E*Trade Asked to Raise New Capital Without Access to TARP

E*Trade is the latest company to have been dragged into the stress tests run by U.S. federal bank regulators and has been asked to raise new capital as a result. But unlike the “too-big-to-fail” 19 major financial institutions also undergoing stress tests, the online broker — which doubles as a bank holding company involved in subprime mortgages — doesn’t have access to government assistance.

So far, disclosure surrounding stress tests on E*Trade has been slim and it’s unlikely more information will accompany results on stress tests for the 19 institutions scheduled to be released next week. All that is known for now is that the Office of Thrift Supervision, E*Trade’s main regulator, has asked the company to raise more capital and reduce leverage to address falling capital ratios, according to the company’s press release announcing its first-quarter earnings results.

Many will be watching to see how much capital E*Trade needs to raise and how long it’s been given to do so. “The only thing we are going to say is stick by our statement that they wish us to do so quickly,” said Don Layton, chairman and chief executive of E*Trade, at the end of Tuesday’s conference call on the company’s first-quarter earnings.

Sandler O’Neill Partners, in a research note published Wednesday but not available on the Internet, estimated that E*Trade will need to raise $200 million to $300 million over the next couple of quarters to target $500 million in excess regulatory capital. “While these are the amounts we believe the company needs to raise, we can’t speak for the regulators, who may take a longer or more severe view of the company’s capital requirements,” it noted.

The other lingering question is how E*Trade will raise that much money. E*Trade may be the only financial institution that have been asked to raise capital by its regulator without being given access to government funds as pointed a Barclays Capital analyst during the conference call.

E*Trade is the only institution “that’s been told to raise capital and given none,” said Roger Freeman, an analyst with Barclays Capital, noting that the situation puts the company “in a really tough spot.” E*Trade applied for $800 million in funding through the Troubled Assets Relief Program last year, but is still waiting for approval.

“TARP would be nice to us, but we think we are in a fine position to raise capital without them,” responded Layton. That means that E*Trade can rely solely on public market issuance and private investors to raise capital. Easier said than done.

With shares trading below $1.50, any new stock issuance would be diluting existing shareholders. Raising new debt would also be expensive, considering the company’s junk ratings. A final question would be whether hedge fund Citadel Investments, its largest investor, will fuel more money in the ailing company.