Morgan Stanley and E*Trade Are an Odd Couple. Why the Bank Did the Deal.

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BARNEWS value BARNEWS status modified wordcount 862 wordcount|862 Photograph by Andrew Harrer/Bloomberg Morgan Stanley and E*Trade Are an Odd Couple. Why the Deal Makes Sense. Morgan Stanley and E*Trade Are an Odd Couple. Why the Deal Makes Sense. Morgan Stanley and E*Trade Are an Odd Couple. Why the Deal Makes Sense.

Morgan Stanley’s deal for E*Trade sends more shock waves through the brokerage industry. It is also a sign that Wall Street wants to transform itself.

Morgan Stanley and E*Trade Are an Odd Couple. Why the Bank Did the Deal.

The acquisition is a sign that Wall Street wants to transform itself into more of a retail investing powerhouse.

https://www.barrons.com/articles/morgan-stanley-investors-are-cool-to-e-trade-deal-51582218872 mailto:daren.fonda@barrons.com Morgan Stanley and E*Trade Are an Odd Couple. Why the Deal Makes Sense. By Daren Fonda Photograph by Andrew Harrer/Bloomberg

Morgan Stanley’s deal to buy E*Trade Financial for $13 billion is sending more shock waves through the brokerage industry. It is also a sign that Wall Street wants to transform itself into more of a retail investing powerhouse.

Morgan Stanley (ticker: MS) is a classic Wall Street wirehouse. It makes money off investment banking, trading, equity research, and advisory services for wealthy clients, including $507 billion in assets under management for Morgan Stanley Investment Management.

E*Trade (ETFC) is the opposite: The firm is mainly a discount broker and online bank, known for its cheeky advertising and efforts to get individual investors to trade stocks—hey, because it’s fun!

They would seem like an odd couple. But their marriage makes sense in the current landscape. Equity trading commissions have vanished as a revenue source for discount brokers. Charles Schwab’s deal to buy TD Ameritrade (AMTD) last year signaled that discount brokers view the future as one where they generate revenue from multiple other channels, including custodial and advisory services, asset management, online banking, and interest income from cash balances in brokerage “sweep” accounts.

Morgan Stanley and other wirehouses are feeling the pricing pressure. They are looking to diversify beyond investment banking, trading and other traditional Wall Street revenue streams. And they see a huge addressable market in retail financial services, which can be quite high margin and profitable.

The trends prompted Goldman Sachs (GS) to start a retail banking business, Marcus. And they have led JPMorgan Chase (JPM) and Bank of America Merrill Lynch (BAC) to launch their own discount brokerage platforms.

As part of the rationale for the deal, Morgan Stanley is telling investors that its profit center will be shifting from institutional trading and securities to wealth and investment management. The company says that 57% of its pretax profits will come from wealth management with E*Trade in the mix, up from 51% in 2019 (and 26% in 2010).

E*Trade may not offer much trading revenue, but it has some crown jewels that fit nicely with Morgan Stanley’s business. It has $39 billion in banking deposits and $18 billion in off-balance sheet deposits that Morgan Stanley can monetize as a cheap source of funding for loans and net interest income. E*Trade Bank includes digital checking and savings accounts, giving Morgan Stanley a foothold in the thriving online banking space.

E*Trade is a major player in corporate stock-plan servicing, overseeing $300 billion in assets across 1.9 million accounts. Morgan Stanley is also a major player in stock-plan servicing with 2.7 million participants, mainly through its acquisition last year of Solium Capital. Combined, Morgan Stanley and E*Trade will have $580 billion in stock-plan assets under their roof.

Stock-plan customers aren’t necessarily brokerage or advisory customers, but they are terrific prospects. As their wealth grows, they become more valuable to financial services firms.

“Morgan Stanley is the pre-eminent money manager for today’s affluent individuals, but they’re facing competition from the discount brokers and robo-advisors for tomorrow’s affluent individuals,” says David Cohen, a financial services entrepreneur and co-founder of HANDLS Indexes. “Buying E*Trade gives Morgan Stanley a stronger platform to reach these people.”

E*Trade was essentially on the auction block after Schwab cut a deal for Ameritrade last fall. Schwab’s elimination of trading commissions drove a dagger into the heart of discount brokers, making them far more vulnerable and open to acquisitions. It was only a matter of time before E*Trade found a home in a larger financial services company.

Nonetheless, it came as a surprise to some that Morgan Stanley was the buyer.

“It is not necessarily surprising that ETFC is selling itself given industry consolidation and pricing pressures on its business,” wrote Wells Fargo analyst Christopher Harris in a note Thursday morning. “However, MS being the acquiring company does surprise us.”

Wall Street initially appears cool to the deal. Shares of Morgan Stanley fell about 4% on the news. The stocks of Charles Schwab (SCHW) and Interactive Brokers Group (IBKR), however, both got a pop.

Investors appear to view the deal as a win for the remaining discount brokers: Less competition could ease some of the pricing pressure they have been feeling, and they may have opportunities to poach more clients and advisors as Morgan Stanley and E*Trade integrate.

“I think it’s very good news,” Thomas Peterffy, chairman of Interactive Brokers, told Barron’s. “It’s going to be easier to draw a distinction among fewer firms. We’ll get more of independent advisors, because we don’t have internal advisors to compete with them.”

Write to Daren Fonda at daren.fonda@barrons.com

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.