Charles Schwab 2013 Annual Report Download - page 56

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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value of expected cash flows and the amortized cost of the security. Management utilizes cash flow models to estimate the
expected future cash flow from the securities and to estimate the credit loss. 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. Impairment
exists when the carrying amount of goodwill exceeds its implied fair value, resulting in an impairment charge for this excess.
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.
The Company’s annual goodwill impairment testing date is April 1st. In testing for a potential impairment of goodwill on
April 1, 2013, management performed a qualitative assessment 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
concluded that goodwill was not impaired.
Allowance for Loan Losses
The appropriateness 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 methodology to establish an allowance for loan losses related to the First Mortgage and HELOC portfolio utilizes
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, LTV 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, and geographical distribution of collateral.
Probable losses are forecast using a loan-level simulation of the delinquency status of the loans over the term of the loans.
The simulation starts with the current relevant risk indicators, including the current delinquent status of each loan, the
estimated current LTV ratio of each loan, the term and structure of each loan, current key interest rates including U.S.
Treasury and London Interbank Offered Rate (LIBOR) rates, and borrower FICO scores. The more significant variables in
the simulation include 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 in a loss) are estimated from the Company’s
historical loss experience adjusted for current trends and market information. Further, the delinquency roll rates within the
loan-level simulation discussed above are calibrated to match a moving average of the delinquency roll rates actually
experienced in the respective First Mortgage and HELOC portfolios. Loss severity estimates are based on the Company’s
historical loss experience and market trends. The estimated loss severity (i.e. loss given default) used in the allowance for
loan loss methodology for HELOCs is higher than that used in the methodology for First Mortgages. Housing price trends are