These are tenuous times for financial companies.
Falling prices and persistently low interest rates are squeezing profits on many of the products and services they offer, from managing funds and other investment assets to credit cards and merger advice. Companies catering to retail customers are facing increasing competition from Wall Street banks. And consolidation is making it hard for niche players to go it alone.
That upheaval continued Thursday, with Morgan Stanley’s announcement that it would buy the discount broker E*Trade Financial for $13 billion in stock. That followed Charles Schwab’s deal in November to acquire TD Ameritrade, another discount broker, for $26 billion.
So where does that leave Fidelity Investments, the Boston giant that competes in many segments of the industry, including discount brokerage, and has 5,000 employees in the city?
Financial services consolidation is no doubt making life tougher for chief executive Abigail Johnson and her management team. Fidelity’s core stock-picking business has been under pressure for years from low-priced index funds. More recently, a price war that has driven online stock-trading commissions to zero has been great for investors but has forced brokers to search for new sources of revenue or to combine with bigger companies.
In many ways, Fidelity has been ahead of the game — a diversified provider whose businesses are the envy of many in the industry.
“Fidelity has a globally recognized and trusted brand," said Lee Beck, a managing partner at Kudu Investment Management, a New York firm that invests in small asset managers. “They have prowess in the investment management side.”
It also has a lot of clients: 30 million individual investors, 13,500 independent financial advisers, and 22,000 employers who use Fidelity for worker retirement savings and benefit programs. The company manages $3.2 trillion in customer assets.
By expanding its customer base and controlling costs, Fidelity has continued to grow its revenues and profits. Its operating income rose 19 percent in 2018, the most recent year for which results are available, while revenue increased 12 percent, to a record $20.4 billion.
The Morgan Stanley-E*Trade deal highlights a key industry trend: the reemergence of banking as a sexy business.
Companies want to vacuum up customer investment and cash accounts so they can lend the money and securities to others. It’s called spread lending — a business Fidelity has long been in — because the company lends at rates that are higher than those paid to the account holders.
With asset management, trading, and other fees under pressure, spread lending has become a growing source of revenue.
Consider E*Trade: In 2019, commissions generated just 15 percent of the Arlington, Va., company’s revenue of nearly $2.9 billion. The bulk of E*Trade’s revenue, 64 percent, came from net interest income — the money it makes lending cash and securities. The same was true for TD Ameritrade, where bank deposit account fees and net interest income accounted for more than half of net revenue last year.
“The shift is to a banking model," said James Angel, an associate professor at Georgetown University’s McDonough School of Business. Commission-free trades are a loss leader that gives the company a chance to sell other services to the customer, he said.
Those services could include checking accounts, home mortgages, consumer loans, and business loans.
“Competition for consumer cash has been a big win for consumers,” said Greg McBride, chief financial analyst at Bankrate.com, a financial data company. “It means more services at cheaper prices.”
A few hours after Morgan Stanley announced its takeover of E*Trade, I talked with Ram Subramaniam, president of Fidelity Brokerage Services.
Calling the E*Trade takeover “one more step in the consolidation process,” he said it “validates our strategy for the last 10 years . . . We are already in these businesses at scale."
He conceded that getting bigger is necessary to stay ahead in financial services. But unlike Morgan Stanley, an investment bank that has been expanding its retail presence, Fidelity believes it can do it organically.
Part of that is necessity. As a privately held company, Fidelity doesn’t have a publicly traded stock it can use as a currency in buyouts.
The company believes the trade-off is worthwhile because management doesn’t have to worry about meeting Wall Street’s quarterly earnings demands and can instead focus on long-term planning. That means it’s easier to attract and retain customers with services such as $0 commission trades, funds with no expense fees, and higher interest rates on the cash in their accounts.
“In a couple of years we grow the size, in assets, of an E*Trade,” Subramaniam said, and the numbers support his contention. “And we don’t have to pay a premium for growth.”
Of course, Subramaniam has to put a positive spin on the news.
But based on how Fidelity has adapted to change in the past and fared through recessions and market crashes, I think there’s a lot of truth behind the hype.