Charles Schwab 2010 Annual Report Download - page 57

THE CHARLES SCHWAB CORPORATION
Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Millions, Except Ratios, or as Noted)
CRITICAL ACCOUNTING ESTIMATES
The consolidated financial statements of the Company have been prepared in accordance with accounting principles generally
accepted in the U.S. While the majority of the Company’s revenues, expenses, assets and liabilities are not based on estimates, there
are certain accounting principles that require management to make estimates regarding matters that are uncertain and susceptible to
change where such change may result in a material adverse impact on the Company’s financial position and reported financial results.
These critical accounting estimates are described below. Management regularly reviews the estimates and assumptions used in the
preparation of the Company’s financial statements for reasonableness and adequacy.
Other-than-Temporary Impairment of Securities Available for Sale and Securities Held to Maturity: Management evaluates whether
securities available for sale and securities held to maturity are other-than-temporarily impaired (OTTI) on a quarterly basis. Debt
securities with unrealized losses are considered OTTI if the Company intends to sell the security or if it is more likely than not that
the Company will be required to sell such security prior to any anticipated recovery. If management determines that a security is
OTTI under these circumstances, the impairment recognized in earnings is measured as the entire difference between the amortized
cost and the then-current fair value.
A security is also OTTI if management does not expect to recover the amortized cost of the security. In this circumstance,
management utilizes cash flow models to estimate the expected future cash flow from the securities and to estimate the credit loss.
The impairment recognized in earnings is measured by the difference between the present value of expected cash flows and the
amortized cost of the security. Expected cash flows are discounted using the security’s effective interest rate.
The evaluation of whether the Company expects to recover the amortized cost of a security is inherently judgmental. The evaluation
includes the assessment of several bond performance indicators including: the portion of the underlying loans that are delinquent (30
days, 60 days, 90+ days), in bankruptcy, in foreclosure or converted to real estate owned; the actual amount of loss incurred on the
underlying loans in which the property has been foreclosed and sold; the amount of credit support provided by the structure of the
security available to absorb credit losses on the underlying loans; the current credit ratings issued by either Standard & Poor’s, Fitch
Ratings, or Moody’s; the current price and magnitude of the unrealized loss; and whether the Company has received all scheduled
principal and interest payments. Management uses cash flow models to further assess the likelihood of other-than-temporary
impairment for the Company’s non-agency residential mortgage-backed securities. To develop the cash flow models, the Company
uses forecasted loss severity, prepayment speeds (i.e. the rate at which the principal on underlying loans are paid down), and default
rates over the securities’ expected remaining maturities.
Valuation of Goodwill: The Company tests goodwill for impairment at least annually, or whenever indications of impairment exist.
An impairment exists when the carrying amount of goodwill exceeds its implied fair value, resulting in an impairment charge for this
excess.
The Company has elected April 1 as its annual goodwill impairment testing date. In testing for a potential impairment of goodwill on
April 1, 2010, management estimated the fair value of each of the Company’s reporting units (generally defined as the Company’s
businesses for which financial information is available and reviewed regularly by management) and compared this value to the
carrying value of the reporting unit. The estimated fair value of each reporting unit exceeded its carrying value, and therefore
management concluded that no amount of goodwill was impaired. The estimated fair value of the reporting units was established
using a discounted cash flow model that includes significant assumptions about the future operating results and cash flows of each
reporting unit. Adverse changes in the Company’s planned business operations such as unanticipated competition, a loss of key
personnel, the sale of a reporting unit or a significant portion of a reporting unit, or other unforeseen developments could result in an
impairment of the Company’s recorded goodwill.
A
llowance for Loan Losses: The adequacy of the allowance is reviewed quarterly by management, taking into consideration current
economic conditions, the existing loan portfolio composition, past loss experience, and risks inherent in the portfolio.
The process to establish an allowance for loan losses utilizes loan-level statistical models that estimate prepayments, defaults, and
probable losses for the loan portfolios based on predicted behavior of individual loans within the portfolios. The
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