• by Thom Forbes  @tforbes, November 26, 2019

The rumored merger between online brokerages Charles Schwab and TD Ameritrade became reality yesterday in an all-stock deal valued at $26 billion. The agreement will create the largest entity in the brokerage business should it pass antitrust review and closes, as expected, in the second half of 2020.

“The merging of the two biggest publicly traded discount brokers will create a mammoth with more than $5 trillion in client assets, $3.8 trillion from Schwab and $1.3 trillion from TD Ameritrade. The combined company will serve more than 24 million clients. San Francisco-based Schwab has a market value of $57.5 billion and Omaha-based TD Ameritrade has a $22.4 billion market cap,” reports  CNBC’s Maggie Fitzgerald.

“Schwab’s current shareholders will own 69% and TD Ameritrade’s existing stockholders will own 18% of the combined company. TD Bank, which currently owns 43% of TD Ameritrade, will own the proportionate 13% of the new company,” Fitzgerald adds.

The combined company, which will be based in the new headquarters Schwab has been building in Westlake, Texas, in the Dallas-Fort Worth area, will “have nearly $2.1 trillion of [registered investment advisers’] assets in custody, or around 51% of the market, according to estimates by Cerulli Associates. The No. 2 player in the space, Fidelity Investments, has about $932 billion in RIA assets, or less than a quarter of the market, Cerulli estimates,” Alexander Osipovich writes  for The Wall Street Journal.

“That scale helped drive the sharp gains in the shares of both Schwab and TD Ameritrade last week, but it has also sparked worries about deteriorating service and less choice for advisers,” Osipovich adds.

Schwab, which was founded in San Francisco in 1971, says it “has maintained a longstanding commitment to the Bay Area, which will continue.” The impact on the 2,300 workers at TD Ameritrade’s Omaha headquarters “isn’t clear,” Bob Glissmann writes for the Omaha World-Herald. The company started in 1975. 

“Last month, Schwab said it would eliminate fees  for trades of stocks and exchange-traded funds; other rivals, including TD Ameritrade and E-Trade, were forced to follow suit,” Tara Siegel Bernard and Matt Phillips write  for The New York Times.

“Technological changes have given rise to automated portfolio advice from so-called roboadvisers, and a fresh wave of start-ups helped push many big firms -- Schwab included -- to drop many trading fees to zero…,” they write. “Schwab is aiming to solidify its place in the established order of the brokerage world as the industry faces a challenge: making more money without charging steep fees to customers managing their wealth.”

So how do these companies pay the rent without commissions? 

“Today, Schwab is basically a brokerage firm that sits atop a more traditional bank: Its offer to facilitate financial trades encourages people to park their money with the firm, and it pays them interest on it. But that money also allows Schwab to engage in other financial and banking activities like lending, and it gets more interest back on that activity than it loses to its clients. It’s making money on the spread, same as a traditional bank,” Jeff Spross explains  for The Week.

Schwab and TD Ameritrade made a combined $2 billion in net interest revenue in their latest quarters,” the AP’s Stan Choe writes. “Rival Fidelity pointed out  how Schwab and TD Ameritrade make some of that money by paying customers lower rates for cash in their trading accounts, known as ‘sweep accounts.’ Fidelity, which is privately held, would still have more in total customer assets than a combined Schwab.”

“Charles Schwab and TD Ameritrade believe a combined company can operate with even lower costs, and that’s really throwing down the gauntlet to other banking giants who will feel some pressure as a result of this combination,” Mark Hamrick, senior economic analyst at Bankrate, tells  USA Today’s Jessica Menton.

“Such combinations in the industry typically see the acquirer shaving off 50% to 70% of the costs of its buyout target, while holding onto about 90% to 95% of its revenue, according to analysts at Barclays,” the AP’s Choe writes.

In order to do that, the new company will need to hold onto its customers, of course.

“I’ve written before about how finance industry professionals can easily get lured into sweeping generalizations. In the case of discount online brokers, the line is that no-fee trading is a big win for the consumer…,” writes Brian Chappatta for Bloomberg Opinion. “If successful, this combination will almost surely bring more investors under Schwab’s tent. It’s up to the company to convince them that even as an industry giant, it’ll always keep the little guy in mind.”