Edgar Filing: E TRADE FINANCIAL CORP

Form 10-K

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

x	ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2006.

¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM TO .

Commission File Number 1-11921

E*TRADE Financial Corporation

(Exact Name of Registrant as Specified in its Charter)

Delaware

94-2844166

(State or Other Jurisdiction

of Incorporation or Organization)

(I.R.S. Employer

Identification Number)

135 East 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)

Securities Registered Pursuant to Section 12(b) of the Act:

(Title of each class and Name of exchange on which registered)

Common Stock—$0.01 par value—NASDAQ

Mandatory Convertible Notes

Securities Registered Pursuant to Section 12(g) of the Act:

None

Indicate by check mark if the registrant is a well-known seasonal issuer, as defined in Rule 405 of the Securities Act. Yes x No ¨

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Securities Act. Yes ¨ No x

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. 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 amendment to this Form 10-K. ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.


Large accelerated filer x		Accelerated filer ¨		Non-accelerated filer ¨

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

At June 30, 2006, the aggregate market value of voting stock, comprised of the registrant’s common stock and shares exchangeable into common stock, held by nonaffiliates of the registrant was approximately $7.8 billion (based upon the closing price for shares of the registrant’s common stock as reported by the New York Stock Exchange on that date). Shares of common stock held by each officer, director and holder of 5% or more of the outstanding common stock have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes.

Number of shares outstanding of the registrant’s common stock as of February 23, 2007: 427,164,672

DOCUMENTS INCORPORATED BY REFERENCE

Definitive Proxy Statement relating to the Company’s Annual Meeting of Shareholders to be held May 23, 2007, to be filed hereafter (incorporated into Part III hereof).

E*TRADE FINANCIAL CORPORATION

FORM 10-K ANNUAL REPORT

For the Year Ended December 31, 2006

TABLE OF CONTENTS


PART I
Forward-Looking Statements		ii
Item 1.	Business	1
	Overview	1
	Products and Services	1
	Customer Service	3
	Technology	3
	Competition	4
	Performance Measurement	4
	International Operations	5
	Regulation	5
Item 1A.	Risk Factors	6
Item 1B.	Unresolved Staff Comments	13
Item 2.	Properties	13
Item 3.	Legal Proceedings	13
Item 4.	Submission of Matters to a Vote of Security Holders	14

PART II		15
Item 5.	Market for Registrant’s Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities	15
Item 6.	Selected Consolidated Financial Data	17
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	19
	Overview	19
	Earnings Overview	25
	Segment Results Review	38
	Balance Sheet Overview	41
	Liquidity and Capital Resources	48
	Risk Management	50
	Summary of Critical Accounting Policies and Estimates	51
	Required Statistical Disclosure by Bank Holding Companies	56
	Glossary of Terms	64
Item 7A.	Quantitative and Qualitative Disclosures about Market Risk	68
Item 8.	Financial Statements and Supplementary Data	71
	Management Report on Internal Control Over Financial Reporting	71
	Reports of Independent Registered Public Accounting Firm	72
	Consolidated Statement of Income	74
	Consolidated Balance Sheet	75
	Consolidated Statement of Comprehensive Income	76
	Consolidated Statement of Shareholders’ Equity	77
	Consolidated Statement of Cash Flows	79
	Notes to Consolidated Financial Statements	81
	Note 1—Organization, Basis of Presentation and Summary of Significant Accounting Policies	81
	Note 2—Business Combinations	91
	Note 3—Discontinued Operations	92
	Note 4—Facility Restructuring and Other Exit Activities	94
	Note 5—Operating Interest Income and Operating Interest Expense	97
	Note 6—Available-for-Sale Mortgage-Backed and Investment Securities	98


	Note 7—Loans, Net	101
	Note 8—Brokerage Receivables, Net and Brokerage Payables	103
	Note 9—Accounting for Derivative Financial Instruments and Hedging Activities	103
	Note 10—Servicing Rights	109
	Note 11—Property and Equipment, Net	110
	Note 12—Goodwill and Other Intangibles, Net	110
	Note 13—Other Assets	112
	Note 14—Deposits	113
	Note 15—Asset Securitization	114
	Note 16—Securities Sold Under Agreement to Repurchase and Other Borrowings	119
	Note 17—Corporate Debt	121
	Note 18—Accounts Payable, Accrued and Other Liabilities	123
	Note 19—Income Taxes	124
	Note 20—Earnings per Share	127
	Note 21—Share Repurchases	128
	Note 22—Employee Share-Based Payments and Other Benefits	128
	Note 23—Regulatory Requirements	131
	Note 24—Lease Arrangements	132
	Note 25—Commitments, Contingencies and Other Regulatory Matters	133
	Note 26—Segment and Geographic Information	135
	Note 27—Fair Value Disclosure of Financial Instruments	139
	Note 28—Related Party Transactions	140
	Note 29—Condensed Financial Information (Parent Company Only)	141
	Note 30—Subsequent Event	144
	Note 31—Quarterly Data (Unaudited)	144
Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	145
Item 9A.	Controls and Procedures	145
Item 9B.	Other Information	145

PART III		145

PART IV		145
Item 15.	Exhibits and Financial Statement Schedules	145
Exhibit Index		146
Signatures		153

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

FORWARD-LOOKING STATEMENTS

This report contains forward-looking statements involve risks and uncertainties. These statements relate to our future plans, objectives, expectations and intentions. These statements may be identified by the use of words such as “expect,” “may,” “anticipate,” “intend,” “plan” and similar expressions. Our actual results could differ materially from those discussed in these forward-looking statements, and we caution that we do not undertake to update these statements. Factors that could contribute to our actual results differing from any forward-looking statements include those discussed under “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and elsewhere in this report. The cautionary statements made in this report should be read as being applicable to all forward-looking statements wherever they appear in this report.

ITEM 1. BUSINESS

OVERVIEW

E*TRADE Financial Corporation is a global financial services company, offering a wide range of financial solutions to retail and institutional customers under the brand “E*TRADE Financial.” We strive to create a differentiated financial services franchise by leveraging technology to deliver a compelling combination of product, service and price to the value-driven mass affluent customer. Information on our website is not a part of this report.

Our corporate offices are located at 135 East 57th Street, New York, New York 10022. We were incorporated in California in 1982 and reincorporated in Delaware in July 1996. We have approximately 4,100 employees. We operate directly and through numerous subsidiaries many of which are overseen by governmental and self-regulatory organizations. Our most significant subsidiaries are described below:

•

E*TRADE Bank is a Federally chartered savings bank that provides lending products to retail customers nationwide and deposit accounts insured by the Federal Deposit Insurance Corporation (“FDIC”);

•

E*TRADE Capital Markets, LLC is a registered broker-dealer, specialist, market-making firm and also acts as agent for our institutional customers;

•

E*TRADE Clearing LLC is the clearing firm for our brokerage subsidiaries. Its main purpose is to transfer securities from one party to another; and

•

E*TRADE Securities LLC is a registered broker-dealer and provider of brokerage services to both retail and institutional customers.

A complete list of our subsidiaries can be found in Exhibit 21.1.

We offer, either alone or with our partners, branded retail websites in the United States, Canada, Denmark, Finland, France, Germany, Hong Kong, Iceland, Italy, Sweden, the United Arab Emirates and the United Kingdom. We provide a branded educational website in China, but do not offer retail services through that website. We have licensed the E*TRADE name to companies that operate in Australia, Japan and Korea.

We primarily provide services through our website at www.etrade.com. We also provide services through our network of customer service representatives, relationship managers and investment advisors. We provide these services over the phone or in person through our 24 E*TRADE Financial Centers.

PRODUCTS AND SERVICES

We offer a wide range of products and services to our customers to assist them with their financial needs. Our primary retail products and services consist of:

•

Investing and trading—includes automated order placement and execution of market and limit equity, futures, options, exchange-traded funds, mutual funds and bond orders. We also offer quick transfer, wireless account access, extended hours trading, quotes, research and advanced planning tools;

•

Banking—includes checking, savings, sweep, money market and certificates of deposit (“CD”) products that offer online bill pay, quick transfer, unlimited ATM transactions on eligible accounts and wireless account access; and

•

Lending—includes mortgage, home equity, margin and credit card products that offer online loan status and quick transfer.

Institutional products include market making, execution services and direct market access.

Retail

Our retail segment offers a full suite of financial solutions to retail customers including investing, trading, banking and lending products. Consistent with our philosophy of being a customer advocate, we offer retail customers an opportunity to view their entire financial picture through E*TRADE Complete. E*TRADE Complete helps customers optimize investing, cash and credit allocations by utilizing tools designed to help them determine the appropriate mix of particular investing, banking and lending products that we offer. E*TRADE Complete tools include the Intelligent Investing Optimizer and Risk Analyzer, the Intelligent Cash Optimizer and the Intelligent Lending Optimizer. With the Intelligent Cash Optimizer, customers can review possible cash allocations based on rate and liquidity preferences and quickly transfer funds to reallocate deposit balances according to those preferences. The Intelligent Investing Optimizer and Risk Analyzer makes it easy for customers to develop an investment strategy that is engineered to match their specific goals, time horizon and risk tolerance. It suggests allocations for large cap, small cap, international investment, fixed income and cash. The Intelligent Lending Optimizer is a tool that provides customers the ability to model multiple lending scenarios. Customers can use E*TRADE Complete to optimize their utilization of our retail products described below.

Retail investing and trading products and services include:

•

automated order placement and execution of market and limit equity, futures, options, exchange-traded funds and bond orders;

•

two-second execution guarantee on all S&P 500 stocks and exchange-traded funds;

•

fraud protection, covering losses that result from the unauthorized use of our retail products and services;

•

margin accounts allowing customers to borrow against their securities;

•

access to some of the lowest cost stock index funds in the industry and to over 6,000 non-proprietary mutual funds;

•

educational services through the Internet, phone or in person and flexible advisory services, including full-service portfolio management; and

•

no fee and no minimum individual retirement accounts.

Retail banking and lending products and services include:

•

interest-earning checking, money market, savings and CD products with FDIC-insurance;

•

FDIC-insured sweep deposit accounts that automatically transfers funds from customer brokerage accounts; and

•

access to deposit account balances and transactions, through the Internet, phone or in person.

All of our retail products are covered by the E*TRADE Complete Protection Guarantee.

Retail customers are offered investing, trading, banking and lending products and services via our website, over the phone and in person. Customers have the ability to transfer funds quickly and easily between their investing, trading, banking and lending accounts, thereby giving them the opportunity to optimize the yield and liquidity of their funds.

In addition to the services above, our retail segment includes employee stock option management software and services which are provided to corporate customers. This software system facilitates the management of employee option plans, employee stock purchase plans and restricted stock plans, including necessary accounting and reporting functions. This business is a component of the retail segment since it serves as an introduction to E*TRADE for many retail customers who conduct equity option transactions as employees of our corporate customers, with our goal being that these individuals will also use our other products and services.

Institutional

Our institutional segment includes market-making activities which match buyers and sellers of securities from both the retail segment and unrelated third parties, often taking principal positions in these securities. Institutional customers are offered access to a range of execution services through traditional sales traders and direct market access to exchanges.

We act as a specialist on the Chicago Stock Exchange for listed securities through E*TRADE Capital Markets, LLC. A specialist is a broker-dealer authorized by an exchange through which trading on the floor of the exchange is transacted. As a specialist, we are responsible for maintaining an orderly market in the securities assigned to us by the exchange and are frequently required to take principal positions in these securities.

We act as a market maker in certain over-the-counter issues. A market maker’s function is similar to that of a specialist except that its trading activities are not on the floor of the exchange. The majority of our share volume for market-making activities involves bulletin board securities, which are securities that are not listed on the NASDAQ Global Select Market (“NASDAQ”) or a national securities exchange.

As a market maker, we take positions in securities and function as a wholesale trader by combining trading lots to match buyers and sellers of securities. Trading gains and losses result from these activities. Our revenues are influenced by overall trading volumes, the number of stocks for which we act as a market maker or a specialist and the trading volumes and volatility of those specific stocks.

We also transact large block trading activity on the New York Stock Exchange (“NYSE”) and NASDAQ exchanges. In addition, we provide institutional customers with trade execution services, including direct access to international exchanges. Our web-based platform offers real-time, online access to statements and electronic settlement capabilities.

In addition to activities with external customers, the institutional segment includes the management of our balance sheet. Balance sheet management functions focus on asset allocation and managing interest rate risk, credit risk and liquidity risk. The retail segment team works in conjunction with the institutional team by originating margin receivables and loans and by gathering retail deposits which are leveraged by the institutional group to enhance overall net interest income.

For additional statistical information regarding products and customers, see Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) beginning on page 23. Three years of segment financial performance and data can also be found in MD&A beginning on page 39.

CUSTOMER SERVICE

We believe providing superior customer service is fundamental to our business. During 2006, we significantly increased the number of customer service representatives and relationship managers in order to increase the quality of our service. We created a new service tier that focuses on the growth and retention of the mass affluent customer. Customers in this category will receive a more personalized level of service from representatives dedicated to providing complete financial solutions. We also added eight new E*TRADE Financial Centers in the United States, which are available to retail customers for any of their customer service needs.

TECHNOLOGY

We believe our focus on being a technological leader in the financial services industry enhances our competitive position. This focus allows us to deploy a secure, scalable technology and a back office platform that promotes innovative product development and delivery. During 2006, we continued to enhance our leading family of E*TRADE Complete optimizer products by enabling our customers to evaluate their investment and lending choices through the Intelligent Investment and Risk Optimizer as well as the Intelligent Lending Optimizer. We further strengthened our leading edge technology for our retail trading customers with the introduction of new conditional order functionality including trailing stops for options and group orders. Our ongoing commitment to investing in our technology infrastructure continued with our conversion to a new

banking and cash management back office system that will support our global initiatives around these key products.

COMPETITION

The electronic financial services market, over the Internet and through other distribution channels, continues to evolve rapidly. As we continue to diversify and expand our services, we expect competition to continue to increase. Our retail segment competes with full commission brokerage firms, discount brokerage firms, online brokerage firms, Internet banks, mortgage banking companies, non-financial service companies originating loans and traditional “brick & mortar” retail banks and thrifts. Some of these competitors also provide Internet trading and banking services, investment advisor services, touchtone telephone and voice response banking services, electronic bill payment services and a host of other financial products. Our institutional segment, in addition to the competitors above, competes with market-making firms, investment banking firms and other users of market liquidity in its quest for the least expensive source of funding.

In offering our products and services, we face competition in the following areas:

•

For investing and trading products, we compete with Internet-based firms and large traditional financial institutions. The market for trading products continues to be highly competitive with both Internet-based firms and large traditional financial institutions focused on growing their customer base.

•

For banking products, we compete with Internet-based banks that traditionally have attractive rates, as well as traditional financial institutions that rely primarily on branch networks to deliver products and services. Deposit pricing continues to come under competitive pressure as banks seek to grow their deposit base by offering appealing rates to attract customers to their businesses.

•

For lending products, we compete with traditional banking institutions as well as consumer finance companies and other non-bank lenders. Loan pricing and credit standards continue to come under competitive pressure as lenders seek to grow their businesses in the face of declining home sales and tightening credit spreads.

We believe we can continue to attract customers to our products and services in these areas through our compelling combination of product, service and price. In addition, we believe our low cost infrastructure allows us to deliver products priced competitively.

In our effort to attract quality employees, we encounter competition in some business lines and corporate functions. Our ability to continue to compete effectively in our business will depend upon our ability to attract new employees and retain existing employees.

Many of our competitors have longer operating histories and greater resources than we do and offer a wider range of financial products and services. Many also have greater name recognition, greater market acceptance and larger customer bases. These competitors may conduct extensive promotional activities and offer better terms, lower prices and/or different products and services than we do. Moreover, some of our competitors have established relationships among themselves or with third parties to enhance their products and services. Our competitors may be able to respond more quickly to new or changing opportunities and demands and withstand changing market conditions better than we can.

Management monitors actions by competitors by reviewing new product and service offerings, including the competitive pricing of investing, trading, banking and lending products. Overall, we believe our ability to compete successfully in the financial services industry is because of the value proposition created through our unique combination of price, functionality and service.

PERFORMANCE MEASUREMENT

We assess the performance of our business based on our primary customer segments, retail and institutional. Retail customers are offered an integrated product set including investing, trading, banking and lending products. Our retail segment also includes providing corporate clients with employee stock plan administration and options management tools. Institutional customers are offered access to a range of execution services through traditional

sales traders and direct market access to exchanges. Our institutional segment also includes our balance sheet management and market making functions.

We consider multiple factors, including the competitiveness of our pricing compared to similar products and services in the market, the overall profitability of our businesses and client relationships when pricing our various products and services. We manage the overall profitability of our business using various financial metrics, including revenue growth, enterprise net interest spread, enterprise interest-earning assets, operating margin and compensation and benefits as a percentage of revenue. The overall profitability of our business is also based on the management of our expenses related to our various products and services. The same or similar products and services may be offered to both segments, utilizing the same infrastructure or in some circumstances, a single infrastructure may be used to support multiple products and services offered to our customers. As such, we do not separately disclose the costs associated with products and services sold or our general and administrative costs. All operating expenses incurred are integral to the operation of the business and are considered when evaluating the profitability of our business.

INTERNATIONAL OPERATIONS

We are focused on our objective of creating an integrated global financial services company. To achieve that goal, we continue to invest in and grow our international operations. We offer services in international markets directly through our website at www.etrade.com as well as through additional branded retail brokerage websites in Canada, Denmark, Finland, France, Germany, Hong Kong, Iceland, Italy, Sweden, the United Arab Emirates and the United Kingdom. During 2006, we re-engineered our technology platform to operate internationally and to be scalable across the international landscape. We believe this platform will allow us to expand to additional international locations with little to no increase in infrastructure costs. In addition, we are focused on emerging markets such as India, where we own a significant percentage of IL&FS Investsmart (“Investsmart”), China, where we currently have a business office and offer an education-only website and the United Arab Emirates, where we have recently established a branch of our United Kingdom operations.

We also have minority equity investments in companies that license the E*TRADE brand and operate websites in Australia, Japan and Korea. Our reported performance metrics do not include operating and financial information from these licensees. Our total net U.S. revenues, which we determine based on the geographic location of the legal entity in which the revenue was earned, were $2.2 billion, $1.5 billion and $1.3 billion for the years ended December 31, 2006, 2005 and 2004, respectively. Our total net non-U.S. revenues were $0.3 billion for the year ended December 31, 2006, and $0.2 billion for both the years ended December 31, 2005 and 2004. No individual country other than the United States accounted for more than 10% of revenues in any of these years.

REGULATION

Our business is subject to regulation by U.S. Federal and state regulatory agencies and securities exchanges and by various non-U.S. governmental agencies or regulatory bodies, securities exchanges and central banks, each of which has been charged with the protection of the financial markets and the protection of the interests of those participating in those markets. These regulatory agencies in the United States include, among others, the Securities and Exchange Commission (“SEC”), the NASD, Inc. (“NASD”), the NYSE, the NASDAQ, the FDIC, the Federal Reserve, the Municipal Securities Rulemaking Board and the Office of Thrift Supervision (“OTS”). Additional legislation, regulations and rulemaking may directly affect our manner of operation and profitability. Our broker-dealers are registered with the SEC and are subject to regulation by the SEC and by self-regulatory organizations, such as the NYSE, the NASDAQ, NASD and the securities exchanges of which each is a member. Our banking entities are subject to regulation, supervision and examination by the OTS, the Federal Reserve and also, in the case of the Bank, the FDIC. Such regulation covers all aspects of the banking business, including lending practices, safeguarding deposits, capital structure, transactions with affiliates and conduct and qualifications of personnel.

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 website as soon as reasonably practicable after they have been filed with the SEC. Our website address is www.etrade.com.

ITEM 1A. RISK FACTORS

Risks Relating to the Nature and Operation of Our Business

Many of our competitors have greater financial, technical, marketing and other resources

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 do and offer a wider range of financial products and services. The impact of competitors with greater name recognition, market acceptance and larger customer bases 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 and/or different products and services or combinations of products and services that could attract current E*TRADE customers and potentially result in price wars within the industry. Some of our competitors may also benefit from established relationships among themselves or with third parties enhancing their products and services.

Downturns or disruptions in the securities markets could reduce trade volumes and margin borrowing and increase our dependence on our more active customers who receive lower pricing

Online investing services to the retail customer, including trading and margin lending, account for a significant portion of our revenues. Although we continue to diversify our revenue sources, we expect online investing services to continue to account for a significant portion of our revenues in the foreseeable future. A downturn in or disruption to the securities markets may lead to changes in volume and price levels of securities and futures transactions which may, in turn, result in lower trading volumes and margin lending. In particular, a decrease in trading activity within our lower activity accounts would significantly impact revenues and increase dependence on more active trading customers who receive more favorable pricing based on their trade volume. A decrease in trading activity or securities prices would also typically be expected to result in a decrease in margin borrowing, which would reduce the revenue that we generate from interest charged on margin borrowing. More broadly, any reduction in overall transaction volumes would likely result in lower revenues and may harm our operating results because many of our overhead costs are fixed.

We depend on payments from our subsidiaries

We depend on dividends, distributions and other payments from our subsidiaries to fund payments on our obligations, including our debt obligations. Regulatory and other legal restrictions may limit our ability to transfer funds to or from our subsidiaries. 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.

We rely heavily on technology, and technology can be subject to interruption and instability

We rely on technology, particularly the Internet, to conduct much of our activity. Our technology operations are vulnerable to disruptions from human error, natural disasters, power loss, computer viruses, spam attacks, unauthorized access and other similar events. Disruptions to or instability of our technology or external technology that allows our customers to use our products and services could harm our business and our reputation. In addition, technology systems, whether they be our own proprietary systems or the systems of third parties on whom we rely to conduct portions of our operations, are potentially vulnerable to security breaches and unauthorized usage. An actual or perceived breach of the security of our technology could harm our business and our reputation.

Vulnerability of our customers’ computers could lead to significant losses related to identity theft or other fraud and harm our reputation and financial performance

Because our business model relies heavily on our customers’ use of their own personal computers 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 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 losses caused by a breach of security of the customers’ own personal systems. Such reimbursements could have a material impact on our financial performance.

Downturns in the securities markets increase the credit risk associated with margin lending or stock loan transactions

We permit customers to purchase securities on margin. A downturn in securities markets may impact the value of collateral held in connection with margin receivables and may reduce its value below the amount borrowed, potentially creating collections issues with our margin receivables. 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 generally 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 fail to honor their commitments.

We may be unsuccessful in managing the effects of changes in interest rates and the enterprise interest-earning assets in our portfolio

Net interest income has become an increasingly important source of our revenue. Our ability to manage interest rate risk could impact our financial condition. Our results of operations depend, in part, on our level of net interest income and our effective management of the impact of changing interest rates and varying asset and liability maturities. We use derivatives to help manage interest rate risk. However, the derivatives we utilize may not be completely 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 net interest income. Many factors affect interest rates, including governmental monetary policies and domestic and international economic and political conditions.

The diversification of our asset portfolio may increase the level of charge-offs

To the extent we continue to diversify our asset portfolio through purchases and originations of higher-yielding asset classes, we will have to manage assets that carry a higher risk of default than our mortgage portfolio. Consequently, the level of charge-offs associated with these assets may be higher than what we have previously experienced given our asset mix. In addition, if the overall economy weakens, we could experience higher levels of charge-offs. If expectations of future charge-offs increase, a corresponding increase in the amount of our allowance for loan losses would be required. The increased level of provision for loan losses recorded to meet additional allowance for loan losses requirements could adversely affect our financial results, if those higher yields do not cover the provision for loan losses.

If we do not successfully manage consolidation opportunities, we could be at a competitive disadvantage

There has recently been significant consolidation in the financial services industry and this consolidation is likely to continue in the future. Should we be excluded from or fail to take advantage of viable consolidation opportunities, our competitors may be able to capitalize on those opportunities and create greater scale and cost efficiencies to our detriment.

We have recently acquired a number of businesses and may continue to acquire businesses in the future. The primary assets of these businesses are their customer accounts. Our retention of these assets and the customers of businesses we acquire may be impacted by our ability to successfully continue to integrate the acquired operations, products (including pricing) and personnel. Diversion of management attention from other business concerns could have a negative impact. In the event that we are not successful in our continued integration efforts, we may experience significant attrition in the acquired accounts or experience other issues that would prevent us from achieving the level of revenue enhancements and cost savings that we expect with respect to an acquisition.

We expect to pursue additional acquisitions of companies in our industry, which may require us to obtain additional financing and subject us to integration risks. There can be no assurance that we will realize a positive return on any acquisition or that future acquisitions will not be dilutive to earnings.

Risks associated with principal trading transactions could result in trading losses

A majority of our specialist and market-making revenues are derived from trading as a principal. We may incur trading losses relating to the purchase, sale or short sale of securities for our own account, as well as trading losses in our specialist and market maker stocks. From time to time, we may have large positions in securities of a single issuer or issuers engaged in a specific industry. Sudden changes in the value of these positions could impact our financial results.

Reduced grants by companies of employee stock options could adversely affect our results of operations

We are a provider of stock plan administration and options management tools, and our revenue from these tools depends in part on the size and complexity of our customers’ employee stock option and stock purchase plans. In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standard (“SFAS”) No. 123(R), Share-Based Payment, which among other things requires public companies to expense employee stock options and other share-based payments at their fair value when issued. SFAS No. 123(R) may result in companies granting fewer employee options and modifying their existing employee stock purchase plans, potentially reducing the amount of products and services we provide these companies and compelling us to incur additional costs so that our tools comply with the new FASB statement. Additionally, we may see a reduction in commission revenues as fewer employee stock options would be available for exercise and sale by the employees of these companies.

Reduced spreads in securities pricing, levels of trading activity and trading through market makers and/or specialists could harm our specialist and market maker business

Computer-generated buy/sell programs and other technological advances and regulatory changes in the marketplace may continue to tighten securities spreads. Tighter spreads could reduce revenue capture per share by our specialists and market makers, thus reducing revenues for this line of business.

Advisory services subject us to additional risks

We provide advisory services to investors to aid them in their decision making and also provide full service portfolio management. Investment decisions 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 the investors’ intended results. In addition, advisors may not understand investor needs or risk tolerances, failures that may result in the recommendation or purchase of a portfolio of assets that may not be suitable for the investor. To the extent that we fail to know our customers or improperly advised them, we could be found liable for any resulting losses suffered by such customers, which could harm our reputation and business.

Our international efforts subject us to additional risks and regulation, which could impair our business growth

One component of our strategy has been an effort to build an international business, sometimes through joint venture and/or licensee relationships. We have limited control over the management and direction of these venture partners and/or licensees, and their action or inaction, including their failure to follow proper practices with respect to regulatory compliance and/or corporate governance, could harm our operations and/or our reputation.

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 securities and banking industries are subject to extensive regulation. All of our broker-dealer subsidiaries have to 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 and execution and settlement of transactions. We are also subject to additional laws and rules as a result of our specialist and market maker operations.

As part of our institutional business we provide clients access to certain third-party research tools and other services in exchange for commissions earned. Currently, these activities are allowed by various regulatory bodies. However, changes to the regulations governing these activities have been considered in the United Kingdom and the United States and may be considered again in the future. If the regulations are changed in the future in a way that limits or eliminates altogether the services we could provide to clients in exchange for commissions, we may realize a decrease in our institutional commission revenues.

Similarly, E*TRADE Financial Corporation, E*TRADE Re, LLC and ETB Holdings, Inc., as savings and loan holding companies, and E*TRADE Bank, as a Federally chartered savings bank, are subject to extensive regulation, supervision and examination by the OTS and, in the case of the Bank, also the FDIC. Such regulation covers all banking business, including lending practices, safeguarding deposits, capital structure, recordkeeping, transactions with affiliates and conduct and qualifications of personnel.

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, damages, penalties or restrictions that could significantly harm our business

The SEC, the NASDAQ, NASD and other self-regulatory organizations 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. The OTS may take similar action with respect to our banking activities. 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 United States 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 system. The failure to establish and enforce reasonable compliance procedures, even if unintentional, could subject us to significant losses or disciplinary or other actions.

If we do not maintain the capital levels required by regulators, we may be fined or even forced out of business

The SEC, NASDAQ, NASD, OTS 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. Net capital is the net worth of a broker or dealer (assets minus liabilities), less deductions for certain types of assets. Failure to maintain the required net capital could result in suspension or revocation of registration by the SEC and suspension or expulsion by the NASDAQ and/or NASD, and could ultimately lead to the firm’s liquidation. In the past, our broker-dealer subsidiaries have depended largely on capital contributions by us in order to comply with net capital requirements. 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, which in turn could limit our ability to repay debt and redeem or purchase shares of our outstanding stock.

Similarly, the Bank is subject to various regulatory capital requirements administered by the OTS. Failure to meet minimum capital requirements can trigger certain mandatory, and possibly additional discretionary actions by regulators that, if undertaken, could harm a bank’s operations and financial statements. A bank must meet specific capital guidelines that involve quantitative measures of a bank’s assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. A bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about the strength of components of its capital, risk weightings of assets, off-balance sheet transactions and other factors.

Quantitative measures established by regulation to ensure capital adequacy require a bank to maintain minimum amounts and ratios of Total and Tier 1 Capital to Risk-weighted Assets and of Tier 1 Capital to adjusted total assets. To satisfy the capital requirements for a “well capitalized” financial institution, a bank must maintain higher Total and Tier 1 Capital to Risk-weighted Assets and Tier 1 Capital to adjusted total assets ratios.

As a non-grandfathered savings and loan holding company, we are subject to regulations that could restrict our ability to take advantage of certain business opportunities

We are required to file periodic reports with the OTS and are subject to examination by the OTS. The OTS also has certain types of enforcement powers over us, ETB Holdings, Inc. and certain of its subsidiaries, including the ability to issue cease-and-desist orders, force divestiture of the Bank and impose civil and monetary penalties for violations of Federal banking laws and regulations or for unsafe or unsound banking practices. In addition, under the Gramm-Leach-Bliley Act, our activities are restricted to those that are financial in nature and certain real estate-related activities. We may make merchant banking investments in companies whose activities are not financial in nature if those investments are made for the purpose of appreciation and ultimate resale of the investment and we do not manage or operate the company. Such merchant banking investments may be subject to maximum holding periods and special recordkeeping and risk management requirements. The Company has also proposed to move its indirect subsidiary, E*TRADE Clearing, LLC to become an operating subsidiary of E*TRADE Bank. Such a move could result in increased regulatory oversight and restrictions on the activities of E*TRADE Clearing, LLC.

We believe all of our existing activities and investments are permissible under the Gramm-Leach-Bliley Act, but the OTS has not yet fully interpreted these provisions. Even if our existing activities and investments are permissible, we are unable to pursue future activities that are not financial in nature. We are also limited in our ability to invest in other savings and loan holding companies.

In addition, the Bank is subject to extensive regulation of its 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 Bank subsidiaries and the commencement of new activities by Bank subsidiaries require the prior approval of the OTS, and in some cases the FDIC, which may deny approval or limit the scope of our planned activity. These regulations and conditions could place us at a competitive disadvantage in an environment in which consolidation within the financial services industry is prevalent. Also, these regulations and conditions could affect our ability to realize synergies from future acquisitions, could negatively affect us following the acquisition and could also delay or prevent the development, introduction and marketing of new products and services.

Risks Relating to Owning Our Stock

We have incurred losses in the past and we cannot assure you that we will be profitable

We have incurred losses in the past and we may do so in the future. While we reported net income for the past four years, we reported a net loss of $186.4 million in 2002.

We are substantially restricted by the terms of our senior notes

In June 2004, we issued an aggregate principal amount of $400 million of senior notes due June 2011. In September and November 2005, we issued an additional aggregate principal amount of $100 million of senior notes due June 2011, $600 million of senior notes due September 2013 and $300 million of senior notes due December 2015. The indentures governing these senior notes contain various covenants and restrictions that limit our ability and certain of our subsidiaries’ ability to, among other things:

•

incur additional indebtedness;

•

create liens;

•

pay dividends or make other distributions;

•

repurchase or redeem capital stock;

•

make investments or other restricted payments;

•

enter into transactions with our stockholders or affiliates;

•

sell assets or shares of capital stock of our subsidiaries;

•

restrict dividend or other payments to us from our subsidiaries; and

•

merge, consolidate or transfer substantially all of our assets.

As a result of the covenants and restrictions contained in the indentures, we are limited in how we conduct our business and we may be unable to raise additional debt or equity financing to compete effectively or to take advantage of new business opportunities. The terms of any future indebtedness could include more restrictive covenants.

We cannot assure you that we will be able to remain in compliance with these covenants in the future and, if we fail to do so, that we will be able to obtain waivers from the appropriate parties and/or amend the covenants.

Our corporate debt levels may limit our ability to obtain additional financing

At December 31, 2006, we had an outstanding balance of $1,401.6 million in senior notes, $440.6 million in mandatory convertible notes and $37.9 million in term loans. Excluding the mandatory convertible notes, our ratio of debt (our senior debt and term loans) to equity (expressed as a percentage) was 34% at December 31, 2006.

We may incur additional indebtedness in the future, including in connection with further acquisitions. Our level of indebtedness, among other things, could:

•

make it more difficult or costly for us to obtain any necessary financing in the future for working capital, capital expenditures, debt service requirements or other purposes;

•

make it more difficult to refinance outstanding debt;

•

limit our flexibility in planning for, or reacting to, changes in our business; or

•

make us more vulnerable in the event of a downturn in our business.

The market price of our common stock may continue to be volatile

From January 1, 2004 through December 31, 2006, the price per share of our common stock ranged from a low of $9.51 to a high of $27.76. The market price of our common stock has been, and is likely to continue to be, highly volatile and subject to wide fluctuations. 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. 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 may need additional funds in the future, which may not be available and which may result in dilution of the value of our common stock

In the future, we may need to raise additional funds via debt and/or equity instruments, which may not be available on favorable terms, if at all. If adequate funds are not available on acceptable terms, we may be unable to fund our plans for the growth of our business. In addition, if funds are available, the issuance of equity securities could dilute the value of our shares of our common stock and cause the market price of our common stock to fall.

We have various mechanisms in place 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 shareholder may consider favorable. Such provisions include:

•

authorization for the issuance of “blank check” preferred stock;

•

provision for a classified Board of Directors (“Board”) with staggered, three-year terms;

•

the prohibition of cumulative voting in the election of directors;

•

a super-majority voting requirement to effect business combinations or certain amendments to our certificate of incorporation and bylaws;

•

limits on the persons who may call special meetings of shareholders;

•

the prohibition of shareholder action by written consent; and

•

advance notice requirements for nominations to the Board or for proposing matters that can be acted on by shareholders at shareholder meetings.

Attempts to acquire control of the Company may also be delayed or prevented by our stockholder rights plan, which is designed to enhance the ability of our Board to protect shareholders against unsolicited attempts to acquire control of the Company that do not offer an adequate price to all shareholders or are otherwise not in the best interests of the Company and our shareholders. In addition, certain provisions of our stock incentive plans, management retention and employment agreements (including severance payments and stock option acceleration), and Delaware law may also discourage, delay or prevent someone from acquiring or merging with us.

ITEM 1B. UNRESOLVED STAFF COMMENTS

None.

ITEM 2. PROPERTIES

A summary of our significant locations at December 31, 2006 is shown in the following table. All facilities are leased, except for 166,000 square feet of our office in Alpharetta, Georgia. Square footage amounts are net of space that has been sublet or part of a facility restructuring.


Location		Approximate Square Footage
Arlington, Virginia		209,000
Alpharetta, Georgia		184,000
Jersey City, New Jersey		107,000
Menlo Park, California		101,000
Charlotte, North Carolina		83,000
Sandy, Utah		80,000
New York, New York		60,000
Irvine, California		48,000
Toronto, Canada		37,000
Boston, Massachusetts		30,000
Tampa, Florida		30,000

All of our facilities are used by both our retail and institutional segments. In addition to the significant facilities above, we also lease all of our 24 E*TRADE Financial Centers, ranging in space from 3,000 to 13,000 square feet. All other leased facilities with space of less than 25,000 square feet are not listed by location. We believe our facilities space is adequate to meet our needs in 2007.

ITEM 3. LEGAL PROCEEDINGS

In June 2002, the Company acquired from MarketXT Holdings, Inc. (formerly known as “Tradescape Corporation”) the following entities: Tradescape Securities, LLC; Tradescape Technologies, LLC; and Momentum Securities, LLC. Disputes subsequently arose between the parties regarding the responsibility for liabilities that first became known to the Company after the sale. On April 8, 2004, MarketXT filed a complaint in the United States District Court for the Southern District of New York against the Company, certain of its officers and directors, and other third parties, including Softbank Investment Corporation (“SBI”) and Softbank Corporation, alleging that defendants were preventing plaintiffs from obtaining certain contingent payments allegedly due, and as a result, claiming damages of $1.5 billion. On April 9, 2004, the Company filed a complaint in the United States District Court for the Southern District of New York against certain directors and officers of MarketXT seeking declaratory relief and unspecified monetary damages for defendants’ fraud in connection with the 2002 sale, including, but not limited to, having presented the Company with fraudulent financial statements regarding the condition of Momentum Securities, LLC during the due diligence process. Subsequently, MarketXT was placed into bankruptcy, and the Company filed an adversary proceeding against MarketXT and others in January 2005, seeking declaratory relief, compensatory and punitive damages, in those Chapter 11 bankruptcy proceedings in the United States Bankruptcy Court for the Southern District of New York entitled, “In re MarketXT Holdings Corp., Debtor.” In that same court, the Company filed a separate adversary proceeding against Omar Amanat in those Chapter 7 bankruptcy proceedings entitled, “In re Amanat, Omar Shariff.” In October 2005, MarketXT answered the Company’s adversary proceeding and asserted its counterclaims, subsequently amending its claims in 2006 to add a $326 million claim for “promissory estoppel” in which Market XT alleged, for the first time, that the Company breached a prior promise to purchase the acquired entities in 1999-2000. In April 2006, Omar Amanat answered the Company’s separate adversary proceeding against him and asserted his counterclaims. In separate motions before the Bankruptcy Court, the

Company has moved to dismiss certain counterclaims brought by MarketXT including those described above, as well as certain counterclaims brought by Mr. Amanat. In a ruling dated September 29, 2006, the Bankruptcy Court in the MarketXT case granted the Company’s motion to dismiss four of the six bases upon which MarketXT asserts its fraud claims against the Company; its conversion claim; and its demand for punitive damages. In the same ruling, the Bankruptcy Court denied in its entirety MarketXT’s competing motion to dismiss the Company’s claims against it. On October 26, 2006, the Bankruptcy Court subsequently dismissed MarketXT’s “promissory estoppel” claim. The Company continues to believe that the respective claims brought against it by MarketXT and Omar Amanat are without merit, and the Company will continue both to vigorously defend itself against all such claims and to fully pursue its own claims and damages as described above.

The SEC, in conjunction with various regional securities exchanges, is conducting an inquiry into the trading activities of certain specialist firms, including the Company’s subsidiary E*TRADE Capital Markets, LLC (“ETCM”), on various regional exchanges in order to determine whether such firms executed proprietary orders in a given security prior to a customer order in the same security (a practice commonly known as “trading ahead”) during the period 1999 – 2005. The SEC has indicated that it will seek disgorgement, prejudgment interest, and penalties from any firm found to have engaged in trading ahead activity to the detriment of its customers during that time period. It is possible that such sanctions, if imposed against ETCM, could have a material impact on the financial results of the Company during the period in which such sanctions are imposed. The Company and ETCM are cooperating with the investigation.

An unfavorable outcome in any matter that is not covered by insurance could have a material adverse effect on our business, financial condition, results of operations or cash flows. In addition, even if the ultimate outcomes are resolved in our favor, the defense of such litigation could entail considerable cost or the diversion of the efforts of management, either of which could have a material adverse effect on our results of operations. In addition to the matters described above, the Company is subject to various legal proceedings and claims that arise in the normal course of business which could have a material adverse effect on our financial position, results of operations or cash flows.

We maintain insurance coverage that we believe is reasonable and prudent. The principal insurance coverage we maintain covers commercial general liability; property damage; hardware/software damage; cyber liability; directors and officers; employment practices liability; certain criminal acts against the Company; and errors and omissions. We believe that such insurance coverage is adequate for the purpose of our business. Our ability to maintain this level of insurance coverage in the future, however, is subject to the availability of affordable insurance in the marketplace.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None.

PART II

ITEM 5.

MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED SHAREHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Price Range of Common Stock

The following table shows the high and low sale prices of our common stock as reported by the NYSE, except where noted, for the periods indicated:


	High		Low
2006:
First Quarter	$	27.12	$	20.41
Second Quarter	$	27.76	$	18.81
Third Quarter	$	25.00	$	20.11
Fourth Quarter⁽¹⁾	$	25.50	$	20.85
2005:
First Quarter	$	14.98	$	11.70
Second Quarter	$	14.39	$	10.53
Third Quarter	$	17.60	$	13.85
Fourth Quarter	$	21.71	$	15.50

⁽¹⁾	On December 27, 2006 we moved from the NYSE to the NASDAQ under the symbol ETFC.

The closing sale price of our common stock as reported on the NASDAQ on February 23, 2007 was $24.05 per share. At that date, there were 1,997 holders of record of our common stock.

Dividends

We have never declared or paid cash dividends on our common stock. Although we do not currently have any plans to do so, we may pay dividends in the future.

Equity Compensation Plan Information

Refer to Note 22—Employee Shared-Based Payments and Other Benefits in Item 8. Financial Statements and Supplementary Data for equity compensation plan information.

Repurchase Plans

In 2004, our Board approved two repurchase plans, the first on April 29th (“April 2004 Plan”) and the second on December 15th (“December 2004 Plan”), each for $200.0 million. Our Board determined that the use of cash to reduce outstanding debt and outstanding common stock was likely to create long-term value for our shareholders. We completed the April 2004 Plan in April 2005 and there are no amounts remaining available under that plan. As of December 31, 2006, $57.2 million remained available under the December 2004 Plan for additional repurchases.

The December 2004 Plan is open-ended and provides the flexibility to buy back common stock, retire debt in the open market or a combination of both. We may conduct these repurchases on the open market, in private transactions or a combination of both. During 2006, we repurchased a total of $122.6 million or nearly 5.3 million shares of common stock under the December 2004 Plan. During 2005, we repurchased a total of $58.2 million or nearly 4.6 million shares of common stock under the repurchase plans approved in 2004. The table below shows the timing and impact of the repurchases during the three months ended December 31, 2006 (dollars in thousands, except per share amounts):


Month	Total Number of Shares Purchased	Average Price Paid per Share		Total Number of Shares Purchased as Part of the December 2004 Plan	Maximum Dollar Value of Shares That May Yet be Purchased Under the December 2004 Plan
October 2006	98,200	$	22.67	98,200	$	94,764
November 2006	649,900	$	23.67	649,900	$	79,381
December 2006	975,000	$	22.79	975,000	$	57,164

Total	1,723,100	$	23.11	1,723,100	$	57,164

Sale of Unregistered Shares

In August 2006, we issued 847,276 shares of common stock in connection with our acquisition of Retirement Advisors of America, Inc (“RAA”). No underwriters were involved, and there were no underwriting discounts or commissions. The securities were issued under the exemption from registration provided under Section 4(2) of the Securities Act. These shares of common stock were sold by the issuer in a transaction not involving a public offering. We filed a registration statement on August 7, 2006, which was declared effective immediately.

Performance Graph

The following performance graph shows the cumulative total return to a holder of the Company’s common stock, assuming dividend reinvestment, compared with the cumulative total return, assuming dividend reinvestment, of the Standard & Poor’s (“S&P”) 500 and the S&P Super Cap Diversified Financials during the period from December 31, 2001 through December 31, 2006.

COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN*

Among E*TRADE Financial Corporation, The S & P 500 Index

And The S & P Super Cap Diversified Financials

LOGO


	12/01	12/02	12/03	12/04	12/05	12/06
E*TRADE Financial Corporation	100.00	47.41	123.41	145.85	203.51	218.73
S & P 500	100.00	77.90	100.24	111.15	116.61	135.03
S & P Super Cap Diversified Financials	100.00	81.40	113.27	126.97	138.91	170.85

•

$100 invested on 12/31/01 in stock or index-including reinvestment of dividends. Fiscal year ending December 31.

•

ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA

(Dollars in millions, shares in thousands, except per share and per trade amounts):


	Year Ended December 31,														Variance
	2006			2005		2004			2003			2002			2006 vs. 2005
Results of Operations:⁽¹⁾
Total net revenue	$	2,420.3		$	1,703.8	$	1,482.9		$	1,342.7		$	1,261.7		42	%
Facility restructuring and other exit activities⁽²⁾	$	(28.5	)	$	30.0	$	(15.7	)	$	(134.2	)	$	(15.4	)	*
Gain (loss) on sale and impairment of investments	$	70.8		$	83.1	$	128.1		$	147.9		$	(20.3	)	(15	)%
Income (loss) from continuing operations⁽³⁾	$	626.8		$	446.2	$	381.8		$	200.5		$	119.0		40	%
Cumulative effect of accounting changes⁽⁴⁾	$	—		$	1.6	$	—		$	—		$	(293.7	)	*
Net income (loss)	$	628.9		$	430.4	$	380.5		$	203.0		$	(186.4	)	46	%
Basic earnings per share from continuing operations	$	1.49		$	1.20	$	1.04		$	0.56		$	0.33		24	%
Diluted earnings per share from continuing operations	$	1.44		$	1.16	$	0.99		$	0.55		$	0.33		24	%
Basic net earnings (loss) per share	$	1.49		$	1.16	$	1.04		$	0.57		$	(0.52	)	28	%
Diluted net earnings (loss) per share	$	1.44		$	1.12	$	0.99		$	0.55		$	(0.52	)	29	%
Weighted average shares—basic		421,127			371,468		366,586			358,320			355,090		13	%
Weighted average shares—diluted⁽⁵⁾		436,357			384,630		405,389			367,361			361,051		13	%

*	Percentage not meaningful.

⁽¹⁾	No cash dividends have been declared in any of the periods presented.

⁽²⁾	Expenses are presented in parentheses.

⁽³⁾

In 2005, we exited the professional proprietary and agency trading businesses and completed the sale of E*TRADE Consumer Finance Corporation (“Consumer Finance Corporation”). In 2004, we completed the sale of substantially all of the assets and liabilities of E*TRADE Access, Inc. (“E*TRADE Access”). We have reflected the results of these operations as discontinued operations for all periods presented.

⁽⁴⁾

In 2005, we recorded a credit of $1.6 million, net of tax, as a cumulative effect of accounting change, to reflect the amount by which compensation expense would have been reduced in periods prior to adoption of SFAS No. 123(R) for restricted stock awards outstanding on July 1, 2005. In 2002, impairment of goodwill that was identified upon adoption of SFAS No. 142, Goodwill and Other Intangible Assets is reported as a cumulative effect of accounting change.

⁽⁵⁾

For 2004, diluted earnings per share is calculated using the “if converted” method, which includes the additional dilutive impact assuming conversion of the Company’s subordinated convertible debt. Under the “if converted” method, the per share numerator excludes the interest expense and related amortization of offering costs from the convertible debt, net of tax, of $20.0 million. The denominator includes the shares issuable from the assumed conversion of the convertible debt of 25.8 million. For all other periods presented, the “if converted” method is not used as its effect would be anti-dilutive.


	December 31,										Variance
	2006		2005		2004		2003		2002		2006 vs. 2005
Financial Condition:
Available-for-sale mortgage-backed and investment securities	$	13,922.0	$	12,763.4	$	12,635.8	$	9,906.2	$	8,273.8	9	%
Total loans, net	$	26,656.2	$	19,512.3	$	11,785.0	$	9,131.4	$	7,365.7	37	%
Brokerage receivables, net	$	7,636.4	$	7,174.2	$	3,034.5	$	2,297.8	$	1,421.8	6	%
Total assets	$	53,739.3	$	44,567.7	$	31,032.6	$	26,049.2	$	21,455.9	21	%
Deposits	$	24,071.0	$	15,948.0	$	12,303.0	$	12,514.5	$	8,400.3	51	%
Corporate debt⁽¹⁾	$	1,842.2	$	2,022.7	$	585.6	$	695.3	$	695.3	(9	)%
Capital lease liability	$	—	$	—	$	0.2	$	0.9	$	4.4	*
Mandatorily redeemable capital preferred securities⁽²⁾	$	—	$	—	$	—	$	—	$	143.4	*
Shareholders’ equity	$	4,196.4	$	3,399.6	$	2,228.2	$	1,918.3	$	1,505.8	23	%

*	Percentage not meaningful.

⁽¹⁾	Corporate debt represents senior notes, mandatory convertible notes and convertible subordinated notes.

⁽²⁾

Mandatorily redeemable capital preferred securities were deconsolidated beginning in 2003 in accordance with SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. These securities are no longer classified as preferred securities; however, they are in the balance sheet under other borrowings.

(Dollars in billions):


	At or For the Year Ended December 31,															Variance
	2006			2005			2004			2003			2002			2006 vs. 2005
Key Measures:
Retail client assets⁽¹⁾	$	194.9		$	177.9		$	100.0		$	82.9		$	49.6		10	%
Customer cash and deposits⁽¹⁾	$	33.6		$	28.2		$	18.7		$	19.0		$	17.3		19	%
Daily Average Revenue Trades		159,348			97,740			83,643			77,052			66,588		63	%
Average commission per trade	$	12.05		$	13.82		$	15.63		$	16.41		$	17.01		(13	)%
Products per customer		2.1			2.1			1.9			1.7			N/A		0	%
Enterprise net interest spread (basis points)⁽²⁾		285			249			229			N/A			N/A		14	%
Enterprise interest-earning assets, average⁽²⁾	$	45.4		$	32.4		$	26.2			N/A			N/A		40	%
Operating margin (%)		41	%		38	%		33	%		14	%		21	%	3	%
Compensation and benefits as a % of revenue		19	%		22	%		24	%		27	%		25	%	(3	)%
Total employees (period end)		4,126			3,439			3,320			3,455			3,478		20	%

⁽¹⁾

Customer cash and deposits, as well as retail client assets, have been re-presented to account for a methodology change in the metric to settlement date from trade date reporting as of December 31, 2005 which reduced both metrics by $564 million. This is not a methodology change in accounting policy and does not impact the reporting of these items on our balance sheet.

⁽²⁾	The Enterprise net interest spread and Enterprise interest-earning assets, average for 2003 and 2002 are not presented as the information was not tracked on an enterprise level for those years.

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.

ITEM 7.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion should be read in conjunction with the consolidated financial statements and the related notes that appear elsewhere in this document.

GLOSSARY OF TERMS

In analyzing and discussing our business, we utilize certain metrics, ratios and other terms that are defined in the Glossary of Terms, which is located at the end of Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

OVERVIEW

Strategy

Our strategy centers on strengthening and growing our retail business and leveraging that growth in our institutional business. We strive to further develop our retail business by acquiring, expanding and retaining our relationships with global retail customers. We offer our retail and institutional customers a suite of investing, trading, banking and lending products. We plan to grow those relationships organically by using technology to deliver an attractive combination of product, service and price to the value-driven mass affluent customer. We also intend to grow, where appropriate, through targeted acquisitions which leverage our existing business platform and through further expansion into certain international markets.

As we expand our global customer base, and increase the retail customer cash and credit products we hold on our balance sheet, we believe that our business will benefit. As our institutional business manages our balance sheet on an enterprise-wide basis, we become less dependent on revenue from market-driven customer trading activity, and our income, while still positioned to benefit from a strong equity market, becomes more recurring in nature. As a result, net operating interest income has become our leading category of revenue, and we anticipate this trend will continue.

Key Factors Affecting Financial Performance

Our financial performance is affected by a number of factors outside of our control, including:

•

customer demand for financial products and services;

•

competitors’ pricing on financial products and services;

•

interest rates and the shape of the interest rate yield curve; and

•

the performance, volume and volatility of the equity and capital markets.

In addition to the items noted above, our success in the future will depend upon, among other things:

•

continuing our success in the acquisition, growth and retention of customers;

•

deepening customer acceptance of our investing, trading, banking and lending products, including E*TRADE Complete;

•

disciplined expense control and improved operational efficiency;

•

maintaining strong overall asset quality; and

•

prudent risk and capital management.

Management monitors a number of metrics in evaluating the Company’s performance. The most significant of these are shown in the table and discussed in the text below:


	At or For the Year Ended December 31,									Variance
	2006			2005			2004			2006 vs. 2005
*Customer Activity Metrics:*
Retail client assets (dollars in billions)⁽¹⁾	$	194.9		$	177.9		$	100.0		10	%
Customer cash and deposits (dollars in billions)⁽¹⁾	$	33.6		$	28.2		$	18.7		19	%
Daily average revenue trades		159,348			97,740			83,643		63	%
Average commission per trade	$	12.05		$	13.82		$	15.63		(13	)%
Products per customer		2.1			2.1			1.9		0	%

*Company Financial Metrics:*
Net revenue growth⁽²⁾		42	%		15	%		10	%	27	%
Enterprise net interest spread (basis points)		285			249			229		14	%
Enterprise interest-earning assets (average in billions)	$	45.4		$	32.4		$	26.2		40	%
Operating margin (%)		41	%		38	%		33	%	3	%
Compensation and benefits as a % of revenue		19	%		22	%		24	%	(3	)%

⁽¹⁾

⁽²⁾	Revenue growth is the difference between the current and prior comparable period total net revenue divided by the prior comparable period total net revenue.

•

Customer Activity Metrics

•

Retail client assets are an indicator of the value of our relationship with the customer. An increase in retail client assets generally indicates that the use of our products and services by existing and new customers is expanding. Changes in this metric are also driven by changes in the valuations of our customers’ underlying securities.

•

Customer cash and deposits are an indicator of a deepening engagement with our customers and a key driver of net operating interest income.

•

Daily average revenue trades (“DARTs”) are the predominant driver of commission revenue from our retail customers.

•

Average commission per trade is impacted by the mix between our retail domestic and international businesses and the mix between active traders, mass affluent and main street customers. This metric is an indicator of changes in our customer mix, product mix and/or product pricing.

•

Products per customer is an indicator of our customer engagement and how well our suite of products and services appeal to our customer base. We believe increases to this measure represent better overall customer engagement with our products and services.

•

Company Financial Metrics

•

Net revenue growth is an indicator of our overall financial well-being and our ability to execute on our strategy. When coupled with operating margin, the two provide information about the general success of our business.

•

Enterprise net interest spread is a broad indicator of our ability to generate net operating interest income.

•

Enterprise interest-earning assets are an indicator of our ability to generate net operating interest income, and growth in these assets, in conjunction with net operating interest spread, indicates our ability to grow net operating interest income.

•

Operating margin is an indicator of the profitability of our operations.

•

Compensation and benefits as a percentage of revenue is an indicator of our productivity. In recent periods, we have grown our revenue faster than our compensation expense. This ratio coupled with operating margin is an indictor of our increasing efficiency.

Significant Events in 2006

Harrisdirect and BrownCo Customer Conversions

We converted Harrisdirect and BrownCo customers to the E*TRADE Financial platform in the first and second quarters of 2006, respectively, which was a key step in the integration of our newly acquired customer base. This allowed us to deliver our functionality and services to these customers while reducing the costs associated with maintaining the legacy platforms.

Enhancements to the Complete Investment Account

We launched a series of functionality enhancements to the E*TRADE Complete Investment Account designed to help retail customers optimize their investing and borrowing relationships while evaluating their portfolio risk, including the Intelligent Lending Optimizer and the Intelligent Investing Optimizer and Risk Analyzer. We believe these new free tools will help customers better manage their security holdings, cash and credit products.

Enhanced Distribution Network

We enhanced our distribution network by opening eight new E*TRADE Financial centers in the United States during the period. With the addition of the centers in Seattle, WA; Farmington, MI; Garden City, NY; Torrance, CA; King of Prussia, PA; Roseville, CA; Fort Lauderdale, FL; and Scarsdale, NY, we increased the number of our nationwide financial centers to a total of 24.

E*TRADE Complete Savings Account

We launched the E*TRADE Complete Savings Account, which allows customers to quickly and easily take advantage of investment opportunities by offering a competitive annual percentage yield, no minimums in balances or account fees and free transfers to any institution.

Acquired RAA

We completed the purchase of RAA, a Dallas, Texas-based investment advisor managing over $1 billion in assets, in the third quarter of 2006. We believe this acquisition strengthens our regional advisor business, which delivers localized wealth management services and advice to retail clients with a minimum of $250,000 in assets. The growth of our wealth management business extends our ability to provide customers with the complete support they are demanding to address their varied financial needs.

Launch of New E*TRADE Website

We launched a new and improved website at www.etrade.com. The new site features intuitive navigation, demonstrations of some of our most popular products and tools, direct access to account opening and customer service on every page and quick access to our powerful quotes and research functionality.

Development of Automated Trading Strategies Functionality

We developed new conditional orders functionality for retail customers including trailing stops for options and group orders such as contingent, one-cancels-all, one-triggers-all and one-trigger-one-cancels-other orders.

When combined with the conditional order functionality already available to customers, such as trailing stops and bracketed orders for stocks, we believe this functionality will allow our customers to better manage risk.

Move of Exchanges to the NASDAQ

On December 27, 2006 we moved the listing of the Company’s common stock from the NYSE to the NASDAQ under the symbol ETFC. We made this move to demonstrate our commitment to our customers and shareholders by aligning ourselves with the market that best meets their needs. As an industry innovator, NASDAQ’s value proposition parallels our own, leveraging technology to provide customers with low fees, superior service and fair, efficient and transparent market access and execution.

Increased Ownership of Investsmart

We increased our ownership stake in Investsmart. Investsmart is an India-based financial services organization providing individuals and corporations with customized financial management solutions. As a result, because we now meet the criteria required to exercise significant influence, we account for Investsmart as an equity method investment.

Upgraded Credit Rating

Three credit agencies, Moody’s Investor Service (“Moody’s”), S&P and Dominion Bond Rating Service (“DBRS”), upgraded our senior unsecured debt rating during 2006. During the second quarter of 2006, Moody’s upgraded our senior unsecured debt rating from B1 to Ba2 and the long-term deposit rating of E*TRADE Bank from Ba2 to Baa3. During the third quarter of 2006, S&P upgraded our rating to BB- (stable) from B+ (positive) and DBRS upgraded our rating by two increments to BB (high) from BB (low). DBRS also upgraded the long-term deposit rating of E*TRADE Bank to BBB (low) from BB. We believe that our improved profitability and the diversity of our business model were key factors in receiving these upgrades and that these upgrades are an important acknowledgement of the progress we have made as a company.

Significant Events in 2005

Acquisition of Harrisdirect and BrownCo

We completed our acquisitions of two online discount brokerage companies, Harrisdirect and BrownCo, in the fourth quarter of 2005. At the time of the acquisitions, the companies had approximately $69.0 billion in customer assets including $8.5 billion in customer cash, margin debt of approximately $0.9 billion and brokerage receivables of approximately $3.1 billion. Harrisdirect was purchased for approximately $709 million in cash from Harris Financial Corp, a subsidiary of BMO Financial Group. As part of the financing to acquire Harrisdirect, we issued $450 million in fixed-rate senior notes. BrownCo was purchased for approximately $1.6 billion in cash from JPMorgan Chase & Co. As part of the financing to acquire BrownCo, we issued $550 million fixed-rate senior notes, $650 million in common stock and $450 million in face value of mandatory convertible notes. The common stock was sold in the market and proceeds were used for the BrownCo acquisition.

Acquisition of Wealth Management Advisors

We acquired two wealth management advisors, Kobren Insight Management, Inc. (“Kobren”) and Howard Capital Management, Inc. (“Howard Capital”) during 2005. These companies provide advisory and asset management services to retail clients. On a combined basis, these companies managed $1.5 billion in customer assets. The growth of our wealth management business extends our ability to provide customers with the complete support they are demanding to address their varied financial needs.

Dispositions

We sold our Consumer Finance Corporation business, exited our institutional proprietary trading business and made a decision to sell our professional agency business, ultimately executing a sale agreement in February 2006. The Consumer Finance Corporation business originated and serviced recreational vehicles and marine loans. We retained the loan portfolio; however, we no longer originate or service recreational vehicle or marine loans.

Introduction of E*TRADE Complete

We launched E*TRADE Complete, which offers consumers tools to aid in the optimization of investing, cash management and lending products. E*TRADE Complete tools initially included the Cash Optimizer, the Intelligent Investing Optimizer and the Intelligent Lending Optimizer. Customers can quickly transfer funds to modify deposit balances to determine the optimal distribution of cash between accounts based on their personal preferences. Each customer’s product selection and mix will depend on their price, liquidity, convenience and risk tolerance preference. The Intelligent Investing Optimizer makes it easy to develop an investment strategy for a customer’s uninvested cash targeted to specific goals, time horizon and risk tolerance. It also suggests allocations for large cap, small cap, international investment, fixed income and cash. The Intelligent Lending Optimizer is a tool that allows customers to model multiple lending scenarios to determine whether they can lower their borrowing costs. Customers can use E*TRADE Complete in conjunction with our other retail products.

Introduction of Token-Based Security

We began offering a token-based security solution to our U.S.-based retail customers on a voluntary basis. Using a token-based security solution provides an added layer of security at their point of access to the Internet to safeguard their personal financial information. The tokens produce a six digit code that changes every sixty seconds and is an extremely effective tool for preventing unauthorized access to a customer’s account. We believe comprehensive security protection is important to financial consumers and our token-based security solution gives us a competitive edge in this area.

Introduction of the E*TRADE Complete Protection Guarantee

We developed the E*TRADE Complete Protection Guarantee, which was launched in January 2006. Our promise to customers is that we will cover certain losses that result from the unauthorized use of our products and services, subject to certain limitations. Under our Complete Payment Protection Guaranty, we ensure that customer payments and transfers are processed exactly as the customer desired. In the unlikely event that any customer payment or transfer is not sent as instructed, we will work with the customer to swiftly resolve the issue and reimburse the customer in full for any late fees, penalties or related finance charges incurred. In addition, under the Complete Privacy Protection Guaranty, we assure our customers that we will undertake our best efforts to maintain their privacy and will not sell personal information to third parties or marketers for any purpose.

Enhanced Pricing Structure

We changed our pricing structure to reward customers for holding assets with us and to align our structure with the competitive marketplace. The table below shows our pricing as of December 31 for each period:


Customer Segment	Base Pricing in 2005 and 2006	Base Pricing in 2004
Active Trader	$6.99 to $9.99 per trade	$9.99 per trade
Mass Affluent	$9.99 per trade	$12.99 per trade
Main Street Investor	$12.99 per trade	$19.99 per trade

We changed our customer segment definitions and lowered our fees charged in February 2005 and October 2005. In addition to the fee schedule above, we have grandfathered certain trade pricing for customers acquired through our Harrisdirect and BrownCo acquisitions.

Change in Reporting Structure

In January 2005, we revised our financial reporting to better reflect the manner in which our chief operating decision maker assesses our performance and makes resource allocation decisions. As a result, in 2005, we began reporting our operating results in two segments, retail and institutional, rather than our former brokerage and banking segments. For our retail segment, the realignment integrated the management and operations of investing, trading, cash management and lending product and service offerings, including margin receivable activities, and stock plan administration products and services for the retail customer. For our institutional segment, the realignment integrated the management and operations of balance sheet management, market-making and global execution and settlement services businesses, with a focus on creating greater integration within our institutional segment and stronger leverage of our retail segment.

Summary Financial Results

Income Statement Highlights for the Year Ended December 31, 2006 (dollars in millions, except per share amounts)


	Year Ended December 31,						Variance
	2006			2005			2006 vs. 2005
Total net revenue	$	2,420.3		$	1,703.8		42	%
Net income	$	628.9		$	430.4		46	%
Diluted net earnings per share	$	1.44		$	1.12		29	%
Net operating interest income after provision for loan losses	$	1,355.1		$	817.1		66	%
Operating margin	$	1,000.8		$	649.8		54	%
Operating margin (%)		41	%		38	%	3	%

During the year ended December 31, 2006, we continued to strengthen our operating and financial performance. Total net revenue increased 42% and net income increased 46% when compared to 2005. We believe this increase was driven both by our acquisitions of Harrisdirect and BrownCo in the fourth quarter of 2005, as well as by our ability to grow customer cash and deposits, loans (including margin receivables) and DARTs. The growth in customer cash and deposits and total enterprise interest-earning assets, including margin receivables, were the primary drivers of our increase in net operating interest income, and the growth in DARTs was the primary driver of our increase in commission revenue. We were able to achieve this growth while increasing our operating margin to 41% from 38% when compared to the prior year. We believe this growth in operating margin reflects increasing efficiencies in our operations.

Net operating interest income after provision for loan losses increased 66% to $1,355.1 million for the year ended December 31, 2006, compared to 2005 and now represents 56% of total net revenue. Net operating interest income benefited from increases in customer cash and deposits coupled with growth in enterprise interest-earning assets. Customer cash and deposits, our lowest cost sources of funds, increased $5.4 billion compared to 2005. The increase in customer cash and deposits resulted from organic growth, which we believe is a result, in part, of the Intelligent Cash Optimizer within E*TRADE Complete, which continues to drive growth in customer cash and deposit balances.

Balance Sheet Highlights (dollars in billions)


	December 31,						Variance
	2006			2005			2006 vs. 2005
Total assets	$	53.7		$	44.6		21	%
Total enterprise interest-earning assets	$	49.9		$	41.1		22	%
Average loans, net and margin receivables as a percentage of enterprise interest-earning assets⁽¹⁾		64	%		56	%	8	%
Average retail deposits and free credits as a percentage of enterprise interest-bearing liabilities⁽¹⁾		62	%		53	%	9	%

⁽¹⁾	The table data on average enterprise interest-earning assets, loans, net and margin receivables, retail deposits and free credits has been prepared on the same basis as our disclosures with respect to the Bank under the SEC’s Industry Guide 3, “Statistical Disclosure by Bank Holding Companies.”

The increase in total assets was attributable primarily to increases of $7.1 billion in loans, net and $1.2 billion in available-for-sale mortgage-backed and investment securities. The increase in loans, net was due principally to growth in our real estate loan portfolio. We continue to focus our efforts on growing our residential mortgage loan portfolios, including one- to four-family and home equity loans, and allowing our consumer loan portfolio to decline. Average enterprise interest-earning assets increased by $13.0 billion in 2006 compared to 2005, which was related primarily to the increase in average loans, net and margin receivables.

Retail deposits and free credits were $30.0 billion, up 41% or $8.7 billion during 2006. The increase related to the Harrisdirect conversion, as well as organic growth in checking, money market and certificate of deposit accounts. Retail deposits and free credits are two of our lowest cost sources of funding and are important contributors to our net operating interest income growth. In addition to acquired customer growth, we experienced organic growth which we believe is a result, in part, of the E*TRADE Complete Intelligent Cash Optimizer, as well as an overall focus on price, functionality and service for our global retail customers.

EARNINGS OVERVIEW

2006 Compared to 2005

Net income from continuing operations increased 40% to $626.8 million for 2006 compared to 2005. We experienced strong growth in customer cash and deposits as well as in DARTs. We also experienced growth in customer margin balances. In addition, we were able to achieve this growth while increasing our operating margin to 41% in 2006 from 38% when compared to the prior year. We believe this growth in operating margin is reflective of increasing efficiencies in our operations.

During 2006, we modified the format of our consolidated income statement to a format that we believe provides a clearer picture of our financial performance and is more consistent with the common presentation found in the financial services industry. We re-ordered the revenue section by placing net operating interest income, which we previously referred to as net interest income, first, and non-interest income second. In addition, we updated our expense presentation to eliminate the remaining bank/brokerage lines. In conjunction with this change, we created a new expense category, “Clearing and servicing.” This new category includes trade clearing-related expense, previously included in “Commissions, clearance and floor brokerage,” and most expenses previously included in “Servicing and other banking expenses.” We also consolidated “Fair value adjustments of financial derivatives” into the “Other” expense category. Information related to fair value adjustments of financial derivatives is detailed in Note 9—Accounting for Derivative Financial Instruments and Hedging Activities to the consolidated financial statements.

In particular, we report corporate interest income and corporate interest expense separately from operating interest income and operating interest expense. We believe reporting these two items separately provides a

clearer picture of the financial performance of our operations than would a presentation that combined these two items. Our operating interest income and operating interest expense is generated from the operations of the Company and is a broad indicator of our success in our banking, lending and balance sheet management businesses. Our corporate debt, which is the primary source of our corporate interest expense, has been used primarily to finance acquisitions, such as Harrisdirect and BrownCo, and generally has not been downstreamed to any of our operating subsidiaries.

Similarly, we report gain on sales and impairment of investments separately from gain on sales of loans and securities, net. We believe reporting these two items separately provides a clearer picture of the financial performance of our operations than would a presentation that combined these two items. Gain on sales of loans and securities, net are the result of activities in our operations, namely our lending and balance sheet management businesses. Gain on sales and impairment of investments relates primarily to historical equity investments of the Company at the corporate level and is not related to the ongoing business of our operating subsidiaries.

The following sections describe in detail the changes in key operating factors and other changes and events that have affected our consolidated net revenue, expense excluding interest, other income (expense), income tax expense, discontinued operations and cumulative effect of accounting change.

Revenue

The components of net revenue and the resulting variances are as follows (dollars in thousands):


							Variance
	Year Ended December 31,						2006 vs. 2005
	2006			2005			Amount			%
Revenue:
Operating interest income	$	2,774,679		$	1,650,264		$	1,124,415		68	%
Operating interest expense		(1,374,647	)		(779,164	)		(595,483	)	76	%

Net operating interest income		1,400,032			871,100			528,932		61	%
Provision for loan losses		(44,970	)		(54,016	)		9,046		(17	)%

Net operating interest income after provision for loan losses		1,355,062			817,084			537,978		66	%

Commission		625,265			458,834			166,431		36	%
Service charges and fees		137,441			135,314			2,127		2	%
Principal transactions		110,235			99,336			10,899		11	%
Gain on sales of loans and securities, net		55,986			98,858			(42,872	)	(43	)%
Other revenue		136,332			94,419			41,913		44	%

Total non-interest income		1,065,259			886,761			178,498		20	%

Total net revenue	$	2,420,321		$	1,703,845		$	716,476		42	%

Net operating interest income after provision for loan losses continues to be our largest source of revenue and now represents 56% of total net revenue for 2006. This reflects our focus on retaining retail customer cash and deposits and retail credit balances. Net operating interest income is earned primarily through holding credit balances, which includes margin, real estate and consumer loans, and by holding customer cash and deposits, which are a low cost source of funding. The table below presents each revenue component as a percentage of total net revenue.


	Year Ended December 31,				Variance
	2006		2005		2006 vs. 2005
Revenue:
Net operating interest income after provision for loan losses	56	%	48	%	8	%
Commission⁽¹⁾	26		27		(1	)%
Service charges and fees	6		8		(2	)%
Principal transactions	4		6		(2	)%
Gain on sales of loans and securities, net	2		6		(4	)%
Other revenue	6		5		1	%

Total net revenue	100	%	100	%	—	%

⁽¹⁾	Retail commission revenue represented 20% of total net revenue for both the years ended December 31, 2006 and 2005. Institutional commission revenue represented 6% and 7% of total net revenue for the years ended December 31, 2006 and 2005, respectively.

Net Operating Interest Income After Provision for Loan Losses

Net operating interest income after provision for loan losses increased 66% to $1,355.1 million for 2006 compared to 2005. The increase in net operating interest income was due primarily to growth in enterprise interest-earning assets coupled with an increase in enterprise net interest spread. The growth in enterprise interest-earning assets was driven by increases in both loans, net and margin receivables. The increase in enterprise net interest spread was driven by changes in our mix of lending and funding sources. Average loans, net and margin receivables as a percentage of average enterprise interest-earning assets increased 8% to 64% for 2006 compared to 2005. Average retail deposits and free credits as a percentage of average enterprise interest-bearing liabilities increased 9% to 62% in 2006 compared to 2005.

The following table presents enterprise average balance sheet data and enterprise income and expense data for our operations, as well as the related net interest spread, and has been prepared on the same basis as our disclosures with respect to E*TRADE Bank under the SEC’s Industry Guide 3, “Statistical Disclosure by Bank Holding Companies” (dollars in thousands):


	Year Ended December 31,
	2006									2005						2004
	Average Balance			Operating Interest Inc./Exp.			Average Yield / Cost			Average Balance		Operating Interest Inc./Exp.		Average Yield / Cost		Average Balance		Operating Interest Inc./Exp.		Average Yield / Cost
Enterprise interest-earning assets:
Loans, net	$	22,193,663		$	1,364,873			6.15	%	$	15,488,527	$	828,717	5.35	%	$	10,065,174	$	490,550	4.87	%
Margin receivables		6,679,510			474,500			7.10	%		2,540,174		159,442	6.28	%		2,048,411		116,533	5.69	%
Mortgage-backed and related available-for-sale securities		11,543,546			590,512			5.12	%		9,421,988		401,782	4.26	%		8,300,536		331,460	3.99	%
Available-for-sale investment securities		3,068,474			193,583			6.31	%		2,715,985		140,041	5.16	%		3,151,515		127,429	4.04	%
Trading securities		132,454			11,388			8.60	%		268,092		12,342	4.60	%		712,819		22,692	3.18	%
Cash and cash equivalents⁽¹⁾		1,226,548			54,492			4.44	%		1,509,313		46,331	3.07	%		1,550,163		27,095	1.75	%
Stock borrow and other		531,809			36,780			6.92	%		441,189		20,942	4.75	%		389,313		11,991	3.08	%

Total enterprise interest-earning assets	$	45,376,004			2,726,128			6.01	%	$	32,385,268		1,609,597	4.97	%	$	26,217,931		1,127,750	4.30	%

Enterprise interest-bearing liabilities:
Retail deposits⁽⁵⁾	$	20,407,534			506,491			2.48	%	$	12,951,635		216,632	1.67	%	$	11,720,333		173,508	1.48	%
Brokered certificates of deposit⁽⁶⁾		535,835			24,726			4.61	%		450,441		15,680	3.48	%		358,665		9,172	2.56	%
Free credits		6,329,407			71,899			1.14	%		3,375,608		19,034	0.56	%		2,930,601		5,912	0.20	%
Repurchase agreements and other borrowings		10,980,134			549,085			5.00	%		10,115,764		374,337	3.70	%		8,139,736		259,196	3.18	%
Federal Home Loan Bank (“FHLB”) advances		3,488,184			165,545			4.75	%		3,260,556		126,495	3.88	%		1,168,519		50,055	4.28	%
Stock loan and other		1,067,726			34,317			3.21	%		464,303		7,838	1.69	%		586,478		3,610	0.62	%

Total enterprise interest-bearing liabilities	$	42,808,820			1,352,063			3.16	%	$	30,618,307		760,016	2.48	%	$	24,904,332		501,453	2.01	%

Enterprise net interest income/spread				$	1,374,065			2.85	%			$	849,581	2.49	%			$	626,297	2.29	%


Reconciliation from enterprise net interest income to net operating interest income (dollars in thousands):

	Year Ended December 31,
	2006			2005			2004
Enterprise net interest income⁽²⁾	$	1,374,065		$	849,581		$	626,297
Taxable equivalent interest adjustment		(19,297	)		(10,523	)		(7,013	)
Stock conduit, net⁽³⁾		427			1,159			1,074
Customer cash held by third parties⁽⁴⁾		44,837			30,883			14,784

Net operating interest income	$	1,400,032		$	871,100		$	635,142

⁽¹⁾	Includes segregated cash balances.

⁽²⁾

Enterprise net interest income is taxable equivalent basis net operating interest income excluding corporate interest income and corporate interest expense, stock conduit interest income and expense and interest earned on customer cash held by third parties. Management believes this non-GAAP measure is useful to analysts and investors as it is a measure of the net operating interest income generated by our operations.

⁽³⁾	Net operating interest income earned on average stock conduit assets of $0.3 billion, $0.6 billion and $0.8 billion for the years ended December 31, 2006, 2005 and 2004, respectively.

⁽⁴⁾

Includes interest earned on average customer assets of $3.6 billion, $2.7 billion and $3.2 billion for the year ended December 31, 2006, 2005 and 2004, respectively, held by parties outside E*TRADE Financial, including third party money market funds and sweep deposit accounts at unaffiliated financial institutions.

⁽⁵⁾	Includes retail certificates of deposit including retail brokered certificates of deposit.

⁽⁶⁾	Includes institutional certificates of deposit.

Despite the flat to inverted yield curve during the period, enterprise net interest spread increased by 36 basis points to 2.85% in 2006, compared to 2005. This increase was primarily the result of our ability to grow low-cost deposits and free credits during these periods, which in turn funded our growth in loans, net and margin receivables.

Average enterprise interest-earning assets increased 40% to $45.4 billion for 2006, compared to 2005. Average loans, net and margin receivables grew 60% to $28.9 billion for 2006 compared to 2005. Average loans, net increased as a result of our focus on growing mortgage loan products. The margin receivable portfolio grew, in part, as a result of our acquisitions of Harrisdirect and BrownCo, as well as organic growth.

Average enterprise interest-bearing liabilities increased 40% to $42.8 billion for 2006 compared to 2005. The increase in average enterprise interest-bearing liabilities was primarily in low-cost customer cash and deposits. Average retail deposits and free credits increased 64% to $26.7 billion for 2006 compared 2005. Increases in average retail deposits and free credits were driven by our acquisitions of Harrisdirect and BrownCo in the fourth quarter of 2005, as well as by organic growth.

Our interest rate risk is impacted by external factors such as the level and shape of the interest rate yield curve, the impact of the competitive environment on our pricing and customer behavior. We utilize interest rate derivatives to manage this risk. In recent years, we have managed our interest rate risk to achieve a minimum to moderate risk profile with limited exposure to earnings volatility resulting from interest rate fluctuations.

Operating interest income and operating interest expense reflect income and expense on hedges that qualify for hedge accounting under SFAS No. 133, as amended, Accounting for Derivative Instruments and Hedging Activities. The following table shows the income (expense) on hedges that are included in operating interest income and expense (dollars in thousands):


							Variance
	Year Ended December 31,						2006 vs. 2005
	2006			2005			Amount			%
Operating interest income:
Operating interest income, gross	$	2,763,041		$	1,662,745		$	1,100,296		66	%
Hedge income (expense)		11,638			(12,481	)		24,119		*

Operating interest income, net		2,774,679			1,650,264			1,124,415		68	%

Operating interest expense:
Operating interest expense, gross		(1,361,170	)		(695,634	)		(665,536	)	96	%
Hedge expense		(13,477	)		(83,530	)		70,053		(84	)%

Operating interest expense, net		(1,374,647	)		(779,164	)		(595,483	)	76	%

Net operating interest income	$	1,400,032		$	871,100		$	528,932		61	%

*	Percentage not meaningful.

Provision for Loan Losses

Provision for loan losses decreased 17% to $45.0 million for 2006 compared to 2005. The decrease in the provision for loan losses was related primarily to a lower provision for our consumer loan portfolio in connection with the decline in the overall size of the consumer loan portfolio. We expect our provision to increase, however, as we grow our mortgage portfolio at a higher growth rate than the decline in the consumer loan portfolio.

Commission

Retail and institutional commission revenue increased 36% to $625.3 million for 2006 compared to 2005. The primary factors that affect our commission revenue are DARTs and average commission per trade, which is impacted by both trade types and the mix between our domestic and international businesses. Each business has a different pricing structure, unique to its customer base and local market practices, and as a result, a change in the relative numbers of executed trades in these businesses impacts average commission per trade. Each business also has different trade types (e.g. equities, options, fixed income, ETFs, CFDs and mutual funds) that can have different commission rates. As a result, changes in the mix of trade types within either of these businesses may impact average commission per trade.

DARTs increased 63% to 159,348 for 2006 compared to 2005. Our U.S. DART volume increased 65% from 2005, driven by both our acquisitions of BrownCo and Harrisdirect as well as organic customer growth and engagement. Our international DARTs grew by 53% compared to 2005, driven entirely by organic growth. Our international operations continue to be a strong growth contributor within our retail trading business, and we believe that over time it will become a significant component of our entire business. In addition, option-related DARTs further increased as a percentage of our total U.S. DARTs and now represent 13% of trading volume versus 10% a year ago.

Average commission per trade decreased 13% to $12.05 for 2006 compared to 2005. The decrease was primarily a function of the mix of customers. Main Street Investors, who generally have a higher commission per trade, traded less during the period which resulted in a heavier weighting of Active Traders, who generally have a lower commission per trade.

Service Charges and Fees

Service charges and fees increased 2% to $137.4 million for 2006 compared to the 2005. The increase in service charges and fees for 2006 was due primarily to an increase in the advisory service fee income. This increase was offset by a decrease in account maintenance fees as our retail customers became more engaged and a greater number of customers exceeded the minimum activity levels required to avoid account maintenance fees. We expect our account maintenance fee income to continue to decline over time; however, we expect our advisory service fee income, which is not currently a significant portion of service charges and fees, to increase over time as we focus on growing this product.

Principal Transactions

Principal transactions increased 11% to $110.2 million for 2006 compared to 2005. The increase in principal transactions resulted from higher trading volumes and market volatility which were offset slightly by a decrease in the average revenue earned per trade. Our principal transactions revenue is influenced by overall trading volumes, the number of stocks for which we act as a market maker, the trading volumes of those specific stocks and the performance of our proprietary trading activities.

Gain on Sales of Loans and Securities, Net

Gain on sales of loans and securities, net decreased 43% to $56.0 million for 2006 compared to 2005, as shown in the following table (dollars in thousands):


							Variance
	Year Ended December 31,						2006 vs. 2005
	2006			2005			Amount			%
Gain on sales of originated loans:
Mortgage loans	$	11,834		$	39,161		$	(27,327	)	(70	)%
Consumer loans⁽¹⁾		184			15,686			(15,502	)	(99	)%

Gain on sales of originated loans		12,018			54,847			(42,829	)	(78	)%
Loss on sales of loans held-for-sale, net		(6,775	)		(1,208	)		(5,567	)	*

Gain on sales of loans, net		5,243			53,639			(48,396	)	(90	)%
Gain on sales of securities, net		50,743			45,219			5,524		12	%

Gain on sales of loans and securities, net	$	55,986		$	98,858		$	(42,872	)	(43	)%

^*	Percentage not meaningful.

⁽¹⁾

Consumer loans originated by our retail segment are sold to our institutional segment at an arm’s length transfer price. The gains (losses) associated with our retail segment were reclassified to discontinued operations and the amounts related to our institutional segment remained in continuing operations.

The decline in the total gain on sales of loans and securities, net during 2006 was due primarily to our lower sales of mortgage and consumer loans compared to 2005. We retained a greater number of originated mortgage loans on the balance sheet in an effort to retain the customer relationship and drive growth in net operating interest income. The decline in gain on sales of consumer loans was also due in part to the sale of our consumer finance business in 2005. The increase in gain on sales of securities, net resulted from higher security sales volumes in 2006 compared to 2005.

Other Revenue

Other revenue increased 44% to $136.3 million for 2006 compared to 2005. The increases were the result of higher payment for order flow from improved option and equity trading volumes, offset by decreases in proprietary fund revenue relating to the closure of certain of our proprietary funds. In addition, other revenue includes foreign exchange margin revenue, stock plan administration products revenue and other revenue ancillary to our retail customer transactions.

Expense Excluding Interest

The components of expense excluding interest and the year-over-year variances are as follows (dollars in thousands):


						Variance
	Year Ended December 31,					2006 vs. 2005
	2006		2005			Amount			%
Compensation and benefits	$	469,202	$	380,803		$	88,399		23	%
Clearing and servicing		253,040		189,736			63,304		33	%
Advertising and marketing development		119,782		105,935			13,847		13	%
Communications		110,346		82,485			27,861		34	%
Professional services		96,947		77,416			19,531		25	%
Depreciation and amortization		73,845		74,981			(1,136	)	(2	)%
Occupancy and equipment		85,568		69,089			16,479		24	%
Amortization of other intangibles		46,220		43,765			2,455		6	%
Facility restructuring and other exit activities		28,537		(30,017	)		58,554		*
Other		136,042		59,860			76,182		127	%

Total expense excluding interest	$	1,419,529	$	1,054,053		$	365,476		35	%

*	Percentage not meaningful.

Expense excluding interest increased 35% to $1,419.5 million for 2006 compared to 2005. The increase in expense excluding interest was driven primarily by an increase in the number of employees in our service organization, higher trading volumes and loan balances, facility restructuring activities and an increase in fraud related losses.

Compensation and Benefits

Compensation and benefits increased 23% to $469.2 million for 2006 compared to 2005. This resulted primarily from a higher number of employees in our service organization, a full year impact of expensing stock options⁽¹⁾ and increased variable and incentive compensation expense. These increases in compensation are in line with the growth and performance of our business and our focus on enhancing customer service with additional representatives. We believe compensation and benefits as a percentage of revenue is a measure of our efficiency and the most relevant metric to assess this increase. This ratio declined to 19% for 2006 from 22% for 2005.

Clearing and Servicing

Clearing and servicing expense increased 33% to $253.0 million for 2006 compared to 2005. This increase was a result of higher trading volumes and higher loan balances during the period.

Communications

Communications expense increased 34% to $110.3 million for 2006 compared to 2005. The increase was due primarily to expenses associated with our newly acquired customers from Harrisdirect and BrownCo. In addition, we experienced higher variable expenses, such as quote services and trade confirmations, related to our increase in trading volume.

Professional Services

Professional services increased 25% to $96.9 million for 2006 compared to 2005. The increase was due primarily to third party support services, including technology and transitional service agreements, associated with our acquisitions of Harrisdirect and BrownCo.

⁽¹⁾	In July 2005 we adopted SFAS No. 123 (R), Share-Based Payment, which requires the expensing of stock options. Stock option expense was $22.1 million for 2006 and $13.7 for 2005.

Facility Restructuring and Other Exit Activities

Facility and restructuring costs were $28.5 million for 2006. During the year, we relocated certain functions out of the state of California. This expense represents certain facility costs as a result of ceasing operations at these locations in addition to severance charges for those employees to whom we communicated our plans and who were terminated as part of this relocation during the year.

Other

Other expenses increased 127% to $136.0 million for 2006 compared to 2005. These increases were due primarily to a 212% increase in fraud related losses to $31.2 million for 2006 and the favorable settlement of the Nomura Securities, Inc. (“Nomura”) litigation, which reduced other expense by $35.0 million in 2005. The fraud related losses were primarily identity theft situations which arose from computer viruses that attacked the personal computers of our customers. We did not suffer from a breach of the security of our systems. We reimbursed customers for their losses through our E*TRADE Complete Protection Guarantee. These fraud schemes have impacted our industry as a whole. While we believe our systems remain safe and secure, we have implemented technological and operational changes to deter unauthorized activity in our customer accounts.

Other Income (Expense)

Other income (expense) decreased to an expense of $72.0 million for 2006 compared to income of $26.3 million for 2005, as shown in the following table (dollars in thousands):


							Variance
	Year Ended December 31,						2006 vs. 2005
	2006			2005			Amount			%
Other income (expense):
Corporate interest income	$	8,433		$	11,043		$	(2,610	)	(24	)%
Corporate interest expense		(152,496	)		(73,956	)		(78,540	)	106	%
Gain on sales and impairment of investments		70,796			83,144			(12,348	)	(15	)%
Loss on early extinguishment of debt		(1,179	)		—			(1,179	)	*
Equity in income of investments and venture funds		2,451			6,103			(3,652	)	(60	)%

Total other income (expense)	$	(71,995	)	$	26,334		$	(98,329	)	*

*	Percentage not meaningful.

Other expense for 2006 primarily consisted of corporate interest expense resulting from the funding of the Harrisdirect and BrownCo acquisitions beginning in late 2005. Offsetting corporate interest expense was $70.8 million in gain on sales and impairment of investments. During 2006, we sold shares of our investments in SBI and International Securities Exchange Holdings, Inc. (“ISE”) resulting in gains of $71.7 million.

Income Tax Expense

Income tax expense from continuing operations increased 31% to $302.0 million for 2006 compared to 2005. The increase in income tax expense was principally related to the increase in pre-tax income over the comparable periods. Our effective tax rate for 2006 was 32.5% compared to 34.0% for 2005. The decrease in the 2006 tax rate compared to the 2005 tax rate is primarily due to benefits recognized on state tax refunds filed in one of our jurisdictions as a result of recent favorable court decisions, a reversal of valuation allowance recorded in prior years related to international operations and a continued decrease in our overall effective state tax rate due to our changing geographic footprint. For additional information, see Note 19—Income Taxes to the consolidated financial statements.

Discontinued Operations

Our net gain (loss) from discontinued operations was $2.0 million for 2006. During 2006 and 2005, our discontinued operations included operating results from our professional agency business E*TRADE Professional Trading, LLC and we recognized a gain of approximately $2.6 million, net of tax, in 2006. In 2005, discontinued operations also included operating losses from our consumer loan origination business and our proprietary trading business E*TRADE Professional Securities, LLC, both of which were sold or discontinued during 2005.

2005 Compared to 2004

Net income from continuing operations increased 17% to $446.2 million for 2005 compared to 2004. We experienced strong growth in customer cash and deposits as well as in DARTs. We also experienced growth in customer margin balances. In addition, we were able to achieve this growth while increasing our operating margin to 38% in 2005 from 33% in 2004. Growth in revenues also was attributed to improved interest rate spread and net interest income from a larger balance sheet. The following sections describe in more detail the changes in key operating factors, and other changes and events that have affected our consolidated net revenue, expense excluding interest, other income (expense), income tax expense, discontinued operations and cumulative effect of accounting change.

Revenue

Net Operating Interest Income After Provision for Loan Losses

Net operating interest income after provision for loan losses increased 37% to $871.1 million for 2005 compared to 2004. The increase in net operating interest income was due primarily to growth in enterprise interest-earning assets coupled with an increase in enterprise net interest spread. The growth in enterprise interest-earning assets was driven by increases in both loans, net and margin receivables. The increase in enterprise net interest spread was driven by changes in our mix of lending and funding sources. Average loans, net and margin receivables as a percentage of average enterprise interest-earning assets increased 10% to 56% for 2005 compared to 2004. Average retail deposits and free credits as a percentage of average enterprise interest-bearing liabilities decreased 6% to 53% 2005 compared to 2004.

Provision for Loan Losses

Provision for loan losses increased 42% to $54.0 million for 2005 compared to 2004. The increase in the provision for loan losses was related primarily to growth in the residential mortgage loan portfolio. In addition, higher consumer loan related losses resulted from higher losses on recreational vehicle loans and higher credit card bankruptcy activity as a significant number of customers filed for personal bankruptcy before the enactment of the new bankruptcy laws in October 2005.

Commission

Commission revenue increased 6% to $458.8 million for 2005 compared to 2004. The primary factors that affect our commission revenue are DARTs and average commission per trade, which is impacted by both trade types and the mix between our domestic and international businesses. Each business has a different pricing structure, unique to its customer base and local market practices, and as a result, a change in the executed trades between these businesses impacts average commission per trade. Each business also has different trade types (e.g. equities, options, fixed income and mutual funds) that can have different commission rates. As a result, changes in the mix of trade types within either of these businesses may impact average commission per trade.

Retail commission revenue increased $10.8 million for 2005 compared 2004 due to higher volumes (DARTs), offset by lower average commission per trade. Average commission per trade decreased 12% to

$13.82 for 2005 compared to 2004. The decrease was primarily a function of increased market pressures, strategic pricing and the mix of customers. During 2005, growth in the Active Trader and Mass Affluent customer trading volumes outweighed Main Street Investors trading volumes, who generally have a higher commission per trade, contributing to our lower average commission per trade.

Due to the factors described above, our 17% growth in DARTs for 2005 equated to a 3% increase in retail commission revenue during 2005 compared to 2004; however, our business model derives revenue not only from trades but also from other aspects of the relationship we have with our customers, especially those who maintain deposits, free credit and lending balances with us. Our average customer uses at least 2 products or services from our suite of retail products, which is the main driver in our diversification of revenue. For 2005, retail commission revenue represents 20% of total net revenue.

Institutional commission revenue increased $16.4 million for 2005 compared to 2004. The increase reflects growth in wholesale trading. In early 2005, an institutional wholesale trading group was created to trade large blocks of stock for institutional customers. We provide institutional customers with global execution and settlement services, as well as worldwide access to research provided by third parties, in exchange for commissions based on negotiated rates, which differ by customer.

Service Charges and Fees

Service charges and fees increased 39% to $135.3 million for 2005 compared to the 2004. The increase in service charges and fees for 2005 was due primarily to an increase in the account service fees and advisory service fees. The increase in account service fees was due to an increase in account service fees charged beginning in the first quarter of 2005, from $25 to $40 per quarter for customers who did not meet certain criteria for balance and/or activity levels. Advisory fees increased as a result of our acquisitions of investment advisory firms.

Principal Transactions

Principal transactions decreased 22% to $99.3 million for 2005 compared to 2004. The decrease in principal transactions resulted from lower market-making volumes and market volatility. Our principal transactions revenue is influenced by overall trading volumes, the number of stocks for which we act as a market maker, the trading volumes of those specific stocks and the trading performance of our proprietary trading activities.

Gain on Sales of Loans and Securities, Net

Gain on sales of loans and securities, net decreased 30% to $98.9 million for 2005 compared to 2004. The decrease was due primarily to lower gain on sales of originated mortgage loans. This was the result of an overall decline in mortgage industry volumes as interest rates continued to rise in 2005.

Impairment losses of $38.3 million in 2005 related primarily to interest-only securities and to a lesser extent certain investment securities. Impairment on certain interest-only securities was the result of short-term movements in interest rates. Impairments on investment securities were the result of credit losses in certain investment securities secured by manufactured housing loans. These impairments were not indicative of a specific issue with our investments, but rather an overall deterioration in the manufactured housing loan market.

Other Revenue

Other revenue increased 6% to $94.4 million for 2005 compared to 2004. The increases were the result of increased options transaction fees and 12b-1 fees, offset by decreases in proprietary fund revenue relating to the closure of certain of our proprietary funds. In addition, other revenue includes foreign exchange margin revenue, stock plan administration products revenue and other revenue ancillary to our retail customer transactions.

Expense Excluding Interest

Expense excluding interest increased 7% to $1,054.1 million for 2005 compared to 2004. The increase in expense excluding interest was driven primarily by higher compensation and benefits expense due to the adoption of SFAS 123(R), increased marketing for the launch of E*TRADE Complete and a larger balance sheet.

Compensation and Benefits

Compensation and benefits increased 9% to $380.8 million for 2005 compared to 2004. This increase resulted primarily from $13.7 million in stock option expense. In July 2005 we adopted SFAS No. 123 (R) which requires the expensing of stock options. We believe compensation and benefits as a percentage of revenue is a measure of our efficiency and the most relevant metric to assess this increase. This ratio declined from 24% for 2004 to 22% for 2005.

Clearing and Servicing

Clearing and servicing expense increased 17% to $189.7 million for 2005 compared to 2004. This increase was primarily a result of an increase in servicing costs due to growth in our loan portfolio which increased 69% compared to 2004.

Communications

Communications expense increased 18% to $82.5 million for 2005 compared to 2004. The increase was due to expenses associated with communications to our newly acquired customers from Harrisdirect and BrownCo. In addition, variable expenses such as quote services and trade confirmations increased with our increase in trading volume.

Professional Services

Professional services increased 12% to $77.4 million for 2005 compared to 2004. The increase was due primarily to third party support services, including technology and transitional service agreements, associated with our acquisitions of Harrisdirect and BrownCo.

Advertising and Marketing

Advertising and marketing costs increased 70% to $105.9 million for 2005 compared to 2004. The increase was due primarily to marketing the launch of E*TRADE Complete, as well as an increase in acquisition-related and customer retention marketing.

Amortization of Other Intangibles

Amortization of other intangibles increased 125% to $43.8 million for 2005 compared to 2004. The increase in amortization expense was due primarily to the impairment of our OTC specialist book.

Facility Restructuring and Other Exit Activities

Facility and restructuring costs were a credit of $30.0 million for 2005. The credit resulted from a $35.5 million, pre-tax gain recognized on the sale of the Consumer Finance Corporation servicing business, which was recorded as a facility restructuring cost as it did not qualify as a discontinued operation.

Other

Other expenses decreased 34% to $59.9 million for 2005 compared to 2004. This decrease was due primarily to the favorable settlement of the Nomura litigation which reduced other expenses by $35.0 million.

Other Income (Expense)

Other income (expense) decreased $42.4 million to income of $26.3 million for 2005 compared to 2004. This decrease was due primarily to lower gain on the sale and impairment of investments of $45.0 million and higher corporate interest expense of $26.4 million resulting from an increase in acquisition-related senior notes in 2005, partially offset by the $23.0 million loss on early extinguishment of debt in 2004. During 2005, we sold shares of our investments in SBI, Archipelago Holdings, Inc., Ameritrade Holding Corporation and ISE resulting in gains of $82.7 million. During 2004, gain on sales and impairment of investments was related primarily to gain on sales of our investments in SBI in the amount of $130.6 million.

Income Tax Expense

Income tax expense from continuing operations increased $48.1 million or 26% for 2005 compared to 2004. The increase in income tax expense was related to the increase in pre-tax income over the comparable periods. Our effective tax rates for 2005 and 2004 were 34.0% and 32.2%, respectively. The lower effective tax rate for 2004 was due principally to tax benefits recognized in 2004 in connection with the sale of partnership interests which generated an excess tax basis adjustment and the closure of several open IRS tax issues.

Discontinued Operations

Our net gain (loss) from discontinued operations was a loss of $17.5 million for 2005 and a loss of $1.3 million for 2004. During 2005, our discontinued operations included operating results from our proprietary trading business E*TRADE Professional Securities, LLC, our professional agency business E*TRADE Professional Trading, LLC and the origination business of Consumer Finance Corporation. During 2004, our discontinued operations included operating results from E*TRADE Access.

Cumulative Effect of Accounting Change

The cumulative effect of accounting change of $1.6 million after tax ($2.8 million pre-tax) for 2005 resulted from the adoption of SFAS No. 123(R) and Staff Accounting Bulletin No. 107, Share-Based Payment, effective July 1, 2005, which required us to record compensation expense for stock options.

Prior to our adoption of SFAS No. 123(R), we recorded compensation expense for restricted stock awards on a straight-line basis over their vesting period. If an employee forfeited the award prior to vesting, we reversed out the previously expensed amounts in the period of forfeiture. As required upon adoption of SFAS No. 123(R), we must base the accruals of compensation expense on the estimated number of awards for which the requisite service period is expected to be rendered. Actual forfeitures are no longer recorded in the period of forfeiture. The pre-tax credit of $2.8 million in cumulative effect of accounting change represents the amount by which compensation expense would have been reduced in periods prior to adoption of SFAS No. 123(R) for restricted stock awards outstanding on July 1, 2005 that are anticipated to be forfeited.

SEGMENT RESULTS REVIEW

Retail

Retail segment income increased 52% to $695.2 million for 2006 compared to 2005, as shown in the following table (dollars in thousands, except for key metrics):


	Year Ended December 31,						Variance
	Year Ended December 31,						2006 vs. 2005
	2006		2005		2004		Amount			%
Retail segment income:
Net operating interest income after provision for loan losses	$	883,563	$	445,124	$	322,278	$	438,439		98	%
Commission		479,876		339,654		328,889		140,222		41	%
Service charges and fees		115,672		116,102		84,445		(430	)	(0	)%
Gain on sales of loans and securities, net		36,698		63,705		93,694		(27,007	)	(42	)%
Other revenue		138,316		112,836		106,457		25,480		23	%

Net segment revenue		1,654,125		1,077,421		935,763		576,704		54	%
Total segment expense		958,882		618,664		628,146		340,218		55	%

Total retail segment income	$	695,243	$	458,757	$	307,617	$	236,486		52	%

Key Metrics:
Retail client assets (dollars in billions)⁽¹⁾	$	194.9	$	177.9	$	100.0	$	17.0		10	%
Customer cash and deposits (dollars in billions)⁽¹⁾	$	33.6	$	28.2	$	18.7	$	5.4		19	%
DARTs		159,348		97,740		83,643		61,608		63	%
Average commission per trade	$	12.05	$	13.82	$	15.63	$	(1.77	)	(13	)%
Average margin receivables (dollars in billions)	$	6.8	$	2.8	$	2.0	$	4.0		143	%
Products per customer		2.1		2.1		1.9		—		—	%

⁽¹⁾

Total customer cash and deposits, as well as total retail client assets, have been re-presented to account for a methodology change in the metric to settlement date from trade date reporting as of December 31, 2005, which reduced both metrics by $564 million. This is not a methodology change in accounting policy and does not impact the reporting of these line items on our balance sheet.

Our retail segment generates revenue from investing, trading, banking and lending relationships with retail customers. These relationships essentially drive five sources of revenue including net operating interest income; commission; service charges and fees; gain on sales of loans and securities, net; and other revenue. This segment also includes results from our stock plan administration products and services, as we are ultimately servicing a retail customer through these corporate relationships. Our geographically dispersed retail accounts grew 3% from 2005 to 2006. As of December 31, 2006, we had approximately 3.6 million active trading and investing accounts and 0.8 million active lending and deposit accounts.

The increase in retail segment income during 2006 compared to a year ago was due to an increase in net operating interest income after provision for loan losses and commission revenue, offset by lower gain on sales of loans and securities, net. Retail net operating interest income after provision for loan losses increased 98% to $883.6 million for 2006 compared to 2005. Average margin receivables increased 143% to $6.8 billion for 2006 compared to 2005. Higher margin balances generally translate into a higher interest rate earned on interest-earning assets. Customer cash and deposits increased 19% at December 31, 2006 compared to December 31, 2005. Higher customer cash and deposit balances generally translate into a lower cost of funds as deposits increased in comparison to other borrowings. Net operating interest income growth included the impact of the Harrisdirect and BrownCo acquisitions which occurred in the fourth quarter of 2005.

Retail commission revenue increased $140.2 million for 2006 compared to 2005 due to higher volumes (DARTs), offset by lower average commission per trade. The increase in DART volumes was the result of the Harrisdirect and BrownCo acquisitions as well as strong organic growth in domestic equity, international equity and option trades.

A shift in the composition of our retail customers who traded during the year resulted in a 13% decrease in average commission per trade for 2006 compared to 2005. As a result, our 63% growth in DARTs for 2006 equated to a 41% increase in retail commission revenue for 2006; however, we derive revenue not only from trades but also from other aspects of our relationship with our customers, especially customers who maintain deposits and free credits with us. Our average customer uses at least 2 products or services from our suite of retail products, which is the main driver in our diversification of revenue. As such, while retail commission revenue increased 41% during 2006, total retail segment revenue increased 54%.

Offsetting these increases were lower gains on the sales of loans and securities, net of $36.7 million for 2006. In addition, service charges and fees decreased $0.4 million for 2006 compared to 2005.

Retail segment expense increased $340.2 million for 2006 compared to 2005. The increase for 2006 was related primarily to the $29.6 million restructuring charge, an increase in the compensation expense due to an increased number of employees in our service organization and increased fraud-related losses.

2005 Compared to 2004

The 49% increase in retail segment income for 2005 compared to 2004 was due to an increase in net revenue driven primarily by an increase in net operating interest income, offset by lower gain on sales of loans and securities, net. DARTs increased 17% in 2005 compared to 2004. While the increase in DARTs did not produce a corresponding increase in commission revenues, these customers did help drive the increase in cash deposits held in sweep deposit accounts.

Retail net operating interest income after provision for loan losses increased 38% to $445.1 million for 2005 compared to 2004. The increase was driven by an increase in both average enterprise interest-earning assets and the net interest spread earned. Growth in average margin receivables was 40% to $2.8 billion in 2005 compared to 2004, including the impact of our acquisitions. Other key drivers of this increase in retail segment income were growth in the average balances of loans and deposits which increased 54% and 11%, respectively over last year. Service charges and fees increased by 37% in 2005 compared to 2004, due primarily to an increase in account service fees. Offsetting these positive variances were lower gains on the sale of loans and securities, net of $30.0 million due to the lower gains on the sale of mortgage loans and securities impairment.

Institutional

Institutional segment income increased 60% to $305.5 million for 2006 compared to 2005, as shown in the following table (dollars in thousands, except for key metrics):


										Variance
	Year Ended December 31,									2006 vs. 2005
	2006			2005			2004			Amount			%
Institutional segment income:
Net operating interest income after provision for loan losses		471,499			372,122			274,743			99,377		27	%
Commission		145,389			119,180			102,749			26,209		22	%
Service charges and fees		21,769			19,212			13,130			2,557		13	%
Principal transactions		110,235			99,175			126,893			11,060		11	%
Gain on sales of loans and securities, net		19,288			35,153			47,024			(15,865	)	(45	)%
Other revenue		9,269			10,383			16,684			(1,114	)	(11	)%

Net segment revenue		777,449			655,225			581,223			122,224		19	%
Total segment expense		471,900			464,190			393,041			7,710		2	%

Total institutional segment income	$	305,549		$	191,035		$	188,182		$	114,514		60	%

Key Metrics:
Total nonperforming loans as a percent of total loans, net		0.28	%		0.18	%		0.17	%		—		0.10	%
Average revenue capture per 1,000 equity shares	$	0.373		$	0.458		$	0.341		$	(0.085	)	(19)	%

Our institutional segment generates earnings from balance sheet management activities, market-making and global execution and settlement services. Balance sheet management activities include purchasing loan receivables from the retail segment as well as third parties, and leveraging these loans and retail customer cash and deposit relationships to generate additional net operating interest income. Retail trading order flow is leveraged by the institutional segment to generate additional revenue for the Company.

Net operating interest income after provision for loan losses increased 27% to $471.5 million for 2006 compared to 2005. This increase was primarily a result of growth in interest-earning assets, which are funded primarily by retail customer cash and deposit balances. These customer balances were kept on-balance sheet as a low-cost source of funding and then utilized by the institutional segment either to purchase interest-earning assets or pay down wholesale liabilities.

Institutional commissions increased 22% to $145.4 million for 2006 compared to 2005. This increase was due to a more favorable trading environment and the continued leveraging of our integrated institutional model with higher retail order flow. We provide institutional customers with global execution and settlement services, as well as worldwide access to research provided by third parties, in exchange for commissions based on negotiated rates, which differ by customer.

The increase in net operating interest income after provision for loan losses and commission revenue was offset by a planned decrease in gain on sales of loans and securities, net of approximately $15.9 million for 2006 compared to 2005. We evaluate our portfolio of securities available-for-sale in light of changing market conditions and where appropriate, take steps intended to optimize our overall economic position. During 2006, we determined that we would not sell securities at similar levels as 2005 because we focused on growing our balance sheet.

Total institutional segment expense increased 2% to $471.9 million for 2006 compared to 2005 and was predominantly volume-related. Compensation and benefits expense increased due to increases in variable- and performance-based compensation and expensing of stock options. Clearing and servicing expense increased due to increased overall trading volumes and the increase in our loan portfolio.

2005 Compared to 2004

The 2% increase in institutional segment income in 2005 compared to 2004 was attributable to a $74.0 million increase in net revenue offset by a $71.1 million increase in expenses. The increase in net revenue resulted from higher net operating interest income due to higher average balances of enterprise interest-earning assets. The increase in the net operating interest income was partially driven by a shift from lower yielding securities to higher yielding loans. The increase in expenses was driven by an increase in intangible amortization due to the impairment of our OTC Specialist Book, compensation and benefits expense due to the adoption of SFAS 123(R) and commissions due to an increase in overall trading volumes and higher servicing expenses related to an increase in loans serviced.

BALANCE SHEET OVERVIEW

The following table sets forth the significant components of our consolidated balance sheet (dollars in thousands):


	December 31,				Variance
	2006		2005		2006 vs. 2005
Assets:
Cash and equivalents⁽¹⁾	$	1,493,856	$	1,454,362	3	%
Trading securities		178,600		146,657	22	%
Available-for-sale mortgage-backed and investment securities		13,921,983		12,763,438	9	%
Loans held-for-sale		283,496		87,371	224	%
Brokerage receivables, net		7,636,352		7,174,175	6	%
Loans receivable, net		26,372,697		19,424,895	36	%
Other assets⁽²⁾		3,852,319		3,516,788	10	%

Total assets	$	53,739,303	$	44,567,686	21	%

Liabilities and shareholders’ equity:
Deposits	$	24,071,012	$	15,948,015	51	%
Securities sold under agreements to repurchase		9,792,422		11,101,542	(12	)%
Brokerage payables		7,824,704		7,342,208	7	%
Other borrowings		5,323,962		4,206,996	27	%
Corporate debt⁽³⁾		1,842,169		2,022,701	(9	)%
Accounts payable, accrued and other liabilities		688,664		546,664	26	%

Total liabilities		49,542,933		41,168,126	20	%
Shareholders’ equity		4,196,370		3,399,560	23	%

Total liabilities and shareholders’ equity	$	53,739,303	$	44,567,686	21	%

⁽¹⁾	Includes balance sheet line items cash and equivalents and cash and investments required to be segregated under Federal or other regulations.

⁽²⁾	Includes balance sheet line items property and equipment, net, goodwill, other intangibles, net and Other assets.

⁽³⁾	Includes balance sheet line items senior notes, mandatory convertible notes and convertible subordinated notes.

During the period, we re-aligned our balance sheet to consolidate several categories and changed the name of “Other borrowings by Bank subsidiary” to “Other borrowings.” Other borrowings include non-Bank subsidiary term notes previously classified in “Accounts payable, accrued and other liabilities.” Categories consolidated and related changes include:

•

“Investment in Federal Home Loan Bank stock” was added to “Available-for-sale mortgage-backed and investment securities”;

•

“Derivative assets” and “Accrued interest receivable” were added to “Other assets”; and

•

“Derivative liabilities” was added to “Accounts payable, accrued and other liabilities.”

These categories were consolidated with other similar items in our balance sheet presentation. The notes to our consolidated financial statements continue to include detailed information about the individual items no longer listed on the face of the balance sheet.

The 21% increase in total assets at December 31, 2006 compared to December 31, 2005 was primarily the result of growth in loans receivable, net and available-for-sale mortgage-backed and investment securities. The growth in loans receivable, net was the result of our continued focus on growing our residential mortgage loan portfolios, including one- to four-family mortgages and home equity loans. The growth in available-for-sale mortgage-backed and investment securities was due primarily to the growth in our asset-backed securities portfolio.

The 20% increase in total liabilities at December 31, 2006 compared to December 31, 2005 was attributable primarily to a $8.1 billion increase in deposits. The increase in deposits was due to higher sweep deposit accounts and money market deposits resulting, in part, from our conversion of Harrisdirect customers during the first quarter of 2006, as well as from organic growth from existing and new customers. The increase in deposits was partially offset by declines in securities sold under agreements to repurchase and corporate debt.

The conversion of Harrisdirect customers to the E*TRADE Financial platform resulted in the transfer of customer brokerage receivables, deposits and customer brokerage payables from a third party provider to us. Customer brokerage receivables or margin receivables of $0.8 billion were transferred to our balance sheet. In addition, sweep deposit balances of $2.7 billion and brokerage payables, specifically free credits, of $1.3 billion were also moved to our balance sheet.

Loans Receivable, Net

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


	December 31,						Variance
	2006			2005			2006 vs. 2005
Real estate loans:
One- to four-family	$	10,870,214		$	7,091,664		53	%
Home equity lines of credit (“HELOC”), Home equity installment loans (“HEIL”) and other		11,809,008			8,106,820		46	%
Consumer and other loans:
Recreational vehicle		2,292,356			2,692,055		(15	)%
Marine		651,764			752,645		(13	)%
Commercial		219,008			89,098		146	%
Credit card		128,583			188,600		(32	)%
Automobile		77,533			235,388		(67	)%
Other		3,706			8,338		(56	)%
Unamortized premiums, net		388,153			323,573		20	%
Allowance for loan losses		(67,628	)		(63,286	)	7	%

Total loans receivable, net	$	26,372,697		$	19,424,895		36	%

Loans receivable, net increased 36% to $26.4 billion at December 31, 2006 from $19.4 billion at December 31, 2005. We continue to focus our growth in real estate loans while allowing our consumer loans to decline. We anticipate that our mortgage and HELOC portfolios will continue to increase over time, and we believe this will improve our credit risk profile. We anticipate that recreational vehicle and marine loan balances will continue to decline over time due to our sale of Consumer Finance Corporation in 2005, and automobile loans will continue to decline due to our exit of the automobile origination business in 2004. Commercial loans increased 146% to $219.0 million at December 31, 2006 compared to December 31, 2005.

Allowance for Loan Losses

The allowance for loan losses is management’s estimate of credit losses inherent in our loan portfolio as of the balance sheet date. The estimate of the allowance for loan losses is based on a variety of factors, including the composition and quality of the portfolio; delinquency levels and trends; probable expected losses for the next twelve months; current and historical charge-off and loss experience; current industry charge-off and loss experience; the condition of the real estate market and geographic concentrations within the loan portfolio; the interest rate climate as it affects adjustable-rate loans; and general economic conditions. Determining the adequacy of the allowance is complex and requires judgment by management about the effect of matters that are inherently uncertain. Subsequent evaluations of the loan portfolio, in light of the factors then prevailing, may result in significant changes in the allowance for loan losses in future periods. In general, we believe the

allowance for loan losses should be equal to at least twelve months of probable projected losses for all loan types. We believe this level is representative of probable losses inherent in the loan portfolio at the balance sheet date.

In determining the allowance for loan losses, we allocate a portion of the allowance to various loan products based on an analysis of individual loans and pools of loans. However, the entire allowance is available to absorb credit losses inherent in the total loan portfolio as of the balance sheet date.

The following table presents the allowance for loan losses by major loan category (dollars in thousands):


	Consumer & Other				Real Estate				Total
	Allowance		Allowances as % of Consumer and Other Loans Receivable		Allowance		Allowances as % of Real Estate Loans Receivable		Allowance		Allowances as % of Total Loans Receivable
December 31, 2006	$	28,197	0.82	%	$	39,431	0.17	%	$	67,628	0.26	%
December 31, 2005	$	32,379	0.80	%	$	30,907	0.20	%	$	63,286	0.32	%

The following table provides an analysis of the allowance for loan losses for the past five years (dollars in thousands):


	Year Ended December 31,
	2006			2005			2004			2003			2002
Allowance for loan losses, beginning of period	$	63,286		$	47,681		$	37,847		$	27,666		$	19,874
Provision for loan losses		44,970			54,016			38,121			38,523			14,664
Allowance acquired through acquisitions⁽¹⁾		—			—			1,547			2,748			14,428
Charge-offs:
Real estate		(616	)		(936	)		(186	)		(364	)		(460	)
HELOC, HEIL and other		(15,372	)		(3,929	)		(1,464	)		(75	)		—
Recreational vehicle		(25,253	)		(20,592	)		(18,419	)		(20,341	)		(3,456	)
Marine		(6,463	)		(8,009	)		(6,003	)		(7,369	)		—
Commercial		—			—			—			—			—
Credit card		(11,371	)		(17,286	)		(10,313	)		(919	)		—
Automobile		(2,430	)		(5,915	)		(13,796	)		(22,695	)		(28,046	)
Other		(338	)		(180	)		(160	)		(1,971	)		—

Total charge-offs		(61,843	)		(56,847	)		(50,341	)		(53,734	)		(31,962	)

Recoveries:
Real estate		167			234			—			223			30
HELOC, HEIL and other		822			526			310			—			—
Recreational vehicle		11,959			7,848			9,088			9,738			—
Marine		4,091			3,960			3,225			3,806			—
Commercial		—			—			—			—			—
Credit card		750			380			141			1			—
Automobile		3,285			5,382			7,464			8,335			10,632
Other		141			106			279			541			—

Total recoveries		21,215			18,436			20,507			22,644			10,662

Net charge-offs		(40,628	)		(38,411	)		(29,834	)		(31,090	)		(21,300	)

Allowance for loan losses, end of period	$	67,628		$	63,286		$	47,681		$	37,847		$	27,666

Net charge-offs to average loans receivable, net outstanding		0.18	%		0.26	%		0.30	%		0.41	%		0.28	%

⁽¹⁾	Acquisition of credit card portfolios in 2004 and 2003 and the Consumer Finance Corporation portfolio in 2002.

The following table allocates the allowance for loan losses by loan category (dollars in thousands):


	December 31,
	2006				2005				2004				2003				2002
	Amount		%⁽¹⁾		Amount		%⁽¹⁾		Amount		%⁽¹⁾		Amount		%⁽¹⁾		Amount		%⁽¹⁾
Real estate loans:
One- to four- family	$	7,760	41.7	%	$	4,858	37.0	%	$	2,812	32.3	%	$	2,360	28.6	%	$	3,343	29.8	%
HELOC, HEIL and other		31,671	45.3			26,049	42.3			15,183	31.9			3,302	19.1			851	6.8

Total real estate loans		39,431	87.0			30,907	79.3			17,995	64.2			5,662	47.7			4,194	36.6

Consumer and other loans:
Recreational vehicle		11,077	8.8			13,465	14.1			11,343	22.4			11,386	28.3			9,480	24.8
Marine		3,648	2.5			4,590	3.9			4,116	6.3			2,503	7.9			3,108	8.4
Commercial		1,635	0.9			669	0.5			22	—			4	—			—	—
Credit card		10,611	0.5			11,714	1.0			9,078	1.8			5,583	1.4			—	—
Automobile		534	0.3			1,080	1.2			4,195	5.1			11,876	14.5			8,190	27.4
Other		692	—			861	—			932	0.2			833	0.2			2,694	2.8

Total consumer and other loans		28,197	13.0			32,379	20.7			29,686	35.8			32,185	52.3			23,472	63.4

Total allowance for loan losses	$	67,628	100.0	%	$	63,286	100.0	%	$	47,681	100.0	%	$	37,847	100.0	%	$	27,666	100.0	%

⁽¹⁾	Represents percentage of loans receivable in category to total loans receivable, excluding premium (discount).

Losses are recognized when it is probable that a loss will be incurred. Our policy is to charge-off closed-end consumer loans when the loan is 120 days delinquent or when we determine that collection is not probable. For first-lien mortgages, a charge-off is recognized when we foreclose on the property. For revolving loans, our policy is to charge-off loans when collection is not probable or the loan has been delinquent for 180 days.

During 2006, the allowance for loan losses increased by $4.3 million from the level at December 31, 2005. The increase was due primarily to growth in the real estate loan portfolio, which increased approximately $7.5 billion over the same period and is not indicative of a decline in our overall credit standards. The allowance increased by $8.5 million related to the growth of the real estate portfolio. Offsetting this increase was a decrease in the allowance for loan losses of $4.2 million related to the decline in the size of the consumer loan portfolio.

Net charge-offs for the year ended 2006 compared to 2005 increased by $2.2 million. The overall increase was due to higher net charge-offs on real estate loans offset by lower net charge-offs on consumer loans. The increase in real estate loan charge-offs was due to the growth of the portfolio and the decrease in consumer loan charge-offs was due primarily to a decline in loan balances as we exited the consumer finance business in 2005. Annualized net charge-offs as a percentage of average loans receivable, net were 0.18% at December 31, 2006 compared to 0.26% at December 31, 2005.

Nonperforming Assets

We classify loans as nonperforming when full and timely collection of interest or principal becomes uncertain or when they are 90 days past due. The following table shows the comparative data for nonperforming loans and assets (dollars in thousands):


	Year Ended December 31,
	2006			2005			2004			2003			2002
Real estate loans:
One- to four-family	$	34,219		$	18,067		$	11,029		$	18,094		$	22,497
HELOC, HEIL and other		32,216			9,568			2,755			269			81

Total real estate loans		66,435			27,635			13,784			18,363			22,578

Consumer and other loans:
Recreational vehicle		2,579			2,826			1,416			1,399			1,486
Marine		1,439			873			908			1,067			94
Commercial		—			—			—			—			—
Credit card		3,795			2,858			2,999			2,147			—
Automobile		1,047			448			826			1,602			2,277
Other		46			14			22			16			53

Total consumer and other loans		8,906			7,019			6,171			6,231			3,910

Total nonperforming loans		75,341			34,654			19,955			24,594			26,488
Real estate owned (“REO”) and other repossessed assets, net		12,904			6,555			5,367			6,690			6,723

Total nonperforming assets, net	$	88,245		$	41,209		$	25,322		$	31,284		$	33,211

Total nonperforming loans as a percentage of total loans, net		0.28	%		0.18	%		0.17	%		0.27	%		0.36	%

Total allowance for loan losses as a percentage of total nonperforming loans receivable⁽¹⁾		90.52	%		186.24	%		281.55	%		187.61	%		N/A	⁽¹⁾

⁽¹⁾	This metric was changed to reflect the percentage of allowance for loan losses in relation to the total nonperforming loans receivable. In 2002, nonperforming loans were not tracked as held-for-investment versus held-for-sale; as such, this metric is not available.

We expect nonperforming loan levels to fluctuate over time due to portfolio growth, portfolio seasoning and resolution through collections, sales or charge-offs. The performance of any loan can be affected by external factors, such as economic conditions or factors particular to the borrower.

During 2006, our nonperforming assets, net increased $47.0 million from $41.2 million at December 31, 2005. The increase was attributed to an increase in nonperforming real estate loans and REO and other repossessed assets, net of $45.1 million and an increase in nonperforming consumer and other loans of $1.9 million. These trends are not the result of a deterioration or improvement in credit quality, but are reflective of our targeted growth in real estate loans and the targeted decrease in consumer loans.

The allowance as a percentage of total nonperforming loans receivable, net decreased from 186% in 2005 to 91% in 2006. As our loan portfolio shifts to mortgage loans, where the risk of charge-off is generally less than the risk of charge-off on a consumer loan, the level of the allowance to nonperforming assets may continue to decrease.

In addition to nonperforming assets in the table above, we monitor loans where a borrower’s past credit history casts doubt on the borrower’s ability to repay a loan, whether or not the loan is delinquent (“Special Mention” loans). Special Mention loans represented $261.5 million, or 1%, and $127.2 million, or 1%, of the total loan portfolio at December 31, 2006 and 2005, respectively. These loans are actively monitored, continue to accrue interest and remain a component of the loans receivable balance. The increase in Special Mention loans was due primarily to an increase in the 30-day delinquency category of mortgage loans. Significant migration from this category to more serious delinquency classifications is not expected to occur.

Available-for-Sale Mortgage-Backed and Investment Securities

Available-for-sale securities are summarized as follows (dollars in thousands):


	December 31,				Variance
	2006		2005		2006 vs. 2005
Mortgage-backed securities:
Backed by U.S. government sponsored and Federal agencies	$	9,109,307	$	9,427,521	(3	)%
Collateralized mortgage obligations and other		1,108,385		995,891	11	%

Total mortgage-backed securities		10,217,692		10,423,412	(2	)%

Investment securities:
Asset-backed securities		2,161,728		1,365,754	58	%
Publicly traded equity securities:
Preferred stock		458,674		288,365	59	%
Corporate investments		24,139		147,400	(84	)%
FHLB stock		244,212		198,700	23	%
Other		815,538		339,807	140	%

Total investment securities		3,704,291		2,340,026	58	%

Total available-for-sale securities	$	13,921,983	$	12,763,438	9	%

Available-for-sale securities represented 26% and 29% of total assets at December 31, 2006 and 2005, respectively. Available-for-sale securities increased 9% to $13.9 billion at December 31, 2006 compared to December 31, 2005, due primarily to the growth in our asset-backed securities portfolio. We evaluate our available-for-sale securities in light of changing market conditions and other factors and, where appropriate, take steps intended to improve our overall position. We determined that we would not sell our mortgage-backed and asset-backed securities at similar levels as 2005 because we focused on growing our balance sheet.

As interest rates increase, the fair value of fixed-rate available-for-sale securities decreases and vice versa. The fair value of the portfolio will be adversely impacted in 2007 if long-term interest rates continue to rise. Net unrealized gains and losses in available-for-sale securities are included in shareholders’ equity as accumulated other comprehensive income or loss, net of tax.

Deposits

Deposits are summarized as follows (dollars in thousands):


	December 31,				Variance
	2006		2005		2006 vs. 2005
Sweep deposit accounts	$	10,837,124	$	7,733,267	40	%
Money market and savings accounts		7,634,241		4,635,866	65	%
Certificates of deposit⁽¹⁾		4,737,253		2,703,605	75	%
Brokered certificates of deposit⁽²⁾		483,777		484,612	(0	)%
Checking accounts		378,617		390,665	(3	)%

Total deposits	$	24,071,012	$	15,948,015	51	%

⁽¹⁾	Includes retail certificates of deposit including retail brokered certificates of deposit.

⁽²⁾	Includes institutional certificates of deposit.

Deposits represented 49% and 39% of total liabilities at December 31, 2006 and 2005, respectively. Deposits increased $8.1 billion to $24.1 billion at December 31, 2006 compared to December 31, 2005, driven by

a $3.1 billion increase in sweep deposit accounts, a $3.0 billion increase in money market and savings accounts and a $2.0 billion increase in certificates of deposit.

The increase in sweep deposit accounts was driven primarily by the Harrisdirect and BrownCo conversions. Prior to the conversions, Harrisdirect customer cash balances were swept to a third party and not reflected on our balance sheet, and BrownCo customer cash balances were generally kept in free credits. Our other deposit products have shown significant growth as a result of our focused sales and retention efforts, as well as the overall impact of the E*TRADE Complete Intelligent Cash Optimizer. E*TRADE Complete Intelligent Cash Optimizer enables customers to better determine the optimal use of their funds and has resulted in higher money market and certificates of deposit balances. The sweep deposit accounts, money market accounts and certificates of deposit generally provide us the benefit of lower interest costs, compared with wholesale funding alternatives.

The deposits balance is a component of the total customer cash and deposits balance reported as a customer activity metric of $33.6 billion for the year ended December 31, 2006. The total customer cash and deposits balance is summarized as follows (dollars in thousands):


							Variance
	December 31,						2006 vs. 2005
	2006			2005			Amount			%
Deposits	$	24,071,012		$	15,948,015		$	8,122,997		51	%
Less: brokered certificates of deposit		(483,777	)		(484,612	)		835		0	%

Deposits excluding brokered certificates of deposit		23,587,235			15,463,403			8,123,832		53	%
Free credits		6,368,749			5,770,751			597,998		10	%
Customer cash balances held by third parties		3,633,783			6,955,830			(3,322,047	)	(48	)%

Total customer cash and deposits	$	33,589,767		$	28,189,984		$	5,399,783		19	%

The decrease in customer cash balances held by third parties was due primarily to the Harrisdirect conversion wherein cash from this account (which is off-balance sheet) was converted to deposits and free credits (which is on balance sheet).

Securities Sold Under Agreements to Repurchase and Other Borrowings

Securities sold under agreements to repurchase and other borrowings are summarized as follows (dollars in thousands):


	December 31,				Variance
	2006		2005		2006 vs. 2005
Securities sold under agreements to repurchase	$	9,792,422	$	11,101,542	(12	)%

FHLB advances	$	4,865,466	$	3,856,106	26	%
Subordinated debentures		385,502		305,046	26	%
Other		72,994		45,844	59	%

Total other borrowings	$	5,323,962	$	4,206,996	27	%

Securities sold under agreements to repurchase decreased by 12% at December 31, 2006 compared to December 31, 2005. Securities sold under agreements to repurchase coupled with FHLB advances are the primary wholesale funding sources of the Bank. During 2006, the Bank used these wholesale sources along with deposit growth to fund the increase in loans receivable. Other borrowings represented 11% and 10% of total liabilities at December 31, 2006 and 2005, respectively. The increase of $1.1 billion during 2006 was due primarily to an increase in FHLB advances. We actively manage our funding sources and determine the optimal mix based on pricing, liquidity and capacity during each period.

Corporate Debt

Corporate debt decreased to $1.8 billion at December 31, 2006 compared to $2.0 billion at December 31, 2005. The Company called the remaining $185.2 million principal amount of its 6.00% convertible subordinated notes due February 2007 (“6.00% Notes”) during the year ended December 31, 2006.

LIQUIDITY AND CAPITAL RESOURCES

Our liquidity and capital resources enable us to fund our operating activities, finance acquisitions and grow our assets. Cash flows are derived from capital market activities and our operations in the retail and institutional segments. The segment cash flows provide capital to fund growth in our regulated subsidiaries. The Company’s cash and equivalents balance increased to $1.2 billion for the year ended December 31, 2006.

Changes in Cash and Equivalents

In 2006, cash and equivalents at E*TRADE Financial Corporation, on a standalone holding company basis, increased $46.0 million to $139.5 million due primarily to a decrease in net cash used in investing activities of $2.2 billion offset by a decrease in cash provided by financing activities of $2.2 billion. The following significant activities and events impacting cash occurred during the year ended December 31, 2006:

•

The acquisition of RAA for $15.3 million; and

•

Repurchases of shares of common stock outstanding of $122.6 million.

During the year ended 2006, the Company called the remaining $185.2 million principal amount of its 6.00% convertible subordinated notes due February 2007 (“6.00% Notes”). In April 2006, the Company completed the partial redemption that was originally announced in March 2006 and called the remaining $92.6 million principal amount of its 6.00% Notes. The table below shows the timing and impact of these calls (dollars and shares in millions):


	Debt Redeemed		Common Stock Shares Issued	Cash Paid
First call in March 2006
March redemptions	$	36.3	1.5	$	—
April redemptions		56.3	2.4		0.9
Second call in April 2006⁽¹⁾		92.6	3.9		0.9

Total redemptions	$	185.2	7.8	$	1.8

⁽¹⁾	All redemptions occurred in April.

Our current senior debt ratings are Ba2 (positive outlook) by Moody’s Investor Service, BB- (stable) by Standard & Poor’s and BB (high) by Dominion Bond Rating Service (“DBRS”). The Company’s long-term deposit ratings are Baa3 by Moody’s Investor Service, BB+ (stable) by Standard & Poor’s and BBB (low) by DBRS. A significant change in these ratings may impact the rate and availability of future borrowings.

Liquidity Available from Subsidiaries

Liquidity available to the Company from its subsidiaries, other than Converging Arrows, Inc. (“Converging Arrows”), is limited by regulatory requirements. Converging Arrows is a subsidiary of the parent company. At December 31, 2006, Converging Arrows had $107.1 million of cash and investment securities available as a source of liquidity for the parent company. Converging Arrows is not restricted in its dealings with the parent company and may transfer funds to the parent company without regulatory approval. In addition to Converging Arrows, brokerage and banking subsidiaries may provide liquidity to the parent; however, they are restricted by regulatory guidelines.

The Bank is prohibited by regulations from lending to the parent company. At December 31, 2006, the Bank had approximately $149.1 million of capital available for dividend declaration without regulatory approval while still maintaining “well capitalized” status. The Bank is also required by OTS regulations to maintain tangible capital of at least 1.50% of tangible assets. The Bank satisfied this requirement at December 31, 2006 and 2005.

The Company’s broker-dealer subsidiaries are subject to the Uniform Net Capital Rule under the Securities Exchange Act of 1934 administered by the SEC, the NYSE and NASD, which requires the maintenance of minimum net capital. At December 31, 2006 and 2005, all of our brokerage subsidiaries met their minimum net capital requirements. The Company’s broker-dealer subsidiaries had excess net capital of $628.1 million at December 31, 2006.

Off-Balance-Sheet Arrangements

We enter into various off-balance-sheet arrangements in the ordinary course of business, primarily to meet the needs of our clients and to reduce our own exposure to interest rate risk. These arrangements include firm commitments to extend credit and letters of credit. Additionally, we enter into guarantees and other similar arrangements as part of transactions in the ordinary course of business. For additional information on each of these arrangements, see Item 8. Financial Statements and Supplementary Data.

Other Sources of Liquidity

We maintain committed and uncommitted financing facilities with banks totaling $800.0 million to meet corporate liquidity needs and finance margin lending. There were no outstanding balances and the full $800.0 million was available under these lines at December 31, 2006 and 2005.

We rely on borrowed funds, such as FHLB advances and securities sold under agreements to repurchase to provide liquidity for the Bank. At December 31, 2006, the Bank had approximately $7.6 billion in additional borrowing capacity.

Contractual Obligations

The following summarizes our contractual obligations at December 31, 2006 and the effect such obligations are expected to have on our liquidity and cash flow in future periods (dollars in thousands):


	Years ending December 31,
	2007			2008		2009		2010		2011		Thereafter		Total
Security commitments to:
Purchase securities	$	3,611,937		$	—	$	—	$	—	$	—	$	—	$	3,611,937
Sell securities		(2,718,931	)		—		—		—		—		—		(2,718,931	)
Loan commitments to:
Purchase loans		1,118,529			—		—		—		—		—		1,118,529
Originate loans⁽¹⁾		456,630			—		—		—		—		—		456,630
Sell loans		(60,282	)		—		—		—		—		—		(60,282	)
Equity funding commitments⁽²⁾		17,393			17,514		43		—		—		—		34,950
Acquisition-related commitments⁽³⁾		1,250			—		—		—		—		—		1,250
Certificates of deposit⁽⁴⁾⁽⁵⁾		4,496,319			388,397		187,764		130,218		128,453		118,313		5,449,464
Securities sold under agreements to repurchase and other borrowings⁽⁵⁾		11,590,124			1,154,323		252,489		226,331		125,391		3,714,084		17,062,742
Convertible and Senior notes⁽⁶⁾		136,062			135,905		135,438		135,438		615,438		1,712,578		2,870,859
Facilities offered for sublease, less estimated future sublease income⁽⁷⁾		11,743			5,542		5,059		3,012		71		68		25,495
Operating lease payments		38,478			36,315		30,874		28,348		21,184		75,414		230,613
Purchase Obligations⁽⁸⁾		74,141			14,574		3,219		2,264		1,833		—		96,031

Total contractual obligations⁽⁹⁾	$	18,773,393		$	1,752,570	$	614,886	$	525,611	$	892,370	$	5,620,457	$	28,179,287

⁽¹⁾	Contains optional commitments to originate.

⁽²⁾	Estimated based on investment plans of the venture capital funds, low income housing tax credit partnerships and joint ventures.

⁽³⁾	Includes portion of RAA acquisition purchase price held in escrow at December 31, 2006.

⁽⁴⁾	Does not include demand deposit, money market, passbook savings accounts or sweep deposit accounts, as there are no maturities and/or scheduled contractual payments.

⁽⁵⁾

Includes annual interest based on the contractual features of each transaction, using market rates at December 31, 2006. Interest rates are assumed to remain at current levels over the life of all adjustable rate instruments. For mandatorily redeemable preferred securities included in other borrowings, does not assume early redemption under current call provisions.

⁽⁶⁾	Includes annual interest payments; does not assume early redemption under current call provisions.

⁽⁷⁾	Included in the facilities restructuring accrual.

⁽⁸⁾	Includes purchase obligations for goods and services covered by non-cancelable contracts and contracts including cancellation fees. Excluded from the table are purchase obligations expected to be settled in cash within one year of the end of the reporting period.

⁽⁹⁾	The tables does not include $6.2 billion of unused lines of credit available to customers under HELOC and $1.2 billion of unused credit card and commercial lines as of December 31, 2006.

Other Liquidity Matters

We currently anticipate that our available cash resources and credit will be sufficient to meet our anticipated working capital and capital expenditure requirements for at least the next 12 months. We may need to raise additional funds in order to support more rapid expansion, develop new or enhanced products and services, respond to competitive pressures, acquire businesses or technologies or take advantage of unanticipated opportunities.

RISK MANAGEMENT

As a financial services company, we are exposed to risks in every component of our business. Transactions including the opening of an account, processing of a trade, acceptance of a deposit, hiring a new employee and acquiring a company, all involve a certain amount of risk. The identification and management of risks are the keys to effective risk management. Our risk management practices support decision-making, improve the success rate for new initiatives and strengthen the organization. Our goal is to balance risks and rewards through effective risk management. We do not believe that risks can be completely eliminated; however, we do believe risks can be identified and managed within the Company’s risk tolerance.

We manage risk through a governance structure involving the various boards, senior management and several risk committees. We use management level risk committees to help ensure that business decisions are executed within our desired risk profile.

The Corporate Risk Committee, consisting of senior management executives, monitors risks throughout the Company. In addition to this committee, various departments throughout the Company aid in the identification and management of risks. These departments include internal audit, compliance, finance, legal, treasury, credit and risk management.

Interest Rate Risk Management

Interest rate risk is the risk of loss from adverse changes in interest rates. Interest rate risks are monitored and managed by the E*TRADE Bank’s Asset Liability Committee (“ALCO”). The ALCO reviews balance sheet trends, market interest rate and sensitivity analyses. The analysis of interest sensitivity to changes in market interest rates under various scenarios is reviewed by ALCO. The scenarios assume both parallel and non-parallel shifts in the yield curve. See Item 7A. Quantitative and Qualitative Disclosures about Market Risk for additional information about our interest rate risks.

Credit Risk Management

Credit risk is the risk of loss resulting from an adverse change in a borrower’s ability to repay their loan. Loan and margin advances are underwritten based on the creditworthiness of the borrower and the fair market value of the underlying collateral, taking into consideration any events that may affect the value of that collateral. The level of credit risk in an individual loan will vary depending on the credit characteristics of the borrower, the magnitude of the transaction and the quality of the collateral, in addition to the terms of the transaction. These risks are monitored at the Bank level by the Credit Risk Committee.

The Credit Risk Committee is responsible for the overall credit risk management of the Bank. This committee reports to the ALCO. The credit risk management process encompasses the entire underwriting and review process from comprehensive credit policies to loan review and regulatory exams. The Credit Risk Committee reviews detail risk measurement and modeling results, and monitors the loan audit review process. The Company conducts independent reviews of the underwriting process for originated and purchased loans. The Credit Risk Committee regularly reviews the results of those reviews. In addition, regulatory examiners review and perform detailed tests of our credit underwriting, loan administration and allowance process.

The Credit Risk Committee’s duties include monitoring asset quality trends, evaluating market conditions including residential real estate markets, determining the adequacy of the allowance, establishing underwriting standards, approving large credit exposures, approving large portfolio purchases and delegating credit approval authority. The Credit Risk Committee uses detailed tracking and analysis to measure credit performance and routinely reviews and modifies credit policies as appropriate. The section below includes some of the information reviewed by the committee in determining asset quality and the level of adequacy of the allowance.

In addition to the Bank’s Credit Risk Committee, margin receivables are monitored by brokerage management. These receivables are evaluated to determine if the margin receivables have sufficient collateral, that is the value of the securities held as collateral are sufficient to cover the margin receivable balance. In addition, brokerage management monitors situations where trades have occurred and payment was not received due to fraud or returned checks and other electronic transaction rejects. These situations are rare but do occasionally occur.

Operational Risk Management

Operational risk is the risk of loss resulting from fraud, inadequate controls or the failure of the internal control process, third party vendor issues, processing issues and external events. Operational risks exist in most areas of the Company from advertising to customer service. While we make every effort to protect against failures in the internal controls system, no system is completely fail proof.

The failure of a third party vendor to adequately meet its responsibilities could result in financial losses and reputation risks. The Vendor Risk Management group monitors our vendor relationships. Third party vendor arrangements are overseen by the Vendor Risk Management group. The vendor risk identification process includes evaluating contracts, renewal options and vendor performance. To ensure the financial soundness of providers, we conducted financial reviews of our large providers. In addition, onsite operational audits are conducted annually for significant providers.

Fraud losses result from unauthorized use of customer and corporate funds and resources. We monitor customer transactions and attempt to identify fraudulent transactions promptly. However, new techniques are constantly being developed by perpetrators to commit fraud.

Among other security measures, we offer customers token based security. The tokens display a six digit code that changes every sixty seconds. The number on the display and a password must be used together to access the customers account. This system is an extremely effective tool for preventing unauthorized access to a customer’s account.

Processing issues and external events may result in opportunity loss or actual losses depending on the situation. These types of losses include issues resulting from inadequate staffing, equipment failures, significant weather events or other related types of events. External events resulting in opportunity or actual losses could include the failure of a competitor to meet its customers’ needs, Internet performance issues, legal, reputation, public policy and strategic risks.

SUMMARY OF CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Our discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements, which have been prepared in conformity with accounting principles generally accepted in the United States of America. Note 1—Organization, Basis of Presentation and Summary of Significant Accounting Policies to the consolidated financial statements contains a summary of our significant accounting policies, many of which require the use of estimates and assumptions. We believe that of our significant accounting policies, the following are noteworthy because they are based on estimates and assumptions that require complex, subjective judgments by management, which can materially impact reported results. Changes in these estimates or assumptions could materially impact our financial condition and results of operation.

Allowances for Loan Losses and Uncollectible Margin Receivables

Description

The allowance for loan losses is management’s estimate of credit losses inherent in our loan portfolio as of the balance sheet date. At December 31, 2006, our allowance for loan losses was $67.6 million on $26.4 billion of loans designated as held-for-investment. In addition to our banking loans, we extend credit to brokerage customers in the form of margin receivables. At December 31, 2006, margin accounts had approximately $6.9 billion in outstanding margin receivables for which we provided an allowance for uncollectible margin receivables of $19.9 million.

Judgments

The estimate of the allowance is based on a variety of factors, including the composition and quality of the portfolio, delinquency levels and trends, expected losses for the next twelve months, current and historical charge-off and loss experience, current industry charge-off and loss experience, the condition of the real estate market and geographic concentrations within the loan portfolio, the interest rate climate as it affects adjustable-rate loans and general economic conditions. Determining the adequacy of the allowance is complex and requires judgment by management about the effect of matters that are inherently uncertain. Subsequent evaluations of the loan portfolio, in light of the factors then prevailing, may result in significant changes in the allowance for loan losses in future periods.

Effects if Actual Results Differ

Although we have considerable experience in performing these reviews, if management’s underlying assumptions prove to be inaccurate or if significant unanticipated changes to the national or regional economies occur, the allowance for loan losses could be insufficient to cover actual losses. If our estimates understate probable losses inherent in the portfolio, this would result in additional expense. A 10% increase or decrease in the allowances would result in a $6.8 million charge or credit to income, respectively.

Classification and Valuation of Certain Investments

Description

We generally classify our investments in debt instruments (including corporate, government and municipal bonds), mortgage-backed securities, asset-backed securities and marketable equity securities as either available-for-sale or trading. We have not classified any investments as held-to-maturity. The classification of an investment determines its accounting treatment. Both unrealized and realized gains and losses on trading securities held by our banking subsidiaries are recognized in gain on sales of loans and securities, net. Securities held by our brokerage subsidiaries are for market-making purposes and gains and losses are recorded as principal transactions revenue. Unrealized gains and losses on available-for-sale securities are included in accumulated other comprehensive income. Declines in fair value that we believe to be other-than-temporary are included in gain on sales of loans and securities, net for our banking investments and gain on sales and impairment of investments for our brokerage (other than those held for market-making purposes) and corporate investments. We have investments in certain publicly-traded and privately-held companies, which we evaluate for other-than-temporary declines in market value. For the years ended December 31, 2006, 2005 and 2004, we recognized $2.8 million, $40.3 million and $18.4 million, respectively, of losses from other-than-temporary declines in market value related to our investments.

Judgments

When possible, the fair value of securities is determined by obtaining quoted market prices. For illiquid securities, fair value is estimated by obtaining market price quotes on similar liquid securities and adjusting the price to reflect differences. For securities where market quotes and similar securities are not available, we use discounted cash flows. We also make estimates about the fair value of investments and the timing for recognizing

losses based on market conditions and other factors. Other-than-temporary impairment is recorded based on management judgment. Management evaluates securities based on market conditions and all available information about the issuer or underlying collateral. This information is used to determine if impairment is other-than-temporary. The determination that impairment is other-than-temporary is judgmental. Based on the facts and circumstances, companies could have different conclusions regarding when securities are other-than-temporarily impaired. Impairment of mortgage-backed or asset-backed securities is recognized when management estimates the fair value of a security is less than its amortized cost and if the current present value of estimated cash flows has decreased since the last periodic estimate. If the security meets both criterion, we write the security down to fair value in the current period. We assess securities for impairment at each reported balance sheet date.

Effects if Actual Results Differ

Earnings could be influenced by the timing of management’s decisions to recognize a security as other-than-temporarily impaired. Our estimates are based on the best available information. Over time additional information may become available and may influence future write-downs. If all securities with fair values lower than amortized book were written-down, a $310.0 million charge would occur. Management believes that its estimates of other-than-temporary impairment are supportable and reasonable. See Note 6–Available-For-Sale Mortgage-Backed and Investment Securities to the consolidated financial statements for additional information regarding securities.

Valuation and Accounting for Financial Derivatives

Description

The Bank’s principal assets are residential mortgages and mortgage-backed securities, which typically pay a fixed interest rate over an extended period of time. However, the principal sources of funds for the Bank are customer deposits and other short-term borrowings with interest rates that are fixed for a shorter period of time, if at all. The Bank purchases interest rate derivatives, including interest rate swaps, caps and floors, to manage this difference between long-term and short-term interest rates and to convert fixed-rate assets or liabilities to variable rates.

Accounting for derivatives differs significantly depending on whether a derivative is designated as a hedge, which is a transaction intended to reduce a risk associated with a specific balance sheet item or future expected cash flow. In order to qualify for hedge accounting treatment, documentation must indicate the intention to designate the derivative as a hedge of a specific asset or liability or a future cash flow. Effectiveness of the hedge must be monitored over the life of the derivative. Substantially all derivatives held on December 31, 2006 were designated as hedges. As of December 31, 2006, we had derivative assets of $208.1 million and derivative liabilities of $78.7 million. As of December 31, 2005, we had derivative assets of $152.5 million and derivative liabilities of $38.1 million.

Judgments

Hedge accounting is complex and involves the interpretation of a significant amount of accounting literature. From time to time, new interpretations are issued, which result in new accounting methods applied to existing and new transactions. The implementation of SFAS No. 133, as amended, involves numerous judgments and Company-level interpretations. We must make assumptions and judgments about the continued effectiveness of our hedging strategies and the nature and timing of forecasted transactions. Judgment is necessary to determine the accounting for our hedging strategies.

Effects if Actual Results Differ

If our hedging strategies were to become significantly ineffective or our assumptions about the nature and timing of forecasted transactions were to be inaccurate, we could no longer apply hedge accounting and our reported results would be significantly affected. Revised accounting interpretations of existing literature could

materially impact our financial results. If 10% of the fair value of derivatives classified in liabilities were determined to relate to derivatives that do not qualify for hedge accounting treatment, the adjustment would reduce income by $7.9 million before taxes. Similarly, if 10% of the fair value of derivatives included in assets were determined to not qualify for hedge accounting treatment, the result would be $20.8 million in additional pre-tax income. The most significant effect of not qualifying for hedge accounting treatment is the earnings volatility that would be created by marking the derivatives to market as interest rates change.

Estimates of Effective Tax Rates, Deferred Taxes and Valuation Allowances

Description

In preparing our consolidated financial statements, we calculate our income tax expense based on the tax laws in the various jurisdictions where we conduct business. This requires us to estimate our current tax obligations and required reserves for potential tax deficiencies and to assess temporary differences between the financial statement carrying amounts and the tax bases of assets and liabilities. These differences result in deferred tax assets and liabilities, the net amount of which we show as other assets or other liabilities on our consolidated balance sheet. We must also assess the likelihood that each of our deferred tax assets will be realized. To the extent we believe that realization is not more likely than not, we establish a valuation allowance. When we establish a valuation allowance or increase this allowance in a reporting period, we generally record a corresponding tax expense in our consolidated statement of income. Conversely, to the extent circumstances indicate that a valuation allowance is no longer necessary, that portion of the valuation allowance is reversed, which generally reduces our overall income tax expense. At December 31, 2006 we had a net deferred tax liability of $58.5 million, net of a valuation allowance of $38.3 million. At December 31, 2005 we had a net deferred tax asset as of $3.9 million net of a valuation allowance of $39.4 million.

Judgments

Management must make significant judgments to determine our provision for income taxes, our deferred tax assets and liabilities and any valuation allowance to be recorded against our net deferred tax asset. Changes in our estimate of these taxes occur periodically due to changes in the tax rates, changes in our business operations, implementation of tax planning strategies, resolution with taxing authorities of issues with previously taken tax positions and newly enacted statutory, judicial and regulatory guidance. These changes in judgment as well as differences between our estimates and actual amount of taxes ultimately due, when they occur, affect accrued taxes and can be material to our operating results for any particular reporting period.

Effects if Actual Results Differ

These changes, when they occur, affect accrued taxes and can be material to our operating results for any particular reporting period.

Valuation of Goodwill and Other Intangibles

Description

We review goodwill and purchased intangible assets with indefinite lives for impairment annually and whenever events or changes indicate the carrying value of an asset may not be recoverable in accordance with SFAS No. 142. Our recorded goodwill at December 31, 2006 was $2.1 billion, and we will continue to evaluate it for impairment at least annually. Our recorded intangible assets at December 31, 2006 were $471.9 million, which have useful lives between three and thirty years.

Judgments

In 2006, we performed our annual impairment test of goodwill with the assistance of a third party. This evaluation indicated that no impairment charges were necessary. We also evaluate the remaining useful lives on

intangible assets each reporting period to determine whether events and circumstances warrant a revision to the remaining period of amortization in accordance with SFAS No. 142. Our estimates of fair value of goodwill and other intangible assets depend on a number of factors, including estimates of future market growth and trends, forecasted revenue and costs, expected useful lives of the assets, appropriate discount rates and other variables.

Effects if Actual Results Differ

If our estimates of goodwill fair value change due to changes in our businesses or other factors, we may determine that an impairment charge is necessary. Estimates of fair value are determined based on a complex model using cash flows and company comparisons. If management’s estimates of future cash flows are inaccurate, the fair value determined could be inaccurate and impairment not recognized in a timely manner. Intangible assets are amortized over their estimated useful lives. If changes in the estimated underlying revenues occurs, impairment or a change in the remaining life may need to be recognized.

Valuation and Expensing of Share-Based Payments

Description

We value and expense employee share-based payments, which is primarily stock options, in accordance with SFAS No. 123(R). We value each granted option using an option pricing model using assumptions that match the characteristics of the granted options. We then assume a forfeiture rate that is used to calculate each period’s compensation expense attributed to these options.

Judgments

We estimate the value of employee stock options using the Black-Scholes-Merton option pricing model. Assumptions necessary for the calculation of fair value include expected term and expected volatility. These assumptions are management’s best estimate of the characteristics of the options. Additionally, forfeiture rates are estimated based on prior option vesting experience.

Effects if Actual Results Differ

If our estimates of employees’ forfeiture rates are not correct at the end of the term of the option, we will record either additional expense or a reduction in expense in the period it completely vests. This adjustment may be material to the period in which it is recorded. In addition, option fair value is based on estimates of volatility determined by us. Many methods are available to determine volatility, so the determination is subjective. Applying a different method to determine volatility could impact earnings. A 10% change in volatility would increase or decrease stock option fair value by 6%. A change in fair value would affect all amortization periods.

Required Statistical Disclosure by Bank Holding Companies

The following table shows where you can find the information required by the SEC’s Industry Guide 3, “Statistical Disclosure by Bank Holding Companies.” These disclosures are at the Bank Holding Company level and do not include brokerage and corporate amounts.


Required Disclosure		Page
Distribution of Assets, Liabilities and Shareholder’s Equity; Interest Rates and Operating Interest Differential
Average Balance Sheet and Analysis of Net Interest Income		57
Net Operating Interest Income—Volumes and Rates Analysis		58
Investment Portfolio
Investment Portfolio—Book Value and Market Value		61
Investment Portfolio Maturity		62
Loan Portfolio
Loans by Type		59
Loan Maturities		60
Loan Sensitivities		60
Risk Elements
Nonaccrual, Past Due and Restructured Loans		45
Past Due Interest		103
Policy for Nonaccrual		45
Potential Problem Loans		45
Summary of Loan Loss Experience
Analysis of Allowance for Loan Losses		43
Allocation of the Allowance for Loan Losses		44
Deposits
Average Balance and Average Rates Paid		57
Time Deposit Maturities		114
Time Deposits in Excess of $100,000		114
Return of Equity and Assets		57
Short-Term Borrowings		63

Distribution of Assets, Liabilities and Shareholder’s Equity; Interest Rates and Operating Interest Differential

The following table presents average balance data and operating interest income and expense data for our banking operations, as well as the related interest yields and rates and interest spread (dollars in thousands):


	Year Ended December 31,
	2006						2005						2004
	Average Balance		Operating Interest Inc./Exp.		Average Yield / Cost		Average Balance		Operating Interest Inc./Exp.		Average Yield / Cost		Average Balance		Operating Interest Inc./Exp.		Average Yield / Cost
Interest-earning banking assets:
Loans, net⁽¹⁾	$	22,193,663	$	1,364,873	6.15	%	$	15,488,527	$	828,717	5.35	%	$	10,065,174	$	490,550	4.87	%
Mortgage-backed and related available-for-sale securities		11,543,546		590,512	5.12	%		9,421,988		401,782	4.26	%		8,300,536		331,460	3.99	%
Available-for-sale investment securities		3,068,474		193,583	6.31	%		2,715,985		140,041	5.16	%		3,151,515		127,429	4.04	%
Trading securities		132,454		11,388	8.60	%		268,092		12,342	4.60	%		712,819		22,692	3.18	%
Other		45,460		2,115	4.65	%		53,252		1,566	2.94	%		101,622		3,286	3.23	%

Total interest-earning banking assets⁽²⁾		36,983,597		2,162,471	5.85	%		27,947,844		1,384,448	4.95	%		22,331,666		975,417	4.37	%

Non-interest-earning banking assets		552,664						451,161						489,282

Total banking assets	$	37,536,261					$	28,399,005					$	22,820,948

Interest-bearing banking liabilities:
Retail deposits:
Sweep deposit accounts	$	10,393,857		87,714	0.84	%	$	6,683,454		36,147	0.54	%	$	5,008,953		13,226	0.26	%
Money market and savings accounts		5,806,811		231,602	3.99	%		3,604,326		89,073	2.47	%		3,792,778		47,297	1.25	%
Certificates of deposit⁽⁵⁾		3,851,463		183,828	4.77	%		2,276,709		88,733	3.90	%		2,564,914		110,577	4.31	%
Checking accounts		355,403		3,347	1.10	%		387,146		2,679	0.69	%		353,688		2,408	0.68	%
Brokered certificates of deposit⁽⁶⁾		535,835		24,726	4.61	%		450,441		15,680	3.48	%		358,665		9,172	2.56	%
Repurchase agreements and other borrowings		10,980,134		549,085	5.00	%		10,115,764		374,337	3.70	%		8,139,736		259,196	3.18	%
FHLB advances		3,488,184		165,545	4.75	%		3,260,556		126,495	3.88	%		1,168,519		50,055	4.28	%

Total interest-bearing banking liabilities		35,411,687		1,245,847	3.52	%		26,778,396		733,144	2.73	%		21,387,253		491,931	2.30	%

Non-interest-bearing banking liabilities		355,026						308,719						345,553

Total banking liabilities		35,766,713						27,087,115						21,732,806
Total banking shareholder’s equity		1,769,548						1,311,890						1,088,142

Total banking liabilities and shareholder’s equity	$	37,536,261					$	28,399,005					$	22,820,948

Excess of interest-earning banking assets over interest-bearing banking liabilities/net operating interest income	$	1,571,910	$	916,624			$	1,169,448	$	651,304			$	944,413	$	483,486

Bank net operating interest:
Spread					2.33	%					2.22	%					2.07	%
Margin (net yield on interest-earning banking assets)					2.48	%					2.33	%					2.17	%
Ratio of interest-earning banking assets to interest-bearing banking liabilities					104.44	%					104.37	%					104.42	%
Return on average:⁽³⁾⁽⁴⁾
Total banking assets					1.03	%					1.04	%					0.90	%
Total banking shareholder’s equity					21.86	%					22.41	%					19.08	%
Average equity to average total banking assets					4.71	%					4.62	%					4.77	%

⁽¹⁾	Nonaccrual loans are included in the respective average loan balances. Income on such nonaccrual loans is recognized on a cash basis.

⁽²⁾	Amount includes a taxable equivalent increase in operating interest income of $19.3 million, $10.5 million and $7.0 million for 2006, 2005 and 2004, respectively.

⁽³⁾	Ratio calculations exclude discontinued operations.

⁽⁴⁾	Ratio calculations are based on stand alone Bank results.

⁽⁵⁾	Includes retail certificates of deposit including retail brokered certificates of deposit.

⁽⁶⁾	Includes institutional certificates of deposit.

Increases and decreases in operating interest income and operating interest expense result from changes in average balances (volume) of interest-earning banking assets and liabilities, as well as changes in average interest rates (rate). The following table shows the effect that these factors had on the interest earned on our interest-earning banking assets and the interest incurred on our interest-bearing banking liabilities. The effect of changes in volume is determined by multiplying the change in volume by the previous year’s average yield/cost. Similarly, the effect of rate changes is calculated by multiplying the change in average yield/cost by the previous year’s volume. Changes applicable to both volume and rate have been allocated proportionately (dollars in thousands):


	2006 Compared to 2005 Increase (Decrease) Due To								2005 Compared to 2004 Increase (Decrease) Due To
	Volume			Rate		Total			Volume			Rate			Total
Interest-earning banking assets:
Loans, net⁽¹⁾	$	398,605		$	137,551	$	536,156		$	286,205		$	51,962		$	338,167
Mortgage-backed and related available-for-sale securities		100,043			88,687		188,730			46,805			23,517			70,322
Available-for-sale investment securities		19,667			33,875		53,542			(19,231	)		31,843			12,612
Trading securities		(8,241	)		7,287		(954	)		(17,841	)		7,491			(10,350	)
Other		(256	)		805		549			(1,445	)		(275	)		(1,720	)