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EX-31.2 - EXHIBIT 31.2 - E TRADE FINANCIAL CORPetfc-20180630xex312.htm
EX-32.1 - EXHIBIT 32.1 - E TRADE FINANCIAL CORPetfc-20180630ex321.htm
EX-31.1 - EXHIBIT 31.1 - E TRADE FINANCIAL CORPetfc-20180630xex311.htm

    
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 June 30, 2018
Commission File Number 1-11921

Eetradeasteriska02.jpgTRADE 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 August 2, 2018, there were 259,675,020 shares of common stock outstanding.




E*TRADE FINANCIAL CORPORATION
FORM 10-Q QUARTERLY REPORT
For the Quarter Ended June 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 Q2 2018 10-Q | Page i
 
                    


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 by E*TRADE, 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 Q2 2018 10-Q | Page ii
 
                    


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 and expected balance sheet size,
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, payment of dividends on our preferred 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,
the potential decline of fees and service charges,
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 condition,
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,
our ability to move capital to our parent company from our subsidiaries,


E*TRADE Q2 2018 10-Q | Page 1
 
                    


adverse developments in litigation,
our ability to manage our balance sheet growth, and
the timing, duration and costs associated with our stock repurchase program.
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 Q2 2018 10-Q | Page 2
 
                    


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 online 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) through Trust Company of America (TCA).
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 Q2 2018 10-Q | Page 3
 
                    


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:
web.jpg
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
 
mob.jpg
Mobile
Powerful trading applications for smartphones, tablets and watches
 
• Award-winning mobile apps
• Platforms to manage accounts on the move
• Stock and portfolio alerts
 
 
actvtrd.jpg
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 Q2 2018 10-Q | Page 4
 
                    


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 excess capital, including through our share repurchase program 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, Apple Pay, 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 (ADRs) 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 lending 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 Q2 2018 10-Q | Page 5
 
                    


Corporate Services
The Company provides stock plan administration services for both public and private companies. Through our industry-leading platform, Equity Edge Online, 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 approximately 1.7 million individual stock plan accounts. Our corporate clients represent approximately 20% of S&P 500 companies and over 50% of publicly traded U.S. technology companies.
Advisor Services
As a result of 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.
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 Q2 2018 10-Q | Page 6
 
                    


Significant Events in the Second Quarter of 2018
Completed Trust Company of America acquisition
On April 9, 2018, we completed the acquisition of TCA for a cash purchase price of $275 million. The acquisition is expected to benefit the Company as the RIA portion of our industry is growing and the Company expects to leverage the E*TRADE brand to accelerate growth. For additional information, see Note 2—Business Acquisition.
Issued $420 million of Senior Notes to redeem Trust Preferred Securities
In June 2018, we issued $420 million of 4.50% Senior Notes due 2028 (Senior Notes) with the intention of using the net proceeds from the sale of the Senior Notes to redeem trust preferred securities (TRUPs) issued by ETB Holdings, Inc. (ETB Holdings), the parent company of E*TRADE Bank. We substantially completed the redemption of TRUPs in July 2018 and expect to redeem the remaining outstanding TRUPs during the third quarter of 2018. For additional information, see Note 16—Subsequent Event.
Repurchased 3.0 million shares of our common stock
We continued to execute on our share repurchase program, under which the Board of Directors has authorized the repurchase of up to $1 billion of shares of our common stock. During the second quarter of 2018, the Company repurchased 3.0 million shares of common stock at an average price of $62.51, for a total of $188 million. As of June 30, 2018, we have repurchased 14.2 million shares of common stock at an average price of $48.64, for a total of $690 million since we began repurchasing shares under this authorization in the third quarter of 2017. As of August 2, 2018, we have subsequently repurchased an additional 2.3 million shares of common stock at an average price of $60.80.


E*TRADE Q2 2018 10-Q | Page 7
 
                    


Key Performance Metrics
Management monitors a number of 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 June 30, 2018 from the same period in 2017. These metrics include the impact of the TCA acquisition as of and for the quarter ended June 30, 2018, as applicable.

chart-9041cdef450e0460172.jpg chart-056f1d24dee252d3b3f.jpg
chart-01ef86251d6d5c17ae6.jpg chart-6f926eb2c517580a83f.jpg
 
Excluding the impact of the TCA acquisition,
adjusted derivative DARTs represented 34%
of total DARTs.
 
      


E*TRADE Q2 2018 10-Q | Page 8
 
                    


chart-ff98ffb0dff953f49f0.jpg chart-7756e67a2b2b5900a19.jpg
 
Excluding the impact of the TCA acquisition, net new brokerage accounts were 40,002.
Excluding the impact of the TCA acquisition, the adjusted annualized net new brokerage account growth rate was 4.3%.

chart-e953b03bd5b250c79af.jpg chart-9d39801498b6568b960.jpg
chart-3e5ca8b4b2d7542192f.jpg chart-454bddfbd17c57b28fa.jpg



E*TRADE Q2 2018 10-Q | Page 9
 
                    


chart-5031b8c350ada207923.jpg chart-e27baed50dfc55a7b44.jpg
 
Excluding the impact of the TCA acquisition, net new brokerage assets were $2.5 billion.
Excluding the impact of the TCA acquisition, the adjusted annualized net new brokerage asset growth rate was 2.8%.

chart-8bdf597e2d0b502da18.jpg
Daily Average Revenue Trades (DARTs) is the predominant driver of commissions revenue from our customers. DARTs were 258,844 and 283,549 for the three and six months ended June 30, 2018, respectively, compared to 208,205 and 207,717 for the same periods in 2017. DARTs for the three and six months ended June 30, 2018 include 2,850 and 1,459, respectively, as a result of the TCA acquisition.
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 86,848 and 92,123 for the three and six months ended June 30, 2018, respectively, compared to 66,350 and 62,743 for the same periods in 2017. Derivative DARTs represented 34% and 32% of total DARTs for the three and six months ended June 30, 2018, respectively, compared to 32% and 30% for the same periods in 2017. Excluding the impact of the TCA acquisition on total DARTs, the adjusted derivative DARTs represented 34% and 32% of total DARTs, for the three and six months ended June 30, 2018, respectively.


E*TRADE Q2 2018 10-Q | Page 10
 
                    


Average commission per trade is an indicator of changes in our customer mix, product mix and/or product pricing. Average commission per trade was $7.31 and $7.29 for the three and six months ended June 30, 2018, respectively, compared to $8.02 and $8.93 for the same periods in 2017. Average commission per trade for the three and six months ended June 30, 2018 was impacted by 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 June 30, 2018 and 2017, respectively. Net new brokerage accounts were 187,642 and 247,327 for the three and six months ended June 30, 2018, respectively, compared to 41,271 and 99,486 for the same periods in 2017. Our annualized net new brokerage account growth rate was 20.3% and 13.6% for the three and six months ended June 30, 2018, respectively, compared to 4.7% and 5.7% for the same periods in 2017. Net new and end of period brokerage accounts for the three and six months ended June 30, 2018 include 147,640 accounts as a result of the TCA acquisition. Excluding the impact of this item, the adjusted annualized net new brokerage account growth rate was 4.3% and 5.5% for the three and six months ended June 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 $11.0 billion and $8.2 billion at June 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 $440.7 billion and $348.2 billion at June 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 $52.8 billion and $51.7 billion at June 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 $21.1 billion and $26.4 billion for the three and six months ended June 30, 2018, respectively, compared to $2.6 billion and $6.8 billion for the same periods in 2017. During the three and six months ended June 30, 2018, our annualized net new brokerage asset growth rate was 24.2% and 15.5%, respectively, compared to 3.5% and 4.9% for the same periods in 2017. Net new brokerage assets for the three and six months ended June 30, 2018 includes $18.6 billion as a result of the TCA acquisition. Excluding the impact of this item, the adjusted annualized net new brokerage asset growth rate was 2.8% and 4.6% for the three and six months ended June 30, 2018, respectively.
Managed products represents customer assets in our Core Portfolio, Blend Portfolio, Dedicated Portfolio and Fixed Income Portfolios. Managed products are a driver of fees and service charges revenue. Managed products were $5.8 billion and $4.6 billion at June 30, 2018 and 2017, respectively.


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Corporate Metrics:
chart-44a78ce650d750369d4.jpg chart-3e96655f0c5058fc814.jpg

chart-7336e5280a4a52feaeb.jpg chart-a611db3d0bb4581395e.jpg

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E*TRADE Q2 2018 10-Q | Page 12
 
                    


chart-3352c85c58db5d7eacd.jpg
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 49% and 48% for the three and six months ended June 30, 2018, respectively, compared to 55% and 48% 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 which is not viewed as a key factor governing our investment in the business and is excluded by management when evaluating operating margin performance. Adjusted operating margin was 46% and 45% for the three and six months ended June 30, 2018, respectively, compared to 38% for both periods in 2017. See MD&A—Earnings Overview for a reconciliation of adjusted operating margin to operating margin.
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 $532 million and $1.1 billion at June 30, 2018 and 2017, respectively, while corporate cash was $943 million and $478 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 7.5% at June 30, 2018 and 2017, respectively. E*TRADE Bank's Tier 1 leverage ratio was 7.2% and 8.0% at June 30, 2018 and 2017, respectively. See MD&A—Liquidity and Capital Resources for additional information, including the calculation of regulatory capital ratios.
Interest-earning assets, along with net interest margin, is an indicator of our ability to generate net interest income. Average interest-earning assets were $60.0 billion and $59.9 billion for the three and six months ended June 30, 2018, respectively, compared to $51.9 billion and $50.3 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 3.02% and 3.00% for the three and six months ended June 30, 2018, respectively, compared to 2.74% and 2.68% for the same periods in 2017.
Total employees were 4,095 and 3,614 at June 30, 2018 and 2017, respectively.


E*TRADE Q2 2018 10-Q | Page 13
 
                    


Regulatory Developments
In April 2016, the US Department of Labor (DOL) published its final Conflicts of Interest Rule- Retirement 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&A - Liquidity and Capital Resources for further information.


E*TRADE Q2 2018 10-Q | Page 14
 
                    


EARNINGS OVERVIEW
We generated net income of $250 million and $497 million on total net revenue of $710 million and $1.4 billion for the three and six months ended June 30, 2018, respectively. The following chart presents a reconciliation of net income for the three months ended June 30, 2017 to net income for the three months ended June 30, 2018 (dollars in millions):
chart-4a93852b9d915b1ca28.jpg
(1)
Includes clearing and servicing, professional services, occupancy and equipment, depreciation and amortization, FDIC insurance premiums, amortization of other intangibles, restructuring and acquisition-related activities and other non-interest expenses.




E*TRADE Q2 2018 10-Q | Page 15
 
                    


The following table presents significant components of the consolidated statement of income (dollars in millions except per share amounts):
 
Three Months Ended June 30,
 
Variance
 
Six Months Ended June 30,
 
Variance
 
 
2018 vs. 2017
 
 
2018 vs. 2017
 
2018
 
2017
 
Amount
 
%
 
2018
 
2017
 
Amount
 
%
Net interest income
$
453

 
$
356

 
$
97

 
27
 %
 
$
898

 
$
675

 
$
223

 
33
 %
Total non-interest income
257

 
221

 
36

 
16
 %
 
520

 
455

 
65

 
14
 %
Total net revenue
710

 
577

 
133

 
23
 %
 
1,418

 
1,130

 
288

 
25
 %
Provision (benefit) for loan losses
(19
)
 
(99
)
 
80

 
(81
)%
 
(40
)
 
(113
)
 
73

 
(65
)%
Total non-interest expense
384

 
359

 
25

 
7
 %
 
779

 
701

 
78

 
11
 %
Income before income tax expense
345

 
317

 
28

 
9
 %
 
679

 
542

 
137

 
25
 %
Income tax expense
95

 
124

 
(29
)
 
(23
)%
 
182

 
204

 
(22
)
 
(11
)%
Net income
$
250

 
$
193

 
$
57

 
30
 %
 
$
497

 
$
338

 
$
159

 
47
 %
Preferred stock dividends

 

 

 
 %
 
12

 
13

 
(1
)
 
(8
)%
Net income available to common shareholders
$
250

 
$
193

 
$
57

 
30
 %
 
$
485

 
$
325

 
$
160

 
49
 %
Diluted earnings per common share
$
0.95

 
$
0.70

 
$
0.25

 
36
 %
 
$
1.82

 
$
1.17

 
$
0.65


56
 %
Net income increased 30% to $250 million and 47% to $497 million for the three and six months ended June 30, 2018, respectively, compared to the same periods in 2017. Net income available to common shareholders was $250 million and $485 million for the three and six months ended June 30, 2018, respectively, which reflects $12 million in preferred stock dividends in the first quarter of 2018, compared to $193 million and $325 million for the three and six months ended, June 30, 2017, which reflects $13 million in preferred stock dividends in the first quarter of 2017.
The increase in net income for both periods was primarily driven by higher interest income due to a larger average balance sheet and an improvement in net interest margin, as well as higher commissions and fees and service charges. 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. A lower effective tax rate resulting from federal tax reform also added to the increase in net income in 2018.
Net Revenue
The following table presents the significant components of net revenue (dollars in millions):
 
Three Months Ended June 30,
 
Variance
 
Six Months Ended June 30,
 
Variance
 
 
2018 vs. 2017
 
 
2018 vs. 2017
 
2018
 
2017
 
Amount
 
%
 
2018
 
2017
 
Amount
 
%
Net interest income
$
453

 
$
356

 
$
97

 
27
%
 
$
898

 
$
675

 
$
223

 
33
%
Commissions
121

 
105

 
16

 
15
%
 
258

 
232

 
26

 
11
%
Fees and service charges
110

 
98

 
12

 
12
%
 
215

 
184

 
31

 
17
%
Gains on securities and other, net
15

 
7

 
8

 
114
%
 
25

 
17

 
8

 
47
%
Other revenue
11

 
11

 

 
%
 
22

 
22

 

 
%
Total non-interest income
257

 
221

 
36

 
16
%
 
520

 
455

 
65

 
14
%
Total net revenue
$
710

 
$
577

 
$
133

 
23
%
 
$
1,418

 
$
1,130

 
$
288

 
25
%


E*TRADE Q2 2018 10-Q | Page 16
 
                    


Net Interest Income
Net interest income increased 27% to $453 million and 33% to $898 million for the three and six months ended June 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 June 30,
 
2018
 
2017
 
Average Balance
 
Interest Inc./Exp.
 
Average Yield/
Cost
 
Average Balance
 
Interest Inc./Exp.
 
Average Yield/
Cost
Cash and equivalents
$
533

 
$
2

 
1.66
%
 
$
890

 
$
2

 
0.87
%
Cash required to be segregated under federal or other regulations
753

 
4

 
1.95
%
 
1,355

 
3

 
0.94
%
Investment securities(1)
44,973

 
303

 
2.69
%
 
37,922

 
232

 
2.45
%
Margin receivables
10,291

 
118

 
4.60
%
 
7,258

 
75

 
4.14
%
Loans(2)
2,468

 
33

 
5.32
%
 
3,332

 
41

 
4.88
%
Broker-related receivables and other
949

 
4

 
1.74
%
 
1,142

 
1

 
0.20
%
Subtotal interest-earning assets
59,967

 
464

 
3.10
%
 
51,899

 
354

 
2.73
%
Other interest revenue(3)

 
25

 
 
 

 
24

 
 
    Total interest-earning assets
59,967

 
489

 
3.26
%
 
51,899

 
378

 
2.91
%
Total non-interest-earning assets
4,364

 
 
 
 
 
4,951

 
 
 
 
Total assets
$
64,331

 
 
 
 
 
$
56,850

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Deposits
$
43,006

 
$
8

 
0.07
%
 
$
37,894

 
$
1

 
0.01
%
Customer payables
9,533

 
4

 
0.16
%
 
8,686

 
2

 
0.06
%
Broker-related payables and other
2,207

 
3

 
0.65
%
 
1,237

 

 
0.00
%
Other borrowings
829

 
8

 
3.77
%
 
674

 
5

 
3.18
%
Corporate debt
1,042

 
10

 
3.68
%
 
991

 
13

 
5.41
%
Subtotal interest-bearing liabilities
56,617

 
33

 
0.23
%
 
49,482

 
21

 
0.17
%
Other interest expense(4)

 
3

 
 
 

 
1

 
 
    Total interest-bearing liabilities
56,617

 
36

 
0.25
%
 
49,482

 
22

 
0.18
%
Total non-interest-bearing liabilities
633

 
 
 
 
 
884

 
 
 
 
Total liabilities
57,250

 
 
 
 
 
50,366

 
 
 
 
Total shareholders' equity
7,081

 
 
 
 
 
6,484

 
 
 
 
Total liabilities and shareholders' equity
$
64,331

 
 
 
 
 
$
56,850

 
 
 
 
Excess interest earning assets over interest bearing liabilities/net interest income/net interest margin
$
3,350

 
$
453

 
3.02
%
 
$
2,417

 
$
356

 
2.74
%
(1)
For the three months ended June 30, 2018, includes $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 Q2 2018 10-Q | Page 17
 
                    


 
Six Months Ended June 30,
 
2018
 
2017
 
Average Balance
 
Interest Inc./Exp.
 
Average Yield/
Cost
 
Average Balance
 
Interest Inc./Exp.
 
Average Yield/
Cost
Cash and equivalents
$
668

 
$
5

 
1.52
%
 
$
1,116

 
$
4

 
0.73
%
Cash required to be segregated under federal or other regulations
774

 
7

 
1.78
%
 
1,519

 
6

 
0.81
%
Investment securities(1)
45,083

 
593

 
2.63
%
 
36,030

 
437

 
2.43
%
Margin receivables
9,881

 
221

 
4.51
%
 
7,021

 
141

 
4.04
%
Loans(2)
2,548

 
66

 
5.19
%
 
3,469

 
84

 
4.82
%
Broker-related receivables and other
949

 
8

 
1.65
%
 
1,131

 
1

 
0.16
%
Subtotal interest-earning assets
59,903

 
900

 
3.01
%
 
50,286

 
673

 
2.68
%
Other interest revenue(3)

 
57

 
 
 

 
46

 
 
    Total interest-earning assets
59,903

 
957

 
3.20
%
 
50,286

 
719

 
2.87
%
Total non-interest-earning assets
4,574

 
 
 
 
 
5,100

 
 
 
 
Total assets
$
64,477

 
 
 
 
 
$
55,386

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Deposits
$
43,092

 
$
10

 
0.04
%
 
$
36,390

 
$
2

 
0.01
%
Customer payables
9,544

 
5

 
0.11
%
 
8,686

 
3

 
0.06
%
Broker-related payables and other
1,889

 
4

 
0.47
%
 
1,199

 

 
0.00
%
Other borrowings
880

 
15

 
3.42
%
 
584

 
10

 
3.46
%
Corporate debt
1,017

 
19

 
3.65
%
 
992

 
27

 
5.40
%
Subtotal interest-bearing liabilities
56,422

 
53

 
0.19
%
 
47,851

 
42

 
0.17
%
Other interest expense(4)

 
6

 
 
 

 
2

 
 
    Total interest-bearing liabilities
56,422

 
59

 
0.21
%
 
47,851

 
44

 
0.18
%
Total non-interest-bearing liabilities
979

 
 
 
 
 
1,142

 
 
 
 
Total liabilities
57,401

 
 
 
 
 
48,993

 
 
 
 
Total shareholders' equity
7,076

 
 
 
 
 
6,393

 
 
 
 
Total liabilities and shareholders' equity
$
64,477

 
 
 
 
 
$
55,386

 
 
 
 
Excess interest earning assets over interest bearing liabilities/net interest income/net interest margin
$
3,481

 
$
898

 
3.00
%
 
$
2,435

 
$
675

 
2.68
%
(1)
For the six months ended June 30, 2018, includes an $8 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 16% to $60.0 billion and 19% to $59.9 billion for the three and six months ended June 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 14% to $56.6 billion and 18% to $56.4 billion for the three and six months ended June 30, 2018, respectively, compared to the same periods in 2017. The increase during both periods 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 during the current period.


E*TRADE Q2 2018 10-Q | Page 18
 
                    


Net interest margin increased 28 basis points to 3.02% and 32 basis points to 3.00% for the three and six months ended June 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 six months ended June 30, 2018, compared to 2017 is due to higher interest rates earned on higher margin receivables and investment securities balances and increased securities lending activities, 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 customer deposits, partially offset by lower corporate debt service costs.
Commissions
Commissions revenue increased 15% to $121 million and 11% to $258 million for the three and six months ended June 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 24% to 258,844 and 37% to 283,549 for the three and six months ended June 30, 2018, respectively, compared to the same periods in 2017. The increase during the three and six months ended June 30, 2018 was mainly driven by continued improved market sentiment along with the higher volatility of the equity markets. Derivative DARTs volume increased 31% to 86,848 and 47% to 92,123 for the three and six months ended June 30, 2018, respectively, compared to the same periods in 2017. Derivative DARTs represented 34% and 32% of total DARTs for the three and six months ended June 30, 2018, respectively, compared to 32% and 30% of trading volume for the same periods in 2017.
Average commission per trade decreased 9% to $7.31 and 18% to $7.29 for the three and six months ended June 30, 2018, respectively, compared to the same periods in 2017. Average commission per trade is impacted by customer mix and differing commission rates on various trade types (e.g. equities, derivatives, stock plan and mutual funds). Average commission per trade for the six months ended June 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.


E*TRADE Q2 2018 10-Q | Page 19
 
                    


Fees and Service Charges
The following table presents the significant components of fees and service charges (dollars in millions):    
 
Three Months Ended June 30,
 
Variance
 
Six Months Ended June 30,
 
Variance
 
 
2018 vs. 2017
 
 
2018 vs. 2017
 
2018
 
2017
 
Amount
 
%
 
2018
 
2017
 
Amount
 
%
Order flow revenue
$
43

 
$
34

 
$
9

 
26
 %
 
$
90

 
$
65

 
$
25

 
38
 %
Money market funds and sweep deposits revenue(1)
18

 
26

 
(8
)
 
(31
)%
 
35

 
48

 
(13
)
 
(27
)%
Advisor management and custody fees
16

 
9

 
7

 
78
 %
 
27

 
17

 
10

 
59
 %
Mutual fund service fees
12

 
10

 
2

 
20
 %
 
23

 
19

 
4

 
21
 %
Foreign exchange revenue
6

 
6

 

 
 %
 
14

 
14

 

 
 %
Reorganization fees
4

 
5

 
(1
)
 
(20
)%
 
7

 
8

 
(1
)
 
(13
)%
Other fees and service charges
11

 
8

 
3

 
38
 %
 
19

 
13

 
6

 
46
 %
Total fees and service charges
$
110

 
$
98

 
$
12

 
12
 %
 
$
215

 
$
184

 
$
31

 
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.
Fees and service charges increased 12% to $110 million and 17% to $215 million for the three and six months ended June 30, 2018, respectively, compared to the same periods in 2017 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 for the three and six months ended June 30, 2018. 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 gross yield of approximately 140 and 135 basis points for the three and six months ended June 30, 2018, respectively, compared to approximately 90 and 70 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 June 30,
 
Variance
 
Six Months Ended June 30,
 
Variance
 
 
2018 vs. 2017
 
 
2018 vs. 2017
 
2018
 
2017
 
Amount
 
%
 
2018
 
2017
 
Amount
 
%
Gains on available-for-sale securities
$
11

 
$
10

 
$
1

 
10
 %
 
$
22

 
$
18

 
$
4

 
22
 %
Equity method investment income (loss) and other(1)(2)
4

 
(3
)
 
7

 
(233
)%
 
3

 
(1
)
 
4

 
(400
)%
Gains on securities and other, net
$
15

 
$
7

 
$
8

 
114
 %
 
$
25

 
$
17

 
$
8

 
47
 %
(1)
Includes $4 million in gains on Community Reinvestment Act (CRA) equity investments for the three months ended June 30, 2018.
(2)
Includes a loss of $2 million and $3 million on hedge ineffectiveness for the three and six months ended June 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.


E*TRADE Q2 2018 10-Q | Page 20
 
                    


Provision (Benefit) for Loan Losses
We recognized a benefit for loan losses of $19 million and $40 million for the three and six months ended June 30, 2018, respectively, compared to a benefit of $99 million and $113 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 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.
Non-Interest Expense
The following table presents the significant components of non-interest expense (dollars in millions):
 
Three Months Ended June 30,
 
Variance
 
Six Months Ended June 30,
 
Variance
 
 
2018 vs. 2017
 
 
2018 vs. 2017
 
2018
 
2017
 
Amount
 
%
 
2018
 
2017
 
Amount
 
%
Compensation and benefits
$
160

 
$
133

 
$
27

 
20
 %
 
$
312

 
$
269

 
$
43

 
16
 %
Advertising and market development
47

 
42

 
5

 
12
 %
 
107

 
85

 
22

 
26
 %
Clearing and servicing
30

 
33

 
(3
)
 
(9
)%
 
66

 
65

 
1

 
2
 %
Professional services
25

 
24

 
1

 
4
 %
 
47

 
46

 
1

 
2
 %
Occupancy and equipment
30

 
29

 
1

 
3
 %
 
60

 
56

 
4

 
7
 %
Communications
28

 
36

 
(8
)
 
(22
)%
 
59

 
61

 
(2
)
 
(3
)%
Depreciation and amortization
23

 
20

 
3

 
15
 %
 
45

 
40

 
5

 
13
 %
FDIC insurance premiums
9

 
8

 
1

 
13
 %
 
18

 
16

 
2

 
13
 %
Amortization of other intangibles
12

 
9

 
3

 
33
 %
 
22

 
18

 
4

 
22
 %
Restructuring and acquisition-related activities
2

 
4

 
(2
)
 
(50
)%
 
2

 
8

 
(6
)
 
(75
)%
Other non-interest expenses
18

 
21

 
(3
)
 
(14
)%
 
41

 
37

 
4

 
11
 %
Total non-interest expense
$
384

 
$
359

 
$
25

 
7
 %
 
$
779

 
$
701

 
$
78

 
11
 %
Compensation and Benefits
Compensation and benefits expense increased 20% to $160 million and 16% to $312 million for the three and six months ended June 30, 2018, respectively, compared to the same periods in 2017. The expense increase was primarily driven by a 9% and 13% increase in headcount as a result of the TCA acquisition and growth in our business as well as higher benefits and incentive compensation.
Advertising and Market Development
Advertising and market development expense increased 12% to $47 million and 26% to $107 million for the three and six months ended June 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.


E*TRADE Q2 2018 10-Q | Page 21
 
                    


Communications
Communications expense decreased 22% to $28 million and 3% to $59 million for the three and six months ended June 30, 2018, respectively, compared to the same periods in 2017. The decrease in the second quarter of 2018 was primarily driven by decreased market data fees as compared to the same period in 2017 when we updated our accrual estimate and recognized $9 million related to previous usage.
Restructuring and Acquisition-Related Activities
Restructuring and acquisition-related activities expenses decreased 50% and 75% to $2 million for the three and six months ended June 30, 2018, respectively, compared to the same periods in 2017. Restructuring and acquisition-related activities during the three and six months ended June 30, 2018 reflected $2 million of acquisition-related expenses in connection with the closing of the TCA acquisition. The restructuring costs for the three and six months ended June 30, 2017 primarily related to the integration of OptionsHouse.
Operating Margin
Operating margin was 49% and 48% for the three and six months ended June 30, 2018, respectively, compared to 55% and 48% for the same periods in 2017. Adjusted operating margin, a non-GAAP measure, was 46% and 45% for the three and six months ended June 30, 2018, respectively, compared to 38% for both 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. 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 June 30,
 
Six Months Ended June 30,
 
2018
 
2017
 
2018
 
2017
 
Amount
 
Operating Margin %
 
Amount
 
Operating Margin %
 
Amount
 
Operating Margin %
 
Amount
 
Operating Margin %
Income before income tax expense / operating margin
$
345

 
49%
 
$
317

 
55%
 
$
679

 
48%
 
$
542

 
48%
Provision (benefit) for loan losses
(19
)
 
 
 
(99
)
 
 
 
(40
)
 
 
 
(113
)
 
 
Adjusted income before income tax expense / adjusted operating margin
$
326

 
46%
 
$
218

 
38%
 
$
639

 
45%
 
$
429

 
38%
Income Tax Expense
Income tax expense was $95 million and $182 million for the three and six months ended June 30, 2018, respectively, compared to $124 million and $204 million for the same periods in 2017. The effective tax rate was 27% for both the three and six months ended June 30, 2018, respectively, compared to 39% and 38% for the same periods in 2017. The lower effective tax rate for both the three and six months ended June 30, 2018 includes the impact of federal tax reform, which resulted in a lower federal tax rate beginning January 1, 2018.


E*TRADE Q2 2018 10-Q | Page 22
 
                    


BALANCE SHEET OVERVIEW
The following table presents the significant components of the consolidated balance sheet (dollars in millions):
 
 
 
Variance
 
June 30,
 
December 31,
 
2018 vs. 2017
 
2018
 
2017
 
Amount
 
%
Assets:
 
 
 
 
 
 
 
Cash and equivalents
$
532

 
$
931

 
$
(399
)
 
(43
)%
Segregated cash
620

 
872

 
(252
)
 
(29
)%
Investment securities(1)
45,009

 
44,518

 
491

 
1
 %
Margin receivables
10,955

 
9,071

 
1,884

 
21
 %
Loans receivable, net
2,375

 
2,654

 
(279
)
 
(11
)%
Receivables from brokers, dealers and clearing organizations
626

 
1,178

 
(552
)
 
(47
)%
Goodwill and other intangibles, net
2,888

 
2,654

 
234

 
9
 %
Other(2)
1,348


1,487

 
(139
)
 
(9
)%
Total assets
$
64,353

 
$
63,365

 
$
988

 
2
 %
Liabilities and shareholders’ equity:
 
 
 
 
 
 
 
Deposits
$
42,664

 
$
42,742

 
$
(78
)
 
 %
Customer payables
9,959

 
9,449

 
510

 
5
 %
Payables to brokers, dealers and clearing organizations
1,666

 
1,542

 
124

 
8
 %
Other borrowings
1,259

 
910

 
349

 
38
 %
Corporate debt
1,408

 
991

 
417

 
42
 %
Other liabilities
494

 
800

 
(306
)
 
(38
)%
Total liabilities
57,450

 
56,434

 
1,016

 
2
 %
Shareholders’ equity
6,903

 
6,931

 
(28
)
 
 %
Total liabilities and shareholders’ equity
$
64,353

 
$
63,365

 
$
988

 
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 43% to $532 million during the six months ended June 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 Q2 2018 10-Q | Page 23
 
                    


Segregated Cash
Cash required to be segregated under federal or other regulations decreased 29% to $620 million during the six months ended June 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 June 30, 2018 and December 31, 2017, $525 million and $800 million, respectively, 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
 
June 30,
 
December 31,
 
2018 vs. 2017
 
2018
 
2017
 
Amount
 
%
Available-for-sale securities:
 
 
 
 
 
 
 
Debt securities:
 
 
 
 
 
 
 
Agency mortgage-backed securities
$
22,314

 
$
19,195

 
$
3,119

 
16
 %
Other debt securities
1,496

 
1,477

 
19

 
1
 %
Total debt securities
23,810

 
20,672

 
3,138

 
15
 %
Publicly traded equity securities(1)

 
7

 
(7
)
 
(100
)%
Total available-for-sale securities
$
23,810

 
$
20,679

 
$
3,131

 
15
 %
Held-to-maturity securities:
 
 
 
 
 
 
 
Agency mortgage-backed securities
$
17,752

 
$
20,502

 
$
(2,750
)
 
(13
)%
Other debt securities
3,447

 
3,337

 
110

 
3
 %
Total held-to-maturity securities
$
21,199

 
$
23,839

 
$
(2,640
)
 
(11
)%
Total investment securities
$
45,009

 
$
44,518

 
$
491

 
1
 %
(1)
Consists of investments in a CRA-related mutual fund. At June 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 70% of total assets at both June 30, 2018 and December 31, 2017. 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. The following portfolio transfers occurred 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 during the three months ended March 31, 2018, 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 during the three months ended March 31, 2018 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.


E*TRADE Q2 2018 10-Q | Page 24
 
                    


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.
Margin Receivables
Margin receivables increased 21% to $11.0 billion during the six months ended June 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
 
June 30,
 
December 31,
 
2018 vs. 2017
 
2018
 
2017
 
Amount
 
%
One- to four-family
$
1,245

 
$
1,432

 
$
(187
)
 
(13
)%
Home equity
956

 
1,097

 
(141
)
 
(13
)%
Consumer and other(1)
219

 
188

 
31

 
16
 %
Total loans receivable
2,420

 
2,717

 
(297
)
 
(11
)%
Unamortized premiums, net
9

 
11

 
(2
)
 
(18
)%
Subtotal
2,429

 
2,728

 
(299
)
 
(11
)%
Less: Allowance for loan losses
54

 
74

 
(20
)
 
(27
)%
Total loans receivable, net
$
2,375

 
$
2,654

 
$
(279
)
 
(11
)%
(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 $75 million and $132 million, respectively, as of June 30, 2018 and $12 million and $35 million, respectively, as of December 31, 2017.
Loans receivable, net decreased 11% to $2.4 billion during the six months ended June 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 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 Q2 2018 10-Q | Page 25
 
                    


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
 
June 30,
 
December 31,
 
2018 vs. 2017
 
2018
 
2017
 
Amount
 
%
Receivables:
 
 
 
 
 
 
 
Securities borrowed
$
156

 
$
740

 
$
(584
)
 
(79
)%
Receivables from clearing organizations
417

 
376

 
41

 
11
 %
Other
53

 
62

 
(9
)
 
(15
)%
Total
$
626

 
$
1,178

 
$
(552
)
 
(47
)%
 
 
 
 
 
 
 
 
Payables:
 
 
 
 
 
 
 
Securities loaned
$
1,630

 
$
1,373

 
$
257

 
19
 %
Payables to clearing organizations
6

 
123

 
(117
)
 
(95
)%
Other
30

 
46

 
(16
)
 
(35
)%
Total
$
1,666

 
$
1,542

 
$
124

 
8
 %
Securities borrowed decreased 79% to $156 million during the six months ended June 30, 2018. The decrease was driven by a lower demand for securities to cover customer short positions during the period.
Securities loaned increased 19% to $1.6 billion during the six months ended June 30, 2018. The increase was driven by funding requirements at E*TRADE Securities, primarily to support 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 9% to $2.9 billion during the six months ended June 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
 
June 30,
 
December 31,
 
2018 vs. 2017
 
2018
 
2017
 
Amount
 
%
Sweep deposits
$
37,794

 
$
37,734

 
$
60

 
 %
Savings deposits
2,859

 
2,912

 
(53
)
 
(2
)%
Other deposits
2,011

 
2,096

 
(85
)
 
(4
)%
Total deposits
$
42,664

 
$
42,742

 
$
(78
)
 
 %
Deposits represented 74% and 76% of total liabilities at June 30, 2018 and December 31, 2017, respectively.


E*TRADE Q2 2018 10-Q | Page 26
 
                    


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
 
June 30,
 
December 31,
 
2018 vs. 2017
 
2018
 
2017
 
Amount
 
%
Brokerage customer cash held on balance sheet:
 
 
 
 
 
 
 
Sweep deposits
$
37,794

 
$
37,734

 
$
60

 
 %
Customer payables
9,959

 
9,449

 
510

 
5
 %
Subtotal
47,753


47,183

 
570

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


 


Sweep deposits
3,505

 
4,724

 
(1,219
)
 
(26
)%
Money market funds and other
1,552

 
1,016

 
536

 
53
 %
Subtotal
5,057

 
5,740

 
(683
)
 
(12
)%
Total brokerage related cash
$
52,810

 
$
52,923

 
$
(113
)
 
 %
 
(1)
Customer cash held by third parties is maintained at unaffiliated financial institutions. Customer cash held by third parties is not reflected on our consolidated balance sheet and is not immediately available for liquidity purposes.
We offer the following sweep deposit account programs to our brokerage customers:
Extended insurance sweep deposit account (ESDA) program
E*TRADE Cash Account Program offered by E*TRADE Savings Bank for uninvested cash held in eligible custodial accounts as part of the Advisor Services offering launched in connection with the TCA acquisition
Retirement sweep deposit account (RSDA) program for retirement plan customers launched in the second quarter of 2018
The programs utilize our bank subsidiaries, in combination with additional third party program banks, to allow customers the ability to have aggregate deposits they hold in the programs insured up to $500,000 or $1,250,000 for each category of legal ownership depending on the program. As of June 30, 2018, 99% of sweep deposits were in these programs. Sweep deposits on balance sheet are held at bank subsidiaries and are included in the deposits line item on our consolidated balance sheet.
Other Borrowings
Other borrowings are summarized as follows (dollars in millions):
 
 
 
Variance
 
June 30,
 
December 31,
 
2018 vs. 2017
 
2018
 
2017
 
Amount
 
%
FHLB advances
$
850

 
$
500

 
$
350

 
70
 %
Trust preferred securities
409

 
410

 
(1
)
 
 %
Total other borrowings
$
1,259

 
$
910

 
$
349

 
38
 %
Other borrowings increased 38% to $1.3 billion during the six months ended June 30, 2018, as we utilized more Federal Home Loan Bank (FHLB) advances for short-term liquidity and funding requirements. See MD&A—Liquidity and Capital Resources for additional information on liquidity and funding sources.


E*TRADE Q2 2018 10-Q | Page 27
 
                    


Corporate Debt
Corporate debt increased 42% to $1.4 billion during the six months ended June 30, 2018, as we issued the Senior Notes with the intention of using the net proceeds from the issuance of the Senior Notes to redeem our TRUPs. We substantially completed the redemption of TRUPs in July 2018 and expect to redeem the remaining outstanding TRUPs during the third quarter of 2018. See Note 11—Corporate Debt, Note 15—Commitments, Contingencies and Other Regulatory Matters and Note 16—Subsequent Event.
LIQUIDITY AND CAPITAL RESOURCES
We have established liquidity and capital policies to support the successful execution of our business strategy, while maintaining ongoing and sufficient liquidity through the business cycle. We believe liquidity is of critical importance to the Company and especially important for E*TRADE Bank and E*TRADE Securities. The objective of our policies is to ensure that we can meet our corporate, banking and broker-dealer liquidity needs under both normal operating conditions and under periods of stress in the financial markets.
Liquidity
Our liquidity needs are primarily driven by capital needs at E*TRADE Bank and E*TRADE Securities as well as by the interest due on our corporate debt and the amount of dividend payments on our preferred stock. Our banking and brokerage subsidiaries' liquidity needs are driven primarily by the level and volatility of our customer activity. Management maintains a set of liquidity sources and monitors certain business trends and market metrics closely in an effort to ensure we have sufficient liquidity. Potential loans by E*TRADE Bank to the parent company and the parent company's other non-bank subsidiaries are subject to various quantitative, arm’s length, collateralization, capital and other requirements. The Company expects to use existing cash during the fourth quarter of 2018 to fund the acquisition of approximately one million retail brokerage accounts from Capital One.
The Company became subject to the modified LCR requirement beginning April 1, 2018 which required the Company to hold at least 70% of its projected net cash outflows over a 30-day period in high-quality liquid assets. At June 30, 2018 the Company was in compliance with the minimum modified LCR requirement. In July 2018, the Federal Reserve Board clarified that, pursuant to EGRRCPA, certain regulatory and reporting requirements, including the modified LCR would no longer apply to firms, like the Company, with less than $100 billion in total consolidated assets.
Parent Company Liquidity
The parent company's primary source of liquidity is corporate cash. Corporate cash, a non-GAAP measure, is a component of cash and equivalents; see the consolidated statement of cash flows for information on cash and equivalents activity. We define corporate cash as cash held at the parent company and subsidiaries, excluding bank, broker-dealer, and FCM subsidiaries that require regulatory approval or notification prior to the payment of certain dividends to the parent company.
We believe corporate cash is a useful measure of the parent company’s liquidity as it is the primary source of capital above and beyond the capital deployed in our regulated subsidiaries. Corporate cash can fluctuate in any given quarter and is impacted primarily by the following:
Dividends from and investments in subsidiaries
Non-cumulative preferred stock dividends
Share repurchases


E*TRADE Q2 2018 10-Q | Page 28
 
                    


Debt activity, including issuances, paydowns and debt service costs
Acquisitions and other investments
Reimbursements from subsidiaries for the use of the parent company's deferred tax assets
Parent company overhead less reimbursements through cost sharing arrangements with subsidiaries
The following chart provides a roll forward of corporate cash at December 31, 2017 to corporate cash at June 30, 2018 (dollars in millions):
chart-a9d48d0c32b959deadea04.jpg
The following table presents a reconciliation of consolidated cash and equivalents to corporate cash, a non-GAAP measure (dollars in millions):
 
June 30,
 
December 31,
 
June 30,
 
2018
 
2017
 
2017
Consolidated cash and equivalents
$
532

 
$
931

 
$
1,091

Less: Cash at regulated subsidiaries
(527
)
 
(659
)