E*Trade: Earnings Preview - TheStreet



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E*Trade Financial

(ETFC) - Get Report

is due to report its fourth-quarter results after the bell on Wednesday, and Wall Street will be looking for signs of progress in the struggling online broker's quest for a return to profitability.

E*Trade is one of the poster children for the financial crisis as its ill-timed foray into risky mortgage lending several years ago eventually crippled its balance sheet. As the credit crisis worsened, the fallout from those toxic assets led the company to accept a whopper of an investment -- more than $2 billion -- from Citadel Investments in late 2007.

Earlier this year E*Trade once again had to make capital concessions as regulators became nervous that credit losses were eating up too much capital. Over the summer it completed a massive recapitalization plan, where Citadel once again was a major player, agreeing to swap debt for equity shares. Citadel's founder Ken Griffin now sits on E*Trade's board.

Capital issues aside, E*Trade has worked to restructure itself over the past two years to focus on products and businesses that have higher margins and efficiency. It has also made significant progress in dealing with its troubled loan portfolio by both ratcheting up credit loss provisions as it gradually winds down the portfolio. In between, it's been the subject of merger speculation, mostly involving

TD Ameritrade Holdings

(AMTD) - Get Report

, more than a few times.



Despite the progress the company has made, Wall Street is still expecting a loss for the fourth quarter. For E*Trade bulls, the hope is that the fourth quarter will be what one analyst referred to as a "trough" quarter, with the company showing improvement in credit quality and exhibiting evidence of leaving its capital issues behind.

Analysts, according to

Thomson Reuters

, expect the online broker to post a loss of 4 cents a share in the December period, vs. a 66-cent loss in the third quarter and a 50-cent loss in the same period a year earlier.

There is cause for concern about a potential miss on the top line this time around, however. Both TD Ameritrade and

Charles Schwab

(SCHW) - Get Report

, E*Trade's two main rivals, which reported their results last week, missed Wall Street estimates for their performance in the final three months of the year.

Still Goldman Sachs analyst Daniel Harris saw good things for E*Trade ahead of those reports, saying the company is "much more sensitive to changes in consumer credit/home prices, which look to be stabilizing rather than deteriorating," in a research note on Jan. 11. "Further we expect the loan loss provision to decline again in

fourth quarter, and continue to see ETFC as a targeted potential M&A candidate." Harris has a buy rating on the stock.



Rich Repetto, an analyst at Sandler O'Neill & Partners, expects E*Trade's "pre-provision" net revenues to drop 12% from third-quarter levels on lower net interest income because of its diminished loan portfolio and a decline in trading commissions.

Retail trading commissions experienced an earlier than usual seasonal decline during the final three months of the year, as traders looking to lock in profits from the market's run-up since spring slowed activity, and many stocks known for high volatility saw decreased volumes.


TD Ameritrade


Charles Schwab

said revenue from retail trading activities fell in the fourth quarter.

On a positive note, E*Trade derives less of its revenue from trading commissions (just 26% compared to roughly 51% as a peer average since 2005, according to Goldman Sachs). However, E*Trade has a higher exposure to consumer credit than other brokers, which as the financial crisis worsened took a toll on its earnings.

Stock Performance


E*Trade shares rested below $2 each for much of 2009, including stretches under $1 in February and March. The last time the stock moved above $2 was on Apr. 28 in the session just prior to the company's announcement of its first-quarter results and news that it would have to raise more capital as a result of its credit loss provisioning, which prompted a sell-off the next day. The stock has traded in a fairly tight range of a $1.60-to-$1.80 over the past two months, and was down 5.7% in 2010, based on Monday's closing price.

FBR Capital Markets is predicting the online brokers are approaching a "trough" in their results, as the impact of near-zero interest rates is almost fully reflected in the numbers, and trading activity has declined substantially, according to an industry note earlier this month. It that's the case, and conditions begin to improve, it should help E*Trade shares.


We continue to favor E*Trade," the note says. "Though it is less sensitive to interest rates, we believe the drag from credit losses will decline, allowing the company to return to profitability in the second half of the year. This, in turn, should translate into a catalyst as investors begin to assign value to E*Trade's deferred tax asset, excess capital building at the bank, increased likelihood of the company being sold, and a return to 'normalized' earnings."

Overall, sentiment on Wall Street is pretty staid. Nine of the 15 analysts covering the company have it rated as a hold. Of the remaining six analysts, three are at strong buy, two are at buy, and one rates it at underperform.



The two main issues, beyond the headline numbers, that investors will be paying close attention to are E*Trade's credit quality and any color from the company about its succession plan.

On the credit quality front, E*Trade's loan portfolio is filled with soured home equity loans, and as the economy worsened -- contaminating prime loans as well. As big banks including

Bank of America

(BAC) - Get Report


Wells Fargo

(WFC) - Get Report


JPMorgan Chase

(JPM) - Get Report

are starting to become cautiously optimistic regarding delinquency levels, particularly in consumer-related losses, E*Trade could also follow suit. The company has already seen some improvement in early-stage delinquencies, particularly in its home equity portfolio, in previous quarters.

The other obvious question mark for E*Trade is the state of its executive management suite. Former Chairman and CEO Don Layton ended his tenure on Dec. 31, after his two-year contract was up. The company has yet to name a permanent successor, instead installing its lead independent director Robert Druskin (a former


(C) - Get Report

executive, pictured above) as chairman and interim CEO. The firm has said Druskin is not in the running to become permanent chief executive.

A lack of a permanent successor is never good for a public company as it adds a layer of uncertainty to the future and makes investors jittery. In many respects, a vacuum at the top is the last thing that E*Trade needs after management spent the past two years cleaning up the mess left by former Chairman and CEO Mitch Caplan. It was Caplan's decision to take the online broker into increasingly risky businesses and investments that led to the Citadel investment and necessitated the recapitalization plan.

So look for the stock to react positively if the company announces or, at the very least, alludes to a permanent decision regarding its top ranks.

--Written by Laurie Kulikowski in New York.