E*Trade Q2 Earnings: Interest-Based Revenues Offset Dip In Trading Commissions

E*Trade Financial (NASDAQ:ETFC) reported its Q2 earnings on July 23. E*Trade’s asset-based business grew by 11% year-on-year (y-o-y) to $270 million, while low trading volumes kept trading commissions’ revenues flat over the prior year quarter at $105 million. As a result, the brokerage posted flat revenues over the prior year quarter at $438 million. ^[1] The company’s loan portfolio declined by $325 million from the prior quarter to $7.1 billion at the end of the quarter, driven by $310 million of payments. The company expects to continue to make payments in the range of $300 million per quarter in the coming quarters.

Most of E*Trade’s operational expenses were flat on a sequential and y-o-y basis. However, the company’s advertising expenses were over 43% higher than the prior year quarter at $33 million. Management attributed this to advertising costs related to its newly launched platform, branded Type E. Management also mentioned that the company does not expect these expenses to recur in the latter half of the year, due to which full-year operational expenses should be only about 10% higher than those in 2013.

According to our analysis, E*Trade’s adjusted EBITDA margin declined by about 3 percentage points from the March quarter to 41.1% in Q2. However, the EBITDA margin was significantly higher than the prior year quarter, when the company posted losses. The slight decline in trading volumes during the quarter was partially responsible for the sequential decline in margins. A similar trend was witnessed in the recent earnings of competing brokerages such as Charles Schwab (NYSE:SCHW) and TD Ameritrade (NYSE:AMTD). A rise in trading volumes in the latter half of the calendar year could help improve margins even further.

See our full analysis for E*Trade Financial

Net Interest Revenue To Gradually Pick Up

E*Trade’s interest earning assets were down to about $40 billion in 2013, an 8% decrease from 2012, mainly due to deleveraging to pay back debt of the parent company. The yields on these assets have been low for most brokerages and financial institutions over the last few years due to the low interest rate environment. However, E*Trade’s net interest-earning assets grew by around 2% y-o-y to around $41.4 billion and the yield on these assets improved by 20 basis points to 2.61% in Q2 over the prior year quarter. Consequently, there was an 11% annual increase in net interest revenues to $270 million. We expect net interest-earning assets to grow at a CAGR of over 5% for the next few years as the company continues to attract more clients to its trading platform.

Customer Base Increasing Despite Low Trading Activity

E*Trade added about 95,000 net new brokerage accounts in 2013, ending the year with nearly 3 million accounts. Comparatively, the company added about 100,000 net new accounts in just the first half of of 2014 (through June) to take its total brokerage accounts to over 3.1 million. Despite lower DARTs in the June quarter, the company continued to add new accounts at a rate similar to Q1. We forecast E*Trade to reach a customer base of 4 million customers through the end of our forecast period.

E*Trade’s daily average revenue trades declined by 22% over the prior year quarter to 155,000 trades per day – still 4% higher than the year-ago period. The implied revenue per trade (calculated by dividing the net revenue generated by trading commissions by the total number of trades conducted) was $11.10 in 2013. This figure declined to about $10.60 in the March quarter before improving slightly to $10.70 in Q2, which the company attributed a higher mix of options traded compared to equity trades and comparatively more trades from corporate services customers. A higher mix of derivatives traded in the coming quarters could further improve the average commission per trade for the brokerage.

In the previous quarter, E*Trade exited its G1X market making services business. Going forward, the company does not expect the sale of G1X to have a material impact on earnings since the net impact of excluding the revenue stream is expected to be offset by a rise in order flow revenue. Fee and services revenues could pick up as the company intends to route all of its order flow to third parties.

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1. E*Trade Q2 2014 Earnings Call Transcript, Seeking Alpha, July 2014 [↩]