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Where Does Schwab Make Its Money Now That It Owns TD Ameritrade?

By James Brumley - Updated May 18, 2021 at 9:07AM

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The new Schwab doesn't look all that different from the old Schwab, and that's a good thing.

Some investors were understandably concerned when in November of 2019 -- shortly before the COVID-19 pandemic took hold of the world -- Charles Schwab (SCHW 3.35%) announced it would be acquiring rival online broker TD Ameritrade. Rather than postpone or cancel that deal in the disruptive wake of the pandemic, Schwab plowed ahead, completing the acquisition in October of last year just as interest rates began to sink even deeper into uncharted territory. Given how much of Schwab's business is dependent on those rates, nobody quite knew what to expect headed into last month's fiscal Q1 report.

As it turns out, the zany stock-trading environment for the past year as well as the adverse impact of ultra-low interest rates wasn't that big of a deal. Charles Schwab generates revenue in a lot of different ways, and all of those profit centers continue to do well.

A simple picture tells the story of the company's resiliency.

Examining a business chart in front of a laptop.

Image source: Getty Images.

Schwab, then and now

You probably know it as an online brokerage firm. Indeed, you might even be a customer. What you may not know is that prior to October's acquisition of TD Ameritrade, Charles Schwab hadn't produced any trading commission revenue since late 2019, when it stopped charging for facilitating these transactions.

Don't sweat it, though -- the company's fine. Even when it was charging for trades, commissions were never a key part of its business, accounting for less than 10% of 2018's full-year revenue. Moreover, even with TD Ameritrade's commissions back in the mix, it's not a game-changing profit center.

So where does Schwab make its money? As has always been the case, from fees and loans.

The graphic below puts things into perspective. Of last quarter's $4.7 billion top-line, $1.9 billion of it came from interest rate-related sources like margin loans and money market funds despite the challenging environment; as is the case with banks, Schwab sees higher margins on these services and products when interest rates are higher rather than lower.

But even when rates are as low as they are now, there's still money to be made. Recurring asset management fees passed along by mutual fund companies as well as fees for administering retirement plans generated a little more than $1 billion in revenue. Bank deposit revenue (TD Ameritrade is also a bank) kicked in another $351 million, up from nothing a year ago when TD wasn't part of the Schwab family.

Charles Schwab's chief revenue source is still net interest payments after TD Ameritrade deal, and despite the low-rate environment.

Data source: Charles Schwab. Chart by author. All dollar figures are in millions.

Yes, trading revenue accounted for an impressive $1.2 billion worth of revenue for the three-month stretch ending in March. But that's an exception to the norm. A raging market pulled investors off the sidelines in a way that's not only unusual but unlikely to be sustainable. TD Ameritrade's pre-acquisition commission revenue for the same quarter a year earlier was a more muted $481 million -- a figure that more accurately reflects the sort of trading revenue it will continually be bringing to the table.

Still, it's nice to know the company's positioned to reap the occasional trading windfall when market interest is piqued.

The takeaway

While shareholders might superficially wish trading commissions would remain this robust forever, that's not an ideal aspiration.

See, net interest revenue and fee-based revenue are far more consistent and less difficult to induce than commission revenue is. They're also not dramatically threatened by market corrections or even full-blown bear markets.

Frequent trading is also a double-edged sword for brokerage firms for the same reason it is for investors. That is, the more often an investor trades, the more likely it is that the investor will grind down an account's value with ill-timed moves. For the same reason most investors are better served just sitting in mutual funds and holding stocks for the long haul, so too are the brokers.

Perhaps best of all, a more consistent stream of recurring fee revenue also makes for more reliable funding of dividend payments. To this end, Schwab has made quarterly dividend payments for years and beefed them up on a pretty regular basis too.

The bottom line? Charles Schwab is a more consistent outfit than most investors may realize. Its top-line mix is still loaded up with recurring fees and interest revenue, which don't change too dramatically from one quarter to the next.

Charles Schwab is an advertising partner of The Ascent, a Motley Fool company. James Brumley has no position in any of the stocks mentioned. The Motley Fool recommends Charles Schwab. The Motley Fool has a disclosure policy.

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