E*Trade's Mortgage Surprise
On Sept. 17, E*Trade Financial (ETFC) Chief Executive Mitch Caplan broke the bad news to Wall Street: The online brokerage would take a hit from the mortgage mess. The damage includes a $245 million expense for loan-loss provisions and up to an additional $100 million for troubled investments tied primarily to second-lien loans and collateralized debt obligations. The expected changes in the second half of the year forced E*Trade to cut its guidance for annual profits by 31%. But to many, the biggest surprise was that the firm was actually in the mortgage business. I asked Caplan to explain E*Trade's exposure:
People are out there saying, look, he should not have been in the mortgage business in the first place. Now you seem to be admitting that, as you return to the basics of the online retail brokerage business.No, that's not true, because I very much believe that what we want to be is an online asset-gathering [firm]. Look at Charles Schwab (SCHW). They have a bank. They are originating mortgages. Look at Fidelity. They are filing for a bank license. They want cash, and they want mortgages, right? Would you not agree that they are in the same online asset-gathering business?
One Citigroup (C) analyst says credit trends continue to deteriorate and disclosure at E*Trade is still lacking. He feels that you did not recognize—or at least did not make clear to the market—that you had more exposure to bad credit than you let on.One of the things I pride this management team on is disclosure. I think if you look at our monthly metrics and, more important, our quarterly press releases, we give pages and pages of disclosure. When you looked at our balance sheet, it was solid and…we had very little exposure in areas that were viewed as risk. I thought we were giving appropriate levels of disclosure. And then we put out the 10-Q, and added a risk factor because we own mortgages, and people went nuts.
So now you're getting out of the mortgage business?No, we're not. We're getting out of the wholesale mortgage business. There's a big difference. I'm not interested in buying or originating a mortgage for somebody who is not our retail customer.
You're increasing reserves because the market is expected to worsen. How do you know that will be enough when some people say you've been under-reserved for two to three quarters already?Here's precisely what happened. The [environment] changed rapidly in the months of July and August. Until that point, our portfolios were performing as expected. And don't forget, from the beginning of time I have always said we are not immune to the credit environment. We are trying to broadly serve customers across a range of products. Part of those products are lending. Some of them are margin, some of them are mortgage.
Does E*trade have the access to capital that it needs?Number one, we have access to cash through our customers. Number two, we have access to the Federal Home Loan Bank because we are a bank. Currently, we have in excess of $13 billion of borrowing capacity with the Federal Home Loan Bank. I could draw it in 15 minutes, in a phone call.
Is it fair to say that when you are talking with Ameritrade about doing a deal—because everybody knows you've talked to [TD Ameritrade (AMTD) CEO Joe] Moglia about a merger—that you are negotiating from a weaker position?No. First [the market] said Ameritrade was negotiating from a position of weakness because they had no organic growth and because the activists were all over them and whatever. Now it's flipped, and we're [supposedly] negotiating from a position of weakness because of the balance sheet.
It sounds as if by this time next year, you will have been acquired.I'm not sure "been acquired" is right. We may have acquired.