (benefit) on income 58 (7) 106 60
Extraordinary gain on sale of
corporate trust business, net of tax 121 12 121
- --------------------------------------------------------------------------------
Net Income $ 98 $ 102 $ 192 $ 199
================================================================================
(1) Excludes an extraordinary pre-tax gain of $22 million for the six months
ended June 30, 2002 and $221 million for the three and six months ended
June 30, 2001.
(2) Restructuring charges include costs relating to workforce, facilities,
systems hardware, software, and equipment reductions. In 2001, other
charges include a regulatory fine, professional service fees for
operational and risk management remediation, and the write-off of certain
software development costs.
(3) Includes retention program compensation related to the merger with USTC,
and intangible asset amortization and retention program compensation
related to the acquisition of CyberTrader. The retention programs related
to the acquisition of CyberTrader and the merger with USTC ended in March
2002 and May 2002, respectively. For 2001, amount also includes goodwill
amortization, which ceased on January 1, 2002 upon the adoption of SFAS No.
142 (see note "2 - Accounting Change").
-8-
13. Supplemental Cash Flow Information
Certain information affecting the cash flows of the Company follows:
- --------------------------------------------------------------------------------
Six
Months Ended
June 30,
2002 2001
- --------------------------------------------------------------------------------
Income taxes paid $ 15 $ 62
================================================================================
Interest paid:
Brokerage client cash balances $ 101 $ 468
Deposits from banking clients 41 76
Long-term debt 27 29
Stock-lending activities 1 15
Short-term borrowings 13 11
Other 2
- --------------------------------------------------------------------------------
Total interest paid $ 183 $ 601
================================================================================
Non-cash investing and financing activities:
Common stock and options issued
for purchase of businesses $ 3 $ 36
================================================================================
14. Subsequent Events
During the period July 1, 2002 through July 31, 2002, CSC repurchased and
recorded as treasury stock a total of 6 million shares of its common stock for
$59 million. As of July 31, 2002, authorization granted by CSC's Board of
Directors allows for future repurchases of up to $309 million.
On August 12, 2002, the Company announced a plan to adjust capacity in its
Retail business by reducing phone-based client support staff. The Company
expects to record a pre-tax charge in the third quarter of 2002 to reflect this
restructuring. In addition, the Company is and will be evaluating its staffing
and facilities, as well as its spending for professional services, development
projects, and advertising, in light of the difficult market environment.
Although no decisions have been made at this time, additional restructuring
charges are likely during the remaining months of 2002. The Company's objective
is to identify and implement actions to further reduce its annual operating
expense base.
-9-
THE CHARLES SCHWAB CORPORATION
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations
Description of Business
The Company: The Charles Schwab Corporation (CSC) and its subsidiaries
(collectively referred to as the Company) provide securities brokerage and
related financial services for 8.0 million active client accounts(a). Client
assets in these accounts totaled $797.0 billion at June 30, 2002. Charles Schwab
& Co., Inc. (Schwab) is a securities broker-dealer with 394 domestic branch
offices in 48 states, as well as a branch in the Commonwealth of Puerto Rico.
U.S. Trust Corporation (USTC, and with its subsidiaries collectively referred to
as U.S. Trust) is a wealth management firm that through its subsidiaries also
provides fiduciary services and private banking services with 34 offices in 12
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 primarily to broker-dealers
and institutional clients, and CyberTrader, Inc. (CyberTrader), an electronic
trading technology and brokerage firm providing services to highly active,
online investors.
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 financial advisors, serves company 401(k) plan sponsors and
third-party administrators, and supports company stock option plans and stock
purchase programs. The Capital Markets segment provides trade execution services
in Nasdaq, exchange-listed, and other securities primarily to broker-dealers,
including Schwab, and institutional clients. The U.S. Trust segment provides
investment and wealth management, fiduciary services, and private banking
services to individual and institutional clients.
Business Strategy: Commencing in 2001, the Company focused on aligning its
infrastructure and resources with six strategic priorities, which include:
- - providing the spectrum of affluent investors with the advice, relationships,
and choices that support their desired investment outcomes;
- - delivering the information, technology, service, and pricing needed to remain
a leader in serving active traders;
- - providing individual investing services through employers, including
retirement and option plans as well as personal brokerage accounts;
- - offering selected banking services and developing investment products that
give clients greater control and understanding of their finances;
- - retaining a strong capital markets business to address investors' financial
product and trade execution needs; and
- - continuing to provide high quality service to clients with smaller investment
portfolios.
For further discussion of the Company's business strategy, see "Management's
Discussion and Analysis of Results of Operations and Financial Condition -
Description of Business - Business Strategy" in the Company's 2001 Annual Report
to Stockholders, which is filed as Exhibit 13.1 to the Company's Form 10-K for
the year ended December 31, 2001. See also Item 1 - Business - Narrative
Description of Business - "Products, Services, and Advice Offerings" in the
Company's Form 10-K for the year ended December 31, 2001. Significant recent
developments relating to these strategic priorities, as well as other
significant developments, follows:
Services for Affluent Investors: During the second quarter of 2002, the
Company announced the nationwide launch of its full-service advice and
relationship service offer, including the Schwab Advisor Network(TM), Schwab
Private Client, and Schwab Equity Ratings(TM). This nationwide rollout also
included a new advertising campaign designed to differentiate Schwab's service
model from those of other full-service firms.
The Schwab Advisor Network is the successor to the Schwab AdvisorSource(R)
referral program, with over 320 participating independent, fee-based investment
advisors (IAs), who have an average of 17 years of experience and $500 million
of assets under management. These IAs provide customized and personalized
portfolio management and financial planning services to investors who prefer to
delegate their financial management responsibilities to an independent
professional. The Schwab Advisor Network strengthens the Schwab/advisor/client
relationship through a pricing model that allows for sharing fee income on
referred accounts, and features IAs more prominently in advertising that targets
affluent investors. During the second quarter of 2002, Schwab held a series of
regional conferences designed to provide IAs with information, ideas, and
contacts to help them develop their businesses. Schwab also upgraded its
Centerpiece(R) portfolio
(a) Accounts with balances or activity within the precedings eight months.
-10-
management software to help IAs with fixed income tracking, analytics, and
enhanced reporting capabilities.
Schwab Private Client is a fee-based service designed to help clients who
want access to an ongoing, one-on-one advice relationship with a designated
Schwab consultant while retaining control over their investment decisions.
Schwab Private Client provides expanded financial planning, asset management
capabilities, and enhanced portfolio tracking and performance reporting. In the
second quarter of 2002, following a 12 month pilot program, the Schwab Private
Client service was expanded to include over 150 designated Schwab consultants
and their support teams, serving 360 branch offices nationwide.
Schwab Equity Ratings provide clients with an objective stock rating system
on more than 3,000 stocks, assigning each equity a single grade: A, B, C, D, or
F. On average, A-rated stocks are expected to strongly outperform the overall
market over the next 12 months, while F-rated stocks are expected to strongly
under-perform the market. Rated stocks are ranked and the number of 'buy
consideration' ratings - As and Bs - equals the number of 'sell consideration'
ratings - Ds and Fs. Schwab Equity Ratings leverages Schwab's November 2000
acquisition of Chicago Investment Analytics, Inc. (CIA) by applying CIA's
research and technology strengths to a systematic ratings methodology that
complements the variety of perspectives already available to clients from
Goldman Sachs, Standard & Poor's, Argus, and First Call.
Banking and Other Financial Products: In the second quarter of 2002, the
Company filed applications with the Office of the Comptroller of the Currency
and the Federal Deposit Insurance Corporation to establish a national bank and
to obtain deposit insurance for the bank. Subject to regulatory approvals, the
Company expects to commence banking operations in early 2003.
Capital Markets: The Company expanded its trade execution capabilities and
financial product offerings during the second quarter of 2002. Through selective
hirings, the Company expanded its institutional equity capabilities to focus on
improving execution capabilities for all clients. Additionally, through an
agreement with Goldman Sachs, clients now have access to OptEx(SM) (a service
mark of Goldman, Sachs & Co.), which uses advanced technology to scan the entire
options marketplace and route orders automatically based on the best price
available nationwide and other execution quality factors. The Schwab
BondSource(TM) service was expanded to link Schwab with 50 other broker-dealers,
allowing clients to choose fixed income securities from a network that supports
trading in all U.S. Treasury securities, over 450 U.S. agency securities, 1,200
corporate bonds, and 3,500 municipal bond issues. The Schwab CDSource(TM)
service, which allows clients to invest in time deposits from over 110
participating banks, handled $620 million of client deposits during the second
quarter of 2002, more than double the year-earlier volume. Client assets in
fixed income securities were a record $116.5 billion at June 30, 2002, an
increase of $21.1 billion, or 22%, from a year ago.
Other Significant Developments: The Company continued to combine people and
technology through several important technology-based initiatives during the
second quarter of 2002. Schwab enhanced its MarketPlace internal Web site to
include an 'Investment Products' home page with lists of investment perspectives
across various products, sectors, and styles. Schwab also expanded MarketPlace
to include a tool that allows Schwab representatives to conduct cash flow
analysis on their clients' bond holdings.
Mutual fund-based investing remains an important element of the Company's
Core & Explore(R) investing philosophy. In the second quarter of 2002, Schwab
expanded its proprietary funds offering by introducing the Schwab MarketMasters
Funds(TM), a suite of four funds that employ third-party investment managers to
oversee portions of the fund assets according to specific investment styles. By
combining different styles and strategies, MarketMasters Funds are designed to
spread investment risk and reduce volatility. Schwab also introduced the Schwab
Core Equity Fund(TM), a large-cap fund that combines the equity selection
capabilities of Schwab Equity Ratings with the diversification and convenience
of a mutual fund. The portfolio managers of the Schwab Core Equity Fund
primarily purchase stocks that have a Schwab Equity Rating of A or B, but may
also purchase lower-rated stocks in order to maintain a risk profile similar to
the Standard & Poor's 500 Index.
Restructuring: On August 12, 2002, the Company announced a plan to adjust
capacity in its Retail business by reducing phone-based client support staff.
The Company will close its service center in Austin, Texas as part of this plan
and will work to sublease the facility. This closing will eliminate
approximately 300 jobs, and the Company will also eliminate approximately 75
support and administrative positions across its four other service centers
located in Denver, Indianapolis, Orlando, and Phoenix. As a result of these
measures, the Company expects to incur pre-tax restructuring charges of
approximately $36 million in the third quarter of 2002, including approximately
$25 million in facilities reduction charges and approximately $11 million in
workforce reduction charges. The Company estimates that this restructuring will
result in pre-tax expense savings of approximately $26 million for full-year
2003. The Company continues to serve its clients on the phone through its
remaining service centers.
In addition, the Company is and will be evaluating its staffing and
facilities, as well as its spending for
-11-
professional services, development projects, and advertising, in light of the
difficult market environment. Although no decisions have been made at this time,
additional restructuring charges are likely during the remaining months of 2002
as the Company works toward its objective of identifying and implementing
actions to further reduce its annual operating expense base by approximately
$200 million in 2003. A portion of any improvement in profitability will likely
be used to enhance employee bonuses.
Risk Management
For discussion on the Company's principal risks and some of the policies and
procedures for risk identification, assessment, and mitigation, see
"Management's Discussion and Analysis of Results of Operations and Financial
Condition - Risk Management" in the Company's 2001 Annual Report to
Stockholders, which is filed as Exhibit 13.1 to the Company's Form 10-K for the
year ended December 31, 2001. See Liquidity and Capital Resources of this report
for a discussion on liquidity risk; and see Item 3 - Quantitative and
Qualitative Disclosures About Market Risk for additional information relating to
market risk.
The Company will enter into a number of new insurance policies during the
quarter ended September 30, 2002 to replace policies which are expiring. Given
the current state of the insurance market, the Company may be confronted with
higher levels of rates and deductibles and with narrower coverages than have
been available in the recent past. There can be no assurance that these changes
will not have a material adverse effect on the Company's results of operations
in any future period, depending partly on the results for that period.
Given the nature of the Company's revenues, expenses, and risk profile, the
Company's earnings and CSC's common stock price has been and may continue to be
subject to significant volatility from period to period. The Company's results
for any interim period are not necessarily indicative of results for a full year
or any other interim period. Risk is inherent in the Company's business.
Consequently, despite the Company's attempts to identify areas of risk, oversee
operational areas involving risk, and implement policies and procedures designed
to mitigate risk, there can be no assurance that the Company will not suffer
unexpected losses due to operating or other risks.
Forward-Looking Statements
This Quarterly Report on Form 10-Q contains "forward-looking statements"
within the meaning of Section 27A of the Securities Act, and Section 21E of the
Securities Exchange Act of 1934. Forward-looking statements are identified by
words such as "believe," "expect," "intend," "plan," "will," "may," and other
similar expressions. In addition, any statements that refer to expectations,
projections or other characterizations of future events or circumstances are
forward-looking statements. These forward-looking statements, which reflect
management's beliefs, objectives, and expectations as of the date hereof, are
necessarily estimates based on the best judgment of the Company's senior
management. These statements relate to, among other things, the Company's
ability to achieve its strategic priorities (see Description of Business -
Business Strategy), the impact of the restructuring plan on the Company's
results of operations (see Description of Business - Restructuring), insurance
coverage (see Description of Business - Risk Management), sources of liquidity
and capital (see Liquidity and Capital Resources - Liquidity and - Commitments),
the Company's cash position, cash flows, and capital expenditures (see Liquidity
and Capital Resources - Cash Flows and Capital Resources) and contingent
liabilities (see Part II - Other Information, Item 1 - Legal Proceedings).
Achievement of the expressed expectations is subject to certain risks and
uncertainties that could cause actual results to differ materially from the
expressed expectations described in these statements. Important factors that may
cause such differences are noted in this interim report and 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 continuing volatility
of equity prices; a significant downturn in the securities markets over a short
period of time or a sustained decline in securities prices, trading volumes, and
investor confidence; 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; evolving legislation,
regulation, accounting pronouncements, and changing industry practices adversely
affecting the Company; adverse results of litigation; the inability to obtain
external financing at acceptable rates; significant changes to the terms of the
Company's insurance coverage; a significant decline in the real estate market,
including the Company's ability to sublease certain properties; and the effects
of competitors' pricing, product, and service decisions, and intensified
industry competition and consolidation.
Critical Accounting Policies
Certain of the Company's accounting policies that involve a higher degree of
judgment and complexity are discussed in "Management's Discussion and Analysis
of Results of Operations and Financial Condition - Critical Accounting Policies"
in the Company's 2001 Annual Report to Stockholders, which is filed as Exhibit
13.1 to the
-12-
Company's Form 10-K for the year ended December 31, 2001. There have been no
material changes to these critical accounting policies in the first half of
2002.
Three Months Ended June 30, 2002 Compared To Three
Months Ended June 30, 2001
All references to earnings per share information in this report reflect
diluted earnings per share unless otherwise noted.
FINANCIAL OVERVIEW
The Company's financial performance in the second quarter of 2002 was
adversely affected by declines in client trading activity as investor confidence
continued to be weighed down by mixed economic news, ongoing corporate
accounting and governance concerns, and geopolitical developments. In the
difficult market environment that prevailed during the second quarter of 2002,
daily average revenue trades decreased 20% and average revenue per equity share
traded in the Capital Markets segment decreased 27% from year-earlier levels. As
a result of these two factors, the Company's trading revenues in the second
quarter of 2002 decreased 13% from the second quarter of 2001.
Non-trading revenues, which include asset management and administration fees,
interest revenue, net of interest expense (referred to as net interest revenue),
and other revenues, increased 5% in the second quarter of 2002 compared to the
year-ago level. The increase in non-trading revenues was primarily due to a 10%
increase in asset management and administration fees, partially offset by a 6%
decrease in net interest revenue. The increase in asset management and
administration fees primarily resulted from an increase in assets in, and
service fees earned on, Schwab's proprietary funds (collectively referred to as
the SchwabFunds). Higher balance-related account fees also contributed to the
increase in asset management and administration fees. Average margin loans to
clients in the second quarter of 2002 decreased 22% from year-ago levels, which
primarily caused the decline in net interest revenue.
Total expenses excluding interest during the second quarter of 2002 were $893
million, down 19% from $1.1 billion during the second quarter of 2001. This
decrease resulted primarily from the Company's continued expense reduction
measures, including the restructuring plan implemented during 2001.
In evaluating the Company's financial performance, management uses adjusted
operating income, which excludes non-operating items as detailed in the
following table. The Company's after-tax operating income for the second quarter
of 2002 was $106 million, up 9% from the second quarter of 2001, and its
after-tax operating profit margin for the second quarter of 2002 was 10.1%, up
from 9.1% for the second quarter of 2001. A reconciliation of the Company's
operating income to net income is shown in the following table (in millions):
- --------------------------------------------------------------------------------
Three Months
Ended
June 30, Percent
2002 2001 Change
- --------------------------------------------------------------------------------
Operating income, after tax $106 $ 97 9%
Non-operating items:
Extraordinary gain (1) 221
Restructuring charges (2) (3) (117) (97)
Other charges (3) (28)
Merger- and acquisition-related charges (4) (11) (30) (63)
- --------------------------------------------------------------------------------
Total non-operating items (14) 46 n/m
Tax effect 6 (41) n/m
- --------------------------------------------------------------------------------
Total non-operating items, after tax (8) 5 n/m
- --------------------------------------------------------------------------------
Net income $ 98 $102 (4%)
================================================================================
(1) The Company recorded an extraordinary pre-tax gain, net of closing and exit
costs, from the sale of USTC's Corporate Trust business to The Bank of New
York Company, Inc. in June 2001.
(2) Primarily includes costs relating to a workforce reduction, a reduction in
operating facilities, and the removal of certain systems hardware,
software, and equipment from service.
(3) For 2001, includes a regulatory fine assessed to USTC and United States
Trust Company of New York (U.S. Trust NY), professional service fees for
operational and risk management remediation at USTC and U.S. Trust NY, and
the write-off of certain software development costs at CSE.
(4) Includes retention program compensation related to the merger with USTC,
and intangible asset amortization and retention program compensation
related to the acquisition of CyberTrader. The retention programs related
to the acquisition of CyberTrader and the merger with USTC ended in March
2002 and May 2002, respectively. For the three months ended June 30, 2001,
amount also includes goodwill amortization, which ceased on January 1, 2002
upon the adoption of Statement of Financial Accounting Standards No. 142.
n/m Not meaningful
The Company's operating income before taxes for the second quarter of 2002
was $170 million, up $21 million, or 14%, from the second quarter of 2001 due to
increases of $19 million, or 40%, in the Individual Investor segment and $20
million, or 80%, in the U.S. Trust segment, partially offset by decreases of $13
million, or 19%, in the Institutional Investor segment and $5 million, or 56%,
in the Capital Markets segment. The increase in the Individual Investor segment
was primarily due to lower expenses resulting from the Company's workforce
reduction under its restructuring plan. Most of the employees affected by the
restructuring plan were from Schwab's retail brokerage division, which is
included in the Individual Investor segment. As certain technology, corporate,
and general administrative expenses are allocated to segments based upon their
full-time equivalent employees, a proportionately larger allocation of expenses
was assigned to the Institutional Investor segment for the second quarter of
-13
2002, which, along with an increase in certain direct costs, resulted in the
operating income decline in that segment. The increase in the U.S. Trust segment
was primarily due to higher net interest revenue, as well as lower expenses. The
decrease in the Capital Markets segment was primarily due to lower average
revenue per equity share traded and lower levels of trading activity.
The Company's net income for the second quarter of 2002 was $98 million, or
$.07 per share, compared to $102 million, or $.07 per share, for the second
quarter of 2001. The Company's after-tax profit margin for the second quarter of
2002 was 9.3%, down from 9.5% for the second quarter of 2001.
The annualized return on stockholders' equity for the second quarter of 2002
was 9%, unchanged from the same period last year.
REVENUES
Revenues declined $22 million, or 2%, to $1.0 billion in the second quarter
of 2002 compared to the second quarter of 2001, due to a $47 million, or 14%,
decrease in commission revenues, a $14 million, or 6%, decrease in net interest
revenue, and a $6 million, or 11%, decrease in principal transaction revenues.
These declines were partially offset by a $39 million, or 10%, increase in asset
management and administration fees and a $6 million, or 17%, increase in other
revenues. As trading volumes decreased 12% during the second quarter of 2002
from the second quarter of 2001, the Company's non-trading revenues represented
67% of total revenues as compared to 63% for the second quarter of 2001 as shown
in the following table:
- --------------------------------------------------------------------------------
Three Months
Ended
June 30,
Composition of Revenues 2002 2001
- --------------------------------------------------------------------------------
Commissions 28% 32%
Principal transactions 5 5
- --------------------------------------------------------------------------------
Total trading revenues 33 37
- --------------------------------------------------------------------------------
Asset management and administration fees 43 38
Net interest revenue 21 22
Other 3 3
- --------------------------------------------------------------------------------
Total non-trading revenues 67 63
- --------------------------------------------------------------------------------
Total 100% 100%
================================================================================
While the Individual Investor and Institutional Investor segments generate
both trading and non-trading revenues, the Capital Markets segment generates
primarily trading revenues and the U.S. Trust segment generates primarily
non-trading revenues. The $22 million decline in revenues from the second
quarter of 2001 was due to decreases in revenues of $28 million, or 4%, in the
Individual Investor segment and $13 million, or 17%, in the Capital Markets
segment, partially offset by increases of $7 million, or 3%, in the
Institutional Investor segment and $12 million, or 7%, in the U.S. Trust
segment. See note "12 - Segment Information" in the Notes to Condensed
Consolidated Financial Statements for financial information by segment.
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 through the Individual Investor, Institutional Investor, and
U.S. Trust 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 through the U.S. Trust, Individual Investor, and Institutional Investor
segments.
Asset management and administration fees were $447 million for the second
quarter of 2002, up $39 million, or 10%, from the second quarter of 2001, as
shown in the following table (in millions):
- --------------------------------------------------------------------------------
Three Months
Ended
Asset Management June 30, Percent
and Administration Fees 2002 2001 Change
- --------------------------------------------------------------------------------
Mutual fund service fees:
Proprietary funds
(SchwabFunds(R)and Excelsior(R)) $217 $200 9%
Mutual Fund OneSource(R) 72 73 (1)
Other 10 7 43
Asset management and related services 148 128 16
- --------------------------------------------------------------------------------
Total $447 $408 10%
================================================================================
The increase in asset management and administration fees was primarily due to
increases in SchwabFunds assets, which led to an increase in service fees, and
higher balance-related account fees.
-14-
Assets in client accounts were $797.0 billion at June 30, 2002, a decrease of
$61.3 billion, or 7%, from a year ago as shown in the following table. This
decrease from a year ago included net new client assets of $58.3 billion, offset
by net market losses of $119.6 billion related to client accounts.
- --------------------------------------------------------------------------------
Change in Client Assets and Accounts
(In billions, at quarter end, June 30, Percent
except as noted) 2002 2001 Change
- --------------------------------------------------------------------------------
Assets in client accounts
Schwab One(R), other cash
equivalents and deposits
from banking clients $ 28.6 $ 27.0 6%
Proprietary funds (SchwabFunds(R)
and Excelsior(R)):
Money market funds 126.7 122.7 3
Equity and bond funds 30.9 30.6 1
- --------------------------------------------------------------------------------
Total proprietary funds 157.6 153.3 3
- --------------------------------------------------------------------------------
Mutual Fund Marketplace(R)(1):
Mutual Fund OneSource(R) 81.6 93.0 (12)
Mutual Fund clearing services 21.9 21.0 4
All other 75.9 74.4 2
- --------------------------------------------------------------------------------
Total Mutual Fund Marketplace 179.4 188.4 (5)
- --------------------------------------------------------------------------------
Total mutual fund assets 337.0 341.7 (1)
- --------------------------------------------------------------------------------
Equity and other securities (1) 323.3 405.7 (20)
Fixed income securities 116.5 95.4 22
Margin loans outstanding (8.4) (11.5) (27)
- --------------------------------------------------------------------------------
Total client assets $797.0 $ 858.3 (7%)
================================================================================
Net change in assets
in client accounts
(for the quarter ended)
Net new client assets $ 11.5 $ 11.3
Net market gains (losses) (72.2) 41.2
- ------------------------------------------------------------------
Net growth (decline) $(60.7) $ 52.5
==================================================================
New client accounts
(in thousands, for the
quarter ended) 224.6 265.9 (16%)
Active client accounts
(in millions) (2) 8.0 7.7 4%
- --------------------------------------------------------------------------------
Active online Schwab client
accounts (in millions) (3) 4.3 4.3
Online Schwab client assets $308.2 $ 349.2 (12%)
- --------------------------------------------------------------------------------
(1) Excludes money market funds and all proprietary money market, equity, and
bond funds.
(2) Active accounts are defined as accounts with balances or activity within
the preceding eight months.
(3) Active online accounts are defined as all accounts within a household that
has had at least one online session within the past twelve months.
Commissions
The Company earns commission revenues by executing client trades primarily
through the Individual Investor and Institutional Investor segments. These
revenues are affected by the number of client accounts that trade, the average
number of commission-generating trades per account, and the average commission
per trade. Commission revenues for the Company were $294 million for the second
quarter of 2002, down $47 million, or 14%, from the second quarter of 2001.
The Company's client trading activity is shown in the following table (in
thousands):
- --------------------------------------------------------------------------------
Three Months
Ended
June 30, Percent
Daily Average Trades 2002 2001 Change
- --------------------------------------------------------------------------------
Revenue Trades
Online 107.8 134.5 (20%)
TeleBroker(R)and Schwab by Phone(TM) 5.7 7.6 (25)
Regional client telephone service
centers, branch offices, and other 15.6 18.3 (15)
- --------------------------------------------------------------------------------
Total 129.1 160.4 (20%)
================================================================================
Mutual Fund OneSource(R) Trades
Online 46.6 34.9 34%
TeleBroker and Schwab by Phone .4 .4
Regional client telephone service
centers, branch offices, and other 10.5 17.3 (39)
- --------------------------------------------------------------------------------
Total 57.5 52.6 9%
================================================================================
Total Daily Average Trades
Online 154.4 169.4 (9%)
TeleBroker and Schwab by Phone 6.1 8.0 (24)
Regional client telephone service
centers, branch offices, and other 26.1 35.6 (27)
- --------------------------------------------------------------------------------
Total 186.6 213.0 (12%)
================================================================================
As shown in the following table, the total number of revenue trades executed
by the Company has decreased 18% as the number of client accounts that traded
and client trading activity per account that traded have declined.
-15-
- --------------------------------------------------------------------------------
Three Months
Ended
Commissions Earned on June 30, Percent
Client Revenue Trades 2002 2001 Change
- --------------------------------------------------------------------------------
Client accounts that traded during
the quarter (in thousands) 1,345 1,426 (6%)
Average client revenue trades
per account that traded 6.1 7.1 (14)
Total revenue trades
(in thousands) 8,253 10,098 (18)
Trading frequency proxy (1) 3.6 4.2 (14)
Number of trading days 64 63 2
Average commission per
revenue trade $38.02 $34.50 10
Commissions earned on client
revenue trades (in millions) (2) $ 314 $ 348 (10)
- --------------------------------------------------------------------------------
(1) Represents annualized revenue trades per $100,000 in client assets.
(2) 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.
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, private banking loans, and securities available for sale) and interest
paid on liabilities (mainly brokerage client cash balances and banking
deposits). Net interest revenue is affected by changes in the volume and mix of
these assets and liabilities, as well as by fluctuations in interest rates and
hedging strategies.
Substantially all of the Company's net interest revenue is earned through the
Individual Investor, Institutional Investor, and U.S. Trust segments.
Net interest revenue was $218 million for the second quarter of 2002, down
$14 million, or 6%, from the second quarter of 2001 as shown in the following
table (in millions):
- --------------------------------------------------------------------------------
Three Months
Ended
June 30, Percent
2002 2001 Change
- --------------------------------------------------------------------------------
Interest Revenue
Margin loans to clients $ 128 $ 211 (39%)
Investments, client-related 82 161 (49)
Private banking loans 59 58 2
Securities available for sale 22 21 5
Other 19 38 (50)
- --------------------------------------------------------------------------------
Total 310 489 (37)
- --------------------------------------------------------------------------------
Interest Expense
Brokerage client cash balances 46 195 (76)
Deposits from banking clients 24 34 (29)
Long-term debt 14 14
Short-term borrowings 7 5 40
Stock-lending activities 1 5 (80)
Other 4 n/m
- --------------------------------------------------------------------------------
Total 92 257 (64)
- --------------------------------------------------------------------------------
Net interest revenue $ 218 $ 232 (6%)
================================================================================
n/m Not meaningful
Client-related and other daily average balances, interest rates, and average
net interest spread for the second quarters of 2002 and 2001 are summarized in
the following table (dollars in millions):
-16-
- --------------------------------------------------------------------------------
Three Months Ended
June 30,
2002 2001
- --------------------------------------------------------------------------------
Interest-Earning Assets (client-related and other):
Investments (client-related):
Average balance outstanding $ 17,444 $ 14,377
Average interest rate 1.89% 4.50%
Margin loans to clients:
Average balance outstanding $ 8,913 $ 11,464
Average interest rate 5.77% 7.38%
Private banking loans:
Average balance outstanding $ 4,094 $ 3,269
Average interest rate 5.75% 7.12%
Securities available for sale:
Average balance outstanding $ 1,557 $ 1,317
Average interest rate 5.47% 6.45%
Average yield on interest-earning assets 3.64% 5.95%
Funding Sources (client-related and other):
Interest-bearing brokerage client cash balances:
Average balance outstanding $ 22,935 $ 22,247
Average interest rate .81% 3.52%
Interest-bearing banking deposits:
Average balance outstanding $ 3,798 $ 3,296
Average interest rate 2.46% 4.14%
Other interest-bearing sources:
Average balance outstanding $ 1,072 $ 1,154
Average interest rate 2.27% 4.58%
Average noninterest-bearing portion $ 4,203 $ 3,730
Average interest rate on funding sources .95% 3.20%
Summary:
Average yield on interest-earning assets 3.64% 5.95%
Average interest rate on funding sources .95% 3.20%
- --------------------------------------------------------------------------------
Average net interest spread 2.69% 2.75%
================================================================================
The decrease in net interest revenue from the second quarter of 2001 was
primarily due to levels of, and lower rates received on, margin loans to
clients, as well as lower rates received on client-related investments,
partially offset by lower rates paid on brokerage client cash balances and
higher average balances of client-related investments.
Principal Transactions
Principal transaction revenues are primarily comprised of revenues from
client fixed income securities trading activity, and net gains from
market-making activities in Nasdaq and other equity 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.
Principal transaction revenues were $49 million for the second quarter of
2002, down $6 million, or 11%, from the second quarter of 2001, as shown in the
following table (in millions):
- --------------------------------------------------------------------------------
Three Months
Ended
June 30, Percent
Principal Transactions 2002 2001 Change
- --------------------------------------------------------------------------------
Fixed income securities $ 25 $ 16 56%
Nasdaq and other equity securities 21 33 (36)
Other 3 6 (50)
- --------------------------------------------------------------------------------
Total $ 49 $ 55 (11%)
================================================================================
The decrease in principal transaction revenues was primarily due to lower
average revenue per equity share traded, which in turn was primarily caused by
market conditions, and lower share volume handled by SCM. This decrease was
substantially offset by higher revenues from client fixed income securities
trading activity.
Other Revenues
Other revenues were $41 million for the second quarter of 2002, up $6
million, or 17%, from the second quarter of 2001. This increase was primarily
due to net gains on investments in 2002, compared to net losses on investments
in 2001, a settlement of a lawsuit in 2002, and higher trade-related service
fees, partially offset by a decrease in payments for order flow.
EXPENSES EXCLUDING INTEREST
Total expenses excluding interest for the second quarter of 2002 declined
$204 million, or 19%, from the second quarter of 2001. The Company's initiatives
under its restructuring plan and other expense reduction measures have resulted
in decreases in most expense categories during the second quarter of 2002 when
compared to the second quarter of 2001. The Company recorded total pre-tax
charges of $3 million in the second quarter of 2002 for restructuring charges
under its restructuring plan. In the second quarter of 2001, the Company
recorded total pre-tax restructuring and other charges of $145 million.
Compensation and benefits expense was $470 million for the second quarter of
2002, down $9 million, or 2%, from the second quarter of 2001 primarily due to a
reduction in full-time equivalent employees, partially offset by the accrual of
discretionary bonuses to employees in the second quarter of 2002. The following
table shows a comparison of certain compensation and benefits components and
employee data (in thousands):
-17-
- --------------------------------------------------------------------------------
Three Months
Ended
June 30,
2002 2001
- --------------------------------------------------------------------------------
Compensation and benefits expense as a
% of total revenues 45% 45%
Variable compensation as a
% of compensation and benefits expense 14% 10%
Compensation for temporary employees,
contractors and overtime hours as a
% of compensation and benefits expense 6% 6%
Full-time equivalent employees
(at end of quarter) (1) 19.1 22.4
Revenues per average full-time equivalent
employee $ 54.5 $ 46.0
- --------------------------------------------------------------------------------
(1) Includes full-time, part-time, and temporary employees, and persons
employed on a contract basis.
Communications expense was $66 million for the second quarter of 2002, down
$23 million, or 26%, from the second quarter of 2001. This decrease was
primarily due to lower client trading volumes and the Company's expense
reduction measures.
Goodwill amortization expense for the second quarter of 2001 was $16 million.
On January 1, 2002, the Company adopted Statement of Financial Accounting
Standards (SFAS) No. 142 - Goodwill and Other Intangible Assets. Upon adoption
of SFAS No. 142, amortization of the existing goodwill ceased and therefore
there was no such expense in the second quarter of 2002. The Company did not
record any goodwill impairment charges in the second quarter of 2002 upon
completion of the initial transitional impairment test under SFAS No. 142.
The Company's effective income tax rate was 37.2% for the second quarter of
2002, down from 47.7% for the second quarter of 2001. The decrease was primarily
due to the cessation of goodwill amortization upon the adoption of SFAS No. 142
in 2002, as well as a regulatory fine at U.S. Trust in 2001 which was
nondeductible for tax purposes.
Six Months Ended June 30, 2002 Compared To Six
Months Ended June 30, 2001
FINANCIAL OVERVIEW
In the difficult market environment that prevailed during the first half of
2002, daily average revenue trades decreased 22% and average revenue per equity
share traded in the Capital Markets segment decreased 48% from year-earlier
levels. As a result of these two factors, the Company's trading revenues in the
first half of 2002 decreased 22% from the first half of 2001 and total revenues
decreased 7% for the same period.
Non-trading revenues increased 3% in the first half of 2002 compared to the
year-ago level. Asset management and administration fees increased 9% in the
first half of 2002 compared to the year-ago level, primarily resulting from an
increase in assets in, and service fees earned on, SchwabFunds, as well as
higher balance-related account fees. This increase was partially offset by a 10%
decrease in net interest revenue, as average margin loans to clients in the
first half of 2002 decreased 29% from year-ago levels.
Total expenses excluding interest during the first half of 2002 were $1.8
billion, down 15% from $2.1 billion during the first half of 2001. This decrease
resulted primarily from the Company's continued expense reduction measures,
including the restructuring plan implemented during 2001.
In June 2001, U.S. Trust sold its Corporate Trust business to The Bank of New
York Company, Inc. (Bank of NY). The Company recorded an extraordinary gain of
$221 million, or $121 million after tax, on this sale in the second quarter of
2001. During the first quarter of 2002, the Company recorded an extraordinary
gain of $22 million, or $12 million after tax, which represented the remaining
proceeds from this sale that were realized upon satisfaction of certain client
retention requirements.
In evaluating the Company's financial performance, management uses adjusted
operating income, which excludes non-operating items as detailed in the
following table. The Company's after-tax operating income for the first half of
2002 was $214 million, relatively flat with the first half of 2001, and its
after-tax operating profit margin for the first half of 2002 was 10.1%, up from
9.6% for the first half of 2001. A reconciliation of the Company's operating
income to net income is shown in the following table (in millions):
-18-
- --------------------------------------------------------------------------------
Six Months
Ended
June 30, Percent
2002 2001 Change
- --------------------------------------------------------------------------------
Operating income, after tax $ 214 $ 217 (1%)
Non-operating items:
Extraordinary gain (1) 22 221 (90)
Restructuring charges (2) (30) (117) (74)
Other charges (3) (28)
Merger- and acquisition-related charges (4) (27) (60) (55)
- --------------------------------------------------------------------------------
Total non-operating items (35) 16 n/m
Tax effect 13 (34) n/m
- --------------------------------------------------------------------------------
Total non-operating items, after tax (22) (18) 22
- --------------------------------------------------------------------------------
Net income $ 192 $ 199 (4%)
================================================================================
(1) The Company recorded an extraordinary pre-tax gain, net of closing and exit
costs, from the sale of USTC's Corporate Trust business to the Bank of NY
in June 2001. In March 2002, the Company recorded an extraordinary pre-tax
gain for the remaining proceeds related to client retention requirements
for this sale.
(2) Primarily includes costs relating to a workforce reduction, a reduction in
operating facilities, the removal of certain systems hardware, software,
and equipment from service, and the withdrawal from certain international
operations.
(3) For 2001, includes a regulatory fine assessed to USTC and U.S. Trust NY,
professional service fees for operational and risk management remediation
at USTC and U.S. Trust NY, and the write-off of certain software
development costs at CSE.
(4) Includes retention program compensation related to the merger with USTC,
and intangible asset amortization and retention program compensation
related to the acquisition of CyberTrader. The retention programs related
to the acquisition of CyberTrader and the merger with USTC ended in March
2002 and May 2002, respectively. For the six months ended June 30, 2001,
amount also includes goodwill amortization, which ceased on January 1, 2002
upon the adoption of SFAS No. 142.
n/m Not meaningful
The Company's operating income before taxes for the first half of 2002 was
$343 million, unchanged from the first half of 2001 as increases of $19 million,
or 17%, in the Individual Investor segment and $18 million, or 29%, in the U.S.
Trust segment, were offset by decreases of $20 million, or 14%, in the
Institutional Investor segment and $17 million, or 57%, in the Capital Markets
segment. These fluctuations were primarily due to the factors described in the
comparison between the three-month periods.
The Company's net income for the first half of 2002 was $192 million, or $.14
per share, compared to $199 million, or $.14 per share, for the first half of
2001. The Company's after-tax profit margin for the first half of 2002 was 9.1%,
up from 8.8% for the first half of 2001.
The annualized return on stockholders' equity for the first half of 2002 was
9%, unchanged from the first half of 2001.
REVENUES
Revenues declined $163 million, or 7%, to $2.1 billion in the first half of
2002 compared to the first half of 2001, due to a $152 million, or 20%, decrease
in commission revenues, a $50 million, or 10%, decrease in net interest revenue,
and a $50 million, or 33%, decrease in principal transaction revenues. These
declines were partially offset by a $72 million, or 9%, increase in asset
management and administration fees and a $17 million, or 27%, increase in other
revenues. As trading volumes decreased substantially during the first half of
2002, the Company's non-trading revenues represented 67% of total revenues as
compared to 60% for the first half of 2001 as shown in the following table:
- --------------------------------------------------------------------------------
Six Months
Ended
June 30,
Composition of Revenues 2002 2001
- --------------------------------------------------------------------------------
Commissions 28% 33%
Principal transactions 5 7
- --------------------------------------------------------------------------------
Total trading revenues 33 40
- --------------------------------------------------------------------------------
Asset management and administration fees 42 36
Net interest revenue 21 22
Other 4 2
- --------------------------------------------------------------------------------
Total non-trading revenues 67 60
- --------------------------------------------------------------------------------
Total 100% 100%
================================================================================
The $163 million decline in revenues from the first half of 2001 was
primarily due to decreases in revenues of $104 million, or 8%, in the Individual
Investor segment and $76 million, or 37%, in the Capital Markets segment. The
decrease in the Capital Markets segment was primarily due to lower average
revenue per equity share traded and lower share volume handled by SCM, partially
offset by higher revenues from client fixed income securities trading activity.
See note "12 - Segment Information" in the Notes to Condensed Consolidated
Financial Statements for financial information by segment.
Asset Management and Administration Fees
Asset management and administration fees were $891 million for the first
half of 2002, up $72 million, or 9%, from the first half of 2001, as shown in
the following table (in millions):
-19
- --------------------------------------------------------------------------------
Six Months
Ended
Asset Management June 30, Percent
and Administration Fees 2002 2001 Change
- --------------------------------------------------------------------------------
Mutual fund service fees:
Proprietary funds
(SchwabFunds(R)and Excelsior(R)) $437 $390 12%
Mutual Fund OneSource(R) 143 145 (1)
Other 20 17 18
Asset management and related services 291 267 9
- --------------------------------------------------------------------------------
Total $891 $819 9%
================================================================================
The increase in asset management and administration fees was due to the
factors described in the comparison between the three-month periods.
During the first half of 2002, net new client assets and new accounts
decreased from the first half of 2001 as shown in the table below.
- --------------------------------------------------------------------------------
Six Months
Ended
Change in Client Assets and Accounts June 30, Percent
(In billions, except as noted) 2002 2001 Change
- --------------------------------------------------------------------------------
Net change in assets
in client accounts
Net new client assets $ 26.9 $ 42.2
Net market losses (75.8) (55.6)
- --------------------------------------------------------------------
Net decline $(48.9) $ (13.4)
====================================================================
New client accounts
(in thousands) 456.9 546.3 (16%)
================================================================================
Commissions
Commission revenues for the Company were $597 million for the first half of
2002, down $152 million, or 20%, from the first half of 2001.
The Company's client trading activity is shown in the following table (in
thousands):
- --------------------------------------------------------------------------------
Six Months
Ended
June 30, Percent
Daily Average Trades 2002 2001 Change
- --------------------------------------------------------------------------------
Revenue Trades
Online 115.6 149.9 (23%)
TeleBroker(R)and Schwab by PhoneTM 6.2 8.3 (25)
Regional client telephone service
centers, branch offices, and other 16.2 19.8 (18)
- --------------------------------------------------------------------------------
Total 138.0 178.0 (22%)
================================================================================
Mutual Fund OneSource(R) Trades
Online 46.5 36.8 26%
TeleBroker and Schwab by Phone .5 .4 25
Regional client telephone service
centers, branch offices, and other 11.0 17.9 (39)
- --------------------------------------------------------------------------------
Total 58.0 55.1 5%
================================================================================
Total Daily Average Trades
Online 162.1 186.7 (13%)
TeleBroker and Schwab by Phone 6.7 8.7 (23)
Regional client telephone service
centers, branch offices, and other 27.2 37.7 (28)
- --------------------------------------------------------------------------------
Total 196.0 233.1 (16%)
================================================================================
As shown in the following table, the total number of revenue trades executed
by the Company has decreased 23% as the number of client accounts that traded
and client trading activity per account that traded have declined.
- --------------------------------------------------------------------------------
Six Months
Ended
Commissions Earned on June 30, Percent
Client Revenue Trades 2002 2001 Change
- --------------------------------------------------------------------------------
Client accounts that traded during
the period (in thousands) 2,014 2,224 (9%)
Average client revenue trades
per account that traded 8.5 10.0 (15)
Total revenue trades
(in thousands) 17,104 22,247 (23)
Trading frequency proxy (1) 3.7 4.6 (20)
Number of trading days 124 125 (1)
Average commission per
revenue trade $36.99 $34.13 8
Commissions earned on client
revenue trades (in millions) (2) $ 633 $ 759 (17)
- --------------------------------------------------------------------------------
(1) Represents annualized revenue trades per $100,000 in client assets.
(2) 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.
-20-
Net Interest Revenue
Net interest revenue was $439 million for the first half of 2002, down $50
million, or 10%, from the first half of 2001 as shown in the following table (in
millions):
- --------------------------------------------------------------------------------
Six Months
Ended
June 30, Percent
2002 2001 Change
- --------------------------------------------------------------------------------
Interest Revenue
Margin loans to clients $ 261 $ 513 (49%)
Investments, client-related 168 320 (48)
Private banking loans 119 116 3
Securities available for sale 39 42 (7)
Other 38 87 (56)
- --------------------------------------------------------------------------------
Total 625 1,078 (42)
- --------------------------------------------------------------------------------
Interest Expense
Brokerage client cash balances 98 460 (79)
Deposits from banking clients 46 74 (38)
Long-term debt 27 29 (7)
Short-term borrowings 13 10 30
Stock-lending activities 2 14 (86)
Other 2 n/m
- --------------------------------------------------------------------------------
Total 186 589 (68)
- --------------------------------------------------------------------------------
Net interest revenue $ 439 $ 489 (10%)
================================================================================
n/m Not meaningful
Client-related and other daily average balances, interest rates, and average
net interest spread for the first halves of 2002 and 2001 are summarized in the
following table (dollars in millions):
- --------------------------------------------------------------------------------
Six Months Ended
June 30,
2002 2001
- --------------------------------------------------------------------------------
Interest-Earning Assets (client-related and other):
Investments (client-related):
Average balance outstanding $ 17,674 $ 13,171
Average interest rate 1.92% 4.90%
Margin loans to clients:
Average balance outstanding $ 9,097 $ 12,860
Average interest rate 5.78% 8.04%
Private banking loans:
Average balance outstanding $ 4,079 $ 3,167
Average interest rate 5.87% 7.39%
Securities available for sale:
Average balance outstanding $ 1,501 $ 1,329
Average interest rate 5.18% 6.34%
Average yield on interest-earning assets 3.65% 6.54%
Funding Sources (client-related and other):
Interest-bearing brokerage client cash balances:
Average balance outstanding $ 23,256 $ 22,375
Average interest rate .86% 4.14%
Interest-bearing banking deposits:
Average balance outstanding $ 3,832 $ 3,315
Average interest rate 2.41% 4.52%
Other interest-bearing sources:
Average balance outstanding $ 1,041 $ 1,299
Average interest rate 2.25% 4.66%
Average noninterest-bearing portion $ 4,222 $ 3,538
Average interest rate on funding sources .98% 3.72%
Summary:
Average yield on interest-earning assets 3.65% 6.54%
Average interest rate on funding sources .98% 3.72%
- --------------------------------------------------------------------------------
Average net interest spread 2.67% 2.82%
- --------------------------------------------------------------------------------
The decrease in net interest revenue from the first half of 2001 was due to
the factors described in the comparison between the three-month periods.
Principal Transactions
Principal transaction revenues were $100 million for the first half of 2002,
down $50 million, or 33%, from the first half of 2001, as shown in the following
table (in millions):
- --------------------------------------------------------------------------------
Six Months
Ended
June 30, Percent
Principal Transactions 2002 2001 Change
- --------------------------------------------------------------------------------
Fixed income securities $ 47 $ 29 62%
Nasdaq and other equity securities 47 109 (57)
Other 6 12 (50)
- --------------------------------------------------------------------------------
Total $100 $150 (33%)
================================================================================
The decrease in principal transaction revenues was due to the change to
decimal pricing, which was not fully
-21-
implemented in the first quarter of 2001, as well as the factors described in
the comparison between the three-month periods.
Other Revenues
Other revenues were $81 million for the first half of 2002, up $17 million,
or 27%, from the first half of 2001. This increase was due to the factors
described in the comparison between the three-month periods, as well as a gain
recorded on the sale of the Company's Canadian operations in the first quarter
of 2002.
EXPENSES EXCLUDING INTEREST
Total expenses excluding interest for the first half of 2002 declined $311
million, or 15%, from the first half of 2001. The Company's initiatives under
its restructuring plan and other expense reduction measures have resulted in
decreases in most expense categories during the first half of 2002 when compared
to the first half of 2001. The Company recorded total pre-tax charges of $30
million in the first half of 2002 for restructuring charges under its
restructuring plan. In the first half of 2001, the Company recorded total
pre-tax restructuring and other charges of $145 million.
Compensation and benefits expense was $941 million for the first half of
2002, down $31 million, or 3%, from the first half of 2001 primarily due to a
reduction in full-time equivalent employees, partially offset by the accrual of
discretionary bonuses to employees in the first half of 2002. The following
table shows a comparison of certain compensation and benefits components and
employee data (in thousands):
- --------------------------------------------------------------------------------
Six Months
Ended
June 30,
2002 2001
- --------------------------------------------------------------------------------
Compensation and benefits expense as a
% of total revenues 45% 43%
Variable compensation as a
% of compensation and benefits expense 14% 10%
Compensation for temporary employees,
contractors and overtime hours as a
% of compensation and benefits expense 5% 7%
Full-time equivalent employees
(at end of period) (1) 19.1 22.4
Revenues per average full-time equivalent
employee $108.8 $ 93.2
- --------------------------------------------------------------------------------
(1) Includes full-time, part-time, and temporary employees, and persons
employed on a contract basis.
Communications expense was $137 million for the first half of 2002, down $48
million, or 26%, from the first half of 2001. This decrease was due to the
factors described in the comparison between the three-month periods.
Advertising and market development expense was $105 million for the first
half of 2002, down $39 million, or 27%, from the first half of 2001. This
decrease was primarily a result of reductions in television and print media
spending as part of the Company's expense reduction measures.
Goodwill amortization expense for the first half of 2001 was $32 million.
Upon adoption of SFAS No. 142 on January 1, 2002, amortization of the existing
goodwill ceased and therefore there was no such expense in the first half of
2002. The Company did not record any goodwill impairment charges in the first
half of 2002 upon completion of the initial transitional impairment test under
SFAS No. 142.
The Company's effective income tax rate was 37.7% for the first half of 2002,
down from 44.6% for the first half of 2001. The decrease was due to the factors
described in the comparison between the three-month periods.
Liquidity and Capital Resources
CSC is 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. 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 "10 - Regulatory Requirements" in the Notes to Condensed
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, meeting CSC's depository institution subsidiaries' capital
guidelines, and maintaining Schwab's and SCM's net capital. Based on their
respective regulatory capital ratios at June 30, 2002, the Company and its
depository institution subsidiaries are considered well capitalized.
CSC has liquidity needs that arise from its issued and outstanding $597
million Senior Medium-Term Notes,
-22-
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 2002 to 2010 and fixed interest rates ranging from 6.04% to 8.05%
with interest payable semiannually (see Item 3 - Quantitative and Qualitative
Disclosures About Market Risk - Interest Rate Swaps). The Medium-Term Notes are
rated A2 by Moody's Investors Service, A- by Standard & Poor's Ratings Group
(S&P), and A by Fitch IBCA, Inc. (Fitch). The rating by S&P was lowered to A-
from A on August 1, 2002. The rating by Fitch was lowered to A from A+ on May
17, 2002.
CSC has a prospectus supplement on file with the Securities and Exchange
Commission enabling CSC to issue up to $750 million in Senior or Senior
Subordinated Medium-Term Notes, Series A. At June 30, 2002, all of these notes
remained unissued.
CSC has authorization from its Board of Directors to issue up to $1.0 billion
in commercial paper. At June 30, 2002, no commercial paper has been issued.
CSC's ratings for these short-term borrowings are P-1 by Moody's Investors
Service, A-2 by S&P, and F1 by Fitch. The rating by S&P was lowered to A-2 from
A-1 on August 1, 2002.
In June 2002, CSC established a $1.0 billion committed, unsecured credit
facility with a group of twenty-two banks which is scheduled to expire in June
2003. This facility replaced a similar $1.2 billion facility that expired in
June 2002. CSC reduced the size of the new facility due to its current and
expected liquidity requirements. These facilities were unused during the first
six months of 2002. Any issuances under CSC's commercial paper program will
reduce the amount available under this facility. 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.
CSC also has direct access to $670 million of the $770 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. These lines were not
used by CSC during the first six months of 2002.
Schwab
Liquidity needs relating to client trading and margin borrowing activities
are met primarily through cash balances in brokerage client accounts, which were
$23.3 billion and $25.0 billion at June 30, 2002 and December 31, 2001,
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 requirement of $1 million. At
June 30, 2002, Schwab's net capital was $1.1 billion (13% of aggregate debit
balances), which was $952 million in excess of its minimum required net capital
and $698 million in excess of 5% of aggregate debit balances. Schwab has
historically targeted net capital to be at least 10% of its aggregate debit
balances, which primarily consist of client margin loans.
To manage Schwab's regulatory capital position, CSC provides Schwab with a
$1.4 billion subordinated revolving credit facility maturing in September 2003,
of which $220 million was outstanding at June 30, 2002. At quarter end, Schwab
also had outstanding $25 million in fixed-rate subordinated term loans from CSC
maturing in 2004. Borrowings under these subordinated lending arrangements
qualify as regulatory capital for Schwab.
To manage short-term liquidity, Schwab maintains uncommitted, unsecured bank
credit lines with a group of eight banks totaling $770 million at June 30, 2002
(as noted previously, $670 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 8 days during the
first six months of 2002, with the daily amounts borrowed averaging $44 million.
There were no borrowings outstanding under these lines at June 30, 2002.
To satisfy the margin requirement of client option transactions with the
Options Clearing Corporation (OCC), Schwab had unsecured letter of credit
agreements with ten banks in favor of the OCC aggregating $765 million at June
30, 2002. Schwab pays a fee to maintain these letters of credit. No funds were
drawn under these letters of credit at June 30, 2002.
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
-23-
depository institution subsidiaries are subject to limitations on the amount of
dividends they can pay to USTC.
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 June 30, 2002, 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 $697 million. At June 30, 2002, $300 million in
short-term borrowings and $101 million in long-term debt were outstanding under
these facilities. Additionally, at June 30, 2002, U.S. Trust had $595 million of
federal funds purchased and $366 million of repurchase agreements outstanding.
CSC provides U.S. Trust with a $300 million short-term credit facility
maturing in 2003. Borrowings under this facility do not qualify as regulatory
capital for U.S. Trust. The amount outstanding under this facility was $30
million at June 30, 2002.
SCM
SCM's liquidity needs are generally met through earnings generated by its
operations. Most of SCM's assets are liquid, consisting primarily of cash and
cash equivalents, marketable securities, 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 June 30, 2002, SCM's net capital was $133
million, which was $132 million in excess of its minimum required net capital.
SCM may borrow up to $150 million under a subordinated lending arrangement
with CSC maturing in 2003. Borrowings under this arrangement qualify as
regulatory capital for SCM. The amount outstanding under this facility was $125
million at June 30, 2002 and had been reduced to $60 million at July 31, 2002.
The advances under this facility reflect increased intra-day capital needs at
SCM to support the expansion of its institutional equities business. In
addition, CSC provides SCM with a $50 million short-term credit facility.
Borrowings under this arrangement do not qualify as regulatory capital for SCM.
No funds were drawn under this facility at June 30, 2002.
Liquidity Risk Factors
Specific risk factors which may affect the Company's liquidity position are
discussed in "Management's Discussion and Analysis of Results of Operations and
Financial Condition - Liquidity and Capital Resources - Liquidity Risk Factors"
in the Company's 2001 Annual Report to Stockholders, which is filed as Exhibit
13.1 to the Company's Form 10-K for the year ended December 31, 2001. There have
been no material changes to these liquidity risk factors in the first half of
2002.
Cash Flows and Capital Resources
Net income plus depreciation and amortization including goodwill amortization
was $356 million for the first half of 2002, down 11% from $398 million for the
first half of 2001. Depreciation and amortization expense related to equipment,
office facilities and property was $159 million for the first half of 2002, as
compared to $162 million for the first half of 2001, or 8% and 7% of revenues
for each period, respectively. Amortization expense related to intangible assets
was $5 million for each of the first halves of 2002 and 2001. Goodwill
amortization expense was $32 million for the first half of 2001.
The Company's cash position (reported as cash and cash equivalents on the
condensed consolidated balance sheet) and cash flows are affected by changes in
brokerage client cash balances and the associated amounts required to be
segregated under federal or other regulatory guidelines. Timing differences
between cash and investments actually segregated on a given date and the amount
required to be segregated for that date may arise in the ordinary course of
business and are addressed by the Company in accordance with applicable
regulations. Other factors which affect the Company's cash position and cash
flows include investment activity in securities owned, levels of capital
expenditures, banking client deposit and loan activity, financing activity in
short-term borrowings and long-term debt, and repurchases of CSC's common stock.
In the first half of 2002, cash and cash equivalents decreased $1.9 billion, or
43%, to $2.5 billion primarily due to movements of brokerage client-related
funds to meet segregation requirements, decreases in brokerage client cash
balances and banking client deposits, and increases in investments in securities
available for sale. Management does not believe that this decline in cash and
cash equivalents is an indication of a trend.
The Company's capital expenditures were $72 million in the first half of 2002
and $208 million in the first half of 2001, or 3% and 9% of revenues for each
period, respectively. Capital expenditures in the first half of 2002 were for
software and equipment relating to the Company's information technology systems
and certain facilities. Capital expenditures as described above include the
capitalized costs for developing internal-use software of $36 million in the
first half of 2002 and $47 million in the first half of 2001. As discussed in
the Company's 2001 Annual Report to Stockholders, which is filed as Exhibit 13.1
to the Company's Form 10-K for the year ended December 31, 2001, management
anticipated that 2002 capital expenditures would be approximately 10% to 20%
lower than 2001 spending. Due to a continued
-24-
economic slowdown and management's continued focus on cost containment, the
Company further reduced its capital expenditures in the first half of 2002.
Management currently anticipates that full-year 2002 capital expenditures will
be approximately 30% to 40% lower than 2001 levels.
During the first half of 2002, 3 million of the Company's stock options, with
a weighted-average exercise price of $6.67, were exercised with cash proceeds
received by the Company of $19 million and a related tax benefit of $4 million.
The cash proceeds are recorded as an increase in cash and a corresponding
increase in stockholders' equity. The tax benefit is recorded as a reduction in
income taxes payable and a corresponding increase in stockholders' equity.
The Company borrowed $100 million and repaid $82 million of long-term debt
during the first half of 2002.
During the first half of 2002, CSC repurchased 3 million shares of its common
stock for $31 million. During the first half of 2001, CSC repurchased 8 million
shares of its common stock for $144 million. At June 30, 2002, the authorization
granted by the Board of Directors allows for future repurchases of CSC's common
stock totaling up to $368 million of the original $500 million authorization.
During each of the first halves of 2002 and 2001, the Company paid common
stock cash dividends of $30 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 June 30, 2002 was $5.1 billion, up $203 million, or 4%,
from December 31, 2001. At June 30, 2002, the Company had long-term debt of $751
million, or 15% of total financial capital, that bears interest at a
weighted-average rate of 6.89%. At June 30, 2002, the Company's stockholders'
equity was $4.3 billion, or 85% of total financial capital.
Commitments
A summary of the Company's principal contractual obligations and other
commitments as of June 30, 2002 is shown in the following table (in millions).
Management believes that funds generated by its operations, as well as cash
provided by external financing, will continue to be the primary funding sources
in meeting these obligations and commitments.
- --------------------------------------------------------------------------------
Less than 1 - 3 4 - 5 After 5
1 Year Years Years Years Total
- --------------------------------------------------------------------------------
Operating leases (1) $ 153 $ 862 $ 254 $ 764 $2,033
Long-term debt (2) 32 337 106 273 748
Short-term borrowings 1,274 1,274
Credit-related financial
instruments (3) 565 115 680
Other commitments (4) 6 6
- --------------------------------------------------------------------------------
Total $2,030 $1,314 $ 360 $1,037 $4,741
================================================================================
(1) Includes minimum rental commitments and maximum guaranteed residual values
under noncancelable leases for office space and equipment.
(2) Excludes the effect of interest rate swaps, see Item 3 - Quantitative and
Qualitative Disclosures About Market Risk - Interest Rate Swaps.
(3) Includes U.S. Trust firm commitments to extend credit primarily for
mortgage loans to private banking clients and standby letters of credit.
(4) Includes committed capital contributions to venture capital funds.
In addition to the commitments summarized above, in the ordinary course of
its business the Company has entered into various agreements with third-party
vendors, including agreements for advertising, sponsorships of sporting events,
data processing equipment purchases, licensing, and software installation. These
agreements typically can be canceled by the Company if notice is given within
the terms specified in the agreements.
Item 3. Quantitative and Qualitative Disclosures
About Market Risk
Financial Instruments Held For Trading Purposes
The Company held municipal, other fixed income and government securities, and
certificates of deposit with a fair value of approximately $59 million and $36
million at June 30, 2002 and December 31, 2001, respectively. These securities,
and the associated interest rate risk, are not material to the Company's
financial position, results of operations, or cash flows.
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 June 30, 2002 was $153 million in long positions and $50 million
in short positions. The fair value of these securities at December 31, 2001 was
$167 million in long positions and $27 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 $10 million and $14 million at June
30, 2002 and December 31, 2001, respectively, due to the offset of change in
fair value in long and short positions. In addition, the Company generally
enters into exchange-traded futures and options to hedge against potential
losses in equity inventory positions, thus offsetting this potential loss
exposure. A hypothetical 10% change in fair value of the futures and options at
June 30, 2002 and December 31, 2001 would substantially offset the potential
-25-
loss or gain on the equity securities discussed above. The notional amount and
fair value of futures and options were not material to the Company's condensed
consolidated balance sheets at June 30, 2002 and December 31, 2001.
Financial Instruments Held For Purposes Other Than Trading
Deferred Compensation
The Company maintains investments in mutual funds related to its deferred
compensation plan, which is available to certain employees. These investments
were approximately $55 million and $61 million at June 30, 2002 and December 31,
2001, respectively. These securities, and the associated market risk, are not
material to the Company's financial position, results of operations, or cash
flows.
Debt Issuances
At June 30, 2002, CSC had $597 million aggregate principal amount of
Medium-Term Notes, with fixed interest rates ranging from 6.04% to 8.05%. At
December 31, 2001, CSC had $679 million aggregate principal amount of
Medium-Term Notes, with fixed interest rates ranging from 6.04% to 8.05%. See
"Interest Rate Swaps" below.
At June 30, 2002 and December 31, 2001, U.S. Trust had $50 million Trust
Preferred Capital Securities outstanding, with a fixed interest rate of 8.41%.
In addition at June 30, 2002 and December 31, 2001, U.S. Trust had $101 million
and $1 million FHLB long-term debt outstanding, respectively. The FHLB long-term
debt had fixed interest rates ranging from 3.90% to 6.69% at June 30, 2002 and a
fixed interest rate of 6.69% at December 31, 2001.
The Company has fixed cash flow requirements regarding these long-term debt
obligations due to the fixed rate of interest. The fair value of these
obligations at June 30, 2002 and December 31, 2001, based on estimates of market
rates for debt with similar terms and remaining maturities, approximated their
carrying amount.
Interest Rate Swaps
As part of its consolidated asset and liability management process, the
Company utilizes interest rate swaps (Swaps) to manage interest rate risk.
U.S. Trust uses Swaps to hedge the interest rate risk associated with its
variable rate deposits from banking clients. These Swaps call for U.S. Trust to
receive a variable rate of interest and pay a fixed rate of interest. At June
30, 2002, these Swaps had a weighted-average variable interest rate of 1.91%, a
weighted-average fixed interest rate of 6.36%, a weighted-average maturity of
2.1 years, and an aggregate notional principal amount of $880 million. At
December 31, 2001, the notional principal amount of such Swaps totaled $905
million, and they carried a weighted-average variable interest rate of 2.15%, a
weighted-average fixed interest rate of 6.37%, and a weighted-average maturity
of 2.6 years. These Swaps have been designated as cash flow hedges under SFAS
No. 133 - Accounting for Derivative Instruments and Hedging Activities, and are
recorded on the condensed consolidated balance sheet, with changes in their fair
values primarily recorded in other comprehensive income (loss), a component of
stockholders' equity. At June 30, 2002 and December 31, 2001, U.S. Trust
recorded a derivative liability of $55 million and $54 million, respectively,
for these Swaps.
During the second quarter of 2002, CSC entered into Swaps with an aggregate
notional principal amount of $293 million that effectively alter the interest
rate characteristics of a like amount of its Medium-Term Notes. These Swaps call
for CSC to receive a fixed rate of interest and pay a variable rate of interest
based on three-month LIBOR. At June 30, 2002, the net effect of the Swaps
converted the Medium-Term Notes from a weighted-average fixed interest rate of
7.57% to a weighted-average variable interest rate of 4.34%. The variable
interest rates reset every three months. These Swaps have been designated as
fair value hedges under SFAS No. 133, and are recorded on the condensed
consolidated balance sheet. Changes in fair value of the Swaps are completely
offset by changes in fair value of the hedged Medium-Term Notes, resulting in no
effect on earnings. At June 30, 2002, CSC recorded a derivative asset of $3
million for these Swaps. Concurrently, the carrying value of the Medium-Term
Notes was increased by $3 million.
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, as well as
Swaps utilized by the Company to hedge its interest rate risk. Key variables in
the model include assumed margin loan and brokerage client cash balance growth
or decline, 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
-26-
management strategies, including changes in asset and liability mix.
As demonstrated by the simulations presented below, the Company is positioned
so that the consolidated balance sheet produces an increase in net interest
revenue when interest rates rise and, conversely, a decrease in net interest
revenue when rates fall (i.e., interest-earning assets are repricing more
quickly than interest-bearing liabilities). The Swaps entered into during the
second quarter of 2002 have the effect of increasing the repricing frequency of
interest-bearing liabilities, thereby reducing the Company's consolidated
interest-rate sensitivity.
The simulations in the following table assume that the asset and liability
structure of the consolidated balance sheet would not be changed as a result of
the simulated changes in interest rates. As the Company actively manages its
consolidated balance sheet and interest rate exposure, in all likelihood the
Company would take steps to manage any additional interest rate exposure that
could result from changes in the interest rate environment. The following table
shows the effect of a gradual 100 basis point increase or decrease in interest
rates relative to the Company's current base rate forecast on simulated net
interest revenue over the next twelve months at June 30, 2002 and December 31,
2001.
- --------------------------------------------------------------------------------
Impact on Net Interest Revenue June 30, December 31,
Percentage Increase (Decrease) 2002 2001
- --------------------------------------------------------------------------------
Increase of 100 basis points 1.5% 3.8%
Decrease of 100 basis points (4.0%) (7.0%)
- --------------------------------------------------------------------------------
The impact of the Company's hedging activities upon net interest revenue for
the quarters ended June 30, 2002 and December 31, 2001 was immaterial to the
Company's results of operations.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
United States Trust Company of New York (U.S. Trust NY) was Escrow Agent and
Indenture Trustee in connection with an offering of approximately $130 million
in senior secured redeemable notes issued in July 1998 by Epic Resorts, LLC
(Epic Notes). In January 2002, certain noteholders filed a complaint in the
Supreme Court of New York, New York County against U.S. Trust NY alleging that
U.S. Trust NY failed to comply with its obligations as Escrow Agent and
Indenture Trustee for the Epic Notes, and are seeking damages. Although USTC
sold its Corporate Trust business in 2001, under the sale agreement, USTC
retains liability arising from certain litigation, including this case. The
plaintiff noteholders claim that as a result of the alleged breaches, they
suffered financial losses, including losing their investment in the Epic Notes.
U.S. Trust NY has answered the complaint, denying plaintiffs' allegations and
asserting affirmative defenses, and intends to vigorously defend the lawsuit.
The nature of the Company's business, including its new products and
services, subjects it to claims, lawsuits, regulatory examinations, and other
proceedings in the ordinary course of business. The results of these matters
cannot be predicted with certainty. There can be no assurance that these matters
will not have a material adverse effect on the Company's results of operations
in any future period, depending partly on the results for that period, and a
substantial judgment could have a material adverse impact on the Company's
financial condition and results of operations. However, it is the opinion of
management, after consultation with legal counsel, that the ultimate outcome of
current matters will not have a material adverse impact on the financial
condition or operating results of the Company.
Item 2. Changes in Securities and Use of Proceeds
None.
Item 3. Defaults Upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders
CSC's Annual Meeting of Stockholders was held on May 13, 2002, and a total of
1,096,840,478 shares were present in person or by proxy at the Annual Meeting.
CSC's stockholders voted upon the following proposals:
-27-
Proposal No. 1 - Election of Four Directors:
Shares For Shares Withheld
----------- -----------------
Frank C. Herringer 1,062,658,100 34,182,378
Stephen T. McLin 1,076,630,429 20,210,049
Charles R. Schwab 992,880,934 103,959,544
Roger O. Walther 1,068,032,148 28,808,330
Proposal No. 2 - Approval of an Amendment to the Corporate Executive Bonus Plan:
Shares For Shares Against Abstentions
------------- --------------- -------------
1,003,629,221 82,962,197 10,249,060
Proposal No. 3 - Approval of an Amendment to the Annual Executive Individual
Performance Plan:
Shares For Shares Against Abstentions
------------- --------------- -------------
1,009,168,288 77,742,968 9,929,222
With respect to each of the above proposals, there were no broker non-votes.
Item 5. Other Information
Effective April 17, 2002, CSC's Board of Directors appointed Paula A. Sneed
to the Board, filling a seat left vacant by Condoleezza Rice when she resigned
in January 2001 to become the National Security Advisor in the Bush
administration. Ms. Sneed is Group Vice President and President of E-Commerce
and Marketing Services for Kraft Foods North America, part of Kraft Foods Inc.
On July 16, 2002, CSC's Board of Directors appointed the following
individuals to their respective positions:
William L. Atwell Executive Vice Effective
President, June 19, 2002
President of Schwab
Institutional
John Philip Coghlan Vice Chairman and Effective
President of Retail July 8, 2002
Jody L. Bilney Executive Vice Effective
President and Chief July 22, 2002
Marketing Officer
With these appointments, Mr. Atwell and Ms. Bilney became members of the
Company's Executive Committee, expanding it from eight to ten members. Mr.
Coghlan was already a member of the Executive Committee.
Mr. Atwell succeeded Mr. Coghlan as President of Schwab Institutional upon
Mr. Coghlan's appointment as President of Retail. The Retail enterprise had been
headed by David S. Pottruck, President and Co-Chief Executive Officer of the
Company, on an interim basis since February 19, 2002.
Item 6. Exhibits and Reports on Form 8-K
(a) The following exhibits are filed as part of this quarterly report on Form
10-Q.
- --------------------------------------------------------------------------------
Exhibit
Number Exhibit
- --------------------------------------------------------------------------------
10.239 The Charles Schwab Corporation Annual Executive Individual
Performance Plan, restated to include amendments approved at
the Annual Meeting of Stockholders on May 13, 2002
(supersedes Exhibit 10.211).
10.240 The Charles Schwab Corporation Corporate Executive Bonus
Plan, restated to include amendments approved at the Annual
Meeting of Stockholders on May 13, 2002 (supersedes Exhibit
10.212).
10.241 Credit Agreement (364-Day Commitment) dated as of June 21,
2002 between the Registrant and the financial institutions
listed therein (supersedes Exhibit 10.238).
12.1 Computation of Ratio of Earnings to Fixed Charges.
99.1 Certification Pursuant To 18 U.S.C. Section 1350, As Adopted
Pursuant To Section 906 Of The Sarbanes-Oxley Act Of 2002.
99.2 Certification Pursuant To 18 U.S.C. Section 1350, As Adopted
Pursuant To Section 906 Of The Sarbanes-Oxley Act Of 2002.
99.3 Certification Pursuant To 18 U.S.C. Section 1350, As Adopted
Pursuant To Section 906 Of The Sarbanes-Oxley Act Of 2002.
- --------------------------------------------------------------------------------
(b) Reports on Form 8-K
None.
-28-
THE CHARLES SCHWAB CORPORATION
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
THE CHARLES SCHWAB CORPORATION
(Registrant)
Date: August 13, 2002 /s/ Christopher V. Dodds
----------------- ---------------------------------
Christopher V. Dodds
Executive Vice President and
Chief Financial Officer
-29-