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ETFC > SEC Filings for ETFC > Form 10-Q on 5-Aug-2014All Recent SEC Filings

Show all filings for E TRADE FINANCIAL CORP

Form 10-Q for E TRADE FINANCIAL CORP


5-Aug-2014

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

The following discussion should be read in conjunction with the consolidated financial statements and the related notes that appear elsewhere in this document and with the Annual Report on Form 10-K for the year ended December 31, 2013.
GLOSSARY OF TERMS
In analyzing and discussing our business, we utilize certain metrics, ratios and other terms that are defined in the Glossary of Terms, which is located at the end of Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.
OVERVIEW
Strategy
Our business strategy is centered on two core objectives: accelerating the growth of our core brokerage business to improve market share, and strengthening our overall financial and franchise position. Accelerate Growth of Core Brokerage Business
Enhance digital and offline customer experience.

We are focused on maintaining our competitive position in trading, margin lending and cash management, while expanding our customer share of wallet in retirement, investing and savings. Through these offerings, we aim to continue acquiring new customers while deepening engagement with both new and existing ones.
Capitalize on value of corporate services business.

This includes leveraging our industry-leading position to improve client acquisition, and bolstering awareness among plan participants of our full suite of offerings. This channel is a strategically important driver of brokerage account growth for us.
Maximize value of deposits through the Company's bank.

Our brokerage business generates a significant amount of deposits, which we monetize through the bank by investing primarily in low-risk, agency mortgage-backed securities.
Strengthen Overall Financial and Franchise Position
Manage down legacy investments and mitigate credit losses.

We continue to manage down the size and risks associated with our legacy loan portfolio, while mitigating credit losses where possible.


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Execute on our capital plan.

The core components of our capital plan include bolstering our capital levels through earnings and de-risking and building out best-in-class enterprise risk management capabilities. A key goal of this plan is to distribute capital from the bank to the parent.
Key Factors Affecting Financial Performance Our financial performance is affected by a number of factors outside of our control, including:
customer demand for financial products and services;

weakness or strength of the residential real estate and credit markets;

performance, volume and volatility of the equity and capital markets;

customer perception of the financial strength of our franchise;

                  market demand and liquidity in the secondary market for
                   mortgage loans and securities;


                  market demand and liquidity in the wholesale borrowings
                   market, including securities sold under agreements to
                   repurchase;

the level and volatility of interest rates;

                  our ability to obtain regulatory approval to move capital from
                   our bank to our parent company; and


                  changes to the rules and regulations governing the financial
                   services industry.

In addition to the items noted above, our success in the future will depend upon, among other things, our ability to:

                  have continued success in the acquisition, growth and
                   retention of brokerage customers;


                  generate meaningful growth in our retirement, investing and
                   savings customer products;

enhance our risk management capabilities;

reduce credit costs;

                  achieve the capital ratios stated in our capital plan, with a
                   particular focus on the Tier 1 leverage ratio at E*TRADE Bank;


                  generate capital sufficient to meet our operating needs at
                   both our bank and our parent company;

assess and manage interest rate risk; and

maintain disciplined expense control and improved operational efficiency.


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Management monitors a number of metrics in evaluating the Company's performance. The most significant of these are shown in the table and discussed in the text below:

                              Three Months Ended June 30,          Variance            Six Months Ended June 30,           Variance
                                2014               2013          2014 vs. 2013          2014               2013          2014 vs. 2013
Customer Activity
Metrics:
Daily average revenue
trades ("DARTs")                155,194             149,670              4  %           176,224             149,122             18  %
Average commission per
trade                     $       10.72       $       11.10             (3 )%     $       10.68       $       11.20             (5 )%
Margin receivables
(dollars in billions)     $         7.3       $         6.0             22  %     $         7.3       $         6.0             22  %
End of period brokerage
accounts                      3,102,966           2,962,731              5  %         3,102,966           2,962,731              5  %
Net new brokerage
accounts                         33,005              29,506             12  %           104,907              59,540             76  %
Annualized brokerage
account attrition rate              8.6 %               8.4 %          *                    8.0 %               8.5 %          *
Customer assets (dollars
in billions)              $       280.9       $       220.1             28  %     $       280.9       $       220.1             28  %
Net new brokerage assets
(dollars in billions)     $         1.0       $         1.7            (41 )%     $         5.1       $         4.8              6  %
Brokerage related cash
(dollars in billions)     $        40.0       $        35.6             12  %     $        40.0       $        35.6             12  %
Company Financial
Metrics:
Corporate cash (dollars
in millions)              $         570       $         251            127  %     $         570       $         251            127  %
E*TRADE Financial Tier 1
leverage ratio                      7.5 %               6.4 %          1.1  %               7.5 %               6.4 %          1.1  %
E*TRADE Financial Tier 1
common ratio                       15.8 %              12.2 %          3.6  %              15.8 %              12.2 %          3.6  %
E*TRADE Bank Tier 1
leverage ratio                     10.2 %               9.5 %          0.7  %              10.2 %               9.5 %          0.7  %
Special mention loan
delinquencies (dollars in
millions)                 $         155       $         269            (42 )%     $         155       $         269            (42 )%
Allowance for loan losses
(dollars in millions)     $         401       $         451            (11 )%     $         401       $         451            (11 )%
Enterprise net interest
spread                             2.55 %              2.35 %         0.20  %              2.51 %              2.33 %         0.18  %
Enterprise
interest-earning assets
(average dollars in
billions)                 $        41.4       $        40.2              3  %     $        41.8       $        40.5              3  %

* Percentage not meaningful.

Customer Activity Metrics
 DARTs are the predominant driver of commissions revenue from our customers.


            Average commission per trade is an indicator of changes in our
             customer mix, product mix and/or product pricing.


            Margin receivables represent credit extended to customers to finance
             their purchases of securities by borrowing against securities they
             own and are a key driver of net operating interest income.


            End of period brokerage accounts, net new brokerage accounts and
             brokerage account attrition rate are indicators of our ability to
             attract and retain brokerage customers. The brokerage account
             attrition rate is calculated by dividing attriting brokerage
             accounts, which are gross new brokerage accounts less net new
             brokerage accounts, by total brokerage accounts at the previous
             period end. This rate is presented on an annualized basis.


            Changes in customer assets are an indicator of the value of our
             relationship with the customer. An increase in customer assets
             generally indicates that the use of our products and services by
             existing and new customers is expanding. Changes in this metric are
             also driven by changes in the valuations of our customers'
             underlying securities.


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            Net new brokerage assets are total inflows to all new and existing
             brokerage accounts less total outflows from all closed and existing
             brokerage accounts and are a general indicator of the use of our
             products and services by new and existing brokerage customers.


            Brokerage related cash is an indicator of the level of engagement
             with our brokerage customers and is a key driver of net operating
             interest income.

Company Financial Metrics
            Corporate cash is an indicator of the liquidity at the parent
             company. It is the primary source of capital above and beyond the
             capital deployed in our regulated subsidiaries. See Liquidity and
             Capital Resources for a reconciliation of this non-GAAP measure to
             the comparable GAAP measure.


            E*TRADE Financial Tier 1 leverage ratio is Tier 1 capital divided by
             average total assets for leverage capital purposes for the parent
             company. E*TRADE Financial Tier 1 common ratio is Tier 1 capital
             less elements of Tier 1 capital that are not in the form of common
             equity, such as trust preferred securities, divided by total
             risk-weighted assets for the holding company. The Tier 1 leverage
             and Tier 1 common ratios are non-GAAP measures as the parent company
             is not yet held to these regulatory capital requirements and are
             indications of E*TRADE Financial's capital adequacy. See Liquidity
             and Capital Resources for a reconciliation of these non-GAAP
             measures to the comparable GAAP measures.


            E*TRADE Bank Tier 1 leverage ratio is Tier 1 capital divided by
             adjusted total assets for E*TRADE Bank and is an indication of
             E*TRADE Bank's capital adequacy.


            Special mention loan delinquencies are loans 30-89 days past due and
             are an indicator of the expected trend for charge-offs in future
             periods as these loans have a greater propensity to migrate into
             nonaccrual status and ultimately charge-off.


            Allowance for loan losses is an estimate of probable losses inherent
             in the loan portfolio as of the balance sheet date and is typically
             equal to management's forecast of loan losses in the twelve months
             following the balance sheet date as well as the forecasted losses,
             including economic concessions to borrowers, over the estimated
             remaining life of loans modified as troubled debt restructurings
             ("TDR").


            Enterprise interest-earning assets, in conjunction with our
             enterprise net interest spread, are indicators of our ability to
             generate net operating interest income.

Significant Events in the Second Quarter of 2014
Completed the Sale of TDRs
            On April 22, 2014, we completed the sale of one- to four-family
             loans modified as TDRs. The sale generated cash proceeds of $0.8
             billion and we recognized a net gain of approximately $7 million on
             the sale.

$75 Million Dividend Issued from E*TRADE Bank to the Parent Company
We received approval from our regulators for a $75 million dividend from E*TRADE Bank to the parent company, totaling $325 million in dividends over the last four quarters, continuing to reflect significant progress on our long-term capital plan.

Completed First Official Stress Test under Dodd-Frank Act
We submitted our first official stress test prior to March 31, 2014 as required under the Dodd-Frank Act, and received feedback from the OCC on our submission in the second quarter of 2014. While the details of our results are not public, we can share the high level result that we remained well above the regulatory well-capitalized levels for all capital ratios across all scenarios and we were satisfied with the feedback around our stress testing process, approach and methodologies.

EARNINGS OVERVIEW
We generated net income of $69 million and $166 million, or $0.24 and $0.56 per diluted share, on total net revenue of $438 million and $913 million for the three and six months ended June 30, 2014, respectively. Net operating interest income increased 11% to $270 million and $536 million for both the three and six months ended June 30, 2014, respectively, compared to the same periods in 2013, which were driven primarily by the size and mix of the balance sheet as well as increases in net


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interest spread. Commissions, fees and service charges and other revenue increased 3% to $161 million and 16% to $345 million for the three and six months ended June 30, 2014, respectively, compared to the same periods in 2013, which were driven primarily by increased order flow revenue for both periods, in addition to increased trading activity during the six months ended June 30, 2014.
Provision for loan losses decreased 74% to $12 million and 82% to $16 million for the three and six months ended June 30, 2014, respectively, compared to the same periods in 2013. The decreases were driven primarily by improving economic conditions, as evidenced by the lower levels of delinquent loans in the one- to four-family and home equity loan portfolios, lower net charge-offs, home price improvement and loan portfolio run-off. Total operating expenses decreased 31% to $284 million and 19% to $574 million for the three and six months ended June 30, 2014, respectively, compared to the same periods in 2013. The decreases for the three and six months ended June 30, 2014 were driven primarily by $142 million in impairment of goodwill that was recognized in the second quarter of 2013 which increased operating expenses for the same periods in 2013. The following sections describe in detail the changes in key operating factors and other changes and events that affected net revenue, provision for loan losses, operating expense, other income (expense) and income tax expense. Revenue
The components of revenue and the resulting variances are as follows (dollars in millions):

                            Three Months Ended June           Variance                                           Variance
                                      30,                  2014 vs. 2013       Six Months Ended June 30,      2014 vs. 2013
                                2014           2013       Amount        %           2014          2013       Amount        %
Net operating interest
income                     $         270     $  243     $    27        11  %   $        536     $  484     $    52        11  %
Commissions                          105        106          (1 )      (1 )%            233        207          26        13  %
Fees and service charges              46         41           5        12  %             93         73          20        27  %
Principal transactions                 -         21         (21 )       *                10         43         (33 )     (77 )%
Gains on loans and
securities, net                        7         21         (14 )     (67 )%             22         37         (15 )     (41 )%
Net impairment                         -         (1 )         1         *                 -         (2 )         2         *
Other revenues                        10          9           1        11  %             19         18           1         6  %
Total non-interest income            168        197         (29 )     (15 )%            377        376           1         0  %
Total net revenue          $         438     $  440     $    (2 )      (0 )%   $        913     $  860     $    53         6  %

* Percentage not meaningful.

Net Operating Interest Income
Net operating interest income increased 11% to $270 million and $536 million for both the three and six months ended June 30, 2014, respectively, compared to the same periods in 2013. Net operating interest income is earned primarily through investing deposits and customer payables in enterprise interest-earning assets, which include: available-for-sale securities, held-to-maturity securities, margin receivables and real estate loans.
The following table presents enterprise average balance sheet data and enterprise income and expense data for our operations, as well as the related net interest spread, yields and rates and have been prepared on the basis required by the SEC's Industry Guide 3, "Statistical Disclosure by Bank Holding Companies" (dollars in millions):


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                                                                                 Three Months Ended June 30,
                                                                  2014                                               2013
                                                               Operating                                          Operating
                                              Average          Interest           Average        Average          Interest           Average
                                              Balance          Inc./Exp.        Yield/Cost       Balance          Inc./Exp.         Yield/Cost
Enterprise interest-earning assets:
Loans(1)                                    $    7,416     $            77          4.18 %     $    9,811     $           102         4.17  %
Available-for-sale securities                   12,742                  72          2.28 %         12,399                  67         2.16  %
Held-to-maturity securities                     11,298                  82          2.91 %          9,770                  61         2.51  %
Margin receivables                               7,330                  65          3.56 %          5,675                  54         3.81  %
Cash and equivalents                             1,310                   1          0.15 %          1,365                   1         0.21  %
Segregated cash                                    799                   1          0.10 %            468                   -         0.10  %
Securities borrowed and other                      500                  21         16.43 %            678                  13         7.95  %
Total enterprise interest-earning assets        41,395                 319          3.08 %         40,166                 298         2.97  %
Non-operating interest-earning and
non-interest earning assets(2)                   4,203                                              4,752
Total assets                                $   45,598                                         $   44,918
Enterprise interest-bearing liabilities:
Deposits                                    $   25,239                   2          0.03 %     $   25,598                   3         0.05  %
Customer payables                                6,250                   3          0.16 %          5,293                   2         0.14  %
Securities sold under agreements to
repurchase                                       4,010                  30          2.98 %          4,465                  37         3.28  %
Federal Home Loan Bank ("FHLB") advances
and other borrowings                             1,285                  17          5.24 %          1,287                  17         5.26  %
Securities loaned and other                      1,506                   -          0.03 %            856                   -         0.02  %
Total enterprise interest-bearing
liabilities                                     38,290                  52          0.53 %         37,499                  59         0.62  %
Non-operating interest-bearing and
non-interest bearing liabilities(3)              2,187                                              2,487
Total liabilities                               40,477                                             39,986
Total shareholders' equity                       5,121                                              4,932
Total liabilities and shareholders' equity  $   45,598                                         $   44,918
Excess of enterprise interest-earning
assets over enterprise interest-bearing
liabilities/Enterprise net interest
income/Spread                               $    3,105     $           267          2.55 %     $    2,667     $           239         2.35  %

Enterprise net interest margin (net yield on enterprise
interest-earning assets)                                                            2.58 %                                            2.38  %
Ratio of enterprise interest-earning assets to
enterprise interest-bearing liabilities                                           108.11 %                                          107.11  %
Return on average:
   Total assets                                                                     0.61 %                                           (0.48 )%
   Total shareholders' equity                                                       5.40 %                                           (4.40 )%
Average equity to average total assets                                             11.23 %                                           10.98  %

Reconciliation from enterprise net interest income to net operating interest income (dollars in millions):

                                                Three Months Ended June 30,
                                                       2014                  2013
Enterprise net interest income           $         267                      $ 239
Customer assets held by third parties(4)             3                          4
Net operating interest income            $         270                      $ 243

(1) Nonaccrual loans are included in the average loan balances. Interest payments received on nonaccrual loans are recognized on a cash basis in operating interest income until it is doubtful that full payment will be collected, at which point payments are applied to principal.

(2) Non-operating interest-earning and non-interest earning assets consist of property and equipment, net, goodwill, other intangibles, net and other assets that do not generate operating interest income. Some of these assets generate corporate interest income.

(3) Non-operating interest-bearing and non-interest bearing liabilities consist of corporate debt and other liabilities that do not generate operating interest expense. Some of these liabilities generate corporate interest expense.

(4) Includes revenue earned on average customer assets of $14.1 billion and $11.2 billion for the three months ended June 30, 2014 and 2013, respectively, held by third parties outside the Company, including money market funds and sweep deposit accounts at unaffiliated financial institutions. Fees earned on the customer assets are based on the federal funds rate plus a negotiated spread or other contractual arrangement with the third party institutions.


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                                                                                  Six Months Ended June 30,
                                                                  2014                                               2013
                                                               Operating                                          Operating
                                              Average          Interest           Average        Average          Interest           Average
                                              Balance          Inc./Exp.        Yield/Cost       Balance          Inc./Exp.         Yield/Cost
Enterprise interest-earning assets:
Loans(1)                                    $    7,904     $           161          4.08 %     $   10,103     $           209         4.13  %
Available-for-sale securities                   13,115                 151          2.30 %         12,691                 131         2.06  %
Held-to-maturity securities                     10,927                 159          2.91 %          9,636                 119         2.48  %
Margin receivables                               7,134                 127          3.60 %          5,671                 108         3.85  %
Cash and equivalents                             1,229                   1          0.15 %          1,478                   2         0.21  %
Segregated cash                                    818                   1          0.10 %            314                   -         0.10  %
Securities borrowed and other                      626                  38         12.24 %            636                  26         8.33  %
Total enterprise interest-earning assets        41,753                 638          3.06 %         40,529                 595         2.95  %
Non-operating interest-earning and
non-interest earning assets(2)                   4,235                                              4,923
Total assets                                $   45,988                                         $   45,452
Enterprise interest-bearing liabilities:
Deposits                                    $   25,465                   4          0.03 %     $   26,270                   6         0.05  %
Customer payables                                6,310                   5          0.16 %          5,177                   4         0.14  %
Securities sold under agreements to
repurchase                                       4,232                  65          3.06 %          4,459                  74         3.29  %
Federal Home Loan Bank ("FHLB") advances
and other borrowings                             1,283                  34          5.26 %          1,274                  34         5.31  %
Securities loaned and other                      1,367                   -          0.04 %            803                   -         0.01  %
. . .
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