The Charles Schwab Corporation (SCHW - Free Report) and TD Ameritrade Holding Corporation’s (AMTD - Free Report) senior unsecured debt ratings were affirmed at A2 by Moody's Investors Service, the rating arm of Moody's Corporation (MCO - Free Report) . Moreover, the rating outlook remains stable for both companies.
The ratings affirmation follows Schwab’s recently announced all-stock deal to acquire TD Ameritrade for roughly $26 billion, which is expected to create a behemoth in online brokerage space, with combined client assets worth more than $5 trillion and serving nearly 24 million brokerage accounts.
Notably, the transaction, which is subject to regulatory approvals and consent of shareholders of both companies, is expected to close in the second half of 2020. The integration process is likely to start immediately thereafter, which will likely take 18-36 months.
During the three-year integration period, the combined firm is expected to face several challenges and incur significant integration costs.
Nevertheless, Moody’s is of the opinion that if the transaction takes place smoothly and Schwab successfully realizes cost and revenue synergies associated with the deal, the firm’s pre-tax margin and debt metrics will improve.
Moreover, per Moody's, the acquisition will further expand Schwab's scale within the wealth management business. Also, the rating agency believes that Schwab's credit profile will benefit significantly in the long run from increased earnings, which it will be able to realize on TD Ameritrade's client cash balances under its cash deposit sweep programs, provided the merger integration takes place successfully.
The above-mentioned factors formed the basis of the ratings affirmation for Schwab.
Moreover, its stable outlook reflects its continued adherence to conservative financial policies, which is clear from the fact that the company has chosen all-stock funding mode for the deal.
For TD Ameritrade, Moody’s expects that once the acquisition gets completed, the company’s outstanding debt will become a direct obligation of Schwab. This expectation formed the basis of the ratings affirmation as well as the stable outlook for TD Ameritrade.
Moody’s believes that currently there is a moderate likelihood of support that TD Ameritrade’s credit profile receives from The Toronto-Dominion Bank (TD - Free Report) , which has nearly 43% stake in TD Ameritrade at present and hence is its largest shareholder.
However, once the acquisition gets completed, Toronto-Dominion Bank will likely have an ownership position of only 13% in the combined company. Hence, the likelihood of support that the combined firm would get from Toronto-Dominion Bank will be low, following the completion of the deal.
What Can Lead to a Rating Upgrade?
Schwab’s ratings could be upgraded if it can sustain its pre-tax margin over 42%, its debt-to-EBITDA on an adjusted basis below 1.7 times and its retained cash flow less capex above 30% of adjusted debt, in addition to maintaining a conservative asset risk appetite.
There are two possibilities for TD Ameritrade. If the acquisition takes place successfully, the direction of TD Ameritrade ratings will be driven by the same considerations as that of Schwab's.
However, if the acquisition is not completed as proposed, TD Ameritrade’s ratings could be upgraded if it can sustain its pre-tax margin more than 45%, its debt-to-EBITDA on an adjusted basis below 1.3 times, and retained cash flow less capex above 30% of adjusted debt.
When Can the Ratings be Downgraded?
For Schwab, its ratings could be downgraded if there is a significant deviation from the firm's conservative financial policy, or if pre-tax margins or debt service capacity decreases significantly, or if there is a significant legal or compliance issue.
TD Ameritrade’s ratings could be downgraded if the company’s debt-to-EBITDA increases to more than 2 times, or if the firm's pre-tax margin declines to 30% or below, or there is a significant legal or compliance issuer.
Currently, both Schwab and TD Ameritrade carry a Zacks Rank #3 (Hold). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
Looking for Stocks with Skyrocketing Upside?
Zacks has just released a Special Report on the booming investment opportunities of legal marijuana.
Ignited by new referendums and legislation, this industry is expected to blast from an already robust $6.7 billion to $20.2 billion in 2021. Early investors stand to make a killing, but you have to be ready to act and know just where to look.
See the pot trades we're targeting>>