Charles Schwab 2011 Annual Report Download - page 70

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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Other-than-Temporary Impairment of Securities Available for Sale and Securities Held to Maturity: Management evaluates
whether securities available for sale and securities held to maturity are other-than-temporarily impaired (OTTI) on a quarterly
basis. Debt securities with unrealized losses are considered OTTI if the Company intends to sell the security or if it is more
likely than not that the Company will be required to sell such security prior to any anticipated recovery. If management
determines that a security is OTTI under these circumstances, the impairment recognized in earnings is measured as the entire
difference between the amortized cost and the then-current fair value.
A security is also OTTI if management does not expect to recover the amortized cost of the security. In this circumstance,
management utilizes cash flow models to estimate the expected future cash flow from the securities and to estimate the credit
loss. The impairment recognized in earnings is measured by the difference between the present value of expected cash flows
and the amortized cost of the security. Expected cash flows are discounted using the security’s effective interest rate.
The evaluation of whether the Company expects to recover the amortized cost of a security is inherently judgmental. The
evaluation includes the assessment of several bond performance indicators including: the portion of the underlying loans that
are delinquent (30 days, 60 days, 90+ days), in bankruptcy, in foreclosure or converted to real estate owned; the actual
amount of loss incurred on the underlying loans in which the property has been foreclosed and sold; the amount of credit
support provided by the structure of the security available to absorb credit losses on the underlying loans; the current price
and magnitude of the unrealized loss; and whether the Company has received all scheduled principal and interest payments.
Management uses cash flow models to further assess the likelihood of other-than-temporary impairment for the Company’s
non-agency residential mortgage-backed securities. To develop the cash flow models, the Company uses forecasted loss
severity, prepayment speeds (i.e. the rate at which the principal on underlying loans are paid down), and default rates over the
securities’ expected remaining maturities.
Valuation of Goodwill: The Company tests goodwill for impairment at least annually, or whenever indications of impairment
exist. An impairment exists when the carrying amount of goodwill exceeds its implied fair value, resulting in an impairment
charge for this excess.
The Company has elected April 1st as its annual goodwill impairment testing date. In testing for a potential impairment of
goodwill on April 1, 2011, management estimated the fair value of each of the Company’s reporting units (generally defined
as the Company’s businesses for which financial information is available and reviewed regularly by management) and
compared this value to the carrying value of the reporting unit. The estimated fair value of each reporting unit substantially
exceeded its carrying value, and therefore management concluded that no amount of goodwill was impaired. The estimated
fair value of the reporting units was established using a discounted cash flow model that includes significant assumptions
about the future operating results and cash flows of each reporting unit. Adverse changes in the Company’s planned business
operations such as unanticipated competition, a loss of key personnel, the sale of a reporting unit or a significant portion of a
reporting unit, or other unforeseen developments could result in an impairment of the Company’s recorded goodwill.
Allowance for Loan Losses: The adequacy of the allowance is reviewed quarterly by management, taking into consideration
current economic conditions, the existing loan portfolio composition, past loss experience, and risks inherent in the portfolio.
The process to establish an allowance for loan losses utilizes loan-level statistical models that estimate prepayments, defaults,
and probable losses for the loan segments based on predicted behavior of individual loans within the segments. The
methodology considers the effects of borrower behavior and a variety of factors including, but not limited to, interest rates,
housing price movements as measured by a housing price index, economic conditions, estimated defaults and foreclosures
measured by historical and expected delinquencies, changes in prepayment speeds, loan-to-value ratios, past loss experience,
estimates of future loss severities, borrower credit risk measured by FICO scores, and the adequacy of collateral. The
methodology also evaluates concentrations in the loan segments including loan products, year of origination, geographical
distribution of collateral, and the portion of borrowers who have other client relationships with the Company.
The more significant variables considered include a measure of delinquency roll rates, loss severity, housing prices, and
interest rates. Delinquency roll rates (i.e., the rates at which loans transition through delinquency stages and ultimately result