Can Charles Schwab learn from E-Trade's flubs?

The thirst for profits has Schwab focused on increasing deposits at its bank.

By Jamie Dlugosch Jan 28, 2010 3:20PM

There's nothing worse than watching good businesses go bad. One lapse in judgment can destroy shareholder value and years of brand equity.


The market can be quite ruthless.


For example, one pioneer in the online brokerage business, E-Trade Financial (ETFC), aggressively grew its banking business during the real-estate boom at the start of the millennium that nearly crippled the company. Yet it looks like Charles Schwab is contemplating the same move.


Take a lesson here, Chuck.


Shares of E-Trade are a mere shell of their former selves -- under $2, from a peak above $26 -- as a result of loan losses and bad assets on its bank balance sheet. This despite the fact that its brokerage business is firing on all cylinders. (Here are 10 Top Stocks for do-it-yourself investors.)


Yesterday the firm posted a narrower quarterly loss as it continued to work its way through a lending morass and easily meeting analyst expectations. Trading volumes in the fourth quarter were lower due to the timing of the holiday.


ETFC saw record trading volumes in 2009 despite the drop in the fourth quarter, and it expects 2010 to be similarly strong.


None of this matters, given the destruction of value from bad loans. Book value collapsed as a result, leaving the company in a liquidity crunch. Looking forward, most expect E-Trade Financial to be acquired by another firm.


All of this then is interesting background for E-Trade competitor Charles Schwab (SCHW).


In the wake of its own earnings report, which showed a 47% drop in quarterly profits, Schwab announced a share offering the proceeds of which would be used to support balance sheet growth and expansion of its deposit base.


Essentially the common stock sale is an effort to grow its banking business. Did the company learn nothing by watching the missteps of its competitor, E-Trade’s?


To be fair, Schwab’s move has more to do with dwindling fees from money market activities than an aggressive move into risky loans, but deposits require lending, and can a discount broker execute a lending strategy without getting itself in trouble?


It is a fair question.


Schwab has been branching out away from its core brokerage business for sometime. In fact, its thirst for fee income appears to dwarf interest in trading commissions, and it is that thirst that may very well have unintended consequences.


Looking forward, I much prefer ETFC to Schwab. ETFC is focused on repairing its balance sheet with growth. Schwab is doing the same with dilution.


Not a good strategy, if you ask me.


(I like these 10 companies with excellent strategies.)


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