Moody's Lowers E*TRADE, Schwab Outlook; Affirms TD Ameritrade

Moody’s Investors Service, the rating arm of Moody's Corporation (NYSE:MCO) , recently announced that it downgraded the outlook for E*TRADE Financial (NASDAQ:ETFC) to negative from stable and that of Charles Schwab (NYSE:SCHW) to stable from positive. This came in after the brokerage firms announced that they are eliminating commissions for stocks, ETFs and options trades, hence, joining Interactive Brokers (NASDAQ:IBKR) in the price war.

TD Ameritrade Holding (NASDAQ:AMTD) , which also announced commission-free trading, did not witness any change in its outlook and the same remained stable.

However, the ratings of the three firms were not changed. Moody's affirmed their ratings.

The issuer as well as senior unsecured debt ratings of E*TRADE Financial has been affirmed at Baa2. The senior unsecured debt rating of Schwab has been affirmed at A2 while its commercial paper rating has been affirmed at P-1. Moreover, TD Ameritrade’s issuer as well as senior unsecured debt ratings has also been affirmed at A2.

Reason Behind the Change in Outlook

Per Moody’s, relatively lower interest rates and flattening of the yield curve are already adversely impacting financials of brokerage firms. Now, with this fee cut, the profitability of these firms will likely be hurt even more. This is the main reason why Moody’s downgraded the outlook for these firms.

From charging $4.95-$6.95 per trade to zero commissions, these brokerage firms will be foregoing substantial fees.

Schwab estimates that zero-commission trades are likely to have 3-4% adverse impact on quarterly net revenues while TD Ameritrade’s net revenues will likely decline 15-16%. E*TRADE Financial estimates that this move will have a 10% adverse impact on its net revenues.

Notably, Schwab seems to be a bit better positioned than its peers because it is less dependent on commissions, which constitute roughly 7% of total revenues. However, E*TRADE Financial’s smaller scale compared with its peers puts it in a competitively disadvantageous position, making it difficult for it to be able to attract new clients.

Moreover, while commission-free trading is expected to adversely impact TD Ameritrade’s revenue growth, it will be partially offset by the company’s cost-saving efforts.

Reasons Behind the Ratings Affirmation

Moody’s affirmed the ratings of E*TRADE Financial because it believes that the company’s credit profile has improved over the past few years. This has benefited from the firm’s balance sheet expansion strategy. Moreover, the company is well positioned to accommodate a growing client base while maintaining a strong leverage ratio.

Coming to Schwab, over the past few years, it has witnessed a significant improvement in its pre-tax margin, aided by rising equity market values and net client inflows, per Moody’s. Its planned acquisition of USAA’s Investment Management Company, efforts to strengthen trading business and improvement in operating efficiency bode well for the future.

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The reason behind the ratings affirmation for TD Ameritrade is that it has a strong franchise in the online brokerage business, with clear leadership in the active trader segment and the growing institutional business, serving registered investment advisors. In fact, the company’s acquisition of Scottrade Financial Services in 2017 significantly enhanced its scale and competitive position, without significantly increasing leverage.

Currently, Schwab and TD Ameritrade carry a Zacks Rank #5 (Strong Sell) while E*TRADE Financial has a Zacks Rank #3 (Hold).

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Written By: Zacks Investment Research