Rate Cut To Hurt Online Brokers Amid Coronavirus Concerns

The current economic scenario has been affecting companies from all sectors in some way or the other. Fear over the coronavirus (COVID-19) outbreak and its financial impact has made people wary of investing in stock markets.

In fact, markets have become extremely volatile. The S&P 500 Index fell 5.2% yesterday. Further, the Dow Jones Industrial Average declined 6.3% to below the 20,000 level, thus hitting its three-year low.

And, like other industries within the broader Finance sector, online brokerage firms (also known as discount brokerages) will have to bear the brunt of the economic slowdown.



In order to support the economy amid the current crisis, the Federal Reserve on Sunday reduced benchmark interest rates to near zero, after unexpectedly cutting rates by 50 basis points early this month. Because of this, online brokerage firms like Charles Schwab (NYSE:SCHW) , E*TRADE Financial (NASDAQ:ETFC) , TD Ameritrade (NASDAQ:AMTD) , Interactive Brokers (NASDAQ:IBKR) and others are expected to witness a decline in their interest-related income (which constitutes a significant portion of their revenues) in the coming quarters.

Brokerage firms earn interest income on clients’ brokerage cash. They reinvest brokerage clients’ cash in higher-yielding securities and bag the difference between the interest they receive on securities and the yield they dole out to clients on their cash.

While most brokerage firms have witnessed an increase in net client assets and new brokerage accounts in the past two months, owing to the heightened volatility, their interest-rate related revenues are expected to be hurt to an extent in the coming months as both long and short-term rates have fallen significantly.

Notably, online brokerage firms are already witnessing a decline in commission revenues since announcing commission-free trading in the second half of 2019. Effective October 2019, the major online brokerages started offering commission-free trading to attract new clients. The companies eliminated commissions for stocks, exchange-traded funds (ETFs) and options trades. Nonetheless, they continue to charge 65 cents per contract for options trading. (Read more: Online Brokers' Price War Likely to Affect Revenue Growth)

While garnering market share was the primary reason for announcing zero commission trades, the move has hurt profitability of discount brokers to some extent as they are foregoing substantial fees. In fact, this comes at a time when low interest rates and significant volatility in the markets are already adversely impacting their financials.

However, Schwab seems to be a bit better positioned in terms of reduction in commission from trading as it is less dependent on commissions, which constituted nearly 6% of its total net revenues in 2019. However, the company’s interest income constitutes more than 60% of total revenues, which will likely be affected by the Fed’s latest move.

Notably, in the current scenario, brokerage firms are moving toward consolidation to dodge the heightened costs of regulatory compliance and increased investments in technology to be competitive. Last year, Schwab announced an all-stock deal to acquire TD Ameritrade for $26 billion. The transaction is expected to create a behemoth in the online brokerage space, with combined client assets worth more than $5 trillion. Also, last month, Morgan Stanley (NYSE:MS) entered into an all-stock deal to acquire E*TRADE for $13 billion.

Thus, consolidations of big players within the online brokerage industry are paving the way for the smaller participants to enter the market.

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