Document
Table of Contents    

    
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2018
Commission File Number 1-11921

Ehttp://api.tenkwizard.com/cgi/image?quest=1&rid=23&ipage=12525593&doc=40TRADE Financial Corporation
(Exact Name of Registrant as Specified in its Charter)

Delaware
 
94-2844166
(State or other jurisdiction
of incorporation or organization)
 
(I.R.S. Employer
Identification Number)
11 Times Square, 32nd Floor, New York, New York 10036
(Address of principal executive offices and Zip Code)
(646) 521-4300
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.   Yes x  No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).   Yes x  No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See definitions of "large accelerated filer," "accelerated filer," "smaller reporting company" and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer   x
Accelerated filer
 
¨
Non-accelerated filer  ¨ (Do not check if a smaller reporting company)
Smaller reporting company
 
¨
Emerging growth company   ¨ 
 
 
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).   Yes ¨  No x
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:
As of October 30, 2018, there were 254,239,061 shares of common stock outstanding.



Table of Contents    

E*TRADE FINANCIAL CORPORATION
FORM 10-Q QUARTERLY REPORT
For the Quarter Ended September 30, 2018
TABLE OF CONTENTS
PART I
FINANCIAL INFORMATION
 
 
Item 1.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
 
 
 
 
 
 
Item 3.
 
Item 4.
Part II
OTHER INFORMATION
 
Item 1.
Item 1A.
Item 2.
Item 3.
Item 4.
Item 5
Item 6.
 
 


E*TRADE Q3 2018 10-Q | Page i
 
                    

Table of Contents    

Unless otherwise indicated, references to "the Company," "we," "us," "our," "E*TRADE" and "E*TRADE Financial" mean E*TRADE Financial Corporation and its subsidiaries, and references to the parent company mean E*TRADE Financial Corporation but not its subsidiaries.
E*TRADE, E*TRADE Financial, E*TRADE Bank, the Converging Arrows logo, OptionsHouse, Equity Edge Online, Trust Company of America (TCA), and LibertyTM are trademarks or registered trademarks of E*TRADE Financial Corporation in the United States and in other countries. All other trademarks are the property of their respective owners.


E*TRADE Q3 2018 10-Q | Page ii
 
                    

Table of Contents    

PART I
 
FORWARD-LOOKING STATEMENTS
This report contains forward-looking statements, within the meaning of the Private Securities Litigation Reform Act of 1995, that involve risks and uncertainties. These statements discuss, among other things:
our future plans, objectives, outlook, strategies, expectations and intentions relating to our business and future financial and operating results and the assumptions that underlie these matters and include statements regarding our proposed transaction with Capital One Financial Corporation (Capital One) and its benefits and timing,
our capital plan initiatives,
the timing and payment of dividends on our capital stock, including our common and preferred stock,
the payment of dividends from our subsidiaries to our parent company,
the management of our legacy mortgage and consumer loan portfolio,
our ability to utilize deferred tax assets, the expected implementation and applicability of government regulation and our ability to comply with these regulations,
our ability to maintain required regulatory capital ratios,
continued repurchases of our common stock,
our ability to meet upcoming debt obligations,
the integration and related restructuring costs of past and any future acquisitions,
the expected outcome of existing or new litigation,
our ability to execute our business plans and manage risk,
future sources of revenue, expense and liquidity, and
any other statement that is not historical in nature.
These statements may be identified by the use of words such as "assume," "expect," "believe," "may," "will," "should," "anticipate," "intend," "plan," "estimate," "continue" and similar expressions.
We caution that actual results could differ materially from those discussed in these forward-looking statements. Important factors that could contribute to our actual results differing materially from any forward-looking statements include, but are not limited to:
the closing of the proposed transaction with Capital One may not occur or may be delayed and that the actual aggregate consideration paid in connection with the proposed transaction is still subject to final determination,
changes in business, economic or political conditions,
performance, volume and volatility in the equity and capital markets,
changes in interest rates or interest rate volatility,
customer demand for financial products and services,
our ability to continue to compete effectively and respond to aggressive price competition within our industry,
cyber security threats, potential system disruptions and other security breaches or incidents,
our ability to participate in consolidation opportunities in our industry, to complete consolidation transactions and to realize synergies or implement integration plans,
our ability to service our corporate debt and, if necessary, to raise additional capital,
changes in government regulation or actions by our regulators, including those that may result from the implementation and enforcement of regulatory reform legislation,


E*TRADE Q3 2018 10-Q | Page 1
 
                    

Table of Contents    

our ability to move capital to our parent company from our subsidiaries,
adverse developments in litigation,
our ability to manage our balance sheet growth,
the timing, duration and costs associated with our stock repurchase program,
our ability to manage credit risk with customers and counterparties, and
the impact of federal tax reform, including as a result of future regulations and guidance.
By their nature forward-looking statements are not guarantees of future performance or results and are subject to risks, uncertainties and assumptions that are difficult to predict or quantify. Actual future results may vary materially from expectations expressed or implied in this report or any of our prior communications. Investors should also consider the risks and uncertainties described elsewhere in this report, including under Part I. Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations and Part II. Item 1A. Risk Factors of this Quarterly Report and Part I. Item 1A. Risk Factors of our Annual Report on Form 10-K for the year ended December 31, 2017, filed with the Securities and Exchange Commission (SEC), which are incorporated herein by reference. The forward-looking statements contained in this report reflect our expectations only as of the date of this report. Investors should not place undue reliance on forward-looking statements, as we do not undertake to update or revise forward-looking statements, except as required by law.


E*TRADE Q3 2018 10-Q | Page 2
 
                    

Table of Contents    

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (MD&A)
The following discussion should be read in conjunction with the consolidated financial statements and the related notes that appear elsewhere in this document and with the Annual Report on Form 10-K for the year ended December 31, 2017.
OVERVIEW
Company Overview
E*TRADE is a financial services company that provides brokerage and related products and services primarily to individual retail investors. Founded on the principle of innovation, we aim to enhance the financial independence of traders and investors through a powerful digital experience that includes tools and educational materials, supported by professional guidance, to help individual investors and traders meet both near- and long-term investing goals. We provide these services to customers through our digital platforms and network of industry-licensed customer service representatives and financial consultants, over the phone, by email and online via two national financial centers and in-person at 30 regional financial centers across the United States. We operate directly and through several subsidiaries, many of which are overseen by governmental and self-regulatory organizations. Our most important subsidiaries are described below:
E*TRADE Securities LLC (E*TRADE Securities) is a registered broker-dealer that clears and settles customer securities transactions.
E*TRADE Bank is a federally chartered savings bank that provides Federal Deposit Insurance Corporation (FDIC) insurance on qualifying amounts of customer deposits and provides other banking and cash management capabilities.
E*TRADE Savings Bank, a subsidiary of E*TRADE Bank, is a federally chartered savings bank that provides FDIC insurance on qualifying amounts of customer deposits and custody solutions for registered investment advisors (RIAs).
E*TRADE Financial Corporate Services is a provider of software and services for managing equity compensation plans to our corporate clients.
E*TRADE Futures LLC (E*TRADE Futures) is a registered non-clearing Futures Commission Merchant (FCM) that provides clearing and settlement services for customer futures transactions.
E*TRADE Capital Management, LLC (E*TRADE Capital Management) is an RIA that provides investment advisory services for our customers.


E*TRADE Q3 2018 10-Q | Page 3
 
                    

Table of Contents    

Delivering a powerful digital offering for our customers is a core pillar of our business strategy and we believe our focus on being a digital leader in the financial services industry is a competitive advantage. Our hybrid delivery model is available through the following award-winning digital platforms:
http://api.tenkwizard.com/cgi/image?quest=1&rid=23&ipage=12525593&doc=43
Web
Our leading-edge sites for customers and our primary channel to interact with prospects
 
• Access to a broad range of trading solutions
• Actionable ideas and information
• Research and education for decision making
 
http://api.tenkwizard.com/cgi/image?quest=1&rid=23&ipage=12525593&doc=41
Mobile
Powerful trading applications for smartphones, tablets and watches
 
• Award-winning mobile apps
• Platforms to manage accounts on the move
• Stock and portfolio alerts
 
 
http://api.tenkwizard.com/cgi/image?quest=1&rid=23&ipage=12525593&doc=14
Active Trading Platforms
Powerful software and web-based trading solutions
 
• Sophisticated trading tools
• Idea generation and analysis
• Advanced portfolio and market tracking
Strategy
Our business strategy is centered on two key objectives: accelerating the growth of our core brokerage business to improve market share, and generating robust earnings growth and healthy returns on capital to deliver long-term value for our shareholders.
Accelerate Growth of Core Brokerage Business
Enhance overall customer experience
We are focused on delivering cutting-edge trading solutions while improving our market position in investing products. Through these offerings, we aim to continue growing our customer base while deepening engagement with our existing customers.
Capitalize on value of corporate services channel
Our corporate services channel is a strategically important driver of brokerage account and asset growth. We leverage our industry-leading position in corporate stock plan administration to improve client acquisition and engage with plan participants to bolster awareness of our full suite of offerings.


E*TRADE Q3 2018 10-Q | Page 4
 
                    

Table of Contents    

Generate Robust Earnings Growth and Healthy Returns on Capital
Utilize balance sheet to enhance returns
We utilize our bank structure to effectively monetize brokerage relationships by investing stable, low-cost deposits primarily in agency mortgage-backed securities. Meanwhile, we continue to manage down the size and risk associated with our legacy mortgage and consumer loan portfolio.
Put capital to work for shareholders
As we continue to deliver on our capital plan initiatives, we are focused on generating and effectively deploying and returning excess capital, including through our share repurchase program and common stock dividends, for the benefit of our shareholders.
Products and Services
We offer a broad range of products and services to our customers. Our core brokerage business is organized into four product areas: Trading, Investing, Corporate Services, and Advisor Services. Additionally, we offer banking and cash management capabilities, including deposit accounts insured by the FDIC, which are fully integrated into customer brokerage accounts. Among other features, customers have access to debit cards with ATM fee refunds, online and mobile bill pay, mobile check deposits, and E*TRADE Line of Credit, a program which allows customers to borrow against the market value of securities pledged as collateral.
Trading
The Company delivers automated trade order placement and execution services, offering our customers a full range of investment vehicles, including US equities, exchange-traded funds (ETFs), options, bonds, futures, American depositary receipts and non-proprietary mutual funds. Margin accounts are also available to qualifying customers, enabling them to borrow against their securities. We help customers plan and execute margin trades through robust margin solutions, including calculators and requirement lookup and analysis tools. The Company also offers a fully paid lending program, which allows our customers to be compensated for allowing us to lend certain securities in their account.
The Company markets trading products and services to self-directed investors and active traders. Products and services are delivered through web, desktop and mobile digital channels. Trading and investing tools are supported by guidance, including fixed income, options and futures specialists available on-call for customers. Other tools and resources include independent research and analytics, live and on-demand education, market commentary, and strategies, trading ideas and screeners for major asset classes.
Investing
The Company endeavors to help investors build wealth and address their long-term investing needs. Products and services include individual retirement accounts (IRAs), including Roth IRAs, and a suite of managed products and asset allocation models. These include our Core Portfolios, Blend Portfolios, Dedicated Portfolios, and Fixed Income Portfolios. Investors are provided a full suite of digital tools across the Company's web and mobile channels to address their investing needs. These include planning and allocation tools, education and editorial content.
The Company also offers guidance through a team of licensed financial consultants and Chartered Retirement Planning CounselorsSM at our 30 regional financial centers across the country. Guidance is also accessible through our two national financial centers by phone, email and online channels. Customers can receive complimentary portfolio reviews and personalized investment recommendations.


E*TRADE Q3 2018 10-Q | Page 5
 
                    

Table of Contents    

Corporate Services
The Company provides stock plan administration services for both public and private companies. Through our industry-leading platform, Equity Edge OnlineTM, the Company offers management of employee stock option plans, employee stock purchase plans and restricted stock plans with fully-automated stock plan administration. Accounting, reporting and scenario modeling tools are also available. The integrated stock plan solutions include multi-currency settlement and delivery, disbursement in various currencies and streamlined tax calculation. Additionally, corporate clients are offered 10b5-1 plan design and implementation and SEC filing assistance. The Company's digital platforms allow participants in corporate client stock plans to view and manage their holdings. Participants have access to education tools, restricted stock sales support and dedicated stock plan service representatives. Our Corporate Services channel is an important driver of brokerage account and asset growth, serving as an introductory channel to the Company, with over 1.7 million individual stock plan accounts. We serve approximately 20% of S&P 500 companies, including nearly 40% of technology companies and nearly 50% of healthcare companies within the index. In total, we serve over 50% of all publicly traded U.S. technology companies. As of September 30, 2018, approximately 35% of customer cash is related to the Corporate Services channel.
Advisor Services
With the acquisition of TCA, which was completed on April 9, 2018, the Company has expanded its ability to provide technology solutions and custody services to independent RIAs. Liberty, our proprietary technology platform, includes sophisticated modeling, rebalancing, reporting and practice management capabilities that are fully customizable for the RIA. We expect our Advisor Services channel to provide access to a growing segment of our industry and help bolster the Company's ability to attract and retain customers in need of specialized and sophisticated customer service engagement. As of September 30, 2018, the Advisor Services channel had approximately $12 billion in commitments for future assets under custody from RIAs, representing a significant increase from the $17 billion in assets under custody when the Company announced the planned acquisition of TCA in October 2017.
For additional information about our business see Part I. Item 1. Business in the Annual Report on Form 10-K for the year ended December 31, 2017.
Financial Performance
Our net revenue is generated primarily from net interest income, commissions and fees and service charges.
Net interest income is largely impacted by the size of our balance sheet, our balance sheet mix, and average yields on our assets and liabilities. Net interest income is driven primarily from interest earned on investment securities, margin receivables, and our legacy loan portfolio, less interest incurred on interest-bearing liabilities, including deposits, customer payables, corporate debt and other borrowings.
Commissions revenue is generated by customer trades and is largely impacted by trade volume, trade type, and commission rates.
Fees and service charges revenue is mainly impacted by order flow revenue, fees earned on off-balance sheet customer cash and other assets, advisor management and custody fees, and mutual fund service fees.
Our net revenue is offset by non-interest expenses, the largest of which are compensation and benefits and advertising and market development.


E*TRADE Q3 2018 10-Q | Page 6
 
                    

Table of Contents    

Significant Events in the Third Quarter of 2018
Declared quarterly dividend on common stock
In October 2018, our Board of Directors declared a quarterly cash dividend of $0.14 per share on our outstanding shares of common stock. The dividend is payable on November 15, 2018, to shareholders of record as of the close of business on October 30, 2018.
Completed prior $1 billion share repurchase program and approved new $1 billion program
During the third quarter of 2018, we completed our prior $1 billion share repurchase program with the repurchase of 5.3 million shares of common stock at an average price of $58.74 per share, or $310 million in the aggregate during the quarter. As of September 30, 2018, we have repurchased 19.5 million shares of common stock at an average price of $51.38 per share since we began repurchasing shares under this authorization in the third quarter of 2017. In October 2018, our Board of Directors authorized a new $1 billion share repurchase program. The timing and exact amount of any common stock repurchases will depend on various factors, including market conditions and our capital position. We have the ability to complete up to half of the authorization during the fourth quarter of 2018 and intend to complete the remainder by the end of 2019. As of October 30, 2018, we have subsequently repurchased an additional 2.5 million shares of common stock at an average price of $47.77 per share.
Redeemed our Trust Preferred Securities (TRUPs)
During the third quarter of 2018, the Company redeemed all $413 million of its outstanding TRUPs. In connection with the redemption, we recognized a loss on early extinguishment of debt of $4 million, consisting of the difference between the carrying value of the TRUPs redeemed, including unamortized debt issuance costs, and the total cash amount paid, including related fees and expenses. Net proceeds from the June 2018 issuance of the 4.50% Senior Notes due 2028 (Senior Notes) were used to redeem the TRUPs. For additional information about the debt issuance, see Note 11—Corporate Debt.




E*TRADE Q3 2018 10-Q | Page 7
 
                    

Table of Contents    

Key Performance Metrics
Management monitors customer activity and corporate metrics to evaluate the Company’s performance. The most significant of these are displayed below along with the percentage variance for the three months ended September 30, 2018 from the same period in 2017. These metrics include the impact of the TCA acquisition from the April 9, 2018 acquisition date, as applicable.
Customer Activity Metrics:
http://api.tenkwizard.com/cgi/image?quest=1&rid=23&ipage=12525593&doc=25 http://api.tenkwizard.com/cgi/image?quest=1&rid=23&ipage=12525593&doc=26
http://api.tenkwizard.com/cgi/image?quest=1&rid=23&ipage=12525593&doc=22 http://api.tenkwizard.com/cgi/image?quest=1&rid=23&ipage=12525593&doc=15
      


E*TRADE Q3 2018 10-Q | Page 8
 
                    

Table of Contents    

http://api.tenkwizard.com/cgi/image?quest=1&rid=23&ipage=12525593&doc=18 http://api.tenkwizard.com/cgi/image?quest=1&rid=23&ipage=12525593&doc=38
 
                     http://api.tenkwizard.com/cgi/image?quest=1&rid=23&ipage=12525593&doc=42
                      http://api.tenkwizard.com/cgi/image?quest=1&rid=23&ipage=12525593&doc=42

http://api.tenkwizard.com/cgi/image?quest=1&rid=23&ipage=12525593&doc=37 http://api.tenkwizard.com/cgi/image?quest=1&rid=23&ipage=12525593&doc=33
http://api.tenkwizard.com/cgi/image?quest=1&rid=23&ipage=12525593&doc=29 http://api.tenkwizard.com/cgi/image?quest=1&rid=23&ipage=12525593&doc=32



E*TRADE Q3 2018 10-Q | Page 9
 
                    

Table of Contents    

http://api.tenkwizard.com/cgi/image?quest=1&rid=23&ipage=12525593&doc=19 http://api.tenkwizard.com/cgi/image?quest=1&rid=23&ipage=12525593&doc=30
 
                     http://api.tenkwizard.com/cgi/image?quest=1&rid=23&ipage=12525593&doc=42
                        http://api.tenkwizard.com/cgi/image?quest=1&rid=23&ipage=12525593&doc=42
http://api.tenkwizard.com/cgi/image?quest=1&rid=23&ipage=12525593&doc=20
Daily Average Revenue Trades (DARTs) is the predominant driver of commissions revenue from our customers. DARTs were 266,290 and 277,796 for the three and nine months ended September 30, 2018, respectively, compared to 205,763 and 207,065 for the same periods in 2017.
Derivative DARTs, a key driver of commissions revenue, is the daily average number of options and futures trades, and Derivative DARTs percentage is the mix of options and futures as a component of total DARTs. Derivative DARTs were 85,977 and 90,075 for the three and nine months ended September 30, 2018, respectively, compared to 66,122 and 63,869 for the same periods in 2017. Derivative DARTs represented 32% of total DARTs for both the three and nine months ended September 30, 2018, compared to 32% and 31% for the same periods in 2017.


E*TRADE Q3 2018 10-Q | Page 10
 
                    

Table of Contents    

Average commission per trade is an indicator of changes in our customer mix, product mix and/or product pricing. Average commission per trade was $7.04 and $7.21 for the three and nine months ended September 30, 2018, respectively, compared to $7.76 and $8.54 for the same periods in 2017. Average commission per trade for the nine months ended September 30, 2018 was impacted by trade mix and the continued migration of customers to lower active trader commission pricing resulting from our reduced commission rates for equity and options trades effective March 13, 2017, which were as follows:
Stock, options and ETF trade commissions reduced to $6.95 from $9.99
For active traders, commissions reduced to $4.95 from $7.99 and options charges reduced to $0.50 per contract from $0.75; trades required for active trader tier reduced to 30 per quarter from 150.
End of period brokerage accounts and net new brokerage accounts are indicators of our ability to attract and retain brokerage customers. End of period brokerage accounts were 3.9 million and 3.6 million at September 30, 2018 and 2017, respectively. Net new brokerage accounts were 67,163 and 314,490 for the three and nine months ended September 30, 2018, respectively, compared to 26,225 and 125,711 for the same periods in 2017. Our annualized net new brokerage account growth rate was 6.9% and 11.5% for the three and nine months ended September 30, 2018, respectively, compared to 2.9% and 4.8% for the same periods in 2017. Excluding the 145,891 accounts acquired on April 9, 2018 as part of the TCA acquisition, the adjusted annualized net new brokerage account growth rate was 6.2% for the nine months ended September 30, 2018.
Customer margin balances represents credit extended to customers to finance their purchases of securities by borrowing against securities they own and is a key driver of net interest income. Customer margin balances were $11.2 billion and $8.5 billion at September 30, 2018 and 2017, respectively.
Customer assets is an indicator of the value of our relationship with the customer. An increase generally indicates that the use of our products and services by new and existing customers is expanding. Changes in this metric are also driven by changes in the valuations of our customers' underlying securities. Customer assets were $472.8 billion and $365.3 billion at September 30, 2018 and 2017, respectively.
Brokerage related cash is an indicator of the level of engagement with our brokerage customers and is a key driver of net interest income as well as fees and service charges revenue, which includes fees earned on customer cash held by third parties. Brokerage related cash was $53.3 billion and $52.3 billion at September 30, 2018 and 2017, respectively.
Net new brokerage assets is total inflows to new and existing brokerage accounts less total outflows from closed and existing brokerage accounts. The net new brokerage assets metric is a general indicator of the use of our products and services by new and existing brokerage customers. Net new brokerage assets were $3.2 billion and $29.6 billion for the three and nine months ended September 30, 2018, respectively, compared to $2.2 billion and $9.0 billion for the same periods in 2017. During the three and nine months ended September 30, 2018, our annualized net new brokerage asset growth rate was 3.3% and 11.6%, respectively, compared to 2.9% and 4.4% for the same periods in 2017. Excluding the $18.4 billion of assets acquired on April 9, 2018 as part of the TCA acquisition, the adjusted annualized net new brokerage asset growth rate was 4.4% for the nine months ended September 30, 2018.
Managed products represents customer assets in our Managed Portfolios which are a driver of fees and service charges revenue. Managed products were $6.2 billion and $4.9 billion at September 30, 2018 and 2017, respectively.


E*TRADE Q3 2018 10-Q | Page 11
 
                    

Table of Contents    

Corporate Metrics:
http://api.tenkwizard.com/cgi/image?quest=1&rid=23&ipage=12525593&doc=34 http://api.tenkwizard.com/cgi/image?quest=1&rid=23&ipage=12525593&doc=24
http://api.tenkwizard.com/cgi/image?quest=1&rid=23&ipage=12525593&doc=35 http://api.tenkwizard.com/cgi/image?quest=1&rid=23&ipage=12525593&doc=17
http://api.tenkwizard.com/cgi/image?quest=1&rid=23&ipage=12525593&doc=39 http://api.tenkwizard.com/cgi/image?quest=1&rid=23&ipage=12525593&doc=36


E*TRADE Q3 2018 10-Q | Page 12
 
                    

Table of Contents    

http://api.tenkwizard.com/cgi/image?quest=1&rid=23&ipage=12525593&doc=27 http://api.tenkwizard.com/cgi/image?quest=1&rid=23&ipage=12525593&doc=16
Operating margin is the percentage of net revenue that results in income before income taxes and is an indicator of the Company's profitability. Operating margin was 52% and 49% for the three and nine months ended September 30, 2018, respectively, compared to 37% and 44% for the same periods in 2017.
Adjusted operating margin is a non-GAAP measure that provides useful information about our ongoing operating performance by excluding the provision (benefit) for loan losses and losses on early extinguishment of debt, which are not viewed as key factors governing our investment in the business and are excluded by management when evaluating operating margin performance. Adjusted operating margin was 48% and 46% for the three and nine months ended September 30, 2018, respectively, compared to 42% and 39% for the same periods in 2017. See MD&A—Earnings Overview for a reconciliation of adjusted operating margin to operating margin.
Return on common equity is calculated by dividing annualized net income available to common shareholders by average common shareholders' equity, which excludes preferred stock. Return on common equity was 17% and 16% for the three and nine months ended September 30, 2018, respectively, compared to 9% and 10% for the same periods in 2017.
Adjusted return on common equity is a non-GAAP measure calculated by dividing annualized adjusted net income available to common shareholders, a non-GAAP measure which excludes the provision (benefit) for loan losses and losses on early extinguishment of debt, which are not viewed as key factors governing our investment in the business and are excluded by management when evaluating return on common equity performance, by average common shareholders' equity, which excludes preferred stock. Adjusted return on common equity was 16% and 15% for the three and nine months ended September 30, 2018, respectively, compared to 10% and 9% for the same periods in 2017. See MD&A—Earnings Overview for a reconciliation of adjusted net income available to common shareholders to net income and adjusted return on common equity to return on common equity.
Corporate cash, a non-GAAP measure, is a component of cash and equivalents and represents the primary source of capital above and beyond the capital deployed in our regulated subsidiaries. Cash and equivalents was $596 million and $896 million at September 30, 2018 and 2017, respectively, while corporate cash was $517 million and $309 million for the same periods. See MD&A—Liquidity and Capital Resources for a reconciliation of corporate cash to cash and equivalents.
Tier 1 leverage ratio is an indicator of capital adequacy for E*TRADE Financial and E*TRADE Bank. Tier 1 leverage ratio is Tier 1 capital divided by adjusted average assets for leverage capital purposes. E*TRADE Financial's Tier 1 leverage ratio was 7.1% and 7.2% at September 30, 2018 and 2017, respectively. E*TRADE Bank's Tier 1 leverage ratio was 7.1% and 7.7% at September 30, 2018 and 2017, respectively. See MD&A—Liquidity and Capital Resources for additional information, including the calculation of regulatory capital ratios.


E*TRADE Q3 2018 10-Q | Page 13
 
                    

Table of Contents    

Interest-earning assets, along with net interest margin, are an indicator of our ability to generate net interest income. Average interest-earning assets were $60.1 billion and $60.0 billion for the three and nine months ended September 30, 2018, respectively, compared to $54.8 billion and $51.8 billion for the same periods in 2017.
Net interest margin is a measure of the net yield on our average interest-earning assets. Net interest margin is calculated for a given period by dividing the annualized sum of net interest income by average interest-earning assets. Net interest margin was 3.10% and 3.03% for the three and nine months ended September 30, 2018, respectively, compared to 2.85% and 2.74% for the same periods in 2017.
Total employees were 4,091 and 3,584 at September 30, 2018 and 2017, respectively.
Regulatory Developments
In April 2016, the US Department of Labor (DOL) published its final Conflicts of Interest RuleRetirement Investment Advice regulations under the Employee Retirement Income Security Act of 1974 and the Internal Revenue Code of 1986 (Fiduciary Rule). The Fiduciary Rule generally subjects particular persons, such as broker-dealers and other financial advisors providing investment advice to individual retirement accounts and other qualified retirement plans and accounts, to fiduciary duties and additional regulatory restrictions for a wider range of customer interactions. On March 5, 2018, the Fifth Circuit Court of Appeals issued a decision vacating the Fiduciary Rule in its entirety, and on June 21, 2018, following expiration of the appeals period for the decision and resolution of certain motions for appeal and intervention, issued a mandate making the decision effective.
In May 2018, the Economic Growth, Regulatory Relief, and Consumer Protection Act of 2018 (EGRRCPA) was passed. The EGRRCPA amended provisions in the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act) as well as other statutes administered by the Federal Reserve Board, the Office of the Comptroller of the Currency, and the FDIC (collectively, the “federal banking agencies”). In July 2018, the federal banking agencies issued a joint release clarifying that as a result of the passage of EGRRCPA, certain requirements, including company-run stress testing requirements under the Dodd-Frank Act, would no longer be required for savings and loan holding companies and banks with less than $100 billion in total consolidated assets, such as the Company and E*TRADE Bank. In addition the Federal Reserve Board issued a separate statement clarifying that, pursuant to EGRRCPA, it will not take action to enforce certain regulatory and reporting requirements, including the modified liquidity coverage ratio (LCR) for firms, like the Company, with less than $100 billion in total consolidated assets. See MD&ALiquidity and Capital Resources for further information.


E*TRADE Q3 2018 10-Q | Page 14
 
                    

Table of Contents    

EARNINGS OVERVIEW
We generated net income of $285 million and $782 million on total net revenue of $720 million and $2.1 billion for the three and nine months ended September 30, 2018, respectively. The following chart presents a reconciliation of net income for the three months ended September 30, 2017 to net income for the three months ended September 30, 2018 (dollars in millions):
http://api.tenkwizard.com/cgi/image?quest=1&rid=23&ipage=12525593&doc=31
(1)
Includes clearing and servicing, professional services, occupancy and equipment, communications, depreciation and amortization, FDIC insurance premiums, amortization of other intangibles, restructuring and acquisition-related activities and other non-interest expenses.



E*TRADE Q3 2018 10-Q | Page 15
 
                    

Table of Contents    

The following table presents significant components of the consolidated statement of income (dollars in millions except per share amounts):
 
Three Months Ended September 30,
 
Variance
 
Nine Months Ended September 30,
 
Variance
 
 
2018 vs. 2017
 
 
2018 vs. 2017
 
2018
 
2017
 
Amount
 
%
 
2018
 
2017
 
Amount
 
%
Net interest income
$
466

 
$
391

 
$
75

 
19
 %
 
$
1,364

 
$
1,066

 
$
298

 
28
 %
Total non-interest income
254

 
208

 
46

 
22
 %
 
774

 
663

 
111

 
17
 %
Total net revenue
720

 
599

 
121

 
20
 %
 
2,138

 
1,729

 
409

 
24
 %
Provision (benefit) for loan losses
(34
)
 
(29
)
 
(5
)
 
17
 %
 
(74
)
 
(142
)
 
68

 
(48
)%
Total non-interest expense
380

 
405

 
(25
)
 
(6
)%
 
1,159

 
1,106

 
53

 
5
 %
Income before income tax expense
374

 
223

 
151

 
68
 %
 
1,053

 
765

 
288

 
38
 %
Income tax expense
89

 
76

 
13

 
17
 %
 
271

 
280

 
(9
)
 
(3
)%
Net income
$
285

 
$
147

 
$
138

 
94
 %
 
$
782

 
$
485

 
$
297

 
61
 %
Preferred stock dividends
24

 
12

 
12

 
100
 %
 
36

 
25

 
11

 
44
 %
Net income available to common shareholders
$
261

 
$
135

 
$
126

 
93
 %
 
$
746

 
$
460

 
$
286

 
62
 %
Diluted earnings per common share
$
1.00

 
$
0.49

 
$
0.51

 
104
 %
 
$
2.82

 
$
1.67

 
$
1.15


69
 %
Net income increased 94% to $285 million and 61% to $782 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in 2017. Net income available to common shareholders was $261 million and $746 million for the three and nine months ended September 30, 2018, respectively, which reflects payments of $24 million and $36 million in preferred stock dividends, respectively. This compares to $135 million and $460 million for the three and nine months ended September 30, 2017 which reflects payments of $12 million and $25 million in preferred stock dividends, respectively.
The increase in net income for both periods was driven by higher interest income due to a larger average balance sheet and an improvement in net interest margin, as well as higher commissions, fees and service charges and net gains on securities and other. Lower losses on early extinguishment of debt also contributed to increase net income for both periods. During the nine months ended September 30, 2018, these increases were partially offset by a lower benefit for loan losses and higher non-interest expense due primarily to increased compensation and benefits and advertising and market development expenses.
Net Revenue
The following table presents the significant components of net revenue (dollars in millions):
 
Three Months Ended September 30,
 
Variance
 
Nine Months Ended September 30,
 
Variance
 
 
2018 vs. 2017
 
 
2018 vs. 2017
 
2018
 
2017
 
Amount
 
%
 
2018
 
2017
 
Amount
 
%
Net interest income
$
466

 
$
391

 
$
75

 
19
%
 
$
1,364

 
$
1,066

 
$
298

 
28
%
Commissions
117

 
100

 
17

 
17
%
 
375

 
332

 
43

 
13
%
Fees and service charges
108

 
92

 
16

 
17
%
 
323

 
276

 
47

 
17
%
Gains on securities and other, net
17

 
6

 
11

 
183
%
 
42

 
23

 
19

 
83
%
Other revenue
12

 
10

 
2

 
20
%
 
34

 
32

 
2

 
6
%
Total non-interest income
254

 
208

 
46

 
22
%
 
774

 
663

 
111

 
17
%
Total net revenue
$
720

 
$
599

 
$
121

 
20
%
 
$
2,138

 
$
1,729

 
$
409

 
24
%


E*TRADE Q3 2018 10-Q | Page 16
 
                    

Table of Contents    

Net Interest Income
Net interest income increased 19% to $466 million and 28% to $1.4 billion for the three and nine months ended September 30, 2018, respectively, compared to the same periods in 2017. Net interest income is earned primarily through investment securities, margin receivables and our legacy mortgage and consumer loan portfolio, offset by funding costs.
The following table presents average balance sheet data and interest income and expense data, as well as the related net interest margin, yields and rates (dollars in millions):
 
Three Months Ended September 30,
 
2018
 
2017
 
Average Balance
 
Interest Inc./Exp.
 
Average Yield/
Cost
 
Average Balance
 
Interest Inc./Exp.
 
Average Yield/
Cost
Cash and equivalents
$
471

 
$
2

 
1.84
%
 
$
905

 
$
2

 
1.06
%
Cash required to be segregated under federal or other regulations
836

 
4

 
2.15
%
 
759

 
3

 
1.26
%
Investment securities(1)
44,773

 
315

 
2.82
%
 
41,226

 
255

 
2.47
%
Margin receivables
10,902

 
130

 
4.74
%
 
8,096

 
87

 
4.26
%
Loans(2)
2,332

 
32

 
5.38
%
 
3,024

 
37

 
4.95
%
Broker-related receivables and other
798

 
4

 
2.02
%
 
829

 
1

 
0.45
%
Subtotal interest-earning assets
60,112

 
487

 
3.24
%
 
54,839

 
385

 
2.80
%
Other interest revenue(3)

 
27

 
 
 

 
28

 
 
    Total interest-earning assets
60,112

 
514

 
3.41
%
 
54,839

 
413

 
3.01
%
Total non-interest-earning assets
4,291

 
 
 
 
 
4,952

 
 
 
 
Total assets
$
64,403

 
 
 
 
 
$
59,791

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Deposits
$
42,456

 
$
16

 
0.15
%
 
$
40,758

 
$
1

 
0.01
%
Customer payables
10,352

 
8

 
0.30
%
 
8,463

 
1

 
0.06
%
Broker-related payables and other
1,880

 
3

 
0.53
%
 
1,301

 

 
0.00
%
Other borrowings
752

 
6

 
2.95
%
 
831

 
6

 
2.91
%
Corporate debt
1,408

 
13

 
3.90
%
 
1,002

 
12

 
4.64
%
Subtotal interest-bearing liabilities
56,848

 
46

 
0.32
%
 
52,355

 
20

 
0.15
%
Other interest expense(4)

 
2

 
 
 

 
2

 
 
    Total interest-bearing liabilities
56,848

 
48

 
0.33
%
 
52,355

 
22

 
0.17
%
Total non-interest-bearing liabilities
859

 
 
 
 
 
820

 
 
 
 
Total liabilities
57,707

 
 
 
 
 
53,175

 
 
 
 
Total shareholders' equity
6,696

 
 
 
 
 
6,616

 
 
 
 
Total liabilities and shareholders' equity
$
64,403

 
 
 
 
 
$
59,791

 
 
 
 
Excess interest earning assets over interest bearing liabilities/net interest income/net interest margin
$
3,264

 
$
466

 
3.10
%
 
$
2,484

 
$
391

 
2.85
%
(1)
For the three months ended September 30, 2018, includes a $5 million net loss related to fair value hedging adjustments, previously referred to as hedge ineffectiveness. Amounts prior to 2018 have not been reclassified to conform to current period presentation and continue to be reflected within the gains on securities and other, net line item. See Note 8—Derivative Instruments and Hedging Activities for additional information.
(2)
Nonaccrual loans are included in the average loan balances. Interest payments received on nonaccrual loans are recognized on a cash basis in interest income until it is doubtful that full payment will be collected, at which point payments are applied to principal.
(3)
Represents interest income on securities loaned.
(4)
Represents interest expense on securities borrowed.


E*TRADE Q3 2018 10-Q | Page 17
 
                    

Table of Contents    

 
Nine Months Ended September 30,
 
2018
 
2017
 
Average Balance
 
Interest Inc./Exp.
 
Average Yield/
Cost
 
Average Balance
 
Interest Inc./Exp.
 
Average Yield/
Cost
Cash and equivalents
$
601

 
$
7

 
1.60
%
 
$
1,045

 
$
6

 
0.83
%
Cash required to be segregated under federal or other regulations
795

 
11

 
1.91
%
 
1,263

 
9

 
0.90
%
Investment securities(1)
44,979

 
908

 
2.69
%
 
37,781

 
692

 
2.44
%
Margin receivables
10,225

 
351

 
4.59
%
 
7,383

 
228

 
4.12
%
Loans(2)
2,475

 
98

 
5.25
%
 
3,319

 
121

 
4.86
%
Broker-related receivables and other
898

 
12

 
1.76
%
 
1,029

 
2

 
0.24
%
Subtotal interest-earning assets
59,973

 
1,387

 
3.09
%
 
51,820

 
1,058

 
2.72
%
Other interest revenue(3)

 
84

 
 
 

 
74

 
 
    Total interest-earning assets
59,973

 
1,471

 
3.27
%
 
51,820

 
1,132

 
2.91
%
Total non-interest-earning assets
4,479

 
 
 
 
 
5,051

 
 
 
 
Total assets
$
64,452

 
 
 
 
 
$
56,871

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Deposits
$
42,877

 
$
26

 
0.08
%
 
$
37,862

 
$
3

 
0.01
%
Customer payables
9,817

 
13

 
0.18
%
 
8,611

 
4

 
0.06
%
Broker-related payables and other
1,885

 
7

 
0.49
%
 
1,233

 

 
0.00
%
Other borrowings
837

 
21

 
3.28
%
 
667

 
16

 
3.23
%
Corporate debt
1,149

 
32

 
3.75
%
 
996

 
39

 
5.14
%
Subtotal interest-bearing liabilities
56,565

 
99

 
0.23
%
 
49,369

 
62

 
0.17
%
Other interest expense(4)

 
8

 
 
 

 
4

 
 
    Total interest-bearing liabilities
56,565

 
107

 
0.25
%
 
49,369

 
66

 
0.18
%
Total non-interest-bearing liabilities
939

 
 
 
 
 
1,033

 
 
 
 
Total liabilities
57,504

 
 
 
 
 
50,402

 
 
 
 
Total shareholders' equity
6,948

 
 
 
 
 
6,469

 
 
 
 
Total liabilities and shareholders' equity
$
64,452

 
 
 
 
 
$
56,871

 
 
 
 
Excess interest earning assets over interest bearing liabilities/net interest income/net interest margin
$
3,408

 
$
1,364

 
3.03
%
 
$
2,451

 
$
1,066

 
2.74
%
(1)
For the nine months ended September 30, 2018, includes a $13 million net loss related to fair value hedging adjustments, previously referred to as hedge ineffectiveness. Amounts prior to 2018 have not been reclassified to conform to current period presentation and continue to be reflected within the gains on securities and other, net line item. See Note 8—Derivative Instruments and Hedging Activities for additional information.
(2)
Nonaccrual loans are included in the average loan balances. Interest payments received on nonaccrual loans are recognized on a cash basis in interest income until it is doubtful that full payment will be collected, at which point payments are applied to principal.
(3)
Represents interest income on securities loaned.
(4)
Represents interest expense on securities borrowed.
Average interest-earning assets increased 10% to $60.1 billion and 16% to $60.0 billion for the three and nine months ended September 30, 2018, respectively, compared to the same periods in 2017. The fluctuation in interest-earning assets is generally driven by changes in interest-bearing liabilities, primarily deposits and customer payables. Average interest-bearing liabilities increased 9% to $56.8 billion and 15% to $56.6 billion for the three and nine months ended September 30, 2018, respectively, compared to the same periods in 2017. The increase during the nine months ended September 30, 2018, was primarily due to higher deposits as a result of transferring customer cash held by third parties to our balance sheet throughout 2017 and early 2018, partially offset by customer net buying of $12.0 billion during the nine months ended September 30, 2018, compared to $6.9 billion during the same period in 2017.



E*TRADE Q3 2018 10-Q | Page 18
 
                    

Table of Contents    

Net interest margin increased 25 basis points to 3.10% and 29 basis points to 3.03% for the three and nine months ended September 30, 2018, respectively, compared to the same periods in 2017. Net interest margin is driven by the mix of average asset and liability balances and the interest rates earned or paid on those balances. The increase during the three and nine months ended September 30, 2018, compared to 2017 is due to higher interest rates earned on higher margin receivables and investment securities balances, partially offset by the continued run-off of our higher yielding legacy mortgage and consumer loan portfolio. Additionally, funding costs increased primarily due to increased rates paid on deposits and customer payables during the three and nine months ended September 30, 2018. These increases were partially offset by lower corporate debt service costs during the nine months ended September 30, 2018.
Commissions
Commissions revenue increased 17% to $117 million and 13% to $375 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in 2017. The primary factors that affect commissions revenue are DARTs, average commission per trade and the number of trading days.
DARTs volume increased 29% to 266,290 and 34% to 277,796 for the three and nine months ended September 30, 2018, respectively, compared to the same periods in 2017. The increase during the three and nine months ended September 30, 2018 was mainly driven by continued improved market sentiment along with the higher volatility of the equity markets. Derivative DARTs volume increased 30% to 85,977 and 41% to 90,075 for the three and nine months ended September 30, 2018, respectively, compared to the same periods in 2017.
Average commission per trade decreased 9% to $7.04 and 16% to $7.21 for the three and nine months ended September 30, 2018, respectively, compared to the same periods in 2017. Average commission per trade is impacted by trade mix and differing commission rates on various trade types (e.g. equities, derivatives, stock plan and mutual funds). Average commission per trade for the nine months ended September 30, 2018 was also impacted by reduced commission rates implemented in March 2017 as well as the continued migration of customers to lower active trader commission pricing.
Fees and Service Charges
The following table presents the significant components of fees and service charges (dollars in millions):    
 
Three Months Ended September 30,
 
Variance
 
Nine Months Ended September 30,
 
Variance
 
 
2018 vs. 2017
 
 
2018 vs. 2017
 
2018
 
2017
 
Amount
 
%
 
2018
 
2017
 
Amount
 
%
Order flow revenue
$
40

 
$
33

 
$
7

 
21
 %
 
$
130

 
$
98

 
$
32

 
33
 %
Money market funds and sweep deposits revenue(1)
18

 
23

 
(5
)
 
(22
)%
 
53

 
71

 
(18
)
 
(25
)%
Advisor management and custody fees
19

 
9

 
10

 
111
 %
 
46

 
26

 
20

 
77
 %
Mutual fund service fees
13

 
10

 
3

 
30
 %
 
36

 
29

 
7

 
24
 %
Foreign exchange revenue
7

 
6

 
1

 
17
 %
 
21

 
20

 
1

 
5
 %
Reorganization fees
3

 
5

 
(2
)
 
(40
)%
 
10

 
13

 
(3
)
 
(23
)%
Other fees and service charges
8

 
6

 
2

 
33
 %
 
27

 
19

 
8

 
42
 %
Total fees and service charges
$
108

 
$
92

 
$
16

 
17
 %
 
$
323

 
$
276

 
$
47

 
17
 %
(1)
Includes revenue earned on average customer cash held by third parties based on the federal funds rate or LIBOR plus a negotiated spread or other contractual arrangements with the third party institutions.


E*TRADE Q3 2018 10-Q | Page 19
 
                    

Table of Contents    

Fees and service charges increased 17% for both the three and nine months ended September 30, 2018, to $108 million and $323 million, respectively, compared to the same periods in 2017. These increases were primarily driven by increased order flow revenue due to higher trade volume and improved rates as well as increased advisor management and custody fees as a result of the acquisition of TCA and higher balances held in our managed products. This increase was partially offset by decreased money market funds and sweep deposits revenue driven by lower customer cash balances held by third parties as a result of transferring cash onto our balance sheet. The impact of the lower balances was partially offset by a higher yield of approximately 145 and 140 basis points for the three and nine months ended September 30, 2018, respectively, compared to approximately 120 and 85 basis points for the same periods in 2017.
Gains on Securities and Other, Net
The following table presents the significant components of gains on securities and other, net (dollars in millions):
 
Three Months Ended September 30,
 
Variance
 
Nine Months Ended September 30,
 
Variance
 
 
2018 vs. 2017
 
 
2018 vs. 2017
 
2018
 
2017
 
Amount
 
%
 
2018
 
2017
 
Amount
 
%
Gains on available-for-sale securities, net(1)
11

 
7

 
4

 
57
%
 
33

 
25

 
8

 
32
%
Equity method investment income (loss) and other(2)(3)
6

 
(1
)
 
7

 
*

 
9

 
(2
)
 
11

 
*

Gains on securities and other, net
$
17

 
$
6

 
$
11

 
183
%
 
$
42

 
$
23

 
$
19

 
83
%
*
Percentage not meaningful.
(1)
In August 2018, the Company sold available-for-sale securities and reinvested the sale proceeds in agency-backed securities at current market rates. See Note 6—Available-for-Sale and Held-to-Maturity Securities for additional information.
(2)
Includes a $5 million gain on the sale of our Chicago Stock Exchange investment for the three and nine months ended September 30, 2018.
(3)
Includes a loss of $2 million and $5 million on hedge ineffectiveness for the three and nine months ended September 30, 2017. Beginning January 1, 2018, fair value hedging adjustments are recognized within net interest income. See Note 1—Organization, Basis of Presentation and Summary of Significant Accounting Policies for additional information.
Provision (Benefit) for Loan Losses
We recognized a benefit for loan losses of $34 million and $74 million for the three and nine months ended September 30, 2018, respectively, compared to a benefit of $29 million and $142 million for the same periods in 2017. The timing and magnitude of the provision (benefit) for loan losses is affected by many factors that could result in variability. These benefits reflected better than expected performance of our portfolio as well as recoveries in excess of prior expectations, including sales of charged-off loans and recoveries of previous charge-offs that were not included in our loss estimates. For additional information on management's estimate of the allowance for loan losses, see Note 7—Loans Receivable, Net.


E*TRADE Q3 2018 10-Q | Page 20
 
                    

Table of Contents    

Non-Interest Expense
The following table presents the significant components of non-interest expense (dollars in millions):
 
Three Months Ended September 30,
 
Variance
 
Nine Months Ended September 30,
 
Variance
 
 
2018 vs. 2017
 
 
2018 vs. 2017
 
2018
 
2017
 
Amount
 
%
 
2018
 
2017
 
Amount
 
%
Compensation and benefits
$
157

 
$
139

 
$
18

 
13
 %
 
$
469

 
$
408

 
$
61

 
15
 %
Advertising and market development
45

 
38

 
7

 
18
 %
 
152

 
123

 
29

 
24
 %
Clearing and servicing
28

 
29

 
(1
)
 
(3
)%
 
94

 
94

 

 
 %
Professional services
23

 
25

 
(2
)
 
(8
)%
 
70

 
71

 
(1
)
 
(1
)%
Occupancy and equipment
29

 
28

 
1

 
4
 %
 
89

 
84

 
5

 
6
 %
Communications
30

 
29

 
1

 
3
 %
 
89

 
90

 
(1
)
 
(1
)%
Depreciation and amortization
25

 
20

 
5

 
25
 %
 
70

 
60

 
10

 
17
 %
FDIC insurance premiums
8

 
8

 

 
 %
 
26

 
24

 
2

 
8
 %
Amortization of other intangibles
12

 
9

 
3

 
33
 %
 
34

 
27

 
7

 
26
 %
Restructuring and acquisition-related activities
4

 
4

 

 
 %
 
6

 
12

 
(6
)
 
(50
)%
Losses on early extinguishment of debt
4

 
58

 
(54
)
 
(93
)%
 
4

 
58

 
(54
)
 
(93
)%
Other non-interest expenses
15

 
18

 
(3
)
 
(17
)%
 
56

 
55

 
1

 
2
 %
Total non-interest expense
$
380

 
$
405

 
$
(25
)
 
(6
)%
 
$
1,159

 
$
1,106

 
$
53

 
5
 %
Compensation and Benefits
Compensation and benefits expense increased 13% to $157 million and 15% to $469 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in 2017. The expense increase was primarily driven by a 14% increase in headcount since September 30, 2017 as a result of the TCA acquisition and growth in our business.
Advertising and Market Development
Advertising and market development expense increased 18% to $45 million and 24% to $152 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in 2017. This planned increase was primarily due to higher media and brand production spend resulting from our increased focus on accelerating the growth of our business by increasing engagement across new and existing customers.
Restructuring and Acquisition-Related Activities
Restructuring and acquisition-related activities expenses remained flat at $4 million and decreased 50% to $6 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in 2017. Restructuring and acquisition-related activities during the three and nine months ended September 30, 2018 reflected $4 million and $6 million, respectively, of expenses in connection with the restructuring of our regulatory and enterprise risk management functions due to bank regulatory reform and the closing of the TCA acquisition. The restructuring costs for the three and nine months ended September 30, 2017 primarily related to the integration of OptionsHouse.


E*TRADE Q3 2018 10-Q | Page 21
 
                    

Table of Contents    

Losses on Early Extinguishment of Debt
Losses on early extinguishment of debt were $4 million for both the three and nine months ended September 30, 2018 and $58 million for both the three and nine months ended September 30, 2017.
During the third quarter of 2018, we used the net proceeds from the June 2018 issuance of Senior Notes to redeem all $413 million of our outstanding TRUPs. In connection with the redemption, we recognized a loss on early extinguishment of debt of $4 million.
During the third quarter of 2017, we issued $600 million of 2.95% Senior Notes due 2022 and $400 million of 3.80% Senior Notes due 2027. We used the net proceeds, along with existing corporate cash, to redeem our outstanding $540 million of 5.375% Senior Notes and $460 million of 4.625% Senior Notes, which resulted in a $58 million loss on early extinguishment of debt.
Operating Margin
Operating margin was 52% and 49% for the three and nine months ended September 30, 2018, respectively, compared to 37% and 44% for the same periods in 2017. Adjusted operating margin, a non-GAAP measure, was 48% and 46% for the three and nine months ended September 30, 2018, respectively, compared to 42% and 39% for the same periods in 2017.
Adjusted operating margin is a non-GAAP measure calculated by dividing adjusted income before income tax expense by total net revenue. Adjusted income before income tax expense, a non-GAAP measure, excludes provision (benefit) for loan losses and losses on early extinguishment of debt. The following table presents a reconciliation of adjusted income before income tax expense and adjusted operating margin, non-GAAP measures, to the most directly comparable GAAP measures (dollars in millions):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
 
Amount
 
Operating Margin %
 
Amount
 
Operating Margin %
 
Amount
 
Operating Margin %
 
Amount
 
Operating Margin %
Income before income tax expense / operating margin
$
374

 
52%
 
$
223

 
37%
 
$
1,053

 
49%
 
$
765

 
44%
Add back impact of pre-tax items:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Provision (benefit) for loan losses
(34
)
 
 
 
(29
)
 
 
 
(74
)
 
 
 
(142
)
 
 
Losses on early extinguishment of debt
4

 
 
 
58

 
 
 
4

 
 
 
58

 
 
Subtotal
(30
)
 
 
 
29

 
 
 
(70
)
 
 
 
(84
)
 
 
Adjusted income before income tax expense / adjusted operating margin
$
344

 
48%
 
$
252

 
42%
 
$
983

 
46%
 
$
681

 
39%
Return on Common Equity
Return on common equity was 17% and 16% for the three and nine months ended September 30, 2018, respectively, compared to 9% and 10% for the same periods in 2017. Adjusted return on common equity, a non-GAAP measure, was 16% and 15% for the three and nine months ended September 30, 2018, respectively, compared to 10% and 9% for the same periods in 2017.


E*TRADE Q3 2018 10-Q | Page 22
 
                    

Table of Contents    

Adjusted return on common equity, a non-GAAP measure, is calculated by dividing annualized adjusted net income available to common shareholders by average common shareholders' equity, which excludes preferred stock. Adjusted net income available to common shareholders, a non-GAAP measure, excludes the after-tax impact of provision (benefit) for loan losses and losses on early extinguishment of debt. The following table provides a reconciliation of GAAP net income available to common shareholders and return on common equity percentage to non-GAAP adjusted net income available to common shareholders and adjusted return on common equity percentage (dollars in millions):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
 
Amount
 
Return on Common Equity %
 
Amount
 
Return on Common Equity %
 
Amount
 
Return on Common Equity %
 
Amount
 
Return on Common Equity %
Net income available to common shareholders and return on common equity
$
261

 
17%
 
$
135

 
9%
 
$
746

 
16%
 
$
460

 
10%
Add back impact of the following items:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Provision (benefit) for loan losses
(34
)
 
 
 
(29
)
 
 
 
(74
)
 
 
 
(142
)
 
 
Losses on early extinguishment of debt
4

 
 
 
58

 
 
 
4

 
 
 
58

 
 
Subtotal
(30
)
 
 
 
29

 
 
 
(70
)
 
 
 
(84
)
 
 
Income tax impact
8

 
 
 
(12
)
 
 
 
18

 
 
 
32

 
 
Net of tax
(22
)
 
 
 
17

 
 
 
(52
)
 
 
 
(52
)
 
 
Adjusted net income available to common shareholders and return on common equity
$
239

 
16%
 
$
152

 
10%
 
$
694

 
15%
 
$
408

 
9%
Income Tax Expense
Income tax expense was $89 million and $271 million for the three and nine months ended September 30, 2018, respectively, compared to $76 million and $280 million for the same periods in 2017. The effective tax rate was 24% and 26% for the three and nine months ended September 30, 2018, respectively, compared to 34% and 37% for the same periods in 2017.
The lower effective tax rate for both the three and nine months ended September 30, 2018 includes the impact of federal tax reform, which resulted in a lower federal tax rate beginning January 1, 2018, and an $8 million income tax benefit related to the revaluation of certain net state deferred tax assets.
The effective tax rates for the three and nine months ended September 30, 2017 also included tax benefits related to the revaluation of certain net state deferred tax assets and the adoption of accounting guidance for employee share-based compensation.


E*TRADE Q3 2018 10-Q | Page 23
 
                    

Table of Contents    

BALANCE SHEET OVERVIEW
The following table presents the significant components of the consolidated balance sheet (dollars in millions):
 
 
 
Variance
 
September 30,
 
December 31,
 
2018 vs. 2017
 
2018
 
2017
 
Amount
 
%
Assets:
 
 
 
 
 
 
 
Cash and equivalents
$
596

 
$
931

 
$
(335
)
 
(36
)%
Segregated cash
856

 
872

 
(16
)
 
(2
)%
Investment securities(1)
44,890

 
44,518

 
372

 
1
 %
Margin receivables
11,184

 
9,071

 
2,113

 
23
 %
Loans receivable, net
2,251

 
2,654

 
(403
)
 
(15
)%
Receivables from brokers, dealers and clearing organizations
786

 
1,178

 
(392
)
 
(33
)%
Goodwill and other intangibles, net
2,876

 
2,654

 
222

 
8
 %
Other(2)
1,267


1,487

 
(220
)
 
(15
)%
Total assets
$
64,706

 
$
63,365

 
$
1,341

 
2
 %
Liabilities and shareholders’ equity:
 
 
 
 
 
 
 
Deposits
$
43,074

 
$
42,742

 
$
332

 
1
 %
Customer payables
10,534

 
9,449

 
1,085

 
11
 %
Payables to brokers, dealers and clearing organizations
1,845

 
1,542

 
303

 
20
 %
Other borrowings
550

 
910

 
(360
)
 
(40
)%
Corporate debt
1,408

 
991

 
417

 
42
 %
Other liabilities
529

 
800

 
(271
)
 
(34
)%
Total liabilities
57,940

 
56,434

 
1,506

 
3
 %
Shareholders’ equity
6,766

 
6,931

 
(165
)
 
(2
)%
Total liabilities and shareholders’ equity
$
64,706

 
$
63,365

 
$
1,341

 
2
 %
(1)
Includes balance sheet line items available-for-sale and held-to-maturity securities.
(2)
Includes balance sheet line items property and equipment, net and other assets. Other assets includes deferred tax assets, net due to a presentation change beginning January 1, 2018. See Note 1—Organization, Basis of Presentation and Summary of Significant Accounting Policies for additional information.
Cash and Equivalents
Cash and equivalents decreased 36% to $596 million during the nine months ended September 30, 2018. Cash and equivalents will fluctuate based on a variety of factors, including, among other drivers, liquidity needs at the parent, customer activity at our regulated subsidiaries, and the timing of investments at E*TRADE Bank. For additional information on our use of cash and equivalents, see MD&A—Liquidity and Capital Resources and the consolidated statement of cash flows.


E*TRADE Q3 2018 10-Q | Page 24
 
                    

Table of Contents    

Segregated Cash
Cash required to be segregated under federal or other regulations decreased 2% to $856 million during the nine months ended September 30, 2018. The level of segregated cash is driven largely by customer payables and securities lending balances we hold as liabilities compared with the amount of margin receivables and securities borrowed balances we hold as assets. The excess represents customer cash that we are required by our regulators to segregate for the exclusive benefit of our brokerage customers. At both September 30, 2018 and December 31, 2017, $800 million of reverse repurchase agreements between E*TRADE Securities and E*TRADE Bank, representing investments that were also segregated under federal or other regulations by E*TRADE Securities, were eliminated in consolidation.
Investment Securities
The following table presents the significant components of available-for-sale and held-to-maturity securities (dollars in millions):
 
 
 
Variance
 
September 30,
 
December 31,
 
2018 vs. 2017
 
2018
 
2017
 
Amount
 
%
Available-for-sale securities:
 
 
 
 
 
 
 
Debt securities:
 
 
 
 
 
 
 
Agency mortgage-backed securities
$
21,639

 
$
19,195

 
$
2,444

 
13
 %
Other debt securities
1,225

 
1,477

 
(252
)
 
(17
)%
Total debt securities
22,864

 
20,672

 
2,192

 
11
 %
Publicly traded equity securities(1)

 
7

 
(7
)
 
(100
)%
Total available-for-sale securities
$
22,864

 
$
20,679

 
$
2,185

 
11
 %
Held-to-maturity securities:
 
 
 
 
 
 
 
Agency mortgage-backed securities
$
18,427

 
$
20,502

 
$
(2,075
)
 
(10
)%
Other debt securities
3,599

 
3,337

 
262

 
8
 %
Total held-to-maturity securities
$
22,026

 
$
23,839

 
$
(1,813
)
 
(8
)%
Total investment securities
$
44,890

 
$
44,518

 
$
372

 
1
 %
(1)
Consists of investments in a Community Reinvestment Act (CRA) related mutual fund. At September 30, 2018, these equity securities are included in other assets on the consolidated balance sheet as a result of the adoption of amended accounting guidance related to the classification and measurement of financial instruments. See Note 1—Organization, Basis of Presentation and Summary of Significant Accounting Policies for additional information.
Securities represented 69% and 70% of total assets at September 30, 2018 and December 31, 2017, respectively. We classify debt securities as available-for-sale or held-to-maturity based on our investment strategy and management’s assessment of our intent and ability to hold the debt securities until maturity.
During the three months ended March 31, 2018 securities with a carrying value of $4.7 billion and related unrealized pre-tax gain of $7 million were transferred from held-to-maturity securities to available-for-sale securities as part of a one-time transition election for early adopting the new derivatives and hedge accounting guidance. Securities with a fair value of $1.2 billion were transferred from available-for-sale to held-to-maturity pursuant to an evaluation of our investment strategy and an assessment by management about our intent and ability to hold those particular securities until maturity.
See Note 1—Organization, Basis of Presentation and Summary of Significant Accounting Policies, Note 6—Available-for-Sale and Held-to-Maturity Securities and Note 12—Shareholders' Equity for additional information.


E*TRADE Q3 2018 10-Q | Page 25
 
                    

Table of Contents    

Margin Receivables
Margin receivables increased 23% to $11.2 billion during the nine months ended September 30, 2018. We believe recent market appreciation of customer assets provided additional capacity which, coupled with market sentiment, drove the increase in margin receivables.
Loans Receivable, Net
The following table presents the significant components of loans receivable, net (dollars in millions):
 
 
 
Variance
 
September 30,
 
December 31,
 
2018 vs. 2017
 
2018
 
2017
 
Amount
 
%
One- to four-family
$
1,150

 
$
1,432

 
$
(282
)
 
(20
)%
Home equity
890

 
1,097

 
(207
)
 
(19
)%
Consumer and other(1)
244

 
188

 
56

 
30
 %
Total loans receivable
2,284

 
2,717

 
(433
)
 
(16
)%
Unamortized premiums, net
8

 
11

 
(3
)
 
(27
)%
Subtotal
2,292

 
2,728

 
(436
)
 
(16
)%
Less: Allowance for loan losses
41

 
74

 
(33
)
 
(45
)%
Total loans receivable, net
$
2,251

 
$
2,654

 
$
(403
)
 
(15
)%
(1)
In 2017 we introduced E*TRADE Line of Credit, a securities-based lending product, where customers can borrow against the market value of their securities pledged as collateral. The drawn amount and unused credit line amount totaled $113 million and $168 million, respectively, as of September 30, 2018 and $12 million and $35 million, respectively, as of December 31, 2017.
Loans receivable, net decreased 15% to $2.3 billion during the nine months ended September 30, 2018. We expect the remaining legacy mortgage and consumer loan portfolio to continue its run-off for the foreseeable future. As our portfolio has seasoned and substantially all interest-only loans have converted to amortizing, we continue to assess underlying performance, the economic environment, and the value of the portfolio in the marketplace. While it is our intention to hold these loans, if the markets improve or our assessment changes, our strategy could change. For additional information on management's estimate of the allowance for loan losses, see Note 7—Loans Receivable, Net.


E*TRADE Q3 2018 10-Q | Page 26
 
                    

Table of Contents    

Receivables from and Payables to Brokers, Dealers and Clearing Organizations
The following table presents the significant components of receivables from and payables to brokers, dealers and clearing organizations (dollars in millions):
 
 
 
Variance
 
September 30,
 
December 31,
 
2018 vs. 2017
 
2018
 
2017
 
Amount
 
%
Receivables:
 
 
 
 
 
 
 
Securities borrowed
$
321

 
$
740

 
$
(419
)
 
(57
)%
Receivables from clearing organizations
405

 
376

 
29

 
8
 %
Other
60

 
62

 
(2
)
 
(3
)%
Total
$
786

 
$
1,178

 
$
(392
)
 
(33
)%
 
 
 
 
 
 
 


Payables:
 
 
 
 
 
 


Securities loaned
$
1,794

 
$
1,373

 
$
421

 
31
 %
Payables to clearing organizations
14

 
123

 
(109
)
 
(89
)%
Other
37

 
46

 
(9
)
 
(20
)%
Total
$
1,845

 
$
1,542

 
$
303

 
20
 %
Securities borrowed decreased 57% to $321 million during the nine months ended September 30, 2018. The decrease was driven by a lower demand for securities to cover customer short positions during the period.
Securities loaned increased 31% to $1.8 billion during the nine months ended September 30, 2018. The increase was driven by funding requirements at E*TRADE Securities, primarily to fund increased margin lending activity. For additional information on E*TRADE Securities liquidity, see MD&A—Liquidity and Capital Resources.
Goodwill and Other Intangibles, Net
Goodwill and other intangibles, net increased 8% to $2.9 billion during the nine months ended September 30, 2018. The increase was driven by the addition of goodwill and other intangibles in connection with the TCA acquisition. See Note 2—Business Acquisition for additional information.
Deposits
The following table presents the significant components of deposits (dollars in millions):
 
 
 
Variance
 
September 30,
 
December 31,
 
2018 vs. 2017
 
2018
 
2017
 
Amount
 
%
Sweep deposits
$
37,998

 
$
37,734

 
$
264

 
1
 %
Savings deposits
3,145

 
2,912

 
233

 
8
 %
Other deposits
1,931

 
2,096

 
(165
)
 
(8
)%
Total deposits
$
43,074

 
$
42,742

 
$
332

 
1
 %
Deposits represented 74% and 76% of total liabilities at September 30, 2018 and December 31, 2017, respectively.


E*TRADE Q3 2018 10-Q | Page 27
 
                    

Table of Contents    

Brokerage Related Cash
The majority of the deposits balance, specifically sweep deposits, is included in brokerage related cash, which is reported as a customer activity metric. The following table presents the significant components of total brokerage related cash (dollars in millions):
 
 
 
Variance
 
September 30,
 
December 31,
 
2018 vs. 2017
 
2018
 
2017
 
Amount
 
%
Brokerage customer cash held on balance sheet:
 
 
 
 
 
 
 
Sweep deposits
$
37,998

 
$
37,734

 
$
264

 
1
 %
Customer payables
10,534

 
9,449

 
1,085

 
11
 %
Subtotal
48,532


47,183

 
1,349

 
3
 %
Customer cash held by third parties(1):
 
 
 
 


 


Sweep deposits
3,007

 
4,724

 
(1,717
)
 
(36
)%
Money market funds and other
1,761

 
1,016

 
745

 
73
 %
Subtotal
4,768

 
5,740

 
(972
)
 
(17
)%
Total brokerage related cash
$
53,300