Analysis: Fed again thwarts Schwab, TD Ameritrade

SAN FRANCISCO Thu Apr 28, 2011 3:49pm EDT

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SAN FRANCISCO (Reuters) - Shares of Charles Schwab Corp and TD Ameritrade Holding Corp have been bolstered by investor expectations that interest rates will rise, allowing the brokers to book millions of dollars of money-market fund fees they are now waiving.

Yesterday's news from the Federal Reserve Board that it's in no hurry to change its easy rate policy may be getting investors to think again.

Shares of San Francisco-based Schwab are up about 8 percent this year while TD Ameritrade's have soared 15 percent. Those gains contrast with a 0.4 percent decline in the 11-member NYSE Arca Securities Broker/Dealer Index, which includes the two discount brokers.

"The reversal of the fee waivers is already baked into the stock," said Morningstar Inc analyst Michael Wong before the Fed said it will continue its easy-money policy. "The market is expecting higher earnings next year or the year after that."

Schwab, TD Ameritrade and other mass distributors of mutual funds -- as well as fund managers that sell directly to investors -- began waiving fees more than two years ago when returns on money-market funds dipped to levels so low that a fee would send the returns into negative territory.

Schwab, which sells dozens of internally and externally managed funds on its commission-free "supermarket" platform, ranks as the 7th largest money-fund manager with about $150 billion in assets, according to Crane Data LLC.

Last year alone, it waived $433 million of fees on money-market funds it sold, a total that could increase this year.

WAIVERS INCREASING

Joseph Martinetto, Schwab's chief financial officer, told investors on April 20 that the company is likely to give up around $125 million of fees this quarter if rates remain where they are. That's up from $112 million in the first quarter, and would surpass the 2010 total if calculated on an annual basis.

TD Ameritrade threw in the towel on $57.2 million of money-market fees from funds it sold in fiscal 2010, which ended on March 31. In the just-ended quarter, it waived $12.7 million.

The firms initiated fee waivers in early 2009 to ensure positive returns for clients. Without them, investors would lose money on their money-market investments. They would be able to argue they'd be better keeping their cash equivalents under the mattress.

Federal Reserve Chairman Ben Bernanke on Wednesday didn't offer much hope for a rapid change in the low-rate policy, which is aimed at stimulating the economy.

Given that outlook, shares of the discounters may have gotten ahead of themselves, according to some analysts.

Schwab shares are trading at about 22 times expected 2011 earnings per share while TD Ameritrade has a multiple of about 19 times anticipated earnings. The broker-dealer index is trading at 14 times analysts' forecasts, about the same as the Standard & Poor's index.

"Schwab is a volatile stock that is interest-sensitive," Sanford C. Bernstein & Co. analyst Brad Hintz wrote in an email.

Hintz recommends Schwab and has a price target of $19 on Schwab's stock, about 50 cents above its actual price on Thursday afternoon, but was cautious even before Bernanke's policy announcement this week.

"Though positive trends are materializing, the low rate environment continues to weigh on earnings," Hintz wrote in an April 18 report. "Until short-term rates rise, revenue will be inhibited."

SUMMER BLUES

Interest rates are not the only conditions influencing shares of Schwab and TD Ameritrade. The companies are often viewed as proxies for retail investors' interest in trading stocks, and by at least one indicator those investors are about to take a holiday.

"There is a typical summer slowdown that tends to pressure Schwab earnings," Hintz wrote in his email. On the other hand, he believes that retail investors' confidence in stock trading is slowly returning, creating a tailwind for the discounters.

Low rates hurt a wide range of banks and brokers beyond fee waivers. That's because they raise charges on loans and margin accounts more quickly than they increase payouts on deposits and margin-account balances when rates are rising.

Brokers such as Schwab, E*Trade Financial Corp and full-service firms such as Bank of America Corp's Merrill Lynch also have bank affiliates that are repositories for spare cash swept from fallow brokerage accounts into deposit accounts, increasing net interest spreads when rates are rising.

Investors, though, may be right to focus on the waivers since their rescission will quickly buttress discounters' bottom lines when rates eventually rise. Schwab's net revenue would jump by 10 percent if the Fed raises its key lending rate by 1 percentage point, according to Morningstar's Wong.

TD Ameritrade has for two years been calculating for investors the correlation between rate rises and revenue. In its 2010 annual report, the Omaha, Nebraska-based firm pointedly noted that a 1 percentage point rate increase would bulk its profits more potently than a rate cut of the same amount would hurt its bottom line.

"When interest rates start to rise, and eventually they will, we are very well positioned to deliver even further earnings growth," TD Ameritrade Chief Executive Officer Fred Tomczyk said after the company posted fiscal second-quarter earnings on April 18.

In an interview, however, he was candid about how long investors may have to wait.

"If you look at the economists' consensus, it's not going to change for another year," he said.

(Reporting by Philipp Gollner, editing by Jed Horowitz)

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