Charles Schwab Corp.’s deal to acquire TD Ameritrade Holding Corp. will gradually erode a lucrative side deal that has contributed hundreds of millions of dollars of revenue a year to Toronto-Dominion Bank.
As part of the takeover announced Monday, Schwab has renegotiated the terms of a deal that allows TD Bank to hold cash from TD Ameritrade client accounts. Brokerage firms typically “sweep” unused cash parked in investors’ accounts into a bank each day to obtain higher interest rates for customers as they wait to decide how to invest. The banks collect fees from the brokerage companies in exchange for the service.
Schwab’s new cash-management deal was a key element in winning TD’s support for the purchase of Ameritrade. The bank earned fees of roughly US$275-million last year from managing cash for TD Ameritrade clients, and the loss of the business would have been a blow to the bank’s earnings.
While the new deal extends TD Bank’s ability to manage Ameritrade’s insured deposit account (IDA) relationships to 2031, it also reduces the payments Schwab will make to TD Bank by 40 per cent and allows Schwab to gradually pull deposits from TD Bank and move the cash on to its own books.
Analyst John Aiken of Barclays Capital says the extension of the agreement is “a somewhat elegant solution" for TD. "We believe that the fact that TD will not immediately lose the broker deposits should receive some relief from investors, despite lower expected revenues in the future as the broker deposits are reduced,” he wrote in a research report Monday.
The impact is large: TD Ameritrade had US$103-billion parked at TD Bank at July 31, and was paying a 0.25-per-cent annual servicing fee on the money. That would yield more than US$250-million annually in revenue for TD Bank.
Under the new 10-year agreement, which takes effect in 2021, the servicing fee is cut to 0.15 per cent, and Schwab will have the right to reduce IDA deposits by up to US$10-billion a year to a floor of US$50-billion. At the floor, 0.15 per cent of US$50-billion is just US$75-million in annual fees.
The IDA terms are not formally linked to TD Bank’s ownership of Schwab, which means TD Bank could collect the fees even if it sold its stake in Schwab. TD Bank owns 43 per cent of TD Ameritrade and will swap its shares for a 13.4-per-cent stake in Schwab.
Despite the decline in fees and deposits, some analysts said the new deal is better than the alternative: Losing the sweep business entirely.
Analyst Patrick O’Shaughnessy of Raymond James & Associates Inc., in a note published last week before the deal was formally announced, estimated Schwab would have to pay TD Bank roughly US$9-billion on top of the merger price for TD Ameritrade, to compensate TD Bank for the money it would lose from the IDA agreement.
The new cash-management deal also gives time for Schwab to absorb taking so much cash into its own accounts. Mr. O’Shaughnessy estimated Schwab would have needed to raise US$8-billion in additional regulatory capital – likely through a share issuance – to immediately bring more than US$100-billion in TD Ameritrade client deposits on to its own balance sheet.
Riaz E. Ahmed, TD Bank’s chief financial officer, said in an investor call Monday that the more gradual decline in deposits under the Schwab deal is a better scenario than having the current agreement expire in 2023 with no replacement.
TD Bank also said it expects to take an earnings boost from its share of the cost savings from the combination of Schwab and TD Ameritrade, which will outweigh any revenue losses from the deposit-sweep revisions. The bank did not break down the numbers.
However, analyst Steve Theriault of Eight Capital said Monday he believes the reduced fees seriously blunt the deal’s benefits to TD Bank.
TD’s forecasts for earnings gains from the deal are “modest” once the new IDA arrangement starts, Mr. Theriault noted. This suggests the trade-off between cost savings and IDA revenue losses "was very significant … While not surprising, this is nonetheless disappointing.”
David Milstead