The reported, but as yet unannounced, $26 billion purchase of TD Ameritrade by Charles Schwab has the financial-advice community in a tizzy. The deal, if it goes through, is set to reduce competition for clearing and custody services for advisors, industry watchers say — by uniting more than 14,000 RIAs and some $5.1 trillion in total assets.
But advisors should be thinking about the news more broadly, key industry watchers insist. The deal is really about the retail or individual investor side of the business and, thus, more attention should be paid to that segment and how changes there could affect the RIA side.
While acknowledging the potential for the deal to hurt RIAs with less than $100 million in client assets, popular blogger and financial planner Michael Kitces said on Twitter: “However, the whole point of this deal for Schwab is to bulk up assets and get better economies of scale. Suspect we won’t see small TD advisors get the boot anytime in the next few years at least. However, will likely get bottom tier Schwab service teams & little other support?”
“In fact, notwithstanding the advisor focus on the prospective deal, suspect Schwab buying TDA is first & foremost about overall asset scale (regardless of channel), second about getting TD retail assets to cross-sell into Schwab solutions, & only third about bulking up on RIAs,” Kitces explained in another tweet.
When it comes to assets, Charles Schwab has about $2 trillion in retail investor, or DIY, accounts, and about $1.8 trillion in advisor-services accounts. TD Ameritrade doesn’t report its advisors assets, but most industry estimates put it at $600 billion (out of the firm’s $1.3 trillion in total assets).
This means the combined entity would have about $2.7 trillion in individual investor assets and roughly $2.4 trillion in assets tied to RIAs and their clients.
Just a few months ago, Schwab struck a deal to add some $90 billion in retail client assets by buying part of USAA’s brokerage business for $1.8 billion.
As for TD Ameritrade, its $40-billion Scottrade purchase of 2017 gave it an extra $170 billion in retail client assets.
(The two firms also have been getting rid on businesses not directly tied to the DIY investor channel. Schwab sold its PortfolioCenter technology to Envestnet earlier this year, while TD Ameritrade Trust sold its retirement-plan custody and trust assets to Broadridge Financial Solutions.)
What about revenues? TD Ameritrade relied more heavily on commissions, which accounted for 36% of net revenues in 2018 vs. Schwab, at 7% at Schwab.
In the quarter ended Sept. 30, Schwab had total sales of $2.7 billion; the lion’s share came from net interest income at $1.6 billion. (Administrative fees and asset management, which includes Schwab’s own funds and its Private Client Manage Portfolios, brought in some $825 million, while trading produced $172 million.)
For TD Ameritrade, of its $1.6 billion in net revenues in the latest period, it derived about $500 million from commissions/transaction fees, $440 million from bank deposit accounts, $414 million from net interest and $150 from investment-product fees.
As for profits, Schwab’s earnings on DIY-investor client assets have been about two times those tied advisor assets, according to Michael Wong, director of equity research, financial services-North America, for Morningstar Research Services.
“For TD Ameritrade, it’s estimated that about two-thirds of its earnings are from retail investors, even with a 50/50 asset split” between DIY and RIA accounts, Wong explained. “That’s a reasonable back-of-the-envelope calculation.”
In addition, there’s been some industry discussion of late about the movement of client cash into Schwab’s proprietary money market fund, which yields roughly 12 basis points.
“Considering the Fed Funds rate is 200 basis points, they’re making a ton on client cash,” said one industry executive who spoke exclusively to ThinkAdvisor and wished to go unnamed.
In its latest quarterly report, Schwab explained about $11% of total client assets, roughly $450 billion or more, sits in cash — much of which could yield 188 basis points for the firm; meanwhile, the custody business for RIAs brings in just 8 to 12 basis points on assets, according to analysts.
“The key theme here is this is a retail play not a custody play. Chuck [Schwab] knows how to go where the money is and has done this often since he invented the discounted brokerage model and became dominant in that field,” the industry veteran said.
According to Kitces, “The real game-changer, though, is that I think Schwab is about to launch a giant retail Direct Indexing offering. Thus the no-commission trades, AND the fractional trading rollout. Schwab is trying to get enough scale to actually kill the mutual fund & ETF industry altogether?”
This outlook comes about a month after Schwab went public with plans to let investors buy and sell fractions of shares, a move that seems aimed at attracting more young DIY investors.
“A $5T+ direct indexing platform opens up immense new revenue opportunities for Schwab,” Kitces tweeted. “Perhaps charging bps for the service. And turning mutual fund & ETF business into a zillion individual stocks can explode payments for order flow & securities lending?”
The direct-indexing field is changing fast. Last week, Motif launched its first free direct-index portfolio, which uses an algorithm to track 500 large-cap companies; the product has a $10,000 minimum.
“Schwab has already intimated that Direct Indexing offering would probably be retail first, though, as advisors are ‘slow adopters’ of such new solutions. (And frankly, #AdvisorTech to manage it is more complex to build & integrate.) Buying TDA retail just expands opportunity,” concluded Kitces.
Returning to the RIA side of the deal, Kitces believes the advisor industry’s dominant reaction to it is perplexing.
“In fact, it’s been surprising that amongst the advisor community, the buzz about a prospective #Schwabitrade has been almost entirely NEGATIVE. No one is excited about lower-cost w/ scale. Just reduced competition & fear service levels may decline (especially for small RIAs),” he said on Twitter.
“Nonetheless, custody & clearing is a scale business. That’s WHY all the big RIA platforms are also retail platforms. They need the mass. Schwab wants more, & I can’t fault them. The question is what #Schwabitrade is really planning to DO with it?” Kitces asked.
This remains to be seen. It’s possible that the combined entity could use “its branding power and pricing power to further undercut advisor fees” in general, the industry insider cautioned.
“When you look at both their advertising and marketing to promote financial planning, wealth management and portfolio management, it looks like they are going after the highly fragmented RIA market made of small firms, and the reps affiliated with independent contractor broker-dealers,” the execution said.
“For RIAs to use these firms as their custodian would be the same as using Merrill Lynch, or Morgan Stanley …,” he added.
The blockbuster deal raises questions for advisors clearly, the financial-services veteran says, “but the biggest concern should be the threat to their [value] proposition because of pricing, branding and service challenges” in a more consolidated and competitive field.
– See Schwab-TD Ameritrade Deal Is No Sure Thing on ThinkAdvisor; and Schwab to Buy TD Ameritrade for $26 Billion: Report