E*Trade Fails to Sway the Skeptics

At first glance, a Jan. 9 report from troubled online broker E*Trade Financial (ETFC) looked like good news. The upbeat press release came one day after E*Trade stock hit an 11-year low, with the firm saying its turnaround plan was finding "early success."

The stock opened 15.6% higher on Jan. 9, but then the rally fizzled. Investors and analysts, trained by the credit crisis to be suspicious, started worrying they were only getting half the story. Key questions about E*Trade's future remained unanswered.

Among the news released by E*Trade: It sold off $3 billion in asset-backed securities over the past month and lost less than $5 million on the transactions. That compares well with the sale of $3 billion of more toxic debt in November. The online bank and broker, which has seen its balance sheet demolished by the credit crisis, netted just $800 million from that transaction — in effect losing $2.2 billion.

After worries about its financial situation surfaced last fall, the firm lost customers, who pulled billions of dollars out of E*Trade accounts. On Jan. 9, E*Trade implied the bleeding had stopped.

Customers opened 87,000 new accounts in December, the firm says. Total client assets fell modestly, from $192 billion on Nov. 29 to $190 billion at the end of the year, but cash held steady at $33 billion.

"We have taken important steps in the execution of our turnaround plan by reducing balance sheet-related risk and maintaining strong bank capital levels," E*Trade's acting chief executive and president R. Jarrett Lilien said in a statement.

E*Trade is providing "partial information," says Standard & Poor's equity analyst Jason Willey. "There are just not enough details." (S&P, like BusinessWeek, is a unit of the McGraw-Hill Companies.)

For example, E*Trade said it signed up 87,000 new accounts in December, but didn't say how many accounts had been closed.

And several analysts said they were worried E*Trade is offering expensive incentives to attract those clients' assets. Bank of America (BAC) analyst Michael Hecht wondered how much the firm is paying in advertising, promotion, high-interest rates on deposits and free trading and bonus offers.

Until recently, E*Trade was a leader among online brokers, attracting thousands of new clients and posting record trading volume. But worries about toxic debt, including subprime mortgages, on E*Trade's balance sheet shook clients' confidence.

While most of the worst debt has been unloaded, investors are still closely watching the $12 billion in home equity loans that E*Trade owns. As home prices around the country fall, the quality of these loans is in question. E*Trade said its home equity balance had fallen a bit, from $12.7 billion to $12 billion in the past quarter, a sign borrowers are paying off their debts, but provided no other information on credit quality.

E*Trade has enough strength to survive financially, says Morningstar (MORN) analyst Jaime Peters. A bailout from Citadel Investment Group may have been expensive — investors had to give up 18% of the company to Citadel — but it put E*Trade's risky balance sheet on firmer footing. However, Peters adds, "The question is: Are customers going to lose confidence in them?"

E*Trade's web- and investment-savvy customers are aware of E*Trade's plight, and are already considering moving their money elsewhere, she says. And E*Trade's rivals are doing whatever they can to win them away. A large-scale defection would be disastrous. As Peters wrote recently, "Keeping client assets is the number-one priority for the company, because without clients, E*Trade has no business."

E*Trade made other announcements Jan. 9, including the decision to close its small institutional trading business and lay off 30 employees.

But the big focus of investors will be Jan. 24, when E*Trade releases its full quarter results. Then, investors will get key information they were looking for on Jan. 9: How many customers have really left E*Trade? How expensive are the incentives being used to keep and attract client money? How is the quality of the home equity portfolio holding up?

By the early afternoon on Jan. 9, E*Trade's stock had given up the day's gains, putting the stock briefly below its 11-year low again. In the late afternoon, as the rest of the market rallied, E*Trade did, too. It ended the day up 15 cents, or 6.7%, to $2.40 per share. Since the beginning of the year, the stock is still down 32%. Since July, it's off almost 90%.

The Jan. 9 release might have stopped E*Trade's fortunes from sliding even further, but it looks like the company will have to provide a second helping of positive news later in the month to ease the market's worries.