Could the sub-prime mortgage crisis push a large online brokerage into bankruptcy?
That possibility was floated Monday, when a securities analyst said there was a 15% chance that heavy mortgage-related losses could force E-Trade Financial Corp. to seek protection from creditors.
The comments in a report by analyst Prashant Bhatia at Citigroup Inc. helped spark a deep sell-off in E-Trade's already battered stock, knocking it down $5.04, or 59%, to $3.55. The shares are down 84% this year.
The report drew a sharp rebuke from E-Trade, which called itself well-capitalized.
In a statement, E-Trade characterized Bhatia's report as irresponsible, saying it had "the potential to unnecessarily damage customers, shareholders and employees."
"We take exception to the sensationalism based on unfounded speculation," the company said.
The analyst's report followed E-Trade's disclosure late Friday that in the fourth quarter it expected to write down the value of its $3-billion asset-backed securities portfolio, which includes $450 million in so-called collateralized debt obligations and second-lien securities, which are at the heart of the mortgage crisis.
In his report, Bhatia reasoned that E-Trade's banking unit could face a run on its cash if large depositors grew worried about the company's viability and suddenly pulled their funds.
E-Trade customers are typically sophisticated investors who would be aware of the company's troubles, Bhatia wrote.
"In our view, customers may withdraw assets first and ask questions later," Bhatia wrote in his report, titled "Bankruptcy Risk Cannot Be Ruled Out."
Raising cash to meet withdrawals could force the company to unload assets at fire-sale prices, leaving it undercapitalized, Bhatia wrote.
By discussing the possibility of a run on the bank and a bankruptcy filing, Bhatia's report increased the odds of a damaging wave of withdrawals to about 20% from 5%, wrote David Trone, an analyst at Fox-Pitt Kelton Cochran Caronia Waller. The mere mention of a possible rush could become a "self-fulfilling prophecy," Trone said.
Nevertheless, he said, a bankruptcy filing is "highly unlikely," in part because E-Trade's board would sell the company before it had to enter Bankruptcy Court.
The bottom line for the super-aggressive: "Bottom-fishing investors may want to jump in," Trone wrote.
Shares of other online brokers rose on expectations that they could take customers from E-Trade or that one of the firms could buy E-Trade at a bargain price, reducing competition in the sector.
Charles Schwab Corp. gained 58 cents, or 2.6%, to $22.81. TD Ameritrade rose 96 cents, or 5.4%, to $18.89. Schwab is up 18% this year, Ameritrade 17%.