3 Reasons to Sell E*TRADE Financial

Editor’s note: A previous version of this article erroneously characterized E-Trade’s earnings guidance.

There are always a multitude of reasons to sell any stock. But some are more worthy of investors' attention than others.

With this in mind, I've identified the three biggest reasons current investors in E*TRADE Financial (NASDAQ: ETFC  ) might want to consider offloading their positions.

1. It's time to take gains
Let's keep things simple: Shares of E*TRADE have nearly doubled in price since the beginning of the year even though, as I’ll explain below, the company’s sitting on large potential losses from its mortgage portfolio.

ETFC Chart

If that doesn't convince you, consider the fact that its shares now trade for almost 1.8 times tangible book value. That's roughly in line with the multiple you'd pay for Wells Fargo (NYSE: WFC  ) .

Now, you tell me, which would you rather own at that price?

2. Turnover at the top
Again, there's no reason to make this overly complicated. 

E*TRADE has had seven chief executive officers over the past six years. 

Most recently, Chairman and Interim CEO Frank Petrilli relinquished both roles at the beginning of this year -- the chairmanship to former Fidelity Investments President Rodger Lawson and the latter to previous Barclays Chief Operating Officer Paul Idzik. 

You do the math.

3. It's sitting on huge latent losses
E*TRADE's balance sheet is like the Ghost of Christmas Past.

According to its most recent 10-K, the carrying value of its home equity and residential mortgage portfolios was $9.3 billion. Meanwhile, the market value was $8.2 billion.

While it's accumulated roughly $420 million in loan loss reserves, the rest of that $1.1 billion will eventually have to come from somewhere -- unless, of course, E*TRADE's prayers come true and they miraculously recover in value.

To add insult to injury, most of the company's $3.6 billion in home equity loans are still in the interest-only phase of their life cycle.

What happens when principal payments start kicking in over the next four years? Your guess is as good as mine, but one would be excused for concluding that default rates will skyrocket.

Does this mean you should sell?
As a general rule, we are buy-and-hold investors here at The Motley Fool. Yet, I can't help but to be skeptical about E*TRADE's chances of heading considerably higher anytime soon. There's simply a limit to how much rational investors are willing to pay for its shares.

The most likely exit strategy for the brokerage company going forward is a third-party buyout. But is that something you're prepared to bet on? And if you are, do you think a suitor would pay a premium to 1.8 times tangible book?

I, for one, wouldn't bet on it.

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Read/Post Comments (8) | Recommend This Article (2)

Comments from our Foolish Readers

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  • Report this Comment On November 27, 2013, at 10:28 AM, tjones111 wrote:

    What a horrible article. Makes Motely Fool look bad.

    Sell because it is at a high? Really?

    He even outright lies, so his short position is clear.

    "even though the company is barely eking by and has warned investors that it will lose money for the foreseeable future."

    ESTIMATES ARE FOR .81 CENTS IN 2014

    Who can\should rad further from a clear liar.

    This is a paniced short, who is way over his head.

    ETFC mortgages are soon to be an asset, with 11% YOY gains in home values (3% in just the last quarter) , it is a short timeline to there being equity in ETFCs mortgage portfolio.

    Also, these people have been making mortgage AND HELOC payments for 10 years, again, 10 years, the number that default over not paying their HELOC loan will be small. Who is going to lose their 300k home by not paying their HELOC loan (and 2nd liens CAN force a forclosure). With home prices predicted to average 4.8 down to 3.5 over the next five years, there will be value in almost every heloc home.

    Again, this article makes Motely Fool look bad.

  • Report this Comment On November 27, 2013, at 1:12 PM, ellidyr wrote:

    This is a terrible article and sounds like it was written by an amateur.

    Selling because it's high?

    Comparing E*Trade to Wells Fargo?

    Come on now, Wells Fargo is a BANK, E*Trade is an online brokerage!!! They generate the majority of their revenue from commission on stock trades.

    If you want to compare E*Trade with anyone, compare them with their peers like Charles Schwab and TD Ameritrade. Why the HECK would you compare E*Trade with Wells Fargo?

    The author is also completely wrong on mortgage portfolio. The losses have been trending DOWN for quite a while now. 0-30 day delinquency (best measure of portfolio health) has dropped dramatically over the past few YEARS and will continue to drop. This is in line with the rest of the industry. Bottom line: housing's in recovery mode and has been for a few years now. The peak of the housing bubble occurred in 2006 and if people are worried about the 5 yr HELOC's, they would have hit the housing industry hard in 2011. If anyone has noticed, we're a month away from 2014.

  • Report this Comment On November 27, 2013, at 1:42 PM, tjones111 wrote:

    You beat me to it, I was just about to comment on the Wells fargo Tangible Book value comparison.

    So, he lies about "barely eking by and has warned investors that it will lose money for the foreseeable future"

    This is a 100% LIE.

    Then he compares a brick and mortar bank, with an online bank/online stock trading company for tangile assets.

    Horrible, horrible article. This guy should be embarassed, but of course he is not, he is short ETFC and desperate.

    Notice how over 2 articles there is no mention of the money being downstreamed from the bank, 100M last quarter, 75 Million this quarter and estimated to continue for at least a couple years.

    How it is going to be used to repay high interest debt, that will hit the bottom line in increased earnings per share?

    This ALONE will bake in great EPS growth all by itself, now add in regular growth and increased income if the fed changes policy and the spread returns to a more normal rate.

    ETFC has a LOT of upside left.

  • Report this Comment On November 27, 2013, at 2:17 PM, JohnMaxfield37 wrote:

    <So, he lies about "barely eking by and has warned investors that it will lose money for the foreseeable future">

    Here are a few quotes from ETFC's most recent 10-K:

    "We have incurred significant losses in recent years and cannot assure that we will be profitable in the future."

    "Although we have taken a significant number of steps to reduce our credit exposure and reported net income of $156.7 million for the year ended December 31, 2011, we likely will continue to suffer credit losses in 2013."

    "In late 2007, we experienced a substantial diminution of customer assets and accounts as a result of customer concerns regarding our credit related exposures. While we were able to stabilize our retail franchise during the ensuing period, it could take additional time to fully mitigate the credit issues in our loan portfolio, which could result in a continued net loss position."

    Also, regarding the mortgage portfolio, here are some quotes from the same document:

    "We will continue to experience losses in our mortgage loan portfolio."

    "The carrying value of the home equity and one- to four-family loan portfolios was $4.0 billion and $5.3 billion, respectively, at December 31, 2012. . . . The fair value of our home equity and one- to four-family loan portfolios was estimated to be $3.6 billion and $4.6 billion, respectively, at December 31, 2012, in accordance with the fair value measurements accounting guidance."

    Regarding the "short timeline to there being equity in ETFCs mortgage portfolio," I would consider two things.

    First, is it safe to assume that home prices will continue to increase at a double-digit rate going forward?

    Second, while the LTV ratio of ETFC's loan portfolios has indeed improved on the back of higher home prices, the average estimated LTV/CLTV on the home equity portfolio is still underwater. In addition, because these are predominantly second liens, having a marginal amount of equity isn't a break-even threshold, as loss severity should be taken into consideration.

    Regarding the point about 5-year HELOC's already "hitting the market," I'm not exactly sure what that means, but I'm guessing the implication is that ETFC's HELOCs are already all amortizing. But according to its most recent 10-Q, a full 80% of ETFC's HELOCs don't begin amortizing until 2015 at the earliest.

    Regarding my position in ETFC, as our disclaimer on the bottom of the article reads, I don't have a position in ETFC -- neither long nor short. I did used to be a customer and was, for the record, very satisfied with the experience.

    John

  • Report this Comment On November 27, 2013, at 2:34 PM, JohnMaxfield37 wrote:

    <Comparing E*Trade to Wells Fargo?

    Come on now, Wells Fargo is a BANK, E*Trade is an online brokerage!!! They generate the majority of their revenue from commission on stock trades.>

    For the first nine months of the year, ETFC generated 57% of its total revenue from net interest income. Only 24% came from commissions.

    By comparison, the contribution to WFC's total revenue from net interest income and noninterest income was split right down the middle at 50%.

    John

  • Report this Comment On November 27, 2013, at 2:51 PM, tjones111 wrote:

    Replies are as stupid as original post.

    1) "barely eking by and has warned investors that it will lose money for the foreseeable future"

    .81 cents a share is NOT eking by, nor is it losing money for the forseable future.

    Everything else you write is drivel. ETFC never said that they would have no losses in portions of their business, but you implied losses in their TOTAL business, which is a TOTAL LIE.

    2) Your wells fargo comments shows that you are clueless on what Tangible Book value is. Here is a clue, any idea why a brick and mortar bank would have more TANGIBLE assets than an online bank?

    You should get out of your short now. Wait till ETFC buys back its debt and that hits EPS. Year after year.

  • Report this Comment On November 27, 2013, at 3:11 PM, JohnMaxfield37 wrote:

    <<Your wells fargo comments shows that you are clueless on what Tangible Book value is. Here is a clue, any idea why a brick and mortar bank would have more TANGIBLE assets than an online bank?>>

    WFC's property plant and equipment is equal to 5.5% of total shareholders equity. ETFC's is equal to 5.1% of total shareholders equity.

    Excluding intangible assets, WFC's property plant and equipment is equal to 6.4% of tangible shareholders equity. ETFC's is 8.7%.

    Also, for the record, the primary subsidiary of ETFC (which is a holding company) is a bank.

    John

  • Report this Comment On November 27, 2013, at 3:27 PM, tjones111 wrote:

    I have a hard time even bothering to read anything you write after the outright lie of "barely eking by and has warned investors that it will lose money for the foreseeable future".

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