BofA Move Scorches Online Brokers

A free trading offer sends Schwab and its peers plunging.
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Updated from 10:09 a.m. (EDT)

Bank of America's

(BAC) - Get Report

decision to offer free online trading to its customers has put online brokers and banks in a pickle.

The nation's second-largest bank announced Wednesday that it will start offering free online stock trading--up to 30 trades a month--to any customer who keeps at least $25,000 in deposits with the Charlotte-based lender. Customers with less than $25,000 will continue to pay the standard $5 to $10 a trade commission charge.

Shares of online brokers

TD Ameritrade

(AMTD) - Get Report

,

E*Trade

(ET) - Get Report

and

Charles Schwab

(SCHW) - Get Report

were in freefall after the surprising news from BofA, which never has ranked as a leader in online trading. In early afternoon trading, both Ameritrade and E*Trade were down about 10%.

BofA, which is first offering no-commission trading in the Northeast, describes the new policy as a "compelling opportunity" to grab additional deposits and revenue. It expects about 40% of its customers--the company serves 54 million households in the U.S.--to be eligible for the service, and anticipates new customers switching to the bank to take advantage of the free trading.

"In our view this is a game changer," Liam McGee, BofA president of its global consumer and small business group. "Quite frankly we find it difficult to imagine a customer that wouldn't want to take advantage of this."

The move is a bold one for B of A, which says the revenue lost on online trading commissions is immaterial to the revenue it plans to add from additional deposits. It's also a potentially risky move, given that other financial-services firms found free trading not too profitable.

Most notably,

American Express

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experimented with free stock trading in 1999 but abandoned the idea because there wasn't much demand for it. Even Ameritrade once experimented with free stock trading through a Web site called FreeTrade.

But for now, at least, investors see the initiative as posing the biggest risk to the online brokers, who derive the majority of their revenues from commissions paid by hyperactive traders.

A little more than a year ago, all the online brokerages were involved in a bitter price-cutting war, which drove most commission prices down to under $10. Most online brokers charge between $5 and $10 a trade depending. BofA's move, however, could spur a new round of price-cuts at the online firms.

Richard Bove, an analyst at Punk Ziegel, writes in a note that the program "is providing a terrific benefit to consumers" and will "force others to discount and it places more pressure on regional brokers to merge."

Michael Mayo, an analyst at Prudential Equity Group, writes in a note that Schwab's average customer "only trades a couple of times per month" and "while trading revenue accounts for less than 20% of total revenue at Schwab, the offering could pressure Schwab's asset growth and account retention."

However Mayo does not expect Schwab to reduce its commissions further in direct response to B of A's changes.

In fact, Schwab said Wednesday it has no plans to cut its fees at this time.

"Free trade offers have been around for quite some time in the marketplace, both from Schwab and from other institutions," says Schwab, in an emailed statement. "Knowing there is no free lunch, consumers look carefully at the whole picture - rates on their cash, trading costs, quality of services and investment advice, etc. We don't have any plans to change our pricing at this time."

E*Trade could not be reached for comment. Ameritrade says it has no plans to change its prices. "To date those types of pricing agreements have not garnered any types of market share," a company spokeswoman says.

Schwab's stock is down 97 cents or 5.4%, to $17.10, E*Trade's stock is down $2.44 a share, or 10% to $22.02, while Ameritrade is down 10.8% or $2.06 a share to $17.04.

BofA, meanwhile, isn't alone in taking another stab at the idea of free trading. Recently, Zecco Trading, a subsidiary of Equinox Securities, began offering free trading for customers that make up to 10 trades a day. or 40 trades a month.

Still, BofA's move could cause some of its bank competitors such as,

Citigroup

(C) - Get Report

,

Wells Fargo

(WFC) - Get Report

and

JP Morgan Chase

(JPM) - Get Report

to reassess their online trading offerings.

For now, at least, analysts seem to think the gamble with free trading is one worth taking for BofA.

"Tthe emphasis is on the deposit side of the business -- making them more appealing against other competitors that do not have the same scale," says Gary Townsend, an analyst at Friedman Billings Ramsey.

"There is a great deal of interest in how to gather liquidity regardless of whether it would be named a deposit or not," Townsend says.