E*Trade's Questionable Receivables

Citigroup has come up with possible $5 billion in writedowns on E*Trade which would more that wipe out E*Trades 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 billion.

Credit Ratings On Asset Backed Securities



click on chart for crisper display

Easily $1.26 billion 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 Billion in asset backed securities is rated AA or higher.

E*Trade Loan Receivables



click on chart for crisper display

Loan to Value and FICO analysis



click on chart for crisper display

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



click on chart for crisper display

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 billion 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 billion. What it's really worth no one knows but a 33% haircut certainly would not be surprising given $448 million 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 million 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 billion 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 (whatever action they take 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.

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Five Most Recent Posts