November 10, 2009
Research Analyst: Madhurima Das, C.A
Editor: Tanuka De, M.Com, MBA
Sr. Ed.: Ian Madsen, CFA: ; 1-800-767-3771 x9417
111 N. Canal Street, Suite 1101Chicago, IL 60606
E*Trade Financial Corporation / (ETFC – NYSE) / $1.45*Note: This report contains substantially new material. Subsequent reports will have changes highlighted.
Reason for Report:3Q09 Earnings Update
Previous Edition: Coverage Initiated by One Broker, October 6, 2009 (broker material considered till October 2)
Brokers’ Recommendations: Neutral: 63.6% (7 firms); Positive: 36.4% (4); Negative: 0% (0) Prev. Ed.: 73; 1
Brokers’ Target Price: $1.95 (↑$0.01from the last edition; 10 firms) Brokers’ Avg. Expected Return: 34.1%
*NOTE: Though dated November 10, 2009, share price and broker material are as of November 3, 2009.
A Flash Update on 3Q09 Earnings was done on October 27, 2009.
Note: The tables below for Revenue, Margins, and Earnings per Share contain less brokers’ material than the brokers’ material used in the Valuation table. The extra figures in the Valuation table come from reports that did not have accompanying spreadsheet models.
Portfolio Manager Executive Summary
E*Trade FinancialCorporation(ETFC or the Company) is a global financial services company offering a wide rangeof financial solutions, including investing, trading, lending, and cashmanagement to retail and institutional clients. The firm delivers its retailproducts and services to its 3.4 million clients, primarily online, but increasinglyvia advisors and branches. In addition, E*Trade offers specialist, and market-making services globally to its institutional clients.
63.6% of the firms in the Digest group renderedneutral ratings, 36.4% ofthe firms assignedpositive ratings. None of the firms provided anegative rating. The firm with the lowest target price rated the stock Market perform and did not provide any valuation metric. One firm with the highest target price rated the stock Buy and valued the price on 15x multiple to pre-provision normalized annual earnings per share of $0.20 beginning in 2012, discounted back 1.5 years using a 20% discount rate. Another firm with the highest target price rated the stock Buy and based the valuation on normalized EPS of $0.22 along with a 20% probability.
Neutral or equivalent outlook–Seven firms or 63.6%-Target Price range: $1.57-$2.00. According to these firms, ETFC has shored up its capital position recently but not without meaningfully diluting common shareholders which should enable management to focus on driving growth in its retail brokerage segment once again. ETFC’s improved capital position will be sufficient to absorb future losses and falling loan loss provisions may even allow the Company to be in position to report a profit as early as the next quarter, which these firms believe would likely be a significant positive catalyst for the firm’s shares. However, despite the progress on capital and credit, elevated credit costs, mixed brokerage trends, and significant dilution are likely to weigh on results in the near term. According to them, any meaningful upside would likely be driven by excess capital being used to pay down debt and/or buybacks and/or a strategic transaction, both of which are not expected in the near term.
Buy or equivalent outlook –Four firms or 36.4% - Target Price range: $2.00-$2.30.Thesefirmsbelieve that ETFC will benefit from the capital raise and commencement of its debt exchange offer, which will be followed by its strong fundamentals, good cash flow, and increased probability of becoming an acquisition candidate. Further, it will provide the investorswith a profitable investment opportunity.
According to these firms, the worst is behind the Company and profitability should be within reach. Though the return to normalized earnings may take more than three years, they believe ETFC offers significant upside potential for patient investors, particularly given the substantially lower risks to the Company, post-capital raise. As credit losses continue to fall, they expect ETFC to become a source of significant capita, going forward. With nearly $1 billion of excess regulatory capital already on hand, they believe ETFC is overcapitalized and soon will be in a position to release capital to the holding company to further de-leverage the parent.
November 10, 2009
Recent Events
On November 4, 2009, ETFC flied its SEC form 10-Q, Quarterly report.
OnOctober 27, 2009, ETFC announced its 3Q09 financial results. Highlights are as follows:
- Net revenue was $575.0 million, up from $377 million in 3Q08.
- Reported net loss from continuing operations, was $832.0 million, or $0.66 per share versus a net loss of $320.8 million, or $0.60 per share in 3Q08. The Company reported a net loss including discontinued operations of $832 million, or $0.66 per share versus a net loss of $50.5 million, or $0.09 per share, in 3Q08.
On October 7, 2009, ETFC announced the launch of Equity Edge Online, the new web- based, integrated, end-to-end equity compensation management platform from E*TRADE FINANCIAL Corporate Services. In an ever-changing regulatory environment, Equity Edge Online provides flexible, accurate and auditable financial reporting, enabling companies to save time, reduce costs and increase efficiencies in their employee stock plan solutions.
Overview
Based in New York City, E*TRADE Financial Corporation (ETFC or the Company) provides financial solutions to retail, and institutional customers globally. It offers retail investing and trading products and services, including automated order placement and execution of market and limit equity, futures, options, exchange-traded funds, and bond orders; real-time streaming quotes, commentary, and news; advanced trading platforms for traders; personalized portfolio tracking; and access to approximately 7,000 non-proprietary, and proprietary mutual funds. ETFC’s products and services also include Federal Deposit Insurance Corporation-insured sweep deposit account; mortgage, home equity lines of credit, and second mortgage loans secured by real estate; vehicle, marine, automobile, and credit card loans; and online bill payment services. In addition, ETFC provides advisory and asset management services to retail clients; and token-based security solution, which offers security at the point of access to the Internet to safeguard personal financial information. The Company serves retail, institutional, and corporate customers through the Internet, and other electronic media. ETFC operates on a calendar year basis.
For more information about the Company, please visit its website at
The analysts identified the following issues in evaluating the investment merits of ETFC:
Key Positive Arguments / Key Negative Arguments- Better expense discipline
- Steady increase in ETFC’s growth rates despite the difficult yield environment
- Strong customer momentum
- International growth
- Strong fundamentals
- Stiff competition from larger financial services companies
- Downturn in domestic equity markets is likely to pressure the Company’s trading revenue
- Interest rate risk and pricing pressure
- Anticipated credit losses based on the loans outstanding, principal transaction losses, and reduced net interest spreads
E*TRADE Retailprimarily consists of retail brokerage operations, and also includes consumer loan originations, and revenue obtained from the Institutional segment with broker sweep deposits. ETFC’s corporate business, which serves corporations with employee stock options services, also falls under Retail. E*TRADE Institutional comprises the institutional securities businesses (market making as well as stock loan operations), as well as balance sheet-sourced spread income of the banking unit.
November 10, 2009
Revenue
Prior to the 3Q09earnings release, the Digest NII growth forecast was 0.0% for FY09and (2.7%) for FY10. The Digest growth forecast for non-interest income was 36.2% for FY09 and (3.5%) for FY10. Following the 3Q09 earnings release, the Digest NII growth forecast decreased to (1.0%) for FY09 and (2.8%) for FY10. The Digest growth forecast for non-interest income increased to 46.6% for FY09, but decreased to (4.0%) for FY10.
($ in Million) / 3Q08A / 2008A / 2Q09A / 3Q09A / 4Q09E / 2009E / 1Q10E / 2010ENet Interest Income / 324.8 / 1,272.3 / 339.7 / 321.3 / 319.5 ↓ / 1,259.2↓ / 323.4↑ / 1,223.6↑
Provision for credit
losses / 517.8 / 1,583.7 / 404.7 / 347.1 / 277.3↓ / 1,483.0↓ / 173.4↑ / 682.5↓
Commissions / 129.5 / 520.6 / 154.1 / 144.6 / 136.3↑ / 560.5↑ / 136.5↓ / 544.2↑
Principal Transactions / 20.7 / 84.9 / 22.8 / 24.9 / 24.4↑ / 89.6↑ / 24.8↑ / 91.9↑
Gain on sale of loans
& securities / (159.8) / (195.8) / 43.4 / 22.8 / 29.6↓ / 105.0↑ / 52.4↑
Service charges
& Fees / 49.7 / 204.6 / 47.9 / 50.3 / 48.8↑ / 193.8↑ / 44.5↑ / 189.1↑
Other Revenue / 13.0 / 52.7 / 13.1 / 11.3 / 11.5↓ / 47.9↓ / 46.2↓
Total Non-Interest
Income / 53.0 / 668.5 / 281.2 / 254.0 / 228.1↑ / 980.0↑ / 940.7↑
Total Revenue
(before provision) / 377.8 / 1,941.4 / 620.9 / 575.2 / 544.7↑ / 2,234.9↑ / 2,162.8↑
Net Revenue
(after provision) / (140.0) / 357.7 / 216.3 / 228.1 / 231.1↑ / 713.6↑ / 1,254.7↑
Note: Blank cells indicate that brokers did not provide estimates.
ETFC posted net revenue of $575.0 million in 3Q09 (in line with Zacks Digest), up from $377.0 million in 3Q08. Net revenues increased 52% y/y due to net gains on the sales of loans and securities of $42 million versus losses of $160 million in 3Q08, but net revenues declined 7% q/q due to lower net gains of loans and securities and slightly lower net interest income and commissions.
ETFC’s online brokerage business continued to perform well, brokerage accounts grew, average commission per trade was higher, and the interest rate spread remains strong despite very low market rates.
The Company reported total DARTs of 196,000 in 3Q09, an 11% sequential quarterly decrease off a record quarter and a 7% increase y/y. ETFC has recorded its highest DART level for the first nine months of any year. The Company added 14,000 net new brokerage accounts during the period. At quarter end, E*TRADE reported 4.5 million customer accounts, which included a record 2.7 million brokerage accounts.
Customer security holdings increased 17% or $14.1 billion, and brokerage-related cash increased by $2.1 billion during the quarter. Net new customer assets were a negative $0.2 billion during the quarter and were impacted by a $1.3 billion decline in savings and other bank related customer deposits, as the Company continued to execute its balance sheet reduction strategy. Customers were net sellers of approximately $1 billion of securities during the quarter. Margin receivables increased from $3.1 billion to $3.4 billion.
3Q09 provision for loan losses was $347.2 million versus $517.8 million in 3Q08.
One firm (Citigroup) believes if provisions continue to trend down from $347 million level to $250 million range, it is possible the bank could become a net generator of capital in late 2010.
Commissions, fees and service charges, principal transactions, and other revenue in 3Q09 were $231 million versus $238 million in the second quarter. This included a$0.45 increase in average commission per trade to $11.50, offset by the sequential decline intrading activity.
The Company reported net interest income of $321 million, compared with $340 million in 2Q09, as a result of a nine basis point contraction in the interest income spread to2.82% and a $918 million decline in average interest-earning assets to $44.3 billion. Thedecline in spread from the prior quarter was due largely to a return to a normalized level ofincome from stock loan transactions.
Please refer to the separately published spreadsheet of ETFC for additional details and updated forecasts.
Margins
Prior to the 3Q09earnings release,the pre-tax operating margin expectation was (37.5%) for FY09. Following the 3Q09 earnings release, the pre-tax operating margin expectation decreased to (81.8%)for FY09.
Margins / 3Q08A / 2008A / 2Q09A / 3Q09A / 4Q09E / 2009E / 1Q10E / 2010EPre-Tax Operating / -65.1% / -34.1% / -200.1% / -81.8%↓
After-Tax Net / -84.9% / -41.6% / -22.9% / -10.2% / -10.3%↑ / -10.5%↑ / -0.3%↓
Efficiency Ratio / 78.3% / 66.9% / 53.0% / 52.5% / 56.1%↑ / 55.0%↑ / 56.5%↑
Note: Blank cells indicate that figures are not provided by the brokers.
Total operating expense decreased by $28 million to $302 million from 2Q09, largely due to the industry-wide special FDIC assessment recorded in 2Q09 of approximately $22 million. Compensation and benefits increased in the quarter due to higher variable compensation, reflecting the Company’s strong year-to-date operating results.
Compensation expense was $97.9 million versus $83.6 million in 3Q08. Advertising expenses were $19.4 million in 3Q09 versus $30.4 million in 3Q08.
Outlook
According to the Zacks Digest model, projected growth rate of total non-interest expenses is (5.0%) and (0.7%), for FY09 andFY10,respectively, as compared with revenue growth rate of 15.1% and (3.2%) for FY09 andFY10,respectively.
Please refer to the separately published spreadsheet of ETFC for additional details and updated forecasts.
Earnings per Share
Prior to the 3Q09 earnings release, the Digest average EPS estimates for FY09 and FY10 were ($0.67) and $0.01, respectively. Following the 3Q09 earnings release, the Digest average EPS estimates increased to ($0.59) for FY09 and to$0.01 for FY10.
ETFC reported net loss (including discontinued operations) of $832 million, or $0.66 per share versus a net loss of $50 million, or $0.09 per share, in 3Q08. Income for continuingoperations, as per the Company was $832 million, or $0.66 per shareversus $321 million, or $0.60 per share, in 3Q08. 3Q09 results included a $968 million pre-tax non-cash charge for corporate debt extinguishment in relation to the Company’s successful $1.74 billion debt exchange, which had an after-tax impact of approximately $773 million, or $0.61 per share. Excluding the impact of this item, the Company reported a net loss of $59 million, or $0.05 per share.
EPS in $ / 3Q08A / 2008A / 2Q09A / 3Q09A / 4Q09E / 2009E / 1Q10E / 2010EGAAP EPS / ($0.09) / ($0.98) / ($0.22) / ($0.66) / ($0.02)↑ / ($1.19) ↑ / $0.01↑ / $0.02↑
Zacks Consensus / ($0.04) ↑ / ($0.67) ↓ / ($0.01) / ($0.01) ↑
Digest High EPS / ($0.59) / ($1.53) / ($0.19) / ($0.05) / $0.01↑ / ($0.42) / $0.01 / $0.07↑
Digest Low EPS / ($0.60) / ($1.59) / ($0.22) / ($0.05) / ($0.05) ↑ / ($0.72) ↑ / ($0.03) ↓ / ($0.03) ↑
Digest Average / ($0.60) / ($1.55) / ($0.21) / ($0.05) / ($0.03) ↑ / ($0.59) ↑ / ($0.01) / $0.01↑
Average Y/Y Growth / -333.4% / 54.3% / 10.3% / 91.6% / 93.4%↑ / 62.0%↑ / 97.6%↓ / 101.4%↓
Sequential Growth / -150.0% / 47.7% / 76.7% / 34.3%↓ / 69.6%↓
Highlights from the EPS chart are as follows:
- 2009 forecasts (total 7) range from ($0.72) to ($0.42); the average is ($0.59).
- 2010 forecasts (total 7) range from ($0.03) to $0.07; the average is $0.01.
Outlook
According to one firm (Goldman) 2Q09 marked for the first time in over two years that ETFC has released reserves after a rapid period of aggressive allowance build. The firm expects this trend to persist through 2012, as ETFC benefits from lower charge-offs than reserve building. Alongside the deferred tax asset, shielding the first $111 million in net income each year until the DTA is exhausted and the firm returns to profitability, there are a few non organic drivers of improving earnings over the next few years.
As per the Zacks Digest model, the analysts expect the share count to increase by 139.8% y/y to 1,222.5 million by the end of FY09, and by 122.3% y/y to 2,717.2 million by the end of FY10. This represents a three-year CAGR of 85.7% on FY07 shares outstanding.
Please refer to the separately published spreadsheet of ETFC for additional details and updated forecasts.
Balance Sheet
The Company continued to make progress during 3Q09 in reducing its balance sheet risk as its loan portfolio contracted by $1.7 billion from 2Q09, of which $0.9 billion was related to prepayments or scheduled principal reductions and $0.4 billion was related to the sale of a pool of home equity loans.
For the Company’s entire loan portfolio, total special mention delinquencies (30-89 days) declined by 4% and total at-risk delinquencies (30-179 days) declined by 10% in the quarter. In the home equity portion of the portfolio, which represents the Company’s greatest exposure to loan losses, special mention delinquencies increased by 1% in the quarter, while at-risk delinquencies declined 10%.
Total net charge-offs in the quarter were $352 million, a decrease of $35 million from 2Q09. Total allowance for loan losses was flat at $1.2 billion, or 6% of gross loans receivable.
Target Price/Valuation
Of the elevenfirms covering the stock, fourassignedpositiveratings,sevenprovided neutral ratings. None of the firms rated the stock negatively. The Digest average target price is $1.95(↑$0.01 from theprevious report; 34.1% upsidefrom the current price). The target prices range from $1.57 (JMP Sec.) (8.3% upside from the current price) to $2.30 (Citigroup, Goldman) (58.6% upsidefrom the current price).
The firm (JMP Sec.) with the lowest target price rated the stock Market perform and did not provide any valuation metric. One firm (Citigroup) with the highest target price rated the stock Buy and valued the price on 15x multiple to pre-provision normalized annual earnings per share of $0.20, beginning in 2012, discounted back 1.5 years using a 20% discount rate. Another firm (Goldman) with the highest target price rated the stock Buy and based the valuation on normalized EPS of $0.22 along with a 20% probability. ETFC is involved in an M&A transaction.
Rating DistributionPositive / 36.4%↑
Neutral / 63.6%
Negative / 0.0%↓
Average Target Price / $1.95↑
Digest High / $2.30
Digest Low / $1.57↓
No. of Analysts with Target Price/Total / 10/11
The key risks to the target price are primarily related to the macroenvironment, including the condition of the economy and the equity markets’ operating environment, interest rate levels, and integration risks. ETFC is also exposed to several industry-specific risks, including a flattening yield curve, a prolonged equity market downturn, intense price competition, and lowlevels of retail client activity. ETFC could also be potentially exposed to credit losses based on its loans outstanding, and principaltransaction losses.
Metrics detailing current management effectiveness are as follows:
Metric (TTM) / ETFC / Industry / S&P 500Return on Assets (ROA) / -3.0%↓ / -0.7%↑ / 3.5%
Return on Investments (ROI) / -4.1%↓ / -2.8%↑ / 4.7%↓
Return on Equity (ROE) / -48.0%↓ / -11.4%↑ / 8.4%
ROA, ROI and ROE are lower than the overall market averages (as measured by S&P 500) of 3.5%, 4.7% and 8.4%, respectively.
Capital Structure/Solvency/Cash Flow/Governance/Other
During the quarter, ETFC successfully completed a comprehensive recapitalization, substantially improving the Company’s financial position.
The Company continues to maintain Bank capital ratios substantially in excess of regulatory well-capitalized thresholds. As of September 30, the Company reported Bank Tier 1 capital ratios of 6.72% to total adjusted assets and 13.15% to risk-weighted assets. The Bank had excess risk-based total capital (i.e., above the level regulators define as well capitalized) of $985 million as of September 30, 2009. These capital ratios reflect $100 million of cash that was contributed as Tier 1 equity to the Bank during the quarter.
In late August, the Company completed its $1.74 billion debt exchange, materially reducing its debt burden. The exchange reduced the Parent company’s annual interest payments by more than half, to $160 million per year, and extended maturities. As of September 30, approximately $592 million of the convertible debt had been converted to equity. In addition, the Company successfully raised $150 million of cash equity during the quarter, further enhancing the Parent company’s liquidity and bringing the total cash gross proceeds from common stock issuances this year to $765 million.
Others
On September 23, 2009, ETFC announced that it has completed its previously announced At the Market (ATM) common stock offering. Pursuant to this offering, the Company sold 80,226,756 shares of common stock for gross proceeds of $150 million, resulting in net proceeds of approximately $147 million after deducting commissions and offering expenses.
On September 9, 2009, ETFC announced that Donald H. Layton, will step down as Chairman and CEO of the Company at the end of 2009 when his contract expires.
November 10, 2009