ETFC

[nicknite20]

David,
Curious to know your thoughts on ETFC..and whether you would recommend buying this here?

I feel, the fear of risk of banruptcy is overdone.

The brokerage business is generating sufficient revenue..and while i do realize that there is client attriction, currently, they generate half a bil a year from commissions.

Assuming a 50% margin & doing a quick DCF over a 10 yr period, im getting a valuation of roughly 4.5b, which is 3 times what the market cap is today.

Appreciate your thougts..
Nick

[David Randolph]

David,
Curious to know your thoughts on ETFC..and whether you would recommend buying this here?

I feel, the fear of risk of banruptcy is overdone.

The brokerage business is generating sufficient revenue..and while i do realize that there is client attriction, currently, they generate half a bil a year from commissions.

Assuming a 50% margin & doing a quick DCF over a 10 yr period, im getting a valuation of roughly 4.5b, which is 3 times what the market cap is today.

Appreciate your thougts..
Nick

At first sight I agree with you Nick, e-Trade is such a well known online brokerage, it's hard to believe it will file for bankruptcy as some analysts argue.

The stock fell an incredible 84% over the last six months, so now it can only be a turnaround candidate. However, it may happen that the company turns around and yet the stock goes nowhere or even falls ... this would happen if there were a lot of dilution.

Let me check the number of shares outstanding and the market cap on an historical basis:



(# of shares outstanding below price, in millions. Market cap above price, in billions)

No me gusta mucho, this 5% CAGR in the number of shares outstanding. But I've seen much worse and there hasn't been significant dilution over the last couple of years - probably they didn't need it, that's the problem.

Well, now they need it, so here you have another 20% dilution:

• E*Trade Falters, Despite Cash Infusion
at TheStreet.com (Thu, Nov 29)

I've used my fundamental data service and the latest 10-Q to learn that ETFC has a great business, which is the retail operations and brokerage services, but like many others got greedy and bought a lot of what at the time were perceived as low risk assets, that is "mortgage-backed and investment securities".

Take a look at the company's balance sheet:



$16.58 B of those securities as assets for sale. The question is, for how much are they going to sell them in the current market environment?

They just got 27 cents on the dollar on that other sale.

I didn't dig much further but my feeling given that the company just sold 20% more shares for cash says "avoid this one". In my view e-Trade the company will survive and eventually prosper, since it has such a good brand and online brokerage business, but it will take a long time and I'm not so sure about the stock.

Maybe it will fall down to $1 before it recovers, I don't know.

I think there are much better plays outthere, in terms of their reward/risk relationship.

I can be wrong though, good luck nicknite20

[nicknite20]

David,
Thanks for the comments..

AFS (available for sale) securities are primarily interest bearing assets which are not term loans (held to maturity). In ETFC's case, they're ABS, which ironically are A+ investment grade securities (but we all know that all the rating agencies messed by ratings on all ABSs.

The only reason they would be sold is if they have additional capital requirement.

No question this is a risky (investment?)..but there maybe some rewards down the road.
Nick

[la-onda]

 E*Trade hits all-time low; Citigroup, Standard & Poor's reiterate sell ratings
Tuesday , January 08, 2008 15:54ET

BOSTON, Jan 09, 2008 (Thomson Financial via COMTEX) -- Shares of E*Trade Financial Corp. extended losses for a fifth consecutive session Tuesday amid fresh concerns on Wall Street about the online broker's shrinking asset base. The stock scraped an all-time low of $2.08 earlier in the session before bouncing slightly to change hands at $2.27, off roughly 19% intraday, in recent trades. Volume of 70 million was 40% beyond the issue's 30-day daily average of roughly 50 million. In a preview of the upcoming earnings season for brokers and asset management companies, Citigroup reiterated a sell rating on E-Trade and estimated that the company will generate negative earnings per share for the next three years. The firm also cut its price target for the stock to $2.75 from $4.50.

Citigroup estimates E-Trade has lost about $30 billion in client assets in the past two months and thinks this attrition will continue.
"Furthermore, we believe the firm (E-Trade) is marketing high yielding deposits attracting 'hot money' which in our view is uneconomical and unsustainable," Citigroup said, adding that it expects the company to cut headcount in the first quarter of 2008 in order to preserve capital and stay above regulatory capital requirements.
Standard & Poor's also reiterated a sell rating on the company and reduced its price target to $2 from $4. The firm said it now believes E*Trade will lose money in 2008, forecasting a loss per share of 10 cents, down from a previous earnings estimate of 60 cents a share.
The current mean estimate of analysts polled by Thomson Financial is for earnings of 19 cents a share in fiscal 2008.
"The lower asset base and higher funding costs are likely to impact interest rate spreads, and combined with the further home equity loan asset write-downs we expect, should driver lower net interest margins," Standard & Poor's said.

The stock is now down nearly 36% in the five trading sessions of 2008.

A spokesperson for E*Trade Financial was not available for comment. Greg Saulnier gs/mb

[nicknite20]

this stock has disconnected from the fundamentals..so talking abt EPS in 2008 is irrelevant.

a buyout is still on the cards though.

[Trumpitall]

Right when you think it can't go any lower .... Another good reason to use stops I guess.  I wonder what they will say on the 24th.  All the bad news should be out after that, but then again I feel like I keep saying that.    

[nicknite20]

Yesterdays press release was pretty significant:

1. Customer outflow is not as high as expected
2. They've started exiting out of asset backed securities

ETFC is trading like its going bankrupt..which I strongly feel is not going to happen.

[David Randolph]

Yesterdays press release was pretty significant:

1. Customer outflow is not as high as expected
2. They've started exiting out of asset backed securities

ETFC is trading like its going bankrupt..which I strongly feel is not going to happen.

I tend to agree with most of what you wrote nicknite20. And ETFC has been holding up well recently, while the general market deteriorated a lot. I wonder if this has to do with anticipation of tomorrow's news.

The only issue I disagree is that ETFC is priced for bankrupcty. The market cap is still $1.2 B, so there's still a lot of value represented by those shares.

It's a shame that such a well known trademark has been killed by management missteps. Wasn't it obvious that the housing market couldn't sustain those high prices fueled by reckless credit? It puzzles me how supposedly bright and very well paid people didn't see the risk.

But I have my own pile of mistakes to be critical about ...

I'll keep watching this one Nick, good luck

[nicknite20]

David,
ETFC has 190b in client assets..the brokerage business alone generates over 2b in annual rev. Im not even adding to it the net interest income which will grow significantly given the WIDE credit spreads thanks to Fed lowering rates. And with all this inflow, its trading at 1.2b market cap??

The market is still spooked by the 12b in HELOCs, which if defaulted & written down, will cause liquidty issues. if all's well..we're looking at a 5-6 bagger over the next 18 - 24 mth timeframe. Thats a chance (that this wont happen) Im willing to take.

Irregardless, today's earnings will be very interesting..
Nick

[nicknite20]

so far so good..conf call is going all just as i wud expect.

Excess capital in 2008 & 2008 estimated above 1 Bil

ETFC has no more chance of going bankrupt than WFC, BAC or even CITI

[nicknite20]

Insider buying y'day was very very encouraging..

[nicknite20]

Nice article..

http://money.cnn.com/2008/02/05/news/companies/barr_etrade.fortune/index.htm?source=yahoo_quote

[David Randolph]

Hi nicknite20, I'm not sure if you're still in ETFC, but the stock rose about 9.7% on Friday, with 57 million shares changing hands, due to the following news:

• E*TRADE FINANCIAL Corporation Announces First Quarter Results and Progress of 2008 Turnaround Plan
Business Wire (Thu, Apr 17)

There are 14 or so analysts covering the stock. Let me copy/paste the analysis of one of them:

Summary Points

Growth:
• As a large, low-cost financial supermarket, E*Trade addresses a large market for banking and brokerage services both domestically and abroad.
• Low-variable cost structure could lead to margin expansion should retail balances and trading volumes grow.

Quality:
• Well-regarded trading platform and customer service, but brand image has been somewhat tarnished due to poor balance sheet management.

Control of Risk:
• Trades at 40x our 2010 pro-forma operating EPS estimate, but credit market uncertainty adds risk to our forecast.
• Retains considerable mortgage exposure, including $11.6 billion in home equity loans.

Recent Developments
As expected, E*Trade posted sharply lower revenues in the March quarter as higher loan loss provisions overshadowed healthy retail brokerage volumes. Following the Citadel deal in November, capital ratios have improved, and are exceeding earlier expectations. The Tier 1 Capital ratio was 6.78% and the Risk Weighted Capital ratio was 12.37%, with excess capital of ~$695 million. Management anticipates a return to quarterly profitability late this year.

191,000 DARTs (daily average trades) were executed in the quarter, up from 170,000 in 1Q07. Margin balances at the end of March stood at $6.7B, down sequentially from $7.26B. A heavy investment in advertising ($60m—up 33% from the prior year) led to 62,000 net new accounts, up from 7,000 the prior quarter. Net new customer assets increased $300m in the quarter, compared to a $16.5B outflow in 4Q07. Customer cash and deposits stood at $34.9B, up from $33.6B in 4Q07. The net enterprise spread compressed q/q and y/y to 2.50bps.

A $234m provision for loan loss (3.5% of gross loans, annualized) was recorded in the quarter. The allowance for loan losses increased by $57m to $566m, or 1.99% of gross loans. The home equity portfolio is performing in line with management's expectations, but uncertainty looms. E*Trade ended the quarter with 172% reserve coverage of nonperforming home equity loans. The firm's risk mitigation group continues to make progress in reducing exposure to open lines. Open commitments fell 23% to $5.6B at quarter end. E*Trade noted that first lien mortgage portfolio is performing worse than expected, with total delinquent loans increasing by $177m to $655m or about 4.5% of total gross loan receivables. Annualized net charge-offs as a percent of average first lien loans increased to 38 bps, up from 10 bps in 1Q07.

Recommendation Rationale
E*Trade is trying to make a comeback after severe balance sheet issues forced the company to shed its problematic asset-backed portfolio at a large loss. A much needed $2.55B capital infusion in late November 2007 quelled fears of bankruptcy, but not before the firm suffered a raft of outflows. Since then, the outflows have stabilized and E*Trade's capital position has shown marked improvement. But concerns over the firm's $11.6B second-lien (HELOC) portfolio remain, which we think will continue to pressure the shares, particularly if house prices and
consumer credit deteriorate further. E*Trade estimates the second-lien portfolio could realize $1 billion to $1.5 billion in losses over the next three years. We think the company could potentially face further customer attrition, which would put it on the defensive compared to some of its peers, particularly Ameritrade, Fidelity, and Schwab. We also note that competition for cash deposits is heating up amidst uncertainties in the market, so we would expect these and other firms to get more aggressive, and would not be surprised to see them target E*Trade customers in particular. On the other hand, we think that investor expectations for E*Trade are fairly low. We believe E*Trade's low-cost "clicks and mortar" structure may be better positioned to weather the challenging environment than other banks with high overhead associated with extensive branch networks. E*Trade is also taking steps to thin its expense structure, which should help improve profitability over time. We also think wholesale improvement in credit markets and or industry consolidation (both unlikely near-term) could be a catalyst for ETFC stock. With a new CEO in place, E*Trade is aggressively trying to restore customer confidence and return to profitability. Early signs are encouraging. Nonetheless, we think this will be a long-term process, and the near-term challenges far outnumber the catalysts, particularly if macro-economic conditions weaken.

Operations
E*Trade is a financial supermarket known by most for its online stock brokerage. Its January 2000 $1.8 billion stock swap for Telebanc has blossomed into a significant internet banking franchise, generating almost half of the firm's nearly $1.1 billion of operating income in 2006. The bank's balance sheet grew rapidly as E*Trade used low-cost cash deposits from brokerage customers to fund first and second lien mortgage loans. Net interest growth was accelerated by using wholesale borrowings (repos, FHLB advances) to purchase real estate loans and asset-backed securities (ABS) from other originators. The strategy worked until credit markets froze. E*Trade was forced to seek $2.55 billion in capital which it received from a group led by Citadel investments. Under the terms, E*Trade issued $1.75B in 12.5% senior notes, and 85m common shares (19.99% of outstanding). The increased debt adds about $220 million to the company's annual interest, bringing the total interest expense to roughly $350 million annually.
As part of the deal, E*Trade sold its $3.0 billion ABS portfolio ($1.35B of which was in prime residential first liens) for $800 million, or 27¢ on the dollar. This marks the beginning of a new chapter for E*Trade.

E*Trade reports in two segments: Retail and Institutional. The breakdown places commissions ($545 million), net interest from margin debt and retail sweep accounts ($985 million), and other items such as service fees and the gain on sales of mortgages into a segment dubbed "Retail," which had $1.825 billion of sales and $790 million of profit in 2007. This resulted in a respectable 43% segment operating margin. E*Trade's other segment, "Institutional," contains the net interest from wholesale borrowing and subsequent asset investment ($625 million)
plus revenue from principal transactions, about 25% of which we estimate are from internalized order flow. It also includes gains and losses on sales of securities, as well as loan loss provisions. These two items were responsible for the segment's $2.8 billion operating loss in 2007 and wiping out profits in the retail segment.

On March 31, 2008, E*Trade had about $45B interest earning assets, consisting of $35.6B in loans and $9.4B in investment securities. The loan portfolio includes about $26.3B in mortgage loans, $6.7B in margin debt, and $2.7B in consumer loans. Of this, $11.6B is in 2nd lien mortgages and $14.7B in 1st lien, 1-4 family mortgages. About 35% of the first lien portfolio was originated in 2006, a potential trouble spot for mortgage loans since housing prices in general were peaking in that year, risk premiums were narrow, and credit standards for certain loans may have weakened as competition intensified. Nearly 85% of this portfolio was purchased from third parties, which calls into question the underwriting standards of the originators. At the end of March, 4.5% of this portfolio was delinquent, more than double what it was the prior year. The first lien portfolio does not have exposure to option or negative amortization ARMs. The 2nd lien (home equity loan) is closely watched by investors, since a charge off could mean losses approach 100% of the principal amount of the loan. About 53% of the $11.6B loan portfolio carried a current loan-to-value (CLTV) ratio of 80% or more. House price deterioration does not bode well for these high CLTV loans, many of which could wind up with negative equity. Some borrowers in this situation might decide to walk away from the loan. About 45% of the portfolio was originated in 2006 and 24% in 2005. Nearly 90% was purchased from third parties. Included in the $9.4B investment securities balance is $7.55B in "AAA" rated Agency mortgage-backs and collateralized mortgage obligations (CMO). About $1.1B is in private label, 90% of which is "AAA" rated. The remaining $700m is in Corporate and municipals with an "AA-" average rating.

Total customer cash and deposits stood at $34.9 billion at the end of March 2008, up from $33.6 billion at the end of December 2007. In November 2007, customers withdrew $6.8B in cash after concerns about the broker's financial viability. Year-over-year, cash was flat. A home deposit solution, slated to be launched in 2008, may make it easier to deposit cash in the absence of a branch office. This, along with very competitive rates, could help drive cash
deposit growth in 2008. E*Trade's average net interest spread on interest earning assets in the first quarter 2008 was 250 bps, down from 274 bps a year earlier. Declining interest rates and the disposal of higher yielding assets, have negatively impacted the asset yield. In an effort to boost cash deposits, the rate paid on cash deposits has lagged recent Fed rate cuts, and this has had a negative impact on the net spread. Margin debt is an important contributor to E*Trade's net interest spreads, and may explain some of the year over year compression. When funded with low cost customer deposits, margin debt can generate an average net spread of over 5%. The 2005 acquisitions of Harrisdirect and BrownCo added $3.5 billion in margin debt to the $2.3B it prior to the purchase. At the end of March 2008, margin debt stood at $6.7B. Balances can be volatile depending on market conditions.

In 2007, E*Trade's brokerage reported strong trading volumes. Average daily revenue generating trades or "DARTs" were 186,000, up from 160,000 in 2006. Although average retail volume has more than doubled from 2003 largely due to acquisitions, retail commission rates have fallen, on average, by 30% over the same period. We believe commission rates may decline by a few more percentage points in 2007, but we view this as controllable and a stimulus to banking revenue. Growth in options trading partially offsets the decline, since commissions on options trades tend to be higher. Options represented about 15% of E*Trade's trading volume compared to 12% a year ago.

Competition
There are about 60 different firms with an online brokerage presence in the United States, down from around 200 in 2001. The industry has become less fragmented with about 90% of retail online trading volume controlled by Ameritrade, Schwab, Fidelity, Scottrade, and optionsXpress. For the quarter ended December 2007, Ameritrade claimed the top spot in the online brokerage industry with 321,000 US daily average revenue trades (DARTs), followed by Schwab (275,500), Fidelity (199,900), and E*TRADE (179,300). Charles Schwab has 7.1 million active brokerage accounts and a typical houshold has about $300,000 in assets. Schwab's total client assets (including Institutional) stood at $1.4 trillion in December 2007. At the end of December 2007, Fidelity Brokerage had 14.9 million retail accounts. Fidelity's deep pockets allow it to invest heavily in technology to improve its brokerage operations which should reduce expenses and give it the operating leverage to weather commission rate cuts. Scottrade's (est. $800m sales) heavily promoted $7 flat-rate online trades and 335 branch offices has helped
boost its market share over the past two years. In October 2006, Bank of America (BofA) announced a commissionfree trading offer to customers that hold over $25,000 in savings and checking accounts. Thus far, this offer seems to have little impact on the operating results of the major online brokers. With $51.6 billion in total assets as of December 2007, E*Trade Bank is the 6th largest thrift. ING Direct is the fifth largest thrift. Since its inception in 2000, ING Direct has serviced 5.5 million accounts, and has grown to $80 billion in assets. It has $60 billion in
deposits and $26 billion in mortgage loans, the majority of which are 1st liens. ING DIRECT claims that it can service its accounts for a third of the industry average cost through a narrow product focus and limited customer service. Net income rose 17% in 2007 to $260 million. The average net interest margin was 1.09% vs. 1.08% in 2006.

Market
E*Trade's target segment, the "Mass Affluent" is likely to drive the majority of the company's revenue and profit. Mass affluent households are defined as those with between $50,000 and $500,000 in investable assets (includes 401k, pension assets). There are 35 million households in the U.S. in this category, collectively holding $6.2 trillion. Many retail clients have accounts open with at least two different firms. For example, we estimate that E*Trade has about 25% of its customers' total investable assets, yet garners about 80% of their trading activity. Large bulge bracket firms have deemphasized relationships with retail investors with less than $100,000 in assets, leaving these accounts up for grabs, in our opinion. Online banking continues to gain traction thanks to advances in security, ease of use, faster online connections, and ATM fee rebates.

Risks
Given the turmoil in financial markets, E*Trade's stock carries numerous risks. Ongoing credit market dislocations, coupled with rising delinquencies present significant risk to our EPS estimates. Greater than expected impairments or a steeper-than-expected decline in net income could put the company at risk of violating its banking capital requirements. Should macroeconomic conditions worsen, it could lead to a decline in retail brokerage volumes
which, if severe enough, could negate many of the benefits of E*Trade's low variable cost structure. A steep decline in commission rates and or trading volume could have an adverse impact on E*Trade's highly profitable commission revenue. As a publicly traded firm, E*Trade's stock is in the spotlight and could be subject to rumors. Negative perception about the company's operating health could lead to rising attrition and/or slow new asset growth. In
2007, the firm was forced to seek capital after the possibility of bankruptcy was voiced.