Rocky ride ahead for online brokers, warns S&P

Rocky ride ahead for online brokers, warns S&P

Online brokers have been hit significantly harder than established full-service firms by the economic malaise and the volatile equity markets, according to data analysis from ratings agency Standard & Poor's.

Third-quarter 2001 commission revenues for E*Trade Group and Charles Schwab are down 50% and 42%, respectively, over the same period in 2000. By contrast, the larger, full-service companies posted lower reductions for the same period, with Morgan Stanley Dean Witter down only 14% and Salomon Smith Barney just 15%. The ratings for E*Trade and Schwab have both been placed on negative outlook.

The decline in revenues at the online brokers has more closely tracked the decline in the Nasdaq index - with its technology stocks - which has fallen 59% in year-over-year comparison, versus 28% in the S&P500. The latter index is composed of more established, blue-chip companies from a broader range of industries.

Baylor Lancaster, an associate with Standard & Poor's financial services group, says: "Institutions, mutual funds, and hedge funds have continued to trade despite the economic downturn while nervous retail investors has been sitting on the sidelines."

He also cites a demand for more personalised service from brokers as another reason for the relative stability of the traditional brokers. During the bull market, many retail customers felt confident in their own judgment of where to invest. Now that making money is not so easy, they are rediscovering the value of advice from professional brokers, says Lancaster.

E*Trade and Schwab have managed to survive so far by trimming costs. Schwab has undergone two rounds of layoffs to more closely align its headcount with the reduced levels of trading, while E*Trade has chopped marketing expenses, curtailed technology development, and consolidated office facilities. They have also diversified their product offering with retail banking services.

In the future, however, as reductions in the fixed-expense base become harder to wring out, further declines in trading volumes will cause downward pressure on ratings, warns Standard & Poor's.

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