TD Ameritrade (NASDAQ:AMTD) continues to grow its base of customers and assets, which has led to regular growth in stock trading activity that is a real positive for the bottom line. And while any Fool knows that more trading is usually bad for returns, other fools keep doing it, and that makes for a profitable investing opportunity for TD Ameritrade's shareholders.
Yet, when TD Ameritrade reported second-quarter earnings on April 21, it announced that net revenue and net income both declined from the same quarter last year, keeping earnings per share flat on a lower stock count. In short, the company is growing, but that growth just didn't translate to the bottom line.
Trades and fees
TD Ameritrade makes money in two main ways: transaction fees from its clients' trading activities, and asset-based fees associated with the management of its clients' assets. While the company increased its daily average trades sequentially in the second quarter, that's typical of the company's historical seasonality:
As you can see above, though, last quarter's average daily trades and activity rates declined from the year before, meaning fewer trades were made by fewer traders. On the earnings call, CFO Bill Gerber said that the average per-trade commissions declined, "primarily due to both mix of products traded and more trading being done by active clients at lower price points as well as lower equity shares traded per trade."
On the other hand, TD Ameritrade's asset-based revenue increased 4% in the quarter. And so far this year, asset-based fees have generated $62 million more revenue than last year, a 7% increase, while transaction revenue is up only 1% following last quarter's decline.
Higher expenses weighing on profits, but it's part of the endgame
While advertising costs dropped substantially from last year due to the company's 2014 Olympics sponsorship, operating expenses surged $30 million in the quarter.
According to Gerber, the biggest driver behind that was increased headcount tied to growth initiatives, meaning that component of the operating expense isn't likely to go away. However, the company said advertising costs should continue to decline, while the added headcount should help the company further increase its customer base -- and thereby revenue.
Fiduciary standard: Potential negative impacts of this investor-friendly move
While not material to last quarter's results -- and unlikely to impact the company before the fourth quarter at the soonest -- there is a proposed rule change in the works that could impact the entire industry. In short, it would eliminate the existing level of ethical standard that allows for a conflict of interest between those in an advisory role and their clients. This is the distinction between the so-called suitability and fiduciary standards.
In short, most advisors operate under the suitability standard, meaning they can legally and ethically operate with conflicts of interest, and offer or recommend products to clients that might not be best option available. In practice this conflict leads those in an advisory role to often recommend products that pay superior commissions to the seller, though they may not offer the best returns to clients.
The fiduciary standard, on the other hand, prohibits advisors from recommending products to their clients that might be better for the advisor's pocketbook than for their clients'. This is a critical distinction that could weigh heavily on brokers in the future, as the Department of Labor has proposed clear rules that would mean that anyone being paid to give you retirement advice would be required to act as a fiduciary, as opposed to under the suitability standard.
Why does this matter? While it doesn't look like new rules would eliminate commissions for selling certain kinds of instruments like mutual funds or annuities, it would hold those in advisory rules to a much higher standard of responsibility for their advice.
While undoubtedly a positive for investors, as it should lead to lower fees and likely better returns, this could impair TD Ameritrade's asset-based business, which is largely based on retirement account fees. But management seems to think it is relatively well positioned for this, as the company purports to already follow the fiduciary standard.
Still, it's frankly too early to say what -- if any -- impact the proposed changes will have on TD Ameritrade. What's good for the investor community isn't always good for the financial services companies that make money on fees and transactions.
In the meantime, TD Ameritrade's focus looks to be on continuing to grow its assets, which should lead to more fees from both assets and transactions over time. As to quarterly non-advertising expenses, CEO Fredric Tomczyk said they will be $410 million to $420 million over the next several quarters, a slight decline from last quarter, while advertising costs will continue to fall post-Olympics.
So costs should be down-to-flat for the rest of this year, and if the asset growth trend continues, that would be a positive confluence of events. Only time will prove if management can get it done. As the old sports cliche' goes, "that's why they play the game."