TD Ameritrade’s USD4 billion acquisition of Scottrade Financial Services is part of a broader trend in the US retail brokerage sector to grow banking and asset management businesses in the face of trading commission revenue pressure, says Fitch Ratings.
Fitch believes that another large-scale merger is possible over the longer term, with E*Trade Financial Corporation, the smallest of the remaining large discount retail brokers, being a potential target.
Over the medium and long term, Fitch expects revenue diversification and growing wallet share to remain major themes for the sector.
Price competition for trading commissions has intensified alongside the growth of zero-commission trading on some exchange-traded funds for certain accounts.
Fitch believes that further downward pressure on commission prices and continued migration toward commission-free trades are likely over the medium term.
It says rising US interest rates could be a catalyst for further price competition and/or consolidation. Net interest margins (NIMs) have remained broadly steady for several years, but should expand alongside the expected gradual rise in US interest rates. NIM expansion will benefit the larger brokers with larger banking and asset management businesses the most. Money market fund (MMF) fee waivers would also be reduced (or eliminated) in a rising interest rate environment.
The offset of rising interest income and reduced MMF fee waivers could embolden larger retail brokers to target market share growth and reduce trading commissions further.
Rising rates, along with the passage of time, will also provide more clarity with respect to the performance of E*Trade's home equity line of credit exposure on its balance sheet, while rising home prices could also mitigate this risk. Both of these factors could increase the likelihood of an acquisition, Fitch says.
US retail brokers are responding to the challenges facing the traditional commission-based business by moving toward new business segments and growing asset management fee income, as well as their banking revenues.
A more diversified business model with greater reliance on asset management fees and banking would help to reduce some of the revenue and income cyclicality in the sector. Notably, if these broad business shifts result in more stable performance through economic, interest rate and market cycles, than it could be positive for these firms' credit profiles, says Fitch.
Amid the ongoing transition, not all US retail brokers are similarly positioned. The largest retail broker, Charles Schwab, has already moved to a largely asset- and net interest revenue-based model, with trading commissions representing only 15 per cent of revenue at 30 September 2016.
As commission pricing competition intensifies further, smaller brokers who remain more reliant on trading commissions will face greater challenges, Fitch says.
The TD Ameritrade-Scottrade tie-up specifically will not result insignificant diversification for the combined entity, with commissions representing roughly 40 per cent of total revenue. However, the combined entity will benefit from increased economies of scale, and TD Ameritrade will be able to access Scottrade's substantially larger branch network.
The additional client accounts and branches, combined with increased scale, could help facilitate a broader transition by helping the new firm grow its asset management and banking businesses, Fitch adds.
