Key Takeaways From E-Trade’s Q3

E*Trade Financial (NASDAQ: ETFC) sustained its growth trend in Q3 with a quarterly revenue of $720 million, an increase of 20% over the same period last year. In line with our expectations, interest earning assets continued to be the primary growth driver, driven by the Fed’s interest rate hikes and a strong net interest yield. Despite the price cut in equity trading commissions, trading commissions were 17% higher than Q3 2017, though this is largely due to the acquisition of OptionsHouse and TCA boosting trading volumes and new brokerage accounts.

Operating expenses declined slightly over 6% in comparison to the prior year, due to reduced losses on early extinguishment of debt, partially offset by higher advertising, compensation and infrastructure spending to cater to the expanding customer base, and we expect them to remain around the same levels this year. As a result, the company’s adjusted operating margin came in at 48%, 6 percentage points above the prior year quarter. Further, the robust performance to date, coupled with the September rate hike, should likely lead to an improvement in operating margins. We believe continued momentum from the Fed’s rate hike should drive near-term growth for E-Trade.

Our price estimate for E-Trade’s stands at $62, which is significantly higher than the market price. Below we discuss some of the key factors which impacted the brokerage’s earnings. With our interactive dashboard, you can modify the asset base and yield to see the change in revenue.

Interest Earning Revenues Grew Due to Fed’s Actions

Interest earning assets account for nearly 65% of E-Trade’s revenue, according to Trefis estimates. Additionally, the company has the highest yield on these assets (at 3.10%) among its peers, which has contributed to remarkable growth in revenues. These assets saw nearly 10% growth along with a 30 basis point increase in yield, resulting in nearly 19% growth in the segment’s revenues for the quarter. We expect about 10 basis points in annual yield growth, driven by interest rate hikes and an increase in demand for loans. As a result, we forecast the company’s Net Interest Income to grow by 16% annually going forward.

Growth In Trading Volumes Reduced Losses Due To Commission Cut  

Transaction-based revenues account for 20% of E-Trade’s overall revenue. The quarter saw 17% growth in trading commissions, despite the company’s decision to slash its commissions by over 35%. The 29% growth in trading volumes managed to more than offset some of the losses. The strong growth in trading volumes was largely due to an improvement in U.S. macro conditions, coupled with the recent acquisition of TCA. The fee cuts make sense strategically given the competitive pressure, but they will impact the company’s near-term trading revenues. That said, we expect a significant jump in trading volumes and brokerage accounts in the near term owing to the TCA acquisition. In addition, the acquisition of 1 million brokerage accounts from Capital One should further boost trading volumes and brokerage accounts from 2019 onwards. As a result, we expect the company’s Trading commissions to grow by 12% annually going forward.

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