Charles Schwab 2010 Annual Report Download - page 71

THE CHARLES SCHWAB CORPORATION
Notes to Consolidated Financial Statements
(Tabular Amounts in Millions, Except Per Share Data, Option Price Amounts, Ratios, or as Noted)
Securities borrowed and securities loaned: Securities borrowed require the Company to deliver cash to the lender in exchange for
securities and are included in receivables from brokers, dealers, and clearing organizations. For securities loaned, the Company
receives collateral in the form of cash in an amount equal to or greater than the market value of securities loaned. Securities loaned
are included in payables to brokers, dealers, and clearing organizations. The Company monitors the market value of securities
borrowed and loaned, with additional collateral obtained to ensure full collateralization or refunded. Fees received or paid are
recorded in interest revenue or interest expense.
L
oans to banking clients are recorded at their contractual principal amounts and include unamortized direct origination costs.
Additionally, loans are recorded net of an allowance for loan losses. The Company’s loan portfolio includes four loan segments:
residential real estate mortgages, home equity lines of credit (HELOC), personal loans secured by securities and other loans.
Residential real estate mortgages include two loan classes: originated first mortgages and purchased first mortgages. Loan segments
are defined as the level to which the Company disaggregates its loan portfolio when developing and documenting a methodology for
determining the allowance for loan losses. A loan class is defined as a group of loans within a loan segment that has homogeneous
risk characteristics.
The Company records an allowance for loan losses through a charge to earnings based on management’s evaluation of the existing
portfolio. 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 methodology
considers the effects of borrower behavior and a variety of factors including, but not limited to, interest rates, housing price
movements as measured by a housing price index, economic conditions, estimated defaults and foreclosures measured by historical
and expected delinquencies, changes in prepayment speeds, loan-to-value ratios, past loss experience, estimates of future loss
severities, borrower credit risk measured by FICO scores, and the adequacy of collateral. The methodology also evaluates
concentrations in the loan portfolios including loan products, year of origination, geographical distribution of collateral, and the
portion of borrowers who have other client relationships with the Company.
The more significant variables considered include a measure of delinquency roll rates, loss severity, housing prices, and interest rates.
Delinquency roll rates (i.e., the rates at which loans transition through delinquency stages and ultimately result in a loss) are estimated
from the Company’s historical loss experience adjusted for current trends and market information. Loss severity estimates are based
on the Company’s historical loss experience and market trends. Housing price trends are derived from historical home price indices
and econometric forecasts of future home values. Factors affecting the home price index include: housing inventory, unemployment,
interest rates, and inflation expectations. Interest rate projections are based on the current term structure of interest rates and historical
volatilities to project various possible future interest rate paths. This quarterly analysis results in a loss factor that is applied to the
outstanding balances to determine the allowance for loan loss for each loan segment.
N
onaccrual loans: Residential real estate mortgages, HELOC, personal, and other loans are placed on nonaccrual status upon
becoming 90 days past due as to interest or principal (unless the loans are well-secured and in the process of collection), or when the
full timely collection of interest or principal becomes uncertain. When a loan is placed on nonaccrual status, the accrued and unpaid
interest receivable is reversed and the loan is accounted for on the cash or cost recovery method thereafter, until qualifying for return
to accrual status. Generally, a loan may be returned to accrual status when all delinquent interest and principal is repaid and the loan
is performing in accordance with the terms of the loan agreement, or when the loan is both well-secured and in the process of
collection and collectability is no longer doubtful.
L
oans held for sale include fixed-rate residential first-mortgage loans intended for sale. Loans held for sale are recorded at the lower
of cost or fair value. The fair value of loans held for sale is estimated using quoted market prices for securities backed by similar
types of loans.
E
quipment, office facilities, and property: Equipment, office facilities, and property are recorded at cost net of accumulated
depreciation and amortization, except for land, which is recorded at cost. Equipment and office facilities are depreciated on a
-52 -