DBRS: ETFC’s Debt Transaction Improves Financial Flexibility; Lowers Funding Costs & Parent Leverage

Summary:
• ETRADE today announced plans to reduce by $400 million its $1.8 billion corporate debt burden, while also refinancing existing notes to further extend its maturity profile • DBRS views this transaction as improving ETRADE’s financial flexibility by lowering its funding costs and reducing Parent-company leverage
• DBRS rates ETRADE’s Issuer & Senior debt at BB (low) and ETRADE Bank’s Deposits & Senior Debt at BB (high); all ratings have a Stable trend

DBRS, Inc. (DBRS) views the transaction announced today by ETRADE Financial Corporation (ETRADE or the Company) as demonstrating the continued positive trends and franchise momentum that has been evident in recent quarters. The transaction, which will reduce corporate debt outstanding and extend ETRADE’s debt maturity profile, will be financed by approximately $460 million of corporate cash and $540 million in proceeds from the issuance of new senior notes. This transaction will result in the early retirement of ETRADE’s outstanding 6.75% Senior Notes due 2016 and 6.0% Senior Notes due 2017. E*TRADE announced that the new senior notes will have a coupon of 5.375% and a maturity of 2022, further contributing to a reduction in corporate interest expense.

Corporate cash has been gradually built up to current levels ($610 million at 3Q14) through the upstreaming of dividends from E*TRADE Bank (the Bank) in the most recent six consecutive quarters. DBRS expects that these dividends will continue uninterrupted as the Bank generates positive earnings, provided that it also maintains solid levels of capitalization. Increased corporate cash enhances the Parent’s ability not only to make interest payments, but also to reduce its corporate debt outstanding and reduce its interest costs, subject to regulatory approvals.

In reducing the amount of expensive corporate debt outstanding, which has been a major constraint on the rating level, ETRADE is reducing the associated interest expense. Despite being less than half that of peak levels, ETRADE’s annual corporate interest expense related to this debt was an elevated $114 million in 2013, constraining overall profitability. DBRS estimates that this interest expense would drop to approximately $80 million annually, adding considerably to net income. The Company reported net income of $86 million in 2013.

E*TRADE’s funding and liquidity position remains strong, and has been further enhanced by the establishment of a three-year $200 million senior secured revolving credit facility. This facility contributes to the financial flexibility of the Parent, while also adding a degree of confidence given the participating banks’ willingness to grant the facility. Corporate cash of approximately $280 million, post-transaction, is sufficient to cover approximately 3.5 years’ worth of debt servicing requirements, post-transaction. Capitalization remains robust, as indicated by the Company’s estimated Tier I Common ratio of 16.1% at the consolidated level and 24.6% at the Bank, as of 3Q14.

While DBRS sees E*TRADE as still exposed to the potential negative impact of adverse events, DBRS perceives this risk as being appropriately factored into the current rating level. Positive rating action is likely, if the Company continues to maintain momentum in its core franchise and grow earnings, while maintaining solid capitalization. The reduction in corporate debt adds to this positive ratings pressure, particularly at the Parent level. While less likely, the trend could revert back to Negative, if DBRS perceives any franchise weakening or significant earnings pressures, especially if driven by rising credit costs.

DBRS rates ETRADE’s Issuer & Senior debt at BB (low) and ETRADE Bank’s Deposits & Senior Debt at BB (high) with a Stable trend.

Note:
All figures are in U.S. Dollars unless otherwise noted.