Tiny commissions, big problem: price war gives TD a headache on its U.S. strategy

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A pricing war has rattled the U.S. discount stock brokerage market, putting Toronto-Dominion Bank in a strategic bind as Canada’s second-largest lender mulls ways to mitigate the damage.

When Charles Schwab Corp., one of the largest U.S. discount brokerages, slashed commissions for online trades of U.S. stocks, exchange-traded funds and options to zero last week, rivals such as TD Ameritrade Holding Corp. were quick to match the new pricing in a bid to level the playing field and retain customers.

But for Ameritrade, the race to zero is an especially deep cut: The lost commissions are expected to wipe out 15 per cent to 16 per cent of the company’s revenue, which would reduce earnings per share by about 40 per cent, all other things being equal, analysts said. TD owns 43 per cent of Ameritrade, and its investors are bracing for proportionate pain for the Canadian bank, which could see earnings per share fall by as much as 2.8 per cent, analysts said. The changes also raise questions about whether commission-free trading could catch on more widely in Canada.

“In the span of two weeks, one of TD’s prized assets lost a lot of value," Gabriel Dechaine, an analyst at National Bank Financial Inc., said in a research note.

That leaves TD to explore an imperfect set of options to strengthen its position. Ameritrade would need to look for ways to cut costs, because slashing commissions does not produce savings. “The punishing impact flows directly to the bottom line [after] taxes,” CIBC World Markets Inc. analyst Robert Sedran said.

In addition, TD and Ameritrade are expected at least to consider acquisitions or divestitures. But none of the available options offers an easy fix, and deal-making could be hampered by the fact that Ameritrade is searching for a new CEO, after announcing unexpectedly in July that chief executive officer Tim Hockey is leaving.

Ameritrade spokesperson Becky Niiya declined to comment on “industry rumors or speculation,” but said the company has “strategic plans in place which we expect will further boost our resiliency, revenue growth and market share.” A TD spokesperson declined to comment.

One option would be for TD to buy all of Ameritrade, which is still profitable even though its share price plunged about 28 per cent after the move to zero-commission trading. The change reduced Ameritrade’s valuation, making it more attractive to TD, whose own share price fell about 5 per cent. “Valuation was a large impediment in owning 100 per cent of TD Ameritrade in the past, but that appears to no longer be the case," said RBC Dominion Securities Inc. analyst Darko Mihelic, adding that such a deal “makes strategic sense" and "could be significantly accretive to TD.”

But there are impediments. Analysts estimate the total purchase price for the remaining 57-per-cent stake could approach $20-billion. Acquiring Ameritrade would cause the goodwill on TD’s balance sheet to increase substantially, and given the state of flux at online brokerages, that “could easily trigger write-down concerns," Mr. Dechaine said. Furthermore, while TD has stockpiled about $6.7-billion in excess capital, it might still need to issue about $14-billion in new equity to fund the purchase, which could spook some investors. “TD acquiring 100 per cent of [TD Ameritrade] makes little sense to us,” Mr. Dechaine said.

When asked at a January conference whether TD would benefit from owning more of Ameritrade, CEO Bharat Masrani replied: “You know, we get what we want now.”

Alternatively, Ameritrade could acquire rival ETrade Financial Corp., which is also feeling competitive pressure from the sudden shift to zero-commission trading and is rumoured to be a takeover target. “Not only do we estimate that an acquisition of [ETrade] would be accretive to [Ameritrade], we estimate that it would remain so for TD," Mr. Dechaine said.

Lastly, TD could push for Ameritrade to be sold to another discount broker, potentially diluting its own stake and influence.

The next hints about Ameritrade’s plans may come when it reports fiscal fourth-quarter earnings on Oct. 21. In the meantime, Mr. Mihelic said he expects TD to “calmly reflect and monitor the situation before transacting (if at all).”