DBRS Ratings Unchanged After E*TRADE’s Q4 & 2009 Earnings Release - Senior at B (High), Negative Trend

DBRS has today commented on the Q4 and full year 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.

ETRADE reported a net loss of $67 million in the quarter, as operating income before provisions and taxes (IBPT) held up at $205 million, but was not sufficient to fully absorb still elevated provisions of $292 million. IBPT covered 70.2% of the provision, leaving an IBPT shortfall of $87 million. The net loss in the quarter was an improvement from a net loss of $855 million in the prior quarter, which was affected by a $773 million non-cash charge related to ETRADE’s debt exchange. Excluding this charge, the net loss was more manageable at $82 million. While this quarter’s loss was the Company’s tenth consecutive quarterly loss, DBRS views positively E*TRADE’s success in restructuring its debt, bolstering its capitalization and strengthening its franchise, are helping it to cope with the still substantial credit costs of its legacy loan portfolios.

Despite the continued quarterly losses, DBRS sees the Company having success with strengthening its core brokerage franchise, as indicated by its strong business performance. Helping to sustain its revenues, ETRADE was able to maintain its healthy net interest spread of 2.86%, which is up 4 basis points from the prior quarter, due to higher margin balances, reduced rates on CSA accounts and the investment of excess cash in high-quality agency securities. Fees, commissions and service charges declined moderately quarter-over- quarter due to lower trading activity and commissions. Though daily average revenue trades (DARTS) declined in Q4 due to seasonality and lower market volatility, the Company achieved record DARTS of 197,000 for the full year 2009 illustrating the strength of the franchise. Brokerage accounts held flat quarter-over-quarter at 2.7 million, while brokerage customer cash ticked up slightly to $20.9 billion. Pursuing its focused strategy, ETRADE looks to drive future growth by building on its active trader franchise and deepening its penetration in the long-term investor segment, while increasing the quality of its customer accounts and reducing the brokerage account attrition rate.

While the strength of the customer franchise is evident in ETRADE’s performance, credit remains its biggest challenge. One positive sign is the 15.8% decline in provisions from Q3, as the Company saw positive trends in delinquencies in both its home equity and first lien mortgage portfolios. ETRADE’s portfolios are well-seasoned with no purchases since 2007. One factor contributing to elevated costs and complexity is that the loan portfolios were acquired from third parties, so that the Company is interacting with numerous servicers in dealing with delinquencies and refinancings. Net charge-offs remain elevated, at $324 million in the quarter as compared to $352 million in Q3 2009 and $306 million in the prior year’s quarter. The Company continues to reduce its balance sheet by running off its mortgage loan portfolio, which declined by 21.6% from year-over-year to $19.2 billion.

In DBRS’s view, recent steps taken by E*TRADE are critical to maintaining its financial resources to absorb its elevated credit costs and provide a cushion in case more adverse scenarios unfold. These include the $765 million in equity raised in 2009 and the $1.7 billion debt exchange offer. These steps boosted the Company’s capital and reduced its corporate interest expense. Tier 1 capital stood at 12.8% at December 31, 2009, which was up from 11.7% at the end of the prior year. Corporate interest expense has been reduced by about half, to approximately $170 million a year.

The Negative trend indicates the pressure on the Company’s ratings, as it copes with negative earnings, elevated credit costs, and maintaining sufficient capitalization to provide a cushion against more adverse scenarios. DBRS anticipates that the Company will not return to profitability in the near-term, as asset quality will need to improve substantially to generate positive earnings. Nevertheless, positive net earnings now appear more feasible later in 2010, as positive trends indicate management’s success with its restructuring and its focus on the core franchise.

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

The applicable methodologies are Global Methodology for Rating Banks and Banking Organisations, 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.