Charles Schwab 2015 Annual Report Download - page 63

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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The fair value of the Company’s investments in mortgage-backed securities totaled $72.3 billion at December 31, 2015. Of
these, $71.0 billion were issued by U.S. agencies and $1.3 billion were issued by private entities (non-agency securities).
These U.S. agency and non-agency securities are included in securities available for sale and securities held to maturity.
The fair value of the Company’s investments in asset-backed securities totaled $21.5 billion at December 31, 2015. Schwab
holds $11.4 billion floating rate Federal Family Education Loan Program Asset-Backed Securities (FFELP ABS). Two
Nationally Recognized Statistical Rating Organizations have placed a portion of FFELP ABS on review for downgrade. Both
agencies have indicated that some classes could be downgraded below investment grade due to the risk that some remainder
of the securities could be outstanding after their legal final maturity date. The timing of FFELP ABS principal payments is
inherently uncertain given the variety of payment options available to student loan borrowers. Loans collateralizing these
securities continue to offer a guarantee from the Department of Education of at least 97%. Schwab holds only senior class
notes that have additional credit enhancement of 3% or more that, together with the Department of Education guarantee,
provide 100% or more credit enhancement. The Company has an independent credit assessment function and it does not rely
on rating agencies. The Company does not consider these securities to be impaired because it expects full payment of
principal and interest. Therefore, the Company continues to assign them the highest internal credit rating.
The fair value of the Company’s investments in corporate debt securities and commercial paper totaled $11.1 billion at
December 31, 2015, with the majority issued by institutions in the financial services industry. These securities are included in
securities available for sale, cash and cash equivalents, and other securities owned in the Company’s consolidated balance
sheets. Issuer, geographic, and sector concentrations are controlled by established credit policy limits to each concentration
type.
The Company’s bank loans include $7.5 billion of adjustable rate First Mortgage loans at December 31, 2015. The
Company’s adjustable rate mortgages have initial fixed interest rates for three to ten years and interest rates that adjust
annually thereafter. Approximately 39% of these mortgages consisted of loans with interest-only payment terms. The interest
rates on approximately 53% of these interest-only loans are not scheduled to reset for three or more years. The Company’s
mortgage loans do not include interest terms described as temporary introductory rates below current market rates.
The Company’s HELOC product has a 30-year loan term with an initial draw period of ten years from the date of origination.
After the initial draw period, the balance outstanding at such time is converted to a 20-year amortizing loan. The interest rate
during the initial draw period and the 20-year amortizing period is a floating rate based on the prime rate plus a margin.
HELOCs that convert to an amortizing loan may experience higher delinquencies and higher loss rates than those in the
initial draw period. The Company’s allowance for loan loss methodology takes this increased inherent risk into consideration.
The following table presents when current outstanding HELOCs will convert to amortizing loans:
December 31, 2015 Balance
Converted to amortizing loan by period end $ 461
Within 1 year 166
> 1 year – 3 years 973
> 3 years – 5 years 334
> 5 years 801
Total $ 2,735
The Company also has exposure to concentration risk from its margin and securities lending, PAL, and client option and
futures activities collateralized by or referencing securities of a single issuer, an index, or within a single industry. This
concentration risk is mitigated by collateral arrangements that require the fair value of such collateral exceeds the amounts
loaned.
The Company has indirect exposure to U.S. Government and agency securities held as collateral to secure its resale
agreements. The Company’s primary credit exposure on these resale transactions is with its counterparty. The Company
would have exposure to the U.S. Government and agency securities only in the event of the counterparty’s default on the
resale agreements. The fair value of U.S. Government and agency securities held as collateral for resale agreements totaled
$8.2 billion at December 31, 2015.