DBRS Ratings Unchanged Following Q3 Earnings of E*TRADE - Senior at B (high), Negative Trend

DBRS has today commented on the Q3 2009 earnings of ETRADE Financial Corporation (ETRADE or the Company). DBRS rates ETRADE’s Issuer & Senior Debt at B (high) and Short-Term Instruments at R-4. DBRS also rates ETRADE Bank (the Bank) at BB. All ratings, except the Short-Term Instruments of the Bank, have a Negative trend. These ratings are unchanged after the earnings release.

Driven primarily by a $773 million non-cash charge related to its debt exchange, ETRADE reported a net loss of $832 million in Q3 2009. Excluding this one-time charge, the Company reduced its quarterly net loss to $59 million compared to a net loss of $143 million in the prior quarter and a net loss of $50 million in Q3 3008. While this quarter’s loss was the Company’s ninth consecutive quarterly loss, ETRADE’s success in restructuring its debt, bolstering its capitalization and preserving the strength of its franchise are helping to cope with the still substantial credit costs of its legacy loan portfolios.

The $773 million charge was mainly due to the significant increase in the Company’s stock price from when the deal terms were announced until the closing of the debt exchange two months later, reflected by a loss on the income statement but offset by an increase to equity on the balance sheet through paid-in capital. In the debt exchange, the Company exchanged all of its 8% Senior Notes due 2011 and certain of its 12.5% Springing Lien Notes due 2017 (together, the Notes) for newly-issued zero coupon Convertible Debentures due 2019. This exchange more than halved E*TRADE’s annual corporate interest payments and extended the Company’s debt maturity profile considerably.

Despite the continued quarterly losses, DBRS sees the Company having success with strengthening its franchise as evidenced by its strong business performance. The strength of the franchise was illustrated by the solid business metrics in Q3 2009, including daily average revenue trades (DARTS) of 196,413, up 7% versus the year-ago quarter, growth in margin receivables and increased average commission per trade. E*TRADE added 14,000 net new brokerage accounts in the quarter bringing the total to a record 2.7 million. Additionally, customer security holdings increased by 17% and brokerage-related cash increased by 12% on a linked quarter basis.

While the strength of the customer franchise is evident, credit remains the key challenge. As the Company struggles with the credit costs of its legacy home equity and first mortgage loan portfolios, there were more positive trends this quarter. With at-risk delinquencies declining and signs of moderating credit deterioration, provisions decreased 14% quarter-over-quarter to $347 million, but still remain elevated. Per DBRS’s calculations, operating income before provisions and taxes (operating IBPT) was $274 million for the quarter. This covered 62% of the provision, leaving an IBPT shortfall of $74 million, down from $112 million in the prior quarter.

At-risk delinquencies (i.e. loans that are 30-179 days delinquent) for one-to-four family loans declined 9% and at-risk delinquencies for home equity loans fell 10% on a linked-quarter basis. The Company’s loan modification program has been a contributor to the decrease in at-risk delinquencies, with $540 million in loan modifications completed to date, although the Company still establishes reserves for these loans. The Company continues to reduce its balance sheet by running off its mortgage loan portfolio, which declined by 17% from year-end 2008 to $20.3 billion.

DBRS views recent steps taken by E*TRADE, including $765 million in equity raised year-to-date and the $1.7 billion debt exchange offer, as critical as the Company boosts capital and reduces corporate interest expense. The Negative trend indicates the pressure on the Company’s ratings, as it copes with negative earnings, elevated credit costs, and maintaining sufficient capitalization. DBRS anticipates that the Company will not return to profitability until 2010, though positive net earnings appear more feasible as a result of the successful restructuring and management’s focus on the core franchise.

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

The applicable methodologies are Rating Banks and Bank Holding Companies Operating in the United States, Rating Securities Firms Operating in the United States, and Enhanced Methodology for Bank Ratings – Intrinsic and Support Assessments which can be found on our website under Methodologies.

This is a Corporate (Financial Institutions) rating.