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Morningstar | While Trading Is Material to TD Ameritrade, Interest Rates Remain Key

While trading revenue is a greater percentage of narrow-moat TD Ameritrade's net revenue than at some peers, much of the company's revenue growth still depends on the evolving interest-rate environment. For the company's fiscal first quarter ending in December, TD Ameritrade reported net income of $604 million, or $1.07 per diluted share, on a record $1.5 billion of net revenue. Given that the company's acquisition of Scottrade closed in September 2017, year-over-year comparisons are more meaningful and can illustrate how the company's results have improved. The $1.5 billion of net revenue in the quarter is 21% higher than a year ago, and non-GAAP adjusted EBITDA, excluding acquisition costs, increased 53% to $876 million. We anticipate moderately lowering our $66 fair value estimate for TD Ameritrade and assess that shares are fairly valued.

The trading revenue pickup in the December quarter helped TD Ameritrade, but interest rates still remain key. Trading revenue increased to $537 million, up 22% from the previous year and 11% sequentially. Since trading revenue is around 35% of net revenue compared with about 10% at peer Charles Schwab, the recently volatile equity markets have helped TD Ameritrade more. That said, there is a secular shift in the brokerage industry to more asset-based fees and ongoing pressures on commission pricing. Going forward, it's the company's growth in investment product fees and interest-related revenue that's more important.

The prospect for rising U.S. interest rates is increasingly precarious. CME Group interest-rate futures are now pricing in a greater likelihood of zero federal-fund rate hikes in 2019 compared with one or more several months ago. Additionally, the 10-year Treasury yield has recently fallen to about 2.75% from 3.25% in the fourth quarter. That said, even at current rates, the company should still have interest-rate-related revenue growth for the foreseeable future.

The importance of the longer end of the yield curve on TD Ameritrade is amply illustrated by updated management commentary. The company estimates that if the fixed portion of its bank deposit account program fully reprices at current rates over the next seven years, the company will generate an incremental $450 million of annual revenue. However, the previous quarter, when interest rates were higher, the company stated that a full repricing of the portfolio would have generated about $900 million of incremental revenue.

TD Ameritrade recently increased its disclosure of its bank deposit account program and has nearly $15 billion of balances maturing in the next year that currently have a net revenue yield of 1.07%. Management has also said that it expects to have a 75- to 80-basis-point improvement on reinvesting those maturing balances. Additionally, balances maturing in years 2 through 6 have net rates ranging from 1.31% to 1.46%, so those balances would also be reinvested at a positive spread if the interest-rate environment remains unchanged. With over 50% of net revenue in the quarter being interest-rate-related, the company still has a fairly long runway for improving earnings.

For our recent analysis of deposit costs and net interest margins, please see our December 2018 Financial Services Observer, "The Return of the Bank: Net Interest Margins Reach a Turning Point."