E*Trade's Bailout Draws Boos

The firm's $2.5 billion rescue plan is met with skepticism on the Street, including an analyst warning the stock could drop another 50%

Despite hopes that a $2.5 billion bailout would lift the stock, E*Trade (ETFC) remains stuck in stock-market quicksand, weighed down by exposure to risky credit and declining investor and customer confidence.

The company's trouble deepened Dec. 3 when Bank of America (BAC) analyst Michael Hecht downgraded the stock to "sell" and lowered his 12-month target price to a rock-bottom $2 per share.

E*Trade's stock was trading above $25 as recently as June. Then came worries about toxic debt on E*Trade's bank balance sheet, followed by worries that credit problems could even send the firm into bankruptcy. A cash infusion from Citadel Investment Group on Nov. 29 dispelled the worst fears about the firm's future, but that's done nothing to revive the stock.

E*Trade shares are down 29% since the Citadel deal was announced. By late morning on Dec. 3, following Hecht's downgrade, shares were selling just above $4, down 12% for the day.

Here are the problems, Hecht says:

First, the Citadel deal unloaded E*Trade's most toxic debt -- with a face value of $3 billion, sold for $800 million -- but it left on the balance sheet $12 billion in home-equity loans. That's a "looming issue" that could result in another $1 billion in losses and wipe out next year's earnings, Hecht wrote.

Second, last week's deal makes Citadel "the clear winner" at the expense of shareholders in E*Trade, which must issue an extra 84 million shares of stock to Citadel and borrow $1.7 billion at a high 12% interest rate.

Third, Hecht wondered if E*Trade is really shifting direction. Chief executive Mitch Caplan lost his job last week but remains on the firm's board, and his "right-hand man" Jarrett Lilien took over as interim CEO. That raises "the question of how much has really changed in the senior management suite at [E*Trade], and [limits] we think the board's ability to attract new senior talent," Hecht wrote.

Finally, there are worries about E*Trade's previously strong retail brokerage business. The broker has seen heavy trading volume in recent months. But bankruptcy scares in mid-November caused customers to pull their money out of accounts. Assets to drop 17% in November. E*Trade has 3.7 million brokerage accounts, and Hecht thinks that could fall 15% or more in the next few months.

E*Trade's retail brokerage business, a "dwindling asset," can no longer can offset the "negative value" of its banking operation, Hecht wrote.

Part of the logic behind E*Trade's expensive deal with Citadel was that it would stop the bleeding from chronic bad news. As a well-known firm in the online trading world, E*Trade is especially susceptible to bad headlines. It couldn't let financial issues rob the firm of its credibility with customers.

Right now, it's not clear yet how much E*Trade's credit issues will hurt its brokerage business. But there's every sign that the gloom hanging over E*Trade will persist for quite a while.

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