Of DOW JONES NEWSWIRES
NEW YORK (Dow Jones)--For investors, the future of E*Trade Financial Corp. (ETFC) is linked to whether it receives an investment from the U.S. government.
The online broker and lender posted its best month of account growth in five years last week. But the results did nothing for E*Trade's stock price, which plunged below $1 a share Wednesday.
On Tuesday, however, E*Trade shares soared as much as 50% after the company said it continues to work with regulators on its application for an $800 million investment from the Troubled Asset Relief Program. E*Trade said it's optimistic of getting approval.
The reason investors want E*Trade to get a TARP investment is to offset trouble in its banking subsidiary. E*Trade has set aside over $1 billion for bad loans this year. Foreclosures and delinquencies have surged, hurting the bank's portfolio of mortgage-backed securities. E*Trade stock has plunged 75% over the past year, due to the bank unit's troubles and also in line with weakness in financial stocks.
While analysts and the company say it has sufficient capital and doesn't need funds from TARP, investors are treating E*Trade's stock price as though the company's survival depends on receiving government funds.
"If they don't get [approval], even though they think they will, it may invite negative coverage and, if that leads to erosion in customer confidence, this could become an issue," said Alexander Yavorsky, assistant vice president of Moody's Finance and Securities team.
E*Trade spokeswoman Pam Erickson said the company is "well-capitalized, with the financial strength and resources to ensure the company's credit exposure remains manageable."
She said E*Trade has already paid for 75% of management's full three-year charge-off forecast - that is, the company has already set aside or taken permanent hits against 75% of the losses it expects its loan portfolios to produce over the next three years.
Capital Position
On E*Trade's third-quarter conference call with analysts last month, Chief Executive Donald Layton said that even with loan losses above its estimates, the company has a large enough capital cushion to deal with credit problems. E*Trade said it has $500 million in excess capital at its bank and $665 million in cash at the parent company.
While E*Trade said it expects losses in its home equity portfolio to rise 20% over its previous $1.5 billion estimate for 2008 to 2010, the company also said its provision expense peaked in the third quarter. Provisions are the money banks set aside to offset current and projected losses. E*Trade said it expects charge-offs to go down next year.
"E*Trade, in our opinion, doesn't need to raise capital," Yavorsky said. "It doesn't have any debt maturing until 2011 and for the rating level we have them right now, their capitalization is pretty sound."
Yavorsky's statement on E*Trade's capital position assumes $1.4 billion in after-tax losses according to a "stress test" that Moody's performed on the bank's mortgage portfolio.
This month, Moody's cut its credit ratings on E*Trade, projecting mortgage troubles for the company to continue into 2009. The downgrade, which reflected the rating agency's forecast for falling home prices and a weak U.S. economy, didn't factor in any additional capital E*Trade could receive from the government.
Yet investors are reacting as if TARP is the driving force behind the stock. While many of its financial peers rose sharply Monday on the government's rescue of banking giant Citigroup Inc. (C), E*Trade reached an all-time intraday low of $0.79 and closed down 2.2%. With the company's TARP update Tuesday, the stock recently traded up 35 cents, or 40%, at $1.23.
Barclays Capital analyst Roger Freeman said the potential to receive government funds is the primary driver for E*Trade's stock right now.
"We view the company's announcement as encouraging because it means they haven't been ruled out," Freeman said.
"For financial services companies, when their valuations are at distressed levels, it's all about perception," he said.
Others say the performance of E*Trade's mortgage portfolio is more important to the stability of the company in the long term. With a weak housing market, the company's home equity portfolio has deteriorated.
"If they are anywhere close to their own [loan loss] projections, the stock seems to me like it has a decent chance for a major rally because they have significant excess capital today," said BMO Capital Markets analyst Mike Vinciquerra.
E*Trade, along with its online brokerage competitors Charles Schwab Corp. (SCHW) and TD Ameritrade Holding Corp. (AMTD), has benefited from high trading volumes. Last week, E*Trade said its October daily average revenue trades, or DARTs, rose 15% over September and 15% over last year.
Analysts and investors maintain that despite troubles at E*Trade's bank, the company's brokerage business will help it navigate through the housing market turmoil.
"What investors care about is if the brokerage franchise is intact," Freeman said. "If it is, then it helps with the ongoing sustainability of franchise."
