eTrade 2009 Annual Report Download - page 95

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” in this report. 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 and
liabilities and we utilize derivatives in a way that reduces our overall exposure to changes in interest rates. In
recent years, we have managed our interest rate risk to achieve a minimum to moderate risk profile with limited
exposure to earnings volatility resulting from interest rate fluctuations. Exposure to interest rate risk requires
management to make 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 premiums 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, 2009, 92% of our total assets were enterprise
interest-earning assets.
At December 31, 2009, approximately 59% of our total assets were residential real estate loans and
available-for-sale mortgage-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.
When real estate loans prepay, unamortized premiums are written off. Depending on the timing of the
prepayment, the write-offs of unamortized premiums may result in lower than anticipated yields. The ALCO
reviews estimates of the impact of changing market rates on prepayments. This information is incorporated into
our interest rate risk management strategy.
Our liability structure consists of two central sources of funding: deposits and wholesale borrowings. Cash
provided to us through deposits is the primary source of our funding. Our key deposit products include sweep
accounts, complete savings accounts and other money market and savings accounts. Our wholesale borrowings
include securities sold under agreements to repurchase and FHLB advances. Customer payables, which
represents customer cash contained within our broker-dealers, is an additional source of funding. In addition, the
parent company has issued a significant amount of corporate debt.
Our deposit accounts and customer payables tend to be less rate-sensitive than wholesale borrowings.
Agreements to repurchase securities re-price as interest rates change. Sweep accounts, complete savings
accounts, other money market and savings accounts re-price at management’s discretion. FHLB advances and
corporate debt generally have fixed rates.
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