Charles Schwab 2011 Annual Report Download - page 36

THE CHARLES SCHWAB CORPORATION
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The Company may suffer significant losses from its credit exposures.
The Company’s businesses are subject to the risk that a client, counterparty or issuer will fail to perform its contractual
obligations, or that the value of collateral held to secure obligations will prove to be inadequate. While the Company has
policies and procedures designed to manage this risk, the policies and procedures may not be fully effective. The Company’s
exposure mainly results from margin lending activities, securities lending activities, mortgage lending activities, its role as a
counterparty in financial contracts and investing activities, and indirectly from the investing activities of certain of the
proprietary funds that the Company sponsors.
The Company has exposure to credit risk associated with its securities available for sale and securities held to maturity
portfolios, which include U.S. agency and non-agency residential mortgage-backed securities, consumer loan asset-backed
securities, corporate debt securities, U.S. agency notes, and certificates of deposit among other investments. These instruments
are also subject to price fluctuations as a result of changes in the financial market’s assessment of issuer credit quality,
increases in the unemployment rate, delinquency and default rates, housing price declines, changes in prevailing interest rates
and other economic factors.
Loss of value of securities available for sale and securities held to maturity can result in charges if management determines
that the impairments are other than temporary. The evaluation of whether other-than-temporary impairment exists is a matter
of judgment, which includes the assessment of several factors. See “Item 7 – Management’s Discussion and Analysis of
Financial Condition and Results of Operations – Critical Accounting Estimates.” If management determines that a security is
other-than-temporarily impaired, the cost basis of the security may be adjusted and a corresponding loss may be recognized in
current earnings. Certain securities available for sale experienced continued credit deterioration in 2011, which resulted in
impairment charges. Deterioration in the performance of securities available for sale and securities held to maturity could
result in the recognition of future impairment charges.
The Company’s loans to banking clients primarily consist of first-lien residential real estate mortgage loans and HELOCs.
Increases in delinquency and default rates, housing price declines, increases in the unemployment rate, and other economic
factors can result in charges for loan loss reserves and write downs on such loans.
Heightened credit exposures to specific counterparties or instruments (concentration risk) can increase the Company’s risk of
loss. Examples of the Company’s credit concentration risk include:
 large positions in financial instruments collateralized by assets with similar economic characteristics or in securities
of a single issuer or industry;
 mortgage loans and HELOCs to banking clients which are secured by properties in the same geographic region; and
 margin and securities lending activities collateralized by securities of a single issuer or industry.
The Company may also be subject to concentration risk when lending to a particular counterparty, borrower or issuer.
The Company sponsors a number of proprietary money market mutual funds and other proprietary funds. Although the
Company has no obligation to do so, the Company may decide for competitive reasons to provide credit, liquidity or other
support to its funds in the event of significant declines in valuation of fund holdings or significant redemption activity that
exceeds available liquidity. Such support could cause the Company to take significant charges and could reduce the
Company’s liquidity. If the Company chose not to provide credit, liquidity or other support in such a situation, the Company
could suffer reputational damage and its business could be adversely affected.
Significant interest rate changes could affect the Company’s profitability and financial condition.
The Company is exposed to interest rate risk primarily from changes in the interest rates on its interest-earning assets (such as
cash equivalents, short- and long-term investments, and mortgage and margin loans) relative to changes in the costs of its
funding sources (including deposits in banking and brokerage accounts, short-term borrowings, and long-term debt). Changes
in interest rates generally affect the interest earned on interest-earning assets differently than the interest the Company pays on
its interest-bearing liabilities. In addition, certain funding sources do not bear interest and their cost therefore does not vary.
Overall, the Company is positioned to benefit from a rising interest rate environment; the Company could be adversely
affected by a decline in interest rates if the rates that the Company earns on interest-earning assets decline more than the rates