Charles Schwab 2014 Annual Report Download - page 28

THE CHARLES SCHWAB CORPORATION
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shelf registration statement filed with the SEC, financing may not be available on acceptable terms or at all due to market
conditions or disruptions in the credit markets. In addition, a significant downgrade in the Company’s credit ratings could
increase its borrowing costs and limit its access to the capital markets.
The Company may suffer significant losses from its credit exposures.
The Company’s businesses are subject to the risk that a client, counterparty or issuer will fail to perform its contractual
obligations, or that the value of collateral held to secure obligations will prove to be inadequate. While the Company has
policies and procedures designed to manage this risk, the policies and procedures may not be fully effective. The Company’s
exposure mainly results from margin lending, clients’ options trading, securities lending, mortgage lending, 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.
When clients purchase securities on margin or trade options or futures, the Company is subject to the risk that clients may
default on their obligations when the value of the securities and cash in their accounts falls below the amount of clients’
indebtedness. Abrupt changes in securities valuations and the failure of clients to meet margin calls could result in substantial
losses.
The Company has exposure to credit risk associated with its securities available for sale and securities held to maturity
portfolios, which include U.S. agency and non-agency mortgage-backed securities, asset-backed securities, corporate debt
securities, U.S. agency notes, certificates of deposit, and commercial paper among other investments. These instruments are
also subject to price fluctuations as a result of changes in the financial market’s assessment of issuer credit quality, increases
in the unemployment rate, delinquency and default rates, housing price declines, changes in prevailing interest rates and other
economic factors. A failure to raise the U.S. debt limit and/or a downgrade of the U.S. government’s credit rating could
decrease the value of the Company’s securities in both the available for sale and held to maturity portfolios.
Loss of value of securities available for sale and securities held to maturity can negatively affect earnings if management
determines that such securities are other than temporarily impaired. The evaluation of whether other-than-temporary
impairment exists is a matter of judgment, which includes the assessment of several factors. See “Item 7 – Management’s
Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Estimates.” If management
determines that a security is other-than-temporarily impaired, the cost basis of the security may be adjusted and a
corresponding loss may be recognized in current earnings. Certain securities available for sale experienced continued credit
deterioration in 2014, which resulted in impairment charges. Deterioration in the performance of securities available for sale
and securities held to maturity could result in the recognition of future impairment charges.
The Company’s loans to banking clients primarily consist of First Mortgages and HELOCs. Increases in delinquency and
default rates, housing price declines, increases in the unemployment rate, and other economic factors can result in charges for
loan loss reserves and write downs on such loans.
Heightened credit exposures to specific counterparties or instruments (concentration risk) can increase the Company’s risk of
loss. Examples of the Company’s credit concentration risk include:
• large positions in financial instruments collateralized by assets with similar economic characteristics or in securities
of a single issuer or industry;
• mortgage loans and HELOCs to banking clients which are secured by properties in the same geographic region; and
• margin and securities lending activities collateralized by securities of a single issuer or industry.
The Company may also be subject to concentration risk when lending to a particular counterparty, borrower or issuer.
The Company sponsors a number of proprietary money market mutual funds and other proprietary funds. Although the
Company has no obligation to do so, the Company may decide for competitive or other reasons to provide credit, liquidity or
other support to its funds in the event of significant declines in valuation of fund holdings or significant redemption activity
that exceeds available liquidity. Such support could cause the Company to take significant charges, could reduce the
Company’s liquidity and, in certain situations, could, with respect to proprietary funds other than money market mutual
funds, result in the Company having to consolidate a supported fund in its financial statements. If the Company chose not to