What If E*Trade (ETFC) Is Worth Zero?

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E*Trade (NASDAQ: ETFC) is making its non-executive chairman Donald Layton CEO today. The move is puzzling since he is a former vice chairman of JP Morgan (NYSE: JPM). He was "installed" in his chairman’s job when Citadel Investment Group dumped $1.75 billion into ETFC to save it from Chapter 11. The financial company’s mortgage portfolio was failing, dragging the entire operation down.

According to The Wall Street Journal "Citadel has nearly a 20% stake, and tapping Mr. Layton is a sign Citadel is getting antsy for results." Aside from its discount brokerage business, E*Trade has $12 billion in home equity loans. Based on most economic data, those loans are losing value every day.

Citadel may want to sell the discount brokerage business to one company, perhaps TDAmeritrade (NASDAQ:AMTD) and the mortgage business to another buyer, probably a fund which would pick it up at a big discount.

The trouble with the idea is that it is not clear that the value of the two pieces of the company add up to better than zero.

Last June, E*Trade was worth over $26. It now trades for a little over $4. But, investors cannot see into the balance sheet of the brokerage, so there is no way to tell what the actual value of the company may be. Its market cap is less than $2 billion.

The home equity portfolio which the company owns is almost certainly dropping in value as each week passes and mortgage defaults rise. Almost every sign points to the fact that housing is getting worse and not better.

Much less than a year ago, the market thought Citigroup (NYSE: C) was worth $250 billion. That number quickly fell to $123 billion, a sign that valuing large financial institutions with complex balance sheets can lead to huge dislocations between perception and reality.

E*Trade may be worth nothing. With the discount brokerage firm tethered to the mortgage business, the firm may appear to have a value. Break those things apart and the curtain gets opened on what the company actually faces as write-downs.

Douglas A. McIntyre