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On Thursday, Standard & Poor's (S&P) Ratings Services downgraded the long-term issuer credit ratings of TCF Financial Corporation (TCB - Analyst Report) and its subsidiary - TCF National Bank to 'BBB-' and 'BBB', respectively. Moreover, short-term rating on TCF Financial was been lowered to 'A-3' from 'A-2' and ratings on preferred stock reduced to 'BB' from 'BB+'.  Further, TCF National Bank's subordinated debt rating was lowered to 'BBB-' from 'BBB'.

Reasons Behind the Downgrade

S&P stated that the downgrade in the ratings was driven mainly by TCF Financial’s increasing level of non-performing assets (NPAs). NPAs remained high at 7.5% of loans including other real estate owned (OREO) in the third quarter ended September 30, 2012, up from 6.9% in the prior quarter.

Even after excluding the effect of new accounting guidance for banks, NPAs elevated for TCF Financial in the third quarter, compared with the prior-year period. Additionally, S&P estimates increased credit risk for the company, attributable to the jump in NPAs associated with borrowers under Chapter 7 bankruptcy.

Moreover, amidst such a challenging environment, the resignation of the company’s chief risk officer added to the woes. S&P believes deteriorating credit quality coupled with operational risk due to management change weakens TCF Financial’s risk position. Therefore, based on its criteria, S&P has also lowered the company’s risk position to ‘moderate’ from ‘adequate’.

Further, S&P commented that expansion in national lending platforms and changes in deposit account strategies of the company leads to increased operational risk. Launched in 2008, TCF Financial's inventory finance business more than doubled in volume since year-end 2011. Additionally, in 2011, the company bought an indirect auto lender. Though such transactions inculcate diversification for the company, yet they bring in new risks.

The ratings services firm also believes that debit interchange and overdraft fees regulatory reform have hugely impacted TCF Financial's non-interest income, destabilizing the profitability. Therefore, taking into consideration all concerns relating to the company’s stability, S&P has taken the step of downgrading the company.

However, S&P has maintained the stable outlook on TCF Financial. The affirmation of the outlook depicts S&P’s belief in gradual reduction in NPAs level over the next year, improvement in profitability level and continual growth in inventory and auto finance businesses of TCF financial.

Rating Actions by other Agencies

Following the asset quality deterioration in the third quarter, in October 2012, Fitch Ratings also downgraded the long-term Issuer Default Ratings (IDRs) for TCF Financial and TCF National Bank to 'BBB' from 'BBB+'. Moreover, a negative outlook was affirmed.

Based on the weak credit profile of TCF Financial, in May 2012, Moody's Investors Service, a rating arm of Moody’s Corp. (MCO - Analyst Report) also reduced the ratings of TCF National Bank to A3 from A2 for long-term deposits, to Baa1 from A3 for subordinated debt, and to C from C+ for standalone bank financial strength. Moreover, the bank's short-term rating was lowered from Prime-1 to Prime-2. Yet, the negative outlook on TCF’s rated subsidiaries was retained. TCF Financial is unrated by Moody’s.

Our Viewpoint

The rating revisions are valuable for the banks as they play a major role in preserving investor confidence in the stock and help boost its creditworthiness in the market.

Though TCF Financial is working to address such issues, further rating downgrades could be implemented following pressure on the credit quality and profitability.

Overall, we expect the company to maintain its superior position in the market based on its positive approach to market conditions and improving net interest income. Moreover, a healthy capital position indicates the company’s robust standing.

Besides, a tepid economic recovery, regulatory issues along with the expectation of continued low interest rate environment are projected to limit the stock’s upside potential in the upcoming quarters.

TCF Financial currently retains its Zacks #3 Rank, which translates into a short-term Hold rating. We believe such downgrades in ratings might lead to negative estimate revisions. This, in turn, could cause a downgrade in the Zacks Rank.

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