eTrade 2001 Annual Report Download - page 105

Interest rate swaps involve the exchange of fixed-rate and variable-rate interest payments between two parties based on a contractual
underlying notional amount but do not involve the exchange of the underlying notional amounts. Option products are utilized primarily
to decrease the effects on market values resulting from the prepayment dynamics of the Bank’ s mortgage portfolios. The types of
options the Bank employs are primarily “caps” and “floors”. Cap options (“caps”) benefit from increases in market interest rates while
floor options (“floors”) benefit from decreases in market interest rates.
The total notional amount of derivative financial instruments relative to total assets is largely the result of the Bank’ s exposure to
mortgage securities and loans which involve both sensitivity to interest rates and sensitivity to the rates at which the borrowers exercise
their option to prepay their loans as interest rates decline. Consequently, a mortgage instrument is hedged with a combination of
interest rate swaps, cap and floor options.
At December 31, 2001, the Bank had derivatives with $11.5 billion in total notional outstanding in comparison to $8.4billion at
September 30, 2000. Interest rate swaps at December 31, 2001, were $6.3 billion in notional with an unrealized loss of $246.2 million.
The unrealized loss was primarily caused by the net decrease of interest rates in 2001. The Bank primarily uses “payer” positions in
which the Bank pays a fixed rate of interest on the notional amount and receives a floating rate in exchange. The terms and conditions
of the swaps are intended to be industry-standard to maintain the liquidity of the instruments. At December 31, 2001, the notional
amounts of options were $4.5 billion in caps and $0.7 billion in floors. At September 30, 2000, the Bank had $5.3 billion in interest
rate swap notional with an unrealized loss of $38.5 million. At September 30, 2000, the notional amounts of options were $3.1 billion
in caps and $25.0 million in floors.
The increase of notional amounts outstanding in the Bank’ s derivatives portfolio was in line with the aggregate 50% increase in the
Bank’ s total assets from September 30, 2000 to December 31, 2001. The derivatives portfolio grew by 36%. In the “+200 basis points
change” scenario, the risk profile of assets decreased as the Bank diversified its assets into automobile loan product. Automobile loans
have less sensitivity to interest rates and refinancing than mortgage product. This diversification mitigated the need for the derivative
portfolio to increase proportionately with the increase in assets.
Statement of Financial Accounting Standards No. 133
The Company adopted Statement of Financial Accounting Standards No. 133, “ Accounting for Derivative Instruments and Hedging
Activities ”, as amended and interpreted, (SFAS 133), on October 1, 2000. See Note 2 of the Consolidated Financial Statements for
additional information on SFAS 133.
Mortgage Production Activities
In the production of mortgage product, the Bank is exposed to interest rate risk between the commitment dates of the loans and their
funding dates. At December 31, 2001, there were $1.5 billion in mortgage loan commitments await funding. At September 30, 2000,
there were $0.5 billion in similar commitments.
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Table of Contents
Item 8.Consolidated Financial Statements and Supplementary Data
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
2002. EDGAR Online, Inc.