DBRS: E*TRADE’s Trend Revised to Positive from Stable; Senior Debt at BB

DBRS, Inc. (DBRS) has today revised the trend for ETRADE Financial Corporation (ETRADE, the Company or the Parent) and ETRADE Bank (the Bank) to Positive from Stable, except the short-term instruments rating at the Parent, where the trend remains Stable. At the same time, DBRS confirmed ETRADE’s Issuer & Senior Debt rating at BB and its Short-Term Instruments rating at R-4. Also confirmed were the Bank’s Deposits & Senior Debt rating at BB (high) and Short-Term Instruments rating at R-3.

The change to a Positive trend reflects the Company’s continued momentum in its core retail brokerage franchise, while delivering generally stable revenues and growing earnings. E*TRADE’s risk profile has been reduced, funding and liquidity profile improved, and capitalization remains solid. The Bank’s rating of BB (high) is positioned a standard one-notch above the Parent’s rating, following DBRS’s upgrade of the Parent’s long-term ratings in March 2015 reflecting the continued strengthening of its position.

Further positive rating action, including an upgrade of the ratings which carry a Positive trend, is feasible if the Company continues to maintain momentum in its core franchise and grow earnings, while maintaining solid capitalization. Alternately, the trend could revert back to Stable if DBRS sees rising credit costs that pressure earnings and limit internal capital generation. Any franchise weakening or lapses in risk management could also add ratings pressure.

ETRADE’s ratings are underpinned by its franchise strength, which is focused on building on its active trader franchise and expanding its customer relationships with long-term investors, areas where the Company continues to demonstrate success. DBRS takes into account ETRADE’s continued strong momentum in its retail investor franchise, highlighted by growth across various brokerage metrics (daily average revenue trades, net new brokerage accounts/assets, margin receivables). The Company also benefits from its well-positioned stock plan administration business that leverages its product capabilities and is an important source of new customers.

ETRADE has made significant progress in improving its financial profile, specifically through reduction of risk exposures and improving its funding profile. The Company’s most significant risk has shifted away from its legacy credit risk exposure, with its more considerable risk being operational risk, which is in line with the nature of ETRADE’s business. Importantly, E*TRADE has significantly invested in enhancing its enterprise risk management framework over the past few years.

While risk remains in the Company’s $6.1 billion loan portfolio, this is down from a peak of over $30 billion at the end of 2007. Credit costs are at historical lows, but future delinquencies could increase in a rising rate environment or with conversions of Home Equity loans to amortizing. The Company estimates that provisioning levels, which stood at just $5 million in 1Q15, could increase up to $20 million per quarter for the remainder of 2015 and are expected to be at or above the top end of this range in 2016, which DBRS views as manageable. While risk remains in ETRADE’s loan portfolio given the proportion of junior liens and still elevated loan-to-value ratios, DBRS sees this risk as appropriately factored into the current rating level. Importantly, with solid revenue generation and much lower provisioning levels, ETRADE is consistently generating sufficient operating income before provisions and taxes (IBPT) that is readily able to absorb provisioning for loan losses.

ETRADE has improved its funding profile considerably over time, as it has significantly reduced its legacy asset and loan exposures allowing for the repayment of all of its high cost corporate debt. Moreover, the remaining corporate debt has been refinanced at much lower rates. Recently, two major debt restructurings reduced ETRADE’s corporate debt burden by $800 million, now down to $1.0 billion, while also refinancing existing notes and extending its overall debt maturity profile. E*TRADE has also reduced other sources of wholesale funding such as repo and FHLB advances. The Company’s solid funding profile is supported by a high level of deposits that are generated by its retail investor base, mainly in the form of brokerage-related cash which is relationship-driven.

The Company’s capitalization remains solid given its level of assets and its risk profile. ETRADE’s ability to generate capital through retained earnings has improved with the significant reduction of expensive corporate debt that was highly constraining to earnings. Lower levels of corporate debt have also contributed to reduced leverage at the Parent. Importantly, the confidence of regulators in ETRADE’s financial profile became more evident with the recent approval for the Company’s realignment, allowing for the broker-dealers to be moved out from under the Bank.

Notes:
All figures are in U.S. dollars unless otherwise noted.

The principal applicable methodology is the Global Methodology for Rating Banks and Banking Organisations (June 2014). Other applicable methodologies include the DBRS Criteria – Support Assessments for Banks and Banking Organisations (March 2015) and DBRS Criteria: Rating Bank Capital Securities – Subordinated, Hybrid, Preferred & Contingent Capital Securities (February 2015). These can be found at: http://www.dbrs.com/about/methodologies.

The primary sources of information used for this rating include company documents and SNL Financial. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

Lead Analyst: Lisa Kwasnowski
Rating Committee Chair: John van Boxmeer
Initial Rating Date: January 27, 2005
Most Recent Rating: March 2, 2015