10-K 1 etfc-2017123110k.htm 10-K Document

    
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
______________________________________
FORM 10-K
______________________________________
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2017
Commission File Number 1-11921
 ________________________________
Eetradeasteriska02.jpgTRADE 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)
11 Times Square, 32nd Floor, New York, New York 10036
(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, a smaller reporting company or an emerging growth company. See definitions of "large accelerated filer," "accelerated filer," "smaller reporting company" and "emerging growth 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
 
¨
Emerging growth company   ¨ 
 
 
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
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, 2017, the aggregate market value of voting stock held by non-affiliates of the registrant was approximately $8.0 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 affiliates' 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 16, 2018, there were 266,334,340 shares of common stock outstanding.
Documents Incorporated by Reference: Certain portions of the definitive Proxy Statement related to the Company’s 2018 Annual Meeting of Stockholders, to be filed hereafter (incorporated into Part III hereof).



E*TRADE FINANCIAL CORPORATION
FORM 10-K ANNUAL REPORT
For the Year Ended December 31, 2017
TABLE OF CONTENTS
PART I
 
 
 
Item 1.
 
 
 
 
 
 
 
Item 1A.
Item 1B.
Item 2.
Item 3.
Item 4.
 
 
 
PART II
 
 
Item 5.
Item 6.
Item 7.
 
 
 
 
 
 
 
 
Item 7A.
 
Item 8.
 
 
 
 
 
 
 
 
 
 
 


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Item 9.
Item 9A.
Item 9B.
 
 
 
PART III
 
 
Item 10.
Item 11.
Item 12.
Item 13.
Item 14.
 
 
 
PART IV
Item 15.
Item 16.
 
 
Unless otherwise indicated, references to "the Company," "we," "us," "our," "E*TRADE" and "E*TRADE Financial" mean E*TRADE Financial Corporation and its subsidiaries, and references to the parent company mean E*TRADE Financial Corporation but not its subsidiaries.
E*TRADE, E*TRADE Financial, E*TRADE Bank, the Converging Arrows logo, OptionsHouse and Equity Edge Online are registered trademarks of E*TRADE Financial Corporation in the United States and in other countries. All other trademarks are the property of their respective owners.


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PART I
 
FORWARD-LOOKING STATEMENTS
This report contains forward-looking statements, within the meaning of the Private Securities Litigation Reform Act of 1995, that involve risks and uncertainties. These statements discuss, among other things, our future plans, objectives, outlook, strategies, expectations and intentions relating to our business and future financial and operating results and the assumptions that underlie these matters and include statements regarding our capital plan initiatives and expected balance sheet size, the payment of dividends from our subsidiaries to our parent company, the management of our legacy loan portfolio, our ability to utilize deferred tax assets, the expected implementation and applicability of government regulation and our ability to comply with these regulations, continued repurchases of our common stock, payment of dividends on our preferred stock, our ability to meet upcoming debt obligations, the integration and related restructuring costs of past and any future acquisitions, the expected outcome of existing or new litigation, our ability to execute our business plans and manage risk, the potential decline of fees and service charges, the future sources of revenue, expense and liquidity and any other statement that is not historical in nature. 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. We caution that actual results could differ materially from those discussed in these forward-looking statements. Important factors that could contribute to our actual results differing materially from any forward-looking statements include, but are not limited to, changes in business, economic or political condition, performance, volume and volatility in the equity and capital markets, changes in interest rates or interest rate volatility, customer demand for financial products and services, our ability to continue to compete effectively and respond to aggressive price competition within our industry, cyber security threats, potential system disruptions and other security breaches or incidents, our ability to participate in consolidation opportunities in our industry, to complete consolidation transactions and to realize synergies or implement integration plans, our ability to service our corporate debt and, if necessary, to raise additional capital, changes in government regulation or actions by our regulators, including those that may result from the implementation and enforcement of regulatory reform legislation, our ability to move capital to our parent company from our subsidiaries, adverse developments in litigation, our ability to manage our balance sheet growth, the timing, duration and costs associated with our stock repurchase program and other factors discussed under MD&A and Item 1A. Risk Factors of this Form 10-K; and elsewhere in this report and in other reports we file with the Securities and Exchange Commission (SEC). By their nature forward-looking statements are not guarantees of future performance or results and are subject to risks, uncertainties and assumptions that are difficult to predict or quantify. Actual future results may vary materially from expectations expressed or implied in this report or any of our prior communications. The forward-looking statements contained in this report reflect our expectations only as of the date of this report. Investors should not place undue reliance on forward-looking statements, as we do not undertake to update or revise forward-looking statements to reflect the impact of circumstances or events that arise after the date the forward-looking statements were made, except as required by law.


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ITEM 1.    BUSINESS
OVERVIEW
We are a financial services company that provides online brokerage and related products and services primarily to individual retail investors. Founded on the principle of innovation, we aim to enhance the financial independence of traders and investors through a powerful digital experience that includes tools and educational material, supported by professional guidance, to help individual investors and traders meet their near- and long-term investing goals. We provide these services to customers through our digital platforms and network of industry-licensed customer service representatives and financial consultants, over the phone, by email and online via two national financial centers and in-person at 30 regional financial centers across the United States. We operate federally chartered savings banks with the primary purpose of maximizing the value of deposits generated through our brokerage business.
Our corporate offices are located at 11 Times Square, 32nd Floor, New York, New York 10036. We were incorporated in California in 1982 and reincorporated in Delaware in July 1996. We had approximately 3,600 employees at December 31, 2017. We operate directly and through several subsidiaries, many of which are overseen by governmental and self-regulatory organizations (SROs). Substantially all of our revenues for the years ended December 31, 2017, 2016 and 2015 were derived from our operations in the United States. Our most important subsidiaries are described below:
E*TRADE Securities LLC (E*TRADE Securities) is a registered broker-dealer that clears and settles customer securities transactions.
E*TRADE Bank is a federally chartered savings bank that provides Federal Deposit Insurance Corporation (FDIC) insurance on qualifying amounts of customer deposits and provides other banking and cash management capabilities.
E*TRADE Savings Bank, a subsidiary of E*TRADE Bank, is a federally chartered savings bank that provides FDIC insurance on qualifying amounts of customer deposits.
E*TRADE Futures LLC (E*TRADE Futures) is a registered non-clearing Futures Commission Merchant (FCM) that provides clearing and settlement services for customer futures transactions.
E*TRADE Capital Management, LLC (E*TRADE Capital Management) is a registered investment adviser that provides investment advisory services for our customers.
E*TRADE Financial Corporate Services is a provider of software and services for managing equity compensation plans to our corporate clients.


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Delivering a powerful digital offering to our customers is a core pillar of our business strategy and we believe our focus on being a digital leader in the financial services industry is a competitive advantage. Our hybrid delivery model is available through the following award-winning digital platforms:
laptopa01.jpg
Web
Our leading-edge sites for customers and our primary channel to interact with prospects
 
• Access to a broad range of trading solutions
• Actionable ideas and information
• Research and education for decision making
 
mobilea01.jpg
Mobile
Powerful trading applications for smartphones, tablets and watches
 
• Award-winning mobile apps
• Platforms to manage accounts on the move
• Stock and portfolio alerts
 
 
etradeproa02.jpg
Active Trading Platforms
Powerful software and web-based trading solutions
 
• Sophisticated trading tools
• Idea generation and analysis
• Advanced portfolio and market tracking
STRATEGY
Our business strategy is centered on two key objectives: accelerating the growth of our core brokerage business to improve market share, and generating robust earnings growth and healthy returns on capital to deliver long-term value for our shareholders.
Accelerate Growth of Core Brokerage Business
Enhance overall customer experience
We are focused on delivering cutting-edge trading solutions while improving our market position in investing products. Through these offerings, we aim to continue growing our customer base while deepening engagement with our existing customers.
Capitalize on value of corporate services channel
Our corporate services channel is a strategically important driver of brokerage account and asset growth. We leverage our industry-leading position in corporate stock plan administration to improve client acquisition and engage with plan participants to bolster awareness of our full suite of offerings.
Generate Robust Earnings Growth and Healthy Returns on Capital
Utilize balance sheet to enhance returns
We utilize our bank structure to effectively monetize brokerage relationships by investing stable, low-cost deposits primarily in agency mortgage-backed securities. Meanwhile, we continue to manage down the size and risk associated with our legacy loan portfolio.


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Put capital to work for shareholders
As we continue to deliver on our capital plan initiatives, we are focused on generating and effectively deploying excess capital, including through our share repurchase program, for the benefit of our shareholders.
PRODUCTS AND SERVICES
We offer a broad range of products and services to our customers. Our core brokerage business is organized into three product areas: Trading, Investing and Corporate Services. Additionally, we offer banking and cash management capabilities, including FDIC-insured deposit accounts, which are fully integrated into customer brokerage accounts. Among other features, customers have access to debit cards with ATM fee refunds, online and mobile bill pay, mobile check deposits, Apple Pay and E*TRADE Line of Credit.
Trading
The Company delivers automated trade order placement and execution services, offering our customers a full range of investment vehicles, including US equities, exchange-traded funds (ETFs), options, bonds, futures, American depositary receipts (ADRs) and non-proprietary mutual funds. Margin accounts are also available to qualifying customers, enabling them to borrow against their securities. We help customers plan and execute margin trades through robust margin solutions, including calculators and requirement lookup and analysis tools. The Company also offers a fully paid lending program, which allows our customers to be compensated for lending certain securities in their account.
The Company markets trading products and services to self-directed investors and active traders. Products and services are delivered through web, desktop and mobile digital channels. Trading and investing tools are supported by guidance, including fixed income, options and futures specialists available on-call for customers. Other tools and resources include independent research and analytics, live and on-demand education, and strategies, trading ideas and screeners for major asset classes.
Investing
The Company endeavors to help investors build wealth and address their long-term investing needs. Products and services include individual retirement accounts (IRAs), including Roth IRAs, and a suite of managed products and asset allocation models. These include our Core Portfolios, Blend Portfolios, Dedicated Portfolios, and Fixed Income Portfolios. Investors are provided a full breadth of digital tools across the Company's web and mobile channels to address their investing needs. These include planning and allocation tools, education, and editorial content.
The Company also offers guidance through a team of licensed financial consultants and Chartered Retirement Planning CounselorsSM at our 30 regional financial centers across the country. Guidance is also accessible through our two national financial centers by phone, email and online channels. Customers can receive complimentary portfolio reviews and personalized investment recommendations.


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Corporate Services
The Company provides stock plan administration services for both public and private companies. Through our industry-leading platform, Equity Edge Online™, the Company offers management of employee stock option plans, employee stock purchase plans and restricted stock plans with fully-automated stock plan administration. Accounting, reporting and scenario modeling tools are also available. The integrated stock plan solutions include multi-currency settlement and delivery, disbursement in international countries and streamlined tax calculation. Additionally, corporate clients are offered 10b5-1 plan design and implementation and SEC filing assistance. The Company's digital platforms allow participants in corporate client stock plans to view and manage their holdings. Additionally, participants have access to education tools, restricted stock sales support and dedicated stock plan service representatives. The Corporate Services channel is an important driver of brokerage account and asset growth, serving as an introductory channel to the Company, with approximately 1.5 million individual stock plan accounts across nearly 1,000 corporate clients that represent approximately 20% of S&P 500 companies.
SALES AND CUSTOMER SERVICE
We believe providing superior sales and customer service is fundamental to our business. We 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 and thorough manner. Our customer service representatives utilize technology solutions that enable our team to reduce the number of touch-points required to answer customer inquiries. We also have specialized customer service programs that are tailored to the needs of each core customer group. We provide sales and customer support through the following channels:
laptopa01.jpg
Online
Our Online Service Center serves as a portal for customer requests, providing answers to frequently asked questions, a secure message portal, and live chat capabilities to engage directly with our customer service representatives. In addition, our Investor Education Center provides customers with access to a variety of live and on-demand educational content and courses.

 
mobilea01.jpg
Phone
We have a toll-free number that connects customers to the appropriate department where an investment advisor or customer service representative can assist with the customer's inquiry.
 
 
branchesa01.jpg
Financial Centers
We have 30 financial centers located across the US where retail investors can get face-to-face support and guidance. Financial consultants are 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.


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COMPETITION
The online financial services industry continues to evolve and remains highly competitive. Our core brokerage business competes with full service, discount, and online brokerage firms, Registered Investment Advisers (RIAs), finance technology start-ups, internet banks, and retail banks and thrifts. Some of these competitors provide online trading and banking services, investment advisor services, robo-advice capabilities, electronic bill payment services and a host of other financial products.
Competition in the financial services industry continues to intensify, particularly amid continued consolidation and recent declines in commission pricing. The proliferation of emerging financial technology start-ups further evidences the continued shift to digital offerings. Our future success will depend upon our ability to continue providing digitally compelling and easy to use products and solutions to retail customers.
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, primarily by US federal and state regulatory agencies and certain SROs, such as central banks and securities exchanges, that have been charged with the protection of the financial markets and the interests of those participating in those markets. We, along with other larger institutions, have been subject to a broad range of rules and regulations and a climate of heightened regulatory scrutiny, particularly with respect to compliance with laws and regulations, including controls and business processes. This scrutiny and related rule-making has resulted in part from the enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) in 2010, which significantly changed the bank regulatory structure of our Company and its thrift subsidiaries. The substance and full impact of the laws and regulations to which we are subject may be affected by changes in the US political landscape, and we expect to continue to incur costs to implement new or phase-in requirements and monitor for continued compliance. For additional regulatory information on our brokerage and banking regulations, see MD&A—Liquidity and Capital Resources and Note 18—Regulatory Requirements.
Financial Services Regulation
Our regulators are increasingly focused on ensuring that our customer privacy, data protection, information security and cyber security-related policies and practices are adequate to inform consumers of our data collection, use, sharing or security practices, to provide them with choices, if required, about how we use and share their information, and to safeguard their personal information. We maintain systems designed to comply with these privacy, data protection, information security and cyber security requirements, including procedures designed to securely process, transmit and store confidential information and protect against unauthorized access to such information.
Our brokerage and banking entities are required by the Gramm-Leach-Bliley Act of 1999 to disclose their privacy policies and practices related to sharing customer information with affiliates and non-affiliates. These rules 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. The Bank Secrecy Act, as amended by the USA PATRIOT ACT of 2001 (BSA/USA PATRIOT Act), applies to our brokerage and banking entities and 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


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regulations. Our brokerage and banking entities are also subject to US sanctions laws administered by the Office of Foreign Assets Control and we have policies and procedures in place to comply with these laws.
Savings and Loan Holding Company and Bank Regulation
The Board of Governors of the Federal Reserve System (Federal Reserve Board, and together with the twelve Federal Reserve Banks, the Federal Reserve) has primary jurisdiction for the supervision and regulation of savings and loan holding companies, including the Company. We are required to file periodic reports with the Federal Reserve and are subject to its examination and supervision. The Federal Reserve Board 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 on such matters as liquidity risk management, securitizations, operational risk management, internal controls and audit systems, business continuity and compensation and other employee benefits.
Our banking entities are regulated, supervised, and examined by the Office of the Comptroller of the Currency (OCC), the Consumer Financial Protection Bureau (CFPB), and the FDIC. The banking entities are also subject to regulation and various requirements and restrictions under state and other federal 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.
In certain circumstances, each of our banking entities may be subject to restrictions on its ability to declare dividends or make capital distributions and may be required to provide notice, submit applications or requests for non-objection from the OCC or the Federal Reserve in connection with a planned capital distribution. A savings and loan holding company, such as the Company, is also required to notify and consult with the Federal Reserve in advance of taking capital actions when, among other things, doing so could create safety and soundness concerns or the savings and loan holding company is experiencing financial weakness.
The US Basel III framework for the calculation of a banking organization’s regulatory capital and risk-weighted assets became effective for us and for our savings association subsidiaries on January 1, 2015, subject to a phase-in period for certain requirements over several years. The Basel III rule established Common Equity Tier 1 capital as a new tier of capital, raised the minimum thresholds for required capital, increased minimum required risk-based capital ratios, narrowed the eligibility criteria for regulatory capital instruments, provided for new regulatory capital deductions and adjustments, and modified methods for calculating risk-weighted assets. A capital conservation buffer was also introduced, which limits a banking organization’s ability to make capital distributions and discretionary bonus payments to executive officers if it fails to maintain a Common Equity Tier 1 capital conservation buffer of at least 2.5%, on a fully phased-in basis, of total risk-weighted assets above certain minimum risk-based capital ratio requirements. This requirement was effective beginning on January 1, 2016, and will be fully phased-in by 2019. In addition, certain deductions from and adjustments to regulatory capital are subject to phase-in over a four year period that began in 2015. The majority of these deductions are scheduled for full implementation in 2018; however, federal banking agencies recently finalized a rule that extended the existing capital requirements for certain items, including certain deferred tax assets. This extension is not expected to have a material impact on the Company's capital ratios and we expect to remain compliant with the Basel III framework as it is phased-in.
The FDIC 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 generally apply only to banks, such as E*TRADE Bank and E*TRADE Savings Bank, the Federal Reserve is authorized to take appropriate action against a parent savings and loan holding company, such as the Company, based on the undercapitalized status of any bank subsidiary. In certain instances, we would be required to guarantee the performance of a capital restoration plan if either of our bank subsidiaries were undercapitalized.


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The Company has historically not been subject to certain regulatory requirements that apply to banking organizations with $50 billion or more in total consolidated assets, as defined by each applicable regulation. Total consolidated assets of $50 billion, which is generally measured on the basis of the average of the four most recent quarters, is a meaningful regulatory threshold, as US banking organizations become subject to a number of additional, and in some cases more stringent, regulatory requirements once they reach that size. The Company surpassed $50 billion in total consolidated assets on a four-quarter average in the first quarter of 2017 and we are continuing to implement policies, procedures, systems and governance structures that are designed to comply with requirements that will become applicable to the Company. The Company is continuing to monitor for regulatory developments as certain regulatory requirements are not yet final or not yet applicable to savings and loan holding companies.
Capital Stress Testing

E*TRADE Bank, as a federal savings association with total consolidated assets of more than $10 billion, is required to conduct annual company-run stress tests using certain regulator-specified scenarios (baseline, adverse and severely adverse), report the results to the OCC, and publicly disclose a summary of results for the severely adverse scenario. E*TRADE Bank conducted its annual stress test using financial statement data as of December 31, 2016, reported the stress test results to the OCC in July 2017, and publicly disclosed a summary of results for the severely adverse scenario in October 2017. The timeline for E*TRADE Bank's stress test reporting to the OCC for 2018 will be the same as that for 2017.

The Company became subject to the annual company-run stress tests requirement in 2017. The Company conducted its first annual stress test using financial statement data as of December 31, 2016, as required by Federal Reserve Board Regulations, reported the stress test results to the Federal Reserve in July 2017, and publicly disclosed a summary of results for the severely adverse scenario in October 2017. For 2018, the Company will be required to complete and report the annual company-run stress test results to the Federal Reserve Board in April 2018 and publicly disclose a summary of results for the severely adverse scenario in June 2018.
As a savings and loan holding company, the Company is not currently subject to the Comprehensive Capital Analysis and Review (CCAR) process conducted pursuant to the Federal Reserve Board's capital plan rule. The Company may be subject to CCAR requirements in the future based on potential changes in regulations.
Liquidity Requirements
Large banking organizations are subject to a quantitative liquidity coverage ratio (LCR) requirement, which required banking organizations to hold minimum amounts of high-quality liquid assets (HQLA) based on a percentage of their net cash outflows over a 30-day period as projected under the LCR rule. Banking organizations with $250 billion or more in total consolidated assets or foreign exposures of $10 billion or more are subject to full LCR requirements. Bank and savings and loan holding companies with total consolidated assets of $50 billion or more but less than $250 billion, based on the average of the four most recent quarters, that do not have foreign exposures of $10 billion or more, such as the Company, are subject to a modified LCR rule requiring them to hold HQLA in an amount equal to at least 70% of their projected net cash outflows over a 30-day period. As a result of the Company's balance sheet growth, we will be subject to the modified LCR requirement beginning April 1, 2018. The Company believes the LCR is an important measure of liquidity and has been managing against it in preparation for the applicability of these requirements. In addition, beginning October 1, 2019, we will be required to disclose certain quantitative and qualitative information related to our LCR calculation after each calendar quarter.
In addition to the modified LCR rule, the Company may in the future be required to comply with rules proposed by the Federal Reserve Board in May 2016 that would impose a net stable funding requirement, the net stable funding ratio (NSFR). The proposed NSFR requirement would require a banking organization subject to the rule to maintain a minimum acceptable level of stable funding based on its liquidity


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characteristics over a one-year time horizon. The proposal contemplates an effective date of January 1, 2018; however, the proposal has yet to be finalized.
Resolution and Recovery Plans
In 2012, the FDIC issued a final rule requiring insured depository institutions with total assets of $50 billion or more, based on the average of the four most recent quarters, to submit to the FDIC periodic plans providing for their resolution by the FDIC in the event of failure (resolution plans) under the receivership and liquidation provisions of the Federal Deposit Insurance Act. E*TRADE Bank is currently not subject to these rules, but if it were to exceed the asset threshold, it would be required to file with the FDIC an annual resolution plan demonstrating how it could be resolved in an orderly and timely manner in the event of receivership such that the FDIC would be able to ensure the bank's depositors receive access to their deposits within one business day, to maximize the net present value of the bank's assets when disposed of, and to minimize losses incurred by the bank's creditors. There is a separate resolution plan requirement for bank holding companies with total consolidated assets of $50 billion or more; however, the Company is not subject to this rule due to its status as a savings and loan holding company.
In September 2016, the OCC published final guidelines that establish standards for recovery planning for federal savings associations with average total consolidated assets of $50 billion or more, based on the average of the four most recent quarters. E*TRADE Bank is currently not subject to these guidelines, but if it were to exceed the asset threshold, it would be required to develop and maintain a recovery plan for identifying and responding rapidly to significant stress events that could affect its financial condition and threaten its viability. The recovery plan would need to identify triggers for escalation of information to senior management and the board of directors, identify a wide range of viable options that E*TRADE Bank could undertake in response to severe stress, and be integrated into E*TRADE Bank’s risk governance function.
Federal Deposit Insurance and Related Assessments
The FDIC’s Deposit Insurance Fund (DIF) provides insurance coverage for certain deposits, generally up to $250,000 per depositor, per insured bank and per account ownership type, and is funded by quarterly assessments on insured depository institutions. Each of our banking entities has deposits insured by the FDIC and pays quarterly assessments to the DIF, maintained by the FDIC, for this insurance coverage. On March 25, 2016, the FDIC published its final rule to add a surcharge to the regular DIF assessments of banks with $10 billion or more in assets, which includes E*TRADE Bank. Under the final rule, E*TRADE Bank is subject to an additional surcharge applied to its assessment base, which took effect for the assessment period beginning on July 1, 2016. Surcharges at an annual rate of 4.5 basis points will be assessed until the sooner of (1) the DIF attaining the minimum reserve ratio of 1.35 percent of insured deposits or (2) the fourth quarter of 2018. The FDIC anticipates eight quarters of surcharge assessments. There may be a one-time “shortfall assessment” in the first quarter of 2019 to bring the fund immediately to 1.35 percent if needed. The surcharge has not had, and is not expected to have, a material impact on our financial condition, results of operations or cash flows.
Home Owners' Loan Act
Under the Home Owners’ Loan Act, the OCC requires E*TRADE Bank and E*TRADE Savings Bank to comply with the qualified thrift lender (QTL) test. Under the QTL test, a federal savings association is required to maintain at least 65% of its “portfolio assets” (defined as the savings association’s total assets less the sum of: (i) specified liquid assets up to 20% of total assets; (ii) intangibles, including goodwill; and (iii) the value of property used to conduct its business) in certain “qualified thrift investments” (primarily residential mortgages and related investments, including certain mortgage-backed securities, credit card loans, student loans and small business loans) in at least nine months of the most recent 12-month period. E*TRADE Bank and E*TRADE Savings Bank currently meet that test. A savings association that fails to meet the QTL test is subject to certain operating restrictions and may be required to convert to a national bank charter.


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Brokerage Regulation and Capital Requirements
Our US broker-dealer, E*TRADE Securities, is registered with the SEC and is subject to regulation by the SEC and by SROs, such as the Financial Industry Regulatory Authority (FINRA) and the securities exchanges of which it is a member, as well as various state regulators. In addition, our FCM subsidiary, E*TRADE Futures, is registered with the CFTC and is a member of the NFA. E*TRADE Capital Management, LLC, is registered with the SEC and is subject to regulation as such by the SEC as well as various state regulators.
Brokerage regulation covers various aspects of brokerage activities, including segregated cash requirements and net capital. E*TRADE Securities carries security accounts for customers and maintains segregated cash and investments pursuant to Rule 15c3-3 under the Securities Exchange Act of 1934. E*TRADE Futures maintains cash deposits that have been segregated or secured for the benefit of futures clients pursuant to CFTC regulations governing FCMs. E*TRADE Securities is subject to the Uniform Net Capital Rule, Rule 15c3-1 under the Securities Exchange Act of 1934, which requires the maintenance of minimum net capital, and E*TRADE Futures is subject to CFTC net capital requirements. Brokerage regulation also covers other brokerage activities, including 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.
In April 2016, the US Department of Labor (DOL) published its final Conflicts of Interest Rule- Retirement Investment Advice regulations under the Employee Retirement Income Security Act of 1974 and the Internal Revenue Code of 1986 (Fiduciary Rule). Certain aspects of the Fiduciary Rule became applicable in June 2017. The Fiduciary Rule generally subjects particular persons, such as broker-dealers and other financial advisers providing investment advice to individual retirement accounts and other qualified retirement plans and accounts, to fiduciary duties and additional regulatory restrictions for a wider range of customer interactions. The DOL extended the transition period for the remaining aspects of the Fiduciary Rule, currently scheduled to take effect on July 1, 2019. During this transition period, the DOL has indicated that it will not take enforcement actions against impacted parties that are in reasonable and good faith compliance with the regulations.
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 corporate website as soon as reasonably practicable after they have been filed with the SEC. Our corporate website address is about.etrade.com. 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. 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
Changes in business, economic, or political conditions that negatively impact global financial markets could reduce trading volumes and margin lending, resulting in lower revenues.
Digital investing services to the retail customer, including trading, margin lending and sweep deposits, account for a significant portion of our revenues. Changes in business, economic or political conditions could cause a downturn in the global financial markets. Such a downturn could decrease the volume of securities transactions which may, in turn, result in lower transactions revenue. A decrease in trading activity or securities prices would also typically be expected to result in a decrease in margin lending, which would reduce our interest income earned on margin receivables and increase our credit risk because the value of the collateral could fall below the amount of indebtedness it secures.
We may be unsuccessful in managing the effects of changes in interest rates on our business.
Net interest income is our most significant source of revenue. Our results of operations depend, in part, on our level of net 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 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 interest income.
Net interest margin may fluctuate based on the size and mix of the balance sheet, as well as the impact of the interest rate environment. Rising interest rates and other market factors may cause the Company's funding costs to increase. Higher funding costs without offsetting increases in asset yields may adversely affect our results of operations.
We rely heavily on technology, which can be subject to interruption and instability due to operational and technological failures, both internal and external.
We rely on technology, particularly the Internet and mobile services, to conduct much of our business activity and allow our customers to conduct financial transactions. Our systems and operations, including our primary and disaster recovery data center operations, are vulnerable to disruptions from natural disasters, power outages, computer and telecommunications failures, software bugs, computer viruses or other malicious software, distributed denial of service (DDoS) attacks, spam attacks, security breaches, technological failure, human error and other similar events. Furthermore, parties may attempt to fraudulently induce employees, customers, clients, third parties or other users of our systems to disclose sensitive information in order to gain access to our data or that of our customers. In addition, extraordinary trading volumes or site usage could cause our computer systems to operate at an unacceptably slow speed or even fail. Disruptions to, instability of or other failure to effectively maintain our information technology systems 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


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significant investments to upgrade, repair or replace our technology infrastructure and may not be able to make such investments on a timely basis. While we have made significant investments designed to enhance the reliability and scalability of our operations, we cannot assure 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 or that we will be able to retain skilled information technology employees. Disruptions in service and slower system response times could result in substantial losses, decreased customer service and satisfaction, customer attrition 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. Social and traditional media may incorrectly report on cyber incidents or exaggerate the effect of a breach. An actual or perceived breach of the security of our technology could harm our business and our reputation. Further, any actual or perceived breach or cybersecurity attack directed at other financial institutions or financial services companies, whether or not we are impacted, could lead to a general loss of customer confidence in the use of technology to conduct financial transactions, which could negatively impact us, including the market perception of the effectiveness of our security measures and technology infrastructure. The occurrence of any of these events may have a material adverse effect on our business or results of operations.
Further, a cybersecurity intrusion could occur and persist for an extended period of time without detection. We expect that any investigation of a cybersecurity intrusion could take a substantial amount of time, and during such time we may not necessarily know the extent of the harm or how best to remediate it, and certain errors or actions could be repeated or compounded before they are discovered and remediated, all of which could further increase the costs and consequences of such an attack.
As 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 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 may not be covered by applicable insurance and could have a material impact on our financial performance and results of operations.
We rely on third parties to perform certain key functions, and their failure to perform those functions could result in the interruption of our operations and systems and could result in significant costs and reputational damage to us.
We rely on third party service providers for certain technology, processing, servicing and support functions. These providers are also susceptible to operational and technology vulnerabilities, which may impact our business. In addition, these third party service providers may rely on other parties (sub-contractors), to provide services to us which also face similar risks. For example, external content providers provide us with financial information, market news, quotes, research reports and other fundamental data that we offer to customers. Also, we do not directly service any of our mortgage loans and, as a result, we rely on third party vendors and servicers to provide information on our loan portfolio.
We have third party oversight capabilities which include enhanced processes to evaluate third party providers, designed to verify that the third party service providers can support the stability of our operations and systems. However, these processes may be insufficient and we cannot assure that we will not experience a failure as a result of a third party service provider. Any significant failures or security breaches by or of our third party service providers or their sub-contractors, including any actual or perceived cybersecurity attacks, security breaches, fraud, phishing attacks, acts of vandalism, information security breaches and computer viruses which could result in unauthorized access, misuse, loss or destruction of data, an interruption in service or other similar events could interrupt our business, cause us to incur losses, subject us to fines or litigation and harm our reputation. 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


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have a material impact on our ability to offer certain products and services and cause us to incur losses. We cannot assure that any of these third party service providers or their sub-contractors will be able to continue to provide their products and services in an efficient, cost effective manner, if at all, or that they will be able to adequately expand their services to meet our needs and those of our customers. We may incur significant additional costs to implement enhanced protective measures and technology, to investigate and remediate vulnerabilities or other exposures or to make required notifications.
We expect that our regulators will hold us responsible for any deficiencies in our oversight and control of our third party relationships and for the performance of such third parties. If there were deficiencies in the oversight and control of our third party relationships, and if our regulators held us responsible for those deficiencies, our business, reputation, and results of operations could be adversely affected.
Unauthorized disclosure of data, 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 data, including 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 to protect against unauthorized access to such information. We also require our third party service providers to have adequate security if they have access to PII. However, risks associated with the management, use and storage of sensitive data have grown in recent years due to increased sophistication and activities of organized crime, hackers, terrorists and other external parties. For example, we, and other financial institutions, experienced a cyber-incident in 2013 which resulted in certain customer contact information being compromised and potentially accessed by unauthorized third parties. As of the date of this Annual Report, we are unaware of any financial fraud or other misuse of customer data resulting from this incident. We are cooperating with government agencies in connection with their investigation.
We have continued to invest in our technology, including advanced security measures, but, despite these investments, we, our customers and our third party service providers may be vulnerable to security breaches, phishing attacks, acts of vandalism, computer viruses or other cybersecurity attacks which could result in unauthorized access, misuse, loss or destruction of data, an interruption in service or other similar events. In addition, because the methods and techniques employed by organized crime, hackers, terrorists and other external parties are increasingly sophisticated and often are not fully recognized or understood until after they have been launched, we may be unable to anticipate, detect or implement effective preventative measures against cybersecurity attacks, which could result in substantial exposure of either employee or customer PII. Any breach of security, real or perceived, involving the misappropriation, loss or other unauthorized disclosure of PII, whether by us, our customers or our third party service providers, 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. In addition, although we maintain insurance coverage that we believe is reasonable, prudent and adequate for the purpose of our business, it may be insufficient to protect us against all losses and costs stemming from breaches of security, cyber-attacks and other types of unlawful activity, or any resulting disruptions from such events.
As a result, we are subject to numerous laws and regulations designed to protect this information, such as US federal and state laws and foreign regulations governing the protection of PII and other customer data. These laws and regulations are increasing in complexity and number, change frequently and sometimes conflict. If any person, including any of our employees, negligently disregards or intentionally breaches our established controls with respect to client data, or otherwise mismanages or misappropriates that data, we could be subject to significant monetary damages, regulatory enforcement actions, fines and/or criminal prosecution in one or more jurisdictions


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We conduct all of our operations through subsidiaries and rely on dividends from our subsidiaries for a substantial amount of our cash flows.
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 certain 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, and otherwise conduct our business.
In particular, a savings association that is part of a savings and loan holding company structure, such as E*TRADE Bank and E*TRADE Savings Bank, must file a notice of a declaration of a dividend with the Federal Reserve at least 30 days before the proposed dividend declaration by the bank’s board of directors. OCC regulations set forth the circumstances under which a federal savings association is required to submit an application or notice before it may make a dividend or capital distribution. See Business—Regulation for additional information.
As of December 31, 2017, much of our capital was invested in our banking subsidiary, E*TRADE Bank. The Federal Reserve may object to a proposed dividend or capital distribution if, among other things, E*TRADE Bank is, or as a result of such dividend or distribution would be, undercapitalized or it has safety and soundness concerns. We cannot be certain, however, that we will receive regulatory approval for such contemplated dividends at the requested levels or at all. We expect to use excess capital generated by E*TRADE Bank to fund balance sheet growth and the contemplated acquisitions previously announced, however we will continue to assess our ability to distribute dividends from E*TRADE Bank during 2018.
Under the OCC stress test regulations, E*TRADE Bank is required to conduct stress-testing using the prescribed stress-testing methodologies. In 2017, E*TRADE Bank submitted and published the results of its third annual stress test, as required. The OCC analyzes and provides feedback on 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 redemption or repurchase of regulatory capital instruments, dividends 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 resources and may have product suites that may appeal to our current or potential customers.
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. 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, or different products and services that could attract current and prospective E*TRADE customers and potentially result in intensified price competition within the industry. During 2017, we experienced this, with aggressive price competition in the industry, including reduced trading commissions and various free trade offers. We may not be able to match the marketing efforts or prices of our competitors. Some of our competitors may also benefit from established relationships among themselves or with third parties that enhance their products and services.


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In addition, we compete in a technology-intensive industry characterized by rapid innovation. We may be unable to effectively use new technologies, adapt 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 and expanding our market position
Attracting and retaining customers
Providing easy to use and innovative financial products and services
Our reputation and the market perception of our brand and overall value
Maintaining competitive pricing
Competing in a concentrated competitive landscape
The effectiveness of our technology (including cybersecurity defenses), 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 our existing employees
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.
Our business could be adversely affected due to risks related to our acquisitions and the subsequent integration of the acquired businesses.
We consider opportunistic acquisitions to grow existing business, add new technologies, or expand distribution. We cannot be certain that we will be able to identify, consummate and successfully integrate acquisitions, and no assurance can be given with respect to the timing, likelihood or business effect of any possible transaction. Transactions that we consummate would involve risks and uncertainties to us, including mispricing the inherent value of the acquired entity, as well as potential difficulties integrating people, systems and customers.
We have entered into agreements to acquire Trust Company of America (TCA), a leading provider of technology solutions and custody services to the independent RIA market for $275 million in cash and to acquire approximately one million retail brokerage accounts from Capital One Financial Corporation (Capital One) for a purchase price of up to $170 million. While we expect to complete the TCA acquisition by the second quarter of 2018, and the Capital One brokerage account acquisition by the third quarter of 2018, there can be no guarantee that the acquisitions will close when expected, or at all. If consummated, the acquisition subjects us to a number of risks, uncertainties, and potential costs. The risks associated with these transactions include:


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We may experience significant attrition in the acquired accounts and assets under custody, and our retention of the accounts and assets may be impacted by our ability to successfully integrate the acquired operations, products and personnel.
We could be subject to undisclosed liabilities that could be material or become subject to litigation or regulatory risks as a result of the acquisition.
Management’s attention may be diverted from other business initiatives.
Unanticipated restructuring costs may be incurred.
We will have less cash available for other purposes, including for use in acquisitions or the development of other technologies or products.
Any future acquisitions could involve these and additional risks. Our ability to pursue additional strategic transactions may also be limited by our corporate debt, including our senior unsecured revolving credit facility. Future acquisitions may also be funded through the issuance of additional debt or preferred stock.
Any of these risks, whether with respect to the current or any future acquisitions, could have a material adverse effect on our business and results of operations.
Our risk management practices may leave us exposed to unidentified or unanticipated risk.
As a financial services company, our business exposes us to certain risks. We seek to monitor and manage our significant risk exposures through a set of board-approved limits as well as Key Risk Indicators (KRIs) or metrics. We have adopted a governance framework which includes reporting of these metrics and other significant risks and exposures to management and the Board of Directors. See MD&A-Risk Management for additional information. However, our risk management methods may not identify future risk exposures and may not be effective in mitigating our key risks. Furthermore, our risk management methods may not properly identify and mitigate the aggregation of risks across our organization or the interdependency of our risk mitigation efforts. In addition, some of our risk management methods are based on an evaluation of information regarding markets, customers and other matters that are based on assumptions that may not be accurate. A failure to manage our risk effectively could materially and adversely affect our business, results of operations and financial condition.
Advisory services subject us to additional risks.
We provide advisory services to investors to aid them in their decision making. Investment recommendations 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. Risks associated with advisory services also include those arising from possible conflicts of interest, inadequate due diligence, inadequate disclosure, human error and fraud. 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 may suffer losses due to credit risk associated with margin lending, securities lending transactions or other financial transactions.
We permit certain customers to purchase securities on margin and borrow against their securities holdings. A downturn in securities markets may impact the value of collateral held in connection with margin receivables and assets pledged for securities-based lending and may reduce its value below the amount borrowed, potentially creating collections issues if deficiencies are not remediated. In addition, we


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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 default on their obligations. We also engage in financial transactions with counterparties, including repurchase agreements, that expose us to credit losses in the event counterparties cannot meet their obligations.
We may continue to experience losses in our mortgage loan portfolio.
At December 31, 2017, the principal balance of our one-to four-family loan portfolio was $1.4 billion with an allowance for loan losses of $24 million. The principal balance of our home equity loan portfolio was $1.1 billion with an allowance for loan losses of $46 million. Certain characteristics of our mortgage loan portfolio indicate an additional risk of loss and we believe the relative importance of these factors varies, depending upon economic conditions. Whether a loan is amortizing is among the key items we track to predict and monitor credit risk in our mortgage portfolio, together with loan-to-value (LTV)/combined loan-to-value (CLTV), borrower Fair Isaac Credit Organization (FICO) scores, loan type, housing prices, loan vintage and geographic location of the underlying property. Second lien loans carry higher credit risk because the holder of the first lien mortgage has priority in right of payment. As second lien holders, we are also exposed to risk associated with the actions and inactions of the first lien holder loans for which we do not hold the first lien positions and we do not have access to complete data on the first lien positions of second lien home equity loans. Actual loan defaults and delinquencies that exceed our current expectations could negatively impact our financial performance. 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. Due to the complexity and judgment required by management regarding the effect of matters that are inherently uncertain, there can be no assurance that our allowance for loan losses will be adequate. See MD&A—Risk Management for additional information.
Our corporate debt may restrict how we conduct our business and failure to comply with the terms of our corporate debt could adversely affect our financial condition and results of operations.
As of December 31, 2017, we have $1 billion of corporate debt and have the capacity to incur $300 million in additional indebtedness under our senior unsecured revolving credit facility, subject to certain covenant requirements. Our expected annual debt service interest payment is approximately $33 million. The degree to which we are leveraged could have important consequences, including:
A portion of our cash flow from operations is dedicated to the payment of 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 may be limited.
Our leverage may affect our ability to adjust rapidly to changing market conditions and make us more vulnerable in the event of a downturn in general economic conditions or our business.
Our senior unsecured revolving credit facility and the indentures governing our corporate debt place limitations on our ability, and certain of our subsidiaries’ ability to, among other things:
Create liens
Merge, consolidate or transfer substantially all of our assets
With respect to our subsidiaries only, incur additional indebtedness


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The senior unsecured revolving credit facility also contains certain financial covenants, including that we maintain a minimum interest coverage ratio, a maximum total leverage ratio and certain capitalization requirements for the parent company and certain of its subsidiaries.
We could be forced to repay immediately any outstanding borrowings under the senior unsecured revolving credit facility and outstanding debt securities at their full principal amount if we were to breach their respective covenants and not cure such breach, even if we otherwise meet our debt service obligations. If we experience a change in control, as defined in the senior unsecured revolving credit facility, we could be required to repay all loans outstanding under the credit facility at their full principal amount plus any accrued interest or fees.
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 are subject to certain business, economic and competitive conditions, regulatory approval or notification, and other factors beyond our control. 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 our existing or future debt instruments may restrict us from adopting some of these alternatives.
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 obtain additional financing in the future. In addition, any future indebtedness could be at a higher interest rate or include covenants that are more restrictive than our current covenants.
The value of our net deferred tax assets may be adversely affected by further changes in statutory tax rates or changes in our estimates of future taxable income.
We had net deferred tax assets of $251 million at December 31, 2017. The Tax Cuts and Jobs Act was enacted on December 22, 2017, which resulted in the remeasurement of certain of our deferred tax assets and liabilities using the new statutory federal corporate income tax rate of 21%. As a result, we recognized $58 million of additional tax expense for the year ended December 31, 2017. Further changes to statutory tax rates may impact the value of deferred tax assets and liabilities. We did not establish a valuation allowance against our federal net deferred tax assets at December 31, 2017 as we believe 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 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. See MD&A— Summary of Critical Accounting Policies and Estimates for additional information.


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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 financial services industry is subject to extensive regulation. Our brokerage 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. E*TRADE Financial Corporation, as a savings and loan holding company, 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, the Federal Reserve and the CFPB, and, in the case of E*TRADE Bank and E*TRADE Savings Bank, the FDIC. Such regulation and supervision covers all aspects of the banking business, including lending practices, safeguarding deposits, capital structure, recordkeeping, transactions with affiliates and conduct and qualifications of personnel.
In providing services to customers, we manage, use and store sensitive customer data including PII. As a result, we are subject to numerous laws and regulations designed to protect this information, such as US federal and state laws and foreign regulations governing the protection of PII. These laws have increased in complexity, change frequently and can conflict with one another. In addition, our results of operations could be affected by regulations which impact the business and financial communities generally, including changes to the laws governing taxation, electronic commerce, customer privacy and security of customer data. If we fail to establish and enforce procedures to comply with applicable regulations, our failure could have a material adverse effect on our business.
While we have implemented policies and procedures designed to provide for compliance with all applicable laws and regulations, our regulators have broad discretion with respect to the enforcement of applicable laws and regulations and 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. Further, to the extent we undertake actions requiring regulatory approval or non-objection, our regulators may make their approval or non-objection subject to conditions or restrictions that could have a material adverse effect on our business, results of operations and financial condition. New, or amended legislation, regulations, guidance and supervisory practices may negatively impact our business and financial results.
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, litigation, investigations, damages, penalties or restrictions that could significantly harm our business.
The financial services industry faces substantial litigation and regulatory risks. We are subject to arbitration claims and lawsuits in the ordinary course of our business, as well as class actions and other significant litigation. We also are the subject of inquiries, investigations and proceedings by regulatory and other governmental agencies. Actions brought against us may result in settlements, awards, injunctions, fines, penalties and other results adverse to us. Predicting the outcome of such matters is inherently difficult, particularly where claims are brought on behalf of various classes of claimants or by a large number of claimants, when claimants seek substantial or unspecified damages or when investigations or legal proceedings are at an early stage. A substantial judgment, settlement, fine or penalty could be material to our operating results or cash flows, or could cause us significant reputational harm, which could harm our business prospects. In market downturns, the volume of legal claims and amount of damages sought in litigation and regulatory proceedings against financial services companies have historically increased. We are also subject to litigation claims from third parties alleging infringement of their intellectual property rights. Such litigation can require the expenditure of significant resources, regardless of whether the claims


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have merit. If we were found to have infringed a third-party patent or other intellectual property right, we could incur substantial liability and in some circumstances could be enjoined from using the relevant technology or providing related products and services, which could have a material adverse effect on our business and results of operations.
The SEC, FINRA and other SROs 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. Clearing securities firms, such as E*TRADE Securities, are subject to substantially more regulatory control and examination than introducing brokers that rely on others to perform clearing functions. 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 US 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.
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 maintained the federal thrift charter, it eliminated certain preemption, branching and other benefits of the charter and imposed new penalties for failure to comply with the QTL test.
We are required to file periodic reports with the Federal Reserve and are subject to examination and supervision by it. The Federal Reserve Board also has certain types of enforcement powers over us, 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. 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. Our thrift subsidiaries are subject to similar reporting, examination, supervision and enforcement oversight by the OCC. For all banks and thrifts with total consolidated assets over $10 billion, including E*TRADE Bank, as well as their affiliates, the CFPB has exclusive rulemaking and examination, and primary enforcement authority, under federal consumer financial laws and regulations. In addition, states may adopt consumer protection laws and regulations that are stricter than those regulations promulgated by the CFPB.
The Company surpassed $50 billion in total consolidated assets on a four-quarter average in the first quarter of 2017 which we believe is a meaningful regulatory threshold, as US banking organizations become subject to a number of additional, and in some cases more stringent, regulatory requirements once they reach that size. These additional regulations may affect how we conduct our business through heightened capital, liquidity, governance, or other requirements. We anticipate that regulators will continue to 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.
New legislation, rule changes or changes in the interpretation or enforcement of existing laws, rules and regulations could increase our compliance costs and adversely affect our business and results of operations. For example, in April 2016, the DOL published its final fiduciary regulations seeking to broaden the definition of who is an investment advice fiduciary and how such advice can be provided to account holders in retirement accounts such as 401(k) plans and IRAs. Certain aspects of these regulations began to take effect in June 2017, and the remaining aspects of these regulations are currently scheduled to take effect on July 1, 2019. For further information on how ongoing regulatory reform could affect us, see Business—Regulation.


E*TRADE 2017 10-K | Page 20
 
                    


If we do not maintain the capital and liquidity levels required by regulators, we may be fined or subject to other disciplinary or corrective actions.
The SEC, FINRA, the OCC, the CFTC, the Federal Reserve and various other regulatory agencies have stringent rules with respect to the maintenance of specific levels of net capital by securities broker-dealers and regulatory capital by banks.
Failure to maintain the required net capital by our US securities broker-dealer or FCM could result in suspension or revocation of registration by the SEC or suspension or expulsion by FINRA, the CFTC or the NFA, as applicable, 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.
E*TRADE Bank and E*TRADE Savings Bank are subject to various regulatory capital requirements administered by the OCC, and the Company is 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 affect the operations and financial performance of these entities. The capital amounts and classifications of the Company, E*TRADE Bank and E*TRADE Savings Bank are subject to qualitative judgments by the regulators of these entities, including about the strength of components of its capital, risk weightings of assets, off-balance sheet transactions and other factors. Any significant reduction in the Company’s, E*TRADE Bank’s or E*TRADE Savings Bank's regulatory capital could result in them being less than "well capitalized" or "adequately capitalized" under applicable capital standards. A failure to be "adequately capitalized" that is not cured within time periods specified in the credit agreement for our senior unsecured revolving credit facility would constitute a default under our senior unsecured revolving credit facility and likely result in any outstanding balance on the senior unsecured revolving credit facility becoming immediately due and payable. In addition, the Federal Deposit Insurance Act prohibits the acceptance, renewal or roll-over of “brokered deposits” by depository institutions that are not “well capitalized,” unless a depository institution is “adequately capitalized” and receives a waiver from the FDIC. Sweep deposits that qualify as “brokered deposits” are a significant source of liquidity for E*TRADE Bank and E*TRADE Savings Bank, and if they were terminated by the FDIC, that could have a material negative effect on our business. If we fail to meet certain capital requirements, the Federal Reserve and the OCC may request we raise equity or otherwise increase the regulatory capital of the Company, E*TRADE Bank or E*TRADE Savings Bank. If we were unable to raise equity or otherwise increase capital, we could face negative regulatory consequences, including under the “prompt corrective action” framework, such as restrictions on our activities 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.
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 applicable law, our banking activities are restricted to those that are financial in nature and certain real estate-related activities. Although we believe all of our existing activities and investments are permissible, 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. Various other laws and regulations require savings and loan holding companies such as the Company, as well as all of our thrift subsidiaries, to be both "well capitalized" or "well managed" in order for us to conduct certain financial activities, such as 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 certain activities as well as other negative regulatory actions.


E*TRADE 2017 10-K | Page 21
 
                    


In addition, E*TRADE Bank and E*TRADE Savings Bank are currently subject to extensive regulation of their 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 certain new activities by these subsidiaries require the prior approval of the OCC and the Federal Reserve, and in some cases the FDIC, any of which may deny approval or condition their approval on the imposition of limitations on the scope of our planned activity. 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.
Risks Relating to Owning Our Stock
The value of our common stock may be diluted if we need additional funds in the future and is subject to the liquidation preference of our preferred stock.
In the future, we may need to raise additional funds via the issuance and sale of our debt or equity instruments, which we may not be able to conduct on favorable terms, if 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 stockholders, without seeking further stockholder approval. We have issued $700 million aggregate liquidation preference of preferred stock in two series, Series A Preferred Stock and Series B Preferred Stock. Future issuances and sales of preferred stock or the perception that such issuances and sales could occur, may also cause prevailing market prices for the Series A Preferred Stock, Series B Preferred Stock and our common stock to decline and may adversely affect our ability to raise additional capital in the financial markets at times and prices favorable to us.
The market price of our common stock may continue to be volatile.
From January 1, 2013 through December 31, 2017, the price per share of our common stock ranged from a low of $9.06 to a high of $51.04. The market price of our common stock has been, and is likely to continue to be, highly volatile and subject to wide fluctuations. Among the factors that may affect our stock price are the following:
Speculation in the investment community or the press about, or actual changes in, our competitive position, organizational structure, executive team, operations, financial condition, financial reporting and results, ability to meet growth targets or plans to engage in strategic transactions
The announcement of new products, services, acquisitions, or dispositions by us or our competitors
Increases or decreases in revenues or earnings, changes in earnings estimates by the investment community, and variations between estimated financial results and actual financial results
The pricing structure for products and services offered to customers by us or our competitors
General stock market volatility or volatility related to our industry may also affect our stock price. 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. We have been a party to litigation related to the decline in the market price of our stock in the past and such litigation could occur again in the future. Declines in the market price of our common stock or


E*TRADE 2017 10-K | Page 22
 
                    


failure of the market price to increase could also harm our ability to retain key employees, reduce our access to capital 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 stockholder 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 stockholders
The prohibition of stockholder action by written consent
Advance notice requirements for nominations to the Board or for proposing matters that can be acted on by stockholders at stockholder meetings
In addition, certain provisions of our stock incentive plans, management retention and employment agreements (including severance payments and stock option acceleration), our senior unsecured revolving credit facility, certain provisions of Delaware law and certain provisions of the indentures governing certain series of our debt securities that would require us to offer to purchase such securities at a premium in the event of certain changes in our ownership may also discourage, delay or prevent someone from acquiring or merging with us, which could limit the opportunity for our stockholders to receive a premium for their shares of our common stock and could also affect the price that some investors are willing to pay for our common stock.
ITEM 1B.    UNRESOLVED STAFF COMMENTS
None.


E*TRADE 2017 10-K | Page 23
 
                    


ITEM 2.    PROPERTIES
A summary of our significant locations at December 31, 2017 is shown in the following table. Square footage amounts are net of space that has been sublet or space that is part of a facility restructuring. 
Location
 
Approximate Square Footage
Alpharetta, Georgia
 
260,000
Jersey City, New Jersey
 
109,000
Arlington, Virginia
 
102,000
Sandy, Utah
 
85,000
Menlo Park, California
 
63,000
Chicago, Illinois
 
46,000
New York, New York
 
31,000
All facilities are leased at December 31, 2017. 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 regional financial centers, ranging in space from approximately 2,500 to 8,000 square feet.
ITEM 3.    LEGAL PROCEEDINGS
Information in response to this item can be found under the heading Legal Matters in Note 20—Commitments, Contingencies and Other Regulatory Matters in this Annual Report and is incorporated by reference into this item.
ITEM 4.     MINE SAFETY DISCLOSURES
Not applicable.


E*TRADE 2017 10-K | Page 24
 
                    


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 graph shows the high and low intraday sale prices of our common stock as reported by the NASDAQ for the periods indicated:
chart-3f0e0b15e88ac7e11f8.jpg
 
2017
 
2016
 
High
 
Low
 
High
 
Low
First Quarter
$
38.61

 
$
32.25

 
$
29.05

 
$
19.61

Second Quarter
$
38.52

 
$
33.06

 
$
28.14

 
$
21.52

Third Quarter
$
43.67

 
$
38.13

 
$
29.36

 
$
21.94

Fourth Quarter
$
51.04

 
$
42.55

 
$
36.04

 
$
27.34

The closing sale price of our common stock as reported on the NASDAQ on February 16, 2018 was $51.81 per share. At that date, there were 628 holders of record of our common stock.
Common Stock Dividends
We have never declared or paid cash dividends on our common stock and have no current plans to do so in the future. For additional information regarding our ability to pay dividends, see Business–Regulation, Note 16–Shareholders' Equity and Note 18–Regulatory Requirements.


E*TRADE 2017 10-K | Page 25
 
                    


Issuer Purchases of Equity Securities
The table below shows the timing and impact of our share repurchase program, if applicable, and the shares withheld from employees to satisfy tax withholding obligations during the three months ended December 31, 2017 (dollars in millions, except per share amounts):
Period
 
Total Number of Shares Purchased(1)
 
Average Price Paid per Share(2)
 
Total Number of Shares Purchased as Part of the Publicly Announced
Plan(3)
 
Maximum Dollar Value of Shares That May Yet Be Purchased Under the Plan(3)
October 1, 2017 - October 31, 2017
 
1,033,764

 
$
43.53

 
1,033,400

 
$
768.0

November 1, 2017 - November 30, 2017
 
2,162,089

 
$
44.19

 
2,153,600

 
$
672.8

December 1, 2017 - December 31, 2017
 
704,668

 
$
49.48

 
702,900

 
$
638.0

Total
 
3,900,521

 
$
44.97

 
3,889,900

 
 
(1)
Of the shares purchased during the three months ended December 31, 2017, 10,621 were withheld to satisfy tax withholding obligations associated with vested share-based payments.
(2)
Excludes commission paid.
(3)
In July 2017, we announced that our Board of Directors authorized the repurchase of up to $1 billion of shares of our common stock. The timing and exact amount of any common stock repurchases will depend on various factors, including market conditions and our capital position. Our share repurchase program does not include specific price targets, may be executed through open market purchases or privately negotiated transactions, may utilize Rule 10b5-1 plans and may be suspended or terminated at any time at our discretion.


E*TRADE 2017 10-K | Page 26
 
                    


Performance Graph
The following performance graph shows the cumulative total return to a holder of our common stock, assuming dividend reinvestment, compared with the cumulative total return, assuming dividend reinvestment, of the Standard & Poor (S&P) 500 Index and the Dow Jones US Financials Index during the period from December 31, 2012 through December 31, 2017.
chart-c30f070f13917bf5fc3.jpg
 
12/12
 
12/13
 
12/14
 
12/15
 
12/16
 
12/17
E*TRADE Financial Corporation
100.00

 
219.44

 
271.01

 
331.17

 
387.15

 
553.85

S&P 500 Index
100.00

 
132.39

 
150.51

 
152.59

 
170.84

 
208.14

Dow Jones US Financials Index
100.00

 
134.22

 
153.80

 
153.94

 
180.64

 
216.82



E*TRADE 2017 10-K | Page 27
 
                    


ITEM 6.    SELECTED FINANCIAL DATA
The selected consolidated financial data should be read in conjunction with MD&A and Financial Statements and Supplementary Data.
(Dollars in millions except per share amounts, shares in thousands):
 
 
Year Ended December 31,
 
Variance
 Results of Operations:
 
2017
 
2016
 
2015
 
2014
 
2013
 
2017 vs. 2016
Net interest income
 
$
1,485

 
$
1,148

 
$
1,021

 
$
961

 
$
855

 
29%
Commissions
 
$
441

 
$
442

 
$
424

 
$
456

 
$
420

 
—%
Total net revenue
 
$
2,366

 
$
1,941

 
$
1,370

 
$
1,704

 
$
1,613

 
22%
Provision (benefit) for loan losses
 
$
(168
)
 
$
(149
)
 
$
(40
)
 
$
36

 
$
143

 
13%
Total non-interest expense
 
$
1,470

 
$
1,252

 
$
1,319

 
$
1,216

 
$
1,275

 
17%
Net income
 
$
614

 
$
552

 
$
268

 
$
293

 
$
86

 
11%
Basic earnings per share
 
$
2.16

 
$
1.99

 
$
0.92

 
$
1.02

 
$
0.30

 
9%
Diluted earnings per share
 
$
2.15

 
$
1.98

 
$
0.91

 
$
1.00

 
$
0.29

 
9%
Weighted average shares—basic
 
273,190

 
277,789

 
290,762

 
288,705

 
286,991

 
(2)%
Weighted average shares—diluted
 
274,352

 
279,048

 
295,011

 
294,103

 
292,589

 
(2)%
 Financial Condition (at year end):
 
 
 
 
 
 
 
 
 
 
 
 
Available-for-sale securities
 
$
20,679

 
$
13,892

 
$
12,589

 
$
12,388

 
$
13,592

 
49%
Held-to-maturity securities
 
$
23,839

 
$
15,751

 
$
13,013

 
$
12,248

 
$
10,181

 
51%
Margin receivables
 
$
9,071

 
$
6,731

 
$
7,398

 
$
7,675

 
$
6,353

 
35%
Loans receivable, net
 
$
2,654

 
$
3,551

 
$
4,613

 
$
5,979

 
$
8,123

 
(25)%
Total assets
 
$
63,365

 
$
48,999

 
$
45,427

 
$
45,530

 
$
46,280

 
29%
Deposits
 
$
42,742

 
$
31,682

 
$
29,445

 
$
24,890

 
$
25,971

 
35%
Customer payables
 
$
9,449

 
$
8,159

 
$
6,544

 
$
6,455

 
$
6,310

 
16%
Corporate debt
 
$
991

 
$
994

 
$
997

 
$
1,366

 
$
1,768

 
—%
Shareholders’ equity
 
$
6,931

 
$
6,272

 
$
5,799

 
$
5,375

 
$
4,856

 
11%


E*TRADE 2017 10-K | Page 28
 
                    


ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (MD&A)
The following discussion should be read in conjunction with the consolidated financial statements and related notes included in Financial Statements and Supplementary Data.
OVERVIEW
Our mission is to enhance the financial independence of investors and traders through a powerful digital offering and professional guidance. Our vision is to be the #1 digital broker and advisor to traders and investors, known for an easy-to-use platform and the completeness of our offering. Our success in the future will depend upon, among other things, our ability to execute on our business strategy. Our financial performance is affected by a number of factors outside of our control, including:
Customer demand for financial products and services and the impact of actions by our competitors
Our ability to attract and retain customers
Performance, volume and volatility of the equity and capital markets
The level and volatility of interest rates
Our ability to move capital to our parent company from our subsidiaries subject to regulatory approvals or notifications
Changes to the rules and regulations governing the financial services industry
The performance of the residential real estate and credit markets
Market demand and liquidity in the secondary market for agency securities
Our net revenue is generated primarily from net interest income, commissions and fees and service charges. Net interest income is largely impacted by the size of our balance sheet, our balance sheet mix, and average yields on our assets and liabilities. Net interest income is driven primarily from interest earned on investment securities and margin receivables, less interest paid on interest-bearing liabilities, including deposits, customer payables, corporate debt and other borrowings. Net interest income is also earned on our legacy mortgage loan portfolio which we expect to continue to run off in future periods. Commissions revenue is generated by customer trades and is largely impacted by trade volume and commission rates. Fees and service charges revenue is mainly impacted by order flow revenue, fees earned on off-balance sheet customer cash, mutual fund service fees and advisor management fees. Our net revenue is offset by non-interest expenses, the largest of which are compensation and benefits and advertising and market development.
Significant Events
Announced acquisition of brokerage accounts from Capital One
In January 2018, we announced an agreement to acquire approximately one million retail brokerage accounts with $18 billion in customer assets from Capital One for a cash purchase price of up to $170 million. We intend to fund this transaction with existing corporate cash. The acquisition is expected to close by the third quarter of 2018, subject to customary closing conditions and regulatory approvals.


E*TRADE 2017 10-K | Page 29
 
                    


Announced Trust Company of America acquisition
In October 2017, we announced an agreement to acquire TCA for $275 million in cash. We intend to fund the transaction with the net proceeds received from our December 2017 issuance of fixed-to-floating rate non-cumulative perpetual preferred stock. The acquisition is expected to close by the second quarter of 2018, subject to customary closing conditions and regulatory approvals.
Completed OptionsHouse integration
In August 2017, we completed the integration of OptionsHouse, which was acquired by the Company in 2016. Completion of the integration included the rollout of OptionsHouse features and functionality through E*TRADE.com and consolidation of retail brokerage accounts and customer-related balances onto our platforms.
Issued $1 billion of senior notes and redeemed higher cost corporate debt
In August 2017, we issued $600 million of 2.95% Senior Notes due 2022 and $400 million of 3.80% Senior Notes due 2027 and used the net proceeds, along with existing corporate cash, to redeem our outstanding $540 million of 5.375% Senior Notes and $460 million of 4.625% Senior Notes, resulting in a $58 million loss on early extinguishment of debt. This transaction reduced our annual corporate debt service costs from $50 million to $33 million.
Repurchased 8.5 million shares of our common stock
In July 2017, we announced that our Board of Directors authorized the repurchase of up to $1 billion of shares of our common stock. During the year ended December 31, 2017, the Company repurchased 8.5 million shares of common stock at an average price of $42.62 for a total of $362 million. As of December 31, 2017, $638 million remained available for additional repurchases. As of February 16, 2018, we have subsequently repurchased an additional 1.1 million shares of common stock at an average price of $49.99.
Tier 1 leverage ratio thresholds reduced for E*TRADE Financial and E*TRADE Bank
Beginning July 2017, E*TRADE Financial's consolidated Tier 1 leverage ratio threshold was reduced to 6.5%, down from the previous threshold of 7.0%. E*TRADE Bank's Tier 1 leverage ratio threshold was reduced to 7.5% from 8.0% in February 2017 and was further reduced to 7.0% beginning January 2018.
Launch of new advertising campaign - Don't Get Mad, Get E*TRADE
We launched a new advertising campaign, Don't Get Mad, Get E*TRADE. This campaign acknowledges the everyday frustrations that consumers feel when bombarded by depictions of exaggerated wealth, and encourages consumers to channel these frustrations into positive action. Through the campaign we aim to tell consumers that we understand them, and we offer a way for them to have greater control over their future.
Reduced commission rates for equity and options trades
In March 2017, we reduced trade commissions for stock, options and exchange-traded funds (ETFs) to $6.95 from $9.99. For active traders, commissions were reduced to $4.95 from $7.99 and options charges were reduced to $0.50 per contract from $0.75. Further, the number of trades required to reach the active tier were reduced to 30 per quarter from 150.


E*TRADE 2017 10-K | Page 30
 
                    


Exceeded $50 billion in total consolidated assets
The Company exceeded $50 billion in total consolidated assets in the first quarter of 2017 and ended the year at over $63 billion. We continue to monitor and prepare for the incremental regulatory and reporting requirements that will apply as a result of this balance sheet growth.


E*TRADE 2017 10-K | Page 31
 
                    


Key Performance Metrics
Management monitors a number of customer activity and company metrics to evaluate the Company’s performance. The most significant of these are displayed below along with the percentage variance from the prior period, where applicable, and includes OptionsHouse from the September 12, 2016 acquisition date.
Customer Activity Metrics:
chart-4e4b3cf95f515904a7e.jpg chart-24635fbd8cd4e2e2e5d.jpg
chart-8356311de4a3592c83d.jpg chart-af87ad3c0d995a8facc.jpg
chart-a618d13fed1c516286c.jpgchart-03478ffa47c75143876.jpg


E*TRADE 2017 10-K | Page 32
 
                    


chart-709485346869554aa35.jpgchart-efe34fdd2995589e921.jpg
chart-fb4fb4e097eb5553806.jpg chart-f4d048feb5e081d920e.jpg

legenda02.jpg
 
chart-f985d339a9abf23d440.jpg chart-189276bdfb495dfdb3d.jpg
 

legenda02.jpg


E*TRADE 2017 10-K | Page 33
 
                    


chart-a56b603ba164107d0ac.jpg chart-52b743e272aa5cbba72.jpg
Daily Average Revenue Trades (DARTs) is the predominant driver of commissions revenue from our customers. DARTs were 214,284, 164,134 and 155,470 for the years ended December 31, 2017, 2016 and 2015, respectively.
Derivative DARTs, a key driver of commissions revenue, is the daily average number of options and futures trades, and Derivative DARTs percentage is the mix of options and futures as a component of total DARTs. Derivative DARTs were 65,264, 42,430 and 37,826 for the years ended December 31, 2017, 2016 and 2015, respectively, and Derivative DARTs represented 30%, 26% and 24%, respectively, of total DARTs.
Average commission per trade is an indicator of changes in our customer mix, product mix and/or product pricing. Average commission per trade was $8.23, $10.70 and $10.86 for the years ended December 31, 2017, 2016 and 2015, respectively. Average commission per trade for the year ended December 31, 2017 was impacted by our reduced commission rates for equity and options trades effective March 13, 2017, which were as follows:
Stock, options and ETF trade commissions reduced to $6.95 from $9.99
For active traders, commissions reduced to $4.95 from $7.99 and options charges reduced to $0.50 per contract from $0.75; trades required for active trader tier reduced to 30 per quarter from 150
Customer margin balances represents credit extended to customers to finance their purchases of securities by borrowing against securities they own and is a key driver of net interest income. Customer margin balances were $9.1 billion, $7.1 billion and $7.4 billion at December 31, 2017, 2016 and 2015, respectively. Customer margin at December 31, 2016 includes OptionsHouse balances which were held by a third party clearing firm. In connection with the integration of OptionsHouse, $0.4 billion of customer margin held by the third party clearing firm was transferred to our balance sheet and is reflected as margin receivables at December 31, 2017.
Managed products represents customer assets in our Managed Investment Portfolio, Unified Managed Account, Fixed Income Portfolio and Adaptive Portfolio. Managed products are a driver of fees and service charges revenue. Managed products were $5.4 billion, $3.9 billion and $3.2 billion at December 31, 2017, 2016 and 2015, respectively.
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. End of period brokerage accounts were 3.6 million, 3.5 million and 3.2 million at December 31, 2017, 2016 and 2015, respectively. Net new brokerage accounts were 171,906, 249,462 and 69,618 for the years ended December 31, 2017, 2106 and 2015, respectively. Our brokerage account attrition rate was 9.4%, 8.5% and 9.7% for the years ended December 31, 2017, 2016 and 2015 respectively. During the years ended December 31, 2017, 2016 and 2015 our net new brokerage account growth rate was 5.0%, 7.8% and 2.2%, respectively. These metrics include the impact of the following:


E*TRADE 2017 10-K | Page 34
 
                    


Net new and end of period brokerage accounts for the year ended December 31, 2016 included 147,761 accounts from the OptionsHouse acquisition. Excluding the impact of this item, the net new brokerage account growth rate was 3.2% for the year ended December 31, 2016.
Net new and end of period brokerage accounts for the year ended December 31, 2015 were impacted by the closure of 23,150 accounts related to the shutdown of the Company's global trading platform and the closure of 3,484 accounts related to the escheatment of unclaimed property. Excluding the impact of these items, the brokerage account attrition rate was 8.9% for the year ended December 31, 2015.
Customer assets is an indicator of the value of our relationship with the customer. An increase 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. Customer assets were $383.3 billion, $311.3 billion and $287.9 billion at December 31, 2017, 2016 and 2015, respectively.
Net new brokerage assets is total inflows to new and existing brokerage accounts less total outflows from closed and existing brokerage accounts. The net new brokerage assets metric is a general indicator of the use of our products and services by new and existing brokerage customers. Net new brokerage assets were $12.2 billion, $13.1 billion and $9.3 billion for the years ended December 31, 2017, 2016 and 2015, respectively. During the years ended December 31, 2017, 2016 and 2015, our net new brokerage asset growth rate was 4.4%, 5.3% and 3.8%, respectively. Net new brokerage assets for the year ended December 31, 2016 included $3.7 billion from the OptionsHouse acquisition. Excluding the impact of this item, the net new brokerage asset growth rate was 3.8% for the year ended December 31, 2016.
Brokerage related cash is an indicator of the level of engagement with our brokerage customers and is a key driver of net interest income as well as fees and service charges revenue, which includes fees earned on customer cash held by third parties. Brokerage related cash was $52.9 billion, $51.4 billion and $41.7 billion at December 31, 2017, 2016 and 2015, respectively.
Company Metrics:
chart-57b5aebff37058f6a25.jpg chart-f1d77abff117520cb44.jpg



E*TRADE 2017 10-K | Page 35
 
                    


chart-ba8512ea65525233820.jpg chart-d9f31c004f605febabf.jpg

chart-c6b45aceadad5c19810.jpg chart-42f02e2dc7e251be8b3.jpg

chart-6eccfa618e7a5fc99f7.jpg chart-065b39f86ec6515abc9.jpg
Operating margin is the percentage of net revenue that results in income before income taxes and is an indicator of the Company's profitability. Operating margin was 45%, 43% and 7% for the years ended December 31, 2017, 2016 and 2015, respectively.


E*TRADE 2017 10-K | Page 36
 
                    


Adjusted operating margin is a non-GAAP measure that provides useful information about our ongoing operating performance by excluding the provision (benefit) for loan losses, the loss on termination of wholesale funding obligations and losses on early extinguishment of debt, which are not viewed as key factors governing our investment in the business and are excluded by management when evaluating operating margin performance. Adjusted operating margin was 40%, 35% and 31% for the years ended December 31, 2017, 2016 and 2015, respectively. See MD&A—Earnings Overview for a reconciliation of adjusted operating margin to operating margin.
Corporate cash, a non-GAAP measure, is a component of cash and equivalents and represents the primary source of capital above and beyond the capital deployed in our regulated subsidiaries. Corporate cash was $541 million, $461 million and $447 million at December 31, 2017, 2016 and 2015, respectively, while cash and equivalents was $931 million, $2.0 billion and $2.2 billion for the same periods. See MD&A—Liquidity and Capital Resources for a reconciliation of corporate cash to cash and equivalents.
Tier 1 leverage ratio is an indicator of capital adequacy for E*TRADE Financial and E*TRADE Bank. Tier 1 leverage ratio is Tier 1 capital divided by adjusted average assets for leverage capital purposes. E*TRADE Financial's Tier 1 leverage ratio was 7.4%, 7.8% and 9.0% at December 31, 2017, 2016 and 2015, respectively. E*TRADE Bank's Tier 1 leverage ratio was 7.6%, 8.8% and 9.7% at December 31, 2017, 2016 and 2015, respectively. See MD&A—Liquidity and Capital Resources for additional information, including the calculation of regulatory capital ratios.
Allowance for loan losses is an estimate of probable losses inherent in the loan portfolio as of 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 (TDRs). Allowance for loan losses was $74 million, $221 million and $353 million at December 31, 2017, 2016 and 2015, respectively.
Interest-earning assets, along with net interest margin, is an indicator of our ability to generate net interest income. Average interest-earning assets were $53.2 billion, $43.3 billion and $41.0 billion for the years ended December 31, 2017, 2016 and 2015, respectively.
Net interest margin is a measure of the net yield on our average interest-earning assets. Net interest margin is calculated for a given period by dividing the annualized sum of net interest income by average interest-earning assets. Net interest margin was 2.79%, 2.65% and 2.50% for the years ended December 31, 2017, 2016 and 2015, respectively.
Total employees were 3,607, 3,601 and 3,421 at December 31, 2017, 2016 and 2015, respectively.


E*TRADE 2017 10-K | Page 37
 
                    


EARNINGS OVERVIEW
We generated net income of $614 million on total net revenue of $2.4 billion for the year ended December 31, 2017. The following chart provides a reconciliation of net income for the year ended December 31, 2016 to net income for the year ended December 31, 2017 (dollars in millions):
chart-3ac5fb514b585ef28e4.jpg
(1)
Includes commissions and other revenue.
(2)
Includes clearing and servicing, professional services, occupancy and equipment, depreciation and amortization, FDIC insurance premiums, amortization of other intangibles, restructuring and acquisition-related activities and other non-interest expenses.



E*TRADE 2017 10-K | Page 38
 
                    


The significant components of the consolidated statement of income are as follows (dollars in millions except per share amounts):
 
Year Ended December 31,
 
Variance
 
Variance
 
 
2017 vs. 2016
2016 vs. 2015
 
2017
 
2016
 
2015
 
Amount
 
%
 
Amount
 
%
Net interest income
$
1,485

 
$
1,148

 
$
1,021

 
$
337

 
29
%
 
$
127

 
12
 %
Total non-interest income
881

 
793

 
349

 
88

 
11
%
 
444

 
127
 %
Total net revenue
2,366

 
1,941

 
1,370

 
425

 
22
%
 
571

 
42
 %
Provision (benefit) for loan losses
(168
)
 
(149
)
 
(40
)
 
(19
)
 
13
%
 
(109
)
 
273
 %
Total non-interest expense
1,470

 
1,252

 
1,319

 
218

 
17
%
 
(67
)
 
(5
)%
Income before income tax expense (benefit)
1,064

 
838

 
91

 
226

 
27
%
 
747

 
821
 %
Income tax expense (benefit)
450

 
286

 
(177
)
 
164

 
57
%
 
463

 
*

Net income
$
614

 
$
552

 
$
268

 
$
62

 
11
%
 
$
284

 
106
 %
Preferred stock dividends
25

 

 

 
25

 
100
%
 

 
 %
Net income available to common shareholders
$
589

 
$
552

 
$
268

 
$
37

 
7
%
 
$
284

 
106
 %
Diluted earnings per common share
$
2.15

 
$
1.98

 
$
0.91

 
$
0.17

 
9
%
 
$
1.07

 
118
 %
*
Percentage not meaningful.
Net income increased 11% to $614 million, or $2.15 per diluted share, for the year ended December 31, 2017 compared to 2016 and increased 106% to $552 million, or $1.98 per diluted share, for the year ended December 31, 2016 compared to 2015. Net income available to common shareholders was $589 million for the year ended December 31, 2017, which reflects payments of $25 million in preferred stock dividends, compared to net income available to common shareholders of $552 million and $268 million in 2016 and 2015, respectively.
The increase in net income from 2016 to 2017 was primarily driven by higher interest income due to a larger balance sheet and higher interest rates, as well as higher fees and service charges revenue. Net income for the year ended December 31, 2017 included a $168 million benefit for loan losses, which was partially offset by $27 million of pre-tax costs primarily incurred in connection with the OptionsHouse integration and preparation for the incremental regulatory and reporting requirements that our balance sheet growth requires, and a $58 million pre-tax loss on early extinguishment of corporate debt. The year ended December 31, 2017 also included a $58 million income tax expense related to the remeasurement of our net deferred tax assets due to tax reform and the new statutory federal income tax rate.
The increase in net income from 2015 to 2016 resulted primarily from the $413 million pre-tax charge on the termination of legacy wholesale funding obligations recognized in 2015. This pre-tax charge included $43 million of losses on early extinguishment of debt and $370 million of losses that were reclassified from accumulated other comprehensive loss related to cash flow hedges into the gains (losses) on securities and other, net line item. The benefit for loan losses increased to $149 million in 2016 from $40 million in 2015. The year ended December 31, 2015 also included a $220 million income tax benefit resulting from the settlement of an IRS examination and a $73 million pre-tax loss on early extinguishment of corporate debt.


E*TRADE 2017 10-K | Page 39
 
                    


Net Revenue
The components of net revenue and the resulting variances are as follows (dollars in millions):
 
Year Ended December 31,
 
Variance
 
Variance
 
 
2017 vs. 2016
 
2016 vs. 2015
 
2017
 
2016
 
2015
 
Amount
 
%
 
Amount
 
%
Net interest income
$
1,485

 
$
1,148

 
$
1,021

 
$
337

 
29
 %
 
$
127

 
12
%
Commissions
441

 
442

 
424

 
(1
)
 
 %
 
18

 
4
%
Fees and service charges
369

 
268

 
210

 
101

 
38
 %
 
58

 
28
%
Gains (losses) on securities and other, net
28

 
42

 
(324
)
 
(14
)
 
(33
)%
 
366

 
*

Other revenue
43

 
41

 
39

 
2

 
5
 %
 
2

 
5
%
Total non-interest income
881

 
793

 
349

 
88

 
11
 %
 
444

 
127
%
Total net revenue
$
2,366

 
$
1,941

 
$
1,370

 
$
425

 
22
 %
 
$
571

 
42
%
*
Percentage not meaningful.
Net Interest Income
Net interest income increased 29% to $1.5 billion for the year ended December 31, 2017 compared to 2016, and increased 12% to $1.1 billion for the year ended December 31, 2016 compared to 2015. Net interest income is earned primarily through investment securities, margin receivables and our legacy mortgage and consumer loan portfolio, offset by funding costs. The legacy wholesale funding obligations termination in 2015 and our investment grade debt refinancing in 2017 significantly reduced our funding costs and improved our ability to generate net interest income.


E*TRADE 2017 10-K | Page 40
 
                    


The following table presents average balance sheet data and interest income and expense data, as well as the related net interest margin, yields and rates (dollars in millions):
 
Year Ended December 31,
 
2017
 
2016
 
2015
 
Average Balance
 
Interest Inc./Exp.
 
Average Yield/
Cost
 
Average Balance
 
Interest Inc./Exp.
 
Average Yield/
Cost
 
Average Balance
 
Interest Inc./Exp.
 
Average Yield/
Cost
Cash and equivalents
$
1,011

 
$
9

 
0.89
%
 
$
1,700

 
$
7

 
0.41
%
 
$
1,728

 
$
3

 
0.18
%
Cash required to be segregated under federal or other regulations
1,186

 
12

 
0.99
%
 
1,553

 
6

 
0.36
%
 
425

 
1

 
0.15
%
Available-for-sale securities
18,391

 
390

 
2.12
%
 
13,265

 
266

 
2.01
%
 
12,541

 
245

 
1.95
%
Held-to-maturity securities
20,699

 
572

 
2.76
%
 
15,217

 
425

 
2.79
%
 
12,201

 
346

 
2.84
%
Margin receivables
7,721

 
320

 
4.15
%
 
6,592

 
249

 
3.77
%
 
7,884

 
276

 
3.50
%
Loans(1)
3,194

 
157

 
4.93
%
 
4,351

 
191

 
4.39
%
 
5,651

 
230

 
4.06
%
Broker-related receivables and other
1,014

 
3

 
0.29
%
 
594

 
1

 
0.16
%
 
527

 
3

 
0.61
%
Subtotal interest-earning assets
53,216

 
1,463

 
2.75
%
 
43,272

 
1,145

 
2.65
%
 
40,957

 
1,104

 
2.70
%
Other interest revenue(2)

 
108

 
 
 

 
88

 
 
 

 
112

 
 
    Total interest-earning assets
53,216

 
1,571

 
2.95
%
 
43,272

 
1,233

 
2.85
%
 
40,957

 
1,216

 
2.97
%
Total non-interest-earning assets
4,979

 
 
 
 
 
4,864

 
 
 
 
 
4,512

 
 
 
 
Total assets
$
58,195

 
 
 
 
 
$
48,136

 
 
 
 
 
$
45,469

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Sweep deposits
$
33,775

 
$
4

 
0.01
%
 
$
26,088

 
$
3

 
0.01
%
 
$
20,638

 
$
4

 
0.02
%
Savings deposits
3,085

 

 
0.01
%
 
3,227

 

 
0.01
%
 
3,534

 

 
0.01
%
Other deposits
2,055

 

 
0.03
%
 
2,018

 

 
0.03
%
 
1,977

 

 
0.03
%
Customer payables
8,793

 
5

 
0.06
%
 
7,221

 
5

 
0.07
%
 
6,435

 
5

 
0.07
%
Broker-related payables and other
1,250

 

 
0.00
%
 
1,286

 

 
0.00
%
 
1,759

 

 
0.00
%
Other borrowings
665

 
22

 
3.33
%
 
416

 
18

 
4.32
%
 
3,500

 
117

 
3.32
%
Corporate debt
994

 
48

 
4.77
%
 
994

 
54

 
5.41
%
 
1,076

 
59

 
5.63
%
Subtotal interest-bearing liabilities
50,617

 
79

 
0.16
%
 
41,250

 
80

 
0.19
%
 
38,919

 
185

 
0.49
%
Other interest expense(3)

 
7

 
 
 

 
5

 
 
 

 
9

 
 
    Total interest-bearing liabilities
50,617

 
86

 
0.17
%
 
41,250

 
85

 
0.21
%
 
38,919

 
194

 
0.50
%
Total non-interest-bearing liabilities
1,058

 
 
 
 
 
954

 
 
 
 
 
894

 
 
 
 
Total liabilities
51,675

 
 
 
 
 
42,204

 
 
 
 
 
39,813

 
 
 
 
Total shareholders' equity
6,520

 
 
 
 
 
5,932

 
 
 
 
 
5,656

 
 
 
 
Total liabilities and shareholders' equity
$
58,195

 
 
 
 
 
$
48,136

 
 
 
 
 
$
45,469

 
 
 
 
Excess interest earning assets over interest bearing liabilities/net interest income/net interest margin(4)
$
2,599

 
$
1,485

 
2.79
%
 
$
2,022

 
$
1,148

 
2.65
%
 
$
2,038

 
$
1,022

 
2.50
%
(1)
Nonaccrual loans are included in the average loan balances. Interest payments received on nonaccrual loans are recognized on a cash basis in interest income until it is doubtful that full payment will be collected, at which point payments are applied to principal.
(2)
Represents interest income on securities loaned.
(3)
Represents interest expense on securities borrowed.
(4)
The taxable equivalent adjustment to reconcile to net interest income was less than $1 million for the years ended December 31, 2017 and 2016 and $1 million for the year ended December 31, 2015.


E*TRADE 2017 10-K | Page 41
 
                    


 
Year Ended December 31,
 
2017
 
2016
 
2015
Ratio of interest-earning assets to interest-bearing liabilities
105.14
%
 
104.90
%
 
105.24
%
Return on average:
 
 
 
 
 
Total assets
1.06
%
 
1.15
%
 
0.59
%
Total shareholders’ equity
9.42
%
 
9.30
%
 
4.75
%
Average total shareholders’ equity to average total assets
11.20
%
 
12.32
%
 
12.44
%
Average interest-earning assets increased 23% to $53.2 billion for the year ended December 31, 2017 compared to 2016. The fluctuation in interest-earning assets is generally driven by changes in interest-bearing liabilities, primarily deposits and customer payables. Average interest-bearing liabilities increased 23% to $50.6 billion for the year ended December 31, 2017 compared to 2016. The increase was primarily due to higher deposits as a result of transferring customer cash held by third parties to our balance sheet. For additional information on our balance sheet growth and customer cash held by third parties, see MD&A—Balance Sheet Overview.
Net interest margin increased 14 basis points to 2.79% for the year ended December 31, 2017 compared to 2016. Net interest margin is driven by the mix of asset and liability average balances and the interest rates earned or paid on those balances. The increase during the year ended December 31, 2017 compared to 2016, is due to higher interest rates earned on increased margin receivable and available-for-sale securities balances, increased securities lending activities and lower corporate debt service cost, partially offset by the continued run-off of our higher yielding legacy mortgage and consumer loan portfolio.
Average interest-earning assets increased 6% to $43.3 billion for the year ended December 31, 2016 compared to 2015. Average interest-bearing liabilities increased 6% to $41.3 billion and net interest margin increased 15 basis points to 2.65%. The increase was primarily due to lower borrowing costs resulting from the termination of legacy wholesale funding obligations during 2015.
Commissions
Commissions revenue decreased by less than 1% to $441 million for the year ended December 31, 2017 compared to 2016, and increased 4% to $442 million for the year ended December 31, 2016 compared to 2015. The main factors that affect commissions revenue are DARTs, average commission per trade and the number of trading days.
DARTs volume increased 31% to 214,284 for the year ended December 31, 2017 compared to 2016, and increased 6% to 164,134 for the year ended December 31, 2016 compared to 2015, mainly driven by the inclusion of OptionsHouse accounts and the strength of the equity markets. Derivative DARTs volume increased 54% to 65,264 for the year ended December 31, 2017 compared to 2016 and increased 12% to 42,430 for the year ended December 31, 2016 compared to 2015. Derivative DARTs represented 30%, 26% and 24% of trading volume for the years ended December 31, 2017, 2016 and 2015, respectively.
Average commission per trade decreased 23% to $8.23 for the year ended December 31, 2017 compared to 2016 and decreased 1% to $10.70 for the year ended December 31, 2016 compared to 2015. Average commission per trade is impacted by customer mix and differing commission rates on various trade types (e.g. equities, derivatives, stock plan and mutual funds). Average commission per trade for the year ended December 31, 2017 was impacted by reduced commission rates implemented in March 2017 as well as increased trading activity from certain customers, qualifying them for lower commission rates due to our new active trader pricing. The lower price structure for customer accounts associated with the OptionsHouse acquisition has also impacted commissions revenue.


E*TRADE 2017 10-K | Page 42
 
                    


Fees and Service Charges
The components of fees and service charges and the resulting variances are as follows (dollars in millions):    
 
Year Ended December 31,
 
Variance
 
Variance
 
 
2017 vs. 2016
 
2016 vs. 2015
 
2017
 
2016
 
2015
 
Amount
 
%
 
Amount
 
%
Order flow revenue
$
135

 
$
96

 
$
85

 
$
39

 
41
%
 
$
11

 
13
%
Money market funds and sweep deposits revenue(1)
92

 
50

 
23

 
42

 
84
%
 
27

 
117
%
Mutual fund service fees
39

 
36

 
27

 
3

 
8
%
 
9

 
33
%
Advisor management fees
36

 
28

 
27

 
8

 
29
%
 
1

 
4
%
Foreign exchange revenue
26

 
21

 
15

 
5

 
24
%
 
6

 
40
%
Reorganization fees
16

 
16

 
12

 

 
%
 
4

 
33
%
Other fees and service charges
25

 
21

 
21

 
4

 
19
%
 

 
%
Total fees and service charges
$
369

 
$
268

 
$
210

 
$
101

 
38
%
 
$
58

 
28
%
(1)
Includes revenue earned on average customer cash held by third parties based on the federal funds rate or LIBOR plus a negotiated spread or other contractual arrangements with the third party institutions.
Fees and service charges increased 38% to $369 million for the year ended December 31, 2017 compared to 2016 and increased 28% to $268 million for the year ended December 31, 2016 compared to 2015. The increase in fees and service charges in both periods was largely driven by an increase in revenue earned on customer cash held by third parties, which was impacted by higher interest rates, partially offset by lower average balances. The gross yield on customer cash held by third parties was approximately 90 basis points, 40 basis points and 15 basis points for the years ended December 31, 2017, 2016 and 2015, respectively. In addition, during 2017 and 2016, fees and service charges benefited from increased order flow revenue from higher trading activity and higher revenue from advisor management fees driven by an increased average balance of assets under management.


E*TRADE 2017 10-K | Page 43
 
                    


Gains (Losses) on Securities and Other, Net
The components of gains (losses) on securities and other, net and the resulting variances are as follows (dollars in millions):
 
Year Ended December 31,
 
Variance
 
Variance
 
 
2017 vs. 2016
 
2016 vs. 2015
 
2017
 
2016
 
2015
 
Amount
 
%
 
Amount
 
%
Reclassification of deferred losses on cash flow hedges
$

 
$

 
$
(370
)
 
$

 
*

 
$
370

 
(100
)%
Gains on available-for-sale securities, net:
 
 
 
 
 
 
 
 
 
 


 


Gains on available-for-sale securities
40

 
54

 
58

 
$
(14
)
 
(26
)%
 
$
(4
)
 
(7
)%
Losses on available-for-sale securities

 
(1
)
 
(20
)
 
1

 
(100
)%
 
19

 
(95
)%
Subtotal
40

 
53


38

 
(13
)
 
(25
)%
 
15

 
39
 %
Hedge ineffectiveness
(14
)
 
(6
)
 
(1
)
 
(8
)
 
133
 %
 
(5
)
 
500
 %
Equity method investment income (loss) and other
2

 
(5
)
 
9

 
7

 
(140
)%
 
(14
)
 
(156
)%
Gains (losses) on securities and other, net
$
28

 
$
42

 
$
(324
)
 
$
(14
)
 
(33
)%
 
$
366

 
*

*
Percentage not meaningful.
Gains (losses) on securities and other, net was $28 million, $42 million and $(324) million for the years ended December 31, 2017, 2016 and 2015, respectively. Gains (losses) on securities and other, net for the year ended December 31, 2015 included $370 million of losses reclassified from accumulated other comprehensive loss related to cash flow hedges as a result of the termination of legacy wholesale funding obligations during 2015.
Provision (Benefit) for Loan Losses
We recognized a benefit for loan losses of $168 million, $149 million and $40 million for the years ended December 31, 2017, 2016 and 2015, respectively. The timing and magnitude of the provision (benefit) for loan losses is affected by many factors that could result in variability. These benefits reflected better than expected performance of our portfolio as well as recoveries in excess of prior expectations, including recoveries of previous charge-offs that were not included in our loss estimates, as well as payoffs on loans converting to amortizing. These benefits also reflected the following enhancements to our allowance for loan loss modeling approach during the periods presented:
The benefit for loan losses for the year ended December 31, 2017 reflected approximately $70 million of benefit resulting from refined default assumptions based on the sustained outperformance of converted mortgage loans that were previously interest-only and had now been amortizing for 12 months or longer.
The benefit for loan losses for the year ended December 31, 2016 included a $25 million benefit resulting from updated expectations based on the sustained outperformance of a substantial volume of high-risk HELOCs.
The benefit for loan losses during the year ended December 31, 2015 reflected a decrease in the allowance for loan losses that was partially offset by the impact of enhancements to our modeling practices.
For additional information on management's estimate of the allowance for loan losses, see MD&ASummary of Critical Accounting Policies and Estimates.


E*TRADE 2017 10-K | Page 44
 
                    


Non-Interest Expense
The components of non-interest expense and the resulting variances are as follows (dollars in millions):
 
Year Ended December 31,
 
Variance
 
Variance
 
 
2017 vs. 2016
 
2016 vs. 2015
 
2017
 
2016
 
2015
 
Amount
 
%
 
Amount
 
%
Compensation and benefits
$
546

 
$
501

 
$
466

 
$
45

 
9
 %
 
$
35

 
8
 %
Advertising and market development
166

 
131

 
124

 
35

 
27
 %
 
7

 
6
 %
Clearing and servicing
124

 
105

 
95

 
19

 
18
 %
 
10

 
11
 %
Professional services
99

 
97

 
103

 
2

 
2
 %
 
(6
)
 
(6
)%
Occupancy and equipment
116

 
98

 
88

 
18

 
18
 %
 
10

 
11
 %
Communications
121

 
87

 
90

 
34

 
39
 %
 
(3
)
 
(3
)%
Depreciation and amortization
82

 
79

 
81

 
3

 
4
 %
 
(2
)
 
(2
)%
FDIC insurance premiums
31

 
25

 
41

 
6

 
24
 %
 
(16
)
 
(39
)%
Amortization of other intangibles
36

 
23

 
20

 
13

 
57
 %
 
3

 
15
 %
Restructuring and acquisition-related activities
15

 
35

 
17

 
(20
)
 
(57
)%
 
18

 
106
 %
Losses on early extinguishment of debt, net
58

 

 
112

 
58

 
100
 %
 
(112
)
 
(100
)%
Other non-interest expenses
76

 
71

 
82

 
5

 
7
 %
 
(11
)
 
(13
)%
Total non-interest expense
$
1,470

 
$
1,252

 
$
1,319

 
$
218

 
17
 %
 
$
(67
)
 
(5
)%
Compensation and Benefits
Compensation and benefits expense increased 9% to $546 million for the year ended December 31, 2017 compared to 2016, and increased 8% to $501 million for the year ended December 31, 2016 compared to 2015. The expense increase in 2017 was primarily driven by higher incentive compensation reflecting improved overall Company performance. The increase in 2016 was primarily driven by a headcount increase of 5% as we hired additional customer service professionals and financial consultants consistent with our key business objective of accelerating growth of the core brokerage business. Headcount during 2016 was also impacted by the acquisition of OptionsHouse. The impact of increased headcount was partially offset by the reversal of share-based compensation and other incentive compensation that will not vest due to the Company's restructuring activities during the second half of 2016.
Advertising and Market Development
Advertising and market development expense increased 27% to $166 million for the year ended December 31, 2017 compared to 2016, and increased 6% to $131 million for the year ended December 31, 2016 compared to 2015. The increase in in both periods was primarily due to investments to drive customer acquisition and deepen engagement, and in 2017 was also driven by higher spending as we launched our new advertising campaign during the second quarter of 2017.
Communications
Communications expense increased 39% to $121 million for the year ended December 31, 2017 compared to 2016, and decreased 3% to $87 million for the year ended December 31, 2016 compared to 2015. The increase in 2017 was primarily driven by increased market data fees resulting from higher trading activity. Additionally, during 2017 we updated our accrual estimate for professional users of real time market data and recognized $8 million related to previous usage.


E*TRADE 2017 10-K | Page 45
 
                    


Restructuring and Acquisition-Related Activities
Restructuring and acquisition-related activities expense decreased 57% to $15 million, for the year ended December 31, 2017 compared to 2016, and increased 106% to $35 million for the year ended December 31, 2016 compared to 2015. Restructuring and acquisition-related activities for the year ended December 31, 2017 primarily related to the OptionsHouse integration costs. Restructuring and acquisition-related activities during the year ended December 31, 2016 reflected $28 million of restructuring costs related to the realignment of our core brokerage business and $7 million of acquisition-related expense from the OptionsHouse acquisition.
Losses on Early Extinguishment of Debt, Net
Losses on early extinguishment of debt, net were $58 million for the year ended December 31, 2017 compared to no losses for the year ended December 31, 2016 and $112 million for the year ended December 31, 2015.
During the third quarter of 2017, we issued $600 million of 2.95% Senior Notes due 2022 and $400 million of 3.80% Senior Notes due 2027 and used the net proceeds, along with existing corporate cash, to redeem our outstanding $540 million of 5.375% Senior Notes and $460 million of 4.625% Senior Notes, which resulted in a $58 million loss on early extinguishment of debt.
The $112 million net loss on early extinguishment of debt during the year ended December 31, 2015 included a $73 million loss on the redemption of 6.375% Senior Notes during the first quarter and a $43 million loss on the termination of legacy wholesale funding obligations during the third quarter, offset by a $4 million gain on the extinguishment of certain trust preferred securities.
Operating Margin
Operating margin was 45% for the year ended December 31, 2017, compared to 43% for the same period in 2016, and 7% for the same period in 2015. Adjusted operating margin, a non-GAAP measure, was 40% for the year ended December 31, 2017 compared to 35% in 2016 and 31% in 2015.
Adjusted operating margin is a non-GAAP measure calculated by dividing adjusted income before income tax expense by adjusted total net revenue. Adjusted income before income tax expense excludes provision (benefit) for loan losses, losses on early extinguishment of debt, net and the loss on termination of legacy wholesale funding obligations recognized in Gains (losses) on securities and other, net during the year ended December 31, 2015. The following table provides a reconciliation of adjusted income before income tax expense and adjusted operating margin, non-GAAP measures, to the most directly comparable GAAP measures (dollars in millions):
 
Year Ended December 31,
 
2017
 
2016
 
2015
 
Amount
 
Operating Margin %
 
Amount
 
Operating Margin %
 
Amount
 
Operating Margin %
Income before income tax expense / operating margin
$
1,064

 
45%
 
$
838

 
43%
 
$
91

 
7%
Add back impact of pre-tax items:
 
 
 
 
 
 
 
 
 
 
 
Loss included in Gains (losses) on securities and other, net

 
 
 

 
 
 
370

 
 
Provision (benefit) for loan losses
(168
)
 
 
 
(149
)
 
 
 
(40
)
 
 
Losses on early extinguishment of debt, net
58

 
 
 

 
 
 
112

 
 
Subtotal
(110
)
 
 
 
(149
)
 
 

442

 
 
Adjusted income before income tax expense / adjusted operating margin
$
954

 
40%
 
$
689

 
35%
 
$
533

 
31%


E*TRADE 2017 10-K | Page 46
 
                    


Adjusted total net revenue excludes the loss on termination of legacy wholesale funding obligations from total net revenue. The following table provides a reconciliation of adjusted total net revenue, a non-GAAP measure, to the most directly comparable GAAP measure (dollars in millions):
 
Year Ended December 31,
 
2017
 
2016
 
2015
Total net revenue
$
2,366

 
$
1,941

 
$
1,370

Add back impact of termination of legacy wholesale funding obligations:
 
 
 
 
 
Loss included in Gains (losses) on securities and other, net

 

 
370

Adjusted total net revenue
$
2,366