Charles Schwab has left open the possibility of leveraging its relationship with end clients to charge asset managers more for access to its distribution platforms, following its move this month to scrap commissions.
Questioned by JPMorgan Analyst Ken Worthington on the firm’s third quarter earnings call, CEO Walt Bettinger said that history has shown firms which are closer to clients are able to capture more of the value chain.
“Our proximity to our clients probably puts us in a position so that, if we choose, we could extract more value overall in a variety of ways,” he said, adding that “striving for a higher percentage of what we might receive shared from asset managers” is one option.
I don’t think I’d go so far as saying we will let anyone and anything onto our platform without regard for the economic implications.
On the firm’s commitment to open architecture, Bettinger said Schwab remains committed to providing clients with the best products and services, but that the industry’s definition of open architecture encompasses a large range of approaches.
Worthington suggested a scenario where Schwab could restrict access to products from a firm such as Vanguard Group if it is unwilling to pay platform fees.
“I don’t think I’d go so far as saying we will let anyone and anything onto our platform without regard for the economic implications,” Bettinger responded.
Speaking earlier on the call, he added: “I do want to be crystal clear: We are on offense at Schwab. We are not resting on our laurels at $3.7trn in client assets.”
Schwab posted net revenues of $2.7bn and net income of $951m in Q3, up 5% and 3% year-over-year respectively.
For the first nine months of 2019, net income stood at $2.6bn –11% higher than at the same point last year. The firm’s pre-tax profit margin increased from 44.9% to 46% for the period.
Commission free timing
Analysts also queried Schwab executives about the timing of their decision to do away with ETF, stock and option commissions this month, rather than wait for a more favorable interest rate environment.
Bettinger countered that after they had decided that commissions were inevitably going to zero at some point, the decision was straightforward and that those who have been tracking the firm should have expected it.
“We recognized that making this move basically meant all our online competitors would follow us, and we would be in a stronger position after they all followed us to zero,” he said.
I have a lot of respect for Fidelity as an organization, but I do think of late that they are not necessarily telling the whole story.
This week, E*Trade CEO Michael Pizzi, on his firm’s Q3 earnings call, blasted the timing of competitors making the move to zero pricing on commissions, forcing it to follow.
“We anticipated the potential impact of continued commission compression consistent with historical trends. What we did not include were value-eroding moves by competitors to slash commission revenue precisely when the markets look least robust,” he said.
Both Bettinger and Pizzi acknowledged the potential for consolidation among the brokerages, and that it could be accelerated by the loss of commission revenue.
Bettinger said Schwab continues to be open to M&A options that both add scale and pay off for clients. “We will see if the pricing move influences any timing around that,” he said.
The executive also railed against statements made by rival Fidelity Investments that accompanied its own pricing move, which focused around highlighting the ways that rival brokerages charge for things such as order flow. Fidelity’s website homepage currently has the slogan “At Fidelity, free is actually free,” front and center.
“I have a lot of respect for Fidelity as an organization, but I do think of late that they are not necessarily telling the whole story,” Bettinger said. “They do in fact take payment for order flow on their options. And for equity flow on the retail side, they internalize it and trade it against their retail book, and take rebates from exchanges.”
He added: “From a consumer standpoint, the ones who care are far more knowledgeable than to be influenced by the statements made publicly.”
Schwab’s share price has been on the up since it announced its earnings numbers on Tuesday, with its shares gaining around 6% this week to finish on $39.94.
Morningstar analyst Michael Wong wrote on Tuesday that the firm’s record quarterly earnings-per-share come ahead of “multiple revenue headwinds,” that include the commission pricing cut and interest rate environment.
“We believe that management is well aware of the revenue headwinds, and the over 3% decline in employee headcount and $62m of severance booked in the quarter is evidence of the company preparing for it,” he said.
He added that another headwind may come in the form of Schwab’s no-transaction fee platforms, which become less of a differentiator when many commissions sit at zero.
This is an area where the potential for asset managers to face more fees may rear its head, as the fees currently paid by managers on the no-transaction fee platforms could be extended.
“If that is extended to funds that aren’t on the no-transaction-fee fund platforms, and if there will be any difference made between the retail investor business and the adviser business, I’m not sure,” Wong told Fund Intelligence.
In his Tuesday note, Worthington set a price target of $46 on Schwab stock along with an “overweight” rating. He highlighted $56.7bn of net asset inflows in the quarter, although said further interest rate cuts will likely weigh on the firm – which makes a large amount of revenue from client cash balances.
“We see Schwab further slowing expense growth by slowing the pace of hiring and slowing certain investment projects, reflecting a lower rate environment,” he said.
Keefe, Bruyette and Woods analyst Kyle Voigt set a $42 target price on the stock with a “market perform” rating.
Bettinger and Schwab CFO Peter Crawford also highlighted the opportunity set presented by its acquisition earlier this year of USAA’s wealth and brokerage business. They said the deal handed it around a million retail investors, and opened the door to referrals from the 12 million USAA members who don’t currently invest via the firm.
The CEO was also on a mission to dispel what he referred to as “myths” about Schwab’s retail business.
These include the idea it can’t attract younger customers, where he highlighted the statistic that 57% of the new to retail households it attracted in Q3 were under 40 years of age.
Next he pointed to the firm’s 900,000 households with more than $250,000 in assets in defense of the idea that those with significant wealth head elsewhere.
He also disagreed with the notion that advisory business being won is cannibalizing from other advice solutions, sharing that 72% of households signing up for its advisory solutions were new to advice.