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Fitch Maintains Scottrade Financial Services' 'BBB-' Ratings on Rating Watch Positive
March 8, 2017 / 7:58 PM / 9 months ago

Fitch Maintains Scottrade Financial Services' 'BBB-' Ratings on Rating Watch Positive

(The following statement was released by the rating agency) CHICAGO, March 08 (Fitch) Fitch Ratings maintains the 'BBB-' ratings of Scottrade Financial Services, Inc. (Scottrade) and its senior unsecured notes on Rating Watch Positive. A full list of rating actions follows at the end of this release. KEY RATING DRIVERS - ISSUER DEFAULT RATINGS (IDRS) AND SENIOR DEBT Scottrade's ratings reflect its established position in the retail brokerage space, a continued shift towards a more balanced business model with lower reliance on transactional revenue, and improving cash flow leverage. Rating constraints include less revenue diversity than peers, industry-wide pressure on trading commissions, the growth of the loan portfolio at Scottrade Bank (SB) which has yet to season, and continued operational risk elements highlighted by the cyber security issue the company disclosed in 2015. The Positive Watch reflects the expected improvement in Scottrade's credit risk profile were the acquisition by TD Ameritrade Holding Corp. (TD Ameritrade) to be consummated. In October 2016, TD Ameritrade announced that it had reached an agreement to acquire Scottrade for $4 billion. The transaction is expected to close in fiscal 2017, subject to shareholder and regulatory approvals. Fitch does not rate TD Ameritrade, but views it as having a stronger credit risk profile than Scottrade based on its franchise position, financial metrics and strategic relationship with TD Bank (rated 'AA-/F1+'). Additionally, the transaction would address certain rating constraints for the standalone Scottrade related to its greater reliance on transaction-based revenue and key man risk, specifically succession, associated with Scottrade's founder and CEO. Fitch notes that the Positive Watch may extend beyond the normal Rating Watch horizon (six months) depending on the timing of closing. Scottrade's pre-acquisition business model is still somewhat reliant on revenues from retail trading activity which have declined since 2013 and represented approximately 27% of net revenues for the trailing 12 months (TTM) ended Dec. 31, 2016. Pressure on trading commissions continues to be driven by an industry-wide decline in price per trade. Scottrade has taken steps to diversify away from transactional trading revenue and evolve towards more fee-based investment management revenue, forming Scottrade Investment Management, Inc. (SIM) in 2013 to provide guidance and investment management for customer accounts. Fitch notes that Scottrade has ramped up branch staffing and recruiting efforts to gather more assets in recent years but it has yet to be a meaningful contributor of revenue (13% of total revenues in 2016). In 2016, loan growth at SB accelerated. Total loans increased to $3.7 billion, up 42% from $2.6 billion at fiscal-year end 2015, driven by an increase in residential real estate mortgages. Credit metrics within the loan portfolio remain strong with low charge-offs and delinquencies; however, Fitch expects incremental credit deterioration as the portfolio seasons. Fitch views favorably Scottrade's bank sweep program which has helped to somewhat moderate the recent growth in Scottrade Bank. Previously, Fitch had been concerned about the growth of Scottrade's bank impacting overall performance metrics and potentially requiring the company to issue additional debt to support growth. Core earnings declined in 2016, due to a 10.4% decline in trading revenue, partially offset by a 3.0% increase in net interest income. In 2016, net interest income accounted for 59% of total revenues compared to 27% for trading revenues. EBITDA margin declined to 20.8% in 2016 compared to 23.4% in 2015 but remains strong. Fitch believes that rising interest rates would contribute to net interest margin expansion and higher earnings. Scottrade's leverage and capitalization metrics remain solid. Cash flow leverage, as calculated by debt to EBITDA of 1.8x for TTM Dec. 31 2016, remained well within Fitch's 'bbb' rating category quantitative leverage benchmark range of 1.5x-2.5x for securities firms with lower balance sheet usage. Additionally, Scottrade and Scottrade Bank continued to maintain strong capital levels (Tier 1 Risk-based capital of 30% and 26%, respectively) at Dec. 31 2016, well in excess of the regulatory minimum. Commensurate with the decline in EBITDA, interest coverage, measured as EBITDA-to-interest expense, declined in 2016 to 7.0x (from 9.1x in 2015) but remained within Fitch's 'bbb' rating category quantitative coverage benchmark range of 6x-10x for securities firms with lower balance sheet usage. RATING SENSITIVITIES - IDRS AND SENIOR DEBT Fitch expects to resolve the Positive Rating Watch following the close of the transaction, which is expected to be sometime in fiscal 2017. Ratings could be upgraded based upon Fitch's evaluation of TD Ameritrade. Ratings could also be withdrawn if Fitch is unable to fully evaluate TD Ameritrade's credit profile. If the transaction were not to occur, Fitch does not anticipate downward pressure on Scottrade's ratings assuming its standalone credit risk profile has not materially changed in the interim. Prior to the acquisition announcement Fitch's Rating Outlook for Scottrade was Positive, reflecting the company's improved cash flow leverage and stable earnings performance. In determining Scottrade's Rating Outlook in a scenario where the TD Ameritrade transaction did not occur, Fitch would balance these improving fundamentals against the tacit indication that Scottrade's agreed-upon sale to TD Ameritrade suggests in terms of Scottrade's long-term competitive position as a smaller, albeit still meaningful, retail brokerage player. Operational risk remains an important factor in ratings of securities firms. Scottrade's security breach disclosed in October 2015 did not cause any noticeable client departures or financial losses. However, it highlights some of the operational risk elements of the business model, which place some upward constraint on Scottrade's pre-acquisition risk profile until a longer track record with no material breaches is observed. Additional operational issues that led to client departure could pressure Scottrade's ratings. Fitch has maintained the Rating Watch Positive on the following ratings: Scottrade Financial Services --Long-Term IDR at 'BBB-'; --Senior unsecured notes at 'BBB-'. Contact: Justin Fuller, CFA Senior Director +1-312-368-2057 Fitch Ratings, Inc. 70 W. Madison Street Chicago, IL 60602 Michael Dodge Associate Director +1-212-908-0379 Committee Chairperson Doriana Gamboa Senior Director +1-212-908-0865 Media Relations: Hannah James, New York, Tel: + 1 646 582 4947, Email: Additional information is available on Applicable Criteria Global Non-Bank Financial Institutions Rating Criteria (pub. 15 Jul 2016) here Additional Disclosures Solicitation Status here Endorsement Policy here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEB SITE AT WWW.FITCHRATINGS.COM. 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