Charles Schwab 2010 Annual Report Download - page 53

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)
Despite the Company’s risk management efforts, it is not always possible to deter or prevent technological or operational failure, or
fraud or other misconduct, and the precautions taken by the Company may not be effective in all cases. The Company may be subject
to litigation, losses, and regulatory actions in such cases, and may be required to expend significant additional resources to remediate
vulnerabilities or other exposures.
The Company also faces technology and operating risk when it employs the services of various external vendors, including domestic
and international outsourcing of certain technology, processing, and support functions. The Company manages its exposure to
external vendor risk through contractual provisions, control standards, and ongoing monitoring of vendor performance. The Company
maintains policies and procedures regarding the standard of care expected with Company data, whether the data is internal company
information, employee information, or non-public client information. The Company clearly defines for employees, contractors, and
vendors the Company’s expected standards of care for confidential data. Regular training is provided by the Company in regard to
data security.
The Company is actively engaged in the research and development of new technologies, services, and products. The Company
endeavors to protect its research and development efforts, and its brands, through the use of copyrights, patents, trade secrets, and
contracts.
Credit Risk
Credit risk is the potential for loss due to a borrower, counterparty, or issuer failing to perform its contractual obligations. The
Company’s direct exposure to credit risk 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. 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 requirements for certain securities. Most of the Company’s credit extensions are supported by collateral
arrangements. Collateral arrangements relating to margin loans, securities lending agreements, and resale agreements include
provisions that require additional collateral in the event that market fluctuations result in declines in the value of collateral received.
The Company’s credit risk exposure related to loans to banking clients is actively managed through individual and portfolio reviews
performed by management. Management regularly reviews asset quality including concentrations, delinquencies, nonperforming
loans, losses, and recoveries. All are factors in the determination of an appropriate allowance for loan losses, which is reviewed
quarterly by senior management. The Company’s mortgage loan portfolios primarily include first lien residential mortgage loans
(First Mortgage portfolio) of $4.7 billion and home equity lines of credit (HELOC portfolio) of $3.5 billion at December 31, 2010.
The Company’s First Mortgage portfolio underwriting requirements are generally consistent with the underwriting requirements in
the secondary market for loan portfolios. The Company’s guidelines include maximum loan-to-value (LTV) ratios, cash out limits,
and minimum Fair Issac & Company (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 is conforming or jumbo). These credit
underwriting standards have limited the exposure to the types of loans that experienced high foreclosures and loss rates elsewhere in
the industry during 2010 and 2009. There have been no significant changes to the LTV ratio or FICO credit score guidelines related to
the Company’s First Mortgage or HELOC portfolios during 2010. At December 31, 2010, the weighted-average originated LTV
ratios were 60% and 59% for the First Mortgage and HELOC portfolios, respectively. The computation of the origination LTV ratio
for a HELOC includes any first lien mortgage outstanding on the same property at the time of origination. At December 31, 2010,
21% of HELOCs ($742 million of the HELOC portfolio) were in a first lien position. The weighted-average originated FICO credit
scores were 764 and 768 for the First Mortgage and HELOC portfolios, respectively, at December 31, 2010.
The Company does not offer loans that allow for negative amortization and does not originate or purchase subprime loans (generally
defined as extensions of credit to borrowers with a FICO credit score of less than 620 at origination), unless the
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