TD Ameritrade Revenue Mix Prompts Credit Suisse to Start Coverage at Underperform

Credit Suisse initiated coverage of TD Ameritrade Holding Corporation (AMTD) shares with an Underperform rating and a $45 price target, saying in a research report that TD Ameritrade has a lower quality of revenue mix compared with its peers.

In a note to clients, Credit Suisse analyst Craig Siegenthaler said that 29% of TD Ameritrade's revenue comes from trading commissions, while 9% comes from payment for order flow and 5% from 12b-1 fees from mutual funds by registered independent advisors (RIAs). While the analyst said that each of these fee streams could be stable or even grow in 2018, there is also risk involved with all of them.

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Take commissions for starters. Siegenthaler said that return on client assets is shifting to institutional investors and away from its direct retail business. That is troublesome because the RIA business has a lower return on client assets because clients tend to have lower cash balances and trade less often, while some RIAs also negotiate fee discounts.

Furthermore, the analyst said that TD Ameritrade's payment for order flow revenue and rebates are declining by a modest rate in 2017, which puts it at risk from new regulations. "AMTD is the most effective at monetizing its order flow, and also could see the largest hit to earnings from new regulations. We think the SEC will introduce new disclosure requirements in 2018-19, and also introduce a pilot program that will test how rule changes would impact the markets," wrote Siegenthaler in the research note to clients.

As for 12b-1 fees, Siegenthaler said that the discount brokerage has $50 billion of client assets in mutual funds that collect the fees and that most of these client assets are in the RIA channel. "12b-1 fee mutual funds are generally only used in brokerage accounts, however, after the final Department of Labor rule was released, many broker-dealers have banned 12b-1 fee mutual funds on their advisory platforms," he said.

While the discount brokerages have been aggressive in lowering commissions and fees associated with investment products, Credit Suisse believes that Fidelity Investments or Charles Schwab could reduce rates even more on equity and option trades in the future, which would affect TD Ameritrade given its higher commission revenue mix. The analyst said that, while TD Ameritrade's rates are so low that it won't have to engage in another round of cuts, it could lose RIAs and their client assets to rivals if there is a wide difference in price. In addition, Siegenthaler believes that TD Ameritrade needs a large marketing budget to generate growth at the firm.

Shares of TD Ameritrade were recently trading at $51.11, down $0.06 or 0.12%. With its price target of $45 per share, Credit Suisse suggests that the stock could see declines of close to 12%.