E*Trade Q3 Results: Limited Revenue Capture From Trades, Low Yields Hinder Growth

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E*TRADE Financial

E*Trade Financial (NASDAQ:ETFC) announced its Q3 2015 earnings on Thursday, October 22. [1] Trading activity picked up in the third quarter after a slowdown in Q2. However, a slightly lower implied revenue earned per trade led trading commission revenues to remain flat over the prior year period. Similarly, the brokerage witnessed limited growth in adding net client assets, with the average client balances standing at $45.5 billion through the quarter. Average client balances were about 2% lower than the comparable prior year period. As a result of relatively low yields – which are likely to continue through the latter half of the year – net interest revenues were also flat over the comparable prior year period.

See our full analysis for E*Trade Financial

Trade Volumes Pick Up In Q3 With Subdued Revenue Capture

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The total number of brokerage accounts at E*Trade stood at just over 3.2 million accounts at the end of September. Although E*Trade has added about 60,000 net new accounts through 2015 thus far, the company managed to add only about 3,000 net new accounts through the September quarter. We currently forecast the total number of brokerage accounts at E*Trade to increase to 3.27 million by the end of 2015, and to over 4 million through the end of our forecast period.

E*Trade’s daily average revenue trades (DARTs) stood at about 170,000 trades per day in Q1, and fell to just under just under 150,000 in the June quarter. Complementing the rise in brokerage accounts, E*Trade witnessed a 21% sequential rise in trade volumes to just under 180,000 trades per day in August. As a result of high volumes in August, E*Trade’s DARTs for Q3 stood at 156,000 trades per day, which was about 2% higher on a y-o-y basis. The implied revenue per trade – calculated by dividing the net trading commission revenue by the total number of trades  – was $10.87 during the quarter, compared to $11.05 in the year ago period. As a result, the transaction-based revenue generated by the brokerage for the quarter was flat over the prior year quarter at $108 million.

Asset-Based Revenues Witness Slowdown

E*Trade earns interest income on client assets through holding credit balances, which include margin, real estate and consumer loans and by holding customer cash and deposits. The company’s average client balances for brokerage accounts for Q3 were about 2% lower than the year-ago period at $45.5 billion. [2] We forecast E*Trade’s average client balance for the full year to be 6% higher than 2014 levels at about $44 billion. Subsequently, we forecast the average balances to rise to over $55 billion through the end of our forecast period.

The net yield on these assets rose in 2014 for the first time in over five years, due to which revenues generated by interest on these balances grew by 11% year over year to $1.1 billion. The implied yield was up by over 20 basis points to 2.63% for the full year. However, the implied annualized yield on these assets in 2015 thus far has been roughly flat over the 2014 average. As a result, the company’s net interest revenues have witnessed limited growth. The trend continued in Q3, with net interest revenue staying flat over the comparable prior year period at $263 million. We currently forecast the average yield for the current year to be around 2.71%; as a result, net interest revenues could be around 4-5% higher than the prior calendar year.

Impact On Margins And Exceptional Items

E*Trade reported an exceptional item on its income statement and balance sheet, due to which its reported net revenue (GAAP) was only about $73 million. The company reported a $370 million net loss on securities, bringing down the net revenue and operating income for the quarter. This was a one time occurrence due to the wholesale funding transaction, which led to the elimination of $4.4 billion of legacy funding obligations. [3] Back in the mid 2000s, the company had committed to future funding in the form of club advances and repurchase agreements, which made sense at that time in a strong interest rate environment. However, in the last few years this funding became burdensome for the company, so it made sense to terminate it and incur a one-time short-term loss. Adjusting for this expense, the company’s net revenue stood at $443 million for the quarter, roughly flat over the prior year period.

According to our estimates, E*Trade’s adjusted EBITDA margin stood at just over 40% through 2014, significantly higher than 2013 levels of about 32.5%. Since most expenses incurred by brokerages are fixed in nature, growth in net revenues in 2014 led to healthier margins. Low trading volumes in the first half of 2015 have caused E*Trade’s adjusted EBITDA margin to compress. Its adjusted EBITDA margin fell by about 5 percentage points to 38.6% in Q1’15 and over 3 percentage points to 38.9% in Q2. The trend continued in Q3, with cash operating expenses rising by over 5% y-o-y to $272 million. As a result, its adjusted EBITDA margin stood at 38.6% for the quarter, about 3 percentage points lower than the prior year period.

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Notes:
  1. E*TRADE Financial Corporation Announces Third Quarter 2015 Results, E*Trade Investor Relations, October 2015 []
  2. E*Trade Monthly Metrics For August, E*Trade Investor Relations, September 2015 []
  3. E*Trade Q3 Earnings Call Transcript, Seeking Alpha, October 2015 []