E*TRADE Beats, DARTs Slumps


E*TRADE Financial Corporation (ETFC) reported second-quarter 2012 net income of 14 cents per share, beating the Zacks Consensus Estimate by 3 cents. Results compared favorably with 13 cents per share reported in the prior quarter, but lagged the prior-year quarter earnings by 2 cents. Prior quarter results exclude an income tax benefit associated with certain losses on 2009 Debt Exchange of 9 cents per share.

The upbeat performance was buoyed by new brokerage accounts, though total daily average revenue trades (DARTs) slumped. In addition, decrease in operating expenses acted as tailwind for the company in the ongoing challenging macro-economic environment. Moreover, improved credit quality was a positive factor. Yet, reduced revenue was a dampener for the quarter.

E*TRADE reported second-quarter net earnings of $39.5 million against net income of $37.0 million in the prior quarter and $47.1 million in the prior-year quarter.

Performance in Detail

Total revenue declined 7.6% sequentially and 12.6% year over year to $452.4 million in the quarter, hurt by overall lower non-interest income and reduced net operating interest income. Moreover, the reported revenues lagged the Zacks Consensus Estimate of $463.0 million.

The DARTs for the reported quarter decreased 12% sequentially and 6% year over year to 139,000. Net new brokerage assets reported were $2.2 billion, significantly down from $4.0 billion in the prior quarter.

At the end of the quarter, E*TRADE reported 4.4 million customer accounts, including a record of 2.9 million brokerage accounts. Net new brokerage accounts of 46,000 remained in line with the prior quarter though improved from 25,000 in the prior-year quarter.

Net operating interest income plummeted 2.0% sequentially and 11.5% year over year to $279.1 million in the quarter under review. The decline was due to lower interest income, though partially offset by reduced interest expenses.

Net interest spread in the quarter was 2.44%, slightly down from 2.49% in the last quarter and from 2.89% in the prior-year quarter. The decrease reflected lower average interest-earning assets in the quarter.

Non-interest income was $173.3 million, down 15.3% sequentially and 14.3% year over year. The descend compared to prior periods was due to reduced net gains on loans and securities, low fees and service charges and decreased commissions.

Total operating expense moved down 8.1% sequentially and 3.2% year over year to $281.5 million. The decline was attributable to lower advertising and market development costs, reduced professional services and other operating expenses. The fall in expenses depicts better expense management of the company.

Credit Quality

Overall credit quality improved during the quarter. E*TRADE's provision for loan losses dropped 6.4% sequentially and 34.7% year over year to $67.3 million. Net charge-offs also plummeted 61.8% sequentially to $120.7 million and was down 32.2% year over year. Allowance for loan losses also decreased 9.2% sequentially and 40.2% year over year to $525.8 million.

Moreover, for E*TRADE’s entire loan portfolio, special mention delinquencies dipped 7% sequentially and 24% year over year, and total at-risk delinquencies slumped 6% sequentially and 28% year over year.

Balance Sheet

E*TRADE reduced its balance sheet risk further. The company’s loan portfolio was $11.8 billion at the end of the reported quarter, down by $624 million from the prior quarter, mainly related to $503 million of paydowns.

The company maintained bank capital ratios well above the regulatory well-capitalized threshold. As of June 30, 2012, E*TRADE reported Tier 1 common ratio of 10.2%, up from 9.4% in the prior quarter and 8.4% in the year-ago quarter.

Total risk-based capital ratio was 18.0%, up from 17.0% in the prior quarter and 16.2% in the prior-year quarter. Similarly, Tier 1 leverage ratio was 7.9%, up from 7.3% in the last quarter though in line with the prior-year quarter.

Performance by Peer

Among E*TRADE’s peers, Charles Schwab Corporation’s (SCHW) second-quarter 2012 earnings of 18 cents per share were in line with the Zacks Consensus Estimate. However, this compares unfavorably with the year-ago quarter’s earnings of 20 cents.

After considering certain non-recurring items related to the resolution of a vendor dispute, net income available to common shareholders was recorded at $261 million or 20 cents per share. This was better than the year-ago quarter’s net income of $238 million or 20 cents per share.

Improved trading revenue and higher net interest income acted as the positives for the quarter. However, higher operating expenses and provision for loan losses as well as fall in asset management and administration fees were the primary dampeners.

Our Viewpoint

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 expand trading and investing business.

Further, E*TRADE’s initiatives to reduce balance sheet risk appear to be promising, although, it will put near-term pressure on the net interest margin. The company’s capital position and improving delinquency trends are impressive and improvement in new brokerage accounts compared to last year suggests that management is focusing more on the company’s core business. Yet, amid challenging economy, reducing DARTs remain a matter of concern.

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

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