8.

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:

 

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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. The Company did not transfer any assets or liabilities between Level 1 and Level 2 during the first nine months of 2012, or the year ended December 31, 2011.

 

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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.

 

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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 September 30, 2012 or December 31, 2011.

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. The Company uses the market and income approaches to determine the fair value of assets and liabilities. When available, the Company uses quoted prices in active markets to measure the fair value of assets. When utilizing market data with a bid-ask spread, the Company uses the price within the bid-ask spread that best represents fair value. 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 generally obtains prices from at least three independent pricing sources for assets recorded at fair value and may obtain up to five prices on assets with higher risk of limited observable information, such as non-agency residential mortgage-backed securities. The Company’s primary independent pricing service provides prices based on observable trades and discounted cash flows that incorporate observable information such as yields for similar types of securities (a benchmark interest rate plus observable spreads) and weighted-average maturity for the same or similar “to-be-issued” securities. The Company compares the prices obtained from its primary independent pricing service to the prices obtained from the additional independent pricing services to determine if the price obtained from the primary independent pricing service is reasonable. 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 September 30, 2012 and December 31, 2011, the Company did not adjust prices received from the primary independent third-party pricing service. 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:

 

September 30, 2012		Quoted Prices in Active Markets for Identical Assets (Level 1)				Significant Other Observable Inputs (Level 2)				Significant     Unobservable     Inputs (Level 3)				Balance at Fair Value
Cash equivalents:
Money market funds		$	218			$	—			$	—			$	218
Commercial paper			—				866				—				866
Total cash equivalents			218				866				—				1,084
Investments segregated and on deposit for regulatory purposes:
Certificates of deposit			—				2,675				—				2,675
Corporate debt securities			—				535				—				535
Total investments segregated and on deposit for regulatory purposes			—				3,210				—				3,210
Other securities owned:
Schwab Funds® money market funds			244				—				—				244
Equity and bond mutual funds			183				—				—				183
State and municipal debt obligations			—				55				—				55
Equity, U.S. Government and corporate debt, and other securities			1				30				—				31
Total other securities owned			428				85				—				513
Securities available for sale:
U.S. agency residential mortgage-backed securities			—				23,772				—				23,772
Non-agency residential mortgage-backed securities			—				782				—				782
Corporate debt securities			—				5,610				—				5,610
Certificates of deposit			—				5,536				—				5,536
Commercial paper			—				449				—				449
U.S. agency notes			—				350				—				350
Asset-backed and other securities			—				5,949				—				5,949
Total securities available for sale			—				42,448				—				42,448
Total		$	646			$	46,609			$	—			$	47,255

 

December 31, 2011		Quoted Prices in Active Markets for Identical Assets (Level 1)				Significant Other Observable Inputs (Level 2)				Significant     Unobservable     Inputs (Level 3)				Balance at Fair Value
Cash equivalents:
Money market funds		$	8			$	—			$	—			$	8
Commercial paper			—				814				—				814
Total cash equivalents			8				814				—				822
Investments segregated and on deposit for regulatory purposes:
Certificates of deposit			—				2,374				—				2,374
Corporate debt securities			—				767				—				767
U.S. Government securities			—				650				—				650
Total investments segregated and on deposit for regulatory purposes			—				3,791				—				3,791
Other securities owned:
Schwab Funds® money market funds			332				—				—				332
Equity and bond mutual funds			183				—				—				183
State and municipal debt obligations			—				46				—				46
Equity, U.S. Government and corporate debt, and other securities			12				20				—				32
Total other securities owned			527				66				—				593
Securities available for sale:
U.S. agency residential mortgage-backed securities			—				20,921				—				20,921
Non-agency residential mortgage-backed securities			—				907				—				907
Corporate debt securities			—				3,571				—				3,571
Certificates of deposit			—				3,622				—				3,622
Commercial paper			—				225				—				225
U.S. agency notes			—				1,800				—				1,800
Asset-backed and other securities			—				2,919				—				2,919
Total securities available for sale			—				33,965				—				33,965
Total		$	535			$	38,636			$	—			$	39,171

Financial Instruments Not Recorded at Fair Value

Descriptions of the valuation methodologies and assumptions used to estimate the fair value of financial instruments not recorded at fair value are described below. There were no significant changes in these methodologies or assumptions during the first nine months of 2012.

Cash and cash equivalents, receivables from/payables to brokers, dealers, and clearing organizations, and receivables from/payables to brokerage clients are short-term in nature and accordingly are recorded at amounts that approximate fair value. Cash and cash equivalents include cash and highly liquid investments with original maturities of three months or less. Receivables from/payables to brokers, dealers, and clearing organizations, and receivables from/payables to brokerage clients are recorded at or near transaction price and historically have been settled or converted to cash at approximately that value.

Cash and investments segregated and on deposit for regulatory purposes include cash and 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 securities 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 similar to investment assets recorded at fair value as discussed above.

 

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 prices obtained from independent third-party pricing services for mortgage-backed securities collateralized by similar types of loans. The Company may adjust the independent third-party prices to account for differences between comparable mortgage-backed securities and loans to banking clients.

Loans held for sale at December 31, 2011, included fixed-rate and adjustable-rate residential first-mortgage loans intended for sale. Loans held for sale were recorded at the lower of cost or fair value. The fair value of the Company’s loans held for sale was estimated using quoted market prices for securities backed by similar types of loans.

Other assets – Financial instruments included in other assets primarily consist of cost method investments and Federal Home Loan Bank (FHLB) stock, whose carrying values approximate their fair values. FHLB stock is 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.

Accrued expenses and other liabilities – Financial instruments included in accrued expenses and other liabilities consist of drafts payable and certain amounts due under contractual obligations which are short-term in nature and accordingly are recorded at amounts that approximate fair value.

Long-term debt includes Senior Notes, Senior Medium-Term Notes, Series A, and a finance lease obligation. The fair values of the Senior Notes and Senior Medium-Term Notes, Series A, are estimated using indicative non-binding quotes from independent brokers. The Company validates indicative prices for its debt through comparison to other independent non-binding quotes. The finance lease obligation is recorded at carrying value, which approximates fair value. Long-term debt at December 31, 2011, included Junior Subordinated Notes, which were estimated using indicative non-binding quotes from independent brokers.

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 rates earned on these balances are based on 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 following table presents the fair value hierarchy for financial instruments not recorded at fair value at September 30, 2012:

 

		Carrying Amount				Quoted Prices  in Active Markets  for Identical Assets (Level 1)				Significant  Other Observable  Inputs (Level 2)				Significant     Unobservable     Inputs (Level 3)				Balance at Fair Value
Assets:
Cash and cash equivalents		$	7,439			$	—			$	7,439			$	—			$	7,439
Cash and investments segregated and on deposit for regulatory purposes			21,824				—				21,824				—				21,824
Receivables from brokers, dealers, and clearing organizations			607				—				607				—				607
Receivables from brokerage clients – net			11,909				—				11,909				—				11,909
Securities held to maturity:
U.S. agency residential mortgage-backed securities			15,450				—				16,067				—				16,067
Other securities			162				—				162				—				162
Total securities held to maturity			15,612				—				16,229				—				16,229
Loans to banking clients – net:
Residential real estate mortgages			5,947				—				6,028				—				6,028
Home equity lines of credit			3,324				—				3,315				—				3,315
Personal loans secured by securities			807				—				807				—				807
Other			24				—				24				—				24
Total loans to banking clients – net			10,102				—				10,174				—				10,174
Other assets			64				—				64				—				64
Total		$	67,557			$	—			$	68,246			$	—			$	68,246
Liabilities:
Deposits from banking clients		$	68,756			$	—			$	68,756			$	—			$	68,756
Payables to brokers, dealers, and clearing organizations			1,445				—				1,445				—				1,445
Payables to brokerage clients			34,761				—				34,761				—				34,761
Accrued expenses and other liabilities			546				—				546				—				546
Long-term debt			1,776				—				1,717				—				1,717
Total		$	107,284			$	—			$	107,225			$	—			$	107,225

The following table presents the Company’s fair value estimates for financial instruments not recorded at fair value at December 31, 2011. The table excludes short-term financial assets and liabilities, for which carrying amounts approximate fair value, and financial instruments recorded at fair value.

 

		Carrying Amount				Fair Value
Financial Assets:
Securities held to maturity		$	15,108			$	15,539
Loans to banking clients – net		$	9,812			$	9,671
Loans held for sale		$	70			$	73
Financial Liabilities:
Long-term debt		$	2,001			$	2,159