eTrade 2000 Annual Report Download - page 63

Banking Operations
Interest Rate Sensitivity Management
We actively monitor the net interest rate sensitivity position of our banking business. Effective interest rate sensitivity management
seeks to ensure that net interest income and the market value of equity are protected from the impact of changes in interest rates. The
risk management function is responsible for measuring, monitoring and controlling market risk and communicating risk limits in
connection with our asset/liability management activities and trading.
Our strategies are intended to stabilize our net interest margin and our exposure to market risk under a variety of changes in interest
rates. By actively managing the maturities of our interest-sensitive assets and liabilities, we seek to maintain a relatively consistent net
interest margin and mitigate much of the interest rate risk associated with such assets and liabilities.
We use a risk management process that allows risk-taking within specific limits. To this end, we have established an asset-liability
committee and implemented a risk measurement guideline employing market value of equity and gap methodologies and other
measures.
An asset-liability committee establishes the policies and guidelines for the management of our assets and liabilities. The committee’ s
policy is directed toward reducing the variability of the market value of our equity under a wide range of interest rate environments.
Fair value of equity represents the net fair value of our financial assets and liabilities, including off-balance sheet hedges. We monitor
the sensitivity of changes in the fair value of equity with respect to various interest rate environments and report regularly to the
asset-liability committee. Effective fair value management maximizes net interest income while constraining the changes in the fair
value of equity with respect to changes in interest rates to acceptable levels. The model calculates a benchmark fair value of equity for
current market conditions.
We use sensitivity analyses to evaluate the rate and extent of changes to the fair value of equity under various market environments. In
preparing simulation analyses, we break down the aggregate investment portfolio into discrete product types that share similar
properties, such as fixed or adjustable rate, similar coupon and similar age. Under this analysis, we calculate net present value of
expected cashflows for interest sensitive assets and liabilities under various interest rate scenarios. In conducting this sensitivity
analysis, the model considers all assets (including whole loan mortgages, mortgage-backed securities, mortgage derivatives and
corporate bonds), liabilities and off-balance sheet hedges (including interest rate swaps, caps and options). The range of interest rate
scenarios evaluated encompasses significant changes to current market conditions. By this process, we subject our interest rate
sensitive assets and liabilities to substantial market stress and evaluate the fair value of equity resulting from various market scenarios.
The asset-liability committee reviews the results of these stress tests and establishes appropriate strategies to promote continued
compliance with established guidelines.
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Management measures the efficiency of its asset-liability management strategies by analyzing, on a quarterly basis, our theoretical fair
value of equity and the expected effect of changes in interest rates. Our board of directors establishes limits within which such changes
in the fair value of equity are to be maintained in the event of changes in interest rates.
We calculated a theoretical fair value of equity in response to a hypothetical change in market interest risk. At September 30, 2000 we
computed our theoretical fair value of equity based on then existing interest rates and the attributes of our portfolio as described above.
The model addresses our exposure to market sensitive non-trading financial instruments. The model excludes our trading portfolio,
which, based on management’ s analysis, has an immaterial impact on our fair value of equity. A hypothetical instantaneous 100 basis
point parallel increase in the yield curve would cause the net portfolio value to decrease by $84.3 million.
Every method of market value sensitivity analysis contains inherent limitations and express and implied assumptions that can affect the
resulting calculations. For example, each interest rate scenario reflects unique prepayment and repricing assumptions. In addition, this
analysis offers a static view of assets, liabilities and hedges held as of September 30, 2000 and makes no assumptions regarding
transactions we might enter into in response to changing market conditions.
Our primary interest risk is the exposure to increasing interest rates. We manage our exposure to increasing interest rates, principally
changes in three-month LIBOR associated with the cost of our deposits and advances from the Federal Home Loan Bank of Atlanta,
by entering into related interest rate swap and cap agreements. These instruments contain principally the same terms and notional
balance as the related designated liabilities.
We employ various techniques to implement the asset-liability committee’ s strategies directed toward managing the variability of the
fair value of equity by controlling the relative sensitivity of market value of interest-earning assets and interest-bearing liabilities. The
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