DBRS Ratings Unchanged Following Q2 Earnings of E*TRADE - Senior at B (High), Negative Trend

DBRS has today commented on the Q2 2009 earnings of ETRADE Financial Corporation (ETRADE or the Company). DBRS rates ETRADE’s Issuer & Senior Debt at B (high) and Short-Term Instruments at R-4. DBRS also rates ETRADE Bank (the Bank) at BB. All ratings, except the Short-Term Instruments of the Bank, have a Negative trend. These ratings are unchanged after the announcement.

ETRADE reported a net loss of $143 million in Q2 2009 following seven consecutive quarterly losses since Q3 2007, though DBRS does not view the continued net losses as indicative of franchise deterioration. The strong franchise is evidenced by record daily average revenue trades (DARTS) of 221,000, record brokerage accounts of 2.7 million and the addition of 54,000 net new brokerage accounts in Q2 2009. ETRADE also continues to benefit from disruptions at full service competitors. The Company has focused on reducing its balance sheet by running off its mortgage loan portfolio, which declined by 10% from year-end 2008 to $21.9 billion. Impressively, margin receivables increased by 12% over the same time period, following quarterly declines since Q2 2008, indicating increased investor confidence. As the loan portfolio is actively being reduced, E*TRADE has used this as an opportunity to reduce its deposit base by lowering the rate paid on its Complete Savings Account (CSA). As a result, bank savings deposits declined in the quarter, but the interest income spread rose to 291 basis points (bps), up 57 bps versus the prior quarter. Non-interest income, which includes commissions, fees and principal transactions revenues, increased by 29% quarter-over-quarter and 48% year-over-year.

While the strength of the customer franchise is evident, credit remains the key challenge for E*TRADE, as the Company struggles with the credit costs of its legacy home equity and first mortgage loan portfolios. While at-risk delinquencies (i.e. loans that are 30-179 days delinquent) decreased by 9% quarter-over-quarter, total delinquencies increased by 4% over the same time period. The Company’s loan modification program has been a contributor to the decrease in at-risk delinquencies, with $250 million in loan modifications completed to date, although the Company still establishes reserves for these loans. With the decline in at-risk delinquencies and signs of moderating deterioration, provisions decreased 11% quarter-over-quarter to $404 million, but still remain elevated. Per DBRS’s calculations, operating income before provisions and taxes (operating IBPT) was $292 million for the quarter, a 43% increase versus the prior quarter, but still only absorbing 72% of the provision.

DBRS views recent steps taken by ETRADE as beneficial for the Company by boosting its capital and reducing corporate interest expense. ETRADE strengthened its capitalization in the quarter by raising over $600 million in new equity and undertaking certain debt exchange offers, which DBRS does not view as distressed debt exchanges, to reduce its substantial corporate debt burden. Once completed, this exchange will cut cash interest payments at the Parent company by more than half.
The Negative trend indicates the pressure on the Company’s ratings, as it seeks to leverage its successful franchise to sustain operating IBPT, while coping with elevated credit costs and maintaining sufficient capitalization. Even with improved operating IBPT in the second quarter, DBRS anticipates that the Company will have quarterly losses for the remainder of 2009. DBRS sees such losses as putting pressure on the Company’s capitalization, especially if provisioning does not continue to decline. At the end of Q2 2009, the Bank was considered well capitalized based on regulatory capital ratios. The most constraining ratio for the Bank, the regulatory Leverage ratio (Tier 1 to adjusted tangible assets) of 6.79% was above the 5% level required to be considered well capitalized by regulators and also above the Company’s own minimum for this ratio at 6%. E*TRADE's application for the TARP funds remains open, having applied for a total of approximately $800 million.

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.