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Rating Action:

Moody's lowers E*TRADE to B2 from Ba3; outlook remains negative

06 Nov 2008
Moody's lowers E*TRADE to B2 from Ba3; outlook remains negative

New York, November 06, 2008 -- Moody's Investors Service lowered E*TRADE Financial Corporation's long-term senior debt rating to B2 from Ba3, and also lowered the long-term deposit rating of its lead thrift subsidiary, E*TRADE Bank, to Ba3 from Ba2. E*TRADE Bank's short term deposit rating and rating on other short-term senior obligations were affirmed at Not Prime, and the thrift's Bank Financial Strength Rating (BFSR) was downgraded to D- from D. The outlook for all long-term ratings at E*TRADE and E*TRADE Bank, including the BFSR, remains negative.

The rating action reflects Moody's expectations that credit costs associated with E*TRADE's $24 billion mortgage portfolio will remain elevated through 2009 as housing prices continue to fall and economic weakness in the US exacerbates asset quality erosion, even among the highest quality borrower segments. E*TRADE has posted operating and net losses for the past five quarters due to substantial loan loss provisions at the bank. For the first nine months of 2008, E*TRADE reported a $236.2 million net loss ($533.2 million from continuing operations) as loss provisions spiked up 350% to $1.1 billion.

E*TRADE's core on-line brokerage business has performed acceptably well through 2008, with trading activity benefiting from elevated market volatility and the firm adding new accounts. Nevertheless, pretax income for the first nine months of 2008 in the Retail Segment was down almost 23% year over year to $464 million. Customer cash and deposits ($33 billion) have held relatively steady since the firm suffered an outflow spike of just under $6 billion (15%) of customer cash and deposits in November 2007. Despite stabilizing the core franchise and achieving sound profitability (42% pretax margin), E*TRADE's Retail Segment remains at risk to a slowdown in client engagement given the large market-wide losses incurred by equity investors and the tendency for retail investors to sit on the sidelines for an extended period of time after a market rout.

Moody's noted that down-sizing and de-risking the bank, as well as maintaining strong regulatory capitalization at the bank, have been top priorities for E*TRADE's management team. Although E*TRADE has indicated that it will seek to participate in the US government's Capital Purchase Program, today's rating action does not factor in any additional capital sourced from the program.

The rating agency added that E*TRADE has made progress working down its legacy loan book and cutting exposure to un-drawn home equity lines, with total loans down $6 billion and un-drawn home equity lines reduced by $7 billion year over year. Also, as a result of the parent contributing $250 million of preferred equity to the bank in Q3-08, E*TRADE Bank currently has a $524 million capital buffer over the levels required to be a well-capitalized institution per the Office of Thrift Supervision (OTS) regulations. Annualized Q3-08 core pretax, pre-provision earnings at the bank totaled $754 million, and will likely remain heavily burdened covering credit costs throughout 2009.

E*TRADE's liquidity at the parent level is currently acceptable, given $665 million of cash and no scheduled debt maturities until June 2011 when $435 million of senior notes mature. However, financial flexibility in the intermediate term is more constrained given the parent's substantial $3 billion of corporate debt and elevated double leverage. Debt excludes $450 million of notes that will convert to common equity in November 2008. Given asset quality challenges at the bank and the need to maintain its well-capitalized status, E*TRADE must look predominantly to brokerage dividends and revenue sharing from its E*TRADE Securities introducing broker to cover annualized parent-level interest expense of $327 million and other operating costs of around $100 million. Moody's also noted that E*TRADE has additional flexibility on its $1.9 billion of 12-1/2% springing lien notes in that payments until May 2010 can be deferred and capitalized, lowering cash interest payments by $242 million.

Moody's said that although E*TRADE's overall liquidity position remains acceptable, the spike in outflows of client cash and deposits last year and the pervasive and persistent pressures throughout credit markets serves to highlight the confidence sensitivity of financial institutions and the need for sound contingent liquidity planning. E*TRADE Bank ended the quarter with over $16 billion of available alternate liqudity, predominantly in the form of cash and available collateral. The bank's access to a collateralized credit line from the Federal Home Loan Bank remains a key alternate liquidity source available to fund mortgage loans. Secured funding availability for agency collateral has also remained largely stable through the recent market turbulence, though advance rates have fallen.

Moody's will continue to assess E*TRADE's liquidity position and customer stability over the coming months. Erosion in these areas or a substantial worsening in asset quality trends would likely result in a negative rating action. Conversely, evidence that attrition and customer cash flows remain stable, credit costs remain manageable relative to pre-provision earnings generation and a return to sustainable profitability are necessary conditions for a return to a stable outlook.

Moody's last rating action on E*TRADE was on November 30, 2007.

E*TRADE Financial Corporation provides internet-based retail brokerage and banking services through its operating subsidiaries. E*TRADE held $142.2 billion of customer assets as of September 30, 2008, and reported an after-tax loss of $236.2 million on net revenues of $1.4 billion for the first nine months of 2008.

Issuer: E*TRADE Bank

..Downgrades:

.... Bank Financial Strength Rating, Downgraded to D- from D

.... Issuer Rating, Downgraded to Ba3 from Ba2

....OSO Senior Unsecured OSO Rating, Downgraded to Ba3 from Ba2

....Senior Unsecured Deposit Rating, Downgraded to Ba3 from Ba2

Issuer: E*TRADE Financial Corp.

..Downgrades:

.... Issuer Rating, Downgraded to B2 from Ba3

....Multiple Seniority Shelf, Downgraded to a range of (P)Caa1 to (P)B2 from a range of (P)B2 to (P)Ba3

....Subordinate Conv./Exch. Bond/Debenture, Downgraded to B3 from B1

....Senior Unsecured Regular Bond/Debenture, Downgraded to B2 from Ba3

New York
Blaine A. Frantz
Senior Vice President
Financial Institutions Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

New York
Alexander Yavorsky
Asst Vice President - Analyst
Financial Institutions Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

No Related Data.
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