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E*Trade's Questionable Receivables


E*Trade ramped up loans at the worst possible time, right as housing peaked and for another year after.


Citigroup (C) has come up with a possible $5 bln in writedowns on E*Trade (ETFC), which would more than wipe out E*Trade's equity.

With that in mind, let's look at E*Trade's 10-Q filed on November 9 and see if we can come up with enough problem areas to reach $5 bln.

Credit Ratings On Asset Backed Securities

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Easily $1.26 bln in asset backed securities is of dubious value. There is also a noticeable distinction right now between AAA and AA. No breakdown is available on that grouping. $1.77 bln in asset backed securities is rated AA or higher.

E*Trade Loan Receivables

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Loan to Value and FICO analysis

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FICO Scores from myFICO

The above APRs are for 30 year fixed as of 2007-11-12 and are provided to give a practical idea of differences between FICO scores as to credit quality.

Portfolio Vintage

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E*Trade ramped up loans at the worst possible time, right as housing peaked and for another year after. Thus I question the loan to value numbers listed earlier.

A 5-10% devaluation of those assets (losses would be far bigger in a forced sale), is certainly within the realm of likely.

Miscellaneous 10-Q Facts and Figures

  • E*Trade has a credit default swap ("CDS") on $4.0 bln of our first lien residential real estate loan portfolio. The CDS provides protection for losses in excess of 10 basis points, but not to exceed approximately 75 basis points.
  • E*Trade no longer originates recreational vehicle, marine and auto loans.
  • Senior debt ratings are Ba2 (positive outlook) by Moody's Investor Service(1), BB- (stable) by Standard & Poor's.
  • As of September 30, 2007, sub-prime real estate loans represented less than one-fifth of one percent of E*Trade's total real estate loan portfolio and E*Trade held no option ARM loans.
  • E*Trade's home equity loan portfolio is primarily second lien loans on residential real estate properties.

In E*Trade Heads For Bankruptcy? I questioned E*Trade's ability to survive. The market clearly agrees.

E*trade shares plunges 58.7% November 12, from $8.59 to $3.55. E*trade shares are down 84.2% on the year

Likewise, Forbes is wondering E*Trade Going Out Of Business?

Is it going from bad to Chapter 11 for E*Trade Financial? The company said the rapid devaluation of mortgage-related securities, has reduced the value of its $3.0 billion asset-backed securities portfolio.

"Management believes the additional deterioration observed since September 30 will likely result in write downs that exceed the previous expectations," the company said. "Actual securities-related losses will depend on future market developments, including the potential for future downgrades by rating agencies."

My comment: The latest 10-Q shows the asset backed securities value at $3.058 bln. What it's really worth no one knows but a 33% haircut certainly would not be surprising given $448 mln is rated BBB or below and that tranche could be close to worthless.

Anything but AAA is being marked down heavily and that adds at least another $814 mln in questionable assets. E*Trade does not distinguish between AAA and AA but the difference could be significant. Even AAA assets are being marked down considerably.

Given the great uncertainty in the credit markets, E*Trade's management said it will no longer provide earnings expectations for the rest of the year.

My comment: Smart move. E*Trade is not going to have any earnings and the value of asset backed securities is likely to be a moving target to the downside.

The gloomy announcement comes roughly two months after the firm said it would exit its troubled wholesale mortgage business.

My comment: When?

According to Bhatia [a Citigroup analyst] , there is a high risk that the company will lose its high-end clients, who have accounts with more than $100,000 (the investment limit that is insured by the government's Federal Deposit Insurance Corporation). These accounts represent $15 billion, and make up 50% of deposits or roughly 25% of E*Trade's funding.

The mass exodus of clients, could force the company to sell-offs assets. The liquidation could total $5 billion in losses, "more than wiping out tangible equity," Bhatia said. He predicted a 15% chance of bankruptcy.

My comment: It's easy to predict a mass exodus of accounts. Who would want to stay? A loss of 25% funding on top of even $2 bln in writedowns would likely do the company in. A 15% chance seem way too low to me.

Economic Zugzwang Yet Again

Clearly E*Trade is caught in the vise of Economic Zugzwang: Whoever Moves Loses.

For example, exiting the business would be a violation of the Don't Ask, Don't Sell policy and result in an unwanted mark to market of asset prices. On the other hand, not exiting could bleed E*Trade to death over time. Quite simply, there are no winning moves for E*Trade.

I am still shaking my head wondering why a trading platform company got so heavily involved in mortgages and home equity loans in the first place.

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