DBRS Confirms E*TRADE, Senior at B (High) with Negative Trend after Q1 2009 Earnings

DBRS has today confirmed the ratings for ETRADE Financial Corporation (ETRADE or the Company), including its Issuer & Senior Debt rating of B (high) and short-term rating of R-4, following a net loss of $233 million in Q1 2009. This follows a net loss in the prior quarter of $276 million and a Q1 2008 net loss of $91 million. The ratings reflect both the resiliency of ETRADE’s on-line retail brokerage franchise and the stress from its legacy loan portfolios that is driving these losses. While ETRADE increased operating income before provisions and taxes from continuing operations (operating IBPT) to $203 million, it was not enough to absorb still elevated provisions of $454 million. All ratings, except Short-Term Instruments of E*Trade Bank (the Bank), have a Negative trend.

The ratings confirmation reflects the Company’s success in sustaining its on-line retail financial services franchise and increasing its operating IBPT, even as substantial credit costs from its legacy loan portfolios are causing overall losses. Focusing on its target segments and benefiting from disruptions at a number of full service competitors, ETRADE continues to have success in adding retail accounts, bringing its total customer accounts to a record 4.5 million with 2.7 million brokerage accounts. While trading volumes were down from high levels in Q4 2008, increased average commissions helped sustain revenues. Market volatility contributed to another quarter of lower margin lending, as customers are deleveraging and reducing risk With customers holding more cash, however, deposits at ETRADE Bank benefited, increasing to $27.6 billion, even as the Company reduced its rates on certain accounts. Increased earning assets and a largely flat net interest margin are enabling ETRADE to increase its net interest income. Although the contribution of commissions, fees and other non-interest income has varied over recent quarters, overall non-interest income has shown modest growth. While still investing in its franchise, ETRADE has also strengthened its operating IBPT by reducing expenses.

The Negative trend indicates the pressure on the Company’s ratings, as it struggles with the credit costs of its legacy loan portfolios. Even with improved operating IBPT in Q1 2009 at a pace that is likely to be sustained in 2009, DBRS anticipates that the Company will have quarterly losses for much of 2009, even though the Company’s expectations are for a lower pace of provisioning. DBRS sees such losses as putting pressure on the Company’s capitalization, especially if provisioning does not decline to the extent management projects. The Company’s ability to build capital is also constrained by the parent’s current quarterly interest payments of $87 million. With anticipated quarterly losses eating away at E*TRADE’s capital base, DBRS would view actions to enhance the Company’s capitalization as an important step in maintaining the current ratings.

At the end of Q1 2009, the Bank was considered well capitalized based on regulatory capital ratios. At 5.63%, however, the Bank’s regulatory leverage ratio (Tier 1 to adjusted tangible assets) has declined from 6.29% in Q4 2008, leaving a more modest cushion of $288 million over the “5%” level required to be considered well capitalized. With the Bank generating only $181 million in IBPT, the current level of provisioning is generating losses in the Bank and reducing its capital. Subsequent to the end of the quarter, the Company downstreamed $150 million to the Bank to bolster capital. To manage its capital position, the Company has indicated that it is considering various approaches to reducing risk on the Bank’s balance sheet, deleveraging the parent company, and generating additional capital. E*TRADE continues to pursue TARP funds to replenish capital, having applied for a total of approximately $800 million.

Bolstering its loan loss reserves, ETRADE took $454 million in provisions in the quarter, charging off $334 million and adding $120 million to its loan loss reserve (LLR). With $1.2 billion in its LLR, the Company has 35% coverage of nonperforming loans (NPLs) in its $12.6 billion one- to four-family mortgage portfolio and 195% coverage of the NPLs in its $9.7 billion home equity portfolio. ETRADE has reduced its exposure to unused home equity lines of credit to $2.0 billion from a peak of over $7 billion at the end of 2007. Positively, at-risk delinquencies were up just 9% quarter-over-quarter, as compared to a 31% increase from Q3 to Q4 2008. Reflecting this improvement in its credit quality trends and the aging of its home equity portfolio, the Company is now expecting quarterly provisions to be in the range of $200 - $250 million, about half the current pace.

The Company has significant liquidity at the Bank with $3.9 billion in cash and $10 billion of unused liquidity lines at the Federal Home Loan Bank. While reduced by the $150 million downstreamed to the Bank in April, parent company cash stood at $406 million at Q1 2009, providing resources for interest payments and further downstreaming capital to the Bank.

DBRS continues to evaluate E*TRADE’s operating performance, financial profile and its efforts to bolster its capitalization. In addition, signs that the Company’s franchise strength is being significantly impaired would be viewed negatively from a ratings perspective.

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

The applicable methodologies are Rating Banks and Bank Holding Companies Operating in the United States, 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.