New York | News reports suggest that The Charles Schwab Corporation (SCHW) may acquire TD Ameritrade Holding Corporation (AMTD). SCHW is a $280 billion thrift holding company (RSSD:1026632) that ranks 14th in the US among large depositories. With $3.2 trillion in assets under management (AUM), SCHW also has a dominant position in the world of providing clearing and custody services to registered investment advisors (RIAs).
Darren Fonda notes in Barron’s that this fact – and the float that it generates – enables the banking side of SCHW to generate 70% of the firm’s combined revenue. It's all about the float kiddies. In our note in ZeroHedge last week (“Schwab + TD Ameritrade: Banks Always Win”) we opine that this gives SCHW an overall cost of funds just 40% of the average of Peer Group 1, as shown in the chart below.
The fact that a combined SCHW and AMTD would have $5 trillion in AUM allow us to estimate that the combined deposit base would be over $300 billion, including customer balances and fiduciary float. Today Charles Schwab Bank, an S&L domiciled in Henderson, NV, has $200 billion in core deposits.
This abundance of liquidity – and fee income – raises an interesting possibility, namely a counter-offer by The Toronto-Dominion Bank (TD), which is the custodian bank for AMTD. Barron’s notes that TD, which owns 43% of AMTD, is presently the bank custodian for the millions of RIAs and individual investors of the smaller non-bank brokerage firm.
TD earns the interest on the float, minus a very legal rebate paid to AMTD. This is a similar arrangement to any non-bank company, which must deposit client balances with an investment grade insured depository institution and then borrow them back if needed.
SO, the question arises: Does the management of TD in Toronto really want to see AMTD acquired by a competitor and another large bank at that? As Barron’s notes rather astutely (and the rest of financial journalism largely missed), the relationship between TD and AMTD is quite lucrative for the $1.3 trillion TD. Again, it’s all about the banking business.
The brokerage side of the business is largely a commodity that does not matter in the grand calculus of valuation. But what supports the lofty valuations of both SCHW and AMTD? One word: AUM.
With AMTD trading around a $26 billion market cap and SCHW at $60 billion, acquiring the 60% of the former it does not own would cost TD something on the order of $15-20 billion. TD trades in line with its large bank peers at ~ 2x book as of Friday, meaning a bid to acquire the rest of AMTD would be very expensive.
News reports speculate that SCHW may cut a deal with TD to allow the Canadian bank to continue to service the deposit business of AMTD until the agreement expires in 2021. We think, however, that SCHW will be anxious to gain full control of the AMTD float as soon as possible. Telis Demos writes in The Wall Street Journal:
“Schwab has long operated its own bank. Ameritrade partners with Toronto-Dominion Bank (a roughly 40% owner of the company) and others to distribute customer cash and earn what is, in effect, a net interest margin on that cash. Schwab currently generates a higher net interest margin than Ameritrade, so in theory that same customer cash could be more lucrative if deposited at Schwab’s bank.”
Ditto Telis. And one veteran wealth manager tells The IRA that a counter-bid is unlikely because most of TD’s revenue comes from Canada, where it operates both a banking franchise and a large wealth management business. TD also has Waterhouse Securities, another discount brokerage which TD acquired two decades ago.
Despite the prospect of losing the AMTD business, the manager views a possible counter-offer by TD for AMTD as a low probability event. TD has benefited from the entire float controlled by AMTD by owning just 40% of the company, but buying the other 60% at north of 3.5x book or higher is a bridge too far for the risk averse Canadians.
TD has a very large core deposit base in Canada and, like most banks, suffers from a dearth of earning assets rather than a shortage of liquidity. A more likely scenario, the manager offers, comes with TD rebranding the Waterhouse brokerage business and taking the gain on the AMTD equity stake off the table.
And, to the headlines about SCHW possibly “surging” above 3.5x book in the event the deal closes, validating the correlation between the SCHW deposit base and the premium valuation is not a straightforward exercise.
The SCHW bank is low risk and provides stability to the business, but again, we’re not sure how that works into a 3.5x book equity multiple for the whole business, as shown in the chart below. Is the off-balance sheet AUM of SCHW more valuable than the huge mortgage and commercial payments float of U.S. Bancorp (USB) at 2x book value??
Liquidity: Please Sir, May We Have Some More?
Despite all of this talk about banks awash in core deposit liquidity, we note with growing concern that we are repeating the scenario seen last year in the short-term money markets. Bids are adequate for overnight funds and a couple of weeks out, but there remains a reluctance to offer cash over the year-end. As the chart below from the DTCC suggests, the volumes for GCF repos of Treasury and conventional Fannie Mae and Freddie Mac collateral are falling as they did last year. Just saying.
Black Friday Sale
We’ll be pushing a 30% off coupon to registered readers of The Institutional Risk Analyst so that you can spend the holiday season pondering the truly extraordinary business model attributes of Citigroup (C) and Goldman Sachs (GS). Yeah, SCHW has 3x the core deposits of GS. Think about that for a moment. Is there a correlation between strong levels of core deposits and premium equity market multiples? Maybe.
And to celebrate the holiday season and shareholder value destruction, we’ve added HSBC Holdings plc (HSBC) to The IRA Bank Dead Pool, as shown in the table below. Trading on a price/book of 0.8x and a beta of 0.6, HSBC has effectively died as a stock – one of the negative side effects of macro prudential regulation. Were this $2.5 trillion asset zombie not a regulated depository, it would have been acquired and broken up years ago. But cowardly regulators refuse to break up the true zombie franchises with no hope of revival. Happy holiday.