July 22, 2011 / 9:15 PM / in 6 years

UPDATE 1-Schwab shops modestly but sees E*Trade's potential

5 Min Read

* Firm currently eyeing only "modest" acquisition targets

* Getting 10 to 12 leads/day on potential franchise owners

* Amount of fees waived on money funds seen rising in H2

* 2011 financial outlook unchanged (Adds that E*Trade retains Morgan Stanley to conduct strategic review of company)

By John McCrank

TORONTO, July 22 (Reuters) - Charles Schwab Corp (SCHW.N) is limiting itself to looking at modest acquisitions at the moment but does see the consolidation opportunity that would arise if discount broker E*Trade (ETFC.O) were to put itself up for sale, Chief Executive Walt Bettinger said on Friday.

"We certainly understand the dynamics around E*Trade and the consolidation opportunity, and the opportunity to potentially derive value from reducing expenses to a meaningful extent within E*Trade," Bettinger said in a business update for Schwab's institutional investors.

But he also said that the purchase price could be a problem, along with depletion of the buyer's capital.

E*Trade's largest shareholder, Citadel LLC, called on Wednesday for the online broker to put itself up for sale and to take other steps to boost shareholder value, sending the firm's shares soaring. [ID:nN1E76J0E7]

E*Trade said after the market close on Friday that it has rejected Citadel's call for a special meeting of shareholders, but that it is retaining Morgan Stanley (MS.N) to assist in a broad review of strategic alternatives.

Bettinger said that any acquisition that Schwab, which has banking, brokerage, and asset management operations, is looking at now would have to have an excellent return on investment and rapid payback. "We always have two or three of those sorts of things that we are considering, but again, very, very modest," he said.

Schwab said in March it would buy online brokerage optionsXpress for $1 billion in stock. [ID:nN21283754] Bettinger said he is optimistic the deal will close in the third quarter. If so, Schwab expects to recognize about $20 million of $55 million in implementation costs in the quarter.

Branching Out

One major area of focus for Schwab is building out a network of franchise branches. The firm announced the plan in January and started talking to prospective franchisees a few months ago.

"We are now getting 10 to 12 leads a day from people interested in opening Schwab franchises," Bettinger said.

He said he is seeing a lot of interest in the model from people at independent broker-dealers, smaller Registered Investment Advisers, younger people at some of the bigger full service firms, and even from some professionals with accounting and legal practices.

Until now San Francisco-based Schwab has faced the public through about 300 employee-operated branches and client service centers. The franchise plan extends Schwab's reach to smaller communities, where it has less of a presence.

Bettinger said there are easily 1,500 or more areas where Schwab would consider putting in a franchise branch, but that it does not plan to open that many. He said there would probably be "a handful" by the end of the year.

Schwab plans to see how the franchise branches match up against employee-run branches over a period of several years before deciding whether to aggressively build on the model, or rethink the strategy.

Money Waiver Fees Likely to Rise

Schwab, like rivals TD Ameritrade (AMTD.O) and E*Trade, has been going through a difficult period of low interest rates and trading volumes.

But income at Schwab, the largest of the U.S. discount brokerages, was still up 16 percent in second quarter as asset management fees and interest revenue offset the slowdown in client trades. [ID:nN1E76H0F2]

The company's 2011 financial outlook is unchanged, with revenues likely to be up around 10 percent for the year, expenses up 8 percent, and a pretax margin of around 30 percent, Chief Financial Officer Joe Martinetto said in the business update.

Schwab and many fund companies have been waiving their fees on money market funds for more than a year because the near-zero interest rates being paid could result in negative returns if fees were charged. The fee waivers have cost broker-dealers hundreds of millions of dollars.

Schwab expects to waive about $150 million in both the third and fourth quarters, up from $128 million in the second quarter and $112 million in the first quarter. Martinetto said the rise was due to fund balances being higher than expected, and to changes at the bottom end of the interest rate curve.

Shares of Schwab ended down 1.28 percent at $15.43 on Friday. (Editing by Peter Galloway)

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