It’s a quaint tale in hindsight: A big hedge fund/quasi-investment bank swoops in to bail out an ailing online brokerage in hopes of turning it into a profit-churning dynamo.
That’s what happened in No-vember 2007, when Chicago-based Citadel Investment Group came to the rescue of E*Trade Financial, which was collapsing under the weight of mortgage-related losses in a $3 billion asset-backed securities portfolio. With help from money manager BlackRock, Citadel infused E*Trade with $1.6 billion in capital, paid another $800 million for its ABS portfolio and took over much of its equity order volume and all of its options trades. When the deal was announced, Citadel brought in Donald Layton as chairman; the former JPMorgan Chase vice chairman became CEO of E*Trade in March 2008.
For the first six months of this year, Citadel’s intended turnaround of E*Trade seemed on track. New television ads were running, debt was falling, balance was being restored. At the end of June, E*Trade held $8.2 billion in mortgage-backed and available-for-sale securities, $27 billion in loans and $330 million in Fannie Mae and Freddie Mac holdings that all looked reasonably redeemable sooner or later.
Then came September, when E*Trade unloaded its Fannie and Freddie stakes at a $150 million loss. It hired a new CFO, Bruce Nolop, from Pitney Bowes. It revised its mortgage loss assumptions from $1 billion to $1.5 billion to an unspecified number. The Citadel executive who arranged the E*Trade deal, Joe Russell, left the firm, and the dismal state of the Dow scared a lot of E*Trade’s brokerage customers out of the market. The bottom line, says an October 3 research note from Citi analyst Prashant Bhatia, is that E*Trade will ultimately endure $2.8 billion in mortgage losses.
Citadel, meantime, has its own troubles — losses, investor redemptions, leverage woes — and rumors of an IPO have faded. It seems the markets have a headache and aren’t in the mood.
