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Citi Investment Research analyst Prashant Bhatia, a longtime critic of E*Trade (NASDAQ:ETFC), has slashed his rating on the bank in a report Sunday headlined, “Bankruptcy risk cannot be ruled out.”

Following Friday’s news of an SEC investigation, further mortgage-related losses and the withdrawal of earnings guidance, Bhatia wrote, “The continued negative news flow about charges resulting from its mortgage & CDO exposure, an SEC inquiry, and continued deterioration in its financial condition, all increase the likelihood of significant client attrition.”

He also said:

Management lowered its earnings guidance for the 5th time in 8 months and now management believes that it is no longer beneficial to provide earnings expectations for 2007.

The extent of poor risk management in our view, has put the viability of the franchise at risk.

Compared to management, the more relevant constituents at this point are the BOD, the auditors and the regulators. Most important is, how clients will react.

This story will likely evolve Monday. As I wrote Friday, a key part of this story is that E-Trade had insisted its loans were high quality. As President Jarrett Lilien told MarketWatch’s Murray Coleman on October 17: “Our issue is that the value of high quality loans is underperforming.”

Source: E*Trade Bankruptcy Can't Be Ruled Out - Citi