The Charles Schwab
Annual Report 2011

Plain-text annual report

1 WHAT I’VE HEARD. THE CHARLES SCHWAB CORPORATION 2011 Annual Report The Charles Schwab Corporation (NYSE: SCHW) is a leading provider of brokerage, banking, home loans, and other financial services to millions of individual investors. The firm also serves independent investment advisors and helps companies manage retirement and stock plans. TABLE OF CONTENTS 15 18 20 22 23 24 25 i ii Letter From the CEO Operating Priorities Letter From the CFO Financial Highlights and Reconciliation Growth in Client Assets and Accounts Executive Management Form 10-K Board of Directors Corporate Information In addition to historical information, this Annual Report to Stockholders contains “forward-looking statements,” which are identified by words such as “believe,” “anticipate,” “expect,” “intend,” “plan,” “will,” “may,” “estimate,” “aim,” “target,” “should,” “growth,” “commit,” “build,” “deliver,” “continue,” “remain” and other similar expressions. In addition, any statements that refer to expectations, projections, or other characterizations of future events or circumstances are forward-looking statements. These forward-looking statements, which reflect management’s beliefs, objectives, and expectations as of the date hereof, are necessarily estimates based on the best judgment of the company’s senior management. These statements relate to, among other things, the company’s growth in revenues, earnings and profits (See “Letter from the Chief Executive Officer” and “Letter from the Chief Financial Officer”), earnings power (See “Letter from the Chief Executive Officer”), and investment spending, expenses and capital position (See “Letter from the Chief Financial Officer”). Achievement of the expressed beliefs, objectives, and expectations described in these statements is subject to certain risks and uncertainties that could cause actual results to differ materially from the expressed beliefs, objectives, and expectations. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this Annual Report to Stockholders. See “Forward-Looking Statements” in Management’s Discussion and Analysis of Financial Condition and Results of Operations on page 43 in the Form 10-K for a discussion of important factors that may cause such differences. 1 Chuck Schwab, Chairman of the Board For many years, our company has invited clients to Talk to Chuck™, to tell us what they need and want from a financial services firm. They responded. And what we’ve heard from them is that a superior experience means listening to what people need and basing our innovations on what we learn. It means providing resources and knowledge that help our clients shape their futures. It means creating a culture of service, and it means providing direct access to the markets. But don’t take it from me. Read their stories for yourself. 2 “ With our Schwab rep, it really was a personal connection. He was trying to plan for his own family just like we were trying to plan for our family.” – Jamie Wulf, Investor “No one can prepare you for it until you are actually going through it” is one of the first things Jamie Wulf says when she talks about becoming a mother. Young, adventurous, and somewhat carefree, Jamie and Nathan Wulf knew their lives would change forever when they learned they were pregnant. “You’re no longer number one,” Nathan says. Their daughter Ashlyn was born on May 20, 2011, and suddenly trips or house improvements became less important than “the diaper fund.” Fortunately, their families live nearby and are quick to help out, but Nathan and Jamie also rely on their Schwab financial consultant. “It was really important to me to make sure that we were investing in the right way, we were saving in the right accounts, and where our Schwab representative came in is really being a check-and- balance system,” Jamie says. Nathan is quick to add: “He sets the roadmap for us, but ultimately leaves the decisions up to Jamie and I.” Nathan and Jamie continue to enjoy working with Schwab because, as Nathan says, they’re “vested in us from a personal standpoint.” 3 Hear Nathan and Jamie Wulf share their story in their own words at www.aboutschwab.com 4 “ In my piloting, I don’t like excitement. In my retirement plan, as a trustee of the plan, I don’t want excitement either.” – Capt. Peter McIsaac, San Francisco Bar Pilots Hear Capt. Peter McIsaac share his story in his own words at www.aboutschwab.com 5 Boarding ships by rope ladder 12 miles off the California coast is a dangerous job, but the San Francisco Bar Pilots’ experience and knowledge of local waters make most days event-free. That is exactly what Capt. Peter McIsaac and his 59 fellow pilots looked for in a retirement plan provider. “In my piloting, I don’t like excitement. In my retirement plan, as a trustee of the plan, I don’t want excitement either.” With approximately $1 billion in commerce passing under the Golden Gate Bridge every day, the Bar Pilots know their job is critical to the nation’s economy. Every vessel transit through San Francisco Bay is important. The pilots feel good knowing the people at Schwab Retirement Plan Services take the same approach in providing services for their retirement plan: “Everyone we’ve dealt with at Schwab has been good and competent,” McIsaac says. “If we have ques- tions, they get back to us with the answer, or they get back to us and tell us they’re going to need another day or two to find the answer. That, to me, is service.” 6 “ During the economic crisis, I thought to myself, ‘Gee, if we could change a generation around financial literacy, it would impact the country.’” – Roxanne Spillett, President Emeritus of Boys & Girls Clubs of America Hear Roxanne Spillett share her story in her own words at www.aboutschwab.com 7 Not long ago, Roxanne Spillett walked into a Boys & Girls Club to find a group of kids poring over a copy of The Wall Street Journal. They were following their stock picks and catching up on the business news of the day. Five years ago, this would have surprised Spillett. Today, it doesn’t. “During the economic crisis, I thought to myself, ‘Gee, if we could change a generation around financial literacy, it would impact the country.’” And with the help of Charles Schwab Foundation, the clubs are doing exactly that with Money Matters: Make It CountSM, a program that helps kids become financially literate. Club members learn everything from how to open a checking or savings account to more advanced lessons such as paying for college or even starting a business. Developing the curriculum with Schwab, Spillett quickly realized financial literacy was a real passion for the company. “They’re not hands-off. They’re engaged in the development of the program, making sure we have the right expertise, the right kinds of activities that resonate with kids. And at a local level, their employees are serving as volunteers.” The experience has reaffirmed Spillett’s belief in the power of corporate relationships, that companies can “carry out their mission and their business at the same time.” 8 Hear Carol Benz share her story in her own words at www.aboutschwab.com “ It’s almost as if Schwab is part of our firm. It’s as if they have an office down the hall.” – Carol Benz, Principal, Bingham, Osborn & Scarborough, LLC, Wealth Management 9 Over the past few years, the number of Registered Independent Advisors has exploded. It’s happening, says Carol Benz, because independent advisors can “choose from a wide variety of investment vehicles to meet the needs of their clients,” instead of pushing proprietary products. But running an independent advisory isn’t as simple as providing transparent, conflict-free advice. It’s a business that requires human resources, strategic planning, technology, operations, and all the other respon- sibilities that fall on Carol’s shoulders to keep her firm, Bingham, Osborn & Scarborough, running. That’s where Schwab Advisor Services comes in: “We’ve worked with the same Schwab representatives for over 10 years. There’s a deep intelligence of the firm and how we operate.” In addition to Schwab’s practice management services, in-house consultants, and “immense library of tools and resources that help drive growth,” Carol says that what defines the Schwab experience is the people: “Working with Schwab is an authentic experience. It’s real, it’s human, and it’s incredibly reliable. Each person we work with tends to look at things with a long-term, futuristic perspective. It’s a very entrepreneurial approach.” 10 Hear Gus and Betty Franke share their story in their own words at www.aboutschwab.com After the constant relocations of a military career, Gus and Betty Franke settled in Georgia and started a business together, producing flags and banners. Gus handles design and sales, while Betty keeps the books. It is a true partnership in work and in life. But for Betty, there was a problem: She wanted to be more involved in the family’s finances. “I realized how it was really important that I understand where our money was, what it meant for my future, not just our future,” she says. “I wanted the empowerment of knowing what was going on.” Schwab made her learning curve easy, she says. “Every time we meet with Schwab they review what our needs are: Where do we stand, what are our thoughts, where do we want to be. They listen to me.” Today, Gus and Betty continue to seek that help and guidance by driving 120 miles round-trip to see their trusted Schwab financial consultant, Steve Marcu. Gus says the drive is worth it. “With Schwab, Betty and I walk out, and we’re not looking at each other going, ‘What did he just tell us?’ We’re going, ‘That was really interesting. I got a lot out of that.’” 11 “ The biggest change for me was when I saw this was going to be something that Gus and I can do together.” – Betty Franke, Investor 12 “ If I think of my running career as a marathon, then it’s the same as investing: They’re both focused on being able to do this into my 60s and hopefully 70s.” – Kirk Larson, Investor During the financial crisis of 2008, Kirk Larson saw that some of the big brokerages were tied in with companies that did not seem financially sound to him. “Yet with Schwab,” he says, “I had complete confidence.” That’s because as a self-directed, independent investor who has successfully managed his own investments for years, Kirk takes a conservative but intuitive approach, studying companies that show long-term value and avoiding the impulse to buy and sell every day. Over the years, this approach gave Kirk a broad range of investments from a broad range of financial services firms, including Schwab. Then around 2008, Kirk saw the benefit of bringing his assets under one roof, choosing a firm he felt shared his values: “To me, Schwab seemed like the complete class of the field. They’d been there a long time.” Kirk knows he found the right firm. Schwab made his consolidation easy four years ago, and today, the company gives him the kind of service he expects: “I’ve never called Schwab and not had somebody who really understood what I was asking, what I needed, and wasn’t able to resolve, or if they couldn’t resolve it, put me in touch with someone who could. That doesn’t happen that often.” 13 Hear Kirk Larson share his story in his own words at www.aboutschwab.com 14 14 LETTER FROM THE CHIEF EXECUTIVE OFFICER Walt Bettinger, President and Chief Executive Officer 15 We delivered outstanding revenue and earnings growth during the six quarters from early 2010 through mid 2011, when interest rates were relatively stable. And when the Federal Reserve allows market forces to determine interest rates, we believe our efforts will yield significant revenue and earnings growth. 2011 can be summarized in three statements: 1. We are not immune to the economic challenges of the day, but we are focused on delivering results in the areas we can control. 2. In difficult times, we remain committed to our strategy and operating priorities — because they are working. 3. We are building significant earnings power that will be delivered to our stockholders as the environment improves. Focusing on What We Can Control to Generate Growth We evaluate our financial performance in two ways. First, we look at our client metrics. Are we building a strong franchise for the long term? Next, we look at our current year results. Did we grow revenue and earnings? On both measures, we delivered quality results in 2011 despite difficult economic times. Clients continued to entrust their assets to Schwab, bringing $82.3 billion in net new assets in 2011 (exclud- ing one-time flows). Perhaps our most important measure of success is the enduring strength of our business and the trust our clients place in us. Since the financial crisis To My Fellow Stockholders: A close friend once suggested that my annual letter to fellow stockholders should be crafted as if I were speaking with a business partner who had been away from the business for the entire year. My friend suggested that the letter offer clear and concise conversation, without spin or corporate-speak. Given the chal- lenges of the past year, I’ve made an extra effort to follow his guidance in preparing this letter to you, my fellow stockholders. Our overall results in 2011 tell the story of a company on a solid growth path, the full potential of which is currently masked by environmental factors that should eventually abate. Last year was an extraordinarily difficult year across the financial services industry — and Schwab was not immune. The downgrade of U.S. debt, the ongoing sovereign debt issues affecting the Eurozone, extreme equity market volatility, and the political stalemate in Washington, were just a few of the contributing factors in a challenging year. Of course, the unprecedented actions taken by the Federal Reserve to manage short- and long-term interest rates to record-low levels pressured Schwab’s earnings in 2011, and as a result our stock performance suffered. But in the middle of this challenging environment, your management team continued to focus on the things we could control — principally, building a world-class invest- ing services firm with strong long-term earnings power. 16 LETTER FROM THE CHIEF EXECUTIVE OFFICER TOTAL CLIENT ASSETS BY BUSINESS (in billions at year end) $1,445.5 $1,422.6 $1,137.0 $1,677.7 $1,574.5 2007 2008 2009 2010 2011 Investor Services Advisor Services Other Institutional Services began in the summer of 2008, clients have invested more than $300 billion in net new assets (NNA) with Schwab— more than the comparable NNA numbers reported by our publicly traded competitors combined. Total client assets reached $1.68 trillion at the end of 2011. We produced revenue and earnings growth in a tough environment. Our net revenues were $4.7 billion in 2011, up 10 percent over 2010. Net income was $864 million in 2011, up 90 percent year-over-year. Prior to the inclu- sion of charges relating to YieldPlus and other previously disclosed matters, net income totaled $775 million in 2010. Our pre-tax profit margin was 29.7 percent in 2011, and diluted earnings per share reached $0.70. As a further indication of the strength of our underlying fun- damentals, for the six quarters from January 2010 through June 2011, a period where interest rates remained relatively stable, we grew revenue 22 percent and pre-tax operating income by about 80 percent. Basing Our Strategy on the Golden Rule Our strategy is as simple as it is successful: We build our business “through clients’ eyes.” Too often in today’s business world, people overcomplicate things. At Schwab, we keep things simple and build our strategy around the Golden Rule. We have a fundamental belief that if you treat clients as you would like to be treated, clients will bring in more business and will refer their friends and family members. We focus our efforts on long-term growth instead of short- term profit-taking. In difficult times, some companies feel compelled to make trade-offs on the backs of their clients. Not at Schwab. We will not make decisions simply to pro- duce gains that are both short-term and shortsighted. At Schwab, we structure our two primary business segments to meet client needs. Investor Services, our retail segment, provides broker- age, banking, financial advice, and related services di- rectly to millions of individual investors. As of December 31, 2011, Investor Services accounted for total client assets of $697.9 billion. Institutional Services, our business-to-business segment, serves independent investment advisors and company benefit plan sponsors. As of December 31, 2011, Advisor Services accounted for $679.0 billion in total client assets, with $300.8 billion contributed by Other Institutional Services. We believe that the best long-term growth strategy is one that puts clients first. Following Our Operating Priorities Our five operating priorities help us translate our client- focused strategy into action. 1. Diversified client acquisition 2. Win-win monetization 3. Long-term client retention 4. Expense discipline 5. Effective capital management In 2011, we took decisive action in each of these areas, including: the acquisition of optionsXpress® to help diver- sify and expand our client base; significant expansion of our money management and retail investment advice, both of which deepen our relationships with clients and help us monetize those relationships to benefit both clients and our firm; and the addition of new capabilities to enhance the client experience and promote long-term retention. (See “Operating Priorities” on page 18.) As a result of our client-focused activities, our Client Pro- moter Score (CPS) for individual investors reached record levels last year, suggesting our strategy and operating priorities are having the impact we strive for. About half of our new clients join because of a referral or recommenda- tion. CPS is a simple measure of how well we’re doing at earning that level of loyalty and advocacy from our clients. When CPS is strong, we know our clients are recommending Schwab to their friends, family, and acquaintances — and that is the most direct measure of whether our client- focused strategy is working successfully. The pronounced turnaround in that score since 2004, when we began to measure it, reaffirms the steady positive impact of our clients-first strategy. CLIENT PROMOTER TRENDS FOR INVESTOR SERVICES* 17 25% 24% 30% 34% 36% 70% 60% 50% 40% 30% 20% 10% 0% -10% -20% -30% 14% -4% -17% Q4 Q4 Q4 Q4 Q4 Q4 Q4 Q4 2004 2005 2006 2007 2008 2009 2010 2011 * Client Promoter Score (CPS) is a program in which we survey clients and ask them to rate us, from 0 to 10, on their willingness to recommend Schwab. CPS is calculated by taking the percentage of “promoters” minus the percentage of “detractors” to arrive at a net indicator of loyalty. Building Earnings Power for Stockholders Whether our activities are focused on acquisition, monetiza- tion, or retention, they have one thing in common: They are designed to deliver outstanding long-term growth of earnings per share. The current record-low interest rate environment makes it difficult to measure the progress we are making at building earnings power. However, a careful review illustrates the progress we have made during the financial crisis. EPS POWER* $0.39 * Does not address performance beyond Q2 2011. $0.27 $0.20 Q2 2008 Q2 2011 Actual EPS Hypothetical based on Q2 2011 and Q2 2008 environment (2% Fed Funds, 1,350 S&P 500 avg.). Our firm’s record quarter for earnings was the second quarter of 2008, when we earned $0.27 per share from continuing operations. If we apply the same economic environment from Q2 2008 to the second quarter of 2011 — including a 2 percent Fed Funds rate and the S&P 500 averaging 1,350 — and assuming no other change, we would have earned $0.39 per share. Put another way, it took us almost 35 years to grow quarterly earnings to $0.27 per share from continuing operations. A mere three years later, we would have grown our EPS power another 44 percent, to $0.39, if conditions had remained constant. Creating and Delivering Long-Term Stockholder Value Our 2011 performance confirms that Schwab is on the right track. As we look toward 2012 and beyond, we will stay the course with our “through clients’ eyes” strategy, and we will continue to focus on our successful operating priorities. Our goal is not just to build earnings power, but also to deliver it to our stockholders as the environment improves. As I write this letter, it is difficult to see the economic envi- ronment improving to a significant extent in the near term. As we move into 2012, we are facing what is likely to be a turbulent, bruising, and important presidential election. In addition, we continue to witness sovereign debt problems in Europe, the ongoing deleveraging of the consumer, and the extraordinary commitments by the Federal Reserve to keep interest rates anchored at record-low levels. Nevertheless, your management team remains focused on continuing to build the Schwab brand and franchise, serving millions more clients and gathering billions of dollars in new assets. Each and every day, we apply our efforts to building earnings power that will benefit our long-term shareholders. For as we all know, the challenges of today won’t last forever. Thank you for your confidence. Warmly, WALT BETTINGER March 10, 2012 18 OPERATING PRIORITIES During 2011, Schwab continued to make progress against our operating priorities. DIVERSIFIED CLIENT ACQUISITION Schwab generated incremental growth last year with the strategic acquisitions of optionsXpress and Compliance11™ and positioned itself for future growth with the launch of Independent Branch Services. The first independent branch opened last fall in Nashua, N.H. Over the next five years, the company expects to award many more branch franchises to qualified financial profes- sionals. By locating these independent branches in markets where Schwab is currently underrepresented, the firm can strengthen its retail presence in a cost-effective way, and independent branch leaders can leverage the well-known Schwab brand as they build their client base. In 2011, Schwab also grew organically by attracting new clients to Schwab’s two primary business segments, Investor Services and Institutional Services. Investor Services added 163,221 new-to-firm households, helping to boost the number of active brokerage accounts to 8.6 million and the number of banking accounts to 780,000. Among the many initiatives designed to acquire new clients were the relaunch of the marketing website at Schwab.com and a refreshed advertising campaign building on the popu- lar Talk to Chuck campaign. In Institutional Services, Schwab gained new clients in two important segments — Registered Investment Advisors (RIAs) and company plan sponsors. costs, Schwab Index Advantage provides index mutual funds with low operating expenses. The program also comes with a low-cost professional, independent advisor service that develops a savings and investment program with the goal of helping participants increase retirement savings. Getting retirement savings right is crucial, and we expect Schwab Index Advantage to be an industry-leading alterna- tive that could benefit millions of Americans who use 401(k) plans to save for retirement. WIN-WIN MONETIZATION In 2011, Schwab’s diversified revenue streams helped generate profitable growth. Asset management and administration fees—our largest single source of revenue — grew 6 percent year-over-year, from $1.8 billion to $1.9 billion in 2011. A number of strategies fueled this growth:  We expanded client investment solutions, including new index exchange-traded funds (ETFs), fixed income, and global investing capabilities. Our fast-growing family of ETFs reached $5.0 billion in assets just two years after the initial ETF launch.  Our clients enrolled in fee-based advisory solutions in increasing numbers. On average, approximately 4,000 clients per month choose to move from do-it-yourself to Schwab advisory solutions. In our retirement plan business, 2012 opened with the launch of Schwab Index Advantage™ — a one-of-a-kind 401(k) plan offer designed to lower costs, simplify investing, and help workers better prepare for retirement. To help lower  We integrated Windhaven Investment Management™ into Schwab’s suite of managed solutions. Since November 2010, the number of Windhaven™ accounts has more than tripled, and client assets have increased by 96 percent. 2% 19 41% 2011 NET REVENUES (in millions) $1,928 Asset management and administration fees $1,725 Net interest revenue $927 Trading revenue $111 Other 20% 37% Net interest revenue continues to be important, even though much of the revenue benefit is currently masked as a result of the ultra-low interest rate environment. In 2011, client cash assets invested on Schwab’s balance sheet grew by 19 percent, from $81.1 billion at the beginning of 2011 to $96.4 billion by year end. We also continued to make prudent home loans from Schwab Bank, thus building our loan book from $8.7 billion in 2010 to $9.8 billion at year end 2011. Trading remains a relatively modest part of Schwab’s revenue mix, contributing only 20 percent of revenue, but it is important to any brokerage firm. At the height of stock market volatility last August, Schwab experienced four of the top trading days in the firm’s history and processed more than 1 million trades on a single day. Maintaining that capacity — and reliability — ensures that the company will be there when clients need us most. Following the completion of the optionsXpress acquisition last year, we made the strategic decision to reduce its trading price, consistent with Schwab’s flat $8.95 trading fee. Although the decision had a very minor impact on total trading revenue, it was the right thing to do for clients. Also last year, we introduced a new state-of-the-art trading platform for active traders, called StreetSmart Edge®. LONG-TERM CLIENT RETENTION Schwab continued to strengthen client relationships by listening, innovating, and providing personalized service. Through the Schwab branch network, more than 600,000 face-to-face meetings were held with retail clients last year. In addition, Schwab phone-based reps personally answered more than 13.8 million calls, with another 12.7 million handled efficiently through automated systems. Schwab.com handled approximately 280 million client log-ins and became the first brokerage website to allow clients to publicly rate and review Schwab accounts. Plus, we pursued innovative new ways to connect with clients and prospects through third-party social media networks, including Facebook, LinkedIn, Twitter, and YouTube. We also expanded access through Schwab Mobile apps available on smart phones and tablets, giving clients one-touch access to their brokerage, banking, and 401(k) accounts. By year end, mobile client log-ins reached nearly 17 million, with about 50 percent of all check deposits at Schwab Bank coming through mobile devices — a remarkable illustration of how quickly Schwab clients adopted this technology. In Advisor Services, we completed the first phase of Schwab Intelligent Integration™, a ground-breaking platform that will enhance the productivity of thousands of independent advisor firms. EXPENSE DISCIPLINE AND EFFECTIVE CAPITAL MANAGEMENT Chief Financial Officer Joe Martinetto addresses progress on our two remaining operating priorities — expense discipline and effective capital management — in his letter on page 20. 20 LETTER FROM THE CHIEF FINANCIAL OFFICER Joe Martinetto, Chief Financial Officer Driving Forward Are there positives for Schwab stockholders to take away from a year like 2011, with interest rates declining further and the markets suffering from global uncertainty and heightened volatility? Absolutely. Why? Because we once again took everything the environment threw at us and still delivered on our financial and operating commitments, and we stand on a very firm footing to drive forward into the future. Let’s review how events unfolded. We started 2011 with a sense of building optimism. We’d seen some stability in the rate and equity markets, which along with the continued growth we’ve experienced in our client base, had begun to turn into consistent growth in revenues and earnings. With that as a backdrop, we’d begun ramping investment spending in late 2010 and were prepared to continue on that track in 2011. We saw opportunities in front of us that we believed were going to be important drivers of growth in the future, and while our profitability had not yet returned fully to pre-financial crisis levels, we strove to find the right balance between near-term profitability and long-term growth. As the year progressed, the economic environment clearly veered away from a consistent recovery, equity markets turned volatile, and the Fed took yet another round of action to drive down rates, this time pushing down the longer end of the yield curve. Given how we make money, this environ- ment created challenges that we didn’t anticipate in our baseline planning scenario. To place these challenges in perspective, our two largest sources of revenue — asset management and administration fees and net interest rev- enue — declined by a combined $129 million, or 7 percent, between the first and second halves of 2011, even as we added over 1 million brokerage accounts and more than $145 billion in net new assets to our client base during the year, including optionsXpress accounts and assets. I think it’s fair to say we hit a bump in the road. Still, we met both our financial commitments and planned investment in our clients for 2011. We originally thought we could deliver 10 percent revenue growth against 8 percent expense growth (including our accelerated investment spending) if rates remained flat and the equity markets produced mid-single-digit returns. In the face of the significantly tougher reality that unfolded, our comparable revenue and expense growth rates were 9 percent and NET REVENUES* (in millions for year ended December 31,) $4,994 $5,150 $4,193 $4,248 $4,691 2007 2008 2009 2010 2011 * Amounts are presented on a continuing operations basis to exclude the impact of the sale of U.S. Trust Corporation, which was completed on July 1, 2007. 7 percent, respectively, after adjusting for optionsXpress and certain charges taken in 2010. Revenue pressure was partially offset by continued growth in non-interest sensitive sources like advice fees, as well as a period of very active trading in the summer. And our expense discipline remained intact, even as we dedicated substantial resources to driving important growth initiatives toward completion as planned. We determined that seeing these projects through would be far more cost-effective in the long run than trying to cut them back and then restart them later. “ We operate the company to be resilient in any economic scenario — our commitment to solid capital, strong liquidity, and managing risk is unyielding.” 21 PRE-TAX PROFIT MARGIN* 39.4% 37.1% 30.4% 29.7% 18.3% 2007 2008 2009 2010 2011 * Amounts are presented on a continuing operations basis to exclude the impact of the sale of U.S. Trust Corporation, which was completed on July 1, 2007. What are we looking for in 2012? Possibly a slow start, with a rebound into the latter part of the year. But we can take that in stride; as we’ve shown in the last couple of years, our basic model works well, turning client growth into earnings growth once economic drivers stabilize. After allocating a record $180-plus million to projects in 2011, we’re planning to trim investment spending by over 20 percent, but not nearly back to the lows of recent years, and we’ll continue to make headway against a number of important initia- tives. This far into the crisis, and running as lean as we are now, operating expense trade-offs get harder to make in the near-term. And they have implications for service and, potentially, growth, so we’re approaching this cautiously. Overall, assuming a flat interest rate environment and mod- est equity market gains in 2012, we believe we can keep core expenses close to 2011 levels before layering on a full year of optionsXpress, with revenues probably making a bit more progress as we grow our client base. That might not sound very dramatic, but it would actually represent a strong rebound in performance as 2012 progresses. This is the fifth year I’ve written a letter to you as fellow stockholders. Reflecting back, I’ve attempted to “call ’em like I see ’em.” Sometimes my crystal ball has been a little cloudy, but there are some things that have been consistent throughout:  We operate the company to be resilient in any economic scenario — our commitment to solid capital, strong liquidity, and managing risk is unyielding.  We make necessary trade-offs to remain solidly profitable in the short run, while also continuing to invest in growth for the future.  We understand that stockholders have entrusted us with their capital, and we look to deploy it efficiently and earn an appropriate return on it. I should spend a minute on capital management before I close. As I’ve said to you before, as environmental headwinds ease and our profitability strengthens, we’d expect that the company’s ongoing growth will be primarily supported by capital generated by earnings, which was the case even in an earnings-constrained year like 2011. Looking ahead into 2012, we see another year of strong balance sheet growth as our client initiatives yield stronger business momentum and we continue our work to optimize net interest revenue. To help ensure that the company can continue to operate as it chooses in the face of headwinds that have yet to improve, we raised $400 million in capital early this year via our first-ever preferred stock offering. We viewed this as a cost-effective, non-dilutive way to support our ongoing growth. You can rest assured that we remain committed to maintaining only the capital level appropriate to run our businesses, and that we’ll look to return anything beyond that level to owners. We’re ready to continue driving forward without waiting for help from the environment. We remain positioned for profitable growth, with a healthy balance sheet and the resources necessary to meet the needs of our clients. This most recent round of volatility may not turn out to be the last bump in the road on the way to a healthier economy, but we remain prepared to serve clients, deliver on our commitments, and build a thriving franchise for the long run. JOE MARTINETTO March 10, 2012 22 FINANCIAL HIGHLIGHTS AND RECONCILIATION FINANCIAL HIGHLIGHTS (In Millions, Except Per Share Amounts and as Noted) Net revenues Expenses excluding interest Net income Basic earnings per share Diluted earnings per share Dividends declared per common share Weighted-average common shares outstanding — diluted Closing market price per share (at year-end) Book value per common share (at year-end) Net revenue growth (decline) Pre-tax profit margin Return on stockholders’ equity Full-time equivalent employees (at year-end, in thousands) Net revenues per average GROWTH RATE 1-YEAR 2010-11 10% (5%) 90% 84% 84% – 3% (34%) 17% 2011 $ 4,691 $ 3,299 $ $ $ $ 864 .70 .70 .24 1,229 $ 11.26 $ 6.07 10% 29.7% 12% 2010 $ 4,248 $ 3,469 $ 454 $ $ $ .38 .38 .24 1,194 $ 17.11 $ 5.18 1% 18.3% 8% 2009 $ 4,193 $ 2,917 $ 787 $ $ $ .68 .68 .24 1,160 $ 18.82 $ 4.37 (19%) 30.4% 17% 10% 14.1 12.8 12.4 full-time equivalent employee (in thousands) 4% $ 350 $ 337 $ 338 RECONCILIATION OF NET REVENUES, EXPENSES EXCLUDING INTEREST, AND NET INCOME EXCLUDING CERTAIN ITEMS TO REPORTED AMOUNTS TWELVE MONTHS ENDED DECEMBER 31, THREE MONTHS ENDED JUNE 30, MARCH 31, (In Millions, Unaudited) 2011 2010 %Change 2011 2010 %Change Net Revenues Excluding Certain Items optionsXpress net revenues (1) Reported Net Revenues $ 4,623 $ 4,248 68 – $ 4,691 $ 4,248 Expenses Excluding Interest and Certain Items $ 3,208 $ 2,987 optionsXpress expenses (2) Class action litigation and regulatory reserve Money market mutual fund charges Other expense Total expenses excluded 84 7 – – – 320 132 30 91 482 9% N/M 10% 7% N/M N/M N/M N/M N/M $ 1,190 $ 978 – – $ 1,190 $ 978 $ 797 $ 760 – 7 – – 7 – 196 – 9 205 Reported Expenses Excluding Interest $ 3,299 $ 3,469 (5%) $ 804 $ 965 Income Excluding Certain Items Before Taxes on Income $ 1,415 $ 1,261 Net Income Excluding Certain Items $ 880 $ 775 Add: Revenues excluded above Less: Expenses excluded above Tax benefit Reported Net Income 68 91 (7) – 482 (161) $ 864 $ 454 12% 14% N/M N/M N/M 90% $ 393 $ 218 $ 242 $ 132 – 7 (3) – 205 (79) $ 238 $ 6 22% – 22% 5% – N/M – N/M N/M (17%) 80% 83% – N/M N/M N/M (1) Includes net revenues of optionsXpress Holdings, Inc. (optionsXpress) from the date of acquisition of September 1, 2011. (2) Includes non-recurring costs relating to the acquisition and integration of optionsXpress, which totaled $20 million in 2011, as well as operating expenses from September 1, 2011. N/M — Not Meaningful - GROWTH IN CLIENT ASSETS AND ACCOUNTS 23 GROWTH RATES COMPOUNDED 4-YEAR ANNUAL 1-YEAR (In Billions, at Year End, Except as Noted) 2007-11 2010-11 2011 2010 2009 2008 2007 Assets in client accounts Schwab One®, other cash equivalents and deposits from banking clients 28% 19% $ 96.4 $ 81.1 $ 65.1 $ 44.4 $ 35.9 Proprietary funds (Schwab Funds® and Laudus Funds®): Money market funds (3%) 3% 159.8 154.5 171.2 209.7 183.1 Equity and bond funds (10%) (17%) 38.2 46.0 41.6 33.9 58.7 Total proprietary funds Mutual Fund Marketplace®(1): Mutual Fund OneSource®(2) Mutual fund clearing services Other third-party mutual funds (2) Total Mutual Fund Marketplace Total mutual fund assets Equity and other securities (1) Fixed income securities Margin loans outstanding Total client assets Client assets by business Investor Services Advisor Services Other Institutional Services Total client assets by business Net growth in assets in client accounts (for the year ended) Net new assets Investor Services Advisor Services Other Institutional Services (3) Total net new assets Net market gains (losses) Net growth (decline) New brokerage accounts (4) (in thousands, for the year ended) Clients (in thousands) Active brokerage accounts Banking accounts (5) Corporate retirement (6) plan participants (5%) (1%) 198.0 200.5 212.8 243.6 241.8 2% 6% 8% 6% 3% 3% 5% (3%) 4% 3% 4% 6% (5%) 198.6 208.6 175.0 110.6 180.9 148% 104.2 42.1 81.8 54.2 81.8 5% 305.9 291.8 243.8 169.1 225.7 12% 608.7 542.5 500.6 333.9 488.4 9% 3% 3% 806.7 743.0 713.4 577.5 730.2 607.9 589.4 485.0 357.2 545.2 176.9 171.3 167.0 164.1 145.8 (1%) (10.2) (10.3) (7.9) (6.2) (11.6) 7% $ 1,677.7 $ 1,574.5 $ 1,422.6 $ 1,137.0 $ 1,445.5 2% $ 697.9 $ 686.5 $ 583.2 $ 482.6 $ 625.3 4% 679.0 654.9 590.4 477.2 583.5 29% 300.8 233.1 249.0 177.2 236.7 4% 7% $ 1,677.7 $ 1,574.5 $ 1,422.6 $ 1,137.0 $ 1,445.5 (11%) 89% $ (9%) (10%) N/M 8% (2%) 24.6 44.6 76.7 $ $ 13.0 49.3 (35.7) 15.3 41.3 30.7 87.3 $ 35.1 $ 60.2 18.1 38.6 65.6 56.0 $ 113.4 $ 160.2 N/M $ 145.9 $ 26.6 $ (16%) (32%) $ 103.2 $ 151.9 $ 285.6 $ (308.5) $ 206.3 42.7 125.3 198.3 (421.9) 46.1 9% 37% 1,138 829 787 889 809 5% 41% 7% 8,552 7,998 7,701 7,401 7,049 13% 780 690 567 377 196 5% 1% 1,492 1,477 1,465 1,407 1,205 (1) Excludes all proprietary money market, equity, and bond funds. (2) Certain client assets at December 31, 2009, have been reclassified from Mutual Fund OneSource® to other third-party mutual funds. (3) Includes inflows of $56.1 billion from a mutual fund clearing services client and $7.5 billion from the acquisition of optionsXpress Holdings, Inc. in 2011. Includes inflows of $2.0 billion from the acquisition of Windhaven Investment Management, Inc. and $1.2 billion from a mutual fund clearing services client, and outflows of $51.5 billion related to the planned deconversion of a mutual fund clearing services client in 2010. Includes inflows of $17.8 billion in 2007 related to the acquisition of The 401(k) Company. Includes inflows of $3.3 billion in 2007 related to a mutual fund clearing services client. Effective 2007, amount includes balances covered by 401(k) record keeping-only services, which totaled $5.2 billion at May 31, 2007, related to the March 2007 acquisition of The 401(k) Company. (4) Includes 315,000 new brokerage accounts from the acquisition of optionsXpress Holdings, Inc. in 2011. (5) Effective 2010, the number of banking accounts excludes credit cards. Prior period amounts have been recast to reflect this change. (6) 2007 includes 398,000 participants related to the acquisition of The 401(k) Company and 100,000 related to Schwab Personal Choice Retirement Account® participants at Schwab. N/M — Not Meaningful - 24 EXECUTIVE MANAGEMENT CHARLES R. SCHWAB Chairman of the Board WALTER W. BETTINGER II President and Chief Executive Officer JAY L. ALLEN Executive Vice President, Human Resources and Employee Services RON CARTER Executive Vice President, Operational Services MARIE A. CHANDOHA President, Chief Executive Officer, and Chief Investment Officer, Charles Schwab Investment Management, Inc. BERNARD J. CLARK Executive Vice President, Advisor Services JOHN S. CLENDENING Executive Vice President, Investor Services LISA KIDD HUNT Executive Vice President, Branch Network JOSEPH R. MARTINETTO Executive Vice President and Chief Financial Officer CARRIE E. DWYER Executive Vice President, General Counsel and Corporate Secretary JAMES D. McCOOL Executive Vice President, Institutional Services LAURINE M. GARRITY Executive Vice President and Chief Marketing Officer G. ANDREW GILL Executive Vice President, Investor Services BRADLEY J. PETERSON Executive Vice President and Chief Information Officer PAUL V. WOOLWAY Executive Vice President and President, Charles Schwab Bank UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2011 Commission file number 1-9700 THE CHARLES SCHWAB CORPORATION (Exact name of registrant as specified in its charter) Delaware (State or other jurisdiction of incorporation or organization) 94-3025021 (I.R.S. Employer Identification Number) 211 Main Street, San Francisco, CA 94105 (Address of principal executive offices and zip code) Registrant’s telephone number, including area code: (415) 667-7000 Securities registered pursuant to Section 12(b) of the Act: Title of each class Common Stock - $.01 par value per share Name of each exchange on which registered New York Stock Exchange Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes No Securities registered pursuant to Section 12(g) of the Act: None Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes No Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes No Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes No Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. Large accelerated filer Accelerated filer Non-accelerated filer (Do not check if a smaller reporting company) Smaller reporting company Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes No As of June 30, 2011, the aggregate market value of the voting stock held by non-affiliates of the registrant was $16.8 billion. For purposes of this information, the outstanding shares of Common Stock owned by directors and executive officers of the registrant, and certain investment companies managed by Charles Schwab Investment Management, Inc. were deemed to be shares of the voting stock held by affiliates. The number of shares of Common Stock outstanding as of January 31, 2012, was 1,271,342,259. DOCUMENTS INCORPORATED BY REFERENCE Part III of this Form 10-K incorporates certain information contained in the registrant’s definitive proxy statement for its annual meeting of stockholders, to be held May 17, 2012, by reference to that document. THE CHARLES SCHWAB CORPORATION Annual Report On Form 10-K For Fiscal Year Ended December 31, 2011 TABLE OF CONTENTS Part I Item 1. Business ------------------------------------------------------------------------------------------------------------------------------- General Corporate Overview ----------------------------------------------------------------------------------------------- Acquisitions and Divestiture ------------------------------------------------------------------------------------------------ Business Strategy and Competitive Environment ----------------------------------------------------------------------- Products and Services ------------------------------------------------------------------------------------------------------- Regulation --------------------------------------------------------------------------------------------------------------------- Sources of Net Revenues ---------------------------------------------------------------------------------------------------- Available Information ------------------------------------------------------------------------------------------------------- Item 1A. Risk Factors -------------------------------------------------------------------------------------------------------------------------- Item 1B. Unresolved Securities and Exchange Commission Staff Comments --------------------------------------------------------- Properties ----------------------------------------------------------------------------------------------------------------------------- Item 2. Legal Proceedings ------------------------------------------------------------------------------------------------------------------- Item 3. Part II Item 4. Item 5. Mine Safety Disclosures -------------------------------------------------------------------------------------------------------------- Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases Item 6. Item 7. of Equity Securities ---------------------------------------------------------------------------------------------------------- Selected Financial Data ------------------------------------------------------------------------------------------------------------- Management’s Discussion and Analysis of Financial Condition and Results of Operations ------------------------------ Overview ---------------------------------------------------------------------------------------------------------------------- Current Market and Regulatory Environment ---------------------------------------------------------------------------- Results of Operations -------------------------------------------------------------------------------------------------------- Liquidity and Capital Resources ------------------------------------------------------------------------------------------- Risk Management ------------------------------------------------------------------------------------------------------------ Fair Value of Financial Instruments --------------------------------------------------------------------------------------- Critical Accounting Estimates ---------------------------------------------------------------------------------------------- Forward-Looking Statements ----------------------------------------------------------------------------------------------- Item 7A. Quantitative and Qualitative Disclosures About Market Risk ----------------------------------------------------------------- Financial Statements and Supplementary Data ---------------------------------------------------------------------------------- Item 8. Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure ----------------------------- Item 9A. Controls and Procedures ------------------------------------------------------------------------------------------------------------ Item 9B. Other Information -------------------------------------------------------------------------------------------------------------------- Part III Item 10. Directors, Executive Officers, and Corporate Governance -------------------------------------------------------------------- Executive Compensation ----------------------------------------------------------------------------------------------------------- Item 11. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters ---------------- Item 12. Certain Relationships and Related Transactions, and Director Independence ----------------------------------------------- Item 13. Principal Accountant Fees and Services ------------------------------------------------------------------------------------------ Item 14. 1 1 1 2 3 5 6 6 7 12 13 13 13 13 16 17 17 20 21 29 35 41 41 43 45 47 93 93 93 93 95 95 95 96 Part IV Item 15. Exhibits and Financial Statement Schedule -------------------------------------------------------------------------------------- Exhibit Index ------------------------------------------------------------------------------------------------------------------ Signatures --------------------------------------------------------------------------------------------------------------------- Index to Financial Statement Schedule ------------------------------------------------------------------------------------ 96 96 102 F-1 THE CHARLES SCHWAB CORPORATION PART I Item 1. Business General Corporate Overview The Charles Schwab Corporation (CSC), headquartered in San Francisco, California, was incorporated in 1986 and engages, through its subsidiaries (together referred to as the Company, and primarily located in San Francisco except as indicated), in securities brokerage, banking, and related financial services. At December 31, 2011, the Company had $1.68 trillion in client assets, 8.6 million active brokerage accounts(a), 1.5 million corporate retirement plan participants, and 780,000 banking accounts. Significant business subsidiaries of CSC include:  Charles Schwab & Co., Inc. (Schwab), which was incorporated in 1971, is a securities broker-dealer with over 300 domestic branch offices in 45 states, as well as a branch in each of the Commonwealth of Puerto Rico and London, U.K., and serves clients in Hong Kong through one of CSC’s subsidiaries;  Charles Schwab Bank (Schwab Bank), which commenced operations in 2003, is a federal savings bank located in Reno, Nevada; and  Charles Schwab Investment Management, Inc. (CSIM), which is the investment advisor for Schwab’s proprietary mutual funds, referred to as the Schwab Funds, and Schwab’s exchange-traded funds, referred to as the Schwab ETFs™. The Company provides financial services to individuals and institutional clients through two segments – Investor Services and Institutional Services. The Investor Services segment provides retail brokerage and banking services to individual investors. The Institutional Services segment provides custodial, trading, and support services to independent investment advisors (IAs). The Institutional Services segment also provides retirement plan services, specialty brokerage services, and mutual fund clearing services. For financial information by segment for the three years ended December 31, 2011, see “Item 8 – Financial Statements and Supplementary Data – Notes to Consolidated Financial Statements – 25. Segment Information.” As of December 31, 2011, the Company had full-time, part-time and temporary employees, and persons employed on a contract basis that represented the equivalent of about 14,100 full-time employees. Acquisitions and Divestiture On September 1, 2011, the Company completed its acquisition of all of the outstanding common shares of optionsXpress Holdings, Inc. (optionsXpress), an online brokerage firm primarily focused on equity option securities and futures. The optionsXpress brokerage platform provides active investors and traders trading tools, analytics and education to execute a variety of investment strategies. The combination of optionsXpress and Schwab offers active investors an additional level of service and platform capabilities. optionsXpress, Inc., a wholly-owned subsidiary of optionsXpress, is a securities broker- dealer. On November 9, 2010, the Company acquired substantially all of the assets of Windward Investment Management, Inc. (Windward), which was an investment advisory firm that managed diversified investment portfolios comprised primarily of exchange-traded fund securities. As a result of the acquisition, Windhaven Investment Management, Inc. (Windhaven) was formed as a wholly-owned subsidiary of Schwab Holdings, Inc. In July 2007, the Company sold all of the outstanding stock of U.S. Trust Corporation, which was a subsidiary that provided wealth management services. In March 2007, the Company acquired The 401(k) Company, which offers retirement plan services. The acquisition enhanced the Company’s ability to meet the needs of retirement plans of all sizes. The acquisition also provided the opportunity to (a) Accounts with balances or activity within the preceding eight months. - 1 - THE CHARLES SCHWAB CORPORATION capture rollover accounts from individuals participating in retirement plans served by The 401(k) Company and to cross-sell the Company’s other investment and banking services to plan participants. Business Strategy and Competitive Environment The Company’s strategy is to meet the financial services needs of investors, advisors, and employers through its two segments. To pursue its strategy, the Company focuses on: building client loyalty; innovating in ways that benefit clients; operating in a disciplined manner; and leveraging its strengths through shared core processes and technology platforms. The Company provides clients with a compelling combination of personalized relationships, superior service, and great value, delivered through a blend of people and technology. People provide the client focus and personal touch that are essential in serving investors, while technology helps create services that are scalable and consistent. This combination helps the Company address a wide range of client needs – from tools and information for self-directed or active investors, to advice solutions, to retirement and equity-based incentive plans, to support services for independent IAs – while enabling each client to easily utilize some or all of these capabilities according to their unique circumstances. The Company’s competition in serving individual investors includes a wide range of brokerage, wealth management, and asset management firms, as well as banks and trust companies. In serving these investors and competing for a growing percentage of the investable wealth in the U.S., the Company offers a multi-channel service delivery model, which includes branch, telephonic, mobile, and online capabilities. Under this model, the Company can offer personalized service at competitive prices while giving clients the choice of where, when, and how they do business with the Company. Schwab’s branches and regional telephone service centers are staffed with trained and experienced financial consultants (FCs) focused on building and sustaining client relationships. The Company offers the ability to meet client investing needs through a single ongoing point of contact, even as those needs change over time. In particular, management believes that the Company’s ability to provide those clients seeking help, guidance, or advice with an integrated, individually tailored solution – ranging from occasional consultations to an ongoing relationship with a Schwab FC or an IA – is a competitive strength compared to the more fragmented offerings of other firms. The Company’s online, telephonic, and mobile channels provide quick and efficient access to an extensive array of information, research, tools, trade execution, and administrative services, which clients can access according to their needs. For example, as clients trade more actively, they can use these channels to access highly competitive pricing, expert tools, and extensive service capabilities – including experienced, knowledgeable teams of trading specialists and integrated product offerings. Individuals investing for retirement through 401(k) plans can take advantage of the Company’s bundled offering of multiple investment choices, education, and third-party advice. Management also believes the Company is able to compete with the wide variety of financial services firms striving to attract individual client relationships by complementing these capabilities with the extensive array of investment, banking, and lending products and services described in the following section. In the IA arena, the Company competes with institutional custodians, traditional and discount brokers, banks, and trust companies. Management believes that its Institutional Services segment can maintain its market leadership position primarily through the efforts of its expanded sales and support teams, which are dedicated to helping IAs grow, compete, and succeed in serving their clients. In addition to focusing on superior service, Institutional Services competes by utilizing technology to provide IAs with a highly-developed, scalable platform for administering their clients’ assets easily and efficiently. Institutional Services sponsors a variety of national, regional, and local events designed to help IAs identify and implement better ways to grow and manage their practices efficiently. Another important aspect of the Company’s ability to compete is its ongoing focus on efficiency and productivity, as lower costs give the Company greater flexibility in its approach to pricing and investing for growth. Management believes that this flexibility remains important in light of the competitive environment, in which a number of competitors offer reduced online trading commission rates and lower expense ratios on certain classes of mutual funds and exchange-traded funds. Additionally, the Company’s nationwide marketing effort is an important competitive tool because it reinforces the attributes of the Schwab brand. - 2 - THE CHARLES SCHWAB CORPORATION Products and Services The Company offers a broad range of products to address individuals’ varying investment and financial needs. Examples of these product offerings include:  Brokerage – an array of brokerage accounts including some with check-writing features, debit card, and billpay; individual retirement accounts; retirement plans for small to large businesses; 529 college savings accounts; designated brokerage accounts; equity incentive plan accounts; and margin loans, as well as access to fixed income securities, equity and debt offerings, options, and futures;  Banking – checking accounts linked to brokerage accounts, savings accounts, certificates of deposit, demand deposit accounts, first mortgages, home equity lines of credit (HELOCs), and personal loans collateralized by securities;  Trust – trust custody services, personal trust reporting services, and administrative trustee services;  Advice solutions– separately managed accounts, customized personal advice for tailored portfolios, and specialized planning and full-time portfolio management;  Mutual funds – third-party mutual funds through Mutual Fund Marketplace, including no-load mutual funds through the Mutual Fund OneSource service, proprietary mutual funds from two fund families – Schwab Funds and Laudus Funds, other third-party mutual funds, and mutual fund trading and clearing services to broker-dealers; and  Exchange-traded funds (ETFs) – third-party and proprietary ETFs, as well as separately managed portfolios of ETFs. These products, and the Company’s full array of investing services, are made available through its two segments – Investor Services and Institutional Services. Investor Services Through the Investor Services segment, the Company provides retail brokerage and banking services to individual investors. The Company offers research, analytic tools, performance reports, market analysis, and educational material to all clients. Clients looking for more guidance have access to online portfolio planning tools, professional advice from Schwab’s portfolio consultants who can help develop an investment strategy and carry out investment and portfolio management decisions, as well as a range of fully delegated managed solutions that provide ongoing portfolio management. Schwab strives to demystify investing by educating and assisting clients in the development of investment plans. Educational tools include workshops, interactive courses, and online information about investing. Additionally, Schwab provides various internet-based research and analysis tools that are designed to help clients achieve better investment outcomes. As an example of such tools, Schwab Equity Ratings is a quantitative model-based stock rating system that provides all clients with ratings on approximately 3,000 stocks, assigning each equity a single grade: A, B, C, D, or F. Stocks are rated based on specific factors relating to fundamentals, valuation, momentum, and risk and ranked so that the number of ‘buy consideration’ ratings – As and Bs – equals the number of ‘sell consideration’ ratings – Ds and Fs. In 2011, the Company launched Schwab Equity Ratings InternationalTM, an international ranking methodology covering approximately 4,000 stocks in 28 foreign equity markets. Clients may need specific investment recommendations, either from time to time or on an ongoing basis. The Company provides clients seeking advice with customized solutions. The Company’s approach to advice is based on long-term investment strategies and guidance on portfolio diversification and asset allocation. This approach is designed to be offered consistently across all of Schwab’s delivery channels. Schwab Private ClientTM features a personal advice relationship with a designated portfolio consultant, supported by a team of investment professionals who provide individualized service, a customized investment strategy developed in collaboration with the client, and ongoing guidance and execution. For clients seeking a relationship in which investment decisions are fully delegated to a financial professional, the Company offers several alternatives. The Company provides investors access to professional investment management in a diversified account that is invested exclusively in either mutual funds or ETFs through the Schwab Managed PortfolioTM and WindhavenTM programs. The Company also refers investors who want to utilize a specific third-party money manager to direct a portion of their investment assets to the Schwab Managed Account program. In addition, clients who want the - 3 - THE CHARLES SCHWAB CORPORATION assistance of an independent professional in managing their financial affairs may be referred to IAs in the Schwab Advisor Network. These IAs provide personalized portfolio management, financial planning, and wealth management solutions. The Company strives to deliver information, education, technology, service, and pricing that meet the specific needs of clients who trade actively. Schwab offers integrated Web- and software-based trading platforms, which incorporate intelligent order routing technology, real-time market data, options trading, premium stock research, and multi-channel access, as well as sophisticated account and trade management features, risk management tools, decision support tools, and dedicated personal support. The Company serves both foreign investors and non-English-speaking U.S. clients who wish to trade or invest in U.S. dollar- based securities. In the U.S., the Company serves Chinese-, Spanish-, and Vietnamese-speaking clients through a combination of its branch offices and Web-based and telephonic services. Institutional Services Through the Institutional Services segment, Schwab provides custodial, trading, technology, practice management, trust asset, and other support services to IAs. To attract and serve IAs, Institutional Services has a dedicated sales force and service teams assigned to meet their needs. IAs who custody client accounts at Schwab may use proprietary software that provides them with up-to-date client account information, as well as trading capabilities. The Institutional Services website is the core platform for IAs to conduct daily business activities online with Schwab, including submitting client account information and retrieving news and market information. This platform provides IAs with a comprehensive suite of electronic and paper-based reporting capabilities. Institutional Services offers online cashiering services, as well as internet-based eDocuments sites for both IAs and their clients that provide multi-year archiving of online statements, trade confirms and tax reports, along with document search capabilities. To help IAs grow and manage their practices, Institutional Services offers a variety of services, including marketing and business development, business strategy and planning, and transition support. Regulatory compliance consulting and support services are available, as well as website design and development capabilities. Institutional Services maintains a website that provides interactive tools, educational content, and research reports to assist advisors thinking about establishing their own independent practices. Institutional Services offers an array of services to help advisors establish their own independent practices through the Business Start-up Solutions package. This includes access to dedicated service teams and outsourcing of back-office operations, as well as third-party firms who provide assistance with real estate, errors and omissions insurance, and company benefits. The Company offers a variety of educational materials and events to IAs seeking to expand their knowledge of industry issues and trends, as well as sharpen their individual expertise and practice management skills. Institutional Services updates and shares market research on an ongoing basis, and it holds a series of events and conferences every year to discuss topics of interest to IAs, including business strategies and best practices. The Company sponsors the annual IMPACT® conference, which provides a national forum for the Company, IAs, and other industry participants to gather and share information and insights. IAs and their clients have access to a broad range of the Company’s products and services, including managed accounts and cash products. The Institutional Services segment also provides retirement plan recordkeeping and related services, retirement plan trust and custody services, specialty brokerage services, and mutual fund clearing services, and supports the availability of Schwab proprietary investment funds on third-party platforms. The Company serves a range of employer sponsored plans: equity compensation plans, defined contribution plans, defined benefit plans, nonqualified deferred compensation plans and other employee benefit plans. - 4 - THE CHARLES SCHWAB CORPORATION The Company’s bundled 401(k) retirement plan product offers plan sponsors a wide array of investment options, trustee or custodial services, and participant-level recordkeeping. Plan design features, which increase plan efficiency and achieve employer goals, are also offered, such as automatic enrollment, automatic fund mapping at conversion, and automatic contribution increases. Services also include support for Roth 401(k) accounts and profit sharing and defined benefit plans. The Company provides a robust suite of tools to plan sponsors to manage their plans, including plan-specific reports, studies and research, access to legislative updates and benchmarking reports that provide perspective on their plan’s features compared with overall industry and segment-specific plans. Participants in bundled plans serviced by the Company receive targeted education materials, have access to electronic tools and resources, may attend onsite and virtual seminars, and can receive third-party advice delivered by Schwab. This third-party advice service is delivered online, by phone, or in person, including recommendations based on the core investment fund choices in their retirement plan and specific recommended savings rates. Through the Retirement Business Services unit, the Company and independent retirement plan providers work together to serve plan sponsors, combining the consulting and administrative expertise of the administrator with the Company’s investment, technology, trust, and custodial services. Retirement Business Services also offers the Schwab Personal Choice Retirement Account, a self-directed brokerage offering for retirement plans. The Company’s Corporate Brokerage Services unit provides specialty brokerage-related services to corporate clients through its Stock Plan Services and Designated Brokerage Services businesses. Stock Plan Services offers equity compensation plan sponsors full-service recordkeeping for stock plans: stock options, restricted stock, performance shares and stock appreciation rights. Specialized services for executive transactions and reporting, grant acceptance tracking and other services are offered to employers to meet the needs of administering the reporting and compliance aspects of an equity compensation plan. Designated Brokerage Services provides solutions for compliance departments of regulated companies and firms with special requirements to monitor employee personal trading, including trade surveillance technology. The Corporate Brokerage Services unit also provides mutual fund clearing services to banks, brokerage firms and trust companies and offers Schwab- generated Investment Solutions outside the Company to institutional channels. Regulation CSC is a savings and loan holding company and Schwab Bank, CSC’s depository institution subsidiary, is a federal savings bank. Prior to July 21, 2011, CSC and Schwab Bank were both subject to supervision and regulation by the Office of Thrift Supervision (OTS). The “Dodd-Frank Wall Street Reform and Consumer Protection Act” legislation (Dodd-Frank Act) eliminated the OTS effective July 21, 2011. As a result, the Board of Governors of the Federal Reserve System (Federal Reserve) became CSC’s primary regulator and the Office of the Comptroller of the Currency became the primary regulator of Schwab Bank. Effective July 21, 2011, CSC is required by the Dodd-Frank Act to serve as a source of strength for Schwab Bank. While under the OTS, CSC was required to have a “prudential level of capital” to support CSC’s risk profile. The OTS did not historically subject savings and loan holding companies, such as CSC, to consolidated regulatory capital requirements. However, under the Dodd-Frank Act, CSC will be subject to new minimum leverage and minimum risk-based capital ratio requirements that will be set by the Federal Reserve that are at least as stringent as the requirements generally applicable to insured depository institutions as of July 21, 2011. Schwab Bank is subject to regulation and supervision and to various requirements and restrictions under federal and state laws, including regulatory capital guidelines. Among other things, these requirements also govern transactions with CSC and its non-depository institution subsidiaries, including loans and other extensions of credit, investments and asset purchases, dividends, and investments. The federal banking agencies have broad powers to enforce these regulations, including the power to terminate deposit insurance, impose substantial fines and other civil and criminal penalties, and appoint a conservator or receiver. Schwab Bank is required to maintain minimum capital levels as specified in federal banking laws and regulations. Failure to meet the minimum levels could result in certain mandatory, and possibly additional discretionary actions by the regulators that, if undertaken, could have a direct material effect on Schwab Bank. The securities industry in the United States is subject to extensive regulation under both federal and state laws. CSC’s principal U.S. broker-dealers are Schwab and optionsXpress, Inc. Schwab is registered as a broker-dealer with the United States Securities and Exchange Commission (SEC), the fifty states, and the District of Columbia and Puerto Rico. optionsXpress, Inc. is registered as a broker-dealer with the SEC, the fifty states, the District of Columbia, Puerto Rico, and - 5 - THE CHARLES SCHWAB CORPORATION the Virgin Islands. Schwab and CSIM are registered as investment advisors with the SEC. Additionally, Schwab and optionsXpress, Inc. are regulated by the Commodities Futures Trading Commission (CFTC) with respect to the commodity futures and commodities trading activities they conduct as an introducing broker and futures commission merchant, respectively. Much of the regulation of broker-dealers has been delegated to self-regulatory organizations (SROs). Schwab and optionsXpress, Inc. are members of the Financial Industry Regulatory Authority, Inc. (FINRA), the Municipal Securities Rulemaking Board (MSRB), NYSE Arca, and the Chicago Board Options Exchange (CBOE). optionsXpress, Inc. is also a member of other exchanges. The primary regulators of Schwab are FINRA and, for municipal securities, the MSRB. The primary regulators of optionsXpress, Inc. are FINRA, CBOE, and for municipal securities, the MSRB. The National Futures Association (NFA) is Schwab and optionsXpress, Inc.’s primary regulator for futures and commodities trading activities. The Company’s business is also subject to oversight by regulatory bodies in other countries in which the Company operates. The principal purpose of regulating broker-dealers and investment advisors is the protection of clients and the securities markets. The regulations to which broker-dealers and investment advisors are subject cover all aspects of the securities business, including, among other things, sales and trading practices, publication of research, margin lending, uses and safekeeping of clients’ funds and securities, capital adequacy, recordkeeping and reporting, fee arrangements, disclosure to clients, fiduciary duties owed to advisory clients, and the conduct of directors, officers and employees. Schwab and optionsXpress, Inc. are both subject to Rule 15c3-1 under the Securities Exchange Act of 1934 (the Uniform Net Capital Rule) and related SRO requirements. The CFTC and NFA also impose net capital requirements. The Uniform Net Capital Rule specifies minimum capital requirements that are intended to ensure the general financial soundness and liquidity of broker-dealers. Because CSC itself is not a registered broker-dealer, it is not subject to the Uniform Net Capital Rule. However, if Schwab or optionsXpress, Inc. fail to maintain specified levels of net capital, such failure would constitute a default by CSC under debt covenants under certain of CSC’s debt agreements. The Uniform Net Capital Rule limits broker-dealers’ ability to transfer capital to parent companies and other affiliates. Compliance with the Uniform Net Capital Rule could limit Schwab’s operations and its ability to repay subordinated debt to CSC, which in turn could limit CSC’s ability to repay debt, pay cash dividends, and purchase shares of its outstanding stock. Sources of Net Revenues The Company’s major sources of net revenues are asset management and administration fees, net interest revenue, and trading revenue. The Company generates asset management and administration fees through its proprietary and third-party mutual fund offerings, as well as fee-based advisory solutions. Net interest revenue is the difference between interest earned on interest-earning assets (such as cash, short- and long-term investments, and mortgage and margin loans) and interest paid on funding sources (including banking deposits and client cash in brokerage accounts, short-term borrowings, and long-term debt). The Company generates trading revenue through commissions earned for executing trades for clients and principal transaction revenue from trading activity in fixed income securities. For revenue information by source for the three years ended December 31, 2011, see “Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations – Results of Operations – Net Revenues.” Available Information The Company files annual, quarterly, and current reports, proxy statements, and other information with the SEC. The Company’s SEC filings are available to the public over the Internet on the SEC’s website at http://www.sec.gov. You may read and copy any document that the Company files with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. On the Company’s Internet website, http://www.aboutschwab.com, the Company posts the following recent filings as soon as reasonably practicable after they are electronically filed with or furnished to the SEC: the Company’s annual reports on Form 10-K, the Company’s quarterly reports on Form 10-Q, the Company’s current reports on Form 8-K, and any - 6 - THE CHARLES SCHWAB CORPORATION amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934. All such filings are available free of charge either on the Company’s website or by request via email (investor.relations@schwab.com), telephone (415-667-1959), or mail (Charles Schwab Investor Relations at 211 Main Street, San Francisco, CA 94105). Item 1A. Risk Factors The Company faces a variety of risks that may affect its operations or financial results, and many of those risks are driven by factors that the Company cannot control or predict. The following discussion addresses those risks that management believes are the most significant, although there may be other risks that could arise, or may prove to be more significant than expected, that may affect the Company’s operations or financial results. For a discussion of the Company’s risk management, including technology and operating risk, credit risk, concentration risk, market risk, fiduciary risk, and legal and regulatory risk, see “Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations – Risk Management.” Developments in the business, economic, and geopolitical environment could negatively impact the Company’s business. The Company’s business can be adversely affected by the general environment – economic, corporate, securities market, regulatory, and geopolitical developments all play a role in client asset valuations, trading activity, interest rates and overall investor engagement, and are outside of the Company’s control. Deterioration in the housing and credit markets, reductions in short-term interest rates, and decreases in securities valuations negatively impact the Company’s net interest revenue, asset management and administration fees, and capital resources. A significant decrease in the Company’s liquidity could negatively affect the Company’s business and financial management as well as reduce client confidence in the Company. Maintaining adequate liquidity is crucial to the business operations of the Company, including margin lending, mortgage lending, and transaction settlement, among other liquidity needs. The Company meets its liquidity needs primarily through cash generated by client activity and operating earnings, as well as cash provided by external financing. Fluctuations in client cash or deposit balances, as well as changes in market conditions, may affect the Company’s ability to meet its liquidity needs. A reduction in the Company’s liquidity position could reduce client confidence in the Company, which could result in the loss of client accounts. In addition, if the Company’s broker-dealer or depository institution subsidiaries fail to meet regulatory capital guidelines, regulators could limit the subsidiaries’ operations or their ability to upstream funds to CSC, which could reduce CSC’s liquidity and adversely affect its ability to repay debt and pay cash dividends. In addition, CSC may need to provide additional funding to such subsidiaries. Factors which may adversely affect the Company’s liquidity position include a reduction in cash held in banking or brokerage client accounts, a dramatic increase in the Company’s client lending activities (including margin and personal lending), unanticipated outflows of company cash, increased capital requirements, other regulatory changes or a loss of market or customer confidence in the Company. Schwab may also experience temporary liquidity demands due to timing differences between clients’ transaction settlements and the availability of segregated cash balances. When cash generated by client activity and operating earnings is not sufficient for the Company’s liquidity needs, the Company must seek external financing. During periods of disruptions in the credit and capital markets, potential sources of external financing could be reduced, and borrowing costs could increase. Although CSC and Schwab maintain committed and uncommitted, unsecured bank credit lines and CSC has a commercial paper issuance program, as well as a universal shelf registration statement filed with the SEC, financing may not be available on acceptable terms or at all due to market conditions and 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. - 7 - THE CHARLES SCHWAB CORPORATION 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 activities, securities lending activities, mortgage lending activities, 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. 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 residential mortgage-backed securities, consumer loan asset-backed securities, corporate debt securities, U.S. agency notes, and certificates of deposit 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. Loss of value of securities available for sale and securities held to maturity can result in charges if management determines that the impairments are other than temporary. 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 2011, 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-lien residential real estate mortgage loans 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 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 and could reduce the Company’s liquidity. If the Company chose not to provide credit, liquidity or other support in such a situation, the Company could suffer reputational damage and its business could be adversely affected. Significant interest rate changes could affect the Company’s profitability and financial condition. The Company is exposed to interest rate risk primarily from changes in the interest rates on its interest-earning assets (such as cash equivalents, short- and long-term investments, and mortgage and margin loans) relative to changes in the costs of its funding sources (including deposits in banking and brokerage accounts, short-term borrowings, and long-term debt). Changes in interest rates generally affect the interest earned on interest-earning assets differently than the interest the Company pays on its interest-bearing liabilities. In addition, certain funding sources do not bear interest and their cost therefore does not vary. Overall, the Company is positioned to benefit from a rising interest rate environment; the Company could be adversely affected by a decline in interest rates if the rates that the Company earns on interest-earning assets decline more than the rates - 8 - THE CHARLES SCHWAB CORPORATION that the Company pays on its funding sources, or if prepayment rates increase on the mortgages and mortgage-backed securities that the Company holds. With the low interest rate environment, the Company’s revenue from interest-earning assets has been declining more than the rates that the Company pays on its funding sources. The Company may also be limited in the amount it can reduce interest rates on deposit accounts and still offer a competitive return. To the extent the overall yield on certain Schwab-sponsored money market mutual funds falls to a level at or below the management fees on those funds, the Company may waive a portion of its fee in order to continue providing some return to clients. As a result of the low interest rate environment, the Company has been waiving and may continue to waive a portion of its management fees for certain Schwab-sponsored money market mutual funds. Such fee waivers negatively impact the Company’s asset management and administration fees. The Company is subject to litigation and regulatory investigations and proceedings and may not always be successful in defending itself against such claims or proceedings. The financial services industry faces substantial litigation and regulatory risks. The Company is subject to claims and lawsuits in the ordinary course of business, including arbitrations, class actions and other litigation, some of which include claims for substantial or unspecified damages. The Company is also the subject of inquiries, investigations, and proceedings by regulatory and other governmental agencies. Actions brought against the Company may result in settlements, awards, injunctions, fines, penalties or other results adverse to the Company including reputational harm. Even if the Company is successful in defending against these actions, the defense of such matters may result in the Company incurring significant expenses. Predicting the outcome of matters is inherently difficult, particularly where claims are brought on behalf of various classes of claimants, claimants seek substantial or unspecified damages, or when investigations or legal proceedings are at an early stage. A substantial judgment, settlement, fine, or penalty could be material to the Company’s operating results or cash flows for a particular future period, depending on the Company’s results for that period. In market downturns, the volume of legal claims and amount of damages sought in litigation and regulatory proceedings against financial services companies have historically increased. See “Item 8 – Financial Statements and Supplementary Data – Notes to Consolidated Financial Statements – 15. Commitments and Contingencies.” From time to time, the Company is subject to litigation claims from third parties alleging infringement of their intellectual property rights (e.g., patents). Such litigation can require the expenditure of significant Company resources. If the Company was found to have infringed a third-party patent, or other intellectual property rights, it could incur substantial liability, and in some circumstances could be enjoined from using certain technology, or providing certain products or services. Extensive regulation of the Company’s businesses limits the Company’s activities and may subject it to significant penalties. As a participant in the securities, banking and financial services industries, the Company is subject to extensive regulation under both federal and state laws by governmental agencies, supervisory authorities, and SROs. Such regulation has become more extensive and complex in response to the recent market disruptions. The requirements imposed by the Company’s regulators are designed to ensure the integrity of the financial markets, the safety and soundness of financial institutions, and the protection of clients. These regulations often serve to limit the Company’s activities by way of capital, customer protection and market conduct requirements, and restrictions on the businesses activities that the Company may conduct. Despite the Company’s efforts to comply with applicable regulations, there are a number of risks, particularly in areas where applicable regulations may be unclear or where regulators revise their previous guidance. Any enforcement actions or other proceedings brought by the Company’s regulators against the Company or its affiliates, officers or employees could result in fines, penalties, cease and desist orders, enforcement actions, suspension or expulsion, or other disciplinary sanctions, including limitations on the Company’s business activities, any of which could harm the Company’s reputation and adversely affect the Company’s results of operations and financial condition. Legislation or changes in rules and regulations could negatively impact the Company’s business and financial results. New legislation, rule changes, or changes in the interpretation or enforcement of existing federal, state and SRO rules and regulations may directly affect the operation and profitability of the Company or its specific business lines. The profitability of the Company could also be affected by rules and regulations which impact the business and financial communities generally, - 9 - THE CHARLES SCHWAB CORPORATION including changes to the laws governing taxation, electronic commerce, client privacy and security of client data. In addition, the rules and regulations could result in limitations on the lines of business the Company conducts, modifications to the Company’s business practices, increased capital requirements, or additional costs. Financial reforms and related regulations may affect the Company’s business activities, financial position and profitability. The “Dodd-Frank Wall Street Reform and Consumer Protection Act” was signed into law in July 2010. This legislation makes extensive changes to the laws regulating financial services firms and requires significant rule-making. In addition, the legislation mandates multiple studies, which could result in additional legislative or regulatory action. Among other things, the legislation authorizes various assessments and fees and requires the establishment of minimum leverage and risk-based capital requirements for insured depository institutions, and requires the SEC to complete studies and develop rules regarding various investor protection issues. The legislation also eliminated the Office of Thrift Supervision effective July 21, 2011 and, as a result, the Federal Reserve became CSC’s primary regulator and the Office of the Comptroller of the Currency became the primary regulator of Schwab Bank. CSC is continuing to review the impact the legislation, studies and related rule-making will have on the Company’s business, financial condition, and results of operations. The legislation charges the Federal Reserve with drafting enhanced regulatory requirements for “systemically important” bank holding companies and certain other non-bank financial institutions designated as “systemically important” by the Financial Stability Oversight Council, which may include CSC. The enhanced requirements include more stringent capital, leverage and liquidity standards. The legislation permits the Federal Reserve to tailor its enhanced requirements to the perceived risk profile of an individual financial institution. Among other things, the legislation authorizes various assessments and fees, requires the establishment of minimum leverage and risk-based capital requirements for insured depository institutions, bans proprietary trading by insured depository institutions and affiliates, and requires the SEC to complete studies and develop rules regarding various investor protection issues. The legislation also established a new independent Consumer Financial Protection Bureau, which has broad rulemaking, supervisory and enforcement authority over consumer products, including mortgages, home-equity loans and credit cards. States will be permitted to adopt stricter consumer protection laws and state attorney generals can enforce consumer protection rules issued by the Bureau. The legislation gives the SEC discretion to adopt rules regarding standards of conduct for broker-dealers providing investment advice to retail customers. The various studies required by the legislation could result in additional rulemaking or legislative action, which could impact the Company’s business and financial results. The changes resulting from the legislation may impact the profitability of the Company’s business activities, require changes to certain of its business practices, impose upon the Company more stringent capital, liquidity and leverage ratio requirements or otherwise adversely affect the Company’s business. These changes may also require the Company to invest significant management attention and resources to evaluate and make necessary changes. Technology and operational failures could subject the Company to losses, litigation, and regulatory actions. The Company faces technology and operating risk which is the potential for loss due to deficiencies in control processes or technology systems of the Company, its vendors or its outsourced service providers that constrain the Company’s ability to gather, process, and communicate information and process client transactions efficiently and securely, without interruptions. This risk also includes the risk of human error, employee misconduct, external fraud, computer viruses, distributed denial of service attacks, terrorist attacks, and natural disaster. It could take several hours or more to restore full functionality in the event of an unforeseen event which could affect the Company’s ability to process and settle client transactions. Extraordinary trading volumes could cause the Company’s computer systems to operate at an unacceptably slow speed or even fail. The Company’s business and operations could be negatively impacted by any significant technology and operational failures. Moreover, instances of fraud or other misconduct, including improper use or disclosure of confidential client, employee, or company information, might also negatively impact the Company’s reputation and client confidence in the Company, in addition to any direct losses that might result from such instances. Despite the Company’s efforts to identify areas of risk, oversee operational areas involving risk, and implement policies and procedures designed to manage risk, there can be no - 10 - THE CHARLES SCHWAB CORPORATION assurance that the Company will not suffer unexpected losses, reputational damage or regulatory action due to technology or other operational failures, including those of its vendors. The Company also faces risk related to its security guarantee which covers client losses from unauthorized account activity, such as those caused by external fraud involving the compromise of clients’ login and password information. Losses reimbursed under the guarantee could have a negative impact on the Company’s results of operations. The Company relies on outsourced service providers to perform key functions. The Company relies on external service providers to perform certain key technology, processing, servicing, and support functions. These service providers face technology, operating, business, and economic risks, and any significant failures by them, including the improper use or disclosure of the Company’s confidential client, employee, or company information, could cause the Company to incur losses and could harm the Company’s reputation. An interruption in or the cessation of service by any external service provider as a result of systems failures, capacity constraints, financial difficulties or for any other reason, and the Company’s inability to make alternative arrangements in a timely manner could disrupt the Company’s operations, impact the Company’s ability to offer certain products and services, and result in financial losses to the Company. Switching to an alternative service provider may require a transition period and result in less efficient operations. Potential strategic transactions could have a negative impact on the Company’s financial position. The Company evaluates potential strategic transactions, including business combinations, acquisitions, and dispositions. Any such transaction could have a material impact on the Company’s financial position, results of operations, or cash flows. The process of evaluating, negotiating, and effecting any such strategic transaction may divert management’s attention from other business concerns, and might cause the loss of key clients, employees, and business partners. Moreover, integrating businesses and systems may result in unforeseen expenditures as well as numerous risks and uncertainties, including the need to integrate operational, financial, and management information systems and management controls, integrate relationships with clients and business partners, and manage facilities and employees in different geographic areas. In addition, an acquisition may cause the Company to assume liabilities or become subject to litigation. Further, the Company may not realize the anticipated benefits from an acquisition, and any future acquisition could be dilutive to the Company’s current stockholders’ percentage ownership or to earnings per share (EPS). The Company’s acquisitions and dispositions are typically subject to closing conditions, including regulatory approvals and the absence of material adverse changes in the business, operations or financial condition of the entity being acquired or sold. To the extent the Company enters into an agreement to buy or sell an entity, there can be no guarantee that the transaction will close when expected, or at all. If a material transaction does not close, the Company’s stock price could decline. The Company’s industry is characterized by aggressive price competition. The Company continually monitors its pricing in relation to competitors and periodically adjusts trade commission rates, interest rates on deposits and loans, fees for advisory services, and other fee structures to enhance its competitive position. Increased price competition from other financial services firms, such as reduced commissions to attract trading volume or higher deposit rates to attract client cash balances, could impact the Company’s results of operations and financial condition. The industry in which the Company competes has undergone a period of consolidation. The Company faces intense competition for the clients that it serves and the products and services it offers. There has been significant consolidation as financial institutions with which the Company competes have been acquired by or merged into or acquired other firms. This consolidation may continue. Competition is based on many factors, including the range of products and services offered, pricing, customer service, brand recognition, reputation, and perceived financial strength. Consolidations may enable other firms to offer a broader range of products and services than the Company does, or offer such products at more competitive prices. - 11 - THE CHARLES SCHWAB CORPORATION The Company faces competition in hiring and retaining qualified employees, especially for employees who are key to the Company’s ability to build and enhance client relationships. The market for quality professionals and other personnel in the Company’s business is highly competitive. Competition is particularly strong for financial consultants who build and sustain the Company’s client relationships. The Company’s ability to continue to compete effectively will depend upon its ability to attract new employees and retain existing employees while managing compensation costs. The Company’s stock price has fluctuated historically, and may continue to fluctuate. The Company’s stock price can be volatile. Among the factors that may affect the volatility of the Company’s stock price are the following:    speculation in the investment community or the press about, or actual changes in, the Company’s competitive position, organizational structure, executive team, operations, financial condition, financial reporting and results, effectiveness of cost reduction initiatives, or strategic transactions; the announcement of new products, services, acquisitions, or dispositions by the Company or its competitors; increases or decreases in revenue or earnings, changes in earnings estimates by the investment community, and variations between estimated financial results and actual financial results. Changes in the stock market generally or as it concerns the Company’s industry, as well as geopolitical, economic, and business factors unrelated to the Company, may also affect the Company’s stock price. Future sales of CSC’s equity securities may adversely affect the market price of CSC’s common stock and result in dilution. CSC’s certificate of incorporation authorizes CSC’s Board of Directors to, among other things, issue additional shares of common or preferred stock or securities convertible or exchangeable into equity securities, without stockholder approval. CSC may issue additional equity or convertible securities to raise additional capital or for other purposes. The issuance of any additional equity or convertible securities could be substantially dilutive to holders of CSC’s common stock and may adversely affect the market price of CSC’s common stock. Item 1B. Unresolved Securities and Exchange Commission Staff Comments None. - 12 - THE CHARLES SCHWAB CORPORATION Item 2. Properties A summary of the Company’s significant locations at December 31, 2011, is presented in the following table. Locations are leased or owned as noted below. The square footage amounts are presented net of space that has been subleased to third parties. (amounts in thousands) Location Corporate office space: San Francisco, CA (1) Service centers: Phoenix, AZ (2) Denver, CO Indianapolis, IN Austin, TX Orlando, FL Richfield, OH (1) (2) Includes the Company’s headquarters. Includes two data centers. Square Footage Leased Owned 776 47 383 - 220 148 - - 709 - 274 - - 117 Substantially all of the Company’s branch offices are located in leased premises. The corporate headquarters, data centers, offices, and service centers support both of the Company’s segments. Item 3. Legal Proceedings For a discussion of legal proceedings, see “Item 8 – Financial Statements and Supplementary Data – Notes to Consolidated Financial Statements – 15. Commitments and Contingencies.” PART II Item 4. Mine Safety Disclosures Not applicable. Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities CSC’s common stock is listed on The New York Stock Exchange under the ticker symbol SCHW. The number of common stockholders of record as of January 31, 2012, was 7,983. The closing market price per share on that date was $11.65. The quarterly high and low sales prices for CSC’s common stock and the other information required to be furnished pursuant to this item are included in “Item 8 – Financial Statements and Supplementary Data – Notes to Consolidated Financial Statements – 28. Quarterly Financial Information (Unaudited) and 20. Employee Incentive, Deferred Compensation, and Retirement Plans.” - 13 - THE CHARLES SCHWAB CORPORATION The following graph shows a five-year comparison of cumulative total returns for CSC’s common stock, the Dow Jones U.S. Investment Services Index, and the Standard & Poor’s 500 Index, each of which assumes an initial investment of $100 and reinvestment of dividends. $150 $100 $50 $0 The Charles Schwab Corporation Dow Jones U.S. Investment Services Index Standard & Poor's 500 Index 12/31/06 12/31/07 12/31/08 12/31/09 12/31/10 12/31/11 December 31, The Charles Schwab Corporation Dow Jones U.S. Investment Services Index Standard & Poor’s 500 Index 2006 $ 100 $ 100 $ 100 2007 $ 140 $ 90 $ 105 2008 $ 90 $ 30 $ 66 2009 $ 106 $ 47 $ 84 2010 $ 98 $ 49 $ 97 2011 $ 65 $ 32 $ 99 - 14 - THE CHARLES SCHWAB CORPORATION Issuer Purchases of Equity Securities The following table summarizes purchases made by or on behalf of CSC of its common stock for each calendar month in the fourth quarter of 2011: Total Number of Shares Purchased (in thousands) Average Price Paid per Share Total Number of Shares Purchased as Part of Publicly Announced Program (1) (in thousands) Approximate Dollar Value of Shares that May Yet be Purchased under the Program (in millions) - 17 - 505 - N/A $ - $ 12.04 $ - $ 11.36 $ 596 N/A Month October: Share Repurchase Program (1) Employee transactions (2) November: Share Repurchase Program (1) Employee transactions (2) December: Share Repurchase Program (1) Employee transactions (2) Total: Share Repurchase Program (1) Employee transactions (2) N/A Not applicable. (1) There were no share repurchases under the Share Repurchase Program during the fourth quarter. Repurchases under this program would occur under two authorizations by CSC’s Board of Directors, each covering up to $500 million of common stock that were publicly announced by the Company on April 25, 2007, and March 13, 2008. The remaining authorizations do not have an expiration date. Includes restricted shares withheld (under the terms of grants under employee stock incentive plans) to offset tax withholding obligations that occur upon vesting and release of restricted shares. The Company may receive shares to pay the exercise price and/or to satisfy tax withholding obligations by employees who exercise stock options (granted under employee stock incentive plans), which are commonly referred to as stock swap exercises. $ 596 N/A 596 $ N/A $ 596 N/A $ - $ 11.80 - $ $ 12.01 - N/A - N/A - N/A - 528 - 6 (2) - 15 - THE CHARLES SCHWAB CORPORATION Item 6. Selected Financial Data Selected Financial and Operating Data (In Millions, Except Per Share Amounts, Ratios, or as Noted) Results of Operations Net revenues Expenses excluding interest Income from continuing operations Net income (2) Income from continuing operations per share — basic Income from continuing operations per share — diluted Basic earnings per share (2, 3) Diluted earnings per share (2, 3) Dividends declared per common share Special dividend declared per common share Weighted-average common shares outstanding — diluted Asset management and administration fees as a percentage of net revenues Net interest revenue as a percentage of net revenues Trading revenue as a percentage of net revenues (4) Effective income tax rate Capital expenditures — purchases of equipment, office facilities, and property, net Capital expenditures, net, as a percentage of net revenues Performance Measures Net revenue growth (decline) Pre-tax profit margin Return on stockholders’ equity Financial Condition (at year end) Total assets Long-term debt Stockholders’ equity Assets to stockholders’ equity ratio Long-term debt to total financial capital (long-term debt plus stockholders’ equity) Employee Information Full-time equivalent employees (at year end, in thousands) Net revenues per average full-time equivalent employee (in thousands) Growth Rates Compounded 4-Year (1) 2007-2011 Annual 1-Year 2010-2011 2011 2010 2009 2008 2007 (2%) 1% (6%) (23%) (7%) (7%) (23%) (23%) 5% N/M - 10% (5%) 90% 90% 84% 84% 84% 84% - - 3% $ 4,691 $ 3,299 $ 864 $ 864 $ .70 $ .70 $ .70 $ .70 .24 $ - $ 1,229 $ 4,248 $ 3,469 $ 454 $ 454 $ .38 $ .38 $ .38 $ .38 $ .24 - $ 1,194 $ 4,193 $ 2,917 $ 787 $ 787 $ .68 $ .68 $ .68 $ .68 $ .24 $ - 1,160 $ 5,150 $ 3,122 $ 1,230 $ 1,212 $ 1.07 $ 1.06 $ 1.06 $ 1.05 .22 $ - $ 1,157 $ $ $ $ $ $ $ $ $ $ 4,994 3,141 1,120 2,407 .93 .92 1.98 1.96 .20 1.00 1,222 41% 37% 20% 37.9% 43% 36% 20% 41.7% 45% 30% 24% 38.3% 46% 33% 21% 39.3% 47% 33% 17% 39.6% 3% 50% $ 190 4% $ 127 3% $ 139 3% $ 194 4% $ 168 3% 10% 29.7% 12% 1% 18.3% 8% (19%) 30.4% 17% 3% 39.4% 31% 16% 37.1% 55% 17% - 24% $ $ $ 108,553 2,001 7,714 14 $ $ $ 92,568 2,006 6,226 15 $ $ $ 75,431 1,512 5,073 15 $ $ $ 51,675 883 4,061 13 $ $ $ 42,286 899 3,732 11 21% 24% 23% 18% 19% 10% 14.1 12.8 12.4 13.4 13.3 4% $ 350 $ 337 $ 338 $ 383 $ 387 27% 22% 20% 1% (2%) Note: Information is presented on a continuing operations basis unless otherwise noted. (1) The compounded 4-year growth rate is computed using the following formula: Compound annual growth rate = (Ending Value / Beginning Value) .25 - 1 (2) Net income in 2007 includes a gain of $1.2 billion, after tax, on the sale of U.S. Trust, which was presented as discontinued operations. (3) Both basic and diluted earnings per share in 2008 and 2007 include discontinued operations. (4) Trading revenue includes commission and principal transaction revenues. N/M Not meaningful. - 16 - 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) Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations OVERVIEW Management of the Company focuses on several key financial and client activity metrics in evaluating the Company’s financial position and operating performance. Results for the years ended December 31, 2011, 2010, and 2009 are shown in the following table: Growth Rate 1-Year 2010-2011 2011 2010 2009 N/M 7% 13% 26.6 $ $ 1,574.5 399.7 145.9 $ $ 1,677.7 451.1 Year Ended December 31, Client Activity Metrics: Net new client assets (1) (in billions) Client assets (in billions, at year end) Clients’ daily average trades (2) (in thousands) Company Financial Metrics: Net revenues Expenses excluding interest Income before taxes on income Taxes on income Net income Earnings per share – diluted Net revenue growth (decline) from prior year Pre-tax profit margin Return on stockholders’ equity Net revenue per average full-time equivalent employee (in thousands) 338 (1) Includes inflows of $56.1 billion and $7.5 billion in 2011 from a mutual fund clearing services client and the acquisition of optionsXpress, respectively. Includes net outflows of $51.5 billion in 2010 related to the planned deconversion of a mutual fund clearing services client. 4,248 3,469 779 (325) 454 .38 1% 18.3% 8% 4,691 3,299 1,392 (528) 864 .70 10% 29.7% 12% 4,193 2,917 1,276 (489) 787 .68 (19%) 30.4% 17% 10% (5%) 79% 62% 90% 84% 87.3 $ $ 1,422.6 414.8 350 337 $ $ $ $ $ $ 4% $ $ $ $ $ $ (2) Beginning in 2010, amounts include all commission-free trades, including the Company’s Mutual Fund OneSource® funds and ETFs, and other proprietary products. Prior period amounts have been recast to reflect this change. N/M Not meaningful.  Net new client assets is defined as the total inflows of client cash and securities to the firm less client outflows. Management believes that this metric depicts how well the Company’s products and services appeal to new and existing clients in a given operating environment.  Client assets is the market value of all client assets custodied at the Company. Management considers client assets to be indicative of the Company’s appeal in the marketplace. Additionally, fluctuations in certain components of client assets (e.g., Mutual Fund OneSource funds) directly impact asset management and administration fees.  Clients’ daily average trades is an indicator of client engagement with securities markets and the most prominent driver of trading revenue.  Management believes that earnings per share, net revenue growth, pre-tax profit margin, and return on stockholders’ equity provide broad indicators of the Company’s overall financial health, operating efficiency, and ability to generate acceptable returns within the context of a given operating environment.  Net revenue per average full-time equivalent employee is considered by management to be the Company’s broadest measure of productivity. The Company’s major sources of net revenues are asset management and administration fees, net interest revenue, and trading revenue. The Company generates asset management and administration fees through its proprietary and third-party - 17 - 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) mutual fund offerings, as well as fee-based advisory solutions. Net interest revenue is the difference between interest earned on interest-earning assets and interest paid on funding sources. Asset management and administration fees and net interest revenue are impacted by securities valuations, interest rates, the amount and mix of interest-earning assets and interest- bearing funding sources, the Company’s ability to attract new clients, and client activity levels. The Company generates trading revenue through commissions earned for executing trades for clients and principal transaction revenue from trading activity in fixed income securities. Trading revenue is impacted by trading volumes, the volatility of prices in the equity and fixed income markets, and commission rates. 2011 Compared to 2010 Economic and market conditions were challenging throughout 2011, marked by volatility in the equity markets, lower market valuations, and further declines in interest rates. The Standard and Poor’s 500 Index, Nasdaq Composite Index, and Dow Jones Industrial Average decreased on average 6%, 5%, and 4%, respectively, between the first and second halves of the year. The federal funds target rate remained unchanged during the year at a range of zero to 0.25% and the three-month Treasury Bill and 10-year Treasury yields declined by 11 and 141 basis points to 0.01% and 1.88%, respectively. The Company’s key client activity metrics in 2011 were stable in the midst of a weakened economic and market environment. Net new client assets totaled $145.9 billion in 2011. Core net new client assets, which exclude significant one- time flows, totaled $82.3 billion in 2011 up from $78.1 billion in 2010. Total client assets ended the year at $1.68 trillion, up 7% from 2010. In addition, clients’ daily average trades were 451,100, up 13% from 2010. Net revenues increased by 10% in 2011 from 2010 due to increases in all of the Company’s major sources of net revenues. Asset management and administration fees increased primarily due to an increase in revenue from the Company’s advice solutions and continued asset inflows, partially offset by money market mutual fund fee waivers, which increased to $568 million in 2011 from $433 million in 2010. Net interest revenue increased primarily due to higher average balances of interest-earning assets during the year, partially offset by the effect of lower interest rate spreads resulting from higher amortization of premiums relating to residential mortgage-backed securities caused by higher mortgage prepayments in 2011. Trading revenue increased primarily due to higher daily average revenue trades and the addition of optionsXpress, which was acquired in September 2011. While total expenses excluding interest were lower by 5% in 2011 compared to 2010, the Company experienced increases in compensation and benefits, professional services, occupancy and equipment, and advertising and market development expenses in aggregate of $266 million in 2011 compared to 2010. Significant charges in 2010 included class action litigation and regulatory reserves relating to the Schwab YieldPlus Fund®, losses recognized for Schwab money market mutual funds, and a charge relating to the termination of the Company’s Invest First® and WorldPoints(a) Visa(b) credit card program for a total of $482 million. As a result of the Company’s ongoing investment in clients and sustained expense discipline, the Company achieved a pre- tax profit margin of 29.7% and return on stockholders’ equity of 12% in 2011. 2010 Compared to 2009 The equity markets improved during 2010 and remained well above their prior year lows. The Nasdaq Composite Index, the Standard & Poor’s 500 Index, and the Dow Jones Industrial Average increased 17%, 13%, and 11%, respectively. The low interest rate environment continued throughout the year as the federal funds target rate remained unchanged during the year at a range of zero to 0.25%. The Company’s sustained investment in expanding and improving product and service capabilities for its clients was reflected in the strength of its key client activity metrics in 2010 - net new client assets totaled $78.1 billion, excluding (a) WorldPoints is a registered trademark of FIA Card Services, N.A. (b) Visa is a registered trademark of Visa International Service Association. - 18 - 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) outflows related to a single mutual fund clearing client who completed a planned transfer to an internal platform during the year, and total client assets ended 2010 at $1.57 trillion, up 11% from 2009. Client trading activity slowed during the year as clients’ daily average trades decreased 4% from 2009 to 399,700. Net revenues were relatively flat in 2010 from 2009. The Company, however, experienced a change in the mix of its revenue sources as the increase in net interest revenue was offset by decreases in trading revenue, asset management and administration fees, and other revenue. Net interest revenue increased due to higher average balances of interest-earning assets, partially offset by a decrease in the average yield earned. Trading revenue decreased due to lower average revenue per revenue trade resulting from improved online trade pricing for clients, which was implemented in January 2010, and slightly lower daily average revenue trades in 2010. While the low interest rate environment caused over $200 million of additional money market mutual fund fee waivers from the prior year, the decrease in asset management and administration fees was limited to 3% due to higher average asset valuations and continued asset inflows. Other revenue was lower in comparison to 2009 primarily due to a gain of $31 million on the repurchase of a portion of the Company’s long-term debt in 2009. Expenses excluding interest were higher by 19% in 2010 compared to 2009 primarily due to the recognition of certain significant charges in 2010. The Company recognized class action litigation and regulatory reserves of $320 million relating to the Schwab YieldPlus Fund. Additionally, the Company decided to cover the net remaining losses recognized by Schwab money market mutual funds as a result of their investments in a single structured investment vehicle that defaulted in 2008 and recorded a charge of $132 million in 2010. Also, as a result of challenging credit card industry economics, the Company ended its sponsorship in its Invest First® and WorldPoints(a) Visa(b) credit cards and recorded a charge of $30 million. The Company’s ongoing expense discipline helped limit the growth in all other expense categories in the aggregate to 3% over the prior year. Business Acquisitions On September 1, 2011, the Company completed its acquisition of all of the outstanding common shares of optionsXpress, an online brokerage firm primarily focused on equity option securities and futures, for total consideration of $714 million. Under the terms of the merger agreement, optionsXpress stockholders received 1.02 shares of the Company’s common stock for each share of optionsXpress stock. As a result, the Company issued 59 million shares of the Company’s common stock valued at $710 million, based on the closing price of the Company’s common stock on September 1, 2011. The Company also assumed optionsXpress’ stock-based compensation awards valued at $4 million. On November 9, 2010, the Company acquired substantially all of the assets of Windward for $106 million in common stock and $44 million in cash. Windward was an investment advisory firm that managed diversified investment portfolios comprised primarily of ETFs. For more information on the acquisitions of optionsXpress and Windward, see “Item 8 – Financial Statements and Supplementary Data – Notes to Consolidated Financial Statements – 3. Business Acquisitions.” Subsequent Event On January 26, 2012, the Company issued and sold 400,000 shares of fixed-to-floating rate non-cumulative perpetual preferred stock, Series A, $0.01 par value, with a liquidation preference of $1,000 per share (Series A Preferred Stock). The Series A Preferred Stock has a fixed dividend rate of 7% until 2022 and a floating rate thereafter. Net proceeds received from the sale were $394 million and are being used for general corporate purposes, including, without limitation, to support the Company’s balance sheet growth and the potential migration of certain client cash balances to deposit accounts at Schwab Bank. (a) WorldPoints is a registered trademark of FIA Card Services, N.A. (b) Visa is a registered trademark of Visa International Service Association. - 19 - 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) CURRENT MARKET AND REGULATORY ENVIRONMENT The economic and market environment was challenging throughout 2011. Further declines in interest rates continue to constrain growth in the Company’s net revenues. While the federal funds target rate was unchanged at a range of zero to 0.25% in 2011, the Federal Reserve took action during the middle of the year to lower longer term interest rates. Further declines in interest rates in 2011 have accelerated the prepayment activity in the Company’s portfolios of residential mortgage-backed securities, which resulted in higher premium amortization. To the extent rates remain at these low levels, the Company’s net interest revenue will continue to be constrained, even as growth in average balances helps to increase such revenue. The low interest rate environment also affects asset management and administration fees. The overall yields on certain Schwab-sponsored money market mutual funds have remained at levels at or below the management fees on those funds. The Company continues to waive a portion of its management fees, which it began in the first quarter of 2009, so that the funds can continue providing a positive return to clients. These and other money market mutual funds may not be able to replace maturing securities with securities of equal or higher yields. As a result, the yields on such funds may remain around or decline from their current levels, and therefore below the management fees on those funds. To the extent this occurs, the Company may continue to waive fees and such waivers could increase from the fourth quarter 2011 level, which would negatively affect asset management and administration fees. The Company recorded net impairment charges of $31 million and $36 million related to certain non-agency residential mortgage-backed securities in 2011 and 2010, respectively, due to credit deterioration of the securities’ underlying loans. Further deterioration in the performance of the underlying loans in the Company’s residential mortgage-backed securities portfolio could result in the recognition of additional impairment charges. The Company is pursuing lawsuits in state court in San Francisco for rescission and damages against issuers, underwriters, and dealers of 51 individual non-agency residential mortgage-backed securities on which the Company has experienced realized and unrealized losses. The lawsuits allege that offering documents for the securities contained material untrue and misleading statements about the securities and the underwriting standards and credit quality of the underlying loans. On January 27, 2012, the court denied defendants’ motions to dismiss the claims with respect to all but 4 of the 51 securities, and allowed the cases to proceed to discovery. The “Dodd-Frank Wall Street Reform and Consumer Protection Act” was signed into law in July 2010. Among other things, the legislation authorizes various assessments and fees and requires the establishment of minimum leverage and risk-based capital requirements for insured depository institutions. The legislation also eliminated the Office of Thrift Supervision effective July 21, 2011 and, as a result, the Federal Reserve became CSC’s primary regulator and the Office of the Comptroller of the Currency became the primary regulator of Schwab Bank. CSC is continuing to review the impact the legislation, studies and related rule-making will have on the Company’s business, financial condition, and results of operations. - 20 - 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) RESULTS OF OPERATIONS The following discussion presents an analysis of the Company’s results of operations for the years ended December 31, 2011, 2010, and 2009. Net Revenues The Company’s major sources of net revenues are asset management and administration fees, net interest revenue, and trading revenue, which all increased in 2011 as compared to 2010. Asset management and administration fees and trading revenue decreased, while net interest revenue increased in 2010 as compared to 2009. Year Ended December 31, 2011 2010 2009 Growth Rate 2010-2011 Amount % of Total Net Revenues Asset management and administration fees Schwab money market funds before fee waivers Fee waivers Schwab money market funds after fee waivers Equity and bond funds Mutual Fund OneSource Total mutual funds Advice solutions Other Asset management and administration fees Net interest revenue Interest revenue Interest expense Net interest revenue Trading revenue Commissions Principal transactions Trading revenue Other Provision for loan losses Net impairment losses on securities Total net revenues - 31% (31%) 4% 12% 5% 36% 10% 6% 10% (12%) 13% 12% 2% 12% 19% (33%) (14%) 10% Asset Management and Administration Fees $ 865 (568) 297 118 680 1,095 522 311 1,928 1,900 (175) 1,725 866 61 927 160 (18) 6% 3% 14% 23% 11% 7% 41% 41% (4%) 37% 19% 1% 20% 3% - Amount $ 865 (433) 432 114 608 1,154 384 284 1,822 1,723 (199) 1,524 770 60 830 135 (27) % of Total Net Revenues % of Total Net Amount Revenues $ 1,011 (224) 787 108 446 1,341 278 256 1,875 1,428 (183) 1,245 884 112 996 175 (38) (60) $ 4,193 18% 3% 11% 32% 7% 6% 45% 34% (4%) 30% 21% 3% 24% 3% (1%) (1%) 100% 10% 3% 14% 27% 9% 7% 43% 41% (5%) 36% 18% 2% 20% 3% (1%) (1%) 100% (31) $ 4,691 (1%) 100% (36) $ 4,248 Asset management and administration fees include mutual fund service fees and fees for other asset-based financial services provided to individual and institutional clients. The Company earns mutual fund service fees for shareholder services, administration, investment management, and transfer agent services (through July 2009) provided to its proprietary funds, and recordkeeping and shareholder services provided to third-party funds. These fees are based upon the daily balances of client assets invested in these funds. The Company also earns asset management fees for advice solutions, which include advisory and managed account services that are based on the daily balances of client assets subject to the specific fee for service. The fair values of client assets included in proprietary and third-party mutual funds are based on quoted market prices and other observable market data. Other asset management and administration fees include various asset based fees, such as trust fees, 401k record keeping fees, and mutual fund clearing and other service fees. Asset management and administration fees may vary with changes in the balances of client assets due to market fluctuations and client activity. For discussion of the impact of current market conditions on asset management and administration fees, see “Current Market and Regulatory Environment.” Asset management and administration fees increased by $106 million, or 6%, in 2011 from 2010 primarily due to an increase in advice solutions fees, partially offset by a decrease in mutual fund service fees. Asset management and administration fees - 21 - 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) decreased by $53 million, or 3%, in 2010 from 2009 primarily due to the decrease in mutual fund service fees, partially offset by an increase in advice solutions fees. Given the low interest rate environment in 2011, 2010, and 2009, the overall yields on certain Schwab-sponsored money market mutual funds have remained at levels at or below the management fees on those funds. As a result, the Company waived a portion of its fees in order to provide a positive return to clients. Mutual fund service fees decreased by $59 million, or 5%, in 2011 from 2010 and by $187 million, or 14%, in 2010 from 2009 primarily due to the increase in money market mutual fund fee waivers, offset by higher average balances of client assets invested in the Company’s Mutual Fund OneSource funds as a result of continued asset inflows. Advice solutions fees increased by $138 million, or 36%, in 2011 from 2010 and by $106 million, or 38%, in 2010 from 2009 primarily due to higher average balances of client assets enrolled in retail advisory and managed account programs, including Schwab Private Client and Schwab Managed Portfolios™. The increase in 2011 was also attributed to the integration of Windhaven, which was acquired in November 2010. Additionally, the increases in advice solutions fees were due to temporary fees rebates of $63 million and $68 million, which reduced advice solutions fees in 2010 and 2009, respectively, under a rebate program that ended in 2010. 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 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 (i.e., interest-earning assets generally reprice more quickly than interest-bearing liabilities). 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. The current low interest rate environment limits the extent to which the Company can reduce interest expense paid on funding sources. However, the spread is influenced by external factors such as the interest rate environment and competition. For discussion of the impact of current market conditions on net interest revenue, see “Current Market and Regulatory Environment.” In clearing its 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 sheet. 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 certificates, mortgage-backed securities guaranteed by the Government National Mortgage Association, certificates of deposit issued by U.S. banks and thrifts, and resale agreements collateralized by qualified securities. Additionally, Schwab and optionsXpress, Inc. have established policies for the minimum credit quality and maximum maturity of these investments. Schwab Bank maintains investment portfolios for liquidity as well as to invest funds from deposits in excess of loans to banking clients and liquidity limits. Schwab Bank’s securities available for sale include residential mortgage-backed securities, certificates of deposit, corporate debt securities, U.S. agency notes, and asset-backed and other securities. Schwab Bank’s securities held to maturity include residential mortgage-backed and other securities. Schwab Bank lends funds to banking clients primarily in the form of mortgage loans and HELOCs. These loans are largely funded by interest-bearing deposits from banking clients. - 22 - $ 33 80 1 351 1 521 74 241 5 1,307 121 $ 1,428 $ 107 3 71 181 2 $ 183 $ 1,245 0.42% 0.49% 0.28% 5.20% 0.79% 2.81% 3.86% 3.61% 4.55% 2.23% 2.44% 0.34% 0.02% 5.77% 0.36% 0.32% 2.12% 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) The Company’s interest-earning assets are financed primarily by brokerage client cash balances and deposits from banking clients. Noninterest-bearing funding sources include noninterest-bearing brokerage client cash balances and proceeds from stock-lending activities, as well as stockholders’equity. The following table presents net interest revenue information corresponding to interest-earning assets and funding sources on the consolidated balance sheet: 2011 Average Interest Average Revenue/ Yield/ Rate Expense Balance 2010 Interest Average Average Revenue/ Yield/ Rate Balance Expense 2009 Interest Average Revenue/ Expense Balance Average Yield/ Rate Year Ended December 31, Interest-earning assets: Cash and cash equivalents Cash and investments segregated Broker-related receivables (1) Receivables from brokerage clients Other securities owned (1) Securities available for sale (2) Securities held to maturity Loans to banking clients Loans held for sale Total interest-earning assets Other interest revenue Total interest-earning assets $ 5,554 $ 25,831 310 10,637 - 27,486 16,050 9,472 65 95,405 13 39 - 467 - 456 492 310 3 1,780 120 $ 95,405 $ 1,900 0.23% 0.15% 0.05% 4.39% - 1.66% 3.07% 3.27% 4.62% 1.87% $ 7,269 19,543 317 8,981 74 24,209 10,440 7,987 80 78,900 1.99% $ 78,900 $ 19 57 - 437 - 486 361 275 4 1,639 84 $ 1,723 0.26% 0.29% 0.08% 4.87% 0.45% 2.01% 3.46% 3.44% 5.00% 2.08% $ 7,848 16,291 363 6,749 126 18,558 1,915 6,671 110 58,631 2.18% $ 58,631 Funding sources: Deposits from banking clients Payables to brokerage clients Long-term debt Total interest-bearing liabilities Noninterest-bearing funding sources Other interest expense Total funding sources Net interest revenue (1) (2) Amounts have been calculated based on amortized cost. $ 52,701 $ 29,992 2,004 84,697 10,708 $ 95,405 $ 2 175 $ 1,725 62 3 108 173 Interest revenue was less than $500,000 in the period or periods presented. 0.12% 0.01% 5.39% 0.20% 0.18% 1.81% $ 44,858 22,715 1,648 69,221 9,679 $ 78,900 $ 105 2 92 199 0.23% 0.01% 5.58% 0.29% - $ 199 $ 1,524 0.25% 1.93% $ 31,249 18,002 1,231 50,482 8,149 $ 58,631 Net interest revenue increased in 2011 from 2010 primarily due to higher average balances of interest-earning assets, partially offset by the effect of lower interest rate spreads resulting from higher amortization of premiums relating to residential mortgage-backed securities. The growth in average balances of deposits from banking clients and payables to brokerage clients funded the increases in the balances of receivables from brokerage clients, securities available for sale, and securities held to maturity. Further declines in interest rates in 2011 accelerated the prepayment activity in the Company’s portfolio of residential mortgage-backed securities, which resulted in higher premium amortization. Net interest revenue increased in 2010 from 2009 due to higher average balances of interest-earning assets. This resulted from significant growth in the average balance of deposits from banking clients, which in turn funded increases in the average balances of securities held to maturity, securities available for sale, and loans to banking clients. These interest- earning assets are invested at rates above the cost of supporting funding sources. The increase in net interest revenue was partially offset by the decline in the yields of almost all interest-earning assets compared to 2009. Trading Revenue Trading revenue includes commission and principal transaction revenues. Commission revenue is affected by the number of revenue trades executed and the average revenue earned per revenue trade. Principal transaction revenue is primarily comprised of revenue from client fixed income securities trading activity. Factors that influence principal transaction revenue include the volume of client trades and market price volatility. Trading revenue increased by $97 million, or 12%, in 2011 from 2010 primarily due to higher daily average revenue trades and the addition of optionsXpress. Trading revenue decreased by $166 million, or 17%, in 2010 from 2009 due to lower - 23 - 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) average revenue per revenue trade resulting from improved online trade pricing for clients and lower daily average revenue trades. As shown in the following table, daily average revenue trades increased by 12% in 2011. The increase was primarily due to a higher volume of option, equity, and mutual fund trades. Average revenue per revenue trade remained relatively flat in 2011. Daily average revenue trades decreased 5% in 2010 from 2009 primarily due to a lower volume of equity and principal transaction trades, partially offset by a higher volume of option trades. Average revenue per revenue trade decreased 11% in 2010 from 2009 primarily due to lower online equity trade commissions, which were implemented in January 2010. Year Ended December 31, Daily average revenue trades (1) (in thousands) Number of trading days Average revenue per revenue trade (1) Growth Rate 2010-2011 12% - (1%) 2011 303.8 251.5 $ 12.15 2010 270.7 251.5 $ 12.28 2009 285.8 251.0 $ 13.86 Includes all client trades that generate trading revenue (i.e., commission revenue or revenue from fixed income securities trading). Other Revenue Other revenue includes software fee revenue relating to the Company’s portfolio management services, exchange processing fee revenue, gains on sales of mortgage loans, and other service fee revenues. Other revenue increased by $25 million, or 19%, in 2011 compared to 2010 primarily due to increases in software and exchange processing fee revenues, as well as the addition of education services revenue from the acquisition of optionsXpress. Other revenue was lower by $40 million, or 23%, in 2010 compared to 2009 primarily due to a gain of $31 million on the repurchase of a portion of the Company’s long- term debt in 2009. Provision for Loan Losses The provision for loan losses decreased by $9 million, or 33%, in 2011 from 2010, due to a decrease in overall expected loss rates resulting primarily from a decrease in first mortgage loan delinquencies. The provision for loan losses decreased by $11 million, or 29%, in 2010 from 2009, primarily due to stabilization in the levels of loan delinquencies and nonaccrual loans in 2010 compared to 2009. Charge-offs were $19 million, $20 million, and $13 million in 2011, 2010, and 2009, respectively. For further discussion on the Company’s credit risk and the allowance for loan losses, see “Risk Management – Credit Risk” and “Item 8 – Financial Statements and Supplementary Data – Notes to Consolidated Financial Statements – 7. Loans to Banking Clients and Related Allowance for Loan Losses.” Net Impairment Losses on Securities Net impairment losses on securities were $31 million, $36 million, and $60 million in 2011, 2010, and 2009, respectively. These charges relate to certain non-agency residential mortgage-backed securities in the Company’s available for sale portfolio as a result of credit deterioration of the securities’ underlying loans. For further discussion, see “Item 8 – Financial Statements and Supplementary Data – Notes to Consolidated Financial Statements – 6. Securities Available for Sale and Securities Held to Maturity.” - 24 - 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) Expenses Excluding Interest As shown in the table below, expenses excluding interest were lower in 2011 compared to 2010 primarily due to certain significant charges in 2010, including class action litigation and regulatory reserves relating to the Schwab YieldPlus Fund and losses recognized for Schwab money market mutual funds. The decrease in expenses excluding interest caused by these charges in 2010 was offset by increases in compensation and benefits, professional services, occupancy and equipment, and advertising and market development expenses in 2011. Expenses excluding interest were higher in 2010 compared to 2009 primarily due to the charges previously discussed. Year Ended December 31, Compensation and benefits Professional services Occupancy and equipment Advertising and market development Communications Depreciation and amortization Class action litigation and regulatory reserve Money market mutual fund charges Other Total expenses excluding interest Expenses as a percentage of total net revenues: Total expenses excluding interest Advertising and market development N/M Not meaningful. Compensation and Benefits Growth Rate 2010-2011 10% 13% 11% 16% 6% 6% N/M N/M (5%) (5%) 2011 $ 1,732 387 301 228 220 155 7 - 269 $ 3,299 2010 $ 1,573 341 272 196 207 146 320 132 282 $ 3,469 2009 $ 1,544 275 318 191 206 159 - - 224 $ 2,917 70% 5% 82% 5% 70% 5% Compensation and benefits expense includes salaries and wages, incentive compensation, and related employee benefits and taxes. Incentive compensation includes variable compensation, discretionary bonus costs, and stock-based compensation. Variable compensation includes payments to certain individuals based on their sales performance. Discretionary bonus costs are based on the Company’s overall performance as measured by earnings per share, and therefore will fluctuate with this measure. In 2009, discretionary bonus costs were based on the achievement of specified performance objectives, including revenue growth and pre-tax profit margin. Stock-based compensation primarily includes employee and board of director stock options, restricted stock awards, and restricted stock units. - 25 - 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) Compensation and benefits expense increased by $159 million, or 10%, in 2011 from 2010 primarily due to increases in salaries and wages and incentive compensation. Compensation and benefits expense increased by $29 million, or 2%, in 2010 from 2009 primarily due to an increase in incentive compensation. The following table shows a comparison of certain compensation and benefits components and employee data: Growth Rate 2010-2011 9% 15% 8% 10% Year Ended December 31, Salaries and wages Incentive compensation Employee benefits and other Total compensation and benefits expense Compensation and benefits expense as a percentage of total net revenues: Salaries and wages Incentive compensation Employee benefits and other Total compensation and benefits expense Full-time equivalent employees (in thousands) (1) At year end Average (1) 10% 6% 2011 $ 1,012 444 276 $ 1,732 $ 2010 931 386 256 $ 1,573 $ 2009 930 355 259 $ 1,544 22% 9% 6% 37% 14.1 13.4 22% 9% 6% 37% 12.8 12.6 22% 8% 7% 37% 12.4 12.4 Includes full-time, part-time and temporary employees, and persons employed on a contract basis, and excludes employees of outsourced service providers. Salaries and wages increased in 2011 from 2010 primarily due to increases in full-time employees and persons employed on a contract basis. The increase in full-time employees was partially due to the addition of full-time employees from the optionsXpress acquisition in September 2011. Incentive compensation increased in 2011 from 2010 primarily due to an increase in discretionary bonus costs and higher variable compensation. Discretionary bonus costs increased based on the Company’s overall performance in 2011, as well as an increase in full time employees. Variable compensation was higher primarily due to the integration of Windhaven, which was acquired in November 2010. Employee benefits and other expense increased in 2011 from 2010 primarily due to increases in payroll taxes and the Company’s 401(k) plan contribution expense as a result of increases in incentive compensation and full-time employees. Salaries and wages were relatively flat in 2010 from 2009 primarily due to increases in persons employed on a contract basis and full-time employees, offset by severance expense of $58 million in 2009 relating to the Company’s cost reduction measures. Incentive compensation increased in 2010 from 2009 primarily due to higher variable compensation resulting from product sales performance in the Company’s branch offices and higher stock-based compensation relating to the amortization of its stock options and restricted stock units. Expenses Excluding Compensation and Benefits Professional services expense increased in 2011 from 2010 primarily due to an increase in fees relating to the Company’s technology investments and client facing infrastructure, and approximately $10 million in costs relating to the integration of optionsXpress. Professional services expense increased in 2010 from 2009 primarily due to increases in fees relating to technology services and enhancements, and investment advisor fees relating to the Company’s managed account service programs. Occupancy and equipment expense increased in 2011 from 2010 primarily due to an increase in the Company’s investments in data processing equipment. Occupancy and equipment expense decreased in 2010 from 2009 primarily due to facilities charges of $43 million in 2009 relating to the Company’s cost reduction measures. Advertising and market development expense increased in 2011 from 2010 primarily due to higher spending on customer and branch promotions and electronic media. - 26 - 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) Communications expense increased in 2011 from 2010 primarily due to higher telephone service expense and third-party news and information expense. Depreciation and amortization expense increased in 2011 from 2010 primarily due to higher amortization of intangible assets resulting from the acquisitions of optionsXpress and Windhaven. Depreciation and amortization expense decreased in 2010 from 2009 primarily due to certain assets becoming fully depreciated. In 2011 and 2010, the Company recorded class action litigation and regulatory reserves relating to the Schwab YieldPlus Fund. For further discussion of the Schwab YieldPlus Fund litigation and regulatory matters, see “Item 8 – Financial Statements and Supplementary Data – Notes to Consolidated Financial Statements – 15. Commitments and Contingencies.” In 2010, the Company decided to cover the net remaining losses of $132 million recognized by Schwab money market mutual funds as a result of their investments in a single structured investment vehicle that defaulted in 2008. Other expense was lower in 2011 compared to 2010 primarily due to a charge of $30 million in 2010, relating to the Company’s Invest First and WorldPoints Visa credit cards, as the Company ended its sponsorship due to challenging credit card industry economics. Other expense was higher in 2010 as compared to 2009 primarily due to this charge and an increase in employee travel expenses. Taxes on Income The Company’s effective income tax rate on income before taxes was 37.9% in 2011, 41.7% in 2010, and 38.3% in 2009. The decrease in 2011 from 2010 was due to a lower effective state income tax rate in 2011 and the impact of non-deductible penalties relating to the Schwab YieldPlus Fund regulatory settlements recorded in 2010. The increase in 2010 from 2009 was primarily due to the impact of non-deductible penalties in 2010. Segment Information The Company provides financial services to individuals and institutional clients through two segments – Investor Services and Institutional Services. The Investor Services segment provides retail brokerage and banking services to individual investors. The Institutional Services segment provides custodial, trading, and support services to independent investment advisors. The Institutional Services segment also provides retirement plan services, specialty brokerage services, and mutual fund clearing services, and supports the availability of Schwab proprietary mutual funds and collective trust funds on third- party platforms. Banking revenues and expenses are allocated to the Company’s two segments based on which segment services the client. The Company evaluates the performance of its segments on a pre-tax basis, excluding items such as impairment charges on non-financial assets, discontinued operations, extraordinary items, and significant restructuring and other charges. Segment assets and liabilities are not disclosed because the balances are not used for evaluating segment performance and deciding how to allocate resources to segments. - 27 - 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) Financial information for the Company’s reportable segments is presented in the following tables: Year Ended December 31, Net Revenues Asset management and administration fees Net interest revenue Trading revenue Other Provision for loan losses Net impairment losses on securities Total net revenues Expenses Excluding Interest Income before taxes on income Growth Rate 2010-2011 Investor Services Institutional Services 2011 2010 2009 Growth Rate 2010-2011 2011 2010 2009 8% 13% 12% 21% (35%) (16%) 12% $ 1,053 1,468 625 85 (15) $ 976 1,297 557 70 (23) $ 968 1,058 679 93 (34) (27) 3,189 (32) 2,845 (54) 2,710 9% 19% 2,261 $ 928 2,065 $ 780 1,906 $ 804 3% 13% 11% 15% (25%) $ 875 257 302 75 (3) $ 846 227 273 65 (4) $ 907 187 317 82 (4) - 7% 8% 5% (4) 1,502 (4) 1,403 (6) 1,483 1,039 $ 463 960 $ 443 929 $ 554 Growth Rate 2010-2011 - - - - - Year Ended December 31, Net Revenues Asset management and administration fees Net interest revenue Trading revenue Other Provision for loan losses Net impairment losses on securities Total net revenues Expenses Excluding Interest N/M Income before taxes on income N/M Taxes on income Net Income N/M Not meaningful. - - Unallocated Total 2011 2010 2009 Growth Rate 2010-2011 2011 2010 2009 $ $ - - - - - - - $ - - - - - - - - - - - - - - (1) 1 444 $ (444) $ 82 (82) $ 6% 13% 12% 19% (33%) (14%) 10% $ 1,928 1,725 927 160 (18) $ 1,822 1,524 830 135 (27) $ 1,875 1,245 996 175 (38) (31) 4,691 (36) 4,248 (60) 4,193 (5%) 79% 62% 90% 3,299 $ 1,392 (528) $ 864 3,469 $ 779 (325) $ 454 2,917 $ 1,276 (489) $ 787 Investor Services Net revenues increased by $344 million, or 12%, in 2011 from 2010 primarily due to increases in net interest revenue, asset management and administration fees, and trading revenue. Net interest revenue increased primarily due to higher average balances of interest-earning assets during the year, partially offset by the effect of higher premium amortization relating to residential mortgage-backed securities caused by higher mortgage prepayments in 2011. Asset management and administration fees increased primarily due to an increase in revenue from the Company’s advice solutions and continued asset inflows, offset by money market mutual fund fee waivers. Trading revenue increased primarily due to higher daily average revenue trades and the addition of optionsXpress, which was acquired in September 2011. Expenses excluding interest increased by $196 million, or 9%, in 2011 from 2010 primarily due to increases in compensation and benefits, professional services, and advertising and market development expenses, which included the integration of optionsXpress. - 28 - 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) Net revenues increased by $135 million, or 5%, in 2010 from 2009 primarily due to an increase in net interest revenue and lower net impairment losses on securities, partially offset by decreases in trading revenue and other revenue. Net interest revenue increased due to higher average balances of interest-earning assets, partially offset by a decrease in the average yield earned. Trading revenue decreased due to lower average revenue per revenue trade resulting from improved online trade pricing for clients, which was implemented in January 2010, and slightly lower daily average revenue trades in 2010. Other revenue was lower in comparison to 2009 due to a gain on the repurchase of a portion of the Company’s long-term debt in 2009. While the low interest rate environment caused additional money market mutual fund fee waivers from 2009, asset management and administration fees were relatively flat due to higher average asset valuations and continued asset inflows. Expenses excluding interest increased by $159 million, or 8%, in 2010 from 2009 primarily due to increases in compensation and benefits, professional services, and other expenses. Other expense includes a charge relating to the Company’s termination of its sponsorship in its Invest First and WorldPoints Visa credit cards in 2010 as a result of challenging credit card economics. Institutional Services Net revenues increased by $99 million, or 7%, in 2011 from 2010 primarily due to increases in net interest revenue, asset management and administration fees, and trading revenue. Net interest revenue increased primarily due to higher average balances of interest-earning assets during the year, partially offset by the effect of higher premium amortization relating to residential mortgage-backed securities caused by higher mortgage prepayments in 2011. Asset management and administration fees increased primarily due to an increase in mutual fund service fees relating to the Company’s Mutual Fund OneSource funds as a result of continued asset inflows, offset by money market mutual fund fee waivers. Trading revenue increased primarily due to higher daily average revenue trades. Expenses excluding interest increased by $79 million, or 8%, in 2011 from 2010 primarily due to increases in compensation and benefits and professional services expenses. Net revenues decreased by $80 million, or 5%, in 2010 from 2009 due to decreases in asset management and administration fees, trading revenue, and other revenue, offset by an increase in net interest revenue. Asset management and administration fees decreased primarily due to money market mutual fund fee waivers, partially offset by the effect of higher average asset valuations and continued asset inflows. Additionally, in August 2010 management transferred client assets associated with the Schwab Advisor Network to the Investor Services segment and started recording the related asset management and administration fee revenue to that segment. Trading revenue decreased due to lower average revenue per revenue trade resulting from improved online trade pricing for clients, which was implemented in January 2010, and slightly lower daily average revenue trades in 2010. Other revenue was lower in comparison to 2009 due to a gain on the repurchase of a portion of the Company’s long-term debt in 2009. Net interest revenue increased due to higher average balances of interest-earning assets, partially offset by a decrease in the average yield earned. Expenses excluding interest increased by $31 million, or 3%, in 2010 from 2009 primarily due to an increase in compensation and benefits expense. Unallocated Expenses excluding interest in 2010 include class action litigation and regulatory reserves relating to the Schwab YieldPlus Fund and a charge relating to the Company’s decision to cover the net remaining losses recognized by Schwab money market mutual funds as a result of their investments in a single structured investment vehicle that defaulted in 2008. Expenses excluding interest in 2009 include facilities and severance charges relating to the Company’s cost reduction measures. LIQUIDITY AND CAPITAL RESOURCES CSC conducts substantially all of its business through its wholly-owned subsidiaries. The Company’s capital structure is designed to provide each subsidiary with capital and liquidity to meet its operational needs and regulatory requirements. CSC is a savings and loan holding company and Schwab Bank, CSC’s depository institution, is a federal savings bank. Prior to July 21, 2011, CSC and Schwab Bank were both subject to supervision and regulation by the OTS. The Dodd-Frank Act eliminated the OTS effective July 21, 2011, and as a result, the Federal Reserve became CSC’s primary regulator and the Office of the Comptroller of the Currency became the primary regulator of Schwab Bank. - 29 - 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) Liquidity CSC While CSC is not currently subject to specific statutory capital requirements, CSC is required to serve as a source of strength for Schwab Bank and must have the ability to provide financial assistance if Schwab Bank experiences financial distress. To manage capital adequacy, the Company currently utilizes a target Tier 1 Leverage Ratio, as defined by the Board of Governors of the Federal Reserve System, of at least 6%. At December 31, 2011, the Company’s Tier 1 Leverage Ratio was 6.3%. CSC’s liquidity needs are generally met through cash generated by its subsidiaries, as well as cash provided by external financing. CSC has a universal automatic shelf registration statement (Shelf Registration Statement) on file with the SEC which enables CSC to issue debt, equity and other securities. CSC maintains excess liquidity in the form of overnight cash deposits and short-term investments to cover daily funding needs and to support growth in the Company’s business. Generally, CSC does not hold liquidity at its subsidiaries in excess of amounts deemed sufficient to support the subsidiaries’ operations, including any regulatory capital requirements. Schwab, Schwab Bank, and optionsXpress, Inc. are subject to regulatory requirements that may restrict them from certain transactions with CSC, as further discussed below. Management believes that funds generated by the operations of CSC’s subsidiaries will continue to be the primary funding source in meeting CSC’s liquidity needs, providing adequate liquidity to meet Schwab Bank’s capital guidelines, and maintaining Schwab and optionsXpress, Inc.’s net capital. In January 2012, the Company completed an equity offering of 400,000 shares of its preferred stock under the Shelf Registration Statement. For further discussion of the equity offering, see “Subsequent Event”. CSC has liquidity needs that arise from the funding of cash dividends, acquisitions, and investments, as well as its Senior Notes, Senior Medium-Term Notes, Series A (Medium-Term Notes), and Junior Subordinated Notes. The following are details of CSC’s long-term debt: December 31, 2011 Senior Notes Medium Term Notes Junior Subordinated Notes (1) Par Outstanding $ $ $ 1,450 250 202 Maturity Interest Rate 2014 – 2020 4.45% to 4.950% fixed 2017 2067 6.375% fixed 7.50% fixed until 2017, floating thereafter Moody’s A2 A2 Baa1 Standard & Poor’s A A BBB+ Fitch A A BBB+ (1) The Junior Subordinated Notes themselves are not rated, however, the trust preferred securities related to these Junior Subordinated Notes are rated. CSC has authorization from its Board of Directors to issue unsecured commercial paper notes (Commercial Paper Notes) not to exceed $1.5 billion. Management has set a current limit for the commercial paper program of $800 million. The maturities of the Commercial Paper Notes may vary, but are not to exceed 270 days from the date of issue. The commercial paper is not redeemable prior to maturity and cannot be voluntarily prepaid. The proceeds of the commercial paper program are to be used for general corporate purposes. There were no borrowings of Commercial Paper Notes outstanding at December 31, 2011. CSC’s ratings for these short-term borrowings are P1 by Moody’s, A1 by Standard & Poor’s, and F1 by Fitch. CSC maintains an $800 million committed, unsecured credit facility with a group of 11 banks, which is scheduled to expire in June 2012. This facility replaced a similar facility that expired in June 2011 and was unused in 2011. The funds under this facility are available for general corporate purposes, including repayment of the Commercial Paper Notes discussed above. The financial covenants under this facility require Schwab to maintain a minimum net capital ratio, as defined, Schwab Bank to be well capitalized, as defined, and CSC to maintain a minimum level of stockholders’ equity. At December 31, 2011, the minimum level of stockholders’ equity required under this facility was $5.0 billion (CSC’s stockholders’ equity at December 31, 2011 was $7.7 billion). Management believes that these restrictions will not have a material effect on CSC’s ability to meet foreseeable dividend or funding requirements. - 30 - 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) CSC also has direct access to $750 million of the $875 million uncommitted, unsecured bank credit lines discussed below, that are primarily utilized by Schwab to manage short-term liquidity. These lines were not used by CSC during 2011. In addition, Schwab provides CSC with a $1.0 billion credit facility maturing in December 2014. This facility replaced a similar facility that expired in December 2011. There were no funds drawn under this facility at December 31, 2011. Schwab Schwab is subject to regulatory requirements that are intended to ensure the general financial soundness and liquidity of broker-dealers. These regulations prohibit Schwab from repaying subordinated borrowings from CSC, paying cash dividends, or making unsecured advances or loans to its parent company or employees if such payment would result in a net capital amount of less than 5% of aggregate debit balances or less than 120% of its minimum dollar requirement of $250,000. At December 31, 2011, Schwab’s net capital was $1.2 billion (10% of aggregate debit balances), which was $948 million in excess of its minimum required net capital and $588 million in excess of 5% of aggregate debit balances. Most of Schwab’s assets are readily convertible to cash, consisting primarily of short-term (i.e., less than 150 days) investment-grade, interest-earning investments (the majority of which are segregated for the exclusive benefit of clients pursuant to regulatory requirements), receivables from brokerage clients, and receivables from brokers, dealers, and clearing organizations. Client margin loans are demand loan obligations secured by readily marketable securities. Receivables from and payables to brokers, dealers, and clearing organizations primarily represent current open transactions, which usually settle, or can be closed out, within a few business days. Liquidity needs relating to client trading and margin borrowing activities are met primarily through cash balances in brokerage client accounts, which were $33.5 billion and $29.9 billion at December 31, 2011 and 2010, respectively. Management believes that brokerage client cash balances and operating earnings will continue to be the primary sources of liquidity for Schwab. Schwab has a finance lease obligation related to an office building and land under a 20-year lease. The remaining finance lease obligation of $100 million at December 31, 2011, is being reduced by a portion of the lease payments over the remaining lease term of 13 years. To manage short-term liquidity, Schwab maintains uncommitted, unsecured bank credit lines with a group of six banks totaling $875 million at December 31, 2011. The need for short-term borrowings arises primarily from timing differences between cash flow requirements, scheduled liquidation of interest-earnings investments, and movements of cash to meet regulatory brokerage client cash segregation requirements. Schwab borrowed an average of $41 million per day for nine days in 2011 under these lines. There were no borrowings outstanding under these lines at December 31, 2011. To partially satisfy the margin requirement of client option transactions with the Options Clearing Corporation (OCC), Schwab has unsecured standby letter of credit agreements (LOCs) with eight banks in favor of the OCC aggregating $350 million at December 31, 2011. In connection with its securities lending activities, Schwab is required to provide collateral to certain brokerage clients. Schwab satisfies the collateral requirements by arranging LOCs, in favor of these brokerage clients, which are issued by multiple banks. At December 31, 2011, the aggregate face amount of these LOCs totaled $78 million. There were no funds drawn under any of these LOCs during 2011. To manage Schwab’s regulatory capital requirement, CSC provides Schwab with a $1.4 billion subordinated revolving credit facility, which is scheduled to expire in March 2012. The amount outstanding under this facility at December 31, 2011, was $245 million. Borrowings under this subordinated lending arrangement qualify as regulatory capital for Schwab. In addition, CSC provides Schwab with a $2.5 billion credit facility, which is scheduled to expire in December 2014. This facility replaced a similar facility that expired in December 2011. Borrowings under this facility do not qualify as regulatory capital for Schwab. There were no funds drawn under this facility at December 31, 2011. - 31 - 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) Schwab Bank Schwab Bank is required to maintain capital levels as specified in federal banking laws and regulations. Failure to meet the minimum levels could result in certain mandatory, and possibly additional discretionary actions by the regulators that, if undertaken, could have a direct material effect on Schwab Bank. Based on its regulatory capital ratios at December 31, 2011, Schwab Bank is considered well capitalized. Schwab Bank’s regulatory capital and ratios at December 31, 2011, are as follows: Tier 1 Risk-Based Capital Total Risk-Based Capital Tier 1 Core Capital Tangible Equity N/A Not applicable. Actual Amount $ 4,984 $ 5,036 $ 4,984 $ 4,984 Ratio 23.4% 23.7% 7.5% 7.5% Minimum Capital Requirement Amount $ 850 $ 1,701 $ 2,642 $ 1,321 Ratio 4.0% 8.0% 4.0% 2.0% Minimum to be Well Capitalized Ratio 6.0% 10.0% 5.0% Amount $ 1,276 $ 2,126 $ 3,302 N/A Management has established a target Tier 1 Core Capital Ratio for Schwab Bank of at least 7.5%. Schwab Bank’s current liquidity needs are generally met through deposits from banking clients and equity capital. The excess cash held in certain Schwab brokerage client accounts is swept into deposit accounts at Schwab Bank. At December 31, 2011, these balances totaled $40.6 billion. Schwab Bank has access to traditional funding sources such as deposits, federal funds purchased, and repurchase agreements. Additionally, Schwab Bank has access to short-term funding through the Federal Reserve Bank (FRB) discount window. Amounts available under the FRB discount window are dependent on the fair value of certain of Schwab Bank’s securities available for sale and securities held to maturity that are pledged as collateral. Schwab Bank maintains policies and procedures necessary to access this funding and tests discount window borrowing procedures annually. At December 31, 2011, $1.2 billion was available under this arrangement. There were no funds drawn under this arrangement during 2011. Schwab Bank maintains a credit facility with the Federal Home Loan Bank System. Amounts available under this facility are dependent on the amount of Schwab Bank’s residential real estate mortgages and HELOCs that are pledged as collateral. At December 31, 2011, $5.2 billion was available under this facility. There were no funds drawn under this facility during 2011. CSC provides Schwab Bank with a $100 million short-term credit facility, which is scheduled to expire in December 2014. This facility replaced a similar facility that expired in December 2011. Borrowings under this facility do not qualify as regulatory capital for Schwab Bank. There were no funds drawn under these facilities during 2011. optionsXpress optionsXpress, Inc., a wholly-owned subsidiary of optionsXpress, is a registered broker-dealer and is subject to regulatory requirements that are intended to ensure the general financial soundness and liquidity of broker-dealers. These regulations prohibit optionsXpress, Inc. from paying cash dividends or making unsecured advances or loans to its parent company or employees if such payment would result in a net capital amount of less than 5% of aggregate debit balances or less than 120% of its minimum dollar requirement of $250,000. At December 31, 2011, optionsXpress Inc.’s net capital was $78 million (29% of aggregate debit balances), which was $73 million in excess of its minimum required net capital and $65 million in excess of 5% of aggregate debit balances. optionsXpress, Inc. is also subject to Commodity Futures Trading Commission Regulation 1.17 (Reg. 1.17) under the Commodity Exchange Act, which also requires the maintenance of minimum net capital. optionsXpress, Inc. as a futures commission merchant, is required to maintain minimum net capital equal to the greater of its net capital requirement under - 32 - 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) Reg. 1.17 ($1 million), or the sum of 8% of the total risk margin requirements for all positions carried in customer accounts and 8% of the total risk margin requirements for all positions carried in non-customer accounts (as defined in Reg. 1.17). Liquidity needs relating to client trading and margin borrowing activities are met primarily through cash balances in brokerage client accounts, which were $1.2 billion at December 31, 2011. Management believes that brokerage client cash balances and operating earnings will continue to be the primary sources of liquidity for optionsXpress, Inc. CSC provides optionsXpress, Inc. with a $100 million credit facility, which is scheduled to expire in December 2014. Borrowings under this facility do not qualify as regulatory capital for optionsXpress, Inc. There were no funds drawn under this facility since the acquisition date. optionsXpress has a term loan with CSC, of which $118 million was outstanding at December 31, 2011, and matures in December 2014. Capital Resources The Company monitors both the relative composition and absolute level of its capital structure. Management is focused on limiting the Company’s use of capital and currently targets a long-term debt to total financial capital ratio not to exceed 30%. The Company’s total financial capital (long-term debt plus stockholders’ equity) at December 31, 2011, was $9.7 billion, up $1.5 billion, or 18%, from December 31, 2010. At December 31, 2011, the Company had long-term debt of $2.0 billion, or 21% of total financial capital, that bears interest at a weighted-average rate of 5.24%. At December 31, 2010, the Company had long-term debt of $2.0 billion, or 24% of total financial capital. The Company repaid $116 million of long-term debt in 2011, which included the pay off of long-term debt acquired from optionsXpress of $110 million subsequent to the acquisition date. In 2010, the Company issued $700 million of additional Senior Notes that mature in 2020 and have a fixed interest rate of 4.45%. The Company repaid $205 million of long-term debt in 2010, which included the maturity of $200 million of Medium-Term Notes. The Company’s cash position (reported as cash and cash equivalents on its consolidated balance sheet) and cash flows are affected by changes in brokerage client cash balances and the associated amounts required to be segregated under regulatory guidelines. Timing differences between cash and investments actually segregated on a given date and the amount required to be segregated for that date may arise in the ordinary course of business and are addressed by the Company in accordance with applicable regulations. Other factors which affect the Company’s cash position and cash flows include investment activity in securities, levels of capital expenditures, acquisition and divestiture activity, banking client deposit activity, brokerage and banking client loan activity, financing activity in long-term debt, payments of dividends, and repurchases and issuances of CSC’s preferred and common stock. The combination of these factors can cause significant fluctuations in the cash position during specific time periods. Capital Expenditures The Company’s capital expenditures were $190 million (4% of net revenues) and $127 million (3% of net revenues) in 2011 and 2010, respectively. Capital expenditures in 2011 and 2010 were primarily for software and equipment relating to the Company’s information technology systems, capitalized costs for developing internal-use software, and leasehold improvements. Capitalized costs for developing internal-use software were $57 million and $21 million in 2011 and 2010, respectively. Management currently anticipates that 2012 capital expenditures will be approximately 30% lower than 2011 spending primarily due to decreased spending on software and equipment relating to the Company’s information technology systems, capitalized costs for developing internal-use software, and leasehold improvements. As has been the case in recent years, the Company may adjust its capital expenditures periodically as business conditions change. Management believes that funds generated by its operations will continue to be the primary funding source of its capital expenditures. - 33 - 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) Equity Offering On January 26, 2010, the Company sold 29,670,300 shares of its common stock, $.01 par value, at a public offering price of $19.00 per share. Net proceeds received from the offering were $543 million and were used to support the Company’s balance sheet growth, including expansion of its deposit base and migration of certain client balances from money market funds into deposit accounts at Schwab Bank. Dividends CSC paid common stock cash dividends of $295 million ($0.24 per share) and $288 million ($0.24 per share) in 2011 and 2010, respectively. Since the initial dividend in 1989, CSC has paid 91 consecutive quarterly dividends and has increased the quarterly dividend rate 19 times, including a 20% increase in the third quarter of 2008. Since 1989, dividends have increased by a 24% compounded annual growth rate, excluding the special cash dividend of $1.00 per common share in 2007. While the payment and amount of dividends are at the discretion of the Board of Directors, subject to certain regulatory and other restrictions, the Company currently targets its cash dividend at approximately 20% to 30% of net income. Under the terms of the Series A Preferred Stock issued in January 2012, the Company’s ability to pay dividends on, make distributions with respect to, or to repurchase, redeem or acquire its common stock is subject to restrictions in the event that the Company does not declare and either pay or set aside a sum sufficient for payment of dividends on the Series A Preferred Stock for the immediately preceding dividend period. Share Repurchases There were no repurchases of CSC’s common stock in 2011 or 2010. As of December 31, 2011, CSC had remaining authority from the Board of Directors to repurchase up to $596 million of its common stock, which does not have an expiration date. Business Acquisitions On September 1, 2011, the Company completed its acquisition of all of the outstanding common shares of optionsXpress, an online brokerage firm primarily focused on equity option securities and futures, for total consideration of $714 million. Under the terms of the merger agreement, optionsXpress stockholders received 1.02 shares of the Company’s common stock for each share of optionsXpress stock. As a result, the Company issued 59 million shares of the Company’s common stock valued at $710 million, based on the closing price of the Company’s common stock on September 1, 2011. The Company also assumed optionsXpress’ stock-based compensation awards valued at $4 million. On November 9, 2010, the Company acquired substantially all of the assets of Windward for $106 million in common stock and $44 million in cash. For more information on the acquisitions of optionsXpress and Windward, see “Item 8 – Financial Statements and Supplementary Data – Notes to Consolidated Financial Statements – 3. Business Acquisitions”. Off-Balance Sheet Arrangements The Company enters into various off-balance sheet arrangements in the ordinary course of business, primarily to meet the needs of its clients. These arrangements include firm commitments to extend credit. Additionally, the Company enters into guarantees and other similar arrangements as part of transactions in the ordinary course of business. For information on each of these arrangements, see “Item 8 – Financial Statements and Supplementary Data – Notes to Consolidated Financial Statements – 15. Commitments and Contingencies.” - 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) Contractual Obligations The Company’s principal contractual obligations as of December 31, 2011, are shown in the following table. Management believes that funds generated by its continuing operations, as well as cash provided by external financing, will continue to be the primary funding sources in meeting these obligations. Excluded from this table are liabilities recorded on the consolidated balance sheet that are generally short-term in nature (e.g., payables to brokers, dealers, and clearing organizations) or without contractual payment terms (e.g., deposits from banking clients, payables to brokerage clients, and deferred compensation). Credit-related financial instruments (1) Long-term debt (2) Leases (3) Purchase obligations (4) Total (1) Represents Schwab Bank’s firm commitments to extend credit to banking clients. (2) 725 930 150 81 $ 1,886 $ 1-3 Years Less than 1 Year 757 $ 99 96 118 $ 1,070 3-5 Years $ 1,130 125 110 33 $ 1,398 More than 5 Years $ 3,186 1,309 201 1 $ 4,697 Total $ 5,798 2,463 557 233 $ 9,051 Includes estimated future interest payments through 2020 for Senior Notes and through 2017 for Medium-Term Notes and Junior Subordinated Notes. The Junior Subordinated Notes have a fixed interest rate of 7.50% until 2017 and a floating rate from 2018 to 2067. Based on the current interest rate of 7.50% and no repayments of principal, the estimated future interest payments on the Junior Subordinated Notes in 2018 to 2067 would be $15 million per year. Amounts exclude maturities under a finance lease obligation and unamortized discounts and premiums. (3) Represents minimum rental commitments, net of sublease commitments, and includes facilities under the Company’s past restructuring initiatives and rental commitments under a finance lease obligation. (4) Consists of purchase obligations for services such as advertising and marketing, telecommunications, professional services, and hardware- and software-related agreements. Includes purchase obligations that can be canceled by the Company without penalty. RISK MANAGEMENT Overview The Company’s business activities expose it to a variety of risks, including technology, operations, credit, market, liquidity, legal, and reputational risk. Identification and management of these risks are essential to the success and financial soundness of the Company. Senior management takes an active role in the Company’s risk management process and has developed policies and procedures under which specific business and control units are responsible for identifying, measuring, and controlling various risks. Oversight of risk management has been delegated to the Global Risk Committee, which is comprised of senior managers of major business and control functions. The Global Risk Committee is responsible for reviewing and monitoring the Company’s risk exposures and leading the continued development of the Company’s risk management policies and practices. Functional risk sub-committees focusing on specific areas of risk report into the Global Risk Committee. These sub- committees include the:  Corporate Asset-Liability Management and Pricing Committee, which focuses on the Company’s liquidity, capital resources, interest rate risk, and investments;  Credit and Market Risk Oversight Committee, which focuses on credit exposures resulting from client borrowing activity (e.g., margin lending activities and loans to banking clients), investing activities of certain of the Company’s proprietary funds, corporate credit and investment activity, and market risk resulting from the Company taking positions in certain securities to facilitate client trading activity; - 35 - 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)    Information Security and Privacy Steering Committee, which oversees information security and privacy policies, procedures and controls; Investment Management and ERISA Risk Committee, which oversees activities in which the Company and its principals operate in an investment advisory capacity or as an ERISA fiduciary; Investment Products Review Board, which provides senior level oversight of investment products and services made available to clients; and  Operational Risk Management Committee, which focuses on risks relating to potential inadequate or failed internal processes, people and systems, and from external events and relationships (e.g., vendors and business partners). The Global Risk Committee reports regularly to the Audit Committee of the Board of Directors (Audit Committee), which reviews major risk exposures and the steps management has taken to monitor and control such exposures. The Company’s Disclosure Committee is responsible for monitoring and evaluating the effectiveness of the Company’s (a) disclosure controls and procedures and (b) internal control over financial reporting as of the end of each fiscal quarter. The Disclosure Committee reports on this evaluation to the CEO and CFO prior to their certification required by Sections 302 and 906 of the Sarbanes Oxley Act of 2002. The Company’s compliance, finance, internal audit, legal, and corporate risk management departments assist management and the various risk committees in evaluating, testing, and monitoring the Company’s risk management. Risk is inherent in the Company’s business. Consequently, despite the Company’s efforts to identify areas of risk and implement risk management policies and procedures, there can be no assurance that the Company will not suffer unexpected losses due to operating or other risks. The following discussion highlights the Company’s policies and procedures for identification, assessment, and management of the principal areas of risk in its operations. Technology and Operating Risk Technology and operating risk is the potential for loss due to deficiencies in control processes or technology systems that constrain the Company’s ability to gather, process, and communicate information and process client transactions efficiently and securely, without interruptions. The Company’s operations are highly dependent on the integrity of its technology systems and the Company’s success depends, in part, on its ability to make timely enhancements and additions to its technology in anticipation of evolving client needs. To the extent the Company experiences system interruptions, errors or downtime (which could result from a variety of causes, including changes in client use patterns, technological failure, changes to its systems, linkages with third-party systems, and power failures), the Company’s business and operations could be significantly negatively impacted. To minimize business interruptions, Schwab has two data centers intended, in part, to further improve the recovery of business processing in the event of an emergency. The Company is committed to an ongoing process of upgrading, enhancing, and testing its technology systems. This effort is focused on meeting client needs, meeting market and regulatory changes, and deploying standardized technology platforms. Technology and operating risk also includes the risk of human error, employee misconduct, external fraud, computer viruses, distributed denial of service attacks, terrorist attacks, and natural disaster. Employee misconduct could include fraud and misappropriation of client or Company assets, improper use or disclosure of confidential client or Company information, and unauthorized activities, such as transactions exceeding acceptable risks or authorized limits. External fraud includes misappropriation of client or Company assets by third parties, including through unauthorized access to Company systems and data and client accounts. The frequency and sophistication of such fraud attempts continue to increase. The Company has specific policies and procedures to identify and manage operational risk, and uses periodic risk self- assessments and internal audit reviews to evaluate the effectiveness of these internal controls. The Company maintains backup and recovery functions, including facilities for backup and communications, and conducts periodic testing of disaster recovery plans. The Company also maintains policies and procedures and technology to protect against fraud and unauthorized access to systems and data. - 36 - 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) Despite the Company’s risk management efforts, it is not always possible to deter or prevent technological or operational failure, or fraud or other misconduct, and the precautions taken by the Company may not be effective in all cases. The Company may be subject to litigation, losses, and regulatory actions in such cases, and may be required to expend significant additional resources to remediate vulnerabilities or other exposures. The Company also faces technology and operating risk when it employs the services of various external vendors, including domestic and international outsourcing of certain technology, processing, servicing, and support functions. The Company manages its exposure to external vendor risk through contractual provisions, control standards, and ongoing monitoring of vendor performance. The Company maintains policies and procedures regarding the standard of care expected with Company data, whether the data is internal company information, employee information, or non-public client information. The Company clearly defines for employees, contractors, and vendors the Company’s expected standards of care for confidential data. Regular training is provided by the Company in regard to data security. The Company is actively engaged in the research and development of new technologies, services, and products. The Company endeavors to protect its research and development efforts, and its brands, through the use of copyrights, patents, trade secrets, and contracts. Credit Risk Credit risk is the potential for loss due to a borrower, counterparty, or issuer failing to perform its contractual obligations. The Company’s direct exposure to credit risk mainly results from margin lending activities, securities lending activities, mortgage lending activities, its role as a counterparty in financial contracts and investing activities. To manage the risks of such losses, the Company has established policies and procedures which include: establishing and reviewing credit limits, monitoring of credit limits and quality of counterparties, and adjusting margin requirements for certain securities. Most of the Company’s credit extensions are supported by collateral arrangements. Collateral arrangements relating to margin loans, securities lending agreements, and resale agreements include provisions that require additional collateral in the event that market fluctuations result in declines in the value of collateral received. The Company’s credit risk exposure related to loans to banking clients is actively managed through individual and portfolio reviews performed by management. Management regularly reviews asset quality including concentrations, delinquencies, nonaccrual loans, charge-offs, and recoveries. All are factors in the determination of an appropriate allowance for loan losses, which is reviewed quarterly by senior management. The Company’s mortgage loan portfolios primarily include first lien residential real estate mortgage loans (First Mortgage) of $5.6 billion and HELOCs of $3.5 billion at December 31, 2011. The Company’s First Mortgage portfolio underwriting requirements are generally consistent with the underwriting requirements in the secondary market for loan portfolios. The Company’s guidelines include maximum loan-to-value (LTV) ratios, cash out limits, and minimum Fair Issac & Company (FICO) credit scores. The specific guidelines are dependent on the individual characteristics of a loan (for example, whether the property is a primary or secondary residence, whether the loan is for investment property, whether the loan is for an initial purchase of a home or refinance of an existing home, and whether the loan is conforming or jumbo). These credit underwriting standards have limited the exposure to the types of loans that experienced high foreclosures and loss rates elsewhere in the industry in recent years. There have been no significant changes to the LTV ratio or FICO credit score guidelines related to the Company’s First Mortgage or HELOC portfolios during 2011. At December 31, 2011, the weighted-average originated LTV ratios were 60% and 59% for the First Mortgage and HELOC portfolios, respectively. The computation of the origination LTV ratio for a HELOC includes any first lien mortgage outstanding on the same property at the time of origination. At December 31, 2011, 22% of HELOCs ($755 million of the HELOC portfolio) were in a first lien position. The weighted-average originated FICO credit scores were 766 and 768 for the First Mortgage and HELOC portfolios, respectively. The Company does not offer loans that allow for negative amortization and does not originate or purchase subprime loans (generally defined as extensions of credit to borrowers with a FICO credit score of less than 620 at origination), unless the borrower has compensating credit factors. At December 31, 2011, approximately 1% of both the First Mortgage and HELOC portfolios consisted of loans to borrowers with FICO credit scores of less than 620. - 37 - 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) The following table presents certain of the Company’s loan quality metrics as a percentage of total outstanding loans: December 31, Loan delinquencies (1) Nonaccrual loans Allowance for loan losses (1) Loan delinquencies are defined as loans that are 30 days or more past due. 2011 0.81% 0.53% 0.55% 2010 0.96% 0.58% 0.60% The Company has exposure to credit risk associated with its securities available for sale and securities held to maturity portfolios, whose fair values totaled $34.0 billion and $15.5 billion at December 31, 2011, respectively. These portfolios include U.S. agency and non-agency residential mortgage-backed securities, certificates of deposit, corporate debt securities, U.S. agency notes, and asset-backed and other securities. U.S. agency residential mortgage-backed securities do not have explicit credit ratings, however, management considers these to be of the highest credit quality and rating given the guarantee of principal and interest by the U.S. government-sponsored enterprises. Included in non-agency residential mortgage-backed securities are securities collateralized by loans that are considered to be “Prime” (defined by the Company as loans to borrowers with a FICO credit score of 620 or higher at origination), and “Alt-A” (defined by the Company as Prime loans with reduced documentation at origination). Residential mortgage-backed securities, particularly Alt-A securities experienced continued credit deterioration in 2011, including increased payment delinquency rates and losses on foreclosures of underlying mortgages. For a discussion of the impact of current market conditions on residential mortgage-backed securities, see “Current Market and Regulatory Environment.” At December 31, 2011, non-agency residential mortgage-backed securities consisted of 3%, based on amortized cost, of total residential mortgage-backed securities. These securities were originated between 2003 and 2007. At December 31, 2011, 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. 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 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 and could reduce the Company’s liquidity. If the Company chose not to provide credit, liquidity or other support in such a situation, the Company could suffer reputational damage and its business could be adversely affected. 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 $37.0 billion at December 31, 2011. Of these, $36.1 billion were U.S. agency securities and $907 million 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, 2011, the amortized cost and fair value of Alt-A mortgage-backed securities were $390 million and $279 million, respectively. - 38 - 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) The Company’s investments in corporate debt securities and commercial paper totaled $5.6 billion at December 31, 2011, 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, 2011, the Company held $867 million 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 $5.6 billion of adjustable rate first lien residential real estate mortgage loans at December 31, 2011. The Company’s adjustable rate mortgages have initial fixed interest rates for three to ten years and interest rates that adjust annually thereafter. Approximately 60% of these mortgages consisted of loans with interest-only payment terms. The interest rates on approximately 65% of these interest-only loans are not scheduled to reset for three or more years. The Company’s mortgage loans do not include interest terms described as temporary introductory rates below current market rates. At December 31, 2011, 44% of the residential real estate mortgages and 50% 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. The fair value of U.S. Government and agency securities held as collateral for resale agreements totaled $18.3 billion at December 31, 2011. European Holdings The Company has exposure to non-sovereign financial institutions in Europe. The following table shows the amortized cost and fair values of cash equivalents, cash segregated and on deposit for regulatory purposes, securities available for sale, and securities held to maturity by each country in Europe in which the issuer or counterparty is domiciled. The Company has no direct exposure to sovereign governments in Europe. The Company does not have unfunded commitments to counterparties in Europe, nor does it have exposure as a result of credit default protection purchased or sold separately as of December 31, 2011. The determination of the domicile of exposure varies by the type of investment. For time deposits and certificates of deposit, the exposure is grouped in the country in which the financial institution is chartered under the regulatory framework of the European country. For asset-backed commercial paper, the exposure is grouped by the country of the sponsoring bank that provides the credit and liquidity support for such instruments. For corporate debt securities, the exposure is grouped by the country in which the issuer is domiciled. In situations in which the Company invests in a corporate debt security of a U.S. subsidiary of a European parent company, such holdings will be attributable to the European country only if significant reliance is placed on the European parent company for credit support underlying the security. For substantially all of the holdings listed below, the issuers or counterparties were financial institutions. All of the Company’s resale agreements, which are included in investments segregated and on deposit for regulatory purposes, are collateralized by U.S. government securities. Additionally, the Company’s securities lending activities are collateralized by cash. Therefore, the Company’s resale agreements and securities lending activities are not included in the table below even if the counterparty is a European institution. - 39 - 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) Cash equivalents: Time deposits Commercial paper Cash segregated and on deposit for regulatory purposes: Trust deposits Securities available for sale: Certificates of deposit Corporate debt securities Securities held to maturity: Corporate debt securities Total fair value Total amortized cost Maturities: Overnight 1 day – < 6 months 6 months – < 1 year 1 year – 2 years > 2 years Total fair value Denmark France Germany Netherlands Sweden Switzerland Kingdom Total Fair Value as of December 31, 2011 United $ $ $ $ $ - - - - 214 - 214 212 - - - 214 - 214 $ 850 350 $ 389 20 $ - 400 300 74 - $ 1,574 $ 1,575 $ 1,200 174 100 100 - $ 1,574 150 - - 959 959 789 20 - 150 - 959 $ $ $ $ $ $ $ $ - - - 300 187 - 487 492 - 200 - 187 100 487 $ - - - 499 97 117 $ 713 $ 716 $ - 200 117 299 97 $ 713 $ $ $ $ $ - - - 550 - 100 650 650 - 150 274 126 100 650 $ 200 200 $ 1,439 570 - 400 700 550 2,499 1,122 - $ 1,650 $ 1,650 217 $ 6,247 $ 6,254 $ 200 700 650 100 - $ 1,650 $ 2,189 1,444 1,141 1,176 297 $ 6,247 In addition to the direct holdings of European companies listed above, the Company also has indirect exposure to Europe through its investments in Schwab sponsored money market funds (collectively, the Funds) resulting from clearing activities. At December 31, 2011, the Company had $332 million in investments in these Funds. Certain of the Funds’ positions include certificates of deposits, time deposits, commercial paper and corporate debt securities issued by counterparties in Europe. Management mitigates exposure to European holdings by employing a separate team of credit analysts that evaluate each issuer, counterparty, and country. Management monitors its exposure to European issuers by 1) performing risk assessments of the foreign countries, which include evaluating the size of the country and economy, currency trends, political landscape and the countries’ regulatory environment and developments, 2) performing ad hoc stress tests that evaluate the impact of sovereign governments’ debt write-downs on the issuers and counterparties to our investments, 3) reviewing publicly available stress tests that are published by various regulators in the European market, 4) establishing credit and maturity limits by issuer, and 5) monitoring aggregate exposures by country. 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.” Fiduciary Risk Fiduciary risk is the potential for financial or reputational loss through breach of fiduciary duties to a client. Fiduciary activities include, but are not limited to, individual and institutional trust, investment management, custody, and cash and securities processing. The Company attempts to manage this risk by establishing procedures to ensure that obligations to clients are discharged faithfully and in compliance with applicable legal and regulatory requirements. Business units have the - 40 - 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) primary responsibility for adherence to the procedures applicable to their business. Guidance and control are provided through the creation, approval, and ongoing review of applicable policies by business units and various risk committees. Legal and Regulatory Risk The Company faces significant legal and compliance risk in its business, and the volume of litigation and regulatory proceedings against financial services firms and the amount of damages claimed have been increasing. Among other things, these risks relate to the suitability of client investments, conflicts of interest, disclosure obligations and performance expectations for Company products and services, supervision of employees, and the adequacy of the Company’s controls. Claims against the Company may increase due to a variety of factors, such as if clients suffer losses during a period of deteriorating equity market conditions, as the Company increases the level of advice it provides to clients, and as the Company enhances the services it provides to IAs. In addition, the Company and its affiliates are subject to extensive regulation by federal, state and foreign regulatory authorities, and SROs, and such regulation is becoming increasingly extensive and complex. The Company attempts to manage legal and compliance risk through policies and procedures reasonably designed to avoid litigation claims and prevent or detect violations of applicable legal and regulatory requirements. These procedures address issues such as business conduct and ethics, sales and trading practices, marketing and communications, extension of credit, client funds and securities, books and records, anti-money laundering, client privacy, employment policies, and contracts management. Despite the Company’s efforts to maintain an effective compliance program and internal controls, legal breaches and rule violations could result in reputational harm, significant losses and disciplinary sanctions, including limitations on the Company’s business activities. FAIR VALUE OF FINANCIAL INSTRUMENTS The Company uses fair value measurements to record certain financial assets and liabilities at fair value, and to determine fair value disclosures. Assets are measured at fair value using quoted prices or market-based information and accordingly are classified as Level 1 or Level 2 measurements in accordance with the fair value hierarchy described in fair value measurement accounting guidance. Liabilities recorded at fair value were not material at December 31, 2011 or 2010. See “Item 8 – Financial Statements and Supplementary Data – Notes to Consolidated Financial Statements – 17. Fair Values of Assets and Liabilities” for more information on the Company’s assets and liabilities recorded at fair value. When available, the Company uses quoted prices in active markets to measure the fair value of assets and liabilities. When quoted prices do not exist, the Company uses prices obtained from independent third-party pricing services to measure the fair value of investment assets. The Company validates prices received from the pricing services using various methods, including comparison to prices received from additional pricing services, comparison to quoted market prices, where available, comparison to internal valuation models, and review of other relevant market data. The Company does not adjust the prices received from independent third-party pricing services unless such prices are inconsistent with the definition of fair value and result in a material difference in the recorded amounts. At December 31, 2011 and 2010, the Company did not adjust prices received from independent third-party pricing services. CRITICAL ACCOUNTING ESTIMATES The consolidated financial statements of the Company have been prepared in accordance with accounting principles generally accepted in the U.S. While the majority of the Company’s revenues, expenses, assets and liabilities are not based on estimates, there are certain accounting principles that require management to make estimates regarding matters that are uncertain and susceptible to change where such change may result in a material adverse impact on the Company’s financial position and reported financial results. These critical accounting estimates are described below. Management regularly reviews the estimates and assumptions used in the preparation of the Company’s financial statements for reasonableness and adequacy. - 41 - 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) 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 - 42 - 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) in a loss) are estimated from the Company’s historical loss experience adjusted for current trends and market information. Loss severity estimates are based on the Company’s historical loss experience and market trends. Housing price trends are derived from historical home price indices and econometric forecasts of future home values. Factors affecting the home price index include: housing inventory, unemployment, interest rates, and inflation expectations. Interest rate projections are based on the current term structure of interest rates and historical volatilities to project various possible future interest rate paths. This quarterly analysis results in a loss factor that is applied to the outstanding balances to determine the allowance for loan loss for each loan segment. Legal Reserve: Reserves for legal and regulatory claims and proceedings reflect an estimate of probable losses for each matter, after considering, among other factors, the progress of the case, prior experience and the experience of others in similar cases, available defenses, insurance coverage and indemnification, and the opinions and views of legal counsel. In many cases, including most class action lawsuits, it is not possible to determine whether a loss will be incurred, or to estimate the range of that loss, until the matter is close to resolution, in which case no accrual is made until that time. Reserves are adjusted as more information becomes available or when an event occurs requiring a change. Significant judgment is required in making these estimates, and the actual cost of resolving a matter may ultimately differ materially from the amount reserved. The Company’s management has discussed the development and selection of these critical accounting estimates with the Audit Committee. Additionally, management has reviewed with the Audit Committee the Company’s significant estimates discussed in this Management’s Discussion and Analysis of Financial Condition and Results of Operations. FORWARD-LOOKING STATEMENTS In addition to historical information, this Annual Report on Form 10-K contains “forward-looking statements” within the meaning of Section 27A of the Securities Act, and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements are identified by words such as “believe,” “anticipate,” “expect,” “intend,” “plan,” “will,” “may,” “estimate,” “appear,” “aim,” “target,” “could,” and other similar expressions. In addition, any statements that refer to expectations, projections, or other characterizations of future events or circumstances are forward-looking statements. These forward-looking statements, which reflect management’s beliefs, objectives, and expectations as of the date hereof, are necessarily estimates based on the best judgment of the Company’s senior management. These statements relate to, among other things:         the Company’s ability to pursue its business strategy (see “Part I – Item 1. – Business – Business Strategy and Competitive Environment”); the impact of legal proceedings and regulatory matters (see “Part I – Item 3. – Legal Proceedings” and “Item 8 – Financial Statements and Supplementary Data – Notes to Consolidated Financial Statements –15. Commitments and Contingencies – Legal Contingencies”); the impact of current market conditions on the Company’s results of operations (see “Current Market and Regulatory Environment” and “Item 8 – Financial Statements and Supplementary Data – Notes to Consolidated Financial Statements – 6. Securities Available for Sale and Securities Held to Maturity”); sources of liquidity, capital, and level of dividends (see “Liquidity and Capital Resources” and “Contractual Obligations”); target capital ratios (see “Liquidity and Capital Resources” and “Item 8 – Financial Statements and Supplementary Data – Notes to Consolidated Financial Statements – 24. Regulatory Requirements”); capital expenditures (see “Liquidity and Capital Resources – Capital Resources”); the impact of changes in management’s estimates on the Company’s results of operations (see “Critical Accounting Estimates”); the impact of changes in the likelihood of indemnification and guarantee payment obligations on the Company’s results of operations (see “Item 8 – Financial Statements and Supplementary Data – Notes to Consolidated Financial Statements – 15. Commitments and Contingencies”); and - 43 - 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)  the impact on the Company’s results of operations of recording stock option expense (see “Item 8 – Financial Statements and Supplementary Data – Notes to Consolidated Financial Statements – 20. Employee Incentive, Deferred Compensation, and Retirement Plans”). Achievement of the expressed beliefs, objectives and expectations described in these statements is subject to certain risks and uncertainties that could cause actual results to differ materially from the expressed beliefs, objectives, and expectations. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this Annual Report on Form 10-K or, in the case of documents incorporated by reference, as of the date of those documents. Important factors that may cause actual results to differ include, but are not limited to:                      changes in general economic and financial market conditions; changes in revenues and profit margin due to changes in interest rates; adverse developments in litigation or regulatory matters; the extent of any charges associated with litigation and regulatory matters; amounts recovered on insurance policies; the Company’s ability to attract and retain clients and grow client assets and relationships; the Company’s ability to develop and launch new products, services and capabilities in a timely and successful manner; fluctuations in client asset values due to changes in equity valuations; the performance or valuation of securities available for sale and securities held to maturity; trading activity; the level of interest rates, including yields available on money market mutual fund eligible instruments; the adverse impact of financial reform legislation and related regulations; the amount of loans to the Company’s brokerage and banking clients; the level of the Company’s stock repurchase activity; the level of brokerage client cash balances and deposits from banking clients; the availability and terms of external financing; capital needs; optionsXpress integration costs and operating expenses; level of expenses; the timing and impact of changes in the Company’s level of investments in software, equipment, and leasehold improvements; and potential breaches of contractual terms for which the Company has indemnification and guarantee obligations. Certain of these factors, as well as general risk factors affecting the Company, are discussed in greater detail in this Annual Report on Form 10-K, including “Item 1A – Risk Factors.” - 44 - THE CHARLES SCHWAB CORPORATION Item 7A. Quantitative and Qualitative Disclosures About 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 the Company’s market risk related to interest rates, a sensitivity analysis, referred to as a net interest revenue simulation model, is shown below. The Company is exposed to interest rate risk primarily from changes in market interest rates on its interest-earning assets relative to changes in the costs of its funding sources that finance these assets. Net interest revenue is affected by various factors, such as the distribution and composition of interest-earning assets and interest-bearing liabilities, the spread between yields earned on interest-earning assets and rates paid on interest-bearing liabilities, which may re-price at different times or by different amounts, and the spread between short and long-term interest rates. Interest-earning assets include residential real estate loans and mortgage-backed securities. These assets are sensitive to changes in interest rates and to changes to prepayment levels, which tend to increase in a declining rate environment. To mitigate the risk of loss, the Company has established policies and procedures which include setting guidelines on the amount of net interest revenue at risk, and monitoring the net interest margin and average maturity of its interest-earning assets and funding sources. To remain within these guidelines, the Company manages the maturity, repricing, and cash flow characteristics of the investment portfolios. Because the Company establishes the rates paid on certain brokerage client cash balances and deposits from banking clients, the rates charged on margin loans, and controls the composition of its investment securities, it has some ability to manage its net interest spread, depending on competitive factors and market conditions. The Company is also subject to market risk as a result of fluctuations in equity prices. The Company’s direct holdings of equity securities and its associated exposure to equity prices are not material. The Company is indirectly exposed to equity market fluctuations in connection with securities collateralizing margin loans to brokerage customers, and customer securities loaned out as part of the Company’s securities lending activities. Equity market valuations may also affect the level of brokerage client trading activity, margin borrowing, and overall client engagement with the Company. Additionally, the Company earns mutual fund service fees and asset management fees based upon daily balances of certain client assets. Fluctuations in these client asset balances caused by changes in equity valuations directly impact the amount of fee revenue earned by the Company. Financial instruments held by the Company are also subject to liquidity risk – that is, the risk that valuations will be negatively affected by changes in demand and the underlying market for a financial instrument. Recent conditions in the credit markets have significantly reduced market liquidity in a wide range of financial instruments, including the types of instruments held by the Company, and fair value can differ significantly from the value implied by the credit quality and actual performance of the instrument’s underlying cash flows. Financial instruments held by the Company are also subject to valuation risk as a result of changes in valuations of the underlying collateral, such as housing prices in the case of residential real estate loans and mortgage-backed securities. For discussion of the impact of current market conditions on asset management and administration fees, net interest revenue, and securities available for sale, see “Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations – Current Market and Regulatory Environment”. The Company’s market risk related to financial instruments held for trading and forward sale and interest rate lock commitments related to its loans held for sale portfolio is not material. Net Interest Revenue Simulation The Company uses net interest revenue simulation modeling techniques to evaluate and manage the effect of changing interest rates. The simulation model (the model) includes all interest-sensitive assets and liabilities. Key variables in the model include the repricing of financial instruments, prepayment, reinvestment, and product pricing assumptions. The Company uses constant balances and market rates in the model assumptions in order to minimize the number of variables and to better isolate risks. The simulations involve assumptions that are inherently uncertain and, as a result, cannot precisely estimate net interest - 45 - THE CHARLES SCHWAB CORPORATION revenue or predict the impact of changes in interest rates on net interest revenue. Actual results may differ from simulated results due to balance growth or decline and the timing, magnitude, and frequency of interest rate changes, as well as changes in market conditions and management strategies, including changes in asset and liability mix. As represented by the simulations presented below, 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 (i.e., interest-earning assets generally reprice more quickly than interest-bearing liabilities). The simulations in the following table assume that the asset and liability structure of the consolidated balance sheet would not be changed as a result of the simulated changes in interest rates. As the Company actively manages its consolidated balance sheet and interest rate exposure, in all likelihood the Company would take steps to manage any additional interest rate exposure that could result from changes in the interest rate environment. The following table shows the results of a gradual 100 basis point increase or decrease in market interest rates relative to the Company’s current market rates forecast on simulated net interest revenue over the next 12 months beginning December 31, 2011 and 2010. December 31, Increase of 100 basis points Decrease of 100 basis points 2011 19.1% (8.1%) 2010 13.5% (4.8%) The sensitivities shown in the simulation reflect the fact that short-term interest rates in 2011 remained at historically low levels, including the federal funds target rate, which was unchanged at a range of zero to 0.25%. The current low interest rate environment limits the extent to which the Company can reduce interest expense paid on funding sources in a declining interest rate scenario. A decline in interest rates could therefore negatively impact the yield on the Company’s investment portfolio to a greater degree than any offsetting reduction in interest expense, further compressing net interest margin. Any increases in short-term interest rates result in a greater impact as yields on interest-earning assets are expected to rise faster than the cost of funding sources. - 46 - THE CHARLES SCHWAB CORPORATION Item 8. Financial Statements and Supplementary Data TABLE OF CONTENTS Consolidated Statements of Income ------------------------------------------------------------------------------------------------- Consolidated Balance Sheets --------------------------------------------------------------------------------------------------------- Consolidated Statements of Cash Flows -------------------------------------------------------------------------------------------- Consolidated Statements of Stockholders’ Equity -------------------------------------------------------------------------------- Notes to Consolidated Financial Statements --------------------------------------------------------------------------------------- Introduction and Basis of Presentation -------------------------------------------------------------------------------- Note 1. Summary of Significant Accounting Policies ------------------------------------------------------------------------ Note 2. Note 3. Business Acquisitions --------------------------------------------------------------------------------------------------- Note 4. Receivables from Brokerage Clients ---------------------------------------------------------------------------------- Note 5. Other Securities Owned ------------------------------------------------------------------------------------------------- Securities Available for Sale and Securities Held to Maturity ----------------------------------------------------- Note 6. Loans to Banking Clients and Related Allowance for Loan Losses ----------------------------------------------- Note 7. Equipment, Office Facilities, and Property --------------------------------------------------------------------------- Note 8. Note 9. Intangible Assets and Goodwill ---------------------------------------------------------------------------------------- Note 10. Other Assets -------------------------------------------------------------------------------------------------------------- Note 11. Deposits from Banking Clients ----------------------------------------------------------------------------------------- Note 12. Payables to Brokers, Dealers, and Clearing Organizations --------------------------------------------------------- Note 13. Payables to Brokerage Clients ------------------------------------------------------------------------------------------ Note 14. Borrowings ---------------------------------------------------------------------------------------------------------------- Note 15. Commitments and Contingencies -------------------------------------------------------------------------------------- Note 16. Financial Instruments Subject to Off-Balance Sheet Risk, Credit Risk, or Market Risk ----------------------- Note 17. Fair Values of Assets and Liabilities ---------------------------------------------------------------------------------- Note 18. Equity Offering ----------------------------------------------------------------------------------------------------------- Note 19. Accumulated Other Comprehensive Income (Loss) ----------------------------------------------------------------- Note 20. Employee Incentive, Deferred Compensation, and Retirement Plans --------------------------------------------- Note 21. Money Market Mutual Fund Charges --------------------------------------------------------------------------------- Note 22. Taxes on Income --------------------------------------------------------------------------------------------------------- Note 23. Earnings Per Share ------------------------------------------------------------------------------------------------------- Note 24. Regulatory Requirements ----------------------------------------------------------------------------------------------- Note 25. Segment Information ---------------------------------------------------------------------------------------------------- Note 26. Subsequent Event -------------------------------------------------------------------------------------------------------- Note 27. The Charles Schwab Corporation – Parent Company Only Financial Statements ------------------------------- Note 28. Quarterly Financial Information (Unaudited) ------------------------------------------------------------------------ Report of Independent Registered Public Accounting Firm --------------------------------------------------------------------- Management’s Report on Internal Control Over Financial Reporting ---------------------------------------------------------- 48 49 50 51 52 52 52 56 58 59 59 63 66 67 67 68 68 68 68 70 72 75 78 79 80 82 82 84 84 86 87 88 90 91 92 - 47 - THE CHARLES SCHWAB CORPORATION Consolidated Statements of Income (In Millions, Except Per Share Amounts) Year Ended December 31, Net Revenues Asset management and administration fees Interest revenue Interest expense Net interest revenue Trading revenue Other Provision for loan losses Net impairment losses on securities (1) Total net revenues Expenses Excluding Interest Compensation and benefits Professional services Occupancy and equipment Advertising and market development Communications Depreciation and amortization Class action litigation and regulatory reserve Money market mutual fund charges Other Total expenses excluding interest Income before taxes on income Taxes on income Net Income 2011 2010 2009 $ 1,928 1,900 (175) 1,725 927 160 (18) (31) 4,691 $ 1,822 1,723 (199) 1,524 830 135 (27) (36) 4,248 $ 1,875 1,428 (183) 1,245 996 175 (38) (60) 4,193 1,732 387 301 228 220 155 7 - 269 3,299 1,392 (528) 1,573 341 272 196 207 146 320 132 282 3,469 779 (325) 1,544 275 318 191 206 159 - - 224 2,917 1,276 (489) $ 864 $ 454 $ 787 Weighted-Average Common Shares Outstanding — Diluted 1,229 1,194 1,160 Earnings Per Share — Basic Earnings Per Share — Diluted $ .70 $ .38 $ .68 $ .70 $ .38 $ .68 (1) Net impairment losses on securities include total other-than-temporary impairment losses of $18 million, $41 million, and $278 million, net of $(13) million, $5 million, and $218 million recognized in other comprehensive income in 2011, 2010, and 2009, respectively. See Notes to Consolidated Financial Statements. - 48 - THE CHARLES SCHWAB CORPORATION Consolidated Balance Sheets (In Millions, Except Share and Per Share Amounts) December 31, Assets Cash and cash equivalents Cash and investments segregated and on deposit for regulatory purposes (including resale agreements of $17,899 and $12,697 at December 31, 2011 and 2010, respectively) Receivables from brokers, dealers, and clearing organizations Receivables from brokerage clients — net Other securities owned — at fair value Securities available for sale Securities held to maturity (fair value — $15,539 and $17,848 at December 31, 2011 and 2010, respectively) Loans to banking clients — net Loans held for sale Equipment, office facilities, and property — net Goodwill Intangible assets — net Other assets Total assets Liabilities and Stockholders’ Equity Deposits from banking clients Payables to brokers, dealers, and clearing organizations Payables to brokerage clients Accrued expenses and other liabilities Long-term debt Total liabilities Stockholders’ equity: Preferred stock — 9,940,000 shares authorized; $.01 par value per share; none issued Common stock — 3 billion shares authorized; $.01 par value per share; 1,487,543,446 shares and 1,428,604,522 shares issued at December 31, 2011 and 2010, respectively Additional paid-in capital Retained earnings Treasury stock, at cost — 216,378,623 shares and 226,222,313 shares at December 31, 2011 and 2010, respectively Accumulated other comprehensive income Total stockholders’ equity Total liabilities and stockholders’ equity See Notes to Consolidated Financial Statements. 2011 2010 $ 8,679 $ 4,931 26,034 230 11,072 593 33,965 15,108 9,812 70 685 1,161 326 818 108,553 $ $ 60,854 1,098 35,489 1,397 2,001 100,839 - 15 3,826 7,978 22,749 415 11,235 337 23,993 17,762 8,725 185 624 631 54 927 92,568 $ $ 50,590 1,389 30,861 1,496 2,006 86,342 - 14 3,034 7,409 (4,113) 8 7,714 108,553 $ (4,247) 16 6,226 92,568 $ - 49 - THE CHARLES SCHWAB CORPORATION Consolidated Statements of Cash Flows (In Millions) Year Ended December 31, Cash Flows from Operating Activities Net income Adjustments to reconcile net income to net cash provided by (used for) operating activities: Provision for loan losses Net impairment losses on securities Stock-based compensation Depreciation and amortization Provision (benefit) for deferred income taxes Premium (discount) amortization, net, on securities available for sale and securities held to maturity Other Originations of loans held for sale Proceeds from sales of loans held for sale Net change in: Cash and investments segregated and on deposit for regulatory purposes Receivables from brokers, dealers, and clearing organizations Receivables from brokerage clients Other securities owned Other assets Payables to brokers, dealers, and clearing organizations Payables to brokerage clients Accrued expenses and other liabilities Net cash provided by (used for) operating activities Cash Flows from Investing Activities Purchases of securities available for sale Proceeds from sales of securities available for sale Principal payments on securities available for sale Purchases of securities held to maturity Principal payments on securities held to maturity Net increase in loans to banking clients Purchase of equipment, office facilities, and property Cash acquired in business acquisition, net of cash paid Other investing activities Net cash used for investing activities Cash Flows from Financing Activities Net change in deposits from banking clients Issuance of long-term debt Repayment of long-term debt Net proceeds from common stock offering Dividends paid Proceeds from stock options exercised and other Other financing activities Net cash provided by financing activities Increase (Decrease) in Cash and Cash Equivalents Cash and Cash Equivalents at Beginning of Year Cash and Cash Equivalents at End of Year Supplemental Cash Flow Information Cash paid during the year for: Interest Income taxes Non-cash investing activities: Common stock issued and equity awards assumed for business acquisitions (See note "3 - Business Acquisitions") Securities purchased during the year but settled after year end Non-cash financing activity: 2011 2010 2009 $ 864 $ 454 $ 787 18 31 99 155 52 136 9 (1,574) 1,703 (2,211) 220 341 (231) (15) (357) 3,407 (183) 2,464 (18,434) 500 7,978 (2,253) 4,786 (1,125) (180) 54 7 (8,667) 10,264 - (116) - (295) 96 2 9,951 3,748 4,931 8,679 $ 27 36 87 146 (51) 35 (3) (2,015) 1,943 (4,376) 148 (2,612) 581 133 283 4,886 289 (9) (15,697) 871 13,261 (14,906) 2,672 (1,443) (129) (44) 5 (15,410) 38 60 75 159 16 (18) (32) (2,746) 2,695 (3,688) 202 (1,503) (290) (253) 56 5,990 (111) 1,437 (14,342) 107 7,063 (5,470) 139 (1,411) (140) - (3) (14,057) 11,328 701 (205) 543 (288) 35 (5) 12,109 (3,310) 8,241 4,931 $ 14,979 747 (80) - (279) 53 (1) 15,419 2,799 5,442 8,241 $ $ $ 168 517 $ $ 178 327 $ $ 173 446 $ $ 714 58 $ 106 $ - $ - $ 1,267 Transfer of trust related balances to deposits from banking clients $ - $ 442 $ - See Notes to Consolidated Financial Statements. - 50 - THE CHARLES SCHWAB CORPORATION Consolidated Statements of Stockholders’ Equity (In Millions) Balance at December 31, 2008 Comprehensive income: Net income Other comprehensive income, net of tax: Net unrealized gain on securities available for sale Total comprehensive income Dividends declared on common stock Stock option exercises and other Stock-based compensation and related tax effects Other Balance at December 31, 2009 Comprehensive income: Net income Other comprehensive income, net of tax: Net unrealized gain on securities available for sale Net unrealized loss on cash flow hedging instruments Total comprehensive income Issuance of common stock Issuance of common stock for business acquisition Dividends declared on common stock Stock option exercises and other Stock-based compensation and related tax effects Other Balance at December 31, 2010 Comprehensive income: Net income Other comprehensive income, net of tax: Net unrealized loss on securities available for sale Foreign currency translation adjustment Total comprehensive income Issuance of common stock for business acquisition Dividends declared on common stock Stock option exercises and other Stock-based compensation and related tax effects Other Balance at December 31, 2011 See Notes to Consolidated Financial Statements. Common Stock Shares 1,392 Amount $ 14 Additional Paid-In Capital $ 2,214 Retained Earnings 6,735 $ Accumulated Other Treasury Stock, Comprehensive Income (Loss) $ (553) (4,349) $ at cost Total $ 4,061 - - - - - - 1,392 - - - 30 7 - - - - 1,429 - - - 59 - - - - - - - - 14 - - - - - - - - - 14 - - - 1 - - - - - - 80 4 2,298 - - - 543 106 - (4) 87 4 3,034 - - - 713 - (24) 787 - (279) - - - 7,243 454 - - - - (288) - - - 7,409 864 - - - (295) - - - - 52 - 6 (4,291) - - - - - - 39 - 5 (4,247) - - - - - 122 - 787 362 - - - - (191) - 208 (1) - - - - - - 16 - (7) (1) - - - 362 1,149 (279) 52 80 10 5,073 454 208 (1) 661 543 106 (288) 35 87 9 6,226 864 (7) (1) 856 714 (295) 98 - - 1,488 - - 15 $ 99 4 3,826 $ - - 7,978 $ - 12 (4,113) $ - - $ 8 99 16 7,714 $ - 51 - THE CHARLES SCHWAB CORPORATION Notes to Consolidated Financial Statements (Tabular Amounts in Millions, Except Per Share Data, Option Price Amounts, Ratios, or as Noted) 1. Introduction and Basis of Presentation The Charles Schwab Corporation (CSC) is a savings and loan holding company engaged, through its subsidiaries, in securities brokerage, banking, and related financial services. Charles Schwab & Co., Inc. (Schwab) is a securities broker-dealer with over 300 domestic branch offices in 45 states, as well as a branch in each of the Commonwealth of Puerto Rico and London, U.K. In addition, Schwab serves clients in Hong Kong through one of CSC’s subsidiaries. Other subsidiaries include Charles Schwab Bank (Schwab Bank), a federal savings bank, and Charles Schwab Investment Management, Inc. (CSIM), the investment advisor for Schwab’s proprietary mutual funds, which are referred to as the Schwab Funds®, and for Schwab’s exchange-traded funds, which are referred to as the Schwab ETFsTM. The accompanying consolidated financial statements include CSC and its majority-owned subsidiaries (collectively referred to as the Company). Intercompany balances and transactions have been eliminated. These consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States, which require management to make certain estimates and assumptions that affect the reported amounts in the accompanying financial statements. Certain estimates relate to other-than-temporary impairment of securities available for sale and securities held to maturity, valuation of goodwill, allowance for loan losses, and legal reserves. Actual results may differ from those estimates. Certain prior-period amounts have been reclassified to conform to the current period presentation. 2. Summary of Significant Accounting Policies Asset management and administration fees, which include mutual fund service fees and fees for other asset-based financial services provided to individual and institutional clients, are recognized as revenue over the period that the related service is provided, based upon average asset balances. The Company earns mutual fund service fees for shareholder services, administration, investment management services, and transfer agent services (through July 2009) provided to its proprietary funds, and recordkeeping and shareholder services provided to third-party funds. These fees are based upon the daily balances of client assets invested in these funds. The Company also earns asset management fees for advice solutions, which include advisory and managed account services that are based on the daily balances of client assets subject to the specific fee for service. The fair values of client assets included in proprietary and third-party mutual funds are based on quoted market prices and other observable market data. Other asset management and administration fees include various asset based fees, such as trust fees, 401k record keeping fees, and mutual fund clearing and other fees. In 2011, 2010 and 2009, the Company waived a portion of its asset management fees earned from certain Schwab-sponsored money market mutual funds in order to provide a positive return to clients. Under agreements with these funds, the Company may recover such fee waivers depending on the future performance of the funds and approval by the boards of the respective funds until the third anniversary of the end of the fiscal year in which such fee waiver occurs, subject to certain limitations. Recoveries of previously-waived asset management fees are recognized as revenue when substantially all uncertainties about timing and amount of realization are resolved. Amounts recognized in revenue for recoveries of previously-waived asset management fees were not material in 2011, 2010 or 2009. Interest revenue represents interest earned on certain assets, which include cash and cash equivalents, cash and investments segregated, receivables from brokers, dealers, and clearing organizations, receivables from brokerage clients, other securities owned, securities available for sale, securities held to maturity, loans to banking clients, and loans held for sale. Interest revenue is recognized in the period earned based upon average or daily asset balances and respective interest rates. Securities transactions: Trading revenue includes commission and principal transaction revenues. Clients’ securities transactions are recorded on the date that they settle, while the related commission revenues and expenses are recorded on the date that the trade occurs. Principal transaction revenues are primarily comprised of revenues from client fixed income securities trading activity, which are recorded on a trade date basis. Cash and cash equivalents: The Company considers all highly liquid investments with original maturities of three months or less that are not segregated and on deposit for regulatory purposes to be cash equivalents. Cash and cash equivalents include - 52 - THE CHARLES SCHWAB CORPORATION Notes to Consolidated Financial Statements (Tabular Amounts in Millions, Except Per Share Data, Option Price Amounts, Ratios, or as Noted) money market funds, deposits with banks, certificates of deposit, federal funds sold, commercial paper, and treasury securities. Cash and cash equivalents also include balances that Schwab Bank maintains at the Federal Reserve Bank. Cash and investments segregated and on deposit for regulatory purposes include securities purchased under agreements to resell (resale agreements), which are collateralized by United States (U.S.) Government and agency securities. Resale agreements are accounted for as collateralized investing transactions that are recorded at their contractual amounts plus accrued interest. The Company obtains control of collateral with a market value equal to or in excess of the principal amount loaned and accrued interest under resale agreements. Collateral is valued daily by the Company, with additional collateral obtained to ensure full collateralization. Cash and investments segregated also include certificates of deposit and U.S. Government securities, as well as corporate debt securities guaranteed by the Federal Deposit Insurance Corporation (FDIC) under the Temporary Liquidity Guarantee Program. Certificates of deposit, U.S. Government securities, and corporate debt securities are recorded at fair value. Receivables from brokerage clients include margin loans to clients and are recorded net of an allowance for doubtful accounts. Receivables from brokerage clients that remain unsecured or partially secured for more than 30 days are fully reserved. Other securities owned include Schwab Funds money market funds, certificates of deposit, equity and bond mutual funds, state and municipal debt obligations, equity securities, U.S. Government and corporate debt, and other securities recorded at fair value based on quoted market prices. Unrealized gains and losses are included in trading revenue. Securities available for sale and securities held to maturity: Securities available for sale include U.S. agency and non-agency residential mortgage-backed securities, certificates of deposit, corporate debt securities, U.S. agency notes, and asset-backed and other securities. Securities available for sale are recorded at fair value and unrealized gains and losses are reported, net of taxes, in accumulated other comprehensive income (loss) included in stockholders’ equity. Securities held to maturity include U.S. agency residential mortgage-backed securities and other securities. Securities held to maturity are recorded at amortized cost based on the Company’s positive intent and ability to hold these securities to maturity. Realized gains and losses from sales of securities available for sale are determined on a specific identification basis and are included in other revenue. 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. - 53 - THE CHARLES SCHWAB CORPORATION Notes to Consolidated Financial Statements (Tabular Amounts in Millions, Except Per Share Data, Option Price Amounts, Ratios, or as Noted) Securities borrowed and securities loaned: Securities borrowed require the Company to deliver cash to the lender in exchange for securities and are included in receivables from brokers, dealers, and clearing organizations. For securities loaned, the Company receives collateral in the form of cash in an amount equal to or greater than the market value of securities loaned. Securities loaned are included in payables to brokers, dealers, and clearing organizations. The Company monitors the market value of securities borrowed and loaned, with additional collateral obtained or refunded to ensure full collateralization. Fees received or paid are recorded in interest revenue or interest expense. Loans to banking clients are recorded at their contractual principal amounts and include unamortized direct origination costs. Additionally, loans are recorded net of an allowance for loan losses. The Company’s loan portfolio includes four loan segments: residential real estate mortgages, home equity lines of credit (HELOC), personal loans secured by securities and other loans. Residential real estate mortgages include two loan classes: originated first mortgages and purchased first mortgages. Loan segments are defined as the level to which the Company disaggregates its loan portfolio when developing and documenting a methodology for determining the allowance for loan losses. A loan class is defined as a group of loans within a loan segment that has homogeneous risk characteristics. The Company records an allowance for loan losses through a charge to earnings based on management’s evaluation of the existing portfolio. 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 Fair Isaac Corporation (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 in a loss) are estimated from the Company’s historical loss experience adjusted for current trends and market information. Loss severity estimates are based on the Company’s historical loss experience and market trends. Housing price trends are derived from historical home price indices and econometric forecasts of future home values. Factors affecting the home price index include: housing inventory, unemployment, interest rates, and inflation expectations. Interest rate projections are based on the current term structure of interest rates and historical volatilities to project various possible future interest rate paths. This quarterly analysis results in a loss factor that is applied to the outstanding balances to determine the allowance for loan loss for each loan segment. Nonaccrual loans: Residential real estate mortgages, HELOC, personal, and other loans are placed on nonaccrual status upon becoming 90 days past due as to interest or principal (unless the loans are well-secured and in the process of collection), or when the full timely collection of interest or principal becomes uncertain. When a loan is placed on nonaccrual status, the accrued and unpaid interest receivable is reversed and the loan is accounted for on the cash or cost recovery method thereafter, until qualifying for return to accrual status. Generally, a loan may be returned to accrual status when all delinquent interest and principal is repaid and the loan is performing in accordance with the terms of the loan agreement, or when the loan is both well-secured and in the process of collection and collectability is no longer doubtful. Loans held for sale include fixed-rate and adjustable-rate residential first-mortgage loans intended for sale. Loans held for sale are recorded at the lower of cost or fair value. The fair value of loans held for sale is estimated using quoted market prices for securities backed by similar types of loans. - 54 - THE CHARLES SCHWAB CORPORATION Notes to Consolidated Financial Statements (Tabular Amounts in Millions, Except Per Share Data, Option Price Amounts, Ratios, or as Noted) Equipment, office facilities, and property are recorded at cost net of accumulated depreciation and amortization, except for land, which is recorded at cost. Equipment and office facilities are depreciated on a straight-line basis over an estimated useful life of three to ten years. Buildings are depreciated on a straight-line basis over 20 to 40 years. Leasehold improvements are amortized on a straight-line basis over the shorter of the estimated useful life of the asset or the term of the lease. Software and certain costs incurred for purchasing or developing software for internal use are amortized on a straight- line basis over an estimated useful life of three or five years. Equipment, office facilities, and property are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. Goodwill represents the fair value of acquired businesses in excess of the fair value of the individually identified net assets acquired. Goodwill is not amortized but is tested for impairment annually or whenever indications of impairment exist. In testing for a potential impairment of goodwill, management estimates the fair value of each of the Company’s reporting units (defined as the Company’s businesses for which financial information is available and reviewed regularly by management), and compares it to their carrying value. If the estimated fair value of a reporting unit is less than its carrying value, management is required to estimate the fair value of all assets and liabilities of the reporting unit, including goodwill. If the carrying value of the reporting unit’s goodwill is greater than the estimated fair value, an impairment charge is recognized for the excess. The Company’s annual impairment testing date is April 1st. The Company did not recognize any goodwill impairment in 2011, 2010, or 2009. Intangible assets include customer relationships, technology, tradenames, and other intangible assets and are recorded at fair value. The Company utilizes independent third-party valuation specialists to determine the fair value of intangible assets acquired in a business combination, and does not have any internally generated intangible assets. Subsequently, intangible assets are amortized over their useful lives in a manner that best reflects their economic benefit. Intangible assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. The Company does not have any indefinite-lived intangible assets. Guarantees and indemnifications: The Company recognizes, at the inception of a guarantee, a liability equal to the estimated fair value of the obligation undertaken in issuing the guarantee. The fair values of the obligations relating to standby letter of credit agreements (LOCs) are estimated based on fees charged to enter into similar agreements, considering the creditworthiness of the counterparties. The fair values of the obligations relating to other guarantees are estimated based on transactions for similar guarantees or expected present value measures. Income taxes: The Company provides for income taxes on all transactions that have been recognized in the consolidated financial statements. Accordingly, deferred tax assets are adjusted to reflect the tax rates at which future taxable amounts will likely be settled or realized. The effects of tax rate changes on future deferred tax assets and deferred tax liabilities, as well as other changes in income tax laws, are recorded in earnings in the period during which such changes are enacted. The Company’s unrecognized tax benefits, which are included in accrued expenses and other liabilities, represent the difference between positions taken on tax return filings and estimated potential tax settlement outcomes. Stock-based compensation includes employee and board of director stock options, restricted stock awards, and restricted stock units. The Company measures compensation expense for these share-based payment arrangements based on their estimated fair values as of the awards’ grant date. The fair value of the share-based award is recognized over the vesting period as stock-based compensation. Stock-based compensation expense is based on awards expected to vest and therefore is reduced for estimated forfeitures. Forfeitures are estimated at the time of grant based on the Company’s historical forfeiture experience and revised in subsequent periods if actual forfeitures differ from those estimates. Adoption of New Accounting Standards Goodwill Impairment Test: In December 2010, the Financial Accounting Standards Board (FASB) issued new guidance on when to perform the second step in the two-step goodwill impairment test, which is effective for all goodwill impairment tests - 55 - THE CHARLES SCHWAB CORPORATION Notes to Consolidated Financial Statements (Tabular Amounts in Millions, Except Per Share Data, Option Price Amounts, Ratios, or as Noted) performed after January 1, 2011. Specifically, if the carrying value of a reporting unit, as computed in step one of the goodwill impairment test, is zero or negative, step two must be performed when it is “more likely than not” that goodwill is impaired; under these circumstances, entities can no longer assume that no impairment exists because fair value, as computed in step two, would generally be greater than zero. The adoption of this new guidance did not have a material impact on the Company’s financial position, results of operations, earnings per share (EPS), or cash flows. A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring: In April 2011, the FASB issued new guidance clarifying when a debt restructuring by a creditor constitutes a troubled debt restructuring, which is effective July 1, 2011 for all restructurings that occur on or after January 1, 2011. This guidance clarifies that a troubled debt restructuring only exists when a creditor makes a concession in interest rates or payment terms to a debtor experiencing financial difficulties. It provides additional guidance on determining what constitutes a concession, and on the use of probability in determining if a debtor could be experiencing financial difficulty prior to defaulting on payments. The adoption of this new guidance did not have a material impact on the Company’s financial position, results of operations, EPS, or cash flows. New Accounting Standard Not Yet Adopted Testing Goodwill for Impairment: In September 2011, the FASB issued new guidance allowing companies to consider qualitative factors before performing a quantitative assessment when determining whether goodwill is impaired, which is effective for goodwill impairment tests performed after January 1, 2012. Specifically, there is no longer a requirement to perform the two-step goodwill impairment test unless the entity determines that based on qualitative factors, it is more likely than not that the fair value of a reporting unit is less than its carrying amount. The adoption of this new guidance is not expected to have a material impact on the Company’s financial position, results of operations, EPS, or cash flows. 3. Business Acquisitions optionsXpress Holdings, Inc. On September 1, 2011, the Company completed its acquisition of all of the outstanding common shares of optionsXpress Holdings, Inc. (optionsXpress) for total consideration of $714 million. optionsXpress is an online brokerage firm primarily focused on equity option securities and futures. The optionsXpress brokerage platform provides active investors and traders trading tools, analytics and education to execute a variety of investment strategies. The combination of optionsXpress and Schwab offers active investors an additional level of service and platform capabilities. Under the terms of the merger agreement, optionsXpress stockholders received 1.02 shares of the Company’s common stock for each share of optionsXpress stock. As a result, the Company issued 59 million shares of the Company’s common stock valued at $710 million, based on the closing price of the Company’s common stock on September 1, 2011. The Company also assumed optionsXpress’ stock-based compensation awards valued at $4 million. The results of optionsXpress’ operations have been included in the Company’s consolidated statement of income for the year ended December 31, 2011, from the date of acquisition. optionsXpress’ net revenues were $68 million and their net loss was not material for the period September 1, 2011 through December 31, 2011. - 56 - THE CHARLES SCHWAB CORPORATION Notes to Consolidated Financial Statements (Tabular Amounts in Millions, Except Per Share Data, Option Price Amounts, Ratios, or as Noted) The following table summarizes the preliminary allocation of the purchase price to the net assets of optionsXpress as of September 1, 2011: Fair value of common stock issued Fair value of equity awards assumed Total consideration paid (1) Fair value of net assets acquired Preliminary goodwill (1) Represents a non-cash investing activity. $ $ $ $ 710 4 714 207 507 The following table summarizes the preliminary fair values of the assets acquired and liabilities assumed as of the acquisition date. The allocation of the purchase price is preliminary and subject to further adjustment as information relative to closing date fair values and related tax balances are finalized. September 1, 2011 Assets Cash and cash equivalents Cash and investments segregated and on deposit for regulatory purposes Receivables from brokers, dealers, and clearing organizations Receivables from brokerage clients Other securities owned - at fair value Intangible assets Other assets Total assets acquired (1) Liabilities Payables to brokerage clients Deferred tax liability Long-term debt (2) Accrued expenses and other liabilities Total liabilities assumed (1) Net assets acquired (1) All assets and liabilities, except for cash and cash equivalents, represent non-cash investing activities. (2) The Company paid off long-term debt acquired from optionsXpress subsequent to the date of acquisition in $ 84 1,074 40 185 32 285 24 $ 1,724 $ 1,221 95 110 91 $ 1,517 207 $ September 2011. Preliminary goodwill of $507 million was assigned to the Investor Services segment and will not be deductible for tax purposes. The Company recorded preliminary intangible assets of $285 million, which are subject to amortization and will be amortized over their estimated useful lives. The following table summarizes the preliminary estimated fair value and useful lives of the intangible assets. September 1, 2011 Customer relationships Technology Trade name Total intangible assets - 57 - $ Estimated Fair Value 200 70 15 285 $ Estimated Useful Life (In Years) 11 9 9 THE CHARLES SCHWAB CORPORATION Notes to Consolidated Financial Statements (Tabular Amounts in Millions, Except Per Share Data, Option Price Amounts, Ratios, or as Noted) Pro Forma Financial Information (Unaudited) The following table presents unaudited pro forma financial information as if optionsXpress had been acquired on January 1, 2009. Pro forma net income for the year ended December 31, 2011, was adjusted to exclude $16 million, after tax, of acquisition related costs incurred by the Company in 2011. Pro forma net income for the year ended December 31, 2009, was adjusted to include these costs. Additionally, pro forma net income below excludes $15 million, before tax, of acquisition related costs because these costs were incurred by optionsXpress prior to the acquisition date. Pro forma net income also reflects the impact of amortizing purchase accounting adjustments relating to intangible assets, net of tax, of $20 million, $22 million, and $24 million, for the years ended December 31, 2011, 2010, and 2009, respectively. Year Ended December 31, Net revenues Net income Basic EPS Diluted EPS 2011 $ 4,857 896 $ .71 $ .71 $ 2010 $ 4,479 481 $ .39 $ .38 $ 2009 $ 4,426 804 $ .66 $ $ .66 The unaudited pro forma financial information above is presented for illustrative purposes only and is not necessarily indicative of the results that actually would have occurred had the acquisition been completed at the beginning of 2009, nor is it indicative of the results of operations for future periods. Windward Investment Management, Inc. On November 9, 2010, the Company completed its acquisition of substantially all of the assets of Windward Investment Management, Inc. (Windward) for $106 million in common stock and $44 million in cash. Windward was an investment advisory firm that managed diversified investment portfolios comprised primarily of exchange-traded fund securities. As a result of the acquisition, Windhaven Investment Management, Inc. was formed as a wholly-owned subsidiary of Schwab Holdings, Inc. The Company’s consolidated financial statements include the net assets and results of operations associated with this acquisition from November 9, 2010. Pro forma financial information for the business acquired from Windward is not presented as it is not material to the Company’s consolidated financial statements. As a result of a fair value allocation, the Company recorded goodwill of $103 million and intangible assets of $47 million, both of which are deductible for tax purposes over a period of 15 years. The intangible assets, which primarily relate to customer relationships and technology, are being amortized on a straight-line basis over 11 years and 9 years, respectively. The goodwill was allocated to the Investor Services and Institutional Services segments in the amounts of $30 million and $73 million, respectively. In connection with the acquisition, the Company established employee retention and incentive programs that provide for cash payments up to an aggregate $100 million. These payments are contingent upon the employees’ continued employment and achievement of certain assets under management thresholds prior to specified time periods concluding 102 months (the Service Period) following the acquisition, with payments due at intervals throughout the period if earned. These payments will be recorded as compensation expense if such payments are deemed probable, and will be recognized over the Service Period. The estimated liability under this program was not material at December 31, 2011 or 2010. 4. Receivables from Brokerage Clients Receivables from brokerage clients are recorded net of an allowance for doubtful accounts. The allowance for doubtful accounts was not material at December 31, 2011 or 2010. Receivables from brokerage clients consist primarily of margin loans to brokerage clients of $10.2 billion and $10.3 billion at December 31, 2011 and 2010, respectively. Securities owned by brokerage clients are held as collateral for margin loans. Such collateral is not reflected in the consolidated financial statements. The average yield earned on margin loans was 4.39% and 4.87% in 2011 and 2010, respectively. - 58 - THE CHARLES SCHWAB CORPORATION Notes to Consolidated Financial Statements (Tabular Amounts in Millions, Except Per Share Data, Option Price Amounts, Ratios, or as Noted) 5. Other Securities Owned A summary of other securities owned is as follows: December 31, Schwab Funds money market funds Equity and bond mutual funds State and municipal debt obligations Equity, U.S. Government and corporate debt, and other securities Total other securities owned (1) (1) Securities pledged were not material at December 31, 2011 or 2010. 2011 332 183 46 32 593 $ $ 2010 $ 172 99 47 19 $ 337 The Company’s positions in Schwab Funds money market funds arise from certain overnight funding of clients’ redemption, check-writing, and debit card activities. Equity and bond mutual funds include mutual fund investments held at CSC, investments made by the Company relating to its deferred compensation plan, and inventory maintained to facilitate certain Schwab Funds and third-party mutual fund clients’ transactions. State and municipal debt obligations, equity, U.S. Government and corporate debt, and other securities include securities held to meet clients’ trading activities. Securities sold, but not yet purchased were not material at December 31, 2011 or 2010, and are recorded at fair value in accrued expenses and other liabilities. 6. Securities Available for Sale and Securities Held to Maturity The amortized cost, gross unrealized gains and losses, and fair value of securities available for sale and securities held to maturity are as follows: December 31, 2011 Securities available for sale: U.S. agency residential mortgage-backed securities Non-agency residential mortgage-backed securities Certificates of deposit Corporate debt securities U.S. agency notes Asset-backed and other securities Total securities available for sale Securities held to maturity: U.S. agency residential mortgage-backed securities Other securities Total securities held to maturity Amortized Cost $ 20,666 1,130 3,623 3,592 1,795 3,144 $ 33,950 $ 14,770 338 $ 15,108 Gross Unrealized Gains Gross Unrealized Losses $ $ $ $ 269 - 2 5 5 7 288 430 3 433 $ $ $ $ 14 223 3 26 - 7 273 2 - 2 Fair Value $ 20,921 907 3,622 3,571 1,800 3,144 $ 33,965 $ 15,198 341 $ 15,539 - 59 - THE CHARLES SCHWAB CORPORATION Notes to Consolidated Financial Statements (Tabular Amounts in Millions, Except Per Share Data, Option Price Amounts, Ratios, or as Noted) December 31, 2010 Securities available for sale: U.S. agency residential mortgage-backed securities Non-agency residential mortgage-backed securities Certificates of deposit Corporate debt securities U.S. agency notes Asset-backed securities Total securities available for sale Securities held to maturity: U.S. agency residential mortgage-backed securities Other securities Total securities held to maturity Amortized Cost $ 12,879 1,701 1,874 2,261 2,757 2,495 $ 23,967 $ 16,722 1,040 $ 17,762 Gross Unrealized Gains Gross Unrealized Losses Fair Value $ $ $ $ 222 3 1 8 23 9 266 209 14 223 $ $ $ $ 3 234 - 1 - 2 240 137 - 137 $ 13,098 1,470 1,875 2,268 2,780 2,502 $ 23,993 $ 16,794 1,054 $ 17,848 A summary of securities with unrealized losses, aggregated by category and period of continuous unrealized loss, is as follows: Less than 12 months Fair Unrealized Value 12 months or longer Fair Unrealized Value Total Fair Unrealized Value $ Losses Losses December 31, 2011 Securities available for sale: U.S. agency residential mortgage-backed securities $ 5,551 121 Non-agency residential mortgage-backed securities 2,158 Certificates of deposit 1,888 Corporate debt securities 1,376 Asset-backed and other securities Total $ 11,094 Securities held to maturity: 384 U.S. agency residential mortgage-backed securities $ $ Total 384 Total securities with unrealized losses (1) $ 11,478 (1) The number of investment positions with unrealized losses totaled 296 for securities available for sale and 3 for securities $ 5,551 $ 867 2,158 1,888 1,528 $ 11,992 $ - 215 - - 1 $ 216 384 $ $ $ 384 $ $ 12,376 $ - 746 - - 152 898 14 223 3 26 7 273 - $ $ - $ 216 14 8 3 26 6 57 - - 898 2 2 275 2 2 59 Losses $ $ $ $ $ $ $ $ $ $ held to maturity. - 60 - THE CHARLES SCHWAB CORPORATION Notes to Consolidated Financial Statements (Tabular Amounts in Millions, Except Per Share Data, Option Price Amounts, Ratios, or as Noted) Less than 12 months Fair Unrealized Value 12 months or longer Fair Unrealized Value Total Fair Unrealized Value Losses Losses Losses December 31, 2010 Securities available for sale: U.S. agency residential mortgage-backed securities $ Non-agency residential mortgage-backed securities Corporate debt securities Asset-backed securities Total Securities held to maturity: U.S. agency residential mortgage-backed securities $ 6,880 $ 6,880 Total Total securities with unrealized losses (1) $ 9,009 (1) The number of investment positions with unrealized losses totaled 178 for securities available for sale and 37 for 707 - 549 873 $ 2,129 - 1,207 - - $ 1,207 707 1,207 549 873 $ 3,336 - 234 - - $ 234 - $ $ - $ 1,207 $ 6,880 $ 6,880 $ 10,216 - $ $ - $ 234 137 137 143 3 - 1 2 6 $ $ $ $ $ $ $ $ $ 3 234 1 2 $ 240 $ 137 $ 137 $ 377 securities held to maturity. Unrealized losses in securities available for sale of $273 million as of December 31, 2011, were concentrated in non-agency residential mortgage-backed securities. Included in non-agency residential mortgage-backed securities are securities collateralized by loans that are considered to be “Prime” (defined as loans to borrowers with a Fair Isaac & Company credit score of 620 or higher at origination), and “Alt-A” (defined as Prime loans with reduced documentation at origination). At December 31, 2011, the amortized cost and fair value of Alt-A residential mortgage-backed securities were $390 million and $279 million, respectively. Management evaluates whether securities available for sale and securities held to maturity are other-than-temporarily impaired (OTTI) on a quarterly basis as described in note “2 – Summary of Significant Accounting Policies.” Certain Alt-A and Prime residential mortgage-backed securities experienced continued credit deterioration in 2011, including increased payment delinquency rates and losses on foreclosures of underlying mortgages. Based on the Company’s cash flow projections, management determined that it does not expect to recover all of the amortized cost of these securities and therefore determined that these securities were OTTI. The Company employs a buy and hold strategy relative to its mortgage- related securities, and does not intend to sell these securities and it will not be required to sell these securities before anticipated recovery of the unrealized losses on these securities. Further, the Company has an adequate liquidity position at December 31, 2011, with cash and cash equivalents totaling $8.7 billion, a loan-to-deposit ratio of 16%, adequate access to short-term borrowing facilities and regulatory capital ratios in excess of “well capitalized” levels. Because the Company does not intend to sell these securities and it is not “more likely than not” that the Company will be required to sell these securities, the Company recognized an impairment charge equal to the securities’ expected credit losses of $31 million in 2011. The expected credit losses were measured as the difference between the present value of expected cash flows and the amortized cost of the securities. Further deterioration in the performance of the underlying loans in the Company’s residential mortgage- backed securities portfolio could result in the recognition of additional impairment charges. Actual credit losses on the Company’s residential mortgage-backed securities were not material in 2011 or 2010. There were no actual credit losses on the Company’s residential mortgage-backed securities in 2009. - 61 - THE CHARLES SCHWAB CORPORATION Notes to Consolidated Financial Statements (Tabular Amounts in Millions, Except Per Share Data, Option Price Amounts, Ratios, or as Noted) The following table is a rollforward of the amount of credit losses recognized in earnings for OTTI securities held by the Company during the period for which a portion of the impairment was recognized in other comprehensive income: Year Ended December 31, Balance at beginning of year Credit losses recognized into current year earnings on debt securities for which an other-than-temporary impairment was not previously recognized Credit losses recognized into current year earnings on debt securities for which an other-than-temporary impairment was previously recognized Balance at the end of year 2011 96 $ 2010 60 $ 6 25 127 $ 7 29 96 $ 2009 - 60 - 60 $ $ The maturities of securities available for sale and securities held to maturity at December 31, 2011, are as follows: After 1 year After 5 years Within 1 year through 5 years through 10 years After 10 years Total $ $ - - 1,897 954 - 225 $ 3,076 $ 3,076 Securities available for sale: U.S. agency residential mortgage-backed securities (1) Non-agency residential mortgage-backed securities (1) Certificates of deposit Corporate debt securities U.S. agency notes Asset-backed and other securities Total fair value Total amortized cost Securities held to maturity: U.S. agency residential mortgage-backed securities (1) Other securities 341 $ Total fair value $ 15,539 $ 15,108 Total amortized cost $ (1) Residential mortgage-backed securities have been allocated to maturity groupings based on final contractual maturities. Actual maturities will differ from final contractual maturities because borrowers on a certain portion of loans underlying these securities have the right to prepay their obligations. $ 2,950 13 - 100 - 534 $ 3,597 $ 3,512 $ 17,969 894 - - - 1,573 $ 20,436 $ 20,491 2 - 1,725 2,517 1,800 812 $ 6,856 $ 6,871 $ 20,921 907 3,622 3,571 1,800 3,144 $ 2,581 - $ 2,581 $ 2,507 $ 12,617 - $ 12,617 $ 12,263 $ 33,965 $ 33,950 - 117 117 116 - 224 224 222 $ 15,198 $ $ $ $ Proceeds and gross realized gains (losses) from sales of securities available for sale are as follows: Year Ended December 31, Proceeds Gross realized gains Gross realized losses 2011 500 1 - $ $ $ 2010 871 1 - $ $ $ 2009 107 1 (4) $ $ $ - 62 - THE CHARLES SCHWAB CORPORATION Notes to Consolidated Financial Statements (Tabular Amounts in Millions, Except Per Share Data, Option Price Amounts, Ratios, or as Noted) 7. Loans to Banking Clients and Related Allowance for Loan Losses The composition of loans to banking clients by loan segment is as follows: December 31, Residential real estate mortgages Home equity lines of credit Personal loans secured by securities Other Total loans to banking clients (1) Allowance for loan losses Total loans to banking clients – net (1) Loans are evaluated for impairment by loan segment. 2011 $ 5,596 3,509 742 19 9,866 (54) $ 9,812 2010 $ 4,695 3,500 562 21 8,778 (53) $ 8,725 The allowance for loan losses is established through charges to earnings based on management’s evaluation of the existing portfolio. 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, as described in note “2 – Summary of Significant Accounting Policies.” In addition to the allowance for loan losses, the Company maintains a separate reserve for the losses inherent in unused commitments on its HELOC loans. This reserve is included in accrued expenses and other liabilities and was not material at December 31, 2011 or 2010. Changes in the allowance for loan losses were as follows: Year Ended December 31, 2011 Balance at beginning of year Charge-offs Recoveries Provision for loan losses Balance at end of year Residential real estate mortgages 38 (11) 1 12 40 $ $ $ Home equity lines of credit 15 (8) 1 6 14 $ December 31, December 31, Total 53 (19) 2 18 54 $ $ 2010 45 (20) 1 27 53 $ $ 2009 20 (13) - 38 45 $ $ Included in the loan portfolio are nonaccrual loans totaling $52 million and $51 million at December 31, 2011 and 2010, respectively. There were no loans accruing interest that were contractually 90 days or more past due at December 31, 2011 or 2010. The amount of interest revenue that would have been earned on nonaccrual loans, versus actual interest revenue recognized on these loans, was not material to the Company’s results of operations in 2011 or 2010. Nonperforming assets, which include nonaccrual loans and other real estate owned, totaled $56 million and $54 million at December 31, 2011 and 2010, respectively. The Company considers loan modifications in which it makes an economic concession to a borrower experiencing financial difficulty to be a troubled debt restructuring. Troubled debt restructurings were not material at December 31, 2011 or 2010. - 63 - THE CHARLES SCHWAB CORPORATION Notes to Consolidated Financial Statements (Tabular Amounts in Millions, Except Per Share Data, Option Price Amounts, Ratios, or as Noted) The delinquency aging analysis by loan class is as follows: December 31, 2011 Residential real estate mortgages: Originated first mortgages Purchased first mortgages Home equity lines of credit Personal loans secured by securities Other Total loans to banking clients December 31, 2010 Residential real estate mortgages: Originated first mortgages Purchased first mortgages Home equity lines of credit Personal loans secured by securities Other Total loans to banking clients Current 30-59 days past due 60-89 days Greater than Total past due 90 days past due Total loans $ $ $ $ 5,380 152 3,494 741 19 9,786 4,527 100 3,489 557 21 8,694 $ $ $ $ 16 2 5 1 - 24 18 2 5 - - 25 $ $ $ $ 2 - 2 - - 4 5 1 2 - - 8 $ $ $ $ 39 5 8 - - 52 38 4 4 5 - 51 $ $ $ $ 57 7 15 1 - 80 61 7 11 5 - 84 $ 5,437 159 3,509 742 19 $ 9,866 $ 4,588 107 3,500 562 21 $ 8,778 In addition to monitoring the delinquency characteristics as presented in the aging analysis above, the Company monitors the credit quality of residential real estate mortgages and HELOCs by stratifying the portfolios by the year of origination, borrower FICO scores at origination, updated FICO scores, and loan-to-value ratios at origination (Origination LTV), as presented in the following tables. Borrowers’ FICO scores are provided by an independent third party credit reporting service and were last updated in December 2011. The Company monitors the credit quality of personal loans secured by securities by reviewing the fair value of collateral to ensure adequate collateralization of at least 100% of the principal amount of the loans. All of these personal loans were fully collateralized by securities with fair values in excess of borrowing amounts at December 31, 2011 and 2010. - 64 - THE CHARLES SCHWAB CORPORATION Notes to Consolidated Financial Statements (Tabular Amounts in Millions, Except Per Share Data, Option Price Amounts, Ratios, or as Noted) Originated first mortgages Residential real estate mortgages Purchased first mortgages $ 291 278 538 553 1,757 2,020 $ 5,437 $ 9 108 1,030 4,290 $ 5,437 $ 55 162 831 4,389 $ 5,437 $ 52 8 8 10 17 64 $ 159 $ 2 19 43 95 $ 159 $ 7 11 44 97 $ 159 Total $ 343 286 546 563 1,774 2,084 $ 5,596 $ 11 127 1,073 4,385 $ 5,596 $ 62 173 875 4,486 $ 5,596 Home equity lines of credit $ 1,074 232 1,262 412 311 218 $ 3,509 $ - 24 667 2,818 $ 3,509 $ 49 112 520 2,828 $ 3,509 December 31, 2011 Year of origination Pre-2007 2007 2008 2009 2010 2011 Total Origination FICO < 620 620 - 679 680 - 739 ≥ 740 Total Updated FICO < 620 620 - 679 680 - 739 ≥ 740 Total Origination LTV (1) ≤ 70% 71% - 89% ≥ 90% Total $ 2,378 1,091 40 $ 3,509 (1) The computation of the Origination LTV ratio for a HELOC includes any first lien mortgage outstanding on the same property at the time of origination. At December 31, 2011, $755 million of $3.5 billion in HELOCs were in a first lien position. $ 3,598 1,964 34 $ 5,596 $ 3,507 1,904 26 $ 5,437 91 60 8 $ 159 $ - 65 - THE CHARLES SCHWAB CORPORATION Notes to Consolidated Financial Statements (Tabular Amounts in Millions, Except Per Share Data, Option Price Amounts, Ratios, or as Noted) Originated first mortgages Residential real estate mortgages Purchased first mortgages $ 352 384 728 884 2,240 $ 4,588 $ 9 115 907 3,557 $ 4,588 $ 63 147 730 3,648 $ 4,588 $ 58 9 8 12 20 $ 107 $ 2 15 33 57 $ 107 $ 9 8 29 61 $ 107 Total $ 410 393 736 896 2,260 $ 4,695 $ 11 130 940 3,614 $ 4,695 $ 72 155 759 3,709 $ 4,695 Home equity lines of credit $ 1,132 245 1,345 466 312 $ 3,500 $ - 26 677 2,797 $ 3,500 $ 49 99 499 2,853 $ 3,500 December 31, 2010 Year of origination Pre-2007 2007 2008 2009 2010 Total Origination FICO < 620 620 - 679 680 - 739 ≥ 740 Total Updated FICO < 620 620 - 679 680 - 739 ≥ 740 Total Origination LTV (1) ≤ 70% 71% - 89% ≥ 90% Total $ 2,375 1,092 33 $ 3,500 (1) The computation of the Origination LTV ratio for a HELOC includes any first lien mortgage outstanding on the same property at the time of origination. At December 31, 2010, $742 million of $3.5 billion in HELOCs were in a first lien position. $ 2,966 1,710 19 $ 4,695 $ 2,911 1,659 18 $ 4,588 55 51 1 $ 107 $ 8. Equipment, Office Facilities, and Property Equipment, office facilities, and property are detailed below: December 31, Software Buildings Information technology equipment Leasehold improvements Furniture and equipment Telecommunications equipment Land Construction in progress Total equipment, office facilities, and property Accumulated depreciation and amortization Total equipment, office facilities, and property – net - 66 - 2011 993 446 430 307 131 104 59 17 2,487 (1,802) 685 $ $ 2010 902 438 405 282 118 91 57 15 2,308 (1,684) 624 $ $ THE CHARLES SCHWAB CORPORATION Notes to Consolidated Financial Statements (Tabular Amounts in Millions, Except Per Share Data, Option Price Amounts, Ratios, or as Noted) 9. Intangible Assets and Goodwill The gross carrying value of intangible assets and accumulated amortization was: December 31, 2011 December 31, 2010 Gross Net Gross Net Customer relationships Technology Trade name Other Total intangible assets $ Carrying Accumulated Carrying Value Amortization Value $ 245 88 15 2 $ 350 $ 228 82 14 2 $ 326 17 6 1 - 24 $ Carrying Accumulated Carrying Value Amortization Value $ $ $ 42 14 - 2 58 $ $ 2 2 - - 4 40 12 - 2 54 Amortization expense for intangible assets was $20 million in 2011 and not material in 2010 or 2009. Estimated future annual amortization expense for intangible assets as of December 31, 2011 is as follows: 2012 2013 2014 2015 2016 Thereafter $ $ $ $ $ $ $ 47 42 39 36 34 128 The changes in the carrying amount of goodwill, as allocated to the Company’s reportable segments for purposes of testing goodwill for impairment going forward, are presented in the following table: Balance at December 31, 2010 Goodwill acquired during the period Balance at December 31, 2011 10. Other Assets The components of other assets are as follows: Investor Services $ 446 507 $ 953 Institutional Services $ 185 23 $ 208 Total $ 631 530 $ 1,161 December 31, Accounts receivable (1) Prepaid expenses Interest and dividends receivable Other investments Deferred tax asset – net Other $ Total other assets (1) Accounts receivable includes accrued service fee income and a receivable from the Company’s loan servicer. 2011 330 153 142 57 27 109 818 $ $ $ 2010 320 172 134 56 170 75 927 - 67 - THE CHARLES SCHWAB CORPORATION Notes to Consolidated Financial Statements (Tabular Amounts in Millions, Except Per Share Data, Option Price Amounts, Ratios, or as Noted) 11. Deposits from Banking Clients Deposits from banking clients consist of interest-bearing and noninterest-bearing deposits as follows: December 31, Interest-bearing deposits: Deposits swept from brokerage accounts Checking Savings and other Total interest-bearing deposits Noninterest-bearing deposits Total deposits from banking clients 2011 2010 $ 40,617 10,765 8,997 60,379 475 $ 60,854 $ 30,980 9,890 9,241 50,111 479 $ 50,590 Demand deposit overdrafts included as other loans within loans to banking clients were not material at December 31, 2011 or 2010. In 2010, the Company entered into deposit account agreements with existing trust clients and accordingly transferred balances totaling $442 million from payables to brokerage clients and accrued expenses and other liabilities to noninterest-bearing deposits from banking clients. 12. Payables to Brokers, Dealers, and Clearing Organizations Payables to brokers, dealers, and clearing organizations include securities loaned of $852 million and $1.3 billion at December 31, 2011 and 2010, respectively. The cash collateral received from counterparties under securities lending transactions was equal to or greater than the market value of the securities loaned at December 31, 2011 and 2010. 13. Payables to Brokerage Clients The principal source of funding for Schwab’s margin lending is cash balances in brokerage client accounts, which are included in payables to brokerage clients. Cash balances in interest-bearing brokerage client accounts were $30.6 billion and $26.2 billion at December 31, 2011 and 2010, respectively. The average rate paid on cash balances in interest-bearing brokerage client accounts was 0.01% in 2011 and 2010. 14. Borrowings Long-term debt including unamortized debt discounts and premiums, where applicable, consists of the following: December 31, Senior Notes Senior Medium-Term Notes, Series A Junior Subordinated Notes Finance lease obligation Total long-term debt 2011 $ 1,450 249 202 100 $ 2,001 2010 $ 1,449 249 202 106 $ 2,006 CSC has a universal automatic shelf registration statement (Shelf Registration Statement) on file with the Securities and Exchange Commission (SEC), which enables CSC to issue debt, equity and other securities. This Shelf Registration Statement was filed in December 2011 to replace the prior Shelf Registration Statement, which expired in the same month. - 68 - THE CHARLES SCHWAB CORPORATION Notes to Consolidated Financial Statements (Tabular Amounts in Millions, Except Per Share Data, Option Price Amounts, Ratios, or as Noted) The Senior Notes outstanding at December 31, 2011 have maturities ranging from 2014 to 2020 and fixed interest rates ranging from 4.45% to 4.950% with interest payable semi-annually. The Company issued $700 million of these Senior Notes in 2010 under the prior Shelf Registration Statement. These Senior Notes mature in 2020 and have a fixed interest rate of 4.45%. The Senior Medium-Term Notes, Series A (Medium-Term Notes) outstanding at December 31, 2011, mature in 2017 and have a fixed interest rate of 6.375% with interest payable semi-annually. In 2010, $200 million of Medium-Term Notes matured. CSC and Schwab Capital Trust I, a statutory trust formed under the laws of the State of Delaware (Trust), previously closed a public offering of $300 million of the Trust’s fixed to floating-rate trust preferred securities. The proceeds from the sale of the trust preferred securities were invested by the Trust in fixed to floating rate Junior Subordinated Notes issued by CSC. The Junior Subordinated Notes, which mature in 2067, have a fixed interest rate of 7.50% until 2017, and a floating rate thereafter. The Junior Subordinated Notes may be redeemed at a redemption price of principal plus accrued but unpaid interest on November 15, 2017, on or after November 15, 2037, or following the occurrence of certain events, and at a make- whole redemption price at any other time. In 2010, the Company terminated the replacement capital covenant related to the trust preferred securities, upon receiving the requisite consents, in order to have more flexibility to manage its capital structure. The replacement capital covenant had restricted the Company from redeeming, repaying or purchasing the Junior Subordinated Notes or the trust preferred securities unless it received proceeds of the issuance of certain replacement capital securities, among other conditions. Schwab has a finance lease obligation related to an office building and land under a 20-year lease. The remaining finance lease obligation of $100 million at December 31, 2011, is being reduced by a portion of the lease payments over the remaining lease term of 13 years. Annual maturities on long-term debt outstanding at December 31, 2011, are as follows: 2012 2013 2014 2015 2016 Thereafter Total maturities Unamortized discount, net Total long-term debt $ 6 6 756 7 7 1,220 2,002 (1) $ 2,001 CSC has authorization from its Board of Directors to issue unsecured commercial paper notes (Commercial Paper Notes) not to exceed $1.5 billion. Management has set a current limit for the commercial paper program of $800 million. The maturities of the Commercial Paper Notes may vary, but are not to exceed 270 days from the date of issue. The commercial paper is not redeemable prior to maturity and cannot be voluntarily prepaid. The proceeds of the commercial paper program are to be used for general corporate purposes. There were no borrowings of Commercial Paper Notes outstanding at December 31, 2011 or 2010. CSC maintains an $800 million committed, unsecured credit facility with a group of 11 banks, which is scheduled to expire in June 2012. This facility replaced a similar facility that expired in June 2011. The funds under this facility are available for general corporate purposes, including repayment of the Commercial Paper Notes discussed above. The financial covenants under this facility require Schwab to maintain a minimum net capital ratio, as defined, Schwab Bank to be well capitalized, as defined, and CSC to maintain a minimum level of stockholders’ equity. At December 31, 2011, the minimum level of stockholders’ equity required under this facility was $5.0 billion (CSC’s stockholders’ equity at December 31, 2011 was $7.7 billion). There were no borrowings outstanding under this facility at December 31, 2011 or 2010. - 69 - THE CHARLES SCHWAB CORPORATION Notes to Consolidated Financial Statements (Tabular Amounts in Millions, Except Per Share Data, Option Price Amounts, Ratios, or as Noted) To manage short-term liquidity, Schwab maintains uncommitted, unsecured bank credit lines with a group of six banks totaling $875 million at December 31, 2011. CSC has direct access to $750 million of these credit lines. There were no borrowings outstanding under these lines at December 31, 2011 or 2010. To partially satisfy the margin requirement of client option transactions with the Options Clearing Corporation (OCC), Schwab has unsecured standby LOCs with eight banks in favor of the OCC aggregating $350 million at December 31, 2011. In connection with its securities lending activities, Schwab is required to provide collateral to certain brokerage clients. Schwab satisfies the collateral requirements by arranging LOCs, in favor of these brokerage clients, which are issued by multiple banks. At December 31, 2011, the aggregate face amount of these LOCs totaled $78 million. There were no funds drawn under any of these LOCs at December 31, 2011 or 2010. 15. Commitments and Contingencies Operating leases and other commitments: The Company has non-cancelable operating leases for office space and equipment. Future annual minimum rental commitments under these leases, net of contractual subleases, at December 31, 2011, are as follows: 2012 2013 2014 2015 2016 Thereafter Total Operating Leases 116 $ 96 83 72 64 139 570 $ Subleases 30 $ 26 24 24 24 18 146 $ Net 86 70 59 48 40 121 424 $ $ Certain leases contain provisions for renewal options, purchase options, and rent escalations based on increases in certain costs incurred by the lessor. Rent expense was $187 million, $168 million, and $213 million in 2011, 2010, and 2009, respectively. Rent expense in 2009 included charges of $37 million relating to the Company’s cost reduction measures. Purchase obligations: The Company has purchase obligations for services such as advertising and marketing, telecommunications, professional services, and hardware- and software-related agreements. At December 31, 2011, the Company has purchase obligations as follows: 2012 2013 2014 2015 2016 Thereafter Total $ $ 118 48 33 27 6 1 233 Guarantees and indemnifications: In the normal course of business, the Company provides certain indemnifications (i.e., protection against damage or loss) to counterparties in connection with the disposition of certain of its assets. Such indemnifications are generally standard contractual terms with various expiration dates and typically relate to title to the assets transferred, ownership of intellectual property rights (e.g., patents), accuracy of financial statements, compliance with laws and regulations, failure to pay, satisfy or discharge any liability, or to defend claims, as well as errors, omissions, and misrepresentations. The maximum potential future liability under these indemnifications cannot be estimated. The Company has not recorded a liability for these indemnifications and believes that the occurrence of events that would trigger payments under these agreements is remote. - 70 - THE CHARLES SCHWAB CORPORATION Notes to Consolidated Financial Statements (Tabular Amounts in Millions, Except Per Share Data, Option Price Amounts, Ratios, or as Noted) The Company has clients that sell (i.e., write) listed option contracts that are cleared by various clearing houses. The clearing houses establish margin requirements on these transactions. The Company partially satisfies the margin requirements by arranging unsecured standby LOCs, in favor of the clearing houses, which are issued by multiple banks. At December 31, 2011, the aggregate face amount of these LOCs totaled $350 million. In connection with its securities lending activities, Schwab is required to provide collateral to certain brokerage clients. Schwab satisfies the collateral requirements by arranging LOCs in favor of these brokerage clients, which are issued by multiple banks. At December 31, 2011, the aggregate face amount of these LOCs totaled $78 million. There were no funds drawn under any of these LOCs at December 31, 2011. The Company also provides guarantees to securities clearing houses and exchanges under standard membership agreements, which require members to guarantee the performance of other members. Under the agreements, if another member becomes unable to satisfy its obligations to the clearing houses and exchanges, other members would be required to meet shortfalls. The Company’s liability under these arrangements is not quantifiable and may exceed the cash and securities it has posted as collateral. However, the potential requirement for the Company to make payments under these arrangements is remote. Accordingly, no liability has been recognized for these guarantees. Legal contingencies: The Company is subject to claims and lawsuits in the ordinary course of business, including arbitrations, class actions and other litigation, some of which include claims for substantial or unspecified damages. The Company is also the subject of inquiries, investigations, and proceedings by regulatory and other governmental agencies. In addition, the Company is responding to certain litigation claims brought against former subsidiaries pursuant to indemnities it has provided to purchasers of those entities. The Company believes it has strong defenses in all significant matters currently pending and is contesting liability and any damages claimed. Nevertheless, some of these matters may result in adverse judgments or awards, including penalties, injunctions or other relief, and the Company may also determine to settle a matter because of the uncertainty and risks of litigation. Described below are certain matters in which there is a reasonable possibility that a material loss could be incurred or where the matter may otherwise be of significant interest to stockholders. With respect to all other pending matters, based on current information and consultation with counsel, it does not appear that the outcome of any such matter could be material to the financial condition, operating results or cash flows of the Company. However, predicting the outcome of a litigation or regulatory matter is inherently difficult, requiring significant judgment and evaluation of various factors, including the procedural status of the matter and any recent developments; prior experience and the experience of others in similar cases; available defenses, including potential opportunities to dispose of a case on the merits or procedural grounds before trial (e.g., motions to dismiss or for summary judgment); the progress of fact discovery; the opinions of counsel and experts regarding potential damages; potential opportunities for settlement and the status of any settlement discussions; and potential insurance coverage and indemnification. Often, as in the case of the Auction Rate Securities Regulatory Inquiries and Total Bond Market Fund Litigation matters described below, it is not possible to reasonably estimate potential liability, if any, or a range of potential liability until the matter is closer to resolution, or pending the outcome of key motions or appeals. Numerous issues may have to be developed, such as discovery of important factual matters and determination of threshold legal issues, which may include novel or unsettled questions of law. Reserves are established or adjusted or further disclosure and estimates of potential loss are provided as the matter progresses and more information becomes available. Auction Rate Securities Regulatory Inquiries: Schwab has been responding to industry wide inquiries from federal and state regulators regarding sales of auction rate securities to clients who were unable to sell their holdings when the normal auction process for those securities froze unexpectedly in February 2008. On August 17, 2009, a civil complaint was filed against Schwab in New York state court by the Attorney General of the State of New York (NYAG) alleging material misrepresentations and omissions by Schwab regarding the risks of auction rate securities, and seeking restitution, disgorgement, penalties and other relief, including repurchase of securities held in client accounts. As reflected in a statement issued August 17, 2009, Schwab has responded that the allegations are without merit, and has been contesting all charges. By order dated October 24, 2011, the court granted Schwab’s motion to dismiss the complaint. On November 30, 2011, the NYAG filed notice of its intention to appeal the ruling. Total Bond Market Fund Litigation: On August 28, 2008, a class action lawsuit was filed in the U.S. District Court for the Northern District of California on behalf of investors in the Schwab Total Bond Market Fund™ (Northstar lawsuit). The - 71 - THE CHARLES SCHWAB CORPORATION Notes to Consolidated Financial Statements (Tabular Amounts in Millions, Except Per Share Data, Option Price Amounts, Ratios, or as Noted) lawsuit, which alleges violations of state law and federal securities law in connection with the fund’s investment policy, names Schwab Investments (registrant and issuer of the fund’s shares) and CSIM as defendants. Allegations include that the fund improperly deviated from its stated investment objectives by investing in collateralized mortgage obligations (CMOs) and investing more than 25% of fund assets in CMOs and mortgage-backed securities without obtaining a shareholder vote. Plaintiffs seek unspecified compensatory and rescission damages, unspecified equitable and injunctive relief, and costs and attorneys’ fees. Plaintiffs’ federal securities law claim and certain of plaintiffs’ state law claims were dismissed in proceedings before the court and following a successful petition by defendants to the Ninth Circuit Court of Appeals. On August 8, 2011, the court dismissed plaintiffs’ remaining claims with prejudice. Plaintiffs have appealed to the Ninth Circuit, where the case is currently pending. A second class action lawsuit filed on September 3, 2010, in the U.S. District Court for the Northern District of California, which raised similar allegations on behalf of investors in the fund (Smit lawsuit), was dismissed with prejudice on April 19, 2011. optionsXpress Merger Litigation: Between March 21, 2011 and April 6, 2011, ten purported class action lawsuits were filed by optionsXpress stockholders challenging the terms of the Company’s merger agreement to acquire optionsXpress. Named defendants included the Company, optionsXpress and members of its board of directors. Seven lawsuits were filed in the Circuit Court of Cook County, Illinois and consolidated in a single amended complaint on May 9, 2011 (Consolidated Illinois Action); and three lawsuits were filed in the Court of Chancery of the State of Delaware and consolidated in a single amended complaint on April 25, 2011 (Consolidated Delaware Action). On April 28, 2011, the Delaware court stayed the Consolidated Delaware Action in favor of the Consolidated Illinois Action. On June 16, 2011, the Illinois court dismissed all claims against the Company with prejudice. On July 29, 2011, the parties entered into a settlement agreement under which the remaining defendants agreed to provide certain supplemental merger disclosures in exchange for full releases of all claims related to the merger, including all claims in the Consolidated Illinois Action and the Consolidated Delaware Action. Defendants also agreed not to oppose any fee application by plaintiffs’ counsel that did not exceed $650,000. The settlement received final approval from the Illinois court on December 7, 2011. optionsXpress Regulatory Matters: The Company is in discussions with the Securities and Exchange Commission (SEC), the Chicago Board Options Exchange and FINRA to resolve several optionsXpress regulatory matters which predate the Company’s acquisition of optionsXpress. optionsXpress entities and individual employees have received Wells notices concerning potential violations of SEC Regulation SHO (short sale delivery rules) in connection with certain customer trading activities, and potential violations of the broker-dealer registration requirements in connection with an unregistered optionsXpress entity. The Company has recorded a contingent liability associated with these matters, which was not material at December 31, 2011. YieldPlus Fund Litigation: As disclosed previously, the Company recorded total charges in 2010 of $199 million, net of insurance proceeds of $39 million under applicable policies, for settlements to resolve consolidated class action litigation in the U.S. District Court for the Northern District of California relating to the Schwab YieldPlus Fund. On April 19, 2011, the court granted final approval of the settlement agreements and entered final judgment in the litigation. 16. Financial Instruments Subject to Off-Balance Sheet Risk, Credit Risk, or Market Risk Securities lending: The Company loans client securities temporarily to other brokers in connection with its securities lending activities and receives cash as collateral for the securities loaned. Increases in security prices may cause the fair value of the securities loaned to exceed the amount of cash received as collateral. In the event the counterparty to these transactions does not return the loaned securities or provide additional cash collateral, the Company may be exposed to the risk of acquiring the securities at prevailing market prices in order to satisfy its client obligations. The Company mitigates this risk by requiring credit approvals for counterparties, by monitoring the fair value of securities loaned, and requiring additional cash as collateral when necessary. The fair value of client securities pledged in securities lending transactions to other broker-dealers was $783 million and $1.2 billion at December 31, 2011 and 2010, respectively. Additionally, the Company borrows - 72 - THE CHARLES SCHWAB CORPORATION Notes to Consolidated Financial Statements (Tabular Amounts in Millions, Except Per Share Data, Option Price Amounts, Ratios, or as Noted) securities from other broker-dealers to fulfill short sales by clients. The fair value of these borrowed securities was $44 million and $113 million at December 31, 2011 and 2010, respectively. Client trade settlement: The Company is obligated to settle transactions with brokers and other financial institutions even if the Company’s clients fail to meet their obligations to the Company. Clients are required to complete their transactions on settlement date, generally three business days after the trade date. If clients do not fulfill their contractual obligations, the Company may incur losses. The Company has established procedures to reduce this risk by requiring deposits from clients in excess of amounts prescribed by regulatory requirements for certain types of trades, and therefore the potential for Schwab to make payments under these client transactions is remote. Accordingly, no liability has been recognized for these transactions. Margin lending: The Company provides margin loans to its clients which are collateralized by securities in their brokerage accounts and may be liable for the margin requirement of its client margin securities transactions. As clients write options or sell securities short, the Company may incur losses if the clients do not fulfill their obligations and the collateral in client accounts is not sufficient to fully cover losses which clients may incur from these strategies. To mitigate this risk, the Company monitors required margin levels and clients are required to deposit additional collateral, or reduce positions to meet minimum collateral requirements. Clients with margin loans have agreed to allow the Company to pledge collateralized securities in their brokerage accounts in accordance with federal regulations and was allowed, under such regulations, to pledge securities with a fair value of $14.7 billion and $15.0 billion at December 31, 2011 and 2010, respectively. The fair value of client securities pledged to fulfill the short sales of its clients was $1.2 billion and $1.4 billion at December 31, 2011 and 2010, respectively. The fair value of client securities pledged to fulfill the Company’s proprietary short sales, which resulted from facilitating clients’ dividend reinvestment elections, was $101 million and $99 million at December 31, 2011 and 2010, respectively. The Company has also pledged a portion of its securities owned in order to fulfill the short sales of clients and in connection with securities lending transactions to other broker-dealers. The fair value of these pledged securities was not material at December 31, 2011 or 2010. The Company may also pledge client securities to fulfill client margin requirements for open option contracts established with the OCC. The fair value of these pledged securities to the OCC was $1.3 billion and $1.2 billion at December 31, 2011 and 2010, respectively. Financial instruments held for trading purposes: The Company maintains inventories in securities on a long and short basis relating to its fixed income operations. The Company could incur losses or gains as a result of changes in the fair value of these securities. To mitigate the risk of losses, long and short positions are marked to fair value and are monitored by management to assure compliance with limits established by the Company. Resale and repurchase agreements: Schwab enters into collateralized resale agreements principally with other broker-dealers, which could result in losses in the event the counterparty fails to purchase the securities held as collateral for the cash advanced and the fair value of the securities declines. To mitigate this risk, Schwab requires that the counterparty deliver securities to a custodian, to be held as collateral, with a fair value in excess of the resale price. Schwab also sets standards for the credit quality of the counterparty, monitors the fair value of the underlying securities as compared to the related receivable, including accrued interest, and requires additional collateral where deemed appropriate. At December 31, 2011 and 2010, the fair value of collateral received in connection with resale agreements that are available to be repledged or sold was $18.3 billion and $13.0 billion, respectively. Schwab utilizes the collateral provided under repurchase agreements to meet obligations under broker-dealer client protection rules, which place limitations on its ability to access such segregated securities. For Schwab to repledge or sell this collateral, it would be required to deposit cash and/or securities of an equal amount into its segregated reserve bank accounts in order to meet its segregated cash and investment requirement. Concentration risk: The Company has exposure to concentration risk when holding large positions of financial instruments collateralized by assets with similar economic characteristics or in securities of a single issuer or industry. For discussion on the Company’s exposure to concentration risk relating to residential mortgage-backed securities, see note “6 – Securities Available for Sale and Securities Held to Maturity.” The Company’s investments in corporate debt securities and commercial paper totaled $5.6 billion and $4.6 billion at December 31, 2011 and 2010, respectively, 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 - 73 - THE CHARLES SCHWAB CORPORATION Notes to Consolidated Financial Statements (Tabular Amounts in Millions, Except Per Share Data, Option Price Amounts, Ratios, or as Noted) deposit for regulatory purposes, cash and cash equivalents, and other securities owned. At December 31, 2011 and 2010, the Company held $867 million and $1.9 billion, respectively, 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 $5.6 billion and $4.7 billion of adjustable rate first lien residential real estate mortgage loans at December 31, 2011 and 2010, respectively. The Company’s adjustable rate mortgages have initial fixed interest rates for three to ten years and interest rates that adjust annually thereafter. At December 31, 2011, approximately 60% of these mortgages consisted of loans with interest-only payment terms. At December 31, 2011, the interest rates on approximately 65% of these interest-only loans are not scheduled to reset for three or more years. The Company’s mortgage loans do not include interest terms described as temporary introductory rates below current market rates. At December 31, 2011, 44% of the residential real estate mortgages and 50% of the HELOC balances were secured by properties which are located in California. 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. The fair value of U.S. Government and agency securities held as collateral for resale agreements totaled $18.3 billion and $13.0 billion at December 31, 2011 and 2010, respectively. Commitments to extend credit: Schwab Bank enters into commitments to extend credit to banking clients primarily relating to mortgage lending. The credit risk associated with these commitments varies depending on the creditworthiness of the client and the value of any collateral expected to be held. Collateral requirements vary by type of loan. These commitments are legally binding agreements to lend to a client that generally have fixed expiration dates or other termination clauses, may require payment of a fee and are not secured by collateral until funds are advanced. Schwab Bank also has commitments to extend credit related to its clients’ unused HELOC. Total amounts outstanding for these commitments to extend credit were $5.8 billion and $6.1 billion at December 31, 2011 and 2010, respectively. Forward sale and interest rate lock commitments: Schwab Bank’s loans held for sale portfolio consists of fixed-rate and adjustable-rate residential mortgage loans, which are subject to a loss in value when market interest rates rise. Schwab Bank uses forward sale commitments to manage this risk. These forward sale commitments have been designated as cash flow hedging instruments, and are recorded on the Company’s consolidated balance sheet at fair value with gains or losses recorded in other comprehensive income (loss). Amounts included in other comprehensive income (loss) are reclassified into earnings when the related loan is sold. At December 31, 2011 and 2010, the derivative asset and liability for these forward sale commitments were not material. Additionally, Schwab Bank uses forward sale commitments to hedge interest rate lock commitments issued on mortgage loans that will be held for sale. Schwab Bank considers the fair value of these commitments to be zero at the commitment date, with subsequent changes in fair value determined solely based on changes in market interest rates. Any changes in fair value of the interest rate lock commitments are completely offset by changes in fair value of the related forward sale commitments. Schwab Bank had interest rate lock commitments on mortgage loans to be held for sale with principal balances totaling approximately $347 million and $628 million at December 31, 2011 and 2010, respectively. At December 31, 2011 and 2010, the derivative asset and liability for these interest rate lock commitments and the related forward sale commitments were not material. - 74 - THE CHARLES SCHWAB CORPORATION Notes to Consolidated Financial Statements (Tabular Amounts in Millions, Except Per Share Data, Option Price Amounts, Ratios, or as Noted) 17. Fair Values of Assets and Liabilities Fair value is defined as the price that would be received to sell an asset or the price paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value measurement accounting guidance describes the fair value hierarchy for disclosing assets and liabilities measured at fair value based on the inputs used to value them. The fair value hierarchy maximizes the use of observable inputs and minimizes the use of unobservable inputs. Observable inputs are based on market pricing data obtained from sources independent of the Company. A quoted price in an active market provides the most reliable evidence of fair value and is generally used to measure fair value whenever available. Unobservable inputs reflect management’s judgment about the assumptions market participants would use in pricing the asset or liability. Where inputs used to measure fair value of an asset or liability are from different levels of the hierarchy, the asset or liability is categorized based on the lowest level input that is significant to the fair value measurement in its entirety. Assessing the significance of a particular input requires judgment. The fair value hierarchy includes three levels based on the objectivity of the inputs as follows:  Level 1 inputs are quoted prices in active markets as of the measurement date for identical assets or liabilities that the Company has the ability to access. This category includes active exchange-traded money market funds, mutual funds, options, and equity securities. The Company did not transfer any assets or liabilities between Level 1 and Level 2 during 2011 or 2010.  Level 2 inputs are inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. Level 2 inputs include quoted prices for similar assets and liabilities in active markets, and inputs other than quoted prices that are observable for the asset or liability, such as interest rates, benchmark yields, issuer spreads, new issue data, and collateral performance. This category includes residential mortgage- backed securities, corporate debt securities, certificates of deposit, commercial paper, U.S. agency and municipal debt securities, U.S. Treasury securities, and asset-backed and other securities.  Level 3 inputs are unobservable inputs for the asset or liability, and include situations where there is little, if any, market activity for the asset or liability. The Company did not have any financial assets or liabilities utilizing Level 3 inputs as of December 31, 2011 or 2010. - 75 - THE CHARLES SCHWAB CORPORATION Notes to Consolidated Financial Statements (Tabular Amounts in Millions, Except Per Share Data, Option Price Amounts, Ratios, or as Noted) Assets and Liabilities Recorded at Fair Value The Company’s assets recorded at fair value include certain cash equivalents, investments segregated and on deposit for regulatory purposes, other securities owned, and securities available for sale. When available, the Company uses quoted prices in active markets to measure the fair value of assets. When quoted prices do not exist, the Company uses prices obtained from independent third-party pricing services to measure the fair value of investment assets. The Company validates prices received from the pricing services using various methods, including comparison to prices received from additional pricing services, comparison to quoted market prices, where available, comparison to internal valuation models, and review of other relevant market data. The Company does not adjust the prices received from independent third-party pricing services unless such prices are inconsistent with the definition of fair value and result in a material difference in the recorded amounts. At December 31, 2011 and 2010, the Company did not adjust prices received from independent third-party pricing services. Liabilities recorded at fair value were not material, and therefore are not included in the following tables. The following tables present the fair value hierarchy for assets measured at fair value: Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Significant Other Observable Unobservable Inputs (Level 2) Inputs (Level 3) Balance at Fair Value $ 8 - 8 - - - - 332 183 - 12 527 - - - - - - - 535 $ - 814 814 2,374 767 650 3,791 - - 46 20 66 20,921 907 3,622 3,571 1,800 3,144 33,965 $ 38,636 $ $ - - - - - - - - - - - - - - - - - - - - $ 8 814 822 2,374 767 650 3,791 332 183 46 32 593 20,921 907 3,622 3,571 1,800 3,144 33,965 $ 39,171 December 31, 2011 Cash equivalents: Money market funds Commercial paper Total cash equivalents Investments segregated and on deposit for regulatory purposes: Certificates of deposit Corporate debt securities U.S. Government securities Total investments segregated and on deposit for regulatory purposes Other securities owned: Schwab Funds money market funds Equity and bond mutual funds State and municipal debt obligations Equity, U.S. Government and corporate debt, and other securities Total other securities owned Securities available for sale: U.S. agency residential mortgage-backed securities Non-agency residential mortgage-backed securities Certificates of deposit Corporate debt securities U.S. agency notes Asset-backed and other securities Total securities available for sale Total $ - 76 - THE CHARLES SCHWAB CORPORATION Notes to Consolidated Financial Statements (Tabular Amounts in Millions, Except Per Share Data, Option Price Amounts, Ratios, or as Noted) December 31, 2010 Cash equivalents: Money market funds Commercial paper Total cash equivalents Investments segregated and on deposit for regulatory purposes: Certificates of deposit Corporate debt securities U.S. Government securities Total investments segregated and on deposit for regulatory purposes Other securities owned: Schwab Funds money market funds Equity and bond mutual funds State and municipal debt obligations Equity, U.S. Government and corporate debt, and other securities Total other securities owned Securities available for sale: U.S. agency residential mortgage-backed securities Non-agency residential mortgage-backed securities Certificates of deposit Corporate debt securities U.S. agency notes Asset-backed securities Total securities available for sale Total $ Fair Value of Assets and Liabilities Not Recorded at Fair Value Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Significant Other Observable Unobservable Inputs (Level 2) Inputs (Level 3) Balance at Fair Value $ 988 - 988 - - - - 172 99 - 1 272 - - - - - - - 1,260 $ - 242 242 2,201 1,704 3,190 7,095 - - 47 18 65 13,098 1,470 1,875 2,268 2,780 2,502 23,993 $ 31,395 $ $ - - - - - - - - - - - - - - - - - - - - $ 988 242 1,230 2,201 1,704 3,190 7,095 172 99 47 19 337 13,098 1,470 1,875 2,268 2,780 2,502 23,993 $ 32,655 Descriptions of the valuation methodologies and assumptions used to estimate the fair value of assets and liabilities not recorded at fair value are described below. There were no significant changes in these methodologies or assumptions during 2011. Other cash equivalents, receivables, payables, and accrued expenses and other liabilities include cash and highly liquid investments, receivables and payables from/ to brokers, dealers and clearing organizations, receivables and payables from/ to brokerage clients, and drafts, accounts, taxes, interest, and compensation payable. Assets and liabilities in these categories are short-term in nature and accordingly are recorded at amounts that approximate fair value. Cash and investments segregated and on deposit for regulatory purposes include securities purchased under resale agreements. Securities purchased under resale agreements are recorded at par value plus accrued interest. Securities purchased under resale agreements are short-term in nature and are backed by collateral that both exceeds the carrying value of the resale agreement and is highly liquid in nature. Accordingly, the carrying value approximates fair value. Securities held to maturity include U.S. agency residential mortgage-backed and other securities. Securities held to maturity are recorded at amortized cost. The fair value of these securities is obtained using an independent third-party pricing service, as discussed above. - 77 - THE CHARLES SCHWAB CORPORATION Notes to Consolidated Financial Statements (Tabular Amounts in Millions, Except Per Share Data, Option Price Amounts, Ratios, or as Noted) Loans to banking clients primarily include adjustable rate residential first-mortgage and HELOC loans. Loans to banking clients are recorded at carrying value net of an allowance for loan losses. The fair value of the Company’s loans to banking clients is estimated based on market prices for mortgage-backed securities collateralized by similar types of loans. Loans held for sale include fixed-rate and adjustable-rate residential first-mortgage loans intended for sale. Loans held for sale are recorded at the lower of cost or fair value. The fair value of the Company’s loans held for sale is estimated using quoted market prices for securities backed by similar types of loans. Other assets include cost method investments whose carrying values approximate their fair values. Other assets also include Federal Home Loan Bank stock recorded at par, which approximates fair value. Deposits from banking clients: The Company considers the fair value of deposits with no stated maturity, such as deposits from banking clients, to be equal to the amount payable on demand as of the balance sheet date. Long-term debt includes Senior Notes, Senior Medium-Term Notes, Series A, Junior Subordinated Notes, and a finance lease obligation. The fair value of the Senior Notes, Senior Medium-Term Notes, Series A, and Junior Subordinated Notes are estimated using indicative, non-binding quotes from independent brokers. The finance lease obligation is recorded at carrying value, which approximates fair value. Firm commitments to extend credit: The Company extends credit to banking clients through HELOC and personal loans secured by securities. The Company considers the fair value of these unused commitments to be not material because the interest rate earned on these balances are based on the market interest rate indices and reset monthly. Future utilization of HELOC and personal loan commitments will earn a then-current market interest rate. The Company does not charge a fee to maintain a HELOC or personal loan. The table below presents the Company’s fair value estimates for financial instruments, excluding short-term financial assets and liabilities, for which carrying amounts approximate fair value, and excluding financial instruments recorded at fair value. December 31, Financial Assets: Securities held to maturity Loans to banking clients – net Loans held for sale Financial Liabilities: Long-term debt 18. Equity Offering 2011 2010 Carrying Amount Fair Value Carrying Amount Fair Value $ 15,108 9,812 $ 70 $ $ 15,539 9,671 $ 73 $ $ 17,762 8,725 $ 185 $ $ 17,848 8,469 $ 194 $ $ 2,001 $ 2,159 $ 2,006 $ 2,116 On January 26, 2010, the Company sold 29,670,300 shares of its common stock, $.01 par value, at a public offering price of $19.00 per share. Net proceeds received from the offering were $543 million and were used to support the Company’s balance sheet growth, including expansion of its deposit base and migration of certain client balances from money market funds into deposit accounts at Schwab Bank. - 78 - THE CHARLES SCHWAB CORPORATION Notes to Consolidated Financial Statements (Tabular Amounts in Millions, Except Per Share Data, Option Price Amounts, Ratios, or as Noted) 19. Accumulated Other Comprehensive Income (Loss) Accumulated other comprehensive income (loss) represents cumulative gains and losses that are not reflected in earnings. The components of other comprehensive income (loss) are as follows: Year Ended December 31, Securities available for sale: Net unrealized (loss) gain arising during the year Reclassification of impairment charges included in earnings Other reclassifications of net losses in earnings Net unrealized (loss) gain on securities available for sale Foreign currency translation adjustment Net unrealized loss on cash flow hedging instruments 2011 Before Tax Net of effect tax tax 2010 Before Tax Net of effect tax tax 2009 Before Tax Net of effect tax tax $ (43) $ 16 $ (27) $ 300 $ (115) $ 185 $ 536 $ (212) $ 324 31 (12) 19 36 (14) 22 60 (24) 36 1 (11) (1) - - 4 - - 1 (7) (1) - 1 - 1 3 (1) 2 337 - (129) 208 - - 599 - (237) 362 - - (1) - (1) - - - Other comprehensive (loss) income $ (12) $ 4 $ (8) $ 336 $ (129) $ 207 $ 599 $ (237) $ 362 Accumulated other comprehensive income (loss) balances were as follows: Net unrealized Total accumulated Foreign currency translation adjustment $ loss on cash flow hedging instruments $ other comprehensive income (loss) $ (553) - 362 (191) - 207 16 - (8) 8 $ - - - - - (1) (1) - - (1) - - - - - - - - (1) (1) $ $ Net unrealized gain (loss) on securities available for sale Portion of unrealized gain (loss) on Non-OTTI securities $ (553) 149 327 (77) 21 144 88 8 - 96 $ Portion of unrealized loss on OTTI securities - $ (149) 35 (114) (21) 64 (71) (8) (7) (86) $ Balance at December 31, 2008 Transfer to OTTI securities Other net changes Balance at December 31, 2009 Transfer to OTTI securities Other net changes Balance at December 31, 2010 Transfer to OTTI securities Other net changes Balance at December 31, 2011 - 79 - THE CHARLES SCHWAB CORPORATION Notes to Consolidated Financial Statements (Tabular Amounts in Millions, Except Per Share Data, Option Price Amounts, Ratios, or as Noted) 20. Employee Incentive, Deferred Compensation, and Retirement Plans A summary of the Company’s stock-based compensation and related income tax benefit is as follows: Year Ended December 31, Stock option expense Restricted stock award expense Restricted stock unit expense Employee stock purchase plan expense Total stock-based compensation expense Income tax benefit on stock-based compensation 2011 $ 61 12 23 3 $ 99 $ (37) 2010 $ 53 21 10 3 $ 87 $ (33) 2009 $ 44 27 1 3 $ 75 $ (29) The Company issues shares for stock options and restricted stock awards from treasury stock. At December 31, 2011, the Company was authorized to grant up to 52 million common shares under its existing stock incentive plans. As of December 31, 2011, there was $192 million of total unrecognized compensation cost, net of forfeitures, related to outstanding stock options, restricted stock awards, and restricted stock units, which is expected to be recognized through 2016 with a remaining weighted-average service period of 2.8 years. Stock Option Plans The Company’s stock incentive plans provide for granting options to employees, officers, and directors. Options are granted for the purchase of shares of common stock at an exercise price not less than market value on the date of grant, and expire within seven or ten years from the date of grant. Options generally vest annually over a three- to five-year period from the date of grant. Certain options were granted at an exercise price above the market value of common stock on the date of grant (i.e., premium-priced options). The Company’s stock option activity is summarized below: Outstanding at December 31, 2010 Granted Exercised Forfeited Expired Outstanding at December 31, 2011 Vested and expected to vest at December 31, 2011 Vested and exercisable at December 31, 2011 Weighted- Average Exercise Price per Share $ 16.41 $ 13.07 $ 12.03 $ 16.32 $ 17.21 $ 16.20 $ 16.31 $ 17.53 Number of Options 60 13 (8) (2) (5) 58 54 31 Weighted- Average Remaining Contractual Life (in years) Aggregate Intrinsic Value 6.30 6.15 4.24 $ $ $ 4 4 3 The aggregate intrinsic value in the table above represents the difference between CSC’s closing stock price and the exercise price of each in-the-money option on the last trading day of the period presented. - 80 - THE CHARLES SCHWAB CORPORATION Notes to Consolidated Financial Statements (Tabular Amounts in Millions, Except Per Share Data, Option Price Amounts, Ratios, or as Noted) Information on stock options granted and exercised is presented below: Year Ended December 31, Weighted-average fair value of options granted per share Cash received from options exercised Tax benefit realized on options exercised Aggregate intrinsic value of options exercised 2011 $ 4.16 96 $ 7 $ 38 $ 2010 $ 5.36 35 $ 5 $ 17 $ 2009 $ 6.42 53 $ 8 $ 25 $ Management uses a binomial option pricing model to estimate the fair value of options granted. The binomial model takes into account the contractual term of the stock option, expected volatility, dividend yield, and risk-free interest rate. Expected volatility is based on the implied volatility of publicly-traded options on CSC’s stock. Dividend yield is based on the average historical CSC dividend yield. The risk-free interest rate is based on the yield of a U.S. Treasury zero-coupon issue with a remaining term equal to the contractual term of the option. Management uses historical option exercise data, which includes employee termination data to estimate the probability of future option exercises. Management uses the Black-Scholes model to solve for the expected life of options valued with the binomial model presented below. The assumptions used to value the Company’s options granted during the years presented and their expected lives were as follows: Year Ended December 31, Weighted-average expected dividend yield Weighted-average expected volatility Weighted-average risk-free interest rate Expected life (in years) Restricted Stock Plans 2011 .85% 36% 2.1% 0.0 – 6.3 2010 .71% 35% 2.8% 3.0 – 5.9 2009 .58% 52% 3.0% 1.4 – 5.3 The Company’s stock incentive plans provide for granting restricted stock awards and restricted stock units to employees, officers, and directors. Restricted stock units are awards that entitle the holder to receive shares of CSC’s common stock following a vesting period. Restricted stock awards and units are restricted from transfer or sale and generally vest annually over a three- to five-year period, but some vest based upon the Company achieving certain financial or other measures. The fair value of restricted stock awards and units is based on the market price of the Company’s stock on the date of grant. The grant date fair value is amortized to compensation expense on a straight-line basis over the requisite service period. The total fair value of the restricted stock awards and units that vested during each of the years 2011, 2010, and 2009 was $24 million, $27 million, and $28 million, respectively. The Company’s restricted stock awards and units activity is summarized below: Outstanding at December 31, 2010 Granted Vested Forfeited Outstanding at December 31, 2011 Restricted Stock Awards Weighted- Average Grant Date Fair Value per Share $ 20.49 $ - $ 20.69 - $ - $ Number of Shares 1 - (1) - - Restricted Stock Units Weighted- Average Grant Date Fair Value per Unit $ 16.04 $ 11.94 $ 16.28 $ - $ 13.23 Number of Units 4 5 (1) - 8 - 81 - THE CHARLES SCHWAB CORPORATION Notes to Consolidated Financial Statements (Tabular Amounts in Millions, Except Per Share Data, Option Price Amounts, Ratios, or as Noted) Employee Stock Purchase Plan Under the Company’s Employee Stock Purchase Plan (ESPP), eligible employees can purchase shares of CSC’s common stock using amounts withheld through payroll deductions, subject to limitations. Payroll deductions are accumulated during six-month offering periods that start each year on February 1st and August 1st. Share purchases are made on the last trading day of each three-month purchase period within the offering period. The three-month purchase periods end on January 31st, April 30th, July 31st, and October 31st of each year. The purchase price for each share of common stock is 85% of the fair market value of the shares on the last trading day of the purchase period. At December 31, 2011, the Company had 45 million shares reserved for future issuance under the ESPP. Other Deferred Compensation Plans The Company sponsors deferred compensation plans for eligible officers and non-employee directors. The Company’s deferred compensation plan for officers permits participants to defer the receipt of certain cash compensation. The deferred compensation liability was $128 million and $139 million at December 31, 2011 and 2010, respectively. The Company’s deferred compensation plan for non-employee directors permits participants to defer receipt of all or a portion of their director fees and to receive either a grant of stock options, or upon ceasing to serve as a director, the number of shares of CSC’s common stock that would have resulted from investing the deferred fee amount into CSC’s common stock. Retirement Plan Upon completing three months of consecutive service, employees of the Company can participate in the Company’s qualified retirement plan, the SchwabPlan® Retirement Savings and Investment Plan. The Company may match certain employee contributions or make additional contributions to this plan at its discretion. The Company’s total contribution expense was $53 million, $50 million, and $49 million in 2011, 2010, and 2009, respectively. 21. Money Market Mutual Fund Charges In 2010, the Company decided to cover the net remaining losses recognized by Schwab money market mutual funds as a result of their investments in a single structured investment vehicle that defaulted in 2008 and recorded a charge of $132 million. 22. Taxes on Income The components of income tax expense are as follows: Year Ended December 31, Current: Federal State Total current Deferred: Federal State Total deferred Taxes on income 2011 2010 2009 $ $ 424 52 476 44 8 52 528 $ $ 326 50 376 (43) (8) (51) 325 $ $ 400 73 473 12 4 16 489 - 82 - THE CHARLES SCHWAB CORPORATION Notes to Consolidated Financial Statements (Tabular Amounts in Millions, Except Per Share Data, Option Price Amounts, Ratios, or as Noted) The temporary differences that created deferred tax assets and liabilities are detailed below: December 31, Deferred tax assets: Employee compensation, severance, and benefits Facilities lease commitments State and local taxes Reserves and allowances Other Total deferred tax assets Deferred tax liabilities: Capitalized internal-use software development costs Depreciation and amortization Deferred cancellation of debt income Deferred loan costs Unrealized gain on securities available for sale – net Total deferred tax liabilities Deferred tax asset – net 2011 2010 $ $ 173 37 8 40 9 267 (42) (162) (11) (20) (5) (240) 27 $ $ 124 44 8 104 10 290 (34) (45) (11) (20) (10) (120) 170 The Company determined that no material valuation allowance against deferred tax assets at December 31, 2011 and 2010 was necessary. A reconciliation of the federal statutory income tax rate to the effective income tax rate is as follows: 2010 Year Ended December 31, 35.0% Federal statutory income tax rate 3.3 State income taxes, net of federal tax benefit Non-deductible penalties (1) 2.7 0.7 Other Effective income tax rate 41.7% (1) Amount reflects the impact of regulatory settlements relating to the Schwab YieldPlus Fund in 2010. 2011 35.0% 2.5 - 0.4 37.9% 2009 35.0% 3.7 - (0.4) 38.3% The Company’s unrecognized tax benefits, which are included in accrued expenses and other liabilities, represent the difference between positions taken on tax return filings and estimated potential tax settlement outcomes. Resolving these uncertain tax matters as of December 31, 2011, in the Company’s favor would reduce taxes on income by $9 million, net of the federal tax benefit. A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows: December 31, Balance at beginning of year Additions for tax positions related to the current year Additions for tax positions related to prior years Reductions for tax positions related to prior years Reductions due to lapse of statute of limitations Reductions for settlements with tax authorities Balance at end of year 2011 11 1 2 - (1) - 13 $ $ 2010 10 4 3 (2) (3) (1) 11 $ $ The Company classifies interest and penalties related to unrecognized tax benefits as a component of income tax expense, which were not material in 2011, 2010, or 2009. The Company’s liability for estimated interest on unrecognized tax benefits was not material at December 31, 2011 or 2010. - 83 - THE CHARLES SCHWAB CORPORATION Notes to Consolidated Financial Statements (Tabular Amounts in Millions, Except Per Share Data, Option Price Amounts, Ratios, or as Noted) Federal tax examinations for all years ending through December 31, 2007, have been completed. The years open to examination by state and local governments vary by jurisdiction. 23. Earnings Per Share Basic EPS is computed by dividing net income available to common stockholders by the weighted-average number of common shares outstanding during the period. The computation of diluted EPS is similar to the computation of basic EPS except that the denominator is increased to include the number of additional common shares that would have been outstanding if dilutive potential common shares had been issued. Dilutive potential common shares include the effect of outstanding stock options and unvested restricted stock awards and units. EPS under the basic and diluted computations is as follows: Year Ended December 31, 2009 Net income available to common stockholders (1) 787 Weighted-average common shares outstanding — basic 1,156 Common stock equivalent shares related to stock incentive plans 4 Weighted-average common shares outstanding — diluted (2) 1,160 Basic EPS .68 .68 Diluted EPS (1) Net income available to participating securities (unvested restricted shares) was not material in 2011, 2010, or 2009. (2) Antidilutive stock options and restricted stock awards excluded from the calculation of diluted EPS were 63 million, 2011 864 1,227 2 1,229 .70 .70 2010 454 1,191 3 1,194 .38 .38 $ $ $ $ $ $ $ $ $ 52 million, and 53 million shares in 2011, 2010, and 2009, respectively. 24. Regulatory Requirements CSC is a savings and loan holding company and Schwab Bank, CSC’s depository institution subsidiary, is a federal savings bank. Prior to July 21, 2011, CSC and Schwab Bank were both subject to supervision and regulation by the Office of Thrift Supervision (OTS). The “Dodd-Frank Wall Street Reform and Consumer Protection Act” legislation (Dodd-Frank Act) eliminated the OTS effective July 21, 2011. As a result, the Board of Governors of the Federal Reserve System (Federal Reserve) became CSC’s primary regulator and the Office of the Comptroller of the Currency became the primary regulator of Schwab Bank. Effective July 21, 2011, CSC is required by the Dodd-Frank Act to serve as a source of strength for Schwab Bank. While under the OTS, CSC was required to have a “prudential level of capital” to support CSC’s risk profile. The OTS did not historically subject savings and loan holding companies, such as CSC, to consolidated regulatory capital requirements. However, under the Dodd-Frank Act, CSC will be subject to new minimum leverage and minimum risk-based capital ratio requirements that will be set by the Federal Reserve that are at least as stringent as the requirements generally applicable to insured depository institutions as of July 21, 2011. Schwab Bank is subject to regulation and supervision and to various requirements and restrictions under federal and state laws, including regulatory capital guidelines. Among other things, these requirements also govern transactions with CSC and its non-depository institution subsidiaries, including loans and other extensions of credit, investments and asset purchases, dividends and investments. The federal banking agencies have broad powers to enforce these regulations, including the power to terminate deposit insurance, impose substantial fines and other civil and criminal penalties, and appoint a conservator or receiver. Under the Federal Deposit Insurance Act, Schwab Bank could be subject to restrictive actions if it were to fall within one of the lowest three of five capital categories. Schwab Bank is required to maintain minimum capital levels as specified in federal banking laws and regulations. Failure to meet the minimum levels could result in certain mandatory, and possibly additional discretionary actions by the regulators that, if undertaken, could have a direct material effect on Schwab Bank. At December 31, 2011, CSC and Schwab Bank met the capital level requirements. - 84 - THE CHARLES SCHWAB CORPORATION Notes to Consolidated Financial Statements (Tabular Amounts in Millions, Except Per Share Data, Option Price Amounts, Ratios, or as Noted) The regulatory capital and ratios for Schwab Bank are as follows: December 31, 2011 Tier 1 Risk-Based Capital Total Risk-Based Capital Tier 1 Core Capital Tangible Equity December 31, 2010 Tier 1 Risk-Based Capital Total Risk-Based Capital Tier 1 Core Capital Tangible Equity N/A Not applicable. Actual Minimum Capital Requirement Amount Ratio Amount Ratio Minimum to be Well Capitalized Ratio Amount $ 4,984 $ 5,036 $ 4,984 $ 4,984 $ 4,157 $ 4,209 $ 4,157 $ 4,157 23.4% 23.7% 7.5% 7.5% 23.7% 24.0% 7.6% 7.6% 850 $ $ 1,701 $ 2,642 $ 1,321 $ 702 $ 1,404 $ 2,195 $ 1,098 4.0% 8.0% 4.0% 2.0% 4.0% 8.0% 4.0% 2.0% $ 1,276 $ 2,126 $ 3,302 N/A $ 1,053 $ 1,755 $ 2,744 N/A 6.0% 10.0% 5.0% 6.0% 10.0% 5.0% Based on its regulatory capital ratios at December 31, 2011 and 2010, Schwab Bank is considered well capitalized (the highest category) pursuant to banking regulatory guidelines. There are no conditions or events since December 31, 2011, that management believes have changed Schwab Bank’s capital category. The Federal Reserve requires Schwab Bank to maintain reserve balances at the Federal Reserve Bank based on certain deposit levels. Schwab Bank’s average reserve requirement was $1.1 billion and $918 million in 2011 and 2010, respectively. CSC’s principal U.S. broker-dealers are Schwab and optionsXpress, Inc. optionsXpress, Inc. is a wholly-owned subsidiary of optionsXpress. Schwab and optionsXpress, Inc. are both subject to Rule 15c3-1 under the Securities Exchange Act of 1934 (the Uniform Net Capital Rule). Schwab and optionsXpress, Inc. compute net capital under the alternative method permitted by the Uniform Net Capital Rule. This method requires the maintenance of minimum net capital, as defined, of the greater of 2% of aggregate debit balances arising from client transactions or a minimum dollar requirement ($250,000 for Schwab), which is based on the type of business conducted by the broker-dealer. Under the alternative method, a broker-dealer may not repay subordinated borrowings, pay cash dividends, or make any unsecured advances or loans to its parent company or employees if such payment would result in a net capital amount of less than 5% of aggregate debit balances or less than 120% of its minimum dollar requirement. optionsXpress, Inc. is also subject to Commodity Futures Trading Commission Regulation 1.17 (Reg. 1.17) under the Commodity Exchange Act, which also requires the maintenance of minimum net capital. optionsXpress, Inc., as a futures commission merchant, is required to maintain minimum net capital equal to the greater of its net capital requirement under Reg. 1.17 ($1 million), or the sum of 8% of the total risk margin requirements for all positions carried in client accounts and 8% of the total risk margin requirements for all positions carried in non-client accounts (as defined in Reg. 1.17). Net capital and net capital requirements for Schwab and optionsXpress, Inc. at December 31, 2011, are as follows: % of Aggregate Net Capital Debit Balances Schwab optionsXpress, Inc. $ 1,188 78 $ 10% 29% Minimum Net Capital Required $ 0.250 1 $ 2% of Aggregate Debit Balances $ $ 240 5 Net Capital in Excess of 5% of Aggregate Net Capital in Excess of Required Net Capital Debit Balances $ $ 948 73 588 65 $ $ Schwab and optionsXpress, Inc. are also subject to Rule 15c3-3 under the Securities Exchange Act of 1934 and/or other applicable regulations, which require them to maintain cash or qualified securities in a segregated reserve account for the - 85 - THE CHARLES SCHWAB CORPORATION Notes to Consolidated Financial Statements (Tabular Amounts in Millions, Except Per Share Data, Option Price Amounts, Ratios, or as Noted) exclusive benefit of clients. In accordance with Rule 15c3-3, Schwab and optionsXpress, Inc. had portions of their cash and investments segregated for the exclusive benefit of clients at December 31, 2011. Amounts included in cash and investments segregated and on deposit for regulatory purposes represent actual balances on deposit, whereas cash and investments required to be segregated and on deposit for regulatory purposes at December 31, 2011 for Schwab and optionsXpress, Inc. totaled $26.3 billion. On January 4, 2012, Schwab and optionsXpress, Inc. deposited a net amount of $1.1 billion of excess segregated cash into their segregated reserve bank accounts. Cash and investments required to be segregated and on deposit for regulatory purposes at December 31, 2010 for Schwab was $22.0 billion. On January 4, 2011, Schwab withdrew a net amount of $194 million of excess segregated cash from its segregated reserve bank accounts. 25. Segment Information Operating segments are defined as components of a company in which separate financial information is evaluated regularly by the chief operating decision maker, or decision-making group, in deciding how to allocate resources and in assessing performance. The Company structures its operating segments according to its various types of clients and the services provided to those clients. The Company’s two reportable segments are Investor Services and Institutional Services. The Investor Services segment provides retail brokerage and banking services to individual investors. The Institutional Services segment provides custodial, trading, and support services to independent investment advisors. The Institutional Services segment also provides retirement plan services, specialty brokerage services, and mutual fund clearing services, and supports the availability of Schwab proprietary mutual funds and collective trust funds on third-party platforms. Banking revenues and expenses are allocated to the Company’s two segments based on which segment services the client. The accounting policies of the segments are the same as those described in note “2 – Summary of Significant Accounting Policies.” Financial information for the Company’s reportable segments is presented in the following table. For the computation of its segment information, the Company utilizes an activity-based costing model to allocate traditional income statement line item expenses (e.g., compensation and benefits, depreciation and amortization, and professional services) to the business activities driving segment expenses (e.g., client service, opening new accounts, or business development) and a funds transfer pricing methodology to allocate certain revenues. The Company evaluates the performance of its segments on a pre-tax basis, excluding items such as impairment charges on non-financial assets, discontinued operations, extraordinary items, and significant restructuring and other charges. Segment assets and liabilities are not disclosed because the balances are not used for evaluating segment performance and deciding how to allocate resources to segments. However, capital expenditures are used in resource allocation and are therefore disclosed. There are no revenues from transactions with other segments within the Company. Capital expenditures are reported gross, and are not net of proceeds from the sale of fixed assets. - 86 - THE CHARLES SCHWAB CORPORATION Notes to Consolidated Financial Statements (Tabular Amounts in Millions, Except Per Share Data, Option Price Amounts, Ratios, or as Noted) Financial information for the Company’s reportable segments is presented in the following table: Year Ended December 31, 2011 2010 2009 2011 2010 2009 2011 2010 2009 2011 Investor Services Institutional Services Unallocated Total 2010 2009 $ 1,053 $ 1,468 625 85 (15) Net Revenues Asset management and administration fees Net interest revenue Trading revenue Other Provision for loan losses Net impairment losses on securities (27) 3,189 Total net revenues Expenses Excluding Interest (1) 2,261 Income before taxes on income $ Taxes on income Net Income 928 $ 976 $ 968 $ 1,297 557 70 (23) 1,058 679 93 (34) 875 $ 257 302 75 (3) 846 $ 227 273 65 (4) 907 $ 187 317 82 (4) - $ - - - - (32) 2,845 (54) (4) 2,710 1,502 (4) 1,403 (6) 1,483 - - 2,065 1,906 1,039 804 $ 463 $ 780 $ 960 443 $ 929 554 $ (1) 1 $ 444 (444) $ 82 3,299 (82) $ 1,392 $ - $ - - - - - - - $ 1,928 $ 1,822 $ 1,875 1,524 1,245 - 1,725 996 927 - 175 160 - (38) (18) - 830 135 (27) - (31) - 4,691 (36) (60) 4,248 4,193 3,469 2,917 779 $ 1,276 (489) (325) 787 454 $ (528) 864 $ $ Capital expenditures $ 120 $ 91 $ 95 $ 70 $ 36 $ 44 $ - $ - $ - $ 190 $ 127 $ Depreciation and amortization $ 47 $ (1) Unallocated amount primarily includes class action litigation and regulatory reserves of $320 million and money market mutual fund charges of 155 $ 108 $ 52 $ 93 $ 100 $ 1 $ 59 $ - $ - $ 146 $ 139 159 $132 million in 2010, and facilities and severance charges relating to the Company’s cost reduction measures in 2009. Fees received from Schwab’s proprietary mutual funds represented approximately 10%, 14%, and 23% of the Company’s net revenues in 2011, 2010, and 2009, respectively. Except for Schwab’s proprietary mutual funds, which are considered a single client for purposes of this computation, no single client accounted for more than 10% of the Company’s net revenues in 2011, 2010, or 2009. Substantially all of the Company’s revenues and assets are generated or located in the U.S. The percentage of Schwab’s total client accounts located in California was approximately 23% at December 31, 2011, 2010, and 2009. 26. Subsequent Event On January 26, 2012, the Company issued and sold 400,000 shares of fixed-to-floating rate non-cumulative perpetual preferred stock, Series A, $0.01 par value, with a liquidation preference of $1,000 per share (Series A Preferred Stock). The Series A Preferred Stock has a fixed dividend rate of 7% until 2022 and a floating rate thereafter. Net proceeds received from the sale were $394 million and are being used for general corporate purposes, including, without limitation, to support the Company’s balance sheet growth and the potential migration of certain client cash balances to deposit accounts at Schwab Bank. Under the terms of the Series A Preferred Stock issued in January 2012, the Company’s ability to pay dividends on, make distributions with respect to, or to repurchase, redeem or acquire its common stock is subject to restrictions in the event that the Company does not declare and either pay or set aside a sum sufficient for payment of dividends on the Series A Preferred Stock for the immediately preceding dividend period. - 87 - THE CHARLES SCHWAB CORPORATION Notes to Consolidated Financial Statements (Tabular Amounts in Millions, Except Per Share Data, Option Price Amounts, Ratios, or as Noted) 27. The Charles Schwab Corporation – Parent Company Only Financial Statements Condensed Statements of Income Year Ended December 31, Interest revenue Interest expense Net interest revenue Other revenues Expenses excluding interest Loss before income tax benefit and equity in net income of subsidiaries Income tax benefit Loss before equity in net income of subsidiaries Equity in net income of subsidiaries: Equity in undistributed net income of subsidiaries Dividends from bank subsidiary Dividends from non-bank subsidiaries Net Income $ $ 2011 4 (103) (99) 8 (30) (121) 43 (78) 600 150 192 864 Condensed Balance Sheets December 31, Assets Cash and cash equivalents Receivables from subsidiaries Other securities owned – at fair value Loans to non-bank subsidiaries Investment in non-bank subsidiaries Investment in bank subsidiary Equipment, office facilities, and property – net Other assets Total assets Liabilities and Stockholders’ Equity Accrued expenses and other liabilities Payables to subsidiaries Long-term debt Total liabilities Stockholders’ equity Total liabilities and stockholders’ equity 2010 3 (86) (83) 6 (18) (95) 36 (59) 478 - 35 454 2011 852 57 77 363 3,363 5,009 4 64 9,789 158 16 1,901 2,075 7,714 9,789 $ $ $ $ $ $ 2009 8 (66) (58) 33 (15) (40) 16 (24) 228 - 583 787 2010 1,149 92 91 265 2,509 4,189 5 91 8,391 232 33 1,900 2,165 6,226 8,391 $ $ $ $ $ $ - 88 - THE CHARLES SCHWAB CORPORATION Notes to Consolidated Financial Statements (Tabular Amounts in Millions, Except Per Share Data, Option Price Amounts, Ratios, or as Noted) Condensed Statements of Cash Flows Year Ended December 31, Cash Flows from Operating Activities Net income Adjustments to reconcile net income to net cash provided by operating activities: Equity in undistributed earnings of subsidiaries Provision for deferred income taxes Other Net change in: Receivables from brokers, dealers, and clearing organizations Other securities owned Other assets Accrued expenses and other liabilities Net cash provided by operating activities Cash Flows from Investing Activities Due from subsidiaries – net Increase in investments in subsidiaries Cash payments for business combinations and investments, net of cash acquired Net cash used for investing activities Cash Flows from Financing Activities Issuance of long-term debt Repayment of long-term debt Net proceeds from common stock offering Dividends paid Proceeds from stock options exercised and other Other financing activities Net cash (used for) provided by financing activities (Decrease) Increase in Cash and Cash Equivalents Cash and Cash Equivalents at Beginning of Year Cash and Cash Equivalents at End of Year 2011 2010 2009 $ 864 $ 454 $ 787 (591) 3 1 - 6 26 (76) 233 24 (366) 8 (334) - - - (295) 96 3 (196) (297) 1,149 852 $ (478) 3 (3) 11 422 40 (2) 447 63 (1,025) 4 (958) 701 (200) 543 (288) 35 (6) 785 274 875 1,149 $ (253) 20 (35) 23 (404) (16) (1) 121 279 (725) - (446) 747 (76) - (279) 53 - 445 120 755 875 $ - 89 - THE CHARLES SCHWAB CORPORATION Notes to Consolidated Financial Statements (Tabular Amounts in Millions, Except Per Share Data, Option Price Amounts, Ratios, or as Noted) 28. Quarterly Financial Information (Unaudited) Fourth Quarter Third Quarter Second Quarter First Quarter $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ 13.41 10.75 1,113 861 163 1,271 .13 .13 .06 1,181 821 220 1,229 .18 .18 .06 1,190 804 238 1,210 .20 .20 .06 Year Ended December 31, 2011: Net Revenues Expenses Excluding Interest Net Income Weighted Average Common Shares Outstanding – Diluted Basic Earnings Per Share Diluted Earnings Per Share Dividends Declared Per Common Share Range of Common Stock Price Per Share: High Low Range of Price/Earnings Ratio (1): High Low Year Ended December 31, 2010: Net Revenues Expenses Excluding Interest Net Income Weighted Average Common Shares Outstanding – Diluted Basic Earnings Per Share Diluted Earnings Per Share Dividends Declared Per Common Share Range of Common Stock Price Per Share: High Low Range of Price/Earnings Ratio (1): High Low (1) Price/earnings ratio is computed by dividing the high and low market prices by diluted earnings per share for the 1,127 898 119 1,200 .10 .10 .06 1,063 864 124 1,194 .10 .10 .06 1,080 742 205 1,195 .17 .17 .06 15.43 12.76 16.72 11.03 17.42 13.98 18.72 15.78 19.88 14.18 47 38 19 15 38 31 25 16 31 26 41 30 $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ 1,207 813 243 1,207 .20 .20 .06 19.45 17.16 34 30 978 965 6 1,188 - - .06 19.78 17.50 40 36 preceding 12-month period ending on the last day of the quarter presented. - 90 - Report of Independent Registered Public Accounting Firm To the Board of Directors and Stockholders of The Charles Schwab Corporation: We have audited the accompanying consolidated balance sheets of The Charles Schwab Corporation and subsidiaries (the Company) as of December 31, 2011 and 2010, and the related consolidated statements of income, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2011. Our audits also included the financial statement schedule of the Company on page F-2. We also have audited the Company’s internal control over financial reporting as of December 31, 2011, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company’s management is responsible for these financial statements and financial statement schedule, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on these financial statements and financial statement schedule and an opinion on the Company’s internal control over financial reporting based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. A company’s internal control over financial reporting is a process designed by, or under the supervision of, the company’s principal executive and principal financial officers, or persons performing similar functions, and effected by the company’s board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2011 and 2010, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2011, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. Also, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2011, based on the criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. /s/ Deloitte & Touche LLP San Francisco, California February 23, 2012 - 91 - THE CHARLES SCHWAB CORPORATION Management’s Report on Internal Control Over Financial Reporting Management of The Charles Schwab Corporation, together with its subsidiaries (the Company), is responsible for establishing and maintaining adequate internal control over financial reporting. The Company’s internal control over financial reporting is a process designed under the supervision of and effected by the Company’s chief executive officer and chief financial officer to provide reasonable assurance regarding the reliability of financial reporting and the preparation of published financial statements in accordance with accounting principles generally accepted in the United States of America. As of December 31, 2011, management conducted an assessment of the effectiveness of the Company’s internal control over financial reporting based on the framework established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment, management has determined that the Company’s internal control over financial reporting was effective as of December 31, 2011. The Company’s internal control over financial reporting includes policies and procedures that pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect transactions and dispositions of assets; provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States of America, and that receipts and expenditures are being made only in accordance with authorizations of management and the directors of the Company; and provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the Company’s financial statements. The Company’s internal control over financial reporting as of December 31, 2011, has been audited by Deloitte & Touche LLP, an independent registered public accounting firm, as stated in their report appearing on the previous page. - 92 - THE CHARLES SCHWAB CORPORATION Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure None. Item 9A. Controls and Procedures Evaluation of disclosure controls and procedures: The management of the Company, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934) as of December 31, 2011. Based on this evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures were effective as of December 31, 2011. Changes in internal control over financial reporting: No change in the Company’s internal control over financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934) was identified during the quarter ended December 31, 2011, that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting. Management’s Report on Internal Control Over Financial Reporting and the Report of Independent Registered Public Accounting Firm are included in “Item 8 – Financial Statements and Supplementary Data.” Item 9B. Other Information None. PART III Item 10. Directors, Executive Officers, and Corporate Governance The information relating to directors of CSC required to be furnished pursuant to this item is incorporated by reference from portions of the Company’s definitive proxy statement for its annual meeting of stockholders to be filed with the SEC pursuant to Regulation 14A by April 30, 2012 (the Proxy Statement) under “Members of the Board of Directors,” “Corporate Governance Information,” “Director Nominations,” and “Section 16(a) Beneficial Ownership Reporting Compliance.” The Company’s Code of Conduct and Business Ethics, applicable to directors and all employees, including senior financial officers, is available on the Company’s website at http://www.aboutschwab.com/governance. If the Company makes any amendments to or grants any waivers from its Code of Conduct and Business Ethics, which are required to be disclosed pursuant to the Securities Exchange Act of 1934, the Company will make such disclosures on this website. - 93 - THE CHARLES SCHWAB CORPORATION Executive Officers of the Registrant The following table provides certain information about each of the Company’s executive officers as of December 31, 2011. Executive Officers of the Registrant Name Age Title Charles R. Schwab Walter W. Bettinger II Jay L. Allen Benjamin L. Brigeman John S. Clendening Carrie E. Dwyer Joseph R. Martinetto James D. McCool 74 51 55 49 49 61 49 53 Chairman of the Board President and Chief Executive Officer Executive Vice President – Human Resources and Employee Services Executive Vice President – Investor Services Executive Vice President – Shared Strategic Services Executive Vice President, General Counsel and Corporate Secretary Executive Vice President and Chief Financial Officer Executive Vice President – Institutional Services Mr. Schwab has been Chairman of the Board and a director of CSC since its incorporation in 1986. He also served as Chief Executive Officer of CSC from 1986 to 1997, and as Co-Chief Executive Officer from 1998 until 2003. He was re-appointed Chief Executive Officer in 2004 and served in that role until 2008. Mr. Schwab is also Chairman of Charles Schwab & Co., Inc. and Charles Schwab Bank, and a trustee of The Charles Schwab Family of Funds, Schwab Investments, Schwab Capital Trust, Schwab Annuity Portfolios, Laudus Trust, and Laudus Institutional Trust, all registered investment companies. Mr. Bettinger has been President and Chief Executive Officer of CSC since 2008. In 2010, he took on responsibility as Chief Executive Officer of Charles Schwab Bank. He also serves on the Board of Directors of CSC, Charles Schwab & Co., Inc. and Charles Schwab Bank, and as a trustee of The Charles Schwab Family of Funds, Schwab Investments, Schwab Capital Trust, Schwab Annuity Portfolios, Laudus Trust, Laudus Institutional Trust, and Schwab Strategic Trust, all registered investment companies. Prior to assuming his current role, Mr. Bettinger served as President and Chief Operating Officer of CSC from 2007 until 2008 and as Executive Vice President and President – Schwab Investor Services of CSC and Schwab from 2005 to 2007. He served as Executive Vice President and Chief Operating Officer – Individual Investor Enterprise of CSC and Schwab from 2004 until 2005, and Executive Vice President – Corporate Services of Schwab from 2002 until 2004. Mr. Bettinger joined Schwab in 1995. Mr. Allen has been Executive Vice President – Human Resources and Employee Services of CSC and Schwab since 2007. He served as Senior Vice President – Human Resources of Schwab Investor Services from 2004 to 2007. Mr. Allen joined Schwab in 2003 as Vice President – Human Resources of Schwab Investor Services. Mr. Brigeman served as Executive Vice President – Investor Services of CSC and Schwab from 2007 to February 2012. Mr. Brigeman was Senior Vice President – Schwab Investor Services of Schwab from 2005 to 2007 and Senior Vice President – Schwab Retirement Plan Services of Schwab from 2000 to 2005. Mr. Brigeman joined Schwab in 1996. Mr. Brigeman stepped down as Executive Vice President – Investor Services of CSC and Schwab, effective February 15, 2012. - 94 - THE CHARLES SCHWAB CORPORATION Mr. Clendening has been Executive Vice President – Shared Strategic Services of CSC and Schwab since 2009. He served as Executive Vice President – Solution Services of CSC and Schwab from 2008 to 2009 and as Executive Vice President – Client Experience, Schwab Investor Services of CSC in 2007 and of Schwab from 2006 to 2008. Mr. Clendening served as Executive Vice President and President – Individual Investor Enterprise Marketing of Schwab from 2005 to 2007. He joined Schwab in 2004 as Senior Vice President – Individual Investor Enterprise Marketing. Ms. Dwyer has been Executive Vice President, General Counsel and Corporate Secretary of CSC and Executive Vice President – Corporate Oversight of Schwab since 1996. Ms. Dwyer joined Schwab in 1996. Mr. Martinetto has been Executive Vice President and Chief Financial Officer of CSC and Schwab since 2007. Mr. Martinetto served as Senior Vice President and Treasurer of CSC and Schwab from 2003 to 2007 and Senior Vice President – Individual Investor Finance of Schwab from 2002 to 2003. Mr. Martinetto joined Schwab in 1997. Mr. McCool has been Executive Vice President – Institutional Services of CSC and Schwab since 2008. Mr. McCool served as Executive Vice President – Schwab Corporate and Retirement Services of CSC from 2007 until 2008 and of Schwab from 2006 until 2008. Mr. McCool served as Senior Vice President – Corporate Services of Schwab from 2004 until 2006. Mr. McCool also served as President and Chief Executive Officer of The Charles Schwab Trust Company (CSTC) from 2005 until 2007. Mr. McCool served as Senior Vice President – Plan Administrative Services of CSTC from 2004 until 2005, Chief Operating Officer of CSTC from 2003 until 2004, and Vice President – Development and Business Technology of CSTC from 2002 until 2003. Mr. McCool joined Schwab in 1995. Item 11. Executive Compensation The information required to be furnished pursuant to this item is incorporated by reference from portions of the Proxy Statement under “Compensation Discussion and Analysis,” “Executive Compensation Tables – 2011 Summary Compensation Table,” “Executive Compensation Tables – 2011 Grants of Plan-Based Awards Table,” “Executive Compensation Tables – Narrative to Summary Compensation and Grants of Plan-Based Awards Tables,” “Executive Compensation Tables – 2011 Termination and Change in Control Benefits Table,” “Executive Compensation Tables – Outstanding Equity Awards as of December 31, 2011,” “Executive Compensation Tables – 2011 Option Exercises and Stock Vested Table,” “Executive Compensation Tables – 2011 Nonqualified Deferred Compensation Table,” “Director Compensation,” and “Compensation Committee Interlocks and Insider Participation.” In addition, the information from a portion of the Proxy Statement under “Compensation Committee Report,” is incorporated by reference from the Proxy Statement and furnished on this Form 10-K, and shall not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, nor shall it be deemed incorporated by reference in any filing under the Securities Act of 1933. Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters The information required to be furnished pursuant to this item is incorporated by reference from portions of the Proxy Statement under “Security Ownership of Certain Beneficial Owners and Management,” and “Securities Authorized for Issuance under Equity Compensation Plans.” Item 13. Certain Relationships and Related Transactions, and Director Independence The information required to be furnished pursuant to this item is incorporated by reference from portions of the Proxy Statement under “Transactions with Related Persons” and “Director Independence.” - 95 - THE CHARLES SCHWAB CORPORATION Item 14. Principal Accountant Fees and Services The information required to be furnished pursuant to this item is incorporated by reference from a portion of the Proxy Statement under “Auditor Fees.” PART IV Item 15. Exhibits and Financial Statement Schedule (a) Documents filed as part of this Report 1. Financial Statements The financial statements and independent auditors’ report are included in “Item 8 – Financial Statements and Supplementary Data” and are listed below: Consolidated Statements of Income Consolidated Balance Sheets Consolidated Statements of Cash Flows Consolidated Statements of Stockholders’ Equity Notes to Consolidated Financial Statements Report of Independent Registered Public Accounting Firm 2. Financial Statement Schedule The financial statement schedule required to be furnished pursuant to this item is listed in the accompanying index appearing on page F-1. (b) Exhibits The exhibits listed below are filed as part of this annual report on Form 10-K. Exhibit Number 2.1 3.11 3.14 3.15 Exhibit Agreement and Plan of Merger, dated March 18, 2011, by and among The Charles Schwab Corporation, Neon Acquisition Corp. and optionsXpress Holdings, Inc., filed as Exhibit 2.1 to the Registrant’s Form 8-K dated March 18, 2011 and incorporated herein by reference. Fifth Restated Certificate of Incorporation, effective May 7, 2001, of the Registrant, filed as Exhibit 3.11 to the Registrant’s Form 10-Q for the quarter ended September 30, 2011 and incorporated herein by reference. Fourth Restated Bylaws, as amended on January 27, 2010, of the Registrant, filed as Exhibit 3.1 to the Registrant’s Form 8-K dated January 27, 2010 and incorporated herein by reference. Certificate of Designations of Fixed to Floating Rate Non-Cumulative Perpetual Preferred Stock, Series A of The Charles Schwab Corporation filed as Exhibit 3.15 to the Registrant’s Form 8-K dated January 24, 2012 and incorporated herein by reference. - 96 - THE CHARLES SCHWAB CORPORATION Exhibit Number 4.2 10.1 10.4 10.57 10.72 10.271 10.272 Neither the Registrant nor its subsidiaries are parties to any instrument with respect to long-term debt for which securities authorized thereunder exceed 10% of the total assets of the Registrant and its subsidiaries on a consolidated basis. Copies of instruments with respect to long-term debt of lesser amounts will be provided to the SEC upon request. Exhibit Voting Agreement, dated as of March 18, 2011, by and among The Charles Schwab Corporation, G-Bar Limited Partnership, JG 2002 delta Trust and optionsXpress Holdings, Inc., filed as Exhibit 10.1 to the Registrant’s Form 8-K dated March 18, 2011 and incorporated herein by reference. Form of Release Agreement dated as of March 31, 1987 among BAC, Registrant, Schwab Holdings, Inc., Charles Schwab & Co., Inc. and former shareholders of Schwab Holdings, Inc., filed as the identically-numbered exhibit to Registrant’s Registration Statement No. 33-16192 on Form S-1 and incorporated herein by reference. Registration Rights and Stock Restriction Agreement, dated as of March 31, 1987, between the Registrant and the holders of the Common Stock, filed as Exhibit 4.23 to Registrant’s Registration Statement No. 33-16192 on Form S-1 and incorporated herein by reference. Restatement of Assignment and License, as amended January 25, 1988, among Charles Schwab & Co., Inc., Charles R. Schwab and the Registrant, filed as Exhibit 10.72 to the Registrant’s Form 10-K for the year ended December 31, 2009 and incorporated herein by reference. The Charles Schwab Corporation Directors’ Deferred Compensation Plan, as amended through December 8, 2004, filed as Exhibit 10.271 to the Registrant’s Form 10-K for the year ended December 31, 2009 and incorporated herein by reference. The Charles Schwab Corporation Deferred Compensation Plan, as amended through December 8, 2004, filed as Exhibit 10.272 to the Registrant’s Form 10-K for the year ended December 31, 2009 and incorporated herein by reference. 10.288 Stock Purchase Agreement by and between the Registrant and Bank of America Corporation, dated as of November 19, 2006 and incorporated herein by reference. 10.289 Form of Notice and Restricted Stock Agreement for Walter W. Bettinger under The Charles Schwab Corporation 2004 Stock Incentive Plan dated February 20, 2007, filed as Exhibit 10.289 to the Registrant’s Form 10-Q for the quarter ended March 31, 2007 and incorporated herein by reference. 10.290 Summary of Non-Employee Director Compensation, filed as Exhibit 10.290 to the Registrant’s Form 10-Q for the quarter ended March 31, 2007 and incorporated herein by reference. 10.294 10.295 10.296 Form of Notice and Restricted Stock Agreement for Joseph R. Martinetto under The Charles Schwab Corporation 2004 Stock Incentive Plan dated May 18, 2007, filed as Exhibit 10.294 to the Registrant’s Form 10-Q for the quarter ended June 30, 2007 and incorporated herein by reference. Form of Notice and Nonqualified Stock Option Agreement for Joseph R. Martinetto under The Charles Schwab Corporation 2004 Stock Incentive Plan dated May 18, 2007, filed as Exhibit 10.295 to the Registrant’s Form 10-Q for the quarter ended June 30, 2007 and incorporated herein by reference. Stock Purchase Agreement dated July 2, 2007, by and among Charles R. Schwab, Helen O. Schwab, The Charles & Helen Schwab Living Trust, HOS Family Partners, LLC, 188 Partners, LP, and the Charles & Helen Schwab Foundation, and The Charles Schwab Corporation, filed as Exhibit 10.296 to the Registrant’s Form 10-Q for the quarter ended June 30, 2007 and incorporated herein by reference. (2) (2) (2) (2) (2) (2) (2) - 97 - THE CHARLES SCHWAB CORPORATION Exhibit Number Exhibit 10.298 Directed Employee Benefit Trust Agreement under the SchwabPlan Retirement Savings and Investment Plan dated August 17, 2007, filed as Exhibit 10.298 to the Registrant’s Form 10-Q for the quarter ended September 30, 2007 and incorporated herein by reference. 10.300 10.301 10.302 10.306 10.307 10.309 10.311 10.312 10.314 10.316 10.317 10.318 The Charles Schwab Corporation Employee Stock Incentive Plan, as amended and restated as of December 12, 2007, filed as Exhibit 10.300 to the Registrant’s Form 10-K for the year ended December 31, 2007 and incorporated herein by reference. The Charles Schwab Corporation 1992 Stock Incentive Plan, as amended and restated as of December 12, 2007, filed as Exhibit 10.301 to the Registrant’s Form 10-K for the year ended December 31, 2007 and incorporated herein by reference. The Charles Schwab Corporation 2001 Stock Incentive Plan, as amended and restated as of December 12, 2007, filed as Exhibit 10.302 to the Registrant’s Form 10-K for the year ended December 31, 2007 and incorporated herein by reference. Form of Notice and Nonqualified Stock Option Agreement under The Charles Schwab Corporation 2004 Stock Incentive Plan, filed as Exhibit 10.306 to the Registrant’s Form 10-K for the year ended December 31, 2007 and incorporated herein by reference. Form of Notice and Restricted Stock Agreement under The Charles Schwab Corporation 2004 Stock Incentive Plan, filed as Exhibit 10.307 to the Registrant’s Form 10-K for the year ended December 31, 2007 and incorporated herein by reference. Form of Notice and Premium-Priced Stock Option Agreement under The Charles Schwab Corporation 2004 Stock Incentive Plan, filed as Exhibit 10.309 to the Registrant’s Form 10-K for the year ended December 31, 2007 and incorporated herein by reference. Form of Notice and Restricted Stock Agreement for Non-Employee Directors under The Charles Schwab Corporation 2004 Stock Incentive Plan, filed as Exhibit 10.311 to the Registrant’s Form 10-K for the year ended December 31, 2007 and incorporated herein by reference. Form of Notice and Option Agreement for Non-Employee Directors under The Charles Schwab Corporation 2004 Stock Incentive Plan, filed as Exhibit 10.312 to the Registrant’s Form 10-K for the year ended December 31, 2007 and incorporated herein by reference. Employment Agreement dated as of March 13, 2008, between the Registrant and Charles R. Schwab, filed as Exhibit 10.314 to the Registrant’s Form 10-Q for the quarter ended March 31, 2008 and incorporated herein by reference. Form of Notice and Restricted Stock Agreement for Walter W. Bettinger under the Charles Schwab Corporation 2004 Stock Incentive Plan dated October 1, 2008, filed as Exhibit 10.316 to the Registrant’s Form 10-Q for the quarter ended September 30, 2008 and incorporated herein by reference. Form of Notice and Nonqualified Stock Option Agreement for Walter W. Bettinger under The Charles Schwab Corporation 2004 Stock Incentive Plan dated October 1, 2008, filed as Exhibit 10.317 to the Registrant’s Form 10-Q for the quarter ended September 30, 2008 and incorporated herein by reference. Form of Notice and Performance-Based Restricted Stock Agreement under the Charles Schwab Corporation 2004 Stock Incentive Plan, filed as Exhibit 10.318 to the Registrant’s Form 10-K for the year ended December 31, 2008 and incorporated herein by reference. (2) (2) (2) (2) (2) (2) (2) (2) (2) (2) (2) (2) (2) - 98 - THE CHARLES SCHWAB CORPORATION Exhibit Number 10.319 10.321 10.322 10.323 10.327 10.331 10.332 10.333 10.335 10.336 10.337 10.338 10.339 Exhibit Form of Notice and Restricted Stock Unit Agreement for Non-Employee Directors under the Charles Schwab Corporation 2004 Stock Incentive Plan, filed as Exhibit 10.319 to the Registrant’s Form 10-K for the year ended December 31, 2008 and incorporated herein by reference. The Charles Schwab Corporation Long Term Incentive Plan, as amended and restated as of October 23, 2008, filed as Exhibit 10.321 to the Registrant’s Form 10-K for the year ended December 31, 2008 and incorporated herein by reference. The Charles Schwab Corporation Deferred Compensation Plan II, as amended and restated as of October 23, 2008, filed as Exhibit 10.322 to the Registrant’s Form 10-K for the year ended December 31, 2008 and incorporated herein by reference. The Charles Schwab Corporation Directors’ Deferred Compensation Plan II, as amended and restated as of October 23, 2008, filed as Exhibit 10.323 to the Registrant’s Form 10-K for the year ended December 31, 2008 and incorporated herein by reference. The Charles Schwab Corporation 2004 Stock Incentive Plan, as amended and restated as of December 10, 2009, filed as Exhibit 10.327 to the Registrant’s Form 10-K for the year ended December 31, 2009 and incorporated herein by reference. The Charles Schwab Corporation Corporate Executive Bonus Plan, restated to include amendments approved at the Annual Meeting of Stockholders on May 13, 2010, filed as Exhibit 10.331 to the Registrant’s Form 10-Q for the quarter ended June 30, 2010 and incorporated herein by reference. Credit Agreement (364-Day Commitment) dated as of June 11, 2010, between the Registrant and the financial institutions listed therein, filed as Exhibit 10.332 to the Registrant’s Form 10-Q for the quarter ended June 30, 2010 and incorporated herein by reference. Form of Notice and Retainer Restricted Stock Unit Agreement for Non-Employee Directors under The Charles Schwab Corporation 2004 Stock Incentive Plan, filed as Exhibit 10.333 to the Registrant’s Form 10-Q for the quarter ended September 30, 2010 and incorporated herein by reference. Form of Notice and Restricted Stock Unit Agreement under The Charles Schwab Corporation 2004 Stock Incentive Plan, filed as Exhibit 10.335 to the Registrant’s Form 10-Q for the quarter ended September 30, 2010 and incorporated herein by reference. Form of Notice and Performance-Based Restricted Stock Unit Agreement under The Charles Schwab Corporation 2004 Stock Incentive Plan, filed as Exhibit 10.336 to the Registrant’s Form 10-K for the year ended December 31, 2010 and incorporated herein by reference. The Charles Schwab Severance Pay Plan, as amended and restated effective July 1, 2011, filed as Exhibit 10.337 to the Registrant’s Form 10-K for the year ended December 31, 2010 and incorporated herein by reference. The Charles Schwab Corporation 2004 Stock Incentive Plan, as approved at the Annual Meeting of Stockholders on May 17, 2011 (supersedes Exhibit 10.327), filed as Exhibit 10.338 to the Registrant’s Form 10-Q for the quarter ended June 30, 2011 and incorporated herein by reference. Credit Agreement (364 – Day Commitment) dated as of June 10, 2011, between the Registrant and financial institutions listed therein (supersedes Exhibit 10.332), filed as Exhibit 10.339 to the Registrant’s Form 10-Q for the quarter ended June 30, 2011 and incorporated herein by reference. (2) (2) (2) (2) (2) (2) (2) (2) (2) (2) (2) - 99 - THE CHARLES SCHWAB CORPORATION Exhibit Number 10.340 The Charles Schwab Severance Pay Plan, as Amended and Restated Effective January 1, 2012 (supersedes Exhibit 10.337). Exhibit 10.341 Form of Notice and Restricted Stock Unit Agreement for Non-Employee Directors under The Charles Schwab Corporation 2004 Stock Incentive Plan (supersedes Exhibit 10.319). 10.342 Form of Notice and Retainer Stock Option Agreement for Non-Employee Directors under The Charles Schwab Corporation 2004 Stock Incentive Plan (supersedes exhibit 10.312). 10.343 Form of Notice and Performance-Based Restricted Stock Unit Agreement under The Charles Schwab Corporation 2004 Stock Incentive Plan (supersedes Exhibit 10.336). 10.344 Form of Notice and Retainer Restricted Stock Unit Agreement for Non-Employee Directors under The Charles Schwab Corporation 2004 Stock Incentive Plan (supersedes Exhibit 10.333). 10.345 Form of Notice and Nonqualified Stock Option Agreement under The Charles Schwab Corporation 2004 Stock Incentive Plan (supersedes Exhibit 10.306). 10.346 Form of Notice and Restricted Stock Unit Agreement under The Charles Schwab Corporation 2004 Stock Incentive Plan (supersedes Exhibit 10.335). 10.347 Form of Notice and Stock Option Agreement for Non-Employee Directors under The Charles Schwab Corporation Directors’ Deferred Compensation Plan II. 12.1 Computation of Ratio of Earnings to Fixed Charges. 21.1 Subsidiaries of the Registrant. 23.1 Independent Registered Public Accounting Firm’s Consent. 31.1 31.2 32.1 32.2 Certification Pursuant to Rule 13a-14(a)/15d-14(a), As Adopted Pursuant to Section 302 of The Sarbanes-Oxley Act of 2002. Certification Pursuant to Rule 13a-14(a)/15d-14(a), As Adopted Pursuant to Section 302 of The Sarbanes-Oxley Act of 2002. Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of The Sarbanes- Oxley Act of 2002. Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of The Sarbanes- Oxley Act of 2002. 101.INS XBRL Instance Document 101.SCH XBRL Taxonomy Extension Schema 101.CAL XBRL Taxonomy Extension Calculation 101.DEF XBRL Extension Definition 101.LAB XBRL Taxonomy Extension Label - 100 - (2) (2) (2) (2) (2) (2) (2) (2) (1) (1) (3) (3) (3) (3) (3) THE CHARLES SCHWAB CORPORATION Exhibit Number Exhibit 101.PRE XBRL Taxonomy Extension Presentation (3) (1) (2) (3) Furnished as an exhibit to this annual report on Form 10-K. Management contract or compensatory plan. Attached as Exhibit 101 to this Annual Report on Form 10-K for the annual period ended December 31, 2011, are the following materials formatted in XBRL (Extensible Business Reporting Language) (i) the Consolidated Statements of Income, (ii) the Consolidated Balance Sheets, (iii) the Consolidated Statements of Cash Flows, (iv) the Consolidated Statements of Stockholders’ Equity, and (v) Notes to Consolidated Financial Statements. - 101 - THE CHARLES SCHWAB CORPORATION SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on February 23, 2012. THE CHARLES SCHWAB CORPORATION (Registrant) BY: /s/ Walter W. Bettinger II Walter W. Bettinger II President and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated, on February 23, 2012. Signature / Title Signature / Title /s/ Walter W. Bettinger II Walter W. Bettinger II, President and Chief Executive Officer /s/ Joseph R. Martinetto Joseph R. Martinetto, Executive Vice President and Chief Financial Officer (principal financial and accounting officer) /s/ Charles R. Schwab Charles R. Schwab, Chairman of the Board /s/ Nancy H. Bechtle Nancy H. Bechtle, Director /s/ C. Preston Butcher C. Preston Butcher, Director /s/ Stephen T. McLin Stephen T. McLin, Director /s/ Paula A. Sneed Paula A. Sneed, Director /s/ Robert N. Wilson Robert N. Wilson, Director /s/ Frank C. Herringer Frank C. Herringer, Director /s/ Arun Sarin Arun Sarin, Director /s/ Roger O. Walther Roger O. Walther, Director - 102 - THE CHARLES SCHWAB CORPORATION Index to Financial Statement Schedule Schedule II - Valuation and Qualifying Accounts Supplemental Financial Data for Charles Schwab Bank (Unaudited) Page F-2 F-3 – F-8 Schedules not listed are omitted because of the absence of the conditions under which they are required or because the information is included in the Company’s consolidated financial statements and notes in “Item 8 – Financial Statements and Supplementary Data.” F-1 THE CHARLES SCHWAB CORPORATION SCHEDULE II Valuation and Qualifying Accounts (In millions) Balance at Beginning of Year Additions Charged to Expense Other (1) Written off of Year Balance at End $ 1 $ 6 $ 3 $ (8) $ 2 $ 2 $ 3 $ - $ (4) $ 1 $ 4 $ 3 $ 2 $ (7) $ 2 Description For the year ended December 31, 2011: Allowance for doubtful accounts of brokerage clients (2) For the year ended December 31, 2010: Allowance for doubtful accounts of brokerage clients (2) For the year ended December 31, 2009: Allowance for doubtful accounts of brokerage clients (2) (1) Includes collections of previously written-off accounts (2) Excludes banking-related valuation and qualifying accounts. See "Item 8 - Financial Statements and Supplementary Data - Notes to Consolidated Financial Statements - 7. Loans to Banking Clients and Related Allowance for Loan Losses." F-2 THE CHARLES SCHWAB CORPORATION Supplemental Financial Data for Charles Schwab Bank (Unaudited) (Dollars in Millions) The following supplemental financial data is consistent with the Securities Exchange Act of 1934, Industry Guide 3 – Statistical Disclosure by Bank Holding Companies. The accompanying unaudited financial information represents Charles Schwab Bank (Schwab Bank), which is a subsidiary of The Charles Schwab Corporation (CSC). CSC is a savings and loan holding company and Schwab Bank is a federal savings bank. The following information excludes intercompany balances and transactions with CSC and its affiliates. 1. Three-year Net Interest Revenue and Average Balances For the Year Ended December 31, Average Balance 2011 Interest Average Rate Average Balance 2010 Interest Average Rate Average Balance 2009 Interest Average Rate Assets: Cash and cash equivalents (1) Securities available for sale (2) Securities held to maturity Loans to banking clients (3) Loans held for sale Other interest-earning assets Total interest-earning assets Net unrealized gain (loss) on securities available for sale Noninterest-earning assets Total Assets Liabilities and Stockholder's Equity: Interest-bearing banking deposits Total sources on which interest is paid Noninterest-bearing liabilities Stockholder's equity Total Liabilities and Stockholder's Equity 64 212 57,528 $ $ 52,701 52,701 345 4,482 57,528 $ $ 4,142 $ 11 27,477 16,050 9,468 65 50 456 492 310 3 1 57,252 1,273 0.27% 1.66% 3.07% 3.27% 4.62% 2.00% 2.22% $ 5,890 $ 16 24,209 10,440 7,983 80 51 486 361 275 4 1 48,653 1,143 0.27% 2.01% 3.46% 3.44% 5.00% 1.96% 2.35% (109) 297 48,841 $ 0.40% 2.81% 3.86% 3.61% 4.55% 0.49% 2.58% $ 6,352 $ 26 521 74 241 5 - 867 18,558 1,915 6,668 110 30 33,633 (614) 331 33,350 $ 62 62 0.12% 0.12% $ 44,858 44,858 105 105 0.23% 0.23% $ 31,249 31,249 107 107 0.34% 0.34% 299 3,684 48,841 $ 513 1,588 33,350 $ Net interest revenue $ 1,211 $ 1,038 $ 760 Net yield on interest-earning assets 2.12% 2.13% 2.26% (1) Includes deposits with banks, short-term investments, and federal funds sold. (2) Amounts have been calculated based on amortized cost. (3) Includes average principal balances of nonaccrual loans. F-3 THE CHARLES SCHWAB CORPORATION Supplemental Financial Data for Charles Schwab Bank (Unaudited) (Dollars in Millions) 2. Analysis of Change in Net Interest Revenue An analysis of the year-to-year changes in the categories of interest revenue and interest expense resulting from changes in volume and rate is as follows: 2011 Compared to 2010 Increase (Decrease) Due to Change in: 2010 Compared to 2009 Increase (Decrease) Due to Change in: Average Volume Average Rate Total Average Volume Average Rate Total Interest-earning assets: Cash and cash equivalents (1) Securities available for sale (2) Securities held to maturity Loans to banking clients (3) Loans held for sale Other interest-earning assets Total interest-earning assets Interest-bearing sources of funds: Interest-bearing banking deposits Total sources on which interest is paid $ $ $ $ $ $ (4) 65 194 51 (1) - 305 (1) (95) (63) (16) - - (175) (5) (30) 131 35 (1) - 130 (2) 159 329 47 (1) - 532 (8) (194) (42) (13) - 1 (256) (10) (35) 287 34 (1) 1 276 $ $ $ $ $ $ $ $ 18 18 $ $ (61) (61) $ $ (43) (43) $ $ 46 46 $ $ (48) (48) $ $ (2) (2) Change in net interest revenue $ 287 $ (114) $ 173 $ 486 $ (208) $ 278 Changes that are not due solely to volume or rate have been allocated to rate. (1) Includes deposits with banks and short-term investments. (2) Amounts have been calculated based on amortized cost. (3) Includes average principal balances of nonaccrual loans. F-4 THE CHARLES SCHWAB CORPORATION Supplemental Financial Data for Charles Schwab Bank (Unaudited) (Dollars in Millions) 3. Securities Available for Sale and Securities Held to Maturity The amortized cost, gross unrealized gains and losses, and fair value of securities available for sale and securities held to maturity are as follows: Gross Unrealized Gains Gross Unrealized Losses $ $ $ $ 269 - 2 5 5 7 288 430 3 433 $ $ $ $ 14 223 3 26 - 7 273 2 - 2 Gross Unrealized Gains Gross Unrealized Losses $ $ $ $ 222 3 1 8 23 9 266 209 14 223 $ $ $ $ 3 234 - 1 - 2 240 137 - 137 Fair Value $ 20,921 907 3,622 3,571 1,800 3,136 $ 33,957 $ 15,198 341 $ 15,539 Fair Value $ 13,098 1,470 1,875 2,268 2,780 2,502 $ 23,993 $ 16,794 1,054 $ 17,848 December 31, 2011 Securities available for sale: U.S. agency residential mortgage-backed securities Non-agency residential mortgage-backed securities Certificates of deposit Corporate debt securities U.S. agency notes Asset-backed and other securities Total securities available for sale Securities held to maturity: U.S. agency residential mortgage-backed securities Other securities Total securities held to maturity December 31, 2010 Securities available for sale: U.S. agency residential mortgage-backed securities Non-agency residential mortgage-backed securities Certificates of deposit Corporate debt securities U.S. agency notes Asset-backed securities Total securities available for sale Securities held to maturity: U.S. agency residential mortgage-backed securities Other securities Total securities held to maturity Amortized Cost $ 20,666 1,130 3,623 3,592 1,795 3,136 $ 33,942 $ 14,770 338 $ 15,108 Amortized Cost $ 12,879 1,701 1,874 2,261 2,757 2,495 $ 23,967 $ 16,722 1,040 $ 17,762 F-5 THE CHARLES SCHWAB CORPORATION Supplemental Financial Data for Charles Schwab Bank (Unaudited) (Dollars in Millions) December 31, 2009 Securities available for sale: U.S. agency residential mortgage-backed securities Non-agency residential mortgage-backed securities Certificates of deposit Corporate debt securities U.S. agency notes Asset-backed securities Total securities available for sale Securities held to maturity: U.S. agency residential mortgage-backed securities Other securities Total securities held to maturity Amortized Cost $ 11,601 2,460 1,950 2,368 2,975 1,077 $ 22,431 $ $ 5,105 1,734 6,839 Gross Unrealized Gains Gross Unrealized Losses $ $ $ $ 199 - 3 13 4 12 231 36 32 68 $ $ $ $ 21 519 - 1 1 - 542 27 - 27 Fair Value $ 11,779 1,941 1,953 2,380 2,978 1,089 $ 22,120 $ 5,114 1,766 $ 6,880 The maturities and related weighted-average yields of securities available for sale and securities held to maturity at December 31, 2011, are as follows: After 1 year After 5 years Within 1 year through 5 years through 10 years After 10 years Total $ $ $ Securities available for sale: U.S. agency residential mortgage-backed securities (1) Non-agency residential mortgage-backed securities (1) Certificates of deposit Corporate debt securities U.S. agency notes Asset-backed and other securities Total fair value Total amortized cost Weighted-average yield (2) Securities held to maturity: U.S. agency residential mortgage-backed securities (1) Other securities Total fair value Total amortized cost Weighted-average yield (2) (1) Residential mortgage-backed securities have been allocated over maturity groupings based on final contractual $ 17,969 894 - - - 1,565 $ 20,428 $ 20,483 1.70% - - 1,897 954 - 225 $ 3,076 $ 3,076 1.29% 2 - 1,725 2,517 1,800 812 $ 6,856 $ 6,871 1.11% 2,950 13 - 100 - 534 3,597 3,512 1.83% $ 12,617 - $ 12,617 $ 12,263 2.59% - 224 224 222 3.00% - 117 117 116 2.67% 2,581 - 2,581 2,507 2.57% $ $ $ $ $ $ $ $ $ $ $ $ 20,921 907 3,622 3,571 1,800 3,136 $ 33,957 $ 33,942 1.56% $ 15,198 341 $ 15,539 $ 15,108 2.60% maturities. Actual maturities will differ from final contractual maturities because borrowers on a certain portion of loans underlying these have the right to prepay their obligations. (2) The weighted-average yield is computed using the amortized cost at December 31, 2011. F-6 THE CHARLES SCHWAB CORPORATION Supplemental Financial Data for Charles Schwab Bank (Unaudited) (Dollars in Millions) 4. Cross-border Holdings The table below sets forth the amount of Schwab Bank’s cross-border holdings, based on carrying value, as of December 31, 2011. Such holdings, by country, that exceed 1% of total assets are disclosed separately, and such holdings, by country, that are between 0.75% and 1% of total assets are listed in the aggregate. Cross-border holdings are comprised of cash equivalents, securities available for sale, and securities held to maturity. Country United Kingdom Canada Sweden Switzerland, France and Australia Total Banks and other financial institutions Exposure as a % of total assets $ $ 1,450 1,098 712 1,849 5,109 2.2% 1.7% 1.1% 2.8% As of December 31, 2010, cross-border holdings in the United Kingdom were $1.5 billion (2.7% of total assets). As of December 31, 2009, cross-border holdings in the Netherlands and the United Kingdom were $351 million (0.8% of total assets) and $983 million (2.3% of total assets), respectively. 5. Loans to Banking Clients and Related Allowance for Loan Losses The composition of the loan portfolio is as follows: December 31, 2011 2010 2009 2008 2007 Residential real estate mortgages Home equity lines of credit Personal loans secured by securities Other Total loans to banking clients $ 5,596 3,509 742 16 $ 9,863 $ 4,695 3,500 562 16 $ 8,773 $ 3,710 3,304 366 11 $ 7,391 $ 3,195 2,662 187 18 $ 6,062 $ 2,101 1,234 102 13 $ 3,450 An analysis of nonaccrual loans is as follows: December 31, Nonaccrual loans Average nonaccrual loans 2011 52 51 $ $ 2010 51 40 $ $ 2009 2008 2007 $ $ 34 17 $ $ 8 6 $ $ 4 1 Changes in the allowance for loan losses were as follows: December 31, Balance at beginning of year Charge-offs Recoveries Provision for loan losses Balance at end of year 2011 2010 2009 2008 2007 $ $ 53 (19) 2 18 54 $ $ 45 (20) 1 27 53 $ $ 20 (13) - 38 45 $ $ 7 (4) - 17 20 $ $ 4 - - 3 7 F-7 THE CHARLES SCHWAB CORPORATION Supplemental Financial Data for Charles Schwab Bank (Unaudited) (Dollars in Millions) The maturities of the loan portfolio at December 31, 2011, are as follows: Residential real estate mortgages (1) Home equity lines of credit (2) Personal loans secured by securities Other Total (1) Maturities are based upon the contractual terms of the loans. (2) Maturities are based on an initial draw period of 10 years. Within 1 year After 1 year through 5 years $ $ - - 52 5 57 $ - 1,074 690 - $ 1,764 After 5 years 5,596 2,435 - 11 8,042 $ $ Total $ 5,596 3,509 742 16 $ 9,863 The interest sensitivity of loans with contractual maturities in excess of one year at December 31, 2011, is as follows: Loans with predetermined interest rates Loans with floating or adjustable interest rates Total 6. Summary of Credit Loss on Banking Loans Experience After 1 year $ $ 473 9,333 9,806 December 31, 2011 2010 2009 2008 2007 Average loans Allowance to year end loans Allowance to nonperforming loans Nonperforming assets to average loans and real estate owned $ 9,468 .55% 104% $ 7,983 .60% 104% $ 6,668 .61% 132% $ 4,831 .33% 235% $ 2,786 .20% 173% .59% .68% .51% .18% .14% 7. Deposits from Banking Clients Analysis of average daily deposits: Certificates of deposit of $100,000 or more Money market and other savings deposits Interest-bearing demand deposits Total deposits 2011 2010 2009 Amount Rate Amount Rate Amount Rate $ - 42,342 10,359 $ 52,701 - 0.09% 0.22% $ - 35,794 9,064 $ 44,858 - 0.18% 0.45% $ - 24,879 6,370 $ 31,249 - 0.14% 0.60% At December 31, 2011, the Company had one certificate of deposit of $100,000 or more, in the amount of $501,784, with a contractual maturity of over twelve months. 8. Ratios December 31, Return on average stockholder’s equity Return on average total assets Average stockholder’s equity as a percentage of average total assets 2011 2010 2009 13.99% 1.10% 14.22% 1.07% 21.95% 1.05% 7.83% 7.54% 4.76% F-8 THE CHARLES SCHWAB CORPORATION EXHIBIT 12.1 Computation of Ratio of Earnings to Fixed Charges (Dollar amounts in millions) (Unaudited) Year Ended December 31, 2011 2010 2009 2008 2007 Earnings from continuing operations before taxes on earnings $ 1,392 $ 779 $ 1,276 $ 2,028 $ 1,853 Fixed charges Interest expense: Deposits from banking clients Payables to brokerage clients Short-term borrowings Long-term debt Other Total Interest portion of rental expense Total fixed charges (A) 62 3 - 108 2 175 62 237 105 2 - 92 - 199 56 255 107 3 - 71 2 183 71 254 104 55 1 59 7 226 62 288 238 329 - 38 15 620 60 680 Earnings from continuing operations before taxes on earnings and fixed charges (B) $ 1,629 $ 1,034 $ 1,530 $ 2,316 $ 2,533 Ratio of earnings to fixed charges (B) ÷ (A) (1) 6.9 4.1 6.0 8.0 3.7 Ratio of earnings to fixed charges, excluding deposits from banking clients and payables to brokerage clients interest expense (2) 9.1 6.3 9.9 16.7 17.4 (1) (2) The ratio of earnings to fixed charges is calculated in accordance with SEC requirements. For such purposes, “earnings” consist of earnings from continuing operations before taxes on earnings and fixed charges. “Fixed charges” consist of interest expense as listed above, and one-third of rental expense, which is estimated to be representative of the interest factor. Because interest expense incurred in connection with both deposits from banking clients and payables to brokerage clients is completely offset by interest revenue on related investments and loans, the Company considers such interest to be an operating expense. Accordingly, the ratio of earnings to fixed charges, excluding deposits from banking clients and payables to brokerage clients interest expense, reflects the elimination of such interest expense as a fixed charge. THE CHARLES SCHWAB CORPORATION Subsidiaries of the Registrant EXHIBIT 21.1 Pursuant to Item 601 (b)(21)(ii) of Regulation S-K, certain subsidiaries of the Registrant have been omitted which, considered in the aggregate as a single subsidiary, would not constitute a significant subsidiary (as defined in Rule 1-02(w) of Regulation S-X) as of December 31, 2011. The following is a listing of the significant subsidiaries of the Registrant: Schwab Holdings, Inc. (holding company for Charles Schwab & Co., Inc.), a Delaware corporation Charles Schwab & Co., Inc., a California corporation Charles Schwab Bank, a Federal Savings Association Charles Schwab Investment Management, Inc., a Delaware corporation CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM We consent to the incorporation by reference in the following Registration Statements of our report dated February 23, 2012, relating to the consolidated financial statements and financial statement schedule of The Charles Schwab Corporation and the effectiveness of The Charles Schwab Corporation’s internal control over financial reporting, appearing in this Annual Report on Form 10-K of The Charles Schwab Corporation for the year ended December 31, 2011. EXHIBIT 23.1 Filed on Form S-3: Registration Statement No. 333-178525 Filed on Form S-8: (Debt Securities, Preferred Stock, Depository Shares, Common Stock, Purchase Contracts, Warrants, and Units Consisting of Two or More Securities) Registration Statement No. 333-175862 (The Charles Schwab Corporation 2004 Stock Incentive Plan) Registration Statement No. 333-173635 (optionsXpress Holdings, Inc. 2008 Equity Incentive Plan, optionsXpress Holdings, Inc. 2005 Equity Incentive Plan, and optionsXpress, Inc. 2001 Equity Incentive Plan) Registration Statement No. 333-144303 (The Charles Schwab Corporation Employee Stock Purchase Plan) Registration Statement No. 333-131502 (The Charles Schwab Corporation Deferred Compensation Plan II) Registration Statement No. 333-101992 (The Charles Schwab Corporation 2004 Stock Incentive Plan) Registration Statement No. 333-93125 (The Charles Schwab Corporation Employee Stock Incentive Plan) Registration Statement No. 333-81840 (The Charles Schwab Corporation Employee Stock Incentive Plan) Registration Statement No. 333-71322 (The SchwabPlan Retirement Savings and Investment Plan) Registration Statement No. 333-63452 (The Charles Schwab Corporation Employee Stock Incentive Plan) Registration Statement No. 333-63448 (The Charles Schwab Corporation 2004 Stock Incentive Plan) Registration Statement No. 333-59280 (The Charles Schwab Corporation Employee Stock Incentive Plan) Registration Statement No. 333-48335 (The Charles Schwab Corporation Employee Stock Incentive Plan) Registration Statement No. 333-47107 (The Charles Schwab Corporation 2004 Stock Incentive Plan) Registration Statement No. 333-44793 (Charles Schwab Profit Sharing and Employee Stock Ownership Plan) /s/ Deloitte & Touche LLP San Francisco, California February 23, 2012 THE CHARLES SCHWAB CORPORATION Exhibit 31.1 CERTIFICATION PURSUANT TO RULE 13a-14(a)/15d-14(a), AS ADOPTED PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 I, Walter W. Bettinger II, certify that: 1. I have reviewed this Annual Report on Form 10-K of The Charles Schwab Corporation; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and 5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting. Date: February 23, 2012 /s/ Walter W. Bettinger II Walter W. Bettinger II President and Chief Executive Officer THE CHARLES SCHWAB CORPORATION Exhibit 31.2 CERTIFICATION PURSUANT TO RULE 13a-14(a)/15d-14(a), AS ADOPTED PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 I, Joseph R. Martinetto, certify that: 1. I have reviewed this Annual Report on Form 10-K of The Charles Schwab Corporation; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and 5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting. Date: February 23, 2012 /s/ Joseph R. Martinetto Joseph R. Martinetto Executive Vice President and Chief Financial Officer THE CHARLES SCHWAB CORPORATION Exhibit 32.1 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of The Charles Schwab Corporation (the Company) on Form 10-K for the year ended December 31, 2011 (the Report), I, Walter W. Bettinger II, President and Chief Executive Officer of the Company, hereby certify, pursuant to 18 U.S.C. section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002, that to the best of my knowledge: (1) (2) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company for the periods presented therein. /s/ Walter W. Bettinger II Walter W. Bettinger II President and Chief Executive Officer Date: February 23, 2012 A signed original of this written statement required by Section 906 has been provided to The Charles Schwab Corporation and will be retained by The Charles Schwab Corporation and furnished to the Securities and Exchange Commission or its staff upon request. THE CHARLES SCHWAB CORPORATION Exhibit 32.2 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of The Charles Schwab Corporation (the Company) on Form 10-K for the year ended December 31, 2011 (the Report), I, Joseph R. Martinetto, Executive Vice President and Chief Financial Officer of the Company, hereby certify, pursuant to 18 U.S.C. section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002, that to the best of my knowledge: (1) (2) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company for the periods presented therein. /s/ Joseph R. Martinetto Joseph R. Martinetto Executive Vice President and Chief Financial Officer Date: February 23, 2012 A signed original of this written statement required by Section 906 has been provided to The Charles Schwab Corporation and will be retained by The Charles Schwab Corporation and furnished to the Securities and Exchange Commission or its staff upon request. i BOARD OF DIRECTORS CHARLES R. SCHWAB Chairman of the Board, The Charles Schwab Corporation Age: 74. Director since 1986; term expires in 2013. NANCY H. BECHTLE Chairman, Sugar Bowl Corporation Age: 74. Director since 1992; term expires in 2012. Member of the Compensation Committee; Nominating and Corporate Governance Committee. WALTER W. BETTINGER II President and Chief Executive Officer, The Charles Schwab Corporation Age: 51. Director since 2008; term expires in 2012. C. PRESTON BUTCHER Chairman and Chief Executive Officer, Legacy Partners, a real estate development and management firm Age: 73. Director since 1988; term expires in 2012. Member of the Audit Committee; Nominating and Corporate Governance Committee. FRANK C. HERRINGER Chairman of the Board of Transamerica Corporation, a financial services company Age: 69. Director since 1996; term expires in 2014. Chairman of the Nominating and Corporate Governance Committee; member of the Compensation Committee. PAULA A. SNEED Chairman and Chief Executive Officer, Phelps Prescott Group, LLC, a strategy and management consulting firm Age: 64. Director since 2002; term expires in 2013. Member of the Compensation Committee; Nominating and Corporate Governance Committee. STEPHEN T. McLIN Chairman and Chief Executive Officer, STM Holdings LLC, which offers merger and acquisition advice Age: 65. Director since 1988; term expires in 2014. Chairman of the Audit Committee; member of the Nominating and Corporate Governance Committee. ARUN SARIN Former Chief Executive Officer, Vodafone Group Plc, a mobile telecommunications company Age: 57. Director since 2009; term expires in 2013. Member of the Audit Committee; Nominating and Corporate Governance Committee. ROGER O. WALTHER Chairman and Chief Executive Officer, Tusker Corporation, a real estate and business management company Age: 76. Director since 1989; term expires in 2014. Chairman of the Compensation Committee; member of the Nominating and Corporate Governance Committee. ROBERT N. WILSON Chairman, Still River Systems, a medical device company Age: 71. Director since 2003; term expires in 2014. Member of the Compensation Committee; Nominating and Corporate Governance Committee. . r e p a p d e l c y c e r n o d e t n i r p s i t r o p e r e r i t n e s i h T | s e v a e r G i n o T y b y h p a r g o t o h p i n a M | . c n I , x i h p a r g o h t i L y b g n i t n i r P | A G , a t n a l t A , . c n I , y r a d n u o b n U y b n g i s e D + y g e t a r t S ii CORPORATE INFORMATION THE CHARLES SCHWAB CORPORATION 211 Main Street San Francisco, CA 94105 (415) 667-7000 www.aboutschwab.com The Charles Schwab Corporation is a leading provider of financial services, with more than 300 offices and 8.6 million active brokerage accounts, 1.49 million corporate retirement plan participants, 780,000 banking accounts, and $1.68 tril- lion in client assets. Through its operating subsidiaries, the company provides a full range of securities brokerage, banking, money management, and financial advisory services to individual investors and independent investment advisors. Our ticker symbol is SCHW and our common stock is listed on NYSE. CEO AND CFO CERTIFICATIONS The Charles Schwab Corporation has included as exhibits to its Annual Report on Form 10-K for the year ended December 31, 2011, filed with the Securities and Exchange Commission, certificates of its Chief Executive Officer and Chief Financial Officer certifying the quality of the company’s public disclosure. PUBLICATIONS To obtain the company’s annual report, 10-K, 10-Q, quarterly earnings report, or other publications without charge, contact: Charles Schwab Investor Relations 211 Main Street San Francisco, CA 94105 (415) 667-1959 These documents may also be viewed in the Investor Relations section of the company’s website at www.aboutschwab.com. © 2012 The Charles Schwab Corporation. All rights reserved. TRADEMARKS OR REGISTERED TRADEMARKS Charles Schwab, Schwab, Talk to Chuck, Schwab Bank, and other trademarks ap- pearing herein, which may be indicated by “®” and “™”, are registered trademarks or trademarks of Charles Schwab & Co., Inc., in the U.S. and/or other countries. These trademarks and registered trademarks are proprietary to Charles Schwab & Co., Inc., in the U.S. and/or other countries. ANNUAL MEETING The annual meeting of stockholders will be conducted at 2:00 p.m. (Pacific Time) on Thursday, May 17, 2012, at 211 Main Street, San Francisco, CA, and via the Internet. To register, visit www.schwabevents.com/corporation STOCK OWNERSHIP SERVICES All stockholders of record are welcome to participate in The Charles Schwab Corporation Dividend Reinvestment and Stock Purchase Plan, managed by Wells Fargo Bank, N.A. For information on the Dividend Reinvestment and Stock Purchase Plan, or for assistance on stock ownership questions, contact: Transfer Agent & Registrar Wells Fargo Bank, N.A. Shareowner Services P.O. Box 64854 St. Paul, MN 55164 (800) 468-9716 www.wellsfargo.com/shareownerservices INDEPENDENT AUDITORS Deloitte & Touche LLP 555 Mission Street San Francisco, CA 94105 (415) 783-4000 www.deloitte.com CUSTOMER SERVICE Investor Services: (800) 435-4000 www.schwab.com Advisor Services: (877) 456-0777 www.schwabadvisorcenter.com/public Corporate and Retirement Services: (877) 456-0777, scrs.schwab.com THE CHARLES SCHWAB CORPORATION Office of the Corporate Secretary (415) 667-9807 CHARLES SCHWAB FOUNDATION Carrie Schwab-Pomerantz, President, Charles Schwab Foundation, and Senior Vice President Phone: (877) 408-5438 www.aboutschwab.com/community INVESTOR RELATIONS Richard G. Fowler, Senior Vice President, Investor Relations Phone: (415) 667-1841 E-mail: investor.relations@schwab.com LEGISLATIVE AND REGULATORY AFFAIRS Jeffrey T. Brown, Senior Vice President, Legislative and Regulatory Affairs 325 7th Street NW, Suite 200 Washington, DC 20004 (202) 662-4902 NEWS MEDIA Greg Gable, Senior Vice President, Corporate Public Relations Media Hotline: (888) 767-5432 E-mail: public.relations@schwab.com OUTSIDE COUNSEL Arnold & Porter LLP 3 Embarcadero Center, 7th Floor San Francisco, CA 94111-4024 (415) 434-1600 www.arnoldporter.com More people. More stories. Experience the real-life relationships we have with our clients at aboutschwab.com. THE CHARLES SCHWAB CORPORATION 211 Main Street San Francisco, CA 94105 (415) 667-7000 www.schwab.com www.aboutschwab.com MKT10448-24 (3/12) 

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