REFILE-UPDATE 5-E*Trade Gets $2.55 Bln Citadel Cash Infusion

(Adds detail throughout, background; updates shares)

By Lilla Zuill

NEW YORK (Reuters) - E*Trade Financial Corp (ETFC.O) is getting a $2.55 billion cash infusion from investors led by Citadel Investment Group, which is also buying the mortgage-related securities portfolio that has been the primary source of the discount brokerage's recent woes.

The bail-out by Chicago-based Citadel will give the alternative fund manager about 18 percent ownership of E*Trade and a seat on the board, E*Trade said on Thursday.

E*Trade shares, which have lost about 80 percent of their value since January, surged about 23 percent in early trading before the bell, but then fell 27 cents or 5 percent to $5.01 in afternoon trade on Nasdaq.

Citadel, which often invests in troubled assets and companies, is leading an investor group that includes BlackRock Inc (BLK.N), the largest publicly traded U.S. money manager.

E*Trade said Mitch Caplan, its chief executive since 2003, is stepping down. Donald Layton, a former vice chairman of J.P. Morgan Chase & Co (JPM.N) who has been a strategic adviser at the brokerage, will become E*Trade's chairman. Jarrett Lilien, now chief operating officer, will become acting chief executive.

The agreement includes immediate funding of about $2.4 billion and rids the company of its troubled $3 billion asset-backed securities (ABS) portfolio.

Citadel will pay $800 million for the portfolio.

Another component of the deal is the purchase of $1.75 billion worth of 10-year notes and stock that will pay an annual interest rate of about 12.5 percent, E*Trade said.

"Citadel is the clear winner in this transaction," said Bank of America analyst Michael Hecht, in a research note entitled "Xmas comes early for Citadel, shareholders get lump of coal."

Hecht said that Citadel's deal gives it a $3 billion asset backed securities book for 27 cents on the dollar and $1.75 billion of secured paper at 12.5 percent, and 84 million shares of stock "for nothing."

Hecht said shareholders, in contrast "suffer (more than) 40 percent earnings per share dilution and 100 percent tangible equity dilution."

Still the deal shows that there is a market for the securities, with investor interest largely going cold amid the subprime mortgage meltdown earlier this year, some analysts said.

It also puts a value, albeit low, on what bargain hunters might be willing to pay. "We finally have a market-determined price for all those mortgage-backed securities, and it is 27 cents on the dollar," said Robert Ellis, senior analyst with Celent, a Boston-based financial research and consulting firm.

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