11 October 2006

S&P Cuts TD Ameritrade to Hold

Shares of discount brokers fell Wednesday after Bank of America announced a plan to offer free online stock trades for some account holders

BusinessWeek, Sonja Ryst, 11 October 2006

Bank of America unveiled a plan to offer free online equity trades to about 40% of its customers, hammering its rivals' stock prices with the latest skirmish in a commission war that has lasted for years. But industry players remain calm.

The Charlotte, N.C.-based financial-services giant serves around 54 million households, or about half of those existing in the U.S. On Oct. 11 its primary retail brokerage unit, Banc of America Investment Services, said it will offer up to 30 free online equity trades per month for self-directed investors with a combined balance of $25,000 or more in Bank of America, N.A. deposit accounts.

"We're interested in building quality relationships with customers," said Liam McGee, president, Bank of America Global Consumer & Small Business Bank, and Brian Moynihan, president, Bank of America Global Wealth & Investment Management, in a conference call on Oct. 11. The new plan, which started on Oct. 11 with promotions in Northeastern cities such as New York, Philadelphia, and Boston, is expected to roll out across the country by February of next year.

When asked how much revenue they expected to lose initially from the new plan, Moynihan and McGee declined to quantify. "It's not a material number," they said at the conference call. They care more about grabbing customers - particularly those that already have deposit accounts with Bank of America but are doing their stock trades with other firms.

Investors sold Bank of America's rivals after the news. TD Ameritrade Holding plunged 11.9% to $16.82 per share and Charles Schwab sank 4.7% to $17.22 near closing time on the Nasdaq, while E*Trade Financial lost 8.8% to $22.31 per share on the New York Stock Exchange.

"It's largely an over-reaction," said Patrick O'Shaughnessy, an equity analyst at the Chicago investment research firm Morningstar.

When online brokerages began their price war a few years ago after the dot.com bubble burst, critics had asked whether the industry could survive. But now, discount brokerage firms have resolved their problem by figuring out other ways to earn revenue, such as selling margin loans for use with investments or charging fees for asset management. Brokerage trading revenue only accounted for about 16% of Charles Schwab's total net revenue as of the second quarter, 22% of E*Trade's, and 39% of TD Ameritrade's.

Now that Bank of America has started to give trades away, O'Shaughnessy expects commissions to fall further industry-wide. "But I don't think it's catastrophic," he added.

Standard & Poor's Corp. pointed out that TD Ameritrade might have a tough time winning market share, in spite of synergies from Ameritrade's $2.9 billion purchase of TD Waterhouse announced last year. (S&P, like BusinessWeek.com, is owned by The McGraw-Hill Companies.) Equity analyst Royal Shepard downgraded the stock to hold from buy on Oct. 11, explaining that TD Ameritrade "faces challenges from Bank of America's announced offer" given competitive pricing conditions and ongoing industry consolidation.

TD Ameritrade disagrees and has no plan to change its pricing, which is currently at $9.99 per online equity trade. "Zero commission pricing is not new within our industry," said Katrina Becker, a spokeswoman at the Omaha, Nebraska-based firm, which has around 6 million clients. Before buying TD Waterhouse, the legacy Ameritrade had charged $10.99 per online equity trade. TD Ameritrade had already tried a free online equity trading offering for some customers in 2000, only to discontinue it in early 2005. Winning market share "is about more than the price," Becker says. "It's things like the tools, the trade execution and the service."

Jarrett Lilien, the president of E*Trade, felt frustrated about how investor fears of a price war made investors sell his company's stock today. "I don't see pricing as the battleground. I see functionality as the battleground," he said. Lilien added that prices are already low in the industry, so businesses have to compete by providing better services, such as advanced order types that automatically sell stocks at predetermined price points. E*Trade added 1,000 customer representatives in the past year so it can compete with better service, for example.

The online business performance services firm Keynote Systems found that Web site service levels in the brokerage industry far exceed other industries, with industry average reliability of 99.5%, the highest reliability rating of any industry measured by the company. According to the study, pages that download in more than one and a half seconds, a download time that is considered excellent in other industries, are outside best of class in the brokerage industry.

"Investors have very high expectations of online brokerage Web sites both in terms of the customer experience and in terms of service levels," said Dr. Bonny Brown, director of research and public services for Keynote. "Given the very competitive state of the brokerage industry, performance problems and customer experience frustrations can translate into problems in attracting new investors." Ameritrade and Schwab were among those judged to provide the industry's best overall service levels.

This isn't the first time Bank of America has gunned for more customers with a price cut. On Dec. 1, 2005, for example, Bank of America established a plan to charge Bank of America personal checking account holders $7 or $10 per trade for online self-directed equity transactions. Customers who had only the self-directed brokerage relationship got charged $14.00 per trade, reduced from $19.95, which had previously been the cost for everyone.

Wells Fargo offered a free online equity trading component for the first time in mid-2005, when customers with more than $250,000 deposited with the San Francisco bank could do 50 online trades per year at no charge. "We don't have plans to change our fees," said Kathleen Golden, a spokeswoman at Wells Fargo.