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TD Ameritrade is a leading financial services firm that specializes in providing securities brokerage services to traders, retail investors, and independent registered investment advisors. The company has a market capitalization of around $12.3 billion and reported total revenue of around $679 million in the quarter ended March 31, 2013. Substantially all of its revenue comes from its operations in the United States.
The company primarily makes money in the following three ways: (1) net interest on client balances, (2) transaction based revenue and (3) investment product fees. The company also makes some money in the form of other sources, but we will ignore it in this article due to its very small contribution to the firm’s valuation.
Net Interest On Client Balances
Much like a bank, a brokerage firm can utilize its client assets (example, customer cash and deposits) to generate interest revenue. A portion of this revenue is passed on to the customers as interest while the remainder is the brokerage’s profit – its net interest income. Ameritrade primarily earns such interest income from two sources:
1) Interest On Money Market Balances: Under a special agreement, Ameritrade allows TD Bank to offer its clients FDIC-insured money market deposit accounts (IDAs). Ameritrade provides marketing, record keeping and support services for such accounts and in turn receives a fee that is based on the yield earned on the assets in such accounts after deducting the actual interest paid to clients and making some other adjustments. The company made around $828 million from this source in calendar year 2012, according to our estimates. [Note: Ameritrade’s reporting cycle ends in September and we make adjustments to its financial statements to arrive at a Jan-Dec cycle. We believe that this makes comparisons across competitors easier.]
2) Interest On Other Balances And Securities: Ameritrade offers its clients margin and securities lending services and generates interest income from this activity. The company generated around $457 million from this business in calendar year 2012.
For both of the above mentioned categories, interest income depends on the amount of interest-earning assets and the interest margin (or spread) that Ameritrade is able to generate on these assets. Even though interest spreads have remained low on these assets due to the low interest rate environment, the company has been very good at gathering assets. For instance, during the quarter ended March 31, 2013, the company’s average client IDA balances grew by 15% while average client margin balances increased by 7%. Overall, the company has gathered more than $170 billion in net new client assets over the last five years even though the macroeconomic climate remained tough, and we see no reason why this momentum should reverse going forward.
Transaction Based Revenue
Ameritrade allows individual investors to use its portal to make trades real time in the stock market and in return charges its clients a certain commission per trade executed. The primary factors driving such revenue are total client trades (trading volume) and average commissions per trade.
Unfortunately, trading volumes have remained depressed industry-wide for the past several quarters as investors sit on the sidelines in an uncertain macroeconomic environment. This has caused a decline in the company’s trading revenue even though average commission per trade has improved lately due to changes in the company’s trade mix. In the quarter ended March 31, 2013, Ameritrade’s transaction based revenues were down by almost 2% y-o-y to $287 million, as the total trades executed on Ameritrade’s platform declined by over 5% y-o-y to 22.7 million.
Going forward, we believe that trading volumes will improve only gradually as investor gain confidence in the viability of the economic recovery and resume trading activity.
Investment Product Fees
Ameritrade charges its clients a fee for allowing them to invest in money market mutual funds, other mutual funds and fee based advice solutions such as AdvisorDirect and Amerivest. The fees called investment product fees are mostly based on a percentage of the market value of the investment. Obviously, Ameritrade’s revenue from this source increases with the assets in these funds and programs.
The company continues to rake in investor assets into these programs at an impressive pace and can be expected to continue this momentum going forward as fee based investment advice solutions continue to attract investors and assets. Ameritrade’s fee-based investment balances were up by over 32% y-o-y and reached $105.7 billion at the end of the quarter ended March 31, 2013.