eTrade 2007 Annual Report Download - page 78

notional amount, but do not involve the exchange of the underlying notional amounts. Option products are
utilized primarily to decrease the market value changes resulting from the prepayment dynamics of the mortgage
portfolio, as well as to protect against increases in funding costs. The types of options employed include Cap
Options (“Caps”) and Floor Options (“Floors”), “Payor Swaptions” and “Receiver Swaptions.” Caps mitigate the
market risk associated with increases in interest rates while Floors mitigate the risk associated with decreases in
market interest rates. Similarly, Payor and Receiver Swaptions mitigate the market risk associated with the
respective increases and decreases in interest rates. See derivative financial instruments discussion at Note 8—
Accounting for Derivative Financial Instruments and Hedging Activities in Item 8. Financial Statements and
Supplementary Data.
For mortgage loans intended to be sold, Interest Rate Lock Commitments (“IRLCs”) are considered
derivatives with changes in fair value recorded in earnings. IRLCs are commitments issued to borrowers that
lock in an interest rate now for a loan closing in one to three months. These locks, initially recorded with a fair
value of zero, will fluctuate in value during the lock period as market interest rates change. See mortgage
banking activities discussion at Note 8—Accounting for Derivative Financial Instruments and Hedging Activities
in Item 8. Financial Statements and Supplementary Data.
Scenario Analysis
Scenario analysis is an advanced approach to estimating interest rate risk exposure. Under the Net Present
Value of Equity (“NPVE”) approach, the present value of all existing assets, liabilities, derivatives and forward
commitments are estimated and then combined to produce a NPVE figure. The sensitivity of this value to
changes in interest rates is then determined by applying alternative interest rate scenarios, which include, but are
not limited to, instantaneous parallel shifts up 100, 200 and 300 basis points and down 100 and 200 basis points.
The NPVE method is used at the E*TRADE Bank level and not for the Company. During the first quarter of
2007, E*TRADE Clearing LLC (“ETC”) became a wholly-owned operating subsidiary of E*TRADE Bank.
E*TRADE Bank has 96% and 81% of our enterprise interest-earning assets at December 31, 2007 and 2006,
respectively, and holds 96% and 79% of our enterprise interest-bearing liabilities at December 31, 2007 and
2006, respectively. The sensitivity of NPVE at December 31, 2007 and 2006 and the limits established by
E*TRADE Bank’s Board of Directors are listed below (dollars in thousands):
Change in NPVE
December 31,
Board
Limit
2007(1) 2006
Parallel Change in Interest Rates (bps) Amount Percentage Amount Percentage
+300 $(434,303) (17)% $ (52,325) (2)% (55)%
+200 $(323,193) (12)% $ (32,680) (1)% (30)%
+100 $(174,280) (7)% $ (15,303) (1)% (20)%
-100 $ 99,245 4 % $(159,618) (6)% (20)%
-200 $ (63,785) (2)% $(560,142) (20)% (30)%
(1) Amounts and percentages include ETC.
Under criteria published by the OTS, E*TRADE Bank’s overall interest rate risk exposure at
December 31, 2007 was characterized as “minimum.” We actively manage our interest rate risk positions. As
interest rates change, we will re-adjust our strategy and mix of assets, liabilities and derivatives to optimize our
position. For example, a 100 basis points increase in rates may not result in a change in value as indicated above.
The ALCO monitors E*TRADE Bank’s interest rate risk position.
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