Online Brokers' Price War Likely To Affect Revenue Growth

Last week, online brokerage firm Interactive Brokers (NYSE:IBKR) kick-started a price war by announcing commission free trading. Now, jumping on the bandwagon are Charles Schwab (NYSE:SCHW) , TD Ameritrade Holding (NASDAQ:AMTD) and E*TRADE Financial (NASDAQ:ETFC) .

Before going in to the details as to why these brokerage firms undertook this drastic step, and its implications on their financials, let’s look at the details related to what’s in store for retail investors.

Beginning with Interactive Brokers, the company plans to launch IBKR Lite service later this month, which will provide U.S. stock market investors “commission-free, unlimited trades on US exchange-listed stocks and Exchange Traded Funds.” Further, no account minimums and no cost to maintain an account for IBKR Lite will be added advantage for retail investors.

Now coming to Schwab, TD Ameritrade and E*TRADE, these three brokerage firms have also eliminated commissions for stocks, ETFs and options trades. Nonetheless, they will be charging 65 cents per contract for option trading. At present, Schwab charges $4.95 for stock trades, while E-Trade and Ameritrade charge $6.95 per trade.

These changes will be effective today for TD Ameritrade, while for Schwab and E*TRADE changes take effect from Oct 7.

Garnering market share seems to be the primary reason for announcing zero commission trades. Increasing competition from the FinTech startups, including Robinhood Markets Inc., M1 Finance, WeBull and TradeZero that offer zero-cost stock trading services, has been weakening online brokerage firms’ foothold.

Schwab’s Chief Financial Officer Peter Crawford in a statement said, “…we are seeing new firms trying to enter our market – using zero or low equity commissions as a lever.” Further, he added, “It has seemed inevitable that commissions would head towards zero, so why wait?”

Financial Implications

At the time when low interest rates and significant volatility in the markets are already adversely impacting their financials, this move is likely to further hurt profitability. From charging $4.95-$6.95 per trade to zero commission, these brokerage firms will be foregoing substantial fees.

Among these, Schwab seem to be a bit better positioned in terms of reduction in commission from trading. The company is less dependent on commissions, which constitute roughly 7% of total revenues. Crawford in his statement noted that zero-commission trades are likely to have 3-4% adverse impact on quarterly net revenues.

On the other hand, for TD Ameritrade (generating about 25% of revenues from trading), the move will result in 15-16% decline in quarterly revenues.

Further, E*Trade, which gets nearly 17% of revenues from commissions, estimates “that the revenue impact of the commission changes on Q2 2019 operating results would have been approximately $75 million.”

This bearish near-term outlook has made investors cautious about these brokerage firms’ prospects, as witnessed from the dismal price performance. Since the announcement by Interactive Brokers on Sep 26, shares of these online brokerage firms have plunged. Interactive Brokers is down 8.6%, Schwab 12.7%, TD Ameritrade 30.7% and E*Trade 20.2%.

Though brokerage firms are expected to perform decently as they have diversified revenue sources and are undertaking measures to counter challenging operating environment, the near-term dismal outlook will hamper growth to some extent.

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