How E*Trade Is Trading Its Way Out Of The TARP Era

(MoneyWatch) 
E*Trade may end up the only major financial services company to make it through the financial crisis without any help from the government's Troubled Asset Relief Program. But that won't be from a lack of trying.

In the company's latest move to shore up as much cash as possible, E*Trade this week sold a higher-than-expected 435 million shares, netting the online broker $478.5 million in an offering discounted at 23 percent to Thursday's closing share price.

And that's only the first part of the capital raising. In the second part, E*Trade is swapping up to $1 billion of new zero-coupon convertible debt for all its senior notes paying 8% interest, and some 12.5% notes. In other words, E*Trade is giving away nearly credit-card sized interest payments in order to stave off the worst case scenario.

Hedge fund Citadel, which is E*Trade's largest outside investor, is expected to participate in the debt exchange by the tune of $800 million.

The offering is somewhat of a last resort for the beleaguered broker. Back in November, E*Trade gleefully announced that it would be accepting $800 million from the federal government in TARP payments. But that money failed to materialize when Treasury deemed the company insufficiently illiquid to take on aid. Ever since, E*Trade has been praying and waiting for TARP approval.

The problem for E*Trade is that while it looks as if it is in better shape than large banks loaded with toxic assets such as Citigroup or Bank of America, it's not that much better off. There is still a lot of bad debt residing on the balance sheets. Hence the desperate capital raising rounds.

Despite the woes, having one of the world's largest hedge funds behind it has certainly helped. Further, ask around the investing community, and you'll find a host of speculators who think that E*Trade is the next "five-bagger," a term used for stocks which have the likely potential to increase by five times or more in value.

And arguably, not accepting TARP funds (albeit through not being allowed to) may mean that the broker didn't suffer the unintended consequences of doing so, such as disincentivizing key employees by introducing ludicrous long-term performance-linked salary structures. In May, E*Trade shareholders voted down a proposal by the company to tie executive bonuses to long-term performance goals.

There's some support for E*Trade's methods in cobbling together the money it needs, too. The Motley Fool's Rick Munarriz likes the latest capital-raising structure:

The stock offering will arm the company with greenbacks, while swapping out notes for zero-coupon bonds will help it preserve greenbacks by reducing its interest-expense exposure. This probably won't be enough to make E*TRADE profitable ... but it's a step in the right direction.

At the end of the TARP era, E*Trade may indeed serve as an example for many economists of how banks ought to have been forced to act once they discovered their woes: selling down nonessential assets, paying a premium for liquidity, and squeezing operating costs. And the fact that E*Trade has had to do that where rivals haven't may ultimately make it more durable and more competitive.

E*Trade is not being shown much compassion by the Treasury Department today, but one day, it might silently thank policymakers for the tough love.

Related Reading at BNET Finance:

• E*Trade's Customers Are Not Happy!