eTrade 2005 Annual Report Download - page 98

Table of Contents
Scenario Analysis
Scenario analysis is an advanced approach to estimating interest rate risk exposure. Under the Net Present Value of Equity (“NPVE”)
approach, the present value of all existing assets, liabilities, derivatives and forward commitments are estimated and then combined to
produce a NPVE figure. 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 and 200
basis points. The NPVE method is used at the Bank level and not for the consolidated Company. The Bank has 79% and 84% of our
interest-earning assets and holds 77% and 85% of our interest-bearing liabilities at December31, 2005 and 2004, respectively.
Interest-earning assets not included in the NPVE approach are floating rate brokerage receivables and a small portfolio of trading
securities. Interest-bearing liabilities not currently included in the analysis consist of brokerage payables and corporate level long-term
debt.
The sensitivity of NPVE at December31, 2005 and 2004 and the limits established by the Bank’s Board of Directors are listed below
(dollars in thousands):
Change in NPVE
At December31,
BoardLimit
Parallel Change in InterestRates(bps)
2005
2004
+300
$
(490,045
)
(22
)
%
$
(158,207
)
(9
)
%
(55
)
%
+200
$
(298,476
)
(13
)
%
$
(69,671
)
(4
)
%
(30
)
%
+100
$
(115,244
)
(5
)
%
$
(2,321
)
—
%
(20
)
%
-100
$
(49,256
)
(2
)
%
$
(149,651
)
(9
)
%
(20
)
%
-200
$
(382,924
)
(17
)
%
*
*
(30
)
%
*
The Interest Rate Risk for down 200 is not presented as of December31, 2004 because the OTS did not require the Bank to monitor this information as of that date.
Under criteria published by the OTS, the Bank’s overall interest rate risk exposure at December31, 2005 was characterized as
“moderate.” We actively manage our interest rate risk positions. As interest rates change, we will readjust our strategy and mix of
assets, liabilities and derivatives to optimize its position. For example, a 100 basis points increase in rates may not result in a change in
value as indicated above. The Bank’s Asset Liability Committee monitors the Bank’s position.
Mortgage Production Activities
Our current strategy is to hold loan production on the balance sheet, thus the current period impact resulting from exposure to
mortgage production activity risks have declined. However, holding mortgage assets on the balance sheet involves similar risks. We
are exposed to changing interest rates between the commitment and funding dates. The most significant mortgage loan risk is
prepayment risk. The cost to originate a mortgage loan can be significant. When mortgage loans prepay, these costs are written off.
Depending on the timing of the prepayment, these write-offs may result in a lower than anticipated yields. The Asset Liability
Committee reviews estimates of the impact of changing market rates on loan production volumes and prepayments. This information is
incorporated into our interest rate risk management strategy.
For mortgage loans intended to be sold, Interest Rate Lock Commitments (“IRLC”) are considered derivatives with changes in fair
value recorded in earnings. IRLC are commitments issued to borrowers that lock in an interest rate now for a loan closing in one to
three months. These locks initially recorded with a fair value of zero will fluctuate in value of the lock period as market interest rates
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