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EX-32.1 - EXHIBIT 32.1 - E TRADE FINANCIAL CORPetfc-2017331xex321.htm
EX-31.2 - EXHIBIT 31.2 - E TRADE FINANCIAL CORPetfc-2017331xex312.htm
EX-31.1 - EXHIBIT 31.1 - E TRADE FINANCIAL CORPetfc-2017331xex311.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
______________________________________
FORM 10-Q
______________________________________

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 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)
1271 Avenue of the Americas, 14th Floor, New York, New York 10020
(Address of principal executive offices and Zip Code)
(646) 521-4300
(Registrant’s telephone number, including area code)
 _____________________________________
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 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
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:
As of April 28, 2017, there were 275,010,754 shares of common stock outstanding.



E*TRADE FINANCIAL CORPORATION
FORM 10-Q QUARTERLY REPORT
For the Quarter Ended March 31, 2017
TABLE OF CONTENTS
PART I
FINANCIAL INFORMATION
 
Item 1.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
 
 
 
 
 
 
Item 3.
 
Item 4.
PART II
 
Item 1.
Item 1A.
Item 2.
Item 3.
Item 4.
Item 5.
Item 6.
 
 



E*TRADE | Q1 2017 10-Q                                       i



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 and OptionsHouse are registered trademarks of E*TRADE Financial Corporation in the United States and in other countries.


E*TRADE | Q1 2017 10-Q                                       ii


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 business strategy, objectives and vision; our plans and ability to deliver new products and solutions; our ability to improve client acquisition and deepen relationships with existing clients; our ability to effectively monetize brokerage relationships by investing in agency mortgage-backed securities; our capital plan initiatives, the expected balance sheet size, any balance sheet growth and the incremental regulatory and reporting requirements that our balance sheet size and growth may require; our ability to maintain required regulatory capital ratios; our plans for the payment of dividends from our subsidiaries to our parent company; our ability to identify and manage risks appropriately; 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; fluctuations in interest rates; customer demand for financial products and services; increased competition; cyber security threats, potential system disruptions and other security breaches; our ability to participate in consolidation opportunities in our industry; the ability to realize synergies or to implement integration plans and other risks from mergers and acquisitions; our ability to service our corporate debt; changes in government regulation or actions by our regulators; our ability to move capital to our parent company from our subsidiaries; adverse developments in litigation or regulatory matters; and other factors discussed under Part II. Item 1A. Risk Factors and Part I. Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations of this Form 10-Q; and Part I. Item 1A. Risk Factors of our Annual Report on Form 10-K for the year ended December 31, 2016, filed with the Securities and Exchange Commission (SEC), which are incorporated herein by reference. 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. You 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.
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the consolidated financial statements and the related notes that appear elsewhere in this document and with the Annual Report on Form 10-K for the year ended December 31, 2016.
OVERVIEW
Company Overview
E*TRADE is a financial services company that provides online brokerage and related products and services primarily to individual retail investors. Our mission is to enhance the financial independence of traders and investors 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 ease of use and the completeness of our offering.


E*TRADE | Q1 2017 10-Q                                       1


Strategy
Our business strategy is centered on two key objectives: accelerating the growth of our core brokerage business to drive organic growth and improve competitive position, and generating robust earnings growth and healthy returns on capital to deliver long-term value for our stakeholders.
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 drive customer acquisition while deepening engagement with our existing customers.
Capitalize on value of corporate services channel
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. Our corporate services channel is a strategically important driver of brokerage account and asset growth.
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.
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 for the benefit of our shareholders.
Financial Performance
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 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 and other assets, 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 in the First Quarter of 2017
Reduced commission rates for equity and options trades
Stock, options and exchange-traded fund (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 for active tier reduced to 30 per quarter from 150
Exceeded $50 billion in total consolidated assets
We exceeded $50 billion in total consolidated assets, ending the quarter at approximately $56 billion. We continue to monitor and prepare for the incremental regulatory and reporting requirements that this balance sheet growth requires.


E*TRADE | Q1 2017 10-Q                                       2


E*TRADE Bank to operate at a 7.5% minimum Tier 1 Leverage Ratio
Effective February 2017, E*TRADE Bank can operate at a 7.5% Tier 1 leverage ratio.
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 for the three months ended March 31, 2017 from the same period in 2016, where applicable, and includes OptionsHouse from the September 12, 2016 acquisition date.
Customer Activity Metrics:
etfc-201733_chartx29422.jpg etfc-201733_chartx30420.jpg
etfc-201733_chartx31740.jpg etfc-201733_chartx32881.jpg
etfc-201733_chartx34223.jpg etfc-201733_chartx35595.jpg


E*TRADE | Q1 2017 10-Q                                       3


etfc-201733_chartx37055.jpg etfc-201733_chartx38029.jpg
etfc-201733_chartx38991.jpg etfc-201733_chartx40030.jpg
etfc-201733_chartx41154.jpg


E*TRADE | Q1 2017 10-Q                                       4


Daily Average Revenue Trades (DARTs) are the predominant driver of commissions revenue from our customers. DARTs were 207,221 and 165,122 for the three months ended March 31, 2017 and 2016, respectively.
Derivative DARTs percentage is the mix of options and futures as a component of total DARTs and a key driver of commissions revenue. Derivative DARTs represented 29% and 24% of total DARTs for the three months ended March 31, 2017 and 2016, respectively.
Average commission per trade is an indicator of changes in our customer mix, product mix and/or product pricing. Average commission per trade was $9.87 and $10.64 for the three months ended March 31, 2017 and 2016, respectively. Average commissions per trade for the three months ended March 31, 2017 was impacted by our reduced commission rates for equity and options trades effective March 13, 2017.
Customer margin balances represent credit extended to customers to finance their purchases of securities by borrowing against securities they own and are a key driver of net interest income. Customer margin balances were $7.3 billion and $6.3 billion at March 31, 2017 and 2016, respectively. Customer margin includes OptionsHouse balances which are currently held by a third party clearing firm. Those balances were $0.4 billion at March 31, 2017.
Managed products represent customer assets in our Managed Investment Portfolio, Unified Managed Account, and Adaptive Portfolio products. Managed products are a driver of fees and service charges revenue from our customers. Managed products were $4.3 billion and $3.3 billion at March 31, 2017 and 2016, 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 3.5 million and 3.3 million at March 31, 2017 and 2016, respectively and net new brokerage accounts were 58,215 and 40,459 for the three months ended March 31, 2017 and 2016, respectively. Our annualized brokerage account attrition rate was 9.2% and 7.8% for the three months ended March 31, 2017 and 2016, respectively. During the three months ended March 31, 2017 and 2016, our annualized net new brokerage account growth rate was 6.7% and 5.0%, respectively.
Customer assets are 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 $335.7 billion and $284.5 billion at March 31, 2017 and 2016, respectively.
Net new brokerage assets are 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 $4.2 billion and $2.9 billion for the three months ended March 31, 2017 and 2016, respectively. During the three months ended March 31, 2017 and 2016, our annualized net new brokerage asset growth was 6.1% and 4.7%, respectively.
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 $53.5 billion and $42.6 billion at March 31, 2017 and 2016, respectively.








E*TRADE | Q1 2017 10-Q                                       5


Company Metrics:
etfc-201733_chartx42120.jpg etfc-201733_chartx42982.jpg

etfc-201733_chartx43975.jpg etfc-201733_chartx45000.jpg

etfc-201733_chartx45882.jpg etfc-201733_chartx46752.jpg



E*TRADE | Q1 2017 10-Q                                       6


etfc-201733_chartx47597.jpg etfc-201733_chartx48631.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 41% for both the three months ended March 31, 2017 and 2016.
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, which is not viewed as a key factor governing our investment in the business and is excluded by management when evaluating operating margin performance. Adjusted operating margin was 38% and 34% for the three months ended March 31, 2017 and 2016, respectively. See Earnings Overview for a reconciliation of this non-GAAP measure to the most directly comparable GAAP measure.
Corporate cash is a component of cash and equivalents which represents the primary source of capital above and beyond the capital deployed in our regulated subsidiaries. Corporate cash was $417 million and $482 million at March 31, 2017 and 2016, respectively. See Liquidity and Capital Resources for a reconciliation of this non-GAAP measure to the most directly comparable GAAP measure.
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 7.2% and 7.8% at March 31, 2017 and 2016, respectively. E*TRADE Bank's Tier 1 leverage ratio was 8.1% and 8.6% at March 31, 2017 and 2016, respectively. See 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 $213 million and $322 million at March 31, 2017 and 2016, respectively.
Interest-earning assets, in conjunction with net interest margin, is an indicator of our ability to generate net interest income. Average interest-earning assets were $48.7 billion and $40.9 billion for the three months ended March 31, 2017 and 2016, 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 2.63% and 2.81% for the three months ended March 31, 2017 and 2016, respectively.
Total employees were 3,629 and 3,498 at March 31, 2017 and 2016, respectively.
Regulatory Developments
In April 2016, the U.S. Department of Labor published its final fiduciary regulations under the Employee Retirement Income Security Act of 1974 and the Internal Revenue Code of 1986. While originally scheduled to take effect in April 2017, the applicability date for the regulations was extended to June 9, 2017. These regulations will subject certain persons, such as broker-dealers and other financial services providers that provide investment advice to individual retirement accounts and other qualified retirement plans and accounts,


E*TRADE | Q1 2017 10-Q                                       7


to fiduciary duties and prohibited transaction restrictions for a wider range of customer interactions. The Company is in the process of implementing the regulations, which has resulted in additional costs. Implementation of the regulations will have an impact on how advice is provided to our customers' tax-qualified retirement accounts and benefit plans and, in their current form, may diminish our profitability and will increase potential legal liability with respect to these accounts and plans.
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 measured in accordance with each applicable regulation, but generally on the basis of the average of the four most recent quarters, is a meaningful regulatory threshold as U.S. 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.
The Company expects these regulatory requirements, not all of which have been finalized, to start becoming applicable to it in 2018. The Company has begun implementing policies, procedures, systems and governance structures that are designed to comply with the requirements. Additionally, while savings and loan holding companies are currently excluded from the scope of certain regulations that apply to bank holding companies, the Company expects it will ultimately be subject to these requirements. For additional information see Part I. Item 1. Business of our Annual Report on Form 10-K for the year ended December 31, 2016.



E*TRADE | Q1 2017 10-Q                                       8


EARNINGS OVERVIEW
We generated net income of $145 million on total net revenue of $553 million for the three months ended March 31, 2017. The following chart provides a reconciliation of net income at March 31, 2016 to net income at March 31, 2017 (dollars in millions):
etfc-201733_chartx34120.jpg
The following table sets forth the significant components of the consolidated statement of income (dollars in millions except per share amounts):
 
Three Months Ended March 31,
 
Variance
 
 
2017 vs. 2016
 
2017
 
2016
 
Amount
 
%
Net interest income
$
319

 
$
287

 
$
32

 
11
 %
Total non-interest income
234

 
185

 
49

 
26
 %
Total net revenue
553

 
472

 
81

 
17
 %
Provision (benefit) for loan losses
(14
)
 
(34
)
 
20

 
(59
)%
Total non-interest expense
342

 
312

 
30

 
10
 %
Income before income tax expense
225

 
194

 
31

 
16
 %
Income tax expense
80

 
41

 
39

 
95
 %
Net income
$
145

 
$
153

 
$
(8
)
 
(5
)%
Preferred stock dividends
13

 

 
13

 
100
 %
Net income available to common shareholders
$
132

 
$
153

 
$
(21
)
 
(14
)%
Diluted earnings per common share
$
0.48

 
$
0.53

 
$
(0.05
)
 
(9
)%


E*TRADE | Q1 2017 10-Q                                       9


Net income decreased 5% to $145 million for the three months ended March 31, 2017, compared to the same period in 2016. Net income available to common shareholders for the three months ended March 31, 2017 was $132 million, which reflects payment of a $13 million preferred stock dividend, compared to $153 million during the same period in 2016. Benefit for loan losses was $14 million for the three months ended March 31, 2017 compared to $34 million for the same period in 2016. Net income for the three months ended March 31, 2017 also included $6 million of costs incurred in connection with the OptionsHouse integration and preparing for the incremental regulatory and reporting requirements that our balance sheet growth requires. Net income for the same period in 2016 included an income tax benefit related to the release of a valuation allowance against certain state deferred tax assets.
Net Revenue
The components of net revenue and the resulting variances are as follows (dollars in millions):
 
Three Months Ended March 31,
 
Variance
 
 
2017 vs. 2016
 
2017
 
2016
 
Amount
 
%
Net interest income
$
319

 
$
287

 
$
32

 
11
%
Commissions
127

 
107

 
20

 
19
%
Fees and service charges
86

 
58

 
28

 
48
%
Gains on securities and other, net
10

 
10

 

 
%
Other revenue
11

 
10

 
1

 
10
%
Total non-interest income
234

 
185

 
49

 
26
%
Total net revenue
$
553

 
$
472

 
$
81

 
17
%
Net Interest Income
Net interest income increased 11% to $319 million for the three months ended March 31, 2017, compared to the same period in 2016. Net interest income is earned primarily through investment securities, margin receivables and our legacy loan portfolio, offset by funding costs.


E*TRADE | Q1 2017 10-Q                                       10


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 prepared on the basis required by the SEC’s Industry Guide 3, "Statistical Disclosure by Bank Holding Companies" (dollars in millions): 
 
Three Months Ended March 31,
 
2017
 
2016
 
Average Balance
 
Interest Inc./Exp.
 
Average Yield/
Cost
 
Average Balance
 
Interest Inc./Exp.
 
Average Yield/
Cost
Cash and equivalents
$
1,345

 
$
2

 
0.64
%
 
$
1,611

 
$
2

 
0.41
%
Cash required to be segregated under federal or other regulations
1,684

 
3

 
0.71
%
 
1,133

 
1

 
0.32
%
Available-for-sale securities
16,586

 
85

 
2.05
%
 
12,642

 
64

 
2.03
%
Held-to-maturity securities
17,531

 
120

 
2.74
%
 
13,676

 
103

 
3.01
%
Margin receivables
6,781

 
66

 
3.93
%
 
6,677

 
64

 
3.89
%
Loans (1)
3,608

 
43

 
4.77
%
 
4,804

 
51

 
4.23
%
Broker-related receivables and other
1,119

 

 
0.12
%
 
349

 

 
0.29
%
Subtotal interest-earning assets
48,654

 
319

 
2.63
%
 
40,892

 
285

 
2.79
%
Other interest revenue (2)

 
22

 
 
 

 
23

 
 
    Total interest-earning assets
48,654

 
341

 
2.81
%
 
40,892

 
308

 
3.01
%
Total non-interest-earning assets (3)
5,252

 
 
 
 
 
4,921

 
 
 
 
Total assets
$
53,906

 
 
 
 
 
$
45,813

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Deposits
$
34,869

 
$
1

 
0.01
%
 
$
29,567

 
$
1

 
0.01
%
Customer payables
8,686

 
1

 
0.06
%
 
6,452

 
1

 
0.07
%
Broker-related payables and other
1,160

 

 
0.00
%
 
1,450

 

 
0.00
%
Other borrowings
492

 
5

 
3.85
%
 
436

 
5

 
4.13
%
Corporate debt
994

 
14

 
5.39
%
 
995

 
13

 
5.39
%
Subtotal interest-bearing liabilities
46,201

 
21

 
0.18
%
 
38,900

 
20

 
0.21
%
Other interest expense (4)

 
1

 
 
 

 
1

 
 
    Total interest-bearing liabilities
46,201

 
22

 
0.19
%
 
38,900

 
21

 
0.21
%
Total non-interest-bearing liabilities (5)
1,402

 
 
 
 
 
1,189

 
 
 
 
Total liabilities
47,603

 
 
 
 
 
40,089

 
 
 
 
Total shareholders' equity
6,303

 
 
 
 
 
5,724

 
 
 
 
Total liabilities and shareholders' equity
$
53,906

 
 
 
 
 
$
45,813

 
 
 
 
Excess of interest earning assets over interest bearing liabilities/net interest income/net interest margin
$
2,453

 
$
319

 
2.63
%
 
$
1,992

 
$
287

 
2.81
%
(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)
Non-interest earning assets consist of property and equipment, net, goodwill, other intangibles, net, deferred tax assets, net and other assets that do not generate interest income.
(4)
Represents interest expense on securities borrowed.
(5)
Non-interest bearing liabilities consist of other liabilities that do not generate interest expense.
Average interest-earning assets increased 19% to $48.7 billion for the three months ended March 31, 2017, compared to the same period in 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 19% to $46.2 billion for the three months ended March 31, 2017, compared to the same period in 2016. The increase was primarily due to increased 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 Balance Sheet Overview.
Net interest margin decreased 18 basis points to 2.63% for the three months ended March 31, 2017, compared to the same period in 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 decline is due to an increase in the overall allocation of lower yielding securities purchased with customer cash transferred to our balance sheet and proceeds from principal payments received on our higher yielding legacy loan portfolio that continues to become a smaller percentage of our interest-earning assets.


E*TRADE | Q1 2017 10-Q                                       11


Commissions
Commissions revenue increased 19% to $127 million for the three months ended March 31, 2017, compared to the same period in 2016. The main factors that affect commissions revenue are DARTs, average commission per trade and the number of trading days. DARTs volume increased 25% to 207,221 for the three months ended March 31, 2017, compared to the same period in 2016, mainly driven by the strength of the equity markets and the inclusion of OptionsHouse accounts. Derivative DARTs represented 29% of trading volume for the three months ended March 31, 2017, compared to 24% of trading volume for the same period in 2016. Average commission per trade decreased 7% to $9.87 for the three months ended March 31, 2017, compared to the same period in 2016. 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 three months ended March 31, 2017 was impacted by the decrease in commission pricing implemented in March 2017 as well as the lower price structure for OptionsHouse customers.
Fees and Service Charges
The components of fees and service charges and the resulting variances are as follows (dollars in millions):    
 
Three Months Ended March 31,
 
Variance
 
 
2017 vs. 2016
 
2017
 
2016
 
Amount
 
%
Order flow revenue
$
31

 
$
22

 
$
9

 
41
%
Money market funds and sweep deposits revenue(1)
22

 
8

 
14

 
175
%
Mutual fund service fees
9

 
9

 

 
%
Advisor management fees
8

 
7

 
1

 
14
%
Foreign exchange revenue
8

 
4

 
4

 
100
%
Reorganization fees
3

 
3

 

 
%
Other fees and service charges
5

 
5

 

 
%
Total fees and service charges
$
86

 
$
58

 
$
28

 
48
%
(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 48% to $86 million for the three months ended March 31, 2017, compared to the same period in 2016. The increase in fees and services charges was primarily driven by the impact of increased term interest rates and higher average balances of customer cash held by third parties. The gross yield on customer cash held by third parties for the three months ended March 31, 2017 of approximately 60 basis points compares to approximately 30 basis points for the same period in 2016. In addition, fees and service charges benefited from increased order flow revenue from higher trading activity.


E*TRADE | Q1 2017 10-Q                                       12


Gains on Securities and Other, Net
The components of gains on securities and other, net and the resulting variances are as follows (dollars in millions):
 
Three Months Ended March 31,
 
Variance
 
 
2017 vs. 2016
 
2017
 
2016
 
Amount
 
%
Gains on available-for-sale securities
$
8

 
$
15

 
$
(7
)
 
(47
)%
Hedge ineffectiveness
(1
)
 
(2
)
 
1

 
(50
)%
Equity method investment income (loss) and other
3

 
(3
)
 
6

 
(200
)%
Gains on securities and other, net
$
10

 
$
10

 
$

 
 %
Provision (Benefit) for Loan Losses
We recognized a benefit for loan losses of $14 million for the three months ended March 31, 2017, compared to a benefit of $34 million for the same period in 2016. The current period benefit reflected recoveries in excess of prior estimates, including recoveries of previous charge-offs. The timing and magnitude of the provision (benefit) for loan losses is affected by many factors that could result in variability, particularly as mortgage loans that have reached the end of their interest-only period continue amortizing and we evaluate their actual performance against our assumptions. For additional information on management's estimate of the allowance for loan losses, see Concentrations of Credit Risk.
Non-Interest Expense
The components of non-interest expense and the resulting variances are as follows (dollars in millions):
 
Three Months Ended March 31,
 
Variance
 
 
2017 vs. 2016
 
2017
 
2016
 
Amount
 
%
Compensation and benefits
$
136

 
$
126

 
$
10

 
8
 %
Advertising and market development
43

 
43

 

 
 %
Clearing and servicing
32

 
24

 
8

 
33
 %
Professional services
22

 
22

 

 
 %
Occupancy and equipment
27

 
23

 
4

 
17
 %
Communications
25

 
23

 
2

 
9
 %
Depreciation and amortization
20

 
20

 

 
 %
FDIC insurance premiums
8

 
6

 
2

 
33
 %
Amortization of other intangibles
9

 
5

 
4

 
80
 %
Restructuring and acquisition-related activities
4

 
2

 
2

 
100
 %
Other non-interest expenses
16

 
18

 
(2
)
 
(11
)%
Total non-interest expense
$
342

 
$
312

 
$
30

 
10
 %


E*TRADE | Q1 2017 10-Q                                       13


Compensation and Benefits
Compensation and benefits increased 8% to $136 million for the three months ended March 31, 2017, compared to the same period in 2016. Employee headcount increased 4% resulting from the acquisition of OptionsHouse and the addition of customer service professionals and financial consultants, partially offset by the impact of realignment within our brokerage business.
Clearing and Servicing
Clearing and servicing expense increased 33% to $32 million for the three months ended March 31, 2017, compared to the same period in 2016. The increase was primarily related to higher trading volume and increased expenses related to customer cash held by third parties.
Operating Margin
Operating margin was 41% for the three months ended March 31, 2017, compared to 41% for the same period in 2016. Adjusted operating margin, a non-GAAP measure, was 38% for the three months ended March 31, 2017, compared to 34% for the same period in 2016.
Adjusted operating margin is a non-GAAP measure calculated by dividing adjusted income before income taxes by total net revenue. Adjusted income before income taxes excludes the provision (benefit) for loan losses. 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):
 
Three Months Ended March 31,
 
2017
 
2016
 
Amount
 
Operating Margin %
 
Amount
 
Operating Margin %
Income before income tax expense / operating margin
$
225

 
41%
 
$
194

 
41%
Provision (benefit) for loan losses
(14
)
 
 
 
(34
)
 
 
Adjusted income before income tax expense / adjusted operating margin
$
211

 
38%
 
$
160

 
34%
Income Tax Expense
Income tax expense was $80 million and $41 million for the three months ended March 31, 2017 and 2016, respectively. The effective tax rate was 36% and 21% for the same periods.
The effective tax rate of 36% for the three months ended March 31, 2017 includes a tax benefit related to the adoption of amended accounting guidance for employee share-based compensation. See Note 1—Organization, Basis of Presentation and Summary of Significant Accounting Policies for additional information. The effective tax rate of 21% for the three months ended March 31, 2016 was impacted by a tax benefit related to the release of valuation allowances against certain state deferred tax assets.


E*TRADE | Q1 2017 10-Q                                       14


BALANCE SHEET OVERVIEW
The following table sets forth the significant components of the consolidated balance sheet (dollars in millions):
 
 
 
Variance
 
March 31,
 
December 31,
 
2017 vs. 2016
 
2017
 
2016
 
Amount
 
%
Assets:
 
 
 
 
 
 
 
Cash and equivalents
$
998

 
$
1,950

 
$
(952
)
 
(49
)%
Segregated cash
1,876

 
1,460

 
416

 
28
 %
Securities(1)
36,960

 
29,643

 
7,317

 
25
 %
Margin receivables
6,906

 
6,731

 
175

 
3
 %
Loans receivable, net
3,288

 
3,551

 
(263
)
 
(7
)%
Receivables from brokers, dealers and clearing organizations(2)
1,410

 
1,056

 
354

 
34
 %
Goodwill and other intangibles, net
2,682

 
2,690

 
(8
)
 
 %
Deferred tax assets, net
653

 
756

 
(103
)
 
(14
)%
Other(3)
1,106

 
1,162

 
(56
)
 
(5
)%
Total assets
$
55,879

 
$
48,999

 
$
6,880

 
14
 %
Liabilities and shareholders’ equity:
 
 
 
 
 
 
 
Deposits
$
37,384

 
$
31,682

 
$
5,702

 
18
 %
Customer payables
8,926

 
8,159

 
767

 
9
 %
Payables to brokers, dealers and clearing organizations(4)
1,288

 
983

 
305

 
31
 %
Other borrowings
409

 
409

 

 
 %
Corporate debt
991

 
994

 
(3
)
 
 %
Other liabilities
437

 
500

 
(63
)
 
(13
)%
Total liabilities
49,435

 
42,727

 
6,708

 
16
 %
Shareholders’ equity
6,444

 
6,272

 
172

 
3
 %
Total liabilities and shareholders’ equity
$
55,879

 
$
48,999

 
$
6,880

 
14
 %
(1)
Includes balance sheet line items available-for-sale and held-to-maturity securities.
(2)
Includes deposits paid for securities borrowed of $995 million and $774 million as of March 31, 2017 and December 31, 2016, respectively.
(3)
Includes balance sheet line items property and equipment, net and other assets.
(4)
Includes deposits received for securities loaned of $1.2 billion and $926 million as of March 31, 2017 and December 31, 2016, respectively.
Cash and Equivalents
Cash and equivalents decreased 49% to $1.0 billion during the three months ended March 31, 2017 and includes corporate cash of $417 million as of March 31, 2017. The decrease in total cash and equivalents reflects net purchases of investment securities during the three months ended March 31, 2017. For additional information on our use of cash and equivalents, including corporate cash, see Liquidity and Capital Resources.
Segregated Cash
Cash required to be segregated under federal or other regulations increased 28% to $1.9 billion during the three months ended March 31, 2017. The level of segregated cash is driven largely by customer payables and securities lending balances we hold as liabilities compared with the amount of margin receivables and securities borrowed balances we hold as assets. The excess represents customer cash that we are required by our regulators to segregate for the exclusive benefit of our brokerage customers. At March 31, 2017, $950 million of reverse repurchase agreements between E*TRADE Securities and E*TRADE Bank,


E*TRADE | Q1 2017 10-Q                                       15


representing investments that are required to be segregated under federal or other regulations by E*TRADE Securities, were eliminated in consolidation.
Securities
Available-for-sale and held-to-maturity securities are summarized as follows (dollars in millions):
 
 
 
Variance
 
March 31,
 
December 31,
 
2017 vs. 2016
 
2017
 
2016
 
Amount
 
%
Available-for-sale securities:
 
 
 
 
 
 
 
Debt securities:
 
 
 
 
 
 
 
Agency mortgage-backed securities
$
16,496

 
$
12,634

 
$
3,862

 
31
%
Other debt securities
1,266

 
1,251

 
15

 
1
%
Total debt securities
17,762

 
13,885

 
3,877

 
28
%
Publicly traded equity securities(1)
7

 
7

 

 
%
Total available-for-sale securities
$
17,769

 
$
13,892

 
$
3,877

 
28
%
Held-to-maturity securities:
 
 
 
 
 
 
 
Agency mortgage-backed securities
$
16,218

 
$
12,868

 
$
3,350

 
26
%
Other debt securities
2,973

 
2,883

 
90

 
3
%
Total held-to-maturity securities
$
19,191

 
$
15,751

 
$
3,440

 
22
%
Total investments in securities
$
36,960

 
$
29,643

 
$
7,317

 
25
%
(1)
Consists of Community Reinvestment Act investments in a mutual fund.
Securities represented 66% and 60% of total assets at March 31, 2017 and December 31, 2016, respectively. We classify debt securities as available-for-sale or held-to-maturity based on our investment strategy and management’s assessment of our intent and ability to hold the debt securities until maturity.
The increase in total investments in securities during the three months ended March 31, 2017 was primarily due to net purchases of investment securities as a result of our efforts to grow the balance sheet by transferring customer cash held by third parties to our balance sheet.
Loans Receivable, Net
Loans receivable, net are summarized as follows (dollars in millions):
 
 
 
Variance
 
March 31,
 
December 31,
 
2017 vs. 2016
 
2017
 
2016
 
Amount
 
%
One- to four-family
$
1,819

 
$
1,950

 
$
(131
)
 
(7
)%
Home equity
1,437

 
1,556

 
(119
)
 
(8
)%
Consumer
230

 
250

 
(20
)
 
(8
)%
Total loans receivable
3,486

 
3,756

 
(270
)
 
(7
)%
Unamortized premiums, net
15

 
16

 
(1
)
 
(6
)%
Allowance for loan losses
(213
)
 
(221
)
 
8

 
(4
)%
Total loans receivable, net
$
3,288

 
$
3,551

 
$
(263
)
 
(7
)%
Loans receivable, net decreased 7% to $3.3 billion during the three months ended March 31, 2017. We expect the legacy loan portfolio to continue its run-off for the foreseeable future. As our portfolio ages, we continue to gather substantive performance data on loan conversions from interest-only to amortizing and assess the economic environment and the value of our portfolio in the marketplace. While it is our intention to hold these loans, if the markets improve our strategy could change. For additional information on management's estimate of the allowance for loan losses, see Concentrations of Credit Risk.


E*TRADE | Q1 2017 10-Q                                       16


Deposits
Deposits are summarized as follows (dollars in millions):
 
 
 
Variance
 
March 31,
 
December 31,
 
2017 vs. 2016
 
2017
 
2016
 
Amount
 
%
Sweep deposits
$
31,955

 
$
26,362

 
$
5,593

 
21
%
Savings deposits
3,238

 
3,185

 
53

 
2
%
Other deposits
2,191

 
2,135

 
56

 
3
%
Total deposits
$
37,384

 
$
31,682

 
$
5,702

 
18
%
Deposits represented 76% and 74% of total liabilities at March 31, 2017 and December 31, 2016, respectively. At March 31, 2017, approximately 90% of our customer deposits were covered by FDIC insurance. Deposits increased $5.7 billion during the three months ended March 31, 2017 primarily as a result of transferring $4.5 billion of customer cash held by third parties to our balance sheet.
The majority of the deposits balance, specifically sweep deposits, is included in brokerage related cash, which is reported as a customer activity metric. Total brokerage related cash is summarized as follows (dollars in millions):
 
 
 
Variance
 
March 31,
 
December 31,
 
2017 vs. 2016
 
2017
 
2016
 
Amount
 
%
Sweep deposits(1)
$
31,955

 
$
26,362

 
$
5,593

 
21
 %
Customer payables
8,926

 
8,159

 
767

 
9
 %
Subtotal
40,881


34,521

 
6,360

 
18
 %
Customer cash held by third parties(2)
12,572

 
16,848

 
(4,276
)
 
(25
)%
Total brokerage related cash
$
53,453

 
$
51,369

 
$
2,084

 
4
 %
 
(1)
Sweep deposits are held at bank subsidiaries and are included in the deposits line item on our consolidated balance sheet.
(2)
Customer cash held by third parties is not reflected on our consolidated balance sheet and is not immediately available for liquidity purposes.
We offer an extended insurance sweep deposit account (ESDA) program to our brokerage customers. The ESDA program utilizes our bank subsidiaries, in combination with additional third party program banks, to allow customers the ability to have aggregate deposits they hold in the ESDA program insured up to $1,250,000 for each category of legal ownership. As of March 31, 2017, approximately 98% of sweep deposits were in the ESDA program.
Customer cash held by third parties is maintained at unaffiliated financial institutions and a third party clearing firm. The components of customer cash held by third parties are summarized as follows (dollars in millions):
 
 
 
Variance
 
March 31,
 
December 31,
 
2017 vs. 2016
 
2017
 
2016
 
Amount
 
%
Sweep deposits held by unaffiliated financial institutions
$
10,550

 
$
14,943

 
$
(4,393
)
 
(29
)%
Customer cash held by third party clearing firm(1)
1,712

 
1,634

 
78

 
5
 %
Municipal funds and other
310

 
271

 
39

 
14
 %
Customer cash held by third parties
$
12,572

 
$
16,848

 
$
(4,276
)
 
(25
)%
(1)
Represents OptionsHouse customer cash held by third party.
As of March 31, 2017, approximately $9 billion of customer cash held by third parties was available for balance sheet growth. The timing of our balance sheet growth will be impacted by a variety of factors, including the bank capital requirements applicable to both the Company and E*TRADE Bank.


E*TRADE | Q1 2017 10-Q                                       17


LIQUIDITY AND CAPITAL RESOURCES
We have established liquidity and capital policies to support the successful execution of our business strategy, while maintaining ongoing and sufficient liquidity through the business cycle. We believe liquidity is of critical importance to the Company and especially important within E*TRADE Bank and our broker-dealer subsidiaries. The objective of our policies is to ensure that we can meet our corporate, banking and broker-dealer liquidity needs under both normal operating conditions and under periods of stress in the financial markets.
Liquidity
Our corporate liquidity needs are primarily driven by capital needs at E*TRADE Bank and E*TRADE Securities as well as by the principal and interest due on our corporate debt and the amount of dividend payments on our preferred stock. Our banking and brokerage subsidiaries' liquidity needs are driven primarily by the level and volatility of our customer activity. Management maintains a set of liquidity sources and monitors certain business trends and market metrics closely in an effort to ensure we have sufficient liquidity. Potential loans by E*TRADE Bank to the parent company and its other non-bank subsidiaries are subject to various quantitative, arm’s length, collateralization, capital and other requirements.
Parent Company Liquidity
The parent company's primary source of liquidity is corporate cash. Corporate cash, a non-GAAP measure, is a component of cash and equivalents; see the consolidated statement of cash flows within Item 1. Condensed Consolidated Financial Statements (Unaudited) for information on cash and equivalents activity. We define corporate cash as cash held at the parent company and certain subsidiaries, not including bank and broker-dealer subsidiaries, that can be distributed to the parent company without any regulatory approval or notification. E*TRADE Bank and its subsidiaries require regulatory approval prior to the payment of certain dividends to the parent company. Our broker-dealer subsidiaries can pay dividends to the parent company with proper regulatory notifications.
We believe corporate cash is a useful measure of the parent company’s liquidity as it is the primary source of capital above and beyond the capital deployed in our regulated subsidiaries. Corporate cash can fluctuate in any given quarter and is impacted primarily by the following:
Dividends from subsidiaries
Non-cumulative preferred stock dividends
Acquisitions and investments
Share repurchases
Debt service costs
Tax payments and the reimbursement from the parent company's subsidiaries for the use of its deferred tax assets
Other overhead and expense reimbursements through cost sharing arrangements









E*TRADE | Q1 2017 10-Q                                       18



The following chart provides a roll forward of corporate cash at December 31, 2016 to corporate cash at March 31, 2017 (dollars in millions):
etfc-201733_chartx29588.jpg
(1) Other activity includes contributions to subsidiaries and parent company overhead, offset by reimbursements from subsidiaries for use of the parent's deferred tax assets and related proceeds under overhead cost sharing arrangements.
The following table provides a reconciliation of consolidated cash and equivalents to corporate cash, a non-GAAP measure (dollars in millions):
 
March 31,
 
December 31,
 
March 31,
 
2017
 
2016
 
2016
Consolidated cash and equivalents
$
998

 
$
1,950

 
$
1,627

Less: Bank cash
(115
)
 
(840
)
 
(680
)
Less: U.S. broker-dealers' cash
(433
)
 
(614
)
 
(440
)
Less: Other cash
(33
)
 
(35
)
 
(25
)
Corporate cash
$
417

 
$
461

 
$
482

Corporate cash decreased $44 million to $417 million during the three months ended March 31, 2017. Corporate cash included a dividend of $70 million from E*TRADE Securities to the parent company during the three months ended March 31, 2017. Corporate cash also included the impact of preferred stock dividends, debt service, overhead cost sharing arrangements between the parent and our operating subsidiaries, and the impact of annual incentive compensation payments in the three months ended March 31, 2017.
We maintain corporate cash at a minimum of two times our scheduled annual corporate debt service payments and scheduled maturities over the next 12 months. As we do not have any scheduled maturities of corporate debt in the coming year, our current minimum is approximately $100 million. Our nearest maturity of interest-bearing corporate debt is November 2022.
At March 31, 2017, we have a senior secured revolving credit facility at the parent company with an available line of credit of $250 million. The revolving credit facility enhances our ability to meet liquidity


E*TRADE | Q1 2017 10-Q                                       19


needs at the parent company, as we have the ability to borrow against this facility for working capital and general corporate purposes. Our revolving credit facility contains certain covenants, including the requirement for the parent company to maintain unrestricted cash of at least $100 million. At March 31, 2017, there was no outstanding balance under this revolving credit facility, which matures in November 2017.
E*TRADE Bank Liquidity
E*TRADE Bank relies on bank cash and deposits for liquidity needs. Management believes that within deposits, sweep deposits are of particular importance as they are a stable source of liquidity for E*TRADE Bank. We have the ability to generate liquidity in the form of additional deposits by raising the yield on our customer deposit products and by bringing additional deposits onto our balance sheet. Sweep deposits on our balance sheet as of March 31, 2017 increased $5.6 billion compared to December 31, 2016. We utilize our sweep deposit platform to efficiently manage our balance sheet size.
We may utilize wholesale funding sources for short-term liquidity and contingency funding requirements. Our ability to borrow these funds is dependent upon the continued availability of funding in the wholesale borrowings market. In addition, we can borrow from the Federal Reserve Bank’s discount window to meet short-term liquidity requirements, although it is not viewed as a primary source of funding. At March 31, 2017, E*TRADE Bank had approximately $4.4 billion and $0.6 billion in additional collateralized borrowing capacity with the Federal Home Loan Bank (FHLB) and the Federal Reserve Bank, respectively.
E*TRADE Securities Liquidity
E*TRADE Securities relies on customer payables, securities lending, and internal and external lines of credit to provide liquidity and to finance margin lending. At March 31, 2017, E*TRADE Securities' external liquidity lines totaled approximately $1.1 billion and included the following:
A 364-day, $400 million senior unsecured committed revolving credit facility with a syndicate of banks that matures in June 2017
Secured committed lines of credit with two unaffiliated banks, aggregating to $175 million with a maturity date of June 2017
Unsecured uncommitted lines of credit with two unaffiliated banks, aggregating to $100 million, of which $75 million is scheduled to mature in June 2017 and the remaining line has no maturity date
Secured uncommitted lines of credit with several unaffiliated banks, aggregating to $375 million with no maturity date
The revolving credit facility contains certain covenants, including maintenance covenants related to E*TRADE Securities' minimum consolidated tangible net worth and regulatory net capital ratio. There were no outstanding balances for any of these lines at March 31, 2017. E*TRADE Securities also maintains lines of credit with the parent company and E*TRADE Bank.
Liquidity Coverage Ratio
As a result of the Company's balance sheet growth, we will be subject to the modified liquidity coverage ratio (LCR) requirement beginning April 1, 2018. The purpose of the LCR is to require 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. Bank and savings and loan holding companies with total consolidated assets of $50 billion or more, based on the average of the four most recent quarters, are subject to a modified LCR requiring them to hold HQLA in an amount equal to at least 70% of their projected net cash outflows over a 30-day period. 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, 2018, we will be required to disclose certain quantitative and qualitative information related to our LCR calculation after each calendar quarter.


E*TRADE | Q1 2017 10-Q                                       20


Capital Resources
Bank Capital Requirements
The Dodd-Frank Act requires all companies, including savings and loan holding companies, that directly or indirectly control an insured depository institution to serve as a source of strength for the institution. The Company and E*TRADE Bank are subject to regulatory capital requirements. Some of these requirements are still subject to phase-in periods, including certain deductions from and adjustments to regulatory capital that will be fully implemented at 100% in 2018. For additional information on bank regulatory requirements and phase-in periods, see Part I. Item 1. Business—Regulation in our Annual Report on Form 10-K for the year ended December 31, 2016. At March 31, 2017, our regulatory capital ratios for E*TRADE Financial were well above the minimum ratios required to be "well capitalized." E*TRADE Financial's capital ratios are as follows:
etfc-201733_chartx31242.jpg



E*TRADE | Q1 2017 10-Q                                       21


E*TRADE Financial's capital ratios are calculated as follows (dollars in millions):
 
March 31,
 
December 31,
 
March 31,
 
2017
 
2016
 
2016
E*TRADE Financial shareholders’ equity
$
6,444

 
$
6,272

 
$
5,737

Deduct:
 
 
 
 
 
Preferred stock
(394
)
 
(394
)
 

E*TRADE Financial Common Equity Tier 1 capital before regulatory adjustments
$
6,050

 
$
5,878

 
$
5,737

Add:
 
 
 
 
 
(Gains) losses in other comprehensive income on available-for-sale debt securities, net of tax
98

 
139

 
17

Deduct:
 
 
 
 
 
Goodwill and other intangible assets, net of deferred tax liabilities
(2,058
)
 
(2,029
)
 
(1,435
)
Disallowed deferred tax assets
(638
)
 
(505
)
 
(909
)
E*TRADE Financial Common Equity Tier 1 capital
3,452

 
3,483

 
3,410

Add:
 
 
 
 
 
Preferred stock
394

 
394

 

Deduct:
 
 
 
 
 
Disallowed deferred tax assets
(136
)
 
(267
)
 

E*TRADE Financial Tier 1 capital
$
3,710

 
$
3,610

 
$
3,410

Add:
 
 
 
 
 
Allowable allowance for loan losses
135

 
124

 
131

Non-qualifying capital instruments subject to phase-out (trust preferred securities)
414

 
414

 
414

E*TRADE Financial total capital
$
4,259

 
$
4,148

 
$
3,955

 
 
 
 
 
 
E*TRADE Financial average assets for leverage capital purposes
$
54,032

 
$
49,113

 
$
45,886

Deduct:
 
 
 
 
 
Goodwill and other intangible assets, net of deferred tax liabilities
(2,058
)
 
(2,029
)
 
(1,435
)
Disallowed deferred tax assets
(774
)
 
(772
)
 
(909
)
E*TRADE Financial adjusted average assets for leverage capital purposes
$
51,200

 
$
46,312

 
$
43,542

 
 
 
 
 
 
E*TRADE Financial total risk-weighted assets(1)
$
10,466

 
$
9,422

 
$
9,882

 
 
 
 
 
 
E*TRADE Financial Tier 1 leverage ratio (Tier 1 capital / Adjusted average assets for leverage capital purposes)
7.2
%
 
7.8
%
 
7.8
%
E*TRADE Financial Common Equity Tier 1 capital / Total risk-weighted assets
33.0
%
 
37.0
%
 
34.5
%
E*TRADE Financial Tier 1 capital / Total risk-weighted assets
35.4
%
 
38.3
%
 
34.5
%
E*TRADE Financial total capital / Total risk-weighted assets
40.7
%
 
44.0
%
 
40.0
%
(1)
Under the regulatory guidelines for risk-based capital, on-balance sheet assets and credit equivalent amounts of derivatives and off-balance sheet items are assigned to one of several broad risk categories according to the obligor or, if relevant, the guarantor or the nature of any collateral. The aggregate dollar amount in each risk category is then multiplied by the risk weight associated with that category. The resulting weighted values from each of the risk categories are aggregated for determining total risk-weighted assets.


E*TRADE | Q1 2017 10-Q                                       22


At March 31, 2017, our regulatory capital ratios for E*TRADE Bank were well above the minimum ratios required to be "well capitalized." We plan to use excess capital at E*TRADE Bank to grow the balance sheet. Accordingly, we do not expect to distribute dividends from E*TRADE Bank to the parent while we fund that growth. E*TRADE Bank's capital ratios are as follows:
etfc-201733_chartx32913.jpg


E*TRADE | Q1 2017 10-Q                                       23


E*TRADE Bank's capital ratios are calculated as follows (dollars in millions):
 
March 31,
 
December 31,
 
March 31,
 
2017
 
2016
 
2016
E*TRADE Bank shareholder's equity
$
3,291

 
$
3,153

 
$
3,126

Add:
 
 
 
 
 
(Gains) losses in other comprehensive income on available-for-sale debt securities, net of tax
98

 
139

 
17

Deduct:
 
 
 
 
 
Goodwill and other intangible assets, net of deferred tax liabilities
(38
)
 
(38
)
 
(38
)
Disallowed deferred tax assets
(100
)
 
(122
)
 
(209
)
E*TRADE Bank Common Equity Tier 1 capital / Tier 1 capital
3,251

 
3,132

 
2,896

Add:
 
 
 
 
 
Allowable allowance for loan losses
118

 
105

 
113

E*TRADE Bank total capital
$
3,369

 
$
3,237

 
$
3,009

 
 
 
 
 
 
E*TRADE Bank average assets for leverage capital purposes
$
40,501

 
$
35,885

 
$
34,073

Deduct:
 
 
 
 
 
Goodwill and other intangible assets, net of deferred tax liabilities
(38
)
 
(38
)
 
(38
)
Disallowed deferred tax assets
(100
)
 
(122
)
 
(209
)
E*TRADE Bank adjusted average assets for leverage capital purposes
$
40,363

 
$
35,725

 
$
33,826

 
 
 
 
 
 
E*TRADE Bank total risk-weighted assets(1)
$
9,280

 
$
8,187

 
$
8,695

 
 
 
 
 
 
E*TRADE Bank Tier 1 leverage ratio (Tier 1 capital / Adjusted average assets for leverage capital purposes)
8.1
%
 
8.8
%
 
8.6
%
E*TRADE Bank Common Equity Tier 1 capital / Total risk-weighted assets
35.0
%
 
38.3
%
 
33.3
%
E*TRADE Bank Tier 1 capital / Total risk-weighted assets
35.0
%
 
38.3
%
 
33.3
%
E*TRADE Bank total capital / Total risk-weighted assets
36.3
%
 
39.5
%
 
34.6
%
(1)
Under the regulatory guidelines for risk-based capital, on-balance sheet assets and credit equivalent amounts of derivatives and off-balance sheet items are assigned to one of several broad risk categories according to the obligor or, if relevant, the guarantor or the nature of any collateral. The aggregate dollar amount in each risk category is then multiplied by the risk weight associated with that category. The resulting weighted values from each of the risk categories are aggregated for determining total risk-weighted assets.
Broker-Dealer Capital Requirements
Our broker-dealer subsidiaries are subject to capital requirements determined by their respective regulators. At March 31, 2017, all of our brokerage subsidiaries met their minimum net capital requirements. We continue to assess our ability to distribute excess net capital to the parent while maintaining adequate capital at the broker-dealers. E*TRADE Securities paid a $70 million dividend to the parent company during the three months ended March 31, 2017. For additional information on our broker-dealer capital requirements, see Note 13—Regulatory Requirements.
Off-Balance Sheet Arrangements
We enter into various off-balance sheet arrangements in the ordinary course of business, primarily to meet the needs of our customers and to reduce our own exposure to interest rate risk. These arrangements include firm commitments to extend credit. Additionally, we enter into guarantees and other similar arrangements as part of transactions in the ordinary course of business. For additional information on these arrangements, see Note 14—Commitments, Contingencies and Other Regulatory Matters.


E*TRADE | Q1 2017 10-Q                                       24


RISK MANAGEMENT
The identification, mitigation and management of existing and potential risks is critical to effective enterprise risk management. There are certain risks inherent to our industry (e.g. execution of transactions) and certain risks that will surface through the conduct of our business operations. We seek to monitor and manage our significant risk exposures by operating under a set of Board-approved limits and by monitoring certain risk indicators. Our governance framework is designed to comply with applicable requirements and requires regular reporting on metrics and significant risks and exposures to senior management and the Board of Directors.
We face the following key types of risks: credit, interest rate, liquidity, market, operational, information security, strategic, reputational as well as legal, regulatory and compliance. We have a Board-approved Enterprise Risk Appetite Statement (RAS) that is provided to all employees. The RAS specifies significant risk exposures and addresses the Company's tolerance of those risks, which are described in further detail within Part II. Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations of our Annual Report on Form 10-K for the year ended December 31, 2016. We are also subject to other risks that could impact our business, financial condition, results of operations or cash flows in future periods. See Part I. Item 1A. Risk Factors in our Annual Report on Form 10-K for the year ended December 31, 2016.
CONCENTRATIONS OF CREDIT RISK
Credit risk is the risk of loss arising from the inability or failure of a borrower or counterparty to meet its credit obligations. Our loan portfolio represents our most significant credit risk exposure. See Part II. Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations of our Annual Report on Form 10-K for the year ended December 31, 2016 for additional information on our management of credit risk.
One- to Four-Family Interest-Only Loans
One- to four-family loans include loans for a five to ten year interest-only period, followed by an amortizing period ranging from 20 to 25 years. At March 31, 2017, 16% of our one- to four-family portfolio was not yet amortizing. The following chart outlines when one- to four-family loans convert to amortizing by percentage of the one- to four-family portfolio at March 31, 2017:
etfc-201733_chartx29298.jpg
Home Equity Lines of Credit
The home equity loan portfolio consists of home equity installment loans (HEILs) and home equity lines of credit (HELOCs) and is primarily second lien loans on residential real estate properties, which have a higher level of credit risk than first lien mortgage loans. HEILs are primarily fixed rate and fixed term, fully amortizing loans that do not offer the option of an interest-only payment. The majority of HELOCs have an interest only draw period and convert to amortizing loans at the end of the draw period, which typically ranges from five to ten years. At March 31, 2017, 4% of the HELOC portfolio had not converted from the


E*TRADE | Q1 2017 10-Q                                       25


interest-only draw period and had not begun amortizing. The following chart outlines when HELOCs convert to amortizing by percentage of the HELOC portfolio at March 31, 2017: 
etfc-201733_chartx30859.jpg
Nonperforming Assets
We classify loans as nonperforming when they are no longer accruing interest, which includes loans that are 90 days and greater past due, TDRs that are on nonaccrual status for all classes of loans (including loans in bankruptcy) and certain junior liens that have a delinquent senior lien. The following table shows comparative data for nonperforming loans and assets at March 31, 2017 and December 31, 2016 (dollars in millions):
 
March 31, 2017
 
December 31, 2016
One- to four-family
$
212

 
$
215

Home equity
130

 
136

Consumer
1

 
1

Total nonperforming loans receivable
343

 
352

Real estate owned and other repossessed assets, net
30

 
36

Total nonperforming assets, net
$
373


$
388



E*TRADE | Q1 2017 10-Q                                       26


Allowance for Loan Losses
The allowance for loan losses is management’s estimate of probable losses inherent in the loan portfolio at the balance sheet date, as well as the forecasted losses, including economic concessions to borrowers, over the estimated remaining life of loans modified as TDRs. The general allowance for loan losses includes a qualitative component to account for a variety of factors that present additional uncertainty that may not be fully considered in the quantitative loss model but are factors we believe may impact the level of credit losses. The following table presents the allowance for loan losses by loan portfolio at March 31, 2017 and December 31, 2016 (dollars in millions): 
 
One- to Four-Family
 
Home Equity
 
Consumer
 
Total
 
March 31, 2017
 
December 31, 2016
 
March 31, 2017
 
December 31, 2016
 
March 31, 2017
 
December 31, 2016
 
March 31, 2017
 
December 31, 2016
General reserve:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Quantitative component
$
40

 
$
34

 
$
116

 
$
118

 
$
5

 
$
5

 
$
161

 
$
157

Qualitative component
1

 
4

 
1

 
2

 

 

 
2

 
6

Specific valuation allowance
5

 
7

 
45

 
51

 

 

 
50

 
58

Total allowance for loan losses
$
46

 
$
45

 
$
162

 
$
171

 
$
5

 
$
5

 
$
213

 
$
221

Allowance as a % of loans
receivable
(1)
2.5
%
 
2.3
%
 
11.2
%
 
11.0
%
 
2.1
%
 
1.9
%
 
6.1
%
 
5.8
%
 
(1)
Allowance as a percentage of loans receivable is calculated based on the gross loans receivable including net unamortized premiums for each respective category.
Total loans receivable designated as held-for-investment decreased $0.3 billion during the three months ended March 31, 2017. The allowance for loan losses was $213 million, or 6.1% of total loans receivable, as of March 31, 2017 compared to $221 million, or 5.8% of total loans receivable, as of December 31, 2016. Our quantitative allowance methodology continues to include the identification of higher risk mortgage loans and the period of our forecasted loan losses captured within the general allowance includes the total probable loss over the remaining life of these loans.
Net recoveries for the three months ended March 31, 2017 were $6 million compared to $3 million in the same period in 2016. Net recoveries for the three months ended March 31, 2017 were positively impacted by increasing home prices and proactive portfolio management. The timing and magnitude of charge-offs and recoveries are affected by many factors and we anticipate variability from quarter to quarter.
For additional information on the loans portfolio and management's estimate of the allowance for loan losses, see Note 6—Loans Receivable, Net and Summary of Critical Accounting Policies and Estimates in Part II. Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations in the Annual Report on Form 10-K for the year ended December 31, 2016.
Securities
We focus primarily on security type and credit rating to monitor credit risk in our securities portfolios. We consider securities backed by the U.S. government or its agencies to have low credit risk as the long-term debt rating of the U.S. government is AA+ by S&P and AAA by Moody’s and Fitch at March 31, 2017. The amortized cost of these securities accounted for over 99% of our total securities portfolio at March 31, 2017. We review the remaining debt securities that were not backed by the U.S. government or its agencies according to their credit ratings from S&P, Moody’s and Fitch where available. At March 31, 2017, all municipal bonds in our securities portfolio were rated investment grade (defined as a rating equivalent to a Moody’s rating of "Baa3" or higher, or an S&P or Fitch rating of "BBB-" or higher).


E*TRADE | Q1 2017 10-Q                                       27


SUMMARY OF CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements, which have been prepared in conformity with GAAP. Note 1—Organization, Basis of Presentation and Summary of Significant Accounting Policies in Part II. Item 8. Financial Statements and Supplementary Data in the Company's Annual Report on Form 10-K for the year ended December 31, 2016 contains a summary of our significant accounting policies, many of which require the use of estimates and assumptions that affect the amounts reported in the consolidated financial statements and related notes for the periods presented. We believe that of our significant accounting policies, the following are critical because they are based on estimates and assumptions that require complex and subjective judgments by management: allowance for loan losses; valuation and impairment of goodwill and acquired intangible assets; and estimates of effective tax rates, deferred taxes and valuation allowance. Changes in these estimates or assumptions could materially impact our financial condition and results of operations, and actual results could differ from our estimates. These policies are more fully described in Part II. Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations—Summary of Critical Accounting Policies and Estimates in our Annual Report on Form 10-K for the year ended December 31, 2016.
ITEM 3.    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The following discussion about market risk includes forward-looking statements. Actual results could differ materially from those projected in the forward-looking statements as a result of certain factors, including, but not limited to, those set forth in Part I. Item 1A. Risk Factors in the Annual Report on Form 10-K for the year ended December 31, 2016.
Interest Rate Risk
Our exposure to interest rate risk is related primarily to interest-earning assets and interest-bearing liabilities. Managing interest rate risk is essential to profitability. The primary objective of the management of interest rate risk is to control exposure to interest rates within the Board-approved limits and with limited exposure to earnings volatility resulting from interest rate fluctuations. Our general strategies to manage interest rate risk include balancing variable-rate and fixed-rate assets and liabilities and utilizing derivatives to help manage exposures to changes in interest rates. Exposure to interest rate risk requires management to make complex assumptions regarding maturities, market interest rates and customer behavior. Changes in interest rates, including the following, could impact interest income and expense:
Interest-earning assets and interest-bearing liabilities may re-price at different times or by different amounts, creating a mismatch.
The yield curve may steepen, flatten or otherwise change shape, which could affect the spread between short- and long-term rates. Widening or narrowing spreads could impact net interest income.
Market interest rates may influence prepayments, resulting in maturity mismatches. In addition, prepayments could impact yields as premiums and discounts amortize.
Exposure to interest rate risk is dependent upon the distribution and composition of interest-earning assets, interest-bearing liabilities and derivatives. The differing risk characteristics of each product are managed to mitigate our exposure to interest rate fluctuations. At March 31, 2017, 92% of our total assets were interest-earning assets and we had no securities classified as trading.
At March 31, 2017, approximately 65% of total assets were available-for-sale and held-to-maturity mortgage-backed securities and residential real estate loans. The values of these assets are sensitive to changes in interest rates as well as expected prepayment levels. As interest rates increase, fixed-rate residential mortgages and mortgage-backed securities tend to exhibit lower prepayments. The inverse is true in a falling rate environment.
When real estate loans are prepaid, unamortized premiums and/or discounts are recognized immediately in interest income. Depending on the timing of the prepayment, these adjustments to income would impact


E*TRADE | Q1 2017 10-Q                                       28


anticipated yields. The Company reviews estimates of the impact of changing market rates on prepayments. This information is incorporated into our interest rate risk management strategy.
Our liability structure consists of two central sources of funding: deposits and customer payables, both of which re-price at management’s discretion. We may utilize wholesale funding sources as needed for short-term liquidity and contingency funding requirements.
Derivative Instruments
We use derivative instruments to help manage interest rate risk using designated hedge relationships. Interest rate swaps involve the exchange of fixed-rate and variable-rate interest payments between two parties based on a contractual underlying notional amount, but do not involve the exchange of the underlying notional amounts. See Note 7—Derivative Instruments and Hedging Activities for additional information about our use of derivative contracts.
Scenario Analysis
Scenario analysis is an advanced approach to estimating interest rate risk exposure. The Company monitors interest rate risk using the Economic Value of Equity (EVE) approach and the Earnings-at-Risk (EAR) approach.
Under the EVE approach, the present value of expected cash flows of all existing interest-earning assets, interest-bearing liabilities, derivatives and forward commitments are estimated and combined to produce an EVE figure. The change in EVE is a long-term sensitivity measure of interest rate risk. The approach values only the current balance sheet in which the most significant assumptions are the prepayment rates of the loan portfolio and mortgage-backed securities and the repricing of deposits. This approach does not incorporate assumptions related to business growth, or liquidation and re-investment of instruments. This approach provides an indicator of future earnings and capital levels because changes in EVE indicate the anticipated change in the value of future cash flows. The sensitivity of this value to changes in interest rates is then determined by applying alternative interest rate scenarios. The change in EVE amounts fluctuate based on instantaneous parallel shifts in interest rates primarily due to the change in timing of cash flows, which considers prepayment estimates, in the Company’s residential loan and mortgage-backed securities portfolios.
EAR is a short-term sensitivity measure of interest rate risk and illustrates the impact of alternative interest rate scenarios on net interest income, including corporate interest expense, over a twelve month time frame. In measuring the sensitivity of net interest income to changes in interest rates, we assume instantaneous parallel interest rate shocks applied to the forward curve. In addition, we assume that cash flows from loan payoffs are reinvested in mortgage-backed securities, we exclude revenue from off-balance sheet customer cash and we assume no balance sheet growth.
The sensitivity of EAR and EVE at the consolidated E*TRADE Financial level at March 31, 2017 and December 31, 2016 is as follows (dollars in millions):
Instantaneous Parallel Change in Interest Rates
(basis points) (1)
 
Economic Value of Equity
 
Earnings-at-Risk
 
March 31, 2017
 
December 31, 2016
 
March 31, 2017
 
December 31, 2016
 
Amount
 
Percentage
 
Amount
 
Percentage
 
Amount
 
Percentage
 
Amount
 
Percentage
+200
 
$
(101
)
 
(1.4
)%
 
$
(129
)
 
(2.1
)%
 
$
162

 
11.5
 %
 
$
169

 
13.9
 %
+100
 
$
88

 
1.2
 %
 
$
59

 
0.9
 %
 
$
105

 
7.5
 %
 
$
109

 
9.0
 %
-50
 
$
(151
)
 
(2.1
)%
 
$
(106
)
 
(1.7
)%
 
$
(73
)
 
(5.2
)%
 
$
(73
)
 
(6.0
)%
(1)
These scenario analyses assume a balance sheet size as of the dates indicated. Any changes in size would cause the amounts to vary.
We actively manage interest rate risk positions. As interest rates change, we will adjust our strategy and mix of assets, liabilities and derivatives to optimize our position. For example, a 100 basis points increase in rates may not result in a change in value as indicated above. We compare the instantaneous parallel shift in interest rate changes in EVE and EAR to the established limits set by the Board of Directors in order to assess interest rate risk. In the event that the percentage change in EVE or EAR exceeds the Board limits, our Chief Executive Officer, Chief Risk Officer, Chief Financial Officer and Treasurer must all be promptly


E*TRADE | Q1 2017 10-Q                                       29


notified in writing and decide upon a plan of remediation. In addition, the Board of Directors must be notified of the exception and the planned resolution. At March 31, 2017, the EVE and EAR percentage changes were within our Board limits.


E*TRADE | Q1 2017 10-Q                                       30


KEY TERMS
Active customers—Customers that have an account with a balance of $25 or more or a trade in the last six months.
Active trader—Customers that execute 30 or more trades per quarter.
Agency—U.S. Government sponsored enterprises and federal agencies, such as Federal National Mortgage Association, Federal Home Loan Mortgage Corporation, Government National Mortgage Association, the Small Business Administration, the Export-Import Bank and the Federal Home Loan Bank.
Average commission per trade—Total commissions revenue divided by total number of revenue trades.
Bank—ETB Holdings, Inc. (ETBH), the entity that is our bank holding company and parent to E*TRADE Bank.
Basel III—Global regulatory standards for bank capital adequacy and liquidity as issued by the international Basel Committee on Banking Supervision.
Basis point—One one-hundredth of a percentage point.
Brokerage account attrition rate—The brokerage account attrition rate is calculated by dividing attriting brokerage accounts by total brokerage accounts from the previous period end, and is presented on an annualized basis. Attriting brokerage accounts are derived by subtracting net new brokerage accounts from gross new brokerage accounts.
Brokerage related cash—Customer sweep deposits held at banking subsidiaries, customer payables and customer cash held by third parties.
BPO—Broker price opinion.
CFTC—Commodity Futures Trading Commission.
Charge-off—The result of removing a loan or portion of a loan from an entity’s balance sheet because the loan is considered to be uncollectible.
CLTV—Combined loan-to-value ratio.
Common Equity Tier 1 Capital—A measurement of the Company's core equity capital used in the calculation of capital adequacy ratios. Common Equity Tier 1 Capital equals: total shareholders' equity, less preferred stock and related surplus, plus/(less) unrealized losses (gains) on certain available-for-sale securities, less goodwill and certain other intangible assets, less certain disallowed deferred tax assets and subject to certain other applicable adjustments.
Consumer loans—Loans that are secured by real personal property, such as recreational vehicles.
Consolidated financial statements—Refers to the consolidated financial statements prepared in accordance with GAAP as included in the Company's annual report on Form 10-K, and the condensed consolidated financial statements included in the Company's interim reports on Form 10-Q.
Corporate cash—Cash held at the parent company as well as cash held in certain subsidiaries that can distribute cash to the parent company without any regulatory approval or notification.
Customer assets—Market value of all customer assets held by the Company including security holdings, sweep and other deposits, customer cash held by third parties, customer payables and vested unexercised stock plan holdings.
Daily average revenue trades (DARTs)—Total revenue trades in a period divided by the number of trading days during that period.
Derivative—A financial instrument or other contract which includes one or more underlying securities, notional amounts, or payment provisions. The contract generally requires no initial net investment and is settled on a net basis.


E*TRADE | Q1 2017 10-Q                                       31


Derivative DARTs—Options and futures revenue trades in a period divided by the number of trading days during that period.
Earnings at Risk (EAR)—The sensitivity of GAAP net interest income to changes in interest rates over a twelve month horizon. It is a short-term measurement of interest rate risk and does not consider risks beyond the simulation time horizon. In addition, it requires reinvestment, funding, and hedging assumptions for the horizon.
Economic Value of Equity (EVE)—The sensitivity of the value of existing assets and liabilities, including derivatives and forward commitments, to changes in interest rates. It is a long-term measurement of interest rate risk and requires assumptions that include prepayment rates on the loan portfolio and mortgage-backed securities and the repricing of deposits.
ESDA—Extended insurance sweep deposit accounts.
Exchange-traded funds (ETFs)—A fund that invests in a group of securities and trades like an individual stock on an exchange.
Fair value—The price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.
Fair value hedge—A derivative instrument designated in a hedging relationship that mitigates exposure to changes in the fair value of a recognized asset or liability or a firm commitment.
FASB—Financial Accounting Standards Board.
FDIC—Federal Deposit Insurance Corporation.
FHLB—Federal Home Loan Bank.
FICO—Fair Isaac Credit Organization.
FINRA—Financial Industry Regulatory Authority.
FCM—Futures Commission Merchant.
Generally Accepted Accounting Principles (GAAP)—Accounting principles generally accepted in the United States of America.
Gross loans receivable—Includes unpaid principal balances and premiums (discounts).
HEIL—Home equity installment loan.
HELOC—Home equity lines of credit.
HQLA—High-quality liquid assets.
Interest-bearing liabilities—Liabilities such as deposits, customer payables, other borrowings, corporate debt and certain customer credit balances and securities lending balances on which the Company pays interest; excludes customer balances held by third parties.
Interest-earning assets—Assets such as available-for-sale securities, held-to-maturity securities, margin receivables, loans, securities borrowed balances and cash and investments required to be segregated under regulatory guidelines that earn interest for the Company.
Interest rate swaps—Contracts that are entered into primarily as an asset/liability management strategy to reduce interest rate risk. Interest rate swap contracts are exchanges of interest rate payments, such as fixed-rate payments for floating-rate payments, based on notional amounts.
LCR—Liquidity coverage ratio. The purpose of LCR is to require banking organizations to hold minimum amounts of HQLA based on a percentage of their net cash outflows over a 30-day period.
LIBOR—London Interbank Offered Rate. LIBOR is the interest rate at which banks borrow funds from other banks in the London wholesale money market (or interbank market).


E*TRADE | Q1 2017 10-Q                                       32


LLC—Limited liability company.
LTV—Loan-to-value ratio.
NASDAQ—National Association of Securities Dealers Automated Quotations.
Net interest income—A measure of interest revenue, net interest income is equal to interest income less interest expense.
Net interest margin—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 new brokerage assets—The total inflows to all new and existing brokerage customer accounts less total outflows from all closed and existing brokerage customer accounts, excluding the effects of market movements in the value of brokerage customer assets.
NFA—National Futures Association.
Nonperforming assets—Assets originally acquired to earn income (nonperforming loans) and those not intended to earn income (real estate owned). Loans are classified as nonperforming when they are no longer accruing interest, which includes loans that are 90 days and greater past due, TDRs that are on nonaccrual status for all classes of loans (including loans in bankruptcy) and certain junior liens that have a delinquent senior lien.
Notional amount—The specified dollar amount underlying a derivative on which the calculated payments are based.
OCC—Office of the Comptroller of the Currency.
Options—Contracts that grant the purchaser, for a premium payment, the right, but not the obligation, to either purchase or sell the associated financial instrument at a set price during a period or at a specified date in the future.
RAS—Risk Appetite Statement.
Real estate owned and other repossessed assets—Ownership or physical possession of real property by the Company, generally acquired as a result of foreclosure or repossession.
Recovery—Cash proceeds received on a loan that had been previously charged off.
Repurchase agreement—An agreement giving the transferor of an asset the right or obligation to repurchase the same or similar securities at a specified price on a given date. These agreements are generally collateralized by mortgage-backed or investment-grade securities.
Risk-weighted assets—Primarily computed by the assignment of specific risk-weightings to assets and off-balance sheet instruments for capital adequacy calculations.
S&P—Standard & Poor’s.
SEC—U.S. Securities and Exchange Commission.
Sweep deposit accounts—Accounts with the functionality to transfer customer cash balances to and from an FDIC insured account.
Tier 1 capital—Adjusted equity capital used in the calculation of capital adequacy ratios. Tier 1 capital equals: Common Equity Tier 1 capital plus qualifying preferred stock and related surplus, subject to certain other applicable adjustments.
Troubled Debt Restructuring (TDR)—A loan modification that involves granting an economic concession to a borrower who is experiencing financial difficulty, and loans that have been charged-off due to bankruptcy notification.


E*TRADE | Q1 2017 10-Q                                       33


TRUPs—Trust preferred securities.
VIE—Variable interest entity.
Wholesale borrowings—Borrowings that consist of repurchase agreements and FHLB advances.


E*TRADE | Q1 2017 10-Q                                       34


PART I - FINANCIAL INFORMATION
ITEM 1.    CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
E*TRADE FINANCIAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF INCOME
(In millions, except share data and per share amounts)
(Unaudited)
 
Three Months Ended March 31,
 
2017
 
2016
Revenue:
 
 
 
Interest income
$
341

 
$
308

Interest expense
(22
)
 
(21
)
Net interest income
319

 
287

Commissions
127

 
107

Fees and service charges
86

 
58

Gains on securities and other, net
10

 
10

Other revenue
11

 
10

Total non-interest income
234

 
185

Total net revenue
553

 
472

Provision (benefit) for loan losses
(14
)
 
(34
)
Non-interest expense:
 
 
 
Compensation and benefits
136

 
126

Advertising and market development
43

 
43

Clearing and servicing
32

 
24

Professional services
22

 
22

Occupancy and equipment
27

 
23

Communications
25

 
23

Depreciation and amortization
20

 
20

FDIC insurance premiums
8

 
6

Amortization of other intangibles
9

 
5

Restructuring and acquisition-related activities
4

 
2

Other non-interest expenses
16

 
18

Total non-interest expense
342

 
312

Income before income tax expense
225

 
194

Income tax expense
80

 
41

Net income
$
145

 
$
153

Preferred stock dividends
13

 

Net income available to common shareholders
$
132

 
$
153

Basic earnings per common share
$
0.48

 
$
0.54

Diluted earnings per common share
$
0.48

 
$
0.53

Shares used in computation of per common share data:
 
 
 
Basic (in thousands)
274,876

 
285,274

Diluted (in thousands)
276,277

 
286,680

See accompanying notes to the condensed consolidated financial statements


E*TRADE | Q1 2017 10-Q                                       35


E*TRADE FINANCIAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
(In millions)
(Unaudited)
 
Three Months Ended March 31,
 
2017
 
2016
Net income
$
145

 
$
153

Other comprehensive income, net of tax
 
 
 
Available-for-sale securities:
 
 
 
Unrealized gains, net
46

 
94

Reclassification into earnings, net
(5
)
 
(9
)
Net change from available-for-sale securities
41

 
85

Reclassification of foreign currency translation gains
(2
)
 

Other comprehensive income
39

 
85

Comprehensive income
$
184

 
$
238

See accompanying notes to the condensed consolidated financial statements


E*TRADE | Q1 2017 10-Q                                       36


E*TRADE FINANCIAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEET
(In millions, except share data)
(Unaudited)
 
March 31,
 
December 31,
 
2017
 
2016
ASSETS
 
 
 
Cash and equivalents
$
998

 
$
1,950

Cash required to be segregated under federal or other regulations
1,876

 
1,460

Available-for-sale securities
17,769

 
13,892

Held-to-maturity securities (fair value of $19,180 and $15,716 at March 31, 2017 and December 31, 2016, respectively)
19,191

 
15,751

Margin receivables
6,906

 
6,731

Loans receivable, net (net of allowance for loan losses of $213 million and $221 million at March 31, 2017 and December 31, 2016, respectively)
3,288

 
3,551

Receivables from brokers, dealers and clearing organizations
1,410

 
1,056

Property and equipment, net
239

 
239

Goodwill
2,370

 
2,370

Other intangibles, net
312

 
320