ETrade Avoids Bankruptcy with Citadel Investment

Three months ago NetBank, one of the first Internet banks closed its doors having been shut down by the FDIC. For the last couple of months, it appeared that E*Trade, another Internet powerhouse bank and securities organization was about to face a similar fate as the sub prime mortgage debacle was painted a bold red line on the bottom line of the industry powerhouse. And customers saw the writing on the wall in October and November to the point that several thousand withdrew their accounts and left E*Trade for safer waters. However, it appears that E*Trade will be able to live to fight another day now that Citadel Investment Group has invested $2.4billion into the bank with another $150million expected by the middle of January.

Since its founding as an electronic brokerage in 1982, E*Trade has grown into a major financial services company that encompassed the online discount brokerage, as well as a banking arm that offered standard banking and lending products. Based in New York City, the financial services company had revenues of just under $2.5billion last year while generating an income of over $600million. While E*Trade's slogan was Be E*traordinary, with the sub prime mortgage collapse the financial services company along with many like it have been anything but extraordinary. In fact, what has become ordinary is for financial services companies to lose money. To that point, Merrill Lynch and Citigroup both replaced their chief executive officers in the face of the crisis. Along with Citadel's investment, a similar change was made at the top post for E*Trade as its CEO Mitchell Caplan resigned and was replaced by Jarret Lillien until a replacement can be found.

While the sub prime market has been in flux for the better part of the entire year, things at E*Trade hit crisis mode as the company flatlined on November 12. On that single day of trading the financial services bank saw its stock plunge 59%. On that one day the company saw itself lose over $2.2billion in asset value and saw itself approach a valuation similar to where it was over five years ago. Part of the reason was simply that so much of the assets of E*Trade were and are invested in mortgage-backed securities.

These securities, mortgage-backed securities are the underpinning for the sub prime mortgage crisis that is being felt around the nation. With foreclosures happening at an all time high in places like Atlanta and Austin, and not just in California, companies that are heavily invested in mortgage-backed securities have found themselves in much peril this year. Those entities that leveraged so much exposure to collateralized debt obligations or CDOs have watched their value plummet. In 2006 over $200billion in collateralized debt obligations were issued and almost three-quarters of the notes were made up of sub prime loans. Used as collateral, when institutions began to make cash calls on the collateral the markets the issuing banks like E*Trade were unable to make good on the margin payments. Which is why a company as fiscally sound as Merrill Lynch would announce that it lost almost $8billion in one quarter from the valuation declines and foreclosure impacts on its mortgage portfolio.

The sub prime collapse helped close the doors at NetBank earlier this year and it appeared that E*Trade was headed towards a similar fate which certainly would have cannibalized the financial impact felt by its customers. However, with Citadel stepping up to the table and investing such a substantial sum for what will amount to be less than 15% of the common stock on the open market, E*Trade can take itself off of the ventilator and breathe on its own a little bit and focus on what it does best and that is its online brokerage.