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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM i 10-K |
| |
i ☒ | ANNUAL
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the fiscal year ended i December 31, 2019 |
| |
i ☐ | TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from _____ to _____
E
TRADE Financial Corporation i E*TRADE
Financial Corporation
(Exact Name of Registrant as Specified in its Charter) |
| | |
i Delaware |
| i 94-2844166 |
(State
or other jurisdiction of incorporation or organization) | | (I.R.S. Employer Identification Number) |
i 671 N. Glebe Road, i Arlington,
i Virginia i 22203
(Address of principal executive offices and Zip Code)
( i 646)
i 521-4340
(Registrant’s telephone number, including area code)
Securities Registered Pursuant to Section 12(b) of the Act:
|
| | |
Title of Each Class | Trading Symbol | Name of Each Exchange on Which Registered |
i Common
Stock, par value $0.01 per share | i ETFC | The NASDAQ Stock Market LLC |
i 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. i 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 ¨ i 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. i Yes x No ¨ Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 such files). i 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. |
| | | | | |
i Large
accelerated filer | x | | Accelerated filer | | ☐ |
Non-accelerated filer ¨ (Do not check if a smaller reporting company) | Smaller reporting company | | i ☐ |
| | Emerging
growth company | | i ☐ |
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 i ☐ No x At June 30, 2019, the aggregate market value of voting stock held by non-affiliates of the
registrant was approximately $ i 7.4 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 14, 2020, there were i 221,750,841 shares of common stock outstanding. i Documents
Incorporated by Reference: Certain portions of the definitive Proxy Statement related to the Annual Meeting of Stockholders, to be filed hereafter (incorporated into Part III hereof).
E*TRADE FINANCIAL CORPORATION
FORM 10-K ANNUAL REPORT
|
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PART
I | | |
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Item 1. | | |
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Item 1A. | | |
Item 1B. | | |
Item
2. | | |
Item 3. | | |
Item 4. | | |
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PART
II | | |
Item 5. | | |
Item 6. | | |
Item
7. | | |
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Item 7A. | | |
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Item
8. | | |
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E*TRADE
2019 10-K | Page i
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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, E*TRADE Savings Bank, the Converging Arrows logo, Power E*TRADE, Equity Edge Online, Trust Company of America, now E*TRADE Advisor Services, E*TRADE Advisor Network, Liberty and Gradifi are trademarks or 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.
E*TRADE 2019 10-K | Page 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 |
| |
• | our capital plan initiatives |
| |
• | the
timing and payment of dividends on our common and preferred stock |
| |
• | the payment of dividends from our subsidiaries to our parent company |
| |
• | the management of our legacy mortgage loan portfolio |
| |
• | our ability
to comply with future changes to government regulations |
| |
• | our ability to maintain required regulatory capital ratios |
| |
• | continued repurchases of our common stock |
| |
• | our ability to meet upcoming debt obligations |
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• | 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 |
| |
• | future sources of revenue, expense and liquidity |
| |
• | the
ability of our technology solution for advisors and our referral program to attract and retain customers seeking specialized services and sophisticated advice |
| |
• | the expected impact of the adoption of the amended accounting and disclosure guidance governing the accounting for credit losses |
| |
• | the expected impact from and responses to the elimination of retail commissions for online US listed stock, exchange-traded funds (ETF), and options trades |
| |
• | 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 conditions |
| |
• | performance,
volume and volatility in the equity and capital markets |
| |
• | changes in interest rates or interest rate volatility |
| |
• | our ability to manage our balance sheet size and capital levels |
| |
• | disruptions or failures of our information technology systems or those of our third-party service providers |
| |
• | cyber
security threats, system disruptions and other potential security breaches or incidents |
| |
• | customer demand for financial products and services |
| |
• | our ability to continue to compete effectively and respond to aggressive competition within our industry, such as through the elimination of retail commissions for online US listed stock, ETF and options trades |
E*TRADE 2019 10-K | Page
1
| |
• | 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 manage our significant risk exposures effectively |
| |
• | the occurrence of risks associated with our advisory services |
| |
• | our ability to manage credit risk with customers and counterparties |
| |
• | our ability to service our corporate debt and, if necessary, to raise additional capital |
| |
• | changes
in government regulation, including interpretations, or actions by our regulators, including those that may result from the implementation and enforcement of regulatory reform legislation |
| |
• | adverse developments in any investigations, disciplinary actions or litigation |
| |
• | changes in actual or forecasted assumptions impacting the measurement of expected credit losses upon adoption of the amended guidance governing the accounting for credit losses |
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. Investors should also consider the risks and uncertainties described elsewhere in this report, including under Part I. Item 1A. Risk Factors and Part II. Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations of this Annual Report. 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, except as required by law.
E*TRADE
2019 10-K | Page 2
ITEM 1. BUSINESS
Company Overview
E*TRADE
is a financial services company that provides brokerage and related products and services for traders, investors, stock plan administrators and participants, and registered investment advisors (RIAs). We were incorporated in California in 1982, reincorporated in Delaware in July 1996 and had approximately 4,100 employees at December 31, 2019. Founded on the principle of innovation, we aim to enhance the financial independence of customers through a powerful digital offering that includes tools and educational materials, complemented by professional advice and support, catering to the complex and unique needs of customers to help meet their near- and long-term investing goals. We provide these services 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 also operate federally chartered savings banks with the primary purpose of maximizing the value of deposits generated through our brokerage business. 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, 2019, 2018, and 2017 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 transactions |
| |
• | E*TRADE Bank is a federally chartered savings bank that provides Federal Deposit Insurance Corporation (FDIC) insurance on certain 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 certain qualifying amounts of customer deposits and provides
custody solutions for RIAs |
| |
• | E*TRADE Financial Corporate Services, Inc. (E*TRADE Financial Corporate Services) is a provider of software and services for managing equity compensation plans and student loan and financial wellness benefits to our corporate clients |
| |
• | E*TRADE Futures LLC (E*TRADE Futures) is a registered non-clearing Futures Commission Merchant (FCM) that provides retail futures transaction capabilities for our customers |
| |
• | E*TRADE
Capital Management LLC (E*TRADE Capital Management) is an RIA that provides investment advisory services for our customers |
Delivering a powerful digital offering for 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. We offer a broad range of products and services to customers through the following channels:
| |
• | Retail: Our retail channel services individual brokerage and banking customers that utilize our web, mobile and/or active trading platforms to meet trading, investing and/or banking needs |
| |
• | Institutional:
Our institutional channels include Corporate Services and Advisor Services. We provide stock plan, student loan and financial wellness solutions for public and private companies globally through our corporate services channel. We provide custody services to independent RIAs through our advisor services channel |
E*TRADE 2019 10-K | Page 3
Our
business strategy is focused on leveraging our brand, hybrid support model, and technology to grow our retail and institutional channels while generating robust earnings growth and maximizing shareholder returns.
Leverage our brand, hybrid support model, and leading technology for scale and growth
E*TRADE's unrivaled and tech-forward brand is synonymous with digital brokerage and drives outsized awareness and consideration among business-to-customer and business-to-business audiences. We are able to serve peak volumes across channels with capacity for growth and acquisition through our strong and scalable infrastructure. Our customers benefit from digitally led experiences, complemented by professional advice and support. We cater to the complex and unique needs of traders, investors, stock plan administrators and participants, and independent RIAs.
Empower
self-directed retail customers through a powerful digital offering and professional guidance
E*TRADE has three core digital offerings for the retail investor—trading, investing, and banking. We maintain a leading position among active and derivatives traders through the Power E*TRADE web-based platform and support model. We connect customers with a range of easy to use wealth management solutions. We are also advancing digital banking capabilities to complement our existing product set and increase engagement with customers and prospects.
Capitalize on symbiotic institutional channels to drive growth
E*TRADE's corporate services and advisor services channels are critical for growth. We aim to expand on our #1 position in stock plan administration through innovative digital solutions, complementary service offerings and expert support—driving
growth in retail and institutional relationships. We plan to leverage the power of E*TRADE's brand, digital ethos, and our broad customer base to grow the advisor services channel. We also plan to connect retail customers and stock plan participants seeking higher touch services to top-tier advisors through our referral network—driving asset growth and retention.
Generate robust earnings growth and shareholder returns
We aim to deliver superior returns on customer assets by capturing the full value of our retail and institutional relationships and leveraging E*TRADE's highly scalable model to generate robust earnings growth and maximize shareholder returns.
E*TRADE 2019 10-K | Page 4
Our hybrid delivery model is available through the following award-winning digital platforms which are complemented by professional advice and support. |
| | | | |
| | Platforms for Retail Channel(1) | Platforms for Institutional Channel(1) |
| | | Web | | Equity
Edge Online(2) |
| | Our easy to use site is the primary channel to interact with customers and prospects | Equity Edge Online is the #1 rated platform in the stock plan administration industry that offers automation and flexibility |
| |
| |
| | | | |
| | | Mobile(3) | | Gradifi |
| | Our
industry leading mobile applications include integrations with leading artificial intelligence assistants | Gradifi is a secure, scalable, and streamlined platform that offers student loan and financial wellness benefits |
| |
| |
| | | | | |
| | | Active Trading Platforms | | Liberty |
| | Active
derivatives trading platforms include sophisticated trading tools, advanced portfolio and market tracking, and idea generation and analysis | Liberty is intuitive technology built for RIAs that simplifies the investment and management of client assets |
| |
| |
| | | | | |
| | Complemented by professional advice and support |
| | | Customer
Service | | Financial Consultants |
| | Customer service is available 24/7 via phone, email or chat from industry licensed representatives. White glove service is available for our highest-tiered customers | Financial consultants are available by phone or at branches to provide one-on-one investing advice |
| |
| |
| | | | | |
| | | Active
Trader Services | | Corporate Services |
| | Active trader services includes specialized support for sophisticated customers with advanced knowledge and skill
| Corporate services support includes personalized service on a global scale driven by dedicated relationship and service managers backed by comprehensive training and education |
| |
| |
| | | | | |
| | | | | Advisor
Services |
| | | Advisor services support includes dedicated relationship managers who act as a single point of contact for specialized support |
| |
| |
| | | |
| |
(1) | In August 2019, E*TRADE was rated the #1 online broker in Kiplinger's 2019 Best Online Brokers review. |
| |
(2) | In
September 2019, Equity Edge Online was rated #1 in Loyalty and Overall Satisfaction for the eighth consecutive year in the Group Five Stock Plan Administration Benchmark Study. |
| |
(3) | E*TRADE maintained its #1 ranking for its Mobile Trading, Options Trading, and Web-based Platform (Power E*TRADE) in Stockbrokers.com's 2020 review of Best Online Brokers for Stock Trading. We also finished Best in Class for research, education, active trading, futures trading, and IRA accounts. |
E*TRADE 2019 10-K | Page 5
We deliver a broad range of products and services through our retail and institutional channels across the following five product areas: Trading, Investing, Banking and Cash Management Capabilities, Corporate Services and Advisor Services.
Trading
The Company delivers automated trade order placement and execution services, offering our customers a full range of investment vehicles, including US equities, ETFs, options, bonds, futures, American depositary receipts and non-proprietary mutual funds. We also offer margin accounts, enabling qualifying customers to borrow against their securities, supported by robust customer tools to analyze positions
and understand collateral requirements. The Company also offers a fully paid lending program which allows customers to earn income on certain securities when they permit us to lend these securities. The Company markets trading products and services to active traders and self-directed investors. Products and services are delivered through web, desktop and mobile platforms. Trading tools are supported by guidance, including options, futures and fixed income specialists available on-call for customers. Other tools and resources include independent research and analytics, live and on-demand education, market commentary, trading ideas, strategies, and screeners for major asset classes. Investing
The
Company endeavors to help investors build wealth and address their long-term investing needs through a suite of managed products, asset allocation models, and other services. These include our Core Portfolios, Blend Portfolios, Dedicated Portfolios, and Fixed Income Portfolios. The Company offers self-directed digital tools across web and mobile platforms, including mutual fund and ETF screeners, All-Star Lists, a collection of pre-built ETF or mutual fund portfolios based on time frame and risk tolerance, an assortment of planning and allocation tools, thematic investing opportunities, education and editorial content. Investors also have access to a wide selection of ETFs and mutual funds, including more than 2,300 ETFs and more than 4,600 no-load, no-transaction fee mutual funds. The
Company also offers guidance through a team of licensed financial consultants and Chartered Retirement Planning CounselorsSM at our 30 regional financial centers and through our two national financial centers by phone, email and online. Customers can also receive complimentary portfolio reviews and personalized investment recommendations. Banking and Cash Management Capabilities
The Company's banking and cash management capabilities include deposit accounts insured by the FDIC, which are fully integrated into customer brokerage accounts. E*TRADE Bank's deposit account offerings include the Premium Savings Account, which provides a higher yield to savings account
customers as compared to our other deposit products. Among other features, E*TRADE Bank's customers can transfer to and from accounts at E*TRADE and elsewhere for free and checking account customers have access to debit cards with ATM fee refunds, online and mobile bill pay, and mobile check deposits. We also offer the E*TRADE Line of Credit, a securities-based lending program, which allows customers to borrow against the market value of securities pledged as collateral.
E*TRADE 2019 10-K | Page 6
Corporate Services
Through our industry-leading platform, Equity Edge Online, the Company offers fully-automated employee stock plan and employee stock purchase plan administration, as well as comprehensive accounting, reporting and scenario modeling tools. The integrated stock plan solutions include multi-currency settlement and delivery, and streamlined tax calculation. Additionally, corporate clients are offered 10b5-1 plan design and implementation, along with SEC filing assistance and automated solutions. Participants have full access to E*TRADE's robust investing and trading capabilities, including tailored education and planning tools, and dedicated stock plan service representatives. Comprehensive financial wellness and student
loan solutions have been introduced to complement our existing corporate services offering with the acquisition of Gradifi, Inc. (Gradifi) in December 2019. Refer to Note 2—Acquisitions and Restructuring for further detail. Corporate Services is an important driver of account and asset growth, serving as a conduit to the retail channel. During the year ended December 31, 2019, there were approximately $100 billion of gross inflows into our corporate services channel, primarily driven by new corporate client implementations and new grants and employee stock purchase plan transactions. Over this same period, domestic stock plan participants generated $35 billion of net proceeds through transactions
of vested assets. These participant proceeds represent a key source of net new assets for the retail customer channel. Advisor Services
Through our proprietary technology platform, Liberty, the Company offers sophisticated modeling, rebalancing, reporting, and practice management capabilities that are fully customizable for the RIA. E*TRADE's financial consultants can refer retail customers to pre-qualified RIAs on our custody platform through our referral program, the E*TRADE Advisor Network, which is offered through our two national and 30 regional financial centers. We expect the E*TRADE Advisor Network will improve the Company's ability to drive asset growth and retain customers seeking specialized services
and sophisticated advice.
E*TRADE 2019 10-K | Page 7
|
|
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 our teams with professionals 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 steps required to address customer needs. We also have specialized customer service programs that are tailored to the needs of various customer groups. We provide sales and customer support as follows: |
| |
| 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. |
|
| Phone Our toll-free number connects customers to the appropriate department where an investment advisor or customer service representative can address the customer's needs. |
| |
| Financial
Centers We have 30 financial centers located across the US where investors can get face-to-face support and guidance. Financial consultants are available on-site, over the phone and via email to help customers assess their asset allocations and develop plans to help them achieve their investment goals. Additionally, the E*TRADE Advisor Network, our RIA referral program, is operational at all financial centers. |
The online financial services industry continues to evolve and remains highly competitive. Our retail
and institutional channels compete with full service and online brokerage firms, RIAs, finance technology start-ups, and retail and savings banks. Some of these competitors also provide online trading and banking services, investment advisor services, robo-advice capabilities, and a host of other financial products and services.
Competition in the financial services industry continues to intensify, particularly amid continued consolidation and pressures on 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 compelling and easy to use products and solutions to our 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 to retain and motivate our existing employees while efficiently managing compensation-related costs.
E*TRADE 2019 10-K | Page 8
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, that 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 federal savings bank subsidiaries. In May 2018, the Economic Growth, Regulatory Relief, and Consumer Protection Act
of 2018 (EGRRCPA) was passed. The EGRRCPA amended provisions in the Dodd-Frank Act as well as other statutes administered by the Federal Reserve Board, the Office of the Comptroller of the Currency (OCC), and the FDIC (collectively, the “federal banking agencies”). On November 1, 2019, the Federal Reserve Board published a final rule that applies certain requirements to savings and loan holding companies with $100 billion or more in total consolidated assets. For the Company, this final rule formalized relief resulting from the passage of EGRRCPA from certain requirements including company-run stress testing requirements and the modified liquidity coverage ratio. The final rule established four categories of U.S. banking organizations that are determined based on risk-based indicators and tailored the application of certain enhanced
prudential standards to those categories, with requirements generally applying beginning at the $100 billion consolidated asset threshold. While the Company currently does not surpass that threshold, it could in the future. 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 and certain state laws, including the California Consumer Privacy Act (CCPA), to disclose their privacy policies and practices related to sharing customer information with affiliates and non-affiliates and to provide customers with the ability to "opt out" of sharing certain non-public information for certain purposes. Additionally, the CCPA requires us to provide California residents, whether or not they are customers, with the ability to make certain requests related to their personal information, including accessing and/or deleting their information, subject to statutory exceptions. The U.S. Congress also continues to consider various proposals for a comprehensive federal data privacy law, and we expect federal
data privacy laws to continue to evolve. For additional information on the privacy and security of our customers' and employees' personal information and the potential impact to our business if we fail to protect such information or comply with relevant laws, rules, and regulations, refer to Item 1A. Risk Factors under the heading Risks Relating to the Regulation of Our Business. 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. 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 AML and counter-terrorist
financing laws and 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. In providing certain retirement account types and services to such accounts, E*TRADE Securities, E*TRADE Capital Management, and E*TRADE Savings Bank are also subject to certain rules and regulations of the Department of Labor and the Internal Revenue Service. For
E*TRADE 2019 10-K | Page 9
additional
regulatory information on our brokerage and banking regulations, see MD&A—Liquidity and Capital Resources and Note 18—Regulatory Requirements.
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 Company is required to serve
as a source of financial and managerial strength for its subsidiary banks. Our banking entities are regulated, supervised, and examined by the OCC, the Consumer Financial Protection Bureau (CFPB), and the FDIC. The Company and the banking entities are also subject to regulations and various requirements and restrictions under state and other federal laws. Such regulations cover 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, and provide the regulatory authorities broad discretion in connection with their supervisory, examination and enforcement activities and policies. 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. The Company’s ability to pay dividends on our stock is subject to limits, including in certain instances the requirement that we consult with or receive approval from the Federal Reserve prior to taking such capital actions to ensure that the proposed actions do not raise safety and soundness considerations. Prior Federal Reserve approval is required for the Company to repurchase its stock and such approval is conditioned on multiple factors, including the
Company’s current and projected financial condition. Basel III Capital Framework
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 federal savings bank subsidiaries on January 1, 2015. The US Basel III rules increased the quantity and quality of required regulatory capital, established a capital conservation buffer, and made changes to the calculation of risk-weighted assets. Failure to maintain the capital conservation buffer limits a banking organization's ability to make capital distributions and discretionary bonus payments to executive officers. Failure to meet capital requirements can
trigger discretionary and mandatory actions by regulators. 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. Resolution
Planning
Current FDIC rules require 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 under the receivership and liquidation provisions of the Federal Deposit Insurance Act. While E*TRADE Bank crossed the applicable total assets threshold of $50 billion in 2019, neither E*TRADE Bank nor E*TRADE Savings Bank will, at this time, be required to submit a resolution plan to the FDIC due to interim FDIC actions. On April 16, 2019, the FDIC approved an advanced
E*TRADE 2019 10-K | Page 10
notice of proposed rulemaking seeking comment on potential changes to this rule (the "IDI Rule") including whether to change the asset threshold. On the same day, the FDIC also announced that its board of directors voted to delay submissions under the IDI Rule until the rulemaking process has been completed.
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 included E*TRADE Bank. Under the final rule, E*TRADE Bank was 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 were 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. In November 2018, the FDIC announced the end of these surcharges, with the last surcharge being assessed for the third quarter of 2018. The surcharge did not 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 bank is required to maintain at least 65% of its “portfolio assets” (defined as the savings bank’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 (MBS), 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 bank that fails to meet the QTL test is subject to certain operating restrictions and may be required to convert to a national bank charter.
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 Commodity Futures Trading Commission (CFTC) and is a member of the National Futures Association (NFA).
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, conflicts, and securities and other investment related recommendations made to customers and prospects.
E*TRADE 2019 10-K | Page 11
Investment Adviser Regulation
E*TRADE Capital Management is registered with the SEC as an investment adviser and is subject to regulation as such by the SEC as well as various state regulators. Investment advisers registered with the SEC are subject to the Investment Advisers Act of 1940 (Advisers Act) and potentially state regulations (in addition to laws and regulations mentioned above in the Financial Services Regulation discussion). The Advisers Act, together with related regulations and interpretations of the SEC, impose numerous obligations and restrictions on investment advisers, including requirements relating to the safekeeping of client funds and securities, limitations on advertising, disclosure, reporting and recordkeeping obligations.
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 SEC maintains a website
that contains the materials we file with the SEC at www.sec.gov. 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 could impact trading volumes, margin lending and sweep deposits, resulting in lower revenues.
Services provided to retail customers, 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 customer transactions which may, in turn, result in lower trading-based revenue, fees and service charges, and a decrease in margin lending, which would reduce our interest income earned on margin receivables. Changes in business, economic or political conditions could also result in our customers reducing their cash allocations or transferring cash away from us, either of which could negatively impact the amount of sweep deposits our customers maintain with the
Company and reduce net revenue. 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 and our ability to manage interest rate risk could impact our financial condition. 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. 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.
E*TRADE
2019 10-K | Page 12
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 and the value of our debt securities to decrease. Increases in funding costs without offsetting increases in asset yields, especially when a flattened or inverted yield curve persists over a sustained period of time, may adversely
affect our results of operations. The manner in which interest rates are calculated could also impact net interest income. For example, recent reforms, when effective after 2021, may cause the London Interbank Offered Rate (LIBOR) to perform differently than in the past, or be replaced as a benchmark. Although it is not possible to predict the effects of the reform, it could result in, among other things, a reduction in the interest payments we receive, reductions in the value of securities with floating interest rates that we hold, and an increase in the dividend payments on our preferred stock and in the interest payments on certain of our borrowings.
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, as well as those of the third parties on whom we rely to conduct certain key functions, are vulnerable to disruptions from natural disasters, power outages, computer and telecommunications failures, software bugs, cyber attacks, computer viruses, malware, distributed denial of service attacks, spam attacks, phishing or other social engineering, ransomware, security breaches, credential stuffing, technological failure, human error, terrorism and other similar events. 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, destruction of, 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 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. Disruptions in service and slower system response times could interrupt our business and result in substantial losses, decreased customer service and satisfaction, customer attrition, fines, litigation, and harm to our reputation. Our insurance coverage may be insufficient to protect us against all losses and costs stemming
from operational and technological failures and we cannot be certain that such insurance will continue to be available to us on economically reasonable terms, or at all, or that any insurer will not deny coverage as to any future claim. The successful assertion of one or more large claims against us that exceed available insurance coverage, or the occurrence of changes in our insurance policies, including premium increases or the imposition of large deductible or co-insurance requirements, could have a material and adverse effect on our business, financial condition 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,
security, processing, servicing and support functions. These providers are susceptible to operational, technological and security vulnerabilities, including security breaches, which may impact our business. In addition, these third-party service providers may rely on other parties (sub-contractors) to provide services to us that face similar risks. For example, third-party service providers provide us with certain transaction processing and customer-facing support services, as well as financial information, market news, quotes, research reports and other fundamental data that we offer to customers.
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We have third party oversight capabilities, including processes to evaluate third-party providers, designed to verify that the third-party service providers can support the functionality, security and stability of our operations and systems. However, these processes may be insufficient and we cannot assure that we will not experience an operational, technological or security failure as a result of a third-party service provider. Any significant failure by or of our third-party service providers or their sub-contractors that result in an interruption in service, unauthorized access, misuse, loss or destruction of data or other similar occurrences, including failures as a result of natural disasters, power outages, computer and telecommunications failures, software bugs, acts of vandalism, actual or perceived cyber attacks, computer viruses, malware, distributed
denial of service attacks, spam attacks, phishing or other social engineering, or ransomware could interrupt our business, cause us to incur losses, result in decreased customer service and satisfaction and increased customer attrition, 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 have a material impact on our ability to offer certain products and services and cause us to incur losses and could lead to a general loss of customer confidence. 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, reliable, secure, legally compliant or 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, if necessary.
Although we may have contractual protections with our third-party service providers, any actual or perceived security breach could harm our reputation and brand, expose us to potential liability or require us to expend significant resources on data security and in responding to any such actual or perceived breach. Any contractual protections we may have from our third-party service providers may not be sufficient to adequately protect us from any such liabilities and losses, and we may be unable to enforce any such contractual protections.
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, use, modification or misappropriation of our data may subject us to significant liability and reputational harm as well as reduced revenues and increased costs.
As part of our business, we are required to collect, transmit, store and otherwise process sensitive and confidential customer and employee data, including personally identifiable information and similar information as defined by applicable federal, state, and international laws and regulations (collectively "Personal Information"), third-party data, and our proprietary and confidential information, including intellectual property and trade secrets. We maintain, and we contractually require our third-party service providers who have access to Personal Information to maintain, systems and procedures designed to securely collect, transmit, store and otherwise process
sensitive and confidential information (including Personal Information) and to protect against unauthorized access to and disclosure of such information. However, risks associated with the collection, transmission, storage and other processing of sensitive and confidential data have grown in recent years due to increasing use of the internet and mobile technologies, and the increasing sophistication and activities of organized crime, hackers, terrorists, nation-states, and other external parties. Like other financial services firms, we experience malicious cyber activity directed at our computer systems, software, networks, and users, including phishing attacks and other forms of social engineering and credential stuffing, attempted unauthorized access, acts of vandalism, computer viruses, malware, ransomware, security breaches, spam attacks, and other cyber attacks. Furthermore, parties may attempt to fraudulently induce employees, customers, clients, third parties
or other users of our systems to disclose sensitive or confidential information in order to gain access to our data or that of our customers. Security and privacy threats could derive from third parties, malicious employees or insiders, human error, or technological failures. In 2013, we, and other financial institutions, experienced a cyber incident that 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
E*TRADE 2019 10-K | Page 14
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 security measures, but, despite these investments, we, our customers and our third-party service providers may be unable to anticipate, detect or implement effective preventative measures against cyber attacks or security or privacy breaches, which could result in theft, unauthorized access, acquisition, use disclosure, modification, misuse, loss or destruction of systems or data, interruptions in service, impacts on financial data reporting, theft of intellectual property, or other similar events. We may be required to expend significant capital and other resources to protect against any potential security breaches or failures and their consequences.
An
actual or perceived breach of the security of our technology or media (whether social or traditional media), the reporting or announcement of such an event, or reports of perceived security vulnerabilities of our systems or the systems of our third-party service providers, whether accurate or not, or our failure or perceived failure to respond or remediate an event or make adequate or timely disclosures to the public or law enforcement agencies following any such event could severely damage our reputation, expose us to the risk of litigation and liability, result in regulatory actions from state or federal governmental authorities and significant fines, orders and sanctions, disrupt our operations, increase our costs with respect to investigations and remediations, reduce our revenues as a result of the theft of intellectual property, distract our management and otherwise have a materially adverse effect on our business. Additionally, if securities analysts or investor
perceive these announcements to be negative, it could, among other things, have a substantial adverse effect on the price of our common stock. Further, any actual or perceived security breach or cyber 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.
A security breach could occur and persist for an extended period of time without detection. We expect that any investigation of a security breach 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 a breach. Further, detecting and remediating such incidents may require specialized expertise and there can be no assurance that we will be able to retain or hire individuals who possess, or otherwise internally develop, such expertise. Our remediation efforts therefore may not be successful. The inability to implement, maintain, and upgrade adequate safeguards could have a material and adverse impact on our business, financial condition and results of operations. Moreover, there could be public announcements regarding any data security-related incidents and any steps we take to respond to or remediate such incidents. Consumers are generally concerned with security and privacy of the internet, and any publicized security problems affecting our businesses or those
of third parties with whom we are affiliated or otherwise conduct business may discourage consumers from doing business with us, which could have a material and adverse effect on our business, financial condition and results of operations.
If any person, including any of our employees, contractors or other agents, negligently disregards or intentionally breaches our established controls with respect to client, employee or third-party 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.
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 certain losses caused by a breach of security of our
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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.
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 security breaches, cyber attacks and other types of unlawful activity, or any resulting disruptions from such events. We cannot be certain that cyber insurance will continue to be available to us on economically reasonable terms, or at all, or that any insurer will not deny coverage as to any future claim. The successful assertion of one or more large claims against us that exceed available insurance coverage, or the occurrence of changes in our insurance policies, including premium increases or the imposition of large deductible or co-insurance requirements,
could have a material and adverse effect on our business, financial condition and results of operations.
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, payments of cash dividends to holders of our preferred stock, as well as capital returns to holders of our common stock. Regulatory and other legal restrictions may limit our ability to transfer funds to or from certain subsidiaries,
including E*TRADE Securities, E*TRADE Bank, and E*TRADE Savings Bank. 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 by, among other things, reducing our liquidity in the form of corporate cash. In addition to negatively affecting our business, a significant decrease in our liquidity could also reduce client confidence in E*TRADE. Under applicable rules, a dividend in excess of 10% of a member firm’s excess net capital may not be paid without FINRA’s prior written approval. Compliance
with these rules may impede our ability to receive dividends from E*TRADE Securities. Additionally, a savings bank 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 bank 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, 2019, much of our capital was invested in our banking subsidiary, E*TRADE Bank. The Federal Reserve and/or OCC 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 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, especially larger competitors that may benefit from more diversified product and
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customer bases. Competitors may conduct extensive promotional activities, offering better terms, lower prices, pay higher interest rates on deposits,
or offer different products and services that could attract current and prospective E*TRADE customers and potentially result in intensified price competition within the industry. We continue to experience aggressive price competition in the industry, including the elimination of retail commissions for online US listed stock, ETFs, and options trades, reduced options contract charges 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 and from consolidation with other competitors. In addition, we compete in a technology-intensive industry characterized by rapid innovation. Some of our competitors, including new and emerging competitors,
are not subject to the same regulatory requirements or scrutiny to which we are subject, which could place us at a competitive disadvantage, in particular in the development of new technology platforms or the ability to rapidly innovate. 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 cyber security 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 |
| |
• | General economic and industry trends, including customer demand for financial products and services |
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 mergers and acquisitions and the subsequent business integrations.
We consider opportunistic acquisitions to grow our existing business, add new technologies, or expand distribution. We cannot be certain that we will be able to identify, consummate and successfully integrate businesses or acquired assets, 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 an acquired entity, as well as potential difficulties integrating people, systems and customers and realizing synergies.
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We completed the acquisition of Gradifi in the fourth quarter of 2019, the acquisition of retail brokerage accounts from Capital One Financial Corporation (Capital One) in the fourth quarter of 2018, and the acquisition of Trust Company of America (TCA) in the second quarter of 2018. The acquisitions subject us to a number of risks, uncertainties, and potential costs. The risks associated with these transactions and any future transactions include:
| |
• | We may experience significant attrition in the acquired customers, 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
and other integration 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 transactions 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, and dividend payments on our common stock and preferred stock. 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 transactions,
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 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.
E*TRADE 2019 10-K | Page 18
Providing
investment advice and recommendations subjects us to additional risks.
We provide investment advice and recommendations to investors to aid them in their decision making. We also provide a variety of investment education and tools to our clients that we do not consider investment advice or an investment recommendation, including web-based educational seminars for new customers, introductions to the equities and options markets, and retirement planning tools. 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, our Financial Consultants’ recommendations may not fulfill regulatory requirements
as a result of their failing to collect sufficient information about a customer or failing to understand the customer’s needs or risk tolerances. Risks associated with providing investment advice and recommendations also include those arising from how we disclose and address possible conflicts of interest, inadequate due diligence, inadequate disclosure, human error and fraud. New regulations, such as the SEC's Regulation Best Interest, will impose heightened conduct standards and requirements when we provide recommendations to retail investors. In addition, various states are considering potential regulations that could impose additional standards of conduct or other obligations on us when we provide investment advice or recommendations to retail investors and possibly to all of our clients. To the extent that we fail to satisfy regulatory requirements, fail to know our customers, improperly advise our customers, or risks associated with advisory services otherwise
materialize, we could be found liable for losses suffered by such customers, or could be subject to regulatory fines, and civil penalties, any of which could harm our reputation and business.
We may suffer losses due to credit risk associated with margin lending, securities lending transactions, our investment and mortgage loan portfolios 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 timely. In addition, we frequently borrow securities from and lend securities to other broker-dealers. Under regulatory guidelines,
when we borrow or lend securities, we must simultaneously disburse or receive cash deposits. A sharp change in security market values may result in losses if counterparties to the borrowing and lending transactions default on their obligations. Even without defaults, the value of debt securities may be negatively affected by the credit deterioration of a security's issuer. We also engage in financial transactions with counterparties, including repurchase agreements and hedging transactions, that expose us to credit losses in the event counterparties cannot meet their obligations.
Our mortgage loan portfolio represents our most significant credit risk exposure. At December 31, 2019, the principal balance of our one-to four-family loan portfolio was $803 million with an allowance for loan losses of $6 million.
The principal balance of our home equity loan portfolio was $635 million with an allowance for loan losses of $11 million. Certain characteristics of our mortgage loan portfolio indicate an additional risk of loss, including lien position and geographical concentration. 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.
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We face competition in hiring and retaining qualified employees.
The market for qualified personnel in the financial services industry, particularly skilled information technology personnel, is highly competitive. At various times, different
functions and roles are in especially high demand in the market, compelling us to pay more to attract talent. Our ability to continue to compete effectively will depend upon our ability to attract new employees and retain existing employees while managing compensation costs.
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, 2019, we have $1.4 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 $52 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
ability to adjust rapidly to changing market conditions, making 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: | |
• | Merge,
consolidate or transfer substantially all of our assets |
| |
• | With respect to our subsidiaries only, incur additional indebtedness |
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.
E*TRADE 2019 10-K | Page 20
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.
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 and investment adviser subsidiaries must comply with many laws and rules, including rules relating
to the provision of investment advice, 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 AML. 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 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, 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 or regulations, rule changes or changes in the interpretation or enforcement of existing laws, rules and regulations and new or amended guidance and supervisory practices could increase our compliance costs and adversely affect our business and results of operations. For example, LIBOR is used in many of our systems and significant work may be required to transition to new benchmark rates following the expected phase-out of LIBOR. This may impact our existing financial models, transaction data, products, systems, operations and pricing processes. For further information on how ongoing regulatory reform could affect us, see Business—Regulation.
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,
E*TRADE
2019 10-K | Page 21
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 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 banks, such as the Company’s two federal savings bank 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 also has certain types of enforcement powers over us, including the ability to issue cease-and-desist orders, force divestiture of our savings bank 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 regulation and guidance that generally aligns the supervisory and regulatory standards of savings and loan holding companies more closely with the standards applicable to bank holding companies. Our savings bank subsidiaries are also subject to reporting, examination, supervision and enforcement oversight by the OCC. For all insured depository institutions, including savings banks with total consolidated assets over $10 billion, such as 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
EGRRCPA, enacted in 2018, relieved the Company of certain regulatory burdens to which it had become subject as a result of surpassing $50 billion in total consolidated assets on a four-quarter average basis in 2017. In addition, the Federal Reserve Board finalized a rulemaking in November 2019 that applies certain requirements to savings and loan holding companies with $100 billion or more in total consolidated assets. While the Company currently does not surpass that threshold, it could in the future. 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 may increase our costs and limit our ability to pursue certain business
opportunities.
E*TRADE 2019 10-K | Page 22
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 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 these entities' 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 their 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.
E*TRADE 2019 10-K | Page 23
As a 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 or specifically authorized by law, such as 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 authorized. 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 our savings bank subsidiaries, to be both "well capitalized" and "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 savings bank 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. 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. Our collection, use, storage, disclosure, transfer and other processing of personal information could give rise to significant costs and liabilities, including as a result of governmental regulation, conflicting legal requirements or differing views of personal privacy rights, which may have a material and adverse impact on our business, financial condition and results of operations.
In providing services to customers, we manage, use, store, disclose, transfer and otherwise process a large volume of consumer and customer data, including Personal Information and other sensitive information. We are subject to numerous data protection laws and regulations, such as US federal and state laws and foreign regulations governing the protection of Personal Information and other consumer and customer data, including, but not limited to, the federal Gramm-Leach-Bliley Act and the
CCPA. These laws and regulations have increased in complexity and number, change frequently and can conflict with one another. In certain cases, they provide a private right of action, which may increase the likelihood of, and risks associated with, data breach litigation. As we seek to expand our business, we are, and may increasingly become, subject to various laws, regulations and standards, as well as contractual obligations, relating to data privacy and security in the jurisdictions in which we operate. In many cases, these laws and regulations apply not only to third-party transactions, but also to transfers of information between or among us, our affiliates and other parties with whom we conduct business. These laws, regulations and standards may be interpreted and applied differently over time and from jurisdiction to jurisdiction, and it is possible that they will be interpreted and applied in ways that may have a material and adverse impact on our business,
financial condition and results of operations. For example, the interpretation and application of the extraterritorial application of certain foreign regulations, including the General Data Protection Regulation, is unclear at this time. The regulatory framework for data privacy and security worldwide is continuously evolving and developing and, as a result, interpretation and implementation standards and enforcement practices are likely to remain uncertain for the foreseeable future.
Many statutory requirements, both in the United States and abroad, include obligations for companies to notify individuals of security breaches involving certain personal information, which could result from
E*TRADE 2019 10-K | Page 24
breaches experienced by us or our third-party service providers. For example, laws in all 50 U.S. states and the District of Columbia require businesses to provide notice to consumers whose personal information has been disclosed as a result of a data breach. These laws are not consistent, and compliance in the event of a widespread data breach is difficult and may be costly. We also may be contractually required to notify consumers or other counterparties of a security breach.
We expect that there will continue to be new proposed laws and regulations concerning data privacy and security, and we cannot yet determine the impact such future laws, regulations and standards may have on our business. New laws, amendments to or re-interpretations of existing laws, regulations, standards and other obligations may require us
to incur additional costs and restrict our business operations. Because the interpretation and application of laws, regulations, standards and other obligations relating to data privacy and security are still uncertain, it is possible that the scope and requirements of these laws may be interpreted and applied broadly by various jurisdictions, and in a manner that is inconsistent with our understanding and practices and with other legal requirements. If so, in addition to the possibility of fines, lawsuits, regulatory investigations, public censure, other claims and penalties, and significant costs for remediation and damage to our reputation, we could be materially and adversely affected if legislation or regulations are expanded to require changes in our data processing practices and policies or if governing jurisdictions interpret or implement their legislation or regulations in ways that negatively impact our business, financial condition and results of operations.
We may be unable to make such changes and modifications in a commercially reasonable manner, or at all. Any inability to adequately address data privacy or security-related concerns, even if unfounded, or to comply with applicable laws, regulations, standards and other obligations relating to data privacy and security, could result in additional cost and liability to us, harm our reputation and brand, damage our relationships with consumers and have a material and adverse impact on our business, financial condition and results of operations.
We make public statements about our use and disclosure of personal information through our privacy policies, information provided on our website and press statements. Although we endeavor to comply with our public statements and documentation, we may at times fail to do
so or be alleged to have failed to do so. The publication of our privacy policies and other statements that provide promises and assurances about data privacy and security can subject us to potential government or legal action if they are found to be deceptive, unfair or misrepresentative of our actual practices. Moreover, from time to time, concerns may be expressed about whether our products and services compromise the privacy of consumers and others. Any concerns about our data privacy and security practices, even if unfounded, could damage the reputation of our businesses, discourage potential users from our products and services and have a material and adverse impact on our business, financial condition and results of operations. Any failure or perceived failure by us or our third-party service providers to comply with our posted privacy policies or with any applicable federal, state or similar foreign laws, regulations,
standards, certifications or orders relating to data privacy, security or consumer protection, or any compromise of security that results in the theft, unauthorized access, acquisition, use, disclosure, or misappropriation of personal information or other user data, could result in fines or proceedings or litigation by governmental agencies or consumers, including class action privacy litigation in certain jurisdictions, which would subject us to significant awards, penalties or judgments, one or all of which could materially and adversely affect our business, financial condition and results of operations. In addition, if our practices are not consistent, or viewed as not consistent, with legal and regulatory requirements, including changes in laws, regulations and standards or new interpretations or applications of existing laws, regulations and standards, we may also become subject to audits, inquiries, whistleblower complaints, adverse media coverage, investigations,
or severe criminal or civil sanctions, all of which may affect our financial condition, operating results and our reputation.
E*TRADE 2019 10-K | Page 25
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.
Our future ability to pay cash dividends to holders of our common stock is subject to the discretion of our board of directors and will be limited by our ability to generate sufficient earnings and cash flows.
In the fourth quarter of 2018 we announced the declaration of a quarterly dividend on shares of our common stock and have continued to declare such dividends quarterly during 2019. Payment of future dividends, if any, will be at the discretion of our board of directors and will depend upon a number of factors that the board of directors deems
relevant, including future earnings, the success of our business activities, capital requirements, the general financial condition and future prospects of our business and general business conditions. If we are unable to generate sufficient earnings and cash flows from our business, we may not be able to pay dividends on our common stock; however, even with sufficient earnings and cash flows from our business, our board of directors may exercise its discretion by not declaring a dividend on our common stock. In addition, our ability to pay dividends on our common stock is subject to statutory and regulatory limitations. As noted above, we depend on dividends from our subsidiaries to fund payments of cash dividends to holders of our common stock and such subsidiaries may not pay dividends
without the non-objection, or in certain cases the approval, of their regulators.
The failure to declare or pay a quarterly dividend in the future could adversely affect the market price of our common stock. Furthermore, the terms of our outstanding preferred stock prohibit us from declaring or paying any dividends on any junior series of our capital stock, including our common stock, or from repurchasing, redeeming or acquiring such junior stock, unless we have declared and paid full dividends on our outstanding preferred stock for the most recently completed dividend period.
E*TRADE 2019 10-K | Page 26
The market price of our common stock may continue to be volatile.
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 maximize shareholder returns or plans to engage in strategic transactions by us or others in the financial services industry |
| |
• | The
announcement of mergers, acquisitions, dispositions or new products or services by us or others in the financial services industry |
| |
• | 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 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 |
| |
• | 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 of directors 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.
E*TRADE 2019 10-K | Page 27
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2. PROPERTIES
A
summary of our significant locations at December 31, 2019 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 | | 236,000 |
Jersey City, New
Jersey | | 132,000 |
Arlington, Virginia | | 101,000 |
Menlo Park, California | | 91,000 |
Sandy, Utah | | 85,000 |
Denver, Colorado | | 58,000 |
Chicago,
Illinois | | 46,000 |
The Company exited its New York headquarters during the three months ended December 31, 2019 and consolidated related operations at its Jersey City, New Jersey location. Refer to Note 2—Acquisitions and Restructuring and Note 19—Lease Arrangements for additional information. All facilities are leased at December 31, 2019. 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 Litigation 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 2019 10-K | Page 28
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. The closing sale price of our common stock as reported on the NASDAQ on February 14, 2020 was $44.19 per share. At that date, there were 574 holders of record of our common stock. Common Stock Dividends
In October 2018, our board of directors declared our first quarterly cash dividend of $0.14 per share on our outstanding shares of common stock. The Company declared quarterly dividends at the rate of $0.14 per share on its outstanding shares of common stock during the year ended
December 31, 2019 and expects to continue to be able to declare dividends at such a rate in the future. Refer to MD&A—Liquidity and Capital Resources and Note 15—Shareholders' Equity for additional information. Issuer Purchases of Equity Securities
The table below shows the timing and impact of our share repurchase programs, and the shares withheld from employees to satisfy tax withholding obligations during the three months ended December 31, 2019 (dollars in millions, except share data and per share amounts): |
| | | | | | | | | | | | | | |
Period | | Total
Number of Shares Purchased(1) | | Average Price Paid per Share(1)(2) | | Total Number of Shares Purchased as Part of the Publicly Announced Programs(3) | | Maximum Dollar Value of Shares That May Yet Be Purchased Under the Program(3) |
| | 1,405,492 |
| | $ | 41.25 |
| | 1,405,492 |
| | $ | 1,033 |
|
| | 2,785,795 |
| | $ | 42.61 |
| | 2,781,601 |
| | $ | 914 |
|
| | 2,695 |
| | $ | 46.31 |
| | — |
| | $ | 914 |
|
Total
| | 4,193,982 |
| | $ | 42.15 |
| | 4,187,093 |
| | |
| |
(1) | Includes
6,889 shares withheld to satisfy tax withholding obligations associated with vesting of share-based awards. The average price paid per share for shares withheld was $45.66. |
| |
(2) | Excludes commission paid, if any. |
E*TRADE 2019 10-K | Page 29
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 S&P 500 Index and the Dow Jones US Financials Index during the period from December 31, 2014 through December 31, 2019. |
| | | | | | | | | | | | | | | | | |
| 12/14 | | 12/15 | | 12/16 | | 12/17 | | 12/18 | | 12/19 |
E*TRADE
Financial Corporation | 100.00 |
| | 122.20 |
| | 142.86 |
| | 204.37 |
| | 181.44 |
| | 189.95 |
|
S&P
500 Index | 100.00 |
| | 101.38 |
| | 113.51 |
| | 138.29 |
| | 132.23 |
| | 173.86 |
|
Dow
Jones US Financials Index | 100.00 |
| | 100.09 |
| | 117.45 |
| | 140.97 |
| | 128.32 |
| | 170.10 |
|
E*TRADE
2019 10-K | Page 30
ITEM 6. SELECTED FINANCIAL DATA
The selected consolidated financial data should be read in conjunction with Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations and Item 8. Financial Statements and Supplementary Data.
As of or for the years ended December 31, dollars in millions except per share amounts, shares in thousands: |
| | | | | | | | | | | | | | | | | | | | | | |
| | Year Ended December 31, | | Variance |
Results
of Operations: | | 2019 | | 2018 | | 2017 | | 2016 | | 2015 | | 2019 vs. 2018 |
Net interest income | | $ | 1,852 |
| | $ | 1,846 |
| | $ | 1,485 |
| | $ | 1,148 |
| | $ | 1,021 |
| | —% |
Total
net revenue | | $ | 2,886 |
| | $ | 2,873 |
| | $ | 2,366 |
| | $ | 1,941 |
| | $ | 1,370 |
| | —% |
Provision
(benefit) for loan losses | | $ | (51 | ) | | $ | (86 | ) | | $ | (168 | ) | | $ | (149 | ) | | $ | (40 | ) | | (41)% |
Total
non-interest expense | | $ | 1,618 |
| | $ | 1,541 |
| | $ | 1,470 |
| | $ | 1,252 |
| | $ | 1,319 |
| | 5% |
Net
income | | $ | 955 |
| | $ | 1,052 |
| | $ | 614 |
| | $ | 552 |
| | $ | 268 |
| | (9)% |
Basic
earnings per common share | | $ | 3.86 |
| | $ | 3.90 |
| | $ | 2.16 |
| | $ | 1.99 |
| | $ | 0.92 |
| | (1)% |
Diluted
earnings per common share | | $ | 3.85 |
| | $ | 3.88 |
| | $ | 2.15 |
| | $ | 1.98 |
| | $ | 0.91 |
| | (1)% |
Weighted average common
shares outstanding —basic | | 237,396 |
| | 260,600 |
| | 273,190 |
| | 277,789 |
| | 290,762 |
| | (9)% |
Weighted average common
shares outstanding—diluted | | 237,931 |
| | 261,669 |
| | 274,352 |
| | 279,048 |
| | 295,011 |
| | (9)% |
Dividends
declared per common share | | $ | 0.56 |
| | $ | 0.14 |
| | $ | — |
| | $ | — |
| | $ | — |
| | 300% |
Performance
Measures: | | | | | | | | | | | | |
Net interest margin | | 3.18 | % | | 3.08 | % | | 2.79 | % | | 2.65 | % | | 2.50 | % | | 0.10% |
Operating
margin | | 46 | % | | 49 | % | | 45 | % | | 43 | % | | 7 | % | | (3)% |
Return
on common equity | | 16 | % | | 17 | % | | 10 | % | | 10 | % | | 5 | % | | (1)% |
Capital
return to shareholders | | 133 | % | | 116 | % | | 61 | % | | 82 | % | | 19 | % | | 17% |
Financial
Condition: | | | | | | | | | | | | |
Investment securities | | $ | 41,470 |
| | $ | 45,037 |
| | $ | 44,518 |
| | $ | 29,643 |
| | $ | 25,602 |
| | (8)% |
Margin
receivables | | $ | 9,675 |
| | $ | 9,560 |
| | $ | 9,071 |
| | $ | 6,731 |
| | $ | 7,398 |
| | 1% |
Loans
receivable, net | | $ | 1,595 |
| | $ | 2,103 |
| | $ | 2,654 |
| | $ | 3,551 |
| | $ | 4,613 |
| | (24)% |
Total
assets | | $ | 61,416 |
| | $ | 65,003 |
| | $ | 63,365 |
| | $ | 48,999 |
| | $ | 45,427 |
| | (6)% |
Deposits | | $ | 38,606 |
| | $ | 45,313 |
| | $ | 42,742 |
| | $ | 31,682 |
| | $ | 29,445 |
| | (15)% |
Customer
payables | | $ | 12,849 |
| | $ | 10,117 |
| | $ | 9,449 |
| | $ | 8,159 |
| | $ | 6,544 |
| | 27% |
Corporate
debt | | $ | 1,410 |
| | $ | 1,409 |
| | $ | 991 |
| | $ | 994 |
| | $ | 997 |
| | —% |
Shareholders’
equity | | $ | 6,543 |
| | $ | 6,562 |
| | $ | 6,931 |
| | $ | 6,272 |
| | $ | 5,799 |
| | —% |
E*TRADE
2019 10-K | Page 31
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 Item 8. Financial Statements and Supplementary Data.
E*TRADE
is a financial services company that provides brokerage and related products and services for traders, investors, stock plan administrators and participants, and RIAs. For additional information related to our business activities see Part 1. Item 1. Business.
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, margin receivables, securities lending,
and our legacy loan portfolio, less interest incurred on interest-bearing liabilities, including deposits, customer payables, corporate debt and other borrowings. |
| |
• | Commissions revenue is generated by customer trades and is largely impacted by trade volume and trade type. With the elimination of retail commissions for online US listed stock, ETF and options trades, we expect the majority of commissions revenue in future periods will be driven from options contract charges. |
| |
• | Fees
and service charges revenue is primarily impacted by order flow revenue, fees earned from off-balance sheet customer cash, advisor management and custody fees, and mutual fund service 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
Acquired Gradifi, student loan benefit and financial wellness provider
On December 9, 2019, the Company completed its acquisition of Gradifi, a student loan benefit and financial wellness provider, for a purchase price of $30 million. The acquisition is expected to enhance the
Company's Corporate Services offering through its comprehensive suite of financial wellness solutions which is expected to complement the Company's leading stock plan administration services. Refer to Note 2—Acquisitions and Restructuring for additional information. Completed $1 billion share repurchase program; progress made on $1.5 billion program
The Company repurchased 10.8 million shares for $499 million during 2019 to complete repurchases under its previous $1 billion share repurchase program which was announced in October 2018. The
Company also repurchased 14.0 million shares for $586 million during 2019 under its $1.5 billion share repurchase program which was announced in July 2019. As of February 14, 2020, we have subsequently repurchased approximately 1.8 million shares of common stock at an average price of $44.02 per share.
E*TRADE 2019 10-K | Page 32
We expect to continue share repurchases in 2020; however, we
retain flexibility to deploy capital in the most accretive way possible.
Eliminated commission rates for equity and options trades
On October 2, 2019, we announced the elimination of retail commissions for online US listed stock, ETF and options trades. We also reduced the options contract charge to $0.65 per contract for all traders while maintaining our active trader pricing at $0.50 per contract. The Company estimated that the annual revenue impact of these changes, which
became effective on October 7, 2019, would be approximately $300 million based on operating results in the second quarter of 2019. We expect the majority of commissions revenue in future periods will be driven from options contract charges. Rated #1 online broker in Kiplinger's annual Best Online Brokers review
In August 2019, E*TRADE was awarded first place overall and "Best for Mutual Fund Investors" in Kiplinger's annual Best Online Brokers Review of 10 firms across seven categories. We also received high marks for user experience, investment choices, advisory services, and mobile as part of the review.
Generated additional capital capacity by repositioning balance sheet
The
Company sold $4.5 billion of lower-yielding investment securities, enabling the reduction of the size of our balance sheet during the three months ended June 30, 2019. Gains (losses) on securities and other, net includes $80 million of losses related to these sales. During the second quarter, the Company moved $6.6 billion of deposits to third-party banks, generating additional capital capacity to support share repurchases. The Company's balance sheet repositioning prioritized longer-term growth in earnings per share and capital return to shareholders over short-term revenue growth and operating margin. See MD&A—Earnings Overview, MD&A—Balance Sheet Overview
and Note 6—Available-for-Sale and Held-to-Maturity Securities for additional information. Key Performance Metrics
Management monitors customer activity and corporate metrics to evaluate the Company’s performance. The most significant of these are displayed below. During 2019, the Company updated the structure of its customer activity metrics to better align to its retail and institutional channels. Additionally, the Company has updated the presentation of certain customer activity metrics, as follows: | |
• | Customer-directed
trades: The definition of trades was updated in November 2019 to reflect all customer-directed trades. This includes trades associated with no-transaction-fee mutual funds, options trades through the Dime Buyback Program, and all ETF transactions, including those that were formerly classified as commission-free. This update was as a result of the commissions reduction announced on October 2, 2019 and impacts daily average revenue trades (DARTs), derivative DARTs, and derivative DARTs percentage. |
| |
• | Customer accounts: The definition of accounts was updated during the first quarter of 2019 to align the minimum threshold for gross new and end of period
retail accounts to $25. The definition for gross new retail accounts sourced from Corporate Services was also updated to include only those accounts which maintain a minimum balance of $25 at the end of the reporting period or trade within the reporting period. |
These updates have been reflected in the customer activity metrics for all periods presented and did not have an impact on the Company’s financial statements.
E*TRADE 2019 10-K | Page 33
Customer Activity Metrics
Daily Average Revenue Trades is an important measure of customer trading activity, and is a key driver of trading-based revenue. DARTs were 291,023, 274,997 and
209,296 for the years ended December 31, 2019, 2018 and 2017, respectively. Derivative DARTs, a key component of overall DARTs that represents advanced trading activities by our customers, is the daily average number of options and futures trades, and Derivative DARTs percentage is the mix of options and futures trades as a component of total DARTs. Derivative DARTs were 97,912, 91,543 and 65,525 for the years ended December 31, 2019, 2018 and 2017, respectively. Derivative DARTs represented
34%, 33% and 31% of total DARTs for the years ended December 31, 2019, 2018 and 2017, respectively. We expect options trades will be the primary driver of commissions revenue in future periods. Margin receivables represent 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. Margin receivables were $9.7 billion, $9.6 billion and $9.1 billion at December 31, 2019, 2018
and 2017, respectively.
E*TRADE 2019 10-K | Page 34
End
of period accounts and net new accounts are indicators of our ability to attract and retain customers. Net new accounts represent gross new accounts less accounts attrited during the period. The following table presents end of period accounts by channel: |
| | | | | | | | |
| |
| 2019 | | 2018 | | 2017 |
End
of period retail accounts | 5,169,757 |
| | 5,007,767 |
| | 3,899,222 |
|
End of period advisor services accounts | 148,198 |
| | 151,241 |
| | — |
|
End
of period corporate services accounts | 1,908,836 |
| | 1,763,829 |
| | 1,492,376 |
|
End of period accounts | 7,226,791 |
| | 6,922,837 |
| | 5,391,598 |
|
The
following table presents net new accounts and annualized growth rates by channel: |
| | | | | | | | |
| |
| 2019 | | 2018 | | 2017 |
Net
new retail accounts | 161,990 |
| | 1,108,545 |
| | 155,180 |
|
Net new advisor services accounts | (3,043) |
| | 151,241 |
| | — |
|
Net
new corporate services accounts | 145,007 |
| | 271,453 |
| | 36,316 |
|
Net new accounts | 303,954 |
| | 1,531,239 |
| | 191,496 |
|
| | | | | |
Net
new retail account growth rate | 3.2 | % | | 28.4 | % | | 4.1 | % |
Net new advisor services account growth rate | (2.0 | )% | | 100.0 | % | | — | % |
Net
new corporate services account growth rate | 8.2 | % | | 18.2 | % | | 2.5 | % |
Net new total account growth rate | 4.4 | % | | 28.4 | % | | 3.7 | % |
We
added 1,057,956 net new accounts as part of acquisitions during the year ended December 31, 2018, including 145,891 advisor services accounts related to the TCA acquisition and 912,065 retail accounts related to the Capital One account acquisition. Refer to Note 2—Acquisitions and Restructuring for additional information
E*TRADE 2019 10-K | Page 35
Total customer assets is an indicator of the value of our relationship with our customers. An increase generally indicates that the use of our products and services is expanding. Changes in this metric are also driven by changes in the valuations of our customers' underlying securities. The following table presents the significant components of total customer assets (dollars in billions):
|
| | | | | | | | | | | |
| |
| 2019 | | 2018 | | 2017 |
Security holdings | $ | 310.7 |
| | $ | 242.0 |
| | $ | 222.0 |
|
Cash
and deposits | 71.0 |
| | 60.2 |
| | 57.9 |
|
Retail and advisor services assets | 381.7 |
| | 302.2 |
| | 279.9 |
|
Corporate
services vested assets | 159.1 |
| | 111.9 |
| | 103.4 |
|
Retail, advisor services, and corporate services vested assets | 540.8 |
| | 414.1 |
| | 383.3 |
|
Corporate
services unvested holdings | 136.7 |
| | 94.4 |
| | 93.9 |
|
Total customer assets | $ | 677.5 |
| | $ | 508.5 |
| | $ | 477.2 |
|
E*TRADE
2019 10-K | Page 36
Customer cash and deposits is a significant component of total customer assets 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. The following table presents the significant components of total customer cash and deposits (dollars in billions): |
| | | | | | | | | | | |
| |
| 2019 | | 2018 | | 2017 |
Sweep deposits: | | | | | |
Brokerage
sweep deposits | $ | 27.9 |
| | $ | 39.3 |
| | $ | 37.7 |
|
Bank sweep deposits(1) | 6.4 |
| | — |
| | — |
|
Customer
payables | 12.8 |
| | 10.1 |
| | 9.5 |
|
Savings, checking, and other banking assets(2) | 4.3 |
| | 6.0 |
| | 5.0 |
|
Total
on-balance sheet customer cash and deposits | 51.4 |
| | 55.4 |
| | 52.2 |
|
Brokerage sweep deposits at unaffiliated financial institutions(3) | 16.9 |
| | 3.0 |
| | 4.7 |
|
Bank
sweep deposits at unaffiliated financial institutions(1)(3) | 0.8 |
| | — |
| | — |
|
Money market funds and other | 1.9 |
| | 1.8 |
| | 1.0 |
|
Total
customer cash held by third parties(4) | 19.6 |
| | 4.8 |
| | 5.7 |
|
Total customer cash and deposits | $ | 71.0 |
| | $ | 60.2 |
| | $ | 57.9 |
|
| |
(1) | Beginning
November 2019, bank sweep deposits include Premium Savings Accounts participating in the newly established bank sweep deposit account program. Refer to MD&A—Balance Sheet Overview for additional information. |
| |
(2) | Savings, checking, and other banking assets include $1.0 billion and $2.0 billion of deposits at December 31, 2019 and December 31, 2018, respectively, in our Premium Savings Account product. We plan to convert the remaining Premium Savings Account balances to the new bank sweep deposit account program. |
| |
(3) | Average
brokerage sweep deposit balances at unaffiliated financial institutions were $8.2 billion, $3.5 billion, $8.3 billion for the years ended December 31, 2019, 2018, and 2017 respectively. The Company received 201 bps, 180 bps, and 94 bps, net of interest paid, on these balances for the same periods. Average bank sweep deposits at unaffiliated institutions were $80 million for the year ended December 31, 2019. The Company received 6 bps, net of interest paid, on these balances for the same period. |
| |
(4) | Customer
cash held by third parties is held outside E*TRADE Financial and includes money market funds and sweep deposit accounts at unaffiliated financial institutions, net of deposit balances from unaffiliated institutions held on-balance sheet. Customer cash held by third parties is not reflected in the Company's consolidated balance sheet and is not immediately available for liquidity purposes. |
Net new retail and advisor services assets equals total inflows to new and existing retail and advisor services accounts less total outflows from closed and existing retail and advisor services accounts. The net new retail and advisor services assets metric is a general indicator of the use of our products and services by new and existing retail and advisor services customers. Net new retail and advisor services
assets exclude the effects of market movements in the value of retail and advisor services assets. Net new retail and advisor services assets were $14.8 billion, $49.7 billion and $11.9 billion for the years ended December 31, 2019, 2018 and 2017, respectively. The following table presents annualized net new retail and advisor services assets growth rates: |
| | | | | | | | |
| |
| 2019 | | 2018 | | 2017 |
Net new retail assets growth rate | 5.3 | % | | 10.9 | % | | 5.1 | % |
Net
new advisor services assets growth rate | (1.6 | )% | | 100.0 | % | | — | % |
Net new retail and advisor services assets growth rate | 4.9 | % | | 17.7 | % | | 5.1 | % |
We
added $33.5 billion in net new retail and advisor services assets as part of acquisitions during the year ended December 31, 2018, including $18.4 billion in advisor services assets related to the TCA acquisition and $15.1 billion in retail assets related to the acquisition of customer accounts from Capital One. Refer to Note 2—Acquisitions and Restructuring for additional information.
E*TRADE 2019 10-K | Page 37
Corporate Metrics:
Diluted earnings per common share is the portion of a company's profit allocated to each diluted share of common stock and is a key indicator of the Company's profitability. Diluted earnings per common share was $3.85, $3.88 and $2.15
for the years ended December 31, 2019, 2018 and 2017, respectively. 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 46%, 49% and 45% for the years ended December 31, 2019, 2018 and 2017, respectively. 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 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 44%, 47% and 40% for the years ended December 31, 2019, 2018 and 2017, respectively. See MD&A—Earnings Overview for a reconciliation of adjusted operating margin to operating margin. 
Capital
return to shareholders represents the amount of earnings returned to shareholders through share repurchases and common stock dividends and Capital return percentage to shareholders is capital returned to shareholders as a percentage of net income available to common shareholders. Capital return to shareholders was $1.2 billion, $1.2 billion and $362 million for the years ended December 31, 2019, 2018 and 2017, respectively. Capital return percentage to shareholders was 133%, 116% and 61%
for the years ended December 31, 2019, 2018 and 2017, respectively. The Company's balance sheet repositioning in the second quarter 2019 generated additional capital to support share repurchases. In addition, the Company also returned capital to shareholders in the form of shares withheld for taxes of $20 million, $28 million and $22 million for the years ended December 31, 2019, 2018 and 2017,
respectively.
E*TRADE 2019 10-K | Page 38
Return on common equity is calculated by dividing net income available to common shareholders by average common shareholders' equity, which excludes preferred stock. Return on common equity was 16%, 17% and 10% for the years ended December 31,
2019, 2018 and 2017, respectively. Adjusted return on common equity is a non-GAAP measure calculated by dividing adjusted net income available to common shareholders by average common shareholders' equity, which excludes preferred stock. Adjusted net income available to common shareholders is a non-GAAP measure which excludes the provision (benefit) for loan losses 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 return on common equity performance. Adjusted return on common equity was 15%, 16% and 9% for the years ended December 31,
2019, 2018 and 2017, respectively. See MD&A—Earnings Overview for a reconciliation of adjusted net income available to common shareholders to net income and adjusted return on common equity to return on common equity. 
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.
Cash and equivalents was $750 million, $2.3 billion and $931 million at December 31, 2019, 2018 and 2017, respectively, while corporate cash was $645 million, $391 million and $541 million for the same periods. See MD&A—Liquidity and Capital Resources for a reconciliation of corporate cash to cash and equivalents.
E*TRADE 2019 10-K | Page 39
Average interest-earning assets, along with net interest margin, are indicators of our ability to generate net interest income. Average interest-earning assets were $58.2 billion, $60.0 billion and $53.2 billion for the years ended December 31, 2019,
2018 and 2017, 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 3.18%, 3.08% and 2.79% for the years ended December 31, 2019, 2018 and 2017, respectively. 
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 6.9%, 6.6% and 7.4% at December 31, 2019, 2018 and 2017, respectively. E*TRADE Bank's Tier 1 leverage ratio was 7.2%, 7.1% and 7.6% at December 31, 2019, 2018 and 2017,
respectively. The internal threshold for E*TRADE Financial's Tier 1 leverage ratio is 6.5% and the internal threshold for E*TRADE Bank's Tier 1 leverage ratio is 7.0%. See MD&A—Liquidity and Capital Resources for additional information, including the calculation of regulatory capital ratios. Total employees is the key driver of compensation and benefits expense, our largest non-interest expense category. Total employees were 4,122, 4,035 and 3,607 at December 31, 2019, 2018 and 2017, respectively.
E*TRADE
2019 10-K | Page 40
We generated net income of $955 million on total net revenue of $2.9 billion for the year
ended December 31, 2019. The following chart presents a reconciliation of net income for the year ended December 31, 2018 to net income for the year ended December 31, 2019 (dollars in millions): | |
(1) | Includes advertising and market development, clearing and servicing, professional services,
depreciation and amortization, losses on early extinguishment of debt and other non-interest expenses. |
E*TRADE 2019 10-K | Page 41
The following table presents significant components of the consolidated statements of income (dollars in millions, except per share amounts): |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Year
Ended December 31, | | Variance | | Variance |
| | 2019 vs. 2018 | | 2018 vs. 2017 |
| 2019 | | 2018 | | 2017 | | Amount | | % | | Amount | | % |
Net
interest income | $ | 1,852 |
| | $ | 1,846 |
| | $ | 1,485 |
| | $ | 6 |
| | — | % | | $ | 361 |
| | 24 | % |
Total
non-interest income | 1,034 |
| | 1,027 |
| | 881 |
| | 7 |
| | 1 | % | | 146 |
| | 17 | % |
Total
net revenue | 2,886 |
| | 2,873 |
| | 2,366 |
| | 13 |
| | — | % | | 507 |
| | 21 | % |
Provision
(benefit) for loan losses | (51 | ) | | (86 | ) | | (168 | ) | | 35 |
| | (41 | )% | | 82 |
| | (49 | )% |
Total
non-interest expense | 1,618 |
| | 1,541 |
| | 1,470 |
| | 77 |
| | 5 | % | | 71 |
| | 5 | % |
Income
before income tax expense | 1,319 |
| | 1,418 |
| | 1,064 |
| | (99 | ) | | (7 | )% | | 354 |
| | 33 | % |
Income
tax expense | 364 |
| | 366 |
| | 450 |
| | (2 | ) | | (1 | )% | | (84 | ) | | (19 | )% |
Net
income | $ | 955 |
| | $ | 1,052 |
| | $ | 614 |
| | $ | (97 | ) | | (9 | )% | | $ | 438 |
| | 71 | % |
Preferred
stock dividends | 40 |
| | 36 |
| | 25 |
| | 4 |
| | 11 | % | | 11 |
| | 44 | % |
Net
income available to common shareholders | $ | 915 |
| | $ | 1,016 |
| | $ | 589 |
| | $ | (101 | ) | | (10 | )% | | $ | 427 |
| | 72 | % |
Diluted
earnings per common share | $ | 3.85 |
| | $ | 3.88 |
| | $ | 2.15 |
| | $ | (0.03 | ) |
| (1 | )% | | $ | 1.73 |
| | 80 | % |
Net
income decreased 9% to $955 million or $3.85 per diluted share, for the year ended December 31, 2019 compared to 2018 and increased 71% to $1.1 billion, or $3.88 per diluted share, for the year ended December 31, 2018 compared to 2017. Net income available to common shareholders was $915 million, $1.0 billion, and $589 million for the years ended December 31, 2019, 2018,
and 2017, respectively, which includes preferred stock dividends of $40 million, $36 million, and $25 million in the same periods, respectively. | |
• | The decrease in net income during 2019 was primarily driven by higher non-interest expense due to increased compensation and benefits expenses, restructuring and acquisition-related activities, and other non-interest expenses partially offset by decreases in communications and FDIC insurance premiums expenses as compared to 2018. Lower benefit for loan losses also contributed to the decrease in net income, which was partially offset by higher net revenue. |
| |
• | The
increase in net income during 2018 was driven by higher interest income due to a larger average balance sheet, an improvement in net interest margin, higher commissions due to increased trading activity, higher fees and service charges and net gains on securities and other as compared to 2017. Lower losses on early extinguishment of debt also contributed to increased net income in 2018. During the year ended December 31, 2018, these increases were partially offset by a lower benefit for loan losses and higher non-interest expense due primarily to increased compensation and benefits and advertising and market development expense. |
E*TRADE 2019 10-K | Page 42
Net Revenue
The following table presents the significant components of total net revenue (dollars in millions): |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Year
Ended December 31, | | Variance | | Variance |
| | 2019 vs. 2018 | | 2018 vs. 2017 |
| 2019 | | 2018 | | 2017 | | Amount | | % | | Amount | | % |
Net
interest income | $ | 1,852 |
| | $ | 1,846 |
| | $ | 1,485 |
| | $ | 6 |
| | — | % | | $ | 361 |
| | 24 | % |
Commissions | 421 |
| | 498 |
| | 441 |
| | (77 | ) | | (15 | )% | | 57 |
| | 13 | % |
Fees
and service charges | 588 |
| | 431 |
| | 369 |
| | 157 |
| | 36 | % | | 62 |
| | 17 | % |
Gains
(losses) on securities and other, net | (23 | ) | | 53 |
| | 28 |
| | (76 | ) | | * |
| | 25 |
| | 89 | % |
Other
revenue | 48 |
| | 45 |
| | 43 |
| | 3 |
| | 7 | % | | 2 |
| | 5 | % |
Total
non-interest income | 1,034 |
| | 1,027 |
| | 881 |
| | 7 |
| | 1 | % | | 146 |
| | 17 | % |
Total
net revenue | $ | 2,886 |
| | $ | 2,873 |
| | $ | 2,366 |
| | $ | 13 |
| | — | % | | $ | 507 |
| | 21 | % |
| |
*
| Percentage not meaningful. |
Net Interest Income
Net interest income increased slightly to $1.9 billion for the year ended December 31, 2019 compared to 2018 and increased 24% to $1.8 billion for the year ended December 31, 2018 compared to 2017. Net interest income is earned primarily through investment securities, margin receivables, securities lending, and our legacy loan portfolio, offset by funding costs.
E*TRADE
2019 10-K | Page 43
The following tables present average balance sheet data and interest income and expense data, as well as related net interest margin, yields, and rates (dollars in millions):
|
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| |
| 2019 | | 2018 | | 2017 |
| 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 | $ | 467 |
| | $ | 10 |
| | 2.14 | % | | $ | 616 |
| | $ | 11 |
| | 1.75 | % | | $ | 1,011 |
| | $ | 9 |
| | 0.89 | % |
Cash
segregated under federal or other regulations | 1,097 |
| | 26 |
| | 2.35 | % | | 743 |
| | 15 |
| | 2.02 | % | | 1,186 |
| | 12 |
| | 0.99 | % |
Investment
securities(1) | 44,108 |
| | 1,360 |
| | 3.08 | % | | 44,993 |
| | 1,241 |
| | 2.76 | % | | 39,090 |
| | 962 |
| | 2.46 | % |
Margin
receivables | 9,850 |
| | 482 |
| | 4.89 | % | | 10,437 |
| | 491 |
| | 4.71 | % | | 7,721 |
| | 320 |
| | 4.15 | % |
Loans(2) | 1,873 |
| | 104 |
| | 5.58 | % | | 2,405 |
| | 128 |
| | 5.31 | % | | 3,194 |
| | 157 |
| | 4.93 | % |
Broker-related
receivables and other | 839 |
| | 17 |
| | 1.98 | % | | 818 |
| | 14 |
| | 1.79 | % | | 1,014 |
| | 3 |
| | 0.29 | % |
Total
interest-earning assets | 58,234 |
| | 1,999 |
| | 3.43 | % | | 60,012 |
| | 1,900 |
| | 3.17 | % | | 53,216 |
| | 1,463 |
| | 2.75 | % |
Other
interest revenue(3) | — |
| | 112 |
| | | | — |
| | 109 |
| | | | — |
| | 108 |
| | |
Total
interest-earning assets | 58,234 |
| | 2,111 |
| | 3.62 | % | | 60,012 |
| | 2,009 |
| | 3.35 | % | | 53,216 |
| | 1,571 |
| | 2.95 | % |
Total
non-interest-earning assets | 5,405 |
| | | | | | 4,428 |
| | | | | | 4,979 |
| | | | |
Total
assets | $ | 63,639 |
| | | | | | $ | 64,440 |
| | | | | | $ | 58,195 |
| | | | |
| | | | | | | | | | | | | | | | | |
Sweep
deposits: | | | | | | | | | | | | | | | | | |
Brokerage
sweep deposits | $ | 33,723 |
| | $ | 54 |
| | 0.16 | % | | $ | 38,039 |
| | $ | 42 |
| | 0.11 | % | | $ | 33,775 |
| | $ | 4 |
| | 0.01 | % |
Bank
sweep deposits(4) | 604 |
| | 11 |
| | 1.77 | % | | — |
| | — |
| | — | % | | — |
| | — |
| | — | % |
Savings
deposits | 6,216 |
| | 85 |
| | 1.36 | % | | 3,049 |
| | 9 |
| | 0.30 | % | | 3,085 |
| | — |
| | 0.01 | % |
Other
deposits | 1,682 |
| | — |
| | 0.03 | % | | 1,965 |
| | — |
| | 0.03 | % | | 2,055 |
| | — |
| | 0.03 | % |
Customer
payables | 10,982 |
| | 30 |
| | 0.27 | % | | 9,881 |
| | 22 |
| | 0.22 | % | | 8,793 |
| | 5 |
| | 0.06 | % |
Broker-related
payables and other | 1,062 |
| | 4 |
| | 0.41 | % | | 1,813 |
| | 10 |
| | 0.57 | % | | 1,250 |
| | — |
| | — | % |
Other
borrowings | 245 |
| | 9 |
| | 3.59 | % | | 745 |
| | 25 |
| | 3.30 | % | | 665 |
| | 22 |
| | 3.33 | % |
Corporate
debt | 1,410 |
| | 55 |
| | 3.93 | % | | 1,214 |
| | 46 |
| | 3.80 | % | | 994 |
| | 48 |
| | 4.77 | % |
Total
interest-bearing liabilities | 55,924 |
| | 248 |
| | 0.44 | % | | 56,706 |
| | 154 |
| | 0.27 | % | | 50,617 |
| | 79 |
| | 0.16 | % |
Other
interest expense(5) | — |
| | 11 |
| | | | — |
| | 9 |
| | | | — |
| | 7 |
| | |
Total
interest-bearing liabilities | 55,924 |
| | 259 |
| | 0.46 | % | | 56,706 |
| | 163 |
| | 0.29 | % | | 50,617 |
| | 86 |
| | 0.17 | % |
Total
non-interest-bearing liabilities | 1,178 |
| | | | | | 896 |
| | | | | | 1,058 |
| | | | |
Total
liabilities | 57,102 |
| | | | | | 57,602 |
| | | | | | 51,675 |
| | | | |
Total
shareholders' equity | 6,537 |
| | | | | | 6,838 |
| | | | | | 6,520 |
| | | | |
Total
liabilities and shareholders' equity | $ | 63,639 |
| | | | | | $ | 64,440 |
| | | | | | $ | 58,195 |
| | | | |
Excess
interest earning assets over interest bearing liabilities/net interest income/net interest margin | $ | 2,310 |
| | $ | 1,852 |
| | 3.18 | % | | $ | 3,306 |
| | $ | 1,846 |
| | 3.08 | % | | $ | 2,599 |
| | $ | 1,485 |
| | 2.79 | % |
| |
(1) | For
the years ended December 31, 2019 and 2018, includes $3 million and $19 million, respectively, of net losses related to fair value hedging adjustments, previously referred to as hedge ineffectiveness. Amounts for the year ended December 31, 2017 have not been reclassified to conform to current period presentation and continue to be reflected within the gains (losses) on securities and other, net line item. See Note 8—Derivative Instruments and Hedging Activities for additional information. |
| |
(2) | 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. |
| |
(3) | Other interest revenue is earned on certain securities loaned balances. Interest expense incurred on other securities loaned balances is presented on the broker-related payables and other line item above. |
| |
(4) | Beginning November 2019, bank sweep deposits include Premium Savings Accounts participating in the newly
established bank sweep deposit account program. Refer to MD&A—Balance Sheet Overview for additional information. |
| |
(5) | Other interest expense is incurred on certain securities borrowed balances. Interest income earned on other securities borrowed balances is presented on the broker-related receivables and other line item above. |
E*TRADE 2019 10-K | Page 44
|
| | | | | | | | |
| |
| 2019 | | 2018 | | 2017 |
Ratio
of interest-earning assets to interest-bearing liabilities | 104.13 | % | | 105.83 | % | | 105.14 | % |
Return on average total assets | 1.50 | % | | 1.63 | % | | 1.06 | % |
Return
on average total shareholders’ equity(1) | 14.61 | % | | 15.38 | % | | 9.42 | % |
Average total shareholders’ equity to average total assets | 10.27 | % | | 10.61 | % | | 11.20 | % |
Dividend
payout ratio(2) | 14.51 | % | | 3.59 | % | | — | % |
| |
(1) | Calculated by dividing net income by average total shareholders’ equity. As described in the Earnings Overview
section below, the Company's return on common equity corporate metric is calculated by dividing net income available to common shareholders by average common shareholders' equity, which excludes preferred stock. |
| |
(2) | Calculated by dividing dividends declared per common share by basic earnings per share. |
Average interest-earning assets decreased 3% to $58.2 billion for the year ended December 31,
2019 as compared to 2018. The fluctuation in interest-earning assets is generally driven by changes in interest-bearing liabilities, primarily deposits and customer payables. Average interest-bearing liabilities decreased 1% to $55.9 billion for the year ended December 31, 2019 compared to 2018 due to the following: | |
• | Deposits and customer payables: The decrease in sweep deposits was primarily driven by the balance sheet repositioning
during the second quarter of 2019, as we moved $6.6 billion of deposits to third-party banks. The increase in savings deposits was primarily driven by the growth in the Premium Savings Account balances during the year, which was partially offset by the conversion of Premium Savings Accounts into a sweep deposit program beginning in November 2019. Refer to MD&A—Balance Sheet Overview for additional information. |
| |
• | Other interest-bearing liabilities: The decrease in broker-related payables and other borrowings was driven by customer activity and short-term liquidity needs at E*TRADE Bank and E*TRADE Securities. In addition, net
proceeds from the June 2018 issuance of corporate debt were used to redeem the Company's trust preferred securities in the third quarter of 2018, resulting in a decrease in other borrowings and an offsetting increase to corporate debt as compared to 2018. |
Net interest margin increased 10 basis points to 3.18% for the year ended December 31, 2019 compared to 2018. Net interest margin is driven by the mix of average asset and liability balances and the interest rates earned or paid on those balances. The increase during the year ended December 31,
2019, compared to 2018, is due to higher interest rates earned on margin receivables, investment securities, and loans balances as well as higher securities lending revenues, partially offset by increased funding costs due to increased rates paid on deposits, including the Premium Savings Account product. The increase in rates was largely driven by the four increases in federal funds rates that occurred during 2018 partially offset by the three federal funds rate cuts during 2019. Our net interest margin was also impacted by the continued run-off of our higher yielding legacy loan portfolio. Average interest-earning assets increased 13% to $60.0 billion for the year ended December 31, 2018 compared to 2017. 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 12% to $56.7 billion for the year ended December 31, 2018 compared to 2017. The increase was driven by higher sweep deposits during 2018 and deposits assumed as part of the acquisition of TCA and retail brokerage accounts from Capital One, partially offset by customer net buying of $13.6 billion during the year ended December 31, 2018, compared to net buying of $9.2 billion during the same period in 2017. Net interest margin increased 29 basis points to 3.08% for the year ended December 31, 2018 compared to 2017. Net interest margin is driven by the mix of average asset and liability balances and the interest rates earned or paid on those balances. The increase during the year ended December 31,
2018, compared to 2017 is due to higher interest rates earned on higher margin receivables and investment securities balances, partially offset by the continued run-off of our higher yielding legacy mortgage and consumer loan portfolio. Additionally, funding costs increased primarily due to increased rates paid on deposits, customer payables, and broker-related payables during the year ended December 31, 2018.
E*TRADE 2019 10-K | Page 45
Commissions
Commissions
revenue decreased 15% to $421 million for the year ended December 31, 2019 compared to 2018 and increased 13% to $498 million for the year ended December 31, 2018 compared to 2017. The decrease during 2019 was primarily related to the elimination of retail commissions which was effective on October 7, 2019. The primary factors that affect commissions revenue are DARTs, derivative DARTs, trade type, and the number of trading days. We expect the majority of commissions revenue in future periods will be driven from options contract
charges. For additional information see MD&A—Overview. DARTs volume increased 6% to 291,023 for the year ended December 31, 2019 compared to 2018 and increased 31% to 274,997 for the year ended December 31, 2018 compared to 2017. DARTs volume is impacted by market sentiment as well as volatility of the equity markets. Derivative DARTs volume increased 7% to 97,912 for the year ended December 31,
2019, compared to 2018 and increased 40% to 91,543 for the year ended December 31, 2018 compared to 2017. Fees and Service Charges
The following table presents the significant components of fees and service charges (dollars in millions): |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Year
Ended December 31, | | Variance | | Variance |
| | 2019 vs. 2018 | | 2018 vs. 2017 |
| 2019 | | 2018 | | 2017 | | Amount | | % | | Amount | | % |
Order
flow revenue | $ | 188 |
| | $ | 174 |
| | $ | 135 |
| | $ | 14 |
| | 8 | % | | $ | 39 |
| | 29 | % |
Money
market funds and sweep deposits revenue(1) | 175 |
| | 71 |
| | 92 |
| | 104 |
| | 146 | % | | (21 | ) | | (23 | )% |
Advisor
management and custody fees | 77 |
| | 64 |
| | 36 |
| | 13 |
| | 20 | % | | 28 |
| | 78 | % |
Mutual
fund service fees | 51 |
| | 48 |
| | 39 |
| | 3 |
| | 6 | % | | 9 |
| | 23 | % |
Foreign
exchange revenue | 33 |
| | 25 |
| | 26 |
| | 8 |
| | 32 | % | | (1 | ) | | (4 | )% |
Reorganization
fees | 24 |
| | 14 |
| | 16 |
| | 10 |
| | 71 | % | | (2 | ) | | (13 | )% |
Other
fees and service charges | 40 |
| | 35 |
| | 25 |
| | 5 |
| | 14 | % | | 10 |
| | 40 | % |
Total
fees and service charges | $ | 588 |
| | $ | 431 |
| | $ | 369 |
| | $ | 157 |
| | 36 | % | | $ | 62 |
| | 17 | % |
| |
(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 36% to $588 million for the year ended December 31, 2019 compared to 2018 and 17% to $431 million for the year ended December 31, 2018 compared to 2017. The increase for the year ended December 31, 2019 was primarily driven by higher average off-balance sheet money market and sweep deposits
balances as a result of the balance sheet repositioning in June 2019 and a higher yield of approximately 175 basis points for the year ended December 31, 2019 compared to 140 basis points in 2018 and 90 basis points in 2017. In both 2019 and 2018 order flow revenue increased driven by higher trade volume and advisor management and custody fees increased as a result of the acquisition of TCA in the second quarter of 2018. The increase in order flow revenue and advisor management and custody fees in 2018 as compared to 2017 was partially offset by decreased money market funds and sweep deposits revenue driven by lower average customer cash balances held by third parties as a result of transferring cash onto our balance sheet.
E*TRADE
2019 10-K | Page 46
Gains (Losses) on Securities and Other, Net
The following table presents the significant components of gains (losses) on securities and other, net (dollars in millions): |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Year
Ended December 31, | | Variance | | Variance |
| | 2019 vs. 2018 | | 2018 vs. 2017 |
| 2019 | | 2018 | | 2017 | | Amount | | % | | Amount | | % |
Gains
(losses) on available-for-sale securities, net: | | | | | | | | | | | | | |
Gains
on available-for-sale securities(1)(2) | $ | 51 |
| | $ | 98 |
| | $ | 40 |
| | $ | (47 | ) | | (48 | )% | | $ | 58 |
| | 145 | % |
Losses
on available-for-sale securities(1)(2) | (80 | ) | | (54 | ) | | — |
| | (26 | ) | | 48 | % | | (54 | ) | | (100 | )% |
Subtotal | (29 | ) | | 44 |
| | 40 |
| | (73 | ) | | (166 | )% | | 4 |
| | 10 | % |
Equity
method investment income (loss) and other(3)(4) | 6 |
| | 9 |
| | (12 | ) | | (3 | ) | | (33 | )% | | 21 |
| | (175 | )% |
Gains
(losses) on securities and other, net | $ | (23 | ) | | $ | 53 |
| | $ | 28 |
| | $ | (76 | ) | | (143 | )% | | $ | 25 |
| | 89 | % |
| |
(1) | In
June 2019, the Company sold $4.5 billion of lower-yielding investment securities at losses as it repositioned its balance sheet. See MD&A—Balance Sheet Overview and Note 6—Available-for-Sale and Held-to-Maturity Securities for additional information. |
| |
(2) | In August 2018, the Company sold available-for-sale securities and reinvested the sale proceeds in agency-backed securities at current market rates. See Note 6—Available-for-Sale and Held-to-Maturity
Securities for additional information. |
| |
(3) | Includes a $5 million gain on the sale of our Chicago Stock Exchange investment for the year ended December 31, 2018. |
| |
(4) | Includes losses of $14 million on hedge ineffectiveness for the year ended December 31, 2017. Beginning January 1, 2018, fair value hedging adjustments are recognized within net interest
income. See Note 1—Organization, Basis of Presentation and Summary of Significant Accounting Policies for additional information. |
Provision (Benefit) for Loan Losses
We recognized a benefit for loan losses of $51 million, $86 million and $168 million for the years ended December 31, 2019, 2018 and 2017, 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 legacy loan portfolio as well as recoveries in excess of prior expectations, including sales of charged-off loans and recoveries
of previous charge-offs that were not included in our loss estimates. For additional information on management's estimate of the allowance for loan losses, see Note 7—Loans Receivable, Net.
E*TRADE 2019 10-K | Page 47
Non-Interest Expense
The following table presents the significant components of non-interest expense (dollars in millions): |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Year
Ended December 31, | | Variance | | Variance |
| | 2019 vs. 2018 | | 2018 vs. 2017 |
| 2019 | | 2018 | | 2017 | | Amount | | % | | Amount | | % |
Compensation
and benefits | $ | 670 |
| | $ | 621 |
| | $ | 546 |
| | $ | 49 |
| | 8 | % | | $ | 75 |
| | 14 | % |
Advertising
and market development | 196 |
| | 200 |
| | 166 |
| | (4 | ) | | (2 | )% | | 34 |
| | 20 | % |
Clearing
and servicing | 133 |
| | 126 |
| | 124 |
| | 7 |
| | 6 | % | | 2 |
| | 2 | % |
Professional
services | 105 |
| | 96 |
| | 99 |
| | 9 |
| | 9 | % | | (3 | ) | | (3 | )% |
Occupancy
and equipment | 135 |
| | 124 |
| | 116 |
| | 11 |
| | 9 | % | | 8 |
| | 7 | % |
Communications | 99 |
| | 116 |
| | 121 |
| | (17 | ) | | (15 | )% | | (5 | ) | | (4 | )% |
Depreciation
and amortization | 88 |
| | 92 |
| | 82 |
| | (4 | ) | | (4 | )% | | 10 |
| | 12 | % |
FDIC
insurance premiums | 14 |
| | 30 |
| | 31 |
| | (16 | ) | | (53 | )% | | (1 | ) | | (3 | )% |
Amortization
of other intangibles | 61 |
| | 48 |
| | 36 |
| | 13 |
| | 27 | % | | 12 |
| | 33 | % |
Restructuring
and acquisition-related activities | 23 |
| | 7 |
| | 15 |
| | 16 |
| | 229 | % | | (8 | ) | | (53 | )% |
Losses
on early extinguishment of debt | — |
| | 4 |
| | 58 |
| | (4 | ) | | (100 | )% | | (54 | ) | | (93 | )% |
Other
non-interest expenses | 94 |
| | 77 |
| | 76 |
| | 17 |
| | 22 | % | | 1 |
| | 1 | % |
Total
non-interest expense | $ | 1,618 |
| | $ | 1,541 |
| | $ | 1,470 |
| | $ | 77 |
| | 5 | % | | $ | 71 |
| | 5 | % |
Compensation
and Benefits
Compensation and benefits expense increased 8% to $670 million for the year ended December 31, 2019 compared to 2018 and 14% to $621 million for the year ended December 31, 2018 compared to 2017. The expense increase during 2019 was primarily driven by higher compensation expense, insurance benefit and payroll taxes due to an increase in average headcount as compared to the prior year and an executive transition in the third quarter of 2019. The expense increase during 2018 was primarily driven by a 12% increase in headcount as a result of the TCA acquisition and to support the onboarding
of the retail brokerage accounts from Capital One, as well as other growth in our business. Advertising and Market Development
Advertising and market development expense decreased 2% to $196 million for the year ended December 31, 2019 compared to 2018 and increased 20% to $200 million for the year ended December 31, 2018 compared to 2017. The expense decrease during 2019 was driven by lower media and brand production spend as compared to prior period. The planned expense
increase during 2018 was primarily due to higher media and brand production spend resulting from our focus on increasing engagement across new and existing customers. Clearing and Servicing
Clearing and servicing expense increased 6% to $133 million for the year ended December 31, 2019, compared to 2018 and 2% to $126 million for the year ended December 31, 2018 compared to 2017. The expense increase during 2019 was primarily due to higher fees driven by increased trading volume and higher average off-balance sheet
customer cash balances held by third parties, partially offset by lower loan servicing fees due to the run-off of our legacy loan portfolio. The expense increase during 2018 was primarily due to increased fees driven by increased trading volume, partially offset by lower loan servicing fees and decreased fees due to lower customer cash balances held by third parties.
E*TRADE 2019 10-K | Page 48
Professional
Services
Professional services expense increased 9% to $105 million for the year ended December 31, 2019, compared to 2018 and decreased 3% to $96 million for the year ended December 31, 2018 compared to 2017. The expense increase during 2019 includes continued investment in projects to drive operational efficiencies and expand our business capabilities. The expense decrease during 2018 was primarily driven by lower legal services expense. Occupancy and Equipment
Occupancy and equipment expense increased 9%
to $135 million for the year ended December 31, 2019 compared to 2018 and 7% to $124 million for the year ended December 31, 2018 compared to 2017. The expense increase during both periods was primarily driven by higher software licenses and facilities expense. Communications
Communications expense decreased 15% to $99 million for the year ended December 31, 2019, compared
to 2018 and 4% to $116 million for the year ended December 31, 2018 compared to 2017. The decrease during both periods was primarily driven by lower market data expenses. Communications expense for the year ended December 31, 2019 included a $14 million benefit related to a change in estimate for previous market data usage. FDIC Insurance Premiums
FDIC insurance premiums expense decreased 53% to $14 million for the year ended December 31, 2019 compared to 2018 and
3% to $30 million for the year ended December 31, 2018 compared to 2017. The decreases were driven by the termination of surcharges paid to the Deposit Insurance Fund after it attained the minimum reserve ratio of 1.35 percent of insured deposits in September 2018, and our balance sheet repositioning during the second quarter 2019 when we moved $6.6 billion of deposits to third-party banks. Amortization of Other Intangibles
Amortization of other intangibles increased 27% to $61 million for the year ended December 31, 2019, compared to 2018 and 33% to $48 million
for the year ended December 31, 2018 compared to 2017. The increase during 2019 related primarily to a full year of amortization associated with the intangible assets recognized in connection with the acquisition of TCA and the acquisition of retail accounts from Capital One during 2018, which also contributed to the increase from 2017. See Note 2—Acquisitions and Restructuring for additional information. Restructuring and Acquisition-Related Activities
Restructuring and acquisition-related activities expense was $23 million for the year ended December 31, 2019 as compared to $7 million and $15 million for the years ended December 31, 2018
and 2017, respectively. Restructuring and acquisition-related activities expense for the year ended December 31, 2019 related primarily to expenses incurred as part of the closure of our New York headquarters, severance from organizational changes driven by enterprise-wide cost containment initiatives, and costs incurred as part of the Gradifi acquisition. Refer to Note 2—Acquisitions and Restructuring and Note 19—Lease Arrangements for additional information. Restructuring and acquisition-related activities expense for the years ended December 31, 2018 included costs incurred in connection with the restructuring of our regulatory and enterprise risk management functions due to bank regulatory reform and the closing of the TCA
acquisition. Restructuring and acquisition-related activities expense during the year ended December 31, 2017 related primarily to costs incurred in connection with the integration of OptionsHouse.
E*TRADE 2019 10-K | Page 49
Losses on Early Extinguishment of Debt
| |
• | During the third quarter of 2018, we used the net proceeds from the June 2018 issuance of Senior Notes to redeem all $413 million of our outstanding trust preferred securities (TRUPs). In connection with the redemption, we recognized a loss on early extinguishment of debt of $4 million. |
| |
• | 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. We 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. |
Other Non-Interest Expenses
Other non-interest expenses increased 22% to $94 million for the year ended December 31, 2019, compared to 2018 and 1% to $77 million for the year ended December 31,
2018 compared to 2017. The increase during 2019 was primarily driven by $8 million impairment of certain technology assets and increased franchise taxes. Refer to Note 9—Property and Equipment, Net for additional information. Operating Margin
Operating margin was 46% for the year ended December 31, 2019 compared to 49% and 45% for the same periods in 2018 and 2017, respectively. Adjusted operating margin, a non-GAAP measure, was 44% for the year ended December 31,
2019 compared to 47% and 40% for the same periods in 2018 and 2017, respectively. Adjusted operating margin is calculated by dividing adjusted income before income tax expense by total net revenue. Adjusted income before income tax expense, a non-GAAP measure, excludes provision (benefit) for loan losses and losses on early extinguishment of debt. The following table presents 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):
|
| | | | | | | | | | | | | | | | | | | | |
| |
| 2019 | | 2018 | | 2017 |
| Amount | | Operating Margin % | | Amount | | Operating
Margin % | | Amount | | Operating Margin % |
Income before income tax expense / operating margin | $ | 1,319 |
| | 46 | % | | $ | 1,418 |
| | 49 | % | | $ | 1,064 |
| | 45 | % |
Add
back impact of pre-tax items: | | | | | | | | | | | |
Provision (benefit) for loan losses | (51 | ) | | | | (86 | ) | | | | (168 | ) | | |
Losses
on early extinguishment of debt | — |
| | | | 4 |
| | | | 58 |
| | |
Subtotal | (51 | ) | | | | (82 | ) | | | | (110 | ) | | |
Adjusted
income before income tax expense / adjusted operating margin | $ | 1,268 |
| | 44 | % | | $ | 1,336 |
| | 47 | % | | $ | 954 |
| | 40 | % |
E*TRADE
2019 10-K | Page 50
Return on Common Equity
Return on common equity was 16% for the year ended December 31, 2019 compared to 17% and 10% for the same periods in 2018 and 2017, respectively. Adjusted return
on common equity, a non-GAAP measure, was 15% for the year ended December 31, 2019 compared to 16% and 9% for 2018 and 2017, respectively. Adjusted return on common equity is calculated by dividing adjusted net income available to common shareholders by average common shareholders' equity, which excludes preferred stock. Adjusted net income available to common shareholders, a non-GAAP measure, excludes the after-tax impact of the provision (benefit) for loan losses and losses on early extinguishment of debt. The following table provides a reconciliation of GAAP net income available to common shareholders
and return on common equity percentage to non-GAAP adjusted net income available to common shareholders and adjusted return on common equity percentage (dollars in millions): |
| | | | | | | | | | | | | | | | | | |
| |
| 2019 | | 2018 | | 2017 |
| Amount | | Return
on Common Equity % | | Amount | | Return on Common Equity % | | Amount | | Return on Common Equity % |
Net income available to common shareholders and return on common equity | $ | 915 |
| | 16% | | $ | 1,016 |
| | 17 | % | | $ | 589 |
| | 10% |
Add
back impact of the following items: | | | | | | | | | | | |
Provision (benefit) for loan losses | (51 | ) | | | | (86 | ) | | | | (168 | ) | | |
Losses
on early extinguishment of debt | — |
| | | | 4 |
| | | | 58 |
| | |
Subtotal | (51 | ) | | | | (82 | ) | | | | (110 | ) | | |
Income
tax impact | 14 |
| | | | 21 |
| | | | 43 |
| | |
Net
of tax | (37 | ) | | | | (61 | ) | | | | (67 | ) | | |
Adjusted
net income available to common shareholders and return on common equity | $ | 878 |
| | 15% | | $ | 955 |
| | 16 | % | | $ | 522 |
| | 9% |
Income
Tax Expense
Income tax expense was $364 million, $366 million and $450 million for the years ended December 31, 2019, 2018 and 2017, respectively. The effective tax rate was 27.6%, 25.8% and 42.2% respectively, for the same periods. | |
• | The effective tax rate of 27.6% for the year ended December 31, 2019 includes additional tax expense related primarily to the remeasurement of net state deferred taxes. |
| |
• | The
effective tax rate of 25.8% for the year ended December 31, 2018 included the new statutory federal income tax rate of 21% which was effective January 1, 2018 as well as a slight benefit related to the remeasurement of certain net state deferred tax assets and the accounting for employee share-based compensation. |
| |
• | The effective tax rate of 42.2% for the year ended December 31, 2017 includes the impact of the Tax Cuts and Jobs Act (TCJA) that was enacted on December 22, 2017. This resulted in a reduction in the value of our net federal deferred tax
assets 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. The effective tax rate also includes the impact of adopting amended accounting guidance for employee share-based compensation. |
Refer to Note 14—Income Taxes for further information.
E*TRADE 2019 10-K | Page 51
The following table presents the significant components of the consolidated balance sheet (dollars in millions): |
| | | | | | | | | | | | | | |
| | | Variance |
| | | 2019 vs. 2018 |
| 2019 | | 2018 | | Amount | | % |
Assets: | | | | | | | |
Cash
and equivalents | $ | 750 |
| | $ | 2,333 |
| | $ | (1,583 | ) | | (68 | )% |
Segregated
cash | 1,879 |
| | 1,011 |
| | 868 |
| | 86 | % |
Investment securities | 41,470 |
| | 45,037 |
| | (3,567 | ) | | (8 | )% |
Margin
receivables | 9,675 |
| | 9,560 |
| | 115 |
| | 1 | % |
Loans receivable, net | 1,595 |
| | 2,103 |
| | (508 | ) | | (24 | )% |
Receivables
from brokers, dealers and clearing organizations | 1,395 |
| | 760 |
| | 635 |
| | 84 | % |
Property and equipment, net | 339 |
| | 281 |
| | 58 |
| | 21 | % |
Goodwill
and other intangibles, net | 2,943 |
| | 2,976 |
| | (33 | ) | | (1 | )% |
Other assets | 1,370 |
|
| 942 |
| | 428 |
| | 45 | % |
Total
assets | $ | 61,416 |
| | $ | 65,003 |
| | $ | (3,587 | ) | | (6 | )% |
Liabilities
and shareholders’ equity: | | | | | | | |
Deposits | $ | 38,606 |
| | $ | 45,313 |
| | $ | (6,707 | ) | | (15 | )% |
Customer
payables | 12,849 |
| | 10,117 |
| | 2,732 |
| | 27 | % |
Payables to brokers, dealers and clearing organizations | 893 |
| | 948 |
| | (55 | ) | | (6 | )% |
Corporate
debt | 1,410 |
| | 1,409 |
| | 1 |
| | — | % |
Other liabilities | 1,115 |
| | 654 |
| | 461 |
| | 70 | % |
Total
liabilities | 54,873 |
| | 58,441 |
| | (3,568 | ) | | (6 | )% |
Shareholders’ equity | 6,543 |
| | 6,562 |
| | (19 | ) | | — | % |
Total
liabilities and shareholders’ equity | $ | 61,416 |
| | $ | 65,003 |
| | $ | (3,587 | ) | | (6 | )% |
Cash
and Equivalents
Cash and equivalents decreased 68% to $750 million during the year ended December 31, 2019. Cash and equivalents will fluctuate based on a variety of factors, including, among other drivers, liquidity needs at the parent, customer activity at our regulated subsidiaries, and the timing of investments at E*TRADE Bank. For additional information on our use of cash and equivalents, see MD&A—Liquidity and Capital Resources and the Consolidated Statements of Cash Flows. Segregated
Cash
Cash segregated under federal or other regulations increased 86% to $1.9 billion during the year ended December 31, 2019. The level of segregated cash is driven 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 segregate for the exclusive benefit of our brokerage customers. Segregated cash can also be impacted by the level of securities purchased under agreements to resell between E*TRADE Securities and E*TRADE Bank, representing investments that were also segregated under federal or other regulations by E*TRADE Securities
and eliminated in consolidation, which increased $1.5 billion to $1.9 billion as of December 31, 2019.
E*TRADE 2019 10-K | Page 52
Investment Securities
The following table presents the significant components of
investment securities (dollars in millions): |
| | | | | | | | | | | | | | |
| | | Variance |
| | | 2019
vs. 2018 |
| 2019 | | 2018 | | Amount | | % |
Available-for-sale securities: | | | | | | | |
Agency
mortgage-backed securities | $ | 17,035 |
| | $ | 22,162 |
| | $ | (5,127 | ) | | (23 | )% |
Other
agency debt securities | 659 |
| | 991 |
| | (332 | ) | | (34 | )% |
US Treasuries | 1,227 |
| | — |
| | 1,227 |
| | 100 | % |
Non-agency
debt securities(1) | 580 |
| | — |
| | 580 |
| | 100 | % |
Total available-for-sale securities | $ | 19,501 |
| | $ | 23,153 |
| | $ | (3,652 | ) | | (16 | )% |
Held-to-maturity
securities: | | | | | | | |
Agency mortgage-backed securities | $ | 20,085 |
| | $ | 18,085 |
| | $ | 2,000 |
| | 11 | % |
Other
agency debt securities | 1,884 |
| | 3,799 |
| | (1,915 | ) | | (50 | )% |
Total held-to-maturity securities | $ | 21,969 |
| | $ | 21,884 |
| | $ | 85 |
| | — | % |
Total
investment securities | $ | 41,470 |
| | $ | 45,037 |
| | $ | (3,567 | ) | | (8 | )% |
| |
(1) | Includes
non-agency asset-backed securities (ABS) and non-agency commercial mortgage-backed securities. |
Securities represented 68% and 69% of total assets at December 31, 2019 and 2018, 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 decrease in available-for-sale securities during the year ended December 31, 2019 related primarily to the sale of $4.5 billion of lower-yielding investment securities as part of the
Company's balance sheet repositioning in June 2019 and the transfer of Securities with a fair value of $744 million from available-for-sale to held-to-maturity based on a change in intent and demonstrated ability to hold them to maturity in December 2019. See MD&A—Overview, MD&A—Earnings Overview and Note 6—Available-for-Sale and Held-to-Maturity Securities for additional information.
E*TRADE 2019 10-K | Page 53
Loans Receivable, Net
The following table presents the significant components of loans receivable, net (dollars in millions): |
| | | | | | | | | | | | | | |
| | | Variance |
| | | 2019 vs. 2018 |
| 2019 | | 2018 | | Amount | | % |
One- to four-family | $ | 803 |
| | $ | 1,071 |
| | $ | (268 | ) | | (25 | )% |
Home
equity | 635 |
| | 836 |
| | (201 | ) | | (24 | )% |
Consumer | — |
| | 118 |
| | (118 | ) | | (100 | )% |
Securities-based
lending(1) | 169 |
| | 107 |
| | 62 |
| | 58 | % |
Total loans receivable | 1,607 |
| | 2,132 |
| | (525 | ) | | (25 | )% |
Unamortized
premiums, net | 5 |
| | 8 |
| | (3 | ) | | (38 | )% |
Subtotal | 1,612 |
| | 2,140 |
| | (528 | ) | | (25 | )% |
Less:
Allowance for loan losses | 17 |
| | 37 |
| | (20 | ) | | (54 | )% |
Total loans receivable, net | $ | 1,595 |
| | $ | 2,103 |
| | $ | (508 | ) | | (24 | )% |
| |
(1) | E*TRADE
Line of Credit is a securities-based lending product where customers can borrow against the market value of their securities pledged as collateral. The unused credit line amount totaled $431 million and $173 million as of December 31, 2019 and 2018, respectively. |
Loans receivable, net decreased 24% to $1.6 billion during the year ended December 31, 2019 on continued paydowns and the sale of our
consumer loan portfolio in December 2019. We expect the remaining legacy mortgage loan portfolio to continue its run-off for the foreseeable future. As our portfolio has seasoned and substantially all interest-only loans have converted to amortizing, we continue to assess underlying performance, the economic environment, and the value of the portfolio in the marketplace. While it is our intention to continue to hold these loans, our strategy could change subject to market conditions. For additional information on management's estimate of the allowance for loan losses, see Note 1—Organization, Basis of Presentation and Summary of Significant Accounting Policies and Note 7—Loans Receivable, Net.
E*TRADE 2019 10-K | Page 54
Receivables from and Payables to Brokers, Dealers and Clearing Organizations
The following table presents the significant components of receivables from and payables to brokers, dealers and clearing organizations (dollars in millions): |
| | | | | | | | | | | | | | |
| | | Variance |
| | | 2019 vs. 2018 |
| 2019 | | 2018 | | Amount | | % |
Receivables: | | | | | | | |
Securities
borrowed | $ | 1,003 |
| | $ | 140 |
| | $ | 863 |
| | * |
|
Receivables
from clearing organizations | 297 |
| | 555 |
| | (258 | ) | | (46 | )% |
Other | 95 |
| | 65 |
| | 30 |
| | 46 | % |
Total | $ | 1,395 |
| | $ | 760 |
| | $ | 635 |
| | 84 | % |
| | | | | | |
|
|
Payables: | | | | | | |
|
|
Securities
loaned | $ | 838 |
| | $ | 887 |
| | $ | (49 | ) | | (6 | )% |
Payables
to clearing organizations | 10 |
| | 11 |
| | (1 | ) | | (9 | )% |
Other | 45 |
| | 50 |
| | (5 | ) | | (10 | )% |
Total | $ | 893 |
| | $ | 948 |
| | $ | (55 | ) | | (6 | )% |
| |
*
| Percentage not meaningful. |
Securities borrowed increased to $1.0 billion during the year ended December 31, 2019. The increase was primarily driven by increased cash available and continued demand for cash from our counterparties. The 46% decrease in receivables from clearing organizations during the year ended December 31, 2019 to $297 million was primarily driven by the decreased use of cash collateral for the
Company's derivatives transactions utilized for hedging activities. Securities loaned decreased 6% to $838 million during the year ended December 31, 2019. The decrease was primarily driven by lower demand for securities from our counterparties. For additional information on E*TRADE Securities liquidity, see MD&A—Liquidity and Capital Resources. Other Assets
Other assets increased 45% to $1.4 billion
during the year ended December 31, 2019. The increase was driven by $200 million of securities purchased under agreements to resell that were outstanding at the end of the period and $195 million of operating lease assets related to the Company's adoption of the new guidance on accounting for leases in 2019. See Note 19—Lease Arrangements for additional information.
E*TRADE 2019 10-K | Page 55
Deposits
The following table presents the significant components of deposits (dollars in millions): |
| | | | | | | | | | | | | | |
| | | Variance |
| | | 2019 vs. 2018 |
| 2019 | | 2018 | | Amount | | % |
Sweep deposits: | | | | | | | |
Brokerage
sweep deposits | $ | 27,949 |
| | $ | 39,322 |
| | $ | (11,373 | ) | | (29 | )% |
Bank
sweep deposits(1) | 6,355 |
| | — |
| | 6,355 |
| | 100 | % |
Savings deposits(2) | 2,592 |
| | 4,133 |
| | (1,541 | ) | | (37 | )% |
Other
deposits | 1,710 |
| | 1,858 |
| | (148 | ) | | (8 | )% |
Total deposits | $ | 38,606 |
| | $ | 45,313 |
| | $ | (6,707 | ) | | (15 | )% |
| |
(1) | Beginning
November 2019, bank sweep deposits include Premium Savings Accounts participating in the newly established bank sweep deposit account program. |
| |
(2) | Savings deposits include $1.0 billion and $2.0 billion of deposits at December 31, 2019 and 2018, respectively, in our Premium Savings Account product. We plan to convert the remaining Premium Savings Account balances to the new bank sweep deposit account program. |
Deposits represented 70% and 78%
of total liabilities at December 31, 2019 and 2018, respectively. The decrease in deposits during the year ended December 31, 2019 was primarily driven by the balance sheet repositioning during the second quarter 2019, partially offset by growth in our Premium Savings Account product. We offer the following sweep deposit account programs to customers which utilize our bank subsidiaries, in combination with additional third-party program banks, as applicable: | |
• | Extended
insurance sweep deposit account (ESDA) program |
| |
• | Retirement sweep deposit account (RSDA) program for retirement plan customers |
| |
• | Cash balance program offered by E*TRADE Savings Bank for uninvested cash held in eligible custodial accounts as part of the advisor services offering launched in connection with the TCA acquisition |
| |
• | Bank
sweep deposit account program offered by E*TRADE Bank for Premium Savings Account holders |
Our sweep deposit programs are designed to offer up to $1.25 million in FDIC coverage for individual accounts ($2.5 million for joint accounts). The bank sweep deposit program, which launched in November 2019, provides the Company with the ability to transfer amounts held on deposit in E*TRADE Bank Premium Savings Accounts to an FDIC-insured account at one or more participating banks if desired. As the bank sweep deposit program was established to allow for reciprocal deposits, E*TRADE Bank may also accept deposits from customers of the participating third-party banks. Bank sweep deposits included $1.0 billion of reciprocal deposits received from third-party banks at December 31, 2019.
See MD&A—Earnings Overview, Note 6—Available-for-Sale and Held-to-Maturity Securities, and Note 12—Deposits for additional information. As of December 31, 2019, approximately 98% of sweep deposits were in these programs. Sweep deposits on balance sheet are held at bank subsidiaries and are included in the deposits line item on our consolidated balance sheet.
E*TRADE 2019 10-K | Page 56
Other Liabilities
Other liabilities increased 70% to $1.1 billion during the year ended December 31, 2019. The increase was driven by $337 million of deferred tax liabilities, net and $235 million of operating lease liabilities related to the Company's adoption of the new guidance on accounting for leases in 2019. See Note 19—Lease Arrangements for additional information. |
|
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 for E*TRADE Bank and E*TRADE Securities. 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 liquidity needs are primarily driven by capital needs at E*TRADE Bank and E*TRADE Securities, interest due on our corporate debt, dividend payments on our preferred
stock and other capital returns to holders of our common 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 or E*TRADE Savings Bank to the parent company or the parent company's 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 Statements of Cash Flows for information on cash and equivalents activity. We define corporate cash as cash held at the parent company and subsidiaries, excluding bank, broker-dealer, and FCM subsidiaries that require regulatory approval or notification prior to the payment of certain dividends to the parent company. Corporate cash includes the parent company's deposits placed with E*TRADE Bank. E*TRADE Bank may use these deposits for investment purposes; however, these investments are not included in consolidated cash and equivalents. 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 is monitored as part of our liquidity risk management. Our current corporate cash target is $300 million and covers approximately 18 months of parent company fixed costs, which include corporate overhead costs, preferred stock dividends, corporate debt interest, and, as applicable, contractual corporate debt maturities over the next 12 months. Parent company fixed costs are defined as minimum expenditures required to operate the business and exclude controllable, or variable costs. The Company maintains additional liquidity through a $300 million unsecured committed revolving credit facility. The parent has the ability to borrow against the
credit facility for working capital and general corporate purposes. Dividends from our operating subsidiaries, including E*TRADE Bank and E*TRADE Securities, are additional sources of corporate cash. Subject to regulatory approval or notification, capital generated by these subsidiaries could be distributed to the parent company to the extent the excess capital levels exceed both regulatory capital requirements and internal capital thresholds. As of December 31, 2019, our subsidiaries maintained excess regulatory capital over internal thresholds and paid dividends of $1.7 billion
to the parent company during the year ended December 31, 2019.
E*TRADE 2019 10-K | Page 57
The following chart presents the key activities impacting corporate cash and provides a roll forward of corporate cash from December 31, 2018 to December 31,
2019 (dollars in millions): The following table presents a reconciliation of consolidated cash and equivalents to corporate cash, a non-GAAP measure (dollars in millions):
|
| | | | | | | | | | | |
| |
| 2019 | | 2018 | | 2017 |
Consolidated
cash and equivalents | $ | 750 |
| | $ | 2,333 |
| | $ | 931 |
|
| (716 | ) | | (2,347 | ) | | (659 | ) |
Add:
Cash on deposit at E*TRADE Bank(1) | 611 |
| | 405 |
| | 269 |
|
Corporate cash | $ | 645 |
| | $ | 391 |
| | $ | 541 |
|
| |
(1) | Corporate
cash includes the parent company's deposits placed with E*TRADE Bank. E*TRADE Bank may use these deposits for investment purposes; however, these investments are not included in consolidated cash and equivalents. |
E*TRADE 2019 10-K | Page 58
Corporate cash increased $254 million to $645 million during the year ended December
31, 2019 primarily due to the following: | |
• | $1.7 billion of dividends received from bank and brokerage subsidiaries |
| |
• | $1.1 billion used for share repurchases |
| |
• | $175 million used for dividends, including
$135 million in common stock dividends and $40 million in preferred stock dividends |
| |
• | $121 million used primarily for parent company overhead, including both fixed and variable costs, less reimbursements from subsidiaries under cost sharing arrangements and the impact of cash activity at other non-regulated subsidiaries |
| |
• | $52 million used
for corporate debt activity |
| |
• | $29 million used for the acquisition of Gradifi |
| |
• | $29 million used for income tax payments, net of refunds and subsidiary reimbursements |
E*TRADE Bank Liquidity
E*TRADE Bank, including its subsidiary E*TRADE Savings Bank, relies primarily on 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. The vast majority of E*TRADE Bank's liquidity is invested in securities backed by the US government or its agencies, representing highly liquid securities with low credit risk.
We may also 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 of Richmond's discount window to meet short-term liquidity requirements, although it is not viewed as a primary source of funding. At December 31, 2019, E*TRADE Bank had $6.8 billion and $1.3 billion in collateralized borrowing capacity with the Federal Home Loan Bank (FHLB) and the Federal Reserve Bank of Richmond, respectively. E*TRADE Securities
Liquidity
E*TRADE Securities relies primarily on customer payables and securities lending to provide liquidity and to fund margin lending. E*TRADE Securities maintains additional liquidity through external lines of credit totaling approximately $1.3 billion. E*TRADE Securities also maintains lines of credit with the parent company and E*TRADE Bank.
E*TRADE 2019 10-K | Page 59
External
Liquidity Sources
|
| | | | | | | | |
Description | Maturity Date | Borrower | Outstanding | Available |
Senior
unsecured, committed revolving credit facility(1) | June 2024 | ETFC | $ | — |
| $ | 300 |
|
FHLB secured credit facility | Determined at trade | ETB | $ | — |
| $ | 6,837 |
|
Federal
Reserve Bank discount window | Overnight | ETB | $ | — |
| $ | 1,336 |
|
Senior unsecured, committed revolving credit facility(2) | June 2020 | ETS | $ | — |
| $ | 600 |
|
Secured,
committed lines of credit | June 2020 | ETS | $ | — |
| $ | 175 |
|
Unsecured, uncommitted lines of credit | June 2020 | ETS | $ | — |
| $ | 50 |
|
Unsecured,
uncommitted lines of credit | None | ETS | $ | — |
| $ | 75 |
|
Secured, uncommitted lines of credit | None | ETS | $ | — |
| $ | 425 |
|
| |
(1) | On
June 21, 2019, the Company entered into a new five year, $300 million senior unsecured committed revolving credit facility, which replaced its three year senior unsecured committed revolving credit facility entered into on June 23, 2017. The senior unsecured committed revolving credit facility contains certain covenants, including maintenance covenants related to the Company's interest coverage, leverage and regulatory net capital ratios with which the Company was in compliance at December 31, 2019. |
| |
(2) | On
June 21, 2019, E*TRADE Securities entered into a 364-day, $600 million senior unsecured committed revolving credit facility, which replaced its 364-day senior unsecured committed revolving credit facility entered into on June 22, 2018. The senior unsecured committed revolving credit facility contains certain covenants, including maintenance covenants related to E*TRADE Securities' minimum consolidated tangible net worth and regulatory net capital ratio with which the Company was in compliance at December 31, 2019. |
Capital Resources
The
Company seeks to manage capital levels in support of our business strategy of generating and effectively deploying capital for the benefit of our shareholders, governed by the Company's risk management framework. For additional information on our bank and brokerage capital requirements, refer to Note 18—Regulatory Requirements.
E*TRADE 2019 10-K | Page 60
Bank
Capital Requirements
At December 31, 2019, our regulatory capital ratios for E*TRADE Financial and E*TRADE Bank were above the minimum ratios required to be "well capitalized." Currently, the internal threshold for E*TRADE Financial's Tier 1 leverage ratio is 6.5% and the internal threshold for E*TRADE Bank's Tier 1 leverage ratio is 7.0%. For additional information on bank regulatory requirements refer to Part I. Item 1. Business—Regulation and to Note 18—Regulatory Requirements. The following table presents E*TRADE Financial and E*TRADE Bank's capital ratios (dollars in millions): |
| | | | | | | | | | | | | | | |
| E*TRADE
Financial | | E*TRADE Bank |
| | | | | | | |
Shareholders’ equity | $ | 6,543 |
| | $ | 6,562 |
| | $ | 3,488 |
| | $ | 3,557 |
|
Deduct: | | | | | | | |
Preferred
stock | (689 | ) | | (689 | ) | | — |
| | — |
|
Common Equity Tier 1 capital before regulatory adjustments | $ | 5,854 |
| | $ | 5,873 |
| | $ | 3,488 |
| | $ | 3,557 |
|
Add: | | | | | | | |
Losses
in other comprehensive income on available-for-sale debt securities, net of tax | 28 |
| | 275 |
| | 28 |
| | 275 |
|
Deduct: | | | | | | | |
Goodwill
and other intangible assets, net of deferred tax liabilities | (2,466 | ) | | (2,540 | ) | | (276 | ) | | (287 | ) |
Disallowed deferred tax assets | (70 | ) | | (200 | ) | | — |
| | (61 | ) |
Common
Equity Tier 1 capital | $ | 3,346 |
| | $ | 3,408 |
| | $ | 3,240 |
| | $ | 3,484 |
|
Add: | | | | | | | |
Preferred
stock | 689 |
| | 689 |
| | — |
| | — |
|
Tier 1 capital | $ | 4,035 |
| | $ | 4,097 |
| | $ | 3,240 |
| | $ | 3,484 |
|
Add: | | | | | | | |
Other | 25 |
| | 46 |
| | 17 |
| | 37 |
|
Total
capital | $ | 4,060 |
| | $ | 4,143 |
| | $ | 3,257 |
| | $ | 3,521 |
|
| | | | | | | |
Average
assets for leverage capital purposes | $ | 60,968 |
| | $ | 64,767 |
| | $ | 45,320 |
| | $ | 49,568 |
|
Deduct: | | | | | | | |
Goodwill
and other intangible assets, net of deferred tax liabilities | (2,466 | ) | | (2,540 | ) | | (276 | ) | | (287 | ) |
Disallowed deferred tax assets | (70 | ) | | (200 | ) | | — |
| | (61 | ) |
Adjusted
average assets for leverage capital purposes | $ | 58,432 |
| | $ | 62,027 |
| | $ | 45,044 |
| | $ | 49,220 |
|
| | | | | | | |
Total
risk-weighted assets(1) | $ | 10,635 |
| | $ | 10,970 |
| | $ | 8,872 |
| | $ | 9,994 |
|
| | | | | | | |
Tier
1 leverage ratio (Tier 1 capital / Adjusted average assets for leverage capital purposes) | 6.9 | % | | 6.6 | % | | 7.2 | % | | 7.1 | % |
Common Equity Tier 1 capital / Total risk-weighted
assets(1) | 31.5 | % | | 31.1 | % | | 36.5 | % | | 34.9 | % |
Tier 1 capital / Total risk-weighted assets | 37.9 | % | | 37.3 | % | | 36.5 | % | | 34.9 | % |
Total
capital / Total risk-weighted assets | 38.2 | % | | 37.8 | % | | 36.7 | % | | 35.2 | % |
| |
(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 2019 10-K | Page 61
Broker-Dealer and FCM Capital Requirements
Our broker-dealer and FCM subsidiaries are subject to capital requirements determined by their respective regulators. At December 31, 2019, these 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-dealer and FCM subsidiaries. For additional information on our broker-dealer and
FCM capital requirements, refer to Note 18—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, refer to Note 20—Commitments, Contingencies and Other Regulatory Matters.
Contractual Obligations and Commitments
The following table summarizes our contractual obligations at December 31,
2019 and the effect such obligations are expected to have on our liquidity and cash flow in future periods (dollars in millions): |
| | | | | | | | | | | | | | | | | | | |
| Payments Due by Period |
| Less Than 1 Year | | 1-3
Years | | 3-5 Years | | Thereafter | | Total |
Corporate debt(1) | $ | 52 |
| | $ | 697 |
| | $ | 68 |
| | $ | 926 |
| | $ | 1,743 |
|
Leases(2) | 41 |
| | 75 |
| | 73 |
| | 107 |
| | 296 |
|
Purchase
obligations(3) | 111 |
| | 44 |
| | 16 |
| | — |
| | 171 |
|
Uncertain
tax positions | 2 |
| | 21 |
| | 11 |
| | — |
| | 34 |
|
Certificates
of deposit(4)(5) | 14 |
| | 4 |
| | 1 |
| | — |
| | 19 |
|
Total
contractual obligations | $ | 220 |
| | $ | 841 |
| | $ | 169 |
| | $ | 1,033 |
| | $ | 2,263 |
|
| |
(1) | Includes
annual interest payments and scheduled maturities. |
| |
(2) | Includes future minimum lease payments for non-cancelable operating leases, including a sale-leaseback that is accounted for as a financing, with initial or remaining terms in excess of one year, net of sublease proceeds. |
| |
(3) | Includes material purchase obligations for goods and services covered by non-cancelable contracts and obligations through the contractual termination
date for cancelable contracts. Includes contracts through the termination date, even if the contract is renewable. |
| |
(4) | Includes annual interest based on the contractual features of each security, using market rates at December 31, 2019. Interest rates are assumed to remain at current levels over the life of all adjustable rate instruments. |
| |
(5) | Does
not include sweep deposits, savings deposits, money market or checking deposits as there are no stated maturity dates and/or scheduled contractual payments. |
The Company also had $43 million in unfunded contingent investment commitments to partnerships, companies and other similar entities, including tax credit partnerships and community development entities, which are not required to be consolidated, at December 31, 2019. Additional information related to commitments and contingent liabilities is detailed in Note 20—Commitments, Contingencies and Other Regulatory Matters.
E*TRADE
2019 10-K | Page 62
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 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 categorized as follows, with further information provided below: | |
• | Credit
Risk—the risk of loss arising from the failure of a borrower or counterparty to meet its credit obligations |
| |
• | Liquidity Risk—the potential inability to meet in a timely and cost-effective manner contractual and contingent financial obligations, either on- or off-balance sheet, as they come due |
| |
• | Market Risk—the risk that asset values or income streams will be adversely affected by changes in market conditions |
| |
• | Operational
Risk—the risk of losses or near misses due to failure of people, processes, and systems, or damage to physical assets |
| |
• | Strategic Risk—the risk of loss of market size, market share, capital or margin in our business, leading to lost revenues and potentially significant reductions to net income, assets, and/or market value |
| |
• | Reputational Risk—the potential that negative perceptions regarding our conduct or business practices or capacity to conduct business will adversely affect valuation, profitability, operations, or
the customer base, or require costly litigation or other measures |
| |
• | Legal and Regulatory Risk—the risk to earnings or capital arising from violations of, or non-conformance with, laws, rules, regulations, applicable guidance, internal policies, or ethical standards, as well as uncertainties surrounding the interpretation or application of laws. Legal and regulatory risk also arises in situations where the rules governing certain related products or activities may be ambiguous, untested, or in the process of significant change or revision. |
We are also subject to other risks that could affect our business, financial condition, results of operations or cash flows in future periods. For
additional information see Part I. Item 1A.— Risk Factors.
We manage risk through a governance structure of risk committees, which consist of members of senior management, to help ensure that business decisions are executed within our stated risk profile and consistent with the RAS. A variety of methodologies and measures are used to monitor, quantify, assess and forecast risk. Measurement criteria, methodologies and calculations are reviewed periodically to ensure that risks are represented appropriately. Certain risks are described in the RAS and related policies which establish processes and limits. The RAS and these policies are reviewed, challenged, and approved by certain risk committees and/or the board of directors, where applicable, at least annually.
The Risk Oversight Committee (ROC), which consists of independent members of the board of directors,
reviews, challenges and approves the RAS and certain risk policies each year, receives regular reports on the status of certain limits and Key Risk Indicators and discusses certain key risks. In addition to this Board-level committee, various management committees and subcommittees throughout the Company aid in the identification, measurement and management of risks, including but not limited to:
E*TRADE 2019 10-K | Page 63
| |
• | Enterprise
Risk Management Committee (ERMC)—the ERMC is the senior-most risk management committee and has primary responsibility for approving risk limits and monitoring risk management activities. The ERMC also resolves issues escalated by the other risk management committees and in certain instances approves exceptions to risk policies |
| |
• | Asset Liability Committee (ALCO)—the ALCO has primary responsibility for monitoring of market, interest rate, and liquidity risk, and approves related risk limits or recommends related risk limits to be approved by the ERMC |
| |
• | Credit
Committee—the Credit Committee has responsibility for approving credit programs, including those supporting margin lending, investments in credit sensitive assets, loan modifications and securities-based lending. The Credit Committee also has responsibility for developing credit risk limits and submitting them to the ERMC for approval |
| |
• | Operational Risk and Control Committee (ORCC)—the ORCC has responsibility for the oversight and management of the operational risks in all business lines, legal entities, and departments, including the development and reporting of key operational risk metrics. The ORCC has oversight of operational risk management in the existing enterprise risk categories, including: transactions execution risk, information security
(e.g. cyber security) and other security risks, legal and regulatory risks, systems and information technology risks, and employment risks |
| |
• | Technology Risk Committee (TRC)—the TRC provides oversight to ensure that all information technology, including information security, objectives and requirements are met and that policies, programs and plans are implemented |
Credit Risk Management
We have expanded our credit risk appetite to include purchases of non-agency securities within risk limits. We face credit risks as follows:
| |
• | We
hold credit risk exposure in our legacy loan portfolio and in connection with our investments in non-agency commercial mortgage-backed and non-agency ABS |
| |
• | We offer securities-based lending products and margin loans to our customers which leads to the risk of credit losses in the event a customer's assets decline due to adverse market conditions, leaving the account with an unsecured debit that the customer is not able or willing to cover |
| |
• | We engage in financial transactions with counterparties, which expose us to counterparty
credit losses or collateral losses in the event a counterparty cannot meet its obligations. These financial transactions include our invested cash, securities lending, repurchase and reverse repurchase agreements, and derivatives portfolios, as well as the settlement of trades. |
Credit risk is monitored by the Credit Committee. The Credit Committee's objective is to evaluate current and expected credit performance of our loans, investments, borrowers and counterparties relative to market conditions and the probable impact on our financial performance. It establishes credit risk guidelines in accordance with our strategic objectives and existing policies, and reviews investment and lending activities with credit risk to ensure consistency with those established guidelines. These reviews involve an analysis of portfolio balances, delinquencies, losses, recoveries, default management and collateral liquidation
performance, as well as any credit risk mitigation efforts relating to the portfolios. In addition, the Credit Committee reviews and approves credit related counterparties engaged in financial transactions with us. The Credit Committee is responsible for corporate governance and oversight with regard to margin risk. The Credit Committee identifies, monitors and mitigates where necessary market, operational and credit risks related to our margin lending activities.
E*TRADE 2019 10-K | Page 64
Loss
Mitigation on the Loan Portfolio
Our credit risk team manages the mitigation of credit risk within the loan portfolio. We continue to have loan modification programs that were established to minimize potential losses in the mortgage portfolios by targeting borrowers experiencing financial difficulties. During the years ended December 31, 2019 and 2018, these programs were utilized to modify $9 million and $15 million, respectively, of one- to four-family loans, and $4 million and $5 million, respectively, of home equity loans. These modifications were classified as troubled debt restructurings (TDRs). We also process minor modifications on certain loans in the normal course of servicing delinquent accounts. Minor modifications resulting in an insignificant delay in the timing of payments are not considered economic concessions
and therefore are not classified as TDRs. At December 31, 2019 and 2018, we had $5 million and $7 million, respectively, of mortgage loans with minor modifications that were not considered TDRs. Currently, our entire mortgage loan portfolio is serviced by third parties. To reduce vendor, operational and regulatory risks, we have assessed our servicing relationships and, where appropriate, consolidated providers or transferred certain mortgage loans to servicers that specialize in managing troubled assets. At December 31, 2019, $981 million gross unpaid principal balance of our mortgage loans were held at servicers that specialize in managing troubled assets. We believe this initiative has improved and will continue to improve the credit performance of the loans transferred compared
to the expected credit performance of these same loans if they had not been transferred. Liquidity Risk Management
Liquidity risk is monitored by the ALCO, the ERMC and the ROC. Liquidity risk arises in a number of key areas:
| |
• | Negative news affecting the financial services and banking sector, in general, could have a systemic liquidity impact |
| |
• | Significant concerns about our solvency or liquidity position could cause idiosyncratic
liquidity stress |
| |
• | Increases in short term rates could cause deposit outflow and funding pressure |
| |
• | The parent company has no revenue sources other than dividends from its subsidiaries to fund corporate debt obligations, which introduces additional liquidity concerns |
| |
• | Our
corporate debt covenants and restrictions could impact our ability to distribute capital or obtain additional debt financing |
We have in place a comprehensive set of liquidity and funding policies as well as contingency funding plans that are intended to maintain our flexibility to address liquidity events specific to us or the market in general. See MD&A—Liquidity and Capital Resources for additional information.
Market Risk Management
The most significant type of market risk we face is interest rate risk. Interest rate risk is the risk of adverse changes in earnings or market value arising from our balance sheet position due to changes in interest rates. We face interest rate risk in the following areas:
| |
• | A
large proportion of our balance sheet is actively invested in MBS, agency notes, and other federal government obligations, which are subject to income and market value changes due to changes in interest rates and spreads |
| |
• | We hold a sizable amount of customer deposits, which can be sensitive to the offer rate and/or the stock market environment |
E*TRADE 2019 10-K | Page 65
| |
• | Our margin customers (inclusive of futures and options customers) are subject to market risk when an account’s value declines due to market conditions |
Market risk is monitored by the Credit Committee, the ALCO, the ERMC and the ROC. The ALCO monitors current and expected market conditions and their probable impact on the Company and provides oversight for interest rate risk. Risks associated with the margin portfolio are reviewed monthly by the Credit Committee. See Part II. Item 7A. Quantitative and Qualitative Disclosures
about Market Risk for additional information about our market risks. Operational Risk Management
Operational risk is reviewed, challenged and monitored by the ORCC, the ERMC and the ROC. Operational risk is one of the most significant risks inherent in our strategy and business model. We face a wide variety of operational risks and consider operational risk across five categories:
Information Security / Cyber Risk is the potential for misuse, disclosure, loss or corruption of our data (including customer data), or damage to information systems, that may adversely impact the confidentiality, integrity, and/or availability of our information resources, including:
| |
• | Internal
Malicious - Deliberate acts of sabotage, theft, or other malicious activities committed by employees or other insiders |
| |
• | Internal Unintentional - Acts leading to misuse, disclosure, loss, or damage stemming from human error committed by employees and other insiders |
| |
• | External Malicious - The most exposed cyber risk; deliberate attacks from outside parties, including criminal syndicates, hacktivists, and nation states |
| |
• | External
Unintentional - Similar to the internal unintentional, these acts cause misuse, disclosure, loss, or damage to the Company by outside parties but are not deliberate |
Information Technology Risk is associated with the use, ownership, operation, influence, and adoption of technology within the Company, including: | |
• | Disaster Recovery Risk - The risk of a natural or human-induced disaster (e.g., weather event, technology outage, unrest, pandemic) resulting in the
inability to continue or recover critical technology systems in a timely manner |
| |
• | Change Management Risk - The risk that changes to technology systems do not meet the objectives and requirements of the business |
| |
• | IT Operations Risk - The risk of issues with network, database, application, or infrastructure systems that result in loss of revenue or productivity |
Vendor Risk is associated
with our reliance on third parties to provide products or services either directly to us or on behalf of us to customers, employees, and/or institutions, including:
| |
• | Failure of third party service providers to adequately perform certain functions or to perform oversight of their own third parties |
| |
• | Unexpected interruptions in service |
| |
• | Breach
of data of the third party that includes our data |
Model Risk is associated with our models used for a variety of internal purposes that may be critical to our day-to-day business, operations, decisions, and/or protection from external factors, such as money
E*TRADE 2019 10-K | Page 66
laundering attempts. Some
of the key risks associated with using models that may affect business decisions and client interactions include:
| |
• | Model design, methodology, modeling choices, data, outputs are not appropriate for the model’s intended use |
| |
• | Model results cannot be interpreted, are not intuitive, or the model’s performance deteriorates, making the model unreliable for use |
General Operational Risk is meant to capture all
other risks not detailed in the other specific operational risk categories above, including:
| |
• | External or internal fraud |
| |
• | Process failures, unrelated to technology |
| |
• | Failure of internal controls, unrelated to technology |
| |
• | High
turnover or loss of key personnel affecting performance |
Strategic Risk Management
Strategic risk is reviewed, challenged and monitored by the ERMC and the ROC. We aim to mitigate strategic risk through the competitive positioning of our offerings. In our efforts to expand market share and product offerings, we may engage in inorganic growth opportunities that broaden our strategic risk profile. The main sources of strategic risk are:
| |
• | A strategy which is ill-defined or which does not respond to trends in our competitive landscape |
| |
• | A
lack of appropriate reaction mechanisms to adapt to changes in the business or regulatory environment |
| |
• | Regulatory changes impacting our strategic flexibility |
| |
• | Performance of our strategic initiatives or investments below key assumptions considered at the time of the investments |
Reputational Risk Management
Reputational risks are reviewed, challenged and monitored by the ERMC and the ROC. Reputational risk can
manifest itself in all areas of our business often due to negative publicity associated with other types of risk. The most significant reputational risks to us are in the following areas:
| |
• | Business disruption, system failures, security breaches, identity theft, vendor, or other cyber related events |
| |
• | Impact of investigations and lawsuits (with or without merit) |
| |
• | Publication
of regulatory findings |
| |
• | Unethical behavior of any employee of the Company or members of the Boards of Directors |
| |
• | Failure of controls supporting the accuracy of financial reports and
disclosures |
| |
• | Errors in public communication |
E*TRADE 2019 10-K | Page 67
Legal and Regulatory Risk Management
Legal and Regulatory risks are reviewed, challenged
and monitored by the ERMC and the ROC. This risk exposes the Company to fines, civil money penalties, diminished reputation, reduced franchise value, limited business opportunities and reduced expansion potential. The following areas of legal and regulatory risk are particularly pertinent: | |
• | Extensive government regulation, including broker-dealer, banking and securities rules and regulations, which could restrict our business practices |
| |
• | Changes
in laws and regulation may have a material impact on our operations. In addition, we could face negative regulatory consequences, which could have a material negative effect on our business, if we are unable to meet these new requirements |
| |
• | Failure to comply with applicable laws or regulations, either domestically or internationally, could subject us to disciplinary actions, monetary or other penalties or restrictions that could significantly harm our business |
| |
• | We may be subject to investigations, threatened or actual
lawsuits as a result of alleged or actual business practices, changes in laws, business disputes, or regulatory expectations. If we fail to take appropriate measures to protect assets (for example, intellectual property) owned by the institution that could lead to a loss in franchise value. |
|
|
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 mortgage loan portfolio represents our most significant credit risk exposure.
| |
• | One-
to Four-Family Interest-Only Loans and Home Equity Loans: One- to four-family loans include loans with a five to ten-year interest-only period, followed by an amortizing period ranging from 20 to 25 years. 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 that 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 had an interest-only draw period at origination and converted to amortizing loans at the end of the draw period, which typically ranged from five to ten years. At December 31,
2019, all of the one-to four-family loans were amortizing and substantially all of the HELOC portfolio had converted from the interest-only draw period. These conversions mitigate the risk associated with these loans; however, the Company is still exposed to the risk if the borrows fail to perform. |
| |
• | Securities: We focus primarily on security type and credit rating to monitor credit risk in our securities portfolios. We consider securities backed by the US government or its agencies to have low credit risk as the long-term debt rating of the US government is AA+ by S&P and Aaa by Moody’s at December 31,
2019. The amortized cost of these securities accounted for 99% of our total securities portfolio at December 31, 2019. We review the remaining debt securities that were not backed by the US government or its agencies according to their credit ratings from S&P and Moody’s where available, and all such debt securities were rated investment grade at December 31, 2019. |
E*TRADE 2019 10-K | Page 68
|
|
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 accounting principles generally accepted in the United States of America (GAAP). Note 1—Organization, Basis of Presentation and Summary of Significant Accounting Policies 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.
Critical Accounting Estimates
We believe that certain accounting estimates are critical because they require complex and subjective judgments by management. Changes in these estimates or assumptions could materially impact our financial condition and results of operations, and actual results could differ from our estimates. Our critical accounting estimates are described below.
Allowance for Loan Losses
The allowance for loan losses is management's estimate of probable losses inherent in the loan portfolio as of the balance sheet date. Determining the adequacy of the allowance is complex and requires judgment by management about the effect of matters that are inherently uncertain. We recognized a benefit
to provision for loan losses of $51 million for the year ended December 31, 2019. The benefit recognized reflected better than expected performance of our portfolio as well as recoveries in excess of prior expectations, including sales of charged-off loans and recoveries of previous charge-offs that were not included in our loss estimates. See Note 1—Organization, Basis of Presentation and Summary of Significant Accounting Policies and Note 7—Loans Receivable, Net for additional information on the allowance methodology and the quantitative and qualitative factors considered in determination of the allowance for loan losses for the periods presented. See New Accounting Standards Not Yet Adopted for additional information on the impact
of the new accounting for credit losses guidance that became effective for the Company beginning on January 1, 2020. Valuation and Impairment of Goodwill and Acquired Intangible Assets
Goodwill is recognized as a result of business combinations and represents the excess of the purchase price over the fair value of net tangible assets and identifiable intangible assets acquired. Goodwill and other intangible assets are evaluated for impairment on an annual basis as of November 30 and in interim periods when events or changes indicate the carrying value may not be recoverable, such as a significant deterioration in the operating environment. See Note 1—Organization, Basis of Presentation and Summary of Significant Accounting
Policies and Note 10—Goodwill and Other Intangibles, Net for additional information on the valuation and impairment policies governing goodwill and acquired intangible assets.
The valuation of goodwill and acquired intangible assets requires significant judgment and estimates by management. For example, the valuation of certain finite lived intangible assets acquired in the Gradifi, Capital One, and TCA transactions were performed using variations of the income approach (relief from royalty method or multi-period excess earnings method) which required management estimates of future earnings and cash flows. The useful life of the finite lived intangible assets was determined based on management's estimate of the period over which those intangible assets are expected to provide economic benefit to the
Company. Management also applies judgment in conducting impairment testing for goodwill and finite lived intangible assets, including estimates of fair value based on the income or market approach and estimates required to determine the useful lives of finite lived intangible assets. The Company evaluated the customer relationship intangibles (CRI) associated with its retail channel for impairment as a result of the commissions reduction announced in the fourth quarter of 2019 and noted that no impairment or resulting change to the useful lives of the related CRIs was indicated as a result of this analysis.
E*TRADE 2019 10-K | Page 69
If our estimates of fair value change due to future events differing significantly from the forecasts used to determine fair value, changes in our business or other factors, the Company may recognize an impairment of goodwill or acquired intangible assets, which could have a material adverse effect on our financial condition and results of operations. If the Company's publicly traded equity were to experience a significant decrease in market capitalization, goodwill would be tested for impairment. Intangible assets with finite lives are amortized over their estimated useful lives, therefore changes in the estimated useful lives could result in the recognition of an impairment. Income
Taxes
In preparing the consolidated financial statements, we calculate income tax expense (benefit) based on our interpretation of the tax laws in the various jurisdictions where we conduct business. This requires us to estimate current tax obligations and the realizability of uncertain positions to assess temporary differences between the financial statement carrying amounts and the tax bases of assets and liabilities, which result in deferred tax assets and liabilities. We must also assess the likelihood that the deferred tax assets will be realized and recognize valuation allowances based on our estimates of the amount that is not realizable. In estimating accrued taxes, we assess the relative metrics and risks of the appropriate tax treatment considering statutory, judicial and regulatory guidance in the context of the tax position. Because of the complexity of tax laws and regulations, interpretation can be difficult and
subject to legal judgment given specific facts and circumstances.
Changes in the estimate of accrued taxes occur periodically due to changes in tax rates, interpretations of tax laws, the status of examinations being conducted by various taxing authorities, and newly enacted statutory, judicial and regulatory guidance that impacts the relative merits and risks of the tax positions. These changes, when they occur, affect accrued taxes and can be significant to the Company's results of operations. See Note 1—Organization, Basis of Presentation and Summary of Significant Accounting Policies and Note 14—Income Taxes for additional information about the Company's income
taxes. New Accounting Standards Not Yet Adopted
Accounting for Credit Losses
In June 2016, the Financial Accounting Standards Board (FASB) amended the guidance on accounting for credit losses and has subsequently issued clarifications and improvements. The new guidance became effective for the Company's interim and annual periods beginning January 1, 2020. The amended guidance requires measurement of an allowance for credit losses for financial instruments, including loans and debt securities, and other commitments to extend credit held at the reporting date. For financial assets measured at amortized cost, factors such as historical performance, current
conditions, and reasonable and supportable forecasts, including expected charge-off recoveries, will be used to estimate expected credit losses. The FASB issued additional amended guidance during the second quarter of 2019 clarifying that the current expected credit losses (CECL) standard allows for subsequent increases in the fair value of collateral for collateral-dependent loans to be recognized up to the amount previously charged-off.
Determining the CECL allowance is complex and requires judgment by management about the effect of matters that are inherently uncertain. The Company has not originated a mortgage loan since 2008 when the Company exited direct retail lending, which was the last remaining loan
origination channel after the Company’s exit from the wholesale mortgage lending channel in 2007. We expect the legacy mortgage portfolio to continue its run-off for the foreseeable future. Our portfolio has seasoned, as the weighted average age of the mortgage loan portfolio is approximately 14 years, and substantially all interest-only loans have converted to amortizing loans. As of December 31, 2019, the Company expects to recognize an after-tax benefit related to mortgage loans of approximately $80 million as an adjustment to opening retained earnings at adoption on January 1, 2020. The expected benefit is related to the fair value of the underlying collateral for mortgage loans that were determined
to be collateral-dependent and previously
E*TRADE 2019 10-K | Page 70
written down to the fair value of the underlying collateral. The final opening adjustment will be included in the Company's periodic filing for the three months ended March 31, 2020.
The
CECL allowance is based on assumptions about quantitative and qualitative factors, and changes to the allowance may result if future conditions differ from these assumptions. For example, in the event the cash received through liquidation or other form of recovery for collateral-dependent loans is less than the fair value of collateral less estimated costs to sell, additional losses may be recognized. Subsequent evaluations of the loan portfolio, in light of the factors then prevailing, may result in significant changes in the CECL allowance in future periods. Our underlying assumptions and judgments could prove to be inaccurate, which could impact our regulatory capital position and results of operations in future periods. See Note 1—Organization, Basis of Presentation and Summary of Significant Accounting Policies for additional information.
E*TRADE
2019 10-K | Page 71
|
|
STATISTICAL DISCLOSURE BY BANK HOLDING COMPANIES |
The following table outlines the information required by the SEC’s Industry Guide 3, Statistical Disclosure by Bank Holding Companies:
|
| |
| |
Required Disclosure | Page |
Distribution of Assets, Liabilities and Shareholders’ Equity; Interest Rates and Interest Differential | |
Average Balance Sheet and Analysis of Net Interest Income | 44 |
Net Interest Income—Volumes and Rates Analysis | 73 |
Investment
Portfolio | |
Investment Portfolio—Book Value and Fair Value | 75 |
Investment Portfolio Maturity | 76 |
Loan Portfolio | |
Loans by Type | 76 |
Loan Maturities | 77 |
Loan Sensitivities | 77 |
Risk
Elements | |
Nonaccrual, Past Due and Restructured Loans | 77 |
Past Due Interest | 77 |
Policy for Nonaccrual | 101 |
Potential Problem Loans | 133 |
Summary of Loan Loss Experience | |
Analysis
of Allowance for Loan Losses | 78 |
Allocation of the Allowance for Loan Losses | 78 |
Deposits | |
Average Balance and Average Rates Paid | 44 |
Time Deposit Maturities | 62 |
Return on Equity and Assets | 45 |
Short-Term
Borrowings | 79 |
E*TRADE 2019 10-K | Page 72
Interest Rates and Interest Differential
Increases and decreases in interest income and interest expense result from changes in average balances (volume) of interest-earning assets and interest-bearing liabilities, as well as changes in average interest rates (rate).
The following table shows the effect that these factors had on the interest earned on our interest-earning assets and the interest incurred on our interest-bearing liabilities. The effect of rate changes is calculated by multiplying the change in average yield/cost by the current year’s average daily balance, with the remaining change applied to volume (dollars in millions): |
| | | | | | | | | | | | | | | | | | | | | | | |
| 2019
Compared to 2018 Increase (Decrease) Due To | | 2018 Compared to 2017
Increase (Decrease) Due To |
| Volume | | Rate | | Total | | Volume | | Rate | | Total |
Interest-earning
assets: | | | | | | | | | | | |
Cash and equivalents | $ | (3 | ) | | $ | 2 |
| | $ | (1 | ) | | $ | (3 | ) | | $ | 5 |
| | $ | 2 |
|
Cash
segregated under federal or other regulation | 7 |
| | 4 |
| | 11 |
| | (5 | ) | | 8 |
| | 3 |
|
Investment
securities | (24 | ) | | 143 |
| | 119 |
| | 145 |
| | 134 |
| | 279 |
|
Margin
receivables | (27 | ) | | 18 |
| | (9 | ) | | 113 |
| | 58 |
| | 171 |
|
Loans(1) | (29 | ) | | 5 |
| | (24 | ) | | (38 | ) | | 9 |
| | (29 | ) |
Broker-related
receivables and other | 1 |
| | 2 |
| | 3 |
| | (1 | ) | | 12 |
| | 11 |
|
Subtotal
interest-earning assets | (75 | ) | | 174 |
| | 99 |
| | 211 |
| | 226 |
| | 437 |
|
Other
interest revenue(2) | | | | | 3 |
| | | |
|
| | 1 |
|
Total
interest-earning assets | (75 | ) | | 174 |
| | 102 |
| | 211 |
| | 226 |
| | 438 |
|
Interest-bearing
liabilities: | | | | | | | | |
|
| | |
Sweep deposits: | | | | | | | | | | | |
Brokerage
sweep deposits | (5 | ) | | 17 |
| | 12 |
| | — |
| | 38 |
| | 38 |
|
Bank
sweep deposits(3) | 11 |
| | — |
| | 11 |
| | — |
| | — |
| | — |
|
Savings
deposits | 10 |
| | 66 |
| | 76 |
| | — |
| | 9 |
| | 9 |
|
Customer
payables | 3 |
| | 5 |
| | 8 |
| | 1 |
| | 16 |
| | 17 |
|
Broker-related
payables and other | (4 | ) | | (2 | ) | | (6 | ) | | — |
| | 10 |
| | 10 |
|
Other
borrowings | (17 | ) | | 1 |
| | (16 | ) | | 3 |
| | — |
| | 3 |
|
Corporate
debt | 7 |
| | 2 |
| | 9 |
| | 10 |
| | (12 | ) | | (2 | ) |
Subtotal
interest-bearing liabilities | 5 |
| | 89 |
| | 94 |
| | 14 |
| | 61 |
| | 75 |
|
Other
interest expense(4) | | | | | 2 |
| | | |
|
| | 2 |
|
Total
interest-bearing liabilities | 5 |
| | 89 |
| | 96 |
| | 14 |
| | 61 |
| | 77 |
|
Change
in net interest income | $ | (80 | ) | | $ | 85 |
| | $ | 6 |
| | $ | 197 |
| | $ | 165 |
| | $ | 361 |
|
| |
(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) | Other interest revenue is earned on certain securities loaned balances. Interest expense incurred on other securities loaned balances is presented on the broker-related payables and other line item above. |
| |
(3) | Beginning November 2019, bank sweep deposits include
Premium Savings Accounts participating in a sweep deposit account program. |
| |
(4) | Other interest expense is incurred on certain securities borrowed balances. Interest income earned on other securities borrowed balances is presented on the broker-related receivables and other line item above. |
E*TRADE 2019 10-K | Page 73
Securities
Our investment portfolio includes a mortgage-backed securities portfolio and other debt securities that are classified into the following categories: available-for-sale or held-to-maturity.
Our mortgage-backed securities portfolio is primarily composed of:
| |
• | Fannie Mae participation certificates, guaranteed by Fannie Mae |
| |
• | Freddie
Mac participation certificates, guaranteed by Freddie Mac |
| |
• | Ginnie Mae participation certificates, guaranteed by Ginnie Mae, which is backed by the full faith and credit of the US Government |
| |
• | Collateralized mortgage obligations (CMO), which are guaranteed by one of the three above organizations |
| |
• | Non-agency
mortgage-backed securities |
Our other debt securities include agency debt securities guaranteed by the Small Business Administration, agency debentures which are unsecured senior debt offered by Fannie Mae, Freddie Mac and other government agencies, US Treasuries, and non-agency ABS collateralized by credit card, automobile loan and student loan receivables.
E*TRADE 2019 10-K | Page 74
The
following table presents the amortized cost and fair value of securities that we held and classified as available-for-sale or held-to-maturity (dollars in millions): |
| | | | | | | | | | | | | | | | | | | | | | | |
| |
| 2019 | | 2018 | | 2017 |
| Amortized Cost | | Fair
Value | | Amortized
Cost | | Fair Value | | Amortized
Cost | | Fair Value |
Available-for-sale securities:(1) | | | | | | | | | | | |
Debt
securities: | | | | | | | | | | | |
Agency mortgage-backed securities | $ | 16,267 |
| | $ | 17,035 |
| | $ | 22,140 |
| | $ | 22,162 |
| | $ | 19,395 |
| | $ | 19,195 |
|
Agency
debentures | 632 |
| | 659 |
| | 833 |
| | 839 |
| | 939 |
| | 966 |
|
US
Treasuries | 1,233 |
| | 1,227 |
| | — |
| | — |
| | 452 |
| | 458 |
|
Non-agency
asset-backed securities(2) | 417 |
| | 417 |
| | — |
| | — |
| | — |
| | — |
|
Non-agency
mortgage-backed securities | 159 |
| | 163 |
| | — |
| | — |
| | — |
| | — |
|
Other
agency debt securities | — |
| | — |
| | 140 |
| | 139 |
| | 34 |
| | 33 |
|
Municipal
bonds | — |
| | — |
| | 12 |
| | 12 |
| | 20 |
| | 20 |
|
Other | — |
| | — |
| | 1 |
| | 1 |
| | — |
| | — |
|
Total
debt securities | 18,708 |
| | 19,501 |
| | 23,126 |
| | 23,153 |
| | 20,840 |
| | 20,672 |
|
Publicly
traded equity securities(3) | — |
| | — |
| | — |
| | — |
| | 7 |
| | 7 |
|
Total
available-for-sale securities | $ | 18,708 |
| | $ | 19,501 |
| | $ | 23,126 |
| | $ | 23,153 |
| | $ | 20,847 |
| | $ | 20,679 |
|
Held-to-maturity
securities:(1) | | | | | | | | | | | |
Agency mortgage-backed securities | $ | 20,085 |
| | $ | 20,329 |
| | $ | 18,085 |
| | $ | 17,748 |
| | $ | 20,502 |
| | $ | 20,404 |
|
Agency
debentures | 267 |
| | 271 |
| | 1,824 |
| | 1,808 |
| | 710 |
| | 708 |
|
Other
agency debt securities | 1,617 |
| | 1,646 |
| | 1,975 |
| | 1,935 |
| | 2,615 |
| | 2,595 |
|
Other | — |
| | — |
| | — |
| | — |
| | 12 |
| | 12 |
|
Total
held-to-maturity securities | $ | 21,969 |
| | $ | 22,246 |
| | $ | 21,884 |
| | $ | 21,491 |
| | $ | 23,839 |
| | $ | 23,719 |
|
| |
(1) | Securities
with a fair value of $744 million were transferred from available-for-sale to held-to-maturity based on a change in intent and demonstrated ability to hold these to maturity during the year ended December 31, 2019. Securities with a carrying value of $4.7 billion and related unrealized pre-tax gain of $7 million were transferred from held-to-maturity to available-for-sale during the year ended December 31, 2018, as part of a one-time transition election for early adopting the new derivatives and hedge accounting guidance. Securities with a fair value of $1.2 billion were transferred from available-for-sale to held-to-maturity during the year ended December 31, 2018, pursuant to an evaluation of our investment strategy and an assessment by management about our intent and ability to hold those particular securities until
maturity. |
| |
(2) | Non-agency ABS collateralized by credit card, automobile loan and student loan receivables represented approximately 54%, 18% and 28%, respectively, of the non-agency ABS held at December 31, 2019. |
| |
(3) | Consists of investments in a mutual fund related to the Community Reinvestment Act (CRA). At December 31, 2018, these equity securities are included in other assets on the consolidated balance sheet as
a result of the adoption of amended accounting guidance related to the classification and measurement of financial instruments. See Note 1—Organization, Basis of Presentation and Summary of Significant Accounting Policies for additional information. |
E*TRADE 2019 10-K | Page 75
The following table presents the contractual maturities, amortized cost and current yields for the
Company’s available-for-sale and held-to-maturity investment portfolio at December 31, 2019 (dollars in millions): |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Within
One Year | | One to Five Years | | Five to Ten Years | | After Ten Years | | Total |
| Balance Due | | Weighted Average Yield | | Balance Due | | Weighted Average Yield | | Balance Due | | Weighted Average Yield | | Balance Due | | Weighted Average Yield | | Balance Due | | Weighted Average Yield |
Available-for-sale
debt securities: | | | | | | | | | | | | | | | | | | | |
Agency
mortgage-backed securities | $ | 37 |
| | 3.75 | % | | $ | 21 |
| | 3.27 | % | | $ | 8,839 |
| | 3.54 | % | | $ | 7,370 |
| | 3.10 | % | | $ | 16,267 |
| | 3.34 | % |
Agency
debentures | — |
| | — | % | | — |
| | — | % | | 404 |
| | 3.39 | % | | 228 |
| | 3.82 | % | | 632 |
| | 3.55 | % |
US
Treasuries | 50 |
| | 2.50 | % | | 175 |
| | 2.50 | % | | — |
| | — | % | | 1,008 |
| | 2.46 | % | | 1,233 |
| | 2.47 | % |
Non-agency
asset-backed securities | — |
| | — | % | | 164 |
| | 2.54 | % | | 136 |
| | 2.39 | % | | 117 |
| | 2.57 | % | | 417 |
| | 2.50 | % |
Non-agency
mortgage-backed securities | — |
| | — | % | | — |
| | — | % | | — |
| | — | % | | 159 |
| | 2.99 | % | | 159 |
| | 2.99 | % |
Total
available-for-sale debt securities | $ | 87 |
| | | | $ | 360 |
| | | | $ | 9,379 |
| | | | $ | 8,882 |
| | | | $ | 18,708 |
| | |
Held-to-maturity
debt securities: | | | | | | | | | | | | | | | | | | | |
Agency
mortgage-backed securities | $ | 29 |
| | 3.70 | % | | $ | 1,558 |
| | 2.71 | % | | $ | 2,372 |
| | 2.85 | % | | $ | 16,126 |
| | 3.11 | % | | $ | 20,085 |
| | 3.05 | % |
Agency
debentures | — |
| | — | % | | 21 |
| | 2.58 | % | | 184 |
| | 3.39 | % | | 62 |
| | 3.22 | % | | 267 |
| | 3.29 | % |
Other
agency debt securities | 18 |
| | 3.21 | % | | 421 |
| | 2.70 | % | | 479 |
| | 2.38 | % | | 699 |
| | 2.74 | % | | 1,617 |
| | 2.63 | % |
Total
held-to-maturity debt securities | $ | 47 |
| | | | $ | 2,000 |
| | | | $ | 3,035 |
| | | | $ | 16,887 |
| | | | $ | 21,969 |
| | |
Lending
Activities
The following table presents the balance and associated percentage of each major loan category (dollars in millions): |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| |
| 2019 | | 2018 | | 2017 | | 2016 | | 2015 |
| Balance | | % | | Balance | | % | | Balance | | % | | Balance | | % | | Balance | | % |
One-
to four-family | $ | 803 |
| | 50 | % | | $ | 1,071 |
| | 50 | % | | $ | 1,432 |
| | 53 | % | | $ | 1,950 |
| | 52 | % | | $ | 2,488 |
| | 50 | % |
Home
equity | 635 |
| | 40 |
| | 836 |
| | 39 |
| | 1,097 |
| | 40 |
| | 1,556 |
| | 41 |
| | 2,114 |
| | 43 |
|
Consumer(1) | — |
| | — |
| | 118 |
| | 6 |
| | 176 |
| | 7 |
| | 250 |
| | 7 |
| | 341 |
| | 7 |
|
Securities-based
lending | 169 |
| | 10 |
| | 107 |
| | 5 |
| | 12 |
| | — |
| | — |
| | — |
| | — |
| | — |
|
Total
loans receivable | 1,607 |
| | 100 | % | | 2,132 |
| | 100 | % | | 2,717 |
| | 100 | % | | 3,756 |
| | 100 | % | | 4,943 |
| | 100 | % |
Adjustments: | | | | | | | | | | | | | | | | | | | |
Unamortized
premiums, net | 5 |
| | | | 8 |
| | | | 11 |
| | | | 16 |
| | | | 23 |
| | |
Allowance
for loan losses | (17 | ) | | | | (37 | ) | | | | (74 | ) | | | | (221 | ) | | | | (353 | ) | | |
Total
adjustments | (12 | ) | | | | (29 | ) | | | | (63 | ) | | | | (205 | ) | | | | (330 | ) | | |
Loans
receivable, net | $ | 1,595 |
| | | | $ | 2,103 |
| | | | $ | 2,654 |
| | | | $ | 3,551 |
| | | | $ | 4,613 |
| | |
| |
(1) | The
Company sold its consumer loan portfolio in December 2019. Refer to Note 7—Loans Receivable, Net for additional information. |
E*TRADE 2019 10-K | Page 76
The following table presents the contractual maturities of the loan portfolio at December 31, 2019, including scheduled principal repayments. This table
does not, however, include any estimate of prepayments. These prepayments could significantly shorten the average loan lives and cause the actual timing of the loan repayments to differ from those shown in the following table (dollars in millions): |
| | | | | | | | | | | | | | | |
| Due in(1) | | |
| < 1 Year | | 1-5
Years | | >5 Years | | Total |
One- to four-family | $ | 26 |
| | $ | 133 |
| | $ | 644 |
| | $ | 803 |
|
Home
equity | 36 |
| | 187 |
| | 412 |
| | 635 |
|
Securities-based lending(2) | 169 |
| | — |
| | — |
| | 169 |
|
Total
loans receivable | $ | 231 |
| | $ | 320 |
| | $ | 1,056 |
| | $ | 1,607 |
|
| |
(1) | Estimated
scheduled principal repayments are calculated using weighted-average interest rate and weighted-average remaining maturity of each loan portfolio. |
| |
(2) | Securities-based lending is reflected in the less than one year category as these loans have no contractual maturity. |
The following table presents the distribution of those loans that mature in more than one year between fixed and adjustable interest rate loans at December 31, 2019 (dollars in millions): |
| | | | | | | | | | | |
| Interest
Rate Type | | |
| Fixed | | Adjustable | | Total |
One- to four-family | $ | 126 |
| | $ | 651 |
| | $ | 777 |
|
Home
equity | 92 |
| | 507 |
| | 599 |
|
Total loans receivable | $ | 218 |
| | $ | 1,158 |
| | $ | 1,376 |
|
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 presents comparative data for nonperforming loans and assets for the past five years (dollars in millions):
|
| | | | | | | | | | | | | | | | | | | |
| |
| 2019 | | 2018 | | 2017 | | 2016 | | 2015 |
One-
to four-family | $ | 114 |
| | $ | 139 |
| | $ | 192 |
| | $ | 215 |
| | $ | 263 |
|
Home
equity | 54 |
| | 71 |
| | 98 |
| | 136 |
| | 154 |
|
Consumer | — |
| | — |
| | — |
| | 1 |
| | 1 |
|
Total
nonperforming loans receivable | 168 |
| | 210 |
| | 290 |
| | 352 |
| | 418 |
|
Real
estate owned and other repossessed assets, net | 13 |
| | 13 |
| | 27 |
| | 36 |
| | 29 |
|
Total
nonperforming assets, net | $ | 181 |
| | $ | 223 |
| | $ | 317 |
| | $ | 388 |
| | $ | 447 |
|
During
the year ended December 31, 2019, we recognized $9 million of interest income on loans that were nonperforming at December 31, 2019. If our nonperforming loans at December 31, 2019 had been performing in accordance with their terms, we would have recorded additional interest income of approximately $15 million for the year ended December 31, 2019. At December 31, 2019 there were no commitments to lend additional funds to any of these borrowers.
E*TRADE 2019 10-K | Page 77
The following table presents an analysis of net charge-offs for the past five years (dollars in millions): |
| | | | | | | | | | | | | | | | | | | |
| |
| 2019 | | 2018 | | 2017 | | 2016 | | 2015 |
Allowance
for loan losses, beginning of period | $ | 37 |
| | $ | 74 |
| | $ | 221 |
| | $ | 353 |
| | $ | 404 |
|
Provision
(benefit) for loan losses | (51 | ) | | (86 | ) | | (168 | ) | | (149 | ) | | (40 | ) |
Charge-offs: | | | | | | | | | |
One-
to four-family(1) | — |
| | — |
| | — |
| | (1 | ) | | (2 | ) |
Home
equity(1) | — |
| | — |
| | (7 | ) | | (17 | ) | | (31 | ) |
Consumer | (3 | ) | | (4 | ) | | (6 | ) | | (7 | ) | | (11 | ) |
Total
charge-offs | (3 | ) | | (4 | ) | | (13 | ) | | (25 | ) | | (44 | ) |
Recoveries:(2) | | | | | | | | | |
One-
to four-family | 6 |
| | 7 |
| | 8 |
| | 8 |
| | — |
|
Home
equity | 26 |
| | 43 |
| | 23 |
| | 29 |
| | 26 |
|
Consumer | 2 |
| | 3 |
| | 3 |
| | 5 |
| | 7 |
|
Total
recoveries | 34 |
| | 53 |
| | 34 |
| | 42 |
| | 33 |
|
Net
(charge-offs) recoveries(2) | 31 |
| | 49 |
| | 21 |
| | 17 |
| | (11 | ) |
Allowance
for loan losses, end of period | $ | 17 |
| | $ | 37 |
| | $ | 74 |
| | $ | 221 |
| | $ | 353 |
|
Net
charge-offs (recoveries) to average loans receivable outstanding | (1.7 | )% | | (2.0 | )% | | (0.7 | )% | | (0.4 | )% | | 0.2 | % |
| |
(1) | Includes
benefits resulting from recoveries of partial charge-offs due to principal paydowns or payoffs for the periods presented. The benefits included in the charge-offs line item exceeded other charge-offs for both one-to-four family and home equity loan portfolios during the year ended 2019 and 2018, and for the one-to-four family loan portfolio during the year ended 2017. |
| |
(2) | Recoveries include the impact of mortgage originator settlements and sale of previously charged-off loans as applicable. For additional information refer to Note 6—Loans Receivable, Net. |
The following table presents the allocation of the allowance for loans losses
by loan category for the past five years (dollars in millions): |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| |
| 2019 | | 2018 | | 2017 | | 2016 | | 2015 |
| Amount | | %(1) | | Amount | | %(1) | | Amount | | %(1) | | Amount | | %(1) | | Amount | | %(1) |
One-to
four family | $ | 6 |
| | 50 | % | | $ | 9 |
| | 50 | % | | $ | 24 |
| | 53 | % | | $ | 45 |
| | 52 | % | | $ | 40 |
| | 50 | % |
Home
equity | 11 |
| | 40 |
| | 26 |
| | 39 |
| | 46 |
| | 40 |
| | 171 |
| | 41 |
| | 307 |
| | 43 |
|
Consumer | — |
| | — |
| | 2 |
| | 6 |
| | 4 |
| | 7 |
| | 5 |
| | 7 |
| | 6 |
| | 7 |
|
Securities-based
lending | — |
| | 10 |
| | — |
| | 5 |
| | — |
| | — |
| | — |
| | — |
| | — |
| | — |
|
Total
allowance for loan losses(2) | $ | 17 |
| | 100 | % | | $ | 37 |
| | 100 | % | | $ | 74 |
| | 100 | % | | $ | 221 |
| | 100 | % | | $ | 353 |
| | 100 | % |
| |
(1) | Represents
percentage of loans receivable in the category to total loans receivable, excluding premiums (discounts). |
| |
(2) | Securities-based lending was launched in 2017. These loans were fully collateralized by cash and securities with fair values in excess of borrowings at December 31, 2019, 2018 and 2017, respectively. |
E*TRADE 2019 10-K | Page 78
Borrowings
Deposits represent our most significant and stable source of funding. In addition, we have utilized wholesale funding sources such as FHLB advances and repurchase agreements.
We are a member of, and own capital stock in, the FHLB system. The FHLB provides us with reserve credit capacity and authorizes us to apply for advances based on the security of pledged mortgage loans and mortgage-backed securities—principally agency-backed securities—provided we meet certain creditworthiness standards.
We are also able to raise funds by entering into agreements to repurchase the same or similar securities. The counterparties to these agreements hold the securities in custody. We account for repurchase agreements as borrowings and
secure them with designated fixed- and variable-rate debt securities. We may use the proceeds from these transactions to meet our cash flow or asset/liability matching needs.
ITEM 7A. 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 Risk Factors in this report.
Interest Rate Risk
Our exposure to interest rate risk is related primarily to interest-earning assets and
interest-bearing liabilities. Managing interest rate risk is essential to profitability. The primary objective of interest rate risk management 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 December 31, 2019, 91% of our total assets were interest-earning assets and we had no securities classified as trading. At December 31, 2019, 62% 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 or mortgage-backed securities 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 anticipated yields. The Company reviews estimates of the impact of
E*TRADE 2019 10-K | Page 79
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 securities lending and 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 8—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 and mortgage-backed securities portfolios and the repricing of deposits. This approach does not incorporate assumptions related to business growth, or liquidation and reinvestment 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 following table presents the sensitivity of EVE and EAR at the consolidated E*TRADE Financial level (dollars in millions): |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Instantaneous Parallel
Change in Interest Rates (basis points) (1) | | Economic Value of Equity | | Earnings-at-Risk |
| December 31, | | |
| 2019 | | 2018 | | 2019 | | 2018 |
| Amount | | Percentage | | Amount | | Percentage | | Amount | | Percentage | | Amount | | Percentage |
+200 | | $ | (217 | ) | | (3.6 | )% | | $ | 148 |
| | 1.8 | % | | $ | 246 |
| | 15.8 | % | | $ | 187 |
| | 9.2 | % |
+100 | | $ | 39 |
| | 0.6 | % | | $ | 198 |
| | 2.4 | % | | $ | 140 |
| | 9.0 | % | | $ | 101 |
| | 5.0 | % |
+50 | | $ | 96 |
| | 1.6 | % | | $ | 146 |
| | 1.8 | % | | $ | 83 |
| | 5.3 | % | | $ | 53 |
| | 2.6 | % |
-50 | | $ | (200 | ) | | (3.3 | )% | | $ | (273 | ) | | (3.4 | )% | | $ | (103 | ) | | (6.6 | )% | | $ | (88 | ) | | (4.3 | )% |
| |
(1) | These
scenario analyses assume a balance sheet size as of the dates indicated. Any changes in size would cause the amounts to vary. |
E*TRADE 2019 10-K | Page 80
We actively manage interest rate risk. As interest rates change, we will adjust our strategy and mix of assets, liabilities and derivatives to optimize our interest rate risk 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 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 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 December 31, 2019 the EVE and EAR percentage changes were within our Board limits. Market Risk
Equity Securities Risk
We are indirectly exposed to equity securities risk in connection with securities
collateralizing margin receivables and amounts borrowed under our E*TRADE Line of Credit, a securities-based lending product, as well as risk related to our securities lending and borrowing activities. We manage risk on margin and securities-based lending by requiring customers to maintain collateral in compliance with internal and, as applicable, regulatory guidelines. We monitor required margin levels daily and require our customers to deposit additional collateral, or to reduce positions, when necessary. We continuously monitor customer accounts to detect excessive concentration, large orders or positions, and other activities that indicate increased risk to us. We manage risks associated with our securities lending and borrowing activities by requiring credit approvals for counterparties, by monitoring the market value of securities loaned and collateral values for securities borrowed on a daily basis and requiring additional cash as collateral for securities loaned
or return of collateral for securities borrowed when necessary, and by participating in a risk-sharing program offered through the Options Clearing Corporation.
Non-Agency Debt Securities Risk
During the fourth quarter of 2018, we expanded our enterprise RAS and updated our investment policies to permit investments in high-credit quality non-agency securities that include commercial mortgage-backed securities and ABS. We are exposed to risk in connection with the investments in non-agency commercial mortgage-backed and non-agency ABS, the latter of which are collateralized by credit card, automobile loan and student loan receivables at December 31, 2019. While our current non-agency investments are limited to senior classes, we may be exposed to a higher level of credit risk in the future if we purchase non-senior classes of notes.
We manage risk with respect to non-agency securities by performing pre-purchase due diligence to assess collateral quality, transaction structure, cash flow sensitivity, and overall transaction risk. The results of the due diligence are reviewed and approved prior to purchase and the related investment performance is monitored monthly to assess any risk or other trends that emerge.
E*TRADE 2019 10-K | Page 81
KEY
TERMS
Active trader—Customers that execute 30 or more trades per quarter.
Adjusted operating margin—A non-GAAP measure calculated by dividing adjusted income before income tax expense by total net revenue. Adjusted income before income tax expense, a non-GAAP measure, excludes provision (benefit) for loan losses and losses on early extinguishment of debt, as applicable.
Adjusted return on common equity—A non-GAAP measure calculated by dividing adjusted net income available to common shareholders, a non-GAAP measure which excludes the provision (benefit) for loan losses and losses on early extinguishment of debt, as applicable, by average common shareholders' equity, which excludes preferred stock.
Advisers Act—Investment
Advisers Act of 1940.
Agency—US Government sponsored enterprises and federal government and other agencies, such as the Federal National Mortgage Association, Federal Home Loan Mortgage Corporation, Government National Mortgage Association, the Small Business Administration, the Export-Import Bank, Federal Home Loan Bank and the Federal Farm Credit Bank.
Asset-backed securities (ABS)—Debt securities backed by financial assets such as credit cards, automobile loans, student loans or other receivables.
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.
Capital
return percentage to shareholders—Represents the amount of earnings returned to shareholders through share repurchases and common stock dividends as a percentage of net income available to common shareholders.
CECL—Current expected credit losses.
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.
CMO—Collateralized mortgage obligations.
Collateral-dependent—Prior to adoption
of the CECL accounting standard, a loan where repayment is expected to be provided solely through the sale of the underlying collateral when the borrower is experiencing financial difficulty. After adoption of the CECL accounting standard, a loan for which foreclosure is probable or a loan where repayment is expected to be provided substantially through the sale of the underlying collateral when the borrower is experiencing financial difficulty.
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. 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, as amended, and the condensed consolidated financial statements included in the Company's Quarterly Reports on Form 10-Q.
E*TRADE 2019 10-K | Page 82
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. CRA—Community Reinvestment Act.
Customer account—Retail and advisor services accounts are defined as those with a minimum balance of $25 or a trade within the prior six months. Corporate services accounts are defined as those holding any type of vested or unvested securities from a corporate services client company or with a trade in the prior six months.
Customer assets—Market
value of all customer assets held by the Company including security holdings, customer cash and deposits, and corporate services vested and unvested equity and option holdings. Customer-directed trades—Includes all customer directed trades, including trades associated with no-transaction-fee mutual funds, options trades through the Dime Buyback Program, and all ETF transactions (including those formerly classified as commission-free).
Daily average revenue trades (DARTs)—Total customer-directed 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. Derivative DARTs—Customer directed options and futures trades in a period divided by the number of trading days during that period.
Dime Buyback Program—A program that allows customers to manage and protect capital by allowing them to close short options without commissions or contract fees. Earnings at risk (EAR)—The sensitivity of 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.
ETB—E*TRADE Bank.
ETFC—E*TRADE Financial Corporation.
ETS—E*TRADE
Securities.
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.
FCM—Futures Commission Merchant.
E*TRADE 2019 10-K | Page 83
FDIC—Federal Deposit Insurance Corporation.
Federal Reserve—Federal Reserve System, including the Board of Governors of the Federal Reserve System and the twelve regional Federal Reserve Banks.
FHLB—Federal Home Loan Bank.
FICO—Fair Isaac Credit Organization.
FINRA—Financial Industry Regulatory Authority.
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 line of credit.
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 cash 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 segregated cash 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. Investment grade—Defined as a rating equivalent to a Moody’s Investors Service (Moody’s) rating of “Baa3” or higher or an S&P rating of “BBB-” or higher.
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).
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.
NFA—National Futures Association.
Notional
amount—The specified dollar amount underlying a derivative on which the calculated payments are based.
OCC—Office of the Comptroller of the Currency.
E*TRADE 2019 10-K | Page 84
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 repossessed assets—Ownership or physical possession of real property by the Company, generally acquired as a result of foreclosure or repossession. Recovery—Represents 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 from the transferee. These agreements are generally collateralized by mortgage-backed or investment-grade securities. From the transferee's perspective the arrangement is referred to as a reverse repurchase agreement.
RIA—Registered Investment Advisor.
Risk-weighted assets—Primarily computed by the assignment of specific risk-weightings to assets and off-balance sheet instruments for capital adequacy calculations.
RSDA—Retirement sweep deposit account.
S&P—Standard & Poor’s.
SEC—US Securities and Exchange Commission.
Sweep deposit accounts—Accounts with
the functionality to transfer customer cash balances to and from an FDIC insured account.
TCA—Trust Company of America, Inc.
TCJA—Tax Cuts and Jobs Act.
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.
TRUPs—Trust preferred
securities.
VIE—Variable interest entity.
Wholesale borrowings—Borrowings that consist of repurchase agreements and FHLB advances.
E*TRADE 2019 10-K | Page 85
ITEM 8. FINANCIAL STATEMENTS
AND SUPPLEMENTARY DATA
|
| |
Management Report on Internal Controls Over Financial Reporting | |
Reports of Independent Registered Public Accounting Firm | |
Consolidated Statements of Income | |
Consolidated
Statements of Comprehensive Income | |
Consolidated Balance Sheets | |
Consolidated Statements of Shareholders’ Equity | |
Consolidated Statements of Cash Flows | |
Notes
to Consolidated Financial Statements | |
Note 1—Organization, Basis of Presentation and Summary of Significant Accounting Policies | |
Note 2—Acquisitions and Restructuring | |
Note 3—Net Revenue | |
Note
4—Fair Value Disclosures | |
Note 5—Offsetting Assets and Liabilities | |
Note 6—Available-for-Sale and Held-to-Maturity Securities | |
Note 7—Loans Receivable, Net | |
Note
8—Derivative Instruments and Hedging Activities | |
Note 9—Property and Equipment, Net | |
Note 10—Goodwill and Other Intangibles, Net | |
Note 11—Receivables From and Payables To Brokers, Dealers and Clearing Organizations | |
Note
12—Deposits | |
Note 13—Other Borrowings and Corporate Debt | |
Note 14—Income Taxes | |
Note 15—Shareholders' Equity | |
Note 16—Earnings Per Share | |
Note
17—Share-Based Compensation, Employee Incentive and Retirement Plans | |
Note 18—Regulatory Requirements | |
Note 19—Lease Arrangements | |
Note 20—Commitments, Contingencies and Other Regulatory Matters | |
Note
21—Condensed Financial Information (Parent Company Only) | |
Note 22—Quarterly Data (unaudited) | |
E*TRADE 2019 10-K | Page 86
MANAGEMENT REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
The Company's management is responsible for establishing and maintaining adequate internal control over financial reporting. The Company's internal control system was designed to provide reasonable assurance to our management and board of directors regarding the preparation and fair presentation of published financial statements. Internal control over financial reporting, as defined in Rules 13a-15(f) promulgated under the Securities Exchange Act of 1934, is a process designed by, or under the supervision of, the
Company’s principal executive and principal financial officers, and effected by the Company’s board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of consolidated financial statements for external purposes in accordance with generally accepted accounting principles (GAAP) and includes those policies and procedures that: | |
• | Pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the Company’s assets |
| |
• | Provide
reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with GAAP, and that receipts and expenditures of the Company are being made only in accordance with authorizations of the Company’s management and directors |
| |
• | Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the consolidated financial statements |
Because
of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Management conducted an assessment of the effectiveness of the Company's internal control over financial reporting using the criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of
Sponsoring Organizations of the Treadway Commission. Based on this assessment, management has concluded that its internal control over financial reporting was effective as of December 31, 2019 to provide reasonable assurance regarding the reliability of financial reporting and the preparation of consolidated financial statements in accordance with GAAP. E*TRADE Financial Corporation’s Independent Registered Public Accounting Firm, Deloitte & Touche LLP, has issued an audit report regarding the Company’s internal control over financial reporting, which appears on page 88.
E*TRADE
2019 10-K | Page 87
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of E*TRADE Financial Corporation
Opinion on Internal Control over Financial Reporting
We have audited the internal control over financial reporting
of E*TRADE Financial Corporation and subsidiaries (the “Company”) as of December 31, 2019, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control - Integrated Framework (2013) issued by COSO. We have also audited, in accordance with the standards of
the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated financial statements as of and for the year ended December 31, 2019, of the Company and our report dated February 19, 2020, expressed an unqualified opinion on those financial statements. Basis for Opinion
The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management Report on Internal Control Over Financial Reporting. Our responsibility is to express
an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness
exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
Definition and Limitations of Internal Control over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the
company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements.
Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
McLean, Virginia
E*TRADE 2019 10-K | Page 88
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of E*TRADE Financial Corporation
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of E*TRADE Financial Corporation and subsidiaries (the "Company") as of December 31, 2019 and 2018, the related consolidated statements of income, comprehensive income, shareholders' equity, and cash flows, for each of the three years in the period ended December
31, 2019, and the related notes (collectively, the "financial statements"). In our opinion, the financial statements present fairly, in all material respects, the consolidated financial position of the Company as of December 31, 2019 and 2018, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2019, in conformity with accounting principles generally accepted in the United States of America. We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal
control over financial reporting as of December 31, 2019, based on criteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 19, 2020, expressed an unqualified opinion on the Company's internal control over financial reporting. Basis for Opinion
These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the
Company's financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the US federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence
regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
Critical Audit Matter
The critical audit matter communicated below is a matter arising from the current-period audit of the financial statements that was communicated or required to be communicated to the audit committee and that (1) relates to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical
audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.
Accounting for Credit Losses—Valuation of Collateral-Dependent Loans—Refer to Note 1 to the financial statements.
Critical Audit Matter Description
In 2016, the Financial Accounting Standards Board (FASB) amended the guidance on accounting for credit losses and has subsequently issued clarifications and improvements. The FASB subsequently issued
E*TRADE 2019 10-K | Page 89
additional amended guidance that clarified that the current expected credit losses (CECL) standard allows for subsequent increases in the fair value of collateral for collateral-dependent loans to be recognized up to the amount previously charged-off. The Company adopted the new standard on January 1, 2020, using a modified retrospective approach. The Company expects to recognize an after-tax benefit related to mortgage loans of approximately $80 million as an adjustment to opening retained earnings at adoption. The adoption impact will also be presented on the balance sheet as a “negative allowance” associated with these loans. When
estimating the fair value of the underlying collateral, management utilizes the most recent “as is” property valuation data available, which includes appraisals, broker price opinions, automated valuation models or updated values using home price indices, reduced by qualifying estimated costs to sell. We identified the accounting for collateral-dependent loans under CECL and related valuations as a critical audit matter because of the significant change in the accounting for these loans and judgments made by management to estimate collateral values, which included unobservable inputs that were significant to the collateral fair value and the magnitude of the impact on the allowance for credit losses. This required a high degree of auditor judgment and an increased extent of effort, including the need to involve professionals in our firm having expertise in the application of the CECL accounting standard.
How
the Critical Audit Matter Was Addressed in the Audit
Our audit procedures related to the accounting and valuation of the collateral-dependent loans under CECL included the following, among others:
| |
• | With the assistance of professionals in our firm having expertise in the CECL accounting standard, we evaluated the Company’s conclusions regarding the accounting for subsequent increases in the fair value of collateral for collateral-dependent loans under CECL. |
| |
• | Tested
the effectiveness of controls over the collateral-dependent loans and related negative allowance, including management’s controls over obtaining the fair value of the underlying collateral and calculation of the negative allowance. |
| |
• | Evaluated the appropriateness of the methodology and valuation sources used by management to develop the estimates of collateral values. |
| |
• | Evaluated management’s ability to estimate fair value by comparing, for a sample of collateral-dependent loans, the estimated fair values to valuation
sources, including appraisals, broker price opinions, automated valuation models, or home price indices, and independently-obtained collateral values, and performed a trend analysis on the collateral fair values. |
| |
• | Tested the mathematical accuracy of management’s calculation of the negative allowance associated with the collateral-dependent loans. |
McLean, Virginia
E*TRADE 2019 10-K | Page 90
E*TRADE FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF
INCOME
(In millions, except share data and per share amounts)
|
| | | | | | | | | | | |
| |
| 2019 | | 2018 | | 2017 |
Revenue: | | | | | |
Interest
income | $ | i 2,111 |
| | $ | i 2,009 |
| | $ | i 1,571 |
|
Interest
expense | ( i 259 | ) | | ( i 163 | ) | | ( i 86 | ) |
Net
interest income | i 1,852 |
| | i 1,846 |
| | i 1,485 |
|
Commissions | i 421 |
| | i 498 |
| | i 441 |
|
Fees
and service charges | i 588 |
| | i 431 |
| | i 369 |
|
Gains
(losses) on securities and other, net | ( i 23 | ) | | i 53 |
| | i 28 |
|
Other
revenue | i 48 |
| | i 45 |
| | i 43 |
|
Total
non-interest income | i 1,034 |
| | i 1,027 |
| | i 881 |
|
Total
net revenue | i 2,886 |
| | i 2,873 |
| | i 2,366 |
|
Provision
(benefit) for loan losses | ( i 51 | ) | | ( i 86 | ) | | ( i 168 | ) |
Non-interest
expense: | | | | | |
Compensation and benefits | i 670 |
| | i 621 |
| | i 546 |
|
Advertising
and market development | i 196 |
| | i 200 |
| | i 166 |
|
Clearing
and servicing | i 133 |
| | i 126 |
| | i 124 |
|
Professional
services | i 105 |
| | i 96 |
| | i 99 |
|
Occupancy
and equipment | i 135 |
| | i 124 |
| | i 116 |
|
Communications | i 99 |
| | i 116 |
| | i 121 |
|
Depreciation
and amortization | i 88 |
| | i 92 |
| | i 82 |
|
FDIC
insurance premiums | i 14 |
| | i 30 |
| | i 31 |
|
Amortization
of other intangibles | i 61 |
| | i 48 |
| | i 36 |
|
Restructuring
and acquisition-related activities | i 23 |
| | i 7 |
| | i 15 |
|
Losses
on early extinguishment of debt | i — |
| | i 4 |
| | i 58 |
|
Other
non-interest expenses | i 94 |
| | i 77 |
| | i 76 |
|
Total
non-interest expense | i 1,618 |
| | i 1,541 |
| | i 1,470 |
|
Income
before income tax expense | i 1,319 |
| | i 1,418 |
| | i 1,064 |
|
Income
tax expense | i 364 |
| | i 366 |
| | i 450 |
|
Net
income | $ | i 955 |
| | $ | i 1,052 |
| | $ | i 614 |
|
Preferred
stock dividends | i 40 |
| | i 36 |
| | i 25 |
|
Net
income available to common shareholders | $ | i 915 |
| | $ | i 1,016 |
| | $ | i 589 |
|
Basic
earnings per common share | $ | i 3.86 |
| | $ | i 3.90 |
| | $ | i 2.16 |
|
Diluted
earnings per common share | $ | i 3.85 |
| | $ | i 3.88 |
| | $ | i 2.15 |
|
Weighted
average common shares outstanding: | | | | | |
Basic (in thousands) | i 237,396 |
| | i 260,600 |
| | i 273,190 |
|
Diluted
(in thousands) | i 237,931 |
| | i 261,669 |
| | i 274,352 |
|
See
accompanying notes to the consolidated financial statements
E*TRADE 2019 10-K | Page 91
E*TRADE FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In millions)
|
| | | | | | | | | | | |
| |
| 2019 | | 2018 | | 2017 |
Net income | $ | i 955 |
| | $ | i 1,052 |
| | $ | i 614 |
|
Other
comprehensive income (loss), net of tax | | | | | |
Available-for-sale securities: | | | | | |
Unrealized gains (losses), net | i 224 |
| | ( i 203 | ) | | i 137 |
|
Reclassification
into earnings, net | i 23 |
| | ( i 31 | ) | | ( i 24 | ) |
Transfer
of held-to-maturity securities to available-for-sale securities(1) | i — |
| | i 6 |
| | i — |
|
Net
change from available-for-sale securities | i 247 |
| | ( i 228 | ) | | i 113 |
|
Reclassification
of foreign currency translation into earnings, net | i — |
| | i — |
| | ( i 2 | ) |
Other
comprehensive income (loss) | i 247 |
| | ( i 228 | ) | | i 111 |
|
Comprehensive
income | $ | i 1,202 |
| | $ | i 824 |
| | $ | i 725 |
|
| |
(1) | During
the year ended December 31, 2018, securities with a carrying value of $ i 4.7 billion and related unrealized pre-tax gain of $ i 7
million, or $6 million net of tax, were transferred from held-to-maturity securities to available-for-sale securities as part of a one-time transition election for early adopting the new derivatives and hedge accounting guidance. |
See accompanying notes to the consolidated financial statements
E*TRADE 2019 10-K | Page 92
E*TRADE
FINANCIAL CORPORATION
CONSOLIDATED BALANCE SHEETS
(In millions, except share data)
|
| | | | | | | |
| |
| 2019 | | 2018 |
ASSETS | | | |
Cash
and equivalents | $ | i 750 |
| | $ | i 2,333 |
|
Cash
segregated under federal or other regulations | i 1,879 |
| | i 1,011 |
|
Available-for-sale
securities | i 19,501 |
| | i 23,153 |
|
Held-to-maturity
securities (fair value of $22,246 and $21,491 at December 31, 2019 and 2018, respectively) | i 21,969 |
| | i 21,884 |
|
Margin
receivables | i 9,675 |
| | i 9,560 |
|
Loans
receivable, net (net of allowance for loan losses of $17 and $37 at December 31, 2019 and 2018, respectively) | i 1,595 |
| | i 2,103 |
|
Receivables
from brokers, dealers and clearing organizations | i 1,395 |
| | i 760 |
|
Property
and equipment, net | i 339 |
| | i 281 |
|
Goodwill | i 2,510 |
| | i 2,485 |
|
Other
intangibles, net | i 433 |
| | i 491 |
|
Other
assets | i 1,370 |
| | i 942 |
|
Total
assets | $ | i 61,416 |
| | $ | i 65,003 |
|
LIABILITIES
AND SHAREHOLDERS’ EQUITY | | | |
Liabilities: | | | |
Deposits | $ | i 38,606 |
| | $ | i 45,313 |
|
Customer
payables | i 12,849 |
| | i 10,117 |
|
Payables
to brokers, dealers and clearing organizations | i 893 |
| | i 948 |
|
Corporate
debt | i 1,410 |
| | i 1,409 |
|
Other
liabilities | i 1,115 |
| | i 654 |
|
Total
liabilities | i 54,873 |
| | i 58,441 |
|
Commitments
and contingencies (see Note 20) | i
|
| | i
|
|
Shareholders’
equity: | | | |
Preferred stock, $0.01 par value, 1,000,000 shares authorized, 403,000 shares issued and outstanding at both December 31, 2019 and 2018, respectively; aggregate liquidation preference of $700 at both December 31, 2019 and 2018, respectively | i 689 |
| | i 689 |
|
Common
stock, $0.01 par value, 400,000,000 shares authorized, 222,622,333
and 246,495,174 shares issued and outstanding at December 31, 2019 and 2018, respectively | i 2 |
| | i 2 |
|
Additional
paid-in-capital | i 4,416 |
| | i 5,462 |
|
Retained
earnings | i 1,464 |
| | i 684 |
|
Accumulated
other comprehensive loss | ( i 28 | ) | | ( i 275 | ) |
Total
shareholders’ equity | i 6,543 |
| | i 6,562 |
|
Total
liabilities and shareholders’ equity | $ | i 61,416 |
| | $ | i 65,003 |
|
See
accompanying notes to the consolidated financial statements
E*TRADE 2019 10-K | Page 93
E*TRADE FINANCIAL CORPORATION CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY (In
millions) |
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | Additional
Paid-in
Capital | | Retained
Earnings (Accumulated Deficit) | | Accumulated
Other
Comprehensive
Loss | | Total
Shareholders’
Equity |
| Preferred Stock | | Common Stock | | | | |
| Amount | | Shares | | Amount | | | | |
| $ | i 394 |
| | i 274 |
| | $ | i 3 |
| | $ | i 6,921 |
| | $ | ( i 909 | ) | | $ | ( i 137 | ) | | $ | i 6,272 |
|
Cumulative
effect of accounting change | — |
| | — |
| | — |
| | — |
| | i 3 |
| | — |
| | i 3 |
|
Net
income | — |
| | — |
| | — |
| | — |
| | i 614 |
| | — |
| | i 614 |
|
Other
comprehensive income | — |
| | — |
| | — |
| | — |
| | — |
| | i 111 |
| | i 111 |
|
Issuance
of preferred stock - Series B | i 295 |
| | — |
| | — |
| | — |
| | — |
| | — |
| | i 295 |
|
Preferred
stock dividends - Series A ($62.02 per share) | — |
| | — |
| | — |
| | — |
| | ( i 25 | ) | | — |
| | ( i 25 | ) |
Repurchases
of common stock | — |
| | ( i 9 | ) | | — |
| | ( i 362 | ) | | — |
| | — |
| | ( i 362 | ) |
Share-based
compensation | — |
| | — |
| | — |
| | i 41 |
| | — |
| | — |
| | i 41 |
|
Other
common stock activity | — |
| | i 2 |
| | — |
| | ( i 18 | ) | | — |
| | — |
| | ( i 18 | ) |
| $ | i 689 |
| | i 267 |
| | $ | i 3 |
| | $ | i 6,582 |
| | $ | ( i 317 | ) | | $ | ( i 26 | ) | | $ | i 6,931 |
|
Cumulative
effect of hedge accounting adoption | — |
| | — |
| | — |
| | — |
| | i 7 |
| | ( i 7 | ) | | — |
|
Reclassification
of tax effects due to federal tax reform | — |
| | — |
| | — |
| | — |
| | i 14 |
| | ( i 14 | ) | | — |
|
Net
income | — |
| | — |
| | — |
| | — |
| | i 1,052 |
| | — |
| | i 1,052 |
|
Other
comprehensive loss | — |
| | — |
| | — |
| | — |
| | — |
| | ( i 228 | ) | | ( i 228 | ) |
Common
stock dividends ($0.14 per share) | — |
| | — |
| | — |
| | — |
| | ( i 36 | ) | | — |
| | ( i 36 | ) |
Preferred
stock dividends - Series A ($58.76 per share) | — |
| | — |
| | — |
| | — |
| | ( i 24 | ) | | — |
| | ( i 24 | ) |
Preferred
stock dividends - Series B ($4,107.50 per share) | — |
| | — |
| | — |
| | — |
| | ( i 12 | ) | | — |
| | ( i 12 | ) |
Repurchases
of common stock | — |
| | ( i 22 | ) | | ( i 1 | ) | | ( i 1,139 | ) | | — |
| | — |
| | ( i 1,140 | ) |
Share-based
compensation | — |
| | — |
| | — |
| | i 46 |
| | — |
| | — |
| | i 46 |
|
Other
common stock activity | — |
| | i 1 |
| | — |
| | ( i 27 | ) | | — |
| | — |
| | ( i 27 | ) |
| $ | i 689 |
| | i 246 |
| | $ | i 2 |
| | $ | i 5,462 |
| | $ | i 684 |
| | $ | ( i 275 | ) | | $ | i 6,562 |
|
Net
income | — |
| | — |
| | — |
| | — |
| | i 955 |
| | — |
| | i 955 |
|
Other
comprehensive income | — |
| | — |
| | — |
| | — |
| | — |
| | i 247 |
| | i 247 |
|
Common
stock dividends ($0.56 per share) | — |
| | — |
| | — |
| | — |
| | ( i 135 | ) | | — |
| | ( i 135 | ) |
Preferred
stock dividends - Series A ($58.76 per share) | — |
| | — |
| | — |
| | — |
| | ( i 24 | ) | | — |
| | ( i 24 | ) |
Preferred
stock dividends - Series B ($5,300.00 per share) | — |
| | — |
| | — |
| | — |
| | ( i 16 | ) | | — |
| | ( i 16 | ) |
Repurchases
of common stock | — |
| | ( i 25 | ) | | — |
| | ( i 1,085 | ) | | — |
| | — |
| | ( i 1,085 | ) |
Share-based
compensation | — |
| | — |
| | — |
| | i 53 |
| | — |
| | — |
| | i 53 |
|
Other
common stock activity | — |
| | i 2 |
| | — |
| | ( i 14 | ) | | — |
| | — |
| | ( i 14 | ) |
| $ | i 689 |
| | i 223 |
| | $ | i 2 |
| | $ | i 4,416 |
| | $ | i 1,464 |
| | $ | ( i 28 | ) | | $ | i 6,543 |
|
See
accompanying notes to the consolidated financial statements
E*TRADE 2019 10-K | Page 94
E*TRADE FINANCIAL CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (In
millions) |
| | | | | | | | | | | |
| |
| 2019 | | 2018 | | 2017 |
Cash
flows from operating activities: | | | | | |
Net income | $ | i 955 |
| | $ | i 1,052 |
| | $ | i 614 |
|
Adjustments
to reconcile net income to net cash provided by operating activities: | | | | | |
Provision (benefit) for loan losses | ( i 51 | ) | | ( i 86 | ) | | ( i 168 | ) |
Depreciation
and amortization (including amortization and accretion on investment securities) | i 225 |
| | i 244 |
| | i 262 |
|
(Gains)
losses on securities and other, net | i 23 |
| | ( i 53 | ) | | ( i 28 | ) |
Losses
on early extinguishment of debt | i — |
| | i 4 |
| | i 58 |
|
Share-based
compensation | i 53 |
| | i 46 |
| | i 41 |
|
Deferred
tax expense | i 245 |
| | i 339 |
| | i 450 |
|
Other | i 15 |
| | i 18 |
| | ( i 7 | ) |
Net
effect of changes in assets and liabilities: | | | | | |
(Increase) decrease in receivables from brokers, dealers and clearing organizations | ( i 635 | ) | | i 418 |
| | ( i 134 | ) |
Increase
in margin receivables | ( i 115 | ) | | ( i 489 | ) | | ( i 2,340 | ) |
(Increase)
decrease in other assets | ( i 204 | ) | | i 159 |
| | ( i 49 | ) |
(Decrease)
increase in payables to brokers, dealers and clearing organizations | ( i 55 | ) | | ( i 594 | ) | | i 559 |
|
Increase
in customer payables | i 2,732 |
| | i 668 |
| | i 1,290 |
|
(Decrease)
increase in other liabilities | ( i 341 | ) | | ( i 40 | ) | | i 34 |
|
Net
cash provided by operating activities | i 2,847 |
| | i 1,686 |
| | i 582 |
|
Cash
flows from investing activities: | | | | | |
Purchases of available-for-sale securities | ( i 8,382 | ) | | ( i 8,386 | ) | | ( i 9,819 | ) |
Proceeds
from sales of available-for-sale securities | i 10,735 |
| | i 7,423 |
| | i 1,645 |
|
Proceeds
from maturities of and principal payments on available-for-sale securities | i 1,588 |
| | i 1,944 |
| | i 1,588 |
|
Purchases
of held-to-maturity securities | ( i 4,688 | ) | | ( i 4,163 | ) | | ( i 10,519 | ) |
Proceeds
from maturities of and principal payments on held-to-maturity securities | i 5,307 |
| | i 2,395 |
| | i 2,556 |
|
Proceeds
from sales of loans | i 80 |
| | i 30 |
| | i 40 |
|
Decrease
in loans receivable | i 463 |
| | i 609 |
| | i 983 |
|
Capital
expenditures for property and equipment | ( i 149 | ) | | ( i 112 | ) | | ( i 102 | ) |
Net
increase in securities purchased under agreements to resell | ( i 200 | ) | | i — |
| | i — |
|
Proceeds
from sale of real estate owned and repossessed assets | i 14 |
| | i 24 |
| | i 29 |
|
Acquisitions,
net of cash acquired | ( i 29 | ) | | ( i 150 | ) | | i — |
|
| ( i 277 | ) | | i 221 |
| | i 66 |
|
Other | ( i 34 | ) | | ( i 25 | ) | | ( i 43 | ) |
Net
cash provided by (used in) investing activities | i 4,428 |
| | ( i 190 | ) | | ( i 13,576 | ) |
| | | | | |
E*TRADE
2019 10-K | Page 95
E*TRADE FINANCIAL CORPORATION CONSOLIDATED STATEMENT OF CASH FLOWS (In millions) |
| | | | | | | | | | | |
| |
| 2019 | | 2018 | | 2017 |
Cash flows from financing activities: | | | | | |
(Decrease)
increase in deposits | $ | ( i 6,707 | ) | | $ | i 1,781 |
| | $ | i 11,060 |
|
Common
stock dividends | ( i 135 | ) | | ( i 36 | ) | | i — |
|
Preferred
stock dividends | ( i 40 | ) | | ( i 36 | ) | | ( i 25 | ) |
Net
(decrease) increase in advances from FHLB | i — |
| | ( i 500 | ) | | i 500 |
|
Proceeds
from issuance of senior notes | i — |
| | i 420 |
| | i 999 |
|
Payments
on senior notes | i — |
| | i — |
| | ( i 1,049 | ) |
Payments
on trust preferred securities | i — |
| | ( i 413 | ) | | i — |
|
Proceeds
from issuance of preferred stock | i — |
| | i — |
| | i 300 |
|
Repurchases
of common stock | ( i 1,085 | ) | | ( i 1,139 | ) | | ( i 362 | ) |
Other | ( i 23 | ) | | ( i 32 | ) | | ( i 36 | ) |
Net
cash (used in) provided by financing activities | ( i 7,990 | ) | | i 45 |
| | i 11,387 |
|
(Decrease)
increase in cash, cash equivalents and segregated cash | ( i 715 | ) | | i 1,541 |
| | ( i 1,607 | ) |
Cash,
cash equivalents and segregated cash, beginning of period | i 3,344 |
| | i 1,803 |
| | i 3,410 |
|
Cash,
cash equivalents and segregated cash, end of period | $ | i 2,629 |
| | $ | i 3,344 |
| | $ | i 1,803 |
|
| | | | | |
Cash
and equivalents, end of period | $ | i 750 |
| | $ | i 2,333 |
| | $ | i 931 |
|
Segregated
cash, end of period | i 1,879 |
| | i 1,011 |
| | i 872 |
|
Cash,
cash equivalents and segregated cash, end of period | $ | i 2,629 |
| | $ | i 3,344 |
| | $ | i 1,803 |
|
| | | | | |
Supplemental
disclosures: | | | | | |
Cash paid for interest | $ | i 255 |
| | $ | i 157 |
| | $ | i 126 |
|
Cash
paid for income taxes, net of refunds | $ | i 112 |
| | $ | i 11 |
| | $ | i 8 |
|
Right-of-use
assets recognized upon adoption of new lease standard | $ | i 193 |
| | $ | i — |
| | $ | i — |
|
Right-of-use
assets obtained during the period | $ | i 43 |
| | $ | i — |
| | $ | i — |
|
Non-cash
investing and financing activities: | | | | | |
Transfers of loans held-for-investment to loans held-for-sale | $ | i 78 |
| | $ | i — |
| | $ | i 57 |
|
Transfers
from loans to other real estate owned and repossessed assets | $ | i 17 |
| | $ | i 15 |
| | $ | i 27 |
|
Conversion
of convertible debentures to common stock | $ | i — |
| | $ | i — |
| | $ | i 3 |
|
Transfer
of available-for-sale securities to held-to-maturity securities | $ | i 744 |
| | $ | i 1,161 |
| | $ | i — |
|
Transfer
of held-to-maturity securities to available-for-sale securities | $ | i — |
| | $ | i 4,672 |
| | $ | i — |
|
See
accompanying notes to the consolidated financial statements
E*TRADE 2019 10-K | Page 96
E*TRADE FINANCIAL CORPORATION
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
i |
|
NOTE 1—ORGANIZATION, BASIS
OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES |
Organization
E*TRADE Financial Corporation is a financial services company that provides brokerage and related products and services for traders, investors, stock plan administrators and participants, and RIAs. The Company also provides investor-focused banking products, including sweep deposit accounts insured by the FDIC, to customers. The
Company's most significant, wholly-owned subsidiaries are described below: | |
• | E*TRADE Securities is a registered broker-dealer that clears and settles customer transactions |
| |
• | E*TRADE Bank is a federally chartered savings bank that provides FDIC insurance on certain 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 certain qualifying amounts of customer deposits and provides custody solutions for RIAs |
| |
• | E*TRADE Financial Corporate Services is a provider of software and services for managing equity compensation plans and student loan and financial wellness benefits to our corporate clients |
| |
• | E*TRADE Futures is a registered non-clearing FCM that provides retail futures transaction capabilities for
our customers |
| |
• | E*TRADE Capital Management is an RIA that provides investment advisory services for our customers |
i Basis of Presentation
The consolidated financial statements include the accounts of the
Company and its majority-owned subsidiaries as determined under the voting interest model. Entities in which the Company has the ability to exercise significant influence but in which the Company does not possess control are generally accounted for by the equity method. Entities in which the Company does not have the ability to exercise significant influence are generally carried at cost. The Company also evaluates its initial and continuing involvement with certain entities to determine if the
Company is required to consolidate the entities under the variable interest entity (VIE) model. This evaluation is based on a qualitative assessment of whether the Company is the primary beneficiary of a VIE, which requires the Company to possess both: 1) the power to direct the activities that most significantly impact the economic performance of the VIE; and 2) the obligation to absorb losses or the right to receive benefits of the VIE that could potentially be significant to the VIE. There are no investments in which the Company represents the primary beneficiary of a VIE; therefore, there are no consolidated VIEs included for all periods presented. The
Company's consolidated financial statements are prepared in accordance with GAAP. Intercompany accounts and transactions are eliminated in consolidation. These consolidated financial statements reflect all adjustments, which are normal and recurring in nature, necessary to present fairly the financial position, results of operations and cash flows for the periods presented. /
E*TRADE 2019 10-K | Page 97
E*TRADE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Beginning January 1, 2018, the Company updated the presentation of its consolidated statements of income to reclassify fair value hedging adjustments, previously referred to as hedge ineffectiveness, to net interest income as a result of the adoption of new accounting guidance. Prior period amounts have not been reclassified to current period presentation and continue to be reflected within gains
(losses) on securities and other, net. Fair value hedging adjustments were losses of $ i 3 million, $ i 19
million and $ i 14 million for the years ended December 31, 2019, 2018 and 2017, respectively. i Use
of Estimates
Preparing the Company's consolidated financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and related notes for the periods presented. Actual results could differ from management’s estimates. Certain significant accounting policies are critical because they are based on estimates and assumptions that require complex and subjective judgments by management including the allowance for loan losses, valuation and impairment of goodwill and acquired intangible assets, and income taxes. Management also makes estimates in recognizing accrued operating expenses and other liabilities. These liabilities are impacted by estimates for litigation and regulatory matters as well as estimates related to general operating expenses,
such as incentive compensation and market data usage within communications expense. Management estimates reflect the liabilities deemed probable at the balance sheet date as determined as part of the Company's ongoing evaluations based on available information. Summary of Significant Accounting Policies
i Cash and Equivalents
The Company considers all highly
liquid investments with original or remaining maturities of three months or less at the time of purchase that are not segregated under federal or other regulations to be cash and equivalents. Cash and equivalents included $ i 322 million and $ i 1.8
billion at December 31, 2019 and 2018, respectively, of overnight cash deposits, a portion of which the Company is required to maintain with the Federal Reserve Bank. / i Cash Segregated
Under Federal or Other Regulations
Certain cash balances that are segregated for the exclusive benefit of the Company’s brokerage and futures customers are included in the cash segregated under federal or other regulations line item. i Investment Securities
Available-for-Sale Securities
Available-for-sale securities are composed principally of debt securities,
primarily residential mortgage-backed securities and agency debt securities. Securities classified as available-for-sale are carried at fair value, with the unrealized gains and losses, after applicable hedge accounting adjustments, reflected as a component of accumulated other comprehensive loss, net of tax. Realized and unrealized gains or losses on available-for-sale debt securities are computed using the specific identification method. Interest earned on available-for-sale securities is included in interest income. Amortization or accretion of premiums and discounts on available-for-sale debt securities is also recognized in interest income using the effective interest method over the contractual life of the security and is adjusted to reflect actual prepayments. Gains or losses resulting from the sale of available-for-sale securities are recognized at the trade-date, based on
E*TRADE
2019 10-K | Page 98
E*TRADE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
the difference between the anticipated proceeds and the amortized cost of the specific securities sold. Realized gains and losses on available-for-sale debt securities, with the exception of other-than-temporary
impairment (OTTI) if applicable, are included in the gains (losses) on securities and other, net line item.
Held-to-Maturity Securities
Held-to-maturity securities consist of debt securities, primarily residential mortgage-backed securities and agency debt securities. Held-to-maturity securities are carried at amortized cost based on the Company’s intent and ability to hold these securities to maturity. Interest earned on held-to-maturity debt securities is included in interest income. Amortization or accretion of premiums and discounts is also recognized in interest income using the effective interest method over the contractual life of the security and is adjusted to reflect actual prepayments. Transfers of debt securities from available-for-sale to held-to-maturity are made at fair value at
the date of transfer. Unrealized holding gains or losses at the date of transfer are included in other comprehensive income and in the carrying value of the held-to-maturity security and are amortized over the remaining life of the security. Other-than-Temporary Impairment
The Company evaluates impaired available-for-sale and held-to-maturity debt securities for OTTI on a quarterly basis. Impaired securities include available-for-sale securities that have an unrealized loss and held-to-maturity securities that have an unrecognized loss. There was i no
OTTI recognized for the periods presented. The Company considers OTTI for an available-for-sale or held-to-maturity debt security to have occurred if one of the following conditions are met: the Company intends to sell the impaired debt security; it is more likely than not that the Company will be required to sell the impaired debt security before recovery of the security’s amortized cost basis; or the Company does not expect to recover the entire amortized cost basis of the security. For impaired debt securities that the
Company does not intend to sell and it is not more likely than not that the Company will be required to sell before recovery of the security’s amortized cost basis, the Company uses both qualitative and quantitative valuation measures to evaluate whether the Company expects to recover the entire amortized cost basis of the security. If the Company does not expect to recover the entire amortized cost basis of these securities then the Company will separate OTTI into two components: 1) the amount related to credit loss, recognized in earnings;
and 2) the noncredit portion of OTTI, recognized through other comprehensive income. If the Company intends to sell an impaired debt security or if it is more likely than not that the Company will be required to sell the impaired debt security before recovery of the security’s amortized cost basis as of the reporting date, the Company will recognize OTTI in earnings equal to the entire difference between the security’s amortized cost basis and the security’s fair value. i Margin
Receivables
Margin receivables represent credit extended to customers to finance their purchases of securities by borrowing against securities they own. Securities owned by customers are held as collateral for amounts due on the margin receivables, the value of which is not reflected in the consolidated balance sheet. The Company is permitted to sell or re-pledge securities held as collateral for amounts due on the margin receivables and to use the securities to enter into securities lending transactions, to collateralize borrowings or for delivery to counterparties to cover customer short positions. Revenues earned from the securities lending transactions are included in interest income and expenses incurred are included in interest expense.
E*TRADE
2019 10-K | Page 99
E*TRADE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Loans Receivable and related Allowance for Loan Losses
i Loans
Receivable, Net
Loans receivable, net consists of real estate and securities-based lending loans that management has the intent and ability to hold for the foreseeable future or until maturity, also known as loans held-for-investment. Management reviews this assessment at each balance sheet date. Loans held-for-investment are carried at amortized cost adjusted for unamortized premiums or discounts on purchased loans, deferred fees or costs on originated loans, net charge-offs, and the allowance for loan losses. Premiums or discounts on purchased loans and deferred fees or costs on originated loans are recognized in interest income using the effective interest method over the contractual life of the loans and are adjusted for actual prepayments. The Company’s classes of loans are one- to four-family, home equity, and securities-based lending.
The Company sold its consumer loan portfolio in December 2019. For additional information on the consumer loan sale, see Note 7—Loans Receivable, Net. Impaired Loans
The Company considers a loan to be impaired when it meets the definition of a TDR. Delinquency status is the primary measure the Company uses to evaluate the performance of loans modified as TDRs. i Troubled
Debt Restructurings
Loan modifications completed under the Company’s loss mitigation programs in which economic concessions were granted to borrowers experiencing financial difficulty are considered TDRs. TDRs also include loans that have been charged-off based on the estimated current value of the underlying property less estimated selling costs due to bankruptcy notification, even if the loan has not been modified under the Company’s programs. Upon being classified as a TDR, such loan is categorized as an impaired loan and is considered impaired until maturity regardless of whether the borrower performs under the terms of the loan. The Company also processes minor modifications
on a number of loans through traditional collections actions taken in the normal course of servicing delinquent accounts. Minor modifications resulting in an insignificant delay in the timing of payments are not considered economic concessions and therefore are not classified as TDRs. Impairment on loan modifications is measured on an individual loan level basis, generally using a discounted cash flow model. When certain characteristics of the modified loan cast substantial doubt on the borrower’s ability to repay the loan, the Company identifies the loan as collateral dependent and charges-off the amount of the modified loan balance in excess of the estimated current value of the underlying property less estimated selling costs. Collateral dependent TDRs are identified based on the terms of the modification, which includes assigning a higher
level of risk to loans in which the loan-to-value (LTV) or combined loan-to-value (CLTV) is greater than 110% or 125%, respectively, a borrower’s credit score is less than 600 and certain types of modifications, such as interest-only payments. TDRs that are not identified as higher risk using this risk assessment process and for which impairment is measured using a discounted cash flow model, continue to be evaluated in the event that they become higher risk collateral dependent TDRs.
E*TRADE 2019 10-K | Page 100
E*TRADE
FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
i Nonperforming Loans
The Company classifies 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. Interest
previously accrued, but not collected, is reversed against current income when a loan is placed on nonaccrual status. Interest payments received on nonperforming 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. The recognition of deferred fees or costs on originated loans and premiums or discounts on purchased loans in interest income is discontinued for nonperforming loans. Nonperforming loans return to accrual status based on the following policy:
| |
• | Nonperforming loans, excluding TDRs and certain junior liens that have a delinquent senior lien, return to accrual status when the loan becomes less than
90 days past due |
| |
• | TDRs, excluding loans in bankruptcy, are classified as nonperforming loans at the time of modification. Such TDRs return to accrual status after six consecutive payments are made in accordance with the modified terms. Accruing TDRs that subsequently become delinquent will immediately return to nonaccrual status |
| |
• | Bankruptcy loan TDRs are classified as nonperforming loans within 60 days of bankruptcy notification and remain on nonaccrual status regardless of the payment performance |
Delinquent
Loans
Loans delinquent 180 days and greater have been written down to the estimated current value of the underlying property less estimated selling costs. Loans delinquent 90 to 179 days generally have not been written down to the estimated current value of the underlying property less estimated selling costs (unless they are in process of bankruptcy or are modifications for which there is substantial doubt as to the borrower’s ability to repay the loan), but present a risk of future charge-off. Additional charge-offs on loans delinquent 180 days and greater are possible if home prices decline beyond current estimates.
The Company monitors loans in which a borrower’s current credit history casts doubt on their ability to repay a loan. Loans are classified as special mention when they are between
30 and 89 days past due. The trend in special mention loan balances is generally indicative of the expected trend for charge-offs in future periods, as these loans have a greater propensity to migrate into nonaccrual status and ultimately charge-off. One- to four-family loans are generally secured in a first lien position by real estate assets, reducing the potential loss when compared to an unsecured loan. Home equity loans are generally secured by real estate assets; however, the majority of these loans are secured in a second lien position, which substantially increases the potential loss when compared to a first lien position.
E*TRADE 2019 10-K | Page 101
E*TRADE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
i Allowance for Loan Losses
The allowance for loan losses is management’s estimate
of probable losses inherent in the loan portfolio as of the balance sheet date. In determining the adequacy of the allowance, the Company performs ongoing evaluations of the loan portfolio and loss assumptions. Loan losses are recognized when, based on management's estimate, it is probable that a loss has been incurred. The property value for both one- to four-family and home equity loans is assessed when the loan has been delinquent for 180 days or when the Company has received bankruptcy notification, regardless of whether or not the property is in foreclosure, and the amount of the loan balance in excess of the estimated current value of the underlying property less estimated selling costs is recognized as a charge-off to the allowance for loan losses. Modified loans considered TDRs are charged
off when they are identified as collateral dependent based on certain terms of the modification. Securities-based lending is collateralized by customers' brokerage holdings, including cash and marketable securities with liquid markets. Credit lines are over-collateralized, and the market value of the collateral is monitored on a daily basis. Committed lines may be reduced or collateral liquidated if the collateral is in danger of falling below specified levels. These collateralization policies and procedures mitigate the risk of potential losses on securities-based lending.
Determining the adequacy of the allowance is complex and requires judgment by management about the effect of matters that are inherently uncertain. Subsequent evaluations of the loan portfolio, in light of the factors then prevailing, may result in significant changes in the allowance for loan losses in future
periods. For loans that are not TDRs, the Company establishes a general allowance and evaluates the adequacy of the allowance for loan losses by loan portfolio segment: one- to four-family, home equity, and securities-based lending. For modified loans accounted for as TDRs that are valued using the discounted cash flow model, a specific allowance is established by forecasting losses, including economic concessions to borrowers, over the estimated remaining life of these loans. The estimate of the allowance for loan losses is based on a variety of quantitative and qualitative factors, including:
| |
• | The composition and quality of the
portfolio |
| |
• | Delinquency and default levels and trends |
| |
• | Charge-off assumptions and loss experience |
| |
• | The
condition of the real estate market and geographic concentrations within the loan portfolio |
| |
• | The interest rate environment |
| |
• | The overall availability of housing credit |
| |
• | General economic conditions, including the impact of weather-related events |
The
allowance for loan losses is typically equal to management’s forecast of loan losses in the 18 months following the balance sheet date as well as the forecasted losses, including economic concessions to borrowers, over the estimated remaining life of loans modified as TDRs. The quantitative allowance methodology also includes the identification of higher risk mortgage loans and the period of loan losses captured within the general allowance includes the total probable loss over the remaining life of these loans.
E*TRADE 2019 10-K | Page 102
E*TRADE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The general allowance for loan losses also 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 that may impact the level of credit losses. The Company utilizes a qualitative factor framework whereby, on a quarterly basis, the risk associated with the following three primary sets of factors are evaluated: external factors,
internal factors, and portfolio specific factors. The uncertainty related to these factors may expand over time, temporarily impacting the qualitative component in advance of the more precise identification of these probable losses being captured within the quantitative component of the general allowance. i Receivables from and Payables to Brokers, Dealers and Clearing Organizations
Receivables from brokers, dealers and clearing organizations include deposits paid for securities borrowed, clearing deposits and net receivables arising from unsettled trades. Payables to brokers, dealers and clearing
organizations include deposits received for securities loaned and net payables arising from unsettled trades.
Deposits paid for securities borrowed and deposits received for securities loaned are recorded at the amount of cash collateral advanced or received. Securities borrowing transactions require the Company to deposit cash with the lender whereas securities lending transactions result in the Company receiving collateral in the form of cash, with both requiring cash in an amount generally in excess of the market value of the securities. Interest income and interest expense are recorded on an accrual basis. The Company monitors the market value of the securities borrowed
and loaned on a daily basis, with additional collateral obtained or refunded, as necessary. i Property and Equipment, Net
Property and equipment is carried at cost and depreciated on a straight-line basis over their estimated useful lives, generally three to seven years. Leasehold improvements are depreciated over the lesser of their estimated useful lives or lease terms. An impairment loss is recognized if the carrying amount of the long-lived asset is not recoverable and exceeds its fair value.
The costs of internally developed
software that qualify for capitalization are included in the property and equipment, net line item. For qualifying internal-use software costs, capitalization begins when the conceptual formulation, design and testing of possible software project alternatives are complete and management authorizes and commits to funding the project. The Company does not capitalize pilot projects and projects where it believes that future economic benefits are less than probable. Technology development costs incurred in the development and enhancement of software used in connection with services provided by the Company that do not otherwise qualify for capitalization treatment are expensed as incurred. Completed projects, as well as other purchased software, are carried at cost and are amortized on a straight-line
basis over their estimated useful lives. The estimated useful life of internally developed software is i four years. / i Goodwill
and Other Intangibles, Net
Goodwill is recognized as a result of business combinations and represents the excess of the purchase price over the fair value of net tangible assets and identifiable intangible assets. The Company evaluates goodwill for impairment on an annual basis as of November 30 and in interim periods when events or changes indicate the carrying value may not be recoverable. The Company has the option of performing a qualitative assessment of goodwill to determine whether it is more likely than not that the fair value of its equity is less than the carrying value. If it is more likely than not that the fair value exceeds the carrying
E*TRADE
2019 10-K | Page 103
E*TRADE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
value, then no further testing is necessary; otherwise, the Company must perform a two-step quantitative assessment
of goodwill. The Company may elect to bypass the qualitative assessment and proceed directly to performing a two-step quantitative assessment. The Company currently does not have any intangible assets with indefinite lives other than goodwill. The Company evaluates intangible assets with finite lives for impairment on an annual basis or when events or changes indicate the carrying value may not be recoverable. The Company also evaluates the remaining useful lives of intangible assets with finite lives each reporting period to determine whether events and circumstances warrant a revision to the remaining period of amortization. Customer
relationship intangibles are amortized on an accelerated basis, while technology is amortized on a straight-line basis. The Company evaluated the CRIs associated with its retail channel for impairment as a result of the commissions reduction announced in the fourth quarter 2019 and noted that no impairment or resulting change to the useful lives of the related CRIs was indicated as a result of this analysis. For additional information on goodwill and other intangibles, net, see Note 10—Goodwill and Other Intangibles, Net.
Other Assets
i Real
Estate Owned and Repossessed Assets
Real estate owned and repossessed assets are included in the other assets line item in the consolidated balance sheet. Real estate owned represents real estate acquired through foreclosure and also includes those properties acquired through a deed in lieu of foreclosure or similar legal agreement. Both real estate owned and repossessed assets are carried at the lower of carrying value or fair value, less estimated selling costs.
i Equity Method Investments, Investments
Measured at Cost and Other Investments
The Company’s equity method investments, investments measured at cost and other investments are generally limited liability investments in partnerships, companies and other similar entities, including tax credit partnerships and community development entities, that are not required to be consolidated. These investments are reported in the other assets line item in the consolidated balance sheet. The Company recognizes a liability for all legally binding unfunded equity commitments to the investees in the other liabilities line item in the consolidated balance sheet. Under the equity method, the
Company recognizes its share of the investee’s net income or loss in the gains (losses) on securities and other, net line item in the consolidated statements of income. The Company’s other investments include those accounted for using the proportional amortization method, whereby the initial cost of the investment is amortized in proportion to the tax credits and other tax benefits received and the net investment performance is recognized in the consolidated statements of income as a component of income tax expense. The Company evaluates its equity investments and investments measured at cost for impairment when events or changes indicate the carrying value may not be recoverable. If the impairment is determined to be other-than-temporary, the
Company will recognize an impairment loss in the gains (losses) on securities
E*TRADE 2019 10-K | Page 104
E*TRADE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
and
other, net line item equal to the difference between the expected realizable value and the carrying value of the investment.
The Company is a member of, and owns capital stock in, the FHLB system. As a condition of its membership in the FHLB, the Company is required to maintain a FHLB stock investment which totaled $ i 20 million at both
December 31, 2019 and 2018. The Company accounts for its investment in FHLB stock at cost. i Deposits and Customer Payables
Deposits are primarily composed of sweep deposits held at bank subsidiaries, which represent uninvested cash balances in certain customer
brokerage accounts, and balances sourced from our Premium Savings Account product. Customer payables primarily represent deposits of customer cash and other credits in customer accounts related to sales of securities and other funds pending completion of securities transactions. Customer payables primarily represent balances held by E*TRADE Securities. The Company pays interest on certain deposits and customer payables balances. i Other Borrowings
Other borrowings includes securities sold under
agreements to repurchase, FHLB advances, and borrowings from lines of credit.
Securities sold under agreements to repurchase the same or similar securities, also known as repurchase agreements, are collateralized by fixed- and variable-rate mortgage-backed securities or investment grade securities. Repurchase agreements are treated as secured borrowings for financial statement purposes and the obligations to repurchase securities sold are therefore reflected as liabilities in the consolidated balance sheet.
The FHLB provides the Company with reserve credit capacity and authorizes advances based on the security of pledged home mortgages and other assets (principally securities that are obligations of, or guaranteed by, the US Government) provided the
Company meets certain creditworthiness standards. i Other Liabilities
Other liabilities includes accrued operating and related expenses. These liabilities are impacted by estimates for litigation and regulatory matters as well as estimates related to general operating expenses, such as incentive compensation and market data usage within communications expense. Management estimates reflect the probable liability as of the balance sheet date. In determining the adequacy of estimated liabilities, the Company
performs ongoing evaluations based on available information. Net Revenue
i Net Interest Income
Interest income is recognized as earned through holding interest-earning assets, such as available-for-sale and held-to-maturity securities, margin receivables, loans, cash, and securities lending transactions. Interest income also includes the impact of the Company’s hedging activities related to interest-earning assets. Interest expense is recognized as incurred through holding
interest-bearing liabilities, such as customer payables and deposits, corporate debt, other borrowings, and securities lending transactions.
E*TRADE 2019 10-K | Page 105
E*TRADE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS
i Non-Interest Income
The Company's significant accounting policies addressing non-interest income reflect the adoption of the new accounting standard, Revenue from Contracts with Customers, and all the related amendments effective January 1, 2018. The
Company's adoption did not result in a change to the financial statements for the comparative periods. The core principle of the Company's policy for recognizing revenue from contracts with customers is to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the Company expects to be entitled in exchange for those goods or services. This core principle is achieved by applying the following steps: | |
• | Identify each performance obligation in the contract, which represents a promise in a contract to transfer a distinct good or service to the customer and is the unit of account |
| |
• | Determine the transaction price |
| |
• | Allocate
the transaction price to each distinct performance obligation |
| |
• | Recognize revenue when, or as, the performance obligation is satisfied |
Judgment is required to determine whether performance obligations are satisfied at a point in time or over time; how to allocate transaction prices where multiple performance obligations are identified; when to recognize revenue based on the appropriate measure of the Company’s progress under the contract; and whether constraints on variable consideration should be applied
due to uncertain future events. i Commissions
Effective October 7, 2019, the Company eliminated retail commissions for online US listed stock, ETF, and options trades. We also reduced the options contract charge to $0.65 per contract
for all traders while maintaining our active trader pricing at $0.50 per contract. Commissions are derived from the Company's customer-directed trades, including options and futures, stock plan, mutual funds and fixed income. Commissions are impacted by DARTs, derivative DARTs, trade type, and the number of trading days. Commissions from customer transactions are recognized on a trade-date basis as the performance obligation is satisfied when the underlying financial instrument or purchaser is identified, the pricing is agreed upon and the risks and rewards of ownership have been transferred to/from the customer. i Fees
and Service Charges
The following policies address the most significant components of the Company's fees and service charges revenue based on agreed upon negotiated prices within the contracts: | |
• | Order Flow Revenue is generated from market centers that accept trade orders from certain customer transactions. Order flow revenue is recognized on a trade-date basis when the Company has satisfied its performance obligation by routing a
trade order to the exchange or market maker. |
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E*TRADE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
| |
• | Money
Market Funds and Sweep Deposits Revenue is driven by fees earned from off-balance sheet customer cash. The fees are based on the federal funds rate or LIBOR plus a negotiated spread or other contractual arrangements with the third-party institutions and are earned on average off-balance sheet customer cash. Revenue is recognized over time as the performance obligation is satisfied. |
| |
• | Advisor Management and Custody Fees vary based on a percentage of average customer assets under management or under custody. Revenue is recognized over time as the services are provided. |
| |
• | Mutual
Fund Service Fees are asset-based fees received from the funds and vary based on the amount of customer assets invested in each fund. Revenue is recognized over time as the performance obligation to provide shareholder services is satisfied. |
Fees and service charges also includes foreign exchange revenue and reorganization fees which are recognized when or as the performance obligations are satisfied.
i Other Revenue
Other revenue includes fees from
stock plan administration software and services provided to the Company's corporate services clients. These fees are recognized as the performance obligations are satisfied. Non-Interest Expense
i Share-Based Payments
The Company recognizes compensation expense
at the grant date fair value of a share-based payment award over the requisite service period less estimated forfeitures. Estimated forfeitures are based on the Company's historical experience and revised as needed based on actual forfeitures. Compensation expense for performance share units is also adjusted based on the Company’s estimated outcome of meeting the performance conditions. Share-based compensation expense is included in the compensation and benefits line item for employees and in the professional services line item for nonemployee members of the board of directors. For additional information on share-based compensation, see Note 17—Share-Based Compensation, Employee Incentive and Retirement Plans. i Advertising
and Market Development
Advertising and market development includes production and placement of advertisements as well as customer promotions. Advertising production costs are expensed when the initial advertisement is run.
i Income Taxes
Income tax expense (benefit) includes (1) current tax expense (benefit), which represents the amount of tax currently payable to or receivable from a taxing authority, and (2) deferred tax expense (benefit), which generally represents the net change
in the deferred tax asset or liability balance during the year plus any change in valuation allowances.
E*TRADE 2019 10-K | Page 107
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Deferred
income taxes are recorded when revenues and expenses are recognized in different periods for financial statement purposes than for tax purposes. Deferred tax asset or liability account balances are calculated at the balance sheet date using current tax laws and rates in effect. Valuation allowances for deferred tax assets are established if it is determined, based on evaluation of available evidence at the time the determination is made, that it is more likely than not that some or all of the deferred tax assets will not be realized.
The Company reports a liability for unrecognized tax benefits resulting from uncertain tax positions taken or expected to be taken in a tax return. The evaluation of a tax position is a two-step process. The Company first
determines whether it is more likely than not that a tax position will be sustained upon examination, including resolution of any related appeals or litigation, based on only the technical merits of the position. The technical merits of a tax position derive from both statutory and judicial authority and their applicability to the facts and circumstances. If a tax position does not meet the more-likely-than-not recognition threshold, the benefit of that position is not recognized in the financial statements. A tax position that meets the more-likely-than-not recognition threshold is then measured to determine the amount of benefit to recognize. The tax position is measured as the largest amount of benefit that is greater than 50 percent likely to be realized upon ultimate resolution with a taxing authority. Uncertain tax positions are evaluated based upon the facts and circumstances that exist at each reporting period. Subsequent changes in judgment based upon new information
may lead to changes in recognition, de-recognition, and measurement. Adjustments may result, for example, upon resolution of an issue with the taxing authorities, or expiration of a statute of limitations barring an assessment for an issue. The Company recognizes interest and penalties, if any, related to unrecognized tax benefits in income tax expense. For additional information on income taxes, see Note 14—Income Taxes.
i Earnings
Per Share
Basic earnings per share is computed by dividing net income available to common shareholders by the weighted-average common shares outstanding for the period. The computation of diluted earnings per share includes the potential impact of additional common share issuances related to unvested share-based payments and other contracts to issue common stock. For additional information, see Note 16—Earnings Per Share. i Comprehensive
Income
The Company’s comprehensive income includes net income, unrealized gains (losses) on available-for-sale debt securities, adjusted for the impact of fair value hedging relationships on these securities, and foreign currency translation gains (losses), net of reclassification adjustments and related tax. i Derivative Instruments and Hedging Activities
The
Company enters into derivative transactions primarily to protect against interest rate risk on the value of certain assets. As these contracts were executed through central clearing organizations and settled by variation margin payments, they are not included as assets or liabilities on the consolidated balance sheet. Cash flows from derivative instruments in hedging relationships are classified in the same category on the consolidated statements of cash flows as the cash flows from the items being hedged. Cash flows related to variation margin payments are classified as operating cash flows. Accounting for derivatives differs depending on whether a derivative is designated as a hedge based on the applicable accounting guidance and, if designated as a hedge, the type of hedge designation. Derivative instruments designated in hedging
relationships that mitigate the exposure to the variability in expected
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E*TRADE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
future
cash flows or other forecasted transactions are considered cash flow hedges. Derivative instruments in hedging relationships that mitigate exposure to changes in the fair value of assets or liabilities are considered fair value hedges. To qualify for hedge accounting, the Company formally documents at inception all relationships between hedging instruments and hedged items and the risk management objective and strategy for each hedge transaction. All of the Company's derivative instruments were designated in fair value hedging relationships at December 31, 2019 and December 31, 2018. For each fair value hedge,
both the gain or loss on the derivative, including interest accruals, as well as the offsetting gain or loss on the hedged item attributable to the hedged risk are recognized in net interest income. Hedge accounting is discontinued for fair value hedges if a derivative instrument is sold, terminated or otherwise de-designated. If fair value hedge accounting is discontinued, the previously hedged item is no longer adjusted for changes in fair value through the consolidated statements of income and the cumulative net gain or loss on the hedged item is amortized to net interest income using the effective interest method over the expected remaining contractual remaining life of the hedged item adjusted for prepayments.
Beginning January 1, 2018, fair value hedging adjustments, previously referred to as hedge ineffectiveness, are included within net interest income. Prior period
amounts have not been reclassified to current period presentation and continue to be reflected within gains (losses) on securities and other, net. The earnings impact of interest accruals on the derivatives are reflected in the interest income line item in the consolidated statements of income. The Company also recognizes certain contracts and commitments as derivatives if the characteristics of those contracts and commitments meet the definition of a derivative. For additional information on derivative instruments and hedging activities, see Note 8—Derivative Instruments and Hedging Activities. i Fair
Value
Fair value is defined as 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. The Company determines the fair value for its financial instruments and for nonfinancial assets and nonfinancial liabilities that are recognized or disclosed at fair value in the consolidated financial statements on a recurring basis. In addition, the Company determines the fair value for nonfinancial assets and nonfinancial liabilities on a nonrecurring basis as required during impairment testing or by other accounting guidance. For additional information on fair value, see Note 4—Fair Value Disclosures. i Adoption
of New Accounting Standards
Accounting for Leases
In February 2016, the FASB amended the guidance on accounting for leases. The new guidance required lessees to recognize right-of-use (ROU) assets and lease liabilities on the balance sheet for the rights and obligations created by all qualifying leases. The recognition, measurement and presentation of expenses and cash flows arising from a lease by a lessee remains substantially unchanged and depends on classification as a finance or operating lease. The Company adopted the new guidance beginning on January 1, 2019 and elected to use the effective date as the date of initial application. As such, restated financial information and the additional disclosures
required under the new standard will not be provided for the comparative periods presented. The new guidance also requires quantitative and qualitative disclosures that provide information about the amounts related to leasing arrangements recorded in the consolidated financial statements. The Company elected to apply the "package of practical expedients," which permits it to not reassess prior conclusions on existing leases regarding lease identification, lease classification and
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E*TRADE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
initial direct costs. In addition, the Company has elected to apply the short-term lease exception for lease arrangements with maximum lease terms of 12 months or less. The Company elected to not apply the use-of-hindsight practical expedient, and the practical expedient relating to land easements is not applicable. Adoption of the standard did not have a material
impact on the Company’s results of operations or cash flows.
At adoption, the Company recognized lease liabilities of $ i 211 million, representing the present value of the remaining minimum fixed
lease payments based on the incremental borrowing rates as of December 31, 2018. Changes in lease liabilities are based on current period interest expense and cash payments. The Company also recognized ROU assets of $ i 193 million at adoption, which represents the measurement of the lease liabilities, prepaid
lease payments made to lessors, initial direct costs incurred by the Company and lease incentives received. For further information, see Note 19—Lease Arrangements. Inclusion of the Secured Overnight Financing Rate (SOFR) Overnight Index Swap (OIS) Rate as a Benchmark Interest Rate for Hedge Accounting Purposes
In October 2018, the FASB amended the guidance on hedge accounting. The amended guidance adds the OIS rate based on the SOFR to the list of permitted benchmark interest rates for hedge accounting purposes. The amended guidance became effective on January 1, 2019, and the Company adopted the guidance on a prospective
basis for qualifying new or redesignated hedging relationships entered into on or after the date of adoption. The adoption did not have a material impact on the Company's financial condition, results of operations or cash flows. New Accounting Standards Not Yet Adopted
Accounting for Credit Losses
In June 2016, the FASB amended the guidance on accounting for credit losses and has subsequently issued clarifications and improvements. The amended guidance requires measurement of an allowance for credit losses for financial instruments, including loans and debt securities, and other commitments to extend credit held at the reporting date. For financial assets measured at amortized cost, factors such as historical
performance, current conditions, and reasonable and supportable forecasts, including expected charge-off recoveries, will be used to estimate expected credit losses. The amended guidance will also result in credit losses on impaired available-for-sale debt securities being recorded through an allowance for credit losses. The FASB issued additional amended guidance during the second quarter of 2019 that clarified that the CECL standard allows for subsequent increases in the fair value of collateral for collateral-dependent loans to be recognized up to the amount previously charged-off. A loan is considered to be collateral-dependent when foreclosure is probable or when repayment is expected to be provided substantially through the sale of the underlying collateral when the borrower is experiencing financial difficulty. Additional amended transition guidance issued during the second quarter of 2019 allows entities to elect
the fair value option on certain financial instruments, on an instrument-by-instrument basis; however, this fair value option election does not apply to held-to-maturity debt securities. The Company adopted the new standard on its effective date of January 1, 2020 using a modified retrospective approach.
The Company has developed credit loss estimation methods for the mortgage loan portfolio. The credit losses for the investment security portfolio, margin receivables, securities-based lending activities and other financial assets held at amortized cost are not expected to be material. The
Company expects to recognize an after-tax benefit related to mortgage loans of approximately $ i 80 million as an adjustment to opening retained earnings at adoption on January 1, 2020.
E*TRADE 2019 10-K | Page 110
E*TRADE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The benefit primarily relates to the fair value of the underlying collateral for mortgage loans that were determined to be collateral-dependent and previously written down to the fair value of the underlying collateral. This adoption impact will be presented on the balance sheet as a “negative allowance” associated with the mortgage loans. When estimating the fair value of collateral, property valuations for these one- to four- family and home equity loans are based on the most
recent "as is" property valuation data available, which may include appraisals, broker price opinions, automated valuation models or updated values using home price indices. These property valuations are then reduced for qualifying estimated costs to sell. These costs do not include carrying costs or other disallowed adjustments, such as estimates for prolonged foreclosure proceedings associated with certain jurisdictions.
The adjustment to opening retained earnings includes the expected credit losses related to the remaining mortgage loans. The Company used a probability of default and loss given default model for determining the allowance for credit losses under CECL for these mortgage loans, which utilized prepayment forecasts, loan amortization
calculations, and other internally derived and externally sourced data and assumptions. The Company also utilized an externally provided macroeconomic forecast over the remaining life of the loans. This forecast includes a forward-looking view of macroeconomic factors over the next two to five years, after which the macroeconomic factors revert to externally provided long-term equilibrium values, rates, or patterns that do not include specific predictions for the economy. Key inputs for the forecast included US home prices and unemployment data. The CECL impact for this portfolio is not expected to be material based on the seasoning of the Company’s mortgage loan portfolio and the credit quality of the remaining loans. Simplifying the Test for Goodwill
Impairment
In January 2017, the FASB amended the guidance to simplify the test for goodwill impairment by eliminating Step 2 from the goodwill impairment test. The amended guidance requires the Company to perform its annual goodwill impairment test by comparing the fair value of a reporting unit to its carrying amount. An impairment charge would be recognized at the amount by which the carrying amount exceeds the fair value of the reporting unit; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. Income tax effects resulting from any tax deductible goodwill should be considered when measuring the goodwill impairment loss, if applicable. The Company has the option to perform a qualitative assessment
to conclude whether it is more likely than not that the carrying amount of the Company exceeds its fair value. The Company adopted the new standard on its effective date of January 1, 2020 and will apply the standard prospectively. Implementation Costs Incurred in a Cloud Computing Arrangement that is a Service Contract In August 2018, the FASB amended the guidance on accounting for implementation costs incurred in a cloud computing arrangement that is a service contract. The amended
guidance aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. The Company adopted the new standard on its effective date of January 1, 2020 and applied the standard prospectively. Implementation costs incurred on and after January 1, 2020 in a cloud computing arrangement that is a service contract are capitalized or expensed in accordance with the accounting guidance, and capitalized
costs are amortized over the term of the hosting arrangement.
E*TRADE 2019 10-K | Page 111
E*TRADE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Codification
Improvements Related to Credit Losses, Financial Instruments, Derivatives and Hedging
In April 2019, the FASB clarified recently released guidance related to credit losses, financial instruments, derivatives and hedging. The FASB has an ongoing project on its agenda for improving the FASB's Accounting Standards Codification or correcting its unintended application. The Company adopted all new guidance related to credit losses on January 1, 2020 using a modified retrospective approach. The new guidance related to financial instruments was applied on January 1, 2020; however, there was no impact to the Company.
The Company will apply the new guidance related to derivatives and hedging on a prospective basis effective January 1, 2020. As part of adoption, the Company will enhance its derivatives and hedging disclosures within its periodic filing for the three months ended March 31, 2020. Simplifying the Accounting for Income Taxes
In December 2019, the FASB amended the guidance to simplify the accounting for income taxes as part of its initiative to reduce complexity in accounting standards. The amendments remove certain exceptions to the general income tax accounting principles and provide for consistent
application of and simplify GAAP for other areas by clarifying and amending existing guidance. The guidance will be effective for interim and annual periods beginning January 1, 2021 and each amendment will be applied on either a retrospective basis, modified retrospective basis, or prospective basis as required in accordance with the new standard. The Company is currently evaluating the impact of these clarifications on the Company's financial condition, results of operations and cash flows. Clarifying the Interactions Between Accounting for Investments in Equity Securities, Investments in Equity Method and Joint Ventures, and Derivatives and Hedging
In January
2020, the FASB amended the guidance to clarify the interaction of the accounting for equity securities and investments accounted for under the equity method of accounting and the accounting for certain forward contracts and purchased options. The amended guidance clarifies that an entity should consider observable transactions that require it to either apply or discontinue the equity method of accounting for the purposes of applying the measurement alternative immediately before applying or upon discontinuing the equity method. The amended guidance also clarifies how a forward contract or purchased option to purchase securities that, upon settlement of the forward contract or exercise of the purchased
option, would be accounted for under the equity method of accounting or the fair value option. The guidance will be effective for interim and annual periods beginning January 1, 2021, and must be applied prospectively. Early adoption is permitted. The Company is currently evaluating the impact of these clarifications on the Company's financial condition, results of operations and cash flows.
E*TRADE 2019 10-K | Page 112
E*TRADE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
i |
|
NOTE 2—ACQUISITIONS
AND RESTRUCTURING |
Gradifi Acquisition
On December 9, 2019, the Company completed its acquisition of Gradifi, a student loan and financial wellness provider, for a purchase price of $ i 30 million. The acquisition is
expected to complement the Company's corporate services offering to include financial wellness and student loan solutions as part of a comprehensive benefits platform integrated into the Company's stock plan administration offering. The results of Gradifi's operations have been included in the Company's consolidated statements of income for the year ended December 31, 2019 from the date of acquisition. Supplementary pro forma financial information related to the acquisition is not included because the impact to the Company's consolidated
statements of income is not material. i The following table summarizes the allocation of the purchase price to the net assets of Gradifi as of December 9, 2019 (dollars in millions): |
| | | |
| |
Purchase price | $ | i 30 |
|
Fair value of net assets acquired | i 5 |
|
Goodwill | $ | i 25 |
|
/ i The
following table summarizes the fair value of assets acquired and liabilities assumed at the date of acquisition (dollars in millions): |
| | | |
| |
Assets | |
Other intangibles | $ | i 3 |
|
Other(1) | i 5 |
|
Total
assets acquired | i 8 |
|
Liabilities | |
Other liabilities | i 3 |
|
Total
liabilities assumed | i 3 |
|
Net assets acquired | $ | i 5 |
|
/ | |
(1) | Includes
balance sheet line items cash and equivalents, property and equipment, net and other assets. |
The goodwill of $ i 25 million includes synergies expected to result from combining operations with Gradifi to enhance the Company's existing product offerings. The goodwill is not deductible for tax purposes. The
Company also recorded technology intangible assets of $ i 3 million, which are subject to amortization over an estimated useful life of i 6
years. The fair value of the intangible assets was determined under the income approach. The intangible assets are not deductible for tax purposes. Capital One Accounts Acquisition
On November 6, 2018, the Company completed its acquisition of approximately i one
million retail brokerage accounts from Capital One for $ i 109 million in cash. The Company recorded a customer relationships intangible asset of $ i 114
million at acquisition, which includes the purchase price plus transaction costs. The fair value of the customer relationships intangible asset was determined using the multi-period excess /
E*TRADE 2019 10-K | Page 113
E*TRADE
FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
earnings method, a discounted cash flow method, and the related asset is subject to amortization over an estimated useful life of i 11 years.
Trust Company of America
Acquisition
On April 9, 2018, the Company completed its acquisition of TCA for $ i 275 million in cash. The Company recorded goodwill of $ i 115
million which primarily includes the synergies expected to result from combining operations with TCA, coupling its custody platform with the Company's existing product offerings and leveraging customer relationships with RIAs. The Company also recorded intangible assets of $ i 140
million, which are subject to amortization over their estimated useful lives. i The following table summarizes the fair value and estimated useful lives of the intangible assets at the date of acquisition (dollars in millions): |
| | | | | |
| Estimated
Fair Value | | Estimated Useful Life (In Years) |
Customer Relationships | $ | i 119 |
| | i 22 |
Technology | i 20 |
| | i 5 |
Trade
name | i 1 |
| | i 2 |
Total
intangible assets | $ | i 140 |
| | |
/ Restructuring
and Acquisition-related Activities Expense
i The following table shows the components of restructuring and acquisition-related activities expense (dollars in millions): |
| | | | | | | | | | | |
| |
| 2019 | | 2018 | | 2017 |
Restructuring activities | $ | i 21 |
| | $ | i 4 |
| | $ | i 12 |
|
Acquisition-related
costs | i 2 |
| | i 3 |
| | i 3 |
|
Total
restructuring and acquisition-related activities | $ | i 23 |
| | $ | i 7 |
| | $ | i 15 |
|
/ Restructuring
and acquisition-related activities during the year ended December 31, 2019 includes $ i 9 million of expenses associated with the exit of our New York headquarters and $ i 12
million of severance resulting from organizational changes driven by an enterprise-wide cost containment initiative. See Note 19—Lease Arrangements for additional information. Also included are acquisition-related costs associated with the Gradifi acquisition as discussed above. Restructuring and acquisition-related costs during the year ended December 31, 2018 relate primarily to costs incurred in connection with the restructuring of our regulatory and enterprise risk management functions due to bank regulatory reform and the closing of the TCA acquisition. Restructuring and acquisition-related costs during the year ended December 31, 2017 related primarily to costs incurred in connection with the integration of OptionsHouse.
E*TRADE
2019 10-K | Page 114
E*TRADE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
i The following table presents the significant components of total net revenue (dollars in millions): |
| | | | | | | | | | | |
| |
| 2019 | | 2018 | | 2017 |
Net
interest income | $ | i 1,852 |
| | $ | i 1,846 |
| | $ | i 1,485 |
|
Commissions | i 421 |
| | i 498 |
| | i 441 |
|
Fees
and service charges | i 588 |
| | i 431 |
| | i 369 |
|
Gains
(losses) on securities and other, net | ( i 23 | ) | | i 53 |
| | i 28 |
|
Other
revenue | i 48 |
| | i 45 |
| | i 43 |
|
Total
net revenue (1) | $ | i 2,886 |
| | $ | i 2,873 |
| | $ | i 2,366 |
|
| |
(1) | Contract
balances and transaction price allocated to remaining performance obligations were not material for the periods presented. |
Effective October 7, 2019, we eliminated retail commissions for online US listed stock, ETF, and options trades. We also reduced the options contract charge to $ i 0.65
per contract for all traders while maintaining our active trader pricing at $ i 0.50 per contract. /
E*TRADE
2019 10-K | Page 115
E*TRADE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Interest Income and Interest Expense
i The
following table presents the significant components of interest income and interest expense (dollars in millions): |
| | | | | | | | | | | |
| |
| 2019 | | 2018 | | 2017 |
Interest
income: | | | | | |
Cash and equivalents | $ | i 10 |
| | $ | i 11 |
| | $ | i 9 |
|
Cash
segregated under federal or other regulations | i 26 |
| | i 15 |
| | i 12 |
|
Investment
securities(1) | i 1,360 |
| | i 1,241 |
| | i 962 |
|
Margin
receivables | i 482 |
| | i 491 |
| | i 320 |
|
Loans | i 104 |
| | i 128 |
| | i 157 |
|
Broker-related
receivables and other | i 17 |
| | i 14 |
| | i 3 |
|
Subtotal
interest income | i 1,999 |
| | i 1,900 |
| | i 1,463 |
|
Other
interest revenue(2) | i 112 |
| | i 109 |
| | i 108 |
|
Total
interest income | i 2,111 |
| | i 2,009 |
| | i 1,571 |
|
Interest
expense: | | | | | |
Sweep deposits: | | | | | |
Brokerage sweep deposits | i 54 |
| | i 42 |
| | i 4 |
|
Bank
sweep deposits(3) | i 11 |
| | i — |
| | i — |
|
Savings
deposits | i 85 |
| | i 9 |
| | i — |
|
Customer
payables | i 30 |
| | i 22 |
| | i 5 |
|
Broker-related
payables and other | i 4 |
| | i 10 |
|
| i — |
|
Other
borrowings | i 9 |
| | i 25 |
| | i 22 |
|
Corporate
debt | i 55 |
| | i 46 |
| | i 48 |
|
Subtotal
interest expense | i 248 |
| | i 154 |
| | i 79 |
|
Other
interest expense(4) | i 11 |
| | i 9 |
| | i 7 |
|
Total
interest expense | i 259 |
| | i 163 |
| | i 86 |
|
Net
interest income | $ | i 1,852 |
| | $ | i 1,846 |
| | $ | i 1,485 |
|
| |
(1) | For
the years ended December 31, 2019 and 2018, includes $ i 3 million and $ i 19
million, respectively, of net fair value hedging adjustments. Amounts for the year ended December 31, 2017 have not been reclassified to conform to current period presentation and continue to be reflected within the gains (losses) on securities and other, net line item. See Note 8—Derivative Instruments and Hedging Activities for additional information. |
| |
(2) | Other interest revenue is earned on certain securities loaned balances. Interest expense incurred on other securities loaned balances is presented on the broker-related payables and other line item above. |
| |
(3) | Beginning
November 2019, bank sweep deposits include Premium Savings Accounts participating in a sweep deposit account program. Refer to Note 12—Deposits for additional information. |
| |
(4) | Other interest expense is incurred on certain securities borrowed balances. Interest income earned on other securities borrowed balances is presented on the broker-related receivables and other line item above. |
/
E*TRADE
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Fees and Service Charges
i The
following table presents the significant components of fees and service charges (dollars in millions): |
| | | | | | | | | | | |
| |
| 2019 | | 2018 | | 2017 |
Fees
and service charges: | | | | | |
Order flow revenue | $ | i 188 |
| | $ | i 174 |
| | $ | i 135 |
|
Money
market funds and sweep deposits revenue | i 175 |
| | i 71 |
| | i 92 |
|
Advisor
management and custody fees | i 77 |
| | i 64 |
| | i 36 |
|
Mutual
fund service fees | i 51 |
| | i 48 |
| | i 39 |
|
Foreign
exchange revenue | i 33 |
| | i 25 |
| | i 26 |
|
Reorganization
fees | i 24 |
| | i 14 |
| | i 16 |
|
Other
fees and service charges | i 40 |
| | i 35 |
| | i 25 |
|
Total
fees and service charges | $ | i 588 |
| | $ | i 431 |
| | $ | i 369 |
|
/ i |
|
NOTE
4—FAIR VALUE DISCLOSURES |
Fair value is defined as 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. In determining fair value, the Company may use various valuation approaches, including market, income and/or cost approaches. The fair value hierarchy requires the Company to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. Fair value is a market-based measure considered from the perspective of a market participant. Accordingly, even when market assumptions are not readily available, the
Company’s own assumptions reflect those that market participants would use in pricing the asset or liability at the measurement date. The fair value measurement accounting guidance describes the following three levels used to classify fair value measurements: | |
• | Level 1 - unadjusted quoted prices in active markets for identical assets or liabilities that are accessible by the Company |
| |
• | Level 2 - quoted prices for similar assets and liabilities in
an active market, quoted prices in markets that are not active or for which all significant inputs are observable, either directly or indirectly |
| |
• | Level 3 - unobservable inputs that are significant to the fair value of the assets or liabilities |
The availability of observable inputs can vary and in certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, the level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. The Company’s assessment of the significance
of a particular input to a fair value measurement requires judgment and consideration of factors specific to the asset or liability.
E*TRADE 2019 10-K | Page 117
E*TRADE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Recurring
Fair Value Measurement Techniques
Agency Debt and Mortgage-backed Securities
The Company’s agency mortgage-backed securities portfolio is comprised of debt securities which are guaranteed by US government sponsored enterprises and federal agencies. The fair value of agency mortgage-backed securities was determined using a market approach with quoted market prices, recent transactions and spread data for identical or similar instruments. Agency mortgage-backed securities were categorized in Level 2 of the fair value hierarchy. The fair value measurements of agency debentures and other agency debt securities were determined using market and income approaches along with the
Company’s own trading activities for identical or similar instruments and were categorized in Level 2 of the fair value hierarchy. US Treasuries
The Company's fair value level classification of US Treasuries is based on the original maturity dates of the securities and whether the securities are the most recent issuances of a given maturity. US Treasuries with original maturities less than one year are classified as Level 1. US Treasuries with original maturities greater than one year are classified as Level 1 if they represent the most recent issuance of a given maturity; otherwise, these securities are classified as Level 2. Non-agency Debt Securities
The
Company's non-agency debt securities include senior classes of commercial mortgage-backed securities and ABS collateralized by credit card, automobile loan and student loan receivables. The fair value of non-agency debt securities was determined using a market approach with recent transactions and spread data for identical or similar instruments. Non-agency debt securities were categorized in Level 2 of the fair value hierarchy. The Company sold its municipal bonds during the three months ended March 31, 2019. As of December 31, 2018, these securities were valued using a market approach with pricing service valuations corroborated by recent market transactions for identical or similar bonds and were categorized in Level 2 of the fair value
hierarchy. Nonrecurring Fair Value Measurement Techniques
Certain other assets are recorded at fair value on a nonrecurring basis: 1) one- to four-family and home equity loans in which the amount of the loan balance in excess of the estimated current value of the underlying property less estimated selling costs has been charged-off; and 2) real estate owned that is carried at the lower of the property’s carrying value or fair value less estimated selling costs.
Loans Receivable
Loans that have been delinquent for 180 days or that are in bankruptcy and certain TDR loan modifications are charged-off based on the estimated current value of the underlying property less estimated selling costs. Property valuations for these one- to four-family and home equity loans are based on the most recent "as
is" property valuation data available, which may include appraisals, broker price opinions, automated valuation models or updated values using home price indices.
E*TRADE 2019 10-K | Page 118
E*TRADE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
Real Estate Owned
Property valuations for real estate owned are based on the lowest value of the most recent property valuation data available, which may include appraisals, listing prices or approved offer prices. Nonrecurring fair value measurements on one- to four-family loans, home equity loans and real estate owned were classified as Level 3 of the fair value hierarchy as the valuations included unobservable inputs that were significant to the fair value. i The
following table presents additional information about significant unobservable inputs used in the valuation of assets measured at fair value on a nonrecurring basis that were categorized in Level 3 of the fair value hierarchy: |
| | | | | | | |
| Unobservable Inputs | | Average | | Range |
| | | | | |
Loans receivable: | | | | | |
One- to four-family | Appraised value | | $ | i 815,900 |
| | $92,000
- $2,700,000 |
Home equity | Appraised value | | $ | i 437,300 |
| | $75,000
- $1,440,000 |
Real estate owned | Appraised value | | $ | i 391,700 |
| | $80,000
- $897,000 |
| | | | | |
| | | | | |
Loans
receivable: | | | | | |
One- to four-family | Appraised value | | $ | i 594,700 |
| | $17,000
- $2,000,000 |
Home equity | Appraised value | | $ | i 397,700 |
| | $73,000
- $1,060,000 |
Real estate owned | Appraised value | | $ | i 329,500 |
| | $57,900
- $900,000 |
E*TRADE 2019 10-K | Page 119
E*TRADE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Recurring
and Nonrecurring Fair Value Measurements
i The following tables present the significant components of assets and liabilities measured at fair value (dollars in millions): |
| | | | | | | | | | | | | | | |
| Level
1 | | Level 2 | | Level 3 | | Total Fair Value |
| | | | | | | |
Recurring
fair value measurements: | | | | | | | |
Assets | | | | | | | |
Available-for-sale
securities: | | | | | | | |
Agency mortgage-backed securities | $ | — |
| | $ | i 17,035 |
| | $ | — |
| | $ | i 17,035 |
|
Agency
debentures | — |
| | i 659 |
| | — |
| | i 659 |
|
US
Treasuries | — |
| | i 1,227 |
| | — |
| | i 1,227 |
|
Non-agency
asset-backed securities | — |
| | i 417 |
| | — |
| | i 417 |
|
Non-agency
mortgage-backed securities | — |
| | i 163 |
| | — |
| | i 163 |
|
Total
available-for-sale securities | — |
| | i 19,501 |
| | — |
| | i 19,501 |
|
Total
assets measured at fair value on a recurring basis(1) | $ | — |
| | $ | i 19,501 |
| | $ | — |
| | $ | i 19,501 |
|
Nonrecurring
fair value measurements: | | | | | | | |
Loans receivable, net: | | | | | | | |
One-
to four-family | $ | — |
| | $ | — |
| | $ | i 14 |
| | $ | i 14 |
|
Home
equity | — |
| | — |
| | i 4 |
| | i 4 |
|
Total
loans receivable | — |
| | — |
| | i 18 |
| | i 18 |
|
Other
assets: | | | | | | | |
Real estate owned | — |
| | — |
| | i 12 |
| | i 12 |
|
Total
assets measured at fair value on a nonrecurring basis(2) | $ | — |
| | $ | — |
| | $ | i 30 |
| | $ | i 30 |
|
/ | |
(2) | Represents
the fair value of assets prior to deducting estimated selling costs that were carried on the consolidated balance sheet at December 31, 2019, and for which a fair value measurement was recorded during the period. |
E*TRADE 2019 10-K | Page 120
E*TRADE
FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|
| | | | | | | | | | | | | | | |
| Level 1 | | Level 2 | | Level
3 | | Total
Fair Value |
| | | | | | | |
Recurring fair value measurements: | | | | | | | |
Assets | | | | | | | |
Available-for-sale
securities: | | | | | | | |
Agency mortgage-backed securities | $ | — |
| | $ | i 22,162 |
| | $ | — |
| | $ | i 22,162 |
|
Agency
debentures | — |
| | i 839 |
| | — |
| | i 839 |
|
Agency
debt securities | — |
| | i 139 |
| | — |
| | i 139 |
|
Municipal
bonds | — |
| | i 12 |
| | — |
| | i 12 |
|
Other | — |
| | i 1 |
| | — |
| | i 1 |
|
Total
available-for-sale securities | — |
| | i 23,153 |
| | — |
| | i 23,153 |
|
Derivative
assets(1) | — |
| | i 1 |
| | — |
| | i 1 |
|
Total
assets measured at fair value on a recurring basis(2) | $ | — |
| | $ | i 23,154 |
| | $ | — |
| | $ | i 23,154 |
|
Nonrecurring
fair value measurements: | | | | | | | |
Loans receivable, net: | | | | | | | |
One-
to four-family | $ | — |
| | $ | — |
| | $ | i 17 |
| | $ | i 17 |
|
Home
equity | — |
| | — |
| | i 6 |
| | i 6 |
|
Total
loans receivable | — |
| | — |
| | i 23 |
| | i 23 |
|
Other
assets: | | | | | | | |
Real estate owned | — |
| | — |
| | i 10 |
| | i 10 |
|
Total
assets measured at fair value on a nonrecurring basis(3) | $ | — |
| | $ | — |
| | $ | i 33 |
| | $ | i 33 |
|
| |
(1) | All
derivative assets were interest rate contracts at December 31, 2018. Information related to derivative instruments is detailed in Note 8—Derivative Instruments and Hedging Activities. |
| |
(3) | Represents the fair value of assets prior to deducting estimated selling costs that were carried on the consolidated balance sheet at December 31, 2018, and for which a fair value measurement was recorded during the period. |
Gains and losses on assets measured at fair value on a nonrecurring basis were not material for the periods presented.
Recurring Fair Value Measurements Categorized within Level
3
For the periods presented, no assets or liabilities measured at fair value on a recurring basis were categorized within Level 3 of the fair value hierarchy. The Company had no transfers between levels during the periods presented.
E*TRADE 2019 10-K | Page 121
E*TRADE
FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Fair Value of Financial Instruments Not Carried at Fair Value
The following tables present the carrying values, fair values and fair value hierarchy level classification of financial instruments that are not carried at fair value on the consolidated balance sheet (dollars in millions): |
| | | | | | | | | | | | | | | | | | | |
| |
| Carrying Value | | Level 1 | | Level 2 | | Level 3 | | Total Fair Value |
Assets | | | | | | | | | |
Cash
and equivalents | $ | i 750 |
| | $ | i 750 |
| | $ | — |
| | $ | — |
| | $ | i 750 |
|
Cash
segregated under federal or other regulations | $ | i 1,879 |
| | $ | i 1,879 |
| | $ | — |
| | $ | — |
| | $ | i 1,879 |
|
Held-to-maturity
securities: | | | | | | | | | |
Agency mortgage-backed securities | $ | i 20,085 |
| | $ | — |
| | $ | i 20,329 |
| | $ | — |
| | $ | i 20,329 |
|
Agency
debentures | i 267 |
| | — |
| | i 271 |
| | — |
| | i 271 |
|
Agency
debt securities | i 1,617 |
| | — |
| | i 1,646 |
| | — |
| | i 1,646 |
|
Total
held-to-maturity securities | $ | i 21,969 |
| | $ | — |
| | $ | i 22,246 |
| | $ | — |
| | $ | i 22,246 |
|
Margin
receivables(1) | $ | i 9,675 |
| | $ | — |
| | $ | i 9,675 |
| | $ | — |
| | $ | i 9,675 |
|
Loans
receivable, net: | | | | | | | | | |
One- to four-family | $ | i 802 |
| | $ | — |
| | $ | — |
| | $ | i 835 |
| | $ | i 835 |
|
Home
equity | i 624 |
| | — |
| | — |
| | i 659 |
| | i 659 |
|
Securities-based
lending | i 169 |
| | — |
| | i 169 |
| | — |
| | i 169 |
|
Total
loans receivable, net(2) | $ | i 1,595 |
|
| $ | — |
| | $ | i 169 |
| | $ | i 1,494 |
| | $ | i 1,663 |
|
Receivables
from brokers, dealers and clearing organizations(1) | $ | i 1,395 |
| | $ | — |
| | $ | i 1,395 |
| | $ | — |
| | $ | i 1,395 |
|
Other
assets(1)(3) | $ | i 313 |
| | $ | — |
| | $ | i 313 |
| | $ | — |
| | $ | i 313 |
|
Liabilities | | | | | | | | | |
Deposits | $ | i 38,606 |
| | $ | — |
| | $ | i 38,605 |
| | $ | — |
| | $ | i 38,605 |
|
Customer
payables | $ | i 12,849 |
| | $ | — |
| | $ | i 12,849 |
| | $ | — |
| | $ | i 12,849 |
|
Payables
to brokers, dealers and clearing organizations | $ | i 893 |
| | $ | — |
| | $ | i 893 |
| | $ | — |
| | $ | i 893 |
|
Corporate
debt | $ | i 1,410 |
| | $ | — |
| | $ | i 1,485 |
| | $ | — |
| | $ | i 1,485 |
|
| |
(1) | The
fair value of securities that the Company received as collateral in connection with margin receivables and securities borrowing activities, including the fully paid lending program, where the Company is permitted to sell or re-pledge the securities, was $ i 14.0 billion at December 31,
2019. Of this amount, $ i 2.1 billion had been pledged or sold in connection with securities loaned and deposits with clearing organizations at December 31, 2019. |
| |
(2) | The
carrying value of loans receivable, net includes the allowance for loan losses of $ i 17 million and loans that are recorded at fair value on a nonrecurring basis at December 31, 2019. |
| |
(3) | Includes $ i 200
million of securities purchased under agreements to resell and $ i 113 million of securities borrowing from customers under the fully paid lending program. The fair value of the securities that the Company received as collateral for securities purchased under agreements to resell was $ i 206
million at December 31, 2019. |
E*TRADE 2019 10-K | Page 122
E*TRADE FINANCIAL CORPORATION
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
i |
| | | | | | | | | | | | | | | | | | | |
| |
| Carrying
Value | | Level 1 | | Level 2 | | Level 3 | | Total
Fair Value |
Assets | | | | | | | | | |
Cash
and equivalents | $ | i 2,333 |
| | $ | i 2,333 |
| | $ | — |
| | $ | — |
| | $ | i 2,333 |
|
Cash
segregated under federal or other regulations | $ | i 1,011 |
| | $ | i 1,011 |
| | $ | — |
| | $ | — |
| | $ | i 1,011 |
|
Held-to-maturity
securities: | | | | | | | | | |
Agency mortgage-backed securities | $ | i 18,085 |
| | $ | — |
| | $ | i 17,748 |
| | $ | — |
| | $ | i 17,748 |
|
Agency
debentures | i 1,824 |
| | — |
| | i 1,808 |
| | — |
| | i 1,808 |
|
Agency
debt securities | i 1,975 |
| | — |
| | i 1,935 |
| | — |
| | i 1,935 |
|
Total
held-to-maturity securities | $ | i 21,884 |
| | $ | — |
| | $ | i 21,491 |
| | $ | — |
| | $ | i 21,491 |
|
Margin
receivables(1) | $ | i 9,560 |
| | $ | — |
| | $ | i 9,560 |
| | $ | — |
| | $ | i 9,560 |
|
Loans
receivable, net: | | | | | | | | | |
One- to four-family | $ | i 1,069 |
| | $ | — |
| | $ | — |
| | $ | i 1,099 |
| | $ | i 1,099 |
|
Home
equity | i 810 |
| | — |
| | — |
| | i 825 |
| | i 825 |
|
Consumer | i 117 |
| | — |
| | — |
| | i 115 |
| | i 115 |
|
Securities-based
lending | i 107 |
| | — |
| | i 107 |
| | — |
| | i 107 |
|
Total
loans receivable, net(2) | $ | i 2,103 |
| | $ | — |
| | $ | i 107 |
| | $ | i 2,039 |
| | $ | i 2,146 |
|
Receivables
from brokers, dealers and clearing organizations(1) | $ | i 760 |
| | $ | — |
| | $ | i 760 |
| | $ | — |
| | $ | i 760 |
|
Other
assets(1)(3) | $ | i 36 |
| | $ | — |
| | $ | i 36 |
| | $ | — |
| | $ | i 36 |
|
Liabilities | | | | | | | | | |
Deposits | $ | i 45,313 |
| | $ | — |
| | $ | i 45,313 |
| | $ | — |
| | $ | i 45,313 |
|
Customer
payables | $ | i 10,117 |
| | $ | — |
| | $ | i 10,117 |
| | $ | — |
| | $ | i 10,117 |
|
Payables
to brokers, dealers and clearing organizations | $ | i 948 |
| | $ | — |
| | $ | i 948 |
| | $ | — |
| | $ | i 948 |
|
Corporate
debt | $ | i 1,409 |
| | $ | — |
| | $ | i 1,372 |
| | $ | — |
| | $ | i 1,372 |
|
| |
(1) | The
fair value of securities that the Company received as collateral in connection with margin receivables and securities borrowing activities, including the fully paid lending program, where the Company is permitted to sell or re-pledge the securities, was $ i 12.9 billion at December 31,
2018. Of this amount, $ i 2.3 billion had been pledged or sold in connection with securities loaned and deposits with clearing organizations at December 31, 2018. |
| |
(2) | The
carrying value of loans receivable, net includes the allowance for loan losses of $ i 37 million and loans that are recorded at fair value on a nonrecurring basis at December 31, 2018. |
/ | |
(3) | The
$ i 36 million in other assets at December 31, 2018 represents securities borrowing from customers under the fully paid lending program. |
Fair Value of Commitments and Contingencies
In the normal course of business, the Company
makes various commitments to extend credit and incur contingent liabilities that are not reflected in the consolidated balance sheet. Changes in the economy or interest rates may influence the impact that these commitments and contingencies have on the Company in the future. The Company does not estimate the fair value of those commitments. Information related to such commitments and contingent liabilities is included in Note 20—Commitments, Contingencies and Other Regulatory Matters.
E*TRADE 2019 10-K | Page 123
E*TRADE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
i |
|
NOTE 5—OFFSETTING
ASSETS AND LIABILITIES |
Securities Purchased Under Agreements to Resell
Securities purchased under agreements to resell are treated as collateralized financing transactions and are recorded at their contractual amounts plus accrued interest. For financial statement purposes, the Company does not offset securities purchased under agreements to resell transactions with securities sold under agreements to repurchase. The Company obtains securities as collateral from the counterparty with a market value in excess of the principal amount loaned. This activity could result in losses if the counterparty fails to repurchase the securities held as collateral for the cash advanced and the
market value of the securities declines. The Company continuously monitors the collateral value and obtains additional collateral from the counterparty in an effort to ensure full collateralization. Securities Lending Transactions
Securities borrowed and securities loaned transactions are recorded at the amount of cash collateral delivered to or received from the counterparty plus accrued interest. For financial statement purposes, the Company does not offset securities borrowing and securities lending transactions. These activities are generally transacted under master agreements that are widely used by counterparties and that may allow for net settlements of payments in the normal course, as well as offsetting
of all contracts with a given counterparty in the event of bankruptcy or default of one of the two parties to the transaction. The Company is required to deliver cash to the lender for securities borrowed whereas the Company receives collateral in the form of cash for securities loaned. These activities both require cash in an amount generally in excess of the market value of the securities and have overnight or continuous remaining contractual maturities. Securities lending transactions expose the Company to counterparty credit risk and market risk. To manage the counterparty
risk, the Company maintains internal standards for approving counterparties, reviews and analyzes the credit rating of each counterparty, and monitors its positions with each counterparty on an ongoing basis. In addition, for certain of the Company's securities lending transactions, the Company uses a program with a clearing organization that guarantees the return of collateral. The Company monitors the market value of the securities borrowed and loaned using collateral arrangements that require additional collateral to be obtained from or excess collateral to be returned to the counterparties based on changes in market value,
in an effort to maintain specified collateral levels.
E*TRADE 2019 10-K | Page 124
E*TRADE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
i The
following table presents information about these transactions to enable the users of the Company’s consolidated financial statements to evaluate the potential effect of rights of set-off between these recognized assets and liabilities (dollars in millions): |
| | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | Gross
Amounts Not Offset in the Consolidated Balance Sheet | | |
| Gross Amounts of Recognized Assets and Liabilities | | Gross Amounts Offset in the Consolidated Balance Sheet | | Net Amounts Presented in the Consolidated Balance Sheet (1)(2) | | Financial
Instruments | | Collateral Received or Pledged (Including Cash) | | Net Amount |
| | | | | | | | | | | |
Assets: | | | | | | | | | | | |
Securities
purchased under agreements to resell (3) | $ | i 200 |
| | $ | i — |
| | $ | i 200 |
| | $ | i — |
| | $ | ( i 200 | ) | | $ | i — |
|
Securities
borrowed (4) | i 1,116 |
| | i — |
| | i 1,116 |
| | ( i 83 | ) | | ( i 1,003 | ) | | i 30 |
|
Total | $ | i 1,316 |
| | $ | i — |
| | $ | i 1,316 |
| | $ | ( i 83 | ) | | $ | ( i 1,203 | ) | | $ | i 30 |
|
| | | | | | | | | | | |
Liabilities: | | | | | | | | | | | |
Securities
loaned (5) | $ | i 838 |
| | $ | i — |
| | $ | i 838 |
| | $ | ( i 83 | ) | | $ | ( i 699 | ) | | $ | i 56 |
|
Total | $ | i 838 |
| | $ | i — |
| | $ | i 838 |
| | $ | ( i 83 | ) | | $ | ( i 699 | ) | | $ | i 56 |
|
| | | | | | | | | | | |
| | | | | | | | | | | |
Assets: | | | | | | | | | | | |
Securities
borrowed (4) | $ | i 176 |
| | $ | i — |
| | $ | i 176 |
| | $ | ( i 104 | ) | | $ | ( i 61 | ) | | $ | i 11 |
|
Total | $ | i 176 |
| | $ | i — |
| | $ | i 176 |
| | $ | ( i 104 | ) | | $ | ( i 61 | ) | | $ | i 11 |
|
| | | | | | | | | | | |
Liabilities: | | | | | | | | | | | |
Securities
loaned (5) | $ | i 887 |
| | $ | i — |
| | $ | i 887 |
| | $ | ( i 104 | ) | | $ | ( i 700 | ) | | $ | i 83 |
|
Total | $ | i 887 |
| | $ | i — |
| | $ | i 887 |
| | $ | ( i 104 | ) | | $ | ( i 700 | ) | | $ | i 83 |
|
| |
(1) | Securities
purchased under agreements to resell are included in the other assets line item in the consolidated balance sheet. |
| |
(2) | The vast majority of the net amount of cash collateral paid for securities borrowed are reflected in the receivables from brokers, dealers and clearing organizations line item while the cash collateral paid for securities borrowed under the fully paid lending program are reflected in other assets. Cash collateral received for securities loaned are reflected in the payables to brokers, dealers and clearing organizations line item in the consolidated balance sheet. |
| |
(3) | Securities
purchased under agreements to resell were over-collateralized at December 31, 2019, as the market value of the securities received by the Company was $ i 206 million. |
| |
(4) | Included
in the gross amounts of cash collateral paid for securities borrowed was $ i 757 million and $ i 65
million at December 31, 2019 and 2018, respectively, transacted through a program with a clearing organization, which guarantees the return of cash to the Company. For presentation purposes, these amounts presented are based on the counterparties under the Company’s master securities loan agreements. |
/ | |
(5) | Included
in the gross amounts of cash collateral received for securities loaned was $ i 401 million and $ i 543
million at December 31, 2019 and 2018, respectively, transacted through a program with a clearing organization, which guarantees the return of securities to the Company. For presentation purposes, these amounts presented are based on the counterparties under the Company’s master securities loan agreements. |
E*TRADE 2019 10-K | Page 125
E*TRADE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Derivative Transactions
At December 31, 2019, all of the derivatives that the Company utilized in its hedging activities were subject to derivatives clearing agreements (centrally cleared derivatives contracts). These cleared derivatives contracts
enable clearing by a derivatives clearing organization through a clearing member. Under the contracts, the clearing member typically has a one-way right to offset all contracts in the event of the Company's default or bankruptcy. Collateral exchanged under these contracts is not included in the preceding table as the contracts may not qualify as master netting agreements. For financial statement purposes, the Company does not offset derivatives
assets and derivative liabilities. See Note 8—Derivative Instruments and Hedging Activities for additional information.
E*TRADE 2019 10-K | Page 126
E*TRADE
FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
i |
|
NOTE 6—AVAILABLE-FOR-SALE AND HELD-TO-MATURITY SECURITIES |
The
following table presents the amortized cost and fair value of available-for-sale and held-to-maturity securities (dollars in millions): |
| | | | | | | | | | | | | | | |
| Amortized Cost | | Gross Unrealized / Unrecognized Gains | | Gross Unrealized
/ Unrecognized Losses | | Fair Value |
| | | | | | | |
Available-for-sale
securities:(1) | | | | | | | |
Agency mortgage-backed securities | $ | i 16,267 |
| | $ | i 836 |
| | $ | ( i 68 | ) | | $ | i 17,035 |
|
Agency
debentures | i 632 |
| | i 27 |
| | i — |
| | i 659 |
|
US
Treasuries | i 1,233 |
| | i 34 |
| | ( i 40 | ) | | i 1,227 |
|
Non-agency
asset-backed securities(2) | i 417 |
| | i 2 |
| | ( i 2 | ) | | i 417 |
|
Non-agency
mortgage-backed securities | i 159 |
| | i 4 |
| | i — |
| | i 163 |
|
Total
available-for-sale securities | $ | i 18,708 |
| | $ | i 903 |
| | $ | ( i 110 | ) | | $ | i 19,501 |
|
Held-to-maturity
securities:(1) | | | | | | | |
Agency mortgage-backed securities | $ | i 20,085 |
| | $ | i 293 |
| | $ | ( i 49 | ) | | $ | i 20,329 |
|
Agency
debentures | i 267 |
| | i 4 |
| | i — |
| | i 271 |
|
Other
agency debt securities | i 1,617 |
| | i 31 |
| | ( i 2 | ) | | i 1,646 |
|
Total
held-to-maturity securities | $ | i 21,969 |
| | $ | i 328 |
| | $ | ( i 51 | ) | | $ | i 22,246 |
|
| | | | | | | |
|
| | | | | |
|
Available-for-sale securities:(1) | | | | | | | |
Agency
mortgage-backed securities | $ | i 22,140 |
| | $ | i 327 |
| | $ | ( i 305 | ) | | $ | i 22,162 |
|
Agency
debentures | i 833 |
| | i 13 |
| | ( i 7 | ) | | i 839 |
|
Other
agency debt securities | i 140 |
| | i 1 |
| | ( i 2 | ) | | i 139 |
|
Municipal
bonds | i 12 |
| | i — |
| | i — |
| | i 12 |
|
Other | i 1 |
| | i — |
| | i — |
| | i 1 |
|
Total
available-for-sale securities | $ | i 23,126 |
| | $ | i 341 |
| | $ | ( i 314 | ) | | $ | i 23,153 |
|
Held-to-maturity
securities:(1) | | | | | | | |
Agency mortgage-backed securities | $ | i 18,085 |
| | $ | i 26 |
| | $ | ( i 363 | ) | | $ | i 17,748 |
|
Agency
debentures | i 1,824 |
| | i — |
| | ( i 16 | ) | | i 1,808 |
|
Other
agency debt securities | i 1,975 |
| | i 4 |
| | ( i 44 | ) | | i 1,935 |
|
Total
held-to-maturity securities | $ | i 21,884 |
| | $ | i 30 |
| | $ | ( i 423 | ) | | $ | i 21,491 |
|
| |
(1) | Securities
with a fair value of $ i 744 million were transferred from available-for-sale to held-to-maturity based on a change in intent and demonstrated ability to hold these to maturity in December 2019. Securities with a carrying value of $ i 4.7
billion and related unrealized pre-tax gain of $ i 7 million were transferred from held-to-maturity to available-for-sale during the year ended December 31, 2018, as part of a one-time transition election for early adopting the new derivatives and hedge accounting
guidance. Securities with a fair value of $ i 1.2 billion were transferred from available-for-sale to held-to-maturity during the year ended December 31, 2018 pursuant to an evaluation of our investment strategy and an assessment by management about our intent and ability to hold those particular securities until maturity. See Note 15—Shareholders' Equity for information on the impact to
accumulated other comprehensive income. |
| |
(2) | Non-agency ABS collateralized by credit card, automobile loan and student loan receivables represented approximately i 54%, i 18%
and i 28%, respectively, of the non-agency ABS held at December 31, 2019. |
/ /
E*TRADE
2019 10-K | Page 127
E*TRADE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Contractual Maturities
i The
following table presents the contractual maturities of all available-for-sale and held-to-maturity debt securities (dollars in millions): |
| | | | | | | |
| |
| Amortized Cost | | Fair Value |
Available-for-sale
debt securities: | | | |
Due within one year | $ | i 87 |
| | $ | i 87 |
|
Due
within one to five years | i 360 |
| | i 364 |
|
Due
within five to ten years | i 9,379 |
| | i 10,107 |
|
Due
after ten years | i 8,882 |
| | i 8,943 |
|
Total
available-for-sale debt securities | $ | i 18,708 |
| | $ | i 19,501 |
|
Held-to-maturity
debt securities: | | | |
Due within one year | $ | i 47 |
| | $ | i 47 |
|
Due
within one to five years | i 2,000 |
| | i 2,029 |
|
Due
within five to ten years | i 3,035 |
| | i 3,102 |
|
Due
after ten years | i 16,887 |
| | i 17,068 |
|
Total
held-to-maturity debt securities | $ | i 21,969 |
| | $ | i 22,246 |
|
/ At
December 31, 2019 and 2018, the Company had pledged $ i 7.4 billion and $ i 6.3
billion, respectively, of held-to-maturity debt securities, and $ i 456 million and $ i 151
million, respectively, of available-for-sale securities, as collateral for FHLB advances, derivatives and other purposes.
E*TRADE 2019 10-K | Page 128
E*TRADE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS
Investments with Unrealized or Unrecognized Losses
i The following table presents the fair value and unrealized or unrecognized losses on available-for-sale and held-to-maturity securities, and the length of time that individual securities have been in a continuous unrealized or unrecognized loss position (dollars in millions): |
| | | | | | | | | | | | | | | | | | | | | | | |
| Less
than 12 Months | | 12 Months or More | | Total |
| Fair Value | | Unrealized / Unrecognized Losses | | Fair Value | | Unrealized
/ Unrecognized Losses | | Fair Value | | Unrealized / Unrecognized Losses |
| | | | | | | | | | | |
Available-for-sale
securities: | | | | | | | | | | | |
Agency mortgage-backed securities | $ | i 2,045 |
| | $ | ( i 32 | ) | | $ | i 1,916 |
| | $ | ( i 36 | ) | | $ | i 3,961 |
| | $ | ( i 68 | ) |
Non-agency
mortgage-backed securities | i 50 |
| | i — |
| | i — |
| | i — |
| | i 50 |
| | i — |
|
US
Treasuries | i 402 |
| | ( i 40 | ) | | i — |
| | i — |
| | i 402 |
| | ( i 40 | ) |
Non-agency
asset-backed securities | i 251 |
| | ( i 2 | ) | | i — |
| | i — |
| | i 251 |
| | ( i 2 | ) |
Total
temporarily impaired available-for-sale securities | $ | i 2,748 |
| | $ | ( i 74 | ) | | $ | i 1,916 |
| | $ | ( i 36 | ) | | $ | i 4,664 |
| | $ | ( i 110 | ) |
Held-to-maturity
securities: | | | | | | | | | | | |
Agency mortgage-backed securities | $ | i 1,337 |
| | $ | ( i 4 | ) | | $ | i 3,600 |
| | $ | ( i 45 | ) | | $ | i 4,937 |
| | $ | ( i 49 | ) |
Other
agency debt securities | i 181 |
| | ( i 1 | ) | | i 135 |
| | ( i 1 | ) | | i 316 |
| | ( i 2 | ) |
Total
temporarily impaired held-to-maturity securities | $ | i 1,518 |
| | $ | ( i 5 | ) | | $ | i 3,735 |
| | $ | ( i 46 | ) | | $ | i 5,253 |
| | $ | ( i 51 | ) |
| | | | | | | | | | | |
| | | | | | | | | | | |
Available-for-sale securities: | | | | | | | | | | | |
Agency
mortgage-backed securities | $ | i 2,945 |
| | $ | ( i 34 | ) | | $ | i 7,826 |
| | $ | ( i 271 | ) | | $ | i 10,771 |
| | $ | ( i 305 | ) |
Agency
debentures | i 383 |
| | ( i 1 | ) | | i 116 |
| | ( i 6 | ) | | i 499 |
| | ( i 7 | ) |
Other
agency debt securities | i — |
| | i — |
| | i 30 |
| | ( i 2 | ) | | i 30 |
| | ( i 2 | ) |
Municipal
bonds | i — |
| | i — |
| | i 9 |
| | i — |
| | i 9 |
| | i — |
|
Other | i 1 |
| | i — |
| | i — |
| | i — |
| | i 1 |
| | i — |
|
Total
temporarily impaired available-for-sale securities | $ | i 3,329 |
| | $ | ( i 35 | ) | | $ | i 7,981 |
| | $ | ( i 279 | ) | | $ | i 11,310 |
| | $ | ( i 314 | ) |
Held-to-maturity securities: | | | | | | | | | | | |
Agency
mortgage-backed securities | $ | i 2,802 |
| | $ | ( i 31 | ) | | $ | i 11,587 |
| | $ | ( i 332 | ) | | $ | i 14,389 |
| | $ | ( i 363 | ) |
Agency
debentures | i 776 |
| | ( i 2 | ) | | i 666 |
| | ( i 14 | ) | | i 1,442 |
| | ( i 16 | ) |
Other
agency debt securities | i 97 |
| | ( i 1 | ) | | i 1,487 |
| | ( i 43 | ) | | i 1,584 |
| | ( i 44 | ) |
Total
temporarily impaired held-to-maturity securities | $ | i 3,675 |
| | $ | ( i 34 | ) | | $ | i 13,740 |
| | $ | ( i 389 | ) | | $ | i 17,415 |
| | $ | ( i 423 | ) |
/ The
Company does not believe that any individual unrealized loss in the available-for-sale portfolio or unrecognized loss in the held-to-maturity portfolio represents an other-than-temporary impairment as of December 31, 2019 or through the date of this report. The Company does not intend to sell the debt securities in an unrealized or unrecognized loss position and it is not more likely than not that the Company will be required to sell the debt securities before the anticipated recovery of its remaining amortized cost of the debt securities in an unrealized or unrecognized loss position. There were i no
impairment losses recognized in earnings on available-for-sale or held-to-maturity securities during the years ended December 31, 2019, 2018 and 2017.
E*TRADE 2019 10-K | Page 129
E*TRADE
FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Gains (Losses) on Securities and Other, Net
i The following table presents the components of gains (losses) on securities and other, net (dollars in millions): |
| | | | | | | | | | | |
| |
| 2019 | | 2018 | | 2017 |
Gains (losses) on available-for-sale securities, net: | | | | | |
Gains
on available-for-sale securities(1)(2) | $ | i 51 |
| | $ | i 98 |
| | $ | i 40 |
|
Losses
on available-for-sale securities(1)(2) | ( i 80 | ) | | ( i 54 | ) | | i — |
|
Subtotal | ( i 29 | ) | | i 44 |
| | i 40 |
|
Equity
method investment income (loss) and other(3)(4) | i 6 |
| | i 9 |
| | ( i 12 | ) |
Gains
(losses) on securities and other, net | $ | ( i 23 | ) | | $ | i 53 |
| | $ | i 28 |
|
| |
(1) | In
the second quarter 2019, the Company repositioned its balance sheet through the sales of $ i 4.5 billion of lower-yielding investment securities. These sales enabled the reduction of our balance sheet size and the Company moved $ i 6.6
billion of deposits to third-party banks generating additional capital capacity to support future share repurchases. Gains (losses) on securities and other, net for the year ended December 31, 2019 includes $ i 80 million of losses related to these sales. As both the change in intent related to these securities and the sale of these securities occurred within the same reporting period, the
Company presented the losses on the sale of these securities within the gains (losses) on securities and other, net line item. |
| |
(2) | In August 2018, the Company sold available-for-sale securities and reinvested the sale proceeds in agency-backed securities at current market rates. A subset of these securities had been purchased in lower interest rate environments and were in unrealized loss positions at the time of sale. As both the change in intent related to these securities and the sale of these securities occurred within the same reporting period, the Company presented
the losses on the sale of these securities within the gains (losses) on securities and other, net line item. |
| |
(3) | Includes a $ i 5 million gain on the sale of our Chicago Stock Exchange investment for the year ended December
31, 2018. |
/ | |
(4) | Includes losses of $ i 14 million on hedge ineffectiveness for the year
ended December 31, 2017. Beginning January 1, 2018, fair value hedging adjustments are recognized within net interest income. See Note 1—Organization, Basis of Presentation and Summary of Significant Accounting Policies for additional information. |
E*TRADE 2019 10-K | Page 130
E*TRADE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
i |
|
NOTE 7—LOANS RECEIVABLE, NET |
The
following table presents loans receivable disaggregated by delinquency status (dollars in millions): |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | Days
Past Due | | | | | | | | |
| | Current | | 30-89 | | 90-179 | | 180+ | | Total | | Unamortized
Premiums, Net | | Allowance for Loans Losses | | Loans Receivable, Net |
| | | | | | | | | | | | | | | | |
One-
to four-family | | $ | i 718 |
| | $ | i 39 |
| | $ | i 11 |
| | $ | i 35 |
| | $ | i 803 |
| | $ | i 5 |
| | $ | ( i 6 | ) | | $ | i 802 |
|
Home
equity | | i 590 |
| | i 21 |
| | i 7 |
| | i 17 |
| | i 635 |
| | i — |
| | ( i 11 | ) | | i 624 |
|
Securities-based
lending(1) | | i 169 |
| | i — |
| | i — |
| | i — |
| | i 169 |
| | i — |
| | i — |
| | i 169 |
|
Total
loans receivable(2) | | $ | i 1,477 |
| | $ | i 60 |
| | $ | i 18 |
| | $ | i 52 |
| | $ | i 1,607 |
| | $ | i 5 |
| | $ | ( i 17 | ) | | $ | i 1,595 |
|
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
One-
to four-family | | $ | i 958 |
| | $ | i 48 |
| | $ | i 9 |
| | $ | i 56 |
| | $ | i 1,071 |
| | $ | i 7 |
| | $ | ( i 9 | ) | | $ | i 1,069 |
|
Home
equity | | i 774 |
| | i 25 |
| | i 13 |
| | i 24 |
| | i 836 |
| | i — |
| | ( i 26 | ) | | i 810 |
|
Consumer | | i 117 |
| | i 1 |
| | i — |
| | i — |
| | i 118 |
| | i 1 |
| | ( i 2 | ) | | i 117 |
|
Securities-based
lending(1) | | i 107 |
| | i — |
| | i — |
| | i — |
| | i 107 |
| | i — |
| | i — |
| | i 107 |
|
Total
loans receivable | | $ | i 1,956 |
| | $ | i 74 |
| | $ | i 22 |
| | $ | i 80 |
| | $ | i 2,132 |
| | $ | i 8 |
| | $ | ( i 37 | ) | | $ | i 2,103 |
|
| |
(1) | E*TRADE
Line of Credit is a securities-based lending product where customers can borrow against the market value of their securities pledged as collateral. The unused credit line amount totaled $ i 431 million and $ i 173
million as of December 31, 2019 and December 31, 2018, respectively. |
| |
(2) | The Company sold its consumer loan portfolio in December 2019 and recognized a corresponding reduction in the allowance for loan losses. |
/
E*TRADE 2019 10-K | Page 131
E*TRADE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Credit Quality and Concentrations of Credit Risk
The Company tracks and reviews factors to predict and monitor credit risk in its mortgage loan portfolio on an ongoing basis. i The
following tables present the distribution of the Company’s mortgage loan portfolios by credit quality indicator (dollars in millions): |
| | | | | | | | | | | | | | | |
| One- to Four-Family | | Home Equity |
| December
31, | | December 31, |
Current LTV/CLTV(1) | 2019 | | 2018 | | 2019 | | 2018 |
<=80% | $ | i 661 |
| | $ | i 823 |
| | $ | i 377 |
| | $ | i 454 |
|
80%-100% | i 97 |
| | i 165 |
| | i 154 |
| | i 215 |
|
100%-120% | i 26 |
| | i 45 |
| | i 68 |
| | i 110 |
|
>120% | i 19 |
| | i 38 |
| | i 36 |
| | i 57 |
|
Total
mortgage loans receivable | $ | i 803 |
| | $ | i 1,071 |
| | $ | i 635 |
| | $ | i 836 |
|
Average
estimated current LTV/CLTV (2) | i 61 | % | | i 66 | % | | i 76 | % | | i 80 | % |
Average
LTV/CLTV at loan origination (3) | i 70 | % | | i 70 | % | | i 82 | % | | i 82 | % |
| |
(1) | Current
CLTV calculations for home equity loans are based on the maximum available line for HELOCs and outstanding principal balance for HEILs. For home equity loans in the second lien position, the original balance of the first lien loan at origination date and updated valuations on the property underlying the loan are used to calculate CLTV. Current property value estimates are updated on a quarterly basis. |
| |
(2) | The average estimated current LTV/CLTV ratio reflects the outstanding balance at the balance sheet date and the maximum available line for HELOCs, divided by the estimated current value of the underlying property. |
| |
(3) | Average
LTV/CLTV at loan origination calculations are based on LTV/CLTV at time of purchase for one- to four-family purchased loans, HEILs and the maximum available line for HELOCs. |
|
| | | | | | | | | | | | | | | |
| One- to Four-Family | | Home Equity |
| December
31, | | December 31, |
Current FICO | 2019 | | 2018 | | 2019 | | 2018 |
>=720 | $ | i 462 |
| | $ | i 617 |
| | $ | i 333 |
| | $ | i 442 |
|
719
- 700 | i 77 |
| | i 89 |
| | i 61 |
| | i 78 |
|
699
- 680 | i 55 |
| | i 80 |
| | i 54 |
| | i 70 |
|
679
- 660 | i 40 |
| | i 66 |
| | i 43 |
| | i 56 |
|
659
- 620 | i 63 |
| | i 79 |
| | i 59 |
| | i 80 |
|
<620 | i 106 |
| | i 140 |
| | i 85 |
| | i 110 |
|
Total
mortgage loans receivable | $ | i 803 |
| | $ | i 1,071 |
| | $ | i 635 |
| | $ | i 836 |
|
One-
to four-family loans include loans with an interest-only period, followed by an amortizing period. At December 31, 2019, i 100% of these loans were amortizing. The home equity loan portfolio consists of HEILs and HELOCs. HEILs are primarily
fully amortizing loans that do not offer the option of an interest-only payment. The majority of HELOCs had an interest only draw period at origination and converted to amortizing loans at the end of the draw period. At December 31, 2019, substantially all of the HELOC portfolio had converted from the interest-only draw period.
E*TRADE 2019 10-K | Page 132
E*TRADE
FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The weighted average age of our mortgage and consumer loans receivable was i 13.7 and i 12.8 years
at December 31, 2019 and 2018, respectively. Approximately i 32% and i 33%
of the Company’s mortgage loans receivable were concentrated in California at December 31, 2019 and 2018, respectively. Approximately i 10%
of the Company's mortgage loans receivable were concentrated in New York at both December 31, 2019 and 2018. i No other state had concentrations of mortgage loans that represented 10% or more of the
Company’s mortgage loans receivable at December 31, 2019 or 2018. At December 31, 2019, i 23% and i 20%
of the Company’s past-due mortgage loans were concentrated in California and New York, respectively. i No other state had concentrations of past-due mortgage loans that represented 10% or more of the Company's past-due mortgage loans. At December 31,
2019, i 41% and i 10%
of the Company’s impaired mortgage loans were concentrated in California and New York, respectively. i No other state had concentrations of impaired mortgage loans that represented 10% or more of the Company's impaired mortgage loans. Nonperforming
Loans
The Company classifies loans as nonperforming when they are no longer accruing interest. i The following table presents nonperforming loans by loan portfolio (dollars in millions): |
| | | | | | | |
| |
| 2019 | | 2018 |
One- to four-family | $ | i 114 |
| | $ | i 139 |
|
Home
equity | i 54 |
| | i 71 |
|
Total
nonperforming loans receivable | $ | i 168 |
| | $ | i 210 |
|
At
both December 31, 2019 and 2018, the Company held $ i 13 million of real estate owned that was acquired through foreclosure or through a deed in lieu of foreclosure or similar legal agreement. The Company held $ i 32
million and $ i 51 million of loans for which formal foreclosure proceedings were in process at December 31, 2019 and 2018, respectively.
E*TRADE 2019 10-K | Page 133
E*TRADE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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.
i The following table presents the allowance for loan losses by loan portfolio (dollars in millions):
|
| | | | | | | | | | | |
| |
| One- to Four-Family | | Home Equity | | Total(1)(2) |
General reserve: | | | | | |
Quantitative
component | $ | i 2 |
| | $ | i 1 |
| | $ | i 3 |
|
Qualitative
component | ( i 1 | ) | | i — |
| | ( i 1 | ) |
Specific
valuation allowance | i 5 |
| | i 10 |
| | i 15 |
|
Total
allowance for loan losses | $ | i 6 |
| | $ | i 11 |
| | $ | i 17 |
|
Allowance as
a % of loans receivable(3) | i 0.7 | % | | i 1.7 | % | | i 1.1 | % |
|
| | | | | | | | | | | | | | | |
| |
| One- to Four-Family | | Home Equity | | Consumer | | Total(2) |
General reserve: | | | | | | | |
Quantitative
component | $ | i 4 |
| | $ | i 6 |
| | $ | i 2 |
| | $ | i 12 |
|
Qualitative
component | i — |
| | i 1 |
| | i — |
| | i 1 |
|
Specific
valuation allowance | i 5 |
| | i 19 |
| | i — |
| | i 24 |
|
Total
allowance for loan losses | $ | i 9 |
| | $ | i 26 |
| | $ | i 2 |
| | $ | i 37 |
|
Allowance as
a % of loans receivable(3) | i 0.8 | % | | i 3.1 | % | | i 1.0 | % | | i 1.7 | % |
| |
(1) | The
Company sold its consumer loan portfolio in December 2019 and recognized a corresponding reduction in the allowance for loan losses. |
| |
(2) | Securities-based lending loans were fully collateralized by cash and securities with fair values in excess of borrowings at both December 31, 2019 and 2018, respectively. |
/ | |
(3) | Allowance
as a percentage of loans receivable is calculated based on the gross loans receivable including net unamortized premiums for each respective category. |
E*TRADE 2019 10-K | Page 134
E*TRADE FINANCIAL CORPORATION
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
The following table presents a roll forward by loan portfolio of the allowance for loan losses (dollars in millions):
|
| | | | | | | | | | | | | | | |
| |
| One-
to Four-Family | | Home Equity | | Consumer(1) | | Total |
Allowance for loan losses, beginning of period | $ | i 9 |
| | $ | i 26 |
| | $ | i 2 |
| | $ | i 37 |
|
Provision
(benefit) for loan losses | ( i 9 | ) | | ( i 41 | ) | | ( i 1 | ) | | ( i 51 | ) |
Charge-offs(2) | i — |
| | i — |
| | ( i 3 | ) | | ( i 3 | ) |
Recoveries(3) | i 6 |
| | i 26 |
| | i 2 |
| | i 34 |
|
Net
(charge-offs) recoveries | i 6 |
| | i 26 |
| | ( i 1 | ) | | i 31 |
|
Allowance
for loan losses, end of period(4) | $ | i 6 |
| | $ | i 11 |
| | $ | i — |
| | $ | i 17 |
|
| | | | | | | |
| |
| One- to Four-Family | | Home Equity | | Consumer | | Total |
Allowance for loan losses, beginning of period | $ | i 24 |
| | $ | i 46 |
| | $ | i 4 |
| | $ | i 74 |
|
Provision
(benefit) for loan losses | ( i 22 | ) | | ( i 63 | ) | | ( i 1 | ) | | ( i 86 | ) |
Charge-offs(2) | i — |
| | i — |
| | ( i 4 | ) | | ( i 4 | ) |
Recoveries(3) | i 7 |
| | i 43 |
| | i 3 |
| | i 53 |
|
Net
(charge-offs) recoveries | i 7 |
| | i 43 |
| | ( i 1 | ) | | i 49 |
|
Allowance
for loan losses, end of period(4) | $ | i 9 |
| | $ | i 26 |
| | $ | i 2 |
| | $ | i 37 |
|
| | | | | | | |
| |
| One- to
Four-Family | | Home
Equity | | Consumer | | Total |
Allowance for loan losses, beginning of period | $ | i 45 |
| | $ | i 171 |
| | $ | i 5 |
| | $ | i 221 |
|
Provision
(benefit) for loan losses | ( i 29 | ) | | ( i 141 | ) | | i 2 |
| | ( i 168 | ) |
Charge-offs(2) | i — |
| | ( i 7 | ) | | ( i 6 | ) | | ( i 13 | ) |
Recoveries | i 8 |
| | i 23 |
| | i 3 |
| | i 34 |
|
Net
(charge-offs) recoveries | i 8 |
| | i 16 |
| | ( i 3 | ) | | i 21 |
|
Allowance
for loan losses, end of period(4) | $ | i 24 |
| | $ | i 46 |
| | $ | i 4 |
| | $ | i 74 |
|
| |
(1) | The
Company sold its consumer loan portfolio in December 2019 and recognized a corresponding reduction in the allowance for loan losses. |
| |
(2) | Includes benefits resulting from recoveries of partial charge-offs due to principal paydowns or payoffs for the periods presented. The benefits included in the charge-offs line item exceeded other charge-offs for one- to four-family portfolio during the years ended December 31, 2019, 2018 and 2017, respectively. The benefits included in the charge-offs line item exceeded other charge-offs for the home equity loan portfolio during the years ended December 31,
2019 and 2018, respectively. |
| |
(3) | Includes $ i 3 million of recoveries recognized during the year ended December 31, 2019 and $ i 15
million of recoveries recognized during the year ended December 31, 2018 related to the sale of previously charged-off home equity loans. |
| |
(4) | Securities-based lending loans were fully collateralized by cash and securities with fair values in excess of borrowings for the years ended December 31, 2019, 2018 and 2017, respectively. |
Total loans receivable designated as held-for-investment decreased $ i 0.5
billion during the year ended December 31, 2019. The allowance for loan losses was $ i 17 million, or i 1.1%
of total loans receivable, as of December 31, 2019 compared to $ i 37 million, or i 1.7%
of total loans receivable, as of December 31, 2018. Net recoveries for the year ended December 31, 2019 were $ i 31 million compared to $ i 49
million in the same period in 2018.
E*TRADE 2019 10-K | Page 135
E*TRADE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The
benefit for loan losses was $ i 51 million for the year ended December 31, 2019. 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 sales of charged-off loans and recoveries of previous charge-offs, as applicable, that were not included in our loss estimates. The following table presents the total recorded investment in loans receivable and allowance for loan losses by loans that have been collectively evaluated for impairment and those that have been individually evaluated for impairment by loan portfolio (dollars in millions): |
| | | | | | | | | | | | | | | |
| Recorded
Investment | | Allowance for Loan Losses |
| December 31, | | |
| 2019 | | 2018 | | 2019 | | 2018 |
Collectively
evaluated for impairment: | | | | | | | |
One- to four-family | $ | i 640 |
| | $ | i 891 |
| | $ | i 1 |
| | $ | i 4 |
|
Home
equity | i 523 |
| | i 698 |
| | i 1 |
| | i 7 |
|
Consumer(1) | i — |
| | i 119 |
| | i — |
| | i 2 |
|
Securities-based
lending | i 169 |
| | i 107 |
| | i — |
| | i — |
|
Total
collectively evaluated for impairment | i 1,332 |
| | i 1,815 |
| | i 2 |
| | i 13 |
|
Individually
evaluated for impairment: | | | | | | | |
One- to four-family | i 168 |
| | i 187 |
| | i 5 |
| | i 5 |
|
Home
equity | i 112 |
| | i 138 |
| | i 10 |
| | i 19 |
|
Total
individually evaluated for impairment | i 280 |
| | i 325 |
| | i 15 |
| | i 24 |
|
Total | $ | i 1,612 |
| | $ | i 2,140 |
| | $ | i 17 |
| | $ | i 37 |
|
| |
(1) | The
Company sold its consumer loan portfolio in December 2019 and recognized a corresponding reduction in the allowance for loan losses. |
Impaired Loans—Troubled Debt Restructurings
The Company considers a loan to be impaired when it meets the definition of a TDR. Delinquency status is the primary measure the Company uses to evaluate the performance of loans modified as TDRs. The Company classifies loans as nonperforming when they are no longer accruing interest. The recorded investment in loans modified as TDRs includes the charge-offs related to certain loans that were written down
to estimated current value of the underlying property less estimated selling costs.
E*TRADE 2019 10-K | Page 136
E*TRADE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The
following table presents a summary of the Company’s recorded investment in TDRs that were on accrual and nonaccrual status, further disaggregated by delinquency status (dollars in millions): |
| | | | | | | | | | | | | | | | | | | | | | | |
| | | Nonaccrual
TDRs | | |
| Accrual TDRs(1) | | Current(2) | | 30-89 Days Delinquent | | 90-179 Days Delinquent | | 180+
Days Delinquent | | Total Recorded Investment in TDRs (3)(4) |
| | | | | | | | | | | |
One-
to four-family | $ | i 81 |
| | $ | i 57 |
| | $ | i 10 |
| | $ | i 3 |
| | $ | i 17 |
| | $ | i 168 |
|
Home
equity | i 73 |
| | i 20 |
| | i 8 |
| | i 2 |
| | i 9 |
| | i 112 |
|
Total | $ | i 154 |
| | $ | i 77 |
| | $ | i 18 |
| | $ | i 5 |
| | $ | i 26 |
| | $ | i 280 |
|
| | | | | | | | | | | |
| | | | | | | | | | | |
One- to four-family | $ | i 87 |
| | $ | i 61 |
| | $ | i 12 |
| | $ | i 4 |
| | $ | i 23 |
| | $ | i 187 |
|
Home
equity | i 90 |
| | i 23 |
| | i 8 |
| | i 5 |
| | i 12 |
| | i 138 |
|
Total | $ | i 177 |
| | $ | i 84 |
| | $ | i 20 |
| | $ | i 9 |
| | $ | i 35 |
| | $ | i 325 |
|
| |
(1) | Represents
loans modified as TDRs that are current and have made six or more consecutive payments. |
| |
(2) | Represents loans modified as TDRs that are current but have not yet made six consecutive payments, bankruptcy loans and certain junior lien TDRs that have a delinquent senior lien. |
| |
(3) | Total recorded investment in TDRs includes premium (discount), as applicable, and is net of charge-offs, which were $ i 46
million and $ i 97 million for one-to four-family and home equity loans, respectively, as of December 31, 2019 and $ i 55
million and $ i 121 million, respectively, as of December 31, 2018. |
| |
(4) | Total
recorded investment in TDRs at December 31, 2019 consisted of $ i 223 million of loans modified as TDRs and $ i 57
million of loans that have been charged off due to bankruptcy notification. Total recorded investment in TDRs at December 31, 2018 consisted of $ i 253 million of loans modified as TDRs and $ i 72
million of loans that have been charged off due to bankruptcy notification. |
The following table presents the monthly average recorded investment and interest income recognized both on a cash and accrual basis for the Company's TDRs (dollars in millions): |
| | | | | | | | | | | | | | | | | | | | | | | |
| Average
Recorded Investment | | Interest Income Recognized |
| December 31, | | |
| 2019 | | 2018 | | 2017 | | 2019 | | 2018 | | 2017 |
One-
to four-family | $ | i 177 |
| | $ | i 201 |
| | $ | i 221 |
| | $ | i 8 |
| | $ | i 9 |
| | $ | i 9 |
|
Home
equity | i 125 |
| | i 152 |
| | i 179 |
| | i 12 |
| | i 13 |
| | i 16 |
|
Total | $ | i 302 |
| | $ | i 353 |
| | $ | i 400 |
| | $ | i 20 |
| | $ | i 22 |
| | $ | i 25 |
|
E*TRADE
2019 10-K | Page 137
E*TRADE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
i The
following table presents detailed information related to the Company’s TDRs and specific valuation allowances (dollars in millions): |
| | | | | | | | | | | | | | | | | | | | | | | |
| | | |
| Recorded Investment in TDRs | | Specific Valuation Allowance | | Net Investment in
TDRs | | Recorded Investment in TDRs | | Specific Valuation Allowance | | Net Investment in TDRs |
With a recorded allowance: | | | | | | | | | | | |
One-
to four-family | $ | i 45 |
| | $ | i 5 |
| | $ | i 40 |
| | $ | i 50 |
| | $ | i 5 |
| | $ | i 45 |
|
Home
equity | $ | i 45 |
| | $ | i 10 |
| | $ | i 35 |
| | $ | i 60 |
| | $ | i 19 |
| | $ | i 41 |
|
Without
a recorded allowance:(1) | | | | | | | | | | | |
One- to four-family | $ | i 123 |
| | $ | — |
| | $ | i 123 |
| | $ | i 137 |
| | $ | — |
| | $ | i 137 |
|
Home
equity | $ | i 67 |
| | $ | — |
| | $ | i 67 |
| | $ | i 78 |
| | $ | — |
| | $ | i 78 |
|
Total: | | | | | | | | | | | |
One-
to four-family | $ | i 168 |
| | $ | i 5 |
| | $ | i 163 |
| | $ | i 187 |
| | $ | i 5 |
| | $ | i 182 |
|
Home
equity | $ | i 112 |
| | $ | i 10 |
| | $ | i 102 |
| | $ | i 138 |
| | $ | i 19 |
| | $ | i 119 |
|
/ | |
(1) | Represents
loans where the discounted cash flow analysis or collateral value is equal to or exceeds the recorded investment in the loan. |
i The following table presents the number of loans and post-modification balances immediately after being modified by major class (dollars in millions): |
| | | | | | | | | | | | | | | | | |
| |
| | | Interest
Rate Reduction | | | | |
| Number of
Loans | | Re-age/
Extension/
Interest
Capitalization | | Other with
Interest Rate
Reduction | | Other(1) | | Total |
| | | | | | | | | |
One- to four-family | i 30 | | $ | i 6 |
| | $ | i — |
| | $ | i 6 |
| | $ | i 12 |
|
Home
equity | i 44 | | i 3 |
| | i — |
| | i — |
| | i 3 |
|
Total | i 74 | | $ | i 9 |
| | $ | i — |
| | $ | i 6 |
| | $ | i 15 |
|
| | | | | | | | | |
| | | | | | | | | |
One- to four-family | i 49 | | $ | i 14 |
| | $ | i — |
| | $ | i 7 |
| | $ | i 21 |
|
Home
equity | i 91 | | i 5 |
| | i 1 |
| | i 1 |
| | i 7 |
|
Total | i 140 | | $ | i 19 |
| | $ | i 1 |
| | $ | i 8 |
| | $ | i 28 |
|
| | | | | | | | | |
| | | | | | | | | |
One- to four-family | i 40 | | $ | i 13 |
| | $ | i 1 |
| | $ | i 4 |
| | $ | i 18 |
|
Home
equity | i 294 | | i 12 |
| | i 1 |
| | i 9 |
| | i 22 |
|
Total | i 334 | | $ | i 25 |
| | $ | i 2 |
| | $ | i 13 |
| | $ | i 40 |
|
/ | |
(1) | Amounts
represent loans whose terms were modified in a manner that did not result in an interest rate reduction, including re-aged loans, extensions, and loans with capitalized interest. |
E*TRADE 2019 10-K | Page 138
E*TRADE
FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
i |
|
NOTE 8—DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES |
Presentation on the Consolidated Balance Sheet
Hedging Instruments
The
Company utilizes fair value hedges to offset exposure to changes in value of certain fixed-rate assets. All derivative contracts were designated as hedging instruments at December 31, 2019 and 2018, and the notional amount associated with these fair value hedge contracts was $ i 10.1
billion and $ i 9.8 billion for the same periods, respectively. The Company had no bilateral derivative contracts at December 31, 2019.
The consolidated balance sheet excludes derivative assets of $ i 52 million and $ i 175
million at December 31, 2019, and 2018, respectively, and derivative liabilities of $ i 457 million and $ i 131
million for the same periods. These contracts were executed through central clearing organizations and were settled by variation margin payments. Credit Risk
As all of the derivatives that the Company utilizes in its hedging activities at December 31, 2019 are subject to derivatives clearing agreements (cleared derivatives contracts), the credit risk associated with these cleared derivatives contracts is largely mitigated by the daily variation
margin exchanged with counterparties. Hedged Assets
i The following table presents the cumulative basis adjustments related to the carrying amount of hedged assets in fair value hedging relationships (dollars in millions): |
| | | | | | | | | | | |
| | | Cumulative
Amount of Fair Value Hedging Basis Adjustment Included in Carrying Amount of Hedged Assets(2) |
| Carrying Amount of Hedged Assets(1) | | Total | | Discontinued |
| | | | | |
Available-for-sale
securities(3) | $ | i 12,480 |
| | $ | i 583 |
| | $ | ( i 227 | ) |
| | | | | |
| | | | | |
Available-for-sale securities(3) | $ | i 13,203 |
| | $ | ( i 10 | ) | | $ | ( i 385 | ) |
| |
(1) | The
carrying amount includes the impact of basis adjustments on active fair value hedges and the impact of basis adjustments from previously discontinued fair value hedges. |
| |
(2) | Represents the increase (decrease) to the carrying amount of hedged assets. If fair value hedge accounting is discontinued, the previously hedged item is no longer adjusted for changes in fair value through the consolidated statements of income and the cumulative net gain or loss on the hedged item is amortized to net interest income using the effective interest method over the contractual life of the hedged item adjusted to reflect actual prepayments. |
/ | |
(3) | Includes
the amortized cost basis of closed portfolios of prepayable securities designated in hedging relationships in which the hedged item is the last layer of principal expected to be remaining throughout the hedge term. As of December 31, 2019 and 2018, respectively, the amortized cost basis of this portfolio was $ i 162 million and $ i 810
million, the amount of the designated hedged items was $ i 148 million and $ i 192
million and the cumulative basis adjustments associated with these hedges was a gain of $ i 1 million and a loss of $ i 6
million. |
/
E*TRADE 2019 10-K | Page 139
E*TRADE FINANCIAL CORPORATION
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
Presentation on the Consolidated Statements of Income
i The following table presents the effects of fair value hedge accounting on the consolidated statements of income
(dollars in millions): |
| | | | | | | |
| Interest Income |
| |
| 2019 | | 2018 |
| | | |
Total
interest income | $ | i 2,111 |
| | $ | i 2,009 |
|
| | | |
Effects
of fair value hedging on total interest income(1)(2) | | | |
Agency debentures: | | | |
Amounts recognized as interest accruals on derivatives | i 1 |
| | ( i 3 | ) |
Changes
in fair value of hedged items | i 2 |
| | ( i 69 | ) |
Changes
in fair value of derivatives | ( i 4 | ) | | i 68 |
|
Net
loss on fair value hedging relationships - agency debentures | ( i 1 | ) | | ( i 4 | ) |
| | | |
Agency
mortgage-backed securities: | | | |
Amounts recognized as interest accruals on derivatives | ( i 7 | ) | | ( i 15 | ) |
Amortization
of basis adjustments from discontinued hedges | i 35 |
| | i 24 |
|
Changes
in fair value of hedged items | i 722 |
| | ( i 111 | ) |
Changes
in fair value of derivatives | ( i 723 | ) | | i 93 |
|
Net
gain (loss) on fair value hedging relationships - agency mortgage-backed securities | i 27 |
| | ( i 9 | ) |
Total
net gain (loss) on fair value hedging relationships | $ | i 26 |
| | $ | ( i 13 | ) |
| |
(1) | Excludes
interest income accruals on hedged items and amounts recognized upon the sale of securities attributable to fair value hedge accounting. |
| |
(2) | Excludes interest on variation margin related to centrally cleared derivative contracts. |
The following table presents the changes in fair value of interest rate derivative contracts designated as fair value hedges and related hedged items as reflected on the consolidated statements of income (dollars in millions): |
| | | | | | | | | | | |
| |
| Hedging Instrument | | Hedged Item | | Hedge Ineffectiveness(1) |
Agency debentures | $ | i 1 |
| | $ | ( i 3 | ) | | $ | ( i 2 | ) |
Agency
mortgage-backed securities | i 36 |
| | ( i 48 | ) | | ( i 12 | ) |
Total
gains (losses) included in earnings | $ | i 37 |
| | $ | ( i 51 | ) | | $ | ( i 14 | ) |
/ | |
(1) | Reflected
in the gains (losses) on securities and other, net line item on the consolidated statements of income. |
E*TRADE 2019 10-K | Page 140
E*TRADE
FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
i |
|
NOTE 9—PROPERTY AND EQUIPMENT, NET |
Property
and equipment, net consisted of the following asset classes at December 31, 2019 and 2018 (dollars in millions): |
| | | | | | | | | | | | | | | | | | | | | | | |
| | | |
| Gross Amount | | Accumulated Depreciation and Amortization | | Net Amount | | Gross Amount | | Accumulated Depreciation and Amortization | | Net Amount |
Software(1) | $ | i 429 |
| | $ | ( i 309 | ) | | $ | i 120 |
| | $ | i 416 |
| | $ | ( i 297 | ) | | $ | i 119 |
|
Equipment | i 171 |
| | ( i 118 | ) | | i 53 |
| | i 147 |
| | ( i 117 | ) | | i 30 |
|
Leasehold
improvements(2) | i 87 |
| | ( i 40 | ) | | i 47 |
| | i 131 |
| | ( i 95 | ) | | i 36 |
|
Buildings | i 72 |
| | ( i 36 | ) | | i 36 |
| | i 72 |
| | ( i 34 | ) | | i 38 |
|
Furniture
and fixtures | i 20 |
| | ( i 4 | ) | | i 16 |
| | i 13 |
| | ( i 3 | ) | | i 10 |
|
Land | i 3 |
| | i — |
| | i 3 |
| | i 3 |
| | i — |
| | i 3 |
|
Construction
in progress(1)(3) | i 64 |
| | — |
| | i 64 |
| | i 45 |
| | i — |
| | i 45 |
|
Total(4) | $ | i 846 |
| | $ | ( i 507 | ) | | $ | i 339 |
| | $ | i 827 |
| | $ | ( i 546 | ) | | $ | i 281 |
|
| |
(1) | The
Company recognized $ i 8 million of impairment of certain technology assets through other non-interest expense during the year ended December 31, 2019. |
| |
(2) | The Company retired
leasehold improvements with a cost and related accumulated depreciation of $ i 70 million and $ i 68
million, respectively, as part of facility renovations and closures during the year ended December 31, 2019. |
| |
(3) | Construction in progress includes software in the process of development of $ i 49
million and $ i 36 million at December 31, 2019 and 2018, respectively. |
/ | |
(4) | The
Company executed a sale-leaseback transaction on its Alpharetta, Georgia office in 2014 and the transaction was accounted for as a financing as it did not qualify for leaseback accounting. The related assets continue to be included in the property and equipment, net line item on the consolidated balance sheet. Refer to Note 19—Lease Arrangements for further detail. |
Depreciation and amortization expense related to property and equipment was $ i 88 million, $ i 92
million and $ i 82 million for the years ended December 31, 2019, 2018 and 2017, respectively. The Company has capitalized salaries and related consulting costs of $ i 72
million, $ i 58 million and $ i 53
million for the years ended December 31, 2019, 2018 and 2017, respectively. These costs are included in software or construction in progress as applicable. Amortization of completed and in-service software was $ i 47 million, $ i 43
million and $ i 36 million for the years ended December 31, 2019, 2018 and 2017, respectively.
/
E*TRADE
2019 10-K | Page 141
E*TRADE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
i |
|
NOTE
10—GOODWILL AND OTHER INTANGIBLES, NET |
Goodwill
The Company had goodwill of $ i 2.5 billion at both December 31, 2019 and 2018, respectively. There was a $ i 25
million addition to the carrying value of the Company's goodwill during the year ended December 31, 2019, which was recognized in connection with the Gradifi acquisition. For additional information, see Note 2—Acquisitions and Restructuring. Other
Intangibles, Net
At December 31, 2019 and 2018, the Company had other intangible assets of $ i 433 million and $ i 491
million, respectively. The Company recognized $ i 3 million of technology intangible assets in connection with the Gradifi acquisition during the year ended December 31, 2019. For additional information, see
Note 2—Acquisitions and Restructuring. i The following table outlines the Company's other intangible assets with finite lives (dollars in millions): |
| | | | | | | | | | | | | | | |
| |
| Weighted Average
Original
Useful Life
(Years) | | Weighted Average Remaining Useful Life (Years) | | Gross Amount | | Accumulated Amortization | | Net Amount |
Customer
relationships | i 18 | | i 12 | | $ | i 786 |
| | $ | ( i 394 | ) | | $ | i 392 |
|
Technology | i 6 | | i 4 | | i 71 |
| | ( i 30 | ) | | i 41 |
|
Trade
name | i 2 | | i 0 | | i 4 |
| | ( i 4 | ) | | i — |
|
Total | | | | | $ | i 861 |
| | $ | ( i 428 | ) | | $ | i 433 |
|
|
| | | | | | | | | | | | | | | |
| |
| Weighted Average
Original
Useful Life
(Years) | | Weighted Average
Remaining
Useful Life
(Years) | | Gross Amount | | Accumulated
Amortization | | Net Amount |
Customer relationships | i 18 | | i 13 | | $ | i 786 |
| | $ | ( i 345 | ) | | $ | i 441 |
|
Technology | i 6 | | i 5 | | i 68 |
| | ( i 19 | ) | | i 49 |
|
Trade
name | i 2 | | i 1 | | i 4 |
| | ( i 3 | ) | | i 1 |
|
Total | | | | | $ | i 858 |
| | $ | ( i 367 | ) | | $ | i 491 |
|
The
Company evaluated the CRIs associated with its retail channel for impairment as a result of the commissions reduction announced in the fourth quarter 2019 and noted that i no impairment or resulting change to the useful lives of the related CRIs was indicated as a result of this analysis.
/
E*TRADE
2019 10-K | Page 142
E*TRADE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
i Assuming
no future impairments of other intangibles or additional acquisitions or dispositions, the following table presents the Company's future annual amortization expense (dollars in millions): |
| | | |
| |
2020 | $ | i 59 |
|
2021 | i 58 |
|
2022 | i 56 |
|
2023 | i 49 |
|
2024 | i 39 |
|
Thereafter | i 172 |
|
Total
future amortization expense | $ | i 433 |
|
/ i |
|
NOTE
11—RECEIVABLES FROM AND PAYABLES TO BROKERS, DEALERS AND CLEARING ORGANIZATIONS |
Receivables from and payables to brokers, dealers and clearing organizations consist of the following (in millions):
|
| | | | | | | |
| |
| 2019 | | 2018 |
Receivables: | | | |
Securities borrowed | $ | i 1,003 |
| | $ | i 140 |
|
Receivables
from clearing organizations | i 297 |
| | i 555 |
|
Other | i 95 |
| | i 65 |
|
Total | $ | i 1,395 |
| | $ | i 760 |
|
| | | |
Payables: | | | |
Securities
loaned | $ | i 838 |
| | $ | i 887 |
|
Payables
to clearing organizations | i 10 |
| | i 11 |
|
Other | i 45 |
| | i 50 |
|
Total | $ | i 893 |
| | $ | i 948 |
|
E*TRADE
2019 10-K | Page 143
E*TRADE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
i i The following table presents the significant components of deposits (dollars in millions): |
| | | | | | | |
| |
| 2019 | | 2018 |
Sweep deposits: | | | |
Brokerage sweep deposits | $ | i 27,949 |
| | $ | i 39,322 |
|
Bank
sweep deposits(1) | i 6,355 |
| | i — |
|
Savings
deposits(2) | i 2,592 |
| | i 4,133 |
|
Other
deposits(3) | i 1,710 |
| | i 1,858 |
|
Total
deposits | $ | i 38,606 |
| | $ | i 45,313 |
|
| |
(1) | Beginning
November 2019, bank sweep deposits include Premium Savings Accounts participating in the newly established bank sweep deposit account program. |
| |
(2) | Savings deposits include $ i 1.0 billion and $ i 2.0
billion of deposits at December 31, 2019, and 2018, respectively, in our Premium Savings Account product. |
/ | |
(3) | Includes checking deposits, money market deposits and certificates of deposit. As of December 31, 2019 and 2018, the Company had $ i 197
million and $ i 193 million in non-interest bearing deposits, respectively. |
/ The decrease in deposits during the year ended December 31, 2019 was primarily driven by the balance sheet repositioning during
the second quarter 2019, partially offset by growth in our Premium Savings Account product. The bank sweep deposit program, which launched in November 2019, provides the Company with the ability to transfer amounts held on deposit in E*TRADE Bank Premium Savings Accounts to an FDIC-insured account at one or more participating banks if desired. As the bank sweep deposit program was established to allow for reciprocal deposits, E*TRADE Bank may also accept deposits from customers of the participating third-party banks. Bank sweep deposits included $ i 1.0
billion of reciprocal deposits received from third-party banks at December 31, 2019. See Note 6—Available-for-Sale and Held-to-Maturity Securities for additional information.
E*TRADE 2019 10-K | Page 144
E*TRADE
FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
i |
|
NOTE 13—OTHER BORROWINGS AND CORPORATE DEBT |
Other Borrowings
i |
| | | | | | | | |
Description | Maturity Date | Borrower | Outstanding | Available |
Senior
unsecured, committed revolving credit facility(1) | June 2024 | ETFC | $ | i — |
| $ | i 300 |
|
FHLB
secured credit facility | Determined at trade | ETB | $ | i — |
| $ | i 6,837 |
|
Federal
Reserve Bank discount window | Overnight | ETB | $ | i — |
| $ | i 1,336 |
|
Senior
unsecured, committed revolving credit facility(2) | June 2020 | ETS | $ | i — |
| $ | i 600 |
|
Secured,
committed lines of credit | June 2020 | ETS | $ | i — |
| $ | i 175 |
|
Unsecured,
uncommitted lines of credit | June 2020 | ETS | $ | i — |
| $ | i 50 |
|
Unsecured,
uncommitted lines of credit | None | ETS | $ | i — |
| $ | i 75 |
|
Secured,
uncommitted lines of credit | None | ETS | $ | i — |
| $ | i 425 |
|
| |
(1) | On
June 21, 2019, the Company entered into a new five year, $ i 300 million senior unsecured committed revolving credit facility, which replaced its three year
senior unsecured committed revolving credit facility entered into on June 23, 2017. The senior unsecured committed revolving credit facility contains certain covenants, including maintenance covenants related to the Company's interest coverage, leverage and regulatory net capital ratios with which the Company was in compliance at December 31, 2019. |
/ | |
(2) | On
June 21, 2019, E*TRADE Securities entered into a 364-day, $ i 600 million senior unsecured committed revolving credit facility, which replaced its 364-day senior unsecured committed revolving credit facility entered into on June
22, 2018. The senior unsecured committed revolving credit facility contains certain covenants, including maintenance covenants related to E*TRADE Securities' minimum consolidated tangible net worth and regulatory net capital ratio with which the Company was in compliance at December 31, 2019. |
Corporate Debt
i The following tables present the significant components of E*TRADE Financial's corporate
debt (dollars in millions): |
| | | | | | | | | | | |
| Face Value | | Discount | | Net |
| | | | | |
Interest-bearing
notes: | | | | | |
2.95% Senior Notes, due 2022 | $ | i 600 |
| | $ | ( i 3 | ) | | $ | i 597 |
|
3.80%
Senior Notes, due 2027 | i 400 |
| | ( i 3 | ) | | i 397 |
|
4.50%
Senior Notes, due 2028 | i 420 |
| | ( i 4 | ) | | i 416 |
|
Total
corporate debt | $ | i 1,420 |
| | $ | ( i 10 | ) | | $ | i 1,410 |
|
|
| | | | | | | | | | | |
| | | | | |
Interest-bearing notes: | | | | | |
2.95% Senior Notes, due 2022 | $ | i 600 |
| | $ | ( i 4 | ) | | $ | i 596 |
|
3.80%
Senior Notes, due 2027 | i 400 |
| | ( i 3 | ) | | i 397 |
|
4.50%
Senior Notes, due 2028 | i 420 |
| | ( i 4 | ) | | i 416 |
|
Total
corporate debt | $ | i 1,420 |
| | $ | ( i 11 | ) | | $ | i 1,409 |
|
/ /
E*TRADE
2019 10-K | Page 145
E*TRADE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Issuance of Corporate Debt
2018 Issuances
During the year ended December
31, 2018, the Company issued $ i 420 million in aggregate principal amount of Senior Notes due 2028. The Senior Notes bear interest at an annual rate of i 4.50%
and will mature on June 20, 2028. The Senior Notes are our general unsecured senior obligations and rank equally in right of payment with all of our existing and future unsubordinated indebtedness. The Senior Notes effectively rank junior to our secured indebtedness, if any, to the extent of the collateral securing such indebtedness, and are structurally subordinated to all liabilities of our subsidiaries. The Senior Notes are not guaranteed by the subsidiaries. Net proceeds from the issuance of $ i 420
million Senior Notes were used to redeem all outstanding TRUPs during the year ended December 21, 2018. In connection with the redemption, the Company recognized a loss on early extinguishment of debt of $ i 4 million, consisting of the difference between the carrying value of the TRUPs redeemed, including unamortized debt issuance costs, and the
total cash amount paid, including related fees and expenses. Ranking of Debt Seniority
All of the Company’s notes rank equal in right of payment with all of the Company’s existing and future unsubordinated indebtedness and rank senior in right of payment to all its existing and future subordinated indebtedness. However, the notes rank effectively junior to the Company's secured indebtedness to the extent of the collateral securing such indebtedness.
E*TRADE 2019 10-K | Page 146
E*TRADE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
i i The
components of income tax expense for the years ended December 31, 2019, 2018 and 2017 were as follows (dollars in millions): |
| | | | | | | | | | | |
| |
| 2019 | | 2018 | | 2017 |
Current
income tax expense (benefit): | | | | | |
Federal | $ | i 63 |
| | $ | i — |
| | $ | i — |
|
State | i 26 |
| | i 13 |
| | ( i 11 | ) |
Total
current | i 89 |
| | i 13 |
| | ( i 11 | ) |
Deferred
income tax expense (benefit): | | | | | |
Federal | i 181 |
| | i 266 |
| | i 399 |
|
State | i 64 |
| | i 73 |
| | i 51 |
|
Total
deferred | i 245 |
| | i 339 |
| | i 450 |
|
Non-current
income tax expense(1) | i 30 |
| | i 14 |
| | i 11 |
|
Income
tax expense | $ | i 364 |
| | $ | i 366 |
| | $ | i 450 |
|
/ | |
(1) | Non-current
income tax expense primarily relates to amortization for investments in qualified affordable housing projects recognized under the proportional amortization method and uncertain tax positions. |
Income tax expense for the year ended December 31, 2018 reflects the impact of the TCJA, which was enacted on December 22, 2017 and resulted in remeasurement of certain deferred tax assets and liabilities during the year ended December 31, 2017 at the new statutory federal corporate income tax rate of i 21%.
Accordingly, the Company recognized $ i 58 million of additional tax expense for the year ended December 31, 2017. /
E*TRADE
2019 10-K | Page 147
E*TRADE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Unrecognized Tax Benefits
i The
following table provides a reconciliation of the beginning and ending amount of unrecognized tax benefits for the years ended December 31, 2019, 2018, and 2017 (dollars in millions): |
| | | | | | | | | | | |
| |
| 2019 | | 2018 | | 2017 |
Unrecognized
tax benefits, beginning of period | $ | i 31 |
| | $ | i 25 |
| | $ | i 28 |
|
Additions
based on tax positions related to prior years | i 2 |
| | i 3 |
| | i 1 |
|
Additions
based on tax positions related to current year | i 11 |
| | i 9 |
| | i 11 |
|
Reductions
based on tax positions related to prior years | ( i 2 | ) | | i — |
| | ( i 3 | ) |
Settlements
with taxing authorities | i — |
| | ( i 2 | ) | | ( i 6 | ) |
Statute
of limitations lapses | ( i 3 | ) | | ( i 4 | ) | | ( i 6 | ) |
Unrecognized
tax benefits, end of period | $ | i 39 |
| | $ | i 31 |
| | $ | i 25 |
|
/ The
unrecognized tax benefits increased $ i 8 million to $ i 39 million during the year ended December 31,
2019. At December 31, 2019, the Company had $ i 31 million, net of federal benefits, of unrecognized tax benefits that, if recognized, would favorably impact the effective income tax rate in future periods. i The
following table summarizes the tax years that are either currently under examination or remain open to assessment under the statute of limitations and subject to examination by the major tax jurisdictions in which the Company operates: |
| |
Jurisdiction | Open Tax Years |
Hong Kong | 2013-2018 |
Philippines | 2016-2019 |
United
Kingdom | 2017 |
United States | 2016-2019 |
Various states(1) | 2013-2019 |
| |
(1) | Major state tax jurisdictions include California, Georgia, Illinois, New York and Virginia. |
It is reasonably possible that the Company's
unrecognized tax benefits could be reduced by as much as $ i 7 million within the next twelve months as a result of settlements of certain examinations or expiration of statutes of limitations. The Company accrues interest and penalties, if any, related to income tax matters in income tax expense. The
Company has total reserves for interest and penalties of $ i 6 million and $ i 3
million as of December 31, 2019 and 2018, respectively.
E*TRADE 2019 10-K | Page 148
E*TRADE
FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Deferred Taxes and Valuation Allowances
Deferred income taxes are recorded when revenues and expenses are recognized in different periods for financial statement and tax return purposes. i The temporary differences and tax carryforwards that created deferred tax assets and deferred tax liabilities at December 31,
2019 and 2018 are summarized in the following table (dollars in millions): |
| | | | | | | |
| |
| 2019 | | 2018 |
Deferred
tax assets: | | | |
Net operating losses | $ | i 96 |
| | $ | i 162 |
|
Reserves
and allowances, net | i 70 |
| | i 105 |
|
Leasing
liability | i 58 |
| | i — |
|
Deferred
compensation | i 20 |
| | i 34 |
|
Financial
instrument valuations | i 1 |
| | i 54 |
|
Tax
credits | i 2 |
| | i 69 |
|
Other | i — |
| | i 1 |
|
Total
deferred tax assets | i 247 |
| | i 425 |
|
Valuation
allowance | ( i 20 | ) | | ( i 20 | ) |
Total
deferred tax assets, net of valuation allowance | i 227 |
| | i 405 |
|
Deferred
tax liabilities: | | | |
Depreciation and amortization | ( i 506 | ) | | ( i 413 | ) |
Leasing
asset | ( i 52 | ) | | i — |
|
Other | ( i 6 | ) | | ( i 2 | ) |
Total
deferred tax liabilities | ( i 564 | ) | | ( i 415 | ) |
Deferred
tax liabilities, net | $ | ( i 337 | ) | | $ | ( i 10 | ) |
The
Company had $ i 14 million of gross federal net operating losses, or $ i 3
million in deferred tax assets related to these losses, at December 31, 2019 that is limited by Internal Revenue Code section 382. There is i no valuation allowance recorded against federal net operating losses. In addition, the Company had $ i 1.9
billion of gross state net operating losses, or $ i 93 million in deferred tax assets related to these losses, at December 31, 2019. The $ i 20
million valuation allowance relates to state net operating losses, which expire between 2026 and 2038. Deferred tax assets, net and deferred tax liabilities are recorded in the Other assets and Other liabilities line items respectively on the consolidated balance sheet. i The following table provides a reconciliation of the beginning and ending amount of valuation allowance for the years ended December 31, 2019, 2018,
and 2017 (dollars in millions): |
| | | | | | | | | | | |
| |
| 2019 | | 2018 | | 2017 |
Valuation
allowance, beginning of period | $ | ( i 20 | ) | | $ | ( i 23 | ) | | $ | ( i 35 | ) |
Additions
related to reduced federal benefit | i — |
| | i — |
| | ( i 4 | ) |
Reductions
related to the wind-down of foreign operations | i 1 |
| | i 2 |
| | i 14 |
|
(Additions)
reductions related to state valuation allowance | ( i 1 | ) | | i 1 |
| | i 2 |
|
Valuation
allowance, end of period | $ | ( i 20 | ) | | $ | ( i 20 | ) | | $ | ( i 23 | ) |
/
E*TRADE
2019 10-K | Page 149
E*TRADE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Effective Tax Rate
i The effective tax rate differed from the federal statutory rate as summarized in the following table for the years ended December 31, 2019, 2018 and 2017: |
| | | | | | | | |
| |
| 2019 | | 2018 | | 2017 |
Federal
statutory tax rate | i 21.0 | % | | i 21.0 | % | | i 35.0 | % |
State
income taxes, net of federal tax benefit | i 5.0 |
| | i 5.1 |
| | i 4.2 |
|
Disallowed
executive compensation | i 0.3 |
| | i 0.2 |
| | i 0.1 |
|
Change
in valuation allowances | i — |
| | i — |
| | ( i 0.1 | ) |
Tax
credits | ( i 0.1 | ) | | ( i 0.1 | ) | | ( i 0.3 | ) |
Estimated
reserve for uncertain tax positions | i 0.7 |
| | i 0.2 |
| | ( i 0.3 | ) |
Deferred
tax adjustments | i 0.5 |
| | ( i 0.5 | ) | | ( i 0.3 | ) |
Tax
reform adjustments | i — |
| | i — |
| | i 5.5 |
|
Excess
tax benefit on share-based compensation | ( i 0.2 | ) | | ( i 0.6 | ) | | ( i 0.7 | ) |
Other | i 0.4 |
| | i 0.5 |
| | ( i 0.9 | ) |
Effective
tax rate | i 27.6 | % | | i 25.8 | % | | i 42.2 | % |
/ i |
|
NOTE
15—SHAREHOLDERS' EQUITY |
Preferred Stock
i The following table presents the preferred stock outstanding (in millions except total shares outstanding and per share data): |
| | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | Carrying
Value at December 31, |
Description | | Issuance Date | | Per Annum Dividend Rate | | Total Shares Outstanding | | Liquidation Preference per Share | | 2019 | | 2018 |
Series
A | | | | | | | | | | | | |
Fixed-to-Floating Rate Non-Cumulative | | 8/25/2016 | | 5.875%
to, but excluding, 9/15/2026; 3-mo LIBOR + 4.435% thereafter | | i 400,000 |
| | $ | i 1,000 |
| | $ | i 394 |
| | $ | i 394 |
|
Series
B | | | | | | | | | | | | |
Fixed-to-Floating Rate Non-Cumulative | | 12/6/2017 | | 5.30%
to, but excluding, 3/15/2023; 3-mo LIBOR + 3.16% thereafter | | i 3,000 |
| | $ | i 100,000 |
| | i 295 |
| | i 295 |
|
Total | | | | | | i 403,000 |
| | | | $ | i 689 |
| | $ | i 689 |
|
/ /
E*TRADE
2019 10-K | Page 150
E*TRADE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Dividend on Preferred Stock
i The
following table presents the cash dividends paid on preferred stock (in millions except per share data): |
| | | | | | | | | | | | |
|
Declaration Date | | Record Date | | Payment
Date | | Dividend per Share | | Dividend Paid |
Series A (1) | | | | | | | | |
i 2/7/2019 | | i 2/28/2019 | | i 3/15/2019 | | $ | i 29.38 |
| | $ | i 12 |
|
i 7/25/2019 | | i 8/30/2019 | | i 9/16/2019 | | $ | i 29.38 |
| | i 12 |
|
Series
B (1) | | | | | | | | |
i 2/7/2019 | | i 2/28/2019 | | i 3/15/2019 | | $ | i 2,650.00 |
| | i 8 |
|
i 7/25/2019 | | i 8/30/2019 | | i 9/16/2019 | | $ | i 2,650.00 |
| | i 8 |
|
Total | | | | | | | | $ | i 40 |
|
| | | | | | | | |
|
Declaration Date | | Record Date | | Payment Date | | Dividend per Share | | Dividend Paid |
Series A (1) | | | | | | | | |
i 2/8/2018 | | i 2/28/2018 | | i 3/15/2018 | | $ | i 29.38 |
| | $ | i 12 |
|
i 7/26/2018 | | i 8/31/2018 | | i 9/17/2018 | | $ | i 29.38 |
| | i 12 |
|
Series
B (1) | | | | | | | | |
i 7/26/2018 | | i 8/31/2018 | | i 9/17/2018 | | $ | i 4,107.50 |
| | i 12 |
|
Total | | | | | | | | $ | i 36 |
|
| | | | | | | | |
|
Declaration Date | | Record Date | | Payment Date | | Dividend per Share | | Dividend Paid |
Series A (1) | | | | | | | | |
i 2/2/2017 | | i 2/28/2017 | | i 3/15/2017 | | $ | i 32.64 |
| | $ | i 13 |
|
i 8/2/2017 | | i 8/31/2017 | | i 9/15/2017 | | $ | i 29.38 |
| | i 12 |
|
Total | | | | | | | | $ | i 25 |
|
/ | |
(1) | Dividends
are non-cumulative and payable semi-annually, if declared. |
On February 6, 2020, the Company declared a cash dividend of $ i 29.38 per share on its Series
A Fixed-to-Floating Rate Non-Cumulative Perpetual Preferred Stock and $ i 2,650.00 per share (equivalent to $ i 26.50
per depository share) on its Series B Fixed-to-Floating Rate Non-Cumulative Perpetual Preferred Stock. The dividends are payable on March 16, 2020, to shareholders of record as of the close of business on March 2, 2020.
E*TRADE 2019 10-K | Page 151
E*TRADE
FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Common Stock
Dividend on Common Stock
i The following table presents the cash dividends paid on common stock (in millions except per share data): |
| | | | | | | | | | | | |
|
Declaration Date | | Record Date | | Payment Date | | Dividend per Share | | Dividend Paid |
i 1/23/2019 | | i 2/1/2019 | | i 2/15/2019 | | $ | i 0.14 |
| | $ | i 35 |
|
i 4/16/2019 | | i 5/13/2019 | | i 5/20/2019 | | $ | i 0.14 |
| | i 34 |
|
i 7/17/2019 | | i 8/19/2019 | | i 8/26/2019 | | $ | i 0.14 |
| | i 34 |
|
i 10/16/2019 | | i 11/8/2019 | | i 11/15/2019 | | $ | i 0.14 |
| | i 32 |
|
Total | | | | | | | | $ | i 135 |
|
| | | | | | | | |
|
Declaration Date | | Record Date | | Payment Date | | Dividend per Share | | Dividend Paid |
i 10/17/2018 | | i 10/30/2018 | | i 11/15/2018 | | $ | i 0.14 |
| | $ | i 36 |
|
Total | | | | | | | | $ | i 36 |
|
/ Share Repurchases
In October 2018, the Company announced that its board of directors authorized the repurchase of up to $ i 1
billion of shares of its common stock. During 2019, the Company completed this $1 billion share repurchase program with the repurchase of i 10.8 million shares of common stock at an average price of $ i 46.18
per share, or $ i 499 million during the year. In July 2019, the Company announced that its board of directors authorized a new $ i 1.5
billion share repurchase program. As of December 31, 2019, the Company had repurchased i 14.0 million shares of common stock at an average price of $ i 41.97
per share, or $ i 586 million under the new program. In total, we utilized $ i 1.1
billion to repurchase i 24.8 million shares at an average price of $ i 43.81
under these programs during the year ended December 31, 2019. The Company accounts for share repurchases retired after repurchase by allocating the excess repurchase price over par to additional paid-in-capital. Other Common Stock Activity
Other common stock activity includes shares withheld to pay taxes for share-based compensation, employee stock purchase plan and other activity. During the year ended December 31, 2017, it also includes a $ i 3
million conversion of the Company's convertible debentures into i 0.3 million shares of common stock. There were i no
conversions of convertible debentures during the years ended December 31, 2018 and 2019.
E*TRADE 2019 10-K | Page 152
E*TRADE FINANCIAL CORPORATION
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
Accumulated Other Comprehensive Loss
i The following tables present after-tax changes in each component of accumulated other comprehensive loss (dollars in millions): |
| | | | | | | |
| 2019 | | 2018 |
Accumulated
other comprehensive loss, beginning of period(1) | $ | ( i 275 | ) | | $ | ( i 26 | ) |
Other
comprehensive income (loss) before reclassifications | i 224 |
| | ( i 203 | ) |
Amounts
reclassified from accumulated other comprehensive loss | i 23 |
| | ( i 31 | ) |
Transfer
of held-to-maturity securities to available-for-sale securities(2) | i — |
| | i 6 |
|
Net
change | i 247 |
| | ( i 228 | ) |
Cumulative
effect of hedge accounting adoption | i — |
| | ( i 7 | ) |
Reclassification
of tax effects due to federal tax reform | i — |
| | ( i 14 | ) |
Accumulated
other comprehensive loss, end of period(1)(3) | $ | ( i 28 | ) | | ( i 275 | ) |
| |
(1) | The
accumulated other comprehensive loss balances and activities were related to available-for-sale securities in both periods. |
| |
(2) | Securities with a carrying value of $ i 4.7 billion and related unrealized pre-tax gain of $ i 7
million, or $6 million net of tax, were transferred from held-to-maturity securities to available-for-sale securities during the year ended December 31, 2018, as part of a one-time transition election for early adopting the new derivatives and hedge accounting guidance. |
| |
(3) | Includes unamortized unrealized pre-tax losses of $ i 21
million at December 31, 2019 of which $ i 1 million and $ i 14
million are related to the transfer of available-for-sale securities to held-to-maturity securities during the years ended December 31, 2019 and 2018, respectively. |
|
| | | | | | | | | | | |
| Available-for-Sale
Securities | | Foreign
Currency
Translation | | Total |
| $ | ( i 139 | ) | | $ | i 2 |
| | $ | ( i 137 | ) |
Other
comprehensive income before reclassifications | i 137 |
| | i — |
| | i 137 |
|
Amounts
reclassified from accumulated other comprehensive loss | ( i 24 | ) | | ( i 2 | ) | | ( i 26 | ) |
Net
change | i 113 |
| | ( i 2 | ) | | i 111 |
|
| $ | ( i 26 | ) | | $ | i — |
| | $ | ( i 26 | ) |
/
E*TRADE
2019 10-K | Page 153
E*TRADE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
i The
following table presents other comprehensive income (loss) activity and the related tax effect (dollars in millions): |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| |
| 2019 | | 2018 | | 2017 |
| Before Tax | | Tax Effect | | After Tax | | Before
Tax | | Tax Effect | | After Tax | | Before Tax | | Tax Effect | | After Tax |
Other comprehensive income (loss) | | | | | | | | | | | | | | | | | |
Available-for-sale
securities: | | | | | | | | | | | | | | | | | |
Unrealized
gains (losses), net | $ | i 300 |
| | $ | ( i 76 | ) | | $ | i 224 |
| | $ | ( i 272 | ) | | $ | i 69 |
| | $ | ( i 203 | ) | | $ | i 213 |
| | $ | ( i 76 | ) | | $ | i 137 |
|
Reclassification
into earnings, net | i 32 |
| | ( i 9 | ) | | i 23 |
| | ( i 42 | ) | | i 11 |
| | ( i 31 | ) | | ( i 39 | ) | | i 15 |
| | ( i 24 | ) |
Transfer
of held-to-maturity securities to available-for-sale securities | i — |
| | i — |
| | i — |
| | i 7 |
| | ( i 1 | ) | | i 6 |
| | i — |
| | i — |
| | i — |
|
Net
change from available-for-sale securities | i 332 |
|
| ( i 85 | ) |
| i 247 |
| | ( i 307 | ) | | i 79 |
| | ( i 228 | ) | | i 174 |
| | ( i 61 | ) | | i 113 |
|
Reclassification
of foreign currency translation into earnings, net | i — |
| | i — |
| | i — |
| | i — |
| | i — |
| | i — |
| | ( i 2 | ) | | i — |
| | ( i 2 | ) |
Other
comprehensive income (loss) | $ | i 332 |
| | $ | ( i 85 | ) | | $ | i 247 |
| | $ | ( i 307 | ) | | $ | i 79 |
| | $ | ( i 228 | ) | | $ | i 172 |
| | $ | ( i 61 | ) | | $ | i 111 |
|
/ i The
following table presents the consolidated statements of income line items impacted by reclassifications out of accumulated other comprehensive loss (dollars in millions): |
| | | | | | | | | | | | | | |
Accumulated Other Comprehensive Loss Components | | Amounts Reclassified from Accumulated Other Comprehensive Loss | | Affected
Line Items in the Consolidated Statements of Income |
| | | | |
| | 2019 | | 2018 | | 2017 | | |
Available-for-sale
securities: | | $ | ( i 29 | ) | | $ | i 45 |
| | $ | i 39 |
| | Gains
(losses) on securities and other, net |
| | ( i 3 | ) | | ( i 3 | ) | | i — |
| | Interest
income |
| | ( i 32 | ) | | i 42 |
| | i 39 |
| | Reclassification
into earnings, before tax |
| | i 9 |
| | ( i 11 | ) | | ( i 15 | ) | | Income
tax benefit (expense) |
| | $ | ( i 23 | ) | | $ | i 31 |
| | $ | i 24 |
| | Reclassification
into earnings, net |
| | | | | | | | |
Foreign currency translation: | | $ | i — |
| | $ | i — |
| | $ | i 2 |
| | Other
non-interest expenses |
| | $ | i — |
| | $ | i — |
| | $ | i 2 |
| | Reclassification
into earnings, net |
/
E*TRADE 2019 10-K | Page 154
E*TRADE
FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
i |
|
NOTE 16—EARNINGS PER SHARE |
Net income available to common shareholders, or net income less preferred stock dividends, represents the numerator used in the computation of basic and diluted earnings per common share. The denominators used in the computation of basic and diluted earnings per common share are
basic and diluted weighted average common shares outstanding, respectively.
Basic weighted average common shares outstanding were i 237.4 million, i 260.6
million and i 273.2 million for the years ended December 31, 2019, 2018 and 2017, respectively. The difference between basic and diluted weighted average common shares outstanding includes the weighted-average dilutive impact of securities, including restricted stock units and awards, dividend equivalent units, employee stock purchase plan shares and stock options, as well
as the weighted-average dilutive impact of convertible debentures. This activity represented i 0.5 million, i 1.1
million and i 1.2 million shares for the years ended December 31, 2019, 2018 and 2017, respectively. This resulted in diluted weighted average common shares outstanding of i 237.9
million, i 261.7 million and i 274.4
million for the years ended December 31, 2019, 2018 and 2017, respectively. The amount of certain restricted stock and options excluded from the calculations of diluted earnings per common share due to the anti-dilutive effect was not material for the years ended December 31, 2019, 2018 and 2017. /
E*TRADE 2019 10-K | Page 155
E*TRADE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
i |
|
NOTE
17—SHARE-BASED COMPENSATION, EMPLOYEE INCENTIVE AND RETIREMENT PLANS |
Share-Based Compensation Plans
In 2015, the Company adopted and the shareholders approved the 2015 Omnibus Incentive Plan (2015 Plan), which replaced the 2005 Stock Incentive Plan (2005 Plan). The 2015 Plan provides the Company the ability to grant equity awards to officers, directors, employees and consultants, including, but not limited to, nonqualified or incentive stock options, restricted stock awards, restricted stock units and deferred restricted stock units at a price based on the date of the grant. The Company typically
issues new shares upon exercise of stock options and vesting of other equity awards. Under the 2015 Plan, the remaining unissued authorized shares of the 2005 Plan that are not subject to outstanding awards thereunder were authorized for issuance. Additionally, any shares that had been awarded but remained unissued under the 2005 Plan that were subsequently canceled, forfeited, or reacquired by the Company would be authorized for issuance under the 2015 Plan. As of December 31, 2019, i 6.9
million shares were available for grant under the 2015 Plan. The Company recognized $ i 53 million, $ i 46
million and $ i 41 million in share-based compensation expense for the years ended December 31, 2019, 2018 and 2017, respectively. Total unrecognized compensation expense related to non-vested restricted stock awards, restricted stock units, and performance share units was $ i 46
million as of December 31, 2019. This cost is expected to be recognized over a weighted-average period of 1.6 years. Employee Stock Option Plans
Through 2011, the Company issued options to directors and to certain of the Company's officers and employees. Options generally vested ratably over a two- to four-year period from the date of grant and expired within seven to ten years from the date of grant. Certain options provide for accelerated vesting upon a change of control. The Company measures compensation expense based on the exercise price which
is equal to the fair value of the shares on the grant date. As of December 31, 2019, there were i no options outstanding and i no
unrecognized compensation expense related to non-vested stock options. Restricted Stock Awards
The Company issues restricted stock awards to directors. Restricted stock awards are issued at the fair value on the date of grant and vest one year from the date of issuance. At December 31, 2019 there were less than i 0.1
million restricted stock awards outstanding. Non-employee directors may also elect to defer all or a portion of their cash and equity compensation into deferred restricted stock units. Restricted Stock and Performance Share Units
The Company issues restricted stock units to certain of the Company's officers and employees. Each restricted stock unit can be converted into i one
share of the Company’s common stock upon vesting. These restricted stock units are issued at the fair value on the date of grant and vest ratably over the requisite service period, generally one to four years. /
E*TRADE 2019 10-K | Page 156
E*TRADE
FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Beginning in 2015, the Company also issued performance share units to certain of the Company’s officers. Each performance share unit can be converted into i one
share of the Company’s common stock upon vesting. Vesting of performance share units is contingent upon achievement of certain predefined performance targets over the performance period. These performance share units are issued at the fair value on the date of grant. Performance share units granted prior to 2019 vest over three successive one-year performance periods based upon the achievement of performance targets. Beginning in 2019, performance share units vest over a single three-year performance period. i A
summary of restricted stock and performance stock unit activity is presented below (shares in thousands): |
| | | | | | | | | | | | | |
| Restricted Stock Units | | Performance Share Units |
| Units | | Weighted
Average Grant Date Fair Value | | Units | | Weighted Average Grant Date Fair Value |
| i 1,987 |
| | $ | i 39.87 |
| | i 229 |
| | $ | i 47.24 |
|
Granted(1) | i 1,053 |
| | i 45.86 |
| | i 180 |
| | i 46.70 |
|
Vested(1) | ( i 1,050 | ) | | i 34.53 |
| | ( i 142 | ) | | i 48.66 |
|
Forfeited | ( i 85 | ) | | i 44.80 |
| | i — |
| | i — |
|
| i 1,905 |
| | i 44.84 |
| | i 267 |
| | i 46.12 |
|
| | | | | | | |
| i 1,859 |
| | i 44.80 |
| | | | |
/ | |
(1) | The
number of performance share units granted and vested includes the impact of the achievement of performance targets. |
The total fair value of restricted stock awards, restricted stock units and performance share units that vested was $ i 56 million, $ i 76
million and $ i 58 million during the years ended December 31, 2019, 2018 and 2017, respectively. On the date that the
Company pays a common stock dividend, holders of restricted stock units, deferred restricted stock units and performance stock units are granted dividend equivalent units which are forfeitable and are subject to the same vesting terms as the stock units with respect to which they have been awarded. The amount of such dividend equivalent units are not material to the year ended December 31, 2019 or December 31, 2018 and are included in the number of shares granted. Employee Incentive and Retirement Plans
Employee Stock Purchase Plan
In May 2018, the shareholders of the
Company approved the 2018 Employee Stock Purchase Plan (2018 ESP Plan), and reserved i 4.0 million shares of common stock for sale to employees at a price no less than i 85%
of the fair market value per share of the common stock on the purchase date. The Company currently offers six month enrollment periods at the end of which employees can purchase shares of the Company's common stock at a price equal to i 95%
of the closing market price on the date of purchase. The initial offering period began on September 1, 2018. i No share-based compensation expense was recorded in connection with the 2018 ESP Plan as it was deemed non-compensatory. Employees purchased i 90,348
shares under the plan during the year ended December 31, 2019.
E*TRADE 2019 10-K | Page 157
E*TRADE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
401(k) Plan
The Company has a 401(k) salary deferral program for eligible employees who have met certain service requirements. The Company matches certain employee contributions; additional contributions to this plan are at the discretion of the Company. Total contribution expense under this plan was $ i 21
million, $ i 19 million and $ i 11
million for the years ended December 31, 2019, 2018, and 2017 respectively. i |
|
NOTE 18—REGULATORY REQUIREMENTS |
Broker-Dealer
and FCM Capital Requirements
The Company's US broker-dealer, E*TRADE Securities, is subject to the Uniform Net Capital Rule under the Securities Exchange Act of 1934 administered by the SEC and FINRA, which requires the maintenance of minimum net capital. The minimum net capital requirements can be met under either the Aggregate Indebtedness method or the Alternative method. Under the Aggregate Indebtedness method, a broker-dealer is required to maintain net capital equal to or in excess of the greater of 6 2/3% of its aggregate indebtedness, as defined, or a minimum dollar amount. E*TRADE Securities has elected the Alternative method, under which it is required to maintain net capital equal to the greater of $ i 250,000
or i 2% of aggregate debit balances arising from customer transactions. The Company's FCM, E*TRADE Futures, is subject to CFTC net capital requirements, including the maintenance of adjusted net capital equal to or in excess of the greater of (1) $ i 1,000,000,
(2) the FCM's risk-based capital requirement, computed as i 8% of the total risk margin requirements for all positions carried in customer and non-customer accounts, or (3) the amount of adjusted net capital required by the NFA. At December 31, 2019 and 2018,
all of the Company’s broker-dealer and FCM subsidiaries met applicable minimum net capital requirements. i The following table presents a summary of the minimum net capital requirements and excess capital for the Company’s broker-dealer and FCM subsidiaries
(dollars in millions): |
| | | | | | | | | | | |
| Required Net Capital | | Net Capital | | Excess Net Capital |
| | | | | |
E*TRADE Securities(1) | $ | i 223 |
| | $ | i 1,251 |
| | $ | i 1,028 |
|
E*TRADE
Futures | i 3 |
| | i 28 |
| | i 25 |
|
Total(2) | $ | i 226 |
| | $ | i 1,279 |
| | $ | i 1,053 |
|
| | | | | |
| | | | | |
E*TRADE Securities | $ | i 209 |
| | $ | i 1,294 |
| | $ | i 1,085 |
|
E*TRADE
Futures | i 1 |
| | i 26 |
| | i 25 |
|
International
broker-dealer | i — |
| | i 18 |
| | i 18 |
|
Total | $ | i 210 |
| | $ | i 1,338 |
| | $ | i 1,128 |
|
| |
(1) | E*TRADE
Securities paid dividends of $ i 910 million to the parent company during the year ended December 31, 2019. |
| |
(2) | The
Company's international broker-dealer de-registered and entered into voluntary liquidation in May 2019. The international broker-dealer was not subject to minimum net capital requirements at December 31, 2019. |
/
E*TRADE 2019 10-K | Page 158
E*TRADE
FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Bank Capital Requirements
E*TRADE Financial and its bank subsidiaries, E*TRADE Bank and E*TRADE Savings Bank, are subject to various regulatory capital requirements administered by federal banking agencies. Failure to meet minimum capital requirements can trigger certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the financial condition and results of operations of these entities. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, these entities must meet specific capital guidelines that involve quantitative measures of assets, liabilities
and certain off-balance sheet items as calculated under regulatory accounting practices. In addition, the Company's bank subsidiaries may not pay dividends to the parent company without the non-objection, or in certain cases the approval, of their regulators, and any loans by the bank subsidiaries to the parent company or its other non-bank subsidiaries are subject to various quantitative, arm’s length, collateralization and other requirements. The capital amounts and classifications of these entities are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Quantitative
measures established by regulation to ensure capital adequacy require these entities to meet minimum Tier 1 leverage, Common Equity Tier 1 capital, Tier 1 risk-based capital and Total risk-based capital ratios. Events beyond management's control, such as deterioration in credit markets, could adversely affect future earnings and their ability to meet future capital requirements. i E*TRADE Financial, E*TRADE Bank and E*TRADE Savings Bank were categorized as "well capitalized" under
the regulatory framework for prompt corrective action for the periods presented in the following table (dollars in millions): |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | |
| Actual | | Well Capitalized Minimum Capital | | Excess Capital | | Actual | | Well
Capitalized Minimum Capital | | Excess Capital |
| Amount | | Ratio | | Amount | | Ratio | | Amount | | Amount | | Ratio | | Amount | | Ratio | | Amount |
E*TRADE
Financial(1) |
Tier 1 leverage | $ | i 4,035 |
| | i 6.9 | % | | $ | i 2,922 |
| | i 5.0 | % | | $ | i 1,113 |
| | $ | i 4,097 |
| | i 6.6 | % | | $ | i 3,101 |
| | i 5.0 | % | | $ | i 996 |
|
Common
Equity Tier 1 | $ | i 3,346 |
| | i 31.5 | % | | $ | i 692 |
| | i 6.5 | % | | $ | i 2,654 |
| | $ | i 3,408 |
| | i 31.1 | % | | $ | i 713 |
| | i 6.5 | % | | $ | i 2,695 |
|
Tier
1 risk-based | $ | i 4,035 |
| | i 37.9 | % | | $ | i 852 |
| | i 8.0 | % | | $ | i 3,183 |
| | $ | i 4,097 |
| | i 37.3 | % | | $ | i 877 |
| | i 8.0 | % | | $ | i 3,220 |
|
Total
risk-based | $ | i 4,060 |
| | i 38.2 | % | | $ | i 1,064 |
| | i 10.0 | % | | $ | i 2,996 |
| | $ | i 4,143 |
| | i 37.8 | % | | $ | i 1,097 |
| | i 10.0 | % | | $ | i 3,046 |
|
E*TRADE
Bank(1)(2) |
Tier 1 leverage | $ | i 3,240 |
| | i 7.2 | % | | $ | i 2,253 |
| | i 5.0 | % | | $ | i 987 |
| | $ | i 3,484 |
| | i 7.1 | % | | $ | i 2,461 |
| | i 5.0 | % | | $ | i 1,023 |
|
Common
Equity Tier 1 | $ | i 3,240 |
| | i 36.5 | % | | $ | i 577 |
| | i 6.5 | % | | $ | i 2,663 |
| | $ | i 3,484 |
| | i 34.9 | % | | $ | i 650 |
| | i 6.5 | % | | $ | i 2,834 |
|
Tier
1 risk-based | $ | i 3,240 |
| | i 36.5 | % | | $ | i 710 |
| | i 8.0 | % | | $ | i 2,530 |
| | $ | i 3,484 |
| | i 34.9 | % | | $ | i 800 |
| | i 8.0 | % | | $ | i 2,684 |
|
Total
risk-based | $ | i 3,257 |
| | i 36.7 | % | | $ | i 888 |
| | i 10.0 | % | | $ | i 2,369 |
| | $ | i 3,521 |
| | i 35.2 | % | | $ | i 999 |
| | i 10.0 | % | | $ | i 2,522 |
|
E*TRADE
Savings Bank(1) |
Tier 1 leverage | $ | i 1,480 |
| | i 40.7 | % | | $ | i 182 |
| | i 5.0 | % | | $ | i 1,298 |
| | $ | i 1,456 |
| | i 26.6 | % | | $ | i 273 |
| | i 5.0 | % | | $ | i 1,183 |
|
Common
Equity Tier 1 | $ | i 1,480 |
| | i 224.7 | % | | $ | i 43 |
| | i 6.5 | % | | $ | i 1,437 |
| | $ | i 1,456 |
| | i 169.4 | % | | $ | i 56 |
| | i 6.5 | % | | $ | i 1,400 |
|
Tier
1 risk-based | $ | i 1,480 |
| | i 224.7 | % | | $ | i 53 |
| | i 8.0 | % | | $ | i 1,427 |
| | $ | i 1,456 |
| | i 169.4 | % | | $ | i 69 |
| | i 8.0 | % | | $ | i 1,387 |
|
Total
risk-based | $ | i 1,480 |
| | i 224.7 | % | | $ | i 66 |
| | i 10.0 | % | | $ | i 1,414 |
| | $ | i 1,456 |
| | i 169.4 | % | | $ | i 86 |
| | i 10.0 | % | | $ | i 1,370 |
|
| |
(1) | Basel
III includes a capital conservation buffer that limits a banking organization’s ability to make capital distributions and discretionary bonus payments to executive officers if a banking organization fails to maintain a Common Equity Tier 1 capital conservation buffer of more than i 2.5%, on a fully phased-in basis, of total risk-weighted assets above each of the following minimum risk-based capital ratio requirements: Common Equity Tier 1 capital ( i 4.5%),
Tier 1 risk-based capital ( i 6.0%), and Total risk-based capital ( i 8.0%).
This requirement was effective beginning on January 1, 2016, and became fully phased-in on January 1, 2019. |
| |
(2) | E*TRADE Bank paid dividends of $ i 835
million to the parent company during the year ended December 31, 2019. |
E*TRADE 2019 10-K | Page 159
E*TRADE
FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
i |
|
NOTE 19—LEASE ARRANGEMENTS |
The Company enters into non-cancelable operating leases for its corporate offices, retail branches and other
facilities. These leases have remaining terms ranging from less than one to i 12 years, and the weighted-average remaining lease term for these leases is i 8.2 years.
Most leases include one or more options to renew, with renewal terms that can extend the lease term up to i 10 years. Only those renewal terms that the Company is reasonably certain of exercising are included in the calculation of the lease liability. Leases that have not yet commenced at December 31, 2019 will have an immaterial impact on the
Company's ROU assets and lease liabilities. Certain lease agreements include rental payments based on power usage or that adjust periodically for inflation or costs incurred by the lessor. None of the Company's current lease agreements contain material residual value guarantees or material restrictive covenants. i The following table presents balance sheet information related to the Company's classification of ROU assets
and operating lease liabilities (dollars in millions): |
| | | | | | |
| | Classification | | |
Operating lease assets, net | | Other assets | | $ | i 195 |
|
Operating
lease liabilities | | Other liabilities | | $ | i 235 |
|
In
December 2019, the Company exited its New York headquarters and consolidated related operations at its Jersey City, New Jersey location. The Company remeasured the ROU asset and lease liability, reducing them both by $ i 9 million respectively, to reflect the shortened lease term and recognized an impairment charge of $ i 6
million in restructuring and acquisition-related activities. Refer to Note 2—Acquisitions and Restructuring for further detail. The Company utilizes incremental borrowing rates to determine the present value of lease payments for each lease. As the Company's leases do not provide an implicit rate, the incremental borrowing rate estimates are based on the terms of each lease as well as the interest rate environment at the later of the adoption date of January 1, 2019, lease commencement date or lease remeasurement date. The incremental borrowing rate has also been adjusted to reflect a secured rate. A weighted-average discount
rate of i 4.3% was used to calculate the lease liability balances for the Company's operating leases. Leases with an initial term of twelve months or less are not recorded on the balance sheet; lease expense for these leases is recognized on a straight-line basis over the lease term. The
Company has elected not to separate lease and non-lease components for all property leases for the purposes of calculating ROU assets and lease liabilities. Cash paid for amounts included in the measurement of operating lease liabilities was $ i 29 million for the year ended December 31, 2019. i The
following table presents the significant components of lease expense (dollars in millions): |
| | | | | | |
| | Classification | | |
Operating lease cost(1) | | Occupancy
and Equipment | | $ | i 35 |
|
Variable lease cost | | Occupancy and Equipment | | $ | i 3 |
|
Net
lease expense(2) | | | | $ | i 38 |
|
| |
(1) | Includes
short-term lease costs which are not material. |
| |
(2) | Net of sublease income which is not material. |
/
E*TRADE 2019 10-K | Page 160
E*TRADE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
i The following table presents the maturities of lease liabilities (dollars in millions): |
| | | |
| Operating Leases |
| |
2020 | $ | i 39 |
|
2021 | i 37 |
|
2022 | i 35 |
|
2023 | i 34 |
|
2024 | i 29 |
|
Thereafter | i 107 |
|
Total
lease payments | i 281 |
|
Imputed interest | ( i 46 | ) |
Present
value of lease liabilities | $ | i 235 |
|
/ The Company executed a sale-leaseback transaction on
its Alpharetta, Georgia office in 2014. The transaction was initially accounted for as a financing as it did not qualify for sale accounting. The Company evaluated this transaction as part of the adoption of the new lease guidance in 2019 and concluded that it did not qualify for sale accounting and should continue to be accounted for as a financing. The office building is included in the property and equipment, net line item and the related financing obligation is included in the other liabilities line item in the Company's consolidated balance sheet. Future minimum lease payments and sublease proceeds to be received under the lease are $ i 24
million and $ i 9 million, respectively. i |
|
NOTE
20—COMMITMENTS, CONTINGENCIES AND OTHER REGULATORY MATTERS |
The Company reviews its lawsuits, regulatory inquiries and other legal proceedings on an ongoing basis and provides disclosure and records loss contingencies in accordance with the loss contingencies accounting guidance. The Company establishes an accrual for losses at management's best estimate when it assesses that it is probable that a loss has been incurred and the amount of the loss can be reasonably estimated. The Company monitors these matters for developments that would affect the likelihood of a loss and the accrued amount, if any, and adjusts the amount as appropriate. Litigation
Matters
On October 27, 2000, Ajaxo, Inc. (Ajaxo) filed a complaint in the Superior Court for the State of California, County of Santa Clara. Ajaxo sought damages and certain non-monetary relief for the Company’s alleged breach of a non-disclosure agreement with Ajaxo pertaining to certain wireless technology that Ajaxo offered the Company as well as damages and other relief against the Company for their alleged misappropriation of Ajaxo’s trade secrets. Following a jury trial, a judgment was entered in 2003 in favor of Ajaxo against the
Company for $ i 1 million for breach of the Ajaxo non-disclosure agreement. The trial court subsequently denied Ajaxo’s requests for additional damages and relief following which Ajaxo appealed. Although the Company paid Ajaxo the full amount due on the above-described judgment, the case was remanded back to the trial court by the California Court of Appeals, and on May 30,
2008, a jury returned a verdict in favor of the Company denying all claims raised and demands for damages against the Company. After various appeals the case was again remanded back to the trial court. Following the third trial in this matter, in a Judgment and Statement of Decision filed September 16, 2015, the Court denied all claims for /
E*TRADE 2019 10-K | Page 161
E*TRADE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
royalties by Ajaxo. Ajaxo’s post-trial motions were denied. Ajaxo has appealed to the Court of Appeals, Sixth District. The Company will continue to defend itself vigorously in this matter. On May 13, 2019, a FINRA Dispute Resolution Statement of Claim was received on behalf of an E*TRADE customer and the customer's limited liability company. The Statement
of Claim alleges that E*TRADE Securities and E*TRADE Capital Management violated Section 10(b) of the Securities Exchange Act, committed common law fraud, breached fiduciary duties, breached contractual duties, failed to supervise, and were negligent in the maintenance of the LLC’s accounts. The claim relates to margin liquidations from the LLC's accounts in February 2018. The Company intends to defend itself vigorously in this matter. In addition to the matters described above, the Company is subject to various legal proceedings and claims that arise in the normal course of business. In each pending matter, the Company contests liability or the amount of claimed damages.
In view of the inherent difficulty of predicting the outcome of such matters, particularly in cases where claimants seek substantial or indeterminate damages, or where investigation or discovery have yet to be completed, the Company is unable to estimate a range of reasonably possible losses on its remaining outstanding legal proceedings; however, the Company believes any losses, both individually or in the aggregate, should not be reasonably likely to have a material adverse effect on the consolidated financial condition or results of operations of the Company. An unfavorable outcome in any matter could have a material adverse effect on the
Company’s business, financial condition, results of operations or cash flows. In addition, even if the ultimate outcomes are resolved in the Company’s favor, the defense of such litigation could entail considerable cost or the diversion of the efforts of management, either of which could have a material adverse effect on the Company’s business, financial condition, results of operations or cash flows. Regulatory Matters
The securities, futures, foreign currency and banking industries are subject to extensive regulation under federal, state and applicable international laws. From time to time, the Company has been threatened
with or named as a defendant in lawsuits, arbitrations and administrative claims involving securities, banking and other matters. The Company is also subject to periodic regulatory examinations and inspections. Compliance and trading problems that are reported to regulators, such as the SEC, FINRA, NASDAQ, CFTC, NFA, FDIC, Federal Reserve Bank of Richmond, OCC, or the CFPB by dissatisfied customers or others are investigated by such regulators, and may, if pursued, result in formal claims being filed against the Company by customers or disciplinary action being taken against the Company or its employees by regulators. Any such claims or disciplinary actions that are decided against the
Company could have a material impact on the financial results of the Company or any of its subsidiaries. Insurance
The Company maintains insurance coverage that management believes is reasonable and prudent. The principal insurance coverage it maintains covers commercial general liability; property damage; hardware/software damage; cyber liability; directors and officers; employment practices liability; certain criminal acts against the Company; and errors and omissions. The
Company believes that such insurance coverage is adequate for the purpose of its business. The Company’s ability to maintain this level of insurance coverage in the future, however, is subject to the availability of affordable insurance in the marketplace.
E*TRADE 2019 10-K | Page 162
E*TRADE
FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Commitments
In the normal course of business, the Company makes various commitments to extend credit and incur contingent liabilities that are not reflected in the consolidated balance sheet. Significant changes in the economy or interest rates may influence the impact that these commitments and contingencies have on the Company in the future. The Company’s equity method investments, investments measured at cost and other investments are generally limited
liability investments in partnerships, companies and other similar entities, including tax credit partnerships and community development entities, which are not required to be consolidated. The Company had $ i 43 million in unfunded contingent investment commitments with respect to these investments at December 31, 2019. Guarantees
In prior periods when the Company sold loans, the
Company provided guarantees to investors purchasing mortgage loans, which are considered standard representations and warranties within the mortgage industry. The primary guarantees are that: the mortgage and the mortgage note have been duly executed and each is the legal, valid and binding obligation of the Company, enforceable in accordance with its terms; the mortgage has been duly acknowledged and recorded and is valid; and the mortgage and the mortgage note are not subject to any right of rescission, set-off, counterclaim or defense, including, without limitation, the defense of usury, and no such right of rescission, set-off, counterclaim or defense has been asserted with respect thereto. The Company is responsible for the guarantees on loans sold. If these claims prove to be untrue, the
investor can require the Company to repurchase the loan and return all loan purchase and servicing release premiums. Management does not believe the potential liability exposure will have a material impact on the Company’s results of operations, cash flows or financial condition due to the nature of the standard representations and warranties, which have resulted in a minimal amount of loan repurchases.
E*TRADE 2019 10-K | Page 163
E*TRADE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
i |
|
NOTE
21—CONDENSED FINANCIAL INFORMATION (PARENT COMPANY ONLY) |
i CONDENSED STATEMENTS OF COMPREHENSIVE INCOME
(In millions) |
| | | | | | | | | | | |
| |
| 2019 | | 2018 | | 2017 |
| $ | i 1,770 |
| | $ | i 1,150 |
| | $ | i 350 |
|
Other
revenues, net | i 404 |
| | i 410 |
| | i 377 |
|
Total
net revenue | i 2,174 |
| | i 1,560 |
| | i 727 |
|
Total
non-interest expense | i 603 |
| | i 575 |
| | i 611 |
|
Income
before income tax expense and equity in income of consolidated subsidiaries | i 1,571 |
| | i 985 |
| | i 116 |
|
Income
tax expense | i 184 |
| | i 149 |
| | i 75 |
|
| ( i 432 | ) | | i 216 |
| | i 573 |
|
Net
income(2) | i 955 |
| | i 1,052 |
| | i 614 |
|
Other
comprehensive income (loss) | i 247 |
| | ( i 228 | ) | | i 111 |
|
Comprehensive
income | $ | i 1,202 |
| | $ | i 824 |
| | $ | i 725 |
|
| |
(1) | Dividends
from subsidiaries includes the gross amount of dividends received. |
/ | |
(2) | Net income available to common shareholders was $ i 915
million, $ i 1.0 billion and $ i 589
million for the years ended December 31, 2019, 2018, and 2017, respectively, and includes the impact of $ i 40 million, $ i 36
million, and $ i 25 million of preferred stock dividends, respectively. |
i CONDENSED
BALANCE SHEETS
(In millions) |
| | | | | | | |
| |
| 2019 | | 2018 |
ASSETS | | | |
Cash
and equivalents | $ | i 614 |
| | $ | i 340 |
|
Property
and equipment, net | i 215 |
| | i 169 |
|
| i 7,578 |
| | i 7,722 |
|
| i 29 |
| | i 24 |
|
Other
assets | i 356 |
| | i 175 |
|
Total
assets | $ | i 8,792 |
| | $ | i 8,430 |
|
LIABILITIES
AND SHAREHOLDERS’ EQUITY | | | |
Liabilities: | | | |
Corporate debt | $ | i 1,410 |
| | $ | i 1,409 |
|
Other
liabilities | i 839 |
| | i 459 |
|
Total
liabilities | i 2,249 |
| | i 1,868 |
|
Total
shareholders’ equity | i 6,543 |
| | i 6,562 |
|
Total
liabilities and shareholders’ equity | $ | i 8,792 |
| | $ | i 8,430 |
|
/ /
E*TRADE 2019 10-K | Page 164
E*TRADE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
i CONDENSED STATEMENTS OF CASH FLOWS
(In millions) |
| | | | | | | | | | | |
| |
| 2019 | | 2018 | | 2017 |
Cash flows from operating activities: | | | | | |
Net
income | $ | i 955 |
| | $ | i 1,052 |
| | $ | i 614 |
|
Adjustments
to reconcile net income to net cash provided by operating activities: | | | | | |
Depreciation and amortization | i 74 |
| | i 55 |
| | i 51 |
|
| i 432 |
| | ( i 216 | ) | | ( i 573 | ) |
Losses
on early extinguishment of debt | i — |
| | i — |
| | i 58 |
|
Other | i 189 |
| | i 292 |
| | i 213 |
|
Net
cash provided by operating activities | i 1,650 |
| | i 1,183 |
| | i 363 |
|
Cash
flows from investing activities: | | | | | |
Capital expenditures for property and equipment | ( i 87 | ) | | ( i 60 | ) | | ( i 59 | ) |
| ( i 31 | ) | | ( i 464 | ) | | ( i 61 | ) |
Other | i — |
| | i 2 |
| | i 6 |
|
Net
cash used in investing activities | ( i 118 | ) | | ( i 522 | ) | | ( i 114 | ) |
Cash
flows from financing activities: | | | | | |
Proceeds from issuance of senior notes | i — |
| | i 420 |
| | i 999 |
|
Payments
on senior notes | i — |
| | i — |
| | ( i 1,049 | ) |
Proceeds
from issuance of preferred stock | i — |
| | i — |
| | i 300 |
|
Repurchases
of common stock | ( i 1,085 | ) | | ( i 1,139 | ) | | ( i 362 | ) |
Preferred
stock dividends | ( i 40 | ) | | ( i 36 | ) | | ( i 25 | ) |
Common
stock dividends | ( i 135 | ) | | ( i 36 | ) | | i — |
|
Other | i 2 |
| | ( i 23 | ) | | ( i 35 | ) |
Net
cash used in financing activities | ( i 1,258 | ) | | ( i 814 | ) | | ( i 172 | ) |
Increase
(decrease) in cash and equivalents | i 274 |
| | ( i 153 | ) | | i 77 |
|
Cash
and equivalents, beginning of period | i 340 |
| | i 493 |
| | i 416 |
|
Cash
and equivalents, end of period | $ | i 614 |
| | $ | i 340 |
| | $ | i 493 |
|
/ Parent
Company Guarantees
Guarantees are contingent commitments issued by the parent for the purpose of guaranteeing the financial obligations of a subsidiary to a third party. The financial obligations of the parent and the relevant subsidiary do not change by the existence of a parent guarantee. Rather, upon the occurrence of certain events, the guarantee shifts ultimate payment responsibility of an existing financial obligation from the relevant subsidiary to the parent company. During the year ended December 31, 2019, no claims had been made against the parent for payment under any guarantees and thus, i no
obligations have been recognized. The parent has not provided any guarantees that are collateralized.
E*TRADE 2019 10-K | Page 165
E*TRADE FINANCIAL CORPORATION
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
i |
|
NOTE 22—QUARTERLY DATA (UNAUDITED) |
The
information presented below reflects all adjustments, which, in the opinion of management, are of a normal and recurring nature necessary to present fairly the results of operations for the quarterly periods presented (dollars in millions, except per share amounts): |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| 2019 | | 2018 |
| First | | Second | | Third | | Fourth | | First | | Second | | Third | | Fourth |
Total
net revenue | $ | i 755 |
| | $ | i 685 |
| | $ | i 767 |
| | $ | i 679 |
| | $ | i 708 |
| | $ | i 710 |
| | $ | i 720 |
| | $ | i 735 |
|
Net
income | $ | i 290 |
| | $ | i 219 |
| | $ | i 274 |
| | $ | i 172 |
| | $ | i 247 |
| | $ | i 250 |
| | $ | i 285 |
| | $ | i 270 |
|
Earnings
per share: | | | | | | | | | | | | | | | |
Basic | $ | i 1.10 |
| | $ | i 0.90 |
| | $ | i 1.08 |
| | $ | i 0.76 |
| | $ | i 0.88 |
| | $ | i 0.95 |
| | $ | i 1.01 |
| | $ | i 1.07 |
|
Diluted | $ | i 1.09 |
| | $ | i 0.90 |
| | $ | i 1.08 |
| | $ | i 0.76 |
| | $ | i 0.88 |
| | $ | i 0.95 |
| | $ | i 1.00 |
| | $ | i 1.06 |
|
/ Net
income in the fourth quarter of 2019 included $ i 21 million of restructuring and acquisition-related activities expense and $ i 8 million
of expense related to the impairment of certain technology assets which was recognized in other non-interest expense. The restructuring and acquisition-related activities expense related primarily to the closure of our New York headquarters, severance from organizational changes driven by enterprise-wide cost containment initiatives, and costs incurred as part of the Gradifi acquisition. See Note 2—Acquisitions and Restructuring and Note 9—Property and Equipment, Net for additional information. Net income and total net revenue in the second quarter of 2019 included $ i 80
million of pre-tax losses from balance sheet repositioning. See Note 6—Available-for-Sale and Held-to-Maturity Securities for additional information.
/
E*TRADE 2019 10-K | Page 166
ITEM
9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A. CONTROLS AND PROCEDURES
| |
(a) | Based on an evaluation under the supervision and with the participation of our management, our Chief Executive Officer and our Chief Financial Officer have concluded that the Company's disclosure controls and procedures, as defined in Rules 13a-15(e) under the Securities Exchange Act of 1934, as amended (the Exchange Act), were effective
as of the end of the period covered by this report to provide reasonable assurance that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is (i) recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission rules and forms and (ii) accumulated and communicated to the Company’s management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. |
| |
(b) | Management's Report on Internal
Controls over Financial Reporting and the attestation report of our independent registered public accounting firm, Deloitte & Touche LLP, are included in Item 8. Financial Statements and Supplementary Data and are incorporated herein by reference. |
| |
(c) | There were no changes in the Company’s internal control over financial reporting during the quarter ended December 31, 2019,
identified in connection with management's evaluation required by paragraph (d) of Exchange Act Rules 13a-15 and 15d-15, that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting. |
ITEM 9B. OTHER INFORMATION
None.
E*TRADE 2019 10-K | Page 167
PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The information required by this item is incorporated by reference from the Company’s definitive proxy statement for its 2020 Annual Meeting of Stockholders to be filed with the SEC pursuant to Regulation 14A within 120 days after
December 31, 2019 (the Proxy Statement). ITEM 11. EXECUTIVE COMPENSATION
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
ITEM
13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
E*TRADE 2019 10-K | Page 168
ITEM 15. EXHIBITS
| |
(a) | The following documents are filed as part of this report: |
| |
1. | Consolidated
Financial Statements: The information concerning our consolidated financial statements required by this Item is incorporated by reference herein to Item 8. Financial Statements and Supplementary Data. |
| |
2. | Financial Statement Schedules: |
Consolidated Financial Statement Schedules have been omitted because the required information is not applicable, not material or is provided in the consolidated financial statements or notes thereto.
|
| | |
Exhibit Number | | Description |
| | |
| | |
| | |
| | |
| | Certificate of Designations of Preferences and Rights of the Fixed-to-Floating Rate Non-Cumulative Perpetual Preferred Stock, Series A of E*TRADE Financial Corporation (incorporated
by reference to Exhibit 3.1 of the Company’s Current Report on Form 8-K filed on August 25, 2016, Commission File Number 1-11921). |
| | Certificate of Designations of Preferences and Rights of the Fixed-to-Floating Rate Non-Cumulative Perpetual Preferred Stock, Series B of E*TRADE Financial Corporation (incorporated by reference to Exhibit 3.1 of the
Company’s Current Report on Form 8-K filed on December 6, 2017, Commission File Number 1-11921). |
| | |
| | |
| | Description of Common Stock. |
| | |
| | |
E*TRADE 2019 10-K | Page 169
|
| | |
Exhibit Number | | Description |
| | |
| | Certificate
of Designations of Preferences and Rights of the Fixed-to-Floating Rate Non-Cumulative Perpetual Preferred Stock, Series A of E*TRADE Financial Corporation (incorporated by reference to Exhibit 3.1 of the Company’s Current Report on Form 8-K filed on August 25, 2016, Commission File Number 1-11921). |
| | |
| | |
| | |
| | |
| | Certificate
of Designations of Preferences and Rights of the Fixed-to-Floating Rate Non-Cumulative Perpetual Preferred Stock, Series B of E*TRADE Financial Corporation (incorporated by reference to Exhibit 3.1 of the Company’s Current Report on Form 8-K filed on December 6, 2017, Commission File Number 1-11921). |
| | |
| | |
| | Form of Depositary Receipt (included in Exhibit 4.13). |
| | |
| | Form
of 2.950% Senior Notes due 2022 (included in Exhibit 4.9). |
| | Form of 3.800% Senior Notes due 2027 (included in Exhibit 4.10). |
| | Form of 4.500% Senior Notes due 2028 (included in Exhibit 4.15). |
| | |
| | |
| | |
| | |
E*TRADE 2019 10-K | Page 170
|
| | |
Exhibit Number | | Description |
| | |
| | |
| | |
| | |
| | |
| | |
| | |
| | |
| | |
| | |
| | |
| | |
| | |
| | Form of Amendment to Employment Agreement between the
Company and each of Michael A. Pizzi, Michael J. Curcio, Alice Milligan and Lori S. Sher. |
| | |
| | |
| | |
| | Consent of Independent Registered Public Accounting Firm. |
| | Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
| | |
E*TRADE
2019 10-K | Page 171
|
| | |
Exhibit Number | | Description |
| | Certification
of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
| | |
| | Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
| | |
*101.INS | | XBRL
Instance Document (the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document) |
| | |
*101.SCH | | Inline XBRL Taxonomy Extension Schema Document |
| | |
*101.CAL | | Inline
XBRL Taxonomy Extension Calculation Linkbase Document |
| | |
*101.DEF | | Inline XBRL Taxonomy Extension Definition Linkbase Document |
| |
*101.LAB | | Inline XBRL Taxonomy Extension Label Linkbase Document |
| |
*101.PRE | | Inline
XBRL Taxonomy Extension Presentation Linkbase Document |
| | |
*104 | | Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101) |
|
| |
+ | Exhibit is a management contract or a compensatory plan or arrangement. |
ITEM 16. FORM
10-K SUMMARY
None.
E*TRADE 2019 10-K | Page 172
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
|
| | |
| | |
E*TRADE Financial Corporation (Registrant) |
| | |
By | | |
| | |
| | Chief Executive Officer |
| | (Principal Executive Officer) |
| |
By | | |
| | |
| | Chief Financial Officer |
| | (Principal Financial Officer) |
| |
By | | |
| | |
| | Corporate Controller |
| | (Principal Accounting Officer) |
E*TRADE 2019 10-K | Page 173
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. |
| | | | |
| | | | |
Signature | | Title | | Date |
| | |
| | Director and Chief Executive Officer (Principal Executive Officer) | | |
| | | |
| | | | |
| | Chief Financial Officer (Principal Financial Officer) | | |
| | | |
| | | | |
| | Corporate Controller (Principal Accounting Officer) | | |
| | | |
| | | | |
| | Chairman of the Board | | |
| | | | |
| | | | |
| | Director | | |
| | | | |
| | | | |
| | Director | | |
| | | | |
| | | | |
| | Director | | |
| | | | |
| | | | |
| | Director | | |
| | | | |
| | | | |
| | Director | | |
| | | | |
| | | | |
| | Director | | |
| | | | |
| | | | |
| | Director | | |
| | | | |
| | | | |
| | Director | | |
| | | | |
| | | | |
| | Director | | |
| | | | |
| | | | |
| | Director | | |
| | | | |
E*TRADE
2019 10-K | Page 174
