/TD sees opportunities in Schwab-Ameritrade deal, but redeploying capital remains an option

TD sees opportunities in Schwab-Ameritrade deal, but redeploying capital remains an option

Toronto-Dominion Bank will have at least eight months to decide what to do with its stake in a U.S. brokerage behemoth once Charles Schwab Corp. closes its proposed acquisition of TD Ameritrade Holding Corp.

TD Bank owns approximately 43 per cent of Omaha, Neb.-based TD Ameritrade, which San Francisco-headquartered Schwab is buying in an approximately US$26-billion all-stock transaction that was formally announced on Monday.

The deal would give TD two seats on Schwab’s board and an approximately 13.4 per cent stake of the broker, made up of 9.9 per cent voting common shares and the rest in non-voting stock.

TD’s chief financial officer, Riaz Ahmed, said a new stockholders’ agreement between TD and Schwab would lock up the bank from selling its Schwab shares for eight months after the deal’s expected close in the second half of 2020, subject to certain conditions and approvals. The stockholder agreement also makes TD subject to “customary” standstill restrictions on the shares.

The value of TD’s 43-per-cent stake in Ameritrade was pegged at $12.9 billion as of Nov. 20, according to the bank, which it claimed could grow by $4 billion to $6 billion in the years ahead as a result of Schwab’s acquisition and plans for cost savings. Toronto-based TD is supporting the deal, and will discuss possible future business with Schwab, the bank’s chief executive said.

“We have an opportunity to explore further business opportunities with one of the preeminent investment firms in the U.S.,” TD president and CEO Bharat Masrani said during a conference call to discuss the deal.

These possibilities would be on top of an agreement TD has with Ameritrade for insured deposit accounts (IDA). A renegotiated version of the agreement with Schwab, which already has a bank, is part of the acquisition.

“Currently we have certain arrangements with TD Ameritrade,” Masrani said in response to an analyst question. “Overall … outside of the IDA, they have not proved to be as material as we would have liked them to be, but our expectation is to undertake those discussions with Schwab to see where are there opportunities that work for both sides.”

… the benefits of size, scale and breadth have taken an even-greater importance to support a rapid pace of innovation and to provide a full suite of services to clients

TD president and CEO Bharat Masrani

The merger of two of the biggest online brokerages in the U.S. comes as the industry is under pressure over moves to cut or completely eliminate commissions. This trend was hastened by Schwab’s announcement on Oct. 1 that it was dropping certain commissions, forcing TD Ameritrade to follow suit (at an estimated cost of around 15 to 16 per cent of its net revenue).

“In an environment where top-line growth is under pressure, and customer expectations are rising, the benefits of size, scale and breadth have taken an even-greater importance to support a rapid pace of innovation and to provide a full suite of services to clients,” Masrani said, adding that this was part of Schwab’s rationale for the deal.

Schwab’s acquisition of TD Ameritrade would see the latter’s stockholders, including TD Bank, get 1.0837 Schwab shares for each TD Ameritrade share, a 17-per-cent premium over the 30-day volume-weighted-average-price exchange ratio as of Nov. 20.

A smaller, yet more valuable, stake in Schwab could give TD some added firepower for mergers and acquisitions of its own. The bank already has a strong presence in the northeastern United States, and Masrani has voiced in the past an interest in the Florida market.

“We do not believe TD’s position in (Schwab) is a permanent one longer term,” wrote National Bank Financial analyst Gabriel Dechaine. “We view this asset as one that can potentially be used to finance any future regional bank acquisitions TD might make.”

TD Ameritrade was created in 2006 with the sale of TD Waterhouse USA to Ameritrade Holding Corp. CIBC World Markets analyst Robert Sedran wrote that until now, they had viewed TD’s stake in Ameritrade “as a strategic rather than financial investment.”

“It seems to us that this holding has now transitioned into the latter bucket and we assume at some point this value will be redeployed, perhaps into the lower-multiple personal and commercial banking business,” Sedran said.

We do not believe TD’s position in (Schwab) is a permanent one longer term

National Bank Financial analyst Gabriel Dechaine

The combined firm of Ameritrade and Schwab would have an expected 24 million client accounts and more than US$5 trillion in assets. Integration is anticipated to take between 18 and 36 months, according to a press release.

Schwab is expecting that a number of “synergies” will help increase earnings per share by 10 to 15 per cent by the third year following the deal’s close. After adjusting for TD’s share of integration charges that Schwab estimates it will take, the bank is projecting an increase in adjusted earnings the same year of $125 million. With those costs included, TD projected earnings will be $10 million lower in year three.

Efficiencies will also be key to offsetting the effect of the revised IDA agreement on TD.

The present arrangement allows TD to earn a 25-basis-point servicing fee on the aggregate average daily balance in “sweep” accounts, where cash is moved from Ameritrade client accounts into interest-bearing accounts at TD. The revised agreement would kick in when the acquisition closes, extending the deal to 2031 and cutting the servicing fee to 15 basis points. Schwab would also have the option starting in July 2021 to reduce the IDA deposit balance, which was US$103 billion as of July 31, by up to US$10 billion a year, but not below a total of US$50 billion.

Dechaine said they are projecting the revised IDA agreement would reduce TD’s earnings per share by an estimated six cents, or 0.9 per cent.

“However, based on (Schwab) achieving US$3.5-4.0 billion of revenue and cost synergies, we estimate no net impact to our forecasts,” Dechaine added.

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