Schwab Played TD Ameritrade

Advisors stand to gain from the reported merger of the two discount brokers. But a slow process could spell trouble.

(Illustration by RIA Intel)

(Illustration by RIA Intel)

Vindication for Charles Schwab came fast.

Last month, the discount broker stunned investors by announcing free commissions. This sparked a fierce sell-off among brokerage stocks as competitors raced to match Schwab’s offering.

Today, according to published reports, Schwab is in talks to acquire TD Ameritrade for $26 billion. The market is cheering the expected deal as TD Ameritrade is up 18% in afternoon trading while Schwab is 7% higher.

Against a backdrop of disruption and consolidation, in which scale is important given low margins, a deal would create a behemoth with more than $5 trillion in assets, combining Schwab’s $3.8 trillion with TD Ameritrade’s $1.3 trillion.

On Oct. 1, when Schwab announced free trades, the stock was at $41.83. Within two days it lost 16%. However, Schwab’s move crushed TD Ameritrade’s stock, which plunged 30% in that time.

Schwab apparently calculated that going commission-free, while bad for all brokers, would be “less bad” for it. That assumption has proved correct.

With today’s rally, Schwab’s stock is up 14% since it announced free trading. And TD Ameritrade, while 5% higher than before Schwab’s shot across the bow, is 20% below levels reached last year.

The upshot is that since Schwab’s “bad news” of announcing free trades, it has seen its stock price rally and acquired the assets of a key competitor.

“Without a doubt, we think that 1+1 would equal more than 2 in a combination between Schwab and Ameritrade and would create an even stronger competitor, particularly if the combined entity pushes the industry further on pricing,” wrote JMP Securities’ Devin Ryan and Brian McKenna in a note.

While antitrust is a potential hurdle, the deal appears to have a good chance of happening. “Our initial reaction is that firms like Schwab and Ameritrade when combined still represent a small percentage of the overall investable wealth market in the U.S, which they are going after,” Ryan and McKenna wrote.

If the deal occurs and is approved, it will force the other custodians to further hone their services and define a unique value proposition. In turn, the competition should improve services offered to investors and the industry overall, according to Michael Papedis, managing partner of Fusion Financial Partners, a consultant to RIAs.

Financial advisors who custody with Schwab and TD Ameritrade, respectively, also stand to gain from the merger, Papedis told RIA Intel.

“One of the benefits for the TD advisors that this presents is that for those looking to go upstream or up market with services and abilities, Schwab will be able to deliver that to those advisors seeking to capitalize for a more discerning clientele.”

TD Ameritrade’s tools and services have demonstrated that they are capable of servicing a large number of advisors who manage fewer assets – something Schwab has not been known for. “Time will tell if this is a remedy for the perception that small advisors service had lapsed,” Papedis said.

The potential benefits wouldn’t happen any time soon, either. The complexity and costs to merge the two companies could slow the businesses during this period.

“I wouldn’t expect much innovation and progress while that’s going on,” Doug Fritz, the CEO and founder of F2 Strategy, a technology and marketing consulting firm to wealth management firms. “Schwab will need to start recouping the cost for this deal quickly…even if this takes three to four years, the uncertainty around it will cast doubt in the minds of advisors either working with these firms or those considering a relationship.”

For Schwab and TD Ameritrade, the phase might be worth the growth spurt but time is not on their side.

“As a consultant to many of RIAs and smaller private banks, I would be very worried that this deal will disrupt the expectations we’ve built around these two firms. Uncertainty is not a welcome guest to strategic planning conversations where custodian partnership is a cornerstone to how firms evolve.”

Fritz added that additional M&A activity in the industry could “possibly accelerate investment in other providers as Schwab/TD start ejecting frustrated clients.”

Others, however, see less drama on the horizon.

“We believe this is actually going to have a minimal impact. They both have great organizations and they will continue to support those advisors well,” Michael Kim, AssetMark’s chief client officer, said.