Comments on: Reader Mailbag – Is E*Trade a Bargain?

By: Chad Brand

Chad Brand — Mon, 01 Oct 2007 12:31:00 +0000

Well, the bankruptcy issue has already been covered in prior comments, and I'm not going to resort to trading personal attacks back and forth from readers, but I will comment on the last post about E-Trade's exit from the wholesale mortgage business.

In my view, it is pretty obvious why lenders are choosing to exit the wholesale area (E-Trade is not the first, Capital One and others have announced similar plans). Wholesale morgtages open up lenders to two risks that they have little to no control over.

First, since they don't originate the loans themselves, they can't control how loose the lending standards are. Second, since these loans are of lesser quality, they are sold to investors, but the secondary market might not be cooperative (again, something beyond their control).

Exiting the wholesale business reduces the riskiness of their lending operation. Doing so allows them to focus on doing high quality loan originations themselves. They will avoid the secondary market because those types of loans are the ones they choose to keep on their balance sheets anyway. After all, a lender is going to hold onto their best loans and sell their riskier ones.

It's true there will be a one-time hit from the wholesale business they've already done, but long term stability is what they are looking for in making that move.

By: Anonymous

Anonymous — Sat, 29 Sep 2007 21:16:00 +0000

One point about mortgage vintage, E*Trade’s recent vintage makes them more at risk, not less, since they were lending money at the top of the market, and in most case, no doc, stated income.. $12 Billion of their mortgages are 2nd liens – the riskiest of all.
And, most of what they were loaning were wholesale, not even underwritten by them. They were buying tons of stuff from NCC, which are widely regarded as having made some of the worst loans around.

All the evidence you need is that E*Trade has now sworn off much of the loan business that they are stuffed to the gills with. If these loans were so low-risk, how come they are exiting so fast from that business?

By: Anonymous

Anonymous — Sat, 29 Sep 2007 20:53:00 +0000

I can't believe the E*mperor Has Clothes! defense here. E*Trade is naked under just $4 Billion of Net worth. If 10% of their loans have to be written off -- not at all an unlikey amount -- the current shareholder equity becomes zero, which means current shareholders' own nothing but a company that has no book value. Not good.
If they go into Bankruptcy to reorganize/re-capitalize, current shareholders will get nothing.
Sure, the brokerage business probably stays in business through bankruptcy, and clients are not at risk...but current shareholders will be wiped out. Pretty basic stuff here.

Why is this so hard for some of you to see?
Buffett's "Be greedy when others are fearful...etc." is dangerous advice when overly simplified and applied to all stocks, regardless of investment merit. You think he was out buying Enron or Worldcom when "others were fearful"?

Chad, nothing personal, son, but you have a long ways to go to have a real claim on any stock market wisdom. Unfortunately, you're a sign of the times.

Original anonymous.

By: Chad Brand

Chad Brand — Fri, 28 Sep 2007 17:20:00 +0000

Well, I suspect E-Trade's vintages aren't that much different than other lenders. 2006 is still the most prominent vintage year for them (~40% of the total), but I could see them having taken share in 2007 (~20% of the total) while other lenders were pulling back a lot quicker due to liquidity issues. So, I doubt they are terribly different in those terms, but perhaps moreso this year.

An interesting point about the resets though. Countrywide has said publicly that ARM resets actually aren't the main reason borrowers are behind on their payments or in foreclosure. The bigger reasons are job/income loss, medical bills, etc. That suggests that ARM resets aren't even as big an issue as low income borrowers not being able to maintain income levels high enough to pay their mortgage on-time. Of course, if your payment goes up, it would make it even harder without a steady income stream.

I am hesitant to extrapolate other firms' numbers to E-Trade (or anyone else for that matter). E-Trade has a much better borrower risk profile than Countrywide does, as seen from their delinqunecy rates that are running more than 50% below those of Countrywide as of 8/31.

By: Anonymous

Anonymous — Fri, 28 Sep 2007 15:50:00 +0000

Same anonymous here that had the ignorance question.

Another point I have thought through before I invested in etrade is that they only fairly recently have built up their mortgage portfolio. As such, a few thoughts.

1) Does this mean that their portfolio is of a newer vintage and therefore not due to reset for a few more years, therefore making all this a moot point for a few years at least (at which point theoretically the market will have rebounded?

2) Given the newer vintage, does this mean that, with the credit profile, more of the borrowers put 20% down and, in a period of one or two years, the property will not have depreciated by that cushion?

Each of these could explain the degree of risk that etrade is seeing and actually create a write-up at some point down the road is how I see it.

Thanks for your thoughts.