E*Trade Aid Would Trickle Down to Citadel

Federal approval of E*Trade Financial's (ETFC Quote) application for government bailout money would benefit its largest investor, ailing hedge fund Citadel Investment Group.

Citadel, like any deep-pocketed investor in the credit crunch, has been hit hard by the market's steep downturn. The Chicago alternative asset firm has suffered losses of 47% in its main funds this year, according to The Wall Street Journal, citing investors. Since its decision a year ago to make a $2.5 billion debt and equity commitment to E*Trade -- while not a make or break investment for a firm with some $12 billion in assets -- Citadel has seen the stock fall nearly 80% from its closing price the day before it made its investment.

E*Trade announced last month that its banking subsidiary had applied for an $800 million investment through the Troubled Assets Relief Program, or TARP. E*Trade has not yet received even preliminary approval for the aid, but has said publicly that it is "optimistic" that it will receive an approval "in the near future."

As E*Trade's largest shareholder, Citadel likely would see the value of its investment stabilize, if not rise, as the capital injection soothes investor fears that the broker will not survive the crisis. As a major E*Trade creditor, Citadel also would see improved chances the brokerage will continue to pay a lucrative 12.5% interest on its $1.2 billion in debt, which is mostly springing lien notes.

A TARP investment would give E*Trade "better capital and liquidity and leverage ratios," says John Jay, a senior analyst at Aite, an independent research and advisory firm. Citadel's connection to E*Trade's bank gives the firm "a small window to liquidity," Jay says.