Online Broker Stocks: Market Over-reacted To BoA's Commission Announcement

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Includes: AMTD, BAC, ETFC, SCHW
by: Neal Shanske

Bank of America (NYSE:BAC)’s announcement Wednesday that it would offer 30 free trades per month to customers with combined balances of $25,000 or more was greeted by investors in online brokers with a stampede for the exits. E*Trade (NYSE:ET) and TD Ameritrade (NASDAQ:AMTD) were both trading down around 10%, and Charles Schwab (NYSE:SCHW) was down more than 5%.

Bank of America’s announcement comes just days after the launch of Zecco, a new online broker which also offers free commissions. Past attempts at commission-less sites (i.e. Freetrade.com) have failed to take market share and have been shut down.

At least for the moment, the market believes this is different. And it is. Bank of America is a behemoth, having relationships with over 50 million American households, 40% of which will already qualify for free trades. ETrade can scarcely afford to eliminate commissions; commission revenue consistently exceeds net income.

So what’s an online broker to do? Relax.

When discount brokers emerged and online stock trading became America’s new national pastime in the late 1990s, it was a widely held belief that full service brokerages would be forced to cut commissions or face the disappearance of their business. Despite the fact that commissions haven’t been cut, these companies are at record stock prices and making record profits. Apparently, commission costs aren’t the only factor driving investor behavior. Full service brokerages also began to shift clients towards non-commission based fees, charging many customers a flat percentage of assets.

The market’s reaction is overdone. ETrade, Ameritrade and Schwab already face lower-priced competitors and have continued to grow. For most investors, the difference between $13, $7, and $0 is not sufficient to motivate them to go through the hassle of switching brokers if they are otherwise happy with the service they’re receiving.

Commissions will not disappear overnight. There is a cost to executing trades, and everyone, even Bank of America, needs to pay it. If brokers aren’t making money off commissions, they’ll need to make it up elsewhere. Whether that’s through higher margin interest rates, lower interest paid on cash accounts, or additional fees, remains to be seen.

Commissions have been consistently falling for the past 10 years, and online brokers have only become more profitable. Is that a guarantee that continued drops will not reduce profit? No, but Bank of America’s move is the beginning of the end. After all, you can’t get cheaper than free.

Disclosure: I have no position in BAC, ET, AMTD, or SCHW