Shares of E-Trade Financial Corp. (ETFC) added to their losses on Wednesday after the online discount brokerage said it would sell $400 million new common stock and swap $1.35 billion of debt for preferred shares.

While the move will help the beleaguered firm plug its capital holes following a government mandate, current shareholders remained discontented as their holdings would be diluted by nearly 40% through the stock sale and once more if the preferred shares are converted in future.

In a regulatory filing, E-Trade said both its capital-raising plans are being heavily backed by hedge fund giant Citadel Investment Group LLC which will buy either $50 million or $100 million shares and exchange up to $800 million in debt. Along with shoring up capital, the move would help E-Trade to eliminate interest payments related to debt.

The transaction could make Citadel a 50% owner of the New York-based financial firm’s common stock. The hedge fund had already become its largest stakeholder in 2007 before the recession took a chunk out of E-Trade’s mortgage-linked business.

E-Trade also forecast second-quarter loan-loss provisions of $375 million to $450 million and $375 million to $400 million in net charge-offs. Shares of the company were down more than 12% to $1.44 at noon on the NASDAQ.

“ETFC” Free Stock Analysis: Buy? Sell? Hold?
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