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October 20, 2011
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E*TRADE Financial Corporation's (ETFC) third-quarter 2011 net income of 24 cents per share outpaced the Zacks Consensus Estimate of 19 cents as well as prior quarter’s earnings of 16 cents per share. Moreover, the company’s net income also compared favorably with net income of 3 cents per share in the prior-year quarter.
Favorable results were attributed to strong brokerage business in the course of considerable market volatility, partially offset by increase in operating expenses.
E*TRADE reported third-quarter net income of $71 million compared with $47 million in the prior quarter and $8 million in the prior-year quarter.
In the quarter, E*TRADE recorded an income tax benefit of $62 million associated with the taxable liquidation of a European subsidiary, related to the company’s international restructuring activities. The tax benefit increased the company’s deferred tax asset, which stood at $1.5 billion as of September 30, 2011.
Performance in Detail
In the third quarter of 2011, total net revenue inched down 2% sequentially but up 3.7% year over year to $507.3 million, above the Zacks Consensus Estimate of $418 million. The year-over-year gain was attributed to higher commissions and overall increase in non-interest income. However, lower operating interest income drove the sequential decline.
The total daily average revenue trades (DARTs) for the reported quarter was 165,000, up 11% sequentially and 30% year over year. Net new brokerage assets reported were $2.6 billion in the quarter, significantly up from $1.5 billion in the prior quarter and $1.4 billion in the prior-year quarter.
At the end of the quarter, E*TRADE reported 4.3 million customer accounts, including a record 2.8 million brokerage accounts. In the quarter, net new brokerage accounts scaled down to 13,000 from 25,000 in the prior quarter but were up from 7,000 in the prior-year quarter.
Net operating interest income was down 3.1% sequentially but up 2.2% year over year to $305.6 million in the quarter. The sequential decrease was due to eight basis points fall in the net interest spread, which was driven by a decline in average interest-earning assets. In the quarter, net interest spread was 2.81%, down from 2.89% in the prior quarter.
Total operating expense edged up 17.5% sequentially and 28.0% year over year to $341.7 million. The sequential increase was attributable to higher FDIC insurance premiums and other operating expenses. Moreover, higher advertising and market development expenses, higher compensation and higher FDIC insurance premiums drove the year-over-year increase.
Credit Quality
Overall credit quality improvement was recorded in the quarter. E*TRADE's provision for loan losses decreased 4.6% sequentially to $98.4 million. Net charge-offs were $157.0 million, down from $178.1 million in the prior quarter, while allowance for loan losses also decreased sequentially to $0.8 billion from $0.9 billion.
For E*TRADE’s entire loan portfolio, special mention delinquencies were flat sequentially and declined 24% year over year, while total at-risk delinquencies plummeted 5.0% sequentially and 28% year over year.
Balance Sheet
E*TRADE reduced its balance sheet risk further, with its loan portfolio contracting $0.7 billion from the last quarter, of which $0.6 billion was due to prepayments or scheduled principal reductions.
The company maintained bank capital ratios well above the regulatory well-capitalized threshold. As of September 30, 2011, E*TRADE reported Bank Tier 1 capital ratios of 8.1% and risk-based capital ratio of 17.2%. Further, Tier 1 common ratio was 9.3%, up from 8.4% in the prior quarter and 5.4% in the prior-year quarter.
Performance by Peers
E*TRADE’s closest competitor, Charles Schwab Corporation (SCHW) reported third-quarter 2011 earnings of 18 cents per share, just a penny below the Zacks Consensus Estimate. However, this compares favorably with the year-ago quarter’s earnings of 10 cents. Charles Schwab’s net income for the reported quarter came in at $220 million, up 77% from $124 million in the prior-year quarter. Improved net interest revenue and trading revenue as well as lower non-interest expenses were among the quarter’s positives. However, higher impairment losses on securities and increased provision for loan losses 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 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, we believe an increase in operating expenses is on the downside. Yet, improvement in credit quality metrics suggests that management can now focus more on the company’s core business.
E*TRADE currently retains its Zacks #3 Rank, which translates to a short-term ‘Hold’ rating. Considering the fundamentals, we are maintaining our ‘Neutral’ recommendation on the stock.
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