Edgar Filing: E TRADE FINANCIAL CORP

Form 10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2005

Commission file number 1-11921

E*TRADE Financial Corporation

(Exact name of registrant as specified in its charter)

Delaware

94-2844166

(State or other jurisdiction of

incorporation or organization)

(I.R.S. Employer

Identification Number)

135 East 57^th Street, New York, New York 10022

(Address of principal executive offices and zip code)

(646) 521-4300

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes x No ¨

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:

As of July 29, 2005, there were 370,953,106 shares of common stock and 1,300,157 shares exchangeable into common stock outstanding (the “Exchangeable Shares”). The Exchangeable Shares, which were issued by EGI Canada Corporation in connection with the acquisition of VERSUS Technologies, Inc. (renamed E*TRADE Technologies Corporation effective January 2, 2001), are exchangeable at any time into common stock on a one-for-one basis and entitle holders to dividend, voting, and other rights equivalent to holders of the registrant’s common stock.

E*TRADE FINANCIAL CORPORATION AND SUBSIDIARIES

FORM 10-Q QUARTERLY REPORT

For the Three Months Ended June 30, 2005

TABLE OF CONTENTS


		Page
PART I—FINANCIAL INFORMATION
Item 1.	Unaudited Condensed Consolidated Financial Statements	3
	Consolidated Balance Sheets	3
	Consolidated Statements of Operations	4
	Consolidated Statements of Comprehensive Income	5
	Consolidated Statements of Shareholders’ Equity	6
	Consolidated Statements of Cash Flows	7
	Notes to Unaudited Condensed Consolidated Financial Statements	9
	Note 1 – Organization and Basis of Presentation	9
	Note 2 – Recent Accounting Pronouncements	10
	Note 3 – Discontinued Operations	11
	Note 4 – Brokerage Receivables, Net and Payables	13
	Note 5 – Available-for-Sale Mortgage-Backed and Investment Securities	14
	Note 6 – Loans, Net	17
	Note 7 – Goodwill and Intangible Assets	18
	Note 8 – Deposits	18
	Note 9 – Other Borrowings by Bank Subsidiary	18
	Note 10 – Shareholders’ Equity	18
	Note 11 – Facility Restructuring and Other Exit Charges	19
	Note 12 – Income Per Share	21
	Note 13 – Regulatory Requirements	22
	Note 14 – Commitments, Contingencies and Other Regulatory Matters	23
	Note 15 – Accounting for Derivative Financial Instruments and Hedging Activities	25
	Note 16 – Segment Information	29
	Note 17 – Subsequent Event	33
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	34
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	54
Item 4.	Controls and Procedures	55

PART II—OTHER INFORMATION
Item 1.	Legal Proceedings	56
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	56
Item 3.	Defaults Upon Senior Securities	56
Item 4.	Submission of Matters to a Vote of Security Holders	56
Item 5.	Other Information	57
Item 6.	Exhibits	57
Signatures		58

Unless otherwise indicated, references to “the Company,” “We,” “Our” and “E*TRADE” mean E*TRADE Financial Corporation and its subsidiaries.

E*TRADE, E*TRADE FINANCIAL, E*TRADE Bank, ClearStation, Equity Edge, Equity Resource, OptionsLink and the converging arrows logo, are registered trademarks of E*TRADE Financial Corporation in the United States and in other countries.

PART I. FINANCIAL INFORMATION

ITEM 1. UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

E*TRADE FINANCIAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(in thousands, except share amounts)

(unaudited)


	June 30, 2005			December 31, 2004
ASSETS
Cash and equivalents (includes repurchase agreements of $249,160 at June 30, 2005 and none at December 31, 2004)	$	1,095,378		$	939,906
Cash and investments required to be segregated under Federal or other regulations (includes repurchase agreements of $224,000 at June 30, 2005 and none at December 31, 2004)		1,461,706			724,026
Brokerage receivables, net		3,459,047			3,034,548
Trading securities		213,816			593,245
Available-for-sale mortgage-backed and investment securities (includes securities pledged to creditors with the right to sell or repledge of $9,294,979 at June 30, 2005 and $10,113,049 at December 31, 2004)		11,065,629			12,543,818
Other investments		52,004			46,269
Loans receivable (net of allowance for loan losses of $55,418 at June 30, 2005 and $47,681 at December 31, 2004)		15,706,553			11,505,755
Loans held-for-sale, net		125,657			279,280
Property and equipment, net		306,611			302,291
Derivative assets		186,474			115,867
Accrued interest receivable		139,140			117,131
Investment in Federal Home Loan Bank Stock		197,395			92,005
Goodwill		396,282			395,043
Other intangibles, net		126,980			134,121
Other assets		408,639			209,278

Total assets	$	34,941,311		$	31,032,583

LIABILITIES AND SHAREHOLDERS’ EQUITY
Brokerage payables	$	4,695,629		$	3,618,892
Deposits		13,057,010			12,302,974
Securities sold under agreements to repurchase		9,350,983			9,897,191
Other borrowings by Bank subsidiary		4,087,749			1,760,732
Derivative liabilities		130,693			52,208
Senior notes		400,258			400,452
Convertible subordinated notes		185,165			185,165
Accounts payable, accrued and other liabilities		724,036			586,767

Total liabilities		32,631,523			28,804,381

Commitments and contingencies		—			—
Shareholders’ equity:
Preferred stock, shares authorized: 1,000,000; issued and outstanding: none at June 30, 2005 and December 31, 2004		—			—
Shares exchangeable into common stock, $0.01 par value, shares authorized: 10,644,223; issued and outstanding: 1,300,301 at June 30, 2005 and 1,302,801 at December 31 2004		13			13
Common stock, $0.01 par value, shares authorized: 600,000,000; issued and outstanding: 369,264,680 at June 30, 2005 and 369,623,604 at December 31, 2004		3,693			3,696
Additional paid-in capital		2,217,522			2,234,093
Deferred stock compensation		(22,089	)		(18,419	)
Retained earnings		343,579			150,018
Accumulated other comprehensive loss		(232,930	)		(141,199	)

Total shareholders’ equity		2,309,788			2,228,202

Total liabilities and shareholders’ equity	$	34,941,311		$	31,032,583

See accompanying notes to unaudited condensed consolidated financial statements.

E*TRADE FINANCIAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share amounts)

(unaudited)


	Three Months Ended June 30,						Six Months Ended June 30,
	2005			2004			2005			2004
Revenues:
Commissions	$	102,051		$	105,319		$	216,227		$	248,032
Principal transactions		21,753			33,947			51,754			67,026
Gain on sales of loans and securities, net		17,256			46,222			62,271			78,663
Service charges and fees		34,531			26,692			67,903			51,592
Other revenues		20,585			22,901			44,797			47,456


Interest income		387,807			273,926			724,390			529,560
Interest expense		(179,640	)		(120,038	)		(328,431	)		(240,764	)

Net interest income		208,167			153,888			395,959			288,796
Provision for loan losses		(12,997	)		(7,501	)		(25,037	)		(16,556	)

Net interest income after provision for loan losses		195,170			146,387			370,922			272,240

Total net revenues		391,346			381,468			813,874			765,009

Expenses excluding interest:
Compensation and benefits		85,917			91,695			179,623			184,325
Occupancy and equipment		17,787			17,790			36,071			35,967
Communications		19,817			17,394			37,245			35,813
Professional services		16,201			14,989			35,608			28,809
Commissions, clearance and floor brokerage		34,344			39,399			70,158			81,042
Advertising and market development		26,482			13,700			53,069			36,520
Servicing and other banking expenses		11,499			8,714			21,678			17,012
Fair value adjustments of financial derivatives		1,748			(2,395	)		2,636			(2,121	)
Depreciation and amortization		18,246			19,829			35,572			39,433
Amortization of other intangibles		4,649			5,078			9,894			10,602
Facility restructuring and other exit charges		407			(34	)		964			(1,006	)
Other		14,849			20,517			40,577			44,581

Total expenses excluding interest		251,946			246,676			523,095			510,977

Income before other income, income taxes and discontinued operations		139,400			134,792			290,779			254,032

Other income:
Corporate interest income		2,425			1,694			4,387			3,057
Corporate interest expense		(11,625	)		(12,540	)		(23,192	)		(23,878	)
Gain on sale and impairment of investments		30,688			31,728			46,230			60,277
Loss on early extinguishment of debt		—			(4,357	)		—			(4,357	)
Equity in income of investments and venture funds		1,398			440			4,039			2,992

Total other income		22,886			16,965			31,464			38,091

Income before income taxes and discontinued operations		162,286			151,757			322,243			292,123
Income tax expense		54,019			48,848			112,209			98,795
Minority interest in subsidiaries		6			89			56			829

Net income from continuing operations		108,261			102,820			209,978			192,499

Discontinued operations, net of tax:
Net loss from discontinued operations		(4,103	)		(11,158	)		(13,826	)		(12,362	)
Net gain (loss) on disposal of discontinued operations		(2,591	)		31,244			(2,591	)		31,244

Net income (loss) from discontinued operations		(6,694	)		20,086			(16,417	)		18,882

Net income	$	101,567		$	122,906		$	193,561		$	211,381

Basic income per share
Basic income per share from continuing operations	$	0.30		$	0.28		$	0.57		$	0.53
Basic income (loss) per share from discontinued operations	$	(0.02	)	$	0.06		$	(0.04	)	$	0.05

Basic net income per share	$	0.28		$	0.34		$	0.53		$	0.58

Diluted income per share
Diluted income per share from continuing operations	$	0.29		$	0.26		$	0.55		$	0.50
Diluted income (loss) per share from discontinued operations	$	(0.02	)	$	0.05		$	(0.04	)	$	0.04

Diluted net income per share	$	0.27		$	0.31		$	0.51		$	0.54

Shares used in computation of per share data:
Basic		365,180			365,072			365,643			364,939
Diluted		376,345			416,713			377,511			420,841

See accompanying notes to unaudited condensed consolidated financial statements.

E*TRADE FINANCIAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(in thousands)

(unaudited)


	Three Months Ended June 30,						Six Months Ended June 30,
	2005			2004			2005			2004
Net income	$	101,567		$	122,906		$	193,561		$	211,381

Other comprehensive loss:
Available-for-sale securities:
Unrealized gains (losses)		115,997			(243,628	)		72,840			(126,782	)
Less impact of realized gains (transferred out of AOCI) included in net income		(41,181	)		(37,586	)		(78,576	)		(92,334	)
Tax effect		(28,424	)		114,142			1,255			93,867

Net change from available-for-sale securities		46,392			(167,072	)		(4,481	)		(125,249	)

Cash flow hedging instruments:
Unrealized gains (losses)		(216,171	)		217,909			(161,155	)		108,902
Amortization of losses into interest expense from de-designated cash flow hedges deferred in AOCI		19,958			23,119			43,434			48,134
Tax effect		74,948			(93,801	)		44,959			(60,999	)

Net change from cash flow hedging instruments		(121,265	)		147,227			(72,762	)		96,037

Foreign currency translation loss		(6,792	)		(8,598	)		(14,488	)		(9,132	)

Other comprehensive loss		(81,665	)		(28,443	)		(91,731	)		(38,344	)

Comprehensive income	$	19,902		$	94,463		$	101,830		$	173,037

See accompanying notes to unaudited condensed consolidated financial statements.

E*TRADE FINANCIAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

(in thousands)

(unaudited)


	Shares Exchangeable into Common Stock					Common Stock					Additional Paid-in Capital			Deferred Stock Compensation			Retained Earnings			Accumulated Other Comprehensive Loss			Total Shareholders’ Equity
	Shares		Amount			Shares		Amount			Additional Paid-in Capital			Deferred Stock Compensation			Retained Earnings			Accumulated Other Comprehensive Loss			Total Shareholders’ Equity
Balance, December 31, 2004	1,303		$	13		369,624		$	3,696		$	2,234,093		$	(18,419	)	$	150,018		$	(141,199	)	$	2,228,202
Net income																		193,561						193,561
Other comprehensive loss																					(91,731	)		(91,731	)
Exercise of stock options and warrants, including tax benefit						2,994			30			24,298												24,328
Issuance of common stock upon acquisition						220			2			2,739												2,741
Repurchases of common stock						(3,951	)		(39	)		(48,902	)											(48,941	)
Issuance of restricted stock						748			7			8,593			(8,600	)								—
Cancellation of restricted stock						(341	)		(3	)		(2,953	)		2,956									—
Retirement of restricted stock to pay taxes						(32	)		—			(448	)											(448	)
Amortization of deferred stock compensation															1,974									1,974
Other	(3	)		—		3			—			102												102

Balance, June 30, 2005	1,300		$	13		369,265		$	3,693		$	2,217,522		$	(22,089	)	$	343,579		$	(232,930	)	$	2,309,788


	Shares Exchangeable into Common Stock					Common Stock					Additional Paid-in Capital			Deferred Stock Compensation			Retained Earnings			Accumulated Other Comprehensive Loss			Total Shareholders’ Equity
	Shares		Amount			Shares		Amount			Additional Paid-in Capital			Deferred Stock Compensation			Retained Earnings			Accumulated Other Comprehensive Loss			Total Shareholders’ Equity
Balance, December 31, 2003	1,386		$	14		366,636		$	3,666		$	2,247,930		$	(12,874	)	$	(230,465	)	$	(89,977	)	$	1,918,294
Net income																		211,381						211,381
Other comprehensive loss																					(38,344	)		(38,344	)
Exercise of stock options and warrants, including tax benefit						5,860			59			39,934												39,993
Repurchases of common stock						(7,855	)		(79	)		(99,919	)											(99,998	)
Issuance of restricted stock						698			7			8,201			(8,108	)								100
Cancellation of restricted stock						(138	)		(1	)		(1,181	)		859									(323	)
Shares issued upon debt conversion						7,242			72			77,762												77,834
Amortization of deferred stock compensation															1,931									1,931
Other	(60	)		(1	)	60			1			3,018												3,018

Balance, June 30, 2004	1,326		$	13		372,503		$	3,725		$	2,275,745		$	(18,192	)	$	(19,084	)	$	(128,321	)	$	2,113,886

See accompanying notes to unaudited condensed consolidated financial statements.

E*TRADE FINANCIAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)


	Six Months Ended June 30,
	2005			2004
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income	$	193,561		$	211,381
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses		25,037			16,556
Depreciation, amortization and accretion		186,422			200,485
Realized loss and impairment of investments		30,950			8,651
Equity in income of subsidiaries and investments		(3,324	)		(7,927	)
Non-cash restructuring costs and other exit charges		4,785			1,278
Amortization of deferred stock compensation		1,974			1,931
Gain on sale of investments		(131,115	)		(205,621	)
Unrealized (gains) losses on venture funds		(950	)		4,793
Other		(12,370	)		(4,516	)
Net effect of changes in brokerage-related assets and liabilities:
Decrease (increase) in cash and investments required to be segregated under Federal or other regulations		(757,411	)		275,146
Increase in brokerage receivables		(472,993	)		(1,369,697	)
Increase in brokerage payables		1,167,407			1,056,394
Net effect of changes in banking-related assets and liabilities:
Proceeds from sales, repayments and maturities of loans held-for-sale		2,076,535			3,946,166
Purchases of loans held-for-sale		(1,998,063	)		(3,345,746	)
Proceeds from sales, repayments and maturities of trading securities		4,171,506			5,604,384
Purchases of trading securities		(3,808,339	)		(5,559,038	)
Other changes, net:
Increase in other assets		(23,965	)		(11,352	)
Accrued interest receivable and payable, net		(24,096	)		6,928
Increase in accounts payable, accrued and other liabilities		9,492			41,459
Decrease in restructuring liabilities		(3,823	)		(9,377	)

Net cash provided by operating activities from continuing operations	$	631,220		$	862,278

See accompanying notes to unaudited condensed consolidated financial statements.

E*TRADE FINANCIAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS—(Continued)

(in thousands)

(unaudited)


	Six Months Ended June 30,
	2005			2004
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of mortgage-backed securities, available-for-sale securities and other investments	$	(7,594,410	)	$	(12,872,329	)
Proceeds from sales, maturities of and principal payments on mortgage-backed securities, available-for-sale securities and other investments		9,079,924			10,906,708
Net increase in loans receivable		(4,172,459	)		(1,475,674	)
Purchases of FHLB stock		(105,390	)		(21,224	)
Purchases of property and equipment		(37,641	)		(43,186	)
Proceeds from sales of property and equipment		—			200
Proceeds from venture fund distributions		12,553			—
Net cash flow from derivatives hedging assets		(87,522	)		(12,372	)
Proceeds from sale of E*TRADE Access		—			106,868
Cash used in acquisitions		(4,937	)		—
Other		3,187			(831	)

Net cash used in investing activities from continuing operations		(2,906,695	)		(3,411,840	)

CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase (decrease) in banking deposits		768,111			(677,211	)
Advances from the Federal Home Loan Bank		13,151,000			1,046,000
Payments on advances from the Federal Home Loan Bank		(10,809,000	)		(823,000	)
Net increase (decrease) in securities sold under agreements to repurchase		(550,593	)		3,127,930
Net decrease (increase) in other borrowed funds		(14,714	)		3,610
Payments on call of convertible subordinated notes		—			(83,427	)
Proceeds from issuance of senior notes		—			394,000
Repayments on loans to related parties, net of loans issued		—			(241	)
Proceeds from issuance of common stock from employee stock transactions		18,403			27,635
Proceeds from issuance of subordinated debentures and trust preferred securities		—			45,880
Purchases of treasury stock		(48,941	)		(99,998	)
Repayment of capital lease obligations		(93	)		(475	)
Net cash flow from derivatives hedging liabilities		(83,226	)		(110,699	)

Net cash provided by financing activities from continuing operations		2,430,947			2,850,004

CASH FLOWS FROM DISCONTINUED OPERATIONS		—			21,765

INCREASE IN CASH AND EQUIVALENTS		155,472			322,207
CASH AND EQUIVALENTS—Beginning of period		939,906			921,364

CASH AND EQUIVALENTS—End of period	$	1,095,378		$	1,243,571

SUPPLEMENTAL DISCLOSURES:
Cash paid for interest	$	346,509		$	200,077

Cash paid for income taxes	$	64,587		$	35,978

Non-cash investing and financing activities:
Tax benefit on exercise of stock options	$	5,925		$	12,207

Reclassification of loans held-for-sale to loans held-for-investment	$	98,955		$	—

Transfer from loans to other real estate owned and repossessed assets	$	25,247		$	21,863

Common stock issued upon conversion of convertible subordinated notes by election of debtholders	$	—		$	77,834

See accompanying notes to unaudited condensed consolidated financial statements.

E*TRADE FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1—ORGANIZATION AND BASIS OF PRESENTATION

Organization

E*TRADE Financial Corporation (the “Company,” “Parent” or “E*TRADE FINANCIAL”) is a family of companies that provide financial services including trading, investing, banking and lending for retail and institutional customers.

Trading and investing products and services are primarily offered by the Company’s broker-dealer subsidiaries. The Company’s significant broker-dealers include:

•

E*TRADE Securities LLC (“E*TRADE Securities”);

•

E*TRADE Clearing LLC (“E*TRADE Clearing”), the clearing firm for the Company’s broker-dealers;

•

E*TRADE Professional Trading, LLC and E*TRADE Professional Securities, LLC which was closed on May 31, 2005 (collectively “E*TRADE Professional”); and

•

E*TRADE Capital Markets—Execution Services, LLC and E*TRADE Capital Markets, LLC (collectively, “E*TRADE Capital Markets”), formerly Dempsey & Company and GVR, respectively.

Banking and lending products and services are primarily offered through subsidiaries of E*TRADE Bank (the “Bank”), a Federally chartered savings bank that provides deposit accounts that are insured by the Federal Deposit Insurance Corporation (“FDIC”). The Bank’s significant subsidiaries include:

•

E*TRADE Consumer Finance Corporation (“E*TRADE Consumer Finance”), a consumer loan originator and servicer; and

•

E*TRADE Mortgage Corporation (“E*TRADE Mortgage”), a direct-to-customer mortgage loan originator.

Basis of Presentation

These condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and Regulation S-X, Article 10 under the Securities Exchange Act of 1934. They are unaudited and exclude some of the disclosures for annual financial statements. Management believes it has made all necessary adjustments so that the financial statements are presented fairly. The results of operations for the three and six months ended June 30, 2005 may not be indicative of future results. Certain prior period items in these condensed consolidated financial statements have been reclassified to conform to the current period presentation. As discussed in Note 3, the operations of certain businesses have been accounted for as discontinued operations in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. Accordingly, results of operations from prior periods have been reclassified to discontinued operations. Unless noted, discussions herein pertain to the Company’s continuing operations. Because the Company operates in the financial services industry, it follows certain accounting guidance used by the brokerage and banking industries.

These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements of E*TRADE Financial Corporation included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2004.

NOTE 2—RECENT ACCOUNTING PRONOUNCEMENTS

SFAS No. 154—Accounting Changes and Error Corrections

In June 2005, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 154, Accounting Changes and Error Corrections. This statement supersedes Accounting Principles Board (“APB”) Opinion No. 20, Accounting Changes, and SFAS No. 3, Reporting Accounting Changes in Interim Financial Statements. The statement applies to all voluntary changes in accounting principle, and changes the requirements for accounting for and reporting of a change in accounting principle. SFAS No. 154 requires retrospective application to prior periods’ financial statements of a voluntary change in accounting principle unless it is impracticable. The statement requires that a change in method of depreciation, amortization, or depletion for long-lived, nonfinancial assets be accounted for as a change in accounting estimate that is effected by a change in accounting principle. SFAS No. 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The statement does not change the transition provisions of any existing accounting pronouncements, including those that are in a transition phase as of the effective date of this statement. The Company will adopt SFAS No. 154, as applicable, beginning in fiscal year 2006.

SFAS No. 123(R)—Share-Based Payment

In December 2004, FASB issued SFAS No. 123 (Revised 2004), Share-Based Payment. This statement supersedes APB Opinion No. 25, and its related implementation guidance. The statement establishes standards for the accounting for transactions in which an entity exchanges its equity instruments for goods and services. This statement focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. The most significant change resulting from this statement is the requirement for public companies to expense employee share-based payments at their fair value through earnings as such options vest. This statement was originally effective for public companies as of the beginning of the first interim or annual reporting period that begins after June 15, 2005. In April 2005, the Securities and Exchange Commission (“SEC”) announced that the effective date was delayed to no later than fiscal years beginning after June 15, 2005. The Company currently plans to adopt this statement effective July 1, 2005, using the modified prospective transition method, but has not made a final decision at this time. Upon adoption of SFAS No. 123(R), the Company will recognize approximately $6 million to $9 million in pre-tax compensation expense per quarter for the remainder of fiscal year 2005. Note 10 contains the pro forma effect on net income had the Company adopted the provisions of SFAS No. 123, for each period presented.

SAB No. 107—Share-Based Payment

In March 2005, the Securities and Exchange Commission (“SEC”) staff issued Staff Accounting Bulletin (“SAB”) No. 107, Share-Based Payment, which expresses the SEC staff’s views on SFAS No. 123(R). In particular, SAB No. 107 describes the SEC staff’s views on share-based payment transactions with non-employees; topics relating to valuation methods such as guidance regarding estimates of expected volatility and term; the classification of compensation expense; non-GAAP financial measures in the financial statements; capitalization of compensation cost related to share-based payment arrangements; first time adoption of SFAS No. 123(R) in an interim period; accounting for income tax effects of share-based payment arrangements upon adoption of SFAS No. 123(R); the modification of employee share options prior to adoption of SFAS No. 123(R) and disclosure in the MD&A subsequent to adoption of SFAS No. 123(R). The Company will adopt SAB No. 107 in conjunction with its adoption of SFAS No. 123(R).

SOP No. 03-3—Accounting for Certain Loans or Debt Securities Acquired in a Transfer

In December 2003, the Accounting Standards Executive Committee of the American Institute of Certified Public Accountants issued SOP No. 03-3, Accounting for Certain Loans or Debt Securities Acquired in a Transfer to address accounting for differences between the contractual cash flows of certain loans and debt securities and the cash flows expected to be collected when loans or debt securities are acquired in a transfer and

those cash flow differences are attributable, at least in part, to credit quality. As such, SOP No. 03-3 applies to loans and debt securities purchased or acquired in purchase business combinations and does not apply to originated loans. The application of SOP No. 03-3 limits the interest income, including accretion of purchase price discounts, that may be recognized for certain loans and debt securities. Additionally, SOP No. 03-3 requires that the excess of contractual cash flows over cash flows expected to be collected (nonaccretable difference) not be recognized as an adjustment of yield or valuation allowance, such as the allowance for credit losses. Subsequent to the initial investment, increases in expected cash flows generally should be recognized prospectively through adjustment of the yield on the loan or debt security over its remaining life. Decreases in expected cash flows should be recognized as impairment. SOP No. 03-3 is effective for loans and debt securities acquired in fiscal years beginning after December 15, 2004, with early application encouraged. In 2005, the Company adopted this new pronouncement, which effect was not material to the Company’s financial condition, results of operations, or cash flows.

NOTE 3—DISCONTINUED OPERATIONS

Proprietary Trading

On May 9, 2005, the Company’s institutional segment closed its E*TRADE Professional unit responsible for both proprietary and hybrid proprietary trading models. In June 2005, the Company filed to withdraw its broker-dealer license related to this business, for E*TRADE Professional Securities, LLC (“ETPS”) with an effective date of May 31, 2005. ETPS was a Philadelphia Stock Exchange member and a standalone entity which employed less than 200 traders. This closure resulted in a $2.6 million, net of tax, loss on disposal of discontinued operations, which included employee terminations, facility closure and write-off of goodwill and intangibles.

The Company will not have significant continuing involvement in the operations of this proprietary trading business and will not continue any significant revenue-producing or cost-generating activities of this proprietary trading business. Therefore, the results of operations, net of income taxes, of this proprietary trading business are presented as discontinued operations on the Company’s unaudited consolidated statements of operations for all periods presented.

The following table summarizes the results of discontinued operations for this proprietary trading business (in thousands):


	Three Months Ended June 30,						Six Months Ended June 30,
	2005			2004			2005			2004
Revenues	$	2,398		$	7,829		$	6,996		$	14,384

Loss from discontinued operations before income taxes	$	(1,992	)	$	(2,068	)	$	(5,804	)	$	(3,438	)
Income tax benefit		(783	)		(900	)		(2,289	)		(1,496	)

Net loss from discontinued operations	$	(1,209	)	$	(1,168	)	$	(3,515	)	$	(1,942	)

Total assets of this proprietary trading business were $5.6 million and $36.1 million at June 30, 2005 and December 31, 2004, respectively. Total liabilities of this proprietary trading business were $5.4 million and $29.8 million at June 30, 2005 and December 31, 2004, respectively.

Consumer Lending

During the three months ended June 30, 2005, the Company’s retail segment decided to sell its recreational vehicle and marine loan origination and servicing businesses. The Company is currently in negotiations with potential buyers for these businesses.

Upon sale of the origination business, the Company will not have significant continuing involvement in the operations and will not continue any significant revenue-producing or cost-generating activities of this origination business. Therefore, the results of operations, net of income taxes, of this origination business are presented as discontinued operations on the Company’s unaudited consolidated statements of operations for all periods presented.

Upon sale of the servicing business, the Company will not have significant continuing involvement in the operations, but will continue to have significant cost-generating activities in the form of a servicing agreement. As such, classification of the servicing business as a discontinued operation is not appropriate and thus, is classified as “held-for-sale”.

The following table summarizes the results of discontinued operations for this origination business (in thousands):


	Three Months Ended June 30,						Six Months Ended June 30,
	2005			2004			2005			2004
Revenues	$	121		$	(8,444	)	$	(6,733	)	$	1,934

Loss from discontinued operations before income taxes	$	(4,687	)	$	(16,800	)	$	(16,699	)	$	(15,663	)
Income tax benefit		(1,793	)		(6,754	)		(6,388	)		(6,297	)

Net loss from discontinued operations	$	(2,894	)	$	(10,046	)	$	(10,311	)	$	(9,366	)

NOTE 4—BROKERAGE RECEIVABLES, NET AND PAYABLES

Brokerage receivables, net and payables consist of the following (in thousands):


	June 30, 2005		December 31, 2004
Receivable from customers and non-customers (less allowance for doubtful accounts of $4,742 at June 30, 2005 and $1,970 at December 31, 2004)	$	2,287,352	$	2,214,210
Receivable from brokers, dealers and clearing organizations:
Net settlement and deposits with clearing organizations		125,850		158,780
Deposits paid for securities borrowed		1,000,317		613,546
Securities failed to deliver		9,621		11,762
Other		35,907		36,250

Total brokerage receivables, net	$	3,459,047	$	3,034,548

Payable to customers and non-customers	$	3,553,681	$	2,805,662
Payable to brokers, dealers and clearing organizations:
Deposits received for securities loaned		1,079,509		735,622
Securities failed to receive		5,193		10,604
Other		57,246		67,004

Total brokerage payables	$	4,695,629	$	3,618,892

Receivable from customers primarily represents credit extended to customers to finance their purchases of securities on margin, as well as commission receivables from customers upon settlement of their trades. Receivable from non-customers primarily represents credit extended to principal officers and directors of the Company to finance their purchase of securities on margin. Securities owned by customers and non-customers are held as collateral for amounts due on margin balances, the value of which is not reflected in the consolidated balance sheets. In many cases, the Company is permitted to sell or repledge these securities held as collateral and use the securities to enter into securities lending transactions, to collateralize borrowings or for delivery to counterparties to cover customer short positions. At June 30, 2005, the fair value of securities that the Company has received as collateral, where the Company is permitted to sell or repledge the securities is approximately $4,021 million. Of this amount, $1,421 million has been pledged or sold at June 30, 2005 in connection with securities loans, bank borrowings and deposits with clearing organizations.

Receivable from and payable to brokers, dealers and clearing organizations result from the Company’s brokerage activities. Payable to customers and non-customers represents free credit balances and other customer and non-customer funds pending completion of securities transactions. The Company pays interest on certain customer and non-customer credit balances.

NOTE 5—AVAILABLE-FOR-SALE MORTGAGE-BACKED AND INVESTMENT SECURITIES

The amortized cost basis and estimated fair values of available-for-sale mortgage-backed and investment securities are shown in the following table (in thousands):


	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Estimated Fair Values
June 30, 2005:
Mortgage-backed securities:
U.S. Government sponsored enterprise obligations:
Federal National Mortgage Association	$	5,413,281	$	2,328	$	(66,512	)	$	5,349,097
Government National Mortgage Association		2,459,388		—		(49,666	)		2,409,722
Federal Home Loan Mortgage Corporation		21,052		—		(426	)		20,626

Total U.S. Government sponsored enterprise		7,893,721		2,328		(116,604	)		7,779,445
Collateralized mortgage obligations		1,103,477		535		(23,951	)		1,080,061
Private issuer and other		5,357		26		(222	)		5,161

Total mortgage-backed securities		9,002,555		2,889		(140,777	)		8,864,667

Investment securities:
Debt securities:
Asset-backed securities		1,513,544		7,998		(14,263	)		1,507,279
Municipal bonds		129,245		2,180		(131	)		131,294
Corporate bonds		75,455		—		(3,342	)		72,113
Other debt securities		80,533		—		(3,140	)		77,393

Total debt securities		1,798,777		10,178		(20,876	)		1,788,079
Publicly traded equity securities		310,722		77,877		(1,643	)		386,956
Retained interests from securitizations		23,665		2,262		—			25,927

Total investment securities		2,133,164		90,317		(22,519	)		2,200,962

Total available-for-sale securities	$	11,135,719	$	93,206	$	(163,296	)	$	11,065,629

December 31, 2004:
Mortgage-backed securities:
U.S. Government sponsored enterprise obligations:
Federal National Mortgage Association	$	5,149,991	$	203	$	(87,990	)	$	5,062,204
Government National Mortgage Association		2,767,087		349		(56,628	)		2,710,808
Federal Home Loan Mortgage Corporation		21,057		—		(862	)		20,195

Total U.S. Government sponsored enterprise		7,938,135		552		(145,480	)		7,793,207
Collateralized mortgage obligations		1,259,497		4,983		(12,539	)		1,251,941
Private issuer and other		7,239		25		(343	)		6,921

Total mortgage-backed securities		9,204,871		5,560		(158,362	)		9,052,069

Investment securities:
Debt securities:
Asset-backed securities		2,789,471		21,662		(14,704	)		2,796,429
Municipal bonds		136,362		1,391		(1,082	)		136,671
Corporate bonds		87,959		—		(3,444	)		84,515
Other debt securities		80,189		—		(4,767	)		75,422

Total debt securities		3,093,981		23,053		(23,997	)		3,093,037
Publicly traded equity securities		295,593		81,304		(2,055	)		374,842
Retained interests from securitizations		23,870		—		—			23,870

Total investment securities		3,413,444		104,357		(26,052	)		3,491,749

Total available-for-sale securities	$	12,618,315	$	109,917	$	(184,414	)	$	12,543,818

Other-Than-Temporary Impairment of Investments

The following table shows the fair value and unrealized losses on investments, aggregated by investment category and the length of time that individual securities have been in a continuous unrealized loss position (in thousands):


	Less than 12 months					12 months or more					Total
	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses			Fair Value		Unrealized Losses
June 30, 2005:
Mortgage-backed securities:
U.S. Government sponsored enterprise	$	3,107,833	$	(51,140	)	$	2,825,588	$	(65,464	)	$	5,933,421	$	(116,604	)
Other		525,332		(18,062	)		386,890		(6,111	)		912,222		(24,173	)

Total mortgage-backed securities		3,633,165		(69,202	)		3,212,478		(71,575	)		6,845,643		(140,777	)

Investment securities:
Asset-backed securities		587,019		(3,404	)		104,580		(10,859	)		691,599		(14,263	)
Municipal bonds		—		—			23,409		(131	)		23,409		(131	)
Corporate bonds		—		—			72,113		(3,342	)		72,113		(3,342	)
Other debt securities		—		—			76,090		(3,140	)		76,090		(3,140	)
Publicly traded equity securities		22,661		(699	)		5,317		(944	)		27,978		(1,643	)

Total investment securities		609,680		(4,103	)		281,509		(18,416	)		891,189		(22,519	)

Total temporarily impaired securities	$	4,242,845	$	(73,305	)	$	3,493,987	$	(89,991	)	$	7,736,832	$	(163,296	)

December 31, 2004:
Mortgage-backed securities:
U.S. Government sponsored enterprise	$	5,504,676	$	(85,020	)	$	2,135,727	$	(60,460	)	$	7,640,403	$	(145,480	)
Other		704,369		(6,715	)		175,678		(6,167	)		880,047		(12,882	)

Total mortgage-backed securities		6,209,045		(91,735	)		2,311,405		(66,627	)		8,520,450		(158,362	)

Investment securities:
Asset-backed securities		771,250		(5,851	)		20,769		(8,853	)		792,019		(14,704	)
Municipal bonds		72,146		(1,082	)		—		—			72,146		(1,082	)
Corporate bonds		—		—			84,515		(3,444	)		84,515		(3,444	)
Other debt securities		—		—			74,700		(4,767	)		74,700		(4,767	)
Publicly traded equity securities		52,717		(2,055	)		—		—			52,717		(2,055	)

Total investment securities		896,113		(8,988	)		179,984		(17,064	)		1,076,097		(26,052	)

Total temporarily impaired securities	$	7,105,158	$	(100,723	)	$	2,491,389	$	(83,691	)	$	9,596,547	$	(184,414	)

The Company regularly analyzes certain available-for-sale investments for other-than-temporary impairment in accordance with its accounting policies, which can be found in the Company’s Annual Report on Form 10-K for the year ended December 31, 2004. The Company has the intent and ability to hold these securities for the foreseeable future and has not made the decision to dispose of these securities as of June 30, 2005. Based on its evaluation, the Company recorded other-than-temporary charges of $30.8 million and $30.9 million for the three and six months ended June 30, 2005, respectively. For the three and six months ended June 30, 2004, the Company recorded other-than-temporary charges of $0.3 million and $4.3 million, respectively.

Publicly Traded Equity Securities

The following table shows the fair value and unrealized gains (losses) on publicly traded equity securities (in thousands):


	Fair Value		Unrealized Gains (Losses)
June 30, 2005:
Federal National Mortgage Association	$	188,572	$	269
Federal Home Loan Mortgage Corporation		101,062		(874	)
International Securities Exchange		41,578		40,626
Softbank Investment Corporation		36,287		29,790
E*TRADE Japan		9,086		(786	)
E*TRADE Australia		6,988		5,601
Other		3,383		1,608

Total publicly traded equity securities	$	386,956	$	76,234

December 31, 2004:
Federal National Mortgage Association	$	187,610	$	(693	)
Federal Home Loan Mortgage Corporation		87,009		1,107
Softbank Investment Corporation		78,608		66,257
Archipelago Holdings, Incorporated		11,280		5,612
E*TRADE Australia		8,156		6,769
Other		2,179		197

Total publicly traded equity securities	$	374,842	$	79,249

During the three and six months ended June 30, 2005, the Company recognized gains on sales of its publicly traded equity securities of $30.8 million and $46.0 million, respectively. These gains included $12.6 million and $27.8 million, for the three and six months ended June 30, 2005, respectively, on sales of Softbank Investment Corporation (“SBI”), reducing the Company’s ownership to 1.55%; sales of all of its holdings in Archipelago, recognizing gains of $9.8 million; and sales of all of its holdings in Ameritrade Holding Corporation, recognizing gains of $8.4 million.

NOTE 6—LOANS, NET

Loans, net are summarized as follows (in thousands):


	Held-for- Investment			Held-for- Sale		Total Loans
June 30, 2005:
Real estate loans:
One- to four-family	$	6,393,657		$	98,641	$	6,492,298
Home equity lines of credit and second mortgage		5,033,299			26		5,033,325
Other		1,603			80		1,683

Total real estate loans		11,428,559			98,747		11,527,306

Consumer and other loans:
Recreational vehicle (“RV”)		2,736,727			19,314		2,756,041
Marine		741,980			5,542		747,522
Automobile		380,233			—		380,233
Credit card		191,842			—		191,842
Commercial		29,673			—		29,673
Other		11,917			—		11,917

Total consumer and other loans		4,092,372			24,856		4,117,228

Total loans		15,520,931			123,603		15,644,534
Unamortized premiums, net		241,040			2,054		243,094
Less allowance for loan losses		(55,418	)		—		(55,418	)

Total loans, net	$	15,706,553		$	125,657	$	15,832,210

December 31, 2004:
Real estate loans:
One- to four-family	$	3,669,594		$	244,593	$	3,914,187
Home equity lines of credit and second mortgage		3,617,074			3,009		3,620,083
Other		1,666			86		1,752

Total real estate loans		7,288,334			247,688		7,536,022

Consumer and other loans:
Recreational vehicle (“RV”)		2,542,645			25,246		2,567,891
Marine		720,513			3,612		724,125
Automobile		583,354			35		583,389
Credit card		203,169			—		203,169
Commercial		3,012			—		3,012
Other		16,481			—		16,481

Total consumer and other loans		4,069,174			28,893		4,098,067

Total loans		11,357,508			276,581		11,634,089
Unamortized premiums, net		195,928			2,699		198,627
Less allowance for loan losses		(47,681	)		—		(47,681	)

Total loans, net	$	11,505,755		$	279,280	$	11,785,035

NOTE 7—GOODWILL AND INTANGIBLE ASSETS

In April 2005, the Company completed its acquisition of SV International, an institutional broker regulated in France, with a client base trading primarily in French and US equities. The Company paid initial consideration of $2.8 million in cash. Additional consideration will be contingent upon the target gross revenue for the two consecutive twelve-month periods commencing April 1, 2005. In connection with the acquisition, the Company recorded $1.8 million in goodwill and $1.6 million in intangible assets.

As discussed in Note 3, in May 2005, the Company closed its proprietary and hybrid proprietary trading businesses within E*TRADE Professional. As a result, the Company wrote off $2.4 million in intangible assets and reduced its goodwill by $1.1 million, which comprised a write-off of $0.3 million and a reduction in deferred taxes of $0.8 million.

NOTE 8—DEPOSITS

Deposits are summarized as follows (dollars in thousands):


	Weighted-Average Rate				Balance at				Percent
	June 30, 2005		December 31, 2004		June 30, 2005		December 31, 2004		June 30, 2005		December 31, 2004
Sweep deposit account	0.56	%	0.40	%	$	6,443,558	$	6,167,436	49.3	%	50.1	%
Money market accounts	2.39	%	1.52	%		3,493,337		3,340,245	26.8		27.2
Certificates of deposit	3.41	%	3.40	%		2,238,273		2,069,674	17.1		16.8
Brokered certificates of deposit	3.69	%	2.51	%		495,020		294,587	3.8		2.4
Passbook savings accounts	1.17	%	1.18	%		646		691	—		—
Checking accounts:
Interest-bearing	0.70	%	0.66	%		386,072		430,022	3.0		3.5
Non-interest-bearing	—	%	—	%		104		319	—		—

Total deposits	1.66	%	1.27	%	$	13,057,010	$	12,302,974	100.0	%	100.0	%

NOTE 9—OTHER BORROWINGS BY BANK SUBSIDIARY

The Company’s other borrowings by Bank subsidiary are shown below (in thousands):


	June 30, 2005		December 31, 2004
Federal Home Loan Bank advances	$	3,829,453	$	1,487,841
Subordinated debentures		255,419		255,300
Other		2,877		17,591

Total other borrowings by Bank subsidiary	$	4,087,749	$	1,760,732

NOTE 10—SHAREHOLDERS’ EQUITY

Stock Repurchases

During the three and six months ended June 30, 2005, the Company repurchased 1.5 million and 4.0 million shares of its common stock for an aggregate $16.4 million and $48.9 million, respectively. As of June 30, 2005, the Company had approximately $189.0 million available under its authorized share repurchase and debt retirement plans to purchase additional shares of its common stock or retire additional debt.

Stock-Based Compensation

The Company accounts for its employee stock option plans under APB Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations which requires compensation expense to be recognized for any intrinsic value in stock options at the grant date.

The following table illustrates the effect on the Company’s reported net income and net income per share if the Company had applied the fair value recognition provisions of SFAS No. 123, to stock-based employee compensation (in thousands, except per share amounts):


	Three Months Ended June 30,						Six Months Ended June 30,
	2005			2004			2005			2004
Net income, as reported	$	101,567		$	122,906		$	193,561		$	211,381
Add back: Stock-based employee compensation expense included in reported net income, net of tax		944			616			1,241			1,373
Deduct: Total stock-based employee compensation expense determined under fair value-based method for all awards, net of tax		(4,501	)		(4,943	)		(8,618	)		(8,873	)

Pro forma net income	$	98,010		$	118,579		$	186,184		$	203,881

Net income per share:
Basic—as reported	$	0.28		$	0.34		$	0.53		$	0.58

Basic—pro forma	$	0.27		$	0.32		$	0.51		$	0.56

Diluted—as reported	$	0.27		$	0.31		$	0.51		$	0.54

Diluted—pro forma	$	0.26		$	0.30		$	0.49		$	0.52

Under SFAS No. 123, the fair value of stock-based awards to employees is calculated using option pricing models, even though such models were developed to estimate the fair value of freely tradable, fully transferable options without vesting restrictions, which significantly differ from the Company’s stock option awards. These models also require subjective assumptions, including future stock price volatility and expected time to exercise, which significantly affect the calculated values.

The Company’s calculations were made using the Black-Scholes-Merton option-pricing model with the following weighted-average assumptions applied to grants made in the following periods:


	Three Months Ended June 30,				Six Months Ended June 30,
	2005		2004		2005		2004
Dividend yield	—		—		—		—
Expected volatility	34	%	49	%	35	%	52	%
Risk-free interest rate	4	%	2	%	4	%	2	%
Expected life of option following vesting (in months)	25		24		29		22

The valuations of the computed weighted-average fair values of all option grants under SFAS No. 123 were $3.79 and $4.29 for the three and six months ended June 30, 2005, respectively, and $4.75 and $5.66 for the three and six months ended June 30, 2004, respectively.

NOTE 11—FACILITY RESTRUCTURING AND OTHER EXIT CHARGES

The following table summarizes the amount recognized by the Company as restructuring and other exit charges for the periods presented (in thousands):


	Three Months Ended June 30,						Six Months Ended June 30,
	2005			2004			2005			2004
2003 Restructuring Plan	$	(96	)	$	41		$	(3	)	$	(438	)
2001 Restructuring Plan		152			(491	)		392			(840	)
Other exit activity		351			416			575			272

Total facility restructuring and other exit charges	$	407		$	(34	)	$	964		$	(1,006	)

In 2005, the Company updated its estimated costs associated with its 2003 and 2001 restructuring plans. Restructuring liabilities are included in accounts payable, accrued and other liabilities in the consolidated balance sheets.

2003 Restructuring Plan

The rollforward of the 2003 Restructuring Plan reserve is presented below (in thousands):


	Facility Consolidation			Other			Total
Original 2003 restructuring reserve:
Facility restructuring and other exit charges recorded in 2003 & 2004	$	57,468		$	57,359		$	114,827
Cash payments		(16,446	)		(18,618	)		(35,064	)
Non-cash charges		(19,254	)		(38,370	)		(57,624	)

Restructuring liabilities at December 31, 2004		21,768			371			22,139

2005 activity on original 2003 restructuring reserve:
Adjustment and additional charges recorded in 2005		(3	)		—			(3	)
Cash payments		(571	)		(132	)		(703	)
Non-cash charges		—			29			29

Restructuring liabilities at June 30, 2005	$	21,194		$	268		$	21,462

2001 Facility Restructuring Plan

The rollforward of the 2001 Restructuring Plan reserve is presented below (in thousands):


	Facility Consolidation			Asset Write-Off			Other			Total
Total 2001 facility restructuring and other nonrecurring charges recorded in 2001	$	128,469		$	52,532		$	21,764		$	202,765
Activity through December 31, 2004:
Adjustments and additional charges		21,404			2,072			3,499			26,975
Cash payments		(98,370	)		(67	)		(19,287	)		(117,724	)
Non-cash charges		(41,263	)		(53,877	)		(5,810	)		(100,950	)

Restructuring liabilities at December 31, 2004		10,240			660			166			11,066
2005 activity on original 2001 restructuring reserve:

Adjustments and additional charges recorded in 2005		392			—			—			392
Cash payments		(1,957	)		—			(2	)		(1,959	)
Non-cash charges		—			—			3			3

Restructuring liabilities at June 30, 2005	$	8,675		$	660		$	167		$	9,502

Other Exit Activity

For the three and six months ended June 30, 2005, other exit activity was primarily related to the following:

•

Liquidation of certain E*TRADE Money Market Funds. The liquidation costs primarily represent costs relating to customer notification, severance and reimbursement of losses taken on sales of securities;

•

Closure of a correspondent mortgage origination channel; and

•

Revisions to previous estimates for past exit activities

For the three and six months ended June 30, 2004, other exit activity was primarily related to the following:

•

Costs, net of recoveries, for the exit of the Company’s proprietary institutional research business; and

•

Costs associated with the Company’s transfer of its consumer automobile loan operations from Arlington, Virginia to Irvine, California

NOTE 12—INCOME PER SHARE

The following table is a reconciliation of basic and diluted income per share (in thousands, except per share data):


	Three Months Ended June 30,					Six Months Ended June 30,
	2005			2004		2005			2004
BASIC:
Numerator:
Income from continuing operations	$	108,261		$	102,820	$	209,978		$	192,499
Net income (loss) from discontinued operations		(6,694	)		20,086		(16,417	)		18,882

Net income	$	101,567		$	122,906	$	193,561		$	211,381

Denominator:
Basic weighted-average shares outstanding		365,180			365,072		365,643			364,939

Per Share:
Income per share from continuing operations	$	0.30		$	0.28	$	0.57		$	0.53
Net income (loss) per share from discontinued operations		(0.02	)		0.06		(0.04	)		0.05

Net income per share	$	0.28		$	0.34	$	0.53		$	0.58

DILUTED:
Numerator:
Income from continuing operations	$	108,261		$	102,820	$	209,978		$	192,499
Interest on convertible subordinated notes, net of tax		—			7,416		—			15,069

Income from continuing operations, as adjusted		108,261			110,236		209,978			207,568
Net income (loss) from discontinued operations		(6,694	)		20,086		(16,417	)		18,882

Net income, as adjusted	$	101,567		$	130,322	$	193,561		$	226,450

Denominator:
Basic weighted-average shares outstanding		365,180			365,072		365,643			364,939
Effect of dilutive securities:
Weighted-average options and restricted stock issued to employees		8,548			9,276		9,251			10,825
Weighted-average warrants and contingent shares outstanding		2,617			2,486		2,617			2,418
Shares issuable for assumed conversion of convertible subordinated notes		—			39,879		—			42,659

Diluted weighted-average shares outstanding		376,345			416,713		377,511			420,841

Per Share:
Income per share from continuing operations	$	0.29		$	0.26	$	0.55		$	0.50
Net income (loss) per share from discontinued operations		(0.02	)		0.05		(0.04	)		0.04

Net income per share	$	0.27		$	0.31	$	0.51		$	0.54

Excluded from the calculation of diluted income per share for both three and six months ended June 30, 2005 are 7.8 million shares of common stock issuable under convertible subordinated notes as the effect of applying treasury stock method on an if-converted basis would be anti-dilutive.

The following options to purchase shares of common stock have not been included in the computation of diluted income per share because the options’ exercise price was greater than the average market price of the Company’s common stock for the periods stated, and, therefore, the effect would be anti-dilutive (in thousands, except exercise price data):


	Three Months Ended June 30,				Six Months Ended June 30,
	2005		2004		2005		2004
Options excluded from computation of diluted income per share		12,277		11,875		11,899		10,586
Exercise price ranges:
High	$	58.19	$	58.19	$	58.19	$	58.19
Low	$	12.21	$	11.78	$	12.76	$	12.76

NOTE 13—REGULATORY REQUIREMENTS

Registered Broker-Dealers

The Company’s broker-dealer subsidiaries are subject to the Uniform Net Capital Rule (the “Rule”) under the Securities Exchange Act of 1934 administered by the SEC, the New York Stock Exchange (“NYSE”), the Chicago Stock Exchange (“CHX”) and the NASD Inc. (“NASD”), which requires the maintenance of minimum net capital. E*TRADE Securities, E*TRADE Clearing and E*TRADE Professional Trading, LLC have elected to use the alternative method to compute net capital permitted by the Rule, which requires that they maintain minimum net capital equal to the greater of $250,000 or two percent of aggregate debit balances arising from customer transactions, as defined.

Under the alternative method, a broker-dealer may not repay subordinated borrowings, pay cash dividends or make any unsecured advances or loans to its parent or employees if such payment would result in net capital of less than 5% of aggregate debit balances or less than 120% of its minimum dollar amount requirement.

The table below summarizes the minimum excess capital requirements for the Company’s broker-dealer subsidiaries (in thousands):


	June 30, 2005
	Required Net Capital		Net Capital		Excess Net Capital
E*TRADE Securities LLC	$	250	$	37,180	$	36,930
E*TRADE Clearing LLC		51,020		316,343		265,323
E*TRADE Capital Markets—Execution Services, LLC		254		9,301		9,047
E*TRADE Capital Markets, LLC		1,401		40,158		38,757
E*TRADE Professional Trading, LLC		250		2,721		2,471
VERSUS Brokerage Service (U.S.) Inc.		100		727		627
E*TRADE Global Asset Management, Inc.		679		13,861		13,182
International broker-dealers		30,786		73,798		43,012

Totals	$	84,740	$	494,089	$	409,349

Banking

The Bank is subject to various regulatory capital requirements administered by Federal banking agencies. Failure to meet minimum capital requirements can trigger certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Bank’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities, and

certain off-balance sheet items as calculated under regulatory accounting practices. The Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.

Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios of Total and Tier I Capital to Risk-weighted assets and Tier I Capital to Adjusted total assets. As shown in the following table, at June 30, 2005, the most recent date of notification, the Office of Thrift Supervision (“OTS”) categorized the Bank as “well capitalized” under the regulatory framework for prompt corrective action. There are no conditions or events since that notification that management believes have changed the Bank’s category. At June 30, 2005, management believes that the Bank meets all capital adequacy requirements to which it is subject. However, events beyond management’s control, such as fluctuations in interest rates or a downturn in the economy in areas in which the Bank’s loans or securities are concentrated, could adversely affect future earnings and consequently, the Bank’s ability to meet its future capital requirements.

The Bank’s required actual capital amounts and ratios are presented in the table below (dollars in thousands):


	Actual				Required for Capital Adequacy Purposes				Required to be Well Capitalized Under Prompt Corrective Action Provisions
	Amount		Ratio		Amount		Ratio		Amount		Ratio
June 30, 2005:
Total Capital to Risk-weighted assets	$	1,726,947	>11.03	%	>$	1,253,072	>8.0	%	>$	1,566,340	>10.0	%
Tier I Capital to Risk-weighted assets	$	1,671,529	>10.67	%	>$	626,536	>4.0	%	>$	939,804	>6.0	%
Tier I Capital to Adjusted total assets	$	1,671,529	>5.93	%	>$	1,127,893	>4.0	%	>$	1,409,867	>5.0	%

December 31, 2004:
Total Capital to Risk-weighted assets	$	1,533,934	>11.09	%	>$	1,106,778	>8.0	%	>$	1,383,472	>10.0	%
Tier I Capital to Risk-weighted assets	$	1,486,422	>10.74	%	>$	553,389	>4.0	%	>$	830,083	>6.0	%
Tier I Capital to Adjusted total assets	$	1,486,422	>5.83	%	>$	1,019,659	>4.0	%	>$	1,274,574	>5.0	%

NOTE 14—COMMITMENTS, CONTINGENCIES AND OTHER REGULATORY MATTERS

Legal Matters

The Company is subject to various legal proceedings and claims that arise in the normal course of business, which we believe will not have a material adverse effect on our financial condition, results of operations or cash flows.

Regulatory Matters

The securities and banking industries are subject to extensive regulation under Federal, state and applicable international laws. As a result, the Company is required to comply with many complex laws and rules and its ability to so comply is dependent in part on the establishment and maintenance of a qualified compliance system. From time to time, the Company has been threatened with, or named as a defendant in, lawsuits, arbitrations and administrative claims involving securities, banking and other matters. The Company is also subject to periodic regulatory audits and inspections. Compliance and trading problems that are reported to regulators, such as the SEC, the NYSE, the NASD or the OTS by dissatisfied customers or others are investigated by such regulators, and may, if pursued, result in formal claims being filed against the Company by customers and/or disciplinary action being taken against the Company by regulators. Any such claims or disciplinary actions that are decided against the Company could harm the Company’s business.

Commitments—Loans

In the normal course of business, the Bank makes various commitments to extend credit and incur contingent liabilities that are not reflected in the consolidated balance sheets. The Bank had the following loan commitments (in thousands):


	June 30, 2005
	Variable Rate		Fixed Rate		Total
Commitments to purchase loans:
Mortgage loans	$	680,219	$	647,827	$	1,328,046
Other loans		—		9,634		9,634

Total commitments to purchase loans	$	680,219	$	657,461	$	1,337,680

Commitments to originate loans:
Mortgage loans	$	47,287	$	306,179	$	353,466
Other loans		—		454,370		454,370

Total commitments to originate loans	$	47,287	$	760,549	$	807,836

Commitments to sell mortgage loans	$	23,128	$	124,678	$	147,806

Significant changes in the economy or interest rates influence the impact that these commitments and contingencies have on the Company in the future.

At June 30, 2005, the Bank had commitments to purchase $2.7 billion and sell $2.7 billion in securities. In addition, the Bank had approximately $1.8 billion of certificates of deposit scheduled to mature in less than one year and $3.8 billion of unfunded commitments to extend credit.

Guarantees

The Bank provides guarantees to investors purchasing mortgage loans, which are considered standard representations and warranties within the mortgage industry. The primary guarantees are as follows:

•

The mortgage and the mortgage note have been duly executed and each is the legal, valid and binding obligation of the Bank, enforceable in accordance with its terms. The mortgage has been duly acknowledged and recorded and is valid. The mortgage and the mortgage note are not subject to any right of rescission, set-off, counterclaim or defense, including, without limitation, the defense of usury, and no such right of rescission, set-off, counterclaim or defense has been asserted with respect thereto. If these claims prove to be untrue, the investor can require the Bank to repurchase the loan and return all loan purchase and servicing release premiums.

•

Should any eligible mortgage loan delivered pay off prior to the receipt of the first payment, the loan purchase and servicing release premiums shall be fully refunded.

•

Should any eligible mortgage loan delivered to an investor pay off between the receipt of the first payment and a contractually designated period of time (typically 60—120 days from the date of purchase), the servicing release premium shall be fully refunded.

Management has determined that the maximum potential liability under these guarantees is $35.6 million and $38.1 million based on all available information at June 30, 2005 and December 31, 2004, respectively. The current carrying amount of the liability recorded at June 30, 2005 is $1.0 million and is considered adequate based upon analysis of historical trends and current economic conditions for these guarantees.

ETB Holdings, Inc. (“ETBH”) raises capital through the formation of trusts, which sell trust preferred stock in the capital markets. The capital securities are mandatorily redeemable in whole at the due date, which is generally 30 years after issuance. Each trust issues Floating Rate Cumulative Preferred Securities at par, with a liquidation amount of $1,000 per capital security. The proceeds from the sale of issuances are invested in

ETBH’s Floating Rate Junior Subordinated Debentures. No trusts were formed or debentures issued during the six months ended June 30, 2005.

During the 30-year period prior to the redemption of these securities, ETBH guarantees the accrued and unpaid distributions on these securities, as well as the redemption price of the securities and certain costs that may be incurred in liquidating, terminating or dissolving the trusts (all of which would otherwise be payable by the trusts). At June 30, 2005, management estimated that the maximum potential liability under this arrangement is equal to approximately $268 million or the total face value of these securities plus dividends, that may be unpaid at the termination of the trust arrangement.

NOTE 15—ACCOUNTING FOR DERIVATIVE FINANCIAL INSTRUMENTS AND HEDGING ACTIVITIES

The Company enters into derivative transactions to protect against the risk of market price or interest rate movements on the value of certain assets and future cash flows. The Company is also required to recognize certain contracts and commitments as derivatives when the characteristics of those contracts and commitments meet the definition of a derivative as promulgated by SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended.

Fair Value Hedges

Overview of Fair Value Hedges

The Company uses a combination of interest rate swaps, purchased options on caps, floors and forward starting swaps to offset its exposure to changes in value of certain fixed rate assets. In calculating the effective portion of the fair value hedges under SFAS No. 133, the change in the fair value of the derivative is recognized currently in earnings, as is the change in value of the hedged asset attributable to the risk being hedged. Accordingly, the net difference or hedge ineffectiveness, if any, is recognized currently in fair value adjustments of financial derivatives in the consolidated statements of operations.

The following table summarizes information related to financial derivatives in fair value hedge relationships (dollars in thousands):


	Notional Amount of Derivative		Fair Value of Derivative								Weighted-Average
	Notional Amount of Derivative		Asset		Liability			Net			Pay Rate		Receive Rate		Strike Rate		Remaining Life (Years)
June 30, 2005:
Pay fixed-interest rate swaps:
Mortgage-backed securities	$	1,485,500	$	125	$	(11,336	)	$	(11,211	)	4.31	%	3.35	%	—	%	4.97
Certificates of deposit		350,000		—		(4,156	)		(4,156	)	3.14	%	3.48	%	—	%	2.34
Investment securities		160,885		437		(6,991	)		(6,554	)	4.63	%	3.16	%	—	%	8.33
Brokered certificates of deposit		133,865		116		(945	)		(829	)	3.27	%	5.22	%	—	%	13.02
Federal Home Loan Bank advances		100,000		—		(1,547	)		(1,547	)	3.22	%	3.64	%	—	%	4.30
Purchased interest rate forward-starting swaps:
Mortgage-backed securities		250,000		255		—			255		4.13	%	N/A		—	%	5.02
Purchased interest rate options ⁽²⁾:
Floors		1,410,000		6,238		—			6,238		N/A		N/A		3.53	%	4.04
Caps		1,240,000		23,506		—			23,506		N/A		N/A		4.76	%	4.49
Forward-starting swaps		2,531,000		43,582		—			43,582		N/A		N/A		4.84	%	12.22

Total fair value hedges	$	7,661,250	$	74,259	$	(24,975	)	$	49,284		4.05	%	3.49	%	4.47	%	7.20

December 31, 2004:
Pay fixed-interest rate swaps:
Mortgage-backed securities	$	1,045,000	$	3,157	$	(5,099	)	$	(1,942	)	4.42	%	2.23	%	—	%	6.06
Investment securities		160,885		—		(3,747	)		(3,747	)	4.63	%	2.09	%	—	%	8.83
Receive fixed-interest rate swaps:
Certificates of deposit		315,000		—		(1,901	)		(1,901	)	2.26	%	3.39	%	—	%	2.90
Federal Home Loan Bank advances		100,000		—		(1,159	)		(1,159	)	2.40	%	3.64	%	—	%	4.80
Brokered certificates of deposit		10,000		—		(160	)		(160	)	2.50	%	5.00	%	—	%	10.01
Senior Notes ⁽¹⁾		50,000		452		—			452		5.98	%	8.00	%	—	%	6.46
Purchased interest rate forward-starting swaps:
Brokered certificates of deposit		20,000		12		(60	)		(48	)	5.25	%	N/A		—	%	12.55
Mortgage-backed securities		209,000		978		—			978		3.60	%	N/A		—	%	3.43
Purchased interest rate options⁽²⁾:
Caps		485,000		7,221		—			7,221		N/A		N/A		6.09	%	5.01
Floors		100,000		352		—			352		N/A		N/A		4.25	%	2.75
Forward-starting swaps		335,000		9,065		—			9,065		N/A		N/A		5.98	%	13.30

Total fair value hedges	$	2,829,885	$	21,237	$	(12,126	)	$	9,111		3.93	%	2.71	%	5.85	%	6.25

(1)

Interest rate swap agreement on the Company’s $400.0 million Senior Notes was none and $50.0 million at June 30, 2005 and December 31, 2004, respectively. Fair value of the Senior Notes of $400.3 million and $400.5 million at June 30, 2005 and December 31, 2004, respectively, are shown in the consolidated balance sheets.

(2)

Purchased interest rate options were used to hedge the Bank’s mortgage-backed securities.

De-designated Fair Value Hedges

During the three and six months ended June 30, 2005, certain fair value hedges were de-designated and, therefore, hedge accounting was discontinued during those periods. The net gain or loss on these derivative instruments at the time of de-designation is amortized to interest expense over the original forecasted period of the underlying transactions being hedged. Changes in the fair value of these derivative instruments after the discontinuance of fair value hedge accounting are recorded in gain on sales of loans and securities, net in the consolidated statements of operations.

Cash Flow Hedges

Overview of Cash Flow Hedges

The Company uses interest rate swaps and caps to hedge the variability of future cash flows associated with existing variable-rate liabilities and forecasted issuances of liabilities. These cash flow hedge relationships are treated as effective hedges as long as the future issuances of liabilities remain probable and the hedges continue to meet the requirements of SFAS No. 133. The Company also enters into interest rate swaps to hedge changes in the future variability of cash flows of certain investment securities resulting from changes in a benchmark interest rate. Additionally, the Company enters into forward purchase and sale agreements, which are considered cash flow hedges, when the terms of the commitments exactly match the terms of the securities purchased or sold.

Changes in the fair value of derivatives that hedge cash flows associated with time deposits, repurchase agreements, advances from the FHLB, dollar rolls and other borrowings and investment securities are reported in accumulated other comprehensive income (“AOCI”) as unrealized gains or losses. The amounts in AOCI are then included in interest expense as a yield adjustment during the same periods in which the related interest on the fundings or investment securities affect earnings. During the upcoming twelve months, the Company expects to include a pre-tax amount of approximately $9.5 million of net unrealized losses that are currently reflected in AOCI in interest expense as a yield adjustment in the same periods in which the related items affect earnings. The Company expects to hedge the majority of forecasted issuance of liabilities over a two-to-sixteen year period.

The Company also recognizes cash flow hedge ineffectiveness. Cash flow hedge ineffectiveness is recorded to the extent that the market value of derivatives used in the hedge relationship outperforms or has a greater increase in market value than a hypothetical derivative, created to match the exact terms of the underlying debt being hedged. The Company recognized this cash flow ineffectiveness as fair value adjustments of financial derivatives in the consolidated statements of operations. Cash flow ineffectiveness is re-measured on a quarterly basis.

The following table summarizes information related to our financial derivatives in cash flow hedge relationships, hedging variable-rate liabilities and the forecasted issuances of liabilities (dollars in thousands):


	Notional Amount of Derivative		Fair Value of Derivative								Weighted-Average
	Notional Amount of Derivative		Asset		Liability			Net			Pay Rate		Receive Rate		Strike Rate		Remaining Life (Years)
June 30, 2005:
Pay fixed-interest rate swaps:
Repurchase agreements	$	1,025,000	$	—	$	(53,515	)	$	(53,515	)	4.98	%	3.26	%	—	%	11.90
Federal Home Loan Bank advances		150,000		—		(7,092	)		(7,092	)	4.94	%	3.27	%	—	%	9.89
Purchased interest rate:
Forward-starting swaps		1,475,000		—		(45,111	)		(45,111	)	4.74	%	N/A		—	%	11.16
Options—Caps⁽¹⁾		4,675,000		105,339		—			105,339		N/A		N/A		4.20	%	4.88
Options—Floor⁽¹⁾		1,900,000		6,525		—			6,525		N/A		N/A		5.50	%	4.04

Total cash flow hedges	$	9,225,000	$	111,864	$	(105,718	)	$	6,146		4.85	%	3.26	%	4.58	%	6.57

December 31, 2004:
Pay fixed-interest rate swaps:
Repurchase agreements	$	1,675,000	$	—	$	(33,121	)	$	(33,121	)	4.91	%	2.28	%	—	%	11.12
Federal Home Loan Bank advances		425,000		—		(6,093	)		(6,093	)	4.68	%	2.13	%	—	%	9.25
Purchased interest rate:
Forward-starting swaps		595,000		—		(868	)		(868	)	4.74	%	N/A		—	%	11.16
Options—caps⁽¹⁾		2,775,000		94,340		—			94,340		N/A		N/A		4.43	%	6.13

Total cash flow hedges	$	5,470,000	$	94,340	$	(40,082	)	$	54,258		4.84	%	2.25	%	4.43	%	8.45

⁽¹⁾

Purchased interest rate options were used to hedge the Bank’s repurchase agreements, Federal Home Loan Bank advances and home equity lines of credit.

Under SFAS No. 133, we are required to record the fair value of gains and losses on derivatives designated as cash flow hedges in AOCI in the consolidated balance sheets. In addition, during the normal course of business, the Company terminates certain interest rate swaps and options.

The following tables show: 1) amounts recorded in AOCI related to derivative instruments accounted for as cash flow hedges; 2) the notional amounts and fair values of derivatives terminated for the periods presented; and 3) the amortization of terminated interest rate swaps included in interest expense (in thousands):


	Three Months Ended June 30,						Six Months Ended June 30,
	2005			2004			2005			2004
Impact on AOCI (net of taxes):
Beginning balance	$	(69,515	)	$	(174,944	)	$	(118,018	)	$	(123,754	)
Gains (losses) on cash flow hedges related to derivatives, net		(133,599	)		133,105			(99,603	)		66,669
Reclassifications to earnings, net		12,334			14,122			26,841			29,368

Ending balance	$	(190,780	)	$	(27,717	)	$	(190,780	)	$	(27,717	)

Derivatives terminated during the quarter:
Notional	$	4,800,000		$	200,000		$	7,645,000		$	1,483,500
Fair value of net gains (losses) recognized in AOCI	$	(51,649	)	$	2,433		$	(75,165	)	$	(27,482	)

Amortization of terminated interest rate swap included in interest expense	$	(20,122	)	$	(25,530	)	$	(43,419	)	$	(52,479	)

The gains (losses) accumulated in AOCI on the derivative instruments terminated shown in the preceding table will be included in interest expense over the periods the hedged forecasted issuance of liabilities will affect earnings, ranging from 1 day to 15 years.

The following table represents the balance in AOCI attributable to open cash flow hedges and discontinued cash flow hedges (in thousands):


	At June 30,
	2005			2004
AOCI balance (net of taxes) related to:
Open cash flow hedges	$	(96,340	)	$	50,446
Discontinued cash flow hedges		(94,440	)		(78,163	)

Total cash flow hedges	$	(190,780	)	$	(27,717	)

Hedge Ineffectiveness

In accordance with SFAS No. 133, the Company recognizes hedge ineffectiveness on both fair value and cash flow hedge relationships. These amounts are reflected in fair value adjustments of financial derivatives in the consolidated statements of operations. The following table summarizes the income (expense) recognized by the Company as fair value and cash flow hedge ineffectiveness (in thousands):


	Three Months Ended June 30,						Six Months Ended June 30,
	2005			2004			2005			2004
Fair value hedges	$	(1,912	)	$	(16	)	$	(2,621	)	$	(2,224	)
Cash flow hedges		164			2,411			(15	)		4,345

Total fair value adjustments of financial derivatives	$	(1,748	)	$	2,395		$	(2,636	)	$	2,121

Mortgage Banking Activities

The Company enters into commitments to originate loans whereby the interest rate on the loan is determined prior to funding; these commitments are referred to as Interest Rate Lock Commitments (“IRLCs”). IRLCs on loans the Bank intends to sell are considered to be derivatives and are, therefore, recorded at fair value with changes in fair value recorded in earnings. For purposes of determining their fair value, the Company performs a net present value analysis of the anticipated cash flows associated with these IRLCs. The net present value analysis performed excludes the market value associated with the anticipated sale of servicing rights related to each loan commitment. The fair value of these IRLCs was a $1.7 million liability and a $1.5 million asset at June 30, 2005 and December 31, 2004, respectively.

IRLCs, as well as closed loans held-for-sale, expose the Company to interest rate risk. The Company manages this risk by selling mortgages or mortgage-backed securities on a forward basis referred to as forward sale agreements. Changes in the fair value of these derivatives are included as gain on sales of loans and securities, net in the consolidated statements of operations.

The net change in IRLCs, closed loans and the related hedging instruments generated a net loss of $0.6 million and a net gain of $0.5 million for the three and six months ended June 30, 2005 and a net gain of $2.2 million and $3.4 million for the corresponding periods in 2004.

NOTE 16—SEGMENT INFORMATION

In January 2005, the Company revised its financial reporting to reflect the manner in which its chief operating decision maker has begun assessing the Company’s performance and makes resource allocation decisions. As a result, the Company now reports its operating results in two segments, retail and institutional, rather than its former brokerage and banking segments.

Retail includes:

•

investing, trading, banking and lending products and services to individuals; and

•

stock plan administration products and services activity

Institutional includes:

•

balance sheet management, including generation of institutional net interest spread, gain on sales of loans and securities, net and management income;

•

market-making; and

•

global execution and settlement services

The Company evaluates the performance of its segments based on segment contribution (net revenues less expenses excluding interest). All corporate overhead, administrative and technology charges are allocated to segments either in proportion to their respective direct costs or based upon specific operating criteria. Financial information for the Company’s reportable segments is presented in the following tables (in thousands):


	Three Months Ended June 30, 2005
	Retail			Institutional			Eliminations(1)			Total
Revenues:
Commissions	$	74,428		$	27,623		$	—		$	102,051
Principal transactions		—			21,753			—			21,753
Gain on sales of loans and securities, net		17,834			(578	)		—			17,256
Service charges and fees		30,253			4,278			—			34,531
Other revenues		27,136			1,418			(7,969	)		20,585

		149,651			54,494			(7,969	)		196,176

Interest income		153,697			330,965			(96,855	)		387,807
Interest expense		(55,174	)		(221,321	)		96,855			(179,640	)

Net interest income		98,523			109,644			—			208,167
Provision for loan losses		—			(12,997	)		—			(12,997	)

Net interest income after provision for loan losses		98,523			96,647						195,170

Total revenues		248,174			151,141			(7,969	)		391,346


Expense excluding interest:
Compensation and benefits		55,890			30,027			—			85,917
Occupancy and equipment		14,723			3,064			—			17,787
Communications		17,197			2,620			—			19,817
Professional services		12,372			3,829			—			16,201
Commissions, clearance and floor brokerage		11,287			24,983			(1,926	)		34,344
Advertising and market development		24,294			2,188			—			26,482
Servicing and other banking expenses		1,600			15,942			(6,043	)		11,499
Fair value adjustments of financial derivatives		—			1,748			—			1,748
Depreciation and amortization		14,526			3,720			—			18,246
Amortization of other intangibles		2,383			2,266			—			4,649
Facility restructuring and other exit charges		435			(28	)		—			407
Other		5,407			9,442			—			14,849

Total expenses excluding interest		160,114			99,801			(7,969	)		251,946

Segment income	$	88,060

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