Charles Schwab 2010 Annual Report Download - page 55

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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)
At December 31, 2010, all of the corporate debt securities and non-mortgage asset-backed securities were rated investment grade
(defined as a rating equivalent to a Moody’s rating of “Baa” or higher, or a Standard & Poor’s rating of “BBB-” or higher).
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 has exposure to concentration risk when holding large positions in financial instruments collateralized by assets with
similar economic characteristics or in securities of a single issuer or industry.
The fair value of the Company’s investments in residential mortgage-backed securities totaled $31.4 billion at December 31, 2010. Of
these, $29.9 billion were U.S. agency securities and $1.5 billion were non-agency securities. The U.S. agency securities are included
in securities available for sale and securities held to maturity and the non-agency securities are included in securities available for
sale. Included in non-agency residential mortgage-backed securities are securities collateralized by Alt-A loans. At December 31,
2010, the amortized cost and fair value of Alt-A mortgage-backed securities were $489 million and $359 million, respectively.
The Company’s investments in corporate debt securities and commercial paper totaled $4.6 billion at December 31, 2010, with the
majority issued by institutions in the financial services industry. These securities are included in securities available for sale,
securities held to maturity, cash and investments segregated and on deposit for regulatory purposes, cash and cash equivalents, and
other securities owned in the Company’s consolidated balance sheets. At December 31, 2010, the Company held $1.9 billion of
corporate debt securities issued by financial institutions and guaranteed under the FDIC Temporary Liquidity Guarantee Program.
The Company’s loans to banking clients include $4.7 billion of adjustable rate first lien residential real estate mortgage loans at
December 31, 2010. The Company’s adjustable rate mortgages have initial fixed interest rates for three to ten years and interest rates
that adjust annually thereafter. Approximately 65% of these mortgages consisted of loans with interest-only payment terms. The
interest rates on approximately 70% of these interest-only loans are not scheduled to reset for three or more years. The Company’s
interest-only loans do not include interest terms described as temporary introductory rates below current market rates. At
December 31, 2010, 42% of the residential real estate mortgages and 49% of the HELOC balances were secured by properties which
are located in California.
The Company also has exposure to concentration risk from its margin and securities lending activities collateralized by securities of a
single issuer or industry.
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. U.S. Government and
agency securities held as collateral for resale agreements totaled $13.0 billion at December 31, 2010.
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.”
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