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E*TRADE Financial Corporation (ETFC - Analyst Report) reported second-quarter 2013 net income of 21 cents per share, significantly outpacing the Zacks Consensus Estimate of 13 cents. Moreover, results improved from a net income of 12 cents per share in the prior quarter.

Top-line improvement with a rise in total daily average revenue trades (DARTs) were the positives for the quarter. In addition, loan portfolio contractions, improved delinquencies and a strong capital position added fuel to the fire. However, increase in provisions and volatile global markets were the headwinds.

Including goodwill impairment of $142 million (pre-tax) and other one-time items, E*TRADE reported net loss of $54 million or 19 cents per share.

Performance in Detail

Net revenue surged 4.8% sequentially to $440 million in the quarter, attributed to lower non-interest income as well as reduced net operating interest income. Moreover, the reported revenues outpaced the Zacks Consensus Estimate of $422 million.

The DARTs for the reported quarter increased 1% sequentially to 150,000.

Net new brokerage assets reported were $4.8 billion, up from $3.1 billion in the prior quarter. At the end of the quarter, E*TRADE reported 4.6 million customer accounts, including 3.0 million brokerage accounts. Net new brokerage accounts of 30,000 were in line with the prior quarter.

Net operating interest income inched up 0.8% sequentially to $243 million in the quarter under review. The modest rise was due to higher interest income, partially offset by increased interest expenses. Moreover, net interest spread in the quarter was 2.35%, up from 2.30% in the last quarter, attributable to higher average interest-earnings assets.

Non-interest income jumped 10% sequentially to $197 million. The rise was primarily due to high net gains on loans and securities, increased fees and service charges along with elevated commissions.

Total operating expenses were $414 million in the quarter, which includes $142 million of goodwill impairment and $10 million of restructuring charges. Excluding the goodwill impairment and other non-recurring items, core operating expenses declined $21 million sequentially from $283 million to $262 million.

Notably, as of Jun 30, 2013, the company has considerably completed its cost reduction program, thereby decreasing annual run-rate expenses by about $95 million, net. However, targeted reductions stood at $110 million, partially offset by investment in enterprise risk management of $15 million.

Credit Quality

Overall, credit quality was a mixed bag during the quarter. Net charge-offs declined 26.5% sequentially to $50 million. Further, allowance for loan losses dipped 0.9% sequentially to $451 million.

For E*TRADE’s entire loan portfolio, special mention delinquencies decreased 14% sequentially, and total at-risk delinquencies moved down 17% sequentially. However, provision for loan losses increased 7% to $46 million on a sequential basis.

Balance Sheet

E*TRADE reduced its balance-sheet risk further. The company’s loan portfolio was $9.6 billion at the end of the reported quarter, down $0.5 billion sequentially.

The company’s total customer assets stood at $220 billion, up from $219 billion in the prior quarter. Total assets ended the quarter at $45.0 billion, up modestly on a sequential basis.

The company commands a strong capital position. As of Jun 30, 2013, E*TRADE reported Tier 1 common ratio of 12.2% compared with 11.2% in the prior quarter. Total risk-based capital ratio was 15.8%, up from 14.8% in the prior quarter. Tier 1 leverage ratio was 6.4%, up from 6.0% in the last quarter.

Competitive Landscape

Among other investment brokers, Charles Schwab Corporation’s (SCHW - Analyst Report) second-quarter 2013 earnings missed the Zacks Consensus Estimate, while results at Interactive Brokers Group, Inc. (IBKR - Analyst Report) came in line with the Zacks Consensus Estimate. However, TD Ameritrade Holding Corporation (AMTD - Analyst Report) reported its fiscal third-quarter 2013 (ended Jun 30, 2013) net income of 33 cents per share, marginally beating the Zacks Consensus Estimate by 2 cents.

In Conclusion

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 to 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 its 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 strong capital position, decreasing delinquencies, increase in customer accounts and improvement in DARTs are impressive.

Moreover, decrease in expenses reflects the company’s successful cost reduction initiatives. Further, E*TRADE’s decision to focus on core operations and exit the market making business is expected to improve profitability.

Yet, amid a challenging economy, rising provision for loan losses and market volatility remain looming concerns. E*TRADE currently carries a Zacks Rank #3 (Hold).

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