| 27 January 2010

E*TRADE Financial Corporation (ETFC) finally hit us with year-end results -- and what a year it's been. The company has been focused on restructuring, raising cash to shore up its balance sheet (at the request of the OTS) and trying to focus on its brokerage business. The result? "A watershed year for E*TRADE," said interim CEO Robert Druskin. If by "watershed" he means losing $1.3 billion, raising another $765 million in dilutive common stock and ending the year by losing over 9,000 brokerage accounts last quarter alone, then yes, it was watershed all right.

To be fair, E*TRADE did see a net increase in brokerage accounts year-on-year, much in line with competitor Charles Schwab (SCHW) which saw a 4% increase in new accounts. But Schwab grew net new assets by a healthy 14% while E*TRADE remained essentially flat.

Schwab cleaned up where E*TRADE left a mess: in the banking business. In addition to record efforts in its RIA and fee-based advice segments, Schwab announced a public offering to raise upwards of $500 million to fund new banking initiatives.

While E*TRADE showed signs of improving, losing only $67 million in Q4 compared with $276 million a year ago, the firm closed 2009 with a whopping $1.3 billion loss, compared with a loss of "only" $512 million in 2008. This was, however, exactly what analysts were expecting.

The real question for us is, how is the firm doing with its core brokerage business? The DARTs are fine -- they dropped 18% year over year which is about on par with Schwab and TD Ameritrade (AMTD). The problem is the hemmoraging of accounts. In Q4 of last year the firm added 75,000 new accounts. During the last three months of this year, however, they actually lost 9,200 accounts.

In recent financial and performance updates the company chose to focus on restructuring efforts above all else. This effort, we believe, needs more work and should continue to be the focus. Seems to us E*TRADE is spending way too much time with SuperBowls, babies and vaporware acquisitions -- especially when those efforts thus far seemed to have done more harm than good.

And the restructuring continues to be a work in progress. "Fourth quarter provision for loan losses decreased $55 million from the prior quarter to $292 million," they clarified in the release. "Total allowance for loan losses was virtually flat at approximately $1.2 billion, or six percent of gross loans receivable.... The Company continues to maintain Bank capital ratios substantially in excess of regulatory well-capitalized thresholds," according to the release.

This was CEO Donald Layton's swan song. He's moving on to greener pastures, but will continue to serve as an adviser to the company. E*TRADE announced in December that it would replace (at least temporarily) Mr. Layton with Robert Druskin, who had been serving on E*TRADE's Board of Directors. Layton's board seat has been filled by Joseph Velli, Chairman and CEO of BNY ConvergEx Group.

It's been a tough year for the online brokers in general, despite a strong investing climate. We think pricing changes are afoot among most brokers in order to reposition themselves in this new normal environment. E*TRADE remains a strong prospect for a potential acquisition.

We saw similar results from TD Ameritrade (AMTD) earlier this month, whose net dropped 26% in Q4. Fred Tomczyk, president and CEO of AMTD, commented on the changes their firm is making to face a rocky future. "We have taken a number of steps over the last year to mitigate the impact of the near-zero interest rate environment," he said . "Everything we did this quarter, from investing in client account and asset acquisition to improving the flexibility of our capital structure, was done with a view towards our long-term growth."