eTrade 2012 Annual Report Download - page 101

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.
Interest Rate Risk
Our exposure to interest rate risk is related primarily to interest-earning assets and interest-bearing
liabilities, the vast majority of which are held for non-trading purposes. The management of interest rate risk is
essential to profitability. The primary objective of the management of interest rate risk is to control exposure to
interest rates within the Board-approved limits, as outlined in the scenario analysis below, and with limited
exposure to earnings volatility resulting from interest rate fluctuations. Our general strategies to manage interest
rate risk include balancing variable-rate and fixed-rate assets and liabilities and utilizing derivatives in a way that
reduces overall exposure to changes in interest rates. 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 interest rate 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, 2012, 89% of our total assets were enterprise
interest-earning assets.
At December 31, 2012, approximately 63% 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.
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