eTrade 2012 Annual Report Download - page 102

Deposit accounts and customer payables tend to be less rate-sensitive than wholesale borrowings.
Agreements to repurchase securities and the majority of FHLB advances re-price as agreements reset. Sweep
accounts, complete savings accounts and other money market and savings accounts re-price at management’s
discretion. Corporate debt has fixed rates.
Derivative Instruments
We use derivative instruments to help manage interest rate risk. 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 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”), 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 instruments discussion in Note 6—Accounting
for Derivative 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 Economic
Value of Equity (“EVE”) approach, the present value of all existing interest-earning assets, interest-bearing
liabilities, derivatives and forward commitments are estimated and then combined to produce an EVE figure. The
approach values only the current balance sheet in which the most significant assumptions are the prepayment
rates of the loan portfolio and mortgage-backed securities and the repricing of deposits. This approach does not
incorporate assumptions related to business growth, or liquidation and re-investment of instruments. This
approach provides an indicator of future earnings and capital levels because changes in EVE indicate the
anticipated change in the value of future cash flows. 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 basis points. The change in EVE
amounts fluctuate based on the parallel shifts in interest rates primarily due to the change in timing of cash flows
in the Company’s residential loan and mortgage-backed securities portfolios. Expected prepayment rates on
residential mortgage loans and mortgage-backed securities increase as interest rates decline. In a rising interest
rate environment, expected prepayment rates decrease.
The EVE method is used at the E*TRADE Bank level and not for the Company. The ALCO monitors
E*TRADE Bank’s interest rate risk position. E*TRADE Bank had nearly 100% and 99% of enterprise interest-
earning assets at December 31, 2012 and 2011, respectively, and held 99% and 98% of enterprise interest-bearing
liabilities at December 31, 2012 and 2011, respectively. The sensitivity of EVE at December 31, 2012 and 2011
and the limits established by E*TRADE Bank’s Board of Directors are listed below (dollars in millions):
Parallel Change in Interest Rates (basis points)(1)
Change in EVE
December 31, 2012 December 31, 2011
Amount Percentage(2) Amount Percentage(2) Board Limit
+300 $(446.3) (11.1)% $ (18.7) (0.5)% (25)%
+200 $(168.5) (4.2)% $ 120.2 3.4% (15)%
+100 $ 23.6 0.6% $ 153.6 4.4% (10)%
-100 $(175.6) (4.4)% $(324.0) (9.2)% (10)%
(1) On December 31, 2012 and 2011, the yield for the three-month treasury bill was 0.05% and 0.02%, respectively. As a result, the
requirements of the EVE model were temporarily modified, resulting in the removal of the minus 200 and 300 basis points scenarios for
the periods ended December 31, 2012 and 2011.
(2) The percentage change represents the amount of change in EVE divided by the base EVE as calculated in the current interest rate
environment.
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