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WEDNESDAY, APRIL 16, 2008
HOT RESEARCH AM
Reasons to Trade Out of E*Trade
E*Trade Financial (ETFC: Nasdaq)
By Credit Suisse ($3.40, April 15, 2008)
REFLECTING CONTINUED DETERIORATION in the mortgage industry and early results from regional bank earnings (Wachovia Monday), we are reducing our estimates and target price for E*Trade.
Despite signs of stability in the core brokerage franchise, we believe the overhang of credit quality deterioration and a limited capital cushion should remain investors' primary focus. Our first-quarter earnings-per-share estimate is now a Street-low 16 cent loss; our full year 2008 estimate now calls for a 25 cent loss. Bottom line: We continue to see no reason to become more constructive on E*Trade shares at current levels.
We are assuming E*Trade net revenues are $308 million for the first quarter, down significantly from last quarter and year ago levels. We anticipate a meaningful step-down in net interest income this quarter completely driven by the continued work-down of E*Trade's balance sheet -- we are modeling in a 15% quarter-over-quarter reduction in the balance sheet to $49 billion in average interest earning assets. We are modeling in a stable net interest spread (2.55%) as we expect balance sheet repositioning should help to alleviate the impact of E*Trade's higher deposit pricing schedules.
We expect commission income to meaningfully decline as well, as a full quarter's impact of fourth quarter's outsized customer attrition levels and an overall tapering of industry retail engagement (down 5%-7% quarter-over-quarter on average) both hurt results. In addition, we expect this quarter's results should also reflect E*Trade's exit of its institutional trading business ($125 million-$150 million in estimated annual revenue).
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The primary driver of today's estimate reduction is our expectations for higher loan-loss provisions. Incorporating further deterioration in U.S. housing prices and recent bank/thrift results, we are now assuming first-quarter provision expense of $210 million driven by increased loss expectations in both E*Trade's $11.9 billion home-equity portfolio (89% brokered, 48% 2006 vintage) and the company's $15.5 billion residential first-lien portfolio (38% California-based inclusive of home-equity line of credit book).
In addition, we expect the company to further build reserves and potentially accelerate their three-year provision plan. For the full year, we now estimate total loan-loss provisions of $720 million, 20% ahead of the high end of management's $400 million-$600 million guidance given our more bearish outlook on industry credit quality and brokered home equity, in particular.
We are modeling in non-interest expenses of $350 million (down 9% quarter-over-quarter excluding restructuring charges), still at elevated levels partially driven by our expectations of higher-retention-related comparable expenses and higher advertising costs (recall this quarter includes Super Bowl-related ad spending). We expect non-interest expense levels to ratchet down as E*Trade continues to exit non-core business lines and further streamline the organization.
Given our assumption for an operating loss and the dilution related to November's Citadel Investment Group transaction, we anticipate further capital erosion this quarter -- we expect book value per share to be in the range of $5.60 and tangible book value to fall to under 60 cents per share.
AI
