DBRS: E*TRADE Ratings Unchanged After 4Q12 Earnings; Senior at B (high)

DBRS, Inc. (DBRS) has today commented that its ratings of ETRADE Financial Corporation (ETRADE or the Company) remain unchanged following the release of the Company’s 4Q12 and full year 2012 results. DBRS rates ETRADE’s Issuer & Senior Debt at B (high) and ETRADE Bank’s (the Bank) Deposits & Senior Debt at BB. All ratings have a Stable trend. For the year, the Company recorded a net loss of $113 million, down from a net profit of $157 million in 2011. For the quarter, the Company reported a net loss of $186 million, following net losses of $29 million 3Q12 and $6 million in 4Q11. While a second consecutive quarterly loss is disappointing, DBRS notes that there was evidence of continued positive underlying trends for the Company in 4Q12 results. Specifically, E*TRADE reported sustained momentum in its flagship brokerage business, registered material progress in strengthening its capital structure, and continued to shrink its legacy loan book.

In general, the Company’s fourth quarter results were reflective of the impact of ongoing strategic actions at ETRADE combined with still weak retail investor confidence. Driving the quarterly loss was a $257 million charge associated with the early debt extinguishment. While the Company took a sizable charge to refinance all of its high-interest Springing Lien Notes (SLNs) as well as its 2015 Senior Notes, ETRADE was able to meaningfully reduce its annual debt servicing costs by approximately $70 million on a pre-tax basis. Capitalizing on attractive market conditions, the Company’s refinancing transaction extended the weighted average maturity of its interest-bearing debt from just under 5 years to approximately 6 years and nearly halved the average coupons to the lowest levels ever issued by E*TRADE. DBRS views this evolution positively as it marks a significant accomplishment for the Company and demonstrates market confidence.

E*TRADE’s net revenues of $468 million in 4Q12 compared unfavorably to prior quarters as net interest income was pressured by a decline in interest-earning assets associated with the Company’s deleveraging plan, only partially offset by a 10bp expansion in the net interest spread. Non-interest income of $207 million for 4Q12 (vs. $229 million for 3Q12 and $186 million for 4Q11) was boosted by net gains of $62 million, a portion of which was related to the aforementioned asset reduction.

Importantly from a ratings perspective, DBRS sees the Company as well-positioned for success in its core brokerage franchise despite a weaker fourth quarter. The Trading and Investment segment, which is largely the online brokerage franchise, generated net income of $109 million in 4Q12, down from 3Q12 net income of $127 million. Reflecting industry trends rather than any franchise weakness, daily average revenue trades (DARTs) of 128,009 were flat from 3Q12 but down 9% YoY. DBRS notes that, as the face of E*TRADE’s franchise, the Company continues to invest in this segment to expand its presence and capabilities in retirement offerings and mobile platforms. Positively for future results, this segment added 10,339 in net new brokerage accounts (vs. 18,247 in 3Q12 and 10,196 in 4Q11) and $2.3 billion in net new brokerage customer assets in 4Q12 (vs. $1.9 billion in 3Q12 and 1.7 billion in 4Q11), while maintaining solid account retention with an annualized churn rate of 9.8% (vs. 8.5% for 3Q12 and 9.5% for 4Q11). DBRS views the segment as relatively well-positioned to capitalize on a recovery in retail investor confidence.

The Company’s other segment, Balance Sheet Management (BSM), which houses ETRADE’s legacy loan portfolio, reported net income of $44 million for 4Q12 reversing a net loss of $12 million in 3Q12. The QoQ improvement was driven by a 47% decline in loan loss provisions to $74 million from an extraordinary high in 3Q12. Overall, ETRADE’s asset quality metrics continue to signal improvement. Although special mention delinquencies (30-89 days past due) were up 5% and total at-risk delinquencies (30-179 days past due) were up 1% sequentially for the entire loan portfolio, they were down 27% and 28% YoY, respectively. Total delinquent loans (excluding TDRs) as a percentage of gross loans declined to 7.8% at year-end 2012 from 9.3% a year earlier. The legacy loan portfolio continued to shrink, decreasing by $557 million during 4Q12 to $10.6 billion.

Management continues to emphasize cost control to help offset revenue pressures. Total 4Q12 operating expenses of $285 million declined by $4 million from 3Q12. Looking ahead, E*TRADE affirmed its commitment to cost savings through adjustments to marketing, compensation, and professional services.

Reducing the size of the balance sheet remains a priority for management. During the quarter, $3.0 billion of deleveraging initiatives were completed bringing the total completed to $6.3 billion (of which $4.9 billion in 2012). Looking forward, management is targeting an additional $2.2 billion in deleveraging actions. The Company is targeting a Bank Tier 1 leverage ratio of 9.5% by year-end 2013, which should facilitate regulatory approval for excess Bank capital to be distributed to the parent to help pay off high cost debt at the parent level. At quarter-end, the Bank’s Tier 1 leverage ratio was 8.7%, up from 7.9% in 3Q12.

On a consolidated basis, ETRADE reported a Tier 1 common ratio of 10.3% at 4Q12, down from 10.9% in 3Q12, but up from 9.4% in 4Q11. Management estimates the consolidated Basel III Tier 1 common capital ratio, under current proposed guidelines, would be approximately 50bps higher. At the Bank level, the Company reported a Tier 1 common ratio of 19.3% at 4Q12, up from 18.0% at 3Q12 and 16.0% at 4Q11. The solid capital ratios reflect ETRADE’s comfortable capital cushion that provides it with it ample loss absorption capacity, in DBRS’s view.

Notes:
All figures are in U.S. dollars unless otherwise noted.

[Amended on June 25, 2014 to remove unnecessary disclosures.]