eTrade 2004 Annual Report Download - page 129

Table of Contents
Index to Financial Statements
The following table represents the balance in AOCI attributable to open cash flow hedges and discontinued cash flow hedges (in
thousands):
Hedge Ineffectiveness
At December 31,
2004 2003 2002
AOCI balance (net of taxes) related to:
Open cash flow hedges
$
(43,027
)
$
(30,775
)
$
(51,901
)
Discontinued cash flow hedges
(74,991
)
(92,979
)
(136,379
)
Total
$
(118,018
)
$
(123,754
)
$
(188,280
)
In accordance with SFAS No. 133, the Company recognizes hedge ineffectiveness on both fair value and cash flow hedge relationships.
These amounts are reflected in fair value adjustments of financial derivatives in the consolidated statements of operations. The following table
summarizes the income (expense) recognized by the Company as fair value and cash flow hedge ineffectiveness (in thousands):
Mortgage Banking Activities
Year Ended December 31,
2004 2003 2002
Fair value hedges
$
(3,895
)
$
(19,711
)
$
(22,379
)
Cash flow hedges
6,194
4,373
10,717
Total
$
2,299
$
(15,338
)
$
(11,662
)
The Company enters into commitments to originate loans whereby the interest rate on the loan is determined prior to funding; these
commitments are referred to as Interest Rate Lock Commitments, (“IRLCs”). IRLCs on loans the Bank intends to sell are considered to be
derivatives and are, therefore, recorded at fair value with changes in fair value recorded in earnings. For purposes of determining their fair
value, the Company performs a net present value analysis of the anticipated cash flows associated with these IRLCs. The net present value
analysis performed excludes the market value associated with the anticipated sale of servicing rights related to each loan commitment. At
December 31, 2004, the fair value of these IRLCs was a $1.5 million asset.
IRLCs expose the Company to interest rate risk. The Company manages this risk by selling mortgages or mortgage-
backed securities on a
forward basis referred to as forward sale agreements. Changes in the fair value of these derivatives are included as gain on sales of loans held-
for-sale and securities, net or gain on sales of originated loans in the consolidated statements of operations based on whether the loan was
purchased or originated. The net change in IRLCs and the related hedging instruments generated a net gain of $3.9 million in 2004, and
resulted in net losses of $3.0 million and $2.6 million in 2003 and 2002, respectively.
The Company also designates fair value relationships of closed loans held-for-sale against a combination of mortgage forwards and short
treasury positions. Short treasury relationships are economic hedges, rather than fair value or cash flow hedges. Short treasury positions are
marked-to-market, but do not receive hedge accounting treatment under SFAS No. 133. The mark-to-markets of the mortgage forwards are
included in the net change of the IRLCs and the related hedging instruments disclosed above. The mark-to-
markets of the closed loans recorded
for 2004 was $4.3 million. Changes in the fair value of these closed loans are included as gain on sales of loans held-for-sale and securities, net
or gain on sales of originated loans in the consolidated statements of operations based on whether the loan was purchased or originated.
Credit risk is managed by limiting activity to approved counterparties and setting aggregate exposure limits for each approved
counterparty. The credit risk that results from interest rate swaps and purchased options is
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