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FORM 10-K
E TRADE FINANCIAL CORP
(Annual Report)
Filed 3/10/2005 For Period Ending 12/31/2004
Address 135 E. 57TH STREET
NEW YORK, New York 10022
Telephone 650-331-6000
CIK 0001015780
Industry Investment Services
Sector Financial
Fiscal Year 12/31

Table of contents

  • Page 1
    E TRADE FINANCIAL CORP FORM 10-K (Annual Report) Filed 3/10/2005 For Period Ending 12/31/2004 Address Telephone CIK Industry Sector Fiscal Year 135 E. 57TH STREET NEW YORK, New York 10022 650-331-6000 0001015780 Investment Services Financial 12/31

  • Page 2
    ... 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2004. or 32 TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR TO . THE TRANSITION PERIOD FROM Commission file number 1-11921 E*TRADE Financial Corporation (Exact name of...

  • Page 3
    ... Statements E*TRADE FINANCIAL CORPORATION FORM 10-K ANNUAL REPORT For the Year ended December 31, 2004 PART I Item 1. Business Overview Brokerage Banking Competition International Operations Regulation Required Financial Data Properties Legal Proceedings Submission of Matters to a Vote of Security...

  • Page 4
    i

  • Page 5
    ... 15-Deposits Note 16-Securities Sold Under Agreements to Repurchase and Other Borrowings by Bank Subsidiary Note 17-Senior Notes and Convertible Subordinated Notes Note 18-Accounts Payable, Accrued and Other Liabilities Note 19-Income Taxes Note 20-Shareholders' Equity Note 21-Employee Benefit Plans...

  • Page 6
    ...research. Corporate clients use our employee stock plan administration and options management tools. These corporate client accounts provide us an opportunity to reach their employees and offer them the products and services that are offered to our retail customers. Our corporate offices are located...

  • Page 7
    ... balances into an FDIC-insured Sweep Deposit Account ("SDA") product at the Bank. The SDA provides the Bank with a lower cost of funds, while continuing to pay brokerage customers a competitive interest rate. In 2004, we swept additional brokerage customer money market and free credit balances (cash...

  • Page 8
    ... the transfer of funds to/from external accounts; • individual retirement accounts and college savings plan products; and • stock option plan administration products and services. Trading and Investing We earn commissions when customers execute trades. The level of a customer's trading activity...

  • Page 9
    ...the changes lowered per contract fees on option trades to as low as $0.75 for qualifying Active Traders from a previous range of $1.25 to $1.50, depending on activity levels. We provide institutional customers with online brokerage services, including direct access to international exchanges through...

  • Page 10
    ... use in margin and stock lending activities, respectively. E*TRADE Clearing has an agreement with ADP Services through 2013, which replaced BETA Systems in 2004, for the provision of computer services to support order entry, order routing, securities processing, customer statement preparation, tax...

  • Page 11
    .... The Bank paid interest rates averaging 1.25% for all of its money market accounts. The Bank also offers customers the opportunity to deposit into three different certificate of deposit ("CD") products. First, customers can elect to deposit funds in fixed-rate CDs. Second, customers may invest in...

  • Page 12
    ...TRADE Financial Corporation offers its services in international markets directly through its website at www.etrade.com as well as through additional branded retail brokerage websites in Canada, Denmark, Germany, Hong Kong, Iceland, Sweden and the United Kingdom. The Company also has minority equity...

  • Page 13
    ...banking business, including lending practices, safeguarding deposits, capital structure, transactions with affiliates and conduct and qualifications of personnel. Our website address is http://www.etrade.com. We make our annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports...

  • Page 14
    ...): Year Ended December 31, 2004 Interest Inc./Exp. Average Yield/Cost 2003 Interest Inc./Exp. Average Yield/Cost 2002 Interest Inc./Exp. Average Yield/Cost Average Balance Interest-earning banking assets: Loans receivable, net (1) Mortgage-backed and related available-for-sale securities Available...

  • Page 15
    ...(2) (3) (4) Amount includes a taxable equivalent increase in interest income in 2004, 2003 and 2002 of $7.0 million, $2.4 million and $0.3 million, respectively. Ratio calculations exclude discontinued operations. Ratio calculated based on standalone Bank results and not banking segment results. 9

  • Page 16
    ... net Mortgage-backed and related available-for-sale securities Available-for-sale investment securities Trading securities Other Total interest-earning banking assets (1) Interest-bearing banking liabilities: Retail deposits Brokered certificates of deposit Repurchase agreements and other borrowings...

  • Page 17
    ... % of Total Balance Real estate loans: One- to four-family: Fixed-rate Adjustable-rate Home equity lines of credit and second mortgage Other Total real estate loans (1)(2) Consumer and other loans: Recreational vehicle Marine Automobile Credit card Other Total consumer and other loans Total loans...

  • Page 18
    ... Statements The following table shows our loan purchase, sale and repayment activity, including loans acquired through business combinations (in thousands): Year Ended December 31, 2004 2003 2002 Loans, net-beginning of year Loan purchases and originations: One- to four-family variable-rate...

  • Page 19
    ...< 1 Year 1-5 Years > 5 Years Total Real estate loans: One- to four-family: Fixed rate Adjustable rate Home equity lines of credit and second mortgage Other Total real estate loans Consumer and other loans: Recreational vehicle Marine Automobile Credit card Other Total consumer and other loans Total...

  • Page 20
    ... value, less estimated selling costs. We use appraisals and other appropriate valuation methods to estimate the fair value of these assets. If the net estimated fair value of the collateral is less than the loan balance, the difference is charged to the allowance for loan losses. We perform periodic...

  • Page 21
    ... groups of loans having similar attributes. These loss ratios are based on our historical charge-off experience, industry loss experience and current market and economic conditions. Our internal policy requires that the allowance for loan losses should be at least equal to twelve months of projected...

  • Page 22
    ..., Three Months Ended December 31, 2000 Year Ended September 30, 2000 2004 2003 2002 2001 Allowance for loan losses-beginning of year Loan charge-offs: Real estate Home equity lines of credit and second mortgage Recreational vehicle Marine Automobile Credit card Other Total loan charge-offs Loan...

  • Page 23
    .... We buy and hold mortgage-backed trading securities principally for the purpose of selling them in the near term. These securities are carried at market value and any realized or unrealized gains and losses are reflected in our consolidated statements of operations as gain on sales of loans held...

  • Page 24
    ... 31, 2004 Cost Basis Mortgage-backed securities Investment securities: Asset-backed securities Municipal bonds Corporate bonds Other debt securities Publicly traded equity securities Total investment securities Total available-for-sale securities $ 9,204,871 $ Fair Value 9,052,069 Cost Basis $ 7,313...

  • Page 25
    ... Financial Statements Deposits and Other Sources of Funds The following table presents information about the Bank's deposits by category (dollars in thousands): Year Ended December 31, 2004 Average Balance for the Year Sweep deposit account Money market Certificates of deposit Brokered certificates...

  • Page 26
    ... Financial Statements The following table sets forth information regarding the weighted-average interest rates and the highest and average month-end balances of our borrowings (dollars in thousands): WeightedEnding Balance Average Rate (1) Maximum Amount At Month-End Balance Yearly Weighted-Average...

  • Page 27
    ... or cash flows. The Company maintains insurance coverage that management believes is reasonable and prudent. The principal insurance coverage it maintains covers commercial general liability, property damage, hardware/software damage, directors and officers, employment practices liability, certain...

  • Page 28
    ...Contents Index to Financial Statements Company and errors and omissions. We believe that such insurance coverage is adequate for the purpose of our business. Our ability to maintain this level of insurance coverage in the future, however, is subject to the availability of affordable insurance in the...

  • Page 29
    ... completion of the 2003 Plan, the Company repurchased shares under the 2003 Plan , all from unrelated third parties and in the open market, as follows: Maximum Dollar Value of Shares That May Yet be Purchased Under the 2003 Plan Month Total Number of Shares Purchased Average Price Paid per Share...

  • Page 30
    ... stock price ranged from $9.51 to $15.17. For the year ended December 31, 2004, the Company repurchased shares under the April 2004 Plan, all from unrelated third parties and in the open market, as follows: Maximum Dollar Value of Shares That May Yet be Total Number of Shares Month Purchased Average...

  • Page 31
    ...52) $ 355,090 361,051 December 31, 2004 2003 2002 2001 Consolidated Balance Sheet Data: Cash and equivalents Brokerage receivables, net Available-for-sale mortgage-backed and investment securities Total loans, net Total assets Deposits Senior notes Convertible subordinated notes Capital lease...

  • Page 32
    ..., market-making activities, proprietary trading, margin lending and brokerage-related fees. The banking segment generates revenues primarily from its diversified interest-earning assets (banking assets held which earn interest income), gains on sales of loans and banking-related service charges and...

  • Page 33
    ... that the financial performance of our Company changed during the past three years; • Liquidity and Capital Resources describes how we obtained and used cash to operate the business; • Summary of Critical Accounting Policies and Estimates describes key accounting policies and estimates that are...

  • Page 34
    ...: Year Ended December 31, Revenue Type Percentage Change 2004 versus 2003 2003 versus 2002 2004 2003 2002 Daily average revenue trades ("DART"s) Average commission per revenue trade Average margin balances (in millions) Average net interest spread (basis points) Average interest-earning assets...

  • Page 35
    ...-earning assets increased in 2004 and 2003 by 30% and 25%, respectively, from the prior comparable years. Our level of average interest-earning assets depends on the relative volumes of our purchases and sales of mortgage-backed securities, availablefor-sale securities and home equity line of credit...

  • Page 36
    ...the result of two items. First, during 2004 the Company reached a favorable tax settlement with the Internal Revenue Service. This agreement resolved various issues for all federal tax liabilities through 2000, including most notably certain research and development credit claims. As a result of the...

  • Page 37
    ... 2002 Daily average revenue trades ("DART"s) Average commission per revenue trade Total brokerage revenue trades (1) Active brokerage accounts, end of period (2) Average (dollars in millions): Customer margin balances Customer money market fund balances SDA balances Stock borrow balances Stock loan...

  • Page 38
    ... institutional customers, market-making revenues and net gains on proprietary trading. The Company provides institutional customers with global trading and settlement services, as well as worldwide access to research provided by third parties, in exchange for commissions based on negotiated rates...

  • Page 39
    ... balance and/or activity levels, closed their accounts or had their account value taken to $0 as a result of the account maintenance fee. • Stock plan administration revenues result from our providing corporate customers with full-service assistance and software to manage their employee stock...

  • Page 40
    ... Statements Brokerage interest income refers to interest income earned on margin loans, stock borrow balances, cash required to be segregated under regulatory guidelines and fees on customer assets invested in money market funds. Brokerage interest income primarily depends on average interest rates...

  • Page 41
    ... in 2004. This increase was driven by a 31% rise in average loans receivable, net and a 30% rise in the average balance of mortgage-backed and other available-for-sale securities. The 2003 decrease reflects a lower average yield on the Company's interest-earning assets due to the decline in market...

  • Page 42
    ... and home purchase volumes spurred by low mortgage interest rates during the period. Our 2003 results also reflected $4.8 million of gains from the sales of RV and marine loans, following the acquisition of E*TRADE Consumer Finance. The following table presents the net gains that the Company earned...

  • Page 43
    ... to sell within one year, as well as gains from the sales of securities sold by the Bank. The following table presents the net gains that the Company earned from the sales of loans held-for-sale and securities (dollars in thousands): Variance Year Ended December 31, 2004 vs. 2003 $ Amount 2004 Gain...

  • Page 44
    ... and home equity lines of credit. LIQUIDITY AND CAPITAL RESOURCES In addition to our cash flows from operations, we have historically met our liquidity needs primarily through investing and financing activities, consisting principally of equity and debt offerings, increases in core deposit accounts...

  • Page 45
    ...-cash restructuring costs and other exit charges Cumulative effect of accounting change Net effect of changes in brokerage-related assets and liabilities Net loans held-for-sale activity Net trading securities activity Other assets Total other net activity* Net cash provided by operating activities...

  • Page 46
    ... numerous agreements with other broker-dealers to provide financing under our stock loan program. In our banking operations, we seek to maintain a stable funding source for future periods, in part, by attracting core deposit accounts that tend to be relatively stable even in a changing interest rate...

  • Page 47
    ... Index to Financial Statements fund balances to the Bank, which were previously held in money market funds not on our balance sheets. On average, our retail banking customers maintained 1.49 accounts with a balance of $20,370 at December 31, 2004. Savings and transactional deposits increased from...

  • Page 48
    ... brokerage and corporate investments. Impairment of mortgage-backed or asset-backed securities is recognized when management estimates the fair value of a security is less than its amortized cost and if the current present value of estimated cash flows has decreased since the last periodic estimate...

  • Page 49
    ... Index to Financial Statements We have investments in certain publicly-traded and privately-held companies, which we evaluate for other-than-temporary declines in market value. During 2004, we recognized $18.4 million of losses from other-than-temporary declines in market value related to our...

  • Page 50
    ... to the net revenues of the Company. Our estimates of fair value of goodwill and other intangible assets depend on a number of factors, including estimates of future market growth and trends, forecasted revenue and costs, expected useful lives of the assets, appropriate discount rates and other...

  • Page 51
    ...our revenues in the foreseeable future. Like other financial services firms, we are affected directly by national and global economic and political conditions, broad trends in business and finance, disruptions to the securities markets and changes in volume and price levels of securities and futures...

  • Page 52
    ... costs so that our tools comply with the new FASB statement. Additionally, we may see a reduction in commission revenues as fewer options would be available for exercise and sale by the employees of these companies. Reduced spreads in securities pricing, levels of trading activity and trading...

  • Page 53
    ..., among other things, sales practices and the suitability of recommendations to customers. As part of our institutional business we provide clients access to certain third-party research tools and other services in exchange for commissions earned. Currently, these activities are allowed by various...

  • Page 54
    ... investing activities, marketing and the financing of customer account balances. Also, our ability to withdraw capital from brokerage subsidiaries could be restricted, which in turn could limit our ability to repay debt and redeem or purchase shares of our outstanding stock. Similarly, the Bank...

  • Page 55
    ... an exercise price at or above fair market value. In December 2004, however, the Financial Accounting Standards Board ("FASB") issued SFAS No. 123 (Revised 2004), Share-Based Payment, which among other things requires public companies to expense employee stock options and other share-based payments...

  • Page 56
    ... Index to Financial Statements make investments or other restricted payments; enter into transactions with our stockholders or affiliates; sell assets or shares of capital stock of our subsidiaries; restrict dividend or other payments to us from our subsidiaries; and merge, consolidate or transfer...

  • Page 57
    ... publicly-traded equity security with a carrying value of $11.3 million and a gross unrealized gain of $5.6 million as of December 31, 2004. BROKERAGE OPERATIONS Our brokerage operations are exposed to market risk related to changes in interest rates, foreign currency exchange rates and equity...

  • Page 58
    ... and mortgage-backed securities. The values of these assets are sensitive to changes in interest rates, as well as expected prepayment levels. The Bank's liability structure consists primarily of transactional deposit relationships, such as money market accounts, shorter-term certificates of deposit...

  • Page 59
    ...-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 Bank's mortgage...

  • Page 60
    ...2-Summary of Significant Accounting Policies Note 3-Discontinued Operations Note 4-Business Combinations Note 5-Brokerage Receivables, Net and Brokerage Payables Note 6-Available-for-Sale Mortgage-Backed and Investment Securities Note 7-Other Investments Note 8-Loans Receivable, Net Note 9-Servicing...

  • Page 61
    ... because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. E*TRADE Financial Corporation's management assessed the effectiveness of its internal control over financial reporting as of December 31, 2004. In making this assessment, it used the...

  • Page 62
    ... Organizations of the Treadway Commission. We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements as of and for the year ended December 31, 2004 of the Company and our report dated March 10, 2005...

  • Page 63
    ... consolidated balance sheets of E*TRADE Financial Corporation and subsidiaries (the "Company") as of December 31, 2004 and 2003, and the related consolidated statements of operations, comprehensive income (loss), shareholders' equity, and cash flows for each of the three years in the period ended...

  • Page 64
    ... except share amounts) December 31, 2004 ASSETS Cash and equivalents Cash and investments required to be segregated under Federal or other regulations (includes repurchase agreements of $0 at December 31, 2004 and $875,800 at December 31, 2003) Brokerage receivables, net Trading securities Available...

  • Page 65
    ...-sale and securities, net Other banking-related revenues Net banking revenues Total net revenues Expenses excluding interest: Compensation and benefits Occupancy and equipment Communications Professional services Commissions, clearance and floor brokerage Advertising and market development Servicing...

  • Page 66
    ... Diluted income (loss) per share from discontinued operations Diluted loss per share from cumulative effect of accounting change Diluted net income (loss) per share Shares used in computation of per share data: Basic Diluted See accompanying notes to consolidated financial statements $ 0.92 0.07...

  • Page 67
    ...) Year Ended December 31, 2004 2003 2002 Net income (loss) Other comprehensive income (loss): Available-for-sale securities: Unrealized gains Less impact of realized gains (transferred out of AOCI) and included in net income (loss) Tax effect Net change from available-for-sale securities Cash flow...

  • Page 68
    ... Stock Shares Exchangeable into Common Stock Amount Shares Balance, December 31, 2001 Income before cumulative effect of accounting change Cumulative effect of accounting change Other comprehensive loss Exercise of stock options and warrants, including tax benefit Employee stock purchase plan...

  • Page 69
    ... Shares to common stock Balance, December 31, 2003 Net income Other comprehensive loss Exercise of stock options and purchase plans, including tax benefit Employee stock purchase plan Adjustment related to change in original option grants Repurchases of common stock Cancellation of restricted stock...

  • Page 70
    See accompanying notes to consolidated financial statements 62

  • Page 71
    ...income (loss) to net cash provided by operating activities: Cumulative effect of accounting change Provision for loan losses Depreciation, amortization and discount accretion Net realized gains on available-for-sale securities, loans held-for-sale and trading securities Gain on disposition of assets...

  • Page 72
    ...of year CASH AND EQUIVALENTS, End of year SUPPLEMENTAL DISCLOSURES: Cash paid for interest Cash paid for income taxes Non-cash investing and financing activities: Tax benefit on exercise of stock options Transfers from loans to other real estate owned and repossessed assets Reclassification of loans...

  • Page 73
    ..., closing and title services for mortgage loans. ETSS is the parent company of: • Lending Link LLC, which acts as a title agency and provides key operational support for home equity loans. • E*TRADE Global Asset Management, Inc. ("ETGAM"), a registered broker-dealer and investment advisor...

  • Page 74
    ... employee salary, bonus, brokerage and banking costs for its customer transactions, customer communications and overhead costs to provide service to customers; • Selling and marketing -included costs for advertising campaigns, independent research provided to institutional customers and fees paid...

  • Page 75
    ... as trading and held by the Bank are included in gain on sales of loans held-for-sale and securities, net and are derived using the specific identification cost method. Realized and unrealized gains and losses on trading securities are recorded in principal transactions for brokerage activities and...

  • Page 76
    ... income for corporate investments. The Company reviews all securities with unrealized losses for other-than-temporary impairment at each balance sheet date. The Company considers market value of equity securities below the Company's cost basis, for a period of greater than six months, an indication...

  • Page 77
    ... Statements amount of the asset sold and the net cash proceeds received. These gains or losses are recorded, as appropriate in either gain on sales of loans held-for-sale and securities, net or in gain on sales of originated loans. Fair value is determined based on quoted market prices, if available...

  • Page 78
    ... that future economic benefits are less than probable. Internally developed software costs include the cost of software tools and licenses used in the development of the Company's systems, as well as payroll and consulting costs. Investment in Federal Home Loan Bank ("FHLB") Stock -Investment in...

  • Page 79
    ...25, Accounting for Stock Issued to Employees , and related Interpretations which requires compensation expense to be recognized for any intrinsic value in stock options at the grant date. The following table illustrates the effect on the Company's reported net income (loss) and earnings per share if...

  • Page 80
    ... gains. E*TRADE Securities receives commissions for providing certain institutional customers with market research and other information, which is a common industry practice. These commission revenues contributed less than 10% of the Company's net revenues for all periods presented. Direct costs...

  • Page 81
    ... on credit balances, interest paid to banks and interest paid to other broker-dealers through a subsidiary's stock loan program. Other Brokerage-Related Revenues -Other brokerage-related revenues consists of account maintenance fees, stock plan administration services, payments for order flow from...

  • Page 82
    ...exchanges its equity instruments for goods and services. This statement focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. The most significant change resulting from this statement is the requirement for public companies...

  • Page 83
    ... operations of E*TRADE Access for periods presented (in thousands): December 31, 2004 2003 Assets: Cash and equivalents Other investments Property and equipment, net Goodwill Other intangibles, net Other assets Total assets of discontinued operations (1) Liabilities: Accounts payable, accrued...

  • Page 84
    ... million of acquisitions costs. Active Accounts In October 2004, the Company acquired certain active accounts from a brokerage company. The Company paid $17.0 million in cash and recorded an intangible asset of $17.0 million which will be amortized over 10 years. ETCF Asset Funding Corporation In...

  • Page 85
    ... income. Using the purchase accounting method, the purchase price was allocated to the assets acquired and liabilities assumed in the E*TRADE Consumer Finance acquisition based on the estimated fair value on the purchase date. E*TRADE Professional In June 2002, the Company's brokerage segment...

  • Page 86
    ...loans, bank borrowings and deposits with clearing organizations. Receivable from and payable to brokers, dealers and clearing organizations result from the Company's brokerage activities. Payable to customers and non-customers represents free credit balances and other customer and non-customer funds...

  • Page 87
    ... Cost Gross Unrealized Gains Gross Unrealized Losses Estimated Fair Values December 31, 2004: Mortgage-backed securities: U.S. Government sponsored enterprise obligations: Federal National Mortgage Association Government National Mortgage Association Federal Home Loan Mortgage Corporation Total...

  • Page 88
    Total available-for-sale securities 79 $ 9,804,150 $ 216,064 $ (193,274) $ 9,826,940

  • Page 89
    ... accordance with EITF 99-20. Accordingly, when the present value of a security's anticipated cash flows declines below the last periodic estimate, the Company recognizes an impairment charge in gain on sales of loans held-for-sale and securities, net in the consolidated statements of operations. 80

  • Page 90
    ... maturities of available-for-sale debt securities, including mortgage-backed securities, at December 31, 2004 are shown below (in thousands): Amortized Cost Estimated Fair Values Due within one year Due within one to five years Due within five to ten years Due after ten years Total $ 61 47...

  • Page 91
    ...thousands): Year Ended December 31, 2004 2003 2002 Mortgage-backed securities: Realized gains Realized losses Impairment on purchased interest-only securities Net realized gains on mortgage-backed securities included in gain on sales of loans held-for-sale and securities, net Other bank investments...

  • Page 92
    Table of Contents Index to Financial Statements Equity Method Investments Equity in the net income (losses) of investments and venture funds were as follows (in thousands): Year Ended December 31, 2004 2003 2002 Joint Ventures: KAP Group E*TRADE Japan K.K. Other Total joint ventures Venture Capital...

  • Page 93
    ... estate loans: One- to four-family Home equity lines of credit and second mortgage Other Total real estate loans Consumer and other loans: Recreational vehicle Marine Automobile Credit card Other Total consumer and other loans Total loans Unamortized premiums, net Allowance for loan losses Total 84...

  • Page 94
    ... One- to four-family Home equity lines of credit and second mortgage Other Total real estate loans Consumer and other loans: Recreational vehicle Marine Automobile Credit card Other Total consumer and other loans Total loans Unamortized premiums, net Allowance for loan losses Total $2,289,196 1,511...

  • Page 95
    ... by the Bank and correspondents. From time-to-time, the Company also sells loans that it originally purchased from others. A summary of these activities is presented below (in thousands): Year Ended December 31, 2004 2003 2002 Loans sold: Correspondent Origination Gain (loss) on sales of loans...

  • Page 96
    ... charges in other banking-related revenues in the consolidated statements of operations. The following table shows the net amortized cost of the Company's servicing rights (in thousands): December 31, 2004 2003 Servicing assets: Balance beginning of period Additions resulting from acquisition...

  • Page 97
    ... value to its carrying value. This initial evaluation indicated that goodwill was impaired, resulting in a non-cash charge totaling $293.7 million ($(0.82) per share). This charge was recorded as a cumulative effect of accounting change. In November 2003 and 2004, the Company performed its annual...

  • Page 98
    ...certain contingencies related to its acquisition of ETCF Asset Funding Corporation. When this business was acquired, the Company recorded deferred tax assets based on management's best estimate of the tax basis that would be accepted by the tax authority upon ultimate settlement. In 2004, management...

  • Page 99
    ... Financial Statements Amortization expense of other intangible assets was $26.9 million for 2004, $30.1 million for 2003 and $22.2 million for 2002. Assuming no future impairments of these assets or additional acquisitions, annual amortization expense will be as follows (in thousands): Years ending...

  • Page 100
    ... in credit, interest rate and prepayment risk. The investment in the preference shares is classified as a trading security in the Company's investment portfolio. Therefore, changes in the market value of these securities are recorded in gain on sales of loans held-for-sale and securities, net in...

  • Page 101
    ... ETCF Asset Funding Corporation retained subordinated interests in each trust. E*TRADE Consumer Finance receives annual servicing fees of 50 basis points of the prior month's balance for the 2004 series trust and all 1999 series trusts and 75 basis points of the prior month's outstanding balance for...

  • Page 102
    ... of Contents Index to Financial Statements The Company acquired ETCF Asset Funding Corporation and the retained beneficial interests in October 2003 (see Note 4). The carrying value of this retained beneficial interest is subject to future volatility in credit, interest rate and prepayment risk. The...

  • Page 103
    ... agreement in the consolidated statement of operations. Other In the normal course of business, the Company extends credit to its principal officers, directors and employees to finance their purchases of securities on margin. Margin loans to the Company's principal officers and directors totaled...

  • Page 104
    ... 31, 2003 Percent December 31, 2004 2003 Sweep deposit account Money market accounts Certificates of deposit Brokered certificates of deposit Passbook savings accounts Checking accounts: Interest-bearing Non-interest-bearing Total Deposits, classified by rates are as follows (in thousands): 0.40...

  • Page 105
    ...TRADE FINANCIAL Sweep Deposit Account ("SDA"). The SDA is a sweep product that transfers brokerage segment customer balances, previously held in money market funds not on our balance sheets, to the banking segment. The Bank holds these funds as customer deposits in FDIC-insured NOW (Negotiable Order...

  • Page 106
    ... Index to Financial Statements NOTE 16-SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE AND OTHER BORROWINGS BY BANK SUBSIDIARY The maturities of borrowings at December 31, 2004 and total borrowings at December 31, 2003 are shown below (dollars in thousands): Other Borrowings by Bank Subsidiary...

  • Page 107
    ...basis) Weighted-average interest rate: During the year (calculated on a daily basis) At year-end Maximum month-end balance during the year Balance at year-end Securities and loans underlying the repurchase agreements at the end of the year: Carrying value, including accrued interest Estimated market...

  • Page 108
    ... of unamortized debt offering costs. In 2002, gain on early extinguishment of debt included an $8.6 million gain from the retirement of $64.9 million of the Company's 6.00% Notes in exchange for approximately 6.5 million shares of the Company's common stock, offset by a $3.3 million loss recorded as...

  • Page 109
    ...the brokers by the settlement date. Other Short-Term Borrowing Arrangements The principal source of financing for E*TRADE Clearing's margin lending activity is cash balances in customers' accounts and financing obtained from other broker-dealers through E*TRADE Clearing's stock loan program. E*TRADE...

  • Page 110
    ...Total deferred tax assets Deferred tax liabilities: Internally developed software Acquired intangibles Basis differences in investments Loan fees Depreciation and amortization Purchased software Retained servicing rights Other Total deferred tax liabilities Valuation allowance Net deferred tax asset...

  • Page 111
    ... excess tax basis in a partnership interest that was sold during 2004. NOTE 20-SHAREHOLDERS' EQUITY Shares Exchangeable into Common Stock In August 2000, EGI Canada Corporation issued approximately 9.4 million Exchangeable Shares in connection with the Company's acquisition of E*TRADE Technologies...

  • Page 112
    ... or incentive stock options to officers, directors, key employees and consultants for the purchase of shares of the Company's common stock at a price determined by the Board of Directors at the date the option is granted. Options are generally exercisable ratably over a four-year period from the...

  • Page 113
    ... 1, 2005. The Company has also assumed option plans as a result of acquisitions in the past. No additional grants will be made under these acquired plans. A summary of stock option activity follows (shares in thousands): Number of Shares WeightedAverage Exercise Price Outstanding at December 31...

  • Page 114
    ...1996 Stock Purchase Plan (the "1996 Purchase Plan"), and reserved 2,600,000 shares of common stock for sale to employees at a price no less than 85% of the lower of the fair market value of the common stock at the beginning of the two-year offering period or the end of each of the six-month purchase...

  • Page 115
    Table of Contents Index to Financial Statements options without vesting restrictions, which significantly differ from the Company's stock option awards. These models also require subjective assumptions, including future stock price volatility and expected time to exercise, which greatly affect the ...

  • Page 116
    ... Contents Index to Financial Statements stores. These unprofitable product lines consisted of our Stock Basket product offered to customers and our online advisory service, eAdvisor, a joint initiative with Enlight Holdings, LLC. The Company terminated its revenue sharing agreements associated with...

  • Page 117
    ...of institutional research business Exit of keyboard lending activities (Gain) loss on exit of E*TRADE Bank AG (German subsidiary) Subsequent recovery related to sale of E*TRADE @ Net Bourse S.A. Resolution of obligation upon the liquidation of E*TRADE South Africa Other Total other exit charges, net...

  • Page 118
    ...from the buyer valued at $5.1 million. The Company recorded these future services in other assets and will amortize the value of these services over the anticipated period during which it expects to receive the actual services. The Company recognized a gain of $3.9 million from the sale in 2003. The...

  • Page 119
    ... of accounting change, net of tax Net Income (loss) Interest on convertible subordinated notes, net of tax Net income (loss), as adjusted Denominator: Basic weighted-average shares outstanding Effect of dilutive securities: Weighted-average options and restricted stock issued to employees Weighted...

  • Page 120
    ...from the calculations of diluted income (loss) per share are 45.4 million of common stock shares for 2003 and 46.0 million of common shares for 2002, issuable under convertible subordinated notes as the effect of applying the treasury stock method on an if-converted basis would be anti-dilutive. 110

  • Page 121
    ... of aggregate debit balances arising from customer transactions, as defined. Under the alternative method, a broker-dealer may not repay subordinated borrowings, pay cash dividends or make any unsecured advances or loans to its parent or employees if such payment would result in net capital of less...

  • Page 122
    ...in which the Bank's loans or securities are concentrated, could adversely affect future earnings and consequently, the Bank's ability to meet its future capital requirements. The Bank's required actual capital amounts and ratios are presented in the table below (dollars in thousands): Required to be...

  • Page 123
    Table of Contents Index to Financial Statements Certain leases contain provisions for renewal options and rent escalations based on increases in certain costs incurred by the lessor. Rent expense was $23.9 million for 2004, $31.4 million for 2003 and $29.2 million for 2002. NOTE 26-COMMITMENTS, ...

  • Page 124
    ... adjusted when there is more information available or when an event occurs requiring a change. Regulatory Matters The securities and banking industries are subject to extensive regulation under Federal, state and applicable international laws. As a result, the Company is required to comply with many...

  • Page 125
    ... completed during the last three years, the Company is obligated to make certain additional payments in cash and/or stock in the event certain milestones are achieved by the acquired entities. See Note 4 for further information. E*TRADE Bank provides guarantees to investors purchasing mortgage loans...

  • Page 126
    ... Statements NOTE 27-ACCOUNTING FOR DERIVATIVE FINANCIAL INSTRUMENTS AND HEDGING ACTIVITIES The Company enters into derivative transactions to protect against the risk of market price or interest rate movements on the value of certain assets and future cash flows. The Company is also required...

  • Page 127
    ... the terms of the securities purchased or sold. Changes in the fair value of derivatives that hedge cash flows associated with time deposits, repurchase agreements, advances from the FHLB, dollar rolls and other borrowings and investment securities are reported in AOCI as unrealized gains or losses...

  • Page 128
    ...rate options were used to hedge the Bank's repurchase agreements. Under SFAS No. 133, we are required to record the fair value of gains and losses on derivatives designated as cash flow hedges in AOCI in the consolidated balance sheets. In addition, during the normal course of business, the Company...

  • Page 129
    ... fair value of these closed loans are included as gain on sales of loans held-for-sale and securities, net or gain on sales of originated loans in the consolidated statements of operations based on whether the loan was purchased or originated. Credit risk is managed by limiting activity to approved...

  • Page 130
    ... market price quotes on similar liquid securities and adjusting the price to reflect differences between the two securities, such as credit risk, liquidity, term coupon, payment characteristics and other information. • FHLB stock -Cost is considered to be a reasonable estimate of fair value...

  • Page 131
    ... of similar credit quality originations by the same company. Deposits -For passbook savings, checking and money market accounts, fair value is estimated to be carrying value. For fixed maturity certificates of deposit, fair value is estimated by discounting future cash flows at the currently offered...

  • Page 132
    ... Statements Financial information for the Company's reportable segments is presented in the following tables (in thousands): Year Ended December 31, 2004 Eliminations Brokerage Banking (1) Total Net revenues: Commissions Principal transactions Interest income Interest expense Gain on sales...

  • Page 133
    ... negotiated rate that approximates market on the average SDA balance. The banking segment reflects this payment as marketing expense as it is a fee associated with deposit gathering activity and the brokerage segment reflects this payment as other revenue as it is a fee for access to customers. 123

  • Page 134
    ...-sale and securities, net Provision for loan losses Other revenues Net revenues Expenses excluding interest: Compensation and benefit Occupancy and equipment Communications Professional services Commissions, clearance and floor brokerage Advertising and market development Servicing and other banking...

  • Page 135
    ... FINANCIAL INFORMATION (PARENT COMPANY ONLY) The following presents the Parent's condensed balance sheets, statements of operations and cash flows: BALANCE SHEETS (in thousands) December 31, 2004 2003 ASSETS Cash and equivalents Property and equipment, net Investments Equity in net assets of bank...

  • Page 136
    ... of accounting change Other income (loss) Corporate interest income Corporate interest expense Gain (loss) on sale and impairment of investments Gain (loss) on early extinguishment of debt Equity in income of investment and venture funds Total other loss Pre-tax loss Income tax benefit Income (loss...

  • Page 137
    ... cash restructuring costs and other exit charges Cumulative effect of accounting change Gain on early extinguishment of debt Other Other changes, net: Other assets and liabilities, net Decrease in restructuring liabilities Net cash provided by (used in) operating activities CASH FLOWS FROM INVESTING...

  • Page 138
    ... 26. Acquisition of Advisory Firm In October 2004, the Company entered into an agreement to purchase a registered investment advisory firm with over $500 million in assets under management, which provides asset management services and general wealth advice to individuals. The transaction closed in...

  • Page 139
    ... periods. (b) Our Chief Executive Officer and Chief Financial Officer have evaluated the changes to the Company's internal control over financial reporting that occurred during our fiscal year ended December 31, 2004, as required by paragraph (d) Rules 13a-15 and 15d-15 under the Securities Exchange...

  • Page 140
    ... Stanley & Co. Incorporated, Credit Suisse First Boston LLC, Deutsche Bank Securities Inc. and Sandler O' Neill & Partners, L.P., as Initial Purchases (Incorporated by reference to Exhibit 1 of the Company's Form S-4 filed July 1, 2004). Agreement and Plan of Acquisition and Reorganization at May 31...

  • Page 141
    ... 5, 2004). Form of Indemnification Agreement entered into between the Registrant and its directors and certain officers (Incorporated by reference to Exhibit 10.1 of the Company's Registration Statement on Form S-1, Registration Statement No. 333-05525). 1983 Employee Incentive Stock Option Plan...

  • Page 142
    ... on April 17, 2000). E*TRADE Ventures II, LLC, Limited Liability Company Operating Agreement (Incorporated by reference to Exhibit 10.30 to the Company's Annual Report on Form 10-K filed November 9, 2000). E*TRADE eCommerce Fund II, L.P., Limited Partnership Agreement (Incorporated by reference to...

  • Page 143
    Table of Contents Index to Financial Statements Exhibit Number Description 10.43 10.44 10.45 10.46 10.47 10.48 10.49 10.50 10.51 10.52 10.53 10.54 10.55 10.56 10.57 10.58 Form of Stock Pledge Agreement by and between the Company and Jerry Gramaglia dated December...

  • Page 144
    ...Agreement and Global Services Schedule, dated April 9, 2003, between E*TRADE Group, Inc. and ADP Financial Information Services, Inc. (Incorporated by reference to Exhibit 10.1 of the Company's Form 10-Q filed August 8, 2003). E*TRADE FINANCIAL Sweep Deposit Account Brokerage and Servicing Agreement...

  • Page 145
    ... undersigned, thereunto duly authorized. Dated: March 10, 2005 E*TRADE F INANCIAL C ORPORATION By: /s/ M ITCHELL H. C APLAN Mitchell H. Caplan Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on...

  • Page 146
    ... Estimated interest portion within rental expense Preference securities dividend requirements of consol. subs Total fixed charges Earnings: Income (loss) before income taxes, discontinued operations and cumulative effect of accounting change less equity in income (loss) of investments Fixed charges...

  • Page 147
    ... Nova Scotia Company 3744221 Canada Inc. TIR (Holdings) Limited E*TRADE Bank A/S E*TRADE SARL E*TRADE Germany Communications GmbH ETRADE Securities (Hong Kong) Limited ETRADE Securities Limited ETRADE Global Research Limited ETRADE Corporate Services (Hong Kong) Limited ETRADE Asia Services Limited

  • Page 148
    ... financial statements and financial statement schedule of E*TRADE Financial Corporation and management's report on the effectiveness of internal control over financial reporting, appearing in this Annual Report on Form 10-K of E*TRADE Financial Corporation for the year ended December 31, 2004. Filed...

  • Page 149
    ... Mitchell H. Caplan Chief Executive Officer Dated: March 10, 2005 Exhibit 31.2 I, Robert J. Simmons, certify that: 1. 2. I have reviewed this annual report on Form 10-K of E*TRADE Financial Corporation; Based on my knowledge, this report does not contain any untrue statement of a material fact...

  • Page 150
    ... Chief Executive Officer and Robert J. Simmons, the Chief Financial Officer of E*TRADE Financial Corporation, each certifies that, to the best of their knowledge: 1. 2. the Annual Report fully complies with the requirements of Section 13(a) or 15(d) of the Exchange Act; and the information contained...