Some bad investments made before the subprime market took a turn for the worse in 2007 continue to cause trouble for E*TRADE Financial (NASDAQ:ETFC). During the recent strategic review of the firm, its huge legacy loan portfolio spooked potential buyers such as Ameritrade (NYSE:AMTD) and Charles Schwab Corporation (NYSE:SCHW), who seemed to prefer to stay away from the company’s risky balance sheet. E*TRADE recently announced that it has to pay $10.75 million to settle class action lawsuits filed in 2007 over losses from its mortgage and home equity loan portfolios. In October, the company agreed to return $100 million to investors whose funds are frozen in auction rate securities, along with a $5 million fine.  While these troubled loans will likely continue to be a cause for concern and overshadow earnings in the next few quarters, we expect that the company will still be able to deliver solid long-term results.
E*TRADE’s shares have lost almost 50% of their value since the beginning of the year. In July, Citadel LLC, the largest shareholder, pressed the company to hire an investment bank to perform a strategic review of the company’s operations. Citadel has lost a significant portion of its initial $2.6 billion investment, made in 2007 to save the company from potential bankruptcy, and had suggested a sale of the company as a possible alternative. The company’s peers showed little interest, likely due to the the mortgage portfolio that stood at $13 billion in September 2011, and the company decided to stay independent after the review.  Furthermore, E*TRADE has agreed to settle a shareholder lawsuit by paying $10.75 million out of a $79 million settlement amount, the remainder of which will be paid by insurers. The lawsuit was filed in relation to subprime-related losses in its portfolio of mortgage and home-equity loans.  This settlement charge will be recognized in the company’s Q4 financial statements and will thus reduce Q4 earnings.
Per the post-strategic review plan, the company is making a concerted effort to increase its client asset base. It has started offering commission-free ETFs and has arranged to sell 93 such ETFs by WisdomTree, db-X and Global X. It is also promoting long-term investing among its customers and is planning to revamp its related marketing campaign.  You can read the details of E*TRADE’s post-review plan here – ETFC Reveals its Post Strategic Review Plan
We believe that through these efforts, the company will accumulate interest earning assets of about $58 billion by the end of our forecast period, compared to $43 billion in 2011. Net interest on assets is the biggest source of value for the company’s stock, constituting 64% of the Trefis valuation despite the prevailing low interest rate environment.
Our price estimate for E*TRADE is $13, which is more than 60% ahead of the current market price.Notes: