How E*Trade Is Trying to Survive in the TARP Era

E*Trade (ETFC) may end up the only major financial services company to make it through the financial crisis without any help from the government’s Troubled Asset Relief Program (TARP). But that won’t be from a lack of trying.

In the company’s latest move to shore up as much cash as possible, E*Trade this past week sold a higher-than-expected 435 million shares, netting the online broker $478.5 million in an offering discounted at 23 percent to Thursday’s closing share price.

And that’s only the first part of the capital raising. In the second part, E*Trade is swapping up to $1 billion of new zero-coupon convertible debt for all its senior notes paying 8% interest, and some 12.5% notes. In other words, E*Trade is giving away nearly credit-card sized interest payments in order to stave off the worst case scenario.

Hedge fund Citadel, which is E*Trade’s largest outside investor, is expected to participate in the debt exchange to the tune of $800 million.

The offering is somewhat of a last resort for the beleaguered broker. Back in November, E*Trade gleefully announced that it would be accepting $800 million from the federal government in TARP payments. But that money failed to materialize when Treasury deemed the company insufficiently illiquid to take on aid. Ever since, E*Trade has been praying and waiting for TARP approval.

The problem for E*Trade is that while it looks as if it is in better shape than large banks loaded with toxic assets such as Citigroup (C) or Bank of America (BAC), it’s not that much better off. There is still a lot of bad debt residing on the balance sheets. Hence the desperate capital raising rounds.

Despite the woes, having one of the world’s largest hedge funds behind it has certainly helped. Further, ask around the investing community, and you’ll find a host of speculators who think that E*Trade is the next “five-bagger,” a term used for stocks which have the likely potential to increase by five times or more in value.

And arguably, not accepting TARP funds (albeit through not being allowed to) may mean that the broker didn’t suffer the unintended consequences of doing so, such as disincentivizing key employees by introducing ludicrous long-term performance-linked salary structures. In May, E*Trade shareholders voted down a proposal by the company to tie executive bonuses to long-term performance goals.

There’s some support for E*Trade’s methods in cobbling together the money it needs, too. The Motley Fool’s Rick Munarriz likes the latest capital-raising structure:

The stock offering will arm the company with greenbacks, while swapping out notes for zero-coupon bonds will help it preserve greenbacks by reducing its interest-expense exposure. This probably won’t be enough to make E*TRADE profitable … but it’s a step in the right direction.

At the end of the TARP era, E*Trade may indeed serve as an example for many economists of how banks ought to have been forced to act once they discovered their woes: selling down nonessential assets, paying a premium for liquidity, and squeezing operating costs. And the fact that E*Trade has had to do that where rivals haven’t may ultimately make it more durable and more competitive.

E*Trade is not being shown much compassion by the Treasury Department today, but one day, it might silently thank policymakers for the tough love.

Comments

[Nyetnichevo:]

Must have horrible management to have run the company into the ground thus costing their shareholders much pain and loss. Now dilution. Hard to believe the executives at this company could be so stupid and reckless, but they are. I'll pass on the cheap shares.

Jun 21 09:18 AM

[msoori:]

"And arguably, not accepting TARP funds (albeit through not being allowed to) may mean that the broker didn’t suffer the unintended consequences of doing so, such as disincentivizing key employees by introducing ludicrous long-term performance-linked salary structures."

These KEY employees who are paid regardless of their performance is the problem. If disincentivizing these KEY employees is a problem, I guess some one needs to ask the question, where will they go? With the whole economy hanging off a cliff due to the risks taken by these KEY employees, they have no place to run and hide. Its time the compensation is tied to their long term performance.

Jun 21 09:48 AM

[Pj568:]

With all the capital restructuring going on it makes me wonder if there is a future big hit on the horizon.

Does anyone know the tax area well enough to comment on whether they might be required to establish large tax valuation account to reduce the 1B in deferred tax assets now carried on the balance sheet?

Jun 21 12:30 PM

[22thoroughbred:]

I bought (so far) 100 of the Jan $2.50 calls for Jan 2011..I will also buy some $5 strikes once the bond deal is done, for about .30, than I have just over 18 months for the company and the sector to resolve their issues, than if it is a 5 bagger, and does go to $7 my $2.50 calls will go from .50 to $5.00...good luck

Jun 21 02:18 PM

[Daniel Harr...:]

The calls are definitely good value, and the long-dated out-of-the-money solution seems like a sensible way to go. But you know, if taking that kind of bet, I'd also get some underlying stock (margined if you want some juice). That's because with a Beta of 2, for me that may not be enough reassurance for the stock to rebound some 600%, but it is enough for me to be comfortable that the stock may come back 300% - 400%, for instance.

You'll kick yourself if you're just in options and 20 cents shy of the strike on op-ex. That's just my opinion, of course.


On Jun 21 02:18 PM 22thoroughbred wrote:

> I bought (so far) 100 of the Jan $2.50 calls for Jan 2011..I will
> also buy some $5 strikes once the bond deal is done, for about .30,
> than I have just over 18 months for the company and the sector to
> resolve their issues, than if it is a 5 bagger, and does go to $7
> my $2.50 calls will go from .50 to $5.00...good luck

Jun 21 02:50 PM

[ain't no fo...:]

As one of the people who opened up new accounts with E*Trade in August 2007, who used the FED WIRE from my local bank to wire in funding to my account, and who then immediately had a 12 day restriction slapped on my account (despite the fact that if Fed-wired funds are received before 3:00 p.m they are eligible for SAME DAY withdrawal, no ifs and or buts, that's SEC law), and who then spent over a week getting lied to by representatives of that company as to the reason the funds were restricted while I watched the stock market crater, E*Trade stock crater worse, and David Faber come on CNBC daily to talk about the people calling in to complain (denied by E*Trade management) that THEIR new accounts had been restricted by E*Trade - AND YES E*TRADE I WAS ONE OF THEM!!!!!!! - and thinking I might never see that money again for a very very long time (and why did they want my money tied up in their system in the first place hmmmm????) if they really went down, well, I for one have a secret little hope about what E*Trade's final destination is... and its very HOT down there.

Jun 21 03:28 PM

[Daniel Harr...:]

That's a valid criticism, and thanks very much for the insight (it's worthy of an entire post in itself, in fact). Customer service experience has to be top-notch for E*Trade to prosper, I agree.


On Jun 21 03:28 PM wpdragon wrote:

> As one of the people who opened up new accounts with E*Trade in August
> 2007, who used the FED WIRE from my local bank to wire in funding
> to my account, and who then immediately had a 12 day restriction
> slapped on my account (despite the fact that if Fed-wired funds are
> received before 3:00 p.m they are eligible for SAME DAY withdrawal,
> no ifs and or buts, that's SEC law), and who then spent over a week
> getting lied to by representatives of that company as to the reason
> the funds were restricted while I watched the stock market crater,
> E*Trade stock crater worse, and David Faber come on CNBC daily to
> talk about the people calling in to complain (denied by E*Trade management)
> that THEIR new accounts had been restricted by E*Trade - AND YES
> E*TRADE I WAS ONE OF THEM!!!!!!! - and thinking I might never see
> that money again for a very very long time (and why did they want
> my money tied up in their system in the first place hmmmm????) if
> they really went down, well, I for one have a secret little hope
> about what E*Trade's final destination is... and its very HOT down
> there.

Jun 21 03:33 PM

[ain't no fo...:]

Clarifying "AND YES E*TRADE I WAS ONE OF THEM!!!!!!! statement - I did not call CNBC or anyone else except E*Trade personnel to complain... I simply meant I was one of the people who had been restricted.

What they did to us that week was reprehensible, egregious, despicable, and the only positive thing that came out from the experience was that I developed a first hand knowledge of just how terrible things were in the financial markets, that people were in such financial trouble that they were grabbing cash anyway they could get it to paint their books so their counter parties didn't find out the truth, that there were some horrifying things lurking under the surface of Wall Street, and that alone made me incredibly suspicious and cynical of anything coming out of the Street, and so I became very disbelieving and short term trading oriented - probably the only reason I survived the next 18 months worth of market collapse.

So thanks E*Trade, if you hadn't shown me the light I might have been one of the sheep who got sheared by believing the great LIE that was the financial industry.

Jun 21 03:41 PM

[ain't no fo...:]

Daniel, that restriction wasn't a customer service situation - they were just the stooges who were on the front line taking the calls.

A restriction like that, which included temporary changes to the website that disappeared as soon as the company COO had to make a public statement of denial on the following Thursday (Aug 16 ) came from a lot higher up than "customer service".

Jun 21 03:48 PM

[Swashbuckler:]

With the cute little stunt cited above by the dragon, I'm surprised E*trade hasn't been sued back to the stoneage. My hunch is that there have probably been other instances of "wonderful" customer service like that discussed by CNBC and wpdragon. Sometimes people get what they deserve, and E*trade may get theirs before the economic picnic has run its course (my guess, at least another year or two).

Jun 21 07:10 PM

[ain't no fo...:]

I could go on with all the gory details... but for now I won't. It was the scariest week in a 30 year investing life and I figured at best I'd be ending up in SIPC phone queue lines for months trying to get a real voice to give me my money back. Like I said it put the capper on my impression about how bad things were under the surface on the Street and ironically kept me very suspicious (and relatively safe) as the whole bubble started to unwind that Fall amidst Bernanke and Paulson's cheerleader stunts and all the denial aisle BS.

DJIA traded in 700 point range that week, as everybody finally started to figure out things were BAD - it hadn't done that in a whole Qtr usually. ETFC on the week traded between upper 16's and 9.92 on the low on Thursday the 16th when the COO came out and made his public denial.

That was all I needed... he flat out said they weren't restricting new account withdrawals. I was flabbergasted by that statement, but it was also the best thing for me because I knew they couldn't prevent me from getting my cash out or I'd have been at CNBC, WSJ, SEC, every other media and govt office I could think of, with plenty of documentation. I called them Friday at 7:00 eastern and got a CSR who was oh so apologetic - "oh we're so sorry for our mistake Mr... it certainly wasn't intentional, we hope you'll stay as a customer. "

Yuh, right. Wire the money right now lady... which she did. When that wire showed up on my online bank screen that Friday afternoon I was one relieved SOB.

On Jun 21 07:10 PM Swashbuckler wrote:

> With the cute little stunt cited above by the dragon, I'm surprised
> E*trade hasn't been sued back to the stoneage. My hunch is that
> there have probably been other instances of "wonderful" customer
> service like that discussed by CNBC and wpdragon. Sometimes people
> get what they deserve, and E*trade may get theirs before the economic
> picnic has run its course (my guess, at least another year or two).

Jun 21 08:51 PM

[Swashbuckler:]

Glad you got your money back. Such a shame that in a 30 year investing life,the scariest week is NOT the P&L of your investments, but instead having to worry about whether a POS company will return YOUR money to you.


On Jun 21 08:51 PM wpdragon wrote:

> I could go on with all the gory details... but for now I won't. It
> was the scariest week in a 30 year investing life and I figured at
> best I'd be ending up in SIPC phone queue lines for months trying
> to get a real voice to give me my money back. Like I said it put
> the capper on my impression about how bad things were under the surface
> on the Street and ironically kept me very suspicious (and relatively
> safe) as the whole bubble started to unwind that Fall amidst Bernanke
> and Paulson's cheerleader stunts and all the denial aisle BS.
>
> DJIA traded in 700 point range that week, as everybody finally started
> to figure out things were BAD - it hadn't done that in a whole Qtr
> usually. ETFC on the week traded between upper 16's and 9.92 on the
> low on Thursday the 16th when the COO came out and made his public
> denial.
>
> That was all I needed... he flat out said they weren't restricting
> new account withdrawals. I was flabbergasted by that statement, but
> it was also the best thing for me because I knew they couldn't prevent
> me from getting my cash out or I'd have been at CNBC, WSJ, SEC, every
> other media and govt office I could think of, with plenty of documentation.
> I called them Friday at 7:00 eastern and got a CSR who was oh so
> apologetic - "oh we're so sorry for our mistake Mr... it certainly
> wasn't intentional, we hope you'll stay as a customer. "
>
> Yuh, right. Wire the money right now lady... which she did. When
> that wire showed up on my online bank screen that Friday afternoon
> I was one relieved SOB.
>
> On Jun 21 07:10 PM Swashbuckler wrote:

Jun 21 09:05 PM

[Al the pal:]

The really sad part is that because of their cute little commercials that there are still people who beleive that this is a viable company when the sad but true facts clearly show that the ongoing loan losses will continue well past the money they just raised through the stock offering and that ETFC will need additional new funds in the future or it will be facing a takeover by the OTS again. This whole secondary offering came rather quickly after Griffin from Citadel put him on the board because it was zero hour.

For those buying the out of the money call leaps, (not that I am advocating going long ETFC but only for those eternal optomists that think this is a viable company) but why don't you invest your money more wisely? Anyone with half a brain would be able to see that you can still buy the shorter maturity bonds at close to par and that you can turn them into the new convertible bonds, that are actually in the money right now and good for a lot longer than your shorter term leaps.

Jun 21 10:32 PM

[ain't no fo...:]

Let's just say that last Fall didn't exactly come as a surprise to me, and you're right, it became return OF capital rather than return ON capital long before that, so I was prepared... the greatest show on earth.


On Jun 21 09:05 PM Swashbuckler wrote:

> Glad you got your money back. Such a shame that in a 30 year investing
> life,the scariest week is NOT the P&L of your investments, but
> instead having to worry about whether a POS company will return YOUR
> money to you.

Jun 21 10:32 PM