Moody's Investor Services fulfilled its earlier warning and downgraded

E*Trade Financial

(ETFC) - Get Report

.

The ratings agency dropped the broker's senior unsecured ratings to Caa3 from B2. Moody's also lowered the firm's long-term issuer rating to B3 from B2, it said.

E*Trade's long-term ratings for its thrift subsidiary, E*Trade Bank, remain on review for possible downgrade, Moody's said. E*Trade Bank's short-term rating remains at Not-Prime.

The downgrade reflects the "increased probability of material credit losses for E*Trade's senior bondholders as a result of the company's stated strategy to employ debt-for-equity exchanges as the primary tool in reducing leverage and improving the company's precarious financial condition," Moody's said.

The company's credit profile is "challenged by persistent asset-quality problems and capital needs at the thrift and ... thin debt-service capacity at the holding company," Moody's said.

"Furthermore, absent a near-term improvement in its capital structure, there exists a real possibility of regulatory intervention aimed at protecting the thrift's depositors, which would in all likelihood lead to losses for holding company creditors," it added.

A debt-for-equity exchange, which would involve E*Trade's largest stock and bondholder Citadel Investment Group, seems "very likely," Moody's analysts say. But whether it will be beneficial to E*Trade and E*Trade Bank's credit profiles is "as yet uncertain."

E*Trade declined to comment on the downgrade.

Moody's had placed

E*Trade's

debt ratings on review following the brokerage's first-quarter earnings loss of $233 million, or 41 cents a share, announced late last month.

At the time, the company said that its primary banking regulator, the Office of Thrift Supervision, alerted the company that it needed to add to its capital levels at the bank and holding company "quickly."

But the company may be running out of

options

for sources of capital, unless it does something drastic.

E*Trade's trading data for the month of April rose 7.2% from the prior month and 34.5% from the year-earlier period to 230,345 average trades a day, it said Wednesday.

E*Trade also said net new customer assets rose $300 million in April, despite total customer assets falling 28% from a year earlier to $121.78 billion. Customer cash and deposits that did not include security holdings or broker-related cash dipped from March to $16.67 billion.

Shares recently were up 5 cents to $1.57.