Weekly Brokerage Notes: Ameritrade, Charles Schwab, E*Trade Await Rate Hike

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The near-zero interest rate levels have eroded the profits of banks and brokerages over the past few years. The financial services industry stands to gain the most from an eventual interest rate hike. The current net interest margin (NIM) for most financial institutions stands at a meager 2.79%. [1] Initial reports in Q3 indicated that a rate hike isn’t likely just yet, as the U.S. economy is still in a precarious state. [2] However, a potential December rate hike was mentioned in the latest Fed meeting. (( Fed Keeps December Rate Hike in Play, Wall Street Journal, October 2015 ))

Brokerages hold customer cash in accounts which pay out set interest rates, which are less than what they earn by investing these client balances in short term instruments, generating net interest income for the brokerages. With renewed expectations of a rate hike, the stocks of financial institutions (particularly brokerages) have rallied over the last month. The stock prices of TD Ameritrade (NYSE:AMTD), Charles Schwab (NYSE:SCHW) and E*Trade Financial (NASDAQ:ETFC) have risen by about 12-15% in that time frame. In the same period, the Dow Jones U.S. Financial and KBW Nasdaq Bank Indices were up by over 5%.

All three brokerages generate significant net interest income. However, in the immediate future the hike is likely to primarily impact short-term interest rates, making the yield curve flatter. In such a scenario, brokerages would likely benefit more than banks, as they generally invest their balances in shorter-term instruments while banks generally benefit from a wider spread. Below we take a look at how interest rates and yields on interest-earning assets impact brokerages.

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TD Ameritrade

Ameritrade’s average client balances were 12% higher than the year-ago period at $21.6 billion in the most recent quarter. However, the implied annualized yield on these assets was about 40 basis points lower than previous year levels at at 2.81%. ((TD Ameritrade Reports Record 2015 Earnings, Ameritrade Press Release, October 2015)) As a result, Ameritrade’s net interest revenue generated through the quarter was flat over the year-ago period at $155 million. Ameritrade’s net interest revenue through fiscal year 2015 ended September stood at $622 million – a 7% annual rise. Its yield for the year was about 6 basis points lower than FY 2014 at 3.03%. Similarly, revenues from insured deposit account (IDA) balances were up by 2% y-o-y to $839 million for FY 2015, while the yield on IDA balances was about 2 basis points lower than FY 2014 at 1.09%

According to our estimates, net interest from client balances comprises about 55% of Ameritrade’s stock. We currently forecast the yield on client assets to go up from 3% in 2015 to over 5% through the end of our forecast period. If the yields increase to over 6.5% by the end of our forecast period, we can expect an upside of 5% in our price estimate for Ameritrade’s stock.

  • Trefis has a $34 price estimate for Ameritrade’s stock, implying a market cap of $18.4 billion. This is slightly lower than the current market price.
  • Ameritrade’s stock price rose by about 15% in the last one month.

See our full analysis for TD Ameritrade

Charles Schwab

Charles Schwab’s average balance for the first three quarters of 2015 was about 12% higher on a year-over-year basis at $154 billion. However, yield on these assets was about 5 basis points lower than the comparable  levels at just 1.60%. [3] As a result, the combined net interest revenue for the nine-month period this year was up by only 8% on a y-o-y basis to $1.8 billion. Net interest revenues contributed about 39% of Schwab’s net revenues in the same period.

According to our estimates, net interest on deposits, loans and securities comprises about 50% of Schwab’s stock. We currently forecast the yield on client assets to go up from 1.60% in 2015 to over 3% through the end of our forecast period. If the yields go up to about 4% by the end of our forecast period, we can expect an upside of about 10% in our price estimate for Schwab’s stock.

  • Trefis has a $28 price estimate for Charles Schwab, translating into a $37.2 billion market cap. This is about 10% lower than the current market price.
  • Schwab’s stock price has risen by over 14% in the last one month.

See our full analysis for Charles Schwab

E*Trade Financial

E*trade’s net interest revenues for the first three quarters of 2015 were about flat over the comparable prior year period at $801 million. E*Trade’s net yield on interest-bearing assets through the nine-month period stood at 2.59%, which was about 4 basis points higher than the year-ago period. Net interest revenue contributed about 60% of E*Trade’s net revenues in 2014.

According to our estimates, net interest on assets makes up about 62% of E*Trade’s stock. We currently forecast E*Trade’s net interest yield to rise from 2.60% in 2015 to 3.70% through the end of our forecast period. If the yields go up to about 4.30% through the end of our forecast period, it could imply a 10% upside to our price estimate for E*Trade.

  • Trefis has a $24 price estimate for E*Trade’s stock, translating into a $7.1 billion market cap. This is about 15% lower than the market price.
  • E*Trade’s stock price has risen by 12% in the last one month.

See our full analysis for E*Trade Financial

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Notes:
  1. Why a Rate Hike Could Benefit the Financial Sector, Market Realist, September 2015 []
  2. 4 reasons why you should be worried about a Fed rate hike, Fortune, September 2015 []
  3. Charles Schwab Q3 2015 Earnings Press Release, Charles Schwab Press Release, October 2015 []