E*Trade firesale seen hurting Wall St portfolios

NEW YORK (Reuters) - E*Trade Financial Corp's ETFC.O firesale of mortgage-backed securities has conjured up a new worst-case scenario for Wall Street's portfolio of subprime assets by knocking their value even lower.

Financial analysts on Friday said E*Trade got anywhere from 11 cents to 27 cents on the dollar for its $3.1 billion portfolio of asset-backed securities. The portfolio sale was part of a $2.5 billion capital infusion from a group led by hedge fund Citadel investment Group.

“The portfolio sale, one of the few observable trades of such assets, has very clear, generally negative, implications for the valuation of like assets on brokers’ balance sheets,” Credit Suisse analyst Susan Roth Katzke said.

The portfolios are hard to value because demand has dried up for them and the brokerages sometimes use their own models to put a value on the assets. Any rare actual transaction could have an effect on other brokerages’ valuations.

Using what she called a simplistic analysis, Katzke estimated Merrill Lynch & Co Inc MER.N could take a $9 billion after-tax hit to the valuation of assets underpinned by subprime mortgages. That estimate assumes the Merrill assets would be marked down to 26 cents on the dollar.

Katzke's write-downs reflect amounts that are incremental to charges taken in the third quarter. She estimated that Citigroup's C.N after-tax write-down could be $26 billion, if the assets were marked down to 26 cents on the dollar.

“Our analysis is far from perfect,” Katzke said. “That said, it’s our best take on a worst case scenario for valuation of like securities. ... Not all brokers are equal.”

Merrill declined to comment. Before the E*Trade deal, analysts had already forecast huge write-downs at Merrill, with some estimates topping $13 billion. Katzke estimates Citigroup will take a write-down of up to $12 billion in the fourth quarter.

Merrill already recorded an $8.4 billion write-down in the third quarter, mostly because it reduced the value of subprime-related assets.

Goldman Sachs analysts said they were surprised by the size of the discount on the E*Trade portfolio because 73 percent of the assets were backed by prime mortgages, or loans to people with solid credit.

In contrast, Wall Street brokerages have taken billions of dollars of write-downs on assets underpinned by subprime mortgages. Escalating defaults on these loans to people with weak credit have roiled credit markets worldwide.

Citigroup investment bank analyst Prashant Bhatia said E*Trade actually received 11 cents on the dollar for its portfolio, if you factor in that the brokerage received $800 million in cash minus 85 million shares it issued. He said that implies Citadel’s received stock compensation worth about $450 million, leaving E*Trade with only $350 million for its $3.1 billion portfolio.

Reporting by Tim McLaughlin; Editing by Gary Hill