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E*Trade Coming Into Its Own

But with maturity come the problems of a mature bank. That currently means the end of refi.
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With its stock up 135% so far this year, online bank and brokerage


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has much to celebrate as it approaches 2004.

On Wednesday, the company affirmed 2003 earnings guidance, and said next year will be better than analysts expected, thanks to strong trade volume and recent cost cuts. Shares were lately up 34 cents, or 3.25%, to $11.44.

However, as E*Trade is becoming a more mature company, it is also beginning to feel some of the aches and pains of more traditional banks -- particularly those that are currently afflicting mortgage lenders.

Last week, Seattle-based

Washington Mutual

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rocked the mortgage space by lowering its earnings outlook for the fourth quarter and 2004, and setting plans for 900 job cuts on top of the 4,500 that have been announced since the summer.

Like the nation's largest thrift, E*Trade got a boost from mortgage refinancing in the past few years -- home lending represented as much as 20% of sales in 2002 -- and is starting to see a drop-off in that business. E*Trade stock fell 3% on the day Washington Mutual issued its outlook on the mortgage sector.

"During the equity market downturn, mortgage refinance originations were E*Trade's revenue mainstay," said Gary Craft, an analyst at Financial DNA, in a recent research note. "However, with rising interest rates, the mortgage business has dropped off considerably."

E*Trade mortgage earnings are expected to be down 80% to 90% from 2003, the company said. "The mortgage outlook is bleak," said Richard Repetto, an analyst at Sandler O'Neill, which has an investment banking relationship with E*Trade. "But the overall numbers get you to their guidance."

E*Trade plans to make up for mortgage weakness with increased trading volume and a widening of its bank spread. The low end of 2004 guidance assumes between 140,000 and 160,000 daily revenue trades. Meanwhile, the bank spread is predicted to widen to between 175 and 195 basis points.

For 2004, E*Trade expects to earn 70 cents to 85 cents a share on total revenue of $1.5 billion to $1.7 billion. Analysts had been forecasting earnings of 69 cents a share on revenue of $1.57 billion, according to Thomson First Call.

The online bank and brokerage expects to earn 50 cents to 54 cents a share on the bottom line in 2003, and 56 cents to 58 cents a share on an ongoing basis. Analysts had been anticipating 58 cents a share on an ongoing basis, according to Thomson First Call.

E*Trade said total November daily revenue trades totaled 146,000, up 2% from October, while margin debt was $1.7 billion at the end of the month, up 8% from the end of October. Overall daily trade volume is up 12% in the first two months of the fourth quarter.

Still, while E*Trade benefits from having multiple revenue streams, the fact that one of them -- the mortgage business -- is drying up may be a problem next year. "We believe that E*Trade's transition away from mortgage represents the greatest execution risk for E*Trade in the near term," said Craft.