A "new normal" of near-zero US interest rates will limit the earnings potential of US discount brokers this quarter and offset a boost in fee income as investors step up trading to keep up with wild market swings. The surge in stock market activity in the past week has come as a welcome bonus for Charles Schwab Corp, TD Ameritrade, E*Trade Financial and other brokers.
But analysts see the benefits as short-lived. Many retail investors are likely to take cover again soon, waiting for clear signs that the economy is on the mend. That could take months. "The current volume spikes represent 'good' volume," UBS analyst Alex Kramm said in a note to clients. "That said, we believe a prolonged period of market stress could ultimately drive investors to disengage."
Even more importantly for brokers, rates are not likely to rise any time soon. That depresses income from assets that they hold and hurts net interest margins - the spreads between earnings on securities loans and the cost of getting the funds. For most of the summer clients had been sitting on their hands, paralysed by an unsteady economic recovery and concerns over US and European debt woes. The tipping point came with the deadlock in Washington over raising the debt ceiling and the possibility of a US default. That tempted many retail investors back into the market. The stream became a flood when Standard & Poor's stripped the United States of its top AAA credit rating.
At Charles Schwab Corp, where client transactions account for about 20 percent of revenue, daily average revenue trades, or DARTs, rose 11 percent in July over both the previous month and the previous year. "The trading numbers are far in excess of what anyone has in their model," said Macquarie Capital analyst Ed Ditmire.
TD Ameritrade generates more than 40 percent of its revenue from client transactions. It recorded four of its five busiest client trading days ever in the span of a week, including a record of about 900,000 stock trades on Monday. Its July DARTs rose 9 percent from June and 11 percent from a year earlier.
The economic expectations that are driving trading volumes higher also signal an extended period of low interest rates. For Raymond James analyst Patrick O'Shaughnessy, the overall scenario contains more bad news for brokers than good news. "We are lowering our estimates to reflect a pushback in our assumption for future interest rate hikes as well as lower-margin balances that will likely result from the recent market sell-off," he said in a note to clients.
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