Document
false--12-31FY20182018-12-310001015780YesfalseLarge Accelerated FilerE TRADE FINANCIAL CORPfalsefalseNoYes2026-09-152023-03-15202220232027202220282027202200.06670.044350.03162018-04-092018-11-060.010.014000000004000000002668278812464951742668278812464951740.0380.02952028-06-20002018-11-152019-02-152019-03-152019-03-152018-10-172019-01-232019-02-072019-02-072018-10-302019-02-012019-02-282019-02-280000000000000000000020000000243000000002031-12-312020-06-23206600012000003800060000106000020000007300017000201620172012201820152018201320182019-12-312037-12-310000.058750.0537000000007000000000.010.0110000001000000403000403000403000P7YP3Y2000000450090000057900P4YP4YP2YP1YP3YP1YP1YP1YP1Y4M24DP10YP7Y
Table of Contents    

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2018
Commission File Number 1-11921
Eetradeasteriska02.jpgTRADE Financial Corporation
(Exact Name of Registrant as Specified in its Charter)
Delaware
 
94-2844166
(State or other jurisdiction
of incorporation or organization)
 
(I.R.S. Employer
Identification Number)
11 Times Square, 32nd Floor, New York, New York 10036
(Address of principal executive offices and Zip Code)
(646) 521-4300
(Registrant’s telephone number, including area code)
Securities Registered Pursuant to Section 12(b) of the act:
Title of Each Class
 
Name of Each Exchange on Which Registered
Common Stock, par value $0.01 per share
 
The NASDAQ Stock Market LLC
NASDAQ Global Select Market
Securities Registered Pursuant to Section 12(g) of the Act: None
 _____________________________________
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.   Yes x  No ¨
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.   Yes ¨  No x
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.   Yes x  No ¨
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).   Yes x  No ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendments to this Form 10-K.   x
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See definitions of "large accelerated filer," "accelerated filer," "smaller reporting company" and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer   x
Accelerated filer
 
¨
Non-accelerated filer  ¨ 
Smaller reporting company
 
¨
Emerging growth company   ¨ 
 
 
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).   Yes ¨  No x
At June 30, 2018, the aggregate market value of voting stock held by non-affiliates of the registrant was approximately $12.1 billion (based upon the closing price per share of the registrant's common stock as reported by the NASDAQ Global Select Market on that date). Shares of common stock held by each officer, director and holder of 5% or more of the outstanding common stock have been excluded in that such persons may be deemed to be affiliates. This determination of affiliates' status is not necessarily a conclusive determination for other purposes.
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:
As of February 15, 2019, there were 246,312,066 shares of common stock outstanding.
Documents Incorporated by Reference: Certain portions of the definitive Proxy Statement related to the Annual Meeting of Stockholders, to be filed hereafter (incorporated into Part III hereof).


Table of Contents    

E*TRADE FINANCIAL CORPORATION
FORM 10-K ANNUAL REPORT
For the Year Ended December 31, 2018
TABLE OF CONTENTS
PART I
 
 
 
Item 1.
 
 
 
 
 
 
 
Item 1A.
Item 1B.
Item 2.
Item 3.
Item 4.
 
 
 
PART II
 
 
Item 5.
Item 6.
Item 7.
 
 
 
 
 
 
 
 
Item 7A.
 
Item 8.
 
 
 
 
 
 
 
 
 
 
 
 
 


E*TRADE 2018 10-K | Page i
 
                    

Table of Contents    

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


E*TRADE 2018 10-K | Page ii
 
                    

Table of Contents    

PART I
 
FORWARD-LOOKING STATEMENTS
This report contains forward-looking statements, within the meaning of the Private Securities Litigation Reform Act of 1995, that involve risks and uncertainties. These statements discuss, among other things:
our future plans, objectives, outlook, strategies, expectations and intentions relating to our business and future financial and operating results and the assumptions that underlie these matters
our capital plan initiatives
the timing and payment of dividends on our common and preferred stock
the payment of dividends from our subsidiaries to our parent company
the management of our legacy mortgage and consumer loan portfolio
our ability to comply with future changes to government regulations
our ability to maintain required regulatory capital ratios
continued repurchases of our common stock
our ability to meet upcoming debt obligations
the integration and related restructuring costs of past and any future acquisitions
the expected outcome of existing or new litigation
our ability to execute our business plans and manage risk
future sources of revenue, expense and liquidity
the ability of our technology solution for advisors and our referral program to attract and retain customers seeking specialized services and sophisticated advice
any other statement that is not historical in nature
These statements may be identified by the use of words such as "assume," "expect," "believe," "may," "will," "should," "anticipate," "intend," "plan," "estimate," "continue" and similar expressions.
We caution that actual results could differ materially from those discussed in these forward-looking statements. Important factors that could contribute to our actual results differing materially from any forward-looking statements include, but are not limited to:
changes in business, economic or political conditions
performance, volume and volatility in the equity and capital markets
changes in interest rates or interest rate volatility
our ability to manage our balance sheet size and capital levels
disruptions or failures of our information technology systems or those of our third party service providers
cyber security threats, system disruptions and other potential security breaches or incidents
customer demand for financial products and services
our ability to continue to compete effectively and respond to aggressive competition within our industry
our ability to participate in consolidation opportunities in our industry, to complete consolidation transactions and to realize synergies or implement integration plans
our ability to manage our significant risk exposures effectively
the occurrence of risks associated with our advisory services
our ability to manage credit risk with customers and counterparties
our ability to service our corporate debt and, if necessary, to raise additional capital


E*TRADE 2018 10-K | Page 1
 
                    

Table of Contents    

changes in government regulation, including interpretations, or actions by our regulators, including those that may result from the implementation and enforcement of regulatory reform legislation
adverse developments in any investigations, disciplinary actions or litigation
By their nature forward-looking statements are not guarantees of future performance or results and are subject to risks, uncertainties and assumptions that are difficult to predict or quantify. Actual future results may vary materially from expectations expressed or implied in this report or any of our prior communications. Investors should also consider the risks and uncertainties described elsewhere in this report, including under Part I. Item 1A. Risk Factors and Part II. Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations of this Annual Report. The forward-looking statements contained in this report reflect our expectations only as of the date of this report. Investors should not place undue reliance on forward-looking statements, as we do not undertake to update or revise forward-looking statements, except as required by law.


E*TRADE 2018 10-K | Page 2
 
                    

Table of Contents    

ITEM 1.    BUSINESS
OVERVIEW
Company Overview
E*TRADE is a financial services company that provides brokerage and related products and services for traders, investors, stock plan administrators and participants, and registered investment advisors (RIAs). Founded on the principle of innovation, we aim to enhance the financial independence of traders and investors through a powerful digital offering that includes tools and educational materials, complemented by professional advice and support, catering to the complex and unique needs of customers to help meet their near- and long-term investing goals. We provide these services to customers through our digital platforms and network of industry-licensed customer service representatives and financial consultants, over the phone, by email and online via two national financial centers and in-person at 30 regional financial centers across the United States. We operate federally chartered savings banks with the primary purpose of maximizing the value of deposits generated through our brokerage business.
Our corporate offices are located at 11 Times Square, 32nd Floor, New York, New York 10036. We were incorporated in California in 1982 and reincorporated in Delaware in July 1996. We had approximately 4,000 employees at December 31, 2018. We operate directly and through several subsidiaries, many of which are overseen by governmental and self-regulatory organizations (SROs). Substantially all of our revenues for the years ended December 31, 2018, 2017 and 2016 were derived from our operations in the United States. Our most important subsidiaries are described below:
E*TRADE Securities LLC (E*TRADE Securities) is a registered broker-dealer that clears and settles customer transactions
E*TRADE Bank is a federally chartered savings bank that provides Federal Deposit Insurance Corporation (FDIC) insurance on certain qualifying amounts of customer deposits and provides other banking and cash management capabilities
E*TRADE Savings Bank, a subsidiary of E*TRADE Bank, is a federally chartered savings bank that provides FDIC insurance on certain qualifying amounts of customer deposits and provides custody solutions for RIAs
E*TRADE Financial Corporate Services is a provider of software and services for managing equity compensation plans to our corporate clients
E*TRADE Futures LLC (E*TRADE Futures) is a registered non-clearing Futures Commission Merchant (FCM) that provides retail futures transaction capabilities for our customers
E*TRADE Capital Management, LLC (E*TRADE Capital Management) is a registered investment advisor that provides investment advisory services for our customers


E*TRADE 2018 10-K | Page 3
 
                    

Table of Contents    

Delivering a powerful digital offering for our customers is a core pillar of our business strategy and we believe our focus on being a digital leader in the financial services industry is a competitive advantage. Our services are available through the following award-winning digital platforms:
web.jpg
Web
Our leading-edge sites for customers and our primary channel to interact with prospects
 
• Access to a broad range of trading and investing solutions
• Actionable ideas and information
• Research and education for decision making
 
mob.jpg
Mobile
Powerful trading and investing applications for smartphones, tablets and watches
 
• Top-rated mobile apps
• Platforms to manage accounts on the move
• Stock and portfolio alerts
 
 
actvtrd.jpg
Active Trading Platforms
Powerful software and web-based trading solutions
 
• Sophisticated trading tools
• Advanced portfolio and market tracking
• Idea generation and analysis
STRATEGY
Our business strategy is focused on leveraging our brand, hybrid support model, and technology to grow our retail and institutional channels to generate robust earnings and exceptional returns for the benefit of our shareholders.
Leverage our brand, hybrid support model, and leading technology for scale and growth
E*TRADE's unrivaled and tech-forward brand is synonymous with digital brokerage and drives outsized awareness and consideration among business-to-customer and business-to-business audiences. We are able to serve peak volumes across channels with capacity for growth and acquisition through our strong and scalable infrastructure. Our customers benefit from digitally led experiences, complemented by professional advice and support. We cater to the complex and unique needs of traders, investors, stock plan administrators and participants, and independent registered investment advisors.
Empower self-directed retail customers through a powerful digital offering and professional guidance
E*TRADE has three core digital offerings for the retail investor—trading, investing, and banking. With trading, we maintain a leading position among active and derivatives traders through the Power E*TRADE web-based platform and support model. On the investing front we connect customers with a range of easy-to-use wealth management solutions. And lastly, we are advancing digital banking capabilities to help increase engagement with customers and prospects.



E*TRADE 2018 10-K | Page 4
 
                    

Table of Contents    

Capitalize on symbiotic institutional channels to drive growth
E*TRADE serves two institutional client segments—stock plan administrators and RIAs. These channels are critical for growth. We aim to expand on our #1 position in stock plan administration through innovative digital solutions and expert support—driving growth in retail and institutional relationships. On the RIA front, we plan to leverage the power of E*TRADE's brand, digital ethos, and our broad customer base to grow the RIA channel. We also plan to connect retail customers and stock plan participants seeking higher touch services to top-tier advisors through our recently launched referral network—driving asset growth and retention.
Generate robust earnings growth and returns
We aim to deliver superior returns on customer assets by capturing the full value of our retail and institutional relationships by leveraging E*TRADE's highly scalable model to expand operating margin. We aim to return a significant portion of our earnings to shareholders and expand return on equity over time. We also aim to generate robust annual earnings growth.
PRODUCTS AND SERVICES
We offer a broad range of products and services to our customers. Our core brokerage business is organized into four product areas: Trading, Investing, Corporate Services, and Advisor Services. Additionally, we offer banking and cash management capabilities through our banking subsidiaries.
Trading
The Company delivers automated trade order placement and execution services, offering our customers a full range of investment vehicles, including US equities, exchange-traded funds (ETFs), options, bonds, futures, American depositary receipts and non-proprietary mutual funds. We also offer margin accounts, enabling qualifying customers to borrow against their securities, supported by robust margin solutions, including calculators and requirement lookup and analysis tools. The Company also offers a fully paid lending program which allows customers to earn income on certain securities held in cash accounts when they permit us to lend those securities.
The Company markets trading products and services to active traders and self-directed investors. Products and services are delivered through web, desktop and mobile channels. Trading and investing tools are supported by guidance, including fixed income, options and futures specialists available on-call for customers. Other tools and resources include independent research and analytics, live and on-demand education, market commentary, and strategies, trading ideas and screeners for major asset classes.
Investing
The Company endeavors to help investors build wealth and address their long-term investing needs through a variety of products and services, a suite of managed products and asset allocation models. These include our Core Portfolios, Blend Portfolios, Dedicated Portfolios, and Fixed Income Portfolios. The Company also offers self-directed digital tools across web and mobile channels, including mutual fund and ETF screeners, All Star Lists, a collection of pre-built ETF or mutual fund portfolios based on time frame and risk tolerance, an assortment of planning and allocation tools, thematic investing opportunities, education and editorial content. Investors also have access to a wide selection of ETFs and mutual funds, including more than 250 commission-free ETFs and more than 4,400 no-load, no-transaction fee mutual funds.
The Company also offers guidance through a team of licensed financial consultants and Chartered Retirement Planning CounselorsSM at our 30 regional financial centers and through our two national financial centers by phone, email and online channels. Customers can receive complimentary portfolio reviews and personalized investment recommendations.


E*TRADE 2018 10-K | Page 5
 
                    

Table of Contents    

Corporate Services
The Company provides stock plan administration services for public and private companies. Through our industry-leading platform, Equity Edge Online, the Company offers management of employee stock option plans, employee stock purchase plans and restricted stock plans with fully-automated stock plan administration. Accounting, reporting and scenario modeling tools are also available. The integrated stock plan solutions include multi-currency settlement and delivery, and streamlined tax calculation. Additionally, corporate clients are offered 10b5-1 plan design and implementation, along with SEC filing assistance and automated solutions. Through our platform, participants have enhanced visibility into the creation and approval of their plan through digital tools and resources. Participants have full access to E*TRADE's robust investing and trading capabilities, including tailored education and planning tools, and dedicated stock plan service representatives. Corporate Services is an important driver of brokerage account and asset growth, serving as an introductory channel to the Company, with approximately 1.8 million stock plan accounts. We serve approximately 20% of S&P 500 companies, including nearly 40% of technology companies and over 50% of healthcare companies within the S&P 500 index. During the year ended December 31, 2018, we had $23.0 billion of new client implementations through this channel.
Advisor Services
With the acquisition of TCA, which was completed on April 9, 2018, the Company has expanded its ability to provide custody services to independent RIAs. Liberty, our proprietary technology platform, includes sophisticated modeling, rebalancing, reporting and practice management capabilities that are fully customizable for the RIA. We have launched a referral program, the E*TRADE Advisor Network, through which E*TRADE's financial consultants can refer retail customers to pre-qualified RIAs on our custody platform. We expect the E*TRADE Advisor Network will improve the Company's ability to drive asset growth and retain customers seeking specialized services and sophisticated advice.
Banking and Cash Management Capabilities
The Company's banking and cash management capabilities include deposit accounts insured by the FDIC, which are fully integrated into customer brokerage accounts. Among other features, E*TRADE Bank's customers are able to transfer to and from accounts at E*TRADE and elsewhere for free and checking account customers have access to debit cards with ATM fee refunds, online and mobile bill pay, and mobile check deposits. E*TRADE Bank's savings account offerings include the new Premium Savings Account, which provides a higher yield to savings account customers as compared to our other deposit products. The E*TRADE Line of Credit program allows customers to borrow against the market value of securities pledged as collateral.


E*TRADE 2018 10-K | Page 6
 
                    

Table of Contents    

SALES AND CUSTOMER SERVICE
We believe providing superior sales and customer service is fundamental to our business. We strive to maintain a high standard of customer service by staffing the customer support team with appropriately trained personnel who are equipped to handle customer inquiries in a prompt and thorough manner. Our customer service representatives utilize technology solutions that enable our team to reduce the number of touch-points required to address customer needs. We also have specialized customer service programs that are tailored to the needs of various customer groups. We provide sales and customer support through the following channels:
web.jpg
Online
Our Online Service Center serves as a portal for customer requests, providing answers to frequently asked questions, a secure message portal, and live chat capabilities to engage directly with our customer service representatives. In addition, our Investor Education Center provides customers with access to a variety of live and on-demand educational content and courses.
 
mob.jpg
Phone
We have a toll-free number that connects customers to the appropriate department where an investment advisor or customer service representative can address a customer's needs.
 
 
iconbankblk01.jpg
Financial Centers
We have 30 financial centers located across the US where retail investors can get face-to-face support and guidance. Financial consultants are available on-site, over the phone and via email to help customers assess their asset allocations and develop plans to help them achieve their investment goals.
COMPETITION
The online financial services industry continues to evolve and remains highly competitive. Our core brokerage business competes with full service, discount, and online brokerage firms, RIAs, finance technology start-ups, and internet, retail and savings banks. Some of these competitors provide online trading and banking services, investment advisor services, robo-advice capabilities, and a host of other financial products and services.
Competition in the financial services industry continues to intensify, particularly amid continued consolidation and pressures on pricing. The proliferation of emerging financial technology start-ups further evidences the continued shift to digital offerings. Our future success will depend upon our ability to continue providing digitally compelling and easy to use products and solutions to our customers.
We also face competition in attracting and retaining qualified employees. Our ability to compete effectively in financial services will depend upon our ability to attract new employees, and to retain and motivate our existing employees while efficiently managing compensation-related costs.


E*TRADE 2018 10-K | Page 7
 
                    

Table of Contents    

REGULATION
Our business is subject to regulation, primarily by US federal and state regulatory agencies and certain SROs, such as central banks and securities exchanges, that have been charged with the protection of the financial markets and the interests of those participating in those markets. We, along with other larger institutions, have been subject to a broad range of rules and regulations and a climate of heightened regulatory scrutiny, that resulted in part from the enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) in 2010, which significantly changed the bank regulatory structure of our Company and its federal savings bank subsidiaries.
In May 2018, the Economic Growth, Regulatory Relief, and Consumer Protection Act of 2018 (EGRRCPA) was passed. The EGRRCPA amended provisions in the Dodd-Frank Act as well as other statutes administered by the Federal Reserve Board, the Office of the Comptroller of the Currency (OCC), and the FDIC (collectively, the “federal banking agencies”). In July 2018, the federal banking agencies issued a joint release clarifying that as a result of the passage of EGRRCPA, certain requirements, including company-run stress testing requirements under the Dodd-Frank Act, would no longer be required for savings and loan holding companies and banks with less than $100 billion in total consolidated assets, such as the Company and E*TRADE Bank. In addition, the Federal Reserve Board issued a separate statement clarifying that, pursuant to EGRRCPA, it will not take action to enforce certain regulatory and reporting requirements, including the modified liquidity coverage ratio for firms, like the Company, with less than $100 billion in total consolidated assets. The Federal Reserve Board issued a proposal in October 2018 that, if adopted as proposed, would apply certain requirements to savings and loan holding companies with $100 billion or more in total consolidated assets; while the Company currently does not surpass that threshold, it could in the future.
Financial Services Regulation
Our regulators are increasingly focused on ensuring that our customer privacy, data protection, information security and cyber security-related policies and practices are adequate to inform consumers of our data collection, use, sharing or security practices, to provide them with choices, if required, about how we use and share their information, and to safeguard their personal information. We maintain systems designed to comply with these privacy, data protection, information security and cyber security requirements, including procedures designed to securely process, transmit and store confidential information and protect against unauthorized access to such information.
Our brokerage and banking entities are required by the Gramm-Leach-Bliley Act of 1999 to disclose their privacy policies and practices related to sharing customer information with affiliates and non-affiliates. These rules give customers the ability to "opt out" of having non-public information disclosed to third parties or receiving marketing solicitations from affiliates and non-affiliates based on non-public information received from our brokerage and banking entities. The Bank Secrecy Act, as amended by the USA PATRIOT ACT of 2001 (BSA/USA PATRIOT Act), applies to our brokerage and banking entities and requires financial institutions to develop anti-money laundering (AML) programs to assist in the prevention and detection of money laundering and combating terrorism. In order to comply with the BSA/USA PATRIOT Act, we have an AML department that is responsible for developing and implementing our enterprise-wide programs for compliance with the various AML and counter-terrorist financing laws and regulations. Our brokerage and banking entities are also subject to US sanctions laws administered by the Office of Foreign Assets Control and we have policies and procedures in place to comply with these laws. In providing certain retirement account types and services to such accounts, E*TRADE Securities, E*TRADE Capital Management, and E*TRADE Savings Bank are also subject to certain rules and regulations of the Department of Labor and the Internal Revenue Service. For additional regulatory information on our brokerage and banking regulations, see MD&A—Liquidity and Capital Resources and Note 19—Regulatory Requirements.


E*TRADE 2018 10-K | Page 8
 
                    

Table of Contents    

Savings and Loan Holding Company and Bank Regulation
The Board of Governors of the Federal Reserve System (Federal Reserve Board, and together with the twelve Federal Reserve Banks, the Federal Reserve) has primary jurisdiction for the supervision and regulation of savings and loan holding companies, including the Company. We are required to file periodic reports with the Federal Reserve and are subject to its examination and supervision. The Company is required to serve as a source of financial and managerial strength for its subsidiary banks.
Our banking entities are regulated, supervised, and examined by the OCC, the Consumer Financial Protection Bureau (CFPB), and the FDIC. The Company and the banking entities are also subject to regulations and various requirements and restrictions under state and other federal laws. Such regulations cover all aspects of the banking business, including lending practices, safeguarding deposits, customer privacy and information security, capital structure, transactions with affiliates and conduct and qualifications of personnel and provide the regulatory authorities broad discretion in connection with their supervisory, examination and enforcement activities and policies.
In certain circumstances, each of our banking entities may be subject to restrictions on its ability to declare dividends or make capital distributions and may be required to provide notice, submit applications or requests for non-objection from the OCC or the Federal Reserve in connection with a planned capital distribution. The Company’s ability to pay dividends on our stock is subject to limits, including in certain instances the requirement that we consult with or receive approval from the Federal Reserve prior to taking such capital actions to ensure that the proposed actions do not raise safety and soundness considerations. Prior Federal Reserve approval is required for the Company to repurchase its stock and such approval is conditioned on multiple factors, including the Company’s current and projected financial condition.
Basel III Capital Framework
The US Basel III framework for the calculation of a banking organization’s regulatory capital and risk-weighted assets became effective for us and for our federal savings bank subsidiaries on January 1, 2015, subject to a phase-in period for certain requirements over several years. The US Basel III rules increased the quantity and quality of required regulatory capital, established a capital conservation buffer, and made changes to the calculation of risk-weighted assets. Failure to maintain the capital conservation buffer limits a banking organization's ability to make capital distributions and discretionary bonus payments to executive officers.
Failure to meet capital requirements can trigger discretionary and mandatory actions by regulators. The FDIC Improvement Act of 1991 requires the appropriate federal banking regulator to take "prompt corrective action" with respect to a depository institution if that institution does not meet certain capital adequacy standards. While these regulations generally apply only to banks, such as E*TRADE Bank and E*TRADE Savings Bank, the Federal Reserve is authorized to take appropriate action against a parent savings and loan holding company, such as the Company, based on the undercapitalized status of any bank subsidiary. In certain instances, we would be required to guarantee the performance of a capital restoration plan if either of our bank subsidiaries were undercapitalized.
Resolution Planning
The FDIC currently requires insured depository institutions with total assets of $50 billion or more, based on the average of the four most recent quarters, to submit to the FDIC periodic plans providing for their resolution by the FDIC in the event of failure under the receivership and liquidation provisions of the Federal Deposit Insurance Act. E*TRADE Bank and E*TRADE Savings Bank are currently not subject to these rules, but if either were to exceed the asset threshold, it would be required to file with the FDIC an annual resolution plan demonstrating how it could be resolved in an orderly and timely manner in the event of receivership such that the FDIC would be able to ensure the bank's depositors receive access to their


E*TRADE 2018 10-K | Page 9
 
                    

Table of Contents    

deposits within one business day, to maximize the net present value of the bank's assets when disposed of, and to minimize losses incurred by the bank's creditors.
Federal Deposit Insurance and Related Assessments
The FDIC’s Deposit Insurance Fund (DIF) provides insurance coverage for certain deposits, generally up to $250,000 per depositor, per insured bank and per account ownership type, and is funded by quarterly assessments on insured depository institutions. Each of our banking entities has deposits insured by the FDIC and pays quarterly assessments to the DIF, maintained by the FDIC, for this insurance coverage. On March 25, 2016, the FDIC published its final rule to add a surcharge to the regular DIF assessments of banks with $10 billion or more in assets, which included E*TRADE Bank. Under the final rule, E*TRADE Bank was subject to an additional surcharge applied to its assessment base, which took effect for the assessment period beginning on July 1, 2016. Surcharges at an annual rate of 4.5 basis points were assessed until the sooner of (1) the DIF attaining the minimum reserve ratio of 1.35 percent of insured deposits or (2) the fourth quarter of 2018. In November 2018, the FDIC announced the end of these surcharges, with the last surcharge being assessed for the third quarter of 2018. The surcharge did not have a material impact on our financial condition, results of operations or cash flows.
Home Owners' Loan Act
Under the Home Owners’ Loan Act, the OCC requires E*TRADE Bank and E*TRADE Savings Bank to comply with the qualified thrift lender (QTL) test. Under the QTL test, a federal savings bank is required to maintain at least 65% of its “portfolio assets” (defined as the savings bank’s total assets less the sum of: (i) specified liquid assets up to 20% of total assets; (ii) intangibles, including goodwill; and (iii) the value of property used to conduct its business) in certain “qualified thrift investments” (primarily residential mortgages and related investments, including certain mortgage-backed securities, credit card loans, student loans and small business loans) in at least nine months of the most recent 12-month period. E*TRADE Bank and E*TRADE Savings Bank currently meet that test. A savings bank that fails to meet the QTL test is subject to certain operating restrictions and may be required to convert to a national bank charter.
Brokerage Regulation and Capital Requirements
Our US broker-dealer, E*TRADE Securities, is registered with the SEC and is subject to regulation by the SEC and by SROs, such as the Financial Industry Regulatory Authority (FINRA) and the securities exchanges of which it is a member, as well as various state regulators. In addition, our FCM subsidiary, E*TRADE Futures, is registered with the CFTC and is a member of the National Futures Association (NFA). E*TRADE Capital Management is registered with the SEC and is subject to regulation as such by the SEC as well as various state regulators.
Brokerage regulation covers various aspects of brokerage activities, including segregated cash requirements and net capital. E*TRADE Securities carries security accounts for customers and maintains segregated cash and investments pursuant to Rule 15c3-3 under the Securities Exchange Act of 1934. E*TRADE Futures maintains cash deposits that have been segregated or secured for the benefit of futures clients pursuant to CFTC regulations governing FCMs. E*TRADE Securities is subject to the Uniform Net Capital Rule, Rule 15c3-1 under the Securities Exchange Act of 1934, which requires the maintenance of minimum net capital, and E*TRADE Futures is subject to CFTC net capital requirements. Brokerage regulation also covers other brokerage activities, including required books and records, safekeeping of funds and securities, trading, prohibited transactions, public offerings, margin lending, customer qualifications for margin and options transactions, registration of personnel and transactions with affiliates.


E*TRADE 2018 10-K | Page 10
 
                    

Table of Contents    

AVAILABLE INFORMATION
We make our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports, available free of charge at our corporate website as soon as reasonably practicable after they have been filed with the SEC. Our corporate website address is about.etrade.com. Information on our website is not part of this report. The SEC maintains a website that contains the materials we file with the SEC at www.sec.gov.
ITEM 1A.    RISK FACTORS
The following discussion sets forth the risk factors which could materially and adversely affect our business, financial condition and results of operations, and should be carefully considered in addition to the other information set forth in this report. Additional risks and uncertainties not currently known to us or that we currently do not deem to be material may also adversely affect our business, financial condition and results of operations.
Risks Relating to the Nature and Operation of Our Business
Changes in business, economic, or political conditions could impact trading volumes, margin lending and sweep deposits, resulting in lower revenues.
Digital investing services to the retail customer, including trading, margin lending and sweep deposits, account for a significant portion of our revenues. Changes in business, economic or political conditions could cause a downturn in the global financial markets. Such a downturn could decrease the volume of customer transactions which may, in turn, result in lower transactions revenue. A decrease in trading activity or securities prices would also typically be expected to result in a decrease in margin lending, which would reduce our interest income earned on margin receivables and increase our credit risk because the value of the collateral could fall below the amount of indebtedness it secures. Changes in business, economic or political conditions could also impact the amount of sweep deposits our customers maintain with the Company, which could reduce net revenue.
We may be unsuccessful in managing the effects of changes in interest rates on our business.
Net interest income is our most significant source of revenue. Our results of operations depend, in part, on our level of net interest income and our effective management of the impact of changing interest rates and varying asset and liability maturities. Our ability to manage interest rate risk could impact our financial condition. We use derivatives as hedging instruments to reduce the potential effects of changes in interest rates on our results of operations. However, the derivatives we utilize may not be effective at managing this risk and changes in market interest rates and the yield curve could reduce the value of our financial assets and reduce our net interest income.
Net interest margin may fluctuate based on the size and mix of the balance sheet, as well as the impact of the interest rate environment. Rising interest rates and other market factors may cause the Company's funding costs to increase and the value of our debt securities to decrease. Higher funding costs without offsetting increases in asset yields may adversely affect our results of operations.
The manner in which interest rates are calculated could also impact net interest income. For example, recent reforms, when effective after 2021, may cause LIBOR to perform differently than in the past, or be replaced as a benchmark. Although it is not possible to predict the effects of the reform, it could result in, among other things, a reduction in the interest payments we receive, reductions in the value of securities with floating interest rates that we hold, and an increase in the dividend payments on our preferred stock and in the interest payments on certain of our borrowings.


E*TRADE 2018 10-K | Page 11
 
                    

Table of Contents    

We rely heavily on technology, which can be subject to interruption and instability due to operational and technological failures, both internal and external.
We rely on technology, particularly the Internet and mobile services, to conduct much of our business activity and allow our customers to conduct financial transactions. Our systems and operations, including our primary and disaster recovery data center operations, as well as those of the third parties on whom we rely to conduct certain key functions, are vulnerable to disruptions from natural disasters, power outages, computer and telecommunications failures, software bugs, computer viruses, malware, distributed denial of service attacks, spam attacks, phishing or other social engineering, ransomware, attempted unauthorized access, technological failure, human error, terrorism and other similar events. In addition, extraordinary trading volumes or site usage could cause our computer systems to operate at an unacceptably slow speed or even fail. Disruptions to, destruction of, instability of or other failure to effectively maintain our information technology systems or external technology that allows our customers to use our products and services could harm our business and our reputation.
Should our technology operations be disrupted, we may have to make significant investments to upgrade, repair or replace our technology infrastructure and may not be able to make such investments on a timely basis. While we have made significant investments designed to enhance the reliability and scalability of our operations, we cannot assure that we will be able to maintain, expand and upgrade our systems and infrastructure to meet future requirements and mitigate future risks on a timely basis or that we will be able to retain skilled information technology employees. Disruptions in service and slower system response times could result in substantial losses, decreased customer service and satisfaction, customer attrition and harm to our reputation. Our insurance coverage may be insufficient to protect us against all losses and costs stemming from operational and technological failures.
We rely on third parties to perform certain key functions, and their failure to perform those functions could result in the interruption of our operations and systems and could result in significant costs and reputational damage to us.
We rely on third party service providers for certain technology, processing, servicing and support functions. These providers are also susceptible to operational and technology vulnerabilities, including security breaches, which may impact our business. In addition, these third party service providers may rely on other parties (sub-contractors), to provide services to us which also face similar risks. For example, external content providers provide us with financial information, market news, quotes, research reports and other fundamental data that we offer to customers. Also, we do not directly service any of our mortgage loans and, as a result, we rely on third party vendors and servicers to provide information on our loan portfolio.
We have third party oversight capabilities which include enhanced processes to evaluate third party providers, designed to verify that the third party service providers can support the stability of our operations and systems. However, these processes may be insufficient and we cannot assure that we will not experience a failure as a result of a third party service provider. Any significant failures or security breaches by or of our third party service providers or their sub-contractors, including any actual or perceived cyber attacks, security breaches, fraud, phishing attacks, acts of vandalism, information security breaches and computer viruses which could result in unauthorized access, misuse, loss or destruction of data, an interruption in service or other similar events could interrupt our business, cause us to incur losses, subject us to fines or litigation and harm our reputation. An interruption in or the cessation of service by any third party service provider and our inability to make alternative arrangements in a timely manner could have a material impact on our ability to offer certain products and services and cause us to incur losses and could lead to a general loss of customer confidence in our security measures and technology infrastructure. We cannot assure that any of these third party service providers or their sub-contractors will be able to continue to provide their products and services in an efficient, cost effective manner, if at all, or that they will be able to adequately expand their services to meet our needs and those of our customers. We may incur significant additional costs to implement enhanced protective measures and technology, to investigate and remediate vulnerabilities or other exposures or to make required notifications.


E*TRADE 2018 10-K | Page 12
 
                    

Table of Contents    

We expect that our regulators will hold us responsible for any deficiencies in our oversight and control of our third party relationships and for the performance of such third parties. If there were deficiencies in the oversight and control of our third party relationships, and if our regulators held us responsible for those deficiencies, our business, reputation, and results of operations could be adversely affected.
Unauthorized disclosure of data, whether through a breach of our computer systems or those of our customers or third parties, may subject us to significant liability and reputational harm as well as reduced revenues and increased costs.
As part of our business, we are required to collect, process, transmit and store sensitive and confidential customer and employee data, including personally identifiable information (PII), third-party data, and our proprietary information, including intellectual property and trade secrets. We maintain, and we contractually require our third-party service providers who have access to PII to maintain, systems and procedures designed to securely collect, process, transmit and store sensitive and confidential information (including PII) and to protect against unauthorized access to such information. However, risks associated with the collection, processing, transmission, and storage of sensitive and confidential data have grown in recent years due to increasing use of the Internet and mobile technologies, and the increasing sophistication and activities of organized crime, hackers, terrorists, nation-states, and other external parties. Like other financial services firms, we, our customers, and our third-party service providers are the targets of attempted unauthorized access, phishing attacks and other forms of social engineering, acts of vandalism, computer viruses, malware, ransomware, spam attacks, and other cyber attacks. Furthermore, parties may attempt to fraudulently induce employees, customers, clients, third parties or other users of our systems to disclose sensitive or confidential information in order to gain access to our data or that of our customers. These threats could derive from third parties, malicious employees or insiders, human error, or technological failures. In 2013, we, and other financial institutions, experienced a cyber-incident that resulted in certain customer contact information being compromised and potentially accessed by unauthorized third parties. As of the date of this Annual Report, we are unaware of any financial fraud or other misuse of customer data resulting from this incident. We are cooperating with government agencies in connection with their investigation.
We have continued to invest in security measures, but, despite these investments, we, our customers and our third-party service providers may be unable to anticipate, detect or implement effective preventative measures against cyber attacks or security breaches, which could result in unauthorized access, misuse, loss or destruction of systems or data, interruptions in service, impacts on financial data reporting, theft of intellectual property, or other similar events.
Any actual or perceived breach of the security of our technology or media (whether social or traditional media) reports of perceived security vulnerabilities of our systems or the systems of our third-party service providers, could severely damage our reputation, expose us to the risk of litigation and liability, disrupt our operations, increase our costs with respect to investigations and remediations, reduce our revenues as a result of the theft of intellectual property, and otherwise have a materially adverse effect on our business. Further, any actual or perceived security breach or cyber attack directed at other financial institutions or financial services companies, whether or not we are impacted, could lead to a general loss of customer confidence in the use of technology to conduct financial transactions, which could negatively impact us, including the market perception of the effectiveness of our security measures and technology infrastructure. The occurrence of any of these events may have a material adverse effect on our business or results of operations.
A security breach could occur and persist for an extended period of time without detection. We expect that any investigation of a security breach could take a substantial amount of time, and during such time we may not necessarily know the extent of the harm or how best to remediate it, and certain errors or actions could be repeated or compounded before they are discovered and remediated, all of which could further increase the costs and consequences of such a breach. Further, detecting and remediating such incidents may


E*TRADE 2018 10-K | Page 13
 
                    

Table of Contents    

require specialized expertise and there can be no assurance that we will be able to retain or hire individuals who possess, or otherwise internally develop, such expertise.
If any person, including any of our employees, negligently disregards or intentionally breaches our established controls with respect to client or employee data, or otherwise mismanages or misappropriates that data, we could be subject to significant monetary damages, regulatory enforcement actions, fines and/or criminal prosecution in one or more jurisdictions.
As our business model relies heavily on our customers’ use of their own personal computers, mobile devices and the Internet, our business and reputation could be harmed by security breaches of our customers and third parties. Computer viruses and other attacks on our customers’ personal computer systems, home networks and mobile devices or against the third-party networks and systems of internet and mobile service providers could create losses for our customers even without any breach in the security of our systems, and could thereby harm our business and our reputation. As part of our E*TRADE Complete Protection Guarantee, we reimburse our customers for certain losses caused by a breach of security of our customers’ own personal systems. Such reimbursements may not be covered by applicable insurance and could have a material impact on our financial performance and results of operations.
Although we maintain insurance coverage that we believe is reasonable, prudent and adequate for the purpose of our business, it may be insufficient to protect us against all losses and costs stemming from security breaches, cyber attacks and other types of unlawful activity, or any resulting disruptions from such events.
We conduct all of our operations through subsidiaries and rely on dividends from our subsidiaries for a substantial amount of our cash flows.
We depend on dividends, distributions and other payments from our subsidiaries to fund payments on our obligations, including our debt obligations, payments of cash dividends to holders of our preferred stock, as well as capital returns to holders of our common stock. Regulatory and other legal restrictions limit our ability to transfer funds to or from certain subsidiaries, including E*TRADE Securities, E*TRADE Bank, and E*TRADE Savings Bank. In addition, many of our subsidiaries are subject to laws and regulations that authorize regulatory bodies to block or reduce the flow of funds to us, or that prohibit such transfers altogether in certain circumstances. These laws and regulations may hinder our ability to access funds that we may need to make payments on our obligations, including our debt obligations, and otherwise conduct our business.
Under applicable rules, a dividend in excess of 10% of a member firm’s excess net capital may not be paid without FINRA’s prior approval. Compliance with these rules may impede our ability to receive dividends from E*TRADE Securities. Additionally, a savings bank that is part of a savings and loan holding company structure, such as E*TRADE Bank and E*TRADE Savings Bank, must file a notice of a declaration of a dividend with the Federal Reserve at least 30 days before the proposed dividend declaration by the bank’s board of directors. OCC regulations set forth the circumstances under which a federal savings bank is required to submit an application or notice before it may make a dividend or capital distribution. See Business—Regulation for additional information.
As of December 31, 2018, much of our capital was invested in our banking subsidiary, E*TRADE Bank. The Federal Reserve may object to a proposed dividend or capital distribution if, among other things, E*TRADE Bank is, or as a result of such dividend or distribution would be, undercapitalized or it has safety and soundness concerns. We cannot be certain, however, that we will receive regulatory approval for such contemplated dividends at the requested levels or at all.


E*TRADE 2018 10-K | Page 14
 
                    

Table of Contents    

We operate in a highly competitive industry where many of our competitors have greater resources and may have product suites that may appeal to our current or potential customers.
The financial services industry is highly competitive, with multiple industry participants competing for the same customers. Many of our competitors have longer operating histories and greater resources than we have and offer a wider range of financial products and services. The impact of competitors with superior name recognition, greater market acceptance, larger customer bases or stronger capital positions could adversely affect our revenue growth and customer retention. Our competitors may also be able to respond more quickly to new or changing opportunities and demands and withstand changing market conditions better than we can. Competitors may conduct extensive promotional activities, offering better terms, lower prices, pay higher interest rates on deposits, or offer different products and services that could attract current and prospective E*TRADE customers and potentially result in intensified price competition within the industry. We continue to experience aggressive price competition in the industry, including reduced trading commissions and various free trade offers. We may not be able to match the marketing efforts or prices of our competitors. Some of our competitors may also benefit from established relationships among themselves or with third parties that enhance their products and services.
In addition, we compete in a technology-intensive industry characterized by rapid innovation. We may be unable to effectively use new technologies, adapt our services to emerging industry standards or develop, introduce and market enhanced or new products and services. If we are not able to update or adapt our products and services to take advantage of the latest technologies and standards, or are otherwise unable to tailor the delivery of our services to the latest personal and mobile computing devices preferred by our retail customers, our business and financial performance could suffer.
Our ability to compete successfully in the financial services industry depends on a number of factors, including, among other things:
Maintaining and expanding our market position
Attracting and retaining customers
Providing easy to use and innovative financial products and services
Our reputation and the market perception of our brand and overall value
Maintaining competitive pricing
Competing in a concentrated competitive landscape
The effectiveness of our technology (including cyber security defenses), products and services
Deploying a secure and scalable technology and back office platform
Innovating effectively in launching new or enhanced products
The differences in regulatory oversight regimes to which we and our competitors are subject
Attracting new employees and retaining our existing employees
General economic and industry trends, including customer demand for financial products and services
Our competitive position within the industry could be adversely affected if we are unable to adequately address these factors, which could have a material adverse effect on our business and financial condition.


E*TRADE 2018 10-K | Page 15
 
                    

Table of Contents    

Our business could be adversely affected due to risks related to our acquisitions and the subsequent integration of the acquired businesses.
We consider opportunistic acquisitions to grow existing business, add new technologies, or expand distribution. We cannot be certain that we will be able to identify, consummate and successfully integrate acquisitions, and no assurance can be given with respect to the timing, likelihood or business effect of any possible transaction. Transactions that we consummate would involve risks and uncertainties to us, including mispricing the inherent value of the acquired entity, as well as potential difficulties integrating people, systems and customers and realizing synergies.
We completed the TCA acquisition in the second quarter of 2018, and the Capital One Financial Corporation (Capital One) retail brokerage account acquisition in the fourth quarter of 2018. The acquisitions subject us to a number of risks, uncertainties, and potential costs. The risks associated with these transactions and any future acquisitions include:
We may experience significant attrition in the acquired accounts and assets under custody, and our retention of the accounts and assets may be impacted by our ability to successfully integrate the acquired operations, products and personnel
We could be subject to undisclosed liabilities that could be material or become subject to litigation or regulatory risks as a result of the acquisition
Management’s attention may be diverted from other business initiatives
Unanticipated restructuring and other integration costs may be incurred
We will have less cash available for other purposes, including for use in acquisitions or the development of other technologies or products
Any future acquisitions could involve these and additional risks. Our ability to pursue additional strategic transactions may also be limited by our corporate debt, including our senior unsecured revolving credit facility, and dividend payments on our common stock and preferred stock. Future acquisitions may also be funded through the issuance of additional debt or preferred stock.
Any of these risks, whether with respect to the current or any future acquisitions, could have a material adverse effect on our business and results of operations.
Our risk management practices may leave us exposed to unidentified or unanticipated risk.
As a financial services company, our business exposes us to certain risks. We seek to monitor and manage our significant risk exposures through a set of board-approved limits as well as Key Risk Indicators or metrics. We have adopted a governance framework which includes reporting of these metrics and other significant risks and exposures to management and the Board of Directors. See MD&A—Risk Management for additional information. However, our risk management methods may not identify future risk exposures and may not be effective in mitigating our key risks. Furthermore, our risk management methods may not properly identify and mitigate the aggregation of risks across our organization or the interdependency of our risk mitigation efforts. In addition, some of our risk management methods are based on an evaluation of information regarding markets, customers and other matters that are based on assumptions that may not be accurate. A failure to manage our risk effectively could materially and adversely affect our business, results of operations and financial condition.


E*TRADE 2018 10-K | Page 16
 
                    

Table of Contents    

Advisory services subject us to additional risks.
We provide advisory services to investors to aid them in their decision making. Investment recommendations and suggestions are based on publicly available documents and communications with investors regarding investment preferences and risk tolerances. Publicly available documents may be inaccurate and misleading, resulting in recommendations or transactions that are inconsistent with investors’ intended results. In addition, advisors may not understand investor needs or risk tolerances, which may result in the recommendation or purchase of a portfolio of assets that may not be suitable for the investor. Risks associated with advisory services also include those arising from possible conflicts of interest, inadequate due diligence, inadequate disclosure, human error and fraud. To the extent that we fail to know our customers, we improperly advise them, or risks associated with advisory services otherwise materialize, we could be found liable for losses suffered by such customers, regulatory fines, and civil penalties, any of which could harm our reputation and business.
We may suffer losses due to credit risk associated with margin lending, securities lending transactions, our investment portfolio or other financial transactions.
We permit certain customers to purchase securities on margin and borrow against their securities holdings. A downturn in securities markets may impact the value of collateral held in connection with margin receivables and assets pledged for securities-based lending and may reduce its value below the amount borrowed, potentially creating collections issues if deficiencies are not remediated. In addition, we frequently borrow securities from and lend securities to other broker-dealers. Under regulatory guidelines, when we borrow or lend securities, we must simultaneously disburse or receive cash deposits. A sharp change in security market values may result in losses if counterparties to the borrowing and lending transactions default on their obligations. Even without defaults, the value of debt securities may be negatively affected by the credit deterioration of a security's issuer. We also engage in financial transactions with counterparties, including repurchase agreements and hedging transactions, that expose us to credit losses in the event counterparties cannot meet their obligations.
We may continue to experience losses in our mortgage loan portfolio.
At December 31, 2018, the principal balance of our one-to four-family loan portfolio was $1.1 billion with an allowance for loan losses of $9 million. The principal balance of our home equity loan portfolio was $836 million with an allowance for loan losses of $26 million. Certain characteristics of our mortgage loan portfolio indicate an additional risk of loss and we believe the relative importance of these factors varies, depending upon economic conditions. Whether a loan is amortizing is among the key items we track to predict and monitor credit risk in our mortgage portfolio, together with loan-to-value (LTV)/combined loan-to-value (CLTV), borrower Fair Isaac Credit Organization (FICO) scores, loan type, housing prices, loan vintage and geographic location of the underlying property. Second lien loans carry higher credit risk because the holder of the first lien mortgage has priority in right of payment. As second lien holders, we are also exposed to risk associated with the actions and inactions of the first lien holder loans for which we do not hold the first lien positions and we do not have access to complete data on the first lien positions of second lien home equity loans. Actual loan defaults and delinquencies that exceed our current expectations could negatively impact our financial performance. In the normal course of conducting examinations, our banking regulators, the OCC and Federal Reserve, continue to review our policies and procedures. This process is dynamic and ongoing and we cannot be certain that additional changes or actions to our policies and procedures will not result from their continuing review. Due to the complexity and judgment required by management regarding the effect of matters that are inherently uncertain, there can be no assurance that our allowance for loan losses will be adequate. See MD&A—Risk Management for additional information.


E*TRADE 2018 10-K | Page 17
 
                    

Table of Contents    

Our corporate debt may restrict how we conduct our business and failure to comply with the terms of our corporate debt could adversely affect our financial condition and results of operations.
As of December 31, 2018, we have $1.4 billion of corporate debt and have the capacity to incur $300 million in additional indebtedness under our senior unsecured revolving credit facility, subject to certain covenant requirements. Our expected annual debt service interest payment is approximately $52 million. The degree to which we are leveraged could have important consequences, including:
A portion of our cash flow from operations is dedicated to the payment of interest on our indebtedness, thereby reducing the funds available for other purposes
Our ability to obtain additional financing for working capital, capital expenditures, acquisitions and other corporate needs may be limited
Our leverage may affect our ability to adjust rapidly to changing market conditions and make us more vulnerable in the event of a downturn in general economic conditions or our business
Our senior unsecured revolving credit facility and the indentures governing our corporate debt place limitations on our ability, and certain of our subsidiaries’ ability to, among other things:
Create liens
Merge, consolidate or transfer substantially all of our assets
With respect to our subsidiaries only, incur additional indebtedness
The senior unsecured revolving credit facility also contains certain financial covenants, including that we maintain a minimum interest coverage ratio, a maximum total leverage ratio and certain capitalization requirements for the parent company and certain of its subsidiaries.
We could be forced to repay immediately any outstanding borrowings under the senior unsecured revolving credit facility and outstanding debt securities at their full principal amount if we were to breach their respective covenants and not cure such breach, even if we otherwise meet our debt service obligations. If we experience a change in control, as defined in the senior unsecured revolving credit facility, we could be required to repay all loans outstanding under the credit facility at their full principal amount plus any accrued interest or fees.
Our ability to make scheduled payments on or to refinance our debt obligations depends on our financial condition, operating performance and our ability to receive dividend payments from our subsidiaries, which are subject to certain business, economic and competitive conditions, regulatory approval or notification, and other factors beyond our control. If our cash flows and capital resources are insufficient to fund our debt service obligations, we may be forced to reduce or delay investments and capital expenditures, or to sell assets, seek additional capital or restructure or refinance our indebtedness. These alternative measures may not be successful and may not permit us to meet our scheduled debt service obligations. In addition, the terms of our existing or future debt instruments may restrict us from adopting some of these alternatives.
Any failure to make payments of interest and principal on our outstanding indebtedness on a timely basis would likely result in a reduction of our credit rating, which could harm our ability to obtain additional financing in the future. In addition, any future indebtedness could be at a higher interest rate or include covenants that are more restrictive than our current covenants.


E*TRADE 2018 10-K | Page 18
 
                    

Table of Contents    

Risks Relating to the Regulation of Our Business
We are subject to extensive government regulation, including banking and securities rules and regulations, which could restrict our business practices.
The financial services industry is subject to extensive regulation. Our brokerage subsidiaries must comply with many laws and rules, including rules relating to sales practices and the suitability of recommendations to customers, possession and control of customer funds and securities, margin lending, execution and settlement of transactions and AML. E*TRADE Financial Corporation, as a savings and loan holding company, and E*TRADE Bank and E*TRADE Savings Bank, as federally chartered savings banks, are subject to extensive regulation, supervision and examination by the OCC, the Federal Reserve and the CFPB, and, in the case of E*TRADE Bank and E*TRADE Savings Bank, the FDIC. Such regulation and supervision covers all aspects of the banking business, including lending practices, safeguarding deposits, capital structure, recordkeeping, transactions with affiliates and conduct and qualifications of personnel.
In providing services to customers, we manage, use and store sensitive customer data including PII. We are subject to numerous data protection laws and regulations, such as US federal and state laws and foreign regulations governing the protection of PII and other customer data. These laws and regulations have increased in complexity and number, change frequently and can conflict with one another. Additionally, the interpretation and application of certain laws, such as the European Union's General Data Protection Regulation, are unclear at this time. It is possible that the scope and requirements of these laws may be interpreted and applied broadly by various jurisdictions, and in a manner that is inconsistent with our understanding and practices and with other legal requirements.
In addition, our results of operations could be affected by regulations which impact the business and financial communities generally, including changes to the laws governing taxation, electronic commerce, customer privacy and security of customer data. If we fail to establish and enforce procedures to comply with applicable regulations, our failure could have a material adverse effect on our business.
While we have implemented policies and procedures designed to provide for compliance with all applicable laws and regulations, regulators have broad discretion with respect to the enforcement of applicable laws and regulations and there can be no assurance that violations will not occur. Failure to comply with applicable laws and regulations and our policies could result in sanctions by regulatory agencies, litigation, civil penalties and harm to our reputation, which could have a material adverse effect on our business, financial condition and results of operations. Further, to the extent we undertake actions requiring regulatory approval or non-objection, our regulators may make their approval or non-objection subject to conditions or restrictions that could have a material adverse effect on our business, results of operations and financial condition.
New or amended legislation or regulations, rule changes or changes in the interpretation or enforcement of existing laws, rules and regulations and new or amended guidance and supervisory practices could increase our compliance costs and adversely affect our business and results of operations. For further information on how ongoing regulatory reform could affect us, see Business—Regulation.
If we fail to comply with applicable securities and banking laws, rules and regulations, either domestically or internationally, we could be subject to disciplinary actions, litigation, investigations, damages, penalties or restrictions that could significantly harm our business.
The financial services industry faces substantial litigation and regulatory risks. We are subject to arbitration claims and lawsuits in the ordinary course of our business, as well as class actions and other significant litigation. We also are the subject of inquiries, investigations and proceedings by regulatory and other governmental agencies. Actions brought against us may result in settlements, awards, injunctions, fines, penalties and other results adverse to us. Predicting the outcome of such matters is inherently difficult,


E*TRADE 2018 10-K | Page 19
 
                    

Table of Contents    

particularly where claims are brought on behalf of various classes of claimants or by a large number of claimants, when claimants seek substantial or unspecified damages or when investigations or legal proceedings are at an early stage. A substantial judgment, settlement, fine or penalty could be material to our operating results or cash flows, or could cause us significant reputational harm, which could harm our business prospects. In market downturns, the volume of legal claims and amount of damages sought in litigation and regulatory proceedings against financial services companies have historically increased. We are also subject to litigation claims from third parties alleging infringement of their intellectual property rights. Such litigation can require the expenditure of significant resources, regardless of whether the claims have merit. If we were found to have infringed a third-party patent or other intellectual property right, we could incur substantial liability and in some circumstances could be enjoined from using the relevant technology or providing related products and services, which could have a material adverse effect on our business and results of operations.
The SEC, FINRA and other SROs and state securities commissions, among other things, can censure, fine, issue cease-and-desist orders or suspend or expel a broker-dealer or any of its officers or employees. Clearing securities firms, such as E*TRADE Securities, are subject to substantially more regulatory control and examination than introducing brokers that rely on others to perform clearing functions. Similarly, the attorneys general of each state could bring legal action on behalf of the citizens of the various states to ensure compliance with local laws. Regulatory agencies in countries outside of the US have similar authority. The ability to comply with applicable laws and rules is dependent in part on the establishment and maintenance of a reasonable compliance function. The failure to establish and enforce reasonable compliance procedures, even if unintentional, could subject us to significant losses or disciplinary or other actions.
The Federal Reserve has primary jurisdiction for the supervision and regulation of savings and loan holding companies, including the Company; and the OCC has primary supervision and regulation of federal savings banks, such as the Company’s two federal savings bank subsidiaries. Although the Dodd-Frank Act maintained the federal thrift charter, it eliminated certain preemption, branching and other benefits of the charter and imposed new penalties for failure to comply with the QTL test.
We are required to file periodic reports with the Federal Reserve and are subject to examination and supervision by it. The Federal Reserve Board also has certain types of enforcement powers over us, including the ability to issue cease-and-desist orders, force divestiture of our saving bank subsidiaries and impose civil and monetary penalties for violations of federal banking laws and regulations or for unsafe or unsound banking practices. The Federal Reserve has issued guidance aligning the supervisory and regulatory standards of savings and loan holding companies more closely with the standards applicable to bank holding companies. Our saving bank subsidiaries are subject to similar reporting, examination, supervision and enforcement oversight by the OCC. For all insured depository institutions, including savings banks with total consolidated assets over $10 billion, such as E*TRADE Bank, as well as their affiliates, the CFPB has exclusive rulemaking and examination, and primary enforcement authority, under federal consumer financial laws and regulations. In addition, states may adopt consumer protection laws and regulations that are stricter than those regulations promulgated by the CFPB.
The EGRRCPA, enacted in 2018, relieved the Company of certain regulatory burdens to which it had become subject as a result of surpassing $50 billion in total consolidated assets on a four-quarter average basis in 2017. In addition, the Federal Reserve Board issued a proposal in October 2018 that, if adopted as proposed, would apply certain requirements to savings and loan holding companies with $100 billion or more in total consolidated assets. While the Company currently does not surpass that threshold, it could in the future. We anticipate that regulators will continue to intensify their supervision through the exam process and increase their enforcement of regulations across the industry. The regulators' heightened expectations and intense supervision may increase our costs and limit our ability to pursue certain business opportunities.


E*TRADE 2018 10-K | Page 20
 
                    

Table of Contents    

If we do not maintain the capital and liquidity levels required by regulators, we may be fined or subject to other disciplinary or corrective actions.
The SEC, FINRA, the OCC, the CFTC, the Federal Reserve and various other regulatory agencies have stringent rules with respect to the maintenance of specific levels of net capital by securities broker-dealers and regulatory capital by banks.
Failure to maintain the required net capital by our US securities broker-dealer or FCM could result in suspension or revocation of registration by the SEC or suspension or expulsion by FINRA, the CFTC or the NFA, as applicable, and could ultimately lead to these entities' liquidation. If such net capital rules are changed or expanded, or if there is an unusually large charge against net capital, operations that require an intensive use of capital could be limited. Such operations may include investing activities, marketing and the financing of customer account balances. Also, our ability to withdraw capital from brokerage subsidiaries could be restricted.
E*TRADE Bank and E*TRADE Savings Bank are subject to various regulatory capital requirements administered by the OCC, and the Company is subject to specific capital requirements administered by the Federal Reserve. Failure to meet minimum capital requirements can trigger certain mandatory, and possibly additional discretionary actions by regulators that, if undertaken, could affect the operations and financial performance of these entities. The capital amounts and classifications of the Company, E*TRADE Bank and E*TRADE Savings Bank are subject to qualitative judgments by the regulators of these entities, including about the strength of components of their capital, risk weightings of assets, off-balance sheet transactions and other factors. Any significant reduction in the Company’s, E*TRADE Bank’s or E*TRADE Savings Bank's regulatory capital could result in them being less than "well capitalized" or "adequately capitalized" under applicable capital standards. A failure to be "adequately capitalized" that is not cured within time periods specified in the credit agreement for our senior unsecured revolving credit facility would constitute a default under our senior unsecured revolving credit facility and likely result in any outstanding balance on the senior unsecured revolving credit facility becoming immediately due and payable. In addition, the Federal Deposit Insurance Act prohibits the acceptance, renewal or roll-over of “brokered deposits” by depository institutions that are not “well capitalized,” unless a depository institution is “adequately capitalized” and receives a waiver from the FDIC. Sweep deposits that qualify as “brokered deposits” are a significant source of liquidity for E*TRADE Bank and E*TRADE Savings Bank, and if they were terminated by the FDIC, that could have a material negative effect on our business. If we fail to meet certain capital requirements, the Federal Reserve and the OCC may request we raise equity or otherwise increase the regulatory capital of the Company, E*TRADE Bank or E*TRADE Savings Bank. If we were unable to raise equity or otherwise increase capital, we could face negative regulatory consequences, including under the “prompt corrective action” framework, such as restrictions on our activities and requirements that we dispose of certain assets and liabilities within a prescribed period. Any such actions could have a material negative effect on our business.
As a savings and loan holding company, we are subject to activity limitations and requirements that could restrict our ability to engage in certain activities and take advantage of certain business opportunities.
Under applicable law, our banking activities are restricted to those that are financial in nature and certain real estate-related activities. Although we believe all of our existing activities and investments are permissible, we are unable to pursue future activities that are not financial in nature or otherwise real-estate related. We are also limited in our ability to invest in other savings and loan holding companies. Various other laws and regulations require savings and loan holding companies such as the Company, as well as our savings bank subsidiaries, to be both "well capitalized" or "well managed" in order for us to conduct certain financial activities, such as securities underwriting. We believe that we will be able to continue to engage in all of our current financial activities. However, if we and our savings bank subsidiaries are unable to satisfy the "well capitalized" and "well managed" requirements, we could be subject to activity restrictions that could prevent us from engaging in certain activities as well as other negative regulatory actions.


E*TRADE 2018 10-K | Page 21
 
                    

Table of Contents    

In addition, E*TRADE Bank and E*TRADE Savings Bank are currently subject to extensive regulation of their activities and investments, capitalization, community reinvestment, risk management policies and procedures and relationships with affiliated companies. Acquisitions of and mergers with other financial institutions, purchases of deposits and loan portfolios, the establishment of new depository institution subsidiaries and the commencement of certain new activities by these subsidiaries require the prior approval of the OCC and the Federal Reserve, and in some cases the FDIC, any of which may deny approval or condition their approval on the imposition of limitations on the scope of our planned activity. Also, these regulations and conditions could affect our ability to realize synergies from future acquisitions, negatively affect us following an acquisition and also delay or prevent the development, introduction and marketing of new products and services.
Risks Relating to Owning Our Stock
The value of our common stock may be diluted if we need additional funds in the future and is subject to the liquidation preference of our preferred stock.
In the future, we may need to raise additional funds via the issuance and sale of our debt or equity instruments, which we may not be able to conduct on favorable terms, if at all. If adequate funds are not available on acceptable terms, we may be unable to fund our capital needs and our plans for the growth of our business.
In addition, if funds are available, the issuance of equity securities could significantly dilute the value of our shares of our common stock and cause the market price of our common stock to fall. We have the ability to issue a significant number of shares of stock in future transactions, which would substantially dilute existing stockholders, without seeking further stockholder approval. We have issued $700 million aggregate liquidation preference of preferred stock in two series, Series A Preferred Stock and Series B Preferred Stock. Future issuances and sales of preferred stock or the perception that such issuances and sales could occur, may also cause prevailing market prices for the Series A Preferred Stock, Series B Preferred Stock and our common stock to decline and may adversely affect our ability to raise additional capital in the financial markets at times and prices favorable to us.
Our future ability to pay cash dividends to holders of our common stock is subject to the discretion of our board of directors and will be limited by our ability to generate sufficient earnings and cash flows.

We recently announced the declaration of a quarterly dividend on shares of our common stock. Payment of future dividends, if any, will be at the discretion of our board of directors and will depend upon a number of factors that the board of directors deems relevant, including future earnings, the success of our business activities, capital requirements, the general financial condition and future prospects of our business and general business conditions. If we are unable to generate sufficient earnings and cash flows from our business, we may not be able to pay dividends on our common stock; however, even with sufficient earnings and cash flows from our business, our board of directors may exercise its discretion by not declaring a dividend on our common stock. In addition, our ability to pay dividends on our common stock is subject to statutory and regulatory limitations. As noted above, we depend on dividends from our subsidiaries to fund payments of cash dividends to holders of our common stock and such subsidiaries may not pay dividends without the non-objection, or in certain cases the approval, of their regulators.

The failure to declare or pay a quarterly dividend in the future could adversely affect the market price of our common stock. Furthermore, the terms of our outstanding preferred stock prohibit us from declaring or paying any dividends on any junior series of our capital stock, including our common stock, or from repurchasing, redeeming or acquiring such junior stock, unless we have declared and paid full dividends on our outstanding preferred stock for the most recently completed dividend period.


E*TRADE 2018 10-K | Page 22
 
                    

Table of Contents    

The market price of our common stock may continue to be volatile.
The market price of our common stock has been, and is likely to continue to be, highly volatile and subject to wide fluctuations. Among the factors that may affect our stock price are the following:
Speculation in the investment community or the press about, or actual changes in, our competitive position, organizational structure, executive team, operations, financial condition, financial reporting and results, ability to execute on our announced capital return strategy or plans to engage in strategic transactions
The announcement of new products, services, acquisitions, or dispositions by us or our competitors
Increases or decreases in revenues or earnings, changes in earnings estimates by the investment community, and variations between estimated financial results and actual financial results
The pricing structure for products and services offered to customers by us or our competitors
General stock market volatility or volatility related to our industry may also affect our stock price. In the past, volatility in the market price of a company’s securities has often led to securities class action litigation. Such litigation could result in substantial costs to us and divert our attention and resources, which could harm our business. We have been a party to litigation related to the decline in the market price of our stock in the past and such litigation could occur again in the future. Declines in the market price of our common stock or failure of the market price to increase could also harm our ability to retain key employees, reduce our access to capital and otherwise harm our business.
We have provisions in our organizational documents that may discourage takeover attempts.
Certain provisions of our certificate of incorporation and bylaws may discourage, delay or prevent a third party from acquiring control of us in a merger, acquisition or similar transaction that a stockholder may consider favorable. Such provisions include:
Authorization for the issuance of "blank check" preferred stock
The prohibition of cumulative voting in the election of directors
A super-majority voting requirement to effect business combinations and certain amendments to our certificate of incorporation and bylaws
Limits on the persons who may call special meetings of stockholders
The prohibition of stockholder action by written consent
Advance notice requirements for nominations to the Board or for proposing matters that can be acted on by stockholders at stockholder meetings
In addition, certain provisions of our stock incentive plans, management retention and employment agreements (including severance payments and stock option acceleration), our senior unsecured revolving credit facility, certain provisions of Delaware law and certain provisions of the indentures governing certain series of our debt securities that would require us to offer to purchase such securities at a premium in the event of certain changes in our ownership may also discourage, delay or prevent someone from acquiring or merging with us, which could limit the opportunity for our stockholders to receive a premium for their shares of our common stock and could also affect the price that some investors are willing to pay for our common stock.


E*TRADE 2018 10-K | Page 23
 
                    

Table of Contents    

ITEM 1B.    UNRESOLVED STAFF COMMENTS
None.
ITEM 2.    PROPERTIES
A summary of our significant locations at December 31, 2018 is shown in the following table. Square footage amounts are net of space that has been sublet or space that is part of a facility restructuring.
Location
 
Approximate Square Footage
Alpharetta, Georgia
 
236,000
Jersey City, New Jersey
 
132,000
Arlington, Virginia
 
107,000
Sandy, Utah
 
85,000
Menlo Park, California
 
63,000
Denver, Colorado
 
58,000
Chicago, Illinois
 
46,000
New York, New York
 
31,000
All facilities are leased at December 31, 2018. All other leased facilities with space of less than 25,000 square feet are not listed by location. In addition to the significant facilities above, we also lease all 30 regional financial centers, ranging in space from approximately 2,500 to 8,000 square feet.
ITEM 3.    LEGAL PROCEEDINGS
Information in response to this item can be found under the heading Litigation Matters in Note 21—Commitments, Contingencies and Other Regulatory Matters in this Annual Report and is incorporated by reference into this item.
ITEM 4.     MINE SAFETY DISCLOSURES
Not applicable.


E*TRADE 2018 10-K | Page 24
 
                    

Table of Contents    

PART II
 
ITEM 5.    MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED SHAREHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Our common stock is listed on the NASDAQ Stock Market under the ticker symbol ETFC. The closing sale price of our common stock as reported on the NASDAQ on February 15, 2019 was $47.46 per share. At that date, there were 600 holders of record of our common stock.
Common Stock Dividends
In October 2018, our Board of Directors declared a quarterly cash dividend of $0.14 per share on our outstanding shares of common stock. The dividend was paid on November 15, 2018, to shareholders of record as of the close of business on October 30, 2018. On January 23, 2019 the Company declared a cash dividend for the first quarter of $0.14 per share on our outstanding shares of common stock. The dividend was paid on February 15, 2019 to shareholders of record as of the close of business on February 1, 2019.
Issuer Purchases of Equity Securities
The table below shows the timing and impact of our share repurchase programs, and the shares withheld from employees to satisfy tax withholding obligations during the three months ended December 31, 2018 (dollars in millions, except share data and per share amounts):
Period
 
Total Number of Shares Purchased(1)
 
Average Price Paid per Share(2)
 
Total Number of Shares Purchased as Part of the Publicly Announced Programs(3)
 
Maximum Dollar Value of Shares That May Yet Be Purchased Under the Program(3)
October 1, 2018 - October 31, 2018
 
2,715,965

 
$
47.80

 
2,715,300

 
$
870

November 1, 2018 - November 30, 2018
 
3,671,073

 
$
51.55

 
3,669,000

 
$
681

December 1, 2018 - December 31, 2018
 
3,943,574

 
$
46.25

 
3,929,800

 
$
499

Total
 
10,330,612

 
$
48.54

 
10,314,100

 
 
(1)
Includes 16,512 shares withheld to satisfy tax withholding obligations associated with vesting of share-based awards.
(2)
Excludes commission paid, if any.
(3)
In October 2018, the Company announced that its Board of Directors authorized a new $1 billion share repurchase program. See MD&A—Overview for further details.



E*TRADE 2018 10-K | Page 25
 
                    

Table of Contents    

Performance Graph
The following performance graph shows the cumulative total return to a holder of our common stock, assuming dividend reinvestment, compared with the cumulative total return, assuming dividend reinvestment, of the Standard & Poor (S&P) 500 Index and the Dow Jones US Financials Index during the period from December 31, 2013 through December 31, 2018.
chart-b9bd3c5d62c5c0e92fb.jpg
 
12/13
 
12/14
 
12/15
 
12/16
 
12/17
 
12/18
E*TRADE Financial Corporation
100.00

 
123.50

 
150.92

 
176.43

 
252.39

 
224.08

S&P 500 Index
100.00

 
113.69

 
115.26

 
129.05

 
157.22

 
150.33

Dow Jones US Financials Index
100.00

 
114.59

 
114.69

 
134.59

 
161.54

 
147.04



E*TRADE 2018 10-K | Page 26
 
                    

Table of Contents    

ITEM 6.    SELECTED FINANCIAL DATA
The selected consolidated financial data should be read in conjunction with Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations and Item 8. Financial Statements and Supplementary Data. As of or for the years ended December 31, dollars in millions except per share amounts, shares in thousands:
 
 
Year Ended December 31,
 
Variance
Results of Operations:
 
2018
 
2017
 
2016
 
2015
 
2014
 
2018 vs. 2017
Net interest income
 
$
1,846

 
$
1,485

 
$
1,148

 
$
1,021

 
$
961

 
24%
Total net revenue
 
$
2,873

 
$
2,366

 
$
1,941

 
$
1,370

 
$
1,704

 
21%
Provision (benefit) for loan losses
 
$
(86
)
 
$
(168
)
 
$
(149
)
 
$
(40
)
 
$
36

 
(49)%
Total non-interest expense
 
$
1,541

 
$
1,470

 
$
1,252

 
$
1,319

 
$
1,216

 
5%
Net income
 
$
1,052

 
$
614

 
$
552

 
$
268

 
$
293

 
71%
Basic earnings per common share
 
$
3.90

 
$
2.16

 
$
1.99

 
$
0.92

 
$
1.02

 
81%
Diluted earnings per common share
 
$
3.88

 
$
2.15

 
$
1.98

 
$
0.91

 
$
1.00

 
80%
Weighted average common shares outstanding —basic
 
260,600

 
273,190

 
277,789

 
290,762

 
288,705

 
(5)%
Weighted average common shares outstanding—diluted
 
261,669

 
274,352

 
279,048

 
295,011

 
294,103

 
(5)%
Dividends declared per common share
 
$
0.14

 
$

 
$

 
$

 
$

 
100%
Performance Measures:
 
 
 
 
 
 
 
 
 
 
 
 
Net interest margin
 
3.08
%
 
2.79
%
 
2.65
%
 
2.50
%
 
2.30
%
 
0.29%
Operating margin
 
49
%
 
45
%
 
43
%
 
7
%
 
27
%
 
4%
Return on common equity
 
17
%
 
10
%
 
10
%
 
5
%
 
6
%
 
7%
Capital return to shareholders
 
116
%
 
61
%
 
82
%
 
19
%
 
%
 
55%
Financial Condition:
 
 
 
 
 
 
 
 
 
 
 
 
Investment securities
 
$
45,037

 
$
44,518

 
$
29,643

 
$
25,602

 
$
24,636

 
1%
Margin receivables
 
$
9,560

 
$
9,071

 
$
6,731

 
$
7,398

 
$
7,675

 
5%
Loans receivable, net
 
$
2,103

 
$
2,654

 
$
3,551

 
$
4,613

 
$
5,979

 
(21)%
Total assets
 
$
65,003

 
$
63,365

 
$
48,999

 
$
45,427

 
$
45,530

 
3%
Deposits
 
$
45,313

 
$
42,742

 
$
31,682

 
$
29,445

 
$
24,890

 
6%
Customer payables
 
$
10,117

 
$
9,449

 
$
8,159

 
$
6,544

 
$
6,455

 
7%
Corporate debt
 
$
1,409

 
$
991

 
$
994

 
$
997

 
$
1,366

 
42%
Shareholders’ equity
 
$
6,562

 
$
6,931

 
$
6,272

 
$
5,799

 
$
5,375

 
(5)%


E*TRADE 2018 10-K | Page 27
 
                    

Table of Contents    

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (MD&A)
The following discussion should be read in conjunction with the consolidated financial statements and related notes included in Item 8. Financial Statements and Supplementary Data.
OVERVIEW
E*TRADE is a financial services company that provides brokerage and related products and services for traders, investors, stock plan administrators and participants, and RIAs. For additional information related to our business activities see Part 1. Item 1. Business.
Financial Performance
Our net revenue is generated primarily from net interest income, commissions and fees and service charges:
Net interest income is largely impacted by the size of our balance sheet, our balance sheet mix, and average yields on our assets and liabilities. Net interest income is driven primarily from interest earned on investment securities, margin receivables, and our legacy loan portfolio, less interest incurred on interest-bearing liabilities, including deposits, customer payables, corporate debt and other borrowings.
Commissions revenue is generated by customer trades and is largely impacted by trade volume, trade type, and commission rates.
Fees and service charges revenue is primarily impacted by order flow revenue, fees earned on off-balance sheet customer cash and other assets, advisor management and custody fees, and mutual fund service fees.
Our net revenue is offset by non-interest expenses, the largest of which are compensation and benefits and advertising and market development.
Significant Events
Declared first ever quarterly dividend on common stock
In October 2018, our Board of Directors declared our first quarterly cash dividend of $0.14 per share on our outstanding shares of common stock. The dividend was paid on November 15, 2018, to shareholders of record as of the close of business on October 30, 2018. On January 23, 2019 the Company declared a cash dividend for the first quarter of $0.14 per share on our outstanding shares of common stock. The dividend was paid on February 15, 2019 to shareholders of record as of the close of business on February 1, 2019.
Completed prior $1 billion share repurchase program and approved new $1 billion program
During 2018, we completed repurchases under the prior $1 billion share repurchase program and our Board of Directors authorized a new $1 billion share repurchase program. We utilized $1.1 billion to repurchase 21.3 million shares at an average price of $53.49 during the year ended December 31, 2018. As of December 31, 2018, $499 million remained available for additional purchase. As of February 15, 2019, we have subsequently repurchased approximately 0.8 million shares of common stock at an average price of $46.78 per share.


E*TRADE 2018 10-K | Page 28
 
                    

Table of Contents    

Acquired approximately one million brokerage accounts from Capital One
In November 2018, we completed the acquisition of approximately one million retail brokerage accounts with $15.1 billion in customer assets from Capital One for a cash purchase price of $109 million. The acquisition introduced a significant number of retail customers to our platforms and service offerings. For additional information, see Note 2—Acquisitions and Restructuring.
Issued $420 million of Senior Notes and redeemed Trust Preferred Securities (TRUPs)
In June 2018, we issued $420 million of 4.50% Senior Notes due 2028 (Senior Notes) and used the net proceeds to redeem all $413 million of outstanding TRUPs during the third quarter of 2018. In connection with the redemption, we recognized a loss on early extinguishment of debt of $4 million, consisting of the difference between the carrying value of the TRUPs redeemed, including unamortized debt issuance costs, and the total cash amount paid, including related fees and expenses. For additional information about the debt issuance, see Note 14—Corporate Debt.
Acquired TCA, a leading provider of technology and custody services to RIAs
On April 9, 2018, we completed the acquisition of TCA for a cash purchase price of $275 million. The acquisition is expected to benefit the Company by leveraging the E*TRADE brand to accelerate growth of the custody offering, and through the establishment of a referral program to address retail customers seeking services available through RIAs. For additional information, see Note 2—Acquisitions and Restructuring.
Tier 1 leverage ratio threshold reduced for E*TRADE Bank
Beginning January 2018, the internal threshold for E*TRADE Bank's Tier 1 leverage ratio was reduced to 7.0% from the previous internal threshold of 7.5%. For additional information, see MD&A—Liquidity and Capital Resources.


E*TRADE 2018 10-K | Page 29
 
                    

Table of Contents    

Key Performance Metrics
Management monitors customer activity and corporate metrics to evaluate the Company’s performance. The most significant of these are displayed below along with the percentage variance from the prior year. These metrics include the impact of the Company's acquisitions at the respective acquisition dates, as applicable. See Note 2—Acquisitions and Restructuring for more information.
Customer Activity Metrics:
chart-e0d5ad20a88aad49d0d.jpg chart-572d333b188956229dc.jpg
Daily Average Revenue Trades (DARTs) are the predominant driver of commissions revenue from our customers. DARTs were 282,243, 214,284 and 164,134 for the years ended December 31, 2018, 2017 and 2016, respectively.
Derivative DARTs, a key driver of commissions revenue, is the daily average number of options and futures trades, and Derivative DARTs percentage is the mix of options and futures trades as a component of total DARTs. Derivative DARTs were 90,811, 65,264 and 42,430 for the years ended December 31, 2018, 2017 and 2016, respectively. Derivative DARTs represented 32%, 30% and 26% of total DARTs for the years ended December 31, 2018, 2017 and 2016, respectively.


E*TRADE 2018 10-K | Page 30
 
                    

Table of Contents    

chart-65c5d801f74c90d3665.jpg chart-9c65d19c6e81f9d62b6.jpg chart-aa8e1dde0654fe0c460.jpg chart-ecdee0544a46f85d4ec.jpg
Average commission per trade is an indicator of changes in our customer mix, product mix and/or product pricing. Average commission per trade was $7.07, $8.23 and $10.70 for the years ended December 31, 2018, 2017 and 2016, respectively.
 
End of period brokerage accounts and net new brokerage accounts are indicators of our ability to attract and retain customers. End of period brokerage accounts were 4.9 million, 3.6 million and 3.5 million at December 31, 2018, 2017 and 2016, respectively. Net new brokerage accounts were 1,261,855, 171,906 and 249,462 for the years ended December 31, 2018, 2017 and 2016, respectively. Our net new brokerage account growth rate was 34.7%, 5.0% and 7.8% for the same periods. We added 1,057,956 net new accounts as part of acquisitions during the year ended December 31, 2018, including 145,891 accounts related to the TCA acquisition and 912,065 accounts related to the Capital One acquisition. Excluding these accounts, the adjusted net new brokerage account growth rate was 5.6% for the year ended December 31, 2018. We added 147,761 net new accounts related to the OptionsHouse acquisition during the year ended December 31, 2016. Excluding these accounts, the adjusted net new brokerage account growth rate was 3.2% for the year ended December 31, 2016.


E*TRADE 2018 10-K | Page 31
 
                    

Table of Contents    

chart-c927174c69f595c28c9.jpg chart-1503652704d06189c44.jpg
Customer margin balances represent credit extended to customers to finance their purchases of securities by borrowing against securities they own and is a key driver of net interest income. Customer margin balances were $9.6 billion, $9.1 billion and $7.1 billion at December 31, 2018, 2017 and 2016, respectively.
Managed products represent customer assets in our Managed Portfolios which are a driver of fees and service charges revenue. Managed products were $5.7 billion, $5.4 billion and $3.9 billion at December 31, 2018, 2017 and 2016, respectively.
chart-c9e6e2db5fabe232b31.jpg chart-9cb6f339285fb293583.jpg
chart-81bae31d04818a17e3c.jpg chart-41490cb5103f266cdae.jpg


E*TRADE 2018 10-K | Page 32
 
                    

Table of Contents    

Customer assets is an indicator of the value of our relationship with the customer. An increase generally indicates that the use of our products and services is expanding. Changes in this metric are also driven by changes in the valuations of our customers' underlying securities. Customer assets were $414.1 billion, $383.3 billion and $311.3 billion at December 31, 2018, 2017 and 2016, respectively.
Brokerage related cash is an indicator of the level of engagement with our brokerage customers and is a key driver of net interest income as well as fees and service charges revenue, which includes fees earned on customer cash held by third parties. Brokerage related cash was $54.2 billion, $52.9 billion and $51.4 billion at December 31, 2018, 2017 and 2016, respectively.
Net new brokerage assets equals total inflows to new and existing brokerage accounts less total outflows from closed and existing brokerage accounts. The net new brokerage assets metric is a general indicator of the use of our products and services by new and existing brokerage customers. Net new brokerage assets were $48.7 billion, $12.2 billion and $13.1 billion for the years ended December 31, 2018, 2017 and 2016, respectively. Our net new brokerage asset growth rate was 14.3%, 4.4% and 5.3% at December 31, 2018, 2017 and 2016, respectively. We added $33.5 billion in net new brokerage assets as part of acquisitions during the year ended December 31, 2018, including $18.4 billion assets related to the TCA acquisition and $15.1 billion assets related to the Capital One acquisition. Excluding these brokerage assets, the adjusted net new brokerage asset growth rate was 4.5% for the year ended December 31, 2018. We added $3.7 billion net new assets related to the OptionsHouse acquisition during the year ended December 31, 2016. Excluding these assets, the adjusted net new brokerage asset growth rate was 3.8% for the year ended December 31, 2016.
Corporate Metrics:
chart-74e595589c0ec5e1775.jpg chart-36cc0ccea958155915a.jpg
Earnings per diluted share is the portion of a company's profit allocated to each diluted share of common stock and is a key indicator of the Company's profitability. Earnings per diluted share was $3.88, $2.15 and $1.98 for the years ended December 31, 2018, 2017 and 2016, respectively.
Operating margin is the percentage of net revenue that results in income before income taxes and is an indicator of the Company's profitability. Operating margin was 49%, 45% and 43% for the years ended December 31, 2018, 2017 and 2016, respectively.
Adjusted operating margin is a non-GAAP measure that provides useful information about our ongoing operating performance by excluding the provision (benefit) for loan losses and losses on early extinguishment of debt, which are not viewed as key factors governing our investment in the business and are excluded by management when evaluating operating margin performance. Adjusted operating margin was 47%, 40% and 35% for the years ended December 31, 2018, 2017 and 2016, respectively. See MD&A—Earnings Overview for a reconciliation of adjusted operating margin to operating margin.


E*TRADE 2018 10-K | Page 33
 
                    

Table of Contents    

chart-9f846e772a24779c20e.jpg chart-2d645fc6c4f2a643b98.jpg
Capital return to shareholders represents the amount of earnings returned to shareholders through share repurchases and common stock dividends and Capital return percentage to shareholders is capital returned to shareholders as a percentage of net income available to common shareholders. Capital return to shareholders was $1.2 billion, $362 million and $452 million for the years ended December 31, 2018, 2017 and 2016, respectively. Capital return percentage to shareholders was 116%, 61% and 82% for the years ended December 31, 2018, 2017 and 2016, respectively.
Return on common equity is calculated by dividing net income available to common shareholders by average common shareholders' equity, which excludes preferred stock. Return on common equity was 17%, 10% and 10% for the years ended December 31, 2018, 2017 and 2016, respectively.
Adjusted return on common equity is a non-GAAP measure calculated by dividing adjusted net income available to common shareholders, a non-GAAP measure which excludes the provision (benefit) for loan losses and losses on early extinguishment of debt, which are not viewed as key factors governing our investment in the business and are excluded by management when evaluating return on common equity performance, by average common shareholders' equity, which excludes preferred stock. Adjusted return on common equity was 16%, 9% and 8% for the years ended December 31, 2018, 2017 and 2016, respectively. See MD&A—Earnings Overview for a reconciliation of adjusted net income available to common shareholders to net income and adjusted return on common equity to return on common equity.
chart-e5b5338f60698e29117.jpg chart-13729c3480d100c3a61.jpg
Corporate cash, a non-GAAP measure, is a component of cash and equivalents and represents the primary source of capital above and beyond the capital deployed in our regulated subsidiaries. Cash and equivalents was $2.3 billion, $931 million and $2.0 billion at December 31, 2018, 2017 and 2016, respectively, while corporate cash was $391 million, $541 million and $461 million for the same periods. See MD&A—Liquidity and Capital Resources for a reconciliation of corporate cash to cash and equivalents.


E*TRADE 2018 10-K | Page 34
 
                    

Table of Contents    

chart-ff28f0f5d1c18d02659.jpg chart-7555d430a8f0863d14f.jpg
Average interest-earning assets, along with net interest margin, are indicators of our ability to generate net interest income. Average interest-earning assets were $60.0 billion, $53.2 billion and $43.3 billion for the years ended December 31, 2018, 2017 and 2016, respectively.
Net interest margin is a measure of the net yield on our average interest-earning assets. Net interest margin is calculated for a given period by dividing the annualized sum of net interest income by average interest-earning assets. Net interest margin was 3.08%, 2.79% and 2.65% for the years ended December 31, 2018, 2017 and 2016, respectively.
chart-ad7a0d70671aa28bd2c.jpg chart-4286f34cb362f032cbb.jpg
Tier 1 leverage ratio is an indicator of capital adequacy for E*TRADE Financial and E*TRADE Bank. Tier 1 leverage ratio is Tier 1 capital divided by adjusted average assets for leverage capital purposes. E*TRADE Financial's Tier 1 leverage ratio was 6.6%, 7.4% and 7.8% at December 31, 2018, 2017 and 2016, respectively. E*TRADE Bank's Tier 1 leverage ratio was 7.1%, 7.6% and 8.8% at December 31, 2018, 2017 and 2016, respectively. See MD&A—Liquidity and Capital Resources for additional information, including the calculation of regulatory capital ratios.
Total employees is the key driver of compensation and benefits expense, our largest non-interest expense category. Total employees were 4,035, 3,607 and 3,601 at December 31, 2018, 2017 and 2016, respectively.


E*TRADE 2018 10-K | Page 35
 
                    

Table of Contents    

EARNINGS OVERVIEW
We generated net income of $1.1 billion on total net revenue of $2.9 billion for the year ended December 31, 2018. The following chart presents a reconciliation of net income for the year ended December 31, 2017 to net income for the year ended December 31, 2018 (dollars in millions):
chart-938732a66e0c526ab8a.jpg
(1)
Includes clearing and servicing, professional services, occupancy and equipment, communications, depreciation and amortization, FDIC insurance premiums, amortization of other intangibles, restructuring and acquisition-related activities and other non-interest expenses.



E*TRADE 2018 10-K | Page 36
 
                    

Table of Contents    

The following table presents significant components of the consolidated statement of income (dollars in millions except per share amounts):
 
Year Ended December 31,
 
Variance
 
Variance
 
 
2018 vs. 2017
2017 vs. 2016
 
2018
 
2017
 
2016
 
Amount
 
%
 
Amount
 
%
Net interest income
$
1,846

 
$
1,485

 
$
1,148

 
$
361

 
24
 %
 
$
337

 
29
%
Total non-interest income
1,027

 
881

 
793

 
146

 
17
 %
 
88

 
11
%
Total net revenue
2,873

 
2,366

 
1,941

 
507

 
21
 %
 
425

 
22
%
Provision (benefit) for loan losses
(86
)
 
(168
)
 
(149
)
 
82

 
(49
)%
 
(19
)
 
13
%
Total non-interest expense
1,541

 
1,470

 
1,252

 
71

 
5
 %
 
218

 
17
%
Income before income tax expense
1,418

 
1,064

 
838

 
354

 
33
 %
 
226

 
27
%
Income tax expense
366

 
450

 
286

 
(84
)
 
(19
)%
 
164

 
57
%
Net income
$
1,052

 
$
614

 
$
552

 
$
438

 
71
 %
 
$
62

 
11
%
Preferred stock dividends
36

 
25

 

 
11

 
44
 %
 
25

 
100
%
Net income available to common shareholders
$
1,016

 
$
589

 
$
552

 
$
427

 
72
 %
 
$
37

 
7
%
Diluted earnings per common share
$
3.88

 
$
2.15

 
$
1.98

 
$
1.73


80
 %
 
$
0.17

 
9
%
Net income increased 71% to $1.1 billion, or $3.88 per diluted share, for the year ended December 31, 2018 compared to 2017 and increased 11% to $614 million, or $2.15 per diluted share, for the year ended December 31, 2017 compared to 2016. Net income available to common shareholders was $1.0 billion for the year ended December 31, 2018, which reflects payments of $36 million in preferred stock dividends, compared to $589 million in 2017 which reflects payments of $25 million in preferred stock dividends. No preferred stock dividends were paid during the year ended December 31, 2016.
The increase in net income from 2017 to 2018 was driven by higher interest income due to a larger average balance sheet, an improvement in net interest margin, higher commissions due to increased trading activity, fees and service charges and net gains on securities and other. Lower losses on early extinguishment of debt also contributed to increased net income in 2018. During the year ended December 31, 2018, these increases were partially offset by a lower benefit for loan losses and higher non-interest expense due primarily to increased compensation and benefits and advertising and market development expenses.
The increase in net income from 2016 to 2017 was primarily driven by higher interest income due to a larger balance sheet, an improvement in net interest margin, as well as higher fees and service charges revenue. Net income for the year ended December 31, 2017 included a $168 million benefit for loan losses, which was partially offset by $27 million of pre-tax costs primarily incurred in connection with the OptionsHouse integration and preparation for the incremental regulatory and reporting requirements that our balance sheet growth required, and a $58 million pre-tax loss on early extinguishment of corporate debt. The year ended December 31, 2017 also included a $58 million income tax expense related to the remeasurement of our net deferred tax assets due to tax reform and the new statutory federal income tax rate.


E*TRADE 2018 10-K | Page 37
 
                    

Table of Contents    

Net Revenue
The following table presents the significant components of net revenue (dollars in millions):
 
Year Ended December 31,
 
Variance
 
Variance
 
 
2018 vs. 2017
 
2017 vs. 2016
 
2018
 
2017
 
2016
 
Amount
 
%
 
Amount
 
%
Net interest income
$
1,846

 
$
1,485

 
$
1,148

 
$
361

 
24
%
 
$
337

 
29
 %
Commissions
498

 
441

 
442

 
57

 
13
%
 
(1
)
 
 %
Fees and service charges
431

 
369

 
268

 
62

 
17
%
 
101

 
38
 %
Gains on securities and other, net
53

 
28

 
42

 
25

 
89
%
 
(14
)
 
(33
)%
Other revenue
45

 
43

 
41

 
2

 
5
%
 
2

 
5
 %
Total non-interest income
1,027

 
881

 
793

 
146

 
17
%
 
88

 
11
 %
Total net revenue
$
2,873

 
$
2,366

 
$
1,941

 
$
507

 
21
%
 
$
425

 
22
 %
Net Interest Income
Net interest income increased 24% to $1.8 billion for the year ended December 31, 2018 compared to 2017 and increased 29% to $1.5 billion for the year ended December 31, 2017 compared to 2016. Net interest income is earned primarily through investment securities, margin receivables and our legacy mortgage and consumer loan portfolio, offset by funding costs.


E*TRADE 2018 10-K | Page 38
 
                    

Table of Contents    

The following table presents average balance sheet data and interest income and expense data, as well as related net interest margin, yields, and rates (dollars in millions):
 
Year Ended December 31,
 
2018
 
2017
 
2016
 
Average Balance
 
Interest Inc./Exp.
 
Average Yield/
Cost
 
Average Balance
 
Interest Inc./Exp.
 
Average Yield/
Cost
 
Average Balance
 
Interest Inc./Exp.
 
Average Yield/
Cost
Cash and equivalents
$
616

 
$
11

 
1.75
%
 
$
1,011

 
$
9

 
0.89
%
 
$
1,700

 
$
7

 
0.41
%
Cash segregated under federal or other regulations
743

 
15

 
2.02
%
 
1,186

 
12

 
0.99
%
 
1,553

 
6

 
0.36
%
Investment securities(1)
44,993

 
1,241

 
2.76
%
 
39,090

 
962

 
2.46
%
 
28,482

 
691

 
2.43
%
Margin receivables
10,437

 
491

 
4.71
%
 
7,721

 
320

 
4.15
%
 
6,592

 
249

 
3.77
%
Loans(2)
2,405

 
128

 
5.31
%
 
3,194

 
157

 
4.93
%
 
4,351

 
191

 
4.39
%
Broker-related receivables and other
818

 
14

 
1.79
%
 
1,014

 
3

 
0.29
%
 
594

 
1

 
0.16
%
Subtotal interest-earning assets
60,012

 
1,900

 
3.17
%
 
53,216

 
1,463

 
2.75
%
 
43,272

 
1,145

 
2.65
%
Other interest revenue(3)

 
109

 
 
 

 
108

 
 
 

 
88

 
 
    Total interest-earning assets
60,012

 
2,009

 
3.35
%
 
53,216

 
1,571

 
2.95
%
 
43,272

 
1,233

 
2.85
%
Total non-interest-earning assets
4,428

 
 
 
 
 
4,979

 
 
 
 
 
4,864

 
 
 
 
Total assets
$
64,440

 
 
 
 
 
$
58,195

 
 
 
 
 
$
48,136

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Sweep deposits
$
38,039

 
$
42

 
0.11
%
 
$
33,775

 
$
4

 
0.01
%
 
$
26,088

 
$
3

 
0.01
%
Savings deposits
3,049

 
9

 
0.30
%
 
3,085

 

 
0.01
%
 
3,227

 

 
0.01
%
Other deposits
1,965

 

 
0.03
%
 
2,055

 

 
0.03
%
 
2,018

 

 
0.03
%
Customer payables
9,881

 
22

 
0.22
%
 
8,793

 
5

 
0.06
%
 
7,221

 
5

 
0.07
%
Broker-related payables and other
1,813

 
10

 
0.57
%
 
1,250

 

 
0.00
%
 
1,286

 

 
0.00
%
Other borrowings
745

 
25

 
3.30
%
 
665

 
22

 
3.33
%
 
416

 
18

 
4.32
%
Corporate debt
1,214

 
46

 
3.80
%
 
994

 
48

 
4.77
%
 
994

 
54

 
5.41
%
Subtotal interest-bearing liabilities
56,706

 
154

 
0.27
%
 
50,617

 
79

 
0.16
%
 
41,250

 
80

 
0.19
%
Other interest expense(4)

 
9

 
 
 

 
7

 
 
 

 
5

 
 
    Total interest-bearing liabilities
56,706

 
163

 
0.29
%
 
50,617

 
86

 
0.17
%
 
41,250

 
85

 
0.21
%
Total non-interest-bearing liabilities
896

 
 
 
 
 
1,058

 
 
 
 
 
954

 
 
 
 
Total liabilities
57,602

 
 
 
 
 
51,675

 
 
 
 
 
42,204

 
 
 
 
Total shareholders' equity
6,838

 
 
 
 
 
6,520

 
 
 
 
 
5,932

 
 
 
 
Total liabilities and shareholders' equity
$
64,440

 
 
 
 
 
$
58,195

 
 
 
 
 
$
48,136

 
 
 
 
Excess interest earning assets over interest bearing liabilities/net interest income/net interest margin
$
3,306

 
$
1,846

 
3.08
%
 
$
2,599

 
$
1,485

 
2.79
%
 
$
2,022

 
$
1,148

 
2.65
%
(1)
For the year ended December 31, 2018, includes a $19 million net loss related to fair value hedging adjustments, previously referred to as hedge ineffectiveness. Amounts prior to 2018 have not been reclassified to conform to current period presentation and continue to be reflected within the gains on securities and other, net line item. See Note 8—Derivative Instruments and Hedging Activities for additional information.
(2)
Nonaccrual loans are included in the average loan balances. Interest payments received on nonaccrual loans are recognized on a cash basis in interest income until it is doubtful that full payment will be collected, at which point payments are applied to principal.
(3)
Represents interest income on securities loaned.
(4)
Represents interest expense on securities borrowed.


E*TRADE 2018 10-K | Page 39
 
                    

Table of Contents    

 
Year Ended December 31,
 
2018
 
2017
 
2016
Ratio of interest-earning assets to interest-bearing liabilities
105.83
%
 
105.14
%
 
104.90
%
Return on average total assets
1.63
%
 
1.06
%
 
1.15
%
Return on average total shareholders’ equity(1)
15.38
%
 
9.42
%
 
9.30
%
Average total shareholders’ equity to average total assets
10.61
%
 
11.20
%
 
12.32
%
Dividend payout ratio(2)
3.59
%
 
%
 
%
(1)
Calculated by dividing net income by average total shareholders’ equity. As described in the Earnings Overview section below, the Company's return on common equity corporate metric is calculated by dividing net income available to common shareholders by average common shareholders' equity, which excludes preferred stock.
(2)
Calculated by dividing dividends declared per common share by basic earnings per share.
Average interest-earning assets increased 13% to $60.0 billion for the year ended December 31, 2018 compared to 2017. The fluctuation in interest-earning assets is generally driven by changes in interest-bearing liabilities, primarily deposits and customer payables. Average interest-bearing liabilities increased 12% to $56.7 billion for the year ended December 31, 2018 compared to 2017. The increase was driven by higher sweep deposits during 2018 and deposits assumed as part of the acquisition of TCA and retail brokerage accounts from Capital One, partially offset by customer net buying of $13.6 billion during the year ended December 31, 2018, compared to net buying of $9.2 billion during the same period in 2017.
Net interest margin increased 29 basis points to 3.08% for the year ended December 31, 2018 compared to 2017. Net interest margin is driven by the mix of average asset and liability balances and the interest rates earned or paid on those balances. The increase during the year ended December 31, 2018, compared to 2017 is due to higher interest rates earned on higher margin receivables and investment securities balances, partially offset by the continued run-off of our higher yielding legacy mortgage and consumer loan portfolio. Additionally, funding costs increased primarily due to increased rates paid on deposits, customer payables, and broker-related payables during the year ended December 31, 2018.
Average interest-earning assets increased 23% to $53.2 billion for the year ended December 31, 2017 compared to 2016. Average interest-bearing liabilities increased 23% to $50.6 billion for the year ended December 31, 2017 compared to 2016. The increase was primarily due to higher deposits as a result of transferring customer cash held by third parties to our balance sheet.
Commissions
Commissions revenue increased 13% to $498 million for the year ended December 31, 2018 compared to 2017, and decreased by less than 1% to $441 million for the year ended December 31, 2017 compared to 2016. The primary factors that affect commissions revenue are DARTs, average commission per trade and the number of trading days.
DARTs volume increased 32% to 282,243 for the year ended December 31, 2018 compared to 2017, and increased 31% to 214,284 for the year ended December 31, 2017 compared to 2016. The increase during the year ended December 31, 2018 was mainly driven by market sentiment along with the higher volatility of the equity markets. Derivative DARTs volume increased 39% to 90,811 for the year ended December 31, 2018 compared to 2017, and increased 54% to 65,264 for the year ended December 31, 2017 compared to 2016.
Average commission per trade decreased 14% to $7.07 for the year ended December 31, 2018 compared to 2017, and decreased 23% to $8.23 for the year ended December 31, 2017 compared to 2016. Average commission per trade is impacted by trade mix and differing commission rates on various trade types (e.g. equities, derivatives, stock plan and mutual funds). Average commission per trade for the years ended December 31, 2018 and 2017 was also impacted by reduced commission rates implemented in March 2017 as well as the continued migration of customers to lower active trader commission pricing.


E*TRADE 2018 10-K | Page 40
 
                    

Table of Contents    

Fees and Service Charges
The following table presents the significant components of fees and service charges (dollars in millions):    
 
Year Ended December 31,
 
Variance
 
Variance
 
 
2018 vs. 2017
 
2017 vs. 2016
 
2018
 
2017
 
2016
 
Amount
 
%
 
Amount
 
%
Order flow revenue
$
174

 
$
135

 
$
96

 
$
39

 
29
 %
 
$
39

 
41
%
Money market funds and sweep deposits revenue(1)
71

 
92

 
50

 
(21
)
 
(23
)%
 
42

 
84
%
Advisor management and custody fees
64

 
36

 
28

 
28

 
78
 %
 
8

 
29
%
Mutual fund service fees
48

 
39

 
36

 
9

 
23
 %
 
3

 
8
%
Foreign exchange revenue
25

 
26

 
21

 
(1
)
 
(4
)%
 
5

 
24
%
Reorganization fees
14

 
16

 
16

 
(2
)
 
(13
)%
 

 
%
Other fees and service charges
35

 
25

 
21

 
10

 
40
 %
 
4

 
19
%
Total fees and service charges
$
431

 
$
369

 
$
268

 
$
62

 
17
 %
 
$
101

 
38
%
(1)
Includes revenue earned on average customer cash held by third parties based on the federal funds rate or LIBOR plus a negotiated spread or other contractual arrangements with the third party institutions.
Fees and service charges increased 17% to $431 million for the year ended December 31, 2018 compared to 2017 and increased 38% to $369 million for the year ended December 31, 2017 compared to 2016. These increases were primarily driven by increased order flow revenue due to higher trade volume as well as increased advisor management and custody fees as a result of the acquisition of TCA and higher balances in our Managed Portfolios. The increase in 2018 was partially offset by decreased money market funds and sweep deposits revenue driven by lower customer cash balances held by third parties as a result of transferring cash onto our balance sheet during 2018. The impact of the lower balances was partially offset by a higher yield of approximately 140 basis points, 90 basis points and 40 basis points for the years ended December 31, 2018, 2017 and 2016, respectively.
Gains on Securities and Other, Net
The following table presents the significant components of gains on securities and other, net (dollars in millions):
 
Year Ended December 31,
 
Variance
 
Variance
 
 
2018 vs. 2017
 
2017 vs. 2016
 
2018
 
2017
 
2016
 
Amount
 
%
 
Amount
 
%
Gains on available-for-sale securities, net(1)
$
44

 
$
40

 
$
53

 
$
4

 
10
 %
 
$
(13
)
 
(25
)%
Equity method investment income (loss) and other(2)(3)
9

 
(12
)
 
(11
)
 
21

 
(175
)%
 
(1
)
 
9
 %
Gains on securities and other, net
$
53

 
$
28

 
$
42

 
$
25

 
89
 %
 
$
(14
)
 
(33
)%
(1)
In 2018, the Company sold available-for-sale securities and reinvested the sale proceeds in agency-backed securities at current market rates. See Note 6—Available-for-Sale and Held-to-Maturity Securities for additional information.
(2)
Includes a $5 million gain on the sale of our Chicago Stock Exchange investment for the year ended December 31, 2018.
(3)
Includes losses of $14 million and $6 million on hedge ineffectiveness for the years ended December 31, 2017 and 2016, respectively. Beginning January 1, 2018, fair value hedging adjustments are recognized within net interest income. See Note 1—Organization, Basis of Presentation and Summary of Significant Accounting Policies for additional information.


E*TRADE 2018 10-K | Page 41
 
                    

Table of Contents    

Provision (Benefit) for Loan Losses
We recognized a benefit for loan losses of $86 million, $168 million and $149 million for the years ended December 31, 2018, 2017 and 2016. The timing and magnitude of the provision (benefit) for loan losses is affected by many factors that could result in variability. These benefits reflected better than expected performance of our portfolio as well as recoveries in excess of prior expectations, including sales of charged-off loans and recoveries of previous charge-offs that were not included in our loss estimates. For additional information on management's estimate of the allowance for loan losses, see Note 7—Loans Receivable, Net.
Non-Interest Expense
The following table presents the significant components of non-interest expense (dollars in millions):
 
Year Ended December 31,
 
Variance
 
Variance
 
 
2018 vs. 2017
 
2017 vs. 2016
 
2018
 
2017
 
2016
 
Amount
 
%
 
Amount
 
%
Compensation and benefits
$
621

 
$
546

 
$
501

 
$
75

 
14
 %
 
$
45

 
9
 %
Advertising and market development
200

 
166

 
131

 
34

 
20
 %
 
35

 
27
 %
Clearing and servicing
126

 
124

 
105

 
2

 
2
 %
 
19

 
18
 %
Professional services
96

 
99

 
97

 
(3
)
 
(3
)%
 
2

 
2
 %
Occupancy and equipment
124

 
116

 
98

 
8

 
7
 %
 
18

 
18
 %
Communications
116

 
121

 
87

 
(5
)
 
(4
)%
 
34

 
39
 %
Depreciation and amortization
92

 
82

 
79

 
10

 
12
 %
 
3

 
4
 %
FDIC insurance premiums
30

 
31

 
25

 
(1
)
 
(3
)%
 
6

 
24
 %
Amortization of other intangibles
48

 
36

 
23

 
12

 
33
 %
 
13

 
57
 %
Restructuring and acquisition-related activities
7

 
15

 
35

 
(8
)
 
(53
)%
 
(20
)
 
(57
)%
Losses on early extinguishment of debt
4

 
58

 

 
(54
)
 
(93
)%
 
58

 
100
 %
Other non-interest expenses
77

 
76

 
71

 
1

 
1
 %
 
5

 
7
 %
Total non-interest expense
$
1,541

 
$
1,470

 
$
1,252

 
$
71

 
5
 %
 
$
218

 
17
 %
Compensation and Benefits
Compensation and benefits expense increased 14% to $621 million for the year ended December 31, 2018 compared to 2017, and increased 9% to $546 million for the year ended December 31, 2017 compared to 2016. The expense increase in 2018 was primarily driven by a 12% increase in headcount as a result of the TCA acquisition and to support the onboarding of the retail brokerage accounts from Capital One, as well as other growth in our business. The expense increase in 2017 was primarily driven by higher incentive compensation reflecting improved overall Company performance.
Advertising and Market Development
Advertising and market development expense increased 20% to $200 million for the year ended December 31, 2018 compared to 2017, and increased 27% to $166 million for the year ended December 31, 2017 compared to 2016. These planned increases were primarily due to higher media and brand production spend resulting from our increased focus on accelerating the growth of our business by increasing engagement across new and existing customers.


E*TRADE 2018 10-K | Page 42
 
                    

Table of Contents    

Amortization of Other Intangibles
Amortization of other intangibles expense increased 33% to $48 million for the year ended December 31, 2018 compared to 2017, and increased 57% to $36 million for the year ended December 31, 2017 compared to 2016. The increase during 2018 was primarily due to the addition of intangible assets recognized in connection with the acquisition of retail brokerage accounts from Capital One and the TCA acquisition. The increase during 2017 was due to the addition of other intangible assets recognized in connection with the OptionsHouse acquisition. See Note 2—Acquisitions and Restructuring for additional information.
Restructuring and Acquisition-Related Activities
Restructuring and acquisition-related activities decreased 53% to $7 million for the year ended December 31, 2018 compared to 2017, and decreased 57% to $15 million, for the year ended December 31, 2017 compared to 2016. Restructuring and acquisition-related expense during the year ended December 31, 2018 primarily includes costs incurred in connection with the restructuring of our regulatory and enterprise risk management functions due to bank regulatory reform and the closing of the TCA acquisition. The restructuring costs for the year ended December 31, 2017 primarily related to the integration of OptionsHouse.
Losses on Early Extinguishment of Debt
Losses on early extinguishment of debt were $4 million for the year ended December 31, 2018 compared to $58 million for the year ended December 31, 2017. There were no losses for the year ended December 31, 2016.
During the third quarter of 2018, we used the net proceeds from the June 2018 issuance of Senior Notes to redeem all $413 million of our outstanding TRUPs. In connection with the redemption, we recognized a loss on early extinguishment of debt of $4 million.
During the third quarter of 2017, we issued $600 million of 2.95% Senior Notes due 2022 and $400 million of 3.80% Senior Notes due 2027. We used the net proceeds, along with existing corporate cash, to redeem our outstanding $540 million of 5.375% Senior Notes and $460 million of 4.625% Senior Notes, which resulted in a $58 million loss on early extinguishment of debt.
Operating Margin
Operating margin was 49% for the year ended December 31, 2018 compared to 45% and 43% for the same period in 2017 and 2016. Adjusted operating margin, a non-GAAP measure, was 47% for the year ended December 31, 2018 compared to 40% and 35% in 2017 and 2016, respectively.


E*TRADE 2018 10-K | Page 43
 
                    

Table of Contents    

Adjusted operating margin is calculated by dividing adjusted income before income tax expense by total net revenue. Adjusted income before income tax expense, a non-GAAP measure, excludes provision (benefit) for loan losses and losses on early extinguishment of debt. The following table presents a reconciliation of adjusted income before income tax expense and adjusted operating margin, non-GAAP measures, to the most directly comparable GAAP measures (dollars in millions):
 
Year Ended December 31,
 
2018
 
2017
 
2016
 
Amount
 
Operating Margin %
 
Amount
 
Operating Margin %
 
Amount
 
Operating Margin %
Income before income tax expense / operating margin
$
1,418

 
49%
 
$
1,064

 
45%
 
$
838

 
43%
Add back impact of pre-tax items: