At first blush, Citadel’s rescue plan Thursday looked like a pretty good deal. But now, many investors are beginning to wonder if E*Trade is burning the village to save it.
Here’s why: Lost in the excitement of the deal was the fact that E*Trade wrote down about $2.6 billion on its balance sheet — $2.2 billion of asset backed securities and $400 million in home equity loans. Citadel will invest roughly the same amount in E*Trade by buying the ABS portfolio for $800 million and taking on $1.75 billion in E*Trade debt.
But E*Trade will pay 12.5% interest on that debt, a hefty premium. (It’s also worth remembering that E*Trade lost about 15% of its deposits for which it paid a much lower interest rate than it will be paying Citadel.)
In addition, Citadel is getting 84 million shares, valued at about $405 million at yesterday’s closing share price, thrown in the pot for free.
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E*Trade has effectively given away 20% of the company and borrowed $1.75 billion at a rate that could impair earnings by one analyst’s reckoning by more than 50 cents a share.
And what happens if further writedowns are necessary? E*Trade wrote down 3% of its $12 billion home-equity loan portfolio. By one rough comparison, Wells Fargo set aside reserves equal to 12% of its own $12 billion portfolio of home equity loans.
Maybe E*Trade’s loans are more sound. Maybe not.
We’ll find out in March when more adjustable rate mortgages reset. In the meantime, E*Trade might want to think about improving its fortifications.
Courtesy WSJ Blog
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