E*Trade bankruptcy not a self-fulfilling prophecy

NEW YORK Wed Nov 14, 2007 8:29am EST

A customer enters the E*Trade offices in New York, November 12, 2007. REUTERS/Lucas Jackson

A customer enters the E*Trade offices in New York, November 12, 2007.

Credit: Reuters/Lucas Jackson

NEW YORK (Reuters) - E*Trade Financial Corp (ETFC.O), the online brokerage whose shares have been crushed by mounting credit losses, should be able to avoid bankruptcy if it can hang on to its customers, analysts said.

If most of its 3.6 million customers stay, E*Trade's balance sheet can withstand the huge losses it has taken from write-downs of the mortgage-backed securities it amassed in recent years to diversify its brokerage business. The mortgage holdings fueled earnings growth for some years before being hammered by this summer's mortgage market crisis.

But an analyst's note forecasting a 15 percent chance the firm will go bankrupt and the 59 percent decline in E*Trade's stock that followed might cause a run that would crush it eventually, analysts said.

Mike Vinciquerra, an analyst at BMO Capital Markets, said on Tuesday a bankruptcy is "highly unlikely" because E*Trade has said it can absorb a $1 billion write-down and remain well capitalized.

"The stock traded (on Monday) as if it was a foregone conclusion that bankruptcy is in the company's future," he wrote in a research note.

On Tuesday, E*Trade shares recovered a portion of the previous day's steep losses, rising 41 percent, or $1.45, to close at $5 on the Nasdaq, after hitting a high of $5.50 during the day.

WILL CLIENTS LEAVE?

The latest turmoil for E*Trade started last Friday, when it projected more write-downs in its $3 billion asset-backed securities portfolio and said it would miss its full-year earnings forecast. Neither could the third-largest U.S. online brokerage by assets provide a new earnings outlook.

The shares of larger rivals TD Ameritrade Holding Corp (AMTD.O) and Charles Schwab Corp SCHW.O gained 5.4 percent and 2.6 percent, respectively, on Monday on speculation they could benefit from E*Trade's problems.

Both declined to comment on Tuesday. But Zecco, a tiny, privately-owned online discount brokerage, said it was trying to attract some worried E*Trade customers with coupons for a free lunch.

"If there's going to be an exodus of customers, it's now and going forward," said Gabriel Dalparto, Zecco's chief marketing and strategy officer, who used to be E*Trade's vice- president of marketing.

But BMO's Vinciquerra said E*Trade's customer deposits have grown despite its mounting credit troubles, which the brokerage first disclosed over the summer.

"Large scale customer defections ... would have to be on a very major scale to start driving the company toward financial turmoil," he said. "A key fact that some people seem to be ignoring is that E*Trade's deposits have actually grown for the last 13 months consecutively."

In October, client assets were up 4 percent to about $227 billion from the previous month.

Deutsche Bank analyst Matthew Fischer also said on Monday that the brokerage's retail business remains strong.

CHOP E*TRADE UP

Analysts, many of whom have recently called for E*Trade to sell a part of all of itself, also said the brokerage's troubles increase the likelihood of a deal.

"Bankruptcy is a very remote possibility for them," said Morningstar analyst Patrick O'Shaughnessy. It was likelier E*Trade would try selling some of its assets, get a cash infusion, or sell its entire business, he added.

Vinciquerra said E*Trade's entire banking and brokerage business would be bought at a "meaningful premium to current levels" before it went bankrupt.

TD Ameritrade, which holds about 16 percent of the market share by client assets, has long been considered a potential merger partner for E*Trade.

In June, two activist hedge funds that own about 8 percent of TD Ameritrade urged the brokerage to consider a sale or merger with either of its rivals.

But analysts said E*Trade's complex balance sheet, combining its banking and brokerage assets, will make it tough to split the two businesses.

They expect E*Trade to pull through the current mess as it focuses on restructuring over the next several quarters.

"But it depends on how much worse the credit news gets and also on whether the recent speculation will actually cause a run on the bank," O'Shaughnessy added.

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