E-Trade Shares Nosedive on Subprime, Downgrade

E-Trade Financialshares were trading sharply lower on Monday after a Citigroup analyst downgraded the stock, citing news Friday that the online brokerage had seen a significant deterioration in the value of its holdings of securities backed by home mortgages, and will take a writedown in the fourth quarter.

E Trade
E Trade

E-Trade said its $3 billion portfolio of asset-backed securities includes about $450 million worth of collateralized debt obligations and second-lien securities. The company did not predict how big its losses will be and withdrew its earnings guidance.

Also, E-Trade said the Securities and Exchange Commission opened an informal inquiry related to issues with E-Trade's loan and securities portfolios.

Citi Investment Research analyst Prashant A. Bhatia cut his rating on the stock to sell from hold and lowered his price target to $7.50 from $13. E-Trade shares were down 34% at $5.65 in recent premarket trading.

Bhatia said there's a 15% chance that E-Trade will declare bankruptcy and said management may be forced to sell loans and securities at significant discounts.

"The continued negative news flow about charges resulting from its mortgage and CDO exposure, an SEC inquiry, and continued deterioration in its financial condition, all increase the likelihood of significant client attrition," Bhatia wrote in a client note.

In a statement, E-Trade said it is "well capitalized by regulatory standards and is capable of adapting to shifting market trends. The management team is focused on serving our customers as we combat the market reaction to the irresponsible comments included in the recent Citigroup analyst report that has the potential to unnecessarily damage customers, shareholders and employees."

"We take exception to the sensationalism based on unfounded speculation," the statement continued. "We continue to grow our retail base, as demonstrated in the October monthly metrics we released today. We have been transparent with regard to our holdings and the associated risks. Addressing customer needs is our paramount concern and that is where our complete focus will remain. Our Customer assets will continue to be protected by FDIC and SIPC insurance."

CDOs combine slices of different kind of risk and are often backed partly by subprime mortgages, or loans given to customers with poor credit history. Bhatia said some of E-Trade's competitors have fared better and questioned E-Trade's leadership and how management is steering the company through its troubles.

"That peers have virtually entirely avoided the credit crisis, again highlights the flawed strategy and lack of credible risk management by E-Trade's senior executives and the board of directors," Bhatia wrote in a client note.

Bhatia said E-Trade may now have trouble keeping employees, noting that the company has seen an 8 reduction in its work force over the past two quarters. "The incentive for employees with options to remain at the firm may now be significantly lower," Bhatia wrote.

-- AP contributed to this report.