UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K/A
(Mark One)
| x | AMENDMENT NO. 1 TO THE ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2005. |
or
| ¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM TO . |
Commission file number 1-11921
E*TRADE Financial Corporation
(Exact name of registrant as specified in its charter)
| Delaware | 94-2844166 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification Number) |
135 East 57th Street, New York, New York 10022
(Address of principal executive offices and zip code)
(646) 521-4300
(Registrant’s telephone number, including area code)
Securities Registered Pursuant to Section 12(b) of the Act:
Title of each class
Common Stock—$0.01 par value
Mandatory Convertible Notes
Securities Registered Pursuant to Section 12(g) of the Act:
None
Indicate by check mark if the registrant is a well-known seasonal issuer, as defined in Rule 405 of the Securities Act. Yes x No ¨
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Securities Act. Yes ¨ No x
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yesx No ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.
| Large accelerated filerx | Accelerated filer¨ | Non-accelerated filer¨ |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.) Yes ¨ No x
At June 30, 2005, the aggregate market value of voting stock, comprised of the registrant’s common stock and shares exchangeable into common stock, held by nonaffiliates of the registrant was approximately $4.8 billion (based upon the closing price for shares of the registrant’s common stock as reported by the New York Stock Exchange on that date.) Shares of common stock held by each officer, director and holder of 5% or more of the outstanding common stock have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes.
Number of shares outstanding of the registrant’s common stock as of February 21, 2006: 417,911,092
Explanatory Note
We are filing this Amendment No. 1 on Form 10-K/A solely to correct a typographical error in the independent registered public accountants’ report on our internal control over financial reporting. The typographical error was an inadvertent omission of a paragraph in the Reports of Independent Registered Public Accounting Firm contained in Item 8. Financial Statements and Supplementary Data of our original Annual Report on Form 10-K filed on March 3, 2006 (Original Report). There are no changes to the financial or supplemental information contained in Item 8. This Amendment relates solely to the Reports of Independent Registered Public Accounting Firm.
In order to comply with certain technical requirements of the SEC’s rules in connection with the filing of this amendment on Form 10-K/A, we are including in this amendment the complete text of Item 8. We are also including in this amendment updated certifications of our principal executive and principal financial officers and an updated Consent of Independent Registered Public Accounting Firm.
This Amendment No. 1 to our Annual Report on Form 10-K as originally filed on March 3, 2006 continues to speak as of the date of our Original Report, and we have not updated the disclosures contained in this Amendment No. 1 to reflect any events that occurred at a date subsequent to the filing of the Original Report.
Item 8. Financial Statements and Supplementary Data
Index
| 2 | ||
| 5 | ||
| 6 | ||
| 7 | ||
| 8 | ||
| 10 | ||
| 12 |
| ITEM 8. | FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA |
MANAGEMENT REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
The management of E*TRADE Financial Corporation is responsible for establishing and maintaining adequate internal control over financial reporting. E*TRADE Financial Corporation’s internal control system was designed to provide reasonable assurance to the company’s management and board of directors regarding the preparation and fair presentation of published financial statements. Internal control over financial reporting is defined in Rule 13a-15(f) or 15d-15(f) promulgated under the Securities Exchange Act of 1934 as 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 financial statements for external purposes in accordance with generally accepted accounting principles 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 assets of the company; |
| • | 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 |
| • | 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. 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.
E*TRADE Financial Corporation’s management assessed the effectiveness of its internal control over financial reporting as of December 31, 2005. In making this assessment, it used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in “Internal Control—Integrated Framework”. Based on our assessment we believe that, as of December 31, 2005, E*TRADE Financial Corporation’s internal control over financial reporting is effective based on those criteria.
E*TRADE Financial Corporation’s audited consolidated financial statements include the results of the following entities, but management’s assessment does not include an assessment of the internal control over financial reporting of these entities because they were acquired during the fourth quarter of 2005. This approach is consistent with published SEC guidance on the permissible scope of management’s internal control report.
| • | The U.S.-based online discount brokerage business of Harrisdirect, LLC, which was acquired on October 6, 2005; and |
| • | The online discount brokerage business of J.P. Morgan Invest, LLC (“BrownCo”), which was acquired on November 30, 2005. |
These entities represented 13% of total assets at December 31, 2005 and 3% of revenues for year ended December 31, 2005.
E*TRADE Financial Corporation’s Independent Registered Public Accounting Firm, Deloitte & Touche LLP, has issued an audit report on our assessment of the E*TRADE Financial Corporation’s internal control over financial reporting. The report of Deloitte & Touche LLP appears on the next page.
1
REPORTS OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
E*TRADE Financial Corporation
Arlington, Virginia
We have audited management’s assessment, included in the accompanying “Management Report on Internal Control Over Financial Reporting,” that E*TRADE Financial Corporation and subsidiaries (the “Company”) maintained effective internal control over financial reporting as of December 31, 2005, based on criteria established in “Internal Control—Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission. As described in the report on Internal Control Over Financial Reporting, management excluded from their assessment the internal control over financial reporting at Harrisdirect, LLC and BrownCo, which were acquired on October 6, 2005 and November 30, 2005, respectively, and whose financial statements represented 13% of total assets at December 31, 2005 and 3% of revenues for 2005. Accordingly, our audit did not include the internal control over financial reporting at Harrisdirect, LLC and BrownCo. 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. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). 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, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.
A company’s internal control over financial reporting is a process designed by, or under the supervision of, the company’s principal executive and principal financial officers, or persons performing similar functions, 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 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 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.
In our opinion, management’s assessment that the Company maintained effective internal control over financial reporting as of December 31, 2005, is fairly stated, in all material respects, based on the criteria established in “Internal Control—Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission. Also in our opinion, the Company maintained, in all material respects, effective
2
internal control over financial reporting as of December 31, 2005, based on the criteria established in “Internal Control—Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements as of and for the year ended December 31, 2005 of the Company and our report dated March 1, 2006 expressed an unqualified opinion on those financial statements.
/s/ Deloitte & Touche LLP
McLean, Virginia
March 1, 2006
3
To the Board of Directors and Stockholders of
E*TRADE Financial Corporation
Arlington, Virginia
We have audited the accompanying consolidated balance sheets of E*TRADE Financial Corporation and subsidiaries (the “Company”) as of December 31, 2005 and 2004, and 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, 2005. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of E*TRADE Financial Corporation and subsidiaries as of December 31, 2005 and 2004, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2005, 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), the effectiveness of the Company’s internal control over financial reporting as of December 31, 2005, based on the criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 1, 2006 expressed an unqualified opinion on management’s assessment of the effectiveness of the Company’s internal control over financial reporting and an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
/s/ Deloitte & Touche LLP
McLean, Virginia
March 1, 2006
4
E*TRADE FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except share amounts)
| December 31, | ||||||||
| 2005 | 2004 | |||||||
| ASSETS | ||||||||
Cash and equivalents | $ | 844,188 | $ | 939,906 | ||||
Cash and investments required to be segregated under Federal or other regulations | 610,174 | 724,026 | ||||||
Brokerage receivables, net | 7,174,175 | 3,034,548 | ||||||
Trading securities | 146,657 | 593,245 | ||||||
Available-for-sale mortgage-backed and investment securities (includes securities pledged to creditors with the right to sell or repledge of $11,792,684 at December 31, 2005 and $10,113,049 at December 31, 2004) | 12,564,738 | 12,543,818 | ||||||
Loans receivable (net of allowance for loan losses of $63,286 at December 31, 2005 and $47,681 at December 31, 2004) | 19,424,895 | 11,505,755 | ||||||
Loans held-for-sale, net | 87,371 | 279,280 | ||||||
Property and equipment, net | 299,256 | 302,291 | ||||||
Derivative assets | 152,477 | 115,867 | ||||||
Accrued interest receivable | 183,814 | 117,131 | ||||||
Investment in Federal Home Loan Bank stock | 198,700 | 92,005 | ||||||
Goodwill | 2,003,456 | 395,043 | ||||||
Other intangibles, net | 532,108 | 134,121 | ||||||
Other assets | 345,677 | 255,547 | ||||||
Total assets | $ | 44,567,686 | $ | 31,032,583 | ||||
| LIABILITIES AND SHAREHOLDERS’ EQUITY | ||||||||
Brokerage payables | $ | 7,315,659 | $ | 3,618,892 | ||||
Deposits | 15,948,015 | 12,302,974 | ||||||
Securities sold under agreements to repurchase | 11,101,542 | 9,897,191 | ||||||
Other borrowings by Bank subsidiary | 4,166,592 | 1,760,732 | ||||||
Derivative liabilities | 38,072 | 52,208 | ||||||
Senior notes | 1,401,947 | 400,452 | ||||||
Mandatory convertible notes | 435,589 | — | ||||||
Convertible subordinated notes | 185,165 | 185,165 | ||||||
Accounts payable, accrued and other liabilities | 575,545 | 586,767 | ||||||
Total liabilities | 41,168,126 | 28,804,381 | ||||||
Shareholders’ equity: | ||||||||
Preferred stock, shares authorized: 1,000,000; issued and outstanding: none at December 31, 2005 and 2004 | — | — | ||||||
Shares exchangeable into common stock, $0.01 par value, shares authorized: 10,644,223; issued and outstanding: None at December 31, 2005 and 1,302,801 at December 31, 2004 | — | 13 | ||||||
Common stock, $0.01 par value, shares authorized: 600,000,000; issued and outstanding: 416,582,164 at December 31, 2005 and 369,623,604 at December 31, 2004 | 4,166 | 3,696 | ||||||
Additional paid-in capital | 2,990,676 | 2,234,093 | ||||||
Deferred stock compensation | — | (18,419 | ) | |||||
Retained earnings | 580,430 | 150,018 | ||||||
Accumulated other comprehensive loss | (175,712 | ) | (141,199 | ) | ||||
Total shareholders’ equity | 3,399,560 | 2,228,202 | ||||||
Total liabilities and shareholders’ equity | $ | 44,567,686 | $ | 31,032,583 | ||||
See accompanying notes to consolidated financial statements
5
E*TRADE FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except per share amounts)
| Year Ended December 31, | ||||||||||||
| 2005 | 2004 | 2003 | ||||||||||
Revenues: | ||||||||||||
Commissions | $ | 458,834 | $ | 431,638 | $ | 422,709 | ||||||
Principal transactions | 99,336 | 126,893 | 107,601 | |||||||||
Gain on sales of loans and securities, net | 98,858 | 140,718 | 247,654 | |||||||||
Service charges and fees | 135,314 | 97,575 | 110,058 | |||||||||
Other revenues | 94,419 | 89,077 | 86,514 | |||||||||
Interest income | 1,650,264 | 1,145,597 | 892,832 | |||||||||
Interest expense | (779,164 | ) | (510,455 | ) | (486,129 | ) | ||||||
Net interest income | 871,100 | 635,142 | 406,703 | |||||||||
Provision for loan losses | (54,016 | ) | (38,121 | ) | (38,523 | ) | ||||||
Net interest income after provision for loan losses | 817,084 | 597,021 | 368,180 | |||||||||
Total net revenues | 1,703,845 | 1,482,922 | 1,342,716 | |||||||||
Expenses excluding interest: | ||||||||||||
Compensation and benefits | 380,803 | 350,440 | 364,598 | |||||||||
Occupancy and equipment | 69,089 | 69,572 | 78,381 | |||||||||
Communications | 82,485 | 69,674 | 73,650 | |||||||||
Professional services | 75,237 | 67,747 | 55,716 | |||||||||
Commissions, clearance and floor brokerage | 140,806 | 129,696 | 124,868 | |||||||||
Advertising and market development | 105,935 | 62,155 | 57,887 | |||||||||
Servicing and other banking expenses | 52,326 | 35,971 | 37,575 | |||||||||
Fair value adjustments of financial derivatives | 4,892 | (2,299 | ) | 15,338 | ||||||||
Depreciation and amortization | 74,981 | 77,892 | 85,615 | |||||||||
Amortization of other intangibles | 43,765 | 19,443 | 24,758 | |||||||||
Facility restructuring and other exit activities | (30,017 | ) | 15,688 | 134,187 | ||||||||
Other | 53,751 | 91,144 | 101,042 | |||||||||
Total expenses excluding interest | 1,054,053 | 987,123 | 1,153,615 | |||||||||
Income before other income, income taxes, minority interest, discontinued operations and cumulative effect of accounting change | 649,792 | 495,799 | 189,101 | |||||||||
Other income: | ||||||||||||
Corporate interest income | 11,043 | 6,692 | 6,550 | |||||||||
Corporate interest expense | (73,956 | ) | (47,525 | ) | (45,596 | ) | ||||||
Gain on sale and impairment of investments | 83,144 | 128,111 | 147,874 | |||||||||
Loss on early extinguishment of debt | — | (22,972 | ) | — | ||||||||
Equity in income of investments and venture funds | 6,103 | 4,382 | 9,132 | |||||||||
Total other income | 26,334 | 68,688 | 117,960 | |||||||||
Income before income taxes, minority interest and discontinued operations | 676,126 | 564,487 | 307,061 | |||||||||
Income tax expense | 229,823 | 181,764 | 111,601 | |||||||||
Minority interest in subsidiaries | 65 | 893 | (5,061 | ) | ||||||||
Net income from continuing operations | 446,238 | 381,830 | 200,521 | |||||||||
Discontinued operations, net of tax: | ||||||||||||
Gain (loss) from discontinued operations, net | (21,495 | ) | (32,755 | ) | 2,506 | |||||||
Gain on disposal of discontinued operations, net | 4,023 | 31,408 | — | |||||||||
Net income (loss) from discontinued operations | (17,472 | ) | (1,347 | ) | 2,506 | |||||||
Cumulative effect of accounting change, net of tax | 1,646 | — | — | |||||||||
Net income | $ | 430,412 | $ | 380,483 | $ | 203,027 | ||||||
Basic income per share | ||||||||||||
Basic income per share from continuing operations | $ | 1.20 | $ | 1.04 | $ | 0.56 | ||||||
Basic income (loss) per share from discontinued operations | (0.04 | ) | (0.00 | ) | 0.01 | |||||||
Basic income per share from cumulative effect of accounting change | 0.00 | — | — | |||||||||
Basic net income per share | $ | 1.16 | $ | 1.04 | $ | 0.57 | ||||||
Diluted income per share | ||||||||||||
Diluted income per share from continuing operations | $ | 1.16 | $ | 0.99 | $ | 0.55 | ||||||
Diluted income (loss) per share from discontinued operations | (0.04 | ) | (0.00 | ) | 0.00 | |||||||
Diluted income per share from cumulative effect of accounting change | 0.00 | — | — | |||||||||
Diluted net income per share | $ | 1.12 | $ | 0.99 | $ | 0.55 | ||||||
Shares used in computation of per share data: | ||||||||||||
Basic | 371,468 | 366,586 | 358,320 | |||||||||
Diluted | 384,630 | 405,389 | 367,361 | |||||||||
See accompanying notes to consolidated financial statements
6
E*TRADE FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(in thousands)
| Year Ended December 31, | ||||||||||||
| 2005 | 2004 | 2003 | ||||||||||
Net income | $ | 430,412 | $ | 380,483 | $ | 203,027 | ||||||
Other comprehensive income (loss): | ||||||||||||
Available-for-sale securities: | ||||||||||||
Unrealized gains, net | 12,946 | 71,488 | 187,012 | |||||||||
Less impact of realized gains (transferred out of AOCI) and included in net income, net | (77,858 | ) | (127,236 | ) | (142,016 | ) | ||||||
Net change from available-for-sale securities | (64,912 | ) | (55,748 | ) | 44,996 | |||||||
Cash flow hedging instruments: | ||||||||||||
Unrealized gains (losses), net | 7,032 | (51,137 | ) | (21,173 | ) | |||||||
Amortization of losses into interest expense related to de-designated cash flow hedges deferred in AOCI, net | 40,155 | 56,873 | 85,699 | |||||||||
Net change from cash flow hedging instruments | 47,187 | 5,736 | 64,526 | |||||||||
Foreign currency translation gains (losses) | (16,788 | ) | (1,210 | ) | 31,958 | |||||||
Other comprehensive income (loss) | (34,513 | ) | (51,222 | ) | 141,480 | |||||||
Comprehensive income | $ | 395,899 | $ | 329,261 | $ | 344,507 | ||||||
See accompanying notes to consolidated financial statements.
7
E*TRADE FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
(in thousands)
Shares Exchangeable into Common Stock | Common Stock | Additional Paid-in Capital | Deferred Stock Compensation | Retained Earnings (Deficit) | Accumulated Other Comprehensive Loss | Total Shareholders’ Equity | ||||||||||||||||||||||||||||
| Shares | Amount | Shares | Amount | |||||||||||||||||||||||||||||||
Balance, December 31, 2002 | 1,627 | $ | 16 | 358,044 | $ | 3,580 | $ | 2,190,200 | $ | (23,058 | ) | $ | (433,492 | ) | $ | (231,457 | ) | $ | 1,505,789 | |||||||||||||||
Net income | 203,027 | 203,027 | ||||||||||||||||||||||||||||||||
Other comprehensive income | 141,480 | 141,480 | ||||||||||||||||||||||||||||||||
Exercise of stock options and warrants, including tax benefit | 8,543 | 85 | 58,917 | 59,002 | ||||||||||||||||||||||||||||||
Employee stock purchase plan | 1,572 | 16 | 5,908 | 5,924 | ||||||||||||||||||||||||||||||
Adjustment related to change in original option grants | 954 | 954 | ||||||||||||||||||||||||||||||||
Cancellation of unvested restricted stock | (3,447 | ) | (34 | ) | (21,271 | ) | 21,305 | — | ||||||||||||||||||||||||||
Issuance of restricted stock | 1,733 | 17 | 13,491 | (13,408 | ) | 100 | ||||||||||||||||||||||||||||
Amortization of deferred stock compensation, net of cancellations and retirements | (50 | ) | (269 | ) | 2,287 | 2,018 | ||||||||||||||||||||||||||||
Conversion of Exchangeable Shares to common stock | (241 | ) | (2 | ) | 241 | 2 | — | |||||||||||||||||||||||||||
Balance, December 31, 2003 | 1,386 | $ | 14 | 366,636 | $ | 3,666 | $ | 2,247,930 | $ | (12,874 | ) | $ | (230,465 | ) | $ | (89,977 | ) | $ | 1,918,294 | |||||||||||||||
Net income | 380,483 | 380,483 | ||||||||||||||||||||||||||||||||
Other comprehensive loss | (51,222 | ) | (51,222 | ) | ||||||||||||||||||||||||||||||
Exercise of stock options and purchase plans, including tax benefit | 6,757 | 68 | 57,686 | 57,754 | ||||||||||||||||||||||||||||||
Employee stock purchase plan | 1,443 | 14 | 8,640 | 8,654 | ||||||||||||||||||||||||||||||
Adjustment related to change in original option grants | 224 | 224 | ||||||||||||||||||||||||||||||||
Repurchases of common stock | (13,664 | ) | (137 | ) | (175,639 | ) | (175,776 | ) | ||||||||||||||||||||||||||
Cancellation of restricted stock | (113 | ) | (1 | ) | (858 | ) | 859 | — | ||||||||||||||||||||||||||
Issuance of restricted stock | 908 | 9 | 11,149 | (11,058 | ) | 100 | ||||||||||||||||||||||||||||
Shares issued upon debt conversion | 7,438 | 74 | 79,889 | 79,963 | ||||||||||||||||||||||||||||||
Amortization of deferred stock compensation, net of cancellations and retirements | (25 | ) | (325 | ) | 4,654 | 4,329 | ||||||||||||||||||||||||||||
Conversion of Exchangeable Shares to common stock | (83 | ) | (1 | ) | 83 | 1 | — | |||||||||||||||||||||||||||
Other | 161 | 2 | 5,397 | 5,399 | ||||||||||||||||||||||||||||||
Balance, December 31, 2004 | 1,303 | $ | 13 | 369,624 | $ | 3,696 | $ | 2,234,093 | $ | (18,419 | ) | $ | 150,018 | $ | (141,199 | ) | $ | 2,228,202 | ||||||||||||||||
See accompanying notes to consolidated financial statements
8
E*TRADE FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY—(Continued)
(in thousands)
Shares Exchangeable into Common Stock | Common Stock | Additional Paid-in Capital | Deferred Stock Compensation | Retained Earnings (Deficit) | Accumulated Other Comprehensive Loss | Total Shareholders’ Equity | |||||||||||||||||||||||||||
| Shares | Amount | Shares | Amount | ||||||||||||||||||||||||||||||
Balance, December 31, 2004 | 1,303 | $ | 13 | 369,624 | $ | 3,696 | $ | 2,234,093 | $ | (18,419 | ) | $ | 150,018 | $ | (141,199 | ) | $ | 2,228,202 | |||||||||||||||
Net income | 430,412 | 430,412 | |||||||||||||||||||||||||||||||
Cumulative effect of accounting change | (2,777 | ) | (2,777 | ) | |||||||||||||||||||||||||||||
Other comprehensive loss | (34,513 | ) | (34,513 | ) | |||||||||||||||||||||||||||||
Issuance of common stock on exercise of forward contract | 14,479 | 14,479 | |||||||||||||||||||||||||||||||
Exercise of stock options and purchase plans, including tax benefit | 7,779 | 78 | 77,657 | 77,735 | |||||||||||||||||||||||||||||
Employee stock purchase plan | 902 | 9 | 8,377 | 8,386 | |||||||||||||||||||||||||||||
Repurchases of common stock | (4,548 | ) | (45 | ) | (58,170 | ) | (58,215 | ) | |||||||||||||||||||||||||
Issuance of common stock upon acquisition | 1,632 | 17 | 26,634 | 26,651 | |||||||||||||||||||||||||||||
Issuance of common stock upon BrownCo Financing | 39,722 | 397 | 691,385 | 691,782 | |||||||||||||||||||||||||||||
Cancellation of restricted stock | (516 | ) | (5 | ) | (2,952 | ) | 2,957 | — | |||||||||||||||||||||||||
Issuance of restricted stock | 830 | 8 | 9,892 | (9,900 | ) | — | |||||||||||||||||||||||||||
Amortization of deferred stock compensation prior to adoption of SFAS No. 123(R), net of cancellations and retirements | (46 | ) | (1 | ) | (709 | ) | 1,974 | 1,264 | |||||||||||||||||||||||||
Reclassification of deferred stock compensation to APIC under SFAS No. 123(R) | (26,165 | ) | 26,165 | — | |||||||||||||||||||||||||||||
Share-based compensation expense under SFAS No. 123(R) | 16,276 | 16,276 | |||||||||||||||||||||||||||||||
Conversion of Exchangeable Shares to common stock | (1,303 | ) | (13 | ) | 1,303 | 13 | — | ||||||||||||||||||||||||||
Other | (100 | ) | (1 | ) | (121 | ) | (122 | ) | |||||||||||||||||||||||||
Balance, December 31, 2005 | — | $ | — | 416,582 | $ | 4,166 | $ | 2,990,676 | $ | — | $ | 580,430 | $ | (175,712 | ) | $ | 3,399,560 | ||||||||||||||||
See accompanying notes to consolidated financial statements
9
E*TRADE FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
| Year Ended December 31, | ||||||||||||
| 2005 | 2004 | 2003 | ||||||||||
CASH FLOWS FROM OPERATING ACTIVITIES: | ||||||||||||
Net income | $ | 430,412 | $ | 380,483 | $ | 203,027 | ||||||
Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||||||
Cumulative effect of accounting change, net of tax | (1,646 | ) | — | — | ||||||||
Provision for loan losses | 54,016 | 38,121 | 38,523 | |||||||||
Depreciation, amortization and discount accretion | 362,965 | 398,297 | 443,746 | |||||||||
Realized gain and impairment of investments | (174,798 | ) | (257,465 | ) | (435,146 | ) | ||||||
Loss (gain) on disposition of assets | 1,342 | (57,451 | ) | — | ||||||||
Gain on sale of Consumer Finance Corporation | (46,099 | ) | — | — | ||||||||
Minority interest and equity in income of subsidiaries and investments | (6,517 | ) | (9,882 | ) | (14,834 | ) | ||||||
Unrealized loss on venture funds | 228 | 5,413 | 5,640 | |||||||||
Noncash restructuring costs and other exit activities | 6,528 | 15,029 | 70,811 | |||||||||
Stock-based compensation | 18,253 | 4,654 | 2,287 | |||||||||
Deferred income taxes | 49,018 | 66,920 | 7,015 | |||||||||
Other | (8,474 | ) | 11,503 | 16,033 | ||||||||
Net effect of changes in assets and liabilities: | ||||||||||||
Decrease (increase) in cash and investments required to be segregated under Federal or other regulations | 518,021 | 936,492 | (171,287 | ) | ||||||||
Increase in brokerage receivables | (953,391 | ) | (713,656 | ) | (856,359 | ) | ||||||
Increase (decrease) in brokerage payables | 339,132 | (117,567 | ) | 924,051 | ||||||||
Proceeds from sales, repayments and maturities of loans held-for-sale | 7,182,775 | 6,857,431 | 13,662,209 | |||||||||
Purchases of loans held-for-sale | (3,717,745 | ) | (6,063,974 | ) | (12,951,831 | ) | ||||||
Proceeds from sales, repayments and maturities of trading securities | 3,779,503 | 9,354,027 | 14,749,315 | |||||||||
Purchases of trading securities | (6,751,698 | ) | (9,122,071 | ) | (15,204,220 | ) | ||||||
Other assets | 28,047 | (69,810 | ) | 75,329 | ||||||||
Accrued interest receivable and payable, net | (38,315 | ) | (13,207 | ) | 12,814 | |||||||
Accounts payable, accrued and other liabilities | (209,768 | ) | (36,757 | ) | 127,666 | |||||||
Restructuring liabilities | (5,053 | ) | (11,564 | ) | (30,626 | ) | ||||||
Net cash provided by operating activities | 856,736 | 1,594,966 | 674,163 | |||||||||
CASH FLOWS FROM INVESTING ACTIVITIES: | ||||||||||||
Purchases of mortgage-backed and investment securities, available-for-sale | (13,761,461 | ) | (20,701,412 | ) | (21,516,669 | ) | ||||||
Proceeds from sales, maturities of and principal payments on mortgage-backed and investment securities, available-for-sale | 13,606,932 | 17,995,471 | 20,271,822 | |||||||||
Net increase in loans receivable | (7,887,040 | ) | (3,487,941 | ) | (2,426,789 | ) | ||||||
Purchase of Federal Home Loans Bank stock | (106,695 | ) | (12,769 | ) | — | |||||||
Purchases of property and equipment | (79,014 | ) | (108,887 | ) | (60,121 | ) | ||||||
Proceeds from sale of property and equipment | — | 5,957 | 3,846 | |||||||||
Cash used in business acquisitions, net | (2,218,932 | ) | (19,025 | ) | (3,466 | ) | ||||||
Cash flow from derivative hedging assets, net | (34,696 | ) | (33,354 | ) | (59,607 | ) | ||||||
Proceeds from sales of discontinued businesses | 56,902 | 106,868 | — | |||||||||
Other | 19,376 | 1,613 | (1,908 | ) | ||||||||
Net cash used in investing activities | $ | (10,404,628 | ) | $ | (6,253,479 | ) | $ | (3,792,892 | ) | |||
See accompanying notes to consolidated financial statements
10
E*TRADE FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS—(Continued)
(in thousands)
| Year Ended December 31, | ||||||||||||
| 2005 | 2004 | 2003 | ||||||||||
CASH FLOWS FROM FINANCING ACTIVITIES: | ||||||||||||
Net increase (decrease) in deposits | $ | 3,668,914 | $ | (202,544 | ) | $ | 4,113,280 | |||||
Advances from the Federal Home Loan Bank | 19,638,000 | 7,041,000 | 1,634,700 | |||||||||
Payments on advances from the Federal Home Loan Bank | (17,267,000 | ) | (6,472,000 | ) | (2,025,000 | ) | ||||||
Net increase (decrease) in securities sold under agreements to repurchase | 1,181,832 | 4,603,641 | (343,324 | ) | ||||||||
Net decrease in other borrowed funds | (12,151 | ) | (64,215 | ) | (208,479 | ) | ||||||
Proceeds from bank loans and lines of credit, net of transaction costs | — | 23,500 | — | |||||||||
Payments on bank loans and lines of credit | — | (753 | ) | (5,090 | ) | |||||||
Net proceeds from senior notes | 992,064 | 394,000 | — | |||||||||
Payments on call of convertible subordinated notes | — | (428,902 | ) | — | ||||||||
Proceeds from issuance of common stock | 691,783 | — | — | |||||||||
Proceeds from issuance of Units | 436,500 | — | — | |||||||||
Proceeds from issuance of common stock from employee stock transactions | 61,351 | 43,974 | 51,740 | |||||||||
Tax benefit from tax deductions in excess of compensation expense recognition | 24,530 | 22,441 | 13,186 | |||||||||
Repayment of capital lease obligations | (157 | ) | (734 | ) | (6,031 | ) | ||||||
Repurchases of common stock | (58,215 | ) | (175,776 | ) | — | |||||||
Proceeds from issuance of subordinated debentures and trust preferred securities | 50,000 | 75,630 | 58,210 | |||||||||
Payments on trust preferred securities | — | (23,375 | ) | — | ||||||||
Net cash flow from derivative hedging liabilities | 45,056 | (159,591 | ) | (30,916 | ) | |||||||
Other | (333 | ) | 759 | 14,212 | ||||||||
Net cash provided by financing activities | 9,452,174 | 4,677,055 | 3,266,488 | |||||||||
INCREASE (DECREASE) IN CASH AND EQUIVALENTS | (95,718 | ) | 18,542 | 147,759 | ||||||||
CASH AND EQUIVALENTS, Beginning of year | 939,906 | 921,364 | 773,605 | |||||||||
CASH AND EQUIVALENTS, End of year | $ | 844,188 | $ | 939,906 | $ | 921,364 | ||||||
SUPPLEMENTAL DISCLOSURES: | ||||||||||||
Cash paid for interest | $ | 723,718 | $ | 437,714 | $ | 430,855 | ||||||
Cash paid for income taxes | $ | 206,494 | $ | 101,309 | $ | 42,555 | ||||||
Non-cash investing and financing activities: | ||||||||||||
Transfers from loans to other real estate owned and repossessed assets | $ | 50,191 | $ | 47,080 | $ | 48,947 | ||||||
Reclassification of loans held-for-sale to loans held-for-investment | $ | 178,347 | $ | — | $ | 289,592 | ||||||
Deconsolidation of trust preferreds to other borrowings | $ | — | $ | — | $ | 201,665 | ||||||
Issuance of common stock to retire debentures | $ | — | $ | 79,963 | $ | — | ||||||
See accompanying notes to consolidated financial statements
11
E*TRADE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization—E*TRADE Financial Corporation (together with its subsidiaries, “E*TRADE” or the “Company”) is a global company offering a wide range of financial services to the consumer under the brand “E*TRADE FINANCIAL.” The Company offers investing, trading, cash management and lending products and services to its retail and institutional customers.
Basis of Presentation—The consolidated financial statements include the accounts of the Company and its majority-owned subsidiaries. Entities in which the Company holds at least a 20% ownership or in which there are other indicators of significant influence are generally accounted for by the equity method. Entities in which the Company holds less than 20% ownership and does not have the ability to exercise significant influence are generally carried at cost. Intercompany accounts and transactions are eliminated in consolidation. The Company evaluates investments including joint ventures, low income housing tax credit partnerships and other limited partnerships to determine if the Company is required to consolidate the entities under the guidance of FASB Interpretation No. 46,Consolidation of Variable Interest Entities-an interpretation of ARB No. 51 (“FIN 46R”.)
Certain prior period items in these consolidated financial statements have been reclassified to conform to the current period presentation. As discussed in Note 3, the operations of certain businesses have been accounted for as discontinued operations in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 144,Accounting for the Impairment or Disposal of Long-Lived Assets. Accordingly, results of operations from prior periods have been reclassified to discontinued operations. Unless noted, discussions herein pertain to the Company’s continuing operations.
Use of Estimates—The consolidated financial statements were prepared in accordance with accounting principles generally accepted in the United States of America, which require 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. Material estimates in which management believes near-term changes could reasonably occur include: allowances for loan losses and uncollectible margin loans; classification and valuation of certain investments; valuation and accounting for financial derivatives; estimates of effective tax rates, deferred taxes and valuation allowances; valuation of goodwill and other intangibles and valuation and expensing of share-based payments.
Financial Statement Descriptions and Related Accounting Policies—Below are descriptions and accounting policies for the Company’s financial statement categories.
Cash and Equivalents—For the purpose of reporting cash flows, 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 required to be segregated under Federal or other regulations to be cash equivalents. Cash and equivalents are composed of interest-bearing and non-interest-bearing deposits, certificates of deposit, commercial paper, funds due from banks and Federal funds. Cash and equivalents included $7.1 million and $23.7 million at December 31, 2005 and 2004, respectively, of overnight cash deposits that the Company is required to maintain with the Federal Reserve Bank.
Cash and Investments Required to be Segregated Under Federal or Other Regulations—Cash and investments required to be segregated under Federal or other regulations consist primarily of interest-bearing cash accounts. Certain cash balances, related to collateralized financing transactions by our brokerage subsidiaries, are required to be segregated for the exclusive benefit of our brokerage customers.
Brokerage Receivables, net and Payables—Brokerage receivables represent credit extended to customers to finance their purchases of securities by borrowing against securities they currently own, as well as commission
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receivables from customers upon settlement of their trades. Receivable from non-customers represent credit extended to principal officers and directors of the Company to finance their purchase of securities by borrowing against securities owned by them. Brokerage receivables are recorded net of allowance for doubtful accounts. Securities owned by customers and non-customers are held as collateral for amounts due on brokerage receivables, the value of which is not reflected in the consolidated balance sheets. In many cases, the Company is permitted to sell or repledge these securities held as collateral and use the securities to enter into securities lending transactions, to collateralize borrowings or for delivery to counterparties to cover customer short positions. Receivables from brokers, dealers and clearing organizations result from the Company’s stock borrowing activities.
Brokerage payables include payables from customers, non-customers, brokers, dealers and clearing organizations. Brokerage payables to customers and non-customers represent credit balances in customer accounts arising from deposits of funds and sales of securities, also referred to as free credit balances, and other funds pending completion of securities transactions. The Company pays interest on certain free credit balances. Payables from brokers, dealers and clearing organizations also result from the Company’s stock lending activities.
Deposits paid for securities borrowed and deposits received for securities loaned are recorded at the amount of cash collateral advanced or received, which are included in brokerage receivables, net and brokerage payables, respectively, on the consolidated balance sheets. Deposits paid for securities borrowed transactions require the Company to deposit cash with the counterparty. This cash is included in cash and investments required to be segregated under federal or other regulations. With respect to deposits received for securities loaned, the Company receives collateral in the form of cash in an amount generally in excess of the market value of the securities loaned. 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.
Trading Securities—Certain trading securities and financial derivative instruments, that are not designated for hedge accounting, are bought and held principally for the purpose of selling them in the near term and are carried at estimated fair value based on quoted market prices. Realized and unrealized gains and losses on securities classified as trading held by the Bank are included in gain on sales of loans and securities, net and are derived using the specific identification cost method. Realized and unrealized gains and losses on trading securities held by broker-dealers are recorded in principal transactions and are also derived by the specific identification method.
Available-for-Sale Mortgage-Backed and Investment Securities—The Company classified its debt, mortgage-backed securities and marketable equity securities as either trading or available-for-sale. None of the Company’s mortgage-backed or investment securities were classified as held-to-maturity at December 31, 2005 or 2004.
Available-for-sale securities consist of mortgage-backed securities, asset-backed securities, corporate bonds, municipal bonds, publicly traded equity securities, retained interests from securitizations and other debt securities. Securities classified as available-for-sale are carried at fair value, with the unrealized gains and losses reflected as a component of accumulated other comprehensive income (“AOCI”), net of tax. Fair value is based on quoted market prices, when available. For illiquid securities, fair value is estimated by obtaining market price quotes on similar liquid securities and adjusting the price to reflect differences between the two securities, such as credit risk, liquidity, term, coupon, payment characteristics and other information. Realized and unrealized gains or losses on available-for-sale securities, except for publicly traded equity securities, are computed using the specific identification cost method. Amortization or accretion of premiums and discounts are recognized in interest income using the interest method over the expected life of the security. Realized and unrealized gains or losses on publicly traded equity securities are computed using the average cost method. Realized gains and losses and declines in fair value judged to be other-than-temporary are included in gain on sales of loans and securities,
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net for the Company’s banking operations; other amounts relating to corporate investments are included in gain on sale and impairment of investments. Interest earned is included in interest income for banking operations or corporate interest income for corporate investments.
The Company regularly analyzes certain available-for-sale investments for other-than-temporary impairment when the fair value of the investment is lower than its book value. The Company’s methodology for determining impairment involves projecting cash flows relating to each investment and using assumptions as to future prepayment speeds, losses and loss severities over the life of the underlying collateral pool. Assumptions about future performance are derived from the actual performance to date and the Company’s view on how the collateral will perform in the future. In projecting future performance, the Company incorporates the views of industry analysts, rating agencies and the management of the issuer, along with its own independent analysis of the issuer of the securities, the servicer, the economy and the relevant sector as a whole. If the Company determines impairment is other-than-temporary, it reduces the recorded book value of the investment by the amount of the impairment and recognizes a realized loss on the investment. The Company does not, however, adjust the recorded book value for declines in fair value that it believes are temporary. Management continues to monitor and evaluate these securities closely for impairment that is other-than-temporary.
Mortgage- and asset-backed securities that both have an unrealized loss and are rated below “AA” by at least half of the agencies that rate the securities, as well as interest-only securities that have unrealized losses, are evaluated for impairment in accordance with Emerging Issues Task Force 99-20 (“EITF 99-20”),Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets. Accordingly, when the present value of a security’s anticipated cash flows declines below the last periodic estimate, the Company recognizes an impairment charge in gain on sales of loans and securities, net in the consolidated statements of income.
Asset Securitization and Retained Interests—An asset securitization involves the transfer of financial assets to another entity in exchange for cash and/or beneficial interests in the assets transferred. Asset transfers in which the Company surrenders control over the financial assets are accounted for as sales to the extent that consideration, other than beneficial interests in the transferred assets, is received in the exchange in accordance with SFAS No. 140Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. The carrying amount of the assets transferred is allocated between the assets sold in these transactions and the retained beneficial interests, based on their relative fair values at the date of the transfer. The Company records gains or losses for the difference between the allocated carrying amount of the assets sold and the net cash proceeds received. These gains or losses are recorded in gain on sales of loans and securities, net. Fair value is determined based on quoted market prices, if available. Generally, quoted market prices are not available for beneficial interests; therefore, the Company estimates the fair value based on the present value of the associated expected future cash flows. In determining the present value of the associated expected future cash flows, management is required to make estimates and assumptions. Key estimates and assumptions include future default rates, credit losses, discount rates, prepayment speeds and collateral repayment rates. Retained beneficial interests are accounted for in accordance with SFAS No. 115,Accounting for Certain Investments in Debt and Equity Securities and EITF 99-20 and are included in available-for-sale investment securities in the consolidated balance sheets.
Loans Receivable, net—Loans receivable, net consists of real estate and consumer loans that management has the intent and ability to hold for the foreseeable future or until maturity. These loans are carried at amortized cost adjusted for charge-offs, net allowance for loan losses, deferred fees or costs on originated loans and unamortized premiums or discounts on purchased loans. Loan fees and certain direct loan origination costs are deferred and the net fee or cost is recognized in interest income using the interest method over the contractual life of the loans. Premiums and discounts on purchased loans are amortized or accreted into income using the interest method over the remaining period to contractual maturity and adjusted for anticipated prepayments. The Company classifies loans as nonperforming when full and timely collection of interest or principal becomes uncertain or when they are 90 days past due. Interest previously accrued, but not collected, is reversed against
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current income when a loan is placed on nonaccrual status and is considered nonperforming. Accretion of deferred fees is discontinued for nonperforming loans. Payments received on nonperforming loans are recognized as interest income when the loan is considered collectible and applied to principal when it is doubtful that full payment will be collected. Real estate loans are generally charged off to the extent that the carrying value of the loan exceeds the estimated net realizable value of the underlying collateral at the time of repossession. HELOCs are charged-off when the loan becomes 180 days past due. Consumer loans are charged off to the extent that the carrying value of the loan exceeds the estimated net realizable value of the underlying collateral when the loan becomes 120 days past due.
Allowance for Loan Losses—The allowance for loan losses is management’s estimate of credit losses inherent in the Company’s loan portfolio as of the balance sheet date. The estimate of the allowance is based on a variety of factors, including the composition and quality of the portfolio, delinquency levels and trends, expected losses for the next twelve months, current and historical charge-off and loss experience, current industry charge-off and loss experience, the condition of the real estate market and geographic concentrations within the loan portfolio, the interest rate climate as it affects adjustable-rate loans and general economic conditions. 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. In general, the allowance for loan losses should be at least equal to twelve months of projected losses for all loan types. Management believes this level is representative of probable losses inherent in the loan portfolio at the balance sheet date. Loan losses are charged and recoveries are credited to the allowance for loan losses.
Loans Held-for-Sale, net—Loans held-for-sale, net consists of mortgages acquired and loans originated by the Company that are intended for sale in the secondary market. These loans are carried at the lower of cost or estimated fair value, as determined on an aggregate basis, based on quoted market price for loans with similar characteristics. Net unrealized losses are recognized in a valuation allowance by charges to income. Premiums and discounts on loans held-for-sale are deferred and recognized as part of gain (loss) on sales of loans held-for-sale, net and are not accreted or amortized.
Property and Equipment, net—Property and equipment are carried at cost and depreciated on a straight-line basis over their estimated useful lives, generally three to ten years. Leasehold improvements are amortized over the lesser of their estimated useful lives or lease terms. Buildings are depreciated over forty years. Land is carried at cost. Technology development costs are charged to operations as incurred. Technology development costs include 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 as internally developed software costs in accordance with Statement of Position (“SOP”) 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use.
In accordance with SOP 98-1, the cost of internally developed software is capitalized and included in property and equipment at the point at which 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. Internally developed software costs include the cost of software tools and licenses used in the development of the Company’s systems, as well as payroll and consulting costs.
Investment in Federal Home Loan Bank (“FHLB”) Stock—Investment in FHLB stock is carried at its amortized cost, which approximates fair value.
Goodwill and Other Intangibles, net—Goodwill and other intangibles, net represents the excess of the purchase price over the fair value of net tangible assets acquired through the Company’s business combinations. The Company tests goodwill and intangible assets with indefinite lives for impairment on at least an annual basis or when certain events occur. The Company evaluates the remaining useful lives of other intangible assets each
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reporting period to determine whether events and circumstances warrant a revision to the remaining period of amortization.
Servicing Rights—Servicing assets are recognized when the Company sells a loan and retains the related servicing rights. The servicing rights are initially recorded at their allocated cost basis based on the relative fair value of the loan sold and the servicing rights are retained at the date of the sale in accordance with SFAS No. 140. The fair value of the servicing retained is estimated based on market quotes for similar servicing assets. Servicing assets are amortized in proportion to and over the period of estimated net servicing income. The Company measures impairment by stratifying the servicing assets, based on the characteristics of the underlying loans and by interest rates. Impairment is recognized through a valuation allowance for each stratum. The valuation allowance is adjusted to reflect the excess of the servicing assets’ cost basis for a given stratum over its fair value. Any fair value in excess of the cost basis of servicing assets for a given stratum is not recognized. The Company estimates the fair value of each stratum based on an industry standard present value of cash flows model. The Company recognizes both amortization of servicing rights and impairment charges in service charges and fees in the consolidated statements of income. Servicing assets are included in other assets in the consolidated balance sheets.
Real Estate Owned and Repossessed Assets—Included in other assets in the consolidated balance sheets is real estate acquired through foreclosure and repossessed consumer assets. Real estate properties acquired through foreclosures, commonly referred to as real estate owned (“REO”) and repossessed assets, are recorded at fair value, less estimated selling costs at acquisition.
Income Taxes—The Company accounts for income taxes in accordance with SFAS No. 109,Accounting for Income Taxes,which prescribes the use of the asset and liability method whereby deferred tax asset or liability account balances are calculated at the balance sheet date using current tax laws and rates in effect. Valuation allowances are established, when necessary, to reduce deferred tax assets when it ismore likely than not that a portion or all of a given deferred tax assets will not be realized. In accordance with SFAS No. 109, income tax expense includes (i) deferred tax expense, which generally represents the net change in the deferred tax asset or liability balance during the year plus any change in valuation allowances and (ii) current tax expense, which represents the amount of tax currently payable to or receivable from a taxing authority plus amounts accrued for expected tax deficiencies (including both tax and interest.) Accruals for expected tax deficiencies are recorded in accordance with SFAS No. 5,Accounting for Contingencies, when management determines that a tax deficiency is both probable and reasonably estimable.
Securities Sold Under Agreements to Repurchase—Securities under agreements to repurchase similar securities (“Repurchase Agreements”) are collateralized by fixed- and variable-rate mortgage-backed securities or investment grade securities. Repurchase Agreements are treated as financings for financial statement purposes and the obligations to repurchase securities sold are reflected as borrowings in the consolidated balance sheets.
Mandatory Convertible Debt—The Company accounts for its mandatory convertible debt by allocating the proceeds using the relative fair value of the stock purchase contracts and the debt securities on the date of issuance. The issue costs are deferred and allocated to the debt securities and the stock purchase contracts based on their relative fair values at issuance date. The portion of issuance costs allocated to the debt is amortized over the life of the debt using the interest method.
The value of the stock purchase contracts is included in equity based on the requirements of SFAS No. 150,Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity, and EITF Issue No. 00-19,Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock.The Company evaluated the mandatory convertible debt under SFAS No. 150 and EITF No. 00-19. In order for the stock purchase contracts to be included in equity, the following statements must be met.
| • | The obligation settlement amount is not based on a fixed monetary amount known at inception, |
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| • | The stock purchase commitment is based on the fair value of the issuer’s equity shares, |
| • | The Company could not be required to net cash settle the stock purchase contract, |
| • | The Company has sufficient authorized and unissued shares available to settle the stock purchase contract, and |
| • | There is an explicit limit on the number of shares of common stock required to be delivered under the stock purchase contract. |
Based on our review of the above criterion and other relevant technical requirements, the stock purchase contracts are included in equity.
Foreign Currency Translation—Assets and liabilities of consolidated subsidiaries outside of the United States are translated into U.S. dollars using the exchange rate in effect at each period end. Revenues and expenses are translated at the average exchange rate during the period. The effects of foreign currency translation adjustments arising from differences in exchange rates from period to period are deferred and included in AOCI as the functional currency of our subsidiaries is their local currency. Currency transaction gains or losses, derived on monetary assets and liabilities stated in a currency other than the functional currency, are recognized in current operations and have not been significant to the Company’s operating results in any period.
Advertising and Market Development—Advertising production costs are expensed when the initial advertisement is run. Costs of print advertising are expensed as the services are received.
Share-Based Payments—Effective July 1, 2005, the Company early adopted SFAS No. 123(R),Share-Based Payment and Staff Accounting Bulletin No. 107,Share-Based Payment, using the modified prospective application method to account for its share-based compensation plans. Upon adoption, the Company began expensing options as compensation and benefits with a one-time pre-tax credit of $2.8 million in cumulative effect of accounting change related to estimated forfeiture on restricted stock for its adoption in 2005 related to restricted stock awards. Results for prior periods have not been restated. Prior to July 1, 2005, the Company accounted for its employee stock option and awards under Accounting Principles Board (“APB”) Opinion No. 25,Accounting for Stock Issued to Employees, and related interpretations, and accordingly, did not record compensation costs for option grants to employees if the exercise price equaled the fair market value on the grant date. Additionally, for restricted stock awards, compensation was recorded on a straight-line basis over the vesting period of the awards with forfeitures recorded as they occurred.
Under this transition method, compensation cost in 2005 includes the portion of options and awards vesting in the period for (1) all share-based payments granted prior to, but not vested as of July 1, 2005, based on the grant date fair value estimated in accordance with the original provisions of SFAS No. 123,Accounting for Stock-Based Compensation and (2) all share-based payments granted subsequent to July 1, 2005, based on the grant date fair value estimated in accordance with the provisions of SFAS No. 123(R.) Compensation cost for options granted prior to July 1, 2005 is recognized on an accelerated amortization method over the vesting period of the options using an estimated forfeiture rate. Compensation cost for options granted on or after July 1, 2005 is recognized on a straight-line basis over the vesting period using an estimated forfeiture rate. Also under SFAS No. 123(R), the Company has reflected the tax benefit from tax deduction in excess of compensation recognized as a financing activity in the consolidated statements of cash flows.
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The following table illustrates the effect on the Company’s reported net income and net income per share if the Company had applied the fair value recognition provisions of SFAS No. 123, to stock-based employee compensation in periods prior to July 1, 2005 (in thousands, except per share amounts):
| Year Ended December 31, | ||||||||||||
| 2005 | 2004 | 2003 | ||||||||||
Net income, as reported | $ | 430,412 | $ | 380,483 | $ | 203,027 | ||||||
Add back: Stock-based employee compensation expense, net of tax included in reported net income, net of tax | 11,356 | 3,081 | 2,033 | |||||||||
Deduct: Total stock-based employee compensation expense determined under fair value-based method for all awards, net of tax | (18,733 | ) | (22,640 | ) | (17,561 | ) | ||||||
Pro forma net income | $ | 423,035 | $ | 360,924 | $ | 187,499 | ||||||
Income per share: | ||||||||||||
Basic—as reported | $ | 1.16 | $ | 1.04 | $ | 0.57 | ||||||
Basic—pro forma | $ | 1.14 | $ | 0.98 | $ | 0.52 | ||||||
Diluted—as reported | $ | 1.12 | $ | 0.99 | $ | 0.55 | ||||||
Diluted—pro forma | $ | 1.10 | $ | 0.94 | $ | 0.51 | ||||||
The underlying assumptions to these fair value calculations are discussed in Note 21.
Comprehensive Income—The Company’s comprehensive income is comprised of net income, foreign currency cumulative translation adjustments, unrealized gains (losses) on available-for-sale mortgage-backed and investment securities and the effective portion of the unrealized gains (losses) on financial derivatives in cash flow hedge relationships, net of reclassification adjustments and related taxes.
Earnings Per Share—Basic earnings per share (“EPS”) is computed by dividing net income by the weighted-average common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock. The Units will be reflected in diluted earnings per share calculations using the treasury stock method as defined by SFAS No. 128,Earning per Share. Under this method, the number of shares of common stock used in calculating diluted earnings per share (based on the settlement formula applied at the end of the reporting period) is deemed to be increased by the excess, if any, of the number of shares that would be issued upon settlement of the purchase contracts less the number of shares that could be purchased by the Company in the market at the average market price during the period using the proceeds to be received upon settlement.
Financial Derivative Instruments and Hedging Activities—The Company enters into derivative transactions to protect against the risk of market price or interest rate movements on the value of certain assets, liabilities and future cash flows. The Company must also recognize certain contracts and commitments as derivatives when the characteristics of those contracts and commitments meet the definition of a derivative promulgated by SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended.
Each derivative is recorded on the balance sheet at fair value as a freestanding asset or liability. Financial derivative instruments in hedging relationships that mitigate exposure to changes in the fair value of assets or liabilities are considered fair value hedges under SFAS No. 133. Financial derivative instruments designated in hedging relationships that mitigate the exposure to the variability in expected future cash flows or other forecasted transactions are considered cash flow hedges. The Company formally documents all relationships between hedging instruments and hedged items and the risk management objective and strategy for each hedge transaction.
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Fair value hedges are accounted for by recording the fair value of the financial derivative instrument and the change in fair value of the asset or liability being hedged on the consolidated balance sheets with the net difference, or hedge ineffectiveness, reported as fair value adjustments of financial derivatives in the consolidated statements of income. Cash payments or receipts and related accruals during the reporting period on derivatives included in fair value hedge relationships are recorded as an adjustment to interest income on the hedged asset or liability. If a financial derivative in a fair value hedging relationship is no longer effective, de-designated from its hedging relationship or terminated, the Company discontinues fair value hedge accounting for the derivative and the hedged item. Changes in the fair value of these derivative instruments no longer designated in an accounting hedge relationship are recorded in gain on sales of loans and securities, net, in the consolidated statements of income. The accumulated adjustment of the carrying amount of the hedged interest-earning asset or liability is recognized in earnings as an adjustment to interest income over the expected remaining life of the asset using the effective interest method.
Cash flow hedges are accounted for by recording the fair value of the financial derivative instrument as either a freestanding asset or a freestanding liability in the consolidated balance sheets, with the effective portion of the change in fair value of the financial derivative recorded in AOCI, net of tax in the consolidated balance sheets. Amounts are then included in interest expense as a yield adjustment in the same period the hedged forecasted transaction affects earnings. The ineffective portion of the change in fair value of the financial derivative is reported as fair value adjustments of financial derivatives in the consolidated statements of income. If it becomes probable that a hedged forecasted transaction will not occur, amounts included in AOCI related to the specific hedging instruments are reported as gain on sales of loans and securities, net in the consolidated statements of income. Derivative gains and losses that are not held as accounting hedges are recognized as gain on sales of loans and securities, net in the consolidated statements of income as these derivatives do not qualify for hedge accounting under SFAS No. 133. If a financial derivative ceases to be highly effective as a hedge, hedge accounting is discontinued prospectively and the financial derivative instrument continues to be recorded at fair value with changes in fair value being reported as gain on sales of loans and securities, net in the consolidated statements of income.
Revenue Recognition
Commissions—The Company derives commissions revenue from its retail and institutional customers. Commissions revenue from securities transactions are recognized on a trade date basis. The Company receives commissions for providing certain institutional customers with market research and other information, which is a common industry practice. These commissions revenue contributed less than 10% of the Company’s net revenues for all periods presented. Direct costs from these arrangements are expensed as the commissions are received, in proportion to the cost of the total arrangement. As a result, payments for independent research are deferred or accrued to properly match expenses at the time commission revenue is earned. For these arrangements, payments for independent research of $6.0 million were deferred and costs of $19.4 million were accrued at December 31, 2005 and payments of $6.3 million were deferred and costs of $18.6 million were accrued at December 31, 2004.
Principal Transactions—Principal transactions consist primarily of revenue from market-making activities. Market-making activities are the matching of buyers and sellers of securities and include transactions where the Company will purchase securities for its balance sheet with the intention of resale to transact the customer’s buy or sell order.
Gain on Sales of Loans and Securities, net—Gain on sales of originated loans are recognized at the date of settlement and are based on the difference between the cash received and the carrying value of the related loans sold, less related transaction costs. In cases where the Company retains the servicing rights associated with loans sold, the gain recognized is the difference between cash received and the allocated basis of the loans sold, less the related transaction costs. In accordance with SFAS No. 140, the allocated basis of the loans, which is determined at the sale date, is the result of the allocation of basis between the loans sold and the associated servicing right, based on the relative fair values of the loans at the date of transfer.
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Gain on sales of loans and securities, net includes gains or losses resulting from sales of loans purchased for resale; the sale or impairment of available-for-sale mortgage-backed and investment securities; and gains or losses on financial derivatives that are not accounted for as hedging instruments under SFAS No. 133. Gains or losses resulting from the sale of loans are recognized at the date of settlement and are based on the difference between the cash received and the carrying value of the related loans, less related transaction costs. Nonrefundable fees and direct costs associated with the origination of mortgage loans are deferred and recognized when the related loans are sold. Gains or losses resulting from the sale of available-for-sale securities are recognized at the trade date, based on the difference between the anticipated proceeds and the amortized cost of the specific securities sold.
Service Charges and Fees—Service charges and fees consist of account maintenance fees, servicing fee income and other customer service fees. Account maintenance fees are charged to the customer either quarterly or annually and accrued as earned.
Other Revenues—Other revenues consists of stock plan administration services, payments for order flow from third party market makers and foreign exchange margin revenue. Stock plan administration services are recognized in accordance with applicable accounting guidance, including SOP 97-2,Software Revenue Recognition. Payments for order flow revenues are accrued in the same period in which the related securities transactions are completed or related services are rendered.
Interest Income—Interest income is recognized as earned on interest-earning assets, customer margin loan balances, stock borrow balances, cash required to be segregated under regulatory guidelines and fees on customer assets invested in money market funds. Interest income includes the effect of hedges on interest-earning assets.
Interest Expense—Interest expense is recognized as incurred on interest-bearing liabilities, customer credit balances, interest paid to banks and interest paid to other broker-dealers through a subsidiary’s stock loan program. Interest expense includes the effect of hedges on interest-bearing liabilities.
New Accounting Standards—Below are the new accounting pronouncements that relate to activities the Company is engaged.
FSP 123(R) -4—Classification of Options and Similar Instruments Issued as Employee Compensation That Allow for Cash Settlement upon the Occurrence of a Contingent Event
On February 3, 2006, the Financial Accounting Standards Board (“FASB”) issued FASB Staff Position (“FSP”) No. 123(R)-4,Classification of Options and Similar Instruments Issued as Employee Compensation That Allow for Cash Settlement upon the Occurrence of a Contingent Event. FSP 123(R)-4 addresses the classification of options and similar instruments issued as employee compensation that allow for cash settlement upon the occurrence of a contingent event. An entity must recognize a share-based liability equal to the portion of the award attributed to past service, multiplied by the award’s fair value on that date for an option or similar instrument that is classified as equity, but subsequently becomes a liability because the contingent cash settlement event is probable of occurring. FSP 123(R)-4 is effective for the Company in the first quarter of 2006, with early adoption permitted. Upon adoption, the Company must retroactively restate prior periods for the change. The Company has not issued any options or similar instruments as employee compensation that allow for cash settlement upon the occurrence of a contingent event that would require a change under the FSP. Therefore, the Company does not believe this FSP will have an impact on its results of operations or financial condition.
EITF 03-01—The Meaning of Other-Than-Temporary Impairment and its Application to Certain Issues
In March 2004, the EITF amended and ratified previous consensus reached on EITF 03-01,The Meaning of Other-Than-Temporary Impairment. This amendment, which was originally effective for financial periods beginning after June 15, 2004, introduced qualitative and quantitative guidance for determining whether securities are other-than-temporarily impaired. In September 2004, the FASB’s staff issued a number of FSPs
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that focused primarily upon the application of EITF 03-01 to debt securities that are impaired solely due to interest rates and/or sector spreads. In November 2005, the FASB issued FSP 115-1/124-1,The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments, which nullified and replaced the qualitative and quantitative guidance for determining whether securities are other-than-temporarily impaired. The new guidance is consistent with the Company’s current practice which is primarily found within SFAS No. 115 and EITF 99-20, as to the measurement and recognition of other-than-temporary impairments of its debt and equity securities.
SFAS No. 154—Accounting Changes and Error Corrections
In June 2005, the FASB issued SFAS No. 154,Accounting Changes and Error Corrections. This statement supersedes APB Opinion No. 20,Accounting Changes and SFAS No. 3,Reporting Accounting Changes in Interim Financial Statements. The statement applies to all voluntary changes in accounting principle and changes the requirements for accounting and reporting of a change in accounting principle. SFAS No. 154 requires retrospective application to prior periods’ financial statements of a voluntary change in accounting principle unless it is impracticable. The statement requires that a change in method of depreciation, amortization, or depletion for long-lived, nonfinancial assets be accounted for as a change in accounting estimate that is effected by a change in accounting principle. SFAS No. 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The statement does not change the transition provisions of any existing accounting pronouncements, including those that are in a transition phase as of the effective date of this statement. The Company will adopt SFAS No. 154, as applicable, beginning in 2006.
SOP No. 03-3—Accounting for Certain Loans or Debt Securities Acquired in a Transfer
In December 2003, the Accounting Standards Executive Committee of the American Institute of Certified Public Accountants issued SOP No. 03-3,Accounting for Certain Loans or Debt Securities Acquired in a Transfer to address accounting for differences between the contractual cash flows of certain loans and debt securities and the cash flows expected to be collected when loans or debt securities are acquired in a transfer and those cash flow differences are attributable, at least in part, to credit quality. As such, SOP No. 03-3 applies to loans and debt securities purchased or acquired in purchase business combinations and does not apply to originated loans. SOP No. 03-3 requires that the excess of contractual cash flows over cash flows expected to be collected (nonaccretable difference) not be recognized as an adjustment of yield or valuation allowance, such as the allowance for credit losses. Subsequent to the initial investment, increases in expected cash flows generally should be recognized prospectively through adjustment of the yield on the loan or debt security over its remaining life. Decreases in expected cash flows should be recognized as impairment. SOP No. 03-3 is effective for loans and debt securities acquired in fiscal years beginning after December 15, 2004, with early application encouraged. In 2005, the Company adopted this new pronouncement, which effect was not material to the Company’s financial condition, result of operations or cash flows.
Over the past two years, the Company completed several business combinations and asset acquisitions which were all accounted for under the purchase method of accounting. The purchase prices have been allocated to the net assets acquired and the liabilities assumed based on their estimated fair values at the date of acquisition. For certain acquisitions, the consolidated financial statements reflect preliminary allocations of purchase price, as appraisals of the net assets acquired have not been finalized. The Company does not expect changes in the preliminary allocations from the finalization of these appraisals to be material to its consolidated statements of income. The results of operations of each are included in the Company’s consolidated statements of income from the date of each acquisition.
BrownCo
On November 30, 2005, the Company completed its acquisition of J.P. Morgan Invest, LLC (“BrownCo”), an online discount brokerage business with approximately 186,000 customer accounts, from JP Morgan Chase &
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Co. for an aggregate purchase price of approximately $1.6 billion in cash. The purchase price included approximately $306.6 million in net assets acquired, $269.7 million in customer list and noncompete intangibles, $9.0 million in contracts and employee termination liabilities, with the remaining $1,062.4 million recorded as goodwill. Regulatory capital of $294.5 million was included in the purchase price. The intangible assets will be amortized over approximately 22 years on an accelerated basis.
Harrisdirect
On October 6, 2005, the Company completed its acquisition of Harrisdirect LLC (“Harrisdirect”), a U.S.-based online discount brokerage business with approximately 425,000 customer accounts, from BMO Financial Group for an aggregate purchase price of approximately $709.0 million in cash. The purchase price included approximately $22.4 million in net assets acquired, $156.4 million in customer list and noncompete intangibles, $11.1 million in contract and employee termination liabilities, with the remaining $541.4 million recorded as goodwill. Regulatory capital of $16.0 million was included in the purchase price. The intangible assets will be amortized over approximately 19 years on an accelerated basis.
Wealth Management Advisors
The Company acquired Kobren Insight Management on November 2, 2005 and Howard Capital Management, Inc. on January 1, 2005. Both companies are registered investment advisory firms. The companies combined have over $1.5 billion in assets under management. The Company recorded $24.6 million of intangible assets and $7.6 million of goodwill related to the acquisitions. The intangible assets will be amortized over approximately 20 years on an accelerated basis. In accordance with the terms of the acquisitions, the Company may pay additional cash and stock if certain milestones are met. These milestones are for certain revenues and earnings targets, which if met, will cause the Company to pay up to an additional $34.6 million.
Active Accounts
In October 2004, the Company acquired certain active accounts from a brokerage company. The Company paid $17.0 million in cash and recorded an intangible asset of $17.0 million which will be amortized over 10 years.
NOTE 3—DISCONTINUED OPERATIONS
In 2005, the Company sold its Consumer Finance Corporation, exited the institutional proprietary trading business conducted by E*TRADE Professional Securities, LLC and announced its intention to sell its professional agency business which conducts its activities as E*TRADE Professional Trading, LLC. In 2004, the Company’s retail segment completed the sale of substantially all of the assets and liabilities of E*TRADE Access, the company that previously owned its ATM network. All of these transactions and intended transactions, except the Consumer Finance Corporation’s servicing operations, were accounted for as discontinued operations as of December 31, 2005, 2004 and 2003.
Below is a table summarizing the gains (losses), net of taxes, resulting from the sale and closure of discontinued operations (in thousands):
| Year ended December 31, | |||||||
| 2005 | 2004 | ||||||
Consumer Finance Corporation—origination business(1) | $ | 6,444 | $ | — | |||
E*TRADE Professional | (2,421 | ) | — | ||||
E*TRADE Access | — | 31,408 | |||||
Total net gain from sale of discontinued operations | $ | 4,023 | $ | 31,408 | |||
| (1) | The gain on the servicing business, which was not accounted for as a discontinued operation, is recorded in facility restructuring and other exit activities. |
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Consumer Finance Corporation
On October 31, 2005, the Company completed the sale of the origination and servicing business of Consumer Finance Corporation to GE Capital. The servicing business exited did not qualify as a discontinued operation; however, the origination business is accounted for as a discontinued operation. The sale resulted in a pre-tax gain of $46.1 million upon close, $35.5 million relating to the servicing business and $10.6 million ($6.4 million, net of tax), relating to the origination business.
The Company will not have significant continuing involvement in the operations of the servicing business but will continue to have significant cost-generating activities in the form of a servicing agreement. As such, the servicing business did not qualify as a discontinued operation. The Company will not have significant continuing involvement in the operations of the origination business and will not continue any significant revenue-producing or cost-generating activities of the origination business. Therefore, the results of operations, net of income taxes, of this origination business are presented as discontinued operations on the Company’s consolidated statements of income for all periods presented.
The following table summarizes the results of discontinued operations for the origination business (in thousands):
| Year ended December 31, | |||||||||||
| 2005 | 2004 | 2003 | |||||||||
Net revenues | $ | (7,750 | ) | $ | (5,898 | ) | $ | 47,318 | |||
Income (loss) from discontinued operations before income taxes | $ | (22,959 | ) | $ | (36,630 | ) | $ | 18,912 | |||
Income tax expense (benefit) | (8,783 | ) | (15,082 | ) | 7,432 | ||||||
Net income (loss) from discontinued operations | $ | (14,176 | ) | $ | (21,548 | ) | $ | 11,480 | |||
E*TRADE Professional
On May 9, 2005, the Company closed E*TRADE Professional Securities, LLC (“ETPS”), a unit that conducted proprietary trading operations. In June 2005, the Company filed to withdraw its broker-dealer license for ETPS, with an effective date of May 31, 2005. ETPS was a Philadelphia Stock Exchange (“PHLX”) member and a standalone entity which employed less than 200 traders. This closure resulted in a $2.4 million, net of tax, loss on disposal of discontinued operations, which included employee terminations, facility closure and impairment of goodwill and intangibles.
In December 2005, the Company decided to sell its professional agency business, E*TRADE Professional Trading, LLC (“ETPT”.) This business includes a broker-dealer registered with the SEC and a member of the NASD Inc. (“NASD”) who currently executes and clears its customer security transactions through an affiliate, E*TRADE Clearing LLC, on a fully disclosed basis under an introducing broker-dealer relationship. The Company executed a sale agreement on February 17, 2006. Under the terms of the sale agreement, the Company continues to retain the obligation for contingent liabilities that existed prior to the sale, which contingent liabilities would not, in the Company’s estimation individually or collectively, be material to the Company’s financial results.
The Company will not have significant continuing involvement in the operations of either its proprietary trading or its professional agency businesses and will not continue any significant revenue-producing or cost-generating activities of these businesses. Therefore, the Company’s results of operations, net of income taxes, include these businesses as discontinued operations on the Company’s consolidated statements of income for all periods presented.
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The following table summarizes the results of discontinued operations for the proprietary and agency trading businesses (in thousands):
| Year ended December 31, | ||||||||||||
| 2005 | 2004 | 2003 | ||||||||||
Net revenues | $ | 21,408 | $ | 50,962 | $ | 48,765 | ||||||
Loss from discontinued operations before income taxes | $ | (11,103 | ) | $ | (13,851 | ) | $ | (12,919 | ) | |||
Income tax benefit | (3,784 | ) | (4,499 | ) | (5,610 | ) | ||||||
Net loss from discontinued operations | $ | (7,319 | ) | $ | (9,352 | ) | $ | (7,309 | ) | |||
E*TRADE Access
In 2004, the Company completed the sale of substantially all of the assets and liabilities of E*TRADE Access to Cardtronics, LP and Cardtronics, Inc. Although the Company believes that an ATM network is an important distribution channel for its customers, it determined that its continued ownership and direct operation of the ATM network was not essential to providing this customer benefit and that the capital it had invested in this endeavor could be better applied to other operations.
The sale resulted in a $57.5 million pre-tax gain ($31.4 million after taxes.) As part of the sales agreement, Cardtronics assumed substantially all of the liabilities of E*TRADE Access. The Company has reflected E*TRADE Access’ results of operations, financial position and cash flows as discontinued operations in the consolidated financial statements for all periods reported herein.
The following table summarizes the results of discontinued operations of our ATM business for the periods presented (in thousands):
| Year Ended December 31, | ||||||||
| 2004 | 2003 | |||||||
Revenues | $ | 20,029 | $ | 44,909 | ||||
Loss from discontinued operations before income taxes | $ | (3,085 | ) | $ | (2,700 | ) | ||
Income tax benefit | (1,230 | ) | (1,035 | ) | ||||
Loss from discontinued operations | $ | (1,855 | ) | $ | (1,665 | ) | ||
NOTE 4—FACILITY RESTRUCTURING AND OTHER EXIT ACTIVITIES
The following table summarizes the amount recognized by the Company as facility restructuring and other exit activities for the periods presented (in thousands):
| Year Ended December 31, | |||||||||||
| 2005 | 2004 | 2003 | |||||||||
Exit of Consumer Finance Corporation—servicing business | $ | (35,496 | ) | $ | — | $ | — | ||||
Israel exit activities | — | 14,500 | 1,435 | ||||||||
2003 Restructuring Plan | 2,002 | 1,857 | 112,564 | ||||||||
2001 Restructuring Plan | 1,096 | (800 | ) | 16,367 | |||||||
Other exit activities | 2,381 | 131 | 3,821 | ||||||||
Total restructuring and other exit activities | $ | (30,017 | ) | $ | 15,688 | $ | 134,187 | ||||
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Exit of Consumer Finance Business
On October 31, 2005, the Company completed the sale of the servicing and origination businesses of Consumer Finance Corporation to GE Capital resulting in a pre-tax gain of $46.1 million. The pre-tax gain from the servicing business of $35.5 million is reflected in other exit activity as the servicing business was not deemed to be a discontinued operation. (See Note 3 for additional information.)
Israel Exit Activity
The Company terminated the trademark and technology license of an Israeli-based company in 2002 due to failure to perform obligations and commenced arbitration proceedings. The Israeli company counterclaimed for wrongful termination. An arbitration tribunal in London decided against the Company and as a result, the Company recognized $14.5 million and $1.4 million in exit activities for 2004 and 2003.
2003 Restructuring Plan
In April 2003, the Company announced a restructuring plan (“2003 Restructuring Plan”) exiting and consolidating leased facilities and exiting and disposing of certain unprofitable product offerings and initiatives. The original 2003 facility consolidation charge primarily related to charges to exit the E*TRADE FINANCIAL Center in New York and consolidation of excess facilities located in Menlo Park and Rancho Cordova, California. The E*TRADE FINANCIAL Center in New York, encompassing approximately 31,000 square feet, was used by customers to access the Company’s products and services and served as an introduction point for new customers to the Company’s products and services. The Company exited this center as it was not cost effective to engage in these activities within a facility of its size, and subsequently, opened an approximately 2,000 square foot new center in New York that was more cost effective. The leased California facilities were used for corporate and administrative functions and were exited as the Company consolidated employees into nearby offices and moved certain functions to its offices in Virginia.
The other charges related to the exit of or write-off of unprofitable product lines and the early termination of certain contracts, such as the revenue sharing agreements associated with 43 E*TRADE Zones located in Target stores. These unprofitable product lines consisted of our Stock Basket product offered to customers and our online advisory service, eAdvisor, a joint initiative with Enlight Holdings, LLC. The Company terminated its revenue sharing agreements associated with its Zones in Target stores to focus on other methods of reaching its current and potential customers.
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In 2004, the Company completed its exit of the Enlight Holdings, LLC product offering resulting in adjustments to estimated costs associated with its exit. In 2005, the Company made additional adjustment to previously estimated costs associated with the consolidation of facilities in California. The rollforward of the 2003 Restructuring Plan reserve is presented below (in thousands):
Facility Consolidation | Other | Total | ||||||||||
Original 2003 Restructuring Reserve: | ||||||||||||
Facility restructuring and other exit activity recorded in 2003 | $ | 55,010 | $ | 57,960 | $ | 112,970 | ||||||
Cash payments | (11,007 | ) | (16,369 | ) | (27,376 | ) | ||||||
Non-cash charges | (19,254 | ) | (38,370 | ) | (57,624 | ) | ||||||
Restructuring liabilities at December 31, 2003 | 24,749 | 3,221 | 27,970 | |||||||||
2004 activity on original 2003 restructuring reserve: | ||||||||||||
Adjustment and additional charges recorded in 2004 | 2,458 | (601 | ) | 1,857 | ||||||||
Cash payments | (5,439 | ) | (2,249 | ) | (7,688 | ) | ||||||
Restructuring liabilities at December 31, 2004 | 21,768 | 371 | 22,139 | |||||||||
2005 activity on original 2003 restructuring reserve: | ||||||||||||
Adjustment and additional charges recorded in 2005 | 2,042 | (40 | ) | 2,002 | ||||||||
Cash payments | (5,093 | ) | (331 | ) | (5,424 | ) | ||||||
Restructuring liabilities at December 31, 2005 | $ | 18,717 | $ | — | $ | 18,717 | ||||||
2001 Restructuring Plan
In August 2001, the Company announced a restructuring plan (“2001 Restructuring Plan”) aimed at streamlining operations primarily by consolidating facilities in the United States and Europe. The restructuring was designed to consolidate certain facilities, bring together key decision-makers and streamline operations. The original 2001 restructuring charge related to facility consolidation represents the undiscounted value of ongoing lease commitments, offset by anticipated third-party sublease revenues, the write-off of capitalized software, hardware and other fixed assets and other costs. Subsequent to 2001, the Company recognized additional facility consolidation adjustments, as a result of updated estimates of sublease income and sublease start dates, driven by economic circumstances. The rollforward of the 2001 Restructuring Plan reserve is presented below (in thousands):
Facility Consolidation | Asset Write-Off | Other | Total | |||||||||||||
Total 2001 facility restructuring and other nonrecurring charges recorded in 2001 | $ | 128,469 | $ | 52,532 | $ | 21,764 | $ | 202,765 | ||||||||
Activity through December 31, 2003: | ||||||||||||||||
Adjustments and additional charges | 22,204 | 2,072 | 3,499 | 27,775 | ||||||||||||
Cash payments | (92,881 | ) | (67 | ) | (19,281 | ) | (112,229 | ) | ||||||||
Non-cash charges | (41,263 | ) | (53,877 | ) | (5,810 | ) | (100,950 | ) | ||||||||
Restructuring liabilities at December 31, 2003 | 16,529 | 660 | 172 | 17,361 | ||||||||||||
2004 activity on original 2001 restructuring reserve: | ||||||||||||||||
Adjustments and additional charges recorded in 2004 | (800 | ) | — | — | (800 | ) | ||||||||||
Cash payments | (5,489 | ) | — | (6 | ) | (5,495 | ) | |||||||||
Restructuring liabilities at December 31, 2004 | 10,240 | 660 | 166 | 11,066 | ||||||||||||
2005 activity on original 2001 restructuring reserve: | ||||||||||||||||
Adjustments and additional charges recorded in 2005 | 543 | (220 | ) | 773 | 1,096 | |||||||||||
Cash payments | (3,328 | ) | (440 | ) | (147 | ) | (3,915 | ) | ||||||||
Restructuring liabilities at December 31, 2005 | $ | 7,455 | $ | — | $ | 792 | $ | 8,247 | ||||||||
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Facility Consolidation Obligations
The components of the facility consolidation restructuring liabilities for the 2003 and 2001 Restructuring Plans at December 31, 2005, and their timing are as follows (in thousands):
| Facilities Obligations | Sublease Income | Discounted Rents and | Net | |||||||||||||||
Year | Contracted | Estimate | ||||||||||||||||
2006 | $ | 12,542 | $ | (2,952 | ) | $ | (224 | ) | $ | (1,000 | ) | $ | 8,366 | |||||
2007 | 10,537 | (2,360 | ) | (966 | ) | (735 | ) | 6,476 | ||||||||||
2008 | 7,886 | (1,839 | ) | (835 | ) | (352 | ) | 4,860 | ||||||||||
2009 | 6,382 | (1,440 | ) | (716 | ) | (151 | ) | 4,075 | ||||||||||
2010 | 3,535 | (731 | ) | (488 | ) | (61 | ) | 2,255 | ||||||||||
Thereafter | 922 | (782 | ) | — | — | 140 | ||||||||||||
Total | $ | 41,804 | $ | (10,104 | ) | $ | (3,229 | ) | $ | (2,299 | ) | $ | 26,172 | |||||
Other Exit Activities
Other exit activities in 2005 are primarily related to the liquidation of proprietary money market funds and the outsourcing of certain brokerage activities. These costs primarily relate to customer notification, reimbursement of losses taken on sale of securities and severance. Other exit charges in 2003 were primarily related to the gain on sale of the Company’s German subsidiary, partially offset by the charges relating to the exit of the Company’s proprietary institutional research business located in Europe.
NOTE 5—BROKERAGE RECEIVABLES, NET AND BROKERAGE PAYABLES
Brokerage receivables, net and brokerage payables consist of the following (in thousands):
| December 31, | ||||||
| 2005 | 2004 | |||||
Receivable from customers and non-customers (less allowance for doubtful accounts of $8,835 at December 31, 2005 and $1,970 at December 31, 2004) | $ | 5,678,923 | $ | 2,214,210 | ||
Receivable from brokers, dealers and clearing organizations: | ||||||
Deposits paid for securities borrowed | 1,163,125 | 613,546 | ||||
Net settlement and deposits with clearing organizations | 230,936 | 158,780 | ||||
Other | 101,191 | 48,012 | ||||
Total brokerage receivables, net | $ | 7,174,175 | $ | 3,034,548 | ||
Payable to customers and non-customers | $ | 5,817,469 | $ | 2,805,662 | ||
Payable to brokers, dealers and clearing organizations: | ||||||
Deposits received for securities loaned | 1,320,853 | 735,622 | ||||
Other | 177,337 | 77,608 | ||||
Total brokerage payables | $ | 7,315,659 | $ | 3,618,892 | ||
Receivables from customers and non-customers are brokerage receivables whereby credit is extended to customers to finance their purchases of securities by borrowing against securities they currently own (also known as margin balances). At December 31, 2005, the fair value of securities that the Company received as collateral, where the Company is permitted to sell or repledge the securities, is approximately $8.8 billion. Of this amount, $2.4 billion has been pledged or sold at December 31, 2005 in connection with securities lending, bank borrowings and deposits with clearing organizations.
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NOTE 6—AVAILABLE-FOR-SALE MORTGAGE-BACKED AND INVESTMENT SECURITIES
The amortized cost basis and estimated fair values of available-for-sale mortgage-backed and investment securities are shown in the following table (in thousands):
| Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Estimated Fair Values | ||||||||||
December 31, 2005: | |||||||||||||
Mortgage-backed securities: | |||||||||||||
U.S. Government sponsored enterprise obligations: | |||||||||||||
Federal National Mortgage Association | $ | 7,468,607 | $ | — | $ | (199,259 | ) | $ | 7,269,348 | ||||
Government National Mortgage Association | 2,198,009 | — | (59,739 | ) | 2,138,270 | ||||||||
Federal Home Loan Mortgage Corporation | 21,050 | — | (1,147 | ) | 19,903 | ||||||||
Total U.S. government sponsored enterprise | 9,687,666 | — | (260,145 | ) | 9,427,521 | ||||||||
Collateralized mortgage obligations and other | 1,014,582 | 315 | (19,006 | ) | 995,891 | ||||||||
Total mortgage-backed securities | 10,702,248 | 315 | (279,151 | ) | 10,423,412 | ||||||||
Investment securities: | |||||||||||||
Debt securities: | |||||||||||||
Asset-backed securities | 1,376,315 | 1,811 | (12,372 | ) | 1,365,754 | ||||||||
Municipal bonds | 168,682 | 1,884 | (882 | ) | 169,684 | ||||||||
Corporate bonds | 74,931 | — | (2,171 | ) | 72,760 | ||||||||
Other debt securities | 78,989 | — | (5,504 | ) | 73,485 | ||||||||
Total debt securities | 1,698,917 | 3,695 | (20,929 | ) | 1,681,683 | ||||||||
Publicly traded equity securities | 343,392 | 94,679 | (2,306 | ) | 435,765 | ||||||||
Retained interests from securitizations | 22,444 | 1,434 | — | 23,878 | |||||||||
Total investment securities | 2,064,753 | 99,808 | (23,235 | ) | 2,141,326 | ||||||||
Total available-for-sale securities | $ | 12,767,001 | $ | 100,123 | $ | (302,386 | ) | $ | 12,564,738 | ||||
December 31, 2004: | |||||||||||||
Mortgage-backed securities: | |||||||||||||
U.S. Government sponsored enterprise obligations: | |||||||||||||
Federal National Mortgage Association | $ | 5,149,991 | $ | 203 | $ | (87,990 | ) | $ | 5,062,204 | ||||
Government National Mortgage Association | 2,767,087 | 349 | (56,628 | ) | 2,710,808 | ||||||||
Federal Home Loan Mortgage Corporation | 21,057 | — | (862 | ) | 20,195 | ||||||||
Total U.S. government sponsored enterprise | 7,938,135 | 552 | (145,480 | ) | 7,793,207 | ||||||||
Collateralized mortgage obligations and other | 1,266,736 | 5,008 | (12,882 | ) | 1,258,862 | ||||||||
Total mortgage-backed securities | 9,204,871 | 5,560 | (158,362 | ) | 9,052,069 | ||||||||
Investment securities: | |||||||||||||
Debt securities: | |||||||||||||
Asset-backed securities | 2,789,471 | 21,662 | (14,704 | ) | 2,796,429 | ||||||||
Municipal bonds | 136,362 | 1,391 | (1,082 | ) | 136,671 | ||||||||
Corporate bonds | 87,959 | — | (3,444 | ) | 84,515 | ||||||||
Other debt securities | 80,189 | — | (4,767 | ) | 75,422 | ||||||||
Total debt securities | 3,093,981 | 23,053 | (23,997 | ) | 3,093,037 | ||||||||
Publicly traded equity securities | 295,593 | 81,304 | (2,055 | ) | 374,842 | ||||||||
Retained interests from securitizations | 23,870 | — | — | 23,870 | |||||||||
Total investment securities | 3,413,444 | 104,357 | (26,052 | ) | 3,491,749 | ||||||||
Total available-for-sale securities | $ | 12,618,315 | $ | 109,917 | $ | (184,414 | ) | $ | 12,543,818 | ||||
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Other-Than-Temporary Impairment of Investments
The following tables show the fair value and unrealized losses on investments, aggregated by investment category and the length of time that individual securities have been in a continuous unrealized loss position (in thousands):
| Less than 12 Months | 12 Months or More | Total | |||||||||||||||||||
Fair Value | Unrealized Losses | Fair Value | Unrealized Losses | Fair Value | Unrealized Losses | ||||||||||||||||
December 31, 2005: | |||||||||||||||||||||
Mortgage-backed securities: | |||||||||||||||||||||
Backed by Federal agencies | $ | 5,914,808 | $ | (142,245 | ) | $ | 3,512,713 | $ | (117,900 | ) | $ | 9,427,521 | $ | (260,145 | ) | ||||||
Other | 351,565 | (5,177 | ) | 546,291 | (13,829 | ) | 897,856 | (19,006 | ) | ||||||||||||
Asset-backed securities | 412,142 | (3,064 | ) | 411,595 | (9,308 | ) | 823,737 | (12,372 | ) | ||||||||||||
Municipal bonds | 21,006 | (165 | ) | 22,775 | (717 | ) | 43,781 | (882 | ) | ||||||||||||
Corporate bonds | — | — | 72,760 | (2,171 | ) | 72,760 | (2,171 | ) | |||||||||||||
Other debt securities | — | — | 73,485 | (5,504 | ) | 73,485 | (5,504 | ) | |||||||||||||
Publicly traded equity securities | 86,538 | (1,335 | ) | 11,759 | (971 | ) | 98,297 | (2,306 | ) | ||||||||||||
Total temporarily impaired securities | $ | 6,786,059 | $ | (151,986 | ) | $ | 4,651,378 | $ | (150,400 | ) | $ | 11,437,437 | $ | (302,386 | ) | ||||||
December 31, 2004: | |||||||||||||||||||||
Mortgage-backed securities: | |||||||||||||||||||||
Backed by Federal agencies | $ | 5,504,676 | $ | (85,020 | ) | $ | 2,135,727 | $ | (60,460 | ) | $ | 7,640,403 | $ | (145,480 | ) | ||||||
Other | 704,369 | (6,715 | ) | 175,678 | (6,167 | ) | 880,047 | (12,882 | ) | ||||||||||||
Asset-backed securities | 771,250 | (5,851 | ) | 20,769 | (8,853 | ) | 792,019 | (14,704 | ) | ||||||||||||
Municipal bonds | 72,146 | (1,082 | ) | — | — | 72,146 | (1,082 | ) | |||||||||||||
Corporate bonds | — | — | 84,515 | (3,444 | ) | 84,515 | (3,444 | ) | |||||||||||||
Other debt securities | — | — | 74,700 | (4,767 | ) | 74,700 | (4,767 | ) | |||||||||||||
Publicly traded equity securities | 52,717 | (2,055 | ) | — | — | 52,717 | (2,055 | ) | |||||||||||||
Total temporarily impaired securities | $ | 7,105,158 | $ | (100,723 | ) | $ | 2,491,389 | $ | (83,691 | ) | $ | 9,596,547 | $ | (184,414 | ) | ||||||
The Company does not believe any individual loss as of December 31, 2005 represents an other-than-temporary impairment. The majority of the unrealized losses on mortgage- and asset-backed securities are attributable to changes in interest rates and not reflective of deterioration in the credit quality of the issuer and/or securitization. Substantially all mortgage-backed securities backed by Federal agencies are “AAA” rated and have unrealized losses due to changes in market interest rates. As market interest rates increase, the fair value of fixed-rate securities will decrease. During 2005, increasing market interest rates caused higher unrealized losses on our fixed-rate securities including mortgage- and asset-backed securities. The Company has the ability and intent to hold these securities until the market value recovers or the securities mature. Asset-backed securities, corporate bonds and other debt securities are evaluated by reviewing the credit worthiness of the lender and based on market conditions. As of December 31, 2005, unrealized losses on mortgage- and asset-backed securities were primarily attributed to rising interest rates and not underlying credit impairment. Based on its evaluation, the Company recorded other-than-temporary charges of $38.3 million, $14.0 million and $2.2 million for 2005, 2004 and 2003, respectively, for its asset- and mortgage-backed securities and interest-only securities. Additionally, the Company recognized $2.0 million and $4.4 million of other-than-temporary impairments for 2005 and 2004, respectively, from retained beneficial interests in securitized receivables held by a subsidiary, ETCF Asset Funding Corporation.
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Publicly Traded Equity Securities
For the years ended December 31, 2005, 2004 and 2003, the Company recognized gains on sales of its publicly traded equity securities of $82.7 million, $130.6 million and $151.7 million, respectively. In 2005, these gains included sales of the Company’s holdings in Softbank Investment Corporation (“SBI”), all of its holdings in Archipelago Holdings Incorporated, Ameritrade Holding Corporation and holdings in International Stock Exchange of $59.7 million, $9.8 million, $8.4 million and $4.8 million, respectively. In 2004 and 2003, these gains primarily included sales of the Company’s holdings in SBI.
Contractual Maturities
The contractual maturities of available-for-sale debt securities, including mortgage-backed securities, at December 31, 2005 are shown below (in thousands):
Amortized Cost | Estimated Fair Values | |||||
Due within one year | $ | 3 | $ | 3 | ||
Due within one to five years | 31,371 | 31,369 | ||||
Due within five to ten years | 99,019 | 93,298 | ||||
Due after ten years | 12,270,772 | 11,980,425 | ||||
Total available-for-sale debt securities | $ | 12,401,165 | $ | 12,105,095 | ||
The Company pledged $11.8 billion at December 31, 2005 and $10.1 billion at December 31, 2004 of mortgage-backed securities as collateral for repurchase agreements, short-term borrowings, derivative instruments and FHLB advances.
Realized Gains (Losses)
Realized gains and losses from the sales and other-than-temporary impairment of available-for-sale investment securities, including mortgage-backed securities, are as follows (in thousands):
| Year Ended December 31, | ||||||||||||
| 2005 | 2004 | 2003 | ||||||||||
Mortgage-backed securities: | ||||||||||||
Realized gains | $ | 130,840 | $ | 105,876 | $ | 138,781 | ||||||
Realized losses | (100,765 | ) | (47,785 | ) | (47,046 | ) | ||||||
Impairment charges | (30,924 | ) | (12,400 | ) | — | |||||||
Net realized gains (losses) on mortgage-backed securities included in gain on sales of loans and securities, net | $ | (849 | ) | $ | 45,691 | $ | 91,735 | |||||
Other investments: | ||||||||||||
Realized gains | $ | 126,104 | $ | 152,480 | $ | 194,511 | ||||||
Realized losses | (8,878 | ) | (6,596 | ) | (21,980 | ) | ||||||
Impairment charges | (7,419 | ) | (1,558 | ) | (2,198 | ) | ||||||
Net realized gains included in gain on sales of loans and securities, net and gain on sale and impairment of investments | $ | 109,807 | $ | 144,326 | $ | 170,333 | ||||||
During 2005, 2004 and 2003, the Company realized gains from the sales of trading securities of $108.8 million, $101.3 million and $81.3 million, respectively. In addition, the Company had unrealized trading asset appreciation of $0.6 million, $2.5 million and $4.8 million in 2005, 2004 and 2003, respectively.
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Loans, net are summarized as follows (in thousands):
| Held-for- Investment | Held-for- Sale | Total Loans | |||||||||
December 31, 2005: | |||||||||||
Real estate loans: | |||||||||||
One- to four-family | $ | 7,091,664 | $ | 87,233 | $ | 7,178,897 | |||||
HELOC, second mortgage and other | 8,106,820 | 74 | 8,106,894 | ||||||||
Total real estate loans | 15,198,484 | 87,307 | 15,285,791 | ||||||||
Consumer and other loans: | |||||||||||
RV | 2,692,055 | — | 2,692,055 | ||||||||
Marine | 752,645 | — | 752,645 | ||||||||
Automobile | 235,388 | — | 235,388 | ||||||||
Credit card | 188,600 | — | 188,600 | ||||||||
Other | 97,436 | — | 97,436 | ||||||||
Total consumer and other loans | 3,966,124 | — | 3,966,124 | ||||||||
Total loans | 19,164,608 | 87,307 | 19,251,915 | ||||||||
Unamortized premiums, net | 323,573 | 64 | 323,637 | ||||||||
Allowance for loan losses | (63,286 | ) | — | (63,286 | ) | ||||||
Total loans, net | $ | 19,424,895 | $ | 87,371 | $ | 19,512,266 | |||||
December 31, 2004: | |||||||||||
Real estate loans: | |||||||||||
One- to four-family | $ | 3,669,594 | $ | 244,593 | $ | 3,914,187 | |||||
HELOC, second mortgage and other | 3,618,740 | 3,095 | 3,621,835 | ||||||||
Total real estate loans | 7,288,334 | 247,688 | 7,536,022 | ||||||||
Consumer and other loans: | |||||||||||
RV | 2,542,645 | 25,246 | 2,567,891 | ||||||||
Marine | 720,513 | 3,612 | 724,125 | ||||||||
Automobile | 583,354 | 35 | 583,389 | ||||||||
Credit card | 203,169 | — | 203,169 | ||||||||
Other | 19,493 | — | 19,493 | ||||||||
Total consumer and other loans | 4,069,174 | 28,893 | 4,098,067 | ||||||||
Total loans | 11,357,508 | 276,581 | 11,634,089 | ||||||||
Unamortized premiums, net | 195,928 | 2,699 | 198,627 | ||||||||
Allowance for loan losses | (47,681 | ) | — | (47,681 | ) | ||||||
Total loans, net | $ | 11,505,755 | $ | 279,280 | $ | 11,785,035 | |||||
In addition to these loans, net, the Company had commitments to originate, buy and sell loans at December 31, 2005 (see Note 24.)
Approximately 32% and 45% of the Company’s real estate loans were concentrated in California at December 31, 2005 and 2004, respectively. No other state had concentrations of real estate loans that represented 10% or more of the Company’s real estate portfolio.
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The following table shows the percentage of adjustable and fixed-rate loans in the Company’s portfolio (dollars in thousands):
| December 31, 2005 | December 31, 2004 | |||||||||||
| $ Amount | % of Total | $ Amount | % of Total | |||||||||
Adjustable rate loans: | ||||||||||||
Real estate | $ | 10,972,028 | 57.0 | % | $ | 6,839,796 | 58.8 | % | ||||
Credit card and other | 277,597 | 1.4 | 206,039 | 1.8 | ||||||||
Total adjustable rate loans | 11,249,625 | 58.4 | 7,045,835 | 60.6 | ||||||||
Fixed rate loans | 8,002,290 | 41.6 | 4,588,254 | 39.4 | ||||||||
Total loans | $ | 19,251,915 | 100.0 | % | $ | 11,634,089 | 100.0 | % | ||||
The weighted-average remaining maturity of mortgage loans secured by one- to four-family residences was 341 and 340 months at December 31, 2005 and 2004, respectively. Additionally, all mortgage loans outstanding at December 31, 2005 and 2004 in the held-for-investment portfolio were serviced by other companies.
The Company actively sells its originated loans and loans originated by correspondents. The Company may sell loans that it originally purchased from others. A summary of these activities is presented below (in thousands):
| Year Ended December 31, | |||||||||||
| 2005 | 2004 | 2003 | |||||||||
Loans sold: | |||||||||||
Originated | $ | 2,728,094 | $ | 4,339,901 | $ | 9,401,248 | |||||
Purchased | 1,028,747 | 2,395,886 | 4,114,563 | ||||||||
Total loans sold | $ | 3,756,841 | $ | 6,735,787 | $ | 13,515,811 | |||||
Gain on sales of loans: | |||||||||||
Originated | $ | 54,847 | $ | 82,716 | $ | 150,393 | |||||
Purchased | (1,208 | ) | (3,447 | ) | 186 | ||||||
Total gain on sale of loans | $ | 53,639 | $ | 79,269 | $ | 150,579 | |||||
Activity in the allowance for loan losses is summarized as follows (in thousands):
| Year Ended December 31, | ||||||||||||
| 2005 | 2004 | 2003 | ||||||||||
Allowance for loan losses, beginning of year | $ | 47,681 | $ | 37,847 | $ | 27,666 | ||||||
Provision for loan losses | 54,016 | 38,121 | 38,523 | |||||||||
Acquired through acquisitions | — | 1,547 | 2,748 | |||||||||
Charge-offs | (56,847 | ) | (50,341 | ) | (53,734 | ) | ||||||
Recoveries | 18,436 | 20,507 | 22,644 | |||||||||
Allowance for loan losses, end of year | $ | 63,286 | $ | 47,681 | $ | 37,847 | ||||||
During 2005, the allowance for loan losses increased by $15.6 million. Approximately $12.9 million of this increase is due to higher real estate loans outstanding which increased by $8.1 billion during 2005. The remaining increase in the allowance was due to slightly higher expected losses on RV and credit card loans offset by lower automobile loan related losses.
The $8.6 million increase in net charge-offs in 2005 was primarily due to higher net charge-offs on credit cards of $6.7 million, marine and RV of $4.7 million and real estate loan portfolios of $2.8 million, offset partially by lower net charge-offs on automobile loans of $5.8 million. Higher credit card charge-offs are the
32
result of increased bankruptcy filings as customers declared bankruptcy ahead of the new bankruptcy laws in October 2005. We do not anticipate that the 2005 level of credit card charge-offs will continue. The increase in net charge-offs was also due to growth in loans receivable and specific events affecting customer behavior during the period and not indicative of a decline in credit quality.
We classify loans as nonperforming when full and timely collection of interest or principal becomes uncertain or when they are 90 days past due. The following is the relative breakout of nonperforming loans (in thousands):
| December 31, | ||||||
| 2005 | 2004 | |||||
First mortgage loans, secured by one- to four-family residences | $ | 18,067 | $ | 11,029 | ||
HELOC and second mortgage | 9,568 | 2,755 | ||||
Credit card | 2,858 | 2,999 | ||||
RV | 2,826 | 1,416 | ||||
Other | 1,335 | 1,756 | ||||
Total nonperforming loans | $ | 34,654 | $ | 19,955 | ||
If the Company’s nonperforming loans at December 31, 2005, had been performing in accordance with their terms, the Company would have recorded additional interest income of approximately $0.8 million, $1.0 million and $1.1 million in 2005, 2004 and 2003, respectively. During 2005, we recognized $1.0 million in interest on loans that were in nonperforming status at December 31, 2005. At December 31, 2005 and 2004, there were no commitments to lend additional funds to any of these borrowers.
Collateralized Debt Obligations
On December 1, 2005, the Company and an unrelated financial advisor transferred asset-backed securities to E*TRADE ABS CDO IV, Ltd. (“CDO IV”.) The Company utilized a warehouse line to purchase the asset-backed securities that were sold to CDO IV. As of December 31, 2005, 92% of the pool of underlying securities had been transferred into CDO IV. Additional purchases of asset-backed securities were made in open market transactions and transferred to CDO IV in January and February 2006. In prior years, the Company transferred asset-backed securities to E*TRADE ABS CDO III, Ltd. (“CDO III”), E*TRADE ABS CDO II, Ltd. (“CDO II”) and E*TRADE ABS CDO I, Ltd. (“CDO I”.) Asset-backed securities were also transferred to CDO III by an unrelated financial advisor. Concurrent with these transfers, the respective CDOs sold beneficial interests to independent investors in the form of senior and subordinated notes and preference shares, collateralized by the asset-backed securities. Neither the CDOs themselves nor the investors in the beneficial interests sold by the CDOs have recourse to the Company. CDO I, II and III are qualifying special purpose entities as defined in SFAS No. 140, and, as such, are not required to be consolidated in the Company’s consolidated financial statements.
CDO IV is not a qualified special purpose entity but rather a special purpose entity, as the Company has been appointed by the CDO to actively manage the collateral of the CDO. The transaction was accounted for as a sale in accordance with SFAS No. 140. The CDO IV transaction differs from the previous three CDO transactions in that it is a managed deal whereby the portfolio manager (E*TRADE Global Asset Management (“ETGAM”)) is appointed to actively manage the collateral of the CDO as opposed to a static deal where the collateral is fixed throughout the life of the CDO. Because CDO IV is a managed deal, it is a special purpose entity and not a qualified special purpose entity.
The Company reviewed CDO IV to determine if consolidation was necessary under the requirements of FIN 46R. The calculation of the CDO’s beneficial interests indicated that ETGAM was not the recipient of the
33
majority of the potential benefits or losses of the deal and therefore, not the primary beneficiary of the transaction and not required to consolidate the CDO.
The Company purchased preference shares in each of the CDOs. Retained interests are subordinate to the notes sold by each CDO and on an equal standing with the preference shares purchased by other preference share investors in each CDO. The Company also purchased $1 million of the BBB subordinated notes in the CDO IV transaction.
The following table summarizes the asset-backed securities transferred to each CDO, the amount of the cash proceeds, the preference shares purchased by the Company and the current rating for those preference shares (dollars in millions):
CDO | Transaction Date | Asset-Backed Securities Transferred to CDO | Preference Shares Purchased by E*TRADE | ||||||||||||||||||
| E*TRADE | Independent Investment Advisor | Total | Proceeds | Amount | Rating at 12/31/05 | ||||||||||||||||
| Moody’s | S&P | ||||||||||||||||||||
CDO IV | December 2005 | $ | 37.0 | $ | 238.6 | $ | 275.6 | $ | 300.0 | $ | 1.4 | N/A | B | ||||||||
CDO III | December 2004 | 124.0 | 175.5 | 299.5 | 304.4 | 5.0 | Ba1 | BB+ | |||||||||||||
CDO II | August 2003 | 400.1 | — | 400.1 | 400.9 | 6.0 | Ba2 | BBB- | |||||||||||||
CDO I | September 2002 | 50.2 | 200.0 | 250.2 | 251.7 | 8.6 | Ca | B+ | |||||||||||||
Total | $ | 611.3 | $ | 614.1 | $ | 1,225.4 | $ | 1,257.0 | $ | 21.0 | |||||||||||
The carrying values of the Company’s retained interest in the CDOs are subject to future volatility in credit, interest rate and prepayment risk. The investment in the preference shares is classified as a trading security in the Company’s investment portfolio. Therefore, changes in the market value of these securities are recorded in gain on sales of loans and securities, net in the consolidated statements of income. The following table presents a sensitivity analysis of the Company’s retained interests in the CDOs at December 31, 2005 (dollars in thousands):
| CDO I | CDO II | CDO III | CDO IV | |||||||||||||
Fair value of retained preference shares(1) | $ | 195 | $ | 6,288 | $ | 5,178 | $ | 1,399 | ||||||||
Weighted-average remaining life (years) | 6.71 | 2.70 | 3.84 | 3.72 | ||||||||||||
Weighted-average prepayment speed | 15 | % | 10 | % | 10 | % | — | % | ||||||||
Impact of 10% adverse change | $ | (10 | ) | $ | (43 | ) | $ | (98 | ) | $ | (14 | ) | ||||
Impact of 20% adverse change | $ | (18 | ) | $ | (85 | ) | $ | (198 | ) | $ | (28 | ) | ||||
Weighted-average discount rate | 2 | % | 16 | % | 15 | % | 16 | % | ||||||||
Impact of 10% adverse change | $ | (7 | ) | $ | (257 | ) | $ | (276 | ) | $ | (78 | ) | ||||
Impact of 20% adverse change | $ | (10 | ) | $ | (499 | ) | $ | (529 | ) | $ | (150 | ) | ||||
Weighted-average expected credit losses | 1.95 | % | 0.44 | % | 0.41 | % | 0.65 | % | ||||||||
Impact of 10% adverse change | $ | (195 | ) | $ | (43 | ) | $ | (22 | ) | $ | (17 | ) | ||||
Impact of 20% adverse change | $ | (195 | ) | $ | (86 | ) | $ | (44 | ) | $ | (33 | ) | ||||
Actual credit losses to date | $ | 13,056 | $ | — | $ | — | $ | — | ||||||||
For the year ended December 31, 2005(2) | ||||||||||||||||
Actual interest payments received | $ | — | $ | 1,080 | $ | 642 | $ | — | ||||||||
| (1) | Based on calculated discounted expected future cash flows, premised on weighted-average life, prepayment speed, discount rate and expected credit losses shown in this table. |
| (2) | No actual principal payments have been received to-date. |
The sensitivities and estimates shown in the preceding table are hypothetical and should be used with the understanding that actual future performance and results can vary significantly. As the sensitivity analysis table shows, changes in the fair value based on a 10% variation in assumptions generally cannot be extrapolated because the relationship of the change in assumption to the change in fair value may not be linear. Also, in this
34
table, the effect of a variation in a particular assumption on the fair value of the preference shares is calculated without changing any other assumption. Changes in one factor may result in changes in another factor (for example, increases in market interest rates could result in lower prepayments and increased credit losses), which could magnify or counteract the sensitivities.
The Company entered into management agreements to provide certain collateral management services for the CDOs. As compensation for its services, it receives a management fee from the trustee based on the quarterly amount of assets managed (as defined.) During 2005, the Company earned $4.2 million of management fees under the CDOs.
At December 31, 2005, the Company managed both its on-balance sheet asset-backed securities and the off-balance sheet securitized asset-backed securities of the CDOs, which are presented in the following table (in thousands):
Managed on-balance sheet asset-backed securities, classified as: | |||
Available-for-sale | $ | 1,365,754 | |
Trading securities | 63,956 | ||
Total managed on-balance sheet asset-backed securities | 1,429,710 | ||
Managed off-balance sheet securitized asset-backed securities: | �� | ||
CDO I | 104,157 | ||
CDO II | 280,657 | ||
CDO III | 284,989 | ||
CDO IV | 274,599 | ||
Total managed off-balance sheet securitized asset-backed securities | 944,402 | ||
Total managed asset-backed securities | $ | 2,374,112 | |
Securitized Consumer Finance Receivables
The origination and servicing businesses of Consumer Finance Corporation were sold in late 2005. As a result of the sale, the Company retained the consumer receivables and beneficial interests in the trusts. Prior to the sale, Consumer Finance Corporation securitized RV and marine consumer receivables by sales or other transfers to ETCF Asset Funding Corporation through the formation of trusts. There were no securitizations of consumer receivables in 2005. During 2004, Consumer Finance Corporation securitized approximately $0.3 billion of RV and marine receivables. On October 20, 2003, the Company acquired ETCF Asset Funding Corporation and the retained beneficial interests in four trusts.
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The carrying values of the retained beneficial interests are subject to future volatility in credit, interest rate and prepayment risk. The following table presents a sensitivity analysis of each of portfolio of securitized receivables (dollars in thousands):
RV 1999-1(1) | Marine 1999-2 | RV 1999-3 | RV/Marine 2001-1 | RV/Marine 2004-1 | ||||||||||||||||
Fair value of residual investment(2) | ||||||||||||||||||||
At December 31, 2005 | $ | 7,870 | $ | 11,861 | $ | 2,021 | $ | 2,125 | $ | 13,527 | ||||||||||
At initial value(3) | $ | 9,740 | $ | 12,775 | $ | 4,223 | $ | 3,981 | $ | 10,877 | ||||||||||
Weighted-average remaining life (years) | 0.08 | 0.33 | 1.24 | 2.24 | 2.28 | |||||||||||||||
Weighted-average prepayment speed | 17 | % | 20 | % | 17 | % | 21 | % | 25 | % | ||||||||||
Impact of 10% adverse change | $ | (1 | ) | $ | (1 | ) | $ | 51 | $ | 50 | $ | (133 | ) | |||||||
Impact of 20% adverse change | $ | (1 | ) | $ | (2 | ) | $ | 51 | $ | 58 | $ | (236 | ) | |||||||
Weighted-average discount rate | 9 | % | 9 | % | 9 | % | 9 | % | 16 | % | ||||||||||
Impact of 10% adverse change | $ | (5 | ) | $ | (32 | ) | $ | (21 | ) | $ | (39 | ) | $ | (477 | ) | |||||
Impact of 20% adverse change | $ | (11 | ) | $ | (64 | ) | $ | (41 | ) | $ | (77 | ) | $ | (926 | ) | |||||
Weighted-average expected credit losses | 1.83 | % | 1.58 | % | 1.92 | % | 1.97 | % | 0.48 | % | ||||||||||
Impact of 10% adverse change | $ | (16 | ) | $ | (32 | ) | $ | (106 | ) | $ | (324 | ) | $ | (269 | ) | |||||
Impact of 20% adverse change | $ | (32 | ) | $ | (64 | ) | $ | (212 | ) | $ | (590 | ) | $ | (511 | ) | |||||
Actual credit losses | ||||||||||||||||||||
Since trust inception(4) | $ | 32,346 | $ | 10,596 | $ | 11,218 | $ | 14,557 | $ | 624 | ||||||||||
Since acquisition on October 20, 2003 | $ | 6,833 | $ | 1,595 | $ | 2,957 | $ | 6,172 | N/A | |||||||||||
For the year ended December 31, 2005 | ||||||||||||||||||||
Actual interest payments received | $ | 259 | $ | 222 | $ | 107 | $ | 253 | $ | — | ||||||||||
Actual principal payments received | $ | 54 | $ | 241 | $ | 310 | N/A | $ | — | |||||||||||
| (1) | On December 14, 2005, the Company exercised its option to redeem at par the collateral associated with 1999-1 and receive cash for its residual interest. Payment of the residual interest was received in January 2006. |
| (2) | Based on calculated discounted expected future cash flows, premised on weighted-average life, prepayment speed, discount rate and expected credit losses shown in this table. |
| (3) | Initial value at December 31, 2004 for 2004-1 and October 20, 2003 for all remaining. |
| (4) | Default base on the entire balance of the amount securitized as follows: 1990-1: $1,000,003; 1992-2: $550,000; 1999-3: $374,531; 2001-1: $529,467; 2004-1: $308,996. |
The sensitivities and estimates shown in the preceding table are hypothetical; actual future performance and results can vary significantly. As the sensitivity analysis table shows, changes in the fair value based on a 10% variation in assumptions generally cannot be extrapolated because the relationship of the change in assumption to the change in fair value may not be linear. Also, in this table, the effect of a variation in a particular assumption on the fair value of the preference shares is calculated without changing any other assumption. Changes in one factor may result in changes in another factor (for example, increases in market interest rates may result in lower prepayments and increased credit losses), which might magnify or counteract the sensitivities.
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The following table shows the net amortized cost of the Company’s servicing rights (in thousands):
| December 31, | ||||||||
| 2005 | 2004 | |||||||
Servicing assets: | ||||||||
Balance beginning of period | $ | 29,659 | $ | 32,773 | ||||
Purchases (sales) (1) | (4,118 | ) | 4,614 | |||||
Amortization of servicing rights | (8,241 | ) | (7,728 | ) | ||||
Balance end of period | 17,300 | 29,659 | ||||||
Valuation allowance for impairment: | ||||||||
Balance beginning of period | (8,146 | ) | (5,379 | ) | ||||
Valuation adjustment(1) | 1,872 | (2,767 | ) | |||||
Balance end of period | (6,274 | ) | (8,146 | ) | ||||
Servicing rights, end of period | $ | 11,026 | $ | 21,513 | ||||
| (1) | Reflects sale of the Consumer Finance business in October 2005. The origination and servicing of RV and marine loans were provided by this business. |
The most important assumptions used in determining the estimated fair value are anticipated loan prepayments and discount rates. The Company uses market-based assumptions and confirms the reasonableness of the Company’s valuation model through management’s quarterly review, analyses of market quotes and independent broker valuations of the fair value of the servicing rights.
The servicing responsibilities retained by Consumer Finance Corporation for each securitization have been transferred to the purchaser. Prior to the sale, Consumer Finance Corporation received annual servicing fees of 50 basis points of the prior month’s balance for the 2004 series trust and all 1999 series trusts and 75 basis points of the prior month’s outstanding balance for the 2001 series trust.
The following summarizes the estimated fair values of the Company’s servicing assets and significant assumptions (dollars in thousands):
| December 31, | ||||
| 2005 | 2004 | |||
Mortgage servicing assets: | ||||
Fair value | $11,026 | $14,761 | ||
Constant prepayment rate | 19% | 23% | ||
Discount rate | 3.5% - 4.0% | 1.0% - 1.5% | ||
Consumer servicing assets: | ||||
Fair value | — | $6,752 | ||
Constant prepayment rate | — | 21% - 24% | ||
Discount rate | — | 8% | ||
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NOTE 10—PROPERTY AND EQUIPMENT, NET
Property and equipment, net consists of the following (in thousands):
| December 31, | ||||||||
| 2005 | 2004 | |||||||
Software | $ | 353,120 | $ | 331,774 | ||||
Equipment and transportation | 193,051 | 240,517 | ||||||
Leasehold improvements | 93,963 | 88,066 | ||||||
Buildings | 71,927 | 71,927 | ||||||
Furniture and fixtures | 19,040 | 14,340 | ||||||
Land | 3,428 | 3,428 | ||||||
Total property and equipment, gross | 734,529 | 750,052 | ||||||
Less accumulated depreciation and amortization | (435,273 | ) | (447,761 | ) | ||||
Total property and equipment, net | $ | 299,256 | $ | 302,291 | ||||
Depreciation and amortization expense related to property and equipment was $75.0 million for 2005, $77.9 million for 2004 and $85.6 million for 2003.
Software includes capitalized internally developed software costs. These costs were $34.7 million for 2005, $31.8 million for 2004 and $41.8 million for 2003. Completed projects are carried at cost and are amortized on a straight-line basis over their estimated useful lives, generally four years. Amortization expense for the capitalized amounts was $31.5 million for 2005, $33.7 million for 2004 and $29.3 million for 2003. Also included in software is $17.6 million of internally developed software in the process of development for which amortization has not begun.
NOTE 11—GOODWILL AND OTHER INTANGIBLES, NET
The following table discloses the changes in the carrying value of goodwill for the periods presented (in thousands):
Balance at December 31, 2003 | $ | 392,845 | ||
Adjustments to 2002 acquisitions | (11,860 | ) | ||
Adjustments to 2003 acquisitions | 15,490 | |||
Other adjustments | (1,432 | ) | ||
Balance at December 31, 2004 | 395,043 | |||
Additions from 2005 acquisitions | 1,612,928 | |||
Write-off related to discontinued operations | (4,515 | ) | ||
Balance at December 31, 2005 | $ | 2,003,456 | ||
The following table discloses the changes in the carrying value of goodwill that occurred in the retail and institutional segments in 2005 (in thousands):
| Retail | Institutional | Total | ||||||||||
Balance at December 31, 2004 | $ | 153,720 | $ | 241,323 | $ | 395,043 | ||||||
Additions from 2005 acquisitions | 1,611,507 | 1,421 | 1,612,928 | |||||||||
Write-offs related to discontinued operations | (3,379 | ) | (1,136 | ) | (4,515 | ) | ||||||
Balance at December 31, 2005 | $ | 1,761,848 | $ | 241,608 | $ | 2,003,456 | ||||||
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Prior periods are not presented, as the Company did not allocate goodwill by its new reporting segments prior to 2005.
The additions to goodwill are the result of our acquisitions during 2005 including Harrisdirect, BrownCo, Kobren and Howard Capital. Note 2 has complete descriptions of the transactions. The write-off of goodwill related to discontinued operations was due to the sale of the Consumer Finance Corporation and the exit of E*TRADE Professional Securities, LLC. See Note 3 for a complete description of these transactions.
Other intangible assets with finite lives, which are primarily amortized on an accelerated basis, consist of the following (dollars in thousands):
| Weighted- Average Useful Life (Years) | December 31, 2005 | December 31, 2004 | ||||||||||||||||||||
| Gross Amount | Accumulated Amortization | Net Amount | Gross Amount | Accumulated Amortization | Net Amount | |||||||||||||||||
Customer list | 21 | $ | 456,953 | $ | (11,592 | ) | $ | 445,361 | $ | 10,248 | $ | (5,189 | ) | $ | 5,059 | |||||||
Specialist books | 28 | 61,820 | (29,280 | ) | 32,540 | 61,820 | (8,522 | ) | 53,298 | |||||||||||||
Active accounts | 8 | 69,023 | (43,234 | ) | 25,789 | 69,023 | (36,121 | ) | 32,902 | |||||||||||||
Credit cards | 15 | 32,604 | (12,496 | ) | 20,108 | 32,672 | (4,981 | ) | 27,691 | |||||||||||||
Other | 5 | 29,274 | (20,964 | ) | 8,310 | 46,859 | (31,688 | ) | 15,171 | |||||||||||||
Total intangible assets | $ | 649,674 | $ | (117,566 | ) | $ | 532,108 | $ | 220,622 | $ | (86,501 | ) | $ | 134,121 | ||||||||
Assuming no future impairments of these assets or additional acquisitions, annual amortization expense will be as follows (in thousands):
Years ending December 31, | |||
2006 | $ | 44,916 | |
2007 | 42,458 | ||
2008 | 37,667 | ||
2009 | 32,776 | ||
2010 | 30,581 | ||
Thereafter | 343,710 | ||
Total future amortization expense | $ | 532,108 | |
Amortization of other intangibles was $43.8 million for 2005, $19.4 million for 2004 and $24.8 million for 2003.
NOTE 12—ACCOUNTING FOR DERIVATIVE FINANCIAL INSTRUMENTS AND HEDGING ACTIVITIES
The Company enters into derivative transactions to protect against the risk of market price or interest rate movements on the value of certain assets, liabilities and future cash flows. The Company is also required to recognize certain contracts and commitments as derivatives when the characteristics of those contracts and commitments meet the definition of a derivative as promulgated by SFAS No. 133.
Fair Value Hedges
Overview of Fair Value Hedges
The Company uses a combination of interest rate swaps and purchased options on forward-starting swaps, caps and floors to offset its exposure to changes in value of certain fixed rate assets and liabilities. In calculating the effective portion of fair value hedges under SFAS No. 133, changes in the fair value of the derivative are recognized currently in earnings, as changes in value of the hedged asset attributable to the risk being hedged.
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Accordingly, the net difference or hedge ineffectiveness, if any, is recognized currently in fair value adjustments of financial derivatives in the consolidated statements of income.
The following table summarizes information related to financial derivatives in fair value hedge relationships (dollars in thousands):
| Notional Amount of Derivative | Fair Value of Derivatives | Weighted-Average | |||||||||||||||||||||||
| Asset | Liability | Net | Pay Rate | Receive Rate | Strike Rate | Remaining Life (Years) | |||||||||||||||||||
December 31, 2005: | |||||||||||||||||||||||||
Pay-fixed interest rate swaps: | |||||||||||||||||||||||||
Mortgage-backed securities | $ | 961,000 | $ | 12,485 | $ | (598 | ) | $ | 11,887 | 4.50 | % | 4.35 | % | N/A | 4.88 | ||||||||||
Investment securities | 119,485 | 1,315 | (1,750 | ) | (435 | ) | 4.62 | % | 4.18 | % | N/A | 7.70 | |||||||||||||
Receive-fixed interest rate swaps: | |||||||||||||||||||||||||
Brokered certificates of deposit | 132,313 | — | (3,740 | ) | (3,740 | ) | 4.33 | % | 5.22 | % | N/A | 12.50 | |||||||||||||
FHLB advances | 100,000 | — | (3,894 | ) | (3,894 | ) | 4.37 | % | 3.64 | % | N/A | 3.79 | |||||||||||||
Purchased interest rate forward-starting swaps: | |||||||||||||||||||||||||
Mortgage-backed securities | 70,000 | — | (470 | ) | (470 | ) | 5.03 | % | N/A | N/A | 10.01 | ||||||||||||||
Purchased interest rate options(1): | |||||||||||||||||||||||||
Caps | 770,000 | 21,324 | — | 21,324 | N/A | N/A | 4.89 | % | 4.82 | ||||||||||||||||
Floors | 1,325,000 | 3,952 | — | 3,952 | N/A | N/A | 3.82 | % | 3.71 | ||||||||||||||||
Swaptions(3) | 2,241,000 | 36,982 | — | 36,982 | N/A | N/A | 4.93 | % | 8.47 | ||||||||||||||||
Total fair value hedges | $ | 5,718,798 | $ | 76,058 | $ | (10,452 | ) | $ | 65,606 | 4.51 | % | 4.37 | % | 4.59 | % | 6.29 | |||||||||
December 31, 2004: | |||||||||||||||||||||||||
Pay-fixed interest rate swaps: | |||||||||||||||||||||||||
Mortgage-backed securities | $ | 1,045,000 | $ | 3,157 | $ | (5,099 | ) | $ | (1,942 | ) | 4.42 | % | 2.23 | % | N/A | 6.06 | |||||||||
Investment securities | 160,885 | — | (3,747 | ) | (3,747 | ) | 4.63 | % | 2.09 | % | N/A | 8.83 | |||||||||||||
Receive-fixed interest rate swaps: | |||||||||||||||||||||||||
Certificates of deposit | 315,000 | — | (1,901 | ) | (1,901 | ) | 2.26 | % | 3.39 | % | N/A | 2.90 | |||||||||||||
Brokered certificates of deposit | 10,000 | — | (160 | ) | (160 | ) | 2.50 | % | 5.00 | % | N/A | 10.01 | |||||||||||||
FHLB advances | 100,000 | — | (1,159 | ) | (1,159 | ) | 2.40 | % | 3.64 | % | N/A | 4.80 | |||||||||||||
Senior Notes(2) | 50,000 | 452 | — | 452 | 5.98 | % | 8.00 | % | N/A | 6.46 | |||||||||||||||
Purchased interest rate forward-starting swaps: | |||||||||||||||||||||||||
Mortgage-backed securities | 209,000 | 978 | — | 978 | 3.60 | % | N/A | N/A | 3.43 | ||||||||||||||||
Brokered certificates of deposit | 20,000 | 12 | (60 | ) | (48 | ) | 5.25 | % | N/A | N/A | 12.55 | ||||||||||||||
Purchased interest rate options(1): | |||||||||||||||||||||||||
Caps | 485,000 | 7,221 | — | 7,221 | N/A | N/A | 6.09 | % | 5.01 | ||||||||||||||||
Floors | 100,000 | 352 | — | 352 | N/A | N/A | 4.25 | % | 2.75 | ||||||||||||||||
Swaptions(3) | 335,000 | 9,065 | — | 9,065 | N/A | N/A | 5.98 | % | 13.30 | ||||||||||||||||
Total fair value hedges | $ | 2,829,885 | $ | 21,237 | $ | (12,126 | ) | $ | 9,111 | 3.93 | % | 2.71 | % | 5.85 | % | 6.25 | |||||||||
| (1) | Purchased interest rate options were used to hedge mortgage-backed securities. |
| (2) | Interest rate swap agreement on the Company’s $400.0 million senior notes was terminated during 2005. |
| (3) | Swaptions are options to enter swaps starting on a given day. |
De-designated Fair Value Hedges
During 2005 and 2004, certain fair value hedges were de-designated; therefore, hedge accounting was discontinued during those periods. The net gain or loss on these derivative instruments at the time of de-designation is amortized to interest expense or interest income over the original forecasted period of the underlying transactions being hedged. Changes in the fair value of these derivative instruments after de-designation of fair value hedge accounting were recorded in gain on sales of loans and securities, net in the consolidated statements of income.
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Cash Flow Hedges
Overview of Cash Flow Hedges
The Company uses a combination of interest rate swaps and purchased options on caps and floors to hedge the variability of future cash flows associated with existing variable-rate liabilities and assets and forecasted issuances of liabilities. These cash flow hedge relationships are treated as effective hedges as long as the future issuances of liabilities remain probable and the hedges continue to meet the requirements of SFAS No. 133. The Company also enters into interest rate swaps to hedge changes in the future variability of cash flows of certain investment securities resulting from changes in a benchmark interest rate. Additionally, the Company enters into forward purchase and sale agreements, which are considered cash flow hedges, when the terms of the commitments exactly match the terms of the securities purchased or sold.
Changes in the fair value of derivatives that hedge cash flows associated with repurchase agreements, FHLB advances and HELOCs are reported in AOCI as unrealized gains or losses. The amounts in AOCI are then included in interest expense or interest income as a yield adjustment during the same periods in which the related interest on the fundings or investment securities affect earnings. During the upcoming twelve months, the Company expects to include a pre-tax amount of approximately $2.4 million of net unrealized gains that are currently reflected in AOCI in interest expense as a yield adjustment in the same periods in which the related items affect earnings.
The Company also recognizes cash flow hedge ineffectiveness. Cash flow hedge ineffectiveness is recorded to the extent that the market value of the derivatives used in the hedge relationship underperforms or outperforms or has a greater increase in market value than a hypothetical derivative, created to match the exact terms of the underlying debt being hedged. The Company recognized this cash flow ineffectiveness as fair value adjustment of financial derivatives in the consolidated statements of income. Cash flow ineffectiveness is re-measured on a quarterly basis.
The following table summarizes information related to our financial derivatives in cash flow hedge relationships, hedging variable rate liabilities and the forecasted issuances of liabilities (dollars in thousands):
Notional | Fair Value of Derivatives | Weighted-Average | |||||||||||||||||||||||
| Asset | Liability | Net | Pay Rate | Receive Rate | Strike Rate | Remaining Life (Years) | |||||||||||||||||||
December 31, 2005: | |||||||||||||||||||||||||
Pay-fixed interest rate swaps: | |||||||||||||||||||||||||
Repurchase agreements | $ | 1,100,000 | $ | 6,959 | $ | (2,223 | ) | $ | 4,736 | 4.87 | % | 4.38 | % | N/A | 9.15 | ||||||||||
Purchased interest rate forward-starting swaps: | |||||||||||||||||||||||||
Repurchase agreements | 2,675,000 | 1,219 | (19,872 | ) | (18,653 | ) | 5.04 | % | N/A | N/A | 9.50 | ||||||||||||||
FHLB advances | 750,000 | — | (4,040 | ) | (4,040 | ) | 5.02 | % | N/A | N/A | 9.46 | ||||||||||||||
Purchased interest rate options(1): | |||||||||||||||||||||||||
Caps | 2,925,000 | 64,301 | — | 64,301 | N/A | N/A | 4.76 | % | 4.59 | ||||||||||||||||
Floors | 1,900,000 | 2,527 | — | 2,527 | N/A | N/A | 5.50 | % | 3.54 | ||||||||||||||||
Total cash flow hedges | $ | 9,350,000 | $ | 75,006 | $ | (26,135 | ) | $ | 48,871 | 5.00 | % | 4.38 | % | 5.05 | % | 6.71 | |||||||||
December 31, 2004: | |||||||||||||||||||||||||
Pay-fixed interest rate swaps: | |||||||||||||||||||||||||
Repurchase agreements | $ | 1,675,000 | $ | — | $ | (33,121 | ) | $ | (33,121 | ) | 4.91 | % | 2.28 | % | N/A | 11.12 | |||||||||
FHLB advances | 425,000 | — | (6,093 | ) | (6,093 | ) | 4.68 | % | 2.13 | % | N/A | 9.25 | |||||||||||||
Purchased interest rate forward-starting swaps: | |||||||||||||||||||||||||
Repurchase agreement | 595,000 | — | (868 | ) | (868 | ) | 4.74 | % | N/A | N/A | 11.16 | ||||||||||||||
Purchased interest rate options(1): | |||||||||||||||||||||||||
Caps | 2,775,000 | 94,340 | — | 94,340 | N/A | N/A | 4.43 | % | 6.13 | ||||||||||||||||
Total cash flow hedges | $ | 5,470,000 | $ | 94,340 | $ | (40,082 | ) | $ | 54,258 | 4.84 | % | 2.25 | % | 4.43 | % | 8.45 | |||||||||
| (1) | Caps are used to hedge repurchase agreements and FHLB advances. Floors are used to hedge HELOCs. |
41
Under SFAS No. 133, we are required to record the fair value of gains and losses on derivatives designated as cash flow hedges in AOCI in the consolidated balance sheets. In addition, during the normal course of business, the Company terminates certain interest rate swaps and options.
The following tables show: 1) amounts recorded in AOCI related to derivative instruments accounted for as cash flow hedges; 2) the notional amounts and fair values of derivatives terminated for the periods presented; and 3) the amortization of terminated interest rate swaps included in interest expense and interest income (in thousands):
| Year Ended December 31, | ||||||||||||
| 2005 | 2004 | 2003 | ||||||||||
Impact on AOCI (net of taxes): | ||||||||||||
Beginning balance | $ | (118,018 | ) | $ | (123,754 | ) | $ | (188,280 | ) | |||
Gains (losses) on cash flow hedges related to derivatives, net | 7,032 | (51,137 | ) | (21,173 | ) | |||||||
Reclassifications into earnings, net | 40,155 | 56,873 | 85,699 | |||||||||
Ending balance | $ | (70,831 | ) | $ | (118,018 | ) | $ | (123,754 | ) | |||
Derivatives terminated during the year: | ||||||||||||
Notional | $ | 17,920,000 | $ | 5,423,500 | $ | 6,329,500 | ||||||
Fair value of net gains (losses) recognized in AOCI | $ | 2,228 | $ | (68,039 | ) | $ | 45,927 | |||||
Amortization of terminated interest rate swaps and options included in interest expense and interest income | $ | 65,110 | $ | 101,807 | $ | 125,800 | ||||||
The gains (losses) accumulated in AOCI on the derivative instruments terminated shown in the preceding table will be included in interest expense and interest income over the periods the hedged forecasted issuance of liabilities will affect earnings, ranging from 6 days to 15 years.
The following table represents the balance in AOCI attributable to open cash flow hedges and discontinued cash flow hedges (in thousands):
| At December 31, | ||||||||||||
| 2005 | 2004 | 2003 | ||||||||||
AOCI balance (net of taxes) related to: | ||||||||||||
Open cash flow hedges | $ | (36,736 | ) | $ | (43,027 | ) | $ | (30,775 | ) | |||
Discontinued cash flow hedges | (34,095 | ) | (74,991 | ) | (92,979 | ) | ||||||
Total cash flow hedges | $ | (70,831 | ) | $ | (118,018 | ) | $ | (123,754 | ) | |||
Hedge Ineffectiveness
In accordance with SFAS No. 133, the Company recognizes hedge ineffectiveness on both fair value and cash flow hedge relationships. These amounts are reflected in fair value adjustments of financial derivatives in the consolidated statements of income. The following table summarizes the income (expense) recognized by the Company as fair value and cash flow hedge ineffectiveness (in thousands):
| Year Ended December 31, | ||||||||||||
| 2005 | 2004 | 2003 | ||||||||||
Fair value hedges | $ | (4,937 | ) | $ | (3,895 | ) | $ | (19,711 | ) | |||
Cash flow hedges | 45 | 6,194 | 4,373 | |||||||||
Total fair value adjustments of financial derivatives | $ | (4,892 | ) | $ | 2,299 | $ | (15,338 | ) | ||||
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Mortgage Banking Activities
The Company enters into commitments to originate loans whereby the interest rate on the loan is determined prior to funding; these commitments are referred to as Interest Rate Lock Commitments, (“IRLCs”.) IRLCs on loans that the Bank intends to sell are considered to be derivatives and are, therefore, recorded at fair value with changes in fair value recorded in earnings. For purposes of determining their fair value, the Company performs a net present value analysis of the anticipated cash flows associated with these IRLCs. The net present value analysis performed excludes the market value associated with the anticipated sale of servicing rights related to each loan commitment. The fair value of these IRLCs was a $1.6 million and $1.5 million asset at December 31, 2005 and 2004, respectively.
The Company also designates fair value relationships of closed loans held-for-sale against a combination of mortgage forwards and short treasury positions. Short treasury relationships are economic hedges, rather than fair value or cash flow hedges. Short treasury positions are marked-to-market, but do not receive hedge accounting treatment under SFAS No. 133. The mark-to-market of the mortgage forwards are included in the net change of the IRLCs and the related hedging instruments. The mark-to-market of the closed loans recorded for 2005 and 2004 were $0.7 million and $4.3 million, respectively.
IRLCs, as well as closed loans held-for-sale, expose the Company to interest rate risk. The Company manages this risk by selling mortgages or mortgage-backed securities on a forward basis referred to as forward sale agreements. Changes in the fair value of these derivatives are included as gain on sales of loans and securities, net in the consolidated statements of income. The net change in IRLCs, closed loans and the related hedging instruments generated a net loss of $0.4 million in 2005 and a net gain of $3.9 million in 2004.
Credit risk is managed by limiting activity to approved counterparties and setting aggregate exposure limits for each approved counterparty. The credit risk that results from interest rate swaps and purchased interest rate options is represented by the fair value of contracts that have unrealized gains at the reporting date. Conversely, we have $36.6 million of derivative contracts with unrealized losses at December 31, 2005. These agreements required the Company to pledge approximately $7.4 million of its mortgage-backed and investment securities as collateral.
While the Company does not expect that any counterparty will fail to perform, the following table shows the maximum exposure, or net credit risk, associated with each counterparty to interest rate swaps and purchased interest rate options at December 31, 2005 (in thousands):
Counterparty | Credit Risk | ||
Union Bank of Switzerland | $ | 27,733 | |
Lehman Brothers | 12,821 | ||
Royal Bank of Scotland | 7,283 | ||
Bank of America | 5,361 | ||
Credit Suisse First Boston | 4,446 | ||
Other | 1,316 | ||
Total exposure | $ | 58,960 | |
43
Other assets consist of the following (in thousands):
| December 31, | ||||||
| 2005 | 2004 | |||||
Third party loan servicing receivable | $ | 79,264 | $ | 3,806 | ||
Other investments | 65,189 | 46,269 | ||||
Unamortized debt issue costs | 36,088 | 9,134 | ||||
Prepaids | 26,239 | 25,947 | ||||
Deferred compensation plan | 18,419 | 11,974 | ||||
Servicing rights | 11,026 | 21,513 | ||||
Securities sold, collateral not delivered | 9,024 | 53,152 | ||||
Deferred tax assets | 3,851 | 41,119 | ||||
Other | 96,577 | 42,633 | ||||
Total other assets | $ | 345,677 | $ | 255,547 | ||
Other Investments
The Company has made investments in low income housing tax credit partnerships (“LIHTC”), venture funds and several non-public, venture capital-backed, high technology companies. The Company recorded no other-than-temporary impairments for 2005 and 2004 and $8.0 million for 2003, associated with these privately held equity investments. These impairments are recorded in gain on sale and impairment of investments in the consolidated statements of income. The Company has $45.3 million in commitments in to fund LIHTC, venture funds and joint ventures.
Securities Sold, Collateral Not Delivered
The Bank has receivables for mortgage-backed securities from third-party brokers that the Bank committed to sell, but did not deliver to the brokers by the settlement date. The Bank was unable to deliver the securities primarily because other parties failed to deliver similar securities to the Bank, which the Bank had committed to buy. Securities sold, collateral not delivered for the brokerage subsidiaries are included in brokerage receivables.
Deposits are summarized as follows (dollars in thousands):
| Weighted-Average Rate | Amount | Percentage to Total | ||||||||||||||||
| December 31, | December 31, | December 31, | ||||||||||||||||
| 2005 | 2004 | 2005 | 2004 | 2005 | 2004 | |||||||||||||
Sweep deposit account | 0.57 | % | 0.40 | % | $ | 7,733,267 | $ | 6,167,436 | 48.5 | % | 50.1 | % | ||||||
Money market and savings accounts | 3.17 | % | 1.52 | % | 4,635,866 | 3,340,936 | 29.1 | 27.2 | ||||||||||
Certificates of deposit | 3.94 | % | 3.40 | % | 2,703,605 | 2,069,674 | 17.0 | 16.8 | ||||||||||
Brokered certificates of deposit | 3.86 | % | 2.51 | % | 484,612 | 294,587 | 3.0 | 2.4 | ||||||||||
Checking accounts | 0.71 | % | 0.66 | % | 390,665 | 430,341 | 2.4 | 3.5 | ||||||||||
Total deposits | 2.00 | % | 1.27 | % | $ | 15,948,015 | $ | 12,302,974 | 100.0 | % | 100.0 | % | ||||||
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Deposits, classified by rates are as follows (in thousands):
| December 31, | ||||||||
| 2005 | 2004 | |||||||
0.00%–1.99% | $ | 8,488,981 | $ | 10,448,712 | ||||
2.00%–3.99% | 5,158,261 | 1,160,915 | ||||||
4.00%–5.99% | 2,278,914 | 435,972 | ||||||
6.00%–9.99% | 27,633 | 257,504 | ||||||
Subtotal | 15,953,789 | 12,303,103 | ||||||
Fair value adjustments | (5,774 | ) | (129 | ) | ||||
Total deposits | $ | 15,948,015 | $ | 12,302,974 | ||||
At December 31, 2005, scheduled maturities of certificates of deposit and brokered certificates of deposit were as follows (in thousands):
| < 1 Year | 1-2 Years | 2-3 Years | 3-4 Years | 4-5 Years | > 5 Years | Total | ||||||||||||||||
Less than 4.00% | $ | 1,510,063 | $ | 167,249 | $ | 89,571 | $ | 10,407 | $ | 1,149 | $ | 5,683 | $ | 1,784,122 | ||||||||
4.00%–5.99% | 827,242 | 234,685 | 76,006 | 59,129 | 85,552 | 99,960 | 1,382,574 | |||||||||||||||
6.00%–7.99% | 3,680 | 984 | 1,314 | 470 | 384 | 20,463 | 27,295 | |||||||||||||||
Subtotal | $ | 2,340,985 | $ | 402,918 | $ | 166,891 | $ | 70,006 | $ | 87,085 | $ | 126,106 | 3,193,991 | |||||||||
Fair value adjustments | (5,774 | ) | ||||||||||||||||||||
Total certificates of deposit and brokered certificates of deposit | $ | 3,188,217 | ||||||||||||||||||||
Scheduled maturities of certificates of deposit and brokered certificates of deposit with denominations greater than or equal to $100,000 were as follows (in thousands):
| December 31, | ||||||
| 2005 | 2004 | |||||
Three months or less | $ | 319,609 | $ | 216,671 | ||
Three through six months | 226,040 | 75,990 | ||||
Six through twelve months | 266,840 | 174,049 | ||||
Over twelve months | 307,885 | 237,533 | ||||
Total certificates of deposit | $ | 1,120,374 | $ | 704,243 | ||
Interest expense on deposits is summarized as follows (in thousands):
| Year Ended December 31, | |||||||||
| 2005 | 2004 | 2003 | |||||||
Sweep deposit account | $ | 36,147 | $ | 13,226 | $ | 1,313 | |||
Money market and savings accounts | 89,073 | 47,297 | 73,634 | ||||||
Certificates of deposit | 88,733 | 110,577 | 185,574 | ||||||
Brokered certificates of deposit | 15,679 | 9,172 | 10,147 | ||||||
Checking accounts | 2,679 | 2,408 | 2,496 | ||||||
Total interest expense | $ | 232,311 | $ | 182,680 | $ | 273,164 | |||
Accrued interest payable on these deposits, which is included in accounts payable, accrued and other liabilities, was $11.6 million at December 31, 2005 and $5.1 million at December 31, 2004.
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The Sweep Deposit Account (“SDA”) is a sweep product that transfers brokerage customer balances. The Bank holds these funds as customer deposits in Federal Deposit Insurance Corporation (“FDIC”)-insured Negotiable Order of Withdrawal (“NOW”) and money market deposit accounts.
NOTE 15—SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE AND OTHER BORROWINGS BY BANK SUBSIDIARY
The maturities of borrowings at December 31, 2005 and total borrowings at December 31, 2004 are shown below (dollars in thousands):
| Repurchase Agreement | Other Borrowings by Bank Subsidiary | Total | Weighted Average Interest Rate | ||||||||||||
| FHLB Advances | Other | ||||||||||||||
Due in: | |||||||||||||||
2006 | $ | 9,746,122 | $ | 1,910,000 | $ | 5,440 | $ | 11,661,562 | 4.20 | % | |||||
2007 | 50,478 | 700,000 | — | 750,478 | 4.45 | % | |||||||||
2008 | — | 50,000 | — | 50,000 | 3.82 | % | |||||||||
2009 | 100,145 | 96,106 | — | 196,251 | 3.15 | % | |||||||||
2010 | — | 100,000 | — | 100,000 | 4.38 | % | |||||||||
Thereafter | 1,204,797 | 1,000,000 | 305,046 | 2,509,843 | 3.80 | % | |||||||||
Total borrowings at December 31, 2005 | $ | 11,101,542 | $ | 3,856,106 | $ | 310,486 | $ | 15,268,134 | 4.13 | % | |||||
Total borrowings at December 31, 2004 | $ | 9,897,191 | $ | 1,487,841 | $ | 272,891 | $ | 11,657,923 | 2.17 | % | |||||
Securities Sold Under Agreements to Repurchase
The Company sells securities under agreements to repurchase similar securities (“Repurchase Agreements”.) Repurchase Agreements are collateralized by fixed- and variable-rate mortgage-backed securities or investment grade securities. Repurchase Agreements are treated as financings for financial statement purposes and obligations to repurchase securities sold are reflected as borrowings in the consolidated balance sheets. The brokers retain possession of the securities collateralizing the repurchase agreements until maturity. At December 31, 2005, there were no counterparties with whom the Company’s amount at risk exceeded 10% of its shareholders’ equity.
Other Borrowings by Bank Subsidiary
FHLB Advances—The Company had $2.2 billion floating-rate and $1.7 billion fixed-rate FHLB advances at December 31, 2005. The floating-rate advances adjust quarterly based on the LIBOR. The Company is required to be a member of the FHLB System and maintain a FHLB investment at least equal to the greater of: one percent of the unpaid principal balance of its residential mortgage loans; one percent of 30 percent of its total assets; or one-twentieth of its outstanding FHLB advances. In addition, the Company must maintain qualified collateral equal to 85 to 90 percent of its advances, depending on the collateral type. These advances are secured with specific mortgage loans and mortgage-backed securities. At December 31, 2005 and 2004, the Company pledged $9.3 billion and $3.4 billion, respectively, of the one- to four-family first-mortgage loans, HELOCs and second mortgage loans as collateral.
Other—ETB Holdings (“ETBH”) raises capital through the formation of trusts, which sell trust preferred stock in the capital markets. The capital securities are mandatorily redeemable in whole at the due date, which is generally 30 years after issuance. Each trust issued Floating Rate Cumulative Preferred Securities, at par with a liquidation amount of $1,000 per capital security. ETBH uses the proceeds from the sale of issuances to purchase Floating Rate Junior Subordinated Debentures issued by ETBH, guarantees the trust obligations and contributes proceeds from the sale of its subordinated debentures to the Bank in the form of a capital contribution.
46
During 2005, ETBH formed two trusts, ETBH Capital Trust XXI and ETBH Capital Trust XXII. These two trusts issued 20,000 shares and 30,000 shares, respectively, of Floating Rate Cumulative Preferred Securities for a total of $20 million and $30 million, respectively. Net proceeds from these issuances were invested in Floating Rate Junior Subordinated Debentures that mature in 2035 and have variable rates of 2.40% and 2.20%, respectively, above the three-month LIBOR, payable quarterly.
The face values of outstanding trusts at December 31, 2005 are shown below (dollars in thousands):
Trusts | Face Value | Maturity Date | Annual Interest Rate | ||||
Telebank Capital Trust I | $ | 9,000 | 2027 | 11.00% | |||
ETBH Capital Trust II | $ | 5,000 | 2031 | 10.25% | |||
ETBH Capital Trust I, III | $ | 35,000 | 2031 | 3.75% above 6-month LIBOR | |||
ETBH Capital Trust V—VIII | $ | 66,000 | 2032 | 3.25%-3.65% above 3-month LIBOR | |||
ETBH Capital Trust IV | $ | 10,000 | 2032 | 3.70% above 6-month LIBOR | |||
ETBH Capital Trust IX—XII | $ | 50,000 | 2033 | 3%-3.25% above 3-month LIBOR | |||
ETBH Capital Trust XIII—XVIII, XX | $ | 77,000 | 2034 | 2.45%-2.90% above 3-month LIBOR | |||
ETBH Capital Trust XIX, XXI, XXII | $ | 60,000 | 2035 | 2.20%-2.4% above 3-month LIBOR | |||
Other borrowings also includes $5.4 million of overnight and other short-term borrowings from the Federal Reserve Bank in connection with the Federal Reserve Bank’s special direct investment and treasury, tax and loan programs. The Company pledged $0.5 billion of securities and RV loans to secure these borrowings.
Below is additional information regarding borrowings (in thousands):
| December 31, | ||||||||
| 2005 | 2004 | |||||||
Weighted-average balance during the year (calculated on a daily basis) | $ | 10,115,764 | $ | 8,139,736 | ||||
Weighted-average interest rate: | ||||||||
During the year (calculated on a daily basis) | 3.70 | % | 3.18 | % | ||||
At year-end | 4.15 | % | 2.15 | % | ||||
Maximum month-end balance during the year | $ | 11,412,028 | $ | 10,285,738 | ||||
Balance at year-end | $ | 11,412,028 | $ | 10,170,082 | ||||
Securities and loans underlying the repurchase agreements at the end of the year: | ||||||||
Carrying value, including accrued interest | $ | 11,665,421 | $ | 10,001,607 | ||||
Estimated market value | $ | 11,325,412 | $ | 9,958,744 | ||||
The Company’s long-term debt by type is shown below (in thousands):
| December 31, | ||||||||
| 2005 | 2004 | |||||||
Senior notes: | ||||||||
8.00% Notes, due 2011 | $ | 504,407 | $ | 400,452 | ||||
7 3/8% Notes, due 2013 | 597,540 | — | ||||||
7 7/8% Notes, due 2015 | 300,000 | — | ||||||
Total senior notes | 1,401,947 | 400,452 | ||||||
Mandatory convertible notes 6 1/8%, due 2018 | 435,589 | — | ||||||
Convertible subordinated notes 6.00%, due 2007 | 185,165 | 185,165 | ||||||
Total corporate debt | $ | 2,022,701 | $ | 585,617 | ||||
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8.00% Senior Notes Due June 2011
In 2005 and 2004, the Company issued an aggregate principal amount of $100 million and $400 million in senior notes due June 2011 (the “8.00% Notes”), respectively. Interest is payable semi-annually and notes are non-callable for four years and may then be called by the Company at a premium, which declines over time. Original debt issuance costs of $1.5 million are included in other assets and are being amortized over the term of the senior notes.
7 3/8% Senior Notes due September 2013
In 2005, the Company issued an aggregate principal amount of $600 million in senior notes due September 2013 (the “7 3/8% Notes”.) Interest is payable semi-annually and the notes are non-callable for four years and may then be called by the Company at a premium, which declines over time. Original debt issuance costs of $8.5 million are included in other assets and are being amortized over the term of the notes.
7 7/8% Senior Notes Due December 2015
In 2005, the Company issued an aggregate principal amount of $300 million in senior notes due December 2015 (the “7 7/8% Notes”.) Interest is payable semi-annually and the notes are non-callable for four years and may then be called by the Company at a premium, which declines over time. Original debt issuance costs of $3.7 million are included in other assets and are being amortized over the term of the notes.
All senior notes are unsecured and will rank equal in right of payment with all of the Company’s existing and future unsubordinated indebtedness and will rank senior in right of payment to all our existing and future subordinated indebtedness.
6 1/4% Mandatory Convertible Notes Due November 2018
In November 2005, the Company issued 18.0 million of mandatory convertible notes (“Units”) with a face value of $450 million. Each Unit consists of a purchase contract and a 6 1/8% senior note. The Company recorded the purchase contracts and senior notes at fair value, with $15 million recorded in equity and $435 million in debt, respectively.
Each purchase contract obligates the holder to purchase, and the Company to sell, at a purchase price of $25.00 in cash, a variable number of shares of the Company’s common stock. The stock conversion ratio varies depending on the average closing price of the Company’s common stock over a 20-day trading period ending on the third trading day immediately preceding November 18, 2008 (“Reference Price”). If the Reference Price is equal to or greater than $21.816 per share, the settlement rate will be 1.1459 shares of common stock. If the Reference Price is less than $21.816 per share but greater than $18.00 per share, the settlement rate is equal to $25.00 divided by the Reference Price. If the Reference Price is less than or equal to $18.00 per share, the settlement rate will be 1.3889 shares of common stock. The Company is obligated under the purchase contract to sell shares of its common stock under the agreement in November 2008. In November 2008, the aggregate principal amount of the senior notes will be remarketed, which may result in a change in the interest rate and maturity date of the senior notes.
Before the Purchase Date, the Units will be reflected in diluted earnings per share calculations using the treasury stock method as defined by SFAS No. 128,Earning per Share. Under this method, the number of shares of common stock used in calculating diluted earnings per share (based on the settlement formula applied at the end of the reporting period) is deemed to be increased by the excess, if any, of the number of shares that would be issued upon settlement of the purchase contracts less the number of shares that could be purchased by the Company in the market at the average market price during the period using the proceeds to be received upon settlement. Therefore, dilution will occur for periods when the average market price of the Company’s common stock for the reporting period is above $21.816.
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6.00% Convertible Subordinated Notes Due February 2007
In 2000, the Company issued an aggregate principal amount of $650 million of the 6.00% convertible subordinated notes due February 2007 (the “6.00% Notes”.) The 6.00% Notes are convertible, at the option of the holder, into common stock at a conversion price of $23.60 per share (7.8 million shares based on the $185.2 million principal amount of notes outstanding at December 31, 2005.) The notes bear interest at 6.00%, payable semiannually, and are non-callable for three years and may then be called by the Company at a premium, which declines over time. The holders have the right to require redemption at a premium in the event of a change in control or other defined redemption events. Debt issuance costs of $19.1 million were incurred in connection with the issuance of this debt and included in other assets. To date, the Company has retired or called $464.8 million of the 6.00% Notes.
Senior Secured Revolving Credit Facility
In September 2005, the Company entered into a $250 million, three-year senior secured revolving credit facility. The facility is secured by certain assets of the Company. The facility will be used for general corporate purposes, including regulatory capital needs arising from acquisitions. Draws under the facility currently bear interest, at our option, at adjusted LIBOR plus 2% or prime plus 1%. Undrawn facility funds currently bear commitment fees of 0.25% per annum payable quarterly in arrears. At December 31, 2005, no amounts were outstanding under this credit facility. Issuance costs of $2.2 million are included in other assets and are being amortized over the term of the facility.
Corporate Debt Covenants
Certain of the Company’s corporate senior debt described above have terms which include customary financial covenants. As of December 31, 2005, the Company was in compliance with all such covenants.
Early Extinguishment of Debt
The Company recorded a $19.4 million loss on early extinguishment of debt in 2004. In 2004, loss on early extinguishment of debt included a $12.6 million loss from the retirement of a portion of our 6.75% convertible subordinated notes and $6.8 million loss from the retirement of the 6.00% Notes, both charges relating to the portion of the premium paid and write-off of unamortized debt offering costs. In 2005, the Company did not have any early extinguishments of debt.
NOTE 17—ACCOUNTS PAYABLE, ACCRUED AND OTHER LIABILITIES
Accounts payable, accrued and other liabilities consist of the following (in thousands):
| December 31, | ||||||
| 2005 | 2004 | |||||
Accounts payable and accrued expenses | $ | 272,402 | $ | 224.989 | ||
Notes payable | 66,953 | 40,393 | ||||
Restructuring liabilities and purchase accounting accruals | 52,808 | 33,049 | ||||
Subserviced loan advances | 27,565 | 14,360 | ||||
Senior and convertible debt accrued interest | 24,396 | 6,021 | ||||
Margin call collaterals | 21,837 | 36,097 | ||||
Securities purchased collateral not delivered | 9,135 | 53,131 | ||||
Income tax payable | — | 53,937 | ||||
Other | 100,449 | 124,790 | ||||
Total accounts payable, accrued and other liabilities | $ | 575,545 | $ | 586,767 | ||
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Securities Purchased, Collateral Not Received
The Bank has payables to third-party brokers for mortgage-backed securities that the Bank committed to buy, but did not receive from the brokers by December 31, 2005 and 2004.
Notes Payable
The Company maintains committed and uncommitted financing facilities with banks totaling $825 million to meet corporate liquidity needs and finance margin lending. There was none outstanding under these lines at December 31, 2005 and 2004. The Company also has multiple term loans from financial institutions. These loans are collateralized by equipment. Borrowings under these term loans bear interest at 5.43% and 2.95% above LIBOR. The Company had approximately $40.5 million of principal outstanding under these loans at December 31, 2005.
The components of income tax expense from continuing operations are as follows (in thousands)
| Year Ended December 31, | |||||||||||
| 2005 | 2004 | 2003 | |||||||||
Current: | |||||||||||
Federal | $ | 158,050 | $ | 95,862 | $ | 80,302 | |||||
Foreign | 3,518 | 4,442 | 5,894 | ||||||||
State | 19,237 | 14,540 | 18,390 | ||||||||
Total current | 180,805 | 114,844 | 104,586 | ||||||||
Deferred: | |||||||||||
Federal | 45,200 | 44,086 | (5,368 | ) | |||||||
Foreign | (1,264 | ) | 2,328 | 5,418 | |||||||
State | 5,082 | 20,506 | 6,965 | ||||||||
Total deferred | 49,018 | 66,920 | 7,015 | ||||||||
Income tax expense from continuing operations | $ | 229,823 | $ | 181,764 | $ | 111,601 | |||||
The Company is subject to examination by the Internal Revenue Service (the “IRS”), taxing authorities in foreign countries and states in which the Company has significant business operations. The Company regularly assesses the likelihood of additional tax deficiencies in each of the taxing jurisdictions resulting from ongoing and subsequent years’ examinations. Included in current tax expense are charges to accruals for expected tax contingencies in accordance with SFAS No. 5.
The components of income before income taxes and discontinued operations are as follows (in thousands):
| Year Ended December 31, | ||||||||||
| 2005 | 2004 | 2003 | ||||||||
Domestic | $ | 653,131 | $ | 545,197 | $ | 308,901 | ||||
Foreign | 22,995 | 19,290 | (1,840 | ) | ||||||
Total income before income taxes and discontinued operations | $ | 676,126 | $ | 564,487 | $ | 307,061 | ||||
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Deferred income taxes are recorded when revenues and expenses are recognized in different periods for financial statement and tax return purposes. The temporary differences and tax carry-forwards that created deferred tax assets and deferred tax liabilities are as follows (in thousands):
| December 31, | ||||||||
| 2005 | 2004 | |||||||
Deferred tax assets: | ||||||||
Reserves and allowances | $ | 20,826 | $ | 15,237 | ||||
Net unrealized gain on equity investments and Bank assets held-for-sale | 109,871 | 78,411 | ||||||
Net operating loss carry-forwards | 59,433 | 68,939 | ||||||
Deferred compensation | 13,613 | 9,235 | ||||||
Capitalized technology development | 4,739 | 7,382 | ||||||
Tax credits | — | 6,520 | ||||||
Restructuring reserve and related write-downs | 56,805 | 66,116 | ||||||
Other | — | 1,225 | ||||||
Total deferred tax assets | 265,287 | 253,065 | ||||||
Deferred tax liabilities: | ||||||||
Internally developed software | (20,925 | ) | (20,690 | ) | ||||
Acquired intangibles | (21,759 | ) | (36,552 | ) | ||||
Basis differences in investments | (117,642 | ) | (53,007 | ) | ||||
Loan fees | (6,966 | ) | (7,092 | ) | ||||
Depreciation and amortization | (32,232 | ) | (28,753 | ) | ||||
Purchased software | (3,024 | ) | (3,024 | ) | ||||
Retained servicing rights | (2,755 | ) | (6,298 | ) | ||||
Other | (16,774 | ) | (3,859 | ) | ||||
Total deferred tax liabilities | (222,077 | ) | (159,275 | ) | ||||
Valuation allowance | (39,359 | ) | (52,671 | ) | ||||
Net deferred tax asset | $ | 3,851 | $ | 41,119 | ||||
The Company maintains a valuation allowance of $39.4 million and $52.7 million at December 31, 2005 and 2004, respectively, against certain of its deferred tax assets, as it is more likely than not that they will not be fully realized. The deferred tax assets for which a valuation allowance has been established include certain state and foreign country net operating loss carry-forwards and excess tax bases in certain illiquid investments.
| • | At December 31, 2005, the Company had foreign country net operating loss carry-forwards of approximately $83.0 million for which a deferred tax asset of approximately $25 million was established. The foreign net operating losses represent the foreign tax loss carry-forwards in numerous foreign countries, some of which are subject to expiration from 2006-2008. In most of these foreign countries, the Company has historical tax losses, and the Company continues to project to incur operating losses in most of these countries. Accordingly, the Company has provided a valuation allowance of $23.5 million against such deferred tax asset at December 31, 2005. |
| • | During 2005, the Company reversed the valuation allowance of approximately $2.0 million related to its Danish subsidiary’s operations due to positive evidence, principally sustained profitability, that led management to conclude that it is now more likely than not that realization of its net operating losses and other tax attributes will be recognized. |
| • | At December 31, 2005, the Company had gross state net operating loss carry-forwards of $171 million that expire between 2012 and 2024, most of which are subject to reduction for apportionment when utilized. A deferred tax asset of approximately $13 million has been established related to these state net |
51
operating loss carry-forwards with a valuation allowance of $2 million against such deferred tax asset at December 31, 2005. |
| • | At December 31, 2005, the Company maintains a valuation allowance against the excess tax basis in certain capital assets of approximately $11 million. The capital assets in question are certain investments in e-commerce and Internet startup venture funds that have no ready market or liquidity at December 31, 2005. The Company has concluded that the realization of these excess tax benefits on these capital assets are uncertain and not in the control of the Company, as there is no ready market or liquidity for these investments. |
| • | The valuation allowance was decreased in 2005 for the elimination of a valuation allowance of $7 million related to foreign tax credits when the corresponding deferred tax asset was written off upon the conversion of all outstanding Exchangeable Shares to the Company’s common stock. The elimination of the valuation allowance did not impact income tax expense. |
| • | The majority of the balance of the reduction in the valuation allowance of approximately $5 million related to foreign net operating loss carry-forwards and other foreign deferred tax items. |
At December 31, 2005, the Company had federal net operating loss carry-forwards of approximately $59 million for which no valuation allowance has been provided. These carry-forwards expire through 2020. These federal net operating loss carry-forwards relate to pre-acquisition losses from acquired subsidiaries and, accordingly, are generally subject to annual limitations in their use of $4.9 million per year in accordance with Internal Revenue Code Section 382. Accordingly, the extent to which the loss carry-forwards can be used to offset future taxable income may be limited.
The Company has not provided deferred income taxes on $31 million of undistributed earnings and profits in its foreign subsidiaries at December 31, 2005. The Company intends to permanently reinvest such earnings. The Company has not provided deferred income taxes of $10.9 million on such undistributed earnings and profits. The American Jobs Creation Act of 2004 (the “Act”) provided for a temporary incentive for U.S. multinational corporations to repatriate accumulated income earned abroad by providing an 85% exclusion from taxable income for certain dividends from controlled foreign corporations. As a result of this special temporary tax incentive, the Company distributed $20 million from its Canadian subsidiaries in 2004. The Company did not record any cumulative tax expense in connection with such repatriation since the Company believes the distribution was a tax-free return of capital for tax purposes.
The effective tax rates differed from the Federal statutory rates as follows:
| Year Ended December 31, | |||||||||
| 2005 | 2004 | 2003 | |||||||
Federal statutory rate | 35.0 | % | 35.0 | % | 35.0 | % | |||
State income taxes, net of Federal tax benefit | 2.3 | 4.4 | 3.6 | ||||||
Difference between statutory rate and foreign effective tax rate and establishment of valuation allowance for foreign deferred tax assets | (0.9 | ) | (0.7 | ) | 3.8 | ||||
IRS tax settlement | — | (2.8 | ) | — | |||||
Excess tax basis upon sale of partnership interests | — | (2.2 | ) | — | |||||
Change in valuation allowance | (0.3 | ) | (0.5 | ) | (5.2 | ) | |||
Other | (2.1 | ) | (1.0 | ) | (0.9 | ) | |||
Effective tax rate | 34.0 | % | 32.2 | % | 36.3 | % | |||
The increase to our 2005 tax rate was principally due to the one-time tax benefits recorded in 2004 related to (i) the IRS tax settlement and (ii) the excess tax basis upon the sale of partnership interests, offset somewhat by our declining state tax rate and overall foreign tax rate differential. In 2004, the Company reached a favorable tax
52
settlement with the IRS. This agreement resolved various issues for all federal tax liabilities through 2000, including most notably certain research and experimentation credit claims.
Preferred Stock
The Company has 1.0 million shares authorized in preferred stock. None were issued and outstanding at December 31, 2005 and 2004.
Shares Exchangeable into Common Stock
At December 31, 2005, there were no shares of common stock that were exchangeable into the Company’s common stock (“Exchangeable Shares”) outstanding. In August 2000, EGI Canada Corporation issued approximately 9.4 million Exchangeable Shares in connection with the Company’s acquisition of E*TRADE Technologies. In 2005, the Company called and exchanged the remaining Exchangeable Shares. Upon exchange, these shares were converted on a one-for-one basis to the Company’s common stock. Exchangeable Shares converted were 1.3 million in 2005, 0.1 million in 2004 and 0.2 million in 2003.
Issuance of Common Stock
In 2005, the Company issued $718.4 million or 41.1 million shares of common stock including $691.8 million sold in conjunction with the funding of our BrownCo acquisition.
Mandatory Convertible Notes
In November 2005, the Company issued 18.0 million Units that are convertible into up to 25.0 million shares of common stock, on or before the Purchase Date. The conversion ratio depends on the market price of our common stock 20 trading days prior to conversion. Units are generally convertible only on or near the Purchase Date. (See Note 16 for additional details on the transaction.)
Share Repurchases
From time to time, the Company’s Board of Directors authorizes share repurchase and debt retirement plans, as they determine that they are likely to create long-term value for its shareholders. These plans are open-ended and provide the flexibility to buy back common stock, redeem for cash its outstanding convertible subordinated notes, retire debt in the open market or a combination of all three. Under these authorized plans, the Company has repurchased common stock and retired portions of its convertible subordinated notes.
In 2005, the Company repurchased nearly 4.6 million shares of its common stock for an aggregate $58.2 million. In 2004, the Company repurchased 13.7 million shares of its common stock for an aggregate $175.8 million. Also under the repurchase plans, the Company used $86.2 million in cash for a partial redemption of its 6.75% convertible subordinated notes.
As of December 31, 2005, the Company had approximately $179.8 million available under its authorized share repurchase and debt retirement plans to purchase additional shares of its common stock or retire additional debt.
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The following table is a reconciliation of basic and diluted EPS (in thousands, except per share data):
| Year Ended December 31, | |||||||||||
| 2005 | 2004 | 2003 | |||||||||
BASIC: | |||||||||||
Numerator: | |||||||||||
Income from continuing operations | $ | 446,238 | $ | 381,830 | $ | 200,521 | |||||
Net income (loss) from discontinued operations | (17,472 | ) | (1,347 | ) | 2,506 | ||||||
Net income before cumulative effect of accounting change | 428,766 | 380,483 | 203,027 | ||||||||
Cumulative effect of accounting change, net of tax | 1,646 | — | — | ||||||||
Net income | $ | 430,412 | $ | 380,483 | $ | 203,027 | |||||
Denominator: | |||||||||||
Basic weighted-average shares outstanding | 371,468 | 366,586 | 358,320 | ||||||||
DILUTED: | |||||||||||
Numerator: | |||||||||||
Net income | $ | 430,412 | $ | 380,483 | $ | 203,027 | |||||
Interest on convertible subordinated notes, net of tax | — | 19,963 | — | ||||||||
Net income, as adjusted | $ | 430,412 | $ | 400,446 | $ | 203,027 | |||||
Denominator: | |||||||||||
Basic weighted-average shares outstanding | 371,468 | 366,586 | 358,320 | ||||||||
Effect of dilutive securities: | |||||||||||
Weighted-average options and restricted stock issued to employees | 11,137 | 10,461 | 6,495 | ||||||||
Weighted-average warrants and contingent shares outstanding | 2,025 | 2,532 | 2,546 | ||||||||
Shares issuable for assumed conversion of convertible subordinated notes | — | 25,810 | — | ||||||||
Diluted weighted-average shares outstanding | 384,630 | 405,389 | 367,361 | ||||||||
PER SHARE: | |||||||||||
Basic Income Per Share: | |||||||||||
Income per share from continuing operations | $ | 1.20 | $ | 1.04 | $ | 0.56 | |||||
Net income (loss) per share from discontinued operations | (0.04 | ) | (0.00 | ) | 0.01 | ||||||
Net income per share before cumulative effect of accounting changes | 1.16 | 1.04 | 0.57 | ||||||||
Cumulative effect of accounting change | 0.00 | — | — | ||||||||
Income per share | $ | 1.16 | $ | 1.04 | $ | 0.57 | |||||
Diluted Income Per Share: | |||||||||||
Income per share from continuing operations | $ | 1.16 | $ | 0.99 | $ | 0.55 | |||||
Net income (loss) per share from discontinued operations | (0.04 | ) | (0.00 | ) | 0.00 | ||||||
Net income per share before cumulative effect of accounting change | 1.12 | 0.99 | 0.55 | ||||||||
Cumulative effect of accounting change | 0.00 | — | — | ||||||||
Net income per share | $ | 1.12 | $ | 0.99 | $ | 0.55 | |||||
Excluded from the calculations of diluted income (loss) per share are 7.8 million and 45.4 million shares of common stock for 2005 and 2003, respectively, issuable under convertible subordinated notes as the effect of applying the treasury stock method on an if-converted basis would be anti-dilutive. In addition, in 2005, 25.0 million shares of common stock potentially issuable related to the conversion of mandatory convertible notes was excluded from the calculations because it would be anti-dilutive.
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The following options to purchase shares of common stock have not been included in the computation of diluted income per share because the options’ exercise price was greater than the average market price of the Company’s common stock for the following years stated, therefore, the effect would be anti-dilutive (in thousands, except exercise price ranges):
| Year Ended December 31, | ||||||||||||
| 2005 | 2004 | 2003 | ||||||||||
Options excluded from computation of diluted income per share | 7,209 | 10,665 | 14,860 | |||||||||
Exercise price ranges: | ||||||||||||
High | $ | 58.19 | $ | 58.19 | $ | 58.19 | ||||||
Low | $ | 12.76 | $ | 12.50 | $ | 7.97 | ||||||
NOTE 21—EMPLOYEE SHARE-BASED PAYMENTS AND OTHER BENEFITS
Adoption of SFAS No. 123(R)
As discussed in Note 1, effective July 1, 2005, the Company early adopted SFAS No. 123(R.) The adoption resulted in the recognition of or changes to the recognition method of expense for the Company’s employee stock option plans, restricted stock awards and employee stock purchase plan. The combined impact of the adoption in 2005 is as follows: $13.7 million in compensation expense for stock options; $0.4 million compensation expense for the stock purchase plan; and a pre-tax credit of $2.8 million in cumulative effect of accounting change for 2005. Results for prior periods have not been restated. Total compensation expense for stock-based compensation also includes $4.2 million for restricted stock awards, which were previously expensed by the Company under APB No. 25, prior to the adoption of SFAS No. 123(R).
Employee Stock Option Plans
In 2005, the Company adopted and the shareholders approved the 2005 Stock Incentive Plan (the “2005 Plan”) to replace the 1996 Stock Incentive Plan (the “1996 Plan”) which provides for the grant of nonqualified or incentive stock options to officers, directors, key employees and consultants for the purchase of newly issued shares of the Company’s common stock at a price determined by the Board of Directors (the “Board”) at the date the option is granted. Options are generally exercisable ratably over a four-year period from the date the option is granted and expire within ten years from the date of grant. Certain options provide for accelerated vesting upon a change in control. Exercise prices are generally equal to the fair market value of the shares on the grant date. A total of 85.4 million shares have been authorized under the 2005 Plan since inception and 36.6 million shares were available for grant at December 31, 2005.
The fair value of each option award is estimated on the date of grant using a Black-Scholes-Merton option pricing model based on the assumptions noted in the table below. Expected volatility is based on a combination of historical volatility of the Company’s stock and implied volatility of publicly traded options on the Company’s stock. The expected term represents the period of time that options granted are expected to be outstanding. The expected term is estimated using employees’ actual historical behavior and projected future behavior based on expected exercise patterns. The risk-free interest rate is based on the U.S. Treasury zero-coupon bond where the remaining term equals the expected term. Dividend yield is zero as the Company has not, nor does it currently plan to, issue dividends to its shareholders.
| Year Ended December 31, | |||||||||
| 2005 | 2004 | 2003 | |||||||
Expected volatility | 34 | % | 55 | % | 66 | % | |||
Expected term (years) | 4.9 | 4.3 | 3.3 | ||||||
Risk-free interest rate | 4 | % | 3 | % | 3 | % | |||
Dividend yield | — | — | — | ||||||
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The weighted-average fair values of options granted were $4.57 for 2005, $5.95 for 2004 and $2.83 for 2003. Intrinsic value of options exercised were $67.0 million for 2005, $53.1 million for 2004 and $30.9 million for 2003.
A summary of option activity under the 2005 Plan is presented below:
Shares (in thousands) | Weighted- Average Exercise Price | Weighted- Average Remaining Contractual Life | Aggregate (in thousands) | ||||||||
Outstanding at December 31, 2004: | 42,789 | $ | 9.68 | ||||||||
Granted | 6,856 | $ | 12.80 | ||||||||
Exercised | (7,780 | ) | $ | 6.84 | |||||||
Canceled | (4,699 | ) | $ | 13.36 | |||||||
Outstanding at December 31, 2005 | 37,166 | $ | 10.37 | 6.76 | $ | 389,766 | |||||
Exercisable at December 31, 2005 | 21,217 | $ | 9.31 | 5.74 | $ | 244,988 | |||||
As of December 31, 2005, there was $31.3 million of total unrecognized compensation cost related to non-vested options. This cost is expected to be recognized over a weighted-average period of 2.2 years. The total fair value of shares vested was $39.8 million for 2005, $60.5 million for 2004 and $122.2 for 2003.
Restricted Stock Awards
The Company recorded $4.2 million for 2005, $4.7 million for 2004 and $2.3 million for 2003 in compensation expense relating to restricted stock awards. In addition, the Company recorded a pre-tax credit of $2.8 million in cumulative effect of accounting change as a result of adopting SFAS No. 123(R) in 2005.
The Company issues restricted stock awards to its officers and senior executives. These awards are issued at the fair market value on the date of grant and generally vest ratably over four years. However, certain awards vest on the fifth anniversary of the date of grant. The fair value is calculated as the market price upon issuance.
Prior to its adoption of SFAS No. 123(R), the Company recorded compensation expense for restricted stock awards on a straight-line basis over their vesting period. If an employee forfeited the award prior to vesting, the Company reversed out the previously expensed amounts in the period of forfeiture. As required upon adoption of SFAS No. 123(R), the Company must base its accruals of compensation expense on the estimated number of awards for which the requisite service period is expected to be rendered. Actual forfeitures are no longer recorded in the period of forfeiture. The Company recorded a pre-tax credit of $2.8 million in cumulative effect of accounting change, that represents the amount by which compensation expense would have been reduced in periods prior to adoption of SFAS No. 123(R) for restricted stock awards outstanding on July 1, 2005 that are anticipated to be forfeited.
Under the provision of SFAS No. 123(R), the recognition of deferred stock compensation, a contra-equity account representing the amount of unrecognized restricted stock expense is no longer required. Therefore, as of July 1, 2005, “Deferred Stock Compensation” was combined with “Additional Paid-in Capital” in the Company’s consolidated balance sheet.
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A summary of non-vested restricted stock award activity is presented below:
Shares (in thousands) | Weighted- Average Grant Date Fair Value | |||||
Non-vested at December 31, 2004: | 2,615 | $ | 9.35 | |||
Issued | 830 | $ | 11.93 | |||
Released (vested) | (276 | ) | $ | 10.31 | ||
Canceled | (516 | ) | $ | 9.18 | ||
Non-vested at December 31, 2005 | 2,653 | $ | 10.09 | |||
As of December 31, 2005, there was $14.0 million of total unrecognized compensation cost related to non-vested awards. This cost is expected to be recognized over a weighted-average period of 2.9 years.
Employee Stock Purchase Plan
For the year ended December 31, 2005, the Company recorded $0.4 million in compensation expense for its employee stock purchase plan. Effective August 1, 2005, the Company changed the terms of its purchase plan to reduce the discount to 5% and discontinued the look-back provision. As a result, the purchase plan was not compensatory beginning August 1, 2005. At December 31, 2005, 1,083,195 shares were available for purchase under the 2002 Employee Stock Purchase Plan (“2002 Purchase Plan”.)
Prior to the plan change, the shareholders of the Company had approved the 2002 Purchase Plan, and reserved 5,000,000 shares of common stock for sale to employees at a price no less than 85% of the lower of the fair market value of the common stock at the beginning of the one-year offering period or the end of each of the six-month purchase periods. Under SFAS No. 123(R), the 2002 Purchase Plan was considered compensatory. As a result, the Company recorded $0.4 million of compensation expense for the subscription period ended July 31, 2005.
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 $5.2 million for 2005, $5.0 million for 2004 and $8.7 million for 2003.
NOTE 22—REGULATORY REQUIREMENTS
Registered Broker-Dealers
The Company’s broker-dealer subsidiaries are subject to the Uniform Net Capital Rule (the “Rule”) under the Securities Exchange Act of 1934 administered by the SEC, the New York Stock Exchange (“NYSE”) and the NASD, which requires the maintenance of minimum net capital. The minimum net capital requirements can be met under either the Aggregate Indebtedness or the Alternative method. Under the Aggregate Indebtedness method, a broker-dealer is required to maintain minimum net capital of at least the greater of 6 2/3% of its aggregate indebtedness, as defined, or a minimum dollar amount. Under the Alternative method, a broker-dealer is required to maintain net capital of at least 5% of aggregate debit balances or a minimum dollar amount. Broker-dealers who do not meet one of these requirements may not repay subordinated borrowings, pay cash dividends or make any unsecured advances or loans to its parent or employees.
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The table below summarizes the minimum excess capital requirements for the Company’s broker-dealer subsidiaries (in thousands):
| December 31, 2005 | |||||||||
| Required Net Capital | Net Capital | Excess Net Capital | |||||||
E*TRADE Clearing LLC(1) | $ | 57,914 | $ | 345,957 | $ | 288,043 | |||
BrownCo LLC(1) | 67,292 | 309,576 | 242,284 | ||||||
E*TRADE Securities LLC(1) | 250 | 33,720 | 33,470 | ||||||
E*TRADE Capital Markets, LLC | 1,206 | 24,018 | 22,812 | ||||||
Harrisdirect LLC(2) | 250 | 19,376 | 19,126 | ||||||
E*TRADE Global Asset Management, Inc.(2) | 1,177 | 18,862 | 17,685 | ||||||
E*TRADE Capital Markets—Execution Services, LLC(2) | 449 | 3,533 | 3,084 | ||||||
E*TRADE Professional Trading, LLC(1) | 250 | 2,044 | 1,794 | ||||||
VERSUS Brokerage Service (U.S.) Inc.(2) | 100 | 797 | 697 | ||||||
International broker-dealers | 28,871 | 68,452 | 39,581 | ||||||
Totals | $ | 157,759 | $ | 826,335 | $ | 668,576 | |||
| (1) | Elected to use the Alternative method to compute net capital. |
| (2) | Elected to use the Aggregate Indebtedness method to compute net capital. |
Banking
The Bank is 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 Bank’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The Bank’s capital amounts and classification 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 the Bank to maintain minimum amounts and ratios of Total and Tier I Capital to Risk-weighted assets and Tier I Capital to Adjusted total assets. As shown in the table below, at December 31, 2005, the most recent date of notification, the Office of Thrift Supervision (“OTS”) categorized the Bank as “well capitalized” under the regulatory framework for prompt corrective action. There are no conditions or events since that notification that management believes have changed the Bank’s category. At December 31, 2005, management believes that the Bank meets all capital adequacy requirements to which it is subject. However, events beyond management’s control, such as fluctuations in interest rates or a downturn in the economy in areas in which the Bank’s loans or securities are concentrated, could adversely affect future earnings and consequently, the Bank’s ability to meet its future capital requirements.
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The Bank’s required actual capital amounts and ratios are presented in the table below (dollars in thousands):
| Actual | Required for Capital Adequacy Purposes | Required to be Well Capitalized Under Prompt Corrective Action Provisions | ||||||||||||||||
| Amount | Ratio | Amount | Ratio | Amount | Ratio | |||||||||||||
At December 31, 2005: | ||||||||||||||||||
Total Capital to risk-weighted assets | $ | 2,021,091 | 10.94 | % | >$1,478,238 | >8.0 | % | >$ | 1,847,797 | >10.0 | % | |||||||
Tier I Capital to risk-weighted assets | $ | 1,957,805 | 10.60 | % | >$ | 739,119 | >4.0 | % | >$ | 1,108,678 | > 6.0 | % | ||||||
Tier I Capital to adjusted total assets | $ | 1,957,805 | 5.92 | % | >$1,322,343 | >4.0 | % | >$ | 1,652,929 | > 5.0 | % | |||||||
At December 31, 2004: | ||||||||||||||||||
Total Capital to risk-weighted assets | $ | 1,533,934 | 11.09 | % | >$1,106,778 | >8.0 | % | >$ | 1,383,472 | >10.0 | % | |||||||
Tier I Capital to risk-weighted assets | $ | 1,486,422 | 10.74 | % | >$ 553,389 | >4.0 | % | >$ | 830,083 | > 6.0 | % | |||||||
Tier I Capital to adjusted total assets | $ | 1,486,422 | 5.83 | % | >$1,019,659 | >4.0 | % | >$ | 1,274,574 | > 5.0 | % | |||||||
The Bank is also required by OTS regulations to maintain tangible capital of at least 1.50% of tangible assets. The Bank satisfied this requirement at both December 31, 2005 and 2004.
The Bank is subject to certain restrictions on the amount of dividends it may declare without prior regulatory approval. At December 31, 2005, the Bank has approximately $192.5 million of capital available for dividend declaration without regulatory approval while still maintaining a “well capitalized” status.
The Company has non-cancelable operating leases for facilities through 2016. Future minimum rental commitments under these leases are as follows (in thousands):
Years ending December 31: | |||
2006 | $ | 27,503 | |
2007 | 26,872 | ||
2008 | 25,374 | ||
2009 | 22,397 | ||
2010 | 19,753 | ||
Thereafter | 27,596 | ||
Total future minimum lease payments | $ | 149,495 | |
Certain leases contain provisions for renewal options and rent escalations based on increases in certain costs incurred by the lessor. Rent expense was $22.2 million for 2005, $23.9 million for 2004 and $31.4 million for 2003.
NOTE 24—COMMITMENTS, CONTINGENCIES AND OTHER REGULATORY MATTERS
Legal Matters
In June 2002, the Company acquired from MarketXT Holdings, Inc. (formerly known as Tradescape Corporation) (“MarketXT”) certain entities referred to as Tradescape Securities, LLC, Tradescape Technologies, LLC and Momentum Securities, LLC. Numerous disputes have arisen among the parties regarding the value of and responsibility for various liabilities that first became apparent following the sale. The parties have been unable to resolve these disputes and have asserted claims against each other. On April 8, 2004, MarketXT filed a complaint in the United States District Court for the Southern District of New York against the Company, certain
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of its officers and directors and other third parties, including Softbank Finance Corporation and Softbank Corporation, alleging that the defendants acted improperly in preventing plaintiffs from obtaining certain contingent payments and claiming damages of $1.5 billion. On April 9, 2004, the Company filed a complaint in the United States District Court for the Southern District of New York against certain directors and officers of MarketXT seeking declaratory relief and monetary damages in an amount to be proven at trial for defendants’ fraud in connection with the 2002 sale transaction, including, but not limited to, having presented the Company with fraudulent financial statements of the condition of Momentum Securities during the due diligence process. The Company amended its complaint in October 2004 to add additional defendants. In January 2005, the Company filed an adversary proceeding against MarketXT and others seeking compensatory and punitive damages, and certain declaratory relief in those Chapter 11 bankruptcy proceedings in the United States Bankruptcy Court for the Southern District of New York entitled, “In re MarketXT Holdings Corp., Debtor” and a separate adversary proceeding against Omar Amanat, in the same bankruptcy court in those Chapter 7 bankruptcy proceedings entitled, “In re Amanat, Omar Shariff.” In October 2005, MarketXT answered the Company’s adversary proceeding and asserted various counterclaims, including some of the claims MarketXT had asserted in its district court action (which action MarketXT subsequently abandoned), seeking unspecified damages according to proof at trial. The Company has moved to dismiss certain aspects of MarketXT’s counterclaim, and discovery related to the adversary proceeding continues. The Company continues to believe that the claims brought against it by MarketXT and Omar Amanat are without merit and intends both to vigorously defend all such claims and to fully pursue its own claims as described above.
In September 2001, the Company engaged in certain stock loan transactions that resulted in litigation between the Company and certain counterparties to the transactions including Nomura Securities, Inc. and certain of its affiliates (“Nomura”). In the lawsuits, Nomura sought approximately $10.0 million in damages and asserted the right to keep an additional $5.0 million, plus interest, unspecified punitive damages, attorney fees, and other relief from the Company for conversion and breach of contract. The Company asserted claims and defenses against Nomura relating to the same amount and alleged,inter alia, that Nomura, among others, participated in a stock lending fraud and violated federal and state securities laws among other allegations. The Company sought, among other things, compensatory damages for all expenses and losses that it had incurred to date. On December 5, 2005, the Company entered into an agreement with Nomura and its subsidiaries and affiliates to settle the lawsuits pending between the parties in New York and Minnesota. Pursuant to that agreement, Nomura, without admission of liability, agreed to pay, and has paid, $35.0 million to the Company to resolve these disputes; the Company and Nomura further agreed to dismiss their claims against each other. With the resolution of these matters, this litigation will no longer be included in our disclosures.
An unfavorable outcome in any matter that is not covered by insurance could have a material adverse effect on our business, financial condition, results of operations and cash flows. In addition, even if the ultimate outcomes are resolved in our favor, the defense of such litigation could entail considerable cost and the diversion of the efforts of management, either of which could have a material adverse effect on our results of operation. 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. The Company contests liability and/or the amount of damages in each pending matter. 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 investigations and proceedings are in the early stages, the Company cannot predict with certainty the loss or range of loss related to such matters, how such matters will be resolved, when they will ultimately be resolved, or what the eventual settlement, fine, penalty or other relief might be. Subject to the foregoing, the Company believes, based on current knowledge and after consultation with counsel, that the outcome of each such pending matter will not have a material adverse effect on the consolidated financial condition of the Company, although the outcome could be material to the Company’s or a business segment’s operating results for a particular future period, depending on, among other things, the level of the Company’s or a business segment’s income for such period. Legal reserves have been established in accordance with SFAS No. 5. Once established, reserves are adjusted when there is more information available or when an event occurs requiring a change.
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Regulatory Matters
The securities and banking industries are subject to extensive regulation under Federal, state and applicable international laws. As a result, the Company is required to comply with many complex laws and rules and its ability to so comply is dependent in part on the establishment and maintenance of a qualified compliance system. 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 audits and inspections. Compliance and trading problems that are reported to regulators, such as the SEC, the NYSE, the NASD or the OTS 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 and/or disciplinary action being taken against the Company by regulators. The regulators may also initiate investigations and take disciplinary action against the Company or its employees. 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 Matters
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.
Commitments—Loans
In the normal course of business, the Bank makes various commitments to extend credit and incur contingent liabilities that are not reflected in the consolidated balance sheets. The Bank had the following mortgage loan commitments (in thousands):
| December 31, 2005 | |||||||||
| Fixed Rate | Variable Rate | Total | |||||||
Purchase loans | $ | 316,040 | $ | 46,163 | $ | 362,203 | |||
Originate loans | $ | 94,512 | $ | 17,940 | $ | 112,452 | |||
Sell loans | $ | 24,294 | $ | 10,793 | $ | 35,087 | |||
Significant changes in the economy or interest rate influence the impact that these commitments and contingencies have on the Company in the future.
At December 31, 2005, the Bank had commitments to purchase $0.9 billion and sell $1.0 billion in securities. In addition, the Bank had approximately $2.3 billion of certificates of deposit scheduled to mature in less than one year and $6.2 billion of unfunded commitments to extend credit.
Guarantees
The Bank provides guarantees to investors purchasing mortgage loans, which are considered standard representations and warranties within the mortgage industry. The primary guarantees are as follows:
| • | The mortgage and the mortgage note have been duly executed and each is the legal, valid and binding obligation of the Bank, enforceable in accordance with its terms. The mortgage has been duly acknowledged and recorded and is valid. 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. If these |
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claims prove to be untrue, the investor can require the Bank to repurchase the loan and return all loan purchase and servicing release premiums. |
| • | Should any eligible mortgage loan delivered pay off prior to the receipt of the first payment, the loan purchase and servicing release premiums shall be fully refunded. |
| • | Should any eligible mortgage loan delivered to an investor pay off between the receipt of the first payment and a contractually designated period of time (typically 60—120 days from the date of purchase), the servicing release premiums shall be fully refunded. |
Management has determined that the maximum potential liability under these guarantees is $18.3 million and $38.1 million based on all available information at December 31, 2005 and December 31, 2004, respectively. The current carrying amount of the liability recorded at December 31, 2005 is $0.4 million and is considered adequate based upon analysis of historical trends and current economic conditions for these guarantees.
During the 30-year period prior to the redemption of the Floating Rate Cumulative Preferred Securities, ETBH guarantees the accrued and unpaid distributions on these securities as well as the redemption price of the securities and certain costs that may be incurred in liquidating, terminating or dissolving the trusts (all of which would otherwise be payable by the trusts.) At December 31, 2005, management estimated that the maximum potential liability under this arrangement is equal to approximately $312 million or the total face value of these securities plus dividends, which may be unpaid at the termination of the trust arrangement.
NOTE 25—SEGMENT AND GEOGRAPHIC INFORMATION
In January 2005, the Company revised its financial reporting to reflect the manner in which its chief operating decision maker has begun assessing the Company’s performance and makes resource allocation decisions. As a result, the Company now reports its operating results in two segments, retail and institutional, rather than its former brokerage and banking segments.
Retail includes:
| • | investing, trading, cash management and lending products and services to individuals; and |
| • | stock plan administration products and services activity |
Institutional includes:
| • | balance sheet management, including generation of institutional net interest spread, gain on sales of loans and securities, net and management income; |
| • | market-making; and |
| • | global execution and settlement services |
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The Company evaluates the performance of its segments based on segment contribution (net revenues less expenses excluding interest.) All corporate overhead, administrative and technology charges are allocated to segments either in proportion to their respective direct costs or based upon specific operating criteria. Financial information for the Company’s reportable segments is presented in the following tables (in thousands):
| Year Ended December 31, 2005 | ||||||||||||||||
| Retail | Institutional | Eliminations(1) | Total | |||||||||||||
Revenues: | ||||||||||||||||
Commissions | $ | 339,654 | $ | 119,180 | $ | — | $ | 458,834 | ||||||||
Principal transactions | — | 99,175 | 161 | 99,336 | ||||||||||||
Gain on sales of loans and securities, net | 63,705 | 35,153 | — | 98,858 | ||||||||||||
Service charges and fees | 116,102 | 19,212 | — | 135,314 | ||||||||||||
Other revenues | 112,836 | 10,383 | (28,800 | ) | 94,419 | |||||||||||
Interest income | 685,067 | 1,395,769 | (430,572 | ) | 1,650,264 | |||||||||||
Interest expense | (239,943 | ) | (969,631 | ) | 430,410 | (779,164 | ) | |||||||||
Net interest income | 445,124 | 426,138 | (162 | ) | 871,100 | |||||||||||
Provision for loan losses | — | (54,016 | ) | — | (54,016 | ) | ||||||||||
Net interest income after provision for loan losses | 445,124 | 372,122 | (162 | ) | 817,084 | |||||||||||
Total revenues | 1,077,421 | 655,225 | (28,801 | ) | 1,703,845 | |||||||||||
Expense excluding interest: | ||||||||||||||||
Compensation and benefits | 232,494 | 148,309 | — | 380,803 | ||||||||||||
Occupancy and equipment | 57,869 | 11,220 | — | 69,089 | ||||||||||||
Communications | 71,693 | 10,792 | — | 82,485 | ||||||||||||
Professional services | 55,081 | 20,156 | — | 75,237 | ||||||||||||
Commissions, clearance and floor brokerage | 42,715 | 106,347 | (8,256 | ) | 140,806 | |||||||||||
Advertising and market development | 96,918 | 9,017 | — | 105,935 | ||||||||||||
Servicing and other banking expenses | 6,166 | 66,705 | (20,545 | ) | 52,326 | |||||||||||
Fair value adjustments of financial derivatives | — | 4,892 | — | 4,892 | ||||||||||||
Depreciation and amortization | 60,604 | 14,377 | — | 74,981 | ||||||||||||
Amortization of other intangibles | 13,894 | 29,871 | — | 43,765 | ||||||||||||
Facility restructuring and other exit activities | (32,754 | ) | 2,737 | — | (30,017 | ) | ||||||||||
Other | 13,984 | 39,767 | — | 53,751 | ||||||||||||
Total expenses excluding interest | 618,664 | 464,190 | (28,801 | ) | 1,054,053 | |||||||||||
Segment income | $ | 458,757 | $ | 191,035 | $ | — | $ | 649,792 | ||||||||
| (1) | Reflects elimination of transactions between retail and institutional segments, which includes deposit transfer pricing, servicing and order flow rebates. |
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| Year Ended December 31, 2004 | ||||||||||||||||
| Retail | Institutional | Eliminations(1) | Total | |||||||||||||
Revenues: | ||||||||||||||||
Commissions | $ | 328,889 | $ | 102,749 | $ | — | $ | 431,638 | ||||||||
Principal transactions | — | 126,893 | — | 126,893 | ||||||||||||
Gain on sales of loans and securities, net | 93,694 | 47,024 | — | 140,718 | ||||||||||||
Service charges and fees | 84,445 | 13,130 | — | 97,575 | ||||||||||||
Other revenues | 106,457 | 16,684 | (34,064 | ) | 89,077 | |||||||||||
Interest income | 492,233 | 956,972 | (303,608 | ) | 1,145,597 | |||||||||||
Interest expense | (169,955 | ) | (644,108 | ) | 303,608 | (510,455 | ) | |||||||||
Net interest income | 322,278 | 312,864 | — | 635,142 | ||||||||||||
Provision for loan losses | — | (38,121 | ) | — | (38,121 | ) | ||||||||||
Net interest income after provision for loan losses | 322,278 | 274,743 | — | 597,021 | ||||||||||||
Total revenues | 935,763 | 581,223 | (34,064 | ) | 1,482,922 | |||||||||||
Expense excluding interest: | ||||||||||||||||
Compensation and benefits | 227,867 | 122,573 | — | 350,440 | ||||||||||||
Occupancy and equipment | 57,437 | 12,135 | — | 69,572 | ||||||||||||
Communications | 61,112 | 8,562 | — | 69,674 | ||||||||||||
Professional services | 43,470 | 24,277 | — | 67,747 | ||||||||||||
Commissions, clearance and floor brokerage | 42,227 | 100,205 | (12,736 | ) | 129,696 | |||||||||||
Advertising and market development | 57,193 | 4,962 | — | 62,155 | ||||||||||||
Servicing and other banking expenses | 7,754 | 49,545 | (21,328 | ) | 35,971 | |||||||||||
Fair value adjustments of financial derivatives | — | (2,299 | ) | — | (2,299 | ) | ||||||||||
Depreciation and amortization | 65,599 | 12,293 | — | 77,892 | ||||||||||||
Amortization of other intangibles | 11,863 | 7,580 | — | 19,443 | ||||||||||||
Facility restructuring and other exit activities | 4,784 | 10,904 | — | 15,688 | ||||||||||||
Other | 48,840 | 42,304 | — | 91,144 | ||||||||||||
Total expenses excluding interest | 628,146 | 393,041 | (34,064 | ) | 987,123 | |||||||||||
Segment income | $ | 307,617 | $ | 188,182 | $ | — | $ | 495,799 | ||||||||
| (1) | Reflects elimination of transactions between retail and institutional segments, which includes deposit transfer pricing, servicing and order flow rebates. |
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| Year Ended December 31, 2003 | ||||||||||||||||
| Retail | Institutional | Eliminations(1) | Total | |||||||||||||
Revenues: | ||||||||||||||||
Commissions | $ | 316,092 | $ | 106,617 | $ | — | $ | 422,709 | ||||||||
Principal transactions | — | 107,601 | — | 107,601 | ||||||||||||
Gain on sales of loans and securities, net | 235,064 | 12,590 | — | 247,654 | ||||||||||||
Service charges and fees | 104,531 | 5,527 | — | 110,058 | ||||||||||||
Other revenues | 104,157 | 24,737 | (42,380 | ) | 86,514 | |||||||||||
Interest income | 353,483 | 748,819 | (209,470 | ) | 892,832 | |||||||||||
Interest expense | (219,513 | ) | (476,086 | ) | 209,470 | (486,129 | ) | |||||||||
Net interest income | 133,970 | 272,733 | — | 406,703 | ||||||||||||
Provision for loan losses | — | (38,523 | ) | — | (38,523 | ) | ||||||||||
Net interest income after provision for loan losses | 133,970 | 234,210 | — | 368,180 | ||||||||||||
Total revenues | 893,814 | 491,282 | (42,380 | ) | 1,342,716 | |||||||||||
Expense excluding interest: | ||||||||||||||||
Compensation and benefits | 256,982 | 107,616 | — | 364,598 | ||||||||||||
Occupancy and equipment | 63,502 | 14,879 | — | 78,381 | ||||||||||||
Communications | 63,645 | 10,005 | — | 73,650 | ||||||||||||
Professional services | 38,827 | 16,889 | — | 55,716 | ||||||||||||
Commissions, clearance and floor brokerage | 33,100 | 104,689 | (12,921 | ) | 124,868 | |||||||||||
Advertising and market development | 55,011 | 2,876 | — | 57,887 | ||||||||||||
Servicing and other banking expenses | 29,518 | 37,516 | (29,459 | ) | 37,575 | |||||||||||
Fair value adjustments of financial derivatives | — | 15,338 | — | 15,338 | ||||||||||||
Depreciation and amortization | 72,531 | 13,084 | — | 85,615 | ||||||||||||
Amortization of other intangibles | 16,530 | 8,228 | — | 24,758 | ||||||||||||
Facility restructuring and other exit activities | 83,864 | 50,323 | — | 134,187 | ||||||||||||
Other | 55,808 | 45,234 | — | 101,042 | ||||||||||||
Total expenses excluding interest | 769,318 | 426,677 | (42,380 | ) | 1153,615 | |||||||||||
Segment income | $ | 124,496 | $ | 64,605 | $ | — | $ | 189,101 | ||||||||
| (1) | Reflects elimination of transactions between retail and institutional segments, which includes deposit transfer pricing, servicing and order flow rebates. |
Total assets for each segment are shown below (in thousands):
| Retail | Institutional | Total | |||||||
At December 31, 2005 | $ | 12,901,008 | $ | 31,666,678 | $ | 44,567,686 | |||
At December 31, 2004 | $ | 5,294,487 | $ | 25,738,096 | $ | 31,032,583 | |||
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Geographic Information
The Company operates in both U.S. and international markets. The Company’s international operations are conducted through offices in Europe, Asia and Canada. The following information provides a reasonable representation of each region’s contribution to the consolidated amounts (in thousands):
| United States | Europe | Asia | Canada | Total | |||||||||||
Net revenues: | |||||||||||||||
Year ended December 31, 2005 | $ | 1,496,204 | $ | 80,505 | $ | 71,683 | $ | 55,453 | $ | 1,703,845 | |||||
Year ended December 31, 2004 | $ | 1,310,234 | $ | 89,979 | $ | 32,360 | $ | 50,349 | $ | 1,482,922 | |||||
Year ended December 31, 2003 | $ | 1,220,774 | $ | 67,815 | $ | 10,384 | $ | 43,743 | $ | 1,342,716 | |||||
Long-lived assets: | |||||||||||||||
At December 31, 2005 | $ | 285,870 | $ | 5,047 | $ | 1,254 | $ | 7,085 | $ | 299,256 | |||||
At December 31, 2004 | $ | 286,183 | $ | 7,699 | $ | 728 | $ | 7,681 | $ | 302,291 | |||||
No single customer accounted for greater than 10% of gross revenues for 2005, 2004 and 2003.
NOTE 26—FAIR VALUE DISCLOSURE OF FINANCIAL INSTRUMENTS
The fair value of financial instruments whose estimated fair values were their carrying values are summarized as follows:
| • | Cash and equivalents, cash and investments required to be segregated, brokerage receivables, net and brokerage payables—Fair value is estimated to be carrying value. |
| • | Available-for-sale investment securities including mortgage-backed, trading securities and other investments—Fair value is estimated by using quoted market prices for most securities. For illiquid securities, market prices are estimated by obtaining market price quotes on similar liquid securities and adjusting the price to reflect differences between the two securities, such as credit risk, liquidity, term coupon, payment characteristics and other information. |
| • | FHLB stock—Cost is considered to be a reasonable estimate of fair value because the FHLB has historically redeemed these securities at cost. |
| • | Financial derivatives and off-balance instruments—The fair value of financial derivatives and off-balance sheet instruments is the amount the Company would pay or receive to terminate the agreement as determined from quoted market prices, which is equal to the carrying value. |
| • | Commitments to purchase and originate loans—The fair value is estimated by calculating the net present value of the anticipated cash flows associated with IRLCs. |
The fair value of financial instruments whose estimated fair values were different from their carrying values are summarized below (in thousands):
| December 31, 2005 | December 31, 2004 | |||||||||||
| Carrying Value | Fair Value | Carrying Value | Fair Value | |||||||||
Assets: | ||||||||||||
Loans receivable, net and loans held-for-sale, net | $ | 19,512,266 | $ | 19,242,275 | $ | 11,785,035 | $ | 11,765,901 | ||||
Liabilities: | ||||||||||||
Deposits | $ | 15,948,015 | $ | 15,937,684 | $ | 12,302,974 | $ | 12,359,634 | ||||
Securities sold under agreements to repurchase | $ | 11,101,542 | $ | 11,014,478 | $ | 9,897,191 | $ | 9,894,611 | ||||
Other borrowings by Bank subsidiary | $ | 4,166,592 | $ | 4,091,755 | $ | 1,760,732 | $ | 1,745,850 | ||||
Senior notes | $ | 1,401,947 | $ | 1,437,132 | $ | 400,452 | $ | 428,452 | ||||
Mandatory convertible notes | $ | 435,589 | $ | 493,958 | — | — | ||||||
Convertible subordinated notes | $ | 185,165 | $ | 187,942 | $ | 185,165 | $ | 189,794 | ||||
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| • | Loans receivable, net and loans held-for-sale, net—For certain residential mortgage loans, fair value is estimated using quoted market prices for similar types of products. The fair value of certain other types of loans is estimated using quoted market prices for securities backed by similar loans. The fair value for loans that could not be reasonably established using the previous two methods was estimated by discounting future cash flows using current rates for similar loans. Management adjusts the discount rate to reflect the individual characteristics of the loan, such as credit risk, coupon, term, payment characteristics and the liquidity of the secondary market for these types of loans. The fair value for certain consumer loans was calculated using a discounted cash flow model incorporating prepayment and loss curves for the specific product type. Loans were valued in groups based on rate and term with the discount rate applied to each group derived from the swap curve. The calculation of loss and prepayment curves was based on past performance of similar credit quality originations by the same counterparty. |
| • | Deposits—For SDA, money market, passbook savings and checking accounts, fair value is estimated to be carrying value. For fixed maturity certificates of deposit, fair value is estimated by discounting future cash flows at the currently offered rates for deposits of similar remaining maturities. |
| • | Securities sold under agreements to repurchase—Fair value is determined by discounting future cash flows at the rate implied for other similar instruments with similar remaining maturities. |
| • | Other borrowings by Bank subsidiary—For adjustable-rate borrowings, fair value is estimated to be carrying value. For fixed-rate borrowings, fair value is estimated by discounting future cash flows at the currently offered rates for fixed-rate borrowings of similar remaining maturities. |
| • | Senior, mandatory convertible and convertible subordinated notes—Fair value is estimated using quoted market prices. |
NOTE 27—RELATED PARTY TRANSACTIONS
In the normal course of business, the Company extends credit to its principal officers, directors and employees to finance their purchases of securities on margin. Margin loans to the Company’s principal officers totaled approximately $5.3 million at December 31, 2005 and $6.6 million as of December 31, 2004; however, there were revolving margin balances outstanding during 2005 and 2004 with certain directors. These margin loans are made on the same terms and conditions as the Company’s loans to other non-affiliated customers.
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NOTE 28—CONDENSED FINANCIAL INFORMATION (PARENT COMPANY ONLY)
The following presents the Parent’s condensed balance sheets, statements of income and cash flows:
BALANCE SHEETS
(in thousands)
| December 31, | ||||||
| 2005 | 2004 | |||||
ASSETS | ||||||
Cash and equivalents | $ | 93,514 | $ | 69,007 | ||
Property and equipment, net | 205,796 | 199,706 | ||||
Investment securities | 48,246 | 49,530 | ||||
Investment in Bank subsidiary | 1,551,024 | 1,246,259 | ||||
Investment in other consolidated subsidiaries | 3,566,531 | 1,402,645 | ||||
Receivable from subsidiaries | 116,100 | 3,382 | ||||
Other assets | 49,074 | 41,709 | ||||
Total assets | $ | 5,630,285 | $ | 3,012,238 | ||
LIABILITIES AND SHAREHOLDERS’ EQUITY | ||||||
Senior notes | $ | 1,401,947 | $ | 400,452 | ||
Mandatory convertible notes | 435,589 | — | ||||
Convertible subordinated notes | 185,165 | 185,165 | ||||
Other liabilities | 208,024 | 198,419 | ||||
Shareholders’ equity | 3,399,560 | 2,228,202 | ||||
Total liabilities and shareholders’ equity | $ | 5,630,285 | $ | 3,012,238 | ||
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STATEMENTS OF INCOME
(in thousands)
| Year Ended December 31, | ||||||||||||
| 2005 | 2004 | 2003 | ||||||||||
Revenues: | ||||||||||||
Management fees from subsidiaries | $ | 224,894 | $ | 318,772 | $ | 312,947 | ||||||
Net revenues | 224,894 | 318,772 | 312,947 | |||||||||
Expenses excluding interest: | ||||||||||||
Compensation and benefits | 130,081 | 124,208 | 107,391 | |||||||||
Occupancy and equipment | 25,036 | 32,335 | 29,543 | |||||||||
Communications | 18,973 | 17,949 | 19,090 | |||||||||
Depreciation and amortization | 50,528 | 54,664 | 57,776 | |||||||||
Professional services | 27,647 | 30,445 | 22,563 | |||||||||
Commissions, clearance and floor brokerage | 206 | (1,062 | ) | 2,347 | ||||||||
Advertising and market development | 13,498 | 6,154 | 3,308 | |||||||||
Facility restructuring and other exit activities | 2,991 | 14,478 | 115,412 | |||||||||
Intercompany allocations and charges | (120,598 | ) | (30,260 | ) | 3,529 | |||||||
Other | 17,545 | 33,089 | 23,879 | |||||||||
Total expenses excluding interest | 165,907 | 282,000 | 384,838 | |||||||||
Income (loss) before other loss, income taxes and cumulative effect of accounting change | 58,987 | 36,772 | (71,891 | ) | ||||||||
Other loss: | ||||||||||||
Corporate interest income | 2,265 | 740 | 1,445 | |||||||||
Corporate interest expense | (71,510 | ) | (45,775 | ) | (44,468 | ) | ||||||
Gain on sale and impairment of investments | 982 | 1,427 | 16,175 | |||||||||
Loss on early extinguishment of debt | — | (19,443 | ) | — | ||||||||
Equity in income of investment and venture funds | 6,247 | 4,858 | 9,051 | |||||||||
Total other loss | (62,016 | ) | (58,193 | ) | (17,797 | ) | ||||||
Pre-tax loss | (3,029 | ) | (21,421 | ) | (89,688 | ) | ||||||
Income tax benefit | (10,806 | ) | (42,007 | ) | (57,821 | ) | ||||||
Income (loss) before cumulative effect of accounting change | 7,777 | 20,586 | (31,867 | ) | ||||||||
Cumulative effect of accounting change | 1,646 | — | — | |||||||||
Equity in income of Bank subsidiary | 284,987 | 215,614 | 133,632 | |||||||||
Equity in income of other consolidated subsidiaries | 136,002 | 144,283 | 101,262 | |||||||||
Net income | 430,412 | 380,483 | 203,027 | |||||||||
Other comprehensive income (loss), net of tax | (34,513 | ) | (51,222 | ) | 141,480 | |||||||
Total comprehensive income | $ | 395,899 | $ | 329,261 | $ | 344,507 | ||||||
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STATEMENTS OF CASH FLOWS
(in thousands)
| Year Ended December 31, | ||||||||||||
| 2005 | 2004 | 2003 | ||||||||||
CASH FLOWS FROM OPERATING ACTIVITIES: | ||||||||||||
Net income | $ | 430,412 | $ | 380,483 | $ | 203,027 | ||||||
Adjustments to reconcile net income to net cash provided by | ||||||||||||
Equity in undistributed income of Bank subsidiary | (284,987 | ) | (215,614 | ) | (133,632 | ) | ||||||
Equity in undistributed loss (income) of other subsidiaries | 229,777 | (100,771 | ) | (51,262 | ) | |||||||
Equity in net income of investments | (6,475 | ) | (10,272 | ) | (14,584 | ) | ||||||
Depreciation and amortization | 50,528 | 54,664 | 57,668 | |||||||||
Stock-based compensation expense | 6,916 | — | — | |||||||||
Gain on investments and impairment charges | (946 | ) | (1,427 | ) | (93 | ) | ||||||
Unrealized loss on venture fund | 228 | 5,412 | 4,103 | |||||||||
Non cash restructuring costs and other exit activities | 2,991 | 14,478 | 30,770 | |||||||||
Cumulative effect of accounting change | (1,646 | ) | — | — | ||||||||
Other | 1,459 | 4,645 | (1,348 | ) | ||||||||
Other changes, net: | ||||||||||||
Other assets and liabilities, net | (83,483 | ) | 77,771 | (45,877 | ) | |||||||
Decrease in restructuring liabilities | (4,581 | ) | (9,299 | ) | (27,389 | ) | ||||||
Net cash provided by operating activities | 340,193 | 200,070 | 21,383 | |||||||||
CASH FLOWS FROM INVESTING ACTIVITIES: | ||||||||||||
Purchase of property and equipment | (66,191 | ) | (70,206 | ) | (38,344 | ) | ||||||
Purchase of investments | (9,785 | ) | (10,566 | ) | (5,800 | ) | ||||||
Proceeds from sale/maturity of investments | 18,803 | 16,409 | 4,246 | |||||||||
Business acquisitions | (2,312,879 | ) | — | — | ||||||||
Cash contribution to subsidiaries | (80,000 | ) | — | (68,153 | ) | |||||||
Other | 1,021 | — | (1,471 | ) | ||||||||
Net cash used in investing activities | (2,449,031 | ) | (64,363 | ) | (109,522 | ) | ||||||
CASH FLOWS FROM FINANCING ACTIVITIES: | ||||||||||||
Proceeds from sale of investments | — | — | 4,946 | |||||||||
Proceeds from issuance of common stock | 753,134 | 43,974 | 51,740 | |||||||||
Tax benefit on option exercises | 10,352 | 17,913 | 13,186 | |||||||||
Proceeds from issuance of senior notes | 992,064 | 394,000 | — | |||||||||
Proceeds from issuance of Units | 436,500 | — | — | |||||||||
Repurchase of treasury stock | (58,215 | ) | (175,776 | ) | — | |||||||
Redemption of subordinated notes | — | (428,902 | ) | — | ||||||||
Payment of capital leases | (157 | ) | (734 | ) | (6,031 | ) | ||||||
Other | (333 | ) | 260 | 9,123 | ||||||||
Net cash provided by (used in) financing activities | 2,133,345 | (149,265 | ) | 72,964 | ||||||||
INCREASE (DECREASE) IN CASH AND EQUIVALENTS | 24,507 | (13,558 | ) | (15,175 | ) | |||||||
CASH AND EQUIVALENTS—Beginning of year | 69,007 | 82,565 | 97,740 | |||||||||
CASH AND EQUIVALENTS—End of year | $ | 93,514 | $ | 69,007 | $ | 82,565 | ||||||
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Parent Company Guarantees
Guarantees are contingent commitments issued by the Company for the purpose of guaranteeing the financial obligations of a subsidiary to a financial institution. The collective obligation of the corporation does not change by the existence of corporate guarantees. Rather, the guarantees shift ultimate payment responsibility of an existing financial obligation from a subsidiary to the parent company.
In support of the Company’s brokerage business, the Company has provided guarantees on the settlement of its subsidiaries’ financial obligations with several financial institutions related to its securities lending activities. Terms and conditions of the guarantees, although typically undefined in the guarantees themselves, are governed by the conditions of the underlying obligation that the guarantee covers. Thus, the Company’s obligation to pay under these guarantees coincides exactly with the terms and conditions of those underlying obligations. At December 31, 2005, no claims had been filed with the Company for payment under any guarantees. These guarantees are not collateralized.
In addition to guarantees issued on behalf of subsidiaries participating in securities lending programs, the Company also issues guarantees for the settlement of foreign exchange transactions. If a subsidiary fails to deliver currency on the settlement date of a foreign exchange arrangement, the beneficiary financial institution may seek payment from the Company. Terms are undefined, and are governed by the terms of the underlying financial obligation. At December 31, 2005, no claims had been made on the Company under these guarantees and thus, no obligations had been recorded. These guarantees are not collateralized.
On February 17, 2006, the Company signed an agreement to sell its professional agency business, E*TRADE Professional Trading, LLC for approximately $5.0 million. This business includes a broker-dealer registered with the SEC and a member of the NASD who currently executes and clears its customer security transactions through E*TRADE Clearing LLC, on a fully disclosed basis under an introducing broker-dealer relationship.
NOTE 30—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 periods presented (in thousands, except per share amounts):
| 2005 | 2004 | |||||||||||||||||||||||
1st Quarter | 2nd Quarter | 3rd Quarter | 4th Quarter | 1st Quarter | 2nd Quarter | 3rd Quarter | 4th Quarter | |||||||||||||||||
Net revenues | $ | 417,397 | $ | 387,687 | $ | 419,836 | $ | 478,925 | $ | 374,662 | $ | 374,465 | $ | 330,122 | $ | 403,673 | ||||||||
Income from continuing operations | $ | 102,206 | $ | 109,383 | $ | 109,138 | $ | 125,511 | $ | 91,045 | $ | 103,204 | $ | 88,103 | $ | 99,478 | ||||||||
Net income | $ | 91,994 | $ | 101,567 | $ | 107,491 | $ | 129,360 | $ | 88,475 | $ | 122,905 | $ | 79,274 | $ | 89,829 | ||||||||
Income per share from continuing operations: | ||||||||||||||||||||||||
Basic | $ | 0.28 | $ | 0.30 | $ | 0.30 | $ | 0.32 | $ | 0.25 | $ | 0.28 | $ | 0.24 | $ | 0.26 | ||||||||
Diluted | $ | 0.27 | $ | 0.29 | $ | 0.29 | $ | 0.31 | $ | 0.23 | $ | 0.27 | $ | 0.23 | $ | 0.26 | ||||||||
Income per share: | ||||||||||||||||||||||||
Basic | $ | 0.25 | $ | 0.28 | $ | 0.29 | $ | 0.33 | $ | 0.24 | $ | 0.34 | $ | 0.21 | $ | 0.24 | ||||||||
Diluted | $ | 0.24 | $ | 0.27 | $ | 0.28 | $ | 0.32 | $ | 0.23 | $ | 0.31 | $ | 0.21 | $ | 0.24 | ||||||||
71
SIGNATURE
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.
Dated: March 24, 2006
E*TRADE Financial Corporation (Registrant) | ||
By | /S/ ROBERT J. SIMMONS | |
Robert J. Simmons Chief Financial Officer (Principal Financial and Accounting Officer) | ||
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Item 15. Exhibits
| 23.1 | Consent of Independent Registered Public Accounting Firm | |
| 31.1 | Certification—Section 302 of the Sarbanes-Oxley | |
| 31.2 | Certification—Section 302 of the Sarbanes-Oxley | |
| 32.1 | Certification—Section 906 of the Sarbanes-Oxley | |
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