eTrade 2006 Annual Report Download - page 71

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The following discussion about our market risk disclosure includes forward-looking statements. Actual
results could differ materially from those projected in the forward-looking statements as a result of certain
factors, including, but not limited to, those set forth in Item 1A. “Risk Factors.” Market risk is our exposure to
changes in interest rates, foreign exchange rates and equity and commodity prices. Our exposure to interest rate
risk is related primarily to interest-earning assets and interest-bearing liabilities.
Interest Rate Risk
The management of interest rate risk is essential to profitability. Interest rate risk is our exposure to changes
in interest rates. In general, we manage our interest rate risk by balancing variable-rate and fixed-rate assets,
liabilities and derivatives in a way that reduces our overall exposure to changes in interest rates. This analysis is
based on complex assumptions regarding maturities, market interest rates and customer behavior. Changes in
interest rates, including the following, could impact interest income and expense:
• Interest-earning assets and interest-bearing liabilities may re-price at different times or by different
amounts creating a mismatch.
• The yield curve may flatten or change shape affecting the spread between short- and long-term rates.
Widening or narrowing spreads could impact net interest income.
• Market interest rates may influence prepayments resulting in maturity mismatches. In addition,
prepayments could impact yields as premium and discounts amortize.
Exposure to market risk is dependent upon the distribution and composition of interest-earning assets,
interest-bearing liabilities and derivatives. The differing risk characteristics of each product are managed to
mitigate our exposure to interest rate fluctuations. At December 31, 2006, 93% of our total assets were interest-
earning assets.
At December 31, 2006, approximately 66% of our total assets were residential mortgages and
available-for-sale mortgage-backed and asset-backed securities. The values of these assets are sensitive to
changes in interest rates, as well as expected prepayment levels. As interest rates increase, fixed rate residential
mortgages and mortgage-backed securities tend to exhibit lower prepayments. The inverse is true in a falling rate
environment.
Our current strategy is to retain more originated mortgage loans on the balance sheet. When mortgage loans
prepay, mortgage origination costs are written off. Depending on the timing of the prepayment, the write-offs of
mortgage origination costs may result in lower than anticipated yields. The ALCO reviews estimates of the
impact of changing market rates on loan production volumes and prepayments. This information is incorporated
into our interest rate risk management strategy.
Our liability structure consists of transactional deposit relationships, such as money market accounts;
certificates of deposit; securities sold under agreements to repurchase; free credits; wholesale collateralized
borrowings from the FHLB and other entities; and long term notes. Our transactional deposit accounts and free
credits tend to be less rate-sensitive than wholesale borrowings. Agreements to repurchase securities and money
market accounts re-price as interest rates change. Certificates of deposit re-price over time depending on
maturities. FHLB advances and long-term notes generally have fixed rates.
We held $178.6 million in trading securities as of December 31, 2006. These securities, and the associated
interest rate risk, are not material to the Company’s financial position, results of operations, or cash flows.
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