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Digging Deeper into E*Trade


Citadel is coming in above the common shareholders should E-Trade ultimately be liquidated.

The following is the latest from Minyan Peter, author of such popular recent articles as Bank Debt Downgrades: Surf's Up and Asset Deflation Driving Move Toward Recession.

Here are some of my top line thoughts on E*Trade's (ETFC) transaction with Citadel:

First, when E*Trade issued its third quarter results in early October it stated that it expected full year earnings to come in at between 85 and 90 cents…with "no additional securities write downs". With this morning's news, E*Trade is taking a $2.2 bln write down on the sale of its $3 bln securities portfolio. As this now represents a real trade, I expect that there are other financial institutions now having to revisit their Level III securities valuations.

Second, even with a $225 mln increase to its home equity loan loss reserve, reserves represent only 1% of loans. With this morning's news that new home prices are down 13% year on year, I don't believe a 1% reserve will ultimately prove to be enough.

Third, the Wall Street Journal lead-in sentence stating that the plan was "overseen by the Office of Thrift Supervision" is a very material point. Remember that the regulators care about one constituent only – the insured depositors. The fact that E*Trade shareholders were wickedly diluted is not of concern to the OTS.

Finally, note that the biggest part of Citadel's investment in E*Trade was in the form of debt, not stock. Like the Citigroup (C) deal with Abu Dhabi and the transactions announced by Freddie Mac (FRE) and Fannie Mae (FNM), Citadel is coming in above the common shareholders should E*Trade ultimately be liquidated. To my note yesterday, credit cycle bottoms are defined by investors' willing to buy common stock along side existing shareholders, not "preference" securities which put them in a superior position.
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