E*TRADE Reports Loss, DARTs Dip

Zacks Equity Research

E*TRADE Financial Corporation (NasdaqGS:ETFC - News) reported fourth-quarter 2011 net loss of 2 cents per share, significantly below the Zacks Consensus Estimate of 20 cents per share. Earnings compared unfavorably with the prior quarter’s earnings of 24 cents per share, though improved from the loss of 11 cents reported in the prior-year quarter.

Quarterly results deteriorated, driven by downturn in brokerage business in the course of considerable market volatility, which aided reduced total daily average revenue trades (DARTs). Yet, decrease in operating expenses was the positive for the quarter.

E*TRADE reported fourth-quarter net loss of $6.3 million compared with the net income of $70.7 million in the prior quarter and loss of $24.1 million in the prior-year quarter.

For full year, net income was $156.7 million or 54 cents per share, up from net loss of $28.5 million or 13 cents per share in the prior-year. However, full year earnings were below the Zacks Consensus Estimate of 69 cents per share.

Performance in Detail

Total net revenue dipped 6.3% sequentially and 8.3% year over year (y/y) to $475.0 million in the quarter. The decreases were attributed to lower operating interest income, reduced commissions and overall decline in non-interest income. Moreover, the reported revenue outpaced the Zacks Consensus Estimate of $428.0 million.

For full year, total net revenue dropped 4.8% y/y to $2.0 billion, driven by a dip in net operating interest income and non-interest income. Yet, full year revenue outpaced the Zacks Consensus Estimate of $1.7 billion.

The DARTs for the reported quarter was 140,000, down 15% sequentially and 7% y/y. For full year, DARTs totaled 157,000, up from 151,000 in the year-ago.

Net new brokerage assets reported were $1.7 billion in the quarter, significantly down from $2.6 billion in the prior quarter and $2.4 billion in the prior-year quarter.

At the end of the quarter, E*TRADE reported 4.3 million customer accounts, including a record of 2.8 million brokerage accounts. Net new brokerage accounts scaled down to 10,000 from 13,000 in the prior quarter and 28,000 in the prior-year quarter. For full year, net new brokerage accounts were 99,000, significantly up from 54,000 in the prior year.

Net operating interest income plummeted 5.3% sequentially and 5.1% y/y to $289.3 million in the quarter. The sequential decrease was due to the 15 basis points (bps) fall in the net interest spread, which was driven by a decline in average interest-earning assets. In the quarter, net interest spread was 2.66%, down from 2.81% in the prior quarter and 2.88% in the prior-year quarter.

Total operating expense came down 10.9% sequentially to $304.3 million. The sequential decline was attributable to lower FDIC insurance premiums and other operating expenses. However, higher advertising and market development expenses, compensation and increased professional services expenses were negatives. Expenses were modestly in line with the prior-year quarter.

Credit Quality

Overall credit quality was mixed during the quarter. E*TRADE's provision for loan losses jumped 25% sequentially to $123 million. Net charge-offs were $120.3 million, down from $157.0 million in the prior quarter, while allowance for loan losses also increased sequentially to $823 million from $820 million.

For E*TRADE’s entire loan portfolio, special mention delinquencies climbed 2% sequentially but declined 21% y/y, while total at-risk delinquencies inched down 1% sequentially and fell 27% y/y.

Balance Sheet

E*TRADE reduced its balance sheet risk further. The company’s loan portfolio ended the quarter at $13.2 billion, down by $664 million from the prior quarter and $3.0 billion from the year-ago quarter, mainly related to $544 million and $2.3 billion of paydowns, respectively.

The company maintained bank capital ratios well above the regulatory well-capitalized threshold. As of December 31, 2011, E*TRADE reported Bank Tier 1 capital ratios of 7.8% and risk-based capital ratio of 17.3%, compared with 8.1% and 17.2%, in the prior quarter and 7.3% and 15.0% in the prior-year quarter. Further, Tier 1 common ratio was 9.4%, up from 9.3% in the prior quarter and 4.8% in the prior-year quarter.

Performance by Peers

Among E*TRADE’s peers, Charles Schwab Corporation (NYSE:SCHW - News) reported fourth-quarter 2011 earnings of 13 cents per share, in line with the Zacks Consensus Estimate. This compares favorably with the year-ago quarter’s earnings of 10 cents. Improved trading revenue, reduced provision for loan losses and lower non-interest expenses were among the quarter’s positives. However, lower net interest revenue as well as asset management and administration fees were the headwinds.

Our Take

The competitive position in the market for brokerage business depends on trading customers, predominantly active traders. As the long-term investing customer group is less developed, compared with the trading customers, there is an opportunity for future growth as and when the long-term customers expand.

Development of innovative online trading and long-term investing products and services, delivery of advanced customer service, creative and cost-effective marketing and sales, and expense discipline can be considered as the key factors in executing E*TRADE’s strategy to profitably grow trading and investing business.

Further, initiatives to reduce balance sheet risk look promising, although it will add near-term pressure on the interest margin. Though the company’s capital position and improving delinquency trends are positive, regulatory issues in the current uncertain environment is on the downside.

Yet, improvement in new brokerage accounts in 2011 suggests that management is focusing more on the company’s core business and decreasing operating expenses reflects better expenses management.

E*TRADE currently retains its Zacks #3 Rank, which translates to a short-term ‘Hold’ rating. Considering the fundamentals, we also maintain our ‘Neutral’ recommendation on the stock.

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