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Stock Analyst Update

E-Trade Reports Good Quarter; Morgan Stanley Deal Nears

We don’t anticipate making a material change to our fair value estimate for the narrow-moat firm and assess shares as moderately undervalued.

E-Trade reported fairly good first-quarter results as it moves closer to a likely merger with Morgan Stanley. E-Trade reported net income to common shareholders of $161 million, or $0.72 per diluted share, on $707 million of net revenue. Net revenue decreased 6% from the previous year and increased 4% sequentially. The decrease in revenue from the previous year was primarily from a combination of $92 million of lower net interest income and $51 million lower commissions offset by an $85 million increase in fees and service charges. Similar to many financial service firms, E-Trade is feeling the effect of the decrease in the federal-funds rate over the past year on net interest income and has yet to lap the cut in online brokerage commission rates that occurred in the fourth quarter of 2019. The increase in fees is from E-Trade moving client cash to third parties where it earns a fee and higher payments for order flow from heightened trading volume. The sequential increase in revenue is from higher commissions and fee revenue. Earnings per share would have been $0.10 higher if not for merger-related expenses, provisions for credit losses, and a technology asset impairment. We don’t anticipate making a material change to our fair value estimate for narrow-moat E-Trade and assess shares as moderately undervalued. We also believe that E-Trade’s merger with Morgan Stanley is likely to be completed later in 2020.

The first quarter had some significant positives, but the decrease in short- and long-term interest rates will have a more material, negative effect in future quarters. Similar to other investment service firms, E-Trade had a spike in trading volumes, record client asset inflows, and higher client cash balances. However, the federal-funds rate was cut 150 basis points in March to a range of 0% to 0.25% and the 10-year U.S. treasury yield has recently been around 0.6% compared with near 1.9% at the beginning of the year.

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