Loan woes hit finance firms
Mortgage woes dealt a double whammy to the securities industry Monday as online broker E-Trade Financial Corp. slashed its 2007 profit forecast, citing losses on home-equity loans, and Merrill Lynch & Co. said it was cutting jobs at its sub-prime lending operation.
The disclosures show how the New York-based financial firms miscalculated in trying to benefit from home loans, a sector outside the companies’ core businesses.
Merrill, which bought its sub-prime unit and a related business nine months ago for $1.3 billion, may have lost most of that investment.
E-Trade said its earnings this year would be 31% below its previous forecast. The main reason was rising delinquencies in home-equity loans, many taken out by homeowners who had good credit but had borrowed excessively, Jarrett Lilien, E-Trade’s president and chief operating officer, said in an interview.
“A lot of consumers with previously good credit scores have taken on a higher debt load than they normally would have, and that’s where you see the deteriorating credit performance,” Lilien said.
Though E-Trade is primarily an online stockbroker, it beefed up its banking unit in recent years as it sought to diversify after the bursting of the late-1990s Internet bubble.
As home values shot higher during the housing boom, many homeowners tapped their rising equity to bankroll spending on cars, vacations and home remodeling.
The company said it expected to earn $1.05 to $1.15 a share this year, down from its previous estimate of $1.53 to $1.67.
E-Trade said it would add $245 million to its accounting allowance for loan losses in the second half of the year. It also might be forced to write off as much as $100 million in its securities portfolio, largely because of troubled bonds backed by home-equity loans.
The E-Trade warning came at the beginning of a week in which several large investment banks are set to divulge how severely the housing crisis and credit crunch have hurt their profits. Lehman Bros. Holdings Inc. will report its earnings today.
Merrill became the latest investment bank to pare its sub-prime operation when it said it was cutting an undisclosed number of jobs. The cutback is further evidence that Wall Street’s mad dash to buy sub-prime lenders in recent years has backfired badly, analysts said.
Merrill bought San Jose-based First Franklin Financial Corp. and a companion loan-servicing operation for $1.3 billion in December just as the years-long surge in sub-prime lending was beginning to show strains.
The servicing unit is worth less than $300 million and First Franklin itself is “essentially worthless” -- meaning Merrill overpaid by more than $1 billion, said Matthew Howlett, a mortgage-industry analyst at Fox-Pitt Kelton in New York.
“That is a textbook business-school study of a company overpaying for something at the top of the market,” Howlett said.
First Franklin’s travails have raised speculation about whether Merrill would take a large write-off to account for the unit’s diminished value. Merrill Lynch spokesman Bill Halldin declined to comment on that possibility.
Sub-prime companies make home loans to people with blemished or incomplete credit histories, charging higher interest rates than those on traditional prime loans.
First Franklin and the servicing operation, Home Loan Services Inc., had 2,800 employees when the sale was announced a year ago, Halldin said, declining to divulge the current head count.
“We have adjusted our staffing levels to be in line with current business requirements,” he said.
Neither of First Franklin’s two Southern California loan-processing offices -- in Laguna and San Bernardino -- will be affected by the cutbacks, Halldin said.
Merrill and other major investment banks, including Bears Stearns Cos., Morgan Stanley and Goldman Sachs Group Inc., bought sub-prime lenders in recent years in hopes of boosting their highly lucrative sales of bonds backed by residential mortgages.
Bear Stearns announced in mid-August that it would eliminate 240 jobs at its sub-prime division. In recent weeks, Lehman said it was closing its sub-prime unit and chopping more than 2,000 mortgage-related jobs.
Wall Street firms will have to cut more mortgage jobs, said Richard X. Bove, an analyst at Punk Ziegel & Co.
“They’re going to have to fire a lot of people,” he said.
