Edgar Filing: E TRADE FINANCIAL CORP

Form 10Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the Quarterly Period Ended September 30, 2008

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

Commission File Number 1-11921

E*TRADE Financial Corporation

(Exact Name of Registrant as Specified in its Charter)

Delaware

94-2844166

(State or Other Jurisdiction

of Incorporation or Organization)

(I.R.S. Employer

Identification Number)

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

(Address of Principal Executive Offices and Zip Code)

(646) 521-4300

(Registrant’s Telephone Number, including Area Code)

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

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


Large accelerated filer x				Accelerated filer ¨
Non-accelerated filer ¨ (Do not check if a smaller reporting company)				Smaller reporting company ¨

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

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

As of October 31, 2008, there were 537,750,272 shares of common stock outstanding.

E*TRADE FINANCIAL CORPORATION

FORM 10-Q QUARTERLY REPORT

For the Quarter Ended September 30, 2008

TABLE OF CONTENTS


PART I—FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements (Unaudited)		3
Consolidated Statement of Income (Loss)		50
Consolidated Balance Sheet		51
Consolidated Statement of Comprehensive Loss		52
Consolidated Statement of Shareholders’ Equity		53
Consolidated Statement of Cash Flows		54
Notes to Consolidated Financial Statements (Unaudited)		56
Note 1—Organization, Basis of Presentation and Summary of Significant Accounting Policies		56
Note 2—Discontinued Operations		60
Note 3—Facility Restructuring and Other Exit Activities		61
Note 4—Operating Interest Income and Operating Interest Expense		62
Note 5—Available-for-Sale Mortgage-Backed and Investment Securities		63
Note 6—Loans, Net		66
Note 7—Accounting for Derivative Financial Instruments and Hedging Activities		66
Note 8—Deposits		71
Note 9—Securities Sold Under Agreements to Repurchase and Other Borrowings		72
Note 10—Corporate Debt		72
Note 11—Shareholders’ Equity		74
Note 12—Earnings (Loss) per Share		74
Note 13—Employee Share-Based Payments		75
Note 14—Regulatory Requirements		77
Note 15—Commitments, Contingencies and Other Regulatory Matters		78
Note 16—Fair Value Disclosures		82
Note 17—Segment Information		88
Note 18—Subsequent Event		92

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		3
Overview		3
Earnings Overview		7
Segment Results Review		18
Balance Sheet Overview		22
Liquidity and Capital Resources		26
Risk Management		30
Summary of Critical Accounting Policies and Estimates		40
Glossary of Terms		44
Item 3. Quantitative and Qualitative Disclosures about Market Risk		48
Item 4. Controls and Procedures		93

PART II —OTHER INFORMATION
Item 1. Legal Proceedings		93
Item 1A. Risk Factors		95
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		96
Item 3. Defaults Upon Senior Securities		96
Item 4. Submission of Matters to a Vote of Security Holders		96
Item 5. Other Information		96
Item 6. Exhibits		96
Signatures		97

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.

ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

This information is set forth immediately following Item 3, “Quantitative and Qualitative Disclosures about Market Risk.”

ITEM 2. 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.

FORWARD-LOOKING STATEMENTS

This report contains forward-looking statements involving 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. Important factors that may cause actual results to differ materially from any forward-looking statements are set forth in our 2007 Form 10-K filed with the Securities and Exchange Commission (“SEC”) under the heading “Risk Factors.”

We further caution that there may be risks associated with owning our securities other than those discussed in such filings.

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 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

OVERVIEW

Strategy

Our strategy centers on growing our retail customer base and mitigating the risks associated with our balance sheet. We plan to grow our retail customer base by appealing to retail investors, specifically those who are customers of large established financial institutions, by providing them with innovative, easy, low-cost financial products and services. Our financial products and services were developed with a focus on providing brokerage and related asset-gathering services to retail investors, and include investor focused banking services, particularly sweep deposits and savings products.

Our plan to mitigate the risks associated with our balance sheet contains three core goals: reduce credit risk in our loan portfolio, reduce our level of corporate debt and reduce operating expenses. We believe that the successful completion of this plan will significantly improve our financial strength.

We are also focused on simplifying and streamlining the business by exiting and/or restructuring certain non-core operations. We believe these changes will better align our business with the retail investor.

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;

•

the weakness or strength of the residential real estate and credit markets;

•

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

•

customer perception of the financial strength of our franchise;

•

market demand and liquidity in the secondary market for mortgage loans and securities; and

•

market demand and liquidity in the wholesale borrowings market, including securities sold under agreements to repurchase.

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 products and services;

•

our ability to assess and manage credit risk;

•

our ability to assess and manage interest rate risk; and

•

disciplined expense control and improved operational efficiency.

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. These metrics have been represented to exclude activity from discontinued operations:


	As of or For the Three Months Ended September 30,						Variance		As of or For the Nine Months Ended September 30,						Variance
							Variance								Variance
	2008			2007			2008 vs. 2007		2008			2007			2008 vs. 2007
**Customer Activity Metrics⁽¹⁾** :
Retail customer assets (dollars in billions)	$	142.2		$	213.1		(33	)%	$	142.2		$	213.1		(33	)%
Net new customer assets (dollars in billions)⁽²⁾	$	0.8		$	1.1		N.M.		$	2.0		$	5.0		N.M.
Customer cash and deposits (dollars in billions)	$	33.4		$	38.6		(13	)%	$	33.4		$	38.6		(13	)%
Total daily average revenue trades		183,691			185,411		(1	)%		178,814			169,110		6	%
Average commission per trade	$	11.10		$	11.71		(5	)%	$	11.07		$	11.90		(7	)%
End of period total accounts		4,436,225			4,274,701		4	%		4,436,225			4,274,701		4	%

**Company Financial Metrics⁽¹⁾**:
Corporate cash (dollars in millions)	$	665.6		$	155.9		327	%	$	665.6		$	155.9		327	%
E*TRADE Bank excess risk-based capital (dollars in millions)	$	523.9		$	192.6		172	%	$	523.9		$	192.6		172	%
Allowance for loan losses (dollars in millions)	$	874.2		$	209.0		318	%	$	874.2		$	209.0		318	%
Allowance for loan losses as a % of nonperforming loans		109.45	%		76.24	%	33.21	%		109.45	%		76.24	%	33.21	%
Nonperforming loans receivable as a % of gross loans receivable		3.02	%		0.84	%	2.18	%		3.02	%		0.84	%	2.18	%
Enterprise net interest spread (basis points)		263			265		(1	)%		261			270		(3	)%
Enterprise interest-earning assets (average in billions)	$	46.6		$	59.0		(21	)%	$	47.7		$	56.0		(15	)%

⁽¹⁾

Metrics have been represented to exclude activity from discontinued operations. All discussions, unless otherwise noted, are based on metrics from continuing operations.

⁽²⁾

For the nine months ended September 30, 2008, net new customer assets were $2.9 billion excluding the sale of Retirement Advisors of America (“RAA”).

Customer Activity Metrics

•

Changes in retail customer assets are an indicator of the value of our relationship with the customer. An increase in retail customer 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, which have declined substantially in recent periods.

•

Net new customer assets are total inflows to all new and existing customer accounts less total outflows from all closed and existing customer accounts and are a general indicator of the use of our products and services by existing and new customers.

•

Customer cash and deposits are an indicator of a deepening engagement with our customers and are 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 an indicator of changes in our customer mix, product mix and/or product pricing. As a result, this metric is impacted by both the mix between our retail domestic and international businesses and the mix between active traders, mass affluent and main street customers.

•

End of period total accounts is an indicator of the Company’s ability to attract and retain customers.

Company Financial Metrics

•

Corporate cash is an indicator of the liquidity at the parent company. It is the primary source of capital above and beyond the capital deployed in our regulated subsidiaries.

•

E*TRADE Bank excess risk-based capital is the excess capital that E*TRADE Bank has compared to the regulatory minimum well-capitalized threshold and is an indicator of E*TRADE Bank’s ability to absorb future loan losses.

•

Allowance for loan losses is an estimate of the losses inherent in our loan portfolio as of the balance sheet date.

•

Allowance for loan losses as a percentage of nonperforming loans is a general indicator of the adequacy of our allowance for loan losses. Changes in this ratio are also driven by changes in the mix of our loan portfolio.

•

Nonperforming loans receivable as a percentage of gross loans receivable is an indicator of the performance of our total loan portfolio.

•

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

•

Enterprise interest-earning assets, in conjunction with our enterprise net interest spread, are indicators of our ability to generate net operating interest income.

Significant Events in the Third Quarter of 2008

Sale of Canadian Brokerage Business

We completed the sale of our Canadian brokerage business to Scotiabank. The sale resulted in proceeds of approximately $515 million, including $54 million in repatriation of capital prior to the close. The sale resulted in a pre-tax gain of $427.9 million.

Sale of IL&FS Investsmart Limited (“Investsmart”) to HSBC Holdings

Our wholly-owned subsidiary, E*TRADE Mauritius Limited (“E*TRADE Mauritius”), completed the sale of its equity shares in Investsmart to HSBC Holdings (“HSBC”). During the third quarter, we received proceeds of approximately $145 million and recorded a pre-tax gain of $22.3 million.

Strengthening Our Core Asset—the Retail Customer

One of our key strategic objectives for 2008 was to strengthen our retail customer base and ensure the credit issues in our balance sheet did not negatively impact our customer base. We believe we have made significant progress in this area throughout 2008. Highlights of our progress during the third quarter of 2008 are as follows:

•

Opened 215,000 gross new accounts and produced 41,000 net new accounts;

•

Net new customer asset flows of $800 million;

•

Customer cash and deposit balances remained stable at $33.4 billion; and

•

Total DARTs of 184,000, up 7% from the second quarter of 2008.

Capital Plan Highlights

•

E*TRADE Bank excess risk-based capital (excess to the regulatory minimum well-capitalized threshold) of $523.9 million, including $250 million of capital down streamed from the parent company, E*TRADE Financial Corporation;

•

Corporate cash of $665.6 million ($915.6 million prior to the down stream of $250 million to E*TRADE Bank); and

•

Completed two key non-core asset sales (the Canadian brokerage business and our equity shares in Investsmart) resulting in net proceeds of approximately $660 million.

Summary Financial Results

Income Statement Highlights for the Three and Nine Months Ended September 30, 2008 (dollars in millions, except per share amounts)


	Three Months Ended September 30,						Variance		Nine Months Ended September 30,					Variance
	2008			2007			2008 vs. 2007		2008			2007		2008 vs. 2007
Total net revenue	$	377.7		$	482.1		(22	)%	$	1,439.2		$	1,793.2	(20	)%
Net operating interest income	$	324.8		$	411.4		(21	)%	$	993.9		$	1,204.7	(17	)%
Provision for loan losses	$	517.8		$	186.5		178	%	$	1,070.8		$	237.8	350	%
Commission revenue	$	129.5		$	180.6		(28	)%	$	374.0		$	495.1	(24	)%
Fees and service charges revenue	$	49.6		$	57.8		(14	)%	$	155.5		$	171.3	(9	)%
Operating margin	$	(436.0	)	$	(59.9	)	628	%	$	(600.4	)	$	471.3	*
Net income (loss) from continuing operations	$	(320.8	)	$	(58.8	)	445	%	$	(533.2	)	$	269.4	*
Net income (loss)	$	(50.5	)	$	(58.4	)	(14	)%	$	(236.2	)	$	270.1	*
Diluted net earnings (loss) per share from continuing operations	$	(0.60	)	$	(0.14	)	329	%	$	(1.07	)	$	0.62	*
Diluted net earnings (loss) per share	$	(0.09	)	$	(0.14	)	(36	)%	$	(0.48	)	$	0.62	*

Percentage not meaningful

The continued deterioration in the residential real estate and credit markets, as well as the nearly unprecedented turmoil in the global financial markets, had a significant impact on our financial performance in the third quarter of 2008. The losses in our institutional segment caused by this deterioration more than offset the strong underlying performance of our retail segment, resulting in a net loss from continuing operations of $320.8 million for the three months ended September 30, 2008. Our retail customer base showed positive growth trends during the three months ended September 30, 2008, including the addition of approximately 41,000 net new accounts and net inflows of customer assets of approximately $800 million. We believe these are indications that our retail segment has not only stabilized, but has returned to modest growth.

Total net revenue for the three and nine months ended September 30, 2008 decreased 22% and 20% compared to the same periods in 2007 due primarily to a decrease in our net operating interest income. Provision for loan losses was $517.8 million for the three months ended September 30, 2008, an increase of $331.3 million when compared to the same period in 2007.

During the third quarter, we completed the sale of our Canadian brokerage business, which resulted in a pre-tax gain of $427.9 million. The gain on sale, along with the results of our Canadian brokerage’s operations, are reported in the discontinued operations, net of tax line item on the consolidated statement of income (loss).

Balance Sheet Highlights (dollars in billions)


	September 30, 2008			December 31, 2007			Variance
	September 30, 2008			December 31, 2007			2008 vs. 2007
Total assets	$	49.7		$	56.8		(13	)%
Total enterprise interest-earning assets	$	44.6		$	52.3		(15	)%
Loans, net and margin receivables as a percentage of enterprise interest-earning assets		72	%		71	%	1	%
Retail deposits and customer payables as a percentage of enterprise interest-bearing liabilities		70	%		61	%	9	%

The decrease in total assets was attributable primarily to a decrease of $4.6 billion in loans, net, a decrease of $1.6 billion in available-for-sale mortgage-backed and investment securities and a decrease of $1.6 billion in margin receivables. For the foreseeable future, we plan to allow our home equity loans to pay down resulting in an overall decline in the balance of the loan portfolio. During this period, we plan to maintain excess regulatory capital at E*TRADE Bank as we focus on mitigating the credit risk inherent in our loan portfolios. During the nine months ended September 30, 2008, we increased our excess risk-based capital at E*TRADE Bank by 20% to $523.9 million compared to December 31, 2007. In connection with this strategy and the Citadel Investment, we have updated our secondary market purchase policies to prohibit the acquisition of asset-backed securities, collateralized debt obligations (“CDO”) and certain other instruments with a high level of credit risk through January 1, 2010.

EARNINGS OVERVIEW

We had a net loss from continuing operations of $320.8 million and $533.2 million for the three and nine months ended September 30, 2008. The losses for the three and nine months ended September 30, 2008 were due principally to increases in our provision for loan losses of $331.3 million to $517.8 million and $833.0 million to $1.1 billion, respectively. In addition, we incurred losses of $153.8 million, net of hedges, on our preferred stock in Federal National Mortgage Association (“Fannie Mae”) and Federal Home Loan Mortgage Corporation (“Freddie Mac”) during the three months ended September 30, 2008. The losses in our institutional segment, which included both of these items, more than offset our retail segment income, which was $171.0 million and $464.5 million for the three and nine months ended September 30, 2008, respectively.

In the second quarter of 2008, we made the decision to sell our Canadian brokerage business and we decided to close our retail mortgage lending business. As a result, the financial results for both the Canadian brokerage business and the mortgage lending business have been reported in discontinued operations for all periods presented. Additionally, we re-defined “Total net revenue” by removing “Provision for loan losses” and separately stating it as its own line item and reclassified SFAS No. 133, as amended hedge ineffectiveness from “Other operating expense” to the “Loss on loans and securities, net” line item.

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 the performance in our banking and balance sheet management businesses. Our corporate debt, which is the primary source of our corporate interest expense, has been issued primarily in connection with the Citadel Investment and past acquisitions, such as Harrisdirect and BrownCo.

Similarly, we report gain (loss) on sales of investments, net separately from loss on 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. Loss on loans and securities, net is the result of activities in our operations, namely our balance sheet management business, including impairment on our available-for sale mortgage-backed and investment securities portfolio. Gain (loss) on sales of investments, net relates to historical equity investments of the Company at the corporate level and are 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, operating expense, other income (expense) and income tax expense (benefit).

Revenue

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


	Three Months Ended September 30,						Variance					Nine Months Ended September 30,						Variance
	Three Months Ended September 30,						2008 vs. 2007					Nine Months Ended September 30,						2008 vs. 2007
	2008			2007			Amount			%		2008			2007			Amount			%
Revenue:
Operating interest income	$	604,071		$	938,979		$	(334,908	)	(36	)%	$	1,929,736		$	2,654,364		$	(724,628	)	(27	)%
Operating interest expense		(279,297	)		(527,537	)		248,240		(47	)%		(935,827	)		(1,449,694	)		513,867		(35	)%

Net operating interest income		324,774			411,442			(86,668	)	(21	)%		993,909			1,204,670			(210,761	)	(17	)%

Commission		129,513			180,622			(51,109	)	(28	)%		374,003			495,108			(121,105	)	(24	)%
Fees and service charges		49,612			57,838			(8,226	)	(14	)%		155,515			171,272			(15,757	)	(9	)%
Principal transactions		20,664			20,734			(70	)	0	%		59,546			77,743			(18,197	)	(23	)%
Loss on loans and securities, net		(159,799	)		(201,130	)		41,331		(21	)%		(184,073	)		(188,896	)		4,823		(3	)%
Other revenue		12,968			12,614			354		3	%		40,263			33,262			7,001		21	%

Total non-interest income		52,958			70,678			(17,720	)	(25	)%		445,254			588,489			(143,235	)	(24	)%

Total net revenue	$	377,732		$	482,120		$	(104,388	)	(22	)%	$	1,439,163		$	1,793,159		$	(353,996	)	(20	)%

Total net revenue declined by 22% to $377.7 million and 20% to $1.4 billion for the three and nine months ended September 30, 2008, respectively, compared to the same periods in 2007. This decline was driven by a decrease in net operating interest income, which was due principally to a decline in our enterprise interest-earning assets, as well as a decline in commission revenue, which was primarily due to the exit of our institutional brokerage operations.

Net Operating Interest Income

Net operating interest income decreased 21% to $324.8 million and 17% to $993.9 million for the three and nine months ended September 30, 2008, respectively, compared to the same periods in 2007. Net operating interest income is earned primarily through holding credit balances, which include margin, real estate and consumer loans, and by holding customer cash and deposits, which are a low cost source of funding. The decrease in net operating interest income was due primarily to the planned decline in enterprise interest-earning assets, which occurred largely in the first half of 2008.

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, yields and rates and has been prepared on the basis required by the SEC’s Industry Guide 3, “Statistical Disclosure by Bank Holding Companies” (dollars in thousands):


	Three Months Ended September 30,
	2008								2007
	Average Balance			Operating Interest Inc./Exp.			Average Yield/ Cost		Average Balance		Operating Interest Inc./Exp.		Average Yield/ Cost
Enterprise interest-earning assets:
Loans, net⁽¹⁾	$	26,928,190		$	379,195		5.63	%	$	32,445,828	$	528,193	6.51	%
Margin receivables		6,420,090			72,291		4.48	%		7,348,376		133,791	7.22	%
Mortgage-backed and related available-for-sale securities		9,494,421			108,511		4.57	%		12,811,113		169,603	5.30	%
Available-for-sale investment securities		131,332			2,140		6.52	%		4,667,136		77,187	6.62	%
Trading securities		272,677			3,211		4.71	%		118,195		3,052	10.33	%
Cash and cash equivalents⁽²⁾		2,630,478			17,850		2.70	%		591,227		6,260	4.20	%
Stock borrow and other		741,127			14,531		7.80	%		1,042,589		19,849	7.55	%

Total enterprise interest-earning assets⁽³⁾		46,618,315			597,729		5.12	%		59,024,464		937,935	6.35	%

Non-operating interest-earning assets and other⁽⁴⁾		4,694,410								5,454,270

Total assets	$	51,312,725							$	64,478,734

Enterprise interest-bearing liabilities:
Retail deposits	$	26,151,874			136,148		2.07	%	$	27,764,658		216,426	3.09	%
Brokered certificates of deposit		883,289			10,984		4.95	%		418,123		5,154	4.89	%
Customer payables		4,368,391			7,444		0.68	%		5,764,590		17,893	1.23	%
Repurchase agreements and other borrowings		7,581,472			71,648		3.70	%		12,582,907		165,925	5.16	%
FHLB advances		4,166,643			50,062		4.70	%		8,650,546		115,531	5.23	%
Stock loan and other		1,055,662			2,848		1.07	%		1,048,037		6,517	2.47	%

Total enterprise interest-bearing liabilities		44,207,331			279,134		2.49	%		56,228,861		527,446	3.70	%

Non-operating interest-bearing liabilities and other⁽⁵⁾		4,550,263								3,929,421

Total liabilities		48,757,594								60,158,282
Total shareholders’ equity		2,555,131								4,320,452

Total liabilities and shareholders’ equity	$	51,312,725							$	64,478,734

Excess of enterprise interest-earning assets over enterprise interest-bearing liabilities/Enterprise net interest income/Spread	$	2,410,984		$	318,595		2.63	%	$	2,795,603	$	410,489	2.65	%

Enterprise net interest margin (net yield on enterprise interest-earning assets)							2.73	%					2.78	%
Ratio of enterprise interest-earning assets to enterprise interest-bearing liabilities							105.45	%					104.97	%
Return on average:
Total assets							(0.39	)%					(0.36	)%
Total shareholders’ equity							(7.90	)%					(5.41	)%
Average equity to average total assets							4.98	%					6.70	%

Reconciliation from enterprise net interest income to net operating interest income (dollars in thousands):
	Three Months Ended September 30,
	2008			2007
Enterprise net interest income⁽⁶⁾	$	318,595		$	410,489
Taxable equivalent interest adjustment		(1,526	)		(8,523	)
Customer cash held by third parties and other⁽⁷⁾		7,705			9,476

Net operating interest income	$	324,774		$	411,442

⁽¹⁾

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

⁽²⁾

Includes segregated cash balances.

⁽³⁾

Amount includes a taxable equivalent increase in operating interest income of $1.5 million and $8.5 million for the three months ended September 30, 2008 and 2007, respectively.

⁽⁴⁾

Non-operating interest-earning assets consist of property and equipment, net, goodwill, other intangibles, net, other assets that do not generate operating interest income and assets from discontinued operations. Some of these assets generate corporate interest income.

⁽⁵⁾

Non-operating interest-bearing liabilities consist of corporate debt, accounts payable, accrued and other liabilities that do not generate operating interest expense and liabilities from discontinued operations. Some of these liabilities generate corporate interest expense.

⁽⁶⁾

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.

⁽⁷⁾

Includes interest earned on average customer assets of $3.3 billion and $4.1 billion for the three months ended September 30, 2008 and 2007, respectively, held by parties outside E*TRADE Financial, including third party money market funds and sweep deposit accounts at unaffiliated financial institutions.


	Nine Months Ended September 30,
	2008						2007
	Average Balance		Operating Interest Inc./Exp.		Average Yield/ Cost		Average Balance		Operating Interest Inc./Exp.		Average Yield/ Cost
Enterprise interest-earning assets:
Loans, net⁽¹⁾	$	28,354,314	$	1,232,872	5.80	%	$	30,541,679	$	1,477,109	6.45	%
Margin receivables		6,633,365		238,610	4.80	%		6,901,064		377,427	7.31	%
Mortgage-backed and related available-for-sale securities		9,141,068		317,170	4.63	%		12,629,026		500,071	5.28	%
Available-for-sale investment securities		144,550		7,123	6.57	%		4,176,830		205,663	6.57	%
Trading securities		457,320		23,070	6.73	%		117,364		9,495	10.79	%
Cash and cash equivalents⁽²⁾		2,155,474		49,460	3.07	%		715,474		25,817	4.82	%
Stock borrow and other		814,133		46,698	7.66	%		928,665		51,228	7.38	%

Total enterprise interest-earning assets⁽³⁾		47,700,224		1,915,003	5.35	%		56,010,102		2,646,810	6.30	%

Non-operating interest-earning assets and other⁽⁴⁾		5,218,220						5,370,803

Total assets	$	52,918,444					$	61,380,905

Enterprise interest-bearing liabilities:
Retail deposits	$	25,871,958		445,210	2.30	%	$	26,424,575		593,836	3.00	%
Brokered certificates of deposit		1,081,185		40,337	4.98	%		436,265		16,033	4.91	%
Customer payables		4,422,244		25,303	0.76	%		5,830,832		52,491	1.20	%
Repurchase agreements and other borrowings		7,678,211		235,212	4.02	%		12,761,556		500,293	5.17	%
FHLB advances		4,920,804		172,473	4.61	%		6,612,725		257,183	5.13	%
Stock loan and other		1,291,261		16,742	1.73	%		1,196,012		27,413	3.06	%

Total enterprise interest-bearing liabilities		45,265,663		935,277	2.74	%		53,261,965		1,447,249	3.60	%

Non-operating interest-bearing liabilities and other⁽⁵⁾		4,937,795						3,803,115

Total liabilities		50,203,458						57,065,080
Total shareholders’ equity		2,714,986						4,315,825

Total liabilities and shareholders’ equity	$	52,918,444					$	61,380,905

Excess of enterprise interest-earning assets over enterprise interest-bearing liabilities/Enterprise net interest income/Spread	$	2,434,561	$	979,726	2.61	%	$	2,748,137	$	1,199,561	2.70	%

Enterprise net interest margin (net yield on enterprise interest-earning assets)					2.74	%					2.86	%
Ratio of enterprise interest-earning assets to enterprise interest-bearing liabilities					105.38	%					105.16	%
Return on average:
Total assets					(0.60	)%					0.59	%
Total shareholders’ equity					(11.60	)%					8.34	%
Average equity to average total assets					5.13	%					7.03	%

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


	Nine Months Ended September 30,
	2008			2007
Enterprise net interest income⁽⁶⁾	$	979,726		$	1,199,561
Taxable equivalent interest adjustment		(8,429	)		(23,330	)
Customer cash held by third parties and other⁽⁷⁾		22,612			28,439

Net operating interest income	$	993,909		$	1,204,670

⁽¹⁾

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

⁽²⁾

Includes segregated cash balances.

⁽³⁾

Amount includes a taxable equivalent increase in operating interest income of $8.4 million and $23.3 million for the nine months ended September 30, 2008 and 2007, respectively.

⁽⁴⁾

⁽⁵⁾

⁽⁶⁾

⁽⁷⁾

Includes interest earned on average customer assets of $3.3 billion and $4.0 billion for the nine months ended September 30, 2008 and 2007, respectively, held by parties outside E*TRADE Financial, including third party money market funds and sweep deposit accounts at unaffiliated financial institutions. Other consists of net operating interest earned on average stock conduit assets of $1.6 million for the nine months ended September 30, 2007. There were not any stock conduit assets at September 30, 2008.

Average enterprise interest-earning assets decreased 21% to $46.6 billion and 15% to $47.7 billion for the three and nine months ended September 30, 2008, respectively, compared to the same periods in 2007, primarily the result of a decrease in our available-for-sale portfolio and loans, net. Average available-for-sale mortgage-backed and investment securities decreased 45% to $9.6 billion and 45% to $9.3 billion for the three and nine months ended September 30, 2008, respectively, compared to the same periods in 2007. This decrease was primarily due to the sale of certain mortgage-backed securities in the first quarter of 2008 and the sale of our asset-backed securities portfolio towards the end of the fourth quarter of 2007. Average loans, net decreased 17% to $26.9 billion and 7% to $28.4 billion for the three and nine months ended September 30, 2008, respectively, compared to the same periods in 2007. Average loans, net decreased as a result of our focus on growing real estate loan products in the first and second quarters of 2007. Beginning in the second half of 2007, we altered our strategy and halted the focus on growing the balance sheet. For the foreseeable future, we plan to allow our home equity loans to pay down resulting in an overall decline in the balance of the loan portfolio.

Average enterprise interest-bearing liabilities decreased 21% to $44.2 billion and 15% to $45.3 billion for the three and nine months ended September 30, 2008, respectively, compared to the same periods in 2007. The decrease in average enterprise interest-bearing liabilities was primarily due to a decrease in repurchase agreements and other borrowings. Average repurchase agreements and other borrowings decreased 40% to $7.6 billion and 40% to $7.7 billion for the three and nine months ended September 30, 2008, respectively, compared to the same periods in 2007.

Enterprise net interest spread decreased by 2 basis points to 2.63% for the three months ended September 30, 2008 compared to the same period in 2007 and decreased by 9 basis points to 2.61% for the nine months ended September 30, 2008 compared to the same period in 2007.

Commission

Commission revenue decreased 28% to $129.5 million and 24% to $374.0 million for the three and nine months ended September 30, 2008, respectively, compared to the same periods in 2007, which was driven primarily by a decrease of $44.8 million and $119.2 million in institutional commission revenue as a result of the exit of our institutional brokerage operations. The primary factors that affect our retail 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 number of executed trades in these businesses impacts average commission per trade. Each business also has different trade types (e.g. equities, options, fixed income, exchange-traded funds, contract for difference 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 decreased 1% to 183,691 and increased 6% to 178,814 for the three and nine months ended September 30, 2008, respectively, compared to the same periods in 2007. Our U.S. DART volume remained relatively flat and increased 5% for the three and nine months ended September 30, 2008, respectively, compared to the same periods in 2007. Our international DARTs decreased by 6% and increased by 9% for the three and nine months ended September 30, 2008, respectively, compared to the same periods in 2007. In addition, option-related DARTs now represent 16% of U.S. trading volume.

Average commission per trade decreased 5% to $11.10 and 7% to $11.07 for the three and nine months ended September 30, 2008, respectively, compared to the same periods in 2007. The decrease was primarily a function of the product and customer mix. The overall poor performance of the equity markets in the first nine months of 2008 disproportionately impacted higher commission products, such as corporate services transactions and mutual funds. Main Street Investors, who generally have a higher commission per trade, traded less during the period compared to Active Traders and Mass Affluent customers, who generally have a lower commission per trade. Customer appreciation, win-back and other promotional campaigns also contributed to the decrease in average commission per trade.

Fees and Service Charges

Fees and service charges decreased 14% to $49.6 million and 9% to $155.5 million for the three and nine months ended September 30, 2008, respectively, compared to the same periods in 2007. This decrease was primarily due to a decrease in order flow revenue, advisory management fees and CDO management fees. The decrease in advisory management fees was primarily due to our sale of RAA.

Principal Transactions

Principal transactions remained flat at $20.7 million and decreased 23% to $59.5 million for the three and nine months ended September 30, 2008, respectively, compared to the same periods in 2007. The decrease in principal transactions for the nine months ended September 30, 2008, resulted from lower institutional trading volumes. 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.

Loss on Loans and Securities, Net

Loss on loans and securities, net was a loss of $159.8 million and $184.1 million for the three and nine months ended September 30, 2008, respectively, as shown in the following table (dollars in thousands):


	Three Months Ended September 30,						Variance					Nine Months Ended September 30,						Variance
	Three Months Ended September 30,						2008 vs. 2007					Nine Months Ended September 30,						2008 vs. 2007
	2008			2007			Amount			%		2008			2007			Amount			%
Loss on sales of loans held-for-sale, net	$	—		$	(2,408	)	$	2,408		(100	)%	$	(783	)	$	(12,123	)	$	11,340		(94	)%
Gain on securities and other investments		5,489			1,701			3,788		223	%		17,966			10,074			7,892		78	%
Loss on impairment		(17,884	)		(159,752	)		141,868		(89	)%		(61,639	)		(162,713	)		101,074		(62	)%
Loss on trading securities, net		(147,777	)		(37,845	)		(109,932	)	290	%		(142,508	)		(22,823	)		(119,685	)	524	%
Hedge ineffectiveness		373			(2,826	)		3,199		*			2,891			(1,311	)		4,202		*

Loss on securities, net		(159,799	)		(198,722	)		38,923		(20	)%		(183,290	)		(176,773	)		(6,517	)	4	%

Loss on loans and securities, net	$	(159,799	)	$	(201,130	)	$	41,331		(21	)%	$	(184,073	)	$	(188,896	)	$	4,823		(3	)%

Percentage not meaningful

The total loss on loans and securities, net during the three and nine months ended September 30, 2008 was due principally to losses on our preferred stock in Fannie Mae and Freddie Mac. During the third quarter, our preferred stock in Fannie Mae and Freddie Mac experienced record price declines and volatility. Based upon our concerns about continuing market instability, all of our positions were liquidated during the three months ended September 30, 2008, resulting in a pre-tax loss of $153.8 million, net of hedges, that was recognized in loss on trading securities, net.

In addition, during the three and nine months ended September 30, 2008, we recognized $17.9 million and $61.6 million of impairment, respectively, on certain securities in our collateralized mortgage obligations (“CMO”) portfolio. Further declines in the performance of our CMO portfolio could result in additional impairments in future periods.

Other Revenue

Other revenue increased 3% to $13.0 million and 21% to $40.3 million for the three and nine months ended September 30, 2008, respectively, compared to the same periods in 2007. The increase in other revenue was due to revenue from the cash surrender value of Bank-Owned Life Insurance, which was entered into during the third quarter of 2007.

Provision for Loan Losses

Provision for loan losses increased $331.3 million to $517.8 million and $833.0 million to $1.1 billion for the three and nine months ended September 30, 2008, respectively, compared to the same periods in 2007. The increase in the provision for loan losses was related primarily to deterioration in the performance of our home equity loan portfolio, which began in the second half of 2007. During the nine months ended September 30, 2008, we also observed deterioration in the performance of our one- to four-family loan portfolio. We believe the deterioration in both of these portfolios was caused by several factors, including: home price depreciation in key markets; growing inventories of unsold homes; rising foreclosure rates; substantial contraction in the availability of credit; and a general decline in economic growth. In addition, the combined impact of home price depreciation and the reduction of available credit continued to make it difficult for borrowers to refinance existing loans. While we do not expect the provision for loan losses to continue at levels in excess of the third quarter of 2008 in future periods, we do believe it will continue at historically high levels.

Operating Expense

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


	Three Months Ended September 30,				Variance					Nine Months Ended September 30,				Variance
	Three Months Ended September 30,				2008 vs. 2007					Nine Months Ended September 30,				2008 vs. 2007
	2008		2007		Amount			%		2008		2007		Amount			%
Compensation and benefits	$	83,644	$	110,092	$	(26,448	)	(24)	%	$	302,854	$	335,476	$	(32,622	)	(10)	%
Clearing and servicing		46,105		74,809		(28,704	)	(38)	%		137,112		208,449		(71,337	)	(34)	%
Advertising and market development		30,381		25,190		5,191		21	%		130,566		100,131		30,435		30	%
Communications		23,029		25,254		(2,225	)	(9	)%		72,623		72,928		(305	)	0	%
Professional services		16,862		19,252		(2,390	)	(12	)%		66,256		64,903		1,353		2	%
Depreciation and amortization		20,569		21,618		(1,049	)	(5	)%		62,607		60,045		2,562		4	%
Occupancy and equipment		20,470		21,143		(673	)	(3	)%		62,666		63,369		(703	)	(1)	%
Amortization of other intangibles		7,937		10,485		(2,548	)	(24	)%		27,982		30,940		(2,958	)	(10)	%
Facility restructuring and other exit activities		5,526		5,037		489		10	%		28,525		3,115		25,410		816	%
Other		41,367		42,599		(1,232	)	(3)	%		77,575		144,709		(67,134	)	(46)	%

Total operating expense		$295,890		$355,479		$(59,589)		(17)	%		$968,766		$1,084,065		$(115,299)		(11)	%

Operating expense declined 17% to $295.9 million and 11% to $968.8 million for the three and nine months ended September 30, 2008, respectively, compared to the same periods in 2007.

Compensation and Benefits

Compensation and benefits decreased 24% to $83.6 million and 10% to $302.9 million for the three and nine months ended September 30, 2008, respectively, compared to the same periods in 2007. This decrease resulted primarily from decreased salary expense due to a reduction in our employee base and decreased variable compensation expense during the three and nine months ended September 30, 2008.

Clearing and Servicing

Clearing and servicing expense decreased 38% to $46.1 million and 34% to $137.1 million for the three and nine months ended September 30, 2008, respectively, compared to the same periods in 2007. This decrease is related primarily to the exit of our institutional brokerage operations, which resulted in lower clearing expenses.

Advertising and Market Development

Advertising and market development expense increased 21% to $30.4 million and 30% to $130.6 million for the three and nine months ended September 30, 2008, respectively, compared to the same periods in 2007. This planned increase was aimed at restoring customer confidence as well as expanded efforts to promote our products and services to retail investors.

Facility Restructuring and Other Exit Activities

Facility restructuring and other exit activities expense increased to $5.5 million and $28.5 million for the three and nine months ended September 30, 2008, respectively. These costs were due primarily to the exit of certain facilities during the nine months ended September 30, 2008. Slightly offsetting the restructuring expense is the gain on the sale of RAA of $2.8 million which was recorded in the second quarter of 2008.

Other

Other expense decreased 3% to $41.4 million and 46% to $77.6 million for the three and nine months ended September 30, 2008, respectively, compared to the same periods in 2007, which was primarily due to items that are not expected to recur in future periods. During the first quarter of 2008, we sold our corporate aircraft related assets, which resulted in a $23.7 million gain on sale. During the second quarter of 2008, we realized approximately $13 million of insurance recoveries of fraud losses incurred in prior periods as well as other recoveries to legal reserves. The decrease is also due to $35.1 million in expense recorded for certain legal and regulatory matters for the comparable period in 2007.

Other Income (Expense)

Other income (expense) increased to an expense of $65.6 million and $233.2 million for the three and nine months ended September 30, 2008, respectively, compared to the same periods in 2007, as shown in the following table (dollars in thousands):


	Three Months Ended September 30,						Variance					Nine Months Ended September 30,						Variance
	Three Months Ended September 30,						2008 vs. 2007					Nine Months Ended September 30,						2008 vs. 2007
	2008			2007			Amount			%		2008			2007			Amount			%
Other income (expense):
Corporate interest income	$	1,387		$	1,018		$	369		36	%	$	5,619		$	3,724		$	1,895		51	%
Corporate interest expense		(88,772	)		(37,365	)		(51,407	)	138	%		(274,262	)		(113,022	)		(161,240	)	143	%
Gain (loss) on sales of investments, net		(213	)		(18	)		(195	)	*			307			37,005			(36,698	)	(99	)%
Gain (loss) on early extinguishment of debt		—			(37	)		37		*			10,084			(6	)		10,090		*
Equity in income (loss) of investments and venture funds		21,965			(741	)		22,706		*			25,070			6,514			18,556		285	%

Total other income (expense)	$	(65,633	)	$	(37,143	)	$	(28,490	)	77	%	$	(233,182	)	$	(65,785	)	$	(167,397	)	254	%

Percentage not meaningful

Total other income (expense) for the three and nine months ended September 30, 2008 primarily consisted of corporate interest expense resulting from our corporate debt, which includes the springing lien notes, senior notes and mandatory convertible notes, partially offset by equity in income of investments and venture funds. Corporate interest expense increased 138% to $88.8 million and 143% to $274.3 million for the three and nine months ended September 30, 2008, respectively, which was primarily due to the interest expense on the springing lien notes that were issued in the fourth quarter of 2007 and first quarter of 2008. During the three months ended September 30, 2008, our wholly-owned subsidiary, E*TRADE Mauritius, sold its equity shares in Investsmart for a gain on sale of $22.3 million, recorded in equity in income (loss) of investments and venture funds.

The gain on early extinguishment of debt is primarily due to a gain of $21.5 million recognized on the exchange of our senior notes for shares of our common stock for the nine months ended September 30, 2008. The gain of $21.5 million is offset by a loss of $10.8 million related to the early extinguishment of FHLB advances and a loss of $0.6 million on the prepayment of debt related to the sale of the corporate aircraft.

Income Tax Expense (Benefit)

Income tax benefit from continuing operations was $180.8 million and $300.4 million during the three and nine months ended September 30, 2008, respectively, compared to an income tax benefit of $38.2 million and an income tax expense of $136.2 million, respectively, for the same periods in 2007. The recording of a net tax benefit in the current period compared to a net tax expense for the same period in 2007 relates primarily to $501.6 million and $833.6 million in loss before income taxes and discontinued operations for the three and nine months ended September 30, 2008, respectively, compared to a loss of $97.0 million and income of $405.5 million, respectively, in income (loss) before income taxes and discontinued operations for the comparable periods in 2007. Our effective tax rates were (36.0)% and (39.4)% for the three months ended September 30, 2008 and 2007, respectively, and (36.0)% and 33.6% for the nine months ended September 30, 2008 and 2007, respectively.

We expect our 2008 tax expense to be based on a pro-forma tax rate in the range of 37% to 38% before taking into account $5.5 million of projected 2008 incremental tax expense, which is summarized in the following table (dollars in millions):


	Projected Incremental Tax Expense
Incremental tax benefits
Tax exempt income	$	10.2
Hong Kong tax settlement		4.3
FIN 48 settlements and reversals		12.1
Low income housing tax credits		2.4

Total tax benefits		29.0
Incremental tax expenses
Non-deductible officer’s compensation		3.4
Sweden valuation allowance		7.3
Removal of foreign earnings from permanently reinvested (APB 23)		1.7
Tax rate differential of international operations		9.2
Non-deductible portion of interest expense on springing lien notes		12.9

Total tax expense		34.5

Projected incremental tax items	$	5.5

A proportionate amount of these incremental tax items were included in the $180.8 million and $300.4 million income tax benefit for the three and nine months ended September 30, 2008, respectively.

During the period ended September 30, 2008, we did not provide for a valuation allowance against our federal deferred tax assets, including those related to our operating loss and credit carryforwards, since we continue to believe that it is not more likely than not that the net deferred federal tax assets will not be recognized. The ability to recognize these deferred tax assets is generally based on our ability to generate future taxable income and can be subject to other limitations in the event of a substantial change in ownership in the Company. Thus, while we currently believe it is more likely than not the deferred tax assets will be recognized, such recognition cannot be assured, nor can there be any assurance that our judgment regarding the need for a valuation allowance will not change at some point in the future. As of September 30, 2008, our deferred tax assets related to our operating loss and credit carryforwards were $538.4 million.

Income from Discontinued Operations, Net of Tax

Our Canadian brokerage business, which has been sold, and our mortgage lending business, which we exited, are both reported in discontinued operations. The following table outlines the components of discontinued operations (dollars of thousands):


	Three Months Ended September 30,						Variance					Nine Months Ended September 30,						Variance
	Three Months Ended September 30,						2008 vs. 2007					Nine Months Ended September 30,						2008 vs. 2007
	2008			2007			Amount			%		2008			2007			Amount			%
Lending loss, net of tax	$	(575	)	$	(5,724	)	$	5,149		(90	)%	$	(6,235	)	$	(13,042	)	$	6,807		(52	)%
Canada income, net of tax		2,753			6,108			(3,355	)	(55	)%		10,910			13,783			(2,873	)	(21	)%
Canada – gain on disposal , net of tax		268,136			—			268,136		*			268,136			—			268,136		*
Canada – tax benefit of excess tax basis over book basis		—			—			—		*			24,121			—			24,121		*

Income from discontinued operations, net of tax	$	270,314		$	384		$	269,930		*		$	296,932		$	741		$	296,191		*

Percentage not meaningful

The benefit of excess tax basis over book basis is related to our Canadian brokerage business, which resulted from the difference between the tax and financial reporting bases of the business. We recognized this difference in the second quarter of 2008 because a commitment to sell the Canadian brokerage business was in place. The sale of the Canadian brokerage business was completed in the third quarter of 2008 for a gain of $268.1 million, net of taxes.

SEGMENT RESULTS REVIEW

Retail

The following table summarizes retail financial and key metrics for the three and nine months ended September 30, 2008 and 2007 (dollars in thousands, except for key metrics):


	Three Months Ended September 30,						Variance					Nine Months Ended September 30,					Variance
	Three Months Ended September 30,						2008 vs. 2007					Nine Months Ended September 30,					2008 vs. 2007
	2008			2007			Amount			%		2008			2007		Amount			%
Retail segment income:
Net operating interest income	$	216,976		$	252,372		$	(35,396	)	(14	)%	$	644,712		$	719,712	$	(75,000	)	(10	)%
Commission		129,459			135,721			(6,262	)	(5	)%		373,252			375,156		(1,904	)	(1	)%
Fees and service charges		50,420			56,380			(5,960	)	(11	)%		154,211			159,701		(5,490	)	(3	)%
Gain (loss) on loans and securities, net		(37	)		(98	)		61		(62	)%		(21	)		180		(201	)	(112	)%
Other revenue		9,318			9,810			(492	)	(5	)%		29,279			30,682		(1,403	)	(5	)%

Net segment revenue		406,136			454,185			(48,049	)	(11	)%		1,201,433			1,285,431		(83,998	)	(7	)%
Total segment expense		235,122			229,840			5,282		2	%		736,944			684,672		52,272		8	%

Total retail segment income	$	171,014		$	224,345		$	(53,331	)	(24	)%	$	464,489		$	600,759	$	(136,270	)	(23	)%

Key Metrics⁽¹⁾:
Retail customer assets (dollars in billions)	$	142.2		$	213.1		$	(70.9	)	(33	)%	$	142.2		$	213.1	$	(70.9	)	(33	)%
Net new customer assets (dollars in billions)⁽²⁾	$	0.8		$	1.1			N.M.		N.M.		$	2.0		$	5.0		N.M.		N.M.
Customer cash and deposits (dollars in billions)	$	33.4		$	38.6		$	(5.2	)	(13	)%	$	33.4		$	38.6	$	(5.2	)	(13	)%
DARTs		183,691			185,411			(1,720	)	(1	)%		178,814			169,110		9,704		6	%
Average commission per trade	$	11.10		$	11.71		$	(0.61	)	(5	)%	$	11.07		$	11.90	$	(0.83	)	(7	)%
End of period margin debt (dollars in billions)	$	5.6		$	7.4		$	(1.8	)	(24	)%	$	5.6		$	7.4	$	(1.8	)	(24	)%
End of period total accounts		4,436,225			4,274,701			161,524		4	%		4,436,225			4,274,701		161,524		4	%

⁽¹⁾

Metrics have been represented to exclude activity from discontinued operations. All discussions, unless otherwise noted, are based on metrics from continuing operations.

⁽²⁾

For the nine months ended September 30, 2008, net new customer assets were $2.9 billion excluding the sale of RAA.

Our retail segment generates revenue from trading, investing and banking relationships with retail customers. These relationships essentially drive five sources of revenue: net operating interest income; commission; fees and service charges; gain (loss) on loans and securities, net; and other revenue. Other revenue includes results from our stock plan administration products and services, as we ultimately service retail customers through these corporate relationships.

During the fourth quarter of 2007, we experienced a disruption in our customer base which caused a decline in the core drivers of our retail segment, including: net new accounts, customer cash and deposits, DARTs, margin debt and retail customer assets. We believe this disruption was due to the uncertainty surrounding the Company in connection with the credit related losses in our institutional segment. While we continue to anticipate credit related losses to be at historically high levels, primarily in our home equity loan portfolio, we believe our retail customer base has stabilized. During the three months ended September 30, 2008, our retail customer base showed positive growth trends, including adding almost 41,000 net new accounts and net growth in customer assets of approximately $800 million. We believe these are indications that our retail segment has not only stabilized but has returned to modest growth.

Retail segment income decreased 24% to $171.0 million and 23% to $464.5 million for the three and nine months ended September 30, 2008, respectively, compared to the same periods in 2007. This was due primarily to a decrease in net operating interest income and an increase in total segment expense during the comparable periods.

Retail net operating interest income decreased 14% to $217.0 million and 10% to $644.7 million for the three and nine months ended September 30, 2008, respectively, compared to the same periods in 2007. This decrease was driven primarily by a decrease in customer cash and deposits during the comparable periods.

Retail commission revenue decreased 5% to 129.5 million and 1% to $373.3 million for the three and nine months ended September 30, 2008, respectively, compared to the same periods in 2007. The decrease in commission revenue for the three months ended September 30, 2008 compared to the same period in 2007 was a result of the decrease in DARTs of 1% and decrease in average commission per trade of 5%. For the nine months ended September 30, 2008, the increase in DARTs of 6% was offset by a 7% decrease in average commission per trade, which resulted in commission revenue being relatively flat for the nine months ended September 30, 2008.

Retail segment expense increased 2% to $235.1 million and 8% to $736.9 million for three and nine months ended September 30, 2008, respectively, compared to the same periods in 2007. This increase related primarily to our planned growth in marketing spend as we expanded efforts to promote our products and services to retail investors.

As of September 30, 2008, we had approximately 3.5 million active trading and investing accounts and 0.9 million active deposit and lending accounts. For the three months ended September 30, 2008 and 2007, our retail trading and investing products contributed 72% and 71%, respectively, and our deposit products contributed 27% and 28%, respectively, of total retail net revenue. For the nine months ended September 30, 2008 and 2007, our retail trading and investing products contributed 72% and 71%, respectively, and our deposit products contributed 27% for both periods, of total retail net revenue. All other products contributed less than 10% of total retail net revenue for the three and nine months ended September 30, 2008 and 2007.

Institutional

The following table summarizes institutional financial and key metrics for the three and nine months ended September 30, 2008 and 2007 (dollars in thousands, except for key metrics):


	Three Months Ended September 30,						Variance					Nine Months Ended September 30,						Variance
	Three Months Ended September 30,						2008 vs. 2007					Nine Months Ended September 30,						2008 vs. 2007
	2008			2007			Amount			%		2008			2007			Amount			%
Institutional segment loss:
Net operating interest income	$	107,796		$	159,070		$	(51,274	)	(32	)%	$	349,195		$	484,958		$	(135,763	)	(28	)%
Commission		54			44,901			(44,847	)	(100	)%		751			119,952			(119,201	)	(99	)%
Fees and service charges		1,704			4,045			(2,341	)	(58	)%		8,219			18,794			(10,575	)	(56	)%
Principal transactions		20,664			20,734			(70	)	(0	)%		59,546			77,743			(18,197	)	(23	)%
Loss on loans and securities, net		(159,762	)		(201,032	)		41,270		(21	)%		(184,052	)		(189,076	)		5,024		(3	)%
Other revenue		3,665			2,948			717		24	%		11,028			3,010			8,018		266	%

Net segment revenue		(25,879	)		30,666			(56,545	)	(184	)%		244,687			515,381			(270,694	)	(53	)%
Provision for loan losses		517,800			186,536			331,264		178	%		1,070,792			237,767			833,025		350	%
Total segment expense		63,293			128,370			(65,077	)	(51	)%		238,779			407,046			(168,267	)	(41	)%

Total institutional segment loss	$	(606,972	)	$	(284,240	)	$	(322,732	)	114	%	$	(1,064,884	)	$	(129,432	)	$	(935,452	)	723	%

Key Metrics⁽¹⁾:
Nonperforming loans receivable as a % of gross loans receivable		3.02	%		0.84	%		*		2.18	%		3.02	%		0.84	%		*		2.18	%
Allowance for loan losses (dollars in millions)	$	874.2		$	209.0		$	665.2		318	%	$	874.2		$	209.0		$	665.2		318	%
Allowance for loan losses as a % of nonperforming loans		109.45	%		76.24	%		*		33.21	%		109.45	%		76.24	%		*		33.21	%
Average revenue capture per 1,000 equity shares	$	0.465		$	0.415		$	0.050		12	%	$	0.495		$	0.472		$	0.023		5	%

Percentage not meaningful

⁽¹⁾

Metrics have been represented to exclude activity from discontinued operations. All discussions, unless otherwise noted, are based on metrics from continuing operations.

Our institutional segment generates revenue from balance sheet management and market-making activities. Balance sheet management activities include managing loans previously purchased 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.

As a result of our exposure to the credit crisis in the residential real estate and credit markets, our institutional segment incurred a loss of $607.0 million and $1.1 billion for the three and nine months ended September 30, 2008. The loss was driven primarily by an increase in the provision for loan losses for our loan portfolio of $331.3 million and $833.0 million for the three and nine months ended September 30, 2008, respectively, compared to the same periods in 2007.

Net operating interest income decreased 32% to $107.8 million and 28% to $349.2 million for the three and nine months ended September 30, 2008, respectively, compared to the same periods in 2007. The decrease in net operating interest income was due primarily to the decrease in average enterprise interest-earning assets of 21% to $46.6 billion and 15% to $47.7 billion for the three and nine months ended September 30, 2008, respectively, compared to the same periods in 2007.

Institutional commission revenue decreased to $0.1 million and $0.8 million for the three and nine months ended September 30, 2008, respectively, compared to the same periods in 2007. The decrease was a result of the exit of our institutional brokerage operations.

Fees and service charges revenue decreased 58% to $1.7 million and 56% to $8.2 million for the three and nine months ended September 30, 2008, respectively, compared to the same periods in 2007. The decrease is primarily the result of a decrease in CDO management fees, which are no longer a revenue stream due to the sale of our collateral management agreements during the first quarter of 2008.

In addition, during the three and nine months ended September 30, 2008, we recognized $17.9 million and $61.6 million of impairment, respectively, on certain securities in our CMO portfolio. Further declines in the performance of our CMO portfolio could result in additional impairments in future periods.

Total institutional segment expense decreased 51% to $63.3 million and 41% to $238.8 million for the three and nine months ended September 30, 2008, respectively, compared to the same periods in 2007 and was due primarily to a decline in our clearing expense related to the exit of our institutional brokerage operations, as well as a reduction in corporate overhead expenses, the majority of which are allocated to the institutional segment.

BALANCE SHEET OVERVIEW

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


	September 30, 2008		December 31, 2007		Variance
					2008 vs. 2007
					Amount			%
Assets:
Cash and equivalents⁽¹⁾	$	3,275,429	$	2,113,075	$	1,162,354		55	%
Trading securities		50,968		130,018		(79,050	)	(61	)%
Available-for-sale mortgage-backed and investment securities		9,620,473		11,255,048		(1,634,575	)	(15	)%
Margin receivables		5,619,593		7,179,175		(1,559,582	)	(22	)%
Loans, net		25,543,121		30,139,382		(4,596,261	)	(15	)%
Investment in FHLB stock		200,892		338,585		(137,693	)	(41	)%
Other assets⁽²⁾		5,394,548		5,690,654		(296,106	)	(5	)%

Total assets	$	49,705,024	$	56,845,937	$	(7,140,913	)	(13	)%

Liabilities and shareholders’ equity:
Deposits	$	26,615,589	$	25,884,755	$	730,834		3	%
Wholesale borrowings⁽³⁾		11,465,776		16,379,197		(4,913,421	)	(30	)%
Customer payables		4,363,885		5,514,675		(1,150,790	)	(21	)%
Corporate debt		3,054,299		3,022,698		31,601		1	%
Accounts payable, accrued and other liabilities		1,668,346		3,215,547		(1,547,201	)	(48	)%

Total liabilities		47,167,895		54,016,872		(6,848,977	)	(13	)%
Shareholders’ equity		2,537,129		2,829,065		(291,936	)	(10	)%

Total liabilities and shareholders’ equity	$	49,705,024	$	56,845,937	$	(7,140,913	)	(13	)%

⁽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 securities sold under agreements to repurchase and other borrowings.

The decrease in total assets was attributable primarily to a decrease of $4.6 billion in loans, net, a decrease of $1.6 billion in available-for-sale mortgage-backed and investment securities and a decrease in margin receivables of $1.6 billion for the period ended September 30, 2008 when compared to December 31, 2007. The decrease in loans, net is due to our strategy of reducing balance sheet risk and halting our previous focus on growing the balance sheet. For the foreseeable future, we plan to allow our home equity loans to pay down resulting in an overall decline in the balance of the loan portfolio. During this period, we plan to maintain excess regulatory capital at E*TRADE Bank as we focus on strengthening our capital position. The decrease in available-for-sale mortgage-backed and investment securities was primarily due to a $0.9 billion decrease in our mortgage-backed securities. We believe the decrease in our margin receivables is due to customers deleveraging and reducing their risk exposure due to the volatility in the financial markets and is not due to a specific issue with the terms or competitiveness of our margin product.

The decrease in total liabilities was attributable primarily to a decrease of $4.9 billion in wholesale borrowings, a decrease of $1.5 billion in accounts payable, accrued and other liabilities and a decrease in customer payables of $1.2 billion for the period ended September 30, 2008 when compared to December 31, 2007. The decrease in wholesale borrowings was a result of paying down our FHLB advances and securities sold under agreements to repurchase in the first quarter of 2008. In addition, stock loan, which is reported within the accounts payable, accrued and other liabilities line item, decreased $1.4 billion to $0.6 billion at September 30,

2008 compared to December 31, 2007. The decrease in our customer payables is related to the sale of our Canadian brokerage business during the three months ended September 30, 2008.

At September 30, 2008, cash and equivalents included $377.7 million of cash held in The Reserve’s Primary Fund. On September 16, 2008, The Primary Fund reported that its shares had fallen below the standard of $1 per share, which is commonly referred to as “breaking the buck.” The Reserve Fund’s Board of Trustees reported that this decline was due to losses on investments in Lehman Brothers Holdings, Inc. (“Lehman Brothers”) and announced its intention to liquidate the assets of The Primary Fund. Prior to the fund “breaking the buck,” we submitted a redemption request for our entire balance in the fund. On October 31, 2008, the fund made a distribution to its investors of approximately $26 billion. The $377.7 million held in cash and equivalents represents the cash that we received in connection with this distribution. The remaining amount of $366.7 million that we invested in The Primary Fund is included as a receivable in the other assets line item. We believe the full amount of our remaining position will be paid to us upon the ultimate distribution of the fund as our redemption request was made when the fund’s net asset value was $1; however, we cannot state with certainty that we will not ultimately incur a loss on this remaining position.

Loans, Net

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


	September 30, 2008			December 31, 2007			Variance
							2008 vs. 2007
							Amount			%
Loans held-for-sale	$	1,013		$	100,539		$	(99,526	)	(99	)%
One- to four-family		13,377,196			15,506,529			(2,129,333	)	(14	)%
Home equity		10,381,898			11,901,324			(1,519,426	)	(13	)%
Consumer and other loans:
Recreational vehicle		1,642,004			1,910,454			(268,450	)	(14	)%
Marine		443,304			526,580			(83,276	)	(16	)%
Commercial		227,400			272,156			(44,756	)	(16	)%
Credit card		84,634			90,764			(6,130	)	(7	)%
Other		6,418			23,334			(16,916	)	(72	)%
Unamortized premiums, net		253,476			315,866			(62,390	)	(20	)%
Allowance for loan losses		(874,222	)		(508,164	)		(366,058	)	72	%

Total loans, net	$	25,543,121		$	30,139,382		$	(4,596,261	)	(15	)%

Loans, net decreased 15% to $25.5 billion at September 30, 2008 from $30.1 billion at December 31, 2007. This decline was due primarily to our strategy of reducing balance sheet risk and halting our previous focus on growing the balance sheet. We do not expect to grow our loan portfolio for the foreseeable future. In addition, we intend to allow our home equity and consumer loan portfolios to decline over time.

We have a credit default swap (“CDS”) on $4.0 billion of our first-lien residential real estate loan portfolio through a synthetic securitization structure. A CDS provides, for a fee, an assumption by a third party of a portion of the credit risk related to the underlying loans. The CDS we entered into provides protection for losses in excess of 10 basis points, but not to exceed approximately 75 basis points. In addition, our regulatory risk-weighted assets were reduced as a result of this transaction because we transferred a portion of our credit risk to an unaffiliated third party.

Available-for-Sale Mortgage-Backed and Investment Securities

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


	September 30, 2008		December 31, 2007		Variance
					2008 vs. 2007
					Amount			%
Mortgage-backed securities:
Backed by U.S. Government sponsored and federal agencies	$	8,735,428	$	9,330,129	$	(594,701	)	(6	)%
CMOs and other		773,799		1,123,255		(349,456	)	(31	)%

Total mortgage-backed securities		9,509,227		10,453,384		(944,157	)	(9	)%

Investment securities:
Municipal bonds		92,152		314,348		(222,196	)	(71	)%
Publicly traded equity securities:
Preferred stock⁽¹⁾		—		371,404		(371,404	)	(100	)%
Corporate investments		1,029		1,271		(242	)	(19	)%
Other		18,065		114,641		(96,576	)	(84	)%

Total investment securities		111,246		801,664		(690,418	)	(86	)%

Total available-for-sale securities	$	9,620,473	$	11,255,048	$	(1,634,575	)	(15	)%

⁽¹⁾

On January 1, 2008, the Company elected the fair value option for preferred stock in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 159, The Fair Value Option for Financial Assets and Financial Liabilities-Including an Amendment of FASB Statement No. 115 (“SFAS No. 159”). As a result of this election, preferred stock was classified on the balance sheet as trading securities during 2008; however, during the third quarter of 2008, all preferred stock positions were sold.

Available-for-sale securities represented 19% and 20% of total assets at September 30, 2008 and December 31, 2007, respectively. Available-for-sale securities decreased 15% to $9.6 billion at September 30, 2008 compared to December 31, 2007, due primarily to the sale of certain mortgage-backed securities in the first half of 2008, offset by the purchase of highly-rated securities backed by U.S. Government sponsored and federal agencies during the third quarter of 2008. All mortgage-backed securities backed by U.S. Government sponsored and federal agencies are AAA-rated.

Margin Receivables

The margin receivables balance is a component of the margin debt balance, which is reported as a key retail metric of $5.6 billion and $7.0 billion at September 30, 2008 and December 31, 2007, respectively. The total margin debt balance is summarized as follows (dollars in thousands):


	September 30, 2008		December 31, 2007			Variance
						2008 vs. 2007
						Amount			%
Margin receivables	$	5,619,593	$	7,179,175		$	(1,559,582	)	(22	)%
Margin held by third parties and other		28,548		81,669			(53,121	)	(65	)%
Margin held by the Canadian brokerage business⁽¹⁾		—		(274,180	)		274,180		(100	)%

Margin debt	$	5,648,141	$	6,986,664		$	(1,338,523	)	(19	)%

⁽¹⁾

Margin held by the Canadian brokerage business prior to its sale was excluded as it is part of discontinued operations.

We believe the decrease in our margin receivables is due to customers deleveraging and reducing their risk exposure given the substantial volatility in the financial markets and is not due to an issue with the terms or

competitiveness of our margin product. During the month of October 2008, our customers continued to deleverage and reduce their risk exposure; therefore, we expect margin receivables to continue to decline in the fourth quarter of 2008.

Deposits

Deposits are summarized as follows (dollars in thousands):


	September 30, 2008		December 31, 2007		Variance
					2008 vs. 2007
					Amount			%
Money market and savings accounts	$	11,834,224	$	10,028,115	$	1,806,109		18	%
Sweep deposit accounts		10,142,245		10,112,123		30,122		0	%
Certificates of deposit ⁽¹⁾		2,765,912		4,156,674		(1,390,762	)	(33	)%
Checking accounts		1,084,094		495,618		588,476		119	%
Brokered certificates of deposit ⁽²⁾		789,114		1,092,225		(303,111	)	(28	)%

Total deposits	$	26,615,589	$	25,884,755	$	730,834		3	%

⁽¹⁾

Includes retail brokered certificates of deposit.

⁽²⁾

Includes institutional brokered certificates of deposit.

Deposits represented 56% and 48% of total liabilities at September 30, 2008 and December 31, 2007, respectively. Deposits increased $0.7 billion to $26.6 billion at September 30, 2008 compared to December 31, 2007, driven by a $1.8 billion increase in money market and savings accounts and a $0.6 billion increase in checking accounts. This increase was slightly offset by a decrease in certificates of deposit and brokered certificates of deposits of $1.7 billion. Deposits 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 $33.4 billion and $32.7 billion at September 30, 2008 and December 31, 2007, respectively. The total customer cash and deposits balance is summarized as follows (dollars in thousands):


	September 30, 2008			December 31, 2007			Variance
							2008 vs. 2007
							Amount			%
Deposits	$	26,615,589		$	25,884,755		$	730,834		3	%
Less: brokered certificates of deposit		(789,114	)		(1,092,225	)		303,111		(28	)%

Deposits excluding brokered certificates of deposit		25,826,475			24,792,530			1,033,945		4	%
Customer payables		4,363,885			5,514,675			(1,150,790	)	(21	)%
Customer cash balances held by third parties and other		3,244,944			3,286,212			(41,268	)	(1	)%
Customer cash balances held by the Canadian brokerage business⁽¹⁾		—			(883,222	)		883,222		(100	)%

Total customer cash and deposits from continuing operations	$	33,435,304		$	32,710,195		$	725,109		2	%

⁽¹⁾

Customer cash balances held by the Canadian brokerage business prior to its sale were excluded as it is part of discontinued operations.

Wholesale Borrowings

Wholesale borrowings, which consist of securities sold under agreements to repurchase and other borrowings are summarized as follows (dollars in thousands):


	September 30, 2008		December 31, 2007		Variance
					2008 vs. 2007
					Amount			%
Securities sold under agreements to repurchase	$	7,062,139	$	8,932,693	$	(1,870,554	)	(21	)%
FHLB advances		3,903,600		6,967,406		(3,063,806	)	(44	)%
Subordinated debentures		427,307		435,830		(8,523	)	(2	)%
Other		72,730		43,268		29,462		68	%

Total other borrowings		4,403,637		7,446,504		(3,042,867	)	(41	)%

Total wholesale borrowings	$	11,465,776	$	16,379,197	$	(4,913,421	)	(30	)%

Wholesale borrowings represented 24% and 30% of total liabilities at September 30, 2008 and December 31, 2007, respectively. The decrease in other borrowings of $3.0 billion for the period ended September 30, 2008 was due primarily to a decrease in FHLB advances. Securities sold under agreements to repurchase coupled with FHLB advances are the primary wholesale funding sources of the Bank. As a result, we expect these balances to fluctuate over time as our deposits and our interest-earning assets fluctuate.

Corporate Debt

Corporate debt is summarized as follows (dollars in thousands):


	September 30, 2008		December 31, 2007		Variance
					2008 vs. 2007
					Amount			%
Senior notes	$	1,128,027	$	1,272,742	$	(144,715	)	(11	)%
Springing lien notes		1,477,623		1,304,391		173,232		13	%
Mandatory convertible notes		448,649		445,565		3,084		1	%

Total corporate debt	$	3,054,299	$	3,022,698	$	31,601		1	%

Corporate debt remained relatively flat at $3.1 billion and $3.0 billion at September 30, 2008 and December 31, 2007, respectively. An additional $150.0 million of 12¹/2% springing lien notes issued to Citadel in the first quarter of 2008 were offset by a decline in senior notes of $144.7 million in principal related to debt for equity exchanges. We expect the outstanding principal of our senior notes to decline in future periods as the mandatory convertible notes are converted to equity and as we continue to pursue debt for equity exchanges.

LIQUIDITY AND CAPITAL RESOURCES

We have established liquidity and capital policies. The objectives of these policies are to support the successful execution of our business strategies while ensuring ongoing and sufficient liquidity through the business cycle. These policies are especially important during periods of stress in the financial markets, which have been ongoing since the fourth quarter of 2007 and will likely continue for the foreseeable future. During the fourth quarter of 2007, we experienced a disruption in our customer base, which caused a significant decline in customer deposits. We believe this disruption was due to the uncertainty surrounding the Company in connection with the credit related losses in our institutional segment. Deposits are the primary source of liquidity for E*TRADE Bank, so this sudden and rapid decline created a substantial amount of liquidity risk. We followed our existing liquidity policies and contingency plans and successfully met our liquidity needs during this extraordinary period. We believe that our ability to meet liquidity needs during this time validates the

effectiveness of the liquidity policies and contingency plans. While the liquidity risk associated with our customer deposits remains at historically high levels, we believe the current level of risk is substantially lower when compared to the fourth quarter of 2007.

Capital is generated primarily through our business operations and our capital market activities. During the second half of 2007, our institutional segment incurred a significant amount of losses as a result of its exposure to the crisis in the residential real estate and credit markets. Consequently, this segment required a significant capital infusion during the fourth quarter of 2007. The Company raised $2.5 billion in cash from Citadel, the majority of which was used to provide capital to the institutional segment. While this segment continues to have exposure to the crisis in the residential real estate and credit markets, our retail segment remains profitable and continues to generate capital through retained earnings.

We also raised additional capital in 2008 by issuing shares of common stock in exchange for existing corporate debt, primarily our senior notes, commonly referred to as “3(a)9 exchanges”. We completed several 3(a)9 exchanges in the first half of 2008, which resulted in a retirement of $120.8 million of existing corporate debt. We did not complete any of these transactions during the third quarter of 2008 as the relative prices of our common stock and corporate debt made it unattractive to do so.

In addition, we raised approximately $660 million in cash through the sale our Canadian brokerage business and our equity shares in Investsmart⁽¹⁾.

We believe the combination of the capital generated in the transactions detailed above, along with the capital that continues to be generated in our retail segment will be sufficient to meet our capital needs for at least the next twelve months.

Furthermore, we believe we qualify to participate in the U.S. Treasury’s Troubled Asset Relief Program (“TARP”) and have submitted an application through our primary regulator. While there is no guarantee that we will be approved, we estimate this program could provide up to approximately $800 million in new preferred equity, at rates substantially discounted to current market rates. If our application is approved, our ability to issue this preferred equity is dependent upon receiving approval to do so from certain of our bond holders, which we expect to receive. While we do not believe we need this capital to fund our operations, it does have the potential to significantly improve the capital position of both E*TRADE Bank and the parent company, which would enhance our ability to maintain the balance sheet at its current level.

Corporate Cash

Corporate cash is the primary source of liquidity at the parent company and is available to invest in our regulated subsidiaries. We define corporate cash as cash held at the parent company as well as cash held in certain subsidiaries that can distribute cash to the parent company without any regulatory approval. As of September 30, 2008, our corporate cash was $665.6 million, the components of which are as follows (dollars in thousands):


	September 30, 2008		December 31, 2007		Variance
					2008 vs. 2007
					Amount
Parent company cash	$	461,411	$	251,663	$	209,748
E*TRADE Mauritius cash		143,172		767		142,405
Converging Arrows, Inc. cash		61,064		59,934		1,130

Total corporate cash⁽²⁾	$	665,647	$	312,364	$	353,283

⁽¹⁾

The equity shares of Investsmart were sold by our wholly-owned subsidiary, E*TRADE Mauritius.

⁽²⁾

Total corporate cash at September 30, 2008 includes $113.5 million that we invested in The Primary Fund and is included as a receivable in the other assets line item, as The Reserve Fund has not indicated when the funds will be distributed back to investors.

Parent company cash increased $209.7 million to $461.4 million as of September 30, 2008 when compared to December 31, 2007, due principally to the cash received from the sale of the Canadian brokerage business. This increase in cash was offset by the $250 million capital infusion made to E*TRADE Bank during the third quarter of 2008. The increase in cash of $142.4 million at E*TRADE Mauritius as of September 30, 2008 when compared to December 31, 2007 was due almost entirely to the entity’s sale of its equity shares in Investsmart.

Cash and Equivalents

In the first nine months of 2008, the consolidated cash and equivalents balance increased to $3.2 billion for the period ended September 30, 2008. The majority of this balance is cash held in regulated subsidiaries, primarily our Bank and Brokerage, outlined as follows:


	September 30, 2008			December 31, 2007		Variance
						2008 vs. 2007
						Amount
Corporate cash	$	645,225		$	290,630	$	354,595
Banking subsidiaries		2,580,204			729,406		1,850,798
Brokerage subsidiaries		295,873			754,331		(458,458	)
Other corporate cash		4,108			3,877		231
Less:
Cash reported in Other assets⁽¹⁾		(366,670	)		—		(366,670	)

Total consolidated cash	$	3,158,740		$	1,778,244	$	1,380,496

⁽¹⁾

Cash reported in other assets at September 30, 2008 consists of cash that we invested in The Primary Fund and is included as a receivable in the other assets line item, as The Reserve Fund has not indicated when the funds will be distributed back to investors.

The cash held in our regulated subsidiaries serves as a source of liquidity for those subsidiaries and is not a primary source of capital for the parent company.

Cash and Equivalents Held in the Reserve Fund

At September 30, 2008, the Company and its subsidiaries held cash in The Reserve’s Primary Fund of $744.3 million. On September 16, 2008, The Primary Fund reported that its shares had fallen below the standard of $1 per share, which is commonly referred to as “breaking the buck.” Prior to the fund “breaking the buck”, we submitted a redemption request for our entire balance in the fund. The following table details our cash held in The Reserve’s Primary Fund as well as the balance sheet classification (dollars in thousands):


	September 30, 2008				Total
	Cash		Other Assets		Total
Corporate cash	$	116,865	$	113,461	$	230,326
Banking subsidiaries		213,335		207,121		420,456
Brokerage subsidiaries		47,471		46,088		93,559

Total cash held in The Primary Fund	$	377,671	$	366,670	$	744,341

On October 31, 2008, the fund made a distribution to its investors of approximately $26 billion. The $377.7 million held in cash and equivalents represents the cash that we received in connection with this distribution. The remaining amount of $366.7 million that we invested in The Primary Fund is included as a receivable in the other assets line item. We believe the full amount of our remaining position will be paid to us upon the ultimate distribution of the fund as our redemption request was made when the fund’s net asset value was $1; however, we cannot state with certainty that we will not ultimately incur a loss on this remaining position.

Liquidity Available from Subsidiaries

Liquidity available to the Company from its subsidiaries, other than Converging Arrows, Inc. (“Converging Arrows”) and E*TRADE Mauritius, a wholly-owned subsidiary of Converging Arrows, is limited by regulatory requirements.

Any loans by E*TRADE Bank to the parent company and its other non-bank subsidiaries are subject to various quantitative, arm’s length, collateralization and other requirements. At September 30, 2008, E*TRADE Bank had approximately $523.9 million of risk-based capital above the “well capitalized” level. In the current credit environment, we plan to maintain this significant level of excess risk-based capital at E*TRADE Bank in order to enhance our ability to absorb credit losses while still maintaining “well capitalized” status. However, events beyond management’s control, such as a continued deterioration in residential real estate and credit markets, could adversely affect future earnings and E*TRADE Bank’s ability to meet its future capital requirements.

Brokerage subsidiaries are required to maintain net capital equal to the greater of $250,000 or 2% of aggregate debit balances arising from customer transactions. At September 30, 2008 and December 31, 2007, all of our brokerage subsidiaries met their minimum net capital requirements. The Company’s broker-dealer subsidiaries had excess net capital of $631.8 million at September 30, 2008, of which $448.7 million is available for dividend while still maintaining a capital level above regulatory “early warning” guidelines.

Other Sources of Liquidity

We also maintain $401.0 million in uncommitted financing to meet margin lending needs. There were no outstanding balances, and the full $401.0 million was available at both September 30, 2008 and December 31, 2007.

We rely on borrowed funds, such as FHLB advances and securities sold under agreements to repurchase, to provide liquidity for the Bank. Our ability to borrow these funds is dependent upon the continued availability of funding in the wholesale borrowings market. At September 30, 2008, the Bank had approximately $10.1 billion in additional borrowing capacity with the FHLB.

We had the option to make interest payments of approximately $605 million on our springing lien notes in the form of either cash or additional springing lien notes through May 2010. During the second quarter of 2008, we elected to make our first interest payment of approximately $121 million on our springing lien notes in cash. This interest payment reduced the amount subject to this option to $484 million through May 2010. Our next interest payment of approximately $121 million is due in the fourth quarter of 2008.

Corporate Debt

Our current senior debt ratings are Ba3 by Moody’s Investor Service, B (negative watch) by Standard & Poor’s and B (high) by Dominion Bond Rating Service (“DBRS”). The Company’s long-term deposit ratings are Ba2 by Moody’s Investor Service, BB- (negative watch) by Standard & Poor’s and BB by DBRS. A significant change in these ratings may impact the rate and availability of future borrowings.

Off-Balance Sheet Arrangements

We enter into various off-balance-sheet arrangements in the ordinary course of business, primarily to meet the needs of our customers and to reduce our own exposure to interest rate risk. These arrangements include firm commitments to extend credit 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 1. Consolidated Financial Statements.

RISK MANAGEMENT

As a financial services company, we are exposed to risks in every component of our business. The identification and management of existing and potential risks are the keys to effective risk management. Our risk management framework, principles and 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. Risks cannot be completely eliminated; however, we do believe risks can be identified and managed within the Company’s risk tolerance.

Our businesses expose us to the following three major categories of risk that often overlap:

•

Credit Risk—Credit risk is the risk of loss resulting from adverse changes in the ability or willingness of a borrower or counterparty to meet the agreed-upon terms of their financial obligations.

•

Interest Rate Risk—Interest rate risk is the risk of loss from adverse changes in interest rates, which could cause fluctuations in our long-term earnings or in the value of the Company’s net assets.

•

Operational Risk—Operational risk is the risk of loss resulting from fraud, inadequate controls or the failure of the internal controls process, third party vendor issues, processing issues and external events. These risks are more fully described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the year ended December 31, 2007.

We also are subject to other risks that could impact our business, financial condition, results of operations or cash flows in future periods. See Part II—Item 1A—Risk Factors.

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. A variety of methodologies and measures are used to monitor, quantify, assess and forecast risk. Measurement criteria, methodologies and calculations are reviewed periodically to assure that risks are represented appropriately. Risks are managed and controlled under policies and related limits that are approved by the Board of Directors and delegated to senior management.

The Finance and Risk Oversight Committee, which was established in the second quarter of 2008 and consists of members of the Board of Directors, monitors the risk process and significant risks throughout the Company. In addition to this committee, various enterprise risk committees and departments throughout the Company aid in the identification and management of risks, including:

•

Asset Liability Committee—E*TRADE Bank’s Asset Liability Committee (“ALCO”) reviews balance sheet trends, market interest rate and sensitivity analyses.

•

Credit Risk Committee—The Credit Risk Committee monitors asset quality trends, evaluates market conditions, determines the adequacy for allowance of loan losses, establishes underwriting standards, approves large credit exposures, approves large portfolio purchases and delegates credit approval authority.

We use various departments throughout the Company to aid in the identification and management of risks. These departments include internal audit, compliance, finance, legal, treasury, credit and enterprise risk management. Risk reporting occurs at the business or operating units and is aggregated across the Company through the enterprise risk management process.

Credit Risk Management

Our primary sources of credit risk are our loan and securities portfolios, where it results from extending credit to customers and purchasing securities, respectively. The degree of credit risk associated with our loans and securities varies based on many factors including the size of the transaction, the credit characteristics of the

borrower, features of the loan product or security, the contractual terms of the related documents and the availability and quality of collateral. Credit risk is one of the most common risks in financial services and is one of our most significant risks.

Credit risk is monitored by our Credit Risk Committee. The Credit Risk Committee uses detailed tracking and analysis to measure credit performance and reviews and modifies credit policies as appropriate.

Housing Market Conditions

Conditions in the residential real estate and credit markets, which deteriorated sharply during 2007, continued to be extremely challenging in the nine months ended September 30, 2008. The significant and abrupt evaporation of secondary market liquidity for various types of mortgage loans, particularly home equity loans, has decreased the overall availability of housing credit. As a result, many borrowers, particularly those in markets with declining housing prices, have been unable to refinance existing loans. This combination of a decline in the availability of credit and a decline in housing prices creates significant credit risk in our loan portfolio, particularly in our home equity loan portfolio.

Loss Mitigation

Given the deterioration in the performance of our loan portfolio, particularly in our home equity loan portfolio, we formed a special credit management team to focus on the mitigation of potential losses in the home equity loan portfolio.

This team’s primary focus is reducing our exposure to open home equity lines. As of December 31, 2007, we had $6.3 billion of unused lines of credit available under home equity lines of credit. Through a variety of strategies, including voluntary line closures, automatically freezing lines on all delinquent accounts, and freezing lines on loans with materially reduced home equity, we have reduced this amount to $3.0 billion as of September 30, 2008.

The team has several other initiatives either in progress or in development which are focused on mitigating losses in our home equity loan portfolio. Those initiatives include improving collection efforts and practices of our servicers as well as increasing our loss recovery efforts to minimize the level of loss on a loan that goes to charge-off.

In addition, we continue to review our purchased home equity loan portfolio in order to identify loans to be repurchased by the originator. More specifically, home equity loans that become 30 days delinquent are reviewed for early payment defaults, violations of transaction representations and warranties, or material misrepresentation on the part of the seller. Any loans identified with these deficiencies are submitted to the original seller for repurchase. During the first nine months of 2008, approximately $70.3 million of loan repurchases were completed by the original sellers.

Underwriting Standards—Originated Loans

During the second half of 2007, we exited our wholesale mortgage origination channel and no longer originate loans through brokers. During the second quarter of 2008, we exited our retail mortgage origination business, which represented our last remaining loan origination channel. In the future, we expect to partner with a third party company to provide access to real estate loans for our customers.

During the three months ended September 30, 2008, we did not originate any one- to four-family loans. Prior to the exit of our retail mortgage origination business in the second quarter of 2008, we did originate approximately $158 million in one- to four-family loans during the six months ended June 30, 2008. These loans were predominately prime credit quality first-lien mortgage loans secured by a single-family residence.

We priced our loans primarily based on the risk elements inherent in the loan. We evaluated criteria such as, but not limited to: borrower credit score, loan-to-value ratio (“LTV”), documentation type, occupancy type and other risk elements. In the first quarter of 2008, we further adjusted our loan origination practices and pricing to significantly curtail originations of higher risk loans, particularly home equity loans with FICO scores below 700 or a combined loan-to-value ratio (“CLTV”) greater than 80%.

Our underwriting guidelines were established with a focus on both the credit quality of the borrower as well as the adequacy of the collateral securing the loan. We designed our underwriting guidelines so that our one- to four-family loans were salable in the secondary market. These guidelines included limitations on loan amount, loan-to-value ratio, debt-to-income ratio, documentation type and occupancy type. We also required borrowers to obtain mortgage insurance on higher loan-to-value first lien mortgage loans. Our past underwriting standards for originating loans are more fully described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the year ended December 31, 2007.

Underwriting Standards—Purchased Loans

In the second half of 2007, we altered our business strategy and halted the focus on growing the balance sheet. As a result, we did not purchase loans during the first nine months of 2008 and we do not anticipate purchasing a significant amount of loans for the foreseeable future. However, we have significantly tightened our underwriting policies for any future loan purchases that do occur. These criteria focus on limiting the acquisition of loans with a high risk of credit loss and require the exclusion of loans with the following attributes: second lien; home equity line of credit; combined loan-to-value ratio above 80%; FICO score below 700 at time of origination; and documentation type is not full documentation.

Loan Portfolio

We track and review many factors to predict and monitor credit risk in our loan portfolios, which are primarily made up of loans secured by residential real estate. These factors include, but are not limited to: borrowers’ debt-to-income ratio when loans are made, borrowers’ credit scores when loans are made, loan-to-value ratios, housing prices, documentation type, occupancy type, and loan type. In economic conditions in which housing prices generally appreciate, we believe that loan type, loan-to-value ratios and credit scores are the key factors in determining future loan performance. In the current housing market with declining home prices and less credit available for refinance, we believe the loan-to-value ratio becomes a more important factor in predicting and monitoring credit risk.

We believe certain categories of loans inherently have a higher level of credit risk due to characteristics of the borrower and/or features of the loan. Two of these categories are sub-prime and option ARM loans. As a general matter, we did not originate or purchase these loans to hold on our balance sheet; however, in the normal course of purchasing large pools of real estate loans, we invariably ended up acquiring a de minimis amount of sub-prime loans. As of September 30, 2008, sub-prime real estate loans represented less than one-fifth of one percent of our total real estate loan portfolio and we held no option ARM loans.

As noted above, we believe loan type, loan-to-value ratios and borrowers’ credit scores are key determinants of future loan performance. Our home equity loan portfolio is primarily second lien loans⁽¹⁾ on residential real estate properties, which have a higher level of credit risk than first lien mortgage loans. We believe home equity loans with a CLTV of 90% or higher or a FICO score below 700 are the loans with the highest levels of credit risk in our portfolios.

⁽¹⁾

Approximately 14% of the home equity portfolio is in the first lien position. For home equity loans that are in a second lien position, we also hold the first lien position on the same residential real estate property for less than 1% of the loans in this portfolio.

The breakdowns by LTV/CLTV and FICO score of our two main loan portfolios, one-to four-family and home equity, are as follows (dollars in thousands)⁽¹⁾:


	One- to Four-Family
LTV/CLTV at Origination	September 30, 2008			June 30, 2008			March 31, 2008			December 31, 2007
<=70%	$	5,777,971		$	5,971,955		$	6,300,710		$	6,666,212
70% - 80%		7,273,553			7,609,794			7,977,419			8,450,977
80% - 90%		165,375			176,933			181,370			202,133
>90%		160,297			171,533			179,646			187,207

Total	$	13,377,196		$	13,930,215		$	14,639,145		$	15,506,529

Average LTV/CLTV at loan origination		68.9	%		69.0	%		70.0	%
Average estimated current LTV/CLTV⁽²⁾		84.3	%		82.5	%		77.7	%


	Home Equity
LTV/CLTV at Origination⁽³⁾	September 30, 2008			June 30, 2008			March 31, 2008			December 31, 2007
<=70%	$	3,177,685		$	3,272,891		$	3,443,039		$	3,628,619
70% - 80%		1,868,763			1,919,988			1,989,506			2,086,277
80% - 90%		3,458,300			3,642,235			3,778,084			3,871,249
>90%		1,877,150			2,017,219			2,175,369			2,315,179

Total	$	10,381,898		$	10,852,333		$	11,385,998		$	11,901,324

Average LTV/CLTV at loan origination⁽⁴⁾		79.3	%		79.5	%		79.5	%
Average estimated current LTV/CLTV⁽²⁾		93.7	%		92.6	%		89.1	%


	One- to Four-Family				Home Equity
FICO at Origination	September 30, 2008		December 31, 2007		September 30, 2008		December 31, 2007
>=720	$	8,930,730	$	10,373,807	$	6,171,032	$	6,992,793
719 - 700		1,815,112		2,089,014		1,661,850		1,898,924
699 - 680		1,384,159		1,585,613		1,444,960		1,668,427
679 - 660		810,458		943,538		629,636		757,016
659 - 620		428,571		503,573		461,579		566,030
<620		8,166		10,984		12,841		18,134

Total	$	13,377,196	$	15,506,529	$	10,381,898	$	11,901,324

⁽¹⁾

Average LTV/CLTV at loan origination and average estimated current LTV/CLTV at December 31, 2007 are not shown as the data is not readily available.

⁽²⁾

The average estimated current loan-to-value ratio reflects the outstanding balance at the balance sheet date, divided by the estimated current property value. Current property values are estimated using the most recent property value data available to us. During the third quarter of 2008, we enhanced our methodology of calculating current property values to utilize home price indices for properties in which we did not have an updated valuation and have reflected this enhancement in the prior periods presented.

⁽³⁾

CLTV at origination calculations for home equity are based on drawn balances.

⁽⁴⁾

Average LTV/CLTV at loan origination calculations for home equity are based on undrawn balances.

In addition to the factors described above, we monitor credit trends in loans by acquisition channel and vintage, which are summarized below as of September 30, 2008 and December 31, 2007 (dollars in thousands):


	One- to Four-Family				Home Equity
Acquisition Channel	September 30, 2008		December 31, 2007		September 30, 2008		December 31, 2007
Purchased from a third party	$	11,314,512	$	12,904,759	$	9,228,344	$	10,638,021
Originated by the Company		2,062,684		2,601,770		1,153,554		1,263,303

Total real estate loans	$	13,377,196	$	15,506,529	$	10,381,898	$	11,901,324


	One- to Four-Family				Home Equity
Vintage Year	September 30, 2008		December 31, 2007		September 30, 2008		December 31, 2007
2003 and prior	$	616,043	$	844,670	$	771,707	$	901,240
2004		1,358,355		1,669,492		1,007,445		1,156,867
2005		2,762,952		3,084,336		2,479,217		2,790,423
2006		5,033,955		5,829,146		4,911,485		5,760,906
2007		3,574,562		4,078,885		1,196,242		1,291,888
2008		31,329		—		15,802		—

Total real estate loans	$	13,377,196	$	15,506,529	$	10,381,898	$	11,901,324

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; the overall availability of housing credit; 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. We believe our allowance for loan losses at September 30, 2008 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):


	One- to Four-Family				Home Equity				Consumer and Other				Total
	Allowance		Allowance as a % of Loans Receivable⁽¹⁾		Allowance		Allowance as a % of Loans Receivable⁽¹⁾		Allowance		Allowance as a % of Loans Receivable⁽¹⁾		Allowance		Allowance as a % of Loans Receivable⁽¹⁾
September 30, 2008	$	125,118	0.93	%	$	691,284	6.55	%	$	57,820	2.37	%	$	874,222	3.31	%
December 31, 2007	$	18,831	0.12	%	$	459,167	3.79	%	$	30,166	1.05	%	$	508,164	1.66	%

⁽¹⁾

Allowance as a percentage of loans receivable is calculated based on the gross loans receivable for each respective category.

During the nine months ended September 30, 2008, the allowance for loan losses increased by $366.1 million from the level at December 31, 2007. This increase was driven primarily by the increase in the allowance allocated to the home equity loan portfolio, which began to deteriorate during the second half of 2007. During the first nine months of 2008, we also observed deterioration in the performance of our one- to four-family loan

portfolio. We believe the deterioration in both of these portfolios was caused by several factors, including: home price depreciation in key markets; growing inventories of unsold homes; rising foreclosure rates; significant contraction in the availability of credit; and a general decline in economic growth. In addition, the combined impact of home price depreciation and the reduction of available credit made it increasingly difficult for borrowers to refinance existing loans. While we do not expect the provision for loan losses to continue at levels in excess of the third quarter of 2008, we do believe it will continue at historically high levels.

The following table provides an analysis of the net charge-offs for the three and nine months ended September 30, 2008 and 2007 (dollars in thousands):


	Charge-offs			Recoveries		Net Charge-offs			% of Average Loans (Annualized)
Three months ended September 30, 2008:
One- to four-family	$	(33,511	)	$	—	$	(33,511	)	0.98	%
Home equity		(233,616	)		2,044		(231,572	)	8.57	%
Recreational vehicle		(14,155	)		4,155		(10,000	)	2.33	%
Marine		(3,198	)		960		(2,238	)	1.95	%
Other		(2,550	)		410		(2,140	)	2.54	%

Total	$	(287,030	)	$	7,569	$	(279,461	)	4.15	%

Three months ended September 30, 2007:
One- to four-family	$	(760	)	$	308	$	(452	)	0.01	%
Home equity		(46,328	)		687		(45,641	)	1.46	%
Recreational vehicle		(8,731	)		4,029		(4,702	)	0.90	%
Marine		(1,878	)		876		(1,002	)	0.70	%
Other		(2,137	)		732		(1,405	)	1.31	%

Total	$	(59,834	)	$	6,632	$	(53,202	)	0.66	%

Nine months ended September 30, 2008:
One- to four-family	$	(80,740	)	$	455	$	(80,285	)	0.75	%
Home equity		(589,254	)		4,638		(584,616	)	6.87	%
Recreational vehicle		(39,290	)		12,235		(27,055	)	2.00	%
Marine		(9,364	)		3,469		(5,895	)	1.61	%
Other		(8,399	)		1,516		(6,883	)	2.56	%

Total	$	(727,047	)	$	22,313	$	(704,734	)	3.32	%

Nine months ended September 30, 2007:
One- to four-family	$	(1,595	)	$	415	$	(1,180	)	0.01	%
Home equity		(75,219	)		2,477		(72,742	)	0.77	%
Recreational vehicle		(24,254	)		12,050		(12,204	)	0.74	%
Marine		(6,246	)		3,522		(2,724	)	0.60	%
Other		(9,767	)		2,260		(7,507	)	2.38	%

Total	$	(117,081	)	$	20,724	$	(96,357	)	0.42	%

Loan 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 credit cards, our policy is to charge-off loans when collection is not probable or the loan has been delinquent for 180 days. Our policy for one- to four-family loan charge-offs prior to January 1, 2008 was to recognize a charge-off when we foreclosed on the property. For home equity loans, our policy prior to January 1, 2008 was to charge-off loans when we foreclosed on the property or when the loan had been delinquent for 180 days. As of January 1, 2008, we adjusted our charge-off policy mainly for loans in the process of foreclosure.

Our updated policy for both one- to four-family and home equity loans is to assess the value of the property when the loan has been delinquent for 180 days, regardless of whether or not the property is in foreclosure, and charge-off the amount of the loan balance in excess of the estimated current property value. As a result of this change, nonperforming loans included a $49.6 million write down as of September 30, 2008.

Net charge-offs for the three and nine months ended September 30, 2008 compared to the same periods in 2007 increased by $226.3 million and $608.4 million, respectively. The overall increase was primarily due to higher net charge-offs on home equity loans, which was driven mainly by the same factors as described above. The continued pressure in the residential real estate market, specifically home price depreciation combined with tighter mortgage lending guidelines, could lead to a higher level of charge-offs in future periods. The following graph illustrates the net charge-offs by quarter:

LOGO

Nonperforming Assets

We classify loans as nonperforming when they are 90 days past due. The following table shows the comparative data for nonperforming loans and assets (dollars in thousands):


	September 30, 2008			December 31, 2007
One- to four-family⁽¹⁾	$	476,625		$	181,315
Home equity		312,970			229,523
Consumer and other loans		9,158			7,604

Total nonperforming loans		798,753			418,442
Real estate owned (“REO”) and other repossessed assets, net		102,697			45,895

Total nonperforming assets, net	$	901,450		$	464,337

Nonperforming loans receivable as a percentage of gross loans receivable		3.02	%		1.37	%
One- to four-family allowance for loan losses as a percentage of one- to four-family nonperforming loans		26.25	%		10.39	%
Home equity allowance for loan losses as a percentage of home equity nonperforming loans		220.88	%		200.05	%
Consumer and other allowance for loan losses as a percentage of consumer and other nonperforming loans		631.36	%		396.71	%
Total allowance for loan losses as a percentage of total nonperforming loans		109.45	%		121.44	%

⁽¹⁾

One- to four-family excludes held-for-sale loans of $0.2 million and $0.1 million at September 30, 2008 and December 31, 2007, respectively. Loans held-for-sale are accounted for at lower of cost or market value with adjustments recorded in the loss on loans and securities, net line item and are not considered in the allowance for loan losses.

During the nine months ended September 30, 2008, our nonperforming assets, net increased $437.1 million from $464.3 million at December 31, 2007. The increase was attributed primarily to an increase in nonperforming one- to four-family loans of $295.3 million and home equity loans of $83.4 million for the period ended September 30, 2008 when compared to December 31, 2007. We expect nonperforming loan levels to increase over time due to the weak conditions in the residential real estate and credit markets.

The following graph illustrates the nonperforming loans by quarter:

LOGO

The allowance as a percentage of total nonperforming loans receivable, net decreased from 121% at December 31, 2007 to 109% at September 30, 2008. This decrease was driven primarily by an increase in one- to four-family non-performing loans, which have a significantly lower level of expected loss when compared to home equity loans. The balance of nonperforming loans includes loans delinquent from 90 to 179 days as well as loans delinquent 180 days and greater. We believe the distinction between these two periods is important as loans delinquent 180 days and greater have been written down to their expected recovery value, whereas loans delinquent 90 to 179 days have not. We believe the allowance for loan losses expressed as a percentage of loans delinquent 90 to 179 days is an important measure of the adequacy of the allowance as these loans are expected to drive the vast majority of future charge-offs. Additional charge-offs on loans delinquent 180 days are possible if home prices decline beyond our current expectations, but we do not anticipate these charge-offs to be significant, particularly when compared to the expected charge-offs on loans delinquent 90 to 179 days. We consider this ratio especially important for one- to four-family loans as we expect the balances of loans delinquent 180 days and greater to increase in the future due to the extensive amount of time it takes to foreclose on a property in the current real estate market.

The following table shows the allowance for loan losses as a percentage of loans delinquent 90 to 179 days for each of our major loan categories (dollars in thousands):


	September 30, 2008		Allowance for loan losses as a % of loans delinquent 90 to 179 days
One- to four-family loans⁽¹⁾	$	228,626	54.73	%
Home equity loans		250,837	275.59	%
Consumer and other loans		8,250	700.85	%

Total loans delinquent 90 to 179 days	$	487,713	179.25	%

⁽¹⁾

One- to four-family excludes held-for-sale loans of $0.1 million at September 30, 2008. Loans held-for-sale are accounted for at lower of cost or market value with adjustments recorded in the loss on loans and securities, net line item and are not considered in the allowance for loan losses.

In addition to nonperforming assets, we monitor loans where a borrower’s past credit history casts doubt on their ability to repay a loan (“Special Mention” loans). We classify loans as Special Mention when they are between 30 and 89 days past due. The following table shows the comparative data for Special Mention loans (dollars in thousands):


	September 30, 2008			December 31, 2007
One- to four-family⁽¹⁾	$	386,624		$	296,764
Home equity		309,666			291,675
Consumer and other loans		29,480			23,800

Total Special Mention loans	$	725,770		$	612,239

Special Mention loans receivable as a percentage of gross loans receivable		2.75	%		2.00	%

⁽¹⁾

One- to four-family excludes held-for-sale loans of $0.3 million and $0.4 million at September 30, 2008 and December 31, 2007, respectively. Loans held-for-sale are accounted for at lower of cost or market value with adjustments recorded in the loss on loans and securities, net line item and are not considered in the allowance for loan losses.

The trend in Special Mention loan balances is generally indicative of the expected trend for charge-offs in future periods, as these loans have a greater propensity to migrate into nonaccrual status and ultimately charge-off. One- to four-family loans are generally secured, in a first lien position, by real estate assets, reducing the potential loss when compared to an unsecured loan. Our home equity loans are generally secured by real estate assets; however, the majority of these loans are secured in a second lien position which substantially increases the potential loss when compared to a first lien position.

The following graph illustrates the Special Mention loans by quarter:

LOGO

Securities

We focus primarily on security type and credit rating to monitor credit risk in our securities portfolios. We believe our asset-backed securities portfolio, which we sold in the fourth quarter of 2007, represented our highest concentration of credit risk within the securities portfolio. Subsequent to the sale of that portfolio, we believe our highest concentration of remaining credit risk, while dramatically lower than the credit risk inherent in asset-backed securities, is our CMO portfolio. The table below details the amortized cost by average credit ratings and type of asset as of September 30, 2008 and December 31, 2007 (dollars in thousands):


September 30, 2008	AAA		AA		A		BBB		Below Investment Grade and Non-Rated		Total
Mortgage-backed securities backed by U.S. Government sponsored and federal agencies	$	9,068,089	$	—	$	—	$	—	$	—	$	9,068,089
CMOs and other		739,052		112,397		33,185		21,151		100,898		1,006,683
Municipal bonds, corporate bonds and FHLB stock		236,367		61,292		34,144		—		—		331,803

Total	$	10,043,508	$	173,689	$	67,329	$	21,151	$	100,898	$	10,406,575


December 31, 2007	AAA		AA		A		BBB		Below Investment Grade and Non-Rated		Total
Mortgage-backed securities backed by U.S. Government sponsored and federal agencies	$	9,697,723	$	—	$	—	$	—	$	—	$	9,697,723
CMOs and other		1,066,290		132,330		469		—		—		1,199,089
Asset-backed securities		—		—		—		—		122		122
Municipal bonds, corporate bonds, preferred stock and FHLB stock		675,058		596,047		8,342		—		—		1,279,447

Total	$	11,439,071	$	728,377	$	8,811	$	—	$	122	$	12,176,381

While the vast majority of this portfolio is AAA-rated, we continue to monitor these securities for impairment. During the period ended September 30, 2008, we identified approximately $284.0 million of CMOs with a possibility of future loss. As a result, $41.3 million of these securities were written down to their estimated fair market value by recording a $17.9 million impairment for the third quarter of 2008. Total impairment on CMOs with the possibility of future loss was $61.6 million for the nine months ended September 30, 2008. Further declines in the performance of our CMO portfolio could result in additional impairments in future periods.

During the nine months ended September 30, 2008, we sold certain of our mortgage-backed securities, which is the primary reason for the decline in our securities balance compared to the balance as of December 31, 2007.

Interest Rate Risk Management

Interest rate risks are monitored and managed by the ALCO. 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 3. Quantitative and Qualitative Disclosures about Market Risk for additional information about our interest rate risks.

SUMMARY OF CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The preparation of our financial condition and results of operations requires us to make judgments and estimates that may have a significant impact upon the financial results of the Company. We believe that of our significant accounting policies, the following require estimates and assumptions that require complex, subjective judgments by management, which can materially impact reported results: allowance for loan losses and uncollectible margin loans; classification and valuation of certain investments; valuation and accounting for financial derivatives; estimates of effective tax rate; deferred taxes and valuation allowances; and valuation of goodwill and other intangibles. These are more fully described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the year ended December 31, 2007.

Classification and Valuation of Certain Investments

Effective January 1, 2008, the Company adopted SFAS No. 157, Fair Value Measurements (“SFAS No. 157”), which defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The Company determines the fair values of its financial instruments and for nonfinancial assets and nonfinancial liabilities that are recognized or disclosed at fair value in the financial statements on a recurring basis in accordance with SFAS No. 157. The Company will not adopt this statement until January 1, 2009 for nonfinancial assets and nonfinancial liabilities that are not recognized or disclosed at fair value in the financial statements on a recurring basis. Examples of nonfinancial assets and nonfinancial liabilities for which the Company has not applied the provisions of SFAS No. 157 include reporting units, nonfinancial assets and nonfinancial liabilities and indefinite-lived intangible assets measured at fair value in impairment tests under SFAS No. 142, Goodwill and Other Intangible Assets (“SFAS No. 142”), nonfinancial long-lived assets measured at fair value for an impairment assessment under SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (“SFAS No. 144”) as well as nonfinancial liabilities for exit or disposal activities initially measured at fair value under SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities (“SFAS No. 146”).

In determining fair value, the Company uses various valuation approaches, including market, income and/or cost approaches. The fair value hierarchy established in SFAS No. 157 requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. Fair value is a market-based measure considered from the perspective of a market participant. As such, even when market assumptions are not readily available, the Company’s own assumptions reflect those that market participants

would use in pricing the asset or liability at the measurement date. The standard describes the following three levels used to classify fair value measurements:

•

Level 1—Quoted prices in active markets for identical assets or liabilities. Examples of assets and liabilities utilizing Level 1 inputs as of September 30, 2008 include actively traded equity securities and U.S. Treasuries.

•

Level 2—Quoted prices in markets that are not active or for which all significant inputs are observable, either directly or indirectly. Examples of assets and liabilities utilizing Level 2 inputs as of September 30, 2008 include mortgage-backed securities backed by U.S. Government sponsored and federal agencies, most CMOs, most investment securities and most over-the-counter (“OTC”) derivatives.

•

Level 3—Unobservable inputs that are significant to the fair value of the assets or liabilities. Examples of assets and liabilities utilizing significant Level 3 inputs or those that require significant management judgment as of September 30, 2008 include certain CMOs, servicing rights, retained interests from securitizations, certain other mortgage-backed securities, and certain OTC derivatives. In certain securities, including a portion of the CMO portfolio, where there has been limited activity or less transparency around inputs to the valuation, securities are classified as Level 3 even though the Company believes that Level 2 inputs could likely be obtainable in a more active market.

The availability of observable inputs can vary from instrument to instrument and in certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, an instrument’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. The Company’s assessment of the significance of a particular input to the fair value measurement of an instrument requires judgment and consideration of factors specific to the instrument.

Level 3 Assets and Liabilities

Level 3 assets and liabilities include instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation. As of September 30, 2008, 20% and less than 1% of the Company’s total assets and total liabilities, respectively, represented instruments measured at fair value on a recurring basis. Instruments measured at fair value on a recurring basis categorized as Level 3 as of September 30, 2008 represented less than 1% of the Company’s total assets and total liabilities. Level 3 assets as of September 30, 2008 includes $140.3 million of CMOs transferred from Level 2 during the three months ended September 30, 2008. In general, these level classification transfers were driven by an increasing lack of price transparency in the CMO market. While the Company’s fair value estimates of these instruments as of September 30, 2008 utilized observable inputs where available, the valuation included significant management judgment in determining the relevance and reliability of market information considered and the financial instruments were therefore classified as Level 3. The Company recorded a $37.3 million and $104.2 million loss in other comprehensive loss on Level 3 CMOs during the three and nine months ended September 30, 2008, respectively. The Company recorded a $7.3 million and $16.3 million loss in other comprehensive loss during the three and nine months ended September 30, 2008, respectively, related to CMOs transferred from Level 2 to Level 3 during the three months ended September 30, 2008. The $17.9 million impairment recorded for the three months ended September 30, 2008 related to CMOs classified as Level 3 as of September 30, 2008. Of the $61.6 million impairment recorded for the nine months ended September 30, 2008, $54.1 million related to CMOs classified as Level 3 as of September 30, 2008. None of the impairment recorded for the three and nine months ended September 30, 2008 related to CMOs transferred from Level 2 to Level 3 during the three months ended September 30, 2008.

Credit Risk

Credit risk is an element of the fair value measurements for certain assets and liabilities, including loans, securities and derivative instruments. The Company monitors collateral requirements through credit support

agreements which reduce risk by permitting the netting of transactions with the same counterparty upon occurrence of certain events. The Company considered the impact of credit risk on the fair value measurement for derivative instruments, including those in liability positions, to be mitigated by the enforcement of credit support agreements, and the collateral requirements therein. During the three and nine months ended September 30, 2008, the consideration of credit risk, the Company’s or the counterparty’s, did not result in an adjustment to the valuation of our derivative financial instruments.

Fair Value Option

Effective January 1, 2008, the Company elected to carry investments in Fannie Mae and Freddie Mac preferred stock at fair value through earnings under SFAS No. 159. The Company elected to carry the investment in preferred stock at fair value through earnings to allow the Company to economically hedge the portfolio without the burden of complying with SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities (“SFAS No. 133”), as amended. The impact of this adoption was an after-tax decrease to opening retained earnings as of January 1, 2008 of approximately $86.9 million. As of December 31, 2007, the Company’s investment in preferred stock was reported in the balance sheet line item available-for-sale mortgage-backed and investment securities. In accordance with SFAS No. 159, as a result of the fair value election the investment in preferred stock was reported in the balance sheet line item trading securities as of January 1, 2008. Realized and unrealized gains and losses on securities classified as trading are included in the loss on loans and securities, net line item. The Company liquidated its investment in preferred stock during the three months ended September 30, 2008, which resulted in a pre-tax loss of $153.8 million, net of hedges.

Valuation Techniques

The fair value for certain financial instruments is derived using pricing models and other valuation techniques that involve significant management judgment. The price transparency of financial instruments is a key determinant of the degree of judgment involved in determining the fair value of the Company’s financial instruments. Financial instruments for which actively quoted prices or pricing parameters are available will generally have a higher degree of price transparency than financial instruments that are thinly traded or not quoted. In accordance with SFAS No. 157, the criteria used to determine whether the market for a financial instrument is active or inactive is based on the particular asset or liability. For equity securities, the Company’s definition of actively traded was based on average daily volume and other market trading statistics. The Company considered the market for other types of financial instruments, including certain CMOs, to be inactive as of September 30, 2008. As a result, the valuation of these financial instruments included significant management judgment in determining the relevance and reliability of market information available. The Company considered the inactivity of the market to be evidenced by several factors, including decreased price transparency caused by decreased volume of trades relative to historical levels. Other inactive market indicators for these financial instruments included stale transaction prices and transaction prices that varied significantly either over time or among market makers.

Mortgage-backed Securities Backed by U.S. Government Sponsored and Federal Agencies

Mortgage-backed securities backed by U.S. Government sponsored and federal agencies include to be announced (“TBA”) securities and mortgage pass-through certificates. The fair value of TBA securities is determined using quoted market prices, recent market transactions and spread data for similar instruments. Mortgage-backed securities backed by U.S. Government sponsored and federal agencies are generally categorized in Level 2 of the fair value hierarchy.

Collateralized Mortgage Obligations

CMOs, generally non-agency mortgage-backed securities, are typically valued using market observable data, when available, including recent external market transactions for similar instruments. The Company also utilized a pricing service to corroborate the market observability of the Company’s inputs used in the fair value measurements. The valuations of CMOs reflect the Company’s best estimate of what market participants would

consider in pricing the financial instruments. The Company considers the price transparency for these financial instruments to be a key determinant of the degree of judgment involved in determining the fair value. Due to the limited activity and low level of transparency around inputs to their valuation, a portion of these securities are classified as Level 3 even though the Company believes that Level 2 inputs could likely be obtainable in a more active market.

Investment Securities

As of September 30, 2008, investment securities includes municipal bonds and corporate bonds. The fair value of municipal bonds is estimated using recent external market transactions for identical instruments, when available. For certain municipal bonds, the Company utilized recent market transactions for similar bonds to corroborate pricing service fair value measurements. Municipal bonds are generally categorized in Level 2 of the fair value hierarchy. The fair value of corporate bonds is estimated using recent market transactions and are generally categorized in Level 2 of the fair value hierarchy.

Derivative Financial Instruments

The majority of the Company’s derivative financial instruments, interest rate swap and option contracts, are valued with pricing models commonly used by the financial services industry using market observable pricing inputs. The Company does not consider these models to involve significant judgment on the part of management and corroborated the fair value measurements with counterparty valuations. The majority of the Company’s derivative financial instruments are categorized in Level 2 of the fair value hierarchy.

U.S. Treasuries

The fair value of U.S. Treasuries is based on quoted market prices in active markets. U.S. Treasuries are classified as Level 1 of the fair value hierarchy.

Securities Owned and Securities Sold, Not Yet Purchased

Proprietary securities transactions entered into by broker-dealer subsidiaries for trading or investment purposes are included in “Securities owned” and “Securities sold, not yet purchased” in the Company’s SFAS No. 157 disclosures. The fair value of securities owned and securities sold, not yet purchased is determined using observable market price quotes from recently executed transactions and are generally categorized in Level 1 or Level 2 of the fair value hierarchy.

Servicing Rights

On January 1, 2008, the Company elected to account for servicing rights under the fair value measurement method in accordance with SFAS No. 156, Accounting for Servicing Financial Assets, an Amendment of SFAS No. 140 (“SFAS No. 156”). The fair value of the servicing rights is determined using models that include observable inputs, if available. To the extent observable inputs are not available, the Company estimates fair value based on the present value of expected future cash flows using its best estimate of the key assumptions, including anticipated loan prepayments and discount rates. Servicing rights are categorized as Level 3 in the fair value hierarchy when unobservable inputs are significant to the fair value measurements.

Retained Interests from Securitizations

The fair value of the retained interests from securitizations is determined using models that include observable inputs, if available. To the extent observable inputs are not available, the Company estimates fair value based on the present value of expected future cash flows using its best estimate of the key assumptions, including forecasted credit losses, prepayments rates and discount rates. Retained interests from securitizations are categorized as Level 3 in the fair value hierarchy when unobservable inputs are significant to the fair value measurements.

GLOSSARY OF TERMS

Active Trader—The customer segment that includes those who execute 30 or more trades per quarter.

Adjusted total assets—Bank-only assets composed of total assets plus/(less) unrealized losses (gains) on available-for-sale securities, less deferred tax assets, goodwill and certain other intangible assets.

Average commission per trade—Total retail segment commission revenue divided by total number of retail trades.

Average equity to average total assets—Average total shareholders’ equity divided by average total assets.

Bank—ETB Holdings, Inc. (“ETBH”), the entity that is our bank holding company and parent to E*TRADE Bank.

Basis point—One one-hundredth of a percentage point.

Cash flow hedge—A financial derivative instrument designated in a hedging relationship that mitigates exposure to variability in expected future cash flows attributable to a particular risk.

Charge-off—The result of removing a loan or portion of a loan from an entity’s balance sheet because the loan is considered to be uncollectible.

Compensation and benefits as a percentage of revenue—Total compensation and benefits expense divided by total net revenue.

Contract for difference (“CFDs”)—A derivative based on an underlying stock or index that covers the difference between the nominal value at the opening of a trade and at the close of a trade. A CFD is researched and traded in the same manner as a stock.

Corporate cash—Cash held at the parent company as well as cash held in certain subsidiaries that can distribute cash to the parent company without any regulatory approval.

Corporate investments—Primarily equity investments held at the parent company level that are not related to the ongoing business of the Company’s operating subsidiaries.

Customer cash and deposits—Deposits (excluding brokered certificates of deposit), customer payables and money market balances, including those held by third parties.

Daily average revenue trades (“DARTs”)—Total revenue trades in a period divided by the number of trading days during that period.

Derivative—A financial instrument or other contract, the price of which is directly dependent upon the value of one or more underlying securities, interest rates or any agreed upon pricing index. Derivatives cover a wide assortment of financial contracts, including forward contracts, options and swaps.

E*TRADE Complete—An integrated trading, investing and banking product that allows customers to manage their relationships with the Company through one account. E*TRADE Complete helps customers optimize cash and credit by utilizing tools designed to inform them of whether or not they are receiving the most appropriate rates for their cash and paying the most appropriate rates for credit.

Enterprise interest-bearing liabilities—Liabilities such as customer deposits, repurchase agreements, other borrowings and advances from the FHLB, certain customer credit balances and stock loan programs on which the Company pays interest; excludes customer money market balances held by third parties.

Enterprise interest-earning assets—Consists of the primary interest-earning assets of the Company and includes: loans receivable, mortgage-backed and available-for-sale securities, margin receivables, stock borrow balances, and cash required to be segregated under regulatory guidelines that earn interest for the Company.

Enterprise net interest income—The 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.

Enterprise net interest spread—The taxable equivalent rate earned on average enterprise interest-earning assets less the rate paid on average enterprise interest-bearing liabilities, excluding corporate interest-earning assets and liabilities, stock conduit and cash held by third parties.

Exchange-traded funds—A fund that invests in a group of securities and trades like an individual stock on an exchange.

Fair value—The exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date.

Fair value hedge—A financial derivative instrument designated in a hedging relationship that mitigates exposure to changes in the fair value of a recognized asset or liability or a firm commitment.

Generally Accepted Accounting Principles (“GAAP”)—Accounting principles generally accepted in the United States of America.

Interest rate cap—An options contract that puts an upper limit on a floating exchange rate. The writer of the cap has to pay the holder of the cap the difference between the floating rate and the upper limit when that upper limit is breached. There is usually a premium paid by the buyer of such a contract.

Interest rate floor—An options contract that puts a lower limit on a floating exchange rate. The writer of the floor has to pay the holder of the floor the difference between the floating rate and the lower limit when that lower limit is breached. There is usually a premium paid by the buyer of such a contract.

Interest rate swaps—Contracts that are entered into primarily as an asset/liability management strategy to reduce interest rate risk. Interest rate swap contracts are exchanges of interest rate payments, such as fixed-rate payments for floating-rate payments, based on notional principal amounts.

Main Street Investor—The customer segment that includes those who execute less than 30 trades per quarter and hold less than $50,000 in assets in combined retail accounts.

Margin debt—The extension of credit to brokerage customers of the Company, on and off balance sheet, where the loan is secured with securities owned by the customer.

Mass Affluent—The customer segment that includes those who hold $50,000 or more in assets in combined retail accounts.

Net Present Value of Equity (“NPVE”)—The present value of expected cash inflows from existing assets, minus the present value of expected cash outflows from existing liabilities, plus the expected cash inflows and outflows from existing derivatives and forward commitments. This calculation is performed for E*TRADE Bank.

Nonperforming assets—Assets that do not earn income, including those originally acquired to earn income (delinquent loans) and those not intended to earn income (REO). Loans are classified as nonperforming when full and timely collection of interest and principal becomes uncertain or when the loans are 90 days past due.

Notional amount—The specified dollar amount underlying a derivative on which the calculated payments are based.

Operating margin—Income (loss) before other income (expense), income taxes and discontinued operations.

Operating margin (%)—Percentage of net revenue that goes to income (loss) before other income (expense), income taxes and discontinued operations. It is calculated by dividing our income (loss) before other income (expense), income taxes and discontinued operations, by our total net revenue.

Option adjustable-rate mortgage (“ARM”) loan—An adjustable-rate mortgage loan that provides the borrower with the option to make a fully-amortizing, interest-only, or minimum payment each month. The minimum payment on an Option ARM loan is usually based on the interest rate charged during the introductory period. This introductory rate is usually significantly below the fully-indexed rate for loans with short duration introductory periods.

Options—Contracts that grant the purchaser, for a premium payment, the right, but not the obligation, to either purchase or sell the associated financial instrument at a set price during a period or at a specified date in the future.

Organic—Business related to new and existing customers as opposed to acquisitions.

Principal transactions—Transactions that primarily consist of revenue from market-making activities.

Real estate owned (“REO”) and other repossessed assets—Ownership of real property by the Company, generally acquired as a result of foreclosure or repossession.

Repurchase agreement—An agreement giving the seller of an asset the right or obligation to buy back the same or similar securities at a specified price on a given date. These agreements are generally collateralized by mortgage-backed or investment-grade securities.

Retail customer assets—Market value of all customer assets held by the Company including security holdings, customer cash and deposits and vested unexercised options.

Retail deposits—Balances of retail customer cash held at the Bank; excludes brokered certificates of deposit.

Return on average total assets—Annualized net income from continuing operations divided by average assets.

Return on average total shareholders’ equity—Annualized net income from continuing operations divided by average shareholders’ equity.

Revenue growth—The difference between the current and prior comparable period total net revenue divided by the prior comparable period total net revenue.

Risk-weighted assets—Primarily computed by the assignment of specific risk-weightings assigned by the Office of Thrift Supervision (“OTS”) to assets and off-balance sheet instruments for capital adequacy calculations. This calculation is for E*TRADE Bank only.

Stock conduit—The borrowing of shares from a Broker-Dealer and subsequently lending the same shares to another Broker-Dealer netting a fee.

Swaptions—Options to enter swaps starting on a given day.

Sweep deposit accounts—Accounts with the functionality to transfer brokerage cash balances to and from an FDIC-insured money market account at the Bank.

Taxable equivalent interest adjustment—The operating interest income earned on certain assets is completely or partially exempt from federal and/or state income tax. As such, these tax-exempt instruments typically yield lower returns than a taxable investment. To provide more meaningful comparison of yields and margins for all interest-earning assets, the interest income earned on tax exempt assets is increased to make it fully equivalent to interest income on other taxable investments. This adjustment is done for the analytic purposes in the net enterprise interest income/spread calculation and is not made on the consolidated statement of income (loss), as that is not permitted under GAAP.

Tier 1 Capital—Adjusted equity capital used in the calculation of capital adequacy ratios at E*TRADE Bank as required by the OTS. Tier 1 capital equals: total shareholder’s equity at E*TRADE Bank, plus/(less) unrealized losses (gains) on available-for-sale securities and cash flow hedges, less deferred tax assets, goodwill and certain other intangible assets.

ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The following discussion about our market risk disclosure includes forward-looking statements. Actual results could differ materially from those projected in the forward-looking statements as a result of certain factors, including, but not limited to, those set forth in Item 1A. “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2007 and as updated in this report. Market risk is our exposure to changes in interest rates, foreign exchange rates and equity and commodity prices. Our exposure to interest rate risk is related primarily to interest-earning assets and interest-bearing liabilities.

Interest Rate Risk

The management of interest rate risk is essential to profitability. Interest rate risk is our exposure to changes in interest rates. In general, we manage our interest rate risk by balancing variable-rate and fixed-rate assets and liabilities and we utilize derivatives in a way that reduces our overall exposure to changes in interest rates. 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. Exposure to interest rate risk requires management to make complex assumptions regarding maturities, market interest rates and customer behavior. Changes in interest rates, including the following, could impact interest income and expense:

•

Interest-earning assets and interest-bearing liabilities may re-price at different times or by different amounts creating a mismatch.

•

The yield curve may flatten or change shape affecting the spread between short- and long-term rates. Widening or narrowing spreads could impact net interest income.

•

Market interest rates may influence prepayments resulting in maturity mismatches. In addition, prepayments could impact yields as premium and discounts amortize.

Exposure to market risk is dependent upon the distribution and composition of interest-earning assets, interest-bearing liabilities and derivatives. The differing risk characteristics of each product are managed to mitigate our exposure to interest rate fluctuations. At September 30, 2008, 90% of our total assets were enterprise interest-earning assets.

At September 30, 2008, approximately 68% of our total assets were residential real estate loans and available-for-sale mortgage-backed securities. The values of these assets are sensitive to changes in interest rates, as well as expected prepayment levels. As interest rates increase, fixed rate residential mortgages and mortgage-backed securities tend to exhibit lower prepayments. The inverse is true in a falling rate environment.

When real-estate loans prepay, unamortized premiums are written off. Depending on the timing of the prepayment, the write-offs of unamortized premiums may result in lower than anticipated yields. The ALCO reviews estimates of the impact of changing market rates on loan production volumes and prepayments. This information is incorporated into our interest rate risk management strategy.

Our liability structure consists of transactional deposit relationships, such as money market and savings accounts; certificates of deposit; securities sold under agreements to repurchase; customer payables; other borrowings; and corporate debt. Our transactional deposit accounts and customer payables tend to be less rate-sensitive than wholesale borrowings. Agreements to repurchase securities re-price as interest rates change. Money market and savings accounts re-price at management’s discretion. Certificates of deposit re-price over time depending on maturities. FHLB advances and corporate debt generally have fixed rates.

Derivative Financial Instruments

We use derivative financial instruments to help manage our interest rate risk. Interest rate swaps involve the exchange of fixed-rate and variable-rate interest payments between two parties based on a contractual underlying notional amount, but do not involve the exchange of the underlying notional amounts. Option products are utilized

primarily to decrease the market value changes resulting from the prepayment dynamics of the mortgage portfolio, as well as to protect against increases in funding costs. The types of options employed include Cap Options (“Caps”) and Floor Options (“Floors”), “Payor Swaptions” and “Receiver Swaptions.” Caps mitigate the market risk associated with increases in interest rates while Floors mitigate the risk associated with decreases in market interest rates. Similarly, Payor and Receiver Swaptions mitigate the market risk associated with the respective increases and decreases in interest rates. See derivative financial instruments discussion at Note 7—Accounting for Derivative Financial Instruments and Hedging Activities in Item 1. Consolidated Financial Statements.

Scenario Analysis

Scenario analysis is an advanced approach to estimating interest rate risk exposure. Under the Net Present Value of Equity (“NPVE”) approach, the present value of all existing assets, liabilities, derivatives and forward commitments are estimated and then combined to produce a NPVE figure. The sensitivity of this value to changes in interest rates is then determined by applying alternative interest rate scenarios, which include, but are not limited to, instantaneous parallel shifts up 100, 200 and 300 basis points and down 100 and 200 basis points. The NPVE method is used at the E*TRADE Bank level and not for the Company.

E*TRADE Bank has 97% and 96% of our enterprise interest-earning assets at September 30, 2008 and December 31, 2007, respectively, and holds 97% and 96% of our enterprise interest-bearing liabilities at September 30, 2008 and December 31, 2007, respectively. The sensitivity of NPVE at September 30, 2008 and December 31, 2007 and the limits established by E*TRADE Bank’s Board of Directors are listed below (dollars in thousands):


	Change in NPVE										Board Limit
	September 30, 2008					December 31, 2007
Parallel Change in Interest Rates (basis points)	Amount			Percentage		Amount			Percentage
+300	$	(503,677	)	(18	)%	$	(434,303	)	(17	)%	(55	)%
+200	$	(246,410	)	(9	)%	$	(323,193	)	(12	)%	(30	)%
+100	$	(56,695	)	(2	)%	$	(174,280	)	(7	)%	(20	)%
-100	$	(141,239	)	(5	)%	$	99,245		4	%	(20	)%
-200⁽¹⁾	$	—		—	%	$	(63,785	)	(2	)%	(30	)%

⁽¹⁾

On September 30, 2008, the yield on the three-month Treasury bill was 0.90%. As a result, the OTS temporarily modified the requirements of the NPV Model, resulting in removal of the minus 200 basis points scenario for the quarter ended September 30, 2008.

Under criteria published by the OTS, E*TRADE Bank’s overall interest rate risk exposure at September 30, 2008 was characterized as “minimum.” We actively manage our interest rate risk positions. As interest rates change, we will re-adjust our strategy and mix of assets, liabilities and derivatives to optimize our position. For example, a 100 basis points increase in rates may not result in a change in value as indicated above. The ALCO monitors E*TRADE Bank’s interest rate risk position.

Other Market Risk

Equity Security Risk

Equity securities risk is the risk of potential loss from investing in public and private equity securities including foreign currency exchange risk. We hold equity securities for corporate investment purposes and in trading securities for market-making purposes. The foreign currency exchange risk associated with these investments is not material to the Company. For corporate investment purposes, we currently hold publicly traded equity securities, in which we had an estimated fair value of $1.0 million as of September 30, 2008. See the corporate investments line item in the publicly traded equity securities discussion at Note 5—Available-for-Sale Mortgage-Backed and Investment Securities in Item 1. Consolidated Financial Statements.

PART I—FINANCIAL INFORMATION

ITEM 1.

CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

E*TRADE FINANCIAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF INCOME (LOSS)

(In thousands, except per share amounts)

(Unaudited)


	Three Months Ended September 30,						Nine Months Ended September 30,
	2008			2007			2008			2007
Revenue:
Operating interest income	$	604,071		$	938,979		$	1,929,736		$	2,654,364
Operating interest expense		(279,297	)		(527,537	)		(935,827	)		(1,449,694	)

Net operating interest income		324,774			411,442			993,909			1,204,670

Commission		129,513			180,622			374,003			495,108
Fees and service charges		49,612			57,838			155,515			171,272
Principal transactions		20,664			20,734			59,546			77,743
Loss on loans and securities, net		(159,799	)		(201,130	)		(184,073	)		(188,896	)
Other revenue		12,968			12,614			40,263			33,262

Total non-interest income		52,958			70,678			445,254			588,489

Total net revenue		377,732			482,120			1,439,163			1,793,159

Provision for loan losses		517,800			186,536			1,070,792			237,767

Operating expense:
Compensation and benefits		83,644			110,092			302,854			335,476
Clearing and servicing		46,105			74,809			137,112			208,449
Advertising and market development		30,381			25,190			130,566			100,131
Communications		23,029			25,254			72,623			72,928
Professional services		16,862			19,252			66,256			64,903
Depreciation and amortization		20,569			21,618			62,607			60,045
Occupancy and equipment		20,470			21,143			62,666			63,369
Amortization of other intangibles		7,937			10,485			27,982			30,940
Facility restructuring and other exit activities		5,526			5,037			28,525			3,115
Other		41,367			42,599			77,575			144,709

Total operating expense		295,890			355,479			968,766			1,084,065

Income (loss) before other income (expense), income taxes and discontinued operations		(435,958	)		(59,895	)		(600,395	)		471,327
Other income (expense):
Corporate interest income		1,387			1,018			5,619			3,724
Corporate interest expense		(88,772	)		(37,365	)		(274,262	)		(113,022	)
Gain (loss) on sales of investments, net		(213	)		(18	)		307			37,005
Gain (loss) on early extinguishment of debt		—			(37	)		10,084			(6	)
Equity in income (loss) of investments and venture funds		21,965			(741	)		25,070			6,514

Total other income (expense)		(65,633	)		(37,143	)		(233,182	)		(65,785	)

Income (loss) before income taxes and discontinued operations		(501,591	)		(97,038	)		(833,577	)		405,542
Income tax expense (benefit)		(180,802	)		(38,206	)		(300,418	)		136,192

Net income (loss) from continuing operations		(320,789	)		(58,832	)		(533,159	)		269,350
Discontinued operations, net of tax:
Income from discontinued operations		2,178			384			28,796			741
Gain on disposal of discontinued operations		268,136			—			268,136			—

Income from discontinued operations, net of tax		270,314			384			296,932			741

Net income (loss)	$	(50,475	)	$	(58,448	)	$	(236,227	)	$	270,091

Basic earnings (loss) per share from continuing operations	$	(0.60	)	$	(0.14	)	$	(1.07	)	$	0.64
Basic earnings per share from discontinued operations		0.51			0.00			0.59			0.00

Basic net earnings (loss) per share	$	(0.09	)	$	(0.14	)	$	(0.48	)	$	0.64

Diluted earnings (loss) per share from continuing operations	$	(0.60	)	$	(0.14	)	$	(1.07	)	$	0.62
Diluted earnings per share from discontinued operations		0.51			0.00			0.59