Analysts say that Bank of Montreal’s sale of its Harrisdirect arm to E*Trade Financial Corp. reflects the reality that scale is a necessity in the direct investing business.

Dominion Bond Rating Service notes that the direct investing industry as a whole has had to adjust to lower volumes and more competitive pricing in recent years. “The resulting restructuring of the industry has left larger businesses at a strategic advantage in terms of generating scale efficiencies,” it says; adding that Harrisdirect on its own may not have had sufficient scale to compete in the longer term.

DBRS notes that BMO has struggled to improve profitability at Harrisdirect (the operation generated just US$12 million in EBITDA over the past 12 months). “BMO will continue to expand its other operations in the U.S., including Harris Bank, as well as private banking and investment banking operations,” it says.

“While a positive development, the sale of Harrisdirect is not expected to have a material impact on the overall credit profile of BMO,” the rating agency concludes. “Total proceeds are expected to be US$750 million; BMO anticipates a modest gain on the sale, a 35 basis point increase in the Bank’s Tier 1 capital ratio, and no impact on per-share earnings.”

As a result of the deal, Standard & Poor’s Ratings Services changed its outlook on E*Trade to stable from positive, and it affirmed its existing ratings.

“The outlook change reflects E*Trade’s increased financial leverage and decreased liquidity as a result of the company’s announced acquisition of Harrisdirect for $700 million,” it says. S&P adds that E*Trade will have limited capacity to issue debt for future acquisitions, “in this intensely competitive industry where competitors are seeking scale and strength through consolidation plays”.

“These negative factors are partially offset by the positive aspects of the strategic gains provided by the Harrisdirect acquisition. Additional positive factors include E*Trade’s diversified revenue streams and improving consolidated operating margins, which hit a high during the quarter ended June 30, reflecting the benefits of E*Trade’s integrated model and leverage of technology.”