E*TRADE Financial Corporation's (ETFC) second-quarter 2011 net income of 16 cents per share was in line with the Zacks Consensus Estimate as well as the prior quarter. However, the company’s net income compared favorably with 12 cents per share in the prior-year quarter attributed to higher net operating interest income and a decrease in provision for loan losses, partially offset by an increase in operating expenses and lower non-interest income.
E*TRADE reported second-quarter net income of $47.0 million compared with $45.0 million in the prior quarter and $35.0 million in the prior-year quarter.
Performance in Detail
In the second quarter of 2011, total net revenue inched down 3.6% sequentially and 3.1% year over year to $517.6 million, attributed to lower commissions and an overall decrease in non-interest income.
The total daily average revenue trades (DARTs) for the reported quarter was 148,000, falling 17% sequentially and 13% year over year. Net new brokerage assets reported were $1.5 billion in the quarter, significantly down from $3.9 billion in the prior quarter and $2.1 billion in the prior-year quarter.
At the end of the quarter, E*TRADE reported 4.3 million customer accounts, which included a record 2.8 million brokerage accounts. In the second quarter of 2011, net new brokerage accounts scaled down to 25,000 from 51,000 in the prior quarter but were up from 18,000 in the prior-year quarter.
Net operating interest income was up 1.8% sequentially and 4.4% year over year to $315.4 million in the quarter. The sequential increase was due to a five basis point gain in the net interest spread, which was driven by a decline in non-performing as well as improved performance in the company’s stock lending business. In the quarter, net interest spread was 2.89%, up from 2.84% in the prior quarter.
Total operating expense inched down 2.4% sequentially, but edged up 5.5% year over year to $290.9 million. The sequential decrease was attributable to lower compensation, advertising expenses and professional services costs, partially offset by higher FDIC insurance premiums, occupancy and equipment expenses and other operating expenses. The year-over-year increase was attributable to higher advertising and market development expenses.
Credit Quality
Overall credit quality improvement was recorded in the quarter. E*TRADE's provision for loan losses decreased 11.2% sequentially to $103.1 million. Net charge-offs were $178.0 million, down from $193.6 million in the prior quarter, while allowance for loan losses also decreased sequentially to $0.9 billion from $1.0 billion.
For E*TRADE’s entire loan portfolio, special mention delinquencies declined 9.0% sequentially and 30.0% year over year, while total at-risk delinquencies plummeted 13.0% sequentially and 33.0% 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 June 30, 2011, E*TRADE reported Bank Tier 1 capital ratios of 7.9% and risk-based capital ratio of 16.2%. Further, Tier 1 common ratio was 8.4%, up from 6.5% in the prior quarter and 5.3% in the prior-year quarter.
Performance by Peers
E*TRADE’s closest competitor, Charles Schwab Corporation (SCHW) reported second-quarter 2011 earnings of 20 cents per share, in line with the Zacks Consensus Estimate. However, this compares favorably with the year-ago quarter’s earnings of 17 cents. Charles Schwab’s net income for the reported quarter came in at $238 million, up 16% from $205 million in the prior-year quarter. The company’s results benefited from improved net interest revenue and lower impairment losses on securities. However, lower trading revenue and higher non-interest expenses were the downside.
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 if 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 its trading and investing business.
Further, initiatives to reduce balance sheet risk look promising, although it will add near-term pressure on the interest margin. While the company’s capital position and improving delinquency trends are a positive, we believe decline in trading activity 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.
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