Moody’s sees risk for both Schwab and TD Ameritrade in diverging ARS strategies

The opposing approaches taken by Charles Schwab and TD Ameritrade to the illiquid auction rate securities bought by their clients raises credit risks for both companies, according to Moody’s.
The Charles Schwab Corp., the San Francisco-based discount brokerage giant, has refused a demand by New York Attorney General Andrew Cuomo to offer to repurchase ARS it sold to clients at par value. Its retail clients hold about $100 million in the securities, but the firm said it never actively solicited sales of ARS, nor was it involved with structuring them.
“To be asked to stand behind losses or illiquidity that a client suffered based on circumstances that we had no knowledge or control of sets a very, very dangerous precedent,” Walt Bettinger, Schwab’s president and chief executive, said in a webcast Monday.
TD Ameritrade Holding Corp. last week said it reached a settlement with federal and state regulators to buy back $400 million to $500 million of ARS from its retail clients. The buyback, which will extend for some investors through next summer, could result in an unrealized pretax earnings charge of $100 million, or 5 cents to 10 cents a share, executives at the Omaha, Neb.-based company said.
Moody’s Investors Service said that TD Ameritrade can absorb the financial impact of the buyback, although discount-brokerage firms are not structured to hold assets on their balance sheets for long periods.
However, it has other concerns about both TD Ameritrade and Schwab.
“From a credit standpoint, we think that both approaches have risks that extend beyond the immediate financial impact,” Alexander Yavorsky, a senior analyst at the New York-based credit-rating firm, said in a report released yesterday.
Moody’s said it is not changing its credit ratings or outlooks on the debt of Schwab (A2/Stable) or TD Ameritrade (Baa2/Stable) but said it will closely monitor the affects of their decisions on the likelihood and potential outcome of future customer complaints.
Several class actions and other litigation have been initiated against brokerage firms and banks that sold auction rate securities, which were marketed for more than 20 years as highly liquid, with slightly better rates than money market funds, but TD Ameritrade’s settlement may make it even more vulnerable to customers who claim it is responsible for their losses, the analyst wrote.
Schwab’s refusal to repurchase the securities raises the reputational risk of making itself seem unfriendly to customers, he added.
Neither firm agreed to buy back auction rate securities from registered investment advisers or their clients.
TD Ameritrade said in a May regulatory filing that it was holding about $190 million of ARS in custody for clients of RIAs.
A Schwab spokeswoman declined to comment on the ARS it sold or holds for its independent-adviser clients.
Both firms have argued that their role in selling auction rate securities was far different from that of large banks and brokers, which structured the securities and conducted weekly or monthly auctions.
The market froze in February 2008 when the firms, worried about deteriorating credit, stopped supporting the auctions.
Investors were left with more than $300 billion of securities that couldn’t be sold, and many of the bigger firms were subsequently forced to buy back billions of dollars of ARS from clients.
In recent months, regulators have turned their attention to so-called downstream brokers such as Schwab and TD Ameritrade.
Mr. Bettinger said that about 90% of ARS held by Schwab clients came from self-directed investors who requested the securities.