E*Trade Gets Approval For Capital Diversion, Signaling Continued Progress In Turnaround
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E*Trade Financial Corp. (NASDAQ:ETFC) recently received regulatory approval to withdraw $75 million from its banking subsidiary in the form of a capital dividend. This marks the second such occasion for the financial services firm this year; in September, it received the go-ahead for a similar dividend of $100 million. As before, the money will be used to pay down corporate debt of the parent company, which stood at around $1.8 billion at the end of Q3 2013. [1]
The $75 million dividend is somewhat below the expectations set by the company earlier. Last quarter, management had suggested that they would distribute capital dividends from their banking unit to the parent firm until the end of 2014 at a run rate of $100 million per quarter. [2] Now, the capital dividend seems to be tied to the net income of E*Trade’s banking subsidiary in the prior quarter. Although this change introduces some variance in the company’s quarterly debt reduction plan, we still expect a significant near-term reduction in debt. We have a price estimate of $16 for its stock, which is slightly below the current market price.
See our full analysis for E*Trade Financial
Debt Reduction Likely To Continue Until 2015
Speaking at an industry conference shortly after the announcement of the $75 million dividend, E*Trade’s CFO suggested that the company intends to continue diverting capital in this way until the Tier I leverage ratio of its bank falls down to 8%. Given that the ratio currently stands at around 9.5% and management intends to reduce it by 50 basis points a year, the process could go on through 2015. [1]
Don’t Read Too Much Into The Smaller Dividend
Although the $75 million dividend is slightly below previous expectations, we would not read too much into the decline. The $100 million run-rate announced earlier by the company’s management was subject to regulatory approval, and was therefore only indicative. Even now, the company must seek approval from the SEC each time it intends to divert capital, so things are still subject to change. Plans may also be revised drastically next year based on the outcome of the stress test that E*Trade Bank is scheduled to undergo at the end of Q1 2014. ((E*TRADE Financial’s Management Presents at KBW Securities Brokerage & Market Structure Conference (Transcript), SeekingAlpha, November 19, 2013))
Additionally, it still seems possible for E*Trade to reduce debt at a faster rate if it chooses to. The company is set to receive $75 million in cash from the sale of its market making business soon, and could use that money in conjunction with the money received from capital dividends to reduce debt.
Its ability to initiate capital dividends could also increase in the future if the net income of E*Trade’s banking subsidiary increases. While there are several factors that could make this happen, the most likely ones are: (1) an increase in banking revenue, or (2) a decline in provisions for loan losses. Banking revenue could increase due to a general improvement in the interest rate environment – as interest rates increase so does the net interest margin on client assets, while provisions for loan losses have been already declining steadily due to the run-off in E*Trade’s loan portfolio. Even if the bank’s net income were to remain at the same level as now, there seems to be some room for the capital dividend to grow. As shown in the table below, E*Trade Bank’s net income was actually around $85 million in Q3, almost $10 million above the actual dividend amount. In contrast, the difference between E*Trade Bank’s Q2 net income and the capital dividend announced in Q3 was just around $2.5 million.
| E*Trade Bank Statement of Income |
Three Months Ended |
||
| ($ in thousands) |
September 30, 2013 |
June 30, 2013 |
September 30, 2012 |
| Total net revenue |
$396,825 |
$411,457 |
$440,562 |
| Provision for loan losses |
37,399 |
46,149 |
141,020 |
| Total operating expenses |
220,490 |
224,941 |
235,157 |
| Other income (expense) |
(94) |
(314) |
(50,588) |
| Income before income tax expense |
138,843 |
140,052 |
13,798 |
| Income tax expense |
54,091 |
37,531 |
12,403 |
| Net income |
$84,742 |
$102,521 |
$1,394 |
(source for table: http://files.shareholder.com/downloads/ET/2801555687x0x707831/3c4d7317-70b8-44b2-87cc-bab23c4d819d/ETFC_Q3_2013_Investor_Presentation_11.19.13_FINAL.pdf)
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Notes:- E*TRADE Financial’s Management Presents at KBW Securities Brokerage & Market Structure Conference (Transcript), SeekingAlpha, November 19, 2013 [↩] [↩]
- E*TRADE Financial’s Management Presents at 2013 Barclays Global Financial Services Conference, SeekingAlpha, September 10, 2013 [↩]