Citadel's E*Trade moves expose limits as rescuer

By Joseph A. Giannone - Analysis

NEW YORK (Reuters) - Citadel Investment Group pumped new capital into E*Trade Financial Corp (ETFC.O) and is refinancing loads of costly debt, yet the moves only buy a little breathing space for the struggling online broker and expose the hedge fund giant's limits as a rescuer.

E*Trade, among the best known brands in finance but hobbled by mortgage losses for two years, on Monday announced Citadel, its largest stockholder, would swap up to between $800 million and $1.2 billion of high-yield debt for convertible bonds paying zero interest.

The Chicago-based firm, led by legendary trader Kenneth Griffin, last week also bought 90.1 million shares for $100 million, giving it a more than 17 percent stake.

Still, analysts say that Griffin may simply be making the best of a bad situation. For a modest $100 million, he buys time for E*Trade -- which expanded into mortgages through its 2000 merger with online bank Telebanc -- to line up a merger partner and could, if all goes well, break even.

"If the company survives, they can sell the broker and salvage whatever is left," Fox-Pitt Kelton analysts David Trone said. "They made a bet and then things got worse. Now they're trying to climb back out."

While its online brokerage business remains vibrant, E*Trade struggles under a mountain of sour and quickly souring loans and other assets. And while the latest balance sheet moves appeases regulators, analysts warn E*Trade needs a lot more capital to get through the downturn.

"They bought some flexibility over the next two to three quarters, betting that things will stabilize," JMP Research analyst Michael Hecht said. "It's about buying time."

Citadel and E*Trade spokeswomen declined to comment.