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E*TRADE Financial Corporation's (NASDAQ:ETFC) first-quarter 2011 net income of 16 cents per share was above the Zacks Consensus Estimate earnings of 12 cents, on the back of operating net revenue, strong brokerage business, decrease in provision for loan losses and improved expense management. The income also compares favorably with loss of 11 cents and 25 cents per share in the prior quarter and prior-year quarter, respectively.

E*TRADE reported fourth-quarter net income of $45.2 million compared with a net loss of $24.1 million in the prior quarter and $47.8 million in the prior-year quarter.

Performance in Detail

In the first quarter of 2011, total net revenue inched up 3.6% sequentially, but was flat year over year to $536.7 million. Moreover, the revenue substantially surpassed the Zacks Consensus Estimate of $381.0 million.

The total daily average revenue trades (DARTs) for the reported quarter was 177,000, surging 18% sequentially and 14% year over year. Net new brokerage assets reported were $3.9 billion in the quarter, up from $2.4 billion in the prior quarter and $2.2 billion in the prior-year quarter.

At the end of the quarter, E*TRADE reported 4.3 million customer accounts, which included a record 2.7 million brokerage accounts. In the first quarter of 2011, net new brokerage accounts scaled up to 51,000 from 28,000 in the prior quarter and 2,000 in the prior-year quarter.

Net operating interest income was up 1.6% sequentially, but down 3.3% year over year to $310.0 million in the quarter. The sequential increase was due to a $1.3 billion increase in average interest-earning assets, largely offset by four basis points decrease in the net interest spread. In the quarter, net interest spread was 2.84%, down from 2.88% in the prior quarter.

Total operating expense inched down 2.2% sequentially, but edged up 0.9% year over year to $298.0 million. The sequential decrease was attributable to lower professional services costs, occupancy and equipment expenses and other operating expenses, partially offset by higher compensation, clearing and advertising expenses. The year-over-year increase was due to higher advertising and market development expenses.

Overall credit quality metrics trends were mixed in the quarter. E*TRADE's provision for loan losses decreased 40.0% sequentially to $116.1 million. Net charge-offs were $193.6 million, down from $195.5 million in the prior quarter, while allowance for loan losses remained flat sequentially at $1.0 billion.

Balance Sheet

E*TRADE reduced its balance sheet risk further, with its loan portfolio contracting $0.9 billion from the last quarter, of which $0.7 billion was due to prepayments or scheduled principal reductions.

The company maintained bank capital ratios well above the regulatory well-capitalized threshold. As of March 31, 2011, E*TRADE reported Bank Tier 1 capital ratios of 7.54% to total adjusted assets and 14.29% to risk-weighted assets.

Performance by Peers

E*TRADE’s closest competitor, Charles Schwab Corporation (SCHW - Analyst Report) reported first-quarter 2011 earnings of 20 cents per share, a penny ahead of the Zacks Consensus Estimate of 19 cents. This also compares favorably with the year-ago quarter’s earnings of 11 cents. Charles Schwab’s results benefited from improved revenue and increase in interest-earning assets. Additionally, fall in non-interest expenses was also a positive for the company.

Our Take

The competitive position in the market for brokerage business depends on trading customers, predominantly active traders. As the long-term investing customer group is less developed compared with the trading customers, there is an opportunity for future growth as and when the long-term customers expand.

Development of innovative online trading and long-term investing products and services, delivery of advanced customer service, creative and cost-effective marketing and sales, and expense discipline can be considered as key factors in executing E*TRADE’s strategy to profitably grow trading and investing business.

Additionally, stabilization in the credit quality suggests that management can now focus more on the company’s core business. The company reported an improvement in the brokerage business and the retail investors’ environment is visible.

Initiatives to reduce balance sheet risk are encouraging but it will add near-term pressure on interest margin. Yet, the company’s capital position and restructuring initiatives are encouraging, but increase in operating expenses can have an adverse impact.

E*TRADE currently retains its Zacks #3 Rank, which translates to a short-term ‘Hold’ rating. Considering the fundamentals, we are maintaining our ‘Neutral’ recommendation on the stock.

Source: E-Trade Returns to Profitability