eTrade 2005 Annual Report Download - page 164

Table of Contents
Mortgage Banking Activities
The Company enters into commitments to originate loans whereby the interest rate on the loan is determined prior to funding; these
commitments are referred to as Interest Rate Lock Commitments, (“IRLCs”.) IRLCs on loans that the Bank intends to sell are considered
to be derivatives and are, therefore, recorded at fair value with changes in fair value recorded in earnings. For purposes of determining
their fair value, the Company performs a net present value analysis of the anticipated cash flows associated with these IRLCs. The net
present value analysis performed excludes the market value associated with the anticipated sale of servicing rights related to each loan
commitment. The fair value of these IRLCs was a $1.6 million and $1.5million asset at December31, 2005 and 2004, respectively.
The Company also designates fair value relationships of closed loans held-for-sale against a combination of mortgage forwards and
short treasury positions. Short treasury relationships are economic hedges, rather than fair value or cash flow hedges. Short treasury
positions are marked-to-market, but do not receive hedge accounting treatment under SFAS No.133. The mark-to-market of the
mortgage forwards are included in the net change of the IRLCs and the related hedging instruments. The mark-to-market of the closed
loans recorded for 2005 and 2004 were $0.7 million and $4.3 million, respectively.
IRLCs, as well as closed loans held-for-sale, expose the Company to interest rate risk. The Company manages this risk by selling
mortgages or mortgage-backed securities on a forward basis referred to as forward sale agreements. Changes in the fair value of these
derivatives are included as gain on sales of loans and securities, net in the consolidated statements of income. The net change in
IRLCs, closed loans and the related hedging instruments generated a net loss of $0.4 million in 2005 and a net gain of $3.9 million in
2004.
Credit risk is managed by limiting activity to approved counterparties and setting aggregate exposure limits for each approved
counterparty. The credit risk that results from interest rate swaps and purchased interest rate options is represented by the fair value of
contracts that have unrealized gains at the reporting date. Conversely, we have $36.6million of derivative contracts with unrealized
losses at December31, 2005. These agreements required the Company to pledge approximately $7.4million of its mortgage-backed and
investment securities as collateral.
While the Company does not expect that any counterparty will fail to perform, the following table shows the maximum exposure, or net
credit risk, associated with each counterparty to interest rate swaps and purchased interest rate options at December31, 2005 (in
thousands):
Counterparty
Credit
Risk
Union Bank of Switzerland
$
27,733
Lehman Brothers
12,821
Royal Bank of Scotland
7,283
Bank of America
5,361
Credit Suisse First Boston
4,446
Other
1,316
Total exposure
$
58,960
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2006. EDGAR Online, Inc.