eTrade 2011 Annual Report Download - page 93

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The following discussion about market risk disclosure includes forward-looking statements. Actual results
could differ materially from those projected in the forward-looking statements as a result of certain factors,
including, but not limited to, those set forth in Item 1A. Risk Factors in this report. Market risk is exposure to
changes in interest rates, foreign exchange rates and equity and commodity prices. Exposure to interest rate risk
is related primarily to interest-earning assets and interest-bearing liabilities.
Interest Rate Risk
The management of interest rate risk is essential to profitability. Interest rate risk is exposure to changes in
interest rates. In general, we manage interest rate risk by balancing variable-rate and fixed-rate assets and
liabilities and we utilize derivatives in a way that reduces overall exposure to changes in interest rates. In recent
years, we have managed interest rate risk to achieve a minimum to moderate risk profile with limited exposure to
earnings volatility resulting from interest rate fluctuations. Exposure to interest rate risk requires management to
make complex assumptions regarding maturities, market interest rates and customer behavior. Changes in
interest rates, including the following, could impact interest income and expense:
• Interest-earning assets and interest-bearing liabilities may re-price at different times or by different
amounts creating a mismatch.
• The yield curve may steepen, flatten or change shape affecting the spread between short- and long-term
rates. Widening or narrowing spreads could impact net interest income.
• Market interest rates may influence prepayments resulting in maturity mismatches. In addition,
prepayments could impact yields as premium and discounts amortize.
Exposure to market risk is dependent upon the distribution and composition of interest-earning assets,
interest-bearing liabilities and derivatives. The differing risk characteristics of each product are managed to
mitigate our exposure to interest rate fluctuations. At December 31, 2011, 90% of our total assets were enterprise
interest-earning assets.
At December 31, 2011, approximately 66% of total assets were residential real estate loans and
available-for-sale and held-to-maturity mortgage-backed securities. The values of these assets are sensitive to
changes in interest rates, as well as expected prepayment levels. As interest rates increase, fixed rate residential
mortgages and mortgage-backed securities tend to exhibit lower prepayments. The inverse is true in a falling rate
environment.
When real estate loans prepay, unamortized premiums are written off. Depending on the timing of the
prepayment, the write-offs of unamortized premiums may result in lower than anticipated yields. The ALCO
reviews estimates of the impact of changing market rates on prepayments. This information is incorporated into
our interest rate risk management strategy.
Our liability structure consists of two central sources of funding: deposits and wholesale borrowings. Cash
provided to us through deposits is the primary source of funding. Key deposit products include sweep accounts,
complete savings accounts and other money market and savings accounts. Wholesale borrowings include
securities sold under agreements to repurchase and FHLB advances. Other sources of funding include customer
payables, which is customer cash contained within our broker-dealers, and corporate debt issued by the parent
company.
Deposit accounts and customer payables tend to be less rate-sensitive than wholesale borrowings.
Agreements to repurchase securities re-price as agreements reset. Sweep accounts, complete savings accounts
and other money market and savings accounts re-price at management’s discretion. FHLB advances and
corporate debt generally have fixed rates.
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