Updated from 11:22 a.m. EDT

E*Trade Financial

(ETFC) - Get Report

is raising $1.2 billion through the sale of common stock and a "significant" debt exchange as part of the online brokerage's plans to raise capital.

The company said on Wednesday that it launched a stock offering in which it plans to raise $400 million through the sale of common shares. Additionally, once the offering is priced, E*Trade will launch a "significant debt exchange" for certain outstanding senior notes, it said.

The proceeds will primarily go to the company's bank subsidiary, which had been told by the Office of Thrift Supervision, its primary regulator, that it needed to

raise capital

in April. Hedge fund Citadel Investment Group, E*Trade's largest equity and bond investor, has agreed to participate in both the common stock offering and debt exchange.

E*Trade also will exchange more than $1 billion of newly-issued zero coupon convertible debt for all of its 8% senior notes due in 2011 and a portion of its 12.5% springing lien notes due in 2017.

The convertible debt will have a maturity of 10 years and will be convertible into shares of common stock based on the public offering price in the common stock offering provided that the conversion price will be no less than $1 per share and no more than $1.20 per share.

The initiative will "significantly reduce the company's debt service burden by eliminating interest costs relating to those debt securities," it said.

Fox-Pitt Kelton Cochran Caronia Waller analyst David Trone is concerned that E*Trade won't be able to complete the capital restructuring plan, given the shareholder dilution that will occur and the company's continued credit woes.

"With these events emerging today, we'd expect the stock to perform poorly, and we are not certain the raise will end up completed," Trone writes in a note.

Moody's Investor Services also is waiting to see if the transactions completed. The firm remains on review for downgrade, the ratings agency said.

"

Given the magnitude of the task, and the company's unstable financial condition, there is substantial execution risk," Moody's said. "This is the main reason why we are continuing our review for a possible downgrade."

E*Trade shares, which were

furiously trading

on Friday, recently were falling 13% to $1.44.

Citadel has agreed to purchase either $50 million or $100 million of stock, depending on the public offering price. The investor, whose founder

Ken Griffin joined E*Trade's board earlier this month, will convert $800 million of the company's long-term debt, E*Trade said.

The $800 million includes $200 million worth of 2011 notes and at least $600 million of 2017 notes, E*Trade said.

Similar to large banks, E*Trade has been hit hard by souring mortgages and declining values in its securities portfolio as the credit crisis unfolded. Whereas

Citigroup

(C) - Get Report

and

Bank of America

(BAC) - Get Report

received double investments through the Treasury's Troubled Asset Relief Program, E*Trade's now seven-month-old application has yet to be approved.

Many strong banks including

Goldman Sachs

(GS) - Get Report

,

Morgan Stanley

(MS) - Get Report

,

JPMorgan Chase

(JPM) - Get Report

and

US Bancorp

(USB) - Get Report

are paying back the federal bailout funds they received last year.

Citadel invested $2.5 billion into the struggling company in late 2007 through the purchase of stock and senior unsecured notes. It included the purchase of E*Trade's $1.3 billion asset-backed securities portfolio, which had fallen sharply in value due to the financial crisis, for roughly 27 cents on the dollar.

Separately, the company said delinquencies for its home equity portfolio -- its most troubled loan portfolio -- fell 11% from March 31 to May 31. Total delinquent loans in its residential mortgage portfolio rose 9% during the same two months.

On the brokerage side, E*Trade's so-called daily average revenue trades for May rose 3.9% from the month before and 34% from a year earlier to 239,439 trades. Second quarter daily trading was "on track" to be approximately 15% higher than the first quarter, it said.

E*Trade said that revenue for April and May totaled $448 million, with "commissions, fees and other revenue" totaling $165 million. Operating expenses for the first two months of the quarter totaled $192 million.

The company expects to take a quarterly loan loss provision in the range of $375 million to $450 million, with charge offs estimated between $375 million and $400 million.

Its Tier-1 capital and risk-based capital ratios were 6.07% and 12.75%, respectively, at May 31.