(Adds CEO quotes, payment for order flow data and details throughout)
By Jed Horowitz and Neha Dimri
April 23 (Reuters) - E*Trade Financial Corp reported a higher-than-expected quarterly profit on Wednesday, helped by a surge in customer trading activity and progress in reducing its bank subsidiary's portfolio of bad loans.
Net income at the discount brokerage company nearly tripled to $97 million, or 33 cents per share, in the first quarter, from $35 million, or 12 cents per share, a year earlier.
That handily beat analysts' average forecast of 23 cents per share, according to Thomson Reuters I/B/E/S.
The company's net revenue rose 13 percent to $475 million, also beating analysts' average estimate of $454.6 million.
E*Trade, which was on the brink of failure during the financial crisis due to its bank's subprime mortgage portfolio, set aside $4 million to cover loan losses, well below a $43 million provision in the first quarter of 2013. That was partly because it sold $800 million of troubled residential loans at a profit during the quarter, reducing its loan portfolio to $7.4 billion.
E*Trade said re-engagement of individual investors in the firm's core business of trading stocks and options after years of caution played a big part in its quarterly gains.
"Customers were overwhelmingly bullish," Paul Idzik, the company's chief executive officer, told analysts on a conference call. Favorable economic conditions and few alternative investment choices brought client activity to "levels not seen in years," he said.
He also insisted that E*Trade takes pain to ensure that its customers trades are executed at the best possible price. Shares of E*Trade and other discount brokers were battered earlier this month after publication of Michael Lewis's book "Flash Boys" said that markets were rigged.
The book raised concerns that regulators could end discount brokers' practice of selling customers' stock and option orders to market-makers and exchanges for execution, a practice known as "payment for order flow."
In an unusual disclosure, E*Trade Chief Financial Officer Matt Audette said on the conference call that the company received $25 million in such payments in the first quarter. Earlier Wednesday, competitor TD Ameritrade Holding also defended its order flow practices but declined to disclose how much revenue they produce.
Idzik joined E*Trade in January 2013 with a mission to return the company to its discount brokerage roots. In his year at the helm he has replaced virtually his entire management team. He also oversaw the demise of the company's famous E*Trade talking baby TV ads because they were not appealing to the core constituency of investors.
Idzik has also helped restore the sustainability of the company's bank that it still uses to hold client cash.
Discount brokers' profits are tied to both customer trading activity and rising interest rates that let them capture a big return on the cash customers leave in their accounts.
Rates remain low, but trading has exploded as investors shake off the long-lingering effects of the 2008-2009 market collapse and search for returns they cannot get from bonds or bank accounts.
The enthusiasm for markets also boosted the firm's interest revenue as customers borrowed in their margin accounts to buy stocks. Margin balances of $7.3 million at the end of the quarter were at their highest level in six years, Idzik said.
Daily average trades at the company hit 198,000 in the quarter, the highest level in almost five years. Its average commission rate fell 6 percent to $10.64 per trade because stock trading was stronger than more expensive options trading.
E*Trade as of March 31 had 3.1 million brokerage accounts, up 5 percent from a year earlier and 2 percent since the end of 2013. The company said clients are closing accounts at a record-low annual rate of 7.1 percent.
Analysts at Wells Fargo raised their rating on E*Trade stock to "outperform" from "market perform" before the results were released on Wednesday, saying E*Trade was likely to continue using capital at its bank to pay down expensive debt and thus eliminate its high interest payments.
In the first quarter, regulators allowed E*Trade's bank to lend the company $75 million. The firm also sold $800 million of subprime home mortgage loans and booked $76 million on the sale of its market-making business during the quarter.
Shares of E*Trade, up 117.6 percent over the past 12 months, gained another 3.3 percent in after-hours trading to $22.20. The stock had earlier closed down .69 percent at $21.50 on the Nasdaq on Wednesday before the company released its earnings report.
(Reporting by Neha Dimri in Bangalore and Jed Horowitz in New York; Editing by Simon Jennings, Matthew Lewis and Cynthia Osterman)