Charles Schwab 2008 Annual Report Download - page 49

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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)
- 35 -
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.
Concentration Risk
The Company is subject to concentration risk when holding large positions of financial instruments collateralized by assets
with similar economic characteristics or in securities of a single issuer or industry.
The Company’s investments in mortgage-backed securities totaled $10.4 billion at December 31, 2008. Of these, $8.2 billion
were U.S. agency securities and $2.2 billion were non-agency securities. Included in non-agency mortgage-backed securities
are securities collateralized by Alt-A loans. At December 31, 2008, the amortized cost and fair value of Alt-A mortgage-
backed securities were $798 million and $429 million, respectively.
The Company’s investments in corporate debt securities and commercial paper totaled $3.5 billion at December 31, 2008,
with the majority issued by institutions in the financial services industry. Included in corporate debt securities and commercial
paper at December 31, 2008, were $2.6 billion of securities issued by financial institutions and guaranteed under the FDIC
Temporary Liquidity Guarantee Program. These corporate debt securities and commercial paper are included in securities
available for sale and cash and investments segregated and on deposit for regulatory purposes in the Company’s consolidated
balance sheets.
The Company’s loans to banking clients includes $3.2 billion of first lien residential real estate mortgage loans at
December 31, 2008. Approximately 80% of these mortgages consisted of loans with interest-only payment terms. The interest
rates on approximately 80% of these interest-only loans are not scheduled to reset for three or more years. All interest-only
loans are underwritten based on underwriting standards that do not include interest terms described as temporary introductory
rates below current market rates. At December 31, 2008, 33% of the residential real estate mortgages and 46% of the home
equity lines of credit balances were secured by properties which are located in California. The Company is also subject to
concentration risk from its margin and securities lending activities collateralized by securities of a single issuer or industry.
The Company is subject to 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. U.S. Government and agency securities held as collateral for resale agreements, at December 31, 2008,
totaled $6.8 billion.
Market Risk
Market risk is the potential for changes in revenue or the value of financial instruments held by the Company as a result of
fluctuations in interest rates, equity prices or market conditions. For discussion of the Company’s market risk, see “Item 7A –
Quantitative and Qualitative Disclosures About Market Risk.”
Fiduciary Risk
Fiduciary risk is the potential for financial or reputational loss through breach of fiduciary duties to a client. Fiduciary
activities include, but are not limited to, individual and institutional trust, investment management, custody, and cash and
securities processing. The Company attempts to manage this risk by establishing procedures to ensure that obligations to
clients are discharged faithfully and in compliance with applicable legal and regulatory requirements. Business units have the
primary responsibility for adherence to the procedures applicable to their business. Guidance and control are provided
through the creation, approval, and ongoing review of applicable policies by business units and various fiduciary risk
committees.