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Some E*TRADE Recovery After Bankruptcy Warning

Some E*TRADE Recovery After Bankruptcy WarningCiti analyst warned bankruptcy a possibility

November 13, 2007

By SAM GARCIA

Shares of E*TRADE Financial Corp. recovered some of yesterday’s stinging losses that were prompted by an analyst’s warning of possible bankruptcy.

According to a Citi Investment Research report Sunday, the New York-based company is likely to lose clients because of continued negative news about its exposure to mortgages and collateralized debt obligations, a Securities and Exchange investigation into its loan and securities portfolio, and continued deterioration in its financial condition.

Despite Citi’s comments, E*TRADE’s president and chief operating officer, R. Jarrett Lilien, said in a statement yesterday, “We continue to see momentum with new and existing customers.”

The company is facing pressure from its deteriorating $12.4 billion home equity portfolio, of which 60 percent has less than full documentation, 60 percent is from 2005 or 2006, and 90 percent was originated from mortgage brokers, Analyst Prashant Bhatiathe wrote. E*TRADE could face quarterly loss provisions of around $100 million from its HEL holdings.

The financial services firm also faces pressure from its $3.1 billion ABS portfolio — which could see $500 million in subprime related losses, Citi explained.

If the company, which is not required to mark certain loans and securities to market, attempted to liquidate its loan and asset backed securities portfolio, Citi estimated it would take $5 billion in charges — “more than wiping out tangible equity.”

E*TRADE faces the possibility of falling below a level considered well capitalized, which could trigger violations of covenants in its $250 million revolving line, Citi wrote.

Top executives and the board of directors face a loss of investor confidence also.

“Management lowered its earnings guidance for the 5th time in 8 months and now management believes that it is no longer beneficial to provide earnings expectations for 2007,” Citi’s analyst wrote. “The extent of poor risk management in our view, has put the viability of the franchise at risk.”

Citi added that more important than executive flaws are the board of directors, auditors and regulators.

Half of E*TRADE’s deposits exceed the FDIC’s maximum insured amount of $100,000 — increasing the likelihood of attrition, the analyst estimated.

Employees, with little hope of profitably cashing in on options, are also leaving the company — with an 8 percent reduction in head count during the past two quarters, the report indicated.

And the company also has little chance of being acquired.

“In its current form, burdened with a significant and deteriorating $42 billion mortgage portfolio, this franchise is an extremely unattractive acquisition candidate,” the report said. “Even without the credit issues, in our view, the core discount brokerage business at E*Trade has virtually no organic growth.”

Citi cited NetBank, which only received a penny for every dollar in deposits as it collapsed.

“Bankruptcy risk cannot be ruled out,” Citi said. “Downgrading to a Sell based on a higher probability of a run on the bank.”

The stock market reacted violently to the report — sending shares more than $5 lower to $3.55 yesterday. Shares are trading 51 cents higher early today — though well below the Jan. 16, 2007, high of $26.08.


E*TRADE profile
 

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