Charles Schwab 2013 Annual Report Download - page 34

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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or 6%, in 2012 from 2011 primarily due to an increase in advice solutions fees and other asset management and
administration fees.
Mutual fund service fees increased by $84 million, or 8%, in 2013 from 2012, due to market appreciation and growth in
client assets invested in the Company’s Mutual Fund OneSource funds and equity and bond funds, partially offset by a
decrease in net money market mutual fund fees as a result of lower yields on fund assets. Mutual fund service fees were
relatively flat in 2012 from 2011, which reflected growth in client assets invested in money market mutual funds, equity and
bond funds, and Mutual Fund OneSource funds, offset by the effect of lower yields on certain fund assets.
Advice solutions fees increased by $138 million, or 24%, in 2013 from 2012 and by $58 million, or 11%, in 2012 from 2011
primarily due to growth in client assets enrolled in advisory and managed account programs, including Windhaven®, Schwab
Private ClientTM, and ThomasPartners.
Other asset management and administration fees increased by $50 million, or 14%, in 2013 from 2012 and $43 million, or
14%, in 2012 from 2011 primarily due to an increase in third-party mutual fund service fees as a result of an increase in client
asset balances invested in other third-party mutual funds.
Net Interest Revenue
Net interest revenue is the difference between interest earned on interest-earning assets and interest paid on funding sources.
Net interest revenue is affected by changes in the volume and mix of these assets and liabilities, as well as by fluctuations in
interest rates and portfolio management strategies. The majority of the Company’s interest-earnings assets and interest-
bearing liabilities are sensitive to changes in short-term interest rates. The Company’s investment strategy is structured to
produce an increase in net interest revenue when interest rates rise and, conversely, a decrease in net interest revenue when
interest rates fall. When interest rates fall, the Company may attempt to mitigate some of this negative impact by extending
the maturities of assets in investment portfolios to lock in asset yields, and by lowering rates paid to clients on interest-
bearing liabilities. Since the Company establishes the rates paid on certain brokerage client cash balances and deposits from
banking clients, as well as the rates charged on receivables from brokerage clients, and also controls the composition of its
investment securities, it has some ability to manage its net interest spread. However, the spread is influenced by external
factors such as the interest rate environment and competition. The current low interest rate environment limits the extent to
which the Company can reduce interest expense paid on funding sources. To a lesser degree, the Company is sensitive to
changes in long-term interest rates through some of its investment portfolios. To mitigate the related risk, the Company may
alter the types of investments purchased. For discussion of the impact of current market conditions on net interest revenue,
see “Current Market and Regulatory Environment and Other Developments.”
The Company’s interest-earning assets are financed primarily by brokerage client cash balances and deposits from banking
clients. Non-interest-bearing funding sources include non-interest-bearing brokerage client cash balances, stockholders’
equity, and proceeds from stock-lending activities. Revenue from stock-lending activities is included in other interest
revenue.
Schwab Bank maintains available for sale and held to maturity investment portfolios for liquidity as well as to invest funds
from deposits that are in excess of loans to banking clients and liquidity requirements. Schwab Bank lends funds to banking
clients primarily in the form of mortgage loans, HELOCs, and personal loans secured by securities. These loans are largely
funded by interest-bearing deposits from banking clients.
In clearing their clients’ trades, Schwab and optionsXpress, Inc. hold cash balances payable to clients. In most cases, Schwab
and optionsXpress, Inc. pay their clients interest on cash balances awaiting investment, and in turn invest these funds and
earn interest revenue. Receivables from brokerage clients consist primarily of margin loans to brokerage clients. Margin
loans are loans made to clients on a secured basis to purchase securities. Pursuant to applicable regulations, client cash
balances that are not used for margin lending are generally segregated into investment accounts that are maintained for the
exclusive benefit of clients, which are recorded in cash and investments segregated on the Company’s consolidated balance
sheets. When investing segregated client cash balances, Schwab and optionsXpress, Inc. must adhere to applicable
regulations that restrict investments to securities guaranteed by the full faith and credit of the U.S. government, participation