E*TRADE Financial 15 Corporation - 2011 Amit J. Shah and Michael L. Monahan Frostburg State University ETFC www.etrade.com Headquartered in New York City, E TRADE Financial Corp. is an online brokerage firm that allows individuals to trade equities, update personal investment portfolios, and obtain market infor- mation around the clock. E*TRADE receives a commission on each trade and receives interest on :. the short positions of their clients. The firm has over 4.3 million account holders who have invested $189 billion in customer assets. Clients can trade stocks in person, by phone, or increasingly via the Internet. The company serves international clients worldwide and is positioning itself to be much more than a brokerage firm. Slowly but surely, E*TRADE is becoming a complete financial sup- port and execution portal for individuals by offering a variety of banking and brokerage services. E*TRADE's first-quarter 2011 net income. was. 515 million, reflecting a strong brokerage business, decrease in provision for loan losses, and improved expense management. For that quarter, the company's total net revenue increased 3.6 percent to $536.7 million but was flat year over year. E*TRADE's total daily average revenue trades (DARTs) for the reported quarter was 177,000, surging 18 percent. Net new brokerage assets reported were $3.9 billion in the quarter, up from $2.4 billion in the prior quarter and $2.2 billion in the prior-year quarter. At the end of the quarter, E*TRADE reported 4.3 million customer accounts, which included a record 2.7 million brokerage accounts. Net new brokerage accounts increased to 51,000 from 28,000 in the prior quarter and 2,000 in the prior-year quarter. As the stock markets dropped more than 1,500 points on August 8-11, 2011, E*TRADE's business nearly doubled. E*TRADE spokeswoman Susan Hickey reported that her company experienced a 42 percent increase in user log-ins on some of those days, compared to an average lay during the prior month. Moreover, mobile traffic (including iPad users) hit an all-time high, more than doubling the July average: Hickey aslo reported major increases in inbound phone calls. "People are very engaged right now with what's happening in the market," Hickey said. History Founded as a service bureau in 1982 by Bill Porter, a physicist and inventor, the early E*TRADE provided online quote and trading services to Fidelity, Charles Schwab, and Quick & Reilly. Seeing the opportunity to capitalize on a potentially huge discount brokerage market, Bill was among the first to envision allowing individuals to use personal computers to invest, paying far less than the traditional brokerage fees. It would take several years for the world to catch up with Bill's vision. In 1992, E*TRADE Securities, Inc. was born and began to offer online investing services through America Online and CompuServe. With the launch of www.etrade.com in 1996, the demand for E*TRADE's services exploded. *TRADE went public in August 1996 and completed another stock offering one year later when Bill handed the reins over to Christos Cotsakos, Under Christos's leadership, E*TRADE became a global leader in online personal financial services with branded websites around the world. The company introduced E*TRADE Bank in 2000 with the purchase of Telebanc Financial (now E*TRADE Financial), an online bank with more than 100,000 depositors. E*TRADE also bought Card Capture Services (now *TRADE Access), an operator of more than 9,000 ATMs across the United States. Continuing to expand its global reach, E*TRADE -acquired Canadian firm VERSUS Technologies, a provider of electronic trading services, and teamed up with UBS Warburg to allow non-U.S. investors to buy U.S. securities without needing150 AMIT J. SHAH AND MICHAEL L. MONAHAN to trade in dollars. Later, its E*TRADE International Capital announced plans to offer an initial public offering (IPO) to European investors. In 2001, E*TRADE entered consumer lending when it acquired online mortgage originator LoansDirect (now E*TRADE Mortgage). E*TRADE sold substantially all of its assets and liabilities of E*TRADE Access in 2004. In an attempt to further its dominance in the financial industry in 2005, E*TRADE acquired Harris Direct, formerly a discount brokerage service of Bank of Montreal, and BrownCo, formerly a discount brokerage service of J.P. Morgan. In 2006, Retirement Advisors of America, Inc. (RAA), a Dallas, Texas-based investment advisory company was acquired. RAA manages more than $1 billion in assets. E*TRADE acquired the start-up social finance company Cake Financial in 2010. Vision/Mission E*TRADE's vision statement is: "to empower self-directed investors to make informed invest- ment decisions and take control of their financial future with anytime, anywhere access to the world's major investment markets." *TRADE's mission statement is: "to create long term shareholder value through superior financial performance driven by the delivery of a diversified range of innovative, customer- focused financial products and services and supported by an operating culture based on the highest levels of teamwork, efficiency and integrity." Source: E*TRADE Financial Corp. The Economy Despite the best effort of companies in the electronic investment services industry to reduce cyclicality, their business is closely tied to the economy, corporate earnings, technology, and . the stock market. During 2011, stock prices are rising, the value of the dollar is falling, unem- ployment remains high, business profits are high, oil prices remain high, the value of gold is at all-time highs, and emerging economies are presenting millions of new customers every day for interested firms. During the first week of August 201 1, the stock market, fell over 1,009 points. Volatility, turbulence, and uncertainty plague the market and investors. The national deficit rose to $ 1.5 trillion in 2011, the largest deficit in the nation's history. The U.S. real gross domestic product (GDP) growth is about 2 percent for 2011, down from 2.9 percent in 2010, and the national unemployment rate is about 9 percent. The U.S. housing market continues to struggle with thousands of new foreclosures and short sells becoming avail- able monthly, as home prices continue to slide lower. In an effort to help the economy, the Federal Reserve in December 2008 lowered the Federal Funds rate to between 0 percent and 0.25 percent. This was the lowest range ever and was maintained through June 2011. Standard & Poor's economists predict the federal funds rate will increase once there is a consistent decrease in the country's unemployment rate. As a result, firms in the financial industry benefitted from these low interest rates. Through January 2011, the S&P Composite Stock Index rose 88 percent since its March 2009 low. Lower interest rates usually equate to higher stock prices. However, for the first time in the history of the United States, S & P in August 2011 downgraded the country's credit rating from AAA to AA. New regulations have been instituted for the financial industry to help prevent an economic disaster. The 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act and the Credit Card Accountability, Responsibility, and Disclosure (CARD) Act of 2009 offer consumers stricter protections from unfair practices as well as increased issuer accountability. E*TRADE faces extensive banking and securities rules and regulations. At the end of February 2010, ap- proximately 7,677 mutual funds were in the United States with approximately $11 trillion in assets under management, an increase of nearly 15 percent from December 2008. Competitors E*TRADE continues to diversify and expand its services beyond online domestic retail broker- age offerings to include banking, global cross-border trading, mutual fund offerings, market- making, consumer lending, institutional investing, financial advice, and insurance. The nature and number of competitors in these varied market places is increasing. E*TRADE faces direct competition from full commission brokerage firms, discount brokerage firms, online brokerageCASE 15 . E*TRADE FINANCIAL CORPORATION - 2011 151 firms, pure-play Internet banks, traditional "brick & mortar" commercial banks, and savings banks. These competitors provide touch-tone telephone, voice response, online banking services, electronic bill payment services, and a host of other financial products. In addition, E*TRADE competes with mutual fund companies, which provide money market funds and cash manage- ment.accounts. E*TRADE's main competitors are Fidelity Investments, Charles Schwab (SCHW), and TD Ameritrade (AMTD). Fidelity Investments is a group of privately held companies that is currently the largest broker in the industry with $5.2 billion in revenue. Schwab is the second largest broker in the industry with revenues totaling $4.5 billion at year-end 2010. TD Ameritrade has approxi- mately $2.6 billion in revenues. E*TRADE ranked fourth with $2.4 billion in revenues. Exhibit 1 presents selected financial information on E*TRADE's key competitors. TD Ameritrade Based in Omaha,. Nebraska, TD Ameritrade provides online brokerage services, an Internet- based personal financial management service, touch-tone telephone and market data, and research tools. Ameritrade's services are very similar to those of E*TRADE. In 2010, Ameritrade reported revenues of $2.6 billion. For the company's second fiscal quarter of 2011, Ameritrade's daily average revenue trades (DARTs) increased by 16 percent over the same quarter last year to 439,158, which is an in- crease of 18 percent over the previous quarter. TD Ameritrade also saw its total client assets increase 21 percent to a record $413 billion. Ameritrade maintained its quarterly dividend of 5 cents per share. College baseball's top sluggers competed in the second annual TD Ameritrade College Home Run Derby, hosted at the new TD Ameritrade Park in Omaha on July 2, 2011. Immediately . . . . . . EXHIBIT 1 Financial Comparison E*TRADE Charles Schwab TD Ameritrade $ Revenue 2.44 B 4.51 B 2.58 1 $ Market Capitalization 3.98 B 22.32 B 12.47 B % 5 Year Annual EPS Growth 67.49238 -7.12813 4.20881 Valuation Stock Price/Earnings -123.08 45.03 18.62 . . Stock Price/ 3.58 25.2 14.33 Stock Price/Sales 1.39 4.53 4.36 Per Share Data Last Dividend 0 42.11 9.52 $ Book Value 18.51 5.32 6.95 S EPS 0.32 0.58 1.05 Profitability S EBIDTA 281.13 M 1. 12 B 1.12 B 9% Operating Margin 1.67% 34.35% 35.69% % Profit Margin -1.17% 10.07% 22.96% Dividend % Dividend Yield 0.00% 1.30% 0.46% Payout Ratio 42.11 9.52 To Dividend Yield 5 Year 0.00% 1.07% 6.86% Average Growth $ Net Income -28.47 M 454.00 M 592.18 M $ EPS 0.32% 0.58% 1.05% Source: http://www.dailyfinance.com/company/c-trade-financial-corporation/etfcas/top-competitors.152 AMIT J. SHAH AND MICHAEL L. MONAHAN following the College Home Run Derby, the 27th annual Omaha World-Herald fireworks display took place in the stadium. Internal Issues Organizational Structure Donald Layton was appointed CEO of E*TRADE in 2008. Following Mr. Layton as CEO was Robert Druskin in 2009. Then Steven Freiberg became CEO of E*TRADE in 2010. Obviously E*TRADE is having difficulties finding sustainable leadership in top management. The company has been losing money annually and needs a clear strategic plan from somebody. In attempts to cut costs and streamline the organization as a whole, E*TRADE has reduced the number of people needed to maintain the firm. Currently the company has about 3,000 employ- ees. Exhibit 2 shows E*TRADE's organization chart. Note the CEO is Steven J. Freiberg. Note this is a divisional-by-product structure. Significant segments of the company include E*TRADE Bank, E*TRADE Capital Markets, E*TRADE Clearing, and E*TRADE Securities. E*TRADE offers, either alone or with its part- ners, branded retail websites in the United States, Canada, Denmark, Finland, France, Germany, Hong Kong, Iceland, Italy, Sweden, the UAE, and the United Kingdom. E*TRADE has also licensed its name to companies that operate in Australia, Japan, and Korea. E*TRADE's primary retail products and services consist of 1) investing and trading, 2) banking, and 3) lending. In the company Form 10K (p. 44, 2010), E*TRADE reveals that it is transitioning to a two division company: We report our operating results in two segments: 1) trading and investing, and 2) balance sheet management. Trading and investing includes retail brokerage products and services, investor-focused banking products, market making, and corporate services. Balance sheet management includes the management of asset allocation and credit, liquidity and interest rate risk, loans previously originated or purchased from third parties, and customer cash and deposits. Finance E*TRADE's total net revenue decreased from $2.2 billion in 2009 to $2, 1 billion in 2010 due to a 16 percent decrease in operating interest revenue amounting to $286 million. In fact, this revenue source decreased $923 million, or 37 percent, since 2008. The firm lost $1.3 billion in 2009, largely due to the loss on early extinguishment of debt. In 2010, the loss amounted to only $28 million. Exhibit 3 and Exhibit 4 present E*TRADE's consolidated financial statements. Exhibit 5 provides E*TRADE's financials by segment. EXHIBIT 2 Organizational Chart Steven J. Freiberg Chief Executive Officer Michael J. Curcio Paul Brandow Matthew J. Audette Gregory A. Framke Executive Executive Executive Nicholas A. Utton Peter Knitzer Executive . Vice President Exccutive Executive Vice President Vice President Vice President : i and Vice President Vice President President of. go and and . E*TRADE Chief Financial Chief Information and . and .. Chief Risk Chief Marketing President of Securities : : Officer Officer . and : Operations Officer Office E'TRADE Bank Source: Developed based on information from E*Trade.com.CASE 15 . E*TRADE FINANCIAL CORPORATION - 2011 153 EXHIBIT 3 Income Statement (in thousands) Year ending Dec. 31, 2010 2009 2008 Revenue Operating interest income $1,546,713 $1,832,558 $2,469,940 Operating interest expense (320,430) (571,956) (1,201,934) Net operating interest income 1,226,283. 1,260,602 1,268,006 Commissions 431,000 547,993. 515,551 Fees and service charges 42,377 192,516 199,956 Principal transactions 103,346 88,053 84,882 Gains (losses) on loans and securities, net 166,212 169,106 (100,473) Other-than-temporary impairment ("OTTI") (41,510) (232,139) (95,010) Less: noncredit portion of OTTI recognized into :. other comprehensive income (loss) (before tax) 3,840 143,044 Net impairment (37,670) (89,095) (95,010) Other revenues 46,327 47,841 52,684 Total noninterest income 851,592 956,414 657,590 Total net revenue $2,077,875 $2,217,016 $1,925,596 Provision for loan losses 779,412 1,498,1 12 1,583,666 Operating expense Compensation and benefits 325,044 366,232 383,385 Clearing and servicing 147,493 170,71 185,082 Advertising and market development 132, 150 1 14,399 175,250 Professional services $1, 177 78,718 94,070 FDIC insurance premiums 77,728 94,258 31,258 Communications 73,342 84,381 96,792 Occupancy and equipment 70,915 78,360 85,766 Depreciation and amortization 87,931 83,337 82,483 Amortization of other intangibles 28,475 29,737 35,746 Facility restructuring and other exit activities 14,346 20,652 29,502 Other operating expenses 103,976 122,544 90,881 Total operating expense 1,142,577 1,243,329 1,290,215 Income (loss) before other income (expense), income 155,886 (524,425) (948,285) tax expense (benefit) and discontinued operations Other income (expense) Corporate interest income 6,188 860 7,210 Corporate interest expense (167,130) 282,688) (362,160) Gains (losses) on sales of investments, net 2,655 (1,714) (4,230) Gains posses) on early extinguishment of debt (1,018,848) 10,084 Equity in income (loss) of investments (740) (8,616) 18,462 and venture funds Total other income (expense) (159,027) (1,31 1,006) (330,634) Loss before income tax expense (benefit) (3,141) (1,835,431) (1,278,919) and discontinued operations Income tax expense (benefit) 25,331 (537,669) (469,535) (continued)154 AMIT J. SHAH AND MICHAEL L. MONAHAN EXHIBIT 3 continued Year ending Dec. 31, 2010 2009 2008 Loss from continuing operations (28,472) (1,297,762) 809,384) Income from discontinued operations, net of tax 297,594 Net loss $(28,472) $(1,297,762) $(51 1,790) Basic loss per share from continuing operations (0.13) (11.85) (15.88) Basic earnings per share from discontinued operations 5.84 Basic net loss per share (0.13) (11.85) (10.04) Shares used in computation of per share data Basic 211,302 109,544 50,986 Source: 2010 10K Report .EXHIBIT 4 Balance Sheet (in thousands, except share amounts) For year ending Dec. 31, . . . . . . 2010 2009 ASSETS Cash and equivalents $2,374,346 $3,483,238 Cash and investments required to be segregated under federal 609,510 1,545,280- or other regulations Trading securities 52,173 38,303 Available-for-sale securities (includes securities pledged 14,805,677 13,319,712 o creditors with the right to sell or repledge of $5,621,156 and $7,298,631 at December 31, 2010, and 2009, respectively) Held-to-maturity securities (fair value of $2,422,335 and 2,462,710 includes securities pledged to creditors with the right to self or repledge of $884,214 at December 31, 2010) Margin receivables 5,120,575 3,827,212 Loans, net (net of. allowance for loan losses of $1,031, 169 15,127,390 19,174,933 and $1,182,738 at December 31, 2010, and 2009, . respectively) Investment in FHLB stock 164,381 183,863 Property and equipment, net 302,658 320,169 Goodwill 1,939,976 1,952,326 Other intangibles, net 325,403 356,404 Other assets 3,078,202 3,165,045 TOTAL ASSETS $46,373,001 $47,366,485 LIABILITIES AND SHAREHOLDERS' EQUITY Liabilities Deposits 25,240,297 . 25,597,721 Securities sold under agreements to repurchase 5,888,249 6,441,875 Customer payables 5,020,086 5,234,199 FHLB advances and other borrowings 2,731,714 2,746,959 Corporate debt 2,145,881 2,458,691 Other liabilities 1,294,329 1,137,485 . TOTAL LIABILITIES $42,320,556 $43,616,930CASE 15 . E*TRADE FINANCIAL CORPORATION - 2011 155 For year ending Dec. 31, 2010 2009 Shareholders' equity Common stock, $0.01 par value, shares authorized 2,208 1,894 400,000,000 at December 31, 2010, and 4,000,000,000 at December 31, 2009; shares issued and outstanding 220,840,821 at December 31, 2010, and 189,397,099 at December 31, 2009 Additional paid-in-capital ("APIC") 6,640,715 6,275,157 Accumulated deficit (2,151,838) (2, 123,366) Accumulated other comprehensive loss (438,640) (404,130) TOTAL SHAREHOLDERS' EQUITY $ 4,052,445 $ 3,749,555 TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 46,373,001 $ 47,366,485 Source: 2010 10K R :. EXHIBIT 5 E*TRADE Financials By-Segment Variance Year Ended December 31 2010 vs 2009 2010 2009 2008 Amoun Net operating interest income $763.0 $699.6 $800.3 $63.4 9% . Commissions 431.0 548.0 514.7 (117.0) 21)% Fees and se 139.1 185.6 191.6 (46.5) (25)% Principal transactions 103.4 88.1 $4.8 15.3 17% Other revenues 37.9 35.5 38.5 2.4 7% Total net revenue 1,474.4 . 1,556.8 1,629.9 (82.4) (5)% Total operating expense 752.6 796.6 926.6 (44.0) (6)% Trading and investing segment income $721.8 $760.2 $703.3 $ (38.4) (5)% Key Metrics DART's 150,532 179,183 169,075 (28,651) (16)% Average commission per trade $11.21 $11.33 $10.98 $(0.12) (1)% Margin receivables (dollars in billions) $ 5.1 $3.7 $2.7 $1.4 38% End of period brokerage accounts 2,684,311 2,630,079 2,515,806 54,232 2% Net new brokerage accounts 54,232 114,273 142,541 (60,041) Customer assets (dollars in billions) $176.2 $150.5 $110.1 $25.7 7% Net new brokerage assets (dollars in billions) $8.1 $7.2 $3.9 $ 0.9 Brokerage related cash (dollars in billions) $24.5 $20.4 $15.8 $ 4.1 20 % Source: E* TRADE'S 2010 Form 10K, p.44. Marketing E*TRADE increased its advertising and marketing development expenditures by over 15 percent in 2010 to $132.2 million as compared to $114.4 million in 2009. E*TRADE returned to advertis- ing during the Super Bowl in 2008. Since then, its Super Bowl ads have featured a talking baby, which has been a hit with TV viewers. In-2011, the company launched its "Investing Unleashed" advertising and marketing campaign, which utilizes traditional advertising mediums as well as social media channels. . E*TRADE uses co-branding to market its services at a discounted price. For example, RTR ADR and Hilton HHonore Worldwide have a marketing relationchin that provides Hilton156 AMIT J. SHAH AND MICHAEL L. MONAHAN HHonors members with HHonors bonus points when they open an account with E*TRADE. The agreement offers HHonors members the opportunity to earn 5,000 HHonors points when they open a new E*TRADE account, and enables E"TRADE to reach a large and highly attrac- tive group of consumers with an expressed allegiance to one of the world's leading frequent- traveler programs. Future In February 2011, Citadel dropped its share of E TRADE's stock to about 20 percent. Then in May 2011, Citadel sold off another 27.5 million shares of E*TRADE's stock to own about 9.5 percent of E*TRADE. Does Citadel Equity Fund know something that most people do not? It is interesting that Citadel's Ken Griffin is on E*TRADE's board. The stock market "crashed" the first ten days of August 2011. . .. . . . . . . . :. .. o