Countering the AP's 'E*Trade Financial Earnings Preview' 21 comments
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Yesterday, AP Online posted an "Earnings Preview" presenting a “summary of key developments and analyst opinion” related to E*Trade’s (ETFC) earnings scheduled for release after the market closes today, July 22, 2008.
The final paragraph of the “AP Earnings Preview” points out the 19 percent stock price decline during the second quarter and the July rebound. This AP report fails to associate the stock price declines and recovery with the 27.3% outstanding short interest.
The recent “SEC's Ongoing Enforcement Investigations” and the “SEC Enhanced Protection Against Naked Short Selling” are directly applicable to E*Trade and, given no other news releases, prompted a significant price recovery last Thursday and Friday.
As shown in the chart below, E*Trade’s short interest reached an all time high of 127.5 million shares as of June 30, 2008. With only 16.5 million shares trading each day, it will take over 7 days of trading to cover this level of short interest. Last week's rapid stock price recovery in reaction to the SEC Protection program is an indication of the abusive way this short interest has been affecting E*Trade’s relevant Stock Price. This high level of short interest and price manipulation is one of the reasons E*Trade is currently being considered for inclusion in the Commission’s list of protected securities.
click to enlarge
Since most of the elements of the “AP Earnings Preview” were negative and did not include recent management disclosures, I hereby present the positive announcements and data that this report failed to acknowledge.
Bank Earnings Exceed Mortgage Losses: In their June 30, 2008 press release, E*Trade announced that it has been able to “generate earnings in the Bank to absorb credit losses in excess of management’s current three-year forecast.” E*Trade investor relations has confirmed multiple times that the word “EXCESS” in this statement is related to the earnings and not to the losses. In other words, in is wrong to interpret this as saying losses are in excess of management’s forecast; the validated disclosure from this message from E*Trade Management is that earnings are exceeding losses.
Outstanding Brokerage Services: According to The Wall Street Journal Magazine 'SmartMoney', E*Trade outperformed both TD Ameritrade (AMTD) and Schwab (SCHW) in Customer Service and Products in their 2008 survey. In the June 2008 report E*Trade beat 15 other major brokerage firms in SmartMoney’s annual broker survey in the areas of Trading Tools, Mutual Funds and Investment Products, Research Tools, Customer Service, and Banking Services. In contrast, TD Ameritrade’s (Ranked 4th) Brokerage service continues to have complaints about instability in Ameritrade’s trading platform (Command center is down, Real-time streamer malfunctioning, Orders not executed in timely manner); and Schwab’s Brokerage Service (Ranked 5th) is currently fighting claims of false advertising and litigation connected to their collapsed Yield Plus Fund.
Outstanding Brokerage Growth: Overall, online brokerages have experienced unprecedented growth and earnings this year, as indicated in monthly DART and Account Growth metrics presented by E*Trade, TD Ameritrade, and Charles Schwab. In 2008 E*Trade has outperformed both TD Ameritrade and Schwab in those monthly Customer Metrics. Last week, in spite of their brokerage quality problems, TD Ameritrade and Schwab both surpassed analyst’s quarterly earnings projections. They also added a combined $30 billion in net new assets from clients. Dow Jones Newswire's report “Online Brokers Gain Assets At Wirehouses’ Expense” confirms the movement wealthy clients to online brokerages:
"As the full-service firms go higher and higher upstream, there is a bigger segment of the market (with) significant assets that aren't as attractive" to the big brokerage firms, said James McGovern, a vice president at Corporate Insight, a financial services research and consulting firm.”
Given this trend and the high quality of E*Trade’s services, E*Trade should also be set to report impressive DART levels and net new assets in tonight’s quarterly report.
In summary, the recent disclosures from E*Trade all indicate a positive successful quarterly performance. E*Trade’s management would not have indicated positive mortgage performance on June 30 if they were going to have to increase their loan-loss provision (as indicated by Richard Repetto in the AP Earnings Preview). Mr. Repetto must have failed to “read up” regarding E*Trade’s positive mortgage performance disclosure.
One thing is sure, E*Trade’s Market Share of Online Trading is increasing. E*Trade has innovative and stable online US Market and Global Market trading tools and platforms and will continue to provide high-quality online brokerage services for our global economy.
Disclosure: Long ETFC
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This article has 21 comments:
This should put them ahead in the entire financial recovery sector as many are still not being forthright about potential losses, while ETFC has admitted its mistake and is raising capital furiously to correct the err in their ways. Would love to see only a loss of -.14 or under as this would be bullish and could result in a profit generation by Q3 and would send the shorts scrambling even more. The Canadian deal only goes to reaffirm the capital raising efforts and gives ETFC the boost it needs for any future losses.
Keep the E-Trade baby rolling out the new customers, just stay away from the creepy clowns that I call the "shorts". Thanks for the nice counter Cindy.
Bottom line, not great news, but not devastating either. The turnaround plan IS working and they are moving in the right direction. A lot depends on the overall economy in terms of how long it might take, but it looks as though they have turned the corner and will survive and hopefully thrive again in 2009. May not generate a profit in Q3 or Q4 this year, but capital raising is estimated to be around $800 million by year end, so that should be sufficient to cover their bad mortgage exposure. I am long ETFC and this report goes to my position. Be patient and this baby will turn around.
I'd like to know how much of their loan portfolio is ALT-A and Option-A (e.g., the next mortgage cliff)? Is anything else hidden shareholders should know about? I was disturbed by the announcement regarding Fannie and Freddie, was this well known (e.g., Cindy, did you know)? Why hadn't E*Trade disposed of these non-core positions before the recent free fall? I guess they were "trying" to avoid taking more losses in 2Q.
Financials like BAC and WFC will be rewarded with increased business and stronger earning in Q3 and Q4 as opportunity, customers and money migrate their way. E*Trade has a longer, slower trajectory to recovery due to past transgressions. Great company and market opportunity, but saddled with untimely baggage left by the previous management team.
Disclosure: No longer long
I think that the market over the next several months will prove that Leyton has made a big mistake in liquidating this sound investment, and taken the $83 million pretax loss.
Cheers,
By Rick Aristotle Munarriz July 23, 2008 Comments (1)
1 Recommendation
The "E" in E*Trade (Nasdaq: ETFC) probably stands for "electronic." It most certainly doesn't stand for "empty."
The discount broker delivered a rough second-quarter report last night. Net revenue fell by a sharp 20% to $532 million. The company posted a wider-than-expected deficit of $0.19 a share, a far cry from the $0.37 a share it earned a year earlier. However, like the company's iconic trading baby in its recent wave of televised ads, you can't judge this company by the aroma of its diaper.
The sluggish broker continues to bounce back after last year's financial debacle. During the quarter itself, E*Trade reduced debt, sold non-core assets, slashed expenses, reduced exposure to undrawn home equity lines, and actually grew its user base.
It seems those memorable baby ads are working. The company closed out the three-month period with 22,000 more retail customers -- and 30,000 more retail accounts -- than when it started.
Daily average revenue trades fell by 5% sequentially, but actually clocked in 7% higher than last year's second quarter. True, rival TD AMERITRADE (Nasdaq: AMTD) posted much healthier client trading activity numbers last week, while bellwether Charles Schwab (Nasdaq: SCHW) came through with a refreshing top-line spurt that E*Trade still can't touch. Then again, E*Trade's peers aren’t trading at value-meal prices.
E*Trade is paying the price for digging too deep into mainstream banking, but it's also been unlucky in its own trades. The company will take a charge during the current quarter, after cashing out of most of its preferred equity positions in Fannie Mae (NYSE: FNM) and Freddie Mac (NYSE: FRE) at a hefty loss earlier this month.
The stock took an after-hours hit on the report, as the company warned that it may not return to profitability from continuing operations later this year, as originally expected. That's good for a smack or two, but I'm keeping my eye on the retail brokerage growth instead. E*Trade will get things right on the way to the bottom line. Future asset hits will always be a risk. However, as long as the company keeps signing up more retail users than it loses, E*Trade will grow in relevance.
If growth continues and the stock doesn't follow, isn't it just a matter of time before TD AMERITRADE, Schwab, or any other financial-services heavy looking for a little skin in the discount-brokerage game gets won over by the E*Trade baby and its toddler-sized share price?
Hang in there, E*Trade. Just make sure you keep clean diapers handy, in case the next few quarters remain a bit on the messy side.
S&P REDUCES RECOMMENDATION ON SHARES OF E TRADE FINANCIAL TO SELL FROM HOLDFont size: A | A | A
5:58 PM ET 7/22/08 | S&P Marketscope
RELATED QUOTES
4:00 PM ET 7/23/08
Symbol Last % Chg
ETFC
3.41 -15.80%
Quotes delayed at least 15 minutes
Q2 loss from continuing operations of $0.24 vs. EPS of $0.37 is wider than our $0.15 loss estimate. Loss provision for home equity portfolio was wider than we expected and credit quality declined, while losses on security sales offset better net interest margin and cost controls. Losses from investments in the GSEs will hurt Q3 results, but capital raised from other asset sales may offset. Net account growth also slowed. We widen our '08 loss estimate widens to $0.65 from $0.49, but keep target price at $3, a discount to a declining projected book value as writedowns continue.
"Bank Earnings Exceed Mortgage Losses: In their June 30, 2008 press release, E*Trade announced that it has been able to “generate earnings in the Bank to absorb credit losses in excess of management’s current three-year forecast.” E*Trade investor relations has confirmed multiple times that the word “EXCESS” in this statement is related to the earnings and not to the losses. In other words, in is wrong to interpret this as saying losses are in excess of management’s forecast; the validated disclosure from this message from E*Trade Management is that earnings are exceeding losses."
Do we need a retraction in light of earnings or am I just misreading it?
Yes, ETFC has a great trading platform and some very loyal clients who love the product and management has worked hard to right the ship; however, these factors don't appear to be enough to mitigate the reality of a continued disturbing weak financial condition. A recent commentary from Credit Suisse noted:
"....adjusting for discontinued operations, net revenues were $213 million, down 28% from first quarter levels. Net interest income was up 5% as net interest spread expansion more than offset a further decline in interest earning assets. Retail commissions held steady as engagement remains relatively healthy. Losses on securities amounted to $16 million but will trend higher in coming quarters. Other revenues were down 7%. Credit quality deteriorated; non-performing assets and delinquent loans trended higher. Operating expenses of $319 mil included myriad charges related to the company's restructuring efforts. Ex. these one-time charges/discontinued ops, expenses declined 11%-mgmt is speaking to having achieved its goal of $50 million of annual run-rate cost savings. Share count continues to rise as the company continues to reduce financial leverage through debt-for equity-swaps-we expect further share count dilution here."
Notwithstanding the 'hope' that things will turnaround, what substance is there upon which to make a sound investment decision with ETFC?
IMHO, the ship has taken on substantial water and is still in danger of foundering.
July 23, 2008
E*TRADE Financial (ETFC - US$ 4.05) 1-Overweight
Change of Earnings Forecast
HELOC Loss Trends Becoming Clearer
Investment Conclusion
We believe the main takeaway from ETFC's 2Q08
results and conference call is that the HELOC
portfolio is well in hand and that losses are unlikely
to extend substantially past the company's capital
provisions. We believe the $620mm of excess
capital currently at the bank plus the $660mm of
net proceeds from asset sales at the parent
company (that ETFC could downstream to the
bank for regulatory capital purposes) would allow
for $2bn of incremental pre-tax writedowns on top
of our already modeled $2bn of provisions from
2007-2009.
Summary
HELOC loss trends, we remain comfortable that
ETFC will be able to bear the weight of the
expected credit losses. We reiterate our long-term
investment thesis that values ETFC on a
fundamental basis on 2011 earnings power (post
mortgage-write-offs). While we acknowledge that
the shares may indeed be quite volatile in the near
term given uncertainty and volatility in the financial
market and mortgage assets in particular, we
believe that the shares represent an attractive
risk-reward for investors with an above average
risk tolerance and holding period.
United States of America
Financial Services
E*Trade (ETFC) had a bad quarter, in large part due to provisions for loan losses of $319 million. The company posted a net loss for the quarter of $119 million against a profit of $158 million in the same quarter last year.
E*Trade did have $535 million in revenue. That was down from $669 million last year, but there are a number of signs that the firm's discount brokerage operation is in good shape.
The broker unit's retail customers increased 22,000 from the prior quarter, and were up 90,000 from the previous year. And, assets per customer rose 17% to $52,172.
At $634 million in revenue E*Trade rival TDAmeritrade (AMTD) is not much larger. It is substantially more profitable, having brought n $204 million in net income last quarter.
The huge difference between the two companies is that AMTD has a market cap of $11.2 billion compared to ETFC's of $1.4 billion.
A potential buyer of E*Trade would to be convinced that the bad assets on the broker's balance sheet would put them into a hole big enough to kill $10 billion in value.
E*Trade still has a profitable discount brokerage business. Less than a week ago, the stock traded at $4. It is now down close to $3.
Is the company worth $4 or $5 a shares to Schwab (SCHW) or AMTD? Either of the brokers could take out large amounts of duplicated costs, and spin off the bad assets.
If E*Trade's stock stays at $3, it is going to be sold.
Douglas A. McIntyre
www.247wallst.com/2008...
And i am concerned that the low stock price is orchestrated to make a private buyout cheap to the acquirer; your thoughts please..
+++
am truly concerned about this possible scenario as I am LONG a significant amount of shares.
CONCERN:
Why would Layton intentionally take higher than necessary write-offs (for losses that won't occur for another year or more) which artificially suppresses the earnings per share and price per share while massive debt to equity swaps are occuring?
By simply delaying the date of these excess write-offs, Layton could increase the EPS and the PPS, which would result in significantly less dilution for shareholders when the debt to equity swaps occur.
I am not accusing Layton of having sinister intentions. However, these issues are never addressed in the conference calls. If his goal is to give E*Trade away at bargain prices, then his current course of action is proving highly successful.
By year end, his goal is to set aside enough cash that E*Trade never has to realize any more losses from its banking segment. But at the same time, he is suppressing the stock price and giving away a significant amount of shares through debt for equity swaps.
If E*Trade is to be taken private by the *Undisclosed Swap Holder*, then the *Undisclosed Swap Holder* would be purchasing a cash cow, money making machine at dirt cheap prices. At the same time, Layton is guaranteeing that the purchaser would have no future losses on the banking side. This is because all losses were taken in advanced of the acquisition with the purpose of artificially suppressing the share price and making the company cheaper to acquire.
Read that last sentence again, it has me very worried.
A SIDE NOTE:
Why increase the loan loss reserves significantly more than is called for? The additional cash just sits in the bank and doesn't earn nearly as much interest as what they are paying on their debt.
Instead, Layton should use the cash to pay down debt. A years worth of interest SAVINGS would go further towards covering loan losses than a years worth of interest earned on the cash set aside.