If there has been one financial merger that never took place but could, it is — or was — the would-be buyout of E*Trade Financial Corp. (NASDAQ: ETFC). The biggest acquiring candidates have always been considered to be TD Ameritrade Holding Corp. (NYSE: AMTD) or Charles Schwab Corp. (NYSE: SCHW).

What investors likely will start to wonder about in the months ahead is whether the expected rising interest rate climate will rekindle those old merger hopes. If that takes place, E*Trade could find itself being targeted for a buyout by Schwab, TD Ameritrade or another firm that wants to grow its retail footprint.

A fresh report from Bank of America Merrill Lynch has hinted at this possibility. The firm raised its rating on Charles Schwab to Buy from Neutral, and the price objective was raised to $36 from $34, which compares to a $31.26 close. Meanwhile, TD Ameritrade was downgraded in the same report to Neutral from Buy and the price objective was kept at $41, versus a $36.72 close.

The big question is what the call really means for E*Trade down the road. Again, these buyout talks have been speculated about for more than a few weeks or months. The recession, particularly due to E*Trade creating a serious mortgage mess for itself, got in the way — and then there was being under Citadel’s thumb, which also got in the way. Now these issues are more or less history.

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24/7 Wall St. pondered this as one of six dream mergers that ought to happen back in March of this year. Again, this was far from the first year that any of us have believed that E*Trade could be (or should be) acquired.

The Merrill Lynch report pegs the notion that competition and M&A activity could rise again in the discount and online brokerage space. The firm’s Michael Carrier and Michael Needham said:

While we think the upside from rising rates and margins, as well as business growth could be significant, other factors could also impact the earnings potential and the stocks, including competitive pricing (where we see Schwab as most defensive and TD-Ameritrade and E*TRADE as more exposed) and/or possible M&A activity …

We view Schwab as well positioned given its exposure to higher short term rates, stronger organic growth (both NNA and balance sheet growth with capital deployment), and less pressure from competition. While we still see upside in Ameritrade, given its higher exposure to medium-term rates/the curve (as well as a longer period to fully normalize), lower organic earnings growth (despite higher NNA growth and a healthy dividend), and more exposure to pricing pressure, we are moving to Neutral.

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As a reminder, it has been known now for years that the near-zero rate environment has suppressed the earnings of the online brokerage firms. They traditionally have been able to make a spread on the interest rate they give clients on their cash balances — and it has always been lower than what the discount and online brokers could get in the financial markets (net interest margin). Merrill Lynch also addressed this in the research note:

While there is significant upside potential to earnings from rising rates (though how rates rise and timing will matter), typically events do not happen in a vacuum, and other strategic factors can come into play, including competitive/pricing changes and/or M&A activity. … We see the most upside to higher interest rates at Schwab and TD-Ameritrade, though there are some nuances among the firms. … We see rate upside of 25% to 90% (assumes 200 bps Fed Funds and a parallel shift, as well as high incremental margins) and four year normalized earnings upside (including core growth and capital deployment) of 150%+ …

While the upside from rising rates and margins, as well as business growth is significant, other factors could also impact the earnings potential and the stocks. Importantly, the windfall from rising rates (after years of pressure) could create some strategic opportunities, including the potential to strategically lower pricing in order to position for market share gains/new segments for growth.

While this report rekindles at least some hope for M&A in the discount and online brokers, 24/7 Wall St. would caution readers not to expect any E*Trade buyout to happen immediately. This is a deal we have talked about as being very likely for years now. The reality is that E*Trade had two black holes in its finances and operations, but for the most part these have been slowly removed through time. Whether they are completely out of the way is up for debate, but most of the issues have dissipated.

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Merrill Lynch even noted on the potentiality, would-be timing and upside of a deal cautiously. The report said:

While we do not view M&A activity as imminent, if these events were to play out, we view the most likely scenario being TD-Ameritrade acquiring E*TRADE. Based on the normalized earnings, potential pricing cuts, synergies, and premium paid, we see the potential for ~30% upside for Ameritrade and E*TRADE, though at current net interest margins, the upside gets cut by roughly half.

By the pricing action on Wednesday morning, it does not look like any investors are playing into the notion that a deal is imminent — nor do the think it may even be brewing any time soon.

E*Trade shares were down 1% at $28.72. The 52-week range is $18.20 to $29.57, and E*Trade has a market cap of $8.3 billion. Its consensus analyst target price is $31.08, and the highest analyst price target is $35.00. E*Trade is also valued currently at 24 times expected 2015 earnings per share and valued at just over 19 times expected 2016 earnings per share.

If Schwab ever wanted to do a deal, it has a market cap of $41 billion. With shares at $31.20, its consensus analyst target is $33.32 and its 52-week range is $23.35 to $31.85.

TD Ameritrade’s market cap is almost $20 billion, and its $36.51 share price compares to a consensus analyst price target of $38.33 and a 52-week range of $28.34 to $38.74.

TD Ameritrade CEO Fred Tomczyk addressed this potential just last September at an industry conference. His comment was that the deal would not be simple, but at least it would not likely have serious regulatory deal-blocking issues, even though this M&A climate is more difficult.

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If you want additional views on how far back this potential deal goes, we noted that there was value in this for a buyout back in 2013 after Citadel was getting cleaned out as an overhang. While buying the company would have come with more potential unknown liabilities and charges, E*Trade shares were closer to $11 back then. Its CEO firing in 2012 was another move that might have given more buyout hopes, which, as history has shown over and over, has proven to be nothing.

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