Investors Pummel E*Trade on Lower Profit Warning

Shares of E*Trade plummeted more than 50 percent Monday after the online stock brokerage firm backed down from previously announced profit targets, said it would be forced to take more write-downs due to its exposure to the subprime mortgage industry and disclosed it was being investigated by the Securities and Exchange Commission (SEC).

E*Trade’s asset-backed securities holdings, valued at around US$3 billion, had suffered substantial declines, especially those tied to the mortgage industry, the company said. About $450 million of that fund was tied to such securities, including $50 million of which was downgraded to below investment grade, E*Trade said.

The Web brokerage backed down from its earlier forecasts for the fourth quarter and said it would not update its guidance for the time being.

Rattling Investors

On Oct. 17, E*Trade said it would earn between 75 and 90 cents per share for the full year of 2007, numbers that it is now asking investors to disregard.

“Investors should no longer expect these earnings levels to be achieved,” E*Trade said. “Actual securities-related losses will depend on future market developments, including the potential for future downgrades by rating agencies, which are extremely difficult to predict in this environment. Accordingly, management believes it is no longer beneficial to provide earnings expectations for the remainder of the year.”

In addition to that disclosure, investors were also rattled by a research note from Citi Investment Research analyst Prashant Bhatia, who not only cut the company to a “sell” rating but said there is a 15 percent chance E*Trade will have to declare bankruptcy. The brokerage will be forced to sell loans and related securities in its portfolio at a significant discount in order to stem losses, the analyst said.

E*Trade shares were down 54 percent in late morning trading to $3.87. The stock traded as high as $26 per share as recently as May but has been steadily losing value since July amid the turmoil in the overall financial markets.

Investigation Revealed

E*Trade also disclosed that the SEC had opened an informal inquiry into the company’s portfolio of loans and related securities. E*Trade said it is cooperating with the investigation, which it said it learned of on Oct. 17. It did not provide any additional information on the inquiry.

E*Trade’s falling fortunes come in contrast to the rise of rivals such as Ameritrade, whose stock rose 6 percent Monday amid a rebound in financial services stocks in general.

Investors have been aggressively pushing for Ameritrade and E*Trade to merge to create a more stable company, but the uncertainty about the true value of E*Trade’s mortgage portfolio may keep would-be buyers at bay for the time being.

Though U.S. stocks have been through a rough patch lately, the recent volatility on Wall Street is generally seen as a positive for brokers such as E*Trade, who see revenue rise as investors sell shares or buy distressed stocks. In October, for instance, E*Trade said Monday, the total assets in customers accounts rose 4 percent compared to the month before.

E*Trade’s latest woes are a direct result of the brokerage’s long-ago decision to diversify aggressively, said Forrester Research analyst Bill Doyle.

“E-Trade moved aggressively to diversify and offer a more complete portfolio of products,” Doyle told the E-Commerce Times. “Given the volatility of the stock trading market and online trading in particular, they felt they need to be better insulated from those ups and downs.”

E*Trade pushed beyond its Web roots to open brick-and-mortar banks and investment storefronts nationwide around the time of the dot-com collapse. More recently, it invested heavily in the mortgage market as the housing boom drove up prices across the country, tripling its exposure to the mortgage market not long before the subprime problems began to arise.

Sharing the Pain

In recent weeks, more of the technology sector has been impacted by the subprime mortgage sector fallout and the housing downturn in general. While the malaise over the housing and mortgage sectors had been seen as contained for some time, both IBM and Cisco Systems cited weakness among financial services customers in terms of information technology spending as a factor in their quarterly results and future forecasts.

A range of companies, especially those exposed through investment to the mortgage security sector will feel the impact of the subprime fallout before it’s over, Peter Cohan, president of Peter S. Cohan & Associates, told the E-Commerce Times.

“The fallout is spreading wherever subprime mortgages have been bought,” Cohan said. While Wall Street banks and mortgage companies have been among the hardest hit, they are far from alone, with hedge funds, insurance companies, pension funds and private equity firms also suffering.

Public companies are showing the impact more readily because they must publicly disclose their write-downs, he noted. “I think hedge funds will get hit but their disclosure will be hard to discern. Same thing for pension funds and privately held private equity firms,” Cohan added.

A concern for E*Trade is that its customers continue to trust the company with their savings, especially amid an already turbulent stock market. “A drop in the stock price this severe could prompt retail trading customers to withdraw cash from their accounts,” Lehman Brothers analyst Roger Freeman wrote in a research note on Monday.