10-K 1 d680999d10k.htm 10-K 10-K
Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-K

 

 

(Mark One)

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2013

or

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from             to             .

Commission File Number 1-11921

 

 

E*TRADE Financial Corporation

(Exact Name of Registrant as Specified in its Charter)

 

 

 

Delaware   94-2844166

(State or other jurisdiction

of incorporation or organization)

 

(I.R.S. Employer

Identification Number)

1271 Avenue of the Americas, 14th Floor, New York, New York 10020

(Address of principal executive offices and Zip Code)

(646) 521-4300

(Registrant’s telephone number, including area code)

Securities Registered Pursuant to Section 12(b) of the act:

 

Title of Each Class   Name of Each Exchange on Which Registered
Common Stock, par value $0.01 per share  

The NASDAQ Stock Market LLC

NASDAQ Global Select Market

Securities Registered Pursuant to Section 12(g) of the Act: None

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  x    No  ¨

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ¨    No  x

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendments to this Form 10-K.    x

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer   x   Accelerated filer   ¨
Non-accelerated filer     ¨  (Do not check if a smaller reporting company)   Smaller reporting company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

At June 30, 2013, the aggregate market value of voting stock held by non-affiliates of the registrant was approximately $2.9 billion (based upon the closing price per share of the registrant’s common stock as reported by the NASDAQ Global Select Market on that date). Shares of common stock held by each officer, director and holder of 5% or more of the outstanding common stock have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes.

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:

As of February 21, 2014, there were 288,271,360 shares of common stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Certain portions of the definitive Proxy Statement related to the Company’s 2014 Annual Meeting of Shareholders, to be filed hereafter (incorporated into Part III hereof).


Table of Contents

E*TRADE FINANCIAL CORPORATION

FORM 10-K ANNUAL REPORT

For the Year Ended December 31, 2013

TABLE OF CONTENTS

 

PART I

    
Forward-Looking Statements      1   

Item 1.

  Business      1   
 

Overview

     1   
 

Strategy

     2   
 

Technology

     2   
 

Products and Services

     2   
 

Sales and Customer Service

     4   
 

Competition

     5   
 

Regulation

     5   
 

Available Information

     9   

Item 1A.

 

Risk Factors

     10   

Item 1B.

 

Unresolved Staff Comments

     23   

Item 2.

 

Properties

     23   

Item 3.

 

Legal Proceedings

     23   

Item 4.

 

Mine Safety Disclosures

     26   

PART II

    

Item 5.

  Market for Registrant’s Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities      27   

Item 6.

  Selected Consolidated Financial Data      29   

Item 7.

  Management’s Discussion and Analysis of Financial Condition and Results of Operations      31   
 

Overview

     31   
 

Earnings Overview

     34   
 

Segment Results Review

     49   
 

Balance Sheet Overview

     56   
 

Liquidity and Capital Resources

     61   
 

Risk Management

     66   
 

Concentrations of Credit Risk

     71   
 

Summary of Critical Accounting Policies and Estimates

     79   
 

Statistical Disclosure by Bank Holding Companies

     88   
 

Glossary of Terms

     93   

Item 7A.

  Quantitative and Qualitative Disclosures about Market Risk      98   

Item 8.

  Financial Statements and Supplementary Data      101   
  Management Report on Internal Control Over Financial Reporting      101   
  Reports of Independent Registered Public Accounting Firm      102   
 

Consolidated Statement of Income (Loss)

     104   
 

Consolidated Statement of Comprehensive Income (Loss)

     105   
 

Consolidated Balance Sheet

     106   
 

Consolidated Statement of Shareholders’ Equity

     107   
 

Consolidated Statement of Cash Flows

     108   
 

Notes to Consolidated Financial Statements

     110   
 

Note 1—Organization, Basis of Presentation and Summary of Significant Accounting Policies

     110   
 

Note 2—Business Held-for-Sale

     123   
 

Note 3—Operating Interest Income and Operating Interest Expense

     123   
 

Note 4—Fair Value Disclosures

     124   
 

Note 5—Available-for-Sale and Held-to-Maturity Securities

     134   

 

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Note 6—Loans Receivable, Net

     139   
 

Note 7—Accounting for Derivative Instruments and Hedging Activities

     148   
 

Note 8—Property and Equipment, Net

     151   
 

Note 9—Goodwill and Other Intangibles, Net

     152   
 

Note 10—Other Assets

     153   
 

Note 11—Deposits

     154   
 

Note 12—Securities Sold Under Agreements to Repurchase and FHLB Advances and Other Borrowings

     155   
 

Note 13—Corporate Debt

     157   
 

Note 14—Other Liabilities

     159   
 

Note 15—Income Taxes

     159   
 

Note 16—Shareholders’ Equity

     164   
 

Note 17—Earnings (Loss) per Share

     166   
 

Note 18—Regulatory Requirements

     166   
 

Note 19—Lease Arrangements

     168   
 

Note 20—Commitments, Contingencies and Other Regulatory Matters

     168   
 

Note 21—Segment Information

     173   
 

Note 22—Condensed Financial Information (Parent Company Only)

     175   
 

Note 23—Quarterly Data (Unaudited)

     177   
 

Note 24—Subsequent Event

     177   

Item 9.

  Changes in and Disagreements with Accountants on Accounting and Financial Disclosure      177   

Item 9A.

  Controls and Procedures      178   

Item 9B.

  Other Information      178   

PART III

  

PART IV

  

Item 15.

  Exhibits and Financial Statement Schedules      179   

Signatures

     182   

 

 

Unless otherwise indicated, references to “the Company,” “we,” “us,” “our” and “E*TRADE” mean E*TRADE Financial Corporation and its subsidiaries.

E*TRADE, E*TRADE Financial, E*TRADE Bank, Equity Edge, OptionsLink and the Converging Arrows logo are registered trademarks of E*TRADE Financial Corporation in the United States and in other countries.

 

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FORWARD-LOOKING STATEMENTS

This report contains forward-looking statements involving risks and uncertainties. These statements relate to our future plans, objectives, expectations and intentions. These statements may be identified by the use of words such as “assume,” “expect,” “believe,” “may,” “will,” “should,” “anticipate,” “intend,” “plan,” “estimate,” “continue” and similar expressions. Our actual results could differ materially from those discussed in these forward-looking statements, and we caution that we do not undertake to update these statements. Factors that could contribute to our actual results differing from any forward-looking statements include those discussed under Risk Factors, Management’s Discussion and Analysis of Financial Condition and Results of Operations and elsewhere in this report and in other reports we file with the SEC. The cautionary statements made in this report should be read as being applicable to all forward-looking statements wherever they appear in this report. We further caution that there may be risks associated with owning our securities other than those discussed in our filings.

 

ITEM 1.     BUSINESS

OVERVIEW

E*TRADE Financial Corporation is a financial services company that provides brokerage and related products and services primarily to individual retail investors under the brand “E*TRADE Financial.” Our primary focus is to profitably grow our retail brokerage business. We also provide investor-focused banking products, primarily sweep deposits and savings products, to retail investors. Our competitive strategy is to attract and retain customers by emphasizing value beyond price, ease of use and innovation, with delivery of our products and services primarily through digital and technology-intensive channels.

Our corporate offices are located at 1271 Avenue of the Americas, 14th Floor, New York, New York 10020. We were incorporated in California in 1982 and reincorporated in Delaware in July 1996. We had approximately 3,000 employees at December 31, 2013. We operate directly and through numerous subsidiaries, many of which are overseen by governmental and self-regulatory organizations. Our most significant subsidiaries are described below:

 

   

E*TRADE Bank is a federally chartered savings bank that provides investor-focused banking products to retail customers nationwide and deposit accounts insured by the Federal Deposit Insurance Corporation (“FDIC”);

 

   

E*TRADE Securities LLC is a registered broker-dealer and is a wholly-owned operating subsidiary of E*TRADE Bank. It is the primary provider of brokerage products and services to our customers;

 

   

E*TRADE Clearing LLC is the clearing firm for our brokerage subsidiaries and is a wholly-owned operating subsidiary of E*TRADE Bank. Its main purpose is to clear and settle securities transactions for customers of E*TRADE Securities LLC; and

 

   

G1 Execution Services, LLC is a registered broker-dealer and market maker. We entered into a definitive agreement to sell G1 Execution Services, LLC to an affiliate of Susquehanna International Group, LLP (“Susquehanna”) for approximately $75 million. The sale of G1 Execution Services, LLC was completed on February 10, 2014.

A complete list of our subsidiaries at December 31, 2013 can be found in Exhibit 21.1.

We provide services to customers in the U.S. through mobile applications and our website at www.etrade.com. We also provide services through our network of customer service representatives and financial consultants, over the phone or in person through our 30 E*TRADE branches. Information on our website is not a part of this report.

 

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STRATEGY

Our business strategy is centered on two core objectives: accelerating the growth of our core brokerage business to improve market share, and strengthening our overall financial and franchise position.

Accelerate Growth of Core Brokerage Business

 

   

Enhance digital and offline customer experience.

We are focused on maintaining our competitive position in trading, margin lending and cash management, while expanding our customer share of wallet in retirement, investing and savings. Through these offerings, we aim to continue acquiring new customers while deepening engagement with both new and existing ones.

 

   

Capitalize on value of corporate services business.

This includes leveraging our industry-leading position to improve client acquisition, and bolstering awareness among plan participants of our full suite of offerings. This channel is a strategically important driver of brokerage account growth for us.

 

   

Maximize value of deposits through the Company’s bank.

Our brokerage business generates a significant amount of deposits, which we monetize through the bank by investing primarily in low-risk, agency mortgage-backed securities.

Strengthen Overall Financial and Franchise Position

 

   

Manage down legacy investments and mitigate credit losses.

We continue to manage down the size and risks associated with our legacy loan portfolio, while mitigating credit losses where possible.

 

   

Execute on our capital plan.

The core components of our capital plan include bolstering our capital levels through earnings and de-risking and building out best-in-class enterprise risk management capabilities. A key goal of this plan is to distribute capital from the bank to the parent.

TECHNOLOGY

Our success and ability to execute on our strategy is largely dependent upon the continued development of our technologies. We believe our focus on being a technological leader in the financial services industry enhances our competitive position. This focus allows us to deploy a secure, scalable, and reliable technology and back office platform that promotes innovative product development and delivery. We continued to invest in these critical platforms in 2013, leveraging the latest technologies to drive significant efficiencies as well as enhancing our service and operational support capabilities. Our sophisticated and proprietary technology platform also enabled us to deliver many upgrades to our retirement, investing and savings customer products and tools across all digital channels.

PRODUCTS AND SERVICES

We assess the performance of our business based on our two core segments; trading and investing, including corporate services, and balance sheet management. With respect to trading and investing, the factors used to judge our performance include profitability, along with the competitiveness of our overall value proposition to the customer and our customers’ engagement with E*TRADE. We also use various customer activity and financial metrics, including daily average revenue trades (“DARTs”), average commission per trade, margin receivables, brokerage accounts, net new brokerage accounts, brokerage account attrition rate, customer assets, net new brokerage assets and brokerage related cash. We assess the performance of our balance sheet management segment using metrics such as regulatory capital ratios, loan delinquencies, allowance for loan losses, enterprise net interest spread and average enterprise interest-earning assets. Costs associated with certain functions that are centrally-managed are separately reported in a corporate/other category.

 

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Trading and Investing

Our trading and investing segment offers a comprehensive suite of financial products and services to individual retail investors. The most significant of these products and services are described below:

Trading Products and Services

 

   

access to our best-in-class customer website, etrade.com, including E*TRADE 360, a fully customizable account page;

 

   

automated order placement and execution of U.S. equities, futures, options, exchange-traded funds, forex and bond orders;

 

   

access to E*TRADE Mobile, which allows customers to securely trade, monitor real-time investment, market and account information, access educational videos and other content, pay bills and transfer funds between accounts via iPhone®, iPad®, Android™ phones and tablets, Windows® Phone or Kindle Fire;

 

   

use of E*TRADE Pro, our desktop trading software for qualified active traders, which provides customers with customizable trading technology, continuous market visibility, news and information, plus live streaming news via CNBC TV;

 

   

margin accounts allowing customers to borrow against their securities, complete with margin analysis tools to help customers manage their account and risk;

 

   

cross-border trading, which allows customers residing outside of the U.S. to trade in U.S. securities;

 

   

access to 77 international markets with American depositary receipts (“ADRs”), exchange-traded funds (“ETFs”), and mutual funds, plus online equity trading in local currencies in Canada, France, Germany, Hong Kong, Japan and the United Kingdom;

 

   

research and investing idea generation tools that assist customers with identifying investment opportunities including analyst and technical research, consensus ratings, and market commentary from Morningstar, Dreyfus and BondDesk Group;

 

   

access to advice from our financial consultants at our 30 branches across the country and via phone and email;

 

   

no annual fee and no minimum individual retirement accounts; plus, Rollover Specialists to guide customers through the rollover process;

 

   

access to our retirement center which offers easy-to-use tools, calculators, education, retirement solutions, and access to Chartered Retirement Planning CounselorsSM who can provide customers with one-on-one portfolio evaluations and personalized plans;

 

   

OneStop Rollover—a simplified, online rollover program that enables investors to invest their 401(k) savings from a previous employer into a professionally-managed portfolio;

 

   

access to all ETFs sold, including over 80 commission-free ETFs from leading independent providers, and over 7,700 non-proprietary mutual funds;

 

   

Managed Investment Portfolio advisory services from an affiliated registered investment advisor, with an investment of $25,000 or more, which provides one-on-one professional portfolio management;

 

   

Unified Managed Account advisory services from an affiliated registered investment advisor, with an investment of $250,000 or more, which provides customers the opportunity to work with a dedicated investment professional to obtain a comprehensive, integrated approach to asset allocation, investments, portfolio rebalancing and tax management;

 

   

comprehensive Online Portfolio Advisor to help customers identify the right asset allocation and provide a range of solutions including a one-time investment portfolio or a managed investment account;

 

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fixed income tools in our Bond Resource Center aimed at helping customers identify, evaluate and implement fixed income investment strategies;

 

   

access to our redesigned investor education center with over 400 individual educational articles and videos from over 10 independent sources and E*TRADE’s financial experts, along with live events, webcasts; web seminars; tutorials and demos totaling more than 100 courses; and

 

   

FDIC insured deposit accounts, including checking, savings and money market accounts, including those that transfer funds to and from customer brokerage accounts.

Corporate Services

We offer software and services for managing equity compensation plans for corporate customers. Our Equity Edge Online™ platform facilitates the management of employee stock option plans, employee stock purchase plans and restricted stock plans, including necessary accounting and reporting functions. This product serves as an important introductory channel to E*TRADE for our corporate services account holders, with our goal being that these individuals will also use our brokerage products and services. Equity Edge Online™ recordkeeping and reporting was rated #1 in overall satisfaction for the second year in a row by Group Five, an independent consulting and research firm, in its 2013 Stock Plan Administration Study Industry Report.

Market Making

Our trading and investing segment also includes market making activities which match buyers and sellers of securities from our retail brokerage business and unrelated third parties. As a market maker, we take positions in securities and function as a wholesale trader by combining trading lots to match buyers and sellers of securities. Trading gains and losses result from these activities. Our revenues are influenced by overall trading volumes, trade mix and the number of stocks for which we act as a market maker and the trading volumes and volatility of those specific stocks. We entered into a definitive agreement to sell the market making business, G1 Execution Services, LLC, to an affiliate of Susquehanna for approximately $75 million. The sale of G1 Execution Services, LLC was completed on February 10, 2014.

Balance Sheet Management

The balance sheet management segment serves as a means to maximize the value of our customer deposits, focusing on asset allocation and managing credit, liquidity and interest rate risks. The balance sheet management segment manages our legacy loan portfolio which has been in runoff mode since 2008, as well as agency mortgage-backed securities, and other investments. Funding sources consist of customer payables and deposits which originate in the trading and investing segment, as well as wholesale funding.

For statistical information regarding products and services, see Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”). Three years of segment financial performance and data can be found in the MD&A and in Note 21—Segment Information of Item 8. Financial Statements and Supplementary Data.

SALES AND CUSTOMER SERVICE

We believe providing superior sales and customer service is fundamental to our business. We also strive to maintain a high standard of customer service by staffing the customer support team with appropriately trained personnel who are equipped to handle customer inquiries in a prompt yet thorough manner. Our customer service representatives utilize our proprietary web-based platform to provide customers with answers to their inquiries. We also have specialized customer service programs that are tailored to the needs of each customer group.

 

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We provide sales and customer support through the following channels of our registered broker-dealer and investment advisory subsidiaries:

 

   

Branches—we have 30 branches located in the U.S. where retail investors can go to service their needs while receiving face to face customer support. Financial consultants are also available on-site to help customers assess their current asset allocation and develop plans to help them achieve their investment goals. Customers can also contact our financial consultants via phone or e-mail if they cannot visit the branches.

 

   

Online—we have an Online Advisor tool available that provides asset allocation and a range of investment solutions that can be managed online or through a dedicated investment professional. We also have an Online Service Center where customers can request services on their accounts and obtain answers to frequently asked questions. The online service center also provides customers with the ability to send a secure message and/or engage in Live Chat with one of our customer service representatives. In addition, we offer our Investor Education Center, providing customers with access to a variety of live and on-demand courses.

 

   

Telephonic—we have a toll free number that connects customers to an automated phone system which will help ensure that they are directed to the appropriate department where a financial consultant or licensed customer service representative can assist with their inquiry.

COMPETITION

The online financial services market continues to evolve and remains highly competitive. Our trading and investing segment competes with full commission brokerage firms, discount brokerage firms, online brokerage firms, Internet banks and traditional “brick & mortar” retail banks and thrifts. Some of these competitors provide Internet trading and banking services, investment advisor services, touchtone telephone and voice response banking services, electronic bill payment services and a host of other financial products. Our balance sheet management segment competes with all users of market liquidity, including the types of competitors listed above, in its quest for the least expensive source of funding.

The financial services industry has become more concentrated as companies involved in a broad range of financial services have been acquired, merged or have declared bankruptcy. We believe we can continue to attract retail customers by providing them with easy-to-use and innovative financial products and services.

We also face competition in attracting and retaining qualified employees. Our ability to compete effectively in financial services will depend upon our ability to attract new employees and retain and motivate our existing employees while efficiently managing compensation-related costs.

REGULATION

Our business is subject to regulation by U.S. federal and state regulatory agencies and various non-U.S. governmental agencies and self-regulatory organizations, including, for example, central banks and securities exchanges, each of which has been charged with the protection of the financial markets and the protection of the interests of those participating in those markets. We have been, along with other large financial institutions, subject to heightened expectations from our regulators with respect to compliance with laws and regulations, including our controls and business processes, which we expect will continue. We also anticipate that our regulators will intensify their supervision through the exam process and increase their enforcement of regulations across the industry. The regulators’ heightened expectations and intense supervision have and will continue to increase our costs and may limit our ability to pursue certain business opportunities.

Our primary regulators, in the U.S. include, among others, the Securities and Exchange Commission (“SEC”), the Financial Industry Regulatory Authority (“FINRA”), The NASDAQ Stock Market (“NASDAQ”), the Commodity Futures Trading Commission (“CFTC”), the National Futures Association (“NFA”), the FDIC,

 

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the Board of Governors of the Federal Reserve System (“Federal Reserve”), the Municipal Securities Rulemaking Board, the Office of the Comptroller of the Currency (“OCC”) and the Consumer Financial Protection Bureau (“CFPB”).

Both our brokerage and banking entities are subject to the Bank Secrecy Act, as amended by the USA PATRIOT ACT of 2001 (“BSA/USA PATRIOT Act”), which requires financial institutions to develop anti-money laundering (“AML”) programs to assist in the prevention and detection of money laundering and combating terrorism. In order to comply with the BSA/USA PATRIOT Act, we have an AML department that is responsible for developing and implementing our enterprise-wide programs for compliance with the various anti-money laundering and counter-terrorist financing laws and regulations. Our brokerage and banking entities are also subject to U.S. sanctions laws administered by the Office of Foreign Assets Control and we have policies and procedures in place to comply with these laws.

For customer privacy and information security, under the rules of the Gramm-Leach-Bliley Act of 1999, our brokerage and banking entities are required to disclose their privacy policies and practices related to sharing customer information with affiliates and non-affiliates. These rules also give customers the ability to “opt out” of having non-public information disclosed to third parties or receiving marketing solicitations from affiliates and non-affiliates based on non-public information received from our brokerage and banking entities.

Brokerage Regulation

Our broker-dealers are registered with the SEC and are subject to regulation by the SEC and by self-regulatory organizations, such as FINRA and the securities exchanges of which each is a member, as well as various state regulators. In addition, E*TRADE Clearing LLC and E*TRADE Securities LLC are registered with the CFTC as a futures commission merchant and introducing broker, respectively, and are both members of the NFA. Such regulation covers various aspects of these businesses, including for example, client protection, net capital requirements, required books and records, safekeeping of funds and securities, trading, prohibited transactions, public offerings, margin lending, customer qualifications for margin and options transactions, registration of personnel and transactions with affiliates. Our international broker-dealers are regulated by their respective local regulators such as the United Kingdom Financial Conduct Authority and Hong Kong Securities & Futures Commission.

The Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”) includes various provisions that affect the regulation of broker-dealers, futures commission merchants and introducing brokers. For example, the SEC is authorized to adopt a fiduciary duty standard applicable to broker-dealers when providing personalized investment advice about securities to retail customers. To date, the SEC has not proposed any rulemaking under this authority. The U.S. Department of Labor is considering revisions to regulations under the Employee Retirement Income Security Act of 1974 that could subject broker-dealers to a fiduciary duty and prohibit specified transactions for a wider range of customer interactions. These developments may impact the manner in which affected businesses are conducted, decrease profitability and increase potential liabilities.

Banking Regulation

Our banking entities are subject to regulation, supervision and examination for safety and soundness by the Federal Reserve, OCC, FDIC and CFPB for compliance with federal consumer finance laws. Such regulation covers all aspects of the banking business, including lending practices, safeguarding deposits, customer privacy and information security, capital structure, transactions with affiliates and conduct and qualifications of personnel.

Each of our banking entities has deposits insured by the FDIC and pays quarterly assessments to the Deposit Insurance Fund (“DIF”), maintained by the FDIC, to pay for this insurance coverage. The Dodd-Frank Act made permanent the general $250,000 deposit insurance limit for insured deposits. As of April 1, 2011, the assessment base for insured depository institutions was changed from domestic deposits, with some adjustments, to average

 

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consolidated total assets minus average tangible equity. The FDIC also changed its methodology for calculating the assessment rate for E*TRADE Bank and other large and highly complex depository institutions. The new risk-based assessment utilizes a scorecard method for calculating a large depository institution’s assessment rate based on a number of factors, including the institution’s CAMELS ratings, asset quality and brokered deposits. In October 2012, the FDIC amended its 2011 rule to revise the definition of certain higher risk assets used to calculate the quarterly insurance assessment beginning on April 1, 2013. The FDIC will continue to assess the changes to the assessment rates at least annually.

In February 2014, the OCC issued clarifying guidance related to secured consumer debt discharged in Chapter 7 bankruptcy proceedings. The guidance provided clarification on when mortgage loans related to borrowers with debt discharged in Chapter 7 bankruptcy proceedings should be charged-off and how to account for future interest payments on these mortgage loans. We are evaluating this clarifying information and currently do not anticipate this guidance to have a meaningful impact on our allowance for loan losses or accounting policy for operating interest income.

Financial Regulatory Reform Legislation

The Dodd-Frank Act was signed into law on July 21, 2010 and includes comprehensive changes to the financial services industry. For example, under the Dodd-Frank Act, our former primary federal bank regulator, the Office of Thrift Supervision (“OTS”), was abolished in July 2011 and its functions and personnel distributed among the OCC, FDIC and Federal Reserve. In addition, the CFPB will oversee compliance by the Company with federal consumer finance laws. Although the Dodd-Frank Act maintains the federal thrift charter, it eliminates certain benefits of the charter and imposes new penalties for failure to comply with the qualified thrift lender test. The Dodd-Frank Act also requires all companies, including savings and loan holding companies, that directly or indirectly control an insured depository institution to serve as a source of strength for the institution.

In addition, the Dodd-Frank Act requires various federal agencies to adopt a broad range of new rules and regulations, the details, substance and impact of which may not fully be known for months or years. However, the implementation of holding company capital requirements will impact us as the parent company was not previously subject to regulatory capital requirements. These requirements will become effective for us on January 1, 2015, as further explained below. We believe these capital ratios are an important measure of capital strength and accordingly we manage our capital against the current capital ratios that apply to bank holding companies. We are currently in compliance with the current capital requirements that apply to bank holding companies and we have no plans to raise additional capital as a result of these new requirements.

Basel III Framework

The current risk-based capital guidelines that apply to E*TRADE Bank are based upon the 1988 capital accords of the Basel Committee on Banking Supervision (“BCBS”), a committee of central banks and bank supervisors, as implemented by the U.S. Federal banking agencies, including the OCC, commonly known as Basel I. The Basel II framework was finalized by U.S. banking agencies in 2007; however, E*TRADE Bank did not meet the threshold requirements for Basel II and, therefore, has never been subject to the requirements of Basel II. In September 2010, the Group of Governors and Heads of Supervision, the oversight body of the BCBS, announced agreement on the calibration and phase-in arrangements for a strengthened set of capital and liquidity requirements, known as the Basel III framework. The final Basel III framework was released in December 2010 and is subject to individual adoption by member nations, including the U.S. The Basel III framework is intended to strengthen the prudential standards for large and internationally active banks; however, it may be applied by U.S. regulators to other banking institutions.

In July 2013, the U.S. Federal banking agencies finalized a rule to implement Basel III in the U.S., a framework for the calculation and components of a banking organization’s regulatory capital and for calculating a banking organization’s risk-weighted assets. Among other things, the Basel III rule raises the minimum

 

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thresholds for required capital and revises certain aspects of the definitions and elements of the capital that can be used to satisfy these required minimum thresholds. While the rules became effective on January 1, 2014 for certain large banking organizations, most U.S. banking organizations, including the Company and E*TRADE Bank, have until January 1, 2015 to begin complying with this new framework, with the fully phased-in Basel III capital standards becoming effective in 2019. We expect to be compliant with the Basel III framework, as it is phased-in.

We believe the most relevant elements of the final rule to us relate to the risk-weighting of mortgage loans, which will remain unchanged from current rules, and margin receivables, which will qualify for 0% risk-weighting. In addition, the final rule gives the option for a one-time permanent election for the inclusion or exclusion in the calculation of Common Tier 1 capital of unrealized gains (losses) on all available-for-sale debt securities; we currently intend to elect to exclude unrealized gains (losses). We believe the incorporation of these elements will have a favorable impact on current capital ratios.

On October 24, 2013, U.S. Federal banking agencies issued an inter-agency notice of proposed rulemaking that would implement a quantitative liquidity requirement generally consistent with, and in some respects stricter than, the “liquidity coverage ratio” (“LCR”) standard established by Basel III. The purpose of the LCR proposal is to require certain financial institutions to hold minimum amounts of high-quality, liquid assets against its projected net cash outflows, over a 30-day period of stressed conditions. While the LCR proposals would apply only to companies with greater than $50 billion in assets and would therefore not apply to us, we will continue to assess the impact of the proposed rule and we expect to be in compliance with this rule.

Prompt Corrective Action

The Federal Deposit Insurance Corporation Improvement Act of 1991 requires the appropriate federal banking regulator to take “prompt corrective action” with respect to a depository institution if that institution does not meet certain capital adequacy standards. While these regulations apply only to banks, such as E*TRADE Bank, the Federal Reserve is authorized to take appropriate action against the parent bank holding company, such as E*TRADE Financial Corporation, based on the undercapitalized status of any bank subsidiary. In certain instances, we would be required to guarantee the performance of the capital restoration plan if our bank subsidiary were undercapitalized.

Derivatives

When fully implemented, Title VII of the Dodd-Frank Act will or potentially could subject derivatives that we enter into for hedging, risk management and other purposes to a comprehensive new regulatory regime. This requires central clearing and execution on designated markets or execution facilities for certain standardized derivatives and imposes or will impose margin, documentation, trade reporting and other new requirements. We are currently in compliance with these requirements and they did not have a material impact on our operations.

Volcker Rule

On December 10, 2013, the Federal Reserve, OCC, FDIC, SEC and CFTC, issued final rules to implement section 619 of the Dodd-Frank Act (these rules collectively known as the “Volcker Rule”). The Volcker Rule imposes prohibitions and restrictions on the ability of banking entities and nonbank financial companies to engage in proprietary trading, and to have certain interests in, or relationships with, hedge funds or private equity funds (“Covered Funds”). Since the adoption of the Volcker Rule, there have been questions in the industry as to whether collateralized debt obligations backed by trust preferred securities (“TruPS CDOs”) constituted Covered Funds under the Rule, thereby requiring banking entities to divest their holdings in the TruPS CDOs by July 2015. On January 14, 2014, the agencies that adopted the Volcker Rule approved an interim final rule to permit banking entities to retain interests in TruPS CDOs that met certain conditions, including (i) that the TruPS CDO be established before May 19, 2010; (ii) that the banking entity’s interest in the TruPS CDO be acquired on or

 

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before December 10, 2013; and (iii) that the TruPS CDO be invested in “qualifying” collateral. We have assessed the impact of the Volcker Rule as it relates to the trust preferred securities that were issued by ETB Holdings, Inc. and have determined that the trust preferred securities are exempt under the provisions of the interim final rule.

Stress Testing

On October 9, 2012, regulators issued final rules implementing provisions of the Dodd-Frank Act that require banking organizations with total consolidated assets of more than $10 billion but less than $50 billion to conduct annual company-run stress tests, report the results to their primary federal regulator and the Federal Reserve and publish a summary of the results. Under the rules, stress tests must be conducted using certain scenarios (baseline, adverse and severely adverse), which the Federal Reserve will publish by November 15 of each year.

Under the OCC and the Federal Reserve stress test regulations, E*TRADE Bank and the Company, respectively, will be required to conduct stress-testing using the prescribed stress-testing methodologies. The final regulations require E*TRADE Bank to conduct its first stress test using financial statement data as of September 30, 2013, and it will be required to report results to the OCC on or before March 31, 2014. The Company will be required to conduct its first stress test using financial statement data as of September 30, 2016, and it will be required to disclose a summary of its stress test results to the Federal Reserve on or before March 31, 2017.

We conducted a company-run stress test for E*TRADE Bank and the Company, which we believe is consistent with the OCC’s and Federal Reserve’s methodologies, respectively, and provided the results to the OCC and the Federal Reserve with the submission of the long-term capital plan in February 2013. We believe that E*TRADE Bank is on schedule to provide the data from its first stress test to the OCC on or before March 31, 2014, as required.

For additional regulatory information on our brokerage and banking regulations, see Note 18—Regulatory Requirements of Item 8. Financial Statements and Supplementary Data.

AVAILABLE INFORMATION

We make our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports, available free of charge at our website as soon as reasonably practicable after they have been filed with the SEC. Our website address is www.etrade.com. Other information on our website is not part of this report.

The public may read and copy any materials we file with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549. The public may obtain information of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains a website that contains the materials we file with the SEC at www.sec.gov.

 

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ITEM 1A.     RISK FACTORS

The following discussion sets forth the risk factors which could materially and adversely affect our business, financial condition and results of operations, and should be carefully considered in addition to the other information set forth in this report. These are not the only risks facing our Company. Additional risks and uncertainties not currently known to us or that we currently do not deem to be material may also adversely affect our business, financial condition and results of operations.

Risks Relating to the Nature and Operation of Our Business

We have incurred significant losses in recent years and cannot assure that we will be profitable in the future.

We incurred a net loss of $112.6 million for the year ended December 31, 2012, due primarily to a $256.9 million loss on the early extinguishment of all the 12 1/2% springing lien notes due November 2017 (“12 1/2% Springing lien notes”) and 7  7/8% senior notes due December 2015 (“7 7/8% Notes”). Although we have taken a significant number of steps to reduce our credit exposure and reported net income of $86.0 million and $156.7 million for the years ended December 31, 2013 and 2011, respectively, we likely will continue to suffer credit losses in 2014. In late 2007, we experienced a substantial diminution of customer assets and accounts as a result of customer concerns regarding our credit related exposures. While we were able to stabilize our retail franchise during the ensuing period, it could take additional time to fully mitigate the credit issues in our loan portfolio, which could result in a net loss position.

We will continue to experience losses in our mortgage loan portfolio.

At December 31, 2013, the principal balance of our home equity loan portfolio was $3.5 billion and the allowance for loan losses for this portfolio was $326.1 million. At December 31, 2013, the principal balance of our one- to four-family loan portfolio was $4.5 billion and the allowance for loan losses for this portfolio was $102.2 million. Although the provision for loan losses has declined in recent periods, performance is subject to variability in any given quarter and we cannot state with certainty that the declining loan loss trend will continue. Due to the complexity and judgment required by management about the effect of matters that are inherently uncertain, there can be no assurance that our allowance for loan losses will be adequate. In the normal course of conducting examinations, our banking regulators, the OCC and Federal Reserve, continue to review our policies and procedures. This process is dynamic and ongoing and we cannot be certain that additional changes or actions to our policies and procedures will not result from their continuing review. We may be required under such circumstances to further increase the allowance for loan losses, which could have an adverse effect on our regulatory capital position and our results of operations in future periods.

The carrying value of the home equity and one- to four-family loan portfolios was $3.1 billion and $4.4 billion, respectively, at December 31, 2013. The home equity and one- to four-family loan portfolios are held on the consolidated balance sheet at carrying value because they are classified as held for investment, which indicates that we have the intent and ability to hold them for the foreseeable future or until maturity. The fair value of our home equity and one- to four-family loan portfolios was estimated to be $2.8 billion and $3.8 billion, respectively, at December 31, 2013, in accordance with the fair value measurements accounting guidance, as disclosed in Note 4—Fair Value Disclosures of Item 8. Financial Statements and Supplementary Data. The fair value of the home equity and one- to four-family loan portfolios was estimated using a modeling technique that discounted future cash flows based on estimated principal and interest payments over the life of the loans, including expected losses and prepayments. There was limited or no observable market data for the home equity and one- to four-family loan portfolios. Given the limited market data, the fair value measurements cannot be determined with precision and the amount that would be realized in a forced liquidation, an actual sale or immediate settlement could be significantly lower than both the carrying value and the estimated fair value of the portfolio. In addition, changes in the underlying assumptions used, including discount rates and estimates of future cash flows, could significantly affect the results of current or future fair value estimates.

 

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Certain characteristics of our mortgage loan portfolio indicate an increased risk of loss. For example, at December 31, 2013:

 

   

approximately 27% and 42% of the one- to four-family and home equity loan portfolios, respectively, had a current loan-to-value (“LTV”)/combined loan-to-value (“CLTV”) of greater than 100%;

 

   

approximately 59% and 49% of the one- to four-family and home equity loan portfolios, respectively, were originated with low or no documentation; and

 

   

borrowers with current Fair Isaac Credit Organization (“FICO”) scores less than 700 consisted of approximately 40% and 38% of the one- to four-family and home equity loan portfolios, respectively.

The foregoing factors are among the key items we track to predict and monitor credit risk in our mortgage portfolio, together with loan type, housing prices, loan vintage and geographic location of the underlying property. We believe the relative importance of these factors varies, depending upon economic conditions.

Home equity loans have certain characteristics that result in higher risk than first lien, amortizing one- to four-family loans.

Approximately 85% of the home equity loan portfolio consists of second lien loans on residential real estate properties. The average estimated current CLTV on our home equity loan portfolio was 98% as of December 31, 2013. We hold both the first and second lien positions in less than 1% of the home equity loan portfolio, exposing us to risk associated with the actions and inactions of the first lien lender.

We monitor our borrowers by refreshing FICO scores and CLTV information on a quarterly basis. We do not have access to complete data on the first lien positions of second lien home equity loans. In addition, we rely on third party servicers to provide payment information on home equity loans, including which borrowers are paying only the minimum amount due.

Home equity lines of credit convert to amortizing loans at the end of the draw period, which typically ranges from five to ten years. Approximately 9% of this portfolio will require borrowers to repay the loan in full at the end of the draw period, commonly referred to as “balloon loans”. At December 31, 2013, the majority of the home equity line of credit portfolio had not converted from the interest-only draw period to an amortizing loan. In addition, approximately 80% of the home equity line of credit portfolio will not begin amortizing until after 2014. As a result, we do not yet have sufficient data relating to loan default and delinquency of amortizing home equity lines of credit to determine if the performance is different than the trends observed for home equity lines of credit in an interest-only draw period.

We rely on third party service providers to perform certain key functions.

We rely on third party service providers for certain technology, processing, servicing and support functions. These third party service providers are also subject to operational and technology vulnerabilities, which may impact our business. An interruption in or the cessation of service by any third party service provider and our inability to make alternative arrangements in a timely manner could have a material impact on our business and financial performance.

We do not directly service any of our loans and as a result, we rely on third party vendors and servicers to provide information on our loan portfolio. From time to time we have discovered that these vendors and servicers have provided incomplete or untimely information to us about our loan portfolio. For example, provision for loan losses increased in the third quarter of 2012 in connection with our discovery that one of our third party loan servicers had not been reporting historical bankruptcy data to us on a timely basis and, as a result, we recorded additional charge-offs in the third quarter of 2012. In connection with this discovery, we implemented an enhanced procedure around all servicer reporting to corroborate bankruptcy reporting with independent third party data.

 

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Loss of customers and assets could destabilize the Company or result in lower revenues in future periods.

During November 2007, well-publicized concerns about E*TRADE Bank’s holdings of asset-backed securities led to widespread concerns about our continued viability. From the beginning of this crisis through December 31, 2007, when the situation stabilized, customers withdrew approximately $5.6 billion of net cash and approximately $12.2 billion of net assets from our bank and brokerage businesses. Many of the accounts that were closed belonged to sophisticated and active customers with large cash and securities balances. While we were able to stabilize our retail franchise, concerns about our viability may recur, which could lead to destabilization and asset and customer attrition. If such destabilization should occur, there can be no assurance that we will be able to successfully rebuild our franchise by reclaiming customers and growing assets. If we are unable to sustain or, if necessary, rebuild our franchise, in future periods our revenues could be lower and our losses could be greater than we have experienced in the past.

We have a large amount of corporate debt which limits how we conduct our business.

We have issued a substantial amount of corporate debt, with restrictive financial and other covenants and our expected annual interest cash outlay is approximately $110 million. Our ratio of corporate debt to equity (expressed as a percentage) was 36% at December 31, 2013. The degree to which we are leveraged could have important consequences, including:

 

   

a substantial portion of our cash flow from operations is dedicated to the payment of principal and interest on our indebtedness, thereby reducing the funds available for other purposes;

 

   

our ability to obtain additional financing for working capital, capital expenditures, acquisitions and other corporate needs is significantly limited; and

 

   

our substantial leverage may place us at a competitive disadvantage, hinder our ability to adjust rapidly to changing market conditions and make us more vulnerable in the event of a further downturn in general economic conditions or our business.

In addition, a significant reduction in revenues could have a material adverse effect on our ability to meet our debt obligations.

We conduct all of our operations through subsidiaries and rely on dividends from our subsidiaries for all of our revenues, which are subject to advance regulatory approval in the case of our most significant subsidiaries.

We depend on dividends, distributions and other payments from our subsidiaries to fund payments on our obligations, including our debt obligations. Regulatory and other legal restrictions limit our ability to transfer funds to or from our subsidiaries. In addition, many of our subsidiaries are subject to laws and regulations that authorize regulatory bodies to block or reduce the flow of funds to us, or that prohibit such transfers altogether in certain circumstances. These laws and regulations may hinder our ability to access funds that we may need to make payments on our obligations, including our debt obligations. The majority of our capital is invested in our banking subsidiary E*TRADE Bank, which may not pay dividends to us without approval from the OCC and the Federal Reserve. Our primary brokerage subsidiaries, E*TRADE Securities LLC and E*TRADE Clearing LLC, are both subsidiaries of E*TRADE Bank; therefore, the OCC, together with the Federal Reserve, controls our ability to receive dividend payments from our brokerage business as well. Furthermore, even if we receive the approval of the OCC and the Federal Reserve to receive dividend payments from our brokerage business, in the event of our bankruptcy or liquidation or E*TRADE Bank’s receivership, we would not be entitled to receive any cash or other property or assets from our subsidiaries (including E*TRADE Bank, E*TRADE Clearing LLC and E*TRADE Securities LLC) until those subsidiaries pay in full their respective creditors, including customers of those subsidiaries and, as applicable, the FDIC and the Securities Investor Protection Corporation.

We submitted an initial long-term capital plan to the OCC and Federal Reserve during the second quarter of 2012. The plan included: our five-year business strategy; forecasts of our business results and capital ratios; capital distribution plans in current and adverse operating conditions; and internally developed stress tests.

 

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During the third quarter of 2012, we received initial feedback from our regulators on this plan and we believe that key elements of this plan, specifically reducing risk, deleveraging the balance sheet and the development of an enterprise risk management function, are critical. We submitted an updated long-term capital plan to the OCC and Federal Reserve in February 2013, which included the key elements outlined in the initial plan as well as the progress made during 2012 on those key elements. We believe we have made important progress on our long-term capital plan, as evidenced by the $100 million and $75 million dividends that our regulators approved from E*TRADE Bank during the third and fourth quarters of 2013, respectively, and the $75 million dividend approved in the first quarter of 2014. We plan to request a dividend each quarter over the near term up to the level of E*TRADE Bank’s net income from the previous quarter, while continuing an active and ongoing dialogue with our regulators to ensure our execution of the plan is consistent with their expectations. We cannot be certain that we will continue to receive regulatory approval for future dividends at consistent levels or at all.

E*TRADE Bank is also required to submit its first company-run stress test to assess the potential impact of hypothetical economic stress scenarios on consolidated earnings, losses and regulatory capital ratios over a nine-quarter planning horizon by March 31, 2014. The OCC will analyze the quality of E*TRADE Bank’s stress test process and results. While there is no formal mechanism for the OCC to “pass” or “fail” E*TRADE Bank’s stress test processes and results, it will likely consider these processes and results in evaluating proposed actions that may affect our bank’s capital, including but not limited to dividend payments, redemption or repurchase of regulatory capital instruments and mergers and acquisitions. If the OCC were to object to any such proposed action, our business prospects, results of operations and financial condition could be adversely affected.

We operate in a highly competitive industry where many of our competitors have greater financial, technical, marketing and other resources.

The financial services industry is highly competitive, with multiple industry participants competing for the same customers. Many of our competitors have longer operating histories and greater resources than we have and offer a wider range of financial products and services. Other of our competitors offer a more narrow range of financial products and services and have not been as susceptible to the disruptions in the credit markets that have impacted our Company, and therefore have not suffered the losses we have. The impact of competitors with superior name recognition, greater market acceptance, larger customer bases or stronger capital positions could adversely affect our revenue growth and customer retention. Our competitors may also be able to respond more quickly to new or changing opportunities and demands and withstand changing market conditions better than we can. Competitors may conduct extensive promotional activities, offering better terms, lower prices and/or different products and services or combination of products and services that could attract current E*TRADE customers and potentially result in price wars within the industry. Some of our competitors may also benefit from established relationships among themselves or with third parties enhancing their products and services.

In addition, we compete in a technology-intensive industry characterized by rapid innovation. We may be unable to effectively use new technologies, adopt our services to emerging industry standards or develop, introduce and market enhanced or new products and services. If we are not able to update or adapt our products and services to take advantage of the latest technologies and standards, or are otherwise unable to tailor the delivery of our services to the latest personal and mobile computing devices preferred by our retail customers, our business and financial performance could suffer.

Our ability to compete successfully in the financial services industry depends on a number of factors, including, among other things:

 

   

maintaining/expanding our market position;

 

   

retaining customers and maintaining customer satisfaction while attracting new customers;

 

   

providing easy to use and innovative financial products and services which appeal to retail investors;

 

   

our reputation and the market perception of our brand and overall value;

 

   

maintaining competitive pricing;

 

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adapting to an increasingly concentrated competitive landscape;

 

   

taking advantage of acquisition and other strategic opportunities;

 

   

the quality of our technology, products and services;

 

   

deploying a secure, and scalable technology and back office platform;

 

   

innovating effectively in launching new or enhanced products;

 

   

the differences in regulatory oversight regimes to which we and our competitors are subject;

 

   

attracting new employees and retaining and motivating our existing employees; and

 

   

general economic and industry trends.

Our competitive position within the industry could be adversely affected if we are unable to adequately address these factors, which could have a material adverse effect on our business and financial condition.

Turmoil in the global financial markets could reduce trade volumes and margin borrowing and increase our dependence on our more active customers who receive lower pricing, resulting in lower revenues.

Online investing services to the retail customer, including trading and margin lending, account for a significant portion of our revenues. Turmoil in the global financial markets could lead to changes in volume and price levels of securities and futures transactions which may, in turn, result in lower trading volumes and margin lending. In particular, a decrease in trading activity within our lower activity accounts could impact revenues and increase dependence on more active trading customers who receive more favorable pricing based on their trade volume. A decrease in trading activity or securities prices would also typically be expected to result in a decrease in margin borrowing, which would reduce the revenue that we generate from interest charged on margin borrowing.

We rely heavily on technology, which can be subject to interruption and instability.

We rely on technology, particularly the Internet, to conduct much of our business activity. Our technology operations, including our primary and disaster recovery data center operations, are vulnerable to disruptions from human error, natural disasters (such as fires, tornados, earthquakes and hurricanes), power outages, computer and telecommunications failures, computer viruses or other malicious software, distributed denial of service attacks, spam attacks, security breaches and other similar events. Extraordinary trading volumes could cause our computer systems to operate at an unacceptably slow speed or even fail. Disruptions to or instability of our technology or external technology that allows our customers to use our products and services could harm our business and our reputation. Should our technology operations be disrupted, we may have to make a significant investment to upgrade, repair or replace our technology infrastructure. While we have made significant investments to ensure the reliability of our operations, we cannot assure you that we will be able to maintain, expand and upgrade our systems and infrastructure to meet future requirements and mitigate future risks on a timely basis. Disruptions in service and slower system response times could result in substantial losses, decreased client satisfaction and harm to our reputation. In addition, technology systems, including our own proprietary systems and the systems of third parties on whom we rely to conduct portions of our operations, are potentially vulnerable to security breaches and unauthorized usage. An actual or perceived breach of the security of our technology could harm our business and our reputation. The occurrence of any of these events may have a material adverse effect on our business or results of operations.

Vulnerability of our customers’ computers and mobile devices could lead to significant losses related to identity theft or other fraud and harm our reputation and financial performance.

Because our business model relies heavily on our customers’ use of their own personal computers, mobile devices and the Internet, our business and reputation could be harmed by security breaches of our customers and third parties. Computer viruses and other attacks on our customers’ personal computer systems, home networks

 

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and mobile devices or against the third-party networks and systems of internet and mobile service providers could create losses for our customers even without any breach in the security of our systems, and could thereby harm our business and our reputation. As part of our E*TRADE Complete Protection Guarantee, we reimburse our customers for losses caused by a breach of security of our customers’ own personal systems. Such reimbursements could have a material impact on our financial performance.

Unauthorized disclosure of confidential customer information, whether through a breach of our computer systems or those of our customers or third parties, may subject us to significant liability and reputational harm.

As part of our business, we are required to collect, use and store customer, employee and third party personally identifiable information (“PII”). This may include, among other information, names, addresses, phone numbers, email addresses, contact preferences, tax identification numbers and account information. We maintain systems and procedures designed to securely process, transmit and store confidential information (including PII) and protect against unauthorized access to such information. We also require our third party vendors to have adequate security if they have access to PII. Despite these security measures, our systems, and those of our customers and third party vendors, may be vulnerable to security breaches, cyber-attacks, acts of vandalism and computer viruses which could result in unauthorized access, misuse, loss or destruction of data, an interruption in service or other similar events. Any security breach involving the misappropriation, loss or other unauthorized disclosure of PII, whether by us or by our customers or third party vendors, could severely damage our reputation, expose us to the risk of litigation and liability, disrupt our operations and have a materially adverse effect on our business.

Downturns in the securities markets increase the credit risk associated with margin lending or securities loaned transactions.

We permit certain customers to purchase securities on margin. A downturn in securities markets may impact the value of collateral held in connection with margin receivables and may reduce its value below the amount borrowed, potentially creating collections issues with our margin receivables. In addition, we frequently borrow securities from and lend securities to other broker-dealers. Under regulatory guidelines, when we borrow or lend securities, we must simultaneously disburse or receive cash deposits. A sharp change in security market values may result in losses if counterparties to the borrowing and lending transactions fail to honor their commitments.

We may be unsuccessful in managing the effects of changes in interest rates and the enterprise interest-earning assets in our portfolio.

Net operating interest income is an important source of our revenue. Our results of operations depend, in part, on our level of net operating interest income and our effective management of the impact of changing interest rates and varying asset and liability maturities. Our ability to manage interest rate risk could impact our financial condition. We use derivatives as hedging instruments to reduce the potential effects of changes in interest rates on our results of operations. However, the derivatives we utilize may not be completely effective at managing this risk and changes in market interest rates and the yield curve could reduce the value of our financial assets and reduce our net operating interest income.

Enterprise net interest spread may fluctuate based on the size and mix of the balance sheet, as well as the impact from changes in market interest rates. Among other items, we periodically enter into repurchase agreements to support the funding and liquidity requirements of E*TRADE Bank. If we are unsuccessful in maintaining our relationships with these counterparties, we could recognize substantial losses on the derivatives we utilized to hedge repurchase agreements.

If we do not successfully participate in consolidation opportunities, we could be at a competitive disadvantage.

There has recently been significant consolidation in the financial services industry and this consolidation is likely to continue in the future. Should we be excluded from or fail to take advantage of viable consolidation opportunities, our competitors may be able to capitalize on those opportunities and create greater scale and cost efficiencies to our detriment.

 

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Although we are currently constrained by the terms of our corporate debt and the memoranda of understanding we and E*TRADE Bank entered into with our primary banking regulators, we may seek to acquire businesses in the future. The assets of businesses we have acquired in the past were primarily customer accounts. In future acquisitions, our retention of customers’ assets may be impacted by our ability to successfully integrate the acquired operations, products (including pricing) and personnel. Diversion of management attention from other business concerns could have a negative impact. If we are not successful in our integration efforts, we may experience significant attrition in the acquired accounts or experience other issues that would prevent us from achieving the level of revenue enhancements and cost savings that we expect with respect to an acquisition.

Advisory services subject us to additional risks.

We provide advisory services to investors to aid them in their decision making. Investment decisions and suggestions are based on publicly available documents and communications with investors regarding investment preferences and risk tolerances. Publicly available documents may be inaccurate and misleading, resulting in recommendations or transactions that are inconsistent with investors’ intended results. In addition, advisors may not understand investor needs or risk tolerances, which may result in the recommendation or purchase of a portfolio of assets that may not be suitable for the investor. To the extent that we fail to know our customers or improperly advise them, we could be found liable for losses suffered by such customers, which could harm our reputation and business.

We have a significant deferred tax asset and cannot assure it will be fully realized.

We had net deferred tax assets of $1,239.0 million at December 31, 2013. We did not establish a valuation allowance against our federal net deferred tax assets at December 31, 2013 as we believe that it is more likely than not that all of these assets will be realized. In evaluating the need for a valuation allowance, we estimated future taxable income based on management approved forecasts. This process required significant judgment by management about matters that are by nature uncertain. If future events differ significantly from our current forecasts, a valuation allowance may need to be established, which could have a material adverse effect on our results of operations and our financial condition.

As a result of a registered offering of the Company’s common stock, an exchange of certain of the Company’s debt securities and related transactions in 2009, we believe that we experienced an “ownership change” for tax purposes that could cause us to permanently lose a significant portion of our U.S. federal and state deferred tax assets.

As a result of a registered offering of the Company’s common stock, an exchange of certain of the Company’s debt securities and related transactions in 2009, we believe that we experienced an “ownership change” as defined under Section 382 of the Internal Revenue Code of 1986, as amended (“Section 382”) (which is generally a greater than 50 percentage point increase by certain “5% shareholders” over a rolling three year period). Section 382 imposes an annual limitation on the utilization of deferred tax assets, such as net operating loss carry forwards and other tax attributes, once an ownership change has occurred. Depending on the size of the annual limitation (which is in part a function of our market capitalization at the time of the ownership change) and the remaining carry forward period of the tax assets (U.S. federal net operating losses generally may be carried forward for a period of 20 years), we could realize a permanent loss of a portion of our U.S. federal and state deferred tax assets and certain built-in losses that have not been recognized for tax purposes. We believe the tax ownership change will extend the period of time it will take to fully utilize our pre-ownership change net operating losses (“NOLs”), but will not limit the total amount of pre-ownership change federal NOLs we can utilize. This is a complex analysis and requires the Company to make certain judgments in determining the annual limitation. As a result, it is possible that we could ultimately lose a significant portion of deferred tax assets, which could have a material adverse effect on our results of operations and financial condition.

 

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Risks Relating to the Regulation of Our Business

We are subject to extensive government regulation, including banking and securities rules and regulations, which could restrict our business practices.

The securities and banking industries are subject to extensive regulation. Our broker-dealer subsidiaries must comply with many laws and rules, including rules relating to sales practices and the suitability of recommendations to customers, possession and control of customer funds and securities, margin lending, execution and settlement of transactions and anti-money laundering.

Similarly, E*TRADE Financial Corporation and ETB Holdings, Inc., as savings and loan holding companies, and E*TRADE Bank and E*TRADE Savings Bank, as federally chartered savings banks, are subject to extensive regulation, supervision and examination by the OCC and the Federal Reserve (including pursuant to the terms of the memoranda of understanding that E*TRADE Financial Corporation entered into with the Federal Reserve and that E*TRADE Bank entered into with the OCC) and, in the case of the savings banks, also the FDIC. Such regulation covers all banking business, including lending practices, safeguarding deposits, capital structure, recordkeeping, transactions with affiliates and conduct and qualifications of personnel.

While we have implemented policies and procedures designed to ensure compliance with all applicable laws and regulations, there can be no assurance that violations will not occur. Failure to comply with applicable laws and regulations and our policies could result in sanctions by regulatory agencies, litigation, civil penalties and harm to our reputation, which could have a material adverse effect on our business, financial condition and results of operations.

Recently enacted regulatory reform legislation may have a material impact on our operations. In addition, if we are unable to meet these new requirements, we could face negative regulatory consequences, which would have a material negative effect on our business.

On July 21, 2010, the President signed into law the Dodd-Frank Act. This law contains various provisions designed to enhance financial stability and to reduce the likelihood of another financial crisis and significantly changed the bank regulatory structure for our Company and its thrift subsidiaries. Portions of the Dodd-Frank Act were effective immediately, but other portions will be effective following extended transition periods or through numerous rulemakings by multiple government agencies and many of those rulemakings have not yet been completed. While there continues to be uncertainty about the full impact of those changes, we do know that we will be subject to a more complex regulatory framework. We will also incur costs to comply with new requirements as well as to monitor for compliance in the future. The key effects of the Dodd-Frank Act, when fully implemented, on our business are:

 

   

changes to the thrift supervisory structure;

 

   

changes to regulatory capital requirements;

 

   

changes to the assessment base used by depository institutions to calculate their FDIC insurance premiums, increases in the minimum reserve ratio for the FDIC’s deposit insurance fund to 1.35%, and imposition of the additional costs of this increase on depository institutions with assets of $10 billion or more; and

 

   

establishment of the CFPB with broad authority to implement new consumer protection regulations and, for banks and thrifts with $10 billion or more in assets, to examine and enforce compliance with federal consumer laws.

The Federal Reserve has primary jurisdiction for the supervision and regulation of savings and loan holding companies, including the Company; and the OCC has primary supervision and regulation of federal savings associations, such as the Company’s two thrift subsidiaries. Although the Dodd-Frank Act maintains the federal thrift charter, it eliminates certain preemption, branching and other benefits of the charter and imposes new penalties for failure to comply with the qualified thrift lender test. The Dodd-Frank Act also requires all

 

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companies, including savings and loan holding companies that directly or indirectly control an insured depository institution, to serve as a source of strength for the institution, including committing necessary capital and liquidity support.

We are required to file periodic reports with the Federal Reserve and are subject to examination and supervision by it. The Federal Reserve also has certain types of enforcement powers over us, ETB Holdings, Inc., and our non-depository institution subsidiaries, including the ability to issue cease-and-desist orders, force divestiture of our thrift subsidiaries and impose civil and monetary penalties for violations of federal banking laws and regulations or for unsafe or unsound banking practices. Our thrift subsidiaries are subject to similar reporting, examination, supervision and enforcement oversight by the OCC. The Federal Reserve has issued guidance aligning the supervisory and regulatory standards of savings and loan holding companies more closely with the standards applicable to bank holding companies. The Federal Reserve had also indicated that its supervision of savings and loan holding companies may entail a more rigorous level of review than previously applied by the OTS, which was eliminated by the Dodd-Frank Act.

The Dodd-Frank Act also created a new independent regulatory body, the CFPB, which has been given broad rulemaking authority to implement the consumer protection laws that apply to banks and thrifts and to prohibit “unfair, deceptive or abusive” acts and practices. For all banks and thrifts with total consolidated assets over $10 billion, including E*TRADE Bank, the CFPB has exclusive rulemaking and examination, and primary enforcement authority, under federal consumer financial laws and regulations. In addition, the Dodd-Frank Act permits states to adopt consumer protection laws and regulations that are stricter than those regulations promulgated by the CFPB.

For us, one of the most significant changes under the new law is that savings and loan holding companies such as our Company for the first time will become subject to the same capital and activity requirements as those applicable to bank holding companies. In addition, we will be subject to the same capital requirements as those applied to banks, which requirements exclude, on a phase-out basis, all trust preferred securities from Tier 1 capital. The phase-in of the adopted rules is scheduled to begin in 2015, and we will be required to comply with the fully phased-in capital standards beginning in 2019. We fully expect to meet the capital requirements applicable to thrift holding companies as they are phased in. However, it is possible that our regulators may impose more stringent capital and other prudential standards on us prior to the end of the five year phase-in period. For example, both the OCC and the Federal Reserve have issued final regulations that will require E*TRADE Bank and will ultimately also require the parent company to conduct capital adequacy stress tests on their operations. E*TRADE Bank will be required to disclose a summary of these stress test results to the OCC on or before March 31, 2014 and the Company will ultimately also be required to disclose a summary of its stress test results to the Federal Reserve on or before March 31, 2017.

If we fail to comply with applicable securities and banking laws, rules and regulations, either domestically or internationally, we could be subject to disciplinary actions, damages, penalties or restrictions that could significantly harm our business.

The SEC, FINRA and other self-regulatory organizations and state securities commissions, among other things, can censure, fine, issue cease-and-desist orders or suspend or expel a broker-dealer or any of its officers or employees. The OCC and Federal Reserve may take similar action with respect to our banking and other financial activities, respectively. Similarly, the attorneys general of each state could bring legal action on behalf of the citizens of the various states to ensure compliance with local laws. Regulatory agencies in countries outside of the U.S. have similar authority. The ability to comply with applicable laws and rules is dependent in part on the establishment and maintenance of a reasonable compliance function. The failure to establish and enforce reasonable compliance procedures, even if unintentional, could subject us to significant losses or disciplinary or other actions.

During 2012, the Company completed a review of order handling practices and pricing for order flow between E*TRADE Securities LLC and G1 Execution Services, LLC. The Company has implemented the

 

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changes to its practices and procedures that were recommended during the review. Banking regulators and federal securities regulators were regularly updated during the course of the review and may initiate investigations into the Company’s historical practices which could subject it to monetary penalties and cease-and-desist orders, which could also prompt claims by customers of E*TRADE Securities LLC. Any of these actions could materially and adversely affect the Company’s broker-dealer businesses. On July 11, 2013, FINRA notified E*TRADE Securities LLC and G1 Execution Services, LLC that it is conducting an examination of both firms’ routing practices. The Company is cooperating fully with FINRA in this examination and, under the agreement governing the sale of G1 Execution Services, LLC to Susquehanna, remains responsible for any resulting actions taken against G1 Execution Services, LLC as a result of such investigation.

If we do not maintain the capital levels required by regulators, we may be fined or even forced out of business.

The SEC, FINRA, the OCC, the Federal Reserve and various other regulatory agencies have stringent rules with respect to the maintenance of specific levels of regulatory capital by banks and net capital by securities broker-dealers. E*TRADE Bank is subject to various regulatory capital requirements administered by the OCC, and E*TRADE Financial Corporation will, for the first time, become subject to specific capital requirements administered by the Federal Reserve. Failure to meet minimum capital requirements can trigger certain mandatory, and possibly additional discretionary actions by regulators that, if undertaken, could harm E*TRADE Bank’s and E*TRADE Financial Corporation’s operations and financial statements.

E*TRADE Bank must meet specific capital guidelines that involve quantitative measures of E*TRADE Bank’s assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. Quantitative measures established by regulation to ensure capital adequacy require E*TRADE Bank to maintain minimum amounts and ratios of total and Tier 1 capital to risk-weighted assets and of Tier 1 leverage. To satisfy the capital requirements for a “well capitalized” financial institution, E*TRADE Bank must maintain higher total and Tier 1 capital to risk-weighted assets and Tier 1 leverage ratios. E*TRADE Bank’s capital amounts and classification are subject to qualitative judgments by the regulators about the strength of components of its capital, risk weightings of assets, off-balance sheet transactions and other factors. Any significant reduction in E*TRADE Bank’s regulatory capital could result in E*TRADE Bank being less than “well capitalized” or “adequately capitalized” under applicable capital rules. A failure of E*TRADE Bank to be “adequately capitalized” which is not cured within time periods specified in the indentures governing our debt securities would constitute a default under our debt securities and likely result in the debt securities becoming immediately due and payable at their full face value.

The regulators may request we raise equity to increase the regulatory capital of E*TRADE Bank or to further reduce debt. If we were unable to raise equity, we could face negative regulatory consequences, such as restrictions on our activities, requirements that we divest ourselves of certain businesses and requirements that we dispose of certain assets and liabilities within a prescribed period. Any such actions could have a material negative effect on our business.

Similarly, failure to maintain the required net capital by our securities broker-dealers could result in suspension or revocation of registration by the SEC and suspension or expulsion by FINRA, and could ultimately lead to the firm’s liquidation. If such net capital rules are changed or expanded, or if there is an unusually large charge against net capital, operations that require an intensive use of capital could be limited. Such operations may include investing activities, marketing and the financing of customer account balances. Also, our ability to withdraw capital from brokerage subsidiaries could be restricted.

In July 2013, the U.S. Federal banking agencies finalized a rule to implement Basel III in the U.S., a framework for the calculation and components of a banking organization’s regulatory capital and for calculating a banking organization’s risk-weighted assets. Among other things, the Basel III rule raises the minimum thresholds for required capital and revises certain aspects of the definitions and elements of the capital that can be used to satisfy these required minimum thresholds. While the rules became effective on January 1, 2014 for

 

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certain large banking organizations, most U.S. banking organizations including the Company and E*TRADE Bank, have until January 1, 2015 to begin complying with this new framework, with the fully phased-in Basel III capital standards becoming effective in 2019. We expect to be compliant with the Basel III framework, as it is phased-in.

We believe the most relevant elements of the final rule to us relate to the risk-weighting of mortgage loans, which will remain unchanged from current rules, and margin receivables, which will qualify for 0% risk-weighting. In addition, the final rule gives the option for a one-time permanent election for the inclusion or exclusion in the calculation of Common Tier 1 capital of unrealized gains (losses) on all available-for-sale debt securities, which we intend to elect to exclude unrealized gains (losses). We believe the incorporation of these elements will have a favorable impact on our current capital ratios.

On October 24, 2013, U.S. Federal banking agencies issued an inter-agency notice of proposed rulemaking that would implement a quantitative liquidity requirement generally consistent with, and in some respects stricter than, the LCR standard established by Basel III. The purpose of the LCR proposal is to require certain financial institutions to hold minimum amounts of high-quality, liquid assets against its projected net cash outflows. While the LCR proposals would apply only to companies with greater than $50 billion in assets and would therefore not apply to us, we will continue to assess the impact of the proposed rule and we expect to be in compliance with this rule.

As a non-grandfathered savings and loan holding company, we are subject to activity limitations and requirements that could restrict our ability to engage in certain activities and take advantage of certain business opportunities.

Under the Gramm-Leach-Bliley Act of 1999, our activities are restricted to those that are financial in nature and certain real estate-related activities. We believe all of our existing activities and investments are permissible under the Gramm-Leach-Bliley Act of 1999. At the same time, we are unable to pursue future activities that are not financial in nature or otherwise real-estate related. We are also limited in our ability to invest in other savings and loan holding companies. The Dodd-Frank Act also requires savings and loan holding companies like ours, as well as all of our thrift subsidiaries, to be both “well capitalized” and “well managed” in order for us to conduct certain financial activities, such as market making and securities underwriting. We believe that we will be able to continue to engage in all of our current financial activities. However, if we and our thrift subsidiaries are unable to satisfy the “well capitalized” and “well managed” requirements, we could be subject to activity restrictions that could prevent us from engaging in market making and securities underwriting, as well as other negative regulatory actions.

In addition, E*TRADE Bank is subject to extensive regulation of its activities and investments, capitalization, community reinvestment, risk management policies and procedures and relationships with affiliated companies. Acquisitions of and mergers with other financial institutions, purchases of deposits and loan portfolios, the establishment of new depository institution subsidiaries and the commencement of new activities by bank subsidiaries require the prior approval of the OCC and the Federal Reserve, and in some cases the FDIC, which may deny approval or limit the scope of our planned activity. Our compliance with these regulations and conditions could place us at a competitive disadvantage in an environment in which consolidation within the financial services industry is prevalent. Also, these regulations and conditions could affect our ability to realize synergies from future acquisitions, negatively affect us following an acquisition and also delay or prevent the development, introduction and marketing of new products and services. In addition, E*TRADE Clearing LLC and E*TRADE Securities LLC, as operating subsidiaries of E*TRADE Bank, are subject to increased regulatory oversight and the same activity restrictions that are applicable to E*TRADE Bank.

 

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Risks Relating to Owning Our Stock

Our business operations are substantially restricted by the terms of our corporate debt.

The indentures governing our corporate debt contain various covenants and restrictions that place limitations on our ability and certain of our subsidiaries’ ability to, among other things:

 

   

incur additional indebtedness;

 

   

create liens;

 

   

pay dividends, make distributions or other payments;

 

   

repurchase or redeem capital stock;

 

   

make investments or other restricted payments;

 

   

enter into transactions with our shareholders or affiliates;

 

   

sell assets or shares of capital stock of our subsidiaries; and

 

   

merge, consolidate or transfer substantially all of our assets.

As a result of the covenants and restrictions contained in the indentures, we are limited in how we conduct our business and we may be unable to raise additional debt or equity financing at all or on terms sufficient to compete effectively or to take advantage of new business opportunities. Each series of our corporate debt contains a limitation, subject to important exceptions, on our ability to incur additional debt if our Consolidated Fixed Charge Coverage Ratio (as defined in the relevant indentures) is less than or equal to 2.5 to 1.0 under the terms of our outstanding convertible notes and 2.0 to 1.0 under the terms of our other outstanding series of notes. As of December 31, 2013, our Consolidated Fixed Charge Coverage Ratio was 4.4 to 1.0. The terms of any future indebtedness could include more restrictive covenants.

Although these covenants provide substantial flexibility, for example the ability to incur “refinancing indebtedness” and to incur up to $300 million of secured debt under a credit facility, the covenants, among other things, generally limit our ability to incur additional debt even if we were to substantially reduce our existing debt through debt exchange transactions. We could be forced to repay immediately all our outstanding debt securities at their full principal amount if we were to breach these covenants and did not cure such breach within the cure periods (if any) specified in the respective indentures. Further, if we experience a change of control, as defined in the indentures, we could be required to offer to purchase our debt securities at 101% of their principal amount. Under certain of our debt securities a “change of control” would occur if, among other things, a person became the beneficial owner of more than 50% of the total voting power of our voting stock which, with respect to the 6 3/4% senior notes due May 2016 (“6 3/4% Notes”), 6% senior notes due November 2017 (“6% Notes”) and 6 3/8% senior notes due November 2019 (“6 3/8% Notes”), would need to be coupled with a ratings downgrade before we would be required to offer to purchase those securities.

We cannot assure that we will be able to remain in compliance with these covenants in the future and, if we fail to comply, we cannot guarantee that we will be able to obtain waivers from the appropriate parties and/or amend the covenants.

The value of our common stock may be diluted if we need additional funds in the future.

In the future, we may need to raise additional funds via debt and/or equity instruments, which may not be available on favorable terms, if available at all. If adequate funds are not available on acceptable terms, we may be unable to fund our capital needs and our plans for the growth of our business. In addition, if funds are available, the issuance of equity securities could significantly dilute the value of our shares of our common stock and cause the market price of our common stock to fall. We have the ability to issue a significant number of shares of stock in future transactions, which would substantially dilute existing shareholders, without seeking further shareholder approval.

 

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In recent periods, the global financial markets were in turmoil and the equity and credit markets experienced extreme volatility, which caused already weak economic conditions to worsen. Continued turmoil in the global financial markets could further restrict our access to the equity and debt markets.

The market price of our common stock may continue to be volatile.

From January 1, 2011 through December 31, 2013, the price per share of our common stock ranged from a low of $7.08 to a high of $19.67. The market price of our common stock has been, and is likely to continue to be, highly volatile and subject to wide fluctuations. In the past, volatility in the market price of a company’s securities has often led to securities class action litigation. Such litigation could result in substantial costs to us and divert our attention and resources, which could harm our business. As discussed in Note 20—Commitments, Contingencies and Other Regulatory Matters of Item 8. Financial Statements and Supplementary Data, we were a party to litigation related to the decline in the market price of our stock and such litigation could occur again in the future. Declines in the market price of our common stock or failure of the market price to increase could also harm our ability to retain key employees, reduce our access to capital, impact our ability to utilize deferred tax assets in the event of another ownership change and otherwise harm our business.

We have provisions in our organizational documents that may discourage takeover attempts.

Certain provisions of our certificate of incorporation and bylaws may discourage, delay or prevent a third party from acquiring control of us in a merger, acquisition or similar transaction that a shareholder may consider favorable. Such provisions include:

 

   

authorization for the issuance of “blank check” preferred stock;

 

   

the prohibition of cumulative voting in the election of directors;

 

   

a super-majority voting requirement to effect business combinations and certain amendments to our certificate of incorporation and bylaws;

 

   

limits on the persons who may call special meetings of shareholders;

 

   

the prohibition of shareholder action by written consent; and

 

   

advance notice requirements for nominations to the Board or for proposing matters that can be acted on by shareholders at shareholder meetings.

In addition, certain provisions of our stock incentive plans, management retention and employment agreements (including severance payments and stock option acceleration), certain provisions of Delaware law and the requirements under our debt securities to offer to purchase such securities at 101% of their principal amount may also discourage, delay or prevent someone from acquiring or merging with us.

We may not be able to generate sufficient cash to service all of our indebtedness and may be forced to take other actions to satisfy our obligations under our indebtedness, which may not be successful.

Our ability to make scheduled payments on or to refinance our debt obligations depends on our financial condition, operating performance and our ability to receive dividend payments from our subsidiaries, which is subject to prevailing economic and competitive conditions, regulatory approval and certain financial, business and other factors beyond our control. We may not be able to maintain a level of cash flows from operating activities sufficient to permit us to pay the principal and interest on our indebtedness.

If our cash flows and capital resources are insufficient to fund our debt service obligations, we may be forced to reduce or delay investments and capital expenditures, or to sell assets, seek additional capital or restructure or refinance our indebtedness. These alternative measures may not be successful and may not permit us to meet our scheduled debt service obligations. In addition, the terms of existing or future debt instruments may restrict us from adopting some of these alternatives.

 

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Our ability to restructure or refinance our debt will depend on the condition of the capital markets and our financial condition at such time. Any refinancing of our debt could be at higher interest rates and may require us to comply with more onerous covenants, which could further restrict our business operations. In addition, any failure to make payments of interest and principal on our outstanding indebtedness on a timely basis would likely result in a reduction of our credit rating, which could harm our ability to incur additional indebtedness. If our cash flows and available cash are insufficient to meet our debt service obligations, we could face substantial liquidity problems and might be required to dispose of material assets or operations to meet our debt service and other obligations. We may not be able to consummate those dispositions or to obtain the proceeds that we could realize from them, and these proceeds may not be adequate to meet any debt service obligations then due.

ITEM 1B.    UNRESOLVED STAFF COMMENTS

None.

ITEM 2.     PROPERTIES

A summary of our significant locations at December 31, 2013 is shown in the following table. All facilities are leased, except for 165,000 square feet of our office in Alpharetta, Georgia. Square footage amounts are net of space that has been sublet or part of a facility restructuring.

 

Location

   Approximate Square Footage  

Alpharetta, Georgia

     254,000   

Jersey City, New Jersey

     107,000   

Arlington, Virginia

     102,000   

Sandy, Utah

     66,000   

Menlo Park, California

     63,000   

New York, New York

     39,000   

Chicago, Illinois(1)

     36,000   

 

(1) 

Includes approximately 25,000 square footage related to G1 Execution Services, LLC. We entered into a definitive agreement to sell G1 Execution Services, LLC to an affiliate of Susquehanna. The lease was assigned to Susquehanna upon closing of the sale on February 10, 2014.

All of our facilities are used by either our trading and investing or balance sheet management segments, in addition to the corporate/other category. All other leased facilities with space of less than 25,000 square feet are not listed by location. In addition to the significant facilities above, we also lease all 30 E*TRADE branches, ranging in space from approximately 2,500 to 8,000 square feet. We believe our facilities space is adequate to meet our needs in 2014.

ITEM 3.     LEGAL PROCEEDINGS

On October 27, 2000, Ajaxo, Inc. (“Ajaxo”) filed a complaint in the Superior Court for the State of California, County of Santa Clara. Ajaxo sought damages and certain non-monetary relief for the Company’s alleged breach of a non-disclosure agreement with Ajaxo pertaining to certain wireless technology that Ajaxo offered the Company as well as damages and other relief against the Company for their alleged misappropriation of Ajaxo’s trade secrets. Following a jury trial, a judgment was entered in 2003 in favor of Ajaxo against the Company for $1.3 million for breach of the Ajaxo non-disclosure agreement. Although the jury found in favor of Ajaxo on its claim against the Company for misappropriation of trade secrets, the trial court subsequently denied Ajaxo’s requests for additional damages and relief. On December 21, 2005, the California Court of Appeal affirmed the above-described award against the Company for breach of the nondisclosure agreement but remanded the case to the trial court for the limited purpose of determining what, if any, additional damages Ajaxo may be entitled to as a result of the jury’s previous finding in favor of Ajaxo on its claim against the Company for misappropriation of trade secrets. Although the Company paid Ajaxo the full amount due on the above-described judgment, the case was remanded back to the trial court, and on May 30, 2008, a jury returned a

 

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verdict in favor of the Company denying all claims raised and demands for damages against the Company. Following the trial court’s filing of entry of judgment in favor of the Company on September 5, 2008, Ajaxo filed post-trial motions for vacating this entry of judgment and requesting a new trial. By order dated November 4, 2008, the trial court denied these motions. On December 2, 2008, Ajaxo filed a notice of appeal with the Court of Appeal of the State of California for the Sixth District. Oral argument on the appeal was heard on July 15, 2010. On August 30, 2010, the Court of Appeal affirmed the trial court’s verdict in part and reversed the verdict in part, remanding the case. The Company petitioned the Supreme Court of California for review of the Court of Appeal decision. On December 16, 2010, the California Supreme Court denied the Company’s petition for review and remanded for further proceedings to the trial court. On September 20, 2011, the trial court granted limited discovery at a conference on November 4, 2011. The testimonial phase of the third trial in this matter concluded on June 12, 2012. Written closing statements were submitted on January 17, 2014. The parties await decision on whether there will be a second phase of this bench trial. The Company will continue to defend itself vigorously.

On October 17, 2007, the SEC initiated an informal inquiry into matters related to the Company’s mortgage loan and mortgage-related securities investment portfolios. The Company has cooperated fully with the SEC in this matter.

A verified shareholder derivative complaint was filed in the United States District Court for the Southern District of New York on October 4, 2007 by Catherine Rubery, against the Company and its then Chief Executive Officer, President/Chief Operating Officer, Chief Financial Officer and individual members of its board of directors at the time. The Rubery complaint was consolidated with another shareholder derivative complaint brought by shareholder Marilyn Clark in the same court and against the same named defendants. On July 26, 2010, plaintiffs served their consolidated amended complaint, in which they also named the Company’s former Capital Markets Division President as a defendant. Plaintiffs contended, among other things, that the value of the Company’s stock between April 19, 2006 and November 9, 2007 was artificially inflated because certain of the Company’s officers made materially false and misleading statements and failed to disclose that the Company was experiencing a rise in delinquencies, and therefore lacked a reasonable basis for statements about the Company’s earnings and prospects. Plaintiffs allege, among other things, causes of action for breach of fiduciary duty, waste of corporate assets, unjust enrichment, and violation of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder. The complaint seeks, among other things, unspecified monetary damages in favor of the Company, changes to certain corporate governance procedures and various forms of injunctive relief. The parties agreed to settle this action and a Stipulation of Settlement was signed on October 2, 2012, which included an agreement to implement or maintain certain corporate governance procedures. The parties did not reach an agreement on the issue of plaintiffs’ attorneys’ fees, however. The Court preliminarily approved the Stipulation of Settlement on April 2, 2013 and granted final approval of the settlement at a hearing on September 13, 2013. In orders entered on October 3, 2013, the Court confirmed final approval of the settlement, awarded fees and expenses to plaintiffs’ attorneys totaling $1.0 million and issued a final judgment and order of dismissal. Pursuant to the terms of the Stipulation of Settlement, payment of settlement proceeds was made and the action is now closed.

On August 15, 2008, Ronald M. Tate as trustee of the Ronald M. Tate Trust dated 4/13/88, and George Avakian filed an action in the United States District Court for the Southern District of New York against the Company and its then Chief Executive Officer and Chief Financial Officer based on the same facts and circumstances, and containing the same claims, as the class action complaint alleging violations of the federal securities laws that was filed in the United States District Court for the Southern District of New York on October 2, 2007 by Larry Freudenberg on his own behalf and on behalf of others similarly situated (the “Freudenberg Action”). By agreement of the parties and approval of the court, the Tate action was consolidated with the Freudenberg Action for the purpose of pre-trial discovery. Plaintiffs seek to recover damages in an amount to be proven at trial, including interest, attorneys’ and expert fees and costs. The parties in the Freudenberg Action entered into a Stipulation of Settlement on May 17, 2012, but the plaintiffs in this action moved for exclusion from the settlement class in Freudenberg. The Court granted that relief on October 11, 2012, and later approved the Freudenberg settlement in a final judgment and order of dismissal dated October 22, 2012.

 

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Tate and Avakian filed an amended complaint on January 23, 2013, adding an additional claim under California law. The Company answered the amended complaint on March 13, 2013. The Company and the plaintiffs reached a confidential settlement at mediation on September 12, 2013 pursuant to which plaintiffs were paid a non-material sum as consideration for mutual releases. Payment of the settlement amount was completed on October 15, 2013, and the parties submitted a stipulation of voluntary dismissal on October 16, 2013. The stipulation of voluntary dismissal was so-ordered by the Court on October 22, 2013, and the action is now closed.

On May 16, 2011, Droplets Inc., the holder of two patents pertaining to user interface servers, filed a complaint in the U.S. District Court for the Eastern District of Texas against E*TRADE Financial Corporation, E*TRADE Securities LLC, E*TRADE Bank and multiple other unaffiliated financial services firms. Plaintiff contends that the defendants engaged in patent infringement under federal law. Plaintiff seeks unspecified damages and an injunction against future infringements, plus royalties, costs, interest and attorneys’ fees. On September 30, 2011, the Company and several co-defendants filed a motion to transfer the case to the Southern District of New York. Venue discovery occurred throughout December 2011. On January 1, 2012, a new judge was assigned to the case. On March 28, 2012, a change of venue was granted and the case was transferred to the United States District Court for the Southern District of New York. The Company filed its answer and counterclaim on June 13, 2012 and plaintiff moved to dismiss the counterclaim. The Company filed a motion for summary judgment. Plaintiffs sought to change venue back to the Eastern District of Texas on the theory that this case is one of several matters that should be consolidated in a single multi-district litigation. On December 12, 2012, the Multidistrict Litigation Panel denied the transfer of this action to Texas. By opinion dated April 4, 2013, the Court denied defendants’ motion for summary judgment and plaintiff’s motion to dismiss the counterclaims. The Court issued its order on claim construction on October 22, 2013, and by order dated January 28, 2014, the Court adopted the defendants’ proposed claims construction. The Company will continue to defend itself vigorously in this matter.

Several cases have been filed nationwide involving the April 2007 leveraged buyout (“LBO”) of the Tribune Company (“Tribune”) by Sam Zell, and the subsequent bankruptcy of Tribune. In William Niese et al. v. A.G. Edwards et al., in Superior Court of Delaware, New Castle County, former Tribune employees and retirees claimed that Tribune was actually insolvent at the time of the LBO and that the LBO constituted a fraudulent transaction that depleted the plaintiffs’ retirement plans, rendering them worthless. E*TRADE Clearing LLC, along with numerous other financial institutions, is a named defendant in this case. One of the defendants removed the action to federal district court in Delaware on July 1, 2011. In Deutsche Bank Trust Company Americas et al. v. Adaly Opportunity Fund et al., filed in the Supreme Court of New York, New York County on June 3, 2011, the Trustees of certain notes issued by Tribune allege wrongdoing in connection with the LBO. In particular the Trustees claim that the LBO constituted a constructive fraudulent transfer under various state laws. G1 Execution Services, LLC (formerly known as E*TRADE Capital Markets, LLC), along with numerous other financial institutions, is a named defendant in this case. In Deutsche Bank et al. v. Ohlson et al., filed in the U.S. District Court for the Northern District of Illinois, noteholders of Tribune asserted claims of constructive fraud and G1 Execution Services, LLC is a named defendant in this case. In EGI-TRB LLC et al. v. ABN-AMRO et al., filed in the Circuit Court of Cook County Illinois, creditors of Tribune assert fraudulent conveyance claims against multiple shareholder defendants and E*TRADE Clearing LLC is a named defendant in this case. These cases have been consolidated into a multi-district litigation. The Company’s time to answer or otherwise respond to the complaints has been stayed pending further orders of the Court. On September 18, 2013, the Court entered the Fifth Amended Complaint. On September 23, 2013, the Court granted the defendants’ motion to dismiss the individual creditors’ complaint. The individual creditors filed a notice of appeal. The Company will defend itself vigorously in these matters.

During 2012, the Company completed a review of order handling practices and pricing for order flow between E*TRADE Securities LLC and G1 Execution Services, LLC. The Company has implemented changes to its practices and procedures that were recommended during the review. Banking regulators and federal securities regulators were regularly updated during the course of the review and may initiate investigations into the Company’s historical practices which could subject it to monetary penalties and cease-and-desist orders,

 

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which could also prompt claims by customers of E*TRADE Securities LLC. Any of these actions could materially and adversely affect the Company’s broker-dealer businesses. On July 11, 2013, FINRA notified E*TRADE Securities LLC and G1 Execution Services, LLC that it is conducting an examination of both firms’ routing practices. The Company is cooperating fully with FINRA in this examination and, under the agreement governing the sale of G1 Execution Services, LLC to Susquehanna, remains responsible for any resulting actions taken against G1 Execution Services, LLC as a result of such investigation.

On April 30, 2013, a putative class action was filed by John Scranton, on behalf of himself and a class of persons similarly situated, against E*TRADE Financial Corporation and E*TRADE Securities LLC in the Superior Court of California, County of Santa Clara, pursuant to the California procedures for a private Attorney General action. The Complaint alleged that the Company misrepresented through its website that it would always automatically exercise options that were in-the-money by $0.01 or more on expiration date. Plaintiffs allege violations of the California Unfair Competition Law, the California Consumer Remedies Act, fraud, misrepresentation, negligent misrepresentation and breach of fiduciary duty. The case has been deemed complex within the meaning of the California Rules of Court, and a case management conference was held on September 13, 2013. The Company’s demurrer and motion to strike the complaint were granted by order dated December 20, 2013. The Court granted leave to amend the complaint. A second amended complaint was filed on January 31, 2014 and the Company’s response is due March 3, 2014. The Company will continue to defend itself vigorously in this matter.

In addition to the matters described above, the Company is subject to various legal proceedings and claims that arise in the normal course of business. In each pending matter, the Company contests liability or the amount of claimed damages. In view of the inherent difficulty of predicting the outcome of such matters, particularly in cases where claimants seek substantial or indeterminate damages, or where investigation or discovery have yet to be completed, the Company is unable to reasonably estimate a range of possible losses on its remaining outstanding legal proceedings; however, the Company believes any losses would not be reasonably likely to have a material adverse effect on the consolidated financial condition or results of operations of the Company.

An unfavorable outcome in any matter could have a material adverse effect on the Company’s business, financial condition, results of operations or cash flows. In addition, even if the ultimate outcomes are resolved in the Company’s favor, the defense of such litigation could entail considerable cost or the diversion of the efforts of management, either of which could have a material adverse effect on the Company’s business, financial condition, results of operations 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; cyber liability; directors and officers; employment practices liability; certain criminal acts against the Company; and errors and omissions. The Company believes that such insurance coverage is adequate for the purpose of its business. The Company’s ability to maintain this level of insurance coverage in the future, however, is subject to the availability of affordable insurance in the marketplace.

ITEM 4.    MINE SAFETY DISCLOSURES

Not applicable.

 

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PART II

 

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED SHAREHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Our common stock is listed on the NASDAQ Stock Market under the ticker symbol ETFC.

Price Range of Common Stock

The following table shows the high and low intraday sale prices of our common stock as reported by the NASDAQ for the periods indicated:

 

     High      Low  

2013:

     

First Quarter

   $ 11.82       $ 9.06   

Second Quarter

   $ 12.73       $ 9.52   

Third Quarter

   $ 17.73       $ 12.66   

Fourth Quarter

   $ 19.67       $ 15.54   

2012:

     

First Quarter

   $ 11.50       $ 7.77   

Second Quarter

   $ 11.16       $ 7.39   

Third Quarter

   $ 10.09       $ 7.08   

Fourth Quarter

   $ 9.54       $ 7.70   

The closing sale price of our common stock as reported on the NASDAQ on February 21, 2014 was $22.37 per share. At that date, there were 1,384 holders of record of our common stock.

Dividends

We have never declared or paid cash dividends on our common stock. The terms of our corporate debt currently prohibit the payment of dividends and will continue to prohibit the payment of dividends for the foreseeable future. E*TRADE Bank may not pay dividends to the parent company without approval from its regulators. This dividend restriction includes E*TRADE Securities LLC and E*TRADE Clearing LLC as they are subsidiaries of E*TRADE Bank.

Equity Compensation Plan Information

In 2005, the Company adopted and the shareholders approved the 2005 Stock Incentive Plan (“2005 Plan”) to replace the 1996 Stock Incentive Plan (“1996 Plan”) which provides for the grant of nonqualified or incentive stock options, restricted stock awards and restricted stock units to officers, directors, employees and consultants for the purchase of newly issued shares of the Company’s common stock at a price determined by the Board at the date of the grant. The Company does not have a specific policy for issuing shares upon stock option exercises and share unit conversions; however, new shares are typically issued in connection with exercises and conversions. The Company intends to continue to issue new shares for future exercises and conversions.

Options are generally exercisable ratably over a two- to four-year period from the date the option is granted and most options expire within seven years from the date of grant. Certain options provide for accelerated vesting upon a change in control. Exercise prices are generally equal to the fair value of the shares on the grant date. As of December 31, 2013, there were 1.6 million shares outstanding related to non-vested stock options with a weighted average exercise price of $62.52.

The Company issues restricted stock awards and restricted stock units to certain employees. Each restricted stock unit can be converted into one share of the Company’s common stock upon vesting. These awards are issued at the fair value on the date of grant and vest ratably over the period, generally two to four years. The fair value is calculated as the market price upon issuance. As of December 31, 2013, there were 3.4 million awards and units outstanding related to non-vested awards.

 

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Under the 2005 Plan, the remaining unissued authorized shares of the 1996 Plan, up to 4.2 million shares, were authorized for issuance. Additionally, any shares that had been awarded but remained unissued under the 1996 Plan that were subsequently canceled, would be authorized for issuance under the 2005 Plan, up to 3.9 million shares. In May 2009 and 2010, an additional 3.0 million and 12.5 million shares, respectively, were authorized for issuance under the 2005 Plan at the Company’s shareholders’ annual meetings in each of those respective years. As of December 31, 2013, 8.4 million shares were available for grant under the 2005 Plan.

Performance Graph

The following performance graph shows the cumulative total return to a holder of the Company’s common stock, assuming dividend reinvestment, compared with the cumulative total return, assuming dividend reinvestment, of the S&P 500 Index and the Dow Jones US Financials Index during the period from December 31, 2008 through December 31, 2013.

 

LOGO

 

     12/08      12/09      12/10      12/11      12/12      12/13  

E*TRADE Financial Corporation

     100.00         153.04         139.13         69.22         77.83         170.78   

S&P 500 Index

     100.00         126.46         145.51         148.59         172.37         228.19   

Dow Jones US Financials Index

     100.00         117.11         132.00         115.05         145.94         195.88   

 

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ITEM 6.    SELECTED CONSOLIDATED FINANCIAL DATA

(Dollars in millions, shares in thousands, except per share amounts):

 

     Year Ended December 31,     Variance  
     2013      2012     2011      2010     2009      2013 vs. 2012   

Results of Operations:

              

Net operating interest income

   $ 981.8       $ 1,085.1      $ 1,220.0       $ 1,226.3      $ 1,260.6        (10 )% 

Total net revenue

   $ 1,723.7       $ 1,899.5      $ 2,036.6       $ 2,077.9      $ 2,217.0        (9 )% 

Provision for loan losses

   $ 143.5       $ 354.6      $ 440.6       $ 779.4      $ 1,498.1        (60 )% 

Net income (loss)

   $ 86.0       $ (112.6   $ 156.7       $ (28.5   $ (1,297.8     *   

Basic net earnings (loss) per share

   $ 0.30       $ (0.39   $ 0.59       $ (0.13   $ (11.85     *   

Diluted net earnings (loss) per share

   $ 0.29       $ (0.39   $ 0.54       $ (0.13   $ (11.85     *   

Weighted average shares—basic

     286,991         285,748        267,291         211,302        109,544        0

Weighted average shares—diluted

     292,589         285,748        289,822         211,302        109,544        2

 

* Percentage not meaningful.

(Dollars in millions):

 

     December 31,      Variance  
     2013      2012      2011      2010      2009       2013 vs. 2012   

Financial Condition:

                 

Available-for-sale securities

   $ 13,592.2       $ 13,443.0       $ 15,651.5       $ 14,805.7       $ 13,319.7         1

Held-to-maturity securities

   $ 10,180.8       $ 9,539.9       $ 6,079.5       $ 2,462.7       $ —           7

Margin receivables

   $ 6,352.7       $ 5,804.0       $ 4,826.3       $ 5,120.6       $ 3,827.2         9

Loans receivable, net

   $ 8,122.6       $ 10,098.7       $ 12,332.8       $ 15,121.9       $ 19,167.1         (20 )% 

Total assets

   $ 46,279.9       $ 47,386.7       $ 47,940.5       $ 46,373.0       $ 47,366.5         (2 )% 

Deposits

   $ 25,970.8       $ 28,392.5       $ 26,460.0       $ 25,240.3       $ 25,597.7         (9 )% 

Corporate debt

                 

Interest-bearing

   $ 1,726.0       $ 1,722.3       $ 1,450.5       $ 1,441.9       $ 1,437.8         0

Non-interest-bearing

   $ 42.6       $ 42.7       $ 43.0       $ 704.0       $ 1,020.9         0

Shareholders’ equity

   $ 4,855.9       $ 4,904.5       $ 4,928.0       $ 4,052.4       $ 3,749.6         (1 )% 

 

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    As of or For the Year Ended December 31,     Variance  
    2013     2012     2011     2010     2009     2013 vs. 2012  

Customer Activity Metrics:(1)

           

DARTs

    150,743        138,112        157,475        150,532        179,183        9

Average commission per trade

  $ 11.13      $ 11.01      $ 11.01      $ 11.21      $ 11.33        1

Margin receivables (dollars in billions)

  $ 6.4      $ 5.8      $ 4.8      $ 5.1      $ 3.7        10

End of period brokerage accounts

    2,998,059        2,903,191        2,783,012        2,684,311        2,630,079        3

Net new brokerage accounts

    94,868        120,179        98,701        54,232        114,273        (21 )% 

Brokerage account attrition rate

    8.8     9.0     10.3     12.2     13.2     *   

Customer assets (dollars in billions)

  $ 260.8      $ 201.2      $ 172.4      $ 176.2      $ 150.5        30

Net new brokerage assets (dollars in billions)

  $ 10.4      $ 10.4      $ 9.7      $ 8.1      $ 7.2        0

Brokerage related cash (dollars in billions)

  $ 39.7      $ 33.9      $ 27.7      $ 24.5      $ 20.4        17

Company Metrics:

           

Corporate cash (dollars in millions)

  $ 415.1      $ 407.6      $ 484.4      $ 470.5      $ 393.2        2

E*TRADE Financial Tier 1 leverage ratio(2)

    6.7     5.5     5.7     3.6     N/A        1.2

E*TRADE Financial Tier 1 common ratio(2)

    13.8     10.3     9.4     4.8     N/A        3.5

E*TRADE Bank Tier 1 leverage ratio(3)

    9.5     8.7     7.8     7.3     6.7     0.8

Special mention loan delinquencies (dollars in millions)

  $ 271.6      $ 342.2      $ 467.1      $ 589.4      $ 804.5        (21 )% 

Allowance for loan losses (dollars in millions)

  $ 453.0      $ 480.7      $ 822.8      $ 1,031.2      $ 1,182.7        (6 )% 

Enterprise net interest spread

    2.33     2.39     2.79     2.91     2.72     (0.06 )% 

Enterprise interest-earning assets (average dollars in billions)

  $ 40.9      $ 44.3      $ 42.7      $ 41.1      $ 44.5        (8 )% 

Total employees (period end)

    3,009        2,988        3,240        2,962        3,084        1

 

* Percentage not meaningful.
(1)

Metrics have been presented to exclude international local market trading for the year ended December 31, 2009.

(2)

E*TRADE Financial Tier 1 leverage ratio is Tier 1 capital divided by average total assets for leverage capital purposes for the parent company. E*TRADE Financial Tier 1 common ratio is Tier 1 capital less elements of Tier 1 capital that are not in the form of common equity, such as trust preferred securities, divided by total risk-weighted assets for the holding company. The Tier 1 leverage and Tier 1 common ratios are non-GAAP measures as the parent company is not yet held to these regulatory capital requirements and are indications of E*TRADE Financial’s capital adequacy. See Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources for a reconciliation of these non-GAAP measures to the comparable GAAP measures.

(3) 

The Company transitioned from reporting under the OTS reporting requirements to reporting under the OCC reporting requirements in the first quarter of 2012. The Tier 1 leverage ratio is the OCC Tier 1 leverage ratio at December 31, 2013 and 2012 and the OTS Tier 1 capital ratio at December 31, 2011, 2010 and 2009. The OTS Tier 1 capital ratio and OCC Tier 1 leverage ratio are both calculated in the same manner using adjusted total assets.

The selected consolidated financial data should be read in conjunction with Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations and Item 8. Financial Statements and Supplementary Data.

 

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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion should be read in conjunction with the consolidated financial statements and the related notes that appear elsewhere in this document.

GLOSSARY OF TERMS

In analyzing and discussing our business, we utilize certain metrics, ratios and other terms that are defined in the Glossary of Terms, which is located at the end of Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

OVERVIEW

Strategy

Our business strategy is centered on two core objectives: accelerating the growth of our core brokerage business to improve market share, and strengthening our overall financial and franchise position.

Accelerate Growth of Core Brokerage Business

 

   

Enhance digital and offline customer experience.

We are focused on maintaining our competitive position in trading, margin lending and cash management, while expanding our customer share of wallet in retirement, investing and savings. Through these offerings, we aim to continue acquiring new customers while deepening engagement with both new and existing ones.

 

   

Capitalize on value of corporate services business.

This includes leveraging our industry-leading position to improve client acquisition, and bolstering awareness among plan participants of our full suite of offerings. This channel is a strategically important driver of brokerage account growth for us.

 

   

Maximize value of deposits through the Company’s bank.

Our brokerage business generates a significant amount of deposits, which we monetize through the bank by investing primarily in low-risk, agency mortgage-backed securities.

Strengthen Overall Financial and Franchise Position

 

   

Manage down legacy investments and mitigate credit losses.

We continue to manage down the size and risks associated with our legacy loan portfolio, while mitigating credit losses where possible.

 

   

Execute on our capital plan.

The core components of our capital plan include bolstering our capital levels through earnings and de-risking and building out best-in-class enterprise risk management capabilities. A key goal of this plan is to distribute capital from the bank to the parent.

Key Factors Affecting Financial Performance

Our financial performance is affected by a number of factors outside of our control, including:

 

   

customer demand for financial products and services;

 

   

weakness or strength of the residential real estate and credit markets;

 

   

performance, volume and volatility of the equity and capital markets;

 

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customer perception of the financial strength of our franchise;

 

   

market demand and liquidity in the secondary market for mortgage loans and securities;

 

   

market demand and liquidity in the wholesale borrowings market, including securities sold under agreements to repurchase;

 

   

our ability to obtain regulatory approval to move capital from our bank to our parent company; and

 

   

changes to the rules and regulations governing the financial services industry.

In addition to the items noted above, our success in the future will depend upon, among other things, our ability to:

 

   

have continued success in the acquisition, growth and retention of brokerage customers;

 

   

generate meaningful growth in our retirement, investing and savings customer products;

 

   

enhance our risk management capabilities;

 

   

reduce credit costs;

 

   

achieve the capital ratios stated in our capital plan, with a particular focus on the Tier 1 leverage ratio at E*TRADE Bank;

 

   

generate capital sufficient to meet our operating needs at both our bank and our parent company;

 

   

assess and manage interest rate risk; and

 

   

maintain disciplined expense control and improved operational efficiency.

Management monitors a number of metrics in evaluating the Company’s performance. The most significant of these are shown in the table and discussed in the text below:

 

      As of or For the
Year Ended December 31,
    Variance  
     2013     2012     2011     2013 vs. 2012  

Customer Activity Metrics:

        

DARTs

     150,743        138,112        157,475        9

Average commission per trade

   $ 11.13      $ 11.01      $ 11.01        1

Margin receivables (dollars in billions)

   $ 6.4      $ 5.8      $ 4.8        10

End of period brokerage accounts

     2,998,059        2,903,191        2,783,012        3

Net new brokerage accounts

     94,868        120,179        98,701        (21 )% 

Brokerage account attrition rate

     8.8     9.0     10.3     *   

Customer assets (dollars in billions)

   $ 260.8      $ 201.2      $ 172.4        30

Net new brokerage assets (dollars in billions)

   $ 10.4      $ 10.4      $ 9.7        0

Brokerage related cash (dollars in billions)

   $ 39.7      $ 33.9      $ 27.7        17

Company Financial Metrics:

        

Corporate cash (dollars in millions)

   $ 415.1      $ 407.6      $ 484.4        2

E*TRADE Financial Tier 1 leverage ratio

     6.7     5.5     5.7     1.2

E*TRADE Financial Tier 1 common ratio

     13.8     10.3     9.4     3.5

E*TRADE Bank Tier 1 leverage ratio(1)

     9.5     8.7     7.8     0.8

Special mention loan delinquencies (dollars in millions)

   $ 271.6      $ 342.2      $ 467.1        (21 )% 

Allowance for loan losses (dollars in millions)

   $ 453.0      $ 480.7      $ 822.8        (6 )% 

Enterprise net interest spread

     2.33     2.39     2.79     (0.06 )% 

Enterprise interest-earning assets (average dollars in billions)

   $ 40.9      $ 44.3      $ 42.7        (8 )% 

 

* Percentage not meaningful.
(1)

The Company transitioned from reporting under the OTS reporting requirements to reporting under the OCC reporting requirements in the first quarter of 2012. The Tier 1 leverage ratio is the OCC Tier 1 leverage ratio at December 31, 2013 and 2012 and the OTS Tier 1 capital ratio at December 31, 2011. The OTS Tier 1 capital ratio and OCC Tier 1 leverage ratio are both calculated in the same manner using adjusted total assets.

 

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Customer Activity Metrics

 

   

DARTs are the predominant driver of commissions revenue from our customers.

 

   

Average commission per trade is an indicator of changes in our customer mix, product mix and/or product pricing.

 

   

Margin receivables represent credit extended to customers to finance their purchases of securities by borrowing against securities they own and are a key driver of net operating interest income.

 

   

End of period brokerage accounts, net new brokerage accounts and brokerage account attrition rate are indicators of our ability to attract and retain brokerage customers. The brokerage account attrition rate is calculated by dividing attriting brokerage accounts, which are gross new brokerage accounts less net new brokerage accounts, by total brokerage accounts at the previous period end.

 

   

Changes in customer assets are an indicator of the value of our relationship with the customer. An increase in customer assets generally indicates that the use of our products and services by existing and new customers is expanding. Changes in this metric are also driven by changes in the valuations of our customers’ underlying securities.

 

   

Net new brokerage assets are total inflows to all new and existing brokerage accounts less total outflows from all closed and existing brokerage accounts and are a general indicator of the use of our products and services by new and existing brokerage customers.

 

   

Brokerage related cash is an indicator of the level of engagement with our brokerage customers and is a key driver of net operating interest income.

Company Financial Metrics

 

   

Corporate cash is an indicator of the liquidity at the parent company. It is the primary source of capital above and beyond the capital deployed in our regulated subsidiaries.

 

   

E*TRADE Financial Tier 1 leverage ratio is Tier 1 capital divided by average total assets for leverage capital purposes for the parent company. E*TRADE Financial Tier 1 common ratio is Tier 1 capital less elements of Tier 1 capital that are not in the form of common equity, such as trust preferred securities, divided by total risk-weighted assets for the holding company. The Tier 1 leverage and Tier 1 common ratios are non-GAAP measures as the parent company is not yet held to these regulatory capital requirements and are indications of E*TRADE Financial’s capital adequacy. See Liquidity and Capital Resources for a reconciliation of these non-GAAP measures to the comparable GAAP measures.

 

   

E*TRADE Bank Tier 1 leverage ratio is Tier 1 capital divided by adjusted total assets for E*TRADE Bank and is an indication of E*TRADE Bank’s capital adequacy.

 

   

Special mention loan delinquencies are loans 30-89 days past due and are an indicator of the expected trend for charge-offs in future periods as these loans have a greater propensity to migrate into nonaccrual status and ultimately charge-off.

 

   

Allowance for loan losses is an estimate of probable losses inherent in the loan portfolio as of the balance sheet date and is typically equal to management’s forecast of loan losses in the twelve months following the balance sheet date as well as the forecasted losses, including economic concessions to borrowers, over the estimated remaining life of loans modified as troubled debt restructurings (“TDR”).

 

   

Enterprise interest-earning assets, in conjunction with our enterprise net interest spread, are indicators of our ability to generate net operating interest income.

 

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Significant Events in 2013

Enhancements to Our Trading and Investing Products and Services

 

   

We launched a revamped tablet experience, and enhanced our iPhone® and AndroidTM platforms, adding useful tools such as mobile bill pay, and access to index futures, giving customers better insight into the markets outside of traditional trading hours;

 

   

We upgraded our E*TRADE Pro platform by enhancing its capabilities with the integration of futures trading, allowing us to provide customers with a much more streamlined futures trading experience; and

 

   

We hosted our second annual National Retirement Education Day in New York and at all our branches to provide customers with perspectives on how to better prepare for and manage their retirement assets.

$175 Million in Dividends Issued from E*TRADE Bank to the Parent Company

 

   

We received approval from our regulators for $175 million in dividends from E*TRADE Bank to the parent company, reflecting significant progress on our long-term capital plan.

Sale of the Market Making Business and Related Order Flow Agreement

 

   

At the end of June 2013, we decided to exit the market making business, and accordingly classified it as held-for-sale. The entire amount of goodwill associated with this business was impaired, resulting in a $142.4 million impairment of goodwill.

 

   

We entered into a definitive agreement to sell the market making business, G1 Execution Services, LLC, to an affiliate of Susquehanna for approximately $75 million. We do not expect the sale of the market making business to have a material impact on our results of operations as the net impact of the removal of principal transaction revenue and associated operating expenses, predominately in compensation and clearing expenses, is expected to be offset by an expected increase in order flow revenue as a result of routing all of our order flow to third parties. The sale of G1 Execution Services, LLC was completed on February 10, 2014.

 

   

Additionally, we entered into an order flow agreement whereby we agree, subject to best execution standards, to route 70% of our customer equity flow to G1 Execution Services, LLC over the next five years.

EARNINGS OVERVIEW

2013 Compared to 2012

We generated net income of $86.0 million, or $0.29 per diluted share, on total net revenue of $1.7 billion for the year ended December 31, 2013. Net operating interest income decreased 10% to $981.8 million for the year ended December 31, 2013 compared to 2012, which was driven primarily by a decrease in enterprise interest-earning assets and enterprise interest-bearing liabilities as a result of our deleveraging initiatives. Commissions, fees and service charges, principal transactions and other revenue increased 8% to $683.6 million for the year ended December 31, 2013, compared to 2012, which was driven primarily by an increase in trading activity during 2013. In addition, gains on loans and securities, net decreased 70% to $60.6 million for the year ended December 31, 2013 compared to 2012, primarily due to increased gains in 2012 as a result of deleveraging activities.

Provision for loan losses decreased 60% to $143.5 million for the year ended December 31, 2013 compared to 2012. The decline was driven primarily by improving economic conditions, including home price improvement and continued loan portfolio run-off. Total operating expenses increased 10% to $1.3 billion for the

 

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year ended December 31, 2013 compared to 2012. This increase was driven primarily by $142.4 million in impairment of goodwill that was recognized in the second quarter of 2013 due to our decision to exit the market making business, which was partially offset by a decrease in advertising and marketing expense for the year ended December 31, 2013 compared to 2012.

The following sections describe in detail the changes in key operating factors and other changes and events that affected net revenue, provision for loan losses, operating expense, other income (expense) and income tax expense (benefit).

Revenue

The components of revenue and the resulting variances are as follows (dollars in millions):

 

                 Variance  
     Year Ended December 31,     2013 vs. 2012  
             2013                 2012         Amount     %  

Net operating interest income

   $ 981.8      $ 1,085.1      $ (103.3     (10 )% 

Commissions

     420.1        377.8        42.3        11

Fees and service charges

     155.0        122.2        32.8        27

Principal transactions

     72.7        93.1        (20.4     (22 )% 

Gains on loans and securities, net

     60.6        200.4        (139.8     (70 )% 

Net impairment

     (2.3     (16.9     14.6        (86 )% 

Other revenues

     35.8        37.8        (2.0     (5 )% 
  

 

 

   

 

 

   

 

 

   

Total non-interest income

     741.9        814.4        (72.5     (9 )% 
  

 

 

   

 

 

   

 

 

   

Total net revenue

   $       1,723.7      $ 1,899.5      $ (175.8     (9 )% 
  

 

 

   

 

 

   

 

 

   

Net Operating Interest Income

Net operating interest income decreased 10% to $981.8 million for the year ended December 31, 2013 compared to 2012. Net operating interest income is earned primarily through investing customer payables and deposits in enterprise interest-earning assets, which include: real estate loans, margin receivables, available-for-sale securities and held-to-maturity securities.

 

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The following tables present enterprise average balance sheet data and enterprise income and expense data for our operations, as well as the related net interest spread, yields and rates and have been prepared on the basis required by the SEC’s Industry Guide 3, “Statistical Disclosure by Bank Holding Companies” (dollars in millions):

 

    Year Ended December 31,  
    2013     2012     2011  
    Average
Balance
    Operating
Interest
Inc./Exp.
    Average
Yield/
Cost
    Average
Balance
    Operating
Interest
Inc./Exp.
    Average
Yield/
Cost
    Average
Balance
    Operating
Interest
Inc./Exp.
    Average
Yield/
Cost
 

Enterprise interest-earning assets:

                 

Loans(1)

  $ 9,568.9      $ 394.6        4.12   $ 12,027.6      $ 496.4        4.13   $ 14,689.8      $ 692.1        4.71

Available-for-sale securities

    13,074.2        279.9        2.14     15,236.9        361.1        2.37     15,326.5        422.5        2.76

Held-to-maturity securities

    9,772.3        255.4        2.61     8,408.9        237.0        2.82     4,177.1        136.9        3.28

Margin receivables

    5,928.9        224.0        3.78     5,471.2        216.1        3.95     5,374.8        221.7        4.13

Cash and equivalents

    1,433.8        2.9        0.20     1,668.3        3.6        0.21     1,618.9        3.2        0.20

Segregated cash

    457.3        0.4        0.10     956.0        0.7        0.08     915.6        0.9        0.10

Securities borrowed and other

    656.5        50.9        7.76     577.2        48.7        8.43     620.9        48.8        7.85
 

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

   

Total enterprise interest-earning assets

    40,891.9        1,208.1        2.95     44,346.1        1,363.6        3.07     42,723.6        1,526.1        3.57
   

 

 

       

 

 

       

 

 

   

Non-operating interest-earning and non-interest earning assets(2)

    4,624.2            5,068.9            4,339.5       
 

 

 

       

 

 

       

 

 

     

Total assets

  $ 45,516.1          $ 49,415.0          $ 47,063.1       
 

 

 

       

 

 

       

 

 

     

Enterprise interest-bearing liabilities:

                 

Deposits:

                 

Sweep deposits

  $ 19,431.6        10.9        0.06   $ 20,776.0        14.7        0.07   $ 17,513.1        13.4        0.08

Complete savings deposits

    4,581.6        0.4        0.01     5,389.1        3.6        0.07     6,174.4        16.1        0.26

Other money market and savings deposits

    940.7        0.1        0.01     1,015.8        0.7        0.07     1,071.5        2.5        0.23

Checking deposits

    1,007.4        0.3        0.03     890.4        0.7        0.08     783.2        0.8        0.10

Time deposits

    81.0        0.9        1.11     166.0        4.4        2.59     319.5        10.0        3.13

Customer payables

    5,494.4        8.1        0.15     5,648.4        10.4        0.18     5,456.3        8.6        0.16

Securities sold under agreements to repurchase

    4,466.4        148.4        3.32     4,775.1        158.5        3.32     5,417.2        153.1        2.83

Federal Home Loan Bank (“FHLB”) advances and other borrowings

    1,291.2        68.4        5.29     2,464.9        92.6        3.76     2,741.1        106.2        3.87

Securities loaned and other

    859.7        0.2        0.02     676.0        0.3        0.04     634.8        1.5        0.23
 

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

   

Total enterprise interest-bearing liabilities

    38,154.0        237.7        0.62     41,801.7        285.9        0.68     40,111.1        312.2        0.78
   

 

 

       

 

 

       

 

 

   

Non-operating interest-bearing and non-interest bearing liabilities(3)

    2,490.4            2,580.0            2,285.9       
 

 

 

       

 

 

       

 

 

     

Total liabilities

    40,644.4            44,381.7            42,397.0       

Total shareholders’ equity

    4,871.7            5,033.3            4,666.1       
 

 

 

       

 

 

       

 

 

     

Total liabilities and shareholders’ equity

  $ 45,516.1          $ 49,415.0          $ 47,063.1       
 

 

 

       

 

 

       

 

 

     

Excess of enterprise interest-earning assets over enterprise interest-bearing liabilities/Enterprise net interest income/Spread

  $ 2,737.9      $ 970.4        2.33   $ 2,544.4      $ 1,077.7        2.39   $ 2,612.5      $ 1,213.9        2.79
 

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

   

Reconciliation from enterprise net interest income to net operating interest income (dollars in millions):

 

     Year Ended December 31,  
     2013     2012     2011  

Enterprise net interest income

   $ 970.4      $ 1,077.7      $ 1,213.9   

Taxable equivalent interest adjustment

     (1.0     (1.1     (1.2

Customer assets held by third parties(4)

     12.4        8.5        7.3   
  

 

 

   

 

 

   

 

 

 

Net operating interest income

   $ 981.8      $ 1,085.1      $ 1,220.0   
  

 

 

   

 

 

   

 

 

 

 

(1)

Nonaccrual loans are included in the average loan balances. Interest payments received on nonaccrual loans are recognized on a cash basis in operating interest income until it is doubtful that full payment will be collected, at which point payments are applied to principal.

(2) 

Non-operating interest-earning and non-interest earning assets consist of certain segregated cash balances, property and equipment, net, goodwill, other intangibles, net and other assets that do not generate operating interest income. Some of these assets generate corporate interest income.

(3) 

Non-operating interest-bearing and non-interest bearing liabilities consist of corporate debt and other liabilities that do not generate operating interest expense. Some of these liabilities generate corporate interest expense.

(4) 

Includes revenue earned on average customer assets of $11.5 billion, $4.3 billion and $3.7 billion for the years ended December 31, 2013, 2012 and 2011, respectively, held by third parties outside the Company, including money market funds and sweep deposit accounts at unaffiliated financial institutions. Fees earned on the customer assets are based on the federal funds rate plus a negotiated spread or other contractual arrangement with the third party institutions.

 

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     Year Ended December 31,  
     2013     2012     2011  

Enterprise net interest:

      

Spread

     2.33     2.39     2.79

Margin (net yield on interest-earning assets)

     2.37     2.43     2.84

Ratio of enterprise interest-earning assets to enterprise interest-bearing liabilities

     107.18     106.09     106.51

Return on average:

      

Total assets

     0.19     (0.23 )%      0.33

Total shareholders’ equity

     1.77     (2.24 )%      3.36

Average total shareholders’ equity to average total assets

     10.70     10.19     9.91

The fluctuation in enterprise interest-earning assets is driven primarily by changes in enterprise interest-bearing liabilities, specifically customer payables and deposits. Average enterprise interest-earning assets decreased 8% to $40.9 billion for the year ended December 31, 2013 compared to 2012. This was primarily a result of decreases in average available-for-sale securities and average loans, which were partially offset by an increase in average held-to-maturity securities.

Average enterprise interest-bearing liabilities decreased 9% to $38.2 billion for the year ended December 31, 2013 compared to 2012. The decrease in average enterprise interest-bearing liabilities was due primarily to decreases in average deposits and average FHLB advances and other borrowings.

As part of our strategy to strengthen our overall financial and franchise position, we have been focused on improving our capital ratios by reducing risk and deleveraging the balance sheet. Our deleveraging strategy included transferring customer deposits to third party institutions, including $3.2 billion of sweep deposits transferred during the year ended December 31, 2013. At December 31, 2013, our customers held $13.8 billion of assets at third party institutions, including third party banks and money market funds. Approximately 68% of these off-balance sheet assets resulted from our deleveraging efforts. We estimate the impact of our deleveraging efforts on net operating interest income to be approximately 130 basis points based on the estimated current re-investment rates on these assets, less approximately 35 basis points of cost associated with holding these assets on our balance sheet, primarily, FDIC insurance premiums. While we may take some tactical actions in future periods, we consider our deleveraging initiatives to be complete.

Enterprise net interest spread decreased by 6 basis points to 2.33% for the year ended December 31, 2013 compared to 2012, due to lower yields on margin and reinvestment in securities at lower rates in the current interest rate environment, partially offset by lower rates on customer payables and deposits. We expect enterprise net interest spread for 2014 will average slightly above the levels from 2013; however, enterprise net interest spread may further fluctuate based on the size and mix of the balance sheet, as well as the impact from the level of interest rates.

Commissions

Commissions revenue increased 11% to $420.1 million for the year ended December 31, 2013 compared to 2012. The main factors that affect commissions are DARTs, average commission per trade and the number of trading days.

DART volume increased 9% to 150,743 for the year ended December 31, 2013 compared to 2012. Option-related DARTs as a percentage of total DARTs represented 24% of trading volume for both years ended December 31, 2013 and 2012. Exchange-traded funds-related DARTs as a percentage of total DARTs represented 7% of trading volume for the year ended December 31, 2013 compared to 8% in 2012.

Average commission per trade increased 1% to $11.13 for the year ended December 31, 2013 compared to 2012. Average commission per trade is impacted by customer mix and the different commission rates on various trade types (e.g. equities, options, fixed income, stock plan, exchange-traded funds, mutual funds, forex and cross border). Accordingly, changes in the mix of trade types will impact average commission per trade.

 

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Fees and Service Charges

Fees and service charges increased 27% to $155.0 million for the year ended December 31, 2013 compared to 2012. The table below shows the components of fees and service charges and the resulting variances (dollars in millions):

 

            Variance  
     Year Ended December 31,      2013 vs. 2012  
         2013              2012           Amount       %  

Order flow revenue

   $ 72.5       $ 58.4       $ 14.1         24

Mutual fund service fees

     21.0         16.4         4.6         28

Foreign exchange revenue

     14.8         10.3         4.5         44

Advisor management fees

     13.9         6.4         7.5         116

Reorganization fees

     9.2         7.7         1.5         20

Other fees and service charges

     23.6         23.0         0.6         3
  

 

 

    

 

 

    

 

 

    

Total fees and service charges

   $ 155.0       $ 122.2       $ 32.8         27
  

 

 

    

 

 

    

 

 

    

The increase in fees and services charges for the year ended December 31, 2013 was driven primarily by increased order flow revenue due to increased trading activity, as well as increased advisor management fees driven from managed accounts within our retirement, investing and savings products, which were $2.4 billion at December 31, 2013, compared to $1.3 billion at December 31, 2012.

The market making business, G1 Execution Services, LLC, had a formal intercompany agreement with E*TRADE Securities LLC, both wholly owned subsidiaries of the Company at December 31, 2013. As part of the intercompany agreement, E*TRADE Securities LLC routed a portion of its order flow to G1 Execution Services, LLC, and received an order flow rebate which was eliminated in consolidation. As the sale of the market making business closed on February 10, 2014, we expect to see an increase in order flow revenue as E*TRADE Securities will be routing all of its order flow to third parties.

Principal Transactions

Principal transactions decreased 22% to $72.7 million for the year ended December 31, 2013 compared to 2012. Principal transactions are derived from our market making business in which we act as a market-maker for our brokerage customers’ orders as well as orders from third party customers. The decrease in principal transactions revenue was driven primarily by a decrease in market making trading volume along with a decrease in average revenue per share earned.

The market making business generates all of our principal transactions revenue. On October 23, 2013, we entered into a definitive agreement to sell the market making business to an affiliate of Susquehanna. The sale closed on February 10, 2014 and we will no longer have principal transactions revenue after that date.

 

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Gains on Loans and Securities, Net

Gains on loans and securities, net decreased 70% to $60.6 million for the year ended December 31, 2013 compared to 2012. The table below shows the activity and resulting variances (dollars in millions):

 

           Variance  
     Year Ended December 31,     2013 vs. 2012  
            2013                   2012            Amount     %  

Gains (losses) on loans, net

   $ (0.9   $ 0.6      $ (1.5     (250 )% 
  

 

 

   

 

 

   

 

 

   

Gains on available-for-sale securities, net

     60.4        207.3        (146.9     (71 )% 

Losses on trading securities, net

     —          (0.3     0.3        *   

Hedge ineffectiveness

     1.1        (7.2     8.3        *   
  

 

 

   

 

 

   

 

 

   

Gains on securities, net

     61.5        199.8        (138.3     (69 )% 
  

 

 

   

 

 

   

 

 

   

Gains on loans and securities, net

   $ 60.6      $ 200.4      $ (139.8     (70 )% 
  

 

 

   

 

 

   

 

 

   

 

* Percentage not meaningful.

The decrease in gains on loans and securities, net for the year ended December 31, 2013, was driven by additional gains recognized during the year ended December 31, 2012 from the sale of available-for-sale securities as a result of our deleveraging initiatives, primarily related to a reduction in wholesale funding obligations.

Net Impairment

We recognized $2.3 million and $16.9 million of net impairment during the years ended December 31, 2013 and 2012, respectively, on certain securities in our non-agency CMO portfolio due to continued deterioration in the expected credit performance of the underlying loans in those specific securities. The gross other-than-temporary impairment (“OTTI”) and the noncredit portion of OTTI, which was or had been previously recorded through other comprehensive income (loss), are shown in the table below (dollars in millions):

 

     Year Ended
December 31,
 
         2013             2012      

Other-than-temporary impairment (“OTTI”)

   $ (0.6   $ (19.8

Less: noncredit portion of OTTI recognized into (out of) other comprehensive income (loss) (before tax)

     (1.7     2.9   
  

 

 

   

 

 

 

Net impairment

   $ (2.3)      $ (16.9
  

 

 

   

 

 

 

Provision for Loan Losses

Provision for loan losses decreased 60% to $143.5 million for the year ended December 31, 2013 compared to 2012. The decrease in provision for loan losses was driven primarily by improving economic conditions, as evidenced by the lower levels of delinquent loans in the one- to four-family and home equity loan portfolios, home price improvement and loan portfolio run-off.

We evaluated and refined our default assumptions related to a subset of the home equity line of credit portfolio that will require borrowers to repay the loan in full at the end of the draw period, commonly referred to as “balloon loans”. These loans were approximately $235 million of the home equity line of credit portfolio at December 31, 2013. We evaluated the significant burden a balloon payment may place on a borrower with a low FICO score and high CLTV ratio, and the estimates around the time period that it might take for these borrowers’ equity positions in their collateral to appreciate in order to allow for possible refinance of the balloon loan at

 

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maturity. As a result of this evaluation of the higher risk balloon loans, we increased our default assumptions and extended the period of management’s forecasted loan losses captured within the general allowance to include the total probable loss on these loans. The overall impact of these refinements drove the substantial majority of provision for loan losses during the year ended December 31, 2013.

During the year ended December 31, 2012, provision for loan losses included approximately $50 million in charge-offs associated with newly identified bankruptcy filings with approximately 80% related to prior years. We utilize third party loan servicers to obtain bankruptcy data on our borrowers, and during the third quarter of 2012 we identified an increase in bankruptcies reported by one specific servicer. In researching this increase, we discovered that the servicer had not been reporting historical bankruptcy data on a timely basis. As a result, we implemented an enhanced procedure around all servicer reporting to corroborate bankruptcy reporting with independent third party data. Through this additional process, approximately $90 million of loans were identified in which servicers failed to report the bankruptcy filing to us, approximately 90% of which were current at the end of the third quarter of 2012. As a result, these loans were written down to the estimated current value of the underlying property less estimated selling costs, or approximately $40 million, during the third quarter of 2012. These charge-offs resulted in an increase to provision for loan losses of $50 million for the year ended December 31, 2012.

Operating Expense

The components of operating expense and the resulting variances are as follows (dollars in millions):

 

            Variance  
     Year Ended December 31,      2013 vs. 2012  
           2013                  2012            Amount     %  

Compensation and benefits

   $ 362.8       $ 352.7       $ 10.1        3

Advertising and market development

     108.4         139.5         (31.1     (22 )% 

Clearing and servicing

     124.0         128.6         (4.6     (4 )% 

FDIC insurance premiums

     103.4         117.2         (13.8     (12 )% 

Professional services

     85.2         86.3         (1.1     (1 )% 

Occupancy and equipment

     72.9         74.4         (1.5     (2 )% 

Communications

     69.1         73.1         (4.0     (6 )% 

Depreciation and amortization

     89.1         90.6         (1.5     (2 )% 

Amortization of other intangibles

     23.5         25.2         (1.7     (7 )% 

Impairment of goodwill

     142.4         —           142.4        *   

Facility restructuring and other exit activities

     28.4         7.7         20.7        269

Other operating expenses

     66.1         66.8         (0.7     (1 )% 
  

 

 

    

 

 

    

 

 

   

Total operating expense

   $ 1,275.3       $ 1,162.1       $ 113.2        10
  

 

 

    

 

 

    

 

 

   

 

* Percentage not meaningful.

Compensation and Benefits

Compensation and benefits increased 3% to $362.8 million for the year ended December 31, 2013 compared to 2012. The increase resulted primarily from increased incentive compensation when compared to 2012.

Advertising and Market Development

Advertising and market development expense decreased 22% to $108.4 million for the year ended December 31, 2013 compared to 2012. The decreases in advertising and marketing were due largely to the planned decreases in advertising expenditures as part of our expense reduction initiatives.

 

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Clearing and Servicing

Clearing and servicing decreased 4% to $124.0 million for the year ended December 31, 2013 compared to 2012. The decrease resulted primarily from lower servicing fees when compared to 2012 as the loan portfolio continues to run-off. The decrease in servicing fees was offset by increased clearing fees as a result of an improvement in DARTs, when compared to 2012.

FDIC Insurance Premiums

FDIC insurance premiums decreased 12% to $103.4 million for the year ended December 31, 2013 compared to 2012. The decrease for the year ended December 31, 2013 was primarily due to the continued improvement and quality of our balance sheet, improving capital ratios and overall risk profile when compared to 2012.

Impairment of Goodwill

Impairment of goodwill was $142.4 million for the year ended December 31, 2013. At the end of June 2013, we decided to exit the market making business, and as a result recorded $142.4 million in goodwill impairment, representing the entire carrying amount of goodwill allocated to this business. For additional information, see the Summary of Critical Accounting Policies and Estimates.

Facility Restructuring and Other Exit Activities

Facility restructuring and other exit activities was $28.4 million for the year ended December 31, 2013 compared to $7.7 million for the year ended 2012. These costs were driven primarily by severance incurred as part of our planned expense reduction initiatives, in addition to costs incurred related to our decision to exit the market making business.

Other Income (Expense)

Other income (expense) decreased 79% to $110.0 million for the year ended December 31, 2013 compared to 2012 as shown in the following table (dollars in millions):

 

           Variance  
     Year Ended December 31,     2013 vs. 2012  
         2013             2012         Amount      %  

Corporate interest income

   $ 0.1      $ 0.1      $ —           (19 )% 

Corporate interest expense

     (114.4     (179.9     65.5         (36 )% 

Losses on early extinguishment of debt:

         

Corporate debt

     —          (256.9     256.9         *   

Wholesale borrowings and other

     (0.1     (78.3     78.2         *   

Equity in income of investments and other

     4.4        1.3        3.1         239
  

 

 

   

 

 

   

 

 

    

Total other income (expense)

   $ (110.0   $ (513.7   $ 403.7         (79 )% 
  

 

 

   

 

 

   

 

 

    

 

* Percentage not meaningful.

Total other income (expense) included corporate interest expense on interest-bearing corporate debt for the years ended December 31, 2013 and 2012. Corporate interest expense decreased 36% to $114.4 million for the year ended December 31, 2013 compared to 2012 as a result of the refinance of $1.3 billion in higher coupon corporate debt during the fourth quarter of 2012. Corporate interest expense for the year ended December 31, 2013 was partially offset by a gain of $4.4 million related to an investment in a venture fund which was included in equity in income of investments and other.

 

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In addition, for the year ended December 31, 2012, $256.9 million in losses on early extinguishment of corporate debt were recorded, as a result of the early extinguishment of all the 12 1/2% Springing lien notes and 7 7/8% Notes during 2012. We also had $78.3 million in losses on early extinguishment of wholesale borrowings as a result of the early extinguishment of approximately $1.1 billion in wholesale borrowings during 2012.

Income Tax Expense (Benefit)

Income tax expense was $108.9 million for the year ended December 31, 2013 compared to a tax benefit of $(18.4) million in 2012. The effective tax rate was 55.9% for the year ended December 31, 2013 compared to (14.0)% in 2012.

With our decision to exit the market making business at the end of June 2013, we recorded a goodwill impairment charge of $142.4 million, which was non-deductible for tax purposes. In addition, the overall state apportionment increased significantly as a result of the decision to exit the market making business and we expect our taxable income to increase in future periods. We now expect to utilize net operating losses in California; therefore we recognized income tax benefit of $24.4 million during the year ended December 31, 2013, the majority of which consists of releasing valuation allowances for net operating losses, research and development credits and revaluation of other deferred tax assets relating to California. Excluding the impact of our decision to exit the market making business, our effective tax rate for the year ended December 31, 2013 would have been 39.5%, calculated in the following table (dollars in thousands):

 

     For the Year Ended December 31, 2013  
     Pre-tax Income     Tax Expense (Benefit)     Tax Rate  

Taxes and tax rate before impact of exit of market making business

   $ 337,362      $ 133,310        39.5

Impact of exit of market making business:

      

Goodwill impairment charge

     (142,423     —       

State apportionment change

     —          (24,383  
  

 

 

   

 

 

   

Income taxes and tax rate as reported

   $ 194,939      $ 108,927        55.9
  

 

 

   

 

 

   

During the first quarter of 2012, we recorded an income tax benefit of $26.3 million related to certain losses on the 2009 Debt Exchange that were previously considered non-deductible. Through additional research completed in the first quarter of 2012, we identified that a portion of those losses were incorrectly treated as non-deductible in 2009 and were deductible for tax purposes. The $26.3 million income tax benefit resulted in a corresponding increase to the net deferred tax asset.

In November 2012, California voters approved Proposition 39, which requires most multistate taxpayers to use a sales factor-only apportionment formula, combined with market–based sourcing for sales, other than sales of tangible personal property, effective for years beginning on or after January 1, 2013. As a result, the overall California apportionment for the Company’s unitary group decreased significantly and we expected this would decrease our taxable income in California in future periods. As a result, we no longer expected to utilize net operating losses in California and we recognized tax expense of $25.1 million consisting of establishing valuation allowances for California net operating losses, research and development credits and other deferred tax assets.

Valuation Allowance

The net deferred tax asset was $1,239.0 million and $1,416.2 million at December 31, 2013 and 2012, respectively. We are required to establish a valuation allowance for deferred tax assets and record a corresponding charge to income tax expense if it is determined, based on evaluation of available evidence at the time the determination is made, that it is more likely than not that some or all of the deferred tax assets will not

 

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be realized. If we were to conclude that a valuation allowance was required, the resulting loss could have a material adverse effect on our financial condition and results of operations. For the three-year period ended December 31, 2012, we were no longer in a cumulative book loss position and continued to generate income for the year ended December 31, 2013. As of December 31, 2013, we did not establish a valuation allowance against our federal deferred tax assets as we believe that it is more likely than not that all of these assets will be realized. More than half of our existing federal deferred tax assets are not related to net operating losses and therefore, have no expiration date. We expect to utilize the majority of our existing federal deferred tax assets within the next five years.

Our evaluation of the need for a valuation allowance focused on identifying significant, objective evidence that we will be able to realize the deferred tax assets in the future. We determined that our expectations regarding future earnings are objectively verifiable due to various factors. One factor is the consistent profitability of the core business, the trading and investing segment, which has generated substantial income for each of the last ten years, including through uncertain economic and regulatory environments. The core business is driven by brokerage customer activity and includes trading, brokerage related cash, margin lending, retirement and investing, and other brokerage related activities. These activities drive variable expenses that correlate to the volume of customer activity, which has resulted in stable, ongoing profitability.

Another factor is the mitigation of losses in the balance sheet management segment, which generated a large net operating loss in 2007 caused by the crisis in the residential real estate and credit markets. Much of this loss came from the sale of the asset-backed securities portfolio and credit losses from the mortgage loan portfolio. We no longer hold any of those asset-backed securities and shut down mortgage loan acquisition activities in 2007. In effect, the key business activities that led to the generation of the deferred tax assets were shut down over six years ago. In addition, we have realized the benefits of various credit loss mitigation activities and improving economic conditions, including home price improvement related to our loan portfolio. As a result, the losses have continued to decline significantly and the balance sheet management segment was profitable in 2012 and 2013.

We maintain a valuation allowance for certain of our state deferred tax assets as we have concluded that it is more likely than not that they will not be realized. At December 31, 2013, we had state deferred tax assets of approximately $38.2 million that related to our state net operating loss carry forwards and temporary differences with a valuation allowance of $36.1 million against such deferred tax assets.

Tax Ownership Change

During the third quarter of 2009, we exchanged $1.7 billion principal amount of interest-bearing debt for an equal principal amount of non-interest-bearing convertible debentures. Subsequent to the 2009 Debt Exchange, $592.3 million and $128.7 million debentures were converted into 57.2 million and 12.5 million shares of common stock during the third and fourth quarters of 2009, respectively. As a result of these conversions, we believe we experienced a tax ownership change during the third quarter of 2009.

As of the date of the ownership change, we had federal NOLs available to carry forward of approximately $1,886.3 million. This amount includes $479.7 million in federal NOLs that were recorded in the third quarter of 2012 due to amended tax returns we filed that related primarily to additional tax deductions on the 2009 Debt Exchange and additional tax losses on bad debts. Section 382 imposes an annual limitation on the use of a corporation’s NOLs, certain recognized built-in losses and other carryovers after an “ownership change” occurs. Section 382 rules governing when a change in ownership occurs are complex and subject to interpretation; however, an ownership change generally occurs when there has been a cumulative change in the stock ownership of a corporation by certain “5% shareholders” of more than 50 percentage points over a rolling three-year period.

Section 382 imposes an annual limitation on the amount of post-ownership change taxable income a corporation may offset with pre-ownership change NOLs. In general, the annual limitation is determined by multiplying the value of the corporation’s stock immediately before the ownership change (subject to certain

 

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adjustments) by the applicable long-term tax-exempt rate. Any unused portion of the annual limitation is available for use in future years until such NOLs are scheduled to expire (in general, NOLs may be carried forward 20 years). In addition, the limitation may, under certain circumstances, be increased or decreased by built-in gains or losses, respectively, which may be present with respect to assets held at the time of the ownership change that are recognized in the five-year period (one-year for loans) after the ownership change. The use of NOLs arising after the date of an ownership change would not be affected unless a corporation experienced an additional ownership change in a future period.

We believe the tax ownership change will extend the period of time it will take to fully utilize our pre-ownership change NOLs, but will not limit the total amount of pre-ownership change federal NOLs we can utilize. Our updated estimate is that we will be subject to an overall annual limitation on the use of our pre-ownership change NOLs of approximately $194 million. The overall pre-ownership change federal NOLs, which were approximately $1,886.3 million, have a statutory carry forward period of 20 years (the majority of which expire in 14 years). As a result, we believe we will be able to fully utilize these NOLs in future periods.

Our ability to utilize the pre-ownership change NOLs is dependent on our ability to generate sufficient taxable income over the duration of the carry forward periods and will not be impacted by our ability or inability to generate taxable income in an individual year.

2012 Compared to 2011

We incurred a net loss of $112.6 million, or $(0.39) per diluted share, on total revenue of $1.9 billion for the year ended December 31, 2012. The net loss for the year ended December 31, 2012 was primarily the result of losses of $256.9 million from the early extinguishment of all the 12 1/2% Springing lien notes and 7 7/8% Notes during 2012.

Net operating interest income decreased 11% to $1.1 billion for the year ended December 31, 2012 compared to 2011, which was driven primarily by a decrease in enterprise net interest spread during 2012. Commissions, fees and service charges, principal transactions and other revenue decreased 11% to $630.9 million for the year ended December 31, 2012, compared to 2011, which was driven primarily by a decrease in trading activity during 2012. In addition, gains on loans and securities, net increased 67% to $200.4 million for the year ended December 31, 2012 compared to 2011. We recognized additional gains from securities sold as a result of our continued deleveraging efforts, primarily related to a reduction in wholesale funding obligations, which resulted in losses on early extinguishment of debt of $78.3 million during the year ended December 31, 2012.

Provision for loan losses declined 20% to $354.6 million for the year ended December 31, 2012 compared to 2011. The decline was driven primarily by improving credit trends and loan portfolio run-off, offset by an increase of $50 million related to charge-offs associated with newly identified bankruptcy filings during the third quarter of 2012. Total operating expenses decreased 6% to $1.2 billion for the year ended December 31, 2012 compared to 2011. This decrease was driven primarily by decreases in clearing and servicing and other operating expenses, partially offset by an increase in compensation and benefits expense for the year ended December 31, 2012.

The following sections describe in detail the changes in key operating factors and other changes and events that affected net revenue, provision for loan losses, operating expense, other income (expense) and income tax expense (benefit).

 

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Revenue

The components of revenue and the resulting variances are as follows (dollars in millions):

 

                 Variance  
     Year Ended December 31,     2012 vs. 2011  
             2012                     2011             Amount     %  

Net operating interest income

   $ 1,085.1      $ 1,220.0      $ (134.9     (11 )% 

Commissions

     377.8        436.2        (58.4     (13 )% 

Fees and service charges

     122.2        130.4        (8.2     (6 )% 

Principal transactions

     93.1        105.4        (12.3     (12 )% 

Gains on loans and securities, net

     200.4        120.2        80.2        67

Net impairment

     (16.9     (14.9     (2.0     13

Other revenues

     37.8        39.3        (1.5     (4 )% 
        

Total non-interest income

     814.4        816.6        (2.2     0
  

 

 

   

 

 

   

 

 

   

Total net revenue

   $ 1,899.5      $ 2,036.6      $ (137.1     (7 )% 
  

 

 

   

 

 

   

 

 

   

Net Operating Interest Income

Net operating interest income decreased 11% to $1.1 billion for the year ended December 31, 2012 compared to 2011. Average enterprise interest-earning assets increased 4% to $44.3 billion for the year ended December 31, 2012 compared to 2011. This was primarily a result of the increases in average held-to-maturity securities, offset by a decrease in average loans.

Average enterprise interest-bearing liabilities increased 4% to $41.8 billion for the year ended December 31, 2012 compared to 2011. The increase in average enterprise interest-bearing liabilities was due primarily to an increase in average deposits offset by a decrease in average securities sold under agreements to repurchase.

Enterprise net interest spread decreased by 40 basis points to 2.39% for the year ended December 31, 2012 compared to 2011, due primarily to lower yields on loans and the impact of the interest rate environment.

Commissions

Commissions revenue decreased 13% to $377.8 million for the year ended December 31, 2012 compared to 2011. DART volume decreased 12% to 138,112 for the year ended December 31, 2012 compared to 2011. Option-related DARTs as a percentage of total DARTs represented 24% of trading volume for the year ended December 31, 2012 compared to 20% in 2011. Exchange-traded funds-related DARTs as a percentage of total DARTs represented 8% of trading volume for the year ended December 31, 2012 compared to 11% in 2011. Average commission per trade was $11.01 for both years ended December 31, 2012 and 2011.

 

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Fees and Service Charges

Fees and service charges decreased 6% to $122.2 million for the year ended December 31, 2012 compared to 2011. The table below shows the components of fees and service charges and the resulting variances (dollars in millions):

 

                   Variance  
     Year Ended December 31,      2012 vs. 2011  
             2012                      2011              Amount     %  

Order flow revenue

   $ 58.4       $ 59.1       $ (0.7     (1 )% 

Mutual fund service fees

     16.4         15.7         0.7        4

Foreign exchange revenue

     10.3         11.0         (0.7     (6 )% 

Advisor management fees

     6.4         4.4         2.0        45

Reorganization fees

     7.7         13.4         (5.7     (43 )% 

Other fees and service charges

     23.0         26.8         (3.8     (14 )% 
  

 

 

    

 

 

    

 

 

   

Total fees and service charges

   $ 122.2       $ 130.4       $ (8.2     (6 )% 
  

 

 

    

 

 

    

 

 

   

The decrease in fees and services charges for the year ended December 31, 2012 was driven primarily by lower reorganization fee revenue in 2012 related to a large public company reorganization in the second quarter of 2011, and by a decline in other fees and service charges due to decreased customer activity.

Principal Transactions

Principal transactions decreased 12% to $93.1 million for the year ended December 31, 2012 compared to 2011. The decrease in principal transactions revenue was driven primarily by a decrease in trading volume, partially offset by an increase in average revenue per share earned.

Gains on Loans and Securities, Net

Gains on loans and securities, net increased 67% to $200.4 million for the year ended December 31, 2012 compared to 2011. We recognized additional gains from securities sold as a result of our continued deleveraging efforts, primarily related to a reduction in wholesale funding obligations, which resulted in losses on early extinguishment of debt of $78.3 million during the year ended December 31, 2012. The table below shows the activity and resulting variances (dollars in millions):

 

                 Variance  
     Year Ended December 31,     2012 vs. 2011  
             2012                     2011             Amount     %  

Gains on loans, net

   $ 0.6      $ 0.1      $ 0.5        *   
  

 

 

   

 

 

   

 

 

   

Gains on available-for-sale securities, net

     207.3        124.4        82.9        67

Losses on trading securities, net

     (0.3     (1.9     1.6        *   

Hedge ineffectiveness

     (7.2     (2.4     (4.8     *   
  

 

 

   

 

 

   

 

 

   

Gains on securities, net

     199.8        120.1        79.7        66
  

 

 

   

 

 

   

 

 

   

Gains on loans and securities, net

   $ 200.4      $ 120.2      $ 80.2        67
  

 

 

   

 

 

   

 

 

   

 

* Percentage not meaningful.

Net Impairment

We recognized $16.9 million and $14.9 million of net impairment during the years ended December 31, 2012 and 2011, respectively, on certain securities in our non-agency CMO portfolio due to continued

 

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deterioration in the expected credit performance of the underlying loans in those specific securities. The gross OTTI and the noncredit portion of OTTI, which was or had been previously recorded through other comprehensive income (loss), are shown in the table below (dollars in millions):

 

     Year Ended December, 31,  
         2012             2011      

Other-than-temporary impairment (“OTTI”)

   $ (19.8   $ (9.2

Less: noncredit portion of OTTI recognized into (out of) other comprehensive income (loss) (before tax)

     2.9        (5.7
  

 

 

   

 

 

 

Net impairment

   $ (16.9   $ (14.9
  

 

 

   

 

 

 

Provision for Loan Losses

Provision for loan losses decreased 20% to $354.6 million for the year ended December 31, 2012 compared to 2011. The decrease in provision for loan losses was driven primarily by improving credit trends, as evidenced by the lower levels of delinquent loans in the one- to four-family and home equity loan portfolios, and loan portfolio run-off. The decrease was partially offset by $50 million in charge-offs associated with newly identified bankruptcy filings during the third quarter of 2012, with approximately 80% related to prior years. We utilize third party loan servicers to obtain bankruptcy data on our borrowers, and during the third quarter of 2012 we identified an increase in bankruptcies reported by one specific servicer. In researching this increase, we discovered that the servicer had not been reporting historical bankruptcy data on a timely basis. As a result, we implemented an enhanced procedure around all servicer reporting to corroborate bankruptcy reporting with independent third party data. Through this additional process, approximately $90 million of loans were identified in which servicers failed to report the bankruptcy filing to us, approximately 90% of which were current at the end of the third quarter of 2012. As a result, these loans were written down to the estimated current value of the underlying property less estimated selling costs, or approximately $40 million, during the third quarter of 2012. These charge-offs resulted in an increase to provision for loan losses of $50 million for the year ended December 31, 2012.

Operating Expense

The components of operating expense and the resulting variances are as follows (dollars in millions):

 

                   Variance  
     Year Ended December 31,      2012 vs. 2011  
             2012                      2011              Amount     %  

Compensation and benefits

   $ 352.7       $ 333.6       $ 19.1        6

Advertising and market development

     139.5         145.2         (5.7     (4 )% 

Clearing and servicing

     128.6         147.1         (18.5     (13 )% 

FDIC insurance premiums

     117.2         105.4         11.8        11

Professional services

     86.3         89.7         (3.4     (4 )% 

Occupancy and equipment

     74.4         68.8         5.6        8

Communications

     73.1         67.3         5.8        8

Depreciation and amortization

     90.6         89.6         1.0        1

Amortization of other intangibles

     25.2         26.2         (1.0     (4 )% 

Facility restructuring and other exit activities

     7.7         7.7         —          0

Other operating expenses

     66.8         154.3         (87.5     (57 )% 
  

 

 

    

 

 

    

 

 

   

Total operating expense

   $ 1,162.1       $ 1,234.9       $ (72.8     (6 )% 
  

 

 

    

 

 

    

 

 

   

 

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Compensation and Benefits

Compensation and benefits increased 6% to $352.7 million for the year ended December 31, 2012 compared to 2011. The increase resulted primarily from $13 million in severance associated with the departure of our former Chief Executive Officer that was recorded during the year ended December 31, 2012.

Clearing and Servicing

Clearing and servicing decreased 13% to $128.6 million for the year ended December 31, 2012 compared to 2011. These decreases resulted primarily from lower trading volumes and lower loan balances compared to 2011.

FDIC Insurance Premiums

FDIC insurance premiums increased 11% to $117.2 million for the year ended December 31, 2012 compared to 2011. The increase for the year ended December 31, 2012 was due primarily to the new FDIC insurance premium assessment calculation, effective in the second quarter of 2011.

Other Operating Expenses

Other operating expenses decreased 57% to $66.8 million for the year ended December 31, 2012 compared to 2011. The decrease was driven primarily by an estimated liability of $48 million related to an offer to purchase auction rate securities from eligible holders recorded in 2011. The costs of this program, which expired on May 15, 2012, were approximately $10.2 million less than our previous estimate and a $10.2 million benefit was recorded during the year ended December 31, 2012. In addition, there was a decrease in expenses related to real estate owned (“REO”) and repossessed assets for the year ended December 31, 2012 compared to 2011.

Other Income (Expense)

Other income (expense) increased 192% to $513.7 million for the year ended December 31, 2012 compared to 2011 as shown in the following table (dollars in millions):

 

                 Variance  
     Year Ended December 31,     2012 vs. 2011  
             2012                     2011             Amount     %  

Corporate interest income

   $       0.1      $ 0.7      $ (0.6     *   

Corporate interest expense

     (179.9     (177.8     (2.1     1

Gains (losses) on early extinguishment of debt:

        

Corporate debt

     (256.9     3.1        (260.0     *   

Wholesale borrowings and other

     (78.3     —          (78.3     *   

Equity in income (loss) of investments and other

     1.3        (1.8     3.1        *   
  

 

 

   

 

 

   

 

 

   

Total other income (expense)

   $ (513.7   $ (175.8   $ (337.9     192
  

 

 

   

 

 

   

 

 

   

 

* Percentage not meaningful.

Total other income (expense) included corporate interest expense on interest-bearing corporate debt for the years ended December 31, 2012 and 2011. Corporate interest expense increased 1% to $179.9 million for the year ended December 31, 2012 compared to 2011.

In addition, for the year ended December 31, 2012, $256.9 million in losses on early extinguishment of corporate debt were recorded, as a result of the early extinguishment of all of the 12 1/2% Springing lien notes and 7 7/8% Notes during 2012. We also had $78.3 million in losses on early extinguishment of wholesale borrowings as a result of the early extinguishment of approximately $1.1 billion in wholesale borrowings during 2012. During the year ended December 31, 2011, we had $3.1 million in gains on early extinguishment of debt related to the call of the 7 3/8% Notes in the second quarter of 2011.

 

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Income Tax Expense (Benefit)

Income tax benefit was $(18.4) million for the year ended December 31, 2012 compared to tax expense of $28.6 million in 2011. The effective tax rate was (14.0)% for the year ended December 31, 2012 compared to 15.4% in 2011.

During the first quarter of 2012, we recorded an income tax benefit of $26.3 million related to certain losses on the 2009 Debt Exchange that were previously considered non-deductible. Through additional research completed in the first quarter of 2012, we identified that a portion of those losses were incorrectly treated as non-deductible in 2009 and were deductible for tax purposes. The $26.3 million income tax benefit resulted in a corresponding increase to the net deferred tax asset.

In November 2012, California voters approved Proposition 39, which requires most multi-state taxpayers to use a sales factor-only apportionment formula, combined with market–based sourcing for sales, other than sales of tangible personal property, effective for years beginning on or after January 1, 2013. As a result, the overall California apportionment for the company’s unitary group decreased significantly and we expected this would decrease our taxable income in California in future periods. As a result, we no longer expected to utilize net operating losses in California and we recognized income tax expense of $25.1 million consisting of establishing valuation allowances for California net operating losses, research and development credits and other deferred tax assets.

During the third quarter of 2011, we recorded an income tax benefit of $61.7 million related to the taxable liquidation of a European subsidiary. The subsidiary was liquidated for U.S. tax purposes in connection with our international restructuring activities. This liquidation resulted in the taxable recognition of certain losses, including historical acquisition premiums that we incurred internationally. This income tax benefit resulted in a corresponding increase to the net deferred tax asset.

Valuation Allowance

The net deferred tax asset was $1,416.2 million and $1,578.7 million at December 31, 2012 and 2011, respectively. We are required to establish a valuation allowance for deferred tax assets and record a corresponding charge to income tax expense it is determined, based on evaluation of available evidence at the time the determination is made, that it is more likely than not that some or all of the deferred tax assets will not be realized. If we were to conclude that a valuation allowance was required, the resulting loss could have a material adverse effect on our financial condition and results of operations. For the three-year period ended December 31, 2012, we were no longer in a cumulative book loss position. As of December 31, 2012, we did not establish a valuation allowance against our federal deferred tax assets as we believe that it is more likely than not that all of these assets will be realized.

SEGMENT RESULTS REVIEW

We report operating results in two segments: 1) trading and investing; and 2) balance sheet management. Trading and investing includes retail brokerage products and services; investor-focused banking products; market making; and corporate services. Balance sheet management includes the management of asset allocation; loans previously originated by the Company or purchased from third parties; customer payables and deposits; and credit, liquidity and interest rate risk for the Company as described in the Risk Management section. Costs associated with certain functions that are centrally-managed are separately reported in a corporate/other category. For more information on our segments, see Note 21—Segment Information in Item 8. Financial Statements and Supplementary Data.

 

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Trading and Investing

The following table summarizes trading and investing financial information and key metrics as of and for the years ended December 31, 2013, 2012 and 2011 (dollars in millions, except for key metrics):

 

     Year Ended December 31,     Variance  
     2013 vs. 2012  
     2013     2012     2011     Amount     %  

Net operating interest income

   $ 539.6      $ 640.5      $ 746.1      $ (100.9     (16 )% 

Commissions

     420.1        377.8        436.2        42.3        11

Fees and service charges

     153.3        119.4        128.0        33.9        28

Principal transactions

     72.7        93.2        105.4        (20.5     (22 )% 

Other revenues

     31.4        32.0        31.2        (0.6     (2 )% 
  

 

 

   

 

 

   

 

 

   

 

 

   

Total net revenue

     1,217.1        1,262.9        1,446.9        (45.8     (4 )% 

Total operating expense

     883.5        769.2        825.9        114.3        15
  

 

 

   

 

 

   

 

 

   

 

 

   

Trading and investing income

   $ 333.6      $ 493.7      $ 621.0      $ (160.1     (32 )% 
  

 

 

   

 

 

   

 

 

   

 

 

   

Key Metrics:

          

DARTs

     150,743        138,112        157,475        12,631        9

Average commission per trade

   $ 11.13      $ 11.01      $ 11.01      $ 0.12        1

Margin receivables (dollars in billions)

   $ 6.4      $ 5.8      $ 4.8      $ 0.6        10

End of period brokerage accounts

     2,998,059        2,903,191        2,783,012        94,868        3

Net new brokerage accounts

     94,868        120,179        98,701        (25,311     (21 )% 

Brokerage account attrition rate

     8.8     9.0     10.3     (0.2 )%      *   

Customer assets (dollars in billions)

   $ 260.8      $ 201.2      $ 172.4      $ 59.6        30

Net new brokerage assets (dollars in billions)

   $ 10.4      $ 10.4      $ 9.7      $ 0.0        0

Brokerage related cash (dollars in billions)

   $ 39.7      $ 33.9      $ 27.7      $ 5.8        17

 

* Percentage not meaningful.

The trading and investing segment offers products and services to individual retail investors, generating revenue from these brokerage and banking relationships and from market making and corporate services activities. This segment generates five main sources of revenue: net operating interest income; commissions; fees and service charges; principal transactions; and other revenues. Net operating interest income is generated primarily from margin receivables and from a deposit transfer pricing arrangement with the balance sheet management segment. The balance sheet management segment utilizes customer payables and deposits and compensates the trading and investing segment via a market-based transfer pricing arrangement. This compensation is reflected in segment results as operating interest income for the trading and investing segment and operating interest expense for the balance sheet management segment and is eliminated in consolidation. Other revenues include results from providing software and services for managing equity compensation plans from corporate customers, as we ultimately service retail investors through these corporate relationships.

2013 Compared to 2012

Trading and investing income decreased 32% to $333.6 million for the year ended December 31, 2013 compared to 2012. The decrease for the year ended December 31, 2013 was driven primarily by $142.4 million of goodwill impairment recorded in the second quarter of 2013 related to the decision to exit market making business. We continued to generate net new brokerage accounts, ending the year with 3.0 million accounts. Brokerage related cash, which is one of our most profitable sources of funding, increased by $5.8 billion to $39.7 billion when compared to 2012.

Trading and investing net operating interest income decreased 16% to $539.6 million for the year ended December 31, 2013, compared to 2012. The decrease was driven by lower interest income from the balance sheet management segment as a result of deleveraging initiatives, in particular as it relates to moving sweep deposits off-balance sheet.

 

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Trading and investing commissions increased 11% to $420.1 million for the year ended December 31, 2013 compared to 2012. This increase in commissions was primarily the result of an increase in DARTs of 9% to 150,743 for the year ended December 31, 2013 compared to 2012.

Trading and investing fees and service charges increased 28% to $153.3 million for the year ended December 31, 2013 compared to 2012. This increase was driven primarily by increases in order flow revenue due to increased trading activity, as well as increases in advisor management fees driven from the managed accounts within our retirement, investing and savings products, which were $2.4 billion at December 31, 2013, compared to $1.3 billion at December 31, 2012. The market making business, G1 Execution Services, LLC, had a formal intercompany agreement with E*TRADE Securities LLC, both wholly owned subsidiaries of the Company at December 31, 2013. As part of the intercompany agreement, E*TRADE Securities LLC routed a portion of its order flow to G1 Execution Services, LLC, and received an order flow rebate which was eliminated in consolidation. As the sale of the market making business closed on February 10, 2014, we expect to see an increase in order flow revenue as E*TRADE Securities will be routing all of its order flow to third parties.

Trading and investing principal transactions decreased 22% to $72.7 million for the year ended December 31, 2013 compared to 2012. The decrease in principal transactions revenue was driven primarily by a decrease in market making trading volume along with a decrease in average revenue per share earned. The market making business generates all of our principal transactions revenue. On October 23, 2013, we entered into a definitive agreement to sell the market making business to an affiliate of Susquehanna. The sale closed on February 10, 2014 and we will no longer have principal transactions revenue after that date.

Trading and investing operating expense increased 15% to $883.5 million for the year ended December 31, 2013 compared to 2012. The increase for the year ended December 31, 2013 was driven primarily by impairment of goodwill of $142.4 million in the second quarter of 2013 related to the decision to exit the market making business.

As of December 31, 2013, we had approximately 3.0 million brokerage accounts, 1.2 million stock plan accounts and 0.4 million banking accounts. For the years ended December 31, 2013 and 2012, our brokerage products contributed 78% and 71%, respectively, and our banking products contributed 22% and 29%, respectively, of total trading and investing net revenue.

2012 Compared to 2011

Trading and investing income decreased 20% to $493.7 million for the year ended December 31, 2012 compared to 2011. We continued to generate net new brokerage accounts, ending the year with 2.9 million accounts. Brokerage related cash, which is one of our most profitable sources of funding, increased by $6.2 billion when compared to 2011.

Trading and investing commissions decreased 13% to $377.8 million for the year ended December 31, 2012 compared to 2011. This decrease in commissions was primarily the result of a decrease in DARTs of 12% to 138,112 for the year ended December 31, 2012 compared to 2011.

Trading and investing fees and service charges decreased 7% to $119.4 million for the year ended December 31, 2012 compared to 2011. This decrease for the year ended December 31, 2012 was driven by lower reorganization fee revenue in 2012 related to a large public company reorganization in the second quarter of 2011.

Trading and investing principal transactions decreased 12% to $93.2 million for the year ended December 31, 2012 compared to 2011. The decrease in principal transactions revenue was driven primarily by a decrease in trading volume, partially offset by an increase in average revenue per share earned, when compared to 2011.

 

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Trading and investing operating expense decreased 7% to $769.2 million for the year ended December 31, 2012 compared to 2011. The decrease for the year ended December 31, 2012 was driven primarily by an estimated liability of $48 million that was recorded in 2011 related to an offer to purchase auction rate securities from eligible holders. The costs of this program, which expired on May 15, 2012, were approximately $10.2 million less than our previous estimate and a $10.2 million benefit was recorded during the year ended December 31, 2012.

As of December 31, 2012, we had approximately 2.9 million brokerage accounts, 1.1 million stock plan accounts and 0.4 million banking accounts. For the years ended December 31, 2012 and 2011, our brokerage products contributed 71% and 69%, respectively, and our banking products contributed 29% and 31%, respectively, of total trading and investing net revenue.

Balance Sheet Management

The following table summarizes balance sheet management financial information and key metrics as of and for the years ended December 31, 2013, 2012 and 2011 (dollars in millions):

 

                       Variance  
     Year Ended December 31,     2013 vs. 2012  
     2013     2012     2011     Amount     %  

Net operating interest income

   $ 442.2      $ 444.6      $ 473.9      $ (2.4     (1 )% 

Fees and service charges

     1.7        2.8        2.4        (1.1     (38 )% 

Gains on loans and securities, net

     60.6        200.8        121.2        (140.2     (70 )% 

Net impairment

     (2.3     (16.9     (14.9     14.6        (86 )% 

Other revenues

     4.4        5.5        7.2        (1.1     (21 )% 
  

 

 

   

 

 

   

 

 

   

 

 

   

Total net revenue

     506.6        636.8        589.8        (130.2     (20 )% 

Provision for loan losses

     143.5        354.6        440.6        (211.1     (60 )% 

Total operating expense

     178.7        220.6        238.4        (41.9     (19 )% 
  

 

 

   

 

 

   

 

 

   

 

 

   

Balance sheet management income (loss)

   $ 184.4      $ 61.6      $ (89.2   $ 122.8        200
  

 

 

   

 

 

   

 

 

   

 

 

   

Key Metrics:

          

Special mention loan delinquencies

   $ 271.6      $ 342.2      $ 467.1      $ (70.6     (21 )% 

Allowance for loan losses

   $ 453.0      $ 480.7      $ 822.8      $ (27.7     (6 )% 

The balance sheet management segment generates revenue from managing loans previously originated by the Company or purchased from third parties, as well as utilizing customer payables and deposits to generate additional net operating interest income. The balance sheet management segment utilizes customer payables and deposits from the trading and investing segment, wholesale borrowings and proceeds from loan pay-downs to invest in available-for-sale and held-to-maturity securities. Net operating interest income is generated from interest earned on available-for-sale and held-to-maturity securities and loans receivable, net of interest paid on wholesale borrowings and on a deposit transfer pricing arrangement with the trading and investing segment. The balance sheet management segment utilizes customer payables and deposits and compensates the trading and investing segment via a market-based transfer pricing arrangement. This compensation is reflected in segment results as operating interest income for the trading and investing segment and operating interest expense for the balance sheet management segment and is eliminated in consolidation.

2013 Compared to 2012

The balance sheet management segment income increased 200% to $184.4 million for the year ended December 31, 2013 compared to 2012. The increase in balance sheet management income was due primarily to a decrease in provision for loan losses of 60% to $143.5 million, partially offset by lower gains on loans and securities, net for the year ended December 31, 2013.

 

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Gains on loans and securities, net decreased 70% to $60.6 million for the year ended December 31, 2013 compared to 2012. The decreases in gains on loans and securities net for the year ended December 31, 2013, were driven by additional gains recognized in the year ended December 31, 2012 from the sale of available-for-sale securities as a result of our deleveraging initiatives, primarily related to a reduction in wholesale funding obligations.

We recognized $2.3 million and $16.9 million of net impairment during the year ended December 31, 2013 and 2012, respectively, on certain securities in the non-agency CMO portfolio due to continued deterioration in the expected credit performance of the underlying loans in those specific securities.

Provision for loan losses decreased 60% to $143.5 million for the year ended December 31, 2013 compared to 2012. The decrease in provision for loan losses was driven primarily by improving economic conditions, as evidenced by the lower levels of delinquent loans in the one- to four-family and home equity loan portfolios, home price improvement and loan portfolio run-off.

We evaluated and refined our default assumptions related to a subset of the home equity line of credit portfolio that will require borrowers to repay the loan in full at the end of the draw period, commonly referred to as “balloon loans”. These loans were approximately $235 million of the home equity line of credit portfolio at the year ended December 31, 2013. We evaluated the significant burden a balloon payment may place on a borrower with a low FICO score and high CLTV ratio, and the estimates around the time period that it might take for these borrowers’ equity positions in their collateral to appreciate in order to allow for possible refinance of the balloon loan at maturity. As a result of this evaluation of the higher risk balloon loans, we increased our default assumptions and extended the period of management’s forecasted loan losses captured within the general allowance to include the total probable loss on these loans. The overall impact of these refinements drove the substantial majority of provision for loan losses during the year ended December 31, 2013.

Total balance sheet management operating expense decreased 19% to $178.7 million for the year ended December 31, 2013 compared to 2012. The decrease in operating expense for the year ended December 31, 2013 resulted primarily from lower FDIC insurance premiums, reduced servicing expenses due to lower loan balances and reduced expenses related to REO when compared the 2012.

2012 Compared to 2011

The balance sheet management segment reported income of $61.6 million and a loss of $89.2 million for the years ended December 31, 2012 and 2011, respectively. Balance sheet management income was due primarily to a decrease in provision for loan losses of 20% to $354.6 million for the year ended December 31, 2012.

Gains on loans and securities, net increased 66% to $200.8 million for the year ended December 31, 2012 compared to 2011. We recognized additional gains from securities sold as a result of our continued deleveraging efforts, primarily related to a reduction in wholesale funding obligations, which resulted in losses on early extinguishment of debt of $78.3 million during the year ended December 31, 2012.

We recognized $16.9 million and $14.9 million of net impairment during the year ended December 31, 2012 and 2011, respectively, on certain securities in the non-agency CMO portfolio due to continued deterioration in the expected credit performance of the underlying loans in those specific securities.

Provision for loan losses decreased 20% to $354.6 million for the year ended December 31, 2012 compared to 2011. The decrease in provision for loan losses was driven primarily by improving credit trends, as evidenced by the lower levels of delinquent loans in the one- to four-family and home equity loan portfolios, and loan portfolio run-off. The decrease was partially offset by $50 million in charge-offs associated with newly identified bankruptcy filings during the third quarter of 2012, with approximately 80% related to prior years. We utilize third party loan servicers to obtain bankruptcy data on our borrowers and during the third quarter of 2012, we

 

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identified an increase in bankruptcies reported by one specific servicer. In researching this increase, we discovered that the servicer had not been reporting historical bankruptcy data on a timely basis. As a result, we implemented an enhanced procedure around all servicer reporting to corroborate bankruptcy reporting with independent third party data. Through this additional process, approximately $90 million of loans were identified in which servicers failed to report the bankruptcy filing to us, approximately 90% of which were current at the end of the third quarter of 2012. As a result, these loans were written down to the estimated current value of the underlying property less estimated selling costs, or approximately $40 million, during the third quarter of 2012. These charge-offs resulted in an increase to provision for loan losses of $50 million for the year ended December 31, 2012.

Total balance sheet management operating expense decreased 7% to $220.6 million for the year ended December 31, 2012 compared to 2011. The decrease in operating expense for the year ended December 31, 2012 resulted primarily from lower clearing and service expense due to lower loan balances compared to 2011, and a decrease in expenses related to REO and repossessed assets. These decreases were offset by an increase in FDIC insurance premium expense as a result of an industry wide change in the FDIC insurance premium assessment calculation, effective in the second quarter of 2011.

Corporate/Other

The following table summarizes corporate/other financial information for the years ended December 31, 2013, 2012 and 2011 (dollars in millions):

 

           Variance  
     Year Ended December 31,     2013 vs. 2012  
     2013     2012     2011     Amount     %  

Total net revenue

   $ —        $ (0.2   $ (0.1   $ 0.2        *   
  

 

 

   

 

 

   

 

 

   

 

 

   

Compensation and benefits

     92.9        81.0        70.3        11.9        15

Professional services

     43.5        37.5        35.4        6.0        16

Occupancy and equipment

     7.1        5.5        2.7        1.6        29

Communications

     1.6        1.7        1.5        (0.1     (7 )% 

Depreciation and amortization

     16.8        16.3        18.4        0.5        3

Facility restructuring and other exit activities

     28.4        7.7        7.7        20.7        269

Other operating expenses

     22.7        22.6        34.5        0.1        1
  

 

 

   

 

 

   

 

 

   

 

 

   

Total operating expense

     213.0        172.3        170.5        40.7        24
  

 

 

   

 

 

   

 

 

   

 

 

   

Operating loss

     (213.0     (172.5     (170.6     (40.5     23

Total other income (expense)

     (110.0     (513.7     (175.8     403.7        (79 )% 
  

 

 

   

 

 

   

 

 

   

 

 

   

Corporate/other loss

   $ (323.0   $ (686.2   $ (346.4   $ 363.2        (53 )% 
  

 

 

   

 

 

   

 

 

   

 

 

   

The corporate/other category includes costs that are centrally-managed, technology related costs incurred to support centrally-managed functions, restructuring and other exit activities, corporate debt and corporate investments.

2013 Compared to 2012

The corporate/other loss before income taxes was $323.0 million for the year ended December 31, 2013, compared to $686.2 million in 2012.

The operating loss increased 23% to $213.0 million for the year ended December 31, 2013 compared to 2012 due primarily to increased facility restructuring and other exit activities expense as a result of costs incurred as part of our expense reduction initiatives, in addition to costs incurred related to our decision to exit the market making business and increased incentive compensation.

 

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Total other income (expense) included corporate interest expense on interest-bearing corporate debt for the years ended December 31, 2013 and 2012. Corporate interest expense decreased 36% to $114.4 million for the year ended December 31, 2013 compared to 2012 as a result of the refinance of $1.3 billion in higher coupon corporate debt during the fourth quarter of 2012. Corporate interest expense for the year ended December 31, 2013 was partially offset by a gain of $4.4 million related to an investment in a venture fund which was included in equity in income of investments and other.

In addition, for the year ended December 31, 2012, $256.9 million in losses on early extinguishment of corporate debt were recorded, as a result of the early extinguishment of all the 12 1/2% Springing lien notes and 7 7/8% Notes during 2012. We also had $78.3 million in losses on early extinguishment of wholesale borrowings as a result of the early extinguishment of approximately $1.1 billion in wholesale borrowings during 2012. During the year ended December 31, 2011, we had $3.1 million in gains on early extinguishment of debt related to the call of the 7 3/8% Notes in the second quarter of 2011.

2012 Compared to 2011

The corporate/other loss before income taxes was $686.2 million for the year ended December 31, 2012, compared to $346.4 million in 2011.

The operating loss increased 1% to $172.5 million for the year ended December 31, 2012 compared to 2011 due primarily to an increase in compensation and benefits as a result of $13 million in severance associated with the departure of our former Chief Executive Officer that was recorded during the year ended December 31, 2012. This increase was partially offset by a decrease in other operating expense primarily due to the recording of a net estimated liability of $10.8 million related to a memorandum of understanding that we entered into to settle the Freudenberg Action during the year ended December 31, 2011, for which there was no similar expense in 2012.

Total other income (expense) included corporate interest expense on interest-bearing corporate debt for the years ended December 31, 2012 and 2011. Corporate interest expense increased 1% to $179.9 million year ended December 31, 2012 compared to 2011. In addition, for the year ended December 31, 2012, $256.9 million in losses on early extinguishment of debt were recorded, driven by the early extinguishment of all of the outstanding 12 1/2% Springing lien notes and 7 7/8% Notes during 2012. Offsetting corporate interest expense for the year ended December 31, 2011 as a $3.1 million gain on early extinguishment of debt related to the call of the 7 3/8% Notes in the second quarter of 2011.

 

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BALANCE SHEET OVERVIEW

The following table sets forth the significant components of the consolidated balance sheet (dollars in millions):

 

                   Variance  
     December 31,      2013 vs. 2012  
     2013      2012      Amount     %  

Assets:

          

Cash and equivalents

   $ 1,838.0       $ 2,761.5       $ (923.5     (33 )% 

Segregated cash

     1,066.1         376.9         689.2        183

Securities(1)

     23,773.0         23,084.2         688.8        3

Margin receivables

     6,352.7         5,804.0         548.7        9

Loans receivable, net

     8,122.6         10,098.7         (1,976.1     (20 )% 

Investment in FHLB stock

     61.4         67.4         (6.0     (9 )% 

Other(2)

     5,066.1         5,194.0         (127.9     (2 )% 
  

 

 

    

 

 

    

 

 

   

Total assets

   $ 46,279.9       $ 47,386.7       $ (1,106.8     (2 )% 
  

 

 

    

 

 

    

 

 

   

Liabilities and shareholders’ equity:

          

Deposits

   $ 25,970.9       $ 28,392.5       $ (2,421.6     (9 )% 

Wholesale borrowings(3)

     5,821.9         5,715.6         106.3        2

Customer payables

     6,309.7         4,964.9         1,344.8        27

Corporate debt

     1,768.7         1,765.0         3.7        0

Other liabilities

     1,552.8         1,644.2         (91.4     (6 )% 
  

 

 

    

 

 

    

 

 

   

Total liabilities

     41,424.0         42,482.2         (1,058.2     (2 )% 

Shareholders’ equity

     4,855.9         4,904.5         (48.6     (1 )% 
  

 

 

    

 

 

    

 

 

   

Total liabilities and shareholders’ equity

   $ 46,279.9       $ 47,386.7       $ (1,106.8     (2 )% 
  

 

 

    

 

 

    

 

 

   

 

(1) 

Includes balance sheet line items trading, available-for-sale and held-to-maturity securities.

(2) 

Includes balance sheet line items property and equipment, net, goodwill, other intangibles, net and other assets.

(3) 

Includes balance sheet line items securities sold under agreements to repurchase and FHLB advances and other borrowings.

Segregated Cash

Segregated cash increased by $0.7 billion to $1.1 billion during the year ended December 31, 2013. The level of cash required to be segregated under federal or other regulations, or segregated cash, is driven largely by customer cash and securities lending balances we hold as a liability in excess of the amount of margin receivables and securities borrowed balances we hold as an asset. The excess represents customer cash that we are required by our regulators to segregate for the exclusive benefit of our brokerage customers.

 

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Securities

Trading, available-for-sale and held-to-maturity securities are summarized as follows (dollars in millions):

 

          Variance  
    December 31,     2013 vs. 2012  
    2013     2012     Amount     %  

Trading securities

  $ —        $ 101.3      $ (101.3     (100 )% 
 

 

 

   

 

 

   

 

 

   

Available-for-sale securities:

       

Residential mortgage-backed securities:

       

Agency mortgage-backed securities and CMOs

  $ 12,236.1      $ 12,097.2      $ 138.9        1

Non-agency CMOs

    14.1        235.2        (221.1     (94 )% 
 

 

 

   

 

 

   

 

 

   

Total residential mortgage-backed securities

    12,250.2        12,332.4        (82.2     (1 )% 

Investment securities

    1,342.0        1,110.6        231.4        21
 

 

 

   

 

 

   

 

 

   

Total available-for-sale securities

  $ 13,592.2      $ 13,443.0      $ 149.2        1
 

 

 

   

 

 

   

 

 

   

Held-to-maturity securities:

       

Residential mortgage-backed securities:

       

Agency mortgage-backed securities and CMOs

  $ 8,358.8      $ 7,887.5      $ 471.3        6

Investment securities

    1,822.0        1,652.4        169.6        10
 

 

 

   

 

 

   

 

 

   

Total held-to-maturity securities

  $ 10,180.8      $ 9,539.9      $ 640.9        7
 

 

 

   

 

 

   

 

 

   

Total securities

  $ 23,773.0      $ 23,084.2      $ 688.8        3
 

 

 

   

 

 

   

 

 

   

Securities represented 51% and 49% of total assets at December 31, 2013 and 2012, respectively. The increase in available-for-sale and held-to-maturity securities during the year ended December 31, 2013 was due primarily to the purchase of agency debt securities, included in investment securities, and the purchase of agency mortgage-backed securities and CMOs. This increase in available-for-sale securities was offset by a decrease in non-agency CMOs as we sold $230.5 million in amortized cost of available-for-sale non-agency CMOs during the first quarter of 2013 as part of our focus to reduce risk and deleverage the balance sheet.

The decrease in trading securities during the year ended December 31, 2013, was due to our decision at the end of the second quarter of 2013 to exit the market making business, G1 Execution Services, LLC. All assets related to the market making business, including all of the trading securities, were reclassified to held-for-sale assets, which are reflected in the other assets line item on the consolidated balance sheet.

Loans Receivable, Net

Loans receivable, net are summarized as follows (dollars in millions):

 

           Variance  
     December 31,     2013 vs. 2012  
     2013     2012     Amount     %  

One- to four-family

   $ 4,474.8      $ 5,442.2      $ (967.4     (18 )% 

Home equity

     3,454.0        4,223.4        (769.4     (18 )% 

Consumer and other

     602.1        844.9        (242.8     (29 )% 

Unamortized premiums, net

     44.7        68.9        (24.2     (35 )% 

Allowance for loan losses

     (453.0     (480.7     27.7        (6 )% 
  

 

 

   

 

 

   

 

 

   

Total loans receivable, net

   $ 8,122.6      $ 10,098.7      $ (1,976.1     (20 )% 
  

 

 

   

 

 

   

 

 

   

Loans receivable, net decreased 20% to $8.1 billion at December 31, 2013 from $10.1 billion at December 31, 2012. This decline was due primarily to our strategy of reducing balance sheet risk by allowing the loan portfolio to pay down, which we plan to do for the foreseeable future.

 

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Other Assets

The other assets balance is summarized as follows (dollars in millions):

 

            Variance  
     December 31,      2013 vs. 2012  
     2013      2012      Amount     %  

Property and equipment, net

   $ 237.2       $ 288.2       $ (51.0     (18 )% 

Goodwill

     1,791.8         1,934.2         (142.4     (7 )% 

Other intangibles, net

     215.9         260.6         (44.7     (17 )%