E*Trade: Why the Strange Earnings Report? 25 comments
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E*Trade (ETFC) financial reported results on 4/28/2009 after the market close.
However, something is really strange at E*Trade. By all means, E*Trade had spectacularly good numbers to report -- you heard it right -- the numbers were spectacularly good and indicated that E*Trade had clearly turned a major corner.
Yet, the spectacular numbers were presented with a major negative twist that led to a huge negative move in stock price and media headlines.
To understand these contradictions, first let us look at the numbers. It is important to compare Q1 numbers against Q4 numbers to see the tremendous progress E*Trade has made. Q4 numbers can be accessed here.
Let us first look at loan performance.
| 2008-Q4 | 2009-Q1 | |
| New delinquencies | ||
| HELOC | $126M | -$25M |
| 1-4 Family | $324M | $282M |
| Total (includes other loans) | $452M | $266M |
| Charge-offs: | ||
| HELOC | $227M | $245M |
| 1-4 Family &nbs... | $57M | $67M |
| Total (includes other loans) | $306M | $334M |
As seen above, new delinquencies are much less than the prior quarter. And indeed, in their HELOC, which is the most risky portfolio, the delinquencies have DECREASED.
Now let us look at income.
| 2008-Q4 | 2009-Q1 | |
| Interest Income | $274M | $278M |
| Non-Interest Income | $212M | $218M |
| Total revenue | $486M | $497M |
Once again -- each segment income increased; which is spectacular given a difficult interest rate and trading environment where other OLBs have seen decreased revenues.
Even E*Trade's expenses looked good.
| 2008-Q4 | 2009-Q1 | |
| Operating expense | $321M | $294M |
So, so far, all numbers are spectacular and show a company that has turned a corner and performing much better on all fronts.
Until we consider the "New Provisions".
| 2008-Q4 | 2009-Q1 | |
| HELOC | $369M | $230M |
| 1-4 Family | $117M | $190M |
| Total | $513M | $454M |
My thesis here is that provisions on 1-4 Family are excessive given the trend in delinquencies and given prior provisioning ratios on this portfolio. Let me explain why.
On December 31, 2008, 1-4 Family new provision was $185M. Total 1-4 Family delinquent loans at that time were $1187M. Which is a ratio of 15.58% -- which is quite reasonable given that these are 1st lien loans with good recovery ratios.
For Q1 2009, E*Trade took a $67M charge-off on 1-4 family portfolio and new delinquencies were at $282M. Against this, E*Trade took $190M in new provisions. This is a ratio of 54.44% of new delinquencies + charge-offs against the provisions. The same ratio was 30.7% in Q4 2008. New provisions on 1-4 Family loans could have been $10M to $50M lower and still be considered conservative.
In general, excessive provisions are a good thing, but if that is coming at the cost of substantial shareholder dilution, it is not a good thing.
The reason I say this over-provision is coming at a substantial dilution is as follows:
- $454M provision caused E*Trade to miss consensus estimates by ONE cent. Consider the impact on stock price if the media headlines were "E*Trade meets analyst expectations" Vs. "E*Trade missed analyst expectations". Clearly the stock tumbled after hours. If the provision was reduced by mere $5.7M, E*Trade would have met analyst estimates.
- Along with missing by one cent, E*Trade announced that they have to do a equity raise quickly because OTS is asking them to do it and it may result in "substantial" dilution to current shareholders. This was the main factor that sent the stock down.
Clearly, missing the target by one cent by over-provisioning, followed by announcing that we need to do an equity offering at substantial dilution to current shareholders is sure to result in the share price dropping. If the equity offering is not concluded already, this is like offering potential new shareholders of E*Trade even a larger stake in company at the cost of current shareholders due to reduced share prices.
In addition, in the conference call, management stated that they have chosen NOT to take advantage of new mark to market rule revisions. The question then becomes, "Shouldn't ALL other measures of balance-sheet improvement be exhausted BEFORE leading down the path of shareholders dilution?"
What is truly concerning is the timing of this announcement, which seems to be when E*Trade is close to its lowest price and its business is thriving and its loan portfolio is turning a corner for better days.
As a long-term E*Trade customer and a shareholder, I am sincerely hoping that:
- ALL alternative means of improving balance-sheet (including mark-to-market revisions) are exhausted fully before any dilutive equity based capital raising.
- All such equity raising is done above the table with full opportunity provided to current shareholders to participate in it.
After doing a commendable job as E*Trade CEO, I hope Mr. Don Layton and Partner Citadel (Citadel was referred to as partner in the conference call yesterday) continue to look after the interests of other shareholders of this great company.
By the way, kudos on Mobile E*Trade Pro for iPhone.
Disclosure: Long E*Trade Financial.
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> I'm guessing that their equity partner is going to be Citadel and
> that Citadel is going to get a BIG chunk of the company for a song.
> Layton and company want to make the strongest case for the need for
> an equity partner so the stock holders don't feel too ripped off
> I'm guessing Citadel is going to get 2/3 of the company for about
> 2 billion dollars.
That does not sound right. If they had taken a mere $5.7M less provisions they would have met earnings estimate. That would be FIRST time since the whole crisis begin in August 2007. Along with that, if they had talked about great improvements on all fronts, the stock would be at $3 or higher today instead of $1.60.
If this drive down of stock price leads to greater ownership by Citadel or any other private investor; this should be considered violation of fiduciary duties towards current shareholders of E*Trade. I do not mean to cast doubt about CEO's intentions. He has done a great job in steering this company back to path of success. And I hope he has best interest of current shareholders at heart. I also hope that our regulatory and legal systems are strong enough to protect against such actions.
E*Trade is the only company in financial markets which has die-hard fans (similar to Apple in hi-tech). I am hoping for this company to come out of this with flying colors and stronger than ever to the benefit of all stakeholders.
What a betrayal of trust! People put their hard-earned money to support ETFC and Layton chooses not to declare a profit?
It's a shame. I always thought of him as a man of honor.
They do need equity to please the bank regulators. It doesn't really matter how they spin the numbers they are going to need the money either this quarter or the next. However this is the worst time to be looking for equity in the marketplace. If the stock is at $3 a share Layton may feel it is overvalued considering their circumstances and at a price that makes getting equity at a dilution acceptable to stockholders impossible. I think the Citadel offer may be the best one they can get. Remember they have a $2 billion dollar investment in Etrade they need to protect.
They do need equity to please the bank regulators. It doesn't really matter how they spin the numbers they are going to need the money either this quarter or the next. However this is the worst time to be looking for equity in the marketplace. If the stock is at $3 a share Layton may feel it is overvalued considering their circumstances and at a price that makes getting equity at a dilution acceptable to stockholders impossible. I think the Citadel offer may be the best one they can get. Remember they have a $2 billion dollar investment in Etrade they need to protect.
"That does not sound right. If they had taken a mere $5.7M less provisions they would have met earnings estimate. That would be FIRST time since the whole crisis begin in August 2007. Along with that, if they had talked about great improvements on all fronts, the stock would be at $3 or higher today instead of $1.60. "
Not quite. They could have said whatever positive they wanted but an equity raise at these levels is bad news. Especially when you factor in the massive run this thing had going in to earnings for no apparent reason. It is still 200% higher than its March low but I for one was quite unhappy to hear they will be selling equity after being assured numerous times that a.) TARP was a lock and b.) even without TARP, "we're fine."
I have been with ETFC as a customer since 2006 and a shareholder late 2007. I was lucky enough to have sold most of my position off before earnings after the inexplicable run it had, but I dumped the rest today. Not happy.
I may consider it again when more details emerge, but this looks anti-shareholder to me.
MM
In all cases, these reasons for equity raising raises serious doubts as to the intentions of management in a down market. If it boils down to ownership protection (common shareholders) versus management and minority shareholder interests, no matter how much you may like the underlying the results most likely will end up very bad for the stock price.
It's a pity because at these prices the stock looks attractive on its own merit excluding further dilution and management politics.
At the parent level E-Trade owes $2 billion in 12.5% notes, much of that to Citadel. Any conversion of this debt to equity would devastate current shareholders. Referring to Citadel as a "partner" in the conference call also makes me nervous.
There was a concerted effort to drive all these companies into the ground and sweep up the pieces for nothing, but it didn't work in all cases. It was pretty successful with Bear Stearns, Lehman, Merrill Lynch, Indy Mac, Wachovia, Washington Mutual, and others. But our government was finally forced to intervene --- to save our system, our government, and our very country. That's the level the game was played to, and our government finally blinked in order to save itself. Much to the dismay of those desiring to pick up even MORE great companies for nothing. (Thinking maybe Goldman Sachs and mostly JP Morgan here.)
But alas, too many small-time investors never gave up the faith and continued to buy these great companies all the way into the dirt. And not being content that no-name investors should be able to realize thousand-percent returns on their investment after the situation was stabilized, those who manipulate the markets have now fallen back to their next-best method of controlling who gets to make how much money --- shareholder dilution.
Everybody is in on it. Our government (using taxpayer money), the big-money guys on Wall Street, and corporate management of the remaining companies (oft under duress or threat of removal). If E*Trade is to go up 1,000 percent from here, then it will only be allowed to do so after the "right" people own most of the stock.
So the company books and reports losses which don't exist, and our government "insists" they raise new capital (IMMEDIATELY!) when it's not needed (while refusing to allow them to participate in TARP although all the right companies who made the right contributions to the right politicians get TARP money), and then somebody swoops in to "save the day" and take a huge chunk of the company from its current owners for pennies on the dollar through dilution.
They wanted it all, but they'll settle for 80 or 90 percent if our government makes them.
But look at the bright side. We've found the true bottom. And while they're going to make 1,000 percent on the way up, those who endured the pain to this point will get to go along for the ride (with their seriously-diluted stake, of course!).
:)
What's that? Paranoid? Who? Me?
;)
I have been holding this stock for so long and to see a 1 cent miss when there was no reason for it says they planned it that way. This is looking criminal - NOT in the best interest of shareholders. Also, why in the world are they being pressured to raise capital now???? This also sounds like someone is pulling strings to force E*Trade to harm current shareholders and get a greater stake in the company at a ridiculous price. Being forced to raise capital when they are doing so much better really smells like something is going on.
seems to me you are clearly mischaracterizing Schwab's comments in response to a question???
""If the time of a willing seller came along we would be there as a player, but more on our terms," Charles Schwab, the company's founder and chairman, said when asked the brokerage's strategy if regulators were to force E*Trade to sell part or all of its business.
"We're not hostile, we want a willing seller," Schwab said of his firm's acquisition strategy in general, adding an acquisition was not necessary to increase market share."