5.

Loans to Banking Clients and Related Allowance for Loan Losses

The composition of loans to banking clients by loan segment is as follows:

 

		September 30, 2012				December 31, 2011
Residential real estate mortgages		$	5,982			$	5,596
Home equity lines of credit			3,346				3,509
Personal loans secured by securities			807				742
Other			24				19
Total loans to banking clients (1)			10,159				9,866
Allowance for loan losses			(57	)			(54	)
Total loans to banking clients – net		$	10,102			$	9,812

 

(1)	All loans are evaluated for impairment by loan segment.

The Company records an allowance for loan losses through a charge to earnings based on management’s evaluation of probable losses in the existing portfolio. Management reviews the allowance for loan losses quarterly, taking into consideration current economic conditions, the composition of the existing loan portfolio, past loss experience, and risks inherent in the portfolio to ensure that the allowance for loan losses is maintained at an appropriate level.

The methodology to establish an allowance for loan losses utilizes statistical models that estimate prepayments, defaults, and probable losses for the loan segments based on predicted behavior of individual loans within the segments. The methodology considers the effects of borrower behavior and a variety of factors including, but not limited to, interest rates, housing price movements as measured by a housing price index, economic conditions, estimated defaults and foreclosures measured by historical and expected delinquencies, changes in prepayment speeds, loan-to-value (LTV) 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.

Probable losses are forecast using a loan-level simulation of the delinquency status of the loans over the term of the loans. The simulation starts with the current relevant risk indicators, including the current delinquent status of each loan, the estimated current LTV ratio of each loan, the term and structure of each loan, current key interest rates including U.S. Treasury and LIBOR rates, and borrower FICO scores. The more significant variables included in the simulation include delinquency roll rates, loss severity, housing prices, and interest rates. Delinquency roll rates (i.e., the rates at which loans transition through delinquency stages and ultimately result in a loss) are estimated from the Company’s historical loss experience adjusted for current trends and market information. Further, the delinquency roll rates within the loan-level simulation discussed above are calibrated to match a moving average of the delinquency roll rates actually experienced in the respective first lien residential real estate mortgage loan (First Mortgage) and home equity line of credit (HELOC) portfolios. 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. As a result, the current state of house prices, including the decrease in general house prices experienced over the last several years, as well as the current state of delinquencies unique to the Company’s First Mortgage and HELOC portfolios, are considered in the allowance for loan loss methodology.

This methodology results in a loss factor that is applied to the outstanding balances to determine the allowance for loan loss for each loan segment.

 

Changes in the allowance for loan losses were as follows:

 

Three Months Ended		September 30, 2012												September 30, 2011
		Residential real estate mortgages				Home equity lines of credit				Total				Residential real estate mortgages				Home equity lines of credit				Total
Balance at beginning of period		$	34			$	17			$	51			$	34			$	16			$	50
Charge-offs			(2	)			(3	)			(5	)			(2	)			(3	)			(5	)
Recoveries			1				—				1				—				—				—
Provision for loan losses			2				8				10				6				2				8
Balance at end of period		$	35			$	22			$	57			$	38			$	15			$	53
Nine Months Ended		September 30, 2012												September 30, 2011
		Residential real estate mortgages				Home equity lines of credit				Total				Residential real estate mortgages				Home equity lines of credit				Total
Balance at beginning of period		$	40			$	14			$	54			$	38			$	15			$	53
Charge-offs			(6	)			(7	)			(13	)			(8	)			(6	)			(14	)
Recoveries			2				—				2				—				1				1
Provision for loan losses			(1	)			15				14				8				5				13
Balance at end of period		$	35			$	22			$	57			$	38			$	15			$	53

Included in the loan portfolio are nonaccrual loans totaling $46 million and $52 million at September 30, 2012 and December 31, 2011, respectively. There were no loans accruing interest that were contractually 90 days or more past due at September 30, 2012 or December 31, 2011. 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 the first nine months of 2012 or 2011. Nonperforming assets, which include nonaccrual loans and other real estate owned, totaled $50 million and $56 million at September 30, 2012 and December 31, 2011, 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 September 30, 2012 or December 31, 2011.

In the first quarter of 2012, Schwab Bank launched a co-branded loan origination program for Schwab Bank clients (the Program) with Quicken Loans, Inc. (Quicken^® Loans^®). Pursuant to the Program, Quicken Loans originates and services loans for Schwab Bank clients and Schwab Bank sets the underwriting standards and pricing for those loans it intends to purchase for its portfolio. These underwriting standards are the same standards that Schwab Bank applied previously to its originated loans. The First Mortgage portion of the Program launched in March 2012 and is included in the originated and purchased first mortgages loan class as of September 30, 2012, in the tables below. The HELOC portion of the Program was launched in May 2012. Under the Program, Schwab Bank purchases all HELOC loans to Schwab Bank clients that are originated by Quicken Loans.

 

The delinquency aging analysis by loan class is as follows:

 

September 30, 2012		Current				30-59 days past due				60-89 days past due				Greater than 90 days				Total past due				Total loans
Residential real estate mortgages:
Originated and purchased first mortgages		$	5,751			$	30			$	3			$	33			$	66			$	5,817
Other purchased first mortgages			160				1				—				4				5				165
Home equity lines of credit			3,326				8				3				9				20				3,346
Personal loans secured by securities			807				—				—				—				—				807
Other			24				—				—				—				—				24
Total loans to banking clients		$	10,068			$	39			$	6			$	46			$	91			$	10,159
December 31, 2011
Residential real estate mortgages:
Originated first mortgages		$	5,380			$	16			$	2			$	39			$	57			$	5,437
Purchased first mortgages			152				2				—				5				7				159
Home equity lines of credit			3,494				5				2				8				15				3,509
Personal loans secured by securities			741				1				—				—				1				742
Other			19				—				—				—				—				19
Total loans to banking clients		$	9,786			$	24			$	4			$	52			$	80			$	9,866

In addition to monitoring delinquency characteristics, 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 (Origination FICO), updated borrower FICO scores (Updated FICO), LTV ratios at origination (Origination LTV), and estimated current LTV ratios (Estimated Current 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 September 2012. The Origination LTV and Estimated Current LTV ratios for a HELOC include any first lien mortgage outstanding on the same property at the time of the HELOC’s origination. The Estimated Current LTV for each loan is estimated by reference to a home price appreciation index.

 

		Residential real estate mortgages
September 30, 2012		Originated and purchased first mortgages				Other purchased first mortgages				Total				Home equity lines of credit
Year of origination
Pre-2008		$	489			$	57			$	546			$	1,220
2008			430				6				436				1,180
2009			354				6				360				362
2010			1,128				14				1,142				270
2011			1,606				62				1,668				214
2012			1,810				20				1,830				100
Total		$	5,817			$	165			$	5,982			$	3,346
Origination FICO
< 620		$	10			$	1			$	11			$	—
620 - 679			96				18				114				24
680 - 739			1,061				40				1,101				643
³740			4,650				106				4,756				2,679
Total		$	5,817			$	165			$	5,982			$	3,346
Updated FICO
< 620		$	56			$	6			$	62			$	47
620 - 679			163				11				174				111
680 - 739			862				39				901				505
³740			4,736				109				4,845				2,683
Total		$	5,817			$	165			$	5,982			$	3,346
Origination LTV
£70%		$	3,807			$	103			$	3,910			$	2,263
>70% - £90%			1,994				55				2,049				1,056
>90% - £100%			16				7				23				27
Total		$	5,817			$	165			$	5,982			$	3,346

 

September 30, 2012		Balance				Weighted Average   Updated FICO				Utilization         Rate (1)				Percent of Loans that are 90+ Days Past Due and Less than 90 Days Past Due but on Nonaccrual Status
Residential real estate mortgages:
Estimated Current LTV
£70%		$	4,024				774				N/A				0.26	%
>70% - £90%			1,557				764				N/A				0.41	%
>90% - £100%			171				748				N/A				1.31	%
>100%			230				748				N/A				1.96	%
Total		$	5,982				769				N/A				0.39	%
Home equity lines of credit:
Estimated Current LTV
£70%		$	1,704				775				37	%			0.07	%
>70% - £90%			1,013				767				47	%			0.33	%
>90% - £100%			265				762				54	%			0.40	%
>100%			364				754				61	%			0.83	%
Total		$	3,346				769				42	%			0.26	%

 

(1)	The Utilization Rate is calculated using the outstanding HELOC balance divided by the associated total line of credit.

N/A Not applicable.

 

		Residential real estate mortgages												Home equity lines of credit
December 31, 2011		Originated first mortgages				Purchased first mortgages				Total
Year of origination
Pre-2008		$	569			$	60			$	629			$	1,306
2008			538				8				546				1,262
2009			553				10				563				412
2010			1,757				17				1,774				311
2011			2,020				64				2,084				218
Total		$	5,437			$	159			$	5,596			$	3,509
Origination FICO
<620		$	9			$	2			$	11			$	—
620 - 679			108				19				127				24
680 - 739			1,030				43				1,073				667
³740			4,290				95				4,385				2,818
Total		$	5,437			$	159			$	5,596			$	3,509
Updated FICO
<620		$	55			$	7			$	62			$	49
620 - 679			162				11				173				112
680 - 739			831				44				875				520
³740			4,389				97				4,486				2,828
Total		$	5,437			$	159			$	5,596			$	3,509
Origination LTV
£70%		$	3,507			$	91			$	3,598			$	2,378
>70% - £90%			1,904				60				1,964				1,091
>90% - £100%			26				8				34				40
Total		$	5,437			$	159			$	5,596			$	3,509

 

December 31, 2011		Balance				Weighted Average   Updated FICO				Utilization         Rate (1)				Percent of Loans that are 90+ Days Past Due and Less than 90 Days Past Due but on Nonaccrual Status
Residential real estate mortgages:
Estimated Current LTV
£70%		$	3,200				773				N/A				0.27	%
>70% - £90%			1,764				766				N/A				0.41	%
>90% - £100%			241				758				N/A				1.33	%
>100%			391				748				N/A				2.34	%
Total		$	5,596				768				N/A				0.50	%
Home equity lines of credit:
Estimated Current LTV
£70%		$	1,561				774				37	%			0.09	%
>70% - £90%			1,099				769				46	%			0.26	%
>90% - £100%			328				765				54	%			0.16	%
>100%			521				755				58	%			0.75	%
Total		$	3,509				769				43	%			0.25	%

 

(1)	The Utilization Rate is calculated using the outstanding HELOC balance divided by the associated total line of credit.

N/A Not applicable.

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 borrowings at September 30, 2012 and December 31, 2011.