Potential Schwab-TD Ameritrade Deal Shocks Broker-Dealers, Advisors

Reports of a hookup between Charles Schwab Corp. and TD Ameritrade Holding Corp. is sending small investment advisers to their medicine chests and rival RIA custodians to their strategy drawing boards.

Schwab has not confirmed reports that it will buy its smaller but still sizable competitor for $26 billion, but the deal sounded plausible to analysts, competitors and consultants. Schwab needs a major economy-of-scale deal at a time when it and its discount brokerage rivals have driven much of their commission rates to zero.

“When you’re as big as Schwab, organic growth is challenging given the trend for compressed revenues from trading,” said H. Adam Holt, CEO of Asset-Map, which sells asset-aggregation software to advisors. “Acquisitions are a clear way to put their capital to work and eliminate a competitor.”

But a deal also sent chills among registered investment advisers who use only TD Ameritrade as custodian and broker-dealer for their clients’ assets. Schwab typically works with RIAs that have at least $100 million of assets under management, and smaller players said they fear integration issues and service deterioration.

“I’m not that scared from a client perception standpoint,  but operationally it’s a different story,” said Adam Cmejla, founder of Integrated Planning & Wealth Management, a Carmel, Indiana, advisory firm with less than $50 million of customer assets that could not meet Schwab’s asset criterion when it was founded.

“My assumption is that we will have to repaper, which is what every advisor just loves, and you don’t know what you don’t know. When two of the largest custodians amass $5 trillion in assets it’s not what or if, but when, something will go wrong in the integration.”

He said the mere whisper of a merger is forcing him to check out other potential custodians.

That attitude is not lost on rivals.

“We’re going to try to take this opportunity and run with it,” said Robb Baldwin, founder of TradePMR, a Florida-based custodian with about 400 RIA customers (in contrast to 7,500 at Schwab and 7,000 at TD Ameritrade, some of whom work with both firms). “It’s going to be probably a year or two of integration work, and there are a lot of things that have to be accomplished before this is a completed transaction.”

Advisors who custody with Schwab and TD Ameritrade have long been antsy about competing with their direct-to-consumer discount brokerage business, particularly with Schwab’s mega-marketing presence. If a deal is consummated, they will have even more to be worried about, competitors said.

“Their brand presence together with their aggressive pricing strategy continues to pose a challenge to advisors serving clients at all wealth levels,” said Mark Tibergien, chief executive of BNY Mellon’s Pershing Advisor Solutions. “They will become an even more dynamic retail brand as one.”

Tibergien’s firm is the fourth largest RIA custodian behind Schwab, Fidelity Investments and TD Ameritrade. A spokeswoman for Fidelity, which provided clearing and custody for 3,900 RIAs and brokerage firms as of June, declined to comment.

Schwab-a-Trade, as some wags were tweeting, will force smaller custodians to refine their strategies and could lead to additional mergers. “We all have to be clear on our strategy,” Tibergien said.

A combined Schwab and TD Ameritrade, a publicly traded affiliate of Toronto Dominion Bank, would have a market cap of nearly $87 billion based on valuations on Thursday morning after reports of a deal. The figure is greater than the $79 billion market cap of Morgan Stanley.

Traditional full-service brokerage firms have been closely monitoring competition from RIAs and their custodians, considering entry points or, like Wells Fargo Advisors, actually launching them, but a Schwab-a-Trade would be a frightening deterrent.

“If I’m a brokerage firm sitting out there thinking about entering the RIA custody world, if I have to look at a firm with $5 trillion in assets and a 40-year head start, that’s daunting,” said Shirl Penney, chief executive of Dynasty Financial Partners, which helps brokers establish RIAs and works particularly closely with Schwab. The San Francisco-based discount broker pioneered the RIA custody business.

Smaller RIAs have other concerns. More than half of the customer assets at Cmejla’s firm are held in Dimensional Fund Advisors index funds that are more expensive to trade on Schwab than on TD Ameritrade, he said.

The two discount brokers also operate different revenue-sharing models for high-end retail customers that they refer to RIAs, and some financial planning networks have negotiated with TD Ameritrade to accept fledgling firms that don’t meet its minimum asset requirements. Questions about these models remain to be answered if a deal is consummated.

To be sure, some TD Ameritrade advisors said the creation of a custodial behemoth supporting financial planners would add further credibility in their ongoing battle to win clients from large broker-dealers.

“There will likely be some operational disruption for the advisor community, but for a young entrepreneur like myself this is a great opportunity to compete,” said Brad Sherman, whose four-year-old Sherman Wealth Management in Gaithersburg, MD, oversees about $36 million of customer assets. “It’s an opportunity to firm up the value proposition for RIAs.”

Acorn Financial Services, a Reston, Virginia, RIA that custodies its more than $800 million of client assets with TD Ameritrade and Schwab, believes they would be savvy enough to operate post-merger with the best technology, such as TDA’s “iRebal” software, according to Andrew Casteel, its chief investment officer. Its primary concern is that the elimination of a major player could curb the competitive innovation that has created such technology, he said.

Discount brokerage stock analysts were cautiously optimistic about the benefits of a blockbuster deal for Schwab and TD Ameritrade shareholders, notwithstanding anti-trust issues that consumer advocates and regulators could raise.

“Scale creates efficiency opportunities on both the revenue and expense front, but also presents growth challenges as well,” analysts at Compass Point Research & Trading wrote in an investor note about the potential deal that would add $1.3 trillion in client assets to the $3.85 trillion held at Schwab. “We believe there is potential for market share attrition over time. We do not believe there will be anti-trust issues as SCHW’s total retail market share is only ~7%, and there are few barriers to clients moving to competitors.”

A deal would create an existential threat for competitor E*Trade Financial Corp., which has been subject to merger rumors since Interactive Brokers and Schwab announced zero-commission equity trades last month, Compass Point analysts Chris Allen and Michael Anagnostakis wrote in their note.

Shares of Schwab were up about 7% at $47.91 in early afternoon trading, while TD Ameritrade soared 18.10% to $48.85. E*Trade stock was changing hands down 8.63%, at $41.90.