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E-Trade slashes profit outlook, to restructure

E-Trade Financial Corp. on Monday slashed forecasts for 2007 profit as the discount brokerage exited the wholesale mortgage business because of a slew of bad home loans.
/ Source: The Associated Press

E-Trade Financial Corp. on Monday slashed forecasts for 2007 profit as the discount brokerage exited the wholesale mortgage business because of a slew of bad home loans.

The New York-based company, which in recent years relied heavily on mortgage lending to power earnings, warned an already jittery Wall Street that it is not immune to the tightening of global credit markets. E-Trade pinned the troubles to its $30 billion home loan portfolio on "significant deterioration in the mortgage market in August."

It set aside $245 million for bad loans during the second half, up from about $55 million during the first half of the year. Another $100 million would be set aside to write down troubled asset-backed securities.

The brokerage said it expects earnings per share between $1.05 and $1.15, compared with an earlier estimate of $1.53 to $1.67. The projections were well below the $1.60 per share expected by analysts polled by Thomson Financial and caused investors to sell off the stock in extended trading late Tuesday.

E-Trade — this year's worst performer in the Amex Securities Broker-Dealer Index — dropped 84 cents, or 5.9 percent, to $13.37. The stock, which had fallen 18 cents to $14.21 in Monday's regular session, is down about 36 percent this year.

Mitchell H. Caplan, E-Trade's chief executive, said the company does not have a liquidity problem. Many of these loans were third-party and were not linked to its own customers — but he does not see an end to the mortgage industry's implosion until 2009.

"What we're seeing in the marketplaces in respect to loans and securities is that this situation will continue aggressively through the later half of this year and all of next year," he told analysts during a conference call. "By the time you get to 2009, you will see things better on the macro-economic side — and by then we have dramatically transformed our balance sheet."

He said E-Trade will also record $32 million in severance and restructuring costs as it focuses the company on retail lending directly to customers. The company said the number of layoffs would be minimal.

E-Trade, along with the big Wall Street investment banks, have been squeezed as defaults in subprime loans have caused investors to become hesitant about taking risk. Dozens of home lenders have halted operations this year and are being slammed as housing prices continue to slide and an increase in defaults forced banks to tighten lending standards.

The news comes weeks ahead of E-Trade's scheduled third-quarter earnings report and gives a glimpse of what some of its Wall Street rivals might report in the coming days. Lehman Brothers Holdings Inc. will post its numbers Tuesday, followed by Morgan Stanley on Wednesday and results from Bear Stearns Cos. and Goldman Sachs Group Inc. on Thursday.

E-Trade, which also operates a bank that provides loans to customers, will continue to offer mortgage products. However, turbulence in the subprime market has hurt E-Trade's business of using its cash to buy third-party loans made by other lenders.

"It is not a subprime thing, the very small portion of subprime loans we have is performing well within expectations," R. Jarrett Lilien, E-Trade's president and chief operating officer, said in an interview with The Associated Press. "Really what is going on right now is your second mortgages, home equity lines of credit, and installment loans. That's really the issue where the market is deteriorating."

The brokerage has been expanding in recent years beyond just online trading and has built up its mortgage business to become one of the company's biggest earnings drivers.

Lilien said that as of the end of August, 2 percent of its $17 billion mortgage portfolio was comprised of delinquent loans. An estimated 2.8 percent of its $12.6 billion home equity portfolio is also considered to be at increased risk.

While exiting or restructuring these businesses, he said the company hopes to increase the portion of its balance sheet being driven by its own customers — moving away from buying third-party securities. He hopes that as much as 85 percent will come from E-Trade customers, up from 60 percent during the third quarter.

There has been speculation that E-Trade was having discussions with rival TD Ameritrade Holding Corp. about a possible combination. Caplan said he is still interested in pursuing a deal, and that turmoil in the mortgage industry "does not change our thinking at all."