Charles Schwab 2015 Annual Report Download - page 61

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)
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Compliance Risk
The Company faces significant compliance risk in its business, that is, the risk of legal or regulatory sanctions, fines or
penalties, financial loss, or damage to reputation resulting from the failure to comply with laws, regulations, rules, or other
regulatory requirements. Among other things, compliance risks relate to the suitability of client investments, conflicts of
interest, disclosure obligations and performance expectations for Company products and services, supervision of employees,
and the adequacy of the Company’s controls. The Company and its affiliates are subject to extensive regulation by federal,
state and foreign regulatory authorities, including SROs. Such regulation is becoming increasingly extensive and complex,
and regulatory proceedings and sanctions against financial services firms continue to increase.
The Company attempts to manage compliance risk through policies, procedures and controls reasonably designed to achieve
and/or monitor compliance with applicable legal and regulatory requirements. These procedures address issues such as
business conduct and ethics, sales and trading practices, marketing and communications, extension of credit, client funds and
securities, books and records, anti-money laundering, client privacy, and employment policies. Despite the Company’s
efforts to maintain an effective compliance program and internal controls, legal breaches and rule violations could result in
reputational harm, significant losses and disciplinary sanctions, including limitations on the Company’s business activities.
Credit Risk
Credit risk is the potential for loss due to a borrower, counterparty, or issuer failing to perform its contractual obligations.
The nature and amount of credit risk depends on the type of transaction, the structure and duration of that transaction, and the
parties involved.
The Company’s exposure to credit risk mainly results from margin lending and client option and futures activities, securities
lending activities, mortgage lending activities, pledged asset lending, its role as a counterparty in financial contracts and other
investing activities. To manage the risks of such losses, the Company has established policies and procedures which include:
establishing and reviewing credit limits, monitoring of credit limits and quality of counterparties, and adjusting margin, PAL,
option, and futures requirements for certain securities. Collateral arrangements relating to margin loans, PALs, option
positions, securities lending agreements, and resale agreements include provisions that require additional collateral in the
event market fluctuations result in declines in the value of collateral received. Additionally, for margin loan, PAL and
securities lending agreements, collateral arrangements require that the fair value of such collateral exceeds the amounts
loaned.
Schwab performs clearing services for all securities transactions in its client accounts. Schwab has exposure to credit risk due
to its obligation to settle transactions with clearing corporations, mutual funds, and other financial institutions even if
Schwab’s client or a counterparty fails to meet its obligations to Schwab.
The Company’s bank loan portfolio includes First Mortgages, HELOCs, PALs and other loans. The credit risk exposure
related to loans is actively managed through individual and portfolio reviews performed by management. Management
regularly reviews asset quality, including concentrations, delinquencies, nonaccrual loans, charge-offs, and recoveries. All are
factors in the determination of an appropriate allowance for loan losses.
The Company’s residential loan underwriting guidelines include maximum loan-to-value (LTV) ratios, cash out limits, and
minimum Fair Isaac Corporation (FICO) credit scores. The specific guidelines are dependent on the individual characteristics
of a loan (for example, whether the property is a primary or secondary residence, whether the loan is for investment property,
whether the loan is for an initial purchase of a home or refinance of an existing home, and whether the loan size is
conforming or jumbo).
The Company does not originate or purchase residential loans that allow for negative amortization and does not purchase
subprime loans (generally defined as extensions of credit to borrowers with a FICO score of less than 620 at origination),
unless the borrower has compensating credit factors. At December 31, 2015, approximately 1% of both the First Mortgage
and HELOC portfolios consisted of loans to borrowers with updated borrower FICO (updated FICO) scores of less than 620.