Charles Schwab 2010 Annual Report Download - page 23

THE CHARLES SCHWAB CORPORATION
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 deteriorating credit characteristics in 2010, 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 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
sin
g
le issuer or industr
y
;
• mortgage loans and HELOCs to banking clients which are secured by properties in the same geographic region; and
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.
• margin and securities lending activities collateralized by securities of a single issuer or industry.
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 that the Company pays on its funding sources,
or if prepayment rates increase on the mortgages and mortgage-backed securities that the Company holds. With the low interest rate
environment, the Company’s revenue from interest-earning assets has been declining more than the rates that the Company pays on
its funding sources. The Company may also be limited in the amount it can reduce interest rates on deposit accounts and still offer a
competitive return.
To the extent the overall yield on certain Schwab-sponsored money market mutual funds falls to a level at or below the management
fees on those funds, the Company may waive a portion of its fee in order to continue providing some return to clients. As a result of
the low interest rate environment, the Company has been waiving and may continue to waive a portion of its management fees for
certain Schwab-sponsored money market mutual funds. Such fee waivers negatively impact the Company’s asset management and
administration fees.
The Company is subject to litigation and regulatory investigations and proceedings and may not always be successful in
defending itself against such claims or proceedings.
The financial services industry faces substantial litigation and regulatory risks. The Company is subject to arbitration claims and
lawsuits in the ordinary course of its business, as well as class actions and other significant litigation. The Company is also the subject
of inquiries, investigations, and proceedings by regulatory and other governmental agencies. Actions brought against the Company
may result in settlements, awards, injunctions, fines, penalties or other results adverse to the Company
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