Edgar Filing: E TRADE FINANCIAL Corp

Form 10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the Quarterly Period Ended March 31, 2012

¨	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)

1271 Avenue of the Americas, 14^th Floor, New York, New York 10020

(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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). 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 April 27, 2012, there were 285,687,131 shares of common stock outstanding.

E*TRADE FINANCIAL CORPORATION

FORM 10-Q QUARTERLY REPORT

For the Quarter Ended March 31, 2012

TABLE OF CONTENTS


PART I—FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements (Unaudited)			46
Consolidated Statement of Income			46
Consolidated Statement of Comprehensive Income			47
Consolidated Balance Sheet			48
Consolidated Statement of Shareholders’ Equity			49
Consolidated Statement of Cash Flows			50
Notes to Consolidated Financial Statements (Unaudited)			52
Note 1—Organization, Basis of Presentation and Summary of Significant Accounting Policies			52
Note 2—Operating Interest Income and Operating Interest Expense			56
Note 3—Fair Value Disclosures			56
Note 4—Available-for-Sale and Held-to-Maturity Securities			65
Note 5—Loans Receivable, Net			69
Note 6—Accounting for Derivative Instruments and Hedging Activities			76
Note 7—Deposits			79
Note 8—Securities Sold Under Agreements to Repurchase and FHLB Advances and Other Borrowings			79
Note 9—Corporate Debt			80
Note 10—Earnings per Share			81
Note 11—Regulatory Requirements			81
Note 12—Commitments, Contingencies and Other Regulatory Matters			83
Note 13—Segment Information			89
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			3
Overview			3
Earnings Overview			6
Segment Results Review			14
Balance Sheet Overview			17
Liquidity and Capital Resources			21
Risk Management			25
Concentrations of Credit Risk			26
Summary of Critical Accounting Policies and Estimates			37
Glossary of Terms			39
Item 3. Quantitative and Qualitative Disclosures about Market Risk			43
Item 4. Controls and Procedures			90

PART II —OTHER INFORMATION
Item 1. Legal Proceedings			90
Item 1A. Risk Factors			95
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			95
Item 3. Defaults Upon Senior Securities			95
Item 4. Mine Safety Disclosures			95
Item 5. Other Information			95
Item 6. Exhibits			95
Signatures			95

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

E*TRADE, E*TRADE Financial, E*TRADE Bank, Equity Edge, OptionsLink and the Converging Arrows logo are registered trademarks of E*TRADE Financial Corporation in the United States and in other countries.

FORWARD-LOOKING STATEMENTS

This report contains forward-looking statements 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. We further caution that there may be risks associated with owning our securities other than those discussed in our filings. Important factors that may cause actual results to differ materially from any forward-looking statements are set forth in Item 1A. Risk Factors in the Annual Report on Form 10-K for the year ended December 31, 2011, and as updated in this report.

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.

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 core business is our trading and investing customer franchise. Building on the strengths of this franchise, our growth strategy is focused on:

•

Strengthening our overall financial and franchise position. We are focused on strengthening our overall capital structure and continuing to mitigate credit losses in our loan portfolio. We are also focused on positioning the Company for future growth and maintaining disciplined expense management.

•

Improving our market position in our retail brokerage business. We plan to grow our customer base by continuing to invest in our sales force, focus on retirement and investing and develop innovative products and services.

•

Accelerating the growth of our corporate services and market making businesses. Our corporate services and market making businesses enhance our strategy by allowing us to realize additional economic benefit from our retail brokerage business.

•

Enhancing our position in retirement and investing. We believe growing our retirement and investing products and services is key to our long term success. Our primary focus is to expand the reach of our brand along with the awareness of our products to this key customer segment.

•

Optimizing the value of our bank franchise. Our retail brokerage business generates a significant amount of customer cash and we plan to continue to utilize our bank to optimize the value of these customer deposits.

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;

•

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

•

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;

•

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

•

our ability to obtain regulatory approval to move capital from our bank to our parent company; and

•

changes to the rules and regulations governing the financial services industry.

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

•

have continued success in the acquisition, growth and retention of trading customers;

•

generate meaningful growth in the retirement and investing customer group;

•

assess and manage credit risk;

•

generate capital sufficient to meet our operating needs at both our bank and our parent company;

•

assess and manage interest rate risk; and

•

have 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:


	As of or For the Three Months Ended March 31,						Variance
	2012			2011			2012 vs. 2011
*Customer Activity Metrics:*
DARTs		156,988			177,279			(11	)%
Average commission per trade	$	11.04		$	11.32			(2	)%
Margin receivables (dollars in billions)	$	5.3		$	5.7			(7	)%
End of period brokerage accounts		2,829,006			2,734,823			3	%
Net new brokerage accounts		45,994			50,512			*
Customer assets (dollars in billions)	$	201.9		$	188.9			7	%
Net new brokerage assets (dollars in billions)	$	4.0		$	3.9			*
Brokerage related cash (dollars in billions)	$	31.0		$	25.9			20	%

*Company Financial Metrics:*
Corporate cash (dollars in millions)	$	483.8		$	460.9			5	%
E*TRADE Financial Tier 1 leverage ratio		5.5	%		4.4	%		1.1	%
E*TRADE Financial Tier 1 common ratio		9.4	%		6.5	%		2.9	%
E*TRADE Bank Tier 1 leverage ratio⁽¹⁾		7.3	%		7.5	%		(0.2	)%
Special mention loan delinquencies (dollars in millions)	$	374.9		$	508.8			(26	)%
Allowance for loan losses (dollars in millions)	$	579.2		$	953.6			(39	)%
Enterprise net interest spread		2.49	%		2.84	%		(0.35	)%
Enterprise interest-earning assets (average dollars in billions)	$	44.9		$	42.7			5	%

Percentage not meaningful.

⁽¹⁾

The Company transitioned from reporting under the Office of Thrift Supervision (“OTS”) reporting requirements to reporting under the Office of the Comptroller of the Currency (“OCC”) reporting requirements in the first quarter of 2012. The Tier 1 leverage ratio is the OCC Tier 1 leverage ratio as of March 31, 2012 and the OTS Tier 1 capital ratio previously reported for prior periods. The OTS Tier 1 capital ratio and OCC Tier 1 leverage ratio are both calculated in the same manner using adjusted total assets.

Customer Activity Metrics

•

DARTs are the predominant driver of commissions revenue from our customers.

•

Average commission per trade is an indicator of changes in our customer mix, product mix and/or product pricing.

•

Margin receivables represent credit extended to customers to finance their purchases of securities by borrowing against securities they own. Margin receivables are a key driver of net operating interest income.

•

End of period brokerage accounts and net new brokerage accounts are indicators of our ability to attract and retain brokerage customers.

•

Changes in customer assets are an indicator of the value of our relationship with the customer. An increase in 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.

•

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

•

Brokerage related cash is an indicator of a deepening engagement with our brokerage customers and is a key driver of net operating interest income.

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 Financial Tier 1 leverage ratio is Tier 1 capital divided by average total assets for the parent company for leverage capital purposes. E*TRADE Financial Tier 1 common ratio is Tier 1 capital less elements of Tier 1 capital that are not in the form of common equity, such as trust preferred securities, divided by total risk-weighted assets for the holding company. The Tier 1 leverage and Tier 1 common ratios are non-GAAP measures as the holding company is not yet held to these regulatory capital requirements and are indications of E*TRADE Financial’s capital adequacy. See Liquidity and Capital Resources for a reconciliation of these non-GAAP measures to the comparable GAAP measures.

•

E*TRADE Bank Tier 1 leverage ratio is Tier 1 capital divided by adjusted total assets for E*TRADE Bank and is an indication of E*TRADE Bank’s capital adequacy.

•

Special mention loan delinquencies are loans 30-89 days past due and are an indicator 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.

•

Allowance for loan losses is an estimate of probable losses inherent in the loan portfolio as of the balance sheet date and is typically equal to management’s forecast of loan losses in the twelve months following the balance sheet date as well as the forecasted losses, including economic concessions to borrowers, over the estimated remaining life of loans modified as troubled debt restructurings (“TDR”). See Summary of Critical Accounting Policies and Estimates for a discussion of the estimates and assumptions used in the allowance for loan losses.

•

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 First Quarter of 2012

Enhancements to Our Trading and Investing Products and Services

•

We launched E*TRADE 360, a fully dynamic and customizable online investing dashboard now available to all customers;

•

We launched our redesigned public website featuring simplified navigation, personalization based on objectives and experience levels and enhanced content;

•

We introduced E*TRADE FX, a no-fee platform enabling customers to trade 56 currency pairs with the additional support of advanced charting, news and analysis, access to Forex Trading Specialists, and paper trading;

•

We redesigned our Bond Resource Center, which offers streamlined access to news, education, intuitive screeners to select individual bonds, and tools to help customers build out their fixed income portfolio;

•

We announced our E*TRADE Mobile offerings on both iPhone^® and Android^TM, including mobile check deposit capability, complex options trading, mutual fund trading and barcode scanning; and

•

We announced voice recognition on E*TRADE Mobile for iPhone^®, which allows customers to verbally prompt stock quotes, news and options chains, navigate to their portfolios and launch a stock order ticket.

EARNINGS OVERVIEW

We generated net income of $62.6 million, or $0.22 per diluted share, on total net revenue of $489.4 million for the three months ended March 31, 2012. Net income for the three months ended March 31, 2012 included a tax benefit of $26.3 million related to certain losses on the 2009 Debt Exchange previously considered non-deductible. Commissions, fees and service charges, principal transactions and other revenue decreased 14% to $173.1 million for the three months ended March 31, 2012 compared to the same period in 2011, which was driven primarily by a decrease in trading activity during the comparable periods. In addition, gains on loans and securities, net and net impairment increased 19% to $31.4 million for the three months ended March 31, 2012 compared to the same period in 2011.

Provision for loan losses declined 38% to $71.9 million for the three months ended March 31, 2012 compared to the same period in 2011, driven by improving credit trends and loan portfolio run-off. Total operating expenses increased 3% to $306.2 million for the three months ended March 31, 2012 compared to the same period in 2011. This increase was driven primarily by increases in compensation and benefits expense and FDIC insurance premiums during the three months ended March 31, 2012.

The following sections describe in detail the changes in key operating factors and other changes and events that affected net revenue, provision for loan losses, operating expense, other income (expense) and income tax expense.

Revenue

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


	Three Months Ended March 31,						Variance
	Three Months Ended March 31,						2012 vs. 2011
	2012			2011			Amount			%
Net operating interest income	$	284.9		$	309.7		$	(24.8	)		(8	)%
Commissions		107.4			124.5			(17.1	)		(14	)%
Fees and service charges		32.0			37.2			(5.2	)		(14	)%
Principal transactions		24.1			29.6			(5.5	)		(18	)%
Gains on loans and securities, net		34.9			32.3			2.6			8	%
Net impairment		(3.5	)		(6.1	)		2.6			*
Other revenues		9.6			9.5			0.1			1	%

Total non-interest income		204.5			227.0			(22.5	)		(10	)%

Total net revenue	$	489.4		$	536.7		$	(47.3	)		(9	)%

Percentage not meaningful.

Net Operating Interest Income

Net operating interest income decreased 8% to $284.9 million for the three months ended March 31, 2012 compared to the same period in 2011. Net operating interest income is earned primarily through investing customer cash and deposits in interest-earning assets, which include: real estate loans, margin receivables, available-for-sale securities and held-to-maturity securities.

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 millions):


	Three Months Ended March 31,
	2012							2011
	Average Balance		Operating Interest Inc./Exp.		Average Yield/ Cost			Average Balance		Operating Interest Inc./Exp.		Average Yield/ Cost
Enterprise interest-earning assets:
Loans⁽¹⁾	$	12,972.7	$	139.5		4.30	%	$	15,824.9	$	186.3		4.71	%
Margin receivables		4,857.3		48.0		3.97	%		5,443.3		56.3		4.19	%
Available-for-sale securities		16,054.9		105.9		2.64	%		15,752.9		111.2		2.82	%
Held-to-maturity securities		6,917.6		53.4		3.09	%		2,518.5		20.8		3.30	%
Cash and equivalents		1,604.6		0.8		0.21	%		1,831.1		0.9		0.21	%
Segregated cash		1,830.0		0.4		0.08	%		727.2		0.2		0.13	%
Securities borrowed and other		653.1		12.7		7.80	%		643.8		9.8		6.16	%

Total enterprise interest-earning assets		44,890.2		360.7		3.22	%		42,741.7		385.5		3.61	%

Non-operating interest-earning and non-interest earning assets⁽²⁾		4,441.2							4,473.1

Total assets	$	49,331.4						$	47,214.8

Enterprise interest-bearing liabilities:
Deposits	$	27,927.9		8.3		0.12	%	$	25,635.3		12.2		0.19	%
Customer payables		5,965.7		2.7		0.18	%		5,319.1		1.9		0.14	%
Securities sold under agreements to repurchase		4,989.2		40.7		3.23	%		5,885.0		38.0		2.58	%
Federal Home Loan Bank (“FHLB”) advances and other borrowings		2,732.2		25.4		3.68	%		2,752.2		25.3		3.67	%
Securities loaned and other		588.5		0.2		0.12	%		685.0		0.3		0.20	%

Total enterprise interest-bearing liabilities		42,203.5		77.3		0.73	%		40,276.6		77.7		0.77	%

Non-operating interest-bearing and non-interest bearing liabilities⁽³⁾		2,153.3							2,786.2

Total liabilities		44,356.8							43,062.8
Total shareholders’ equity		4,974.6							4,152.0

Total liabilities and shareholders’ equity	$	49,331.4						$	47,214.8

Excess of enterprise interest-earning assets over enterprise interest-bearing liabilities/Enterprise net interest income/Spread	$	2,686.7	$	283.4		2.49	%	$	2,465.1	$	307.8		2.84	%

Enterprise net interest margin (net yield on enterprise interest-earning assets)						2.53	%						2.88	%
Ratio of enterprise interest-earning assets to enterprise interest-bearing liabilities						106.37	%						106.12	%
Return on average:
Total assets						0.51	%						0.38	%
Total shareholders’ equity						5.03	%						4.36	%
Average equity to average total assets						10.08	%						8.79	%

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


	Three Months Ended March 31,
	2012			2011
Enterprise net interest income	$	283.4		$	307.8
Taxable equivalent interest adjustment		(0.3	)		(0.3	)
Earnings on customer cash held by third parties and other⁽⁴⁾		1.8			2.2

Net operating interest income	$	284.9		$	309.7

⁽¹⁾

Nonaccrual loans are included in the respective average loan balances. Interest payments received on nonaccrual loans are recognized on a cash basis in operating interest income until it is doubtful that full payment will be collected, at which point payments are applied to principal.

⁽²⁾

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

⁽³⁾

Non-operating interest-bearing and non-interest bearing liabilities consist of corporate debt and other liabilities that do not generate operating interest expense. Some of these liabilities generate corporate interest expense.

⁽⁴⁾

Includes interest earned on average customer assets of $4.0 billion and $3.6 billion for the three months ended March 31, 2012 and 2011, respectively, held by parties outside E*TRADE Financial, including third party money market funds and sweep deposit accounts at unaffiliated financial institutions.

The fluctuation in enterprise interest-earning assets is driven primarily by changes in enterprise interest-bearing liabilities, specifically customer cash and deposits. Average enterprise interest-earning assets increased 5% to $44.9 billion for the three months ended March 31, 2012 compared to the same period in 2011. This was primarily a result of the increases in average segregated cash and average available-for-sale and held-to-maturity securities, offset by decreases in average loans and average margin receivables.

Average enterprise interest-bearing liabilities increased 5% to $42.2 billion for the three months ended March 31, 2012 compared to the same period in 2011. The increase in average enterprise interest-bearing liabilities was primarily due to increases in average deposits and average customer payables, offset by a decrease in average securities sold under agreements to repurchase.

Enterprise net interest spread decreased by 35 basis points to 2.49% for the three months ended March 31, 2012 compared to the same period in 2011, due primarily to lower yields on loans and the impact of the current interest rate environment, which remains challenging. We expect enterprise net interest spread to continue to decline during the remainder of 2012; however, we do not expect the decline to be as significant as the decline we experienced during the three months ended March 31, 2012.

Commissions

Commissions revenue decreased 14% to $107.4 million for the three months ended March 31, 2012 compared to the same period in 2011. The main factors that affect commissions are DARTs, average commission per trade and the number of trading days during the period. Average commission per trade is impacted by different trade types (e.g. equities, options, fixed income, stock plan, exchange-traded funds, mutual funds, forex and cross border) that can have different commission rates. Accordingly, changes in the mix of trade types will impact average commission per trade.

DART volume decreased 11% to 156,988 for the three months ended March 31, 2012 compared to the same period in 2011. Option-related DARTs as a percentage of total DARTs represented 23% of trading volume for the three months ended March 31, 2012 compared to 19% in the same period in 2011. Exchange-traded funds-related DARTs as a percentage of total DARTs represented 8% of trading volume for both the three months ended March 31, 2012 and 2011.

Average commission per trade decreased 2% to $11.04 for the three months ended March 31, 2012 compared to the same period in 2011. The decrease was driven by a change in the customer mix; specifically customers who have a higher commission per trade traded less during the three months ended March 31, 2012 compared to our active trader customers, who generally have lower commission per trade, when compared to the same period in 2011.

Fees and Service Charges

Fees and service charges decreased 14% to $32.0 million for the three months ended March 31, 2012 compared to the same period in 2011. This decline was driven by decreases in order flow revenue, reorganization fee revenue and advisor management fee revenue compared to the same period in 2011.

Principal Transactions

Principal transactions decreased 18% to $24.1 million for the three months ended March 31, 2012 compared to the same period in 2011. Principal transactions are derived from our market making business in which we act as a market-maker for our brokerage customers’ orders as well as orders from third party customers. The decrease in principal transactions revenue was driven primarily by a decrease in trading volume when compared to the same period in 2011.

Gains on Loans and Securities, Net

Gains on loans and securities, net were $34.9 million and $32.3 million for the three months ended March 31, 2012 and 2011, respectively, as shown in the following table (dollars in millions):


	Three Months Ended					Variance
	March 31,					2012 vs. 2011
	2012		2011			Amount			%
Gains on loans, net	$	0.0	$	0.0		$	0.0			*

Gains on available-for-sale securities, net		34.9		35.8			(0.9	)		(2	)%
Gains on trading securities, net		0.0		0.6			(0.6	)		*
Hedge ineffectiveness		0.0		(4.1	)		4.1			*

Gains on securities, net		34.9		32.3			2.6			8	%

Gains on loans and securities, net	$	34.9	$	32.3		$	2.6			8	%

Percentage not meaningful.

Net Impairment

We recognized $3.5 million and $6.1 million of net impairment during the three months ended March 31, 2012 and 2011, respectively, on certain securities in our non-agency CMO portfolio due to continued deterioration in the expected credit performance of the underlying loans in those specific securities. The gross other-than-temporary impairment (“OTTI”) and the noncredit portion of OTTI, which was or had been previously recorded through other comprehensive income, are shown in the table below (dollars in millions):


	Three Months Ended March 31,
	2012			2011
Other-than-temporary impairment (“OTTI”)	$	(12.6	)	$	(4.9	)
Less: noncredit portion of OTTI recognized into (out of) other comprehensive income (before tax)		9.1			(1.2	)

Net impairment	$	(3.5	)	$	(6.1	)

Provision for Loan Losses

Provision for loan losses decreased 38% to $71.9 million for the three months ended March 31, 2012 compared to the same period in 2011. The decrease in provision for loan losses was driven by improving credit trends and loan portfolio run-off, as evidenced by the lower levels of delinquent loans in the one- to four-family and home equity loan portfolios. The provision for loan losses has declined 86% from its peak of $517.8 million in the third quarter of 2008. We expect provision for loan losses to continue to decline through the end of 2012 when compared to 2011, although it is subject to variability from quarter to quarter.

During the first quarter of 2012, we completed an evaluation of certain programs and practices that were designed in accordance with guidance from our former regulator, the OTS. This evaluation was initiated in connection with our transition from the OTS to the OCC, our new primary banking regulator. As a result of our evaluation, loan modification policies and procedures were aligned with the guidance from the OCC. The review resulted in a significant increase in charge-offs during the three months ended March 31, 2012. The majority of the losses associated with these charge-offs were previously reflected in the specific valuation allowance and qualitative component of the general allowance for loan losses. The provision for loan losses for three months ended March 31, 2012 was not significantly impacted as a result of this review.

During the fourth quarter of 2011, we suspended certain home equity loan modification programs that required changes. These suspended programs were discontinued in the first quarter of 2012, which we expect to result in a decrease in the volume of TDRs in 2012. A portion of the qualitative component of the general allowance for loan losses captures estimated losses associated with the impact of the historical loan modification activity assumed in the quantitative general allowance for loan losses; therefore, we do not anticipate a material impact to provision for loan losses in future periods.

Operating Expense

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


	Three Months Ended					Variance
	March 31,					2012 vs. 2011
	2012			2011		Amount			%
Compensation and benefits	$	92.3		$	84.0	$	8.3			10	%
Clearing and servicing		34.6			39.2		(4.6	)		(12	)%
Advertising and market development		47.6			44.4		3.2			7	%
FDIC insurance premiums		28.4			20.6		7.8			38	%
Professional services		20.3			23.5		(3.2	)		(13	)%
Occupancy and equipment		17.8			16.8		1.0			6	%
Communications		19.1			15.6		3.5			23	%
Depreciation and amortization		22.2			22.0		0.2			1	%
Amortization of other intangibles		6.3			6.5		(0.2	)		(4	)%
Facility restructuring and other exit activities		(0.4	)		3.5		(3.9	)		*
Other operating expenses		18.0			21.9		(3.9	)		(18	)%

Total operating expense	$	306.2		$	298.0	$	8.2			3	%

Percentage not meaningful.

Compensation and Benefits

Compensation and benefits increased 10% to $92.3 million for the three months ended March 31, 2012 compared to the same period in 2011. The increase resulted primarily from higher compensation expense as a result of a 7% increase in the employee base from March 31, 2011 to March 31, 2012.

Clearing and Servicing

Clearing and servicing decreased 12% to $34.6 million for the three months ended March 31, 2012 compared to the same period in 2011. This decrease resulted primarily from lower trading volumes and lower loan balances compared to the same period in 2011.

Advertising and Market Development

Advertising and market development expense increased 7% to $47.6 million for the three months ended March 31, 2012 compared to the same period in 2011. This fluctuation was due largely to the planned increase in advertising expenditures in our continuing effort to attract new accounts and customer assets during the three months ended March 31, 2012.

FDIC Insurance Premiums

FDIC insurance premiums increased 38% to $28.4 million for the three months ended March 31, 2012 compared to the same period in 2011. The increase was due primarily to an industry wide change in the FDIC insurance premium assessment calculation, effective in the second quarter of 2011.

Professional Services

Professional services decreased 13% to $20.3 million for the three months ended March 31, 2012 compared to the same period in 2011. The decrease was driven primarily by a decline in legal expenses compared to the same period in 2011.

Communications

Communications expense increased 23% to $19.1 million for the three months ended March 31, 2012 compared to the same period in 2011. This was driven primarily by an increase in vendor service fees compared to the same period in 2011.

Other Operating Expenses

Other operating expenses decreased 18% to $18.0 million for the three months ended March 31, 2012 compared to the same period in 2011. The decrease was driven by a decrease in expenses related to real estate owned (“REO”) compared to the same period in 2011.

Other Income (Expense)

Other income (expense) increased 4% to $45.2 million for the three months ended March 31, 2012 compared to the same period in 2011 as shown in the following table (dollars in millions):


	Three Months Ended						Variance
	March 31,						2012 vs. 2011
	2012			2011			Amount			%
Corporate interest income	$	0.0		$	0.6		$	(0.6	)		*
Corporate interest expense		(45.1	)		(43.3	)		(1.8	)		4	%
Equity in loss of investments and venture funds		(0.1	)		(1.0	)		0.9			*

Total other income (expense)	$	(45.2	)	$	(43.7	)	$	(1.5	)		4	%

Percentage not meaningful.

Total other income (expense) primarily consisted of corporate interest expense on interest-bearing corporate debt for the three months ended March 31, 2012. Corporate interest expense increased 4% to $45.1 million for the three months ended March 31, 2012 compared to the same period in 2011. In addition to the stated interest on corporate debt, the corporate interest expense line item included the benefit of discontinued fair value hedges on corporate debt, which decreased $1.4 million for the three months ended March 31, 2012 compared to the same period in 2011.

Income Tax Expense

Income tax expense and the effective tax rate were $3.4 million and 5.2% for the three months ended March 31, 2012, compared to $33.7 million and 42.7%, respectively for the same period in 2011. During the three months ended March 31, 2012, we recorded an income tax benefit of $26.3 million related to certain losses on the 2009 Debt Exchange that were previously considered non-deductible. Through additional research completed in the first quarter of 2012, we identified that a portion of those losses were incorrectly treated as non-deductible in 2009 and were deductible for tax purposes. The $26.3 million tax benefit resulted in a corresponding increase to the deferred tax assets, which were $1.6 billion as of March 31, 2012. Without this benefit, our effective tax rate for the three months ended March 31, 2012 would have been 45.0%, calculated as follows (dollars in thousands):


	Pre-tax Income		Tax Expense (Benefit)			Tax Rate
Tax rate before tax benefit	$	65,994	$	29,687			45.0	%
Income tax benefit related to certain losses on the 2009 Debt Exchange		—		(26,284	)		N/A

Total as reported	$	65,994	$	3,403			5.2	%

Valuation Allowance

We are required to establish a valuation allowance for deferred tax assets and record a charge to income if we determine, based on available evidence at the time the determination is made, that it is more likely than not that some portion or all of the deferred tax assets will not be realized. If we did conclude that a valuation allowance was required, the resulting loss could have a material adverse effect on our financial condition and results of operations.

We did not establish a valuation allowance against federal deferred tax assets as of March 31, 2012 as we believe that it is more likely than not that all of these assets will be realized. We continue to maintain a valuation allowance for certain of our state deferred tax assets as it is more likely than not that they will not be realized.

Tax Ownership Change

During the third quarter of 2009, we exchanged $1.7 billion principal amount of interest-bearing debt for an equal principal amount of non-interest-bearing convertible debentures. Subsequent to the Debt Exchange, $592.3 million and $128.7 million debentures were converted into 57.2 million and 12.5 million shares of common stock during the third and fourth quarters of 2009, respectively. As a result of these conversions, we believe we experienced a tax ownership change during the third quarter of 2009.

As of the date of the ownership change, we had federal net operating losses (“NOLs”) available to carry forward of approximately $1.4 billion. Section 382 imposes an annual limitation on the amount of post-ownership change taxable income a corporation may offset with pre-ownership change NOLs. We believe the tax ownership change will extend the period of time it will take to fully utilize our pre-ownership change NOLs, but will not limit the total amount of pre-ownership change NOLs we can utilize. Our updated estimate is that we will be subject to an overall annual limitation on the use of our pre-ownership change NOLs of approximately $194 million. The overall pre-ownership change NOLs, which were approximately $1.4 billion, have a statutory carry forward period of 20 years (the majority of which expire in 16 years). As a result, we believe we will be able to fully utilize these NOLs in future periods.

Our ability to utilize the pre-ownership change NOLs is dependent on our ability to generate sufficient taxable income over the duration of the carry forward periods and will not be impacted by our ability or inability to generate taxable income in an individual year.

SEGMENT RESULTS REVIEW

We report operating results in two segments: 1) trading and investing; and 2) balance sheet management. Trading and investing includes retail brokerage products and services; investor-focused banking products; market making; and corporate services. Balance sheet management includes the management of asset allocation and credit, liquidity and interest rate risk; loans previously originated by the Company or purchased from third parties; and customer cash and deposits. Costs associated with certain functions that are centrally-managed are separately reported in a corporate/other category.

Trading and Investing

The following table summarizes trading and investing financial information and key metrics as of and for the three months ended March 31, 2012 and 2011 (dollars in millions, except for key metrics):


	Three Months Ended March 31,				Variance
	Three Months Ended March 31,				2012 vs. 2011
	2012		2011		Amount			%
Net operating interest income	$	170.4	$	188.8	$	(18.4	)		(10	)%
Commissions		107.4		124.5		(17.1	)		(14	)%
Fees and service charges		31.0		36.1		(5.1	)		(14	)%
Principal transactions		24.1		29.6		(5.5	)		(18	)%
Other revenues		7.9		8.0		(0.1	)		(2	)%

Total net revenue		340.8		387.0		(46.2	)		(12	)%
Total operating expense		211.5		202.6		8.9			4	%

Trading and investing income	$	129.3	$	184.4	$	(55.1	)		(30	)%

Key Metrics:
DARTs		156,988		177,279		(20,291	)		(11	)%
Average commission per trade	$	11.04	$	11.32	$	(0.28	)		(2	)%
Margin receivables (dollars in billions)	$	5.3	$	5.7	$	(0.4	)		(7	)%
End of period brokerage accounts		2,829,006		2,734,823		94,183			3	%
Net new brokerage accounts		45,994		50,512		(4,518	)		*
Customer assets (dollars in billions)	$	201.9	$	188.9	$	13.0			7	%
Net new brokerage assets (dollars in billions)	$	4.0	$	3.9	$	0.1			*
Brokerage related cash (dollars in billions)	$	31.0	$	25.9	$	5.1			20	%

Percentage not meaningful.

The trading and investing segment generates revenue from brokerage and banking relationships with investors and from market making and corporate services activities. This segment generates five main sources of revenue: net operating interest income; commissions; fees and service charges; principal transactions; and other revenues. Other revenues include results from providing software and services for managing equity compensation plans from corporate customers, as we ultimately service retail investors through these corporate relationships.

Trading and investing income decreased 30% to $129.3 million for the three months ended March 31, 2012 compared to the same period in 2011. We continued to generate net new brokerage accounts, ending the quarter with 2.8 million accounts. Our brokerage related cash, which is one of our most profitable sources of funding, increased by $5.1 billion when compared to the same period in 2011.

Trading and investing commissions decreased by 14% to $107.4 million for the three months ended March 31, 2012 compared to the same period in 2011. This decrease in commissions was primarily the result of a decrease in DARTs of 11% to 156,988 for the three months ended March 31, 2012 compared to the same period in 2011.

Trading and investing fees and service charges decreased 14% to $31.0 million for the three months ended March 31, 2012 compared to the same period in 2011. This decrease for the three months ended March 31, 2012 was driven by decreases in order flow revenue, reorganization fee revenue and advisor management fee revenue compared to the same period in 2011.

Trading and investing principal transactions decreased 18% to $24.1 million for the three months ended March 31, 2012 compared to the same period in 2011. The decrease in principal transactions revenue was driven primarily by a decrease in trading volume when compared to the same period in 2011.

Trading and investing operating expense increased 4% to $211.5 million for the three months ended March 31, 2012 compared to the same period in 2011. The increase for the three months ended March 31, 2012 was driven primarily by an increase in compensation and benefits expense resulting from an increase in the employee base from March 31, 2011 to March 31, 2012.

As of March 31, 2012, we had approximately 2.8 million brokerage accounts, 1.1 million stock plan accounts and 0.5 million banking accounts. For the three months ended March 31, 2012 and 2011, our brokerage products contributed 70% and 71%, respectively, and our banking products contributed 30% and 29%, respectively, of total trading and investing net revenue.

Balance Sheet Management

The following table summarizes balance sheet management financial information and key metrics as of and for the three months ended March 31, 2012 and 2011 (dollars in millions):


	Three Months Ended March 31,						Variance
	Three Months Ended March 31,						2012 vs. 2011
	2012			2011			Amount			%
Net operating interest income	$	114.4		$	120.9		$	(6.5	)		(5	)%
Fees and service charges		1.0			1.1			(0.1	)		(6	)%
Gains on loans and securities, net		35.0			32.2			2.8			9	%
Net impairment		(3.5	)		(6.1	)		2.6			*
Other revenues		1.6			1.5			0.1			8	%

Total net revenue		148.5			149.6			(1.1	)		(1	)%
Provision for loan losses		71.9			116.1			(44.2	)		(38	)%
Total operating expense		58.6			53.4			5.2			10	%

Balance sheet management income (loss)	$	18.0		$	(19.9	)	$	37.9			*

Key Metrics:
Special mention loan delinquencies	$	374.9		$	508.8		$	(133.9	)		(26	)%
Allowance for loan losses	$	579.2		$	953.6		$	(374.4	)		(39	)%
Allowance for loan losses as a % of gross loans receivable		4.68	%		6.24	%		*			(1.56	)%

Percentage not meaningful.

The balance sheet management segment generates revenue from managing loans previously originated by the Company or purchased from third parties as well as customer cash and deposit relationships to generate additional net operating interest income.

The balance sheet management segment reported income of $18.0 million for the three months ended March 31, 2012. The balance sheet management income was due primarily to a decrease in provision for loan losses of 38% to $71.9 million for the three months ended March 31, 2012.

Gains on loans and securities, net were $35.0 million for the three months ended March 31, 2012 compared to $32.2 million for the same period in 2011 due to gains on the sale of certain agency mortgage-backed securities and agency debentures.

We recognized $3.5 million of net impairment during the three months ended March 31, 2012 on certain securities in the non-agency CMO portfolio due to continued deterioration in the expected credit performance of the underlying loans in those specific securities. The net impairment included gross OTTI of $12.6 million for the three months ended March 31, 2012, of which $9.1 million related to the noncredit portion of OTTI, which was recorded through other comprehensive income.

Total balance sheet management operating expense increased 10% to $58.6 million for the three months ended March 31, 2012 compared to the same period in 2011. The increase in operating expense for the three months ended March 31, 2012 was due primarily to increased FDIC insurance premiums as a result of an industry wide change in the FDIC insurance premium assessment calculation, effective in the second quarter of 2011.

Corporate/Other

The following table summarizes corporate/other financial information for the three months ended March 31, 2012 and 2011 (dollars in millions):


	Three Months Ended						Variance
	March 31,						2012 vs. 2011
	2012			2011			Amount			%
Total net revenue	$	—		$	—		$	—			*

Compensation and benefits		18.3			17.7			0.6			4	%
Professional services		7.3			9.5			(2.2	)		(24	)%
Occupancy and equipment		0.9			1.0			(0.1	)		(7	)%
Communications		0.4			0.3			0.1			32	%
Depreciation and amortization		4.3			4.7			(0.4	)		(9	)%
Facility restructuring and other exit activities		(0.4	)		3.6			(4.0	)		*
Other operating expenses		5.3			5.1			0.2			3	%

Total operating expense		36.1			41.9			(5.8	)		(14	)%

Operating loss		(36.1	)		(41.9	)		5.8			(14	)%
Total other income (expense)		(45.2	)		(43.7	)		(1.5	)		4	%

Corporate/other loss	$	(81.3	)	$	(85.6	)	$	4.3			(5	)%

Percentage not meaningful.

The corporate/other category includes costs that are centrally-managed, technology related costs incurred to support centrally-managed functions, restructuring and other exit activities, corporate debt and corporate investments.

The corporate/other loss before income taxes was $81.3 million for the three months ended March 31, 2012, compared to $85.6 million for the same period in 2011. The decrease in the loss was due primarily to restructuring activities for the three months ended March 31, 2011, for which there were not similar expenses for the three months ended March 31, 2012.

corporate debt, the corporate interest expense line item included the benefit of discontinued fair value hedges on corporate debt, which decreased $1.4 million for the three months ended March 31, 2012 compared to the same period in 2011.

BALANCE SHEET OVERVIEW

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


					Variance
	March 31, 2012		December 31, 2011		2012 vs. 2011
	March 31, 2012		December 31, 2011		Amount			%
Assets:
Cash and equivalents	$	2,018.4	$	2,099.8	$	(81.4	)		(4	)%
Segregated cash		1,411.7		1,275.6		136.1			11	%
Securities⁽¹⁾		25,195.6		21,785.4		3,410.2			16	%
Margin receivables		5,285.8		4,826.3		459.5			10	%
Loans receivable, net		11,796.5		12,332.8		(536.3	)		(4	)%
Investment in FHLB stock		140.3		140.2		0.1			0	%
Other⁽²⁾		5,443.4		5,480.4		(37.0	)		(1	)%

Total assets	$	51,291.7	$	47,940.5	$	3,351.2			7	%

Liabilities and shareholders’ equity:
Deposits	$	29,581.4	$	26,460.0	$	3,121.4			12	%
Wholesale borrowings⁽³⁾		7,755.1		7,752.4		2.7			0	%
Customer payables		5,706.2		5,590.9		115.3			2	%
Corporate debt		1,497.4		1,493.5		3.9			0	%
Other liabilities		1,715.7		1,715.7		—			0	%

Total liabilities		46,255.8		43,012.5		3,243.3			8	%
Shareholders’ equity		5,035.9		4,928.0		107.9			2	%

Total liabilities and shareholders’ equity	$	51,291.7	$	47,940.5	$	3,351.2			7	%

⁽¹⁾

Includes balance sheet line items trading, available-for-sale and held-to-maturity securities.

⁽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 FHLB advances and other borrowings.

Segregated Cash

The level of cash required to be segregated under federal or other regulations, or segregated cash, is driven largely by the amount of customer payables we hold as a liability in excess of the amount of margin receivables we hold as an asset. This difference represents excess customer cash that we are required by our regulators to segregate in a cash account for the exclusive benefit of our brokerage customers. Segregated cash increased by $0.1 billion during the three months ended March 31, 2012, driven primarily by an increase in customer payables of $0.1 billion during that same period.

Securities

Trading, available-for-sale and held-to-maturity securities are summarized as follows (dollars in millions):


	March 31, 2012		December 31, 2011		Variance
					2012 vs. 2011
					Amount			%
Trading securities	$	58.8	$	54.4	$	4.4			8	%

Available-for-sale securities:
Residential mortgage-backed securities:
Agency mortgage-backed securities and CMOs	$	15,745.3	$	13,965.7	$	1,779.6			13	%
Non-agency CMOs		323.0		341.6		(18.6	)		(5	)%

Total residential mortgage-backed securities		16,068.3		14,307.3		1,761.0			12	%
Investment securities		1,428.4		1,344.2		84.2			6	%

Total available-for-sale securities	$	17,496.7	$	15,651.5	$	1,845.2			12	%

Held-to-maturity securities:
Residential mortgage-backed securities:
Agency mortgage-backed securities and CMOs	$	6,641.1	$	5,296.5	$	1,344.6			25	%
Investment securities		999.0		783.0		216.0			28	%

Total held-to-maturity securities	$	7,640.1	$	6,079.5	$	1,560.6			26	%

Total securities	$	25,195.6	$	21,785.4	$	3,410.2			16	%

Securities represented 49% and 45% of total assets at March 31, 2012 and December 31, 2011, respectively. The increase in available-for-sale securities was due primarily to an increase of $1.8 billion in agency mortgage-backed securities and CMOs. The increase in held-to-maturity securities was due primarily to an increase of $1.3 billion in agency mortgage-backed securities and CMOs. The purchases of securities were driven primarily by the increase in customer deposits, which we invested in available-for-sale and held-to-maturity securities.

Loans Receivable, Net

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


	March 31, 2012			December 31, 2011			Variance
							2012 vs. 2011
							Amount			%
One- to four-family	$	6,294.1		$	6,615.8		$	(321.7	)		(5	)%
Home equity		4,960.5			5,328.7			(368.2	)		(7	)%
Consumer and other		1,031.2			1,113.2			(82.0	)		(7	)%
Unamortized premiums, net		89.9			97.9			(8.0	)		(8	)%
Allowance for loan losses		(579.2	)		(822.8	)		243.6			(30	)%

Total loans receivable, net	$	11,796.5		$	12,332.8		$	(536.3	)		(4	)%

Loans receivable, net decreased 4% to $11.8 billion at March 31, 2012 from $12.3 billion at December 31, 2011. This decline was due primarily to our strategy of reducing balance sheet risk by allowing the loan portfolio to pay down, which we plan to do for the foreseeable future.

evaluation was initiated in connection with our transition from the OTS to the OCC, our new primary banking regulator. As a result of our evaluation, loan modification policies and procedures were aligned with the guidance from the OCC. The review resulted in a significant increase in charge-offs during the three months ended March 31, 2012. The majority of the losses associated with these charge-offs were previously reflected in the specific valuation allowance and qualitative component of the general allowance for loan losses. See Summary of Critical Accounting Policies and Estimates for a discussion of the estimates and assumptions used in the allowance for loan losses, including the qualitative reserve.

Deposits

Deposits are summarized as follows (dollars in millions):


					Variance
	March 31, 2012		December 31, 2011		2012 vs. 2011
	March 31, 2012		December 31, 2011		Amount			%
Sweep deposits	$	21,588.0	$	18,619.0	$	2,969.0			16	%
Complete savings deposits		5,802.2		5,720.8		81.4			1	%
Other money market and savings deposits		1,065.4		1,033.2		32.2			3	%
Checking deposits		923.6		863.3		60.3			7	%
Certificates of deposit		171.3		190.5		(19.2	)		(10	)%
Brokered certificates of deposit		30.9		33.2		(2.3	)		(7	)%

Total deposits	$	29,581.4	$	26,460.0	$	3,121.4			12	%

Deposits represented 64% and 62% of total liabilities at March 31, 2012 and December 31, 2011, respectively. At March 31, 2012, 92% of our customer deposits were covered by FDIC insurance. Deposits provide the benefit of lower interest costs compared with wholesale funding alternatives. Deposits increased 12% to $29.6 billion at March 31, 2012 from $26.5 billion at December 31, 2011. The increase was driven primarily by an increase of $3.0 billion in sweep deposits.

The deposits balance is a component of the total customer cash and deposits balance reported as a customer activity metric of $39.0 billion and $35.5 billion at March 31, 2012 and December 31, 2011, respectively. The total customer cash and deposits balance is summarized as follows (dollars in millions):


							Variance
	March 31, 2012			December 31, 2011			2012 vs. 2011
	March 31, 2012			December 31, 2011			Amount		%
Deposits	$	29,581.4		$	26,460.0		$	3,121.4		12	%
Less: brokered certificates of deposit		(30.9	)		(33.2	)		2.3		(7	)%

Retail deposits		29,550.5			26,426.8			3,123.7		12	%
Customer payables		5,706.2			5,590.9			115.3		2	%
Customer cash balances held by third parties and other		3,773.7			3,520.1			253.6		7	%

Total customer cash and deposits	$	39,030.4		$	35,537.8		$	3,492.6		10	%

Wholesale Borrowings

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


					Variance
	March 31, 2012		December 31, 2011		2012 vs. 2011
	March 31, 2012		December 31, 2011		Amount			%
Securities sold under agreements to repurchase	$	5,022.2	$	5,015.5	$	6.7			0	%

FHLB advances	$	2,301.9	$	2,302.7	$	(0.8	)		(0	)%
Subordinated debentures		427.6		427.6		—			0	%
Other		3.4		6.6		(3.2	)		(50	)%

Total FHLB advances and other borrowings	$	2,732.9	$	2,736.9	$	(4.0	)		(0	)%

Total wholesale borrowings	$	7,755.1	$	7,752.4	$	2.7			0	%

Wholesale borrowings represented 17% and 18% of total liabilities at March 31, 2012 and December 31, 2011, respectively. Securities sold under agreements to repurchase and FHLB advances are the primary wholesale funding sources of the Bank. We anticipate decreases in securities sold under agreements to repurchase of approximately $300 million during the second quarter of 2012 and $150 million during the fourth quarter of 2012.

Corporate Debt

Corporate debt by type is shown as follows (dollars in millions):


	Face Value		Discount			Fair Value Hedge Adjustment		Net
March 31, 2012
Interest-bearing notes:
7⁷/8% Notes, due 2015	$	243.2	$	(1.1	)	$	6.9	$	249.0
6³/4% Notes, due 2016		435.0		(7.0	)		—		428.0
12¹/2% Springing lien notes, due 2017		930.2		(158.8	)		6.0		777.4

Total interest-bearing notes		1,608.4		(166.9	)		12.9		1,454.4
Non-interest-bearing debt:
0% Convertible debentures, due 2019		43.0		—			—		43.0

Total corporate debt	$	1,651.4	$	(166.9	)	$	12.9	$	1,497.4


	Face Value		Discount			Fair Value Hedge Adjustment		Net
December 31, 2011
Interest-bearing notes:
7⁷/8% Notes, due 2015	$	243.2	$	(1.2	)	$	7.4	$	249.4
6³/4% Notes, due 2016		435.0		(7.4	)		—		427.6
12¹/2% Springing lien notes, due 2017		930.2		(162.9	)		6.2		773.5

Total interest-bearing notes		1,608.4		(171.5	)		13.6		1,450.5
Non-interest-bearing debt:
0% Convertible debentures, due 2019		43.0		—			—		43.0

Total corporate debt	$	1,651.4	$	(171.5	)	$	13.6	$	1,493.5

Shareholders’ Equity

The activity in shareholders’ equity during the three months ended March 31, 2012 is summarized as follows (dollars in millions):


	Common Stock/ Additional Paid-In Capital		Accumulated Deficit/Other Comprehensive Loss			Total

Beginning balance, December 31, 2011	$	7,309.7	$	(2,381.7	)	$	4,928.0
Net income		—		62.6			62.6
Net change from available-for-sale securities		—		16.6			16.6
Net change from cash flow hedging instruments		—		27.7			27.7
Other⁽¹⁾		0.3		0.7			1.0

Ending balance, March 31, 2012	$	7,310.0	$	(2,274.1	)	$	5,035.9

⁽¹⁾

Other includes employee share-based compensation and changes in accumulated other comprehensive loss from foreign currency translation.

LIQUIDITY AND CAPITAL RESOURCES

We have established liquidity and capital policies 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 could continue for some time.

We believe liquidity is of critical importance to the Company and especially important within E*TRADE Bank. The objective of our policies is to ensure that we can meet our corporate and banking liquidity needs under both normal operating conditions and under periods of stress in the financial markets. Our corporate liquidity needs are primarily driven by the amount of principal and interest due on our corporate debt as well as any capital needs at E*TRADE Bank. Our banking liquidity needs are driven primarily by the level and volatility of our customer deposits. Management maintains an extensive set of liquidity sources and monitors certain business trends and market metrics closely in an effort to ensure we have sufficient liquidity and to avoid dependence on other more expensive sources of funding. Management believes the following sources of liquidity are of critical importance in maintaining ample funding for liquidity needs: Corporate cash, Bank cash, deposits and unused FHLB borrowing capacity. Management believes that within deposits, sweep deposits are of particular importance as they are the most stable source of liquidity for E*TRADE Bank when compared to non-sweep deposits. Overall, management believes that these liquidity sources, which we expect to fluctuate in any given period, are more than sufficient to meet our needs for the foreseeable future.

Capital is generated primarily through our business operations and our capital market activities. The primary business operations of both the trading and investing and balance sheet management segments are contained within E*TRADE Bank; therefore, we believe a key indicator of the capital generated or used in our business operations is the level of regulatory capital in E*TRADE Bank. As of March 31, 2012, E*TRADE Bank’s total capital ratio and Tier 1 leverage ratio were 17.0% and 7.3%, respectively. E*TRADE Bank’s Tier 1 leverage ratio, which is its most constraining ratio, decreased from 7.8% at December 31, 2011 to 7.3% at March 31, 2012, primarily due to significant growth in brokerage related cash during the first quarter of 2012. We are focused on improving the Tier 1 leverage ratio at E*TRADE Bank through a reduction in our balance sheet size by focusing on a reduction in our wholesale borrowings and banking-related deposits.

Consolidated Cash and Equivalents

The consolidated cash and equivalents balance decreased by $81.4 million to $2.0 billion for the three months ended March 31, 2012. The majority of this balance is cash held in regulated subsidiaries, primarily the Bank, outlined as follows (dollars in millions):


					Variance
	March 31, 2012		December 31, 2011		2012 vs. 2011
Corporate cash	$	483.8	$	484.4	$	(0.6	)
Bank cash		1,486.4		1,574.1		(87.7	)
International brokerage and other cash		48.2		41.3		6.9

Total consolidated cash	$	2,018.4	$	2,099.8	$	(81.4	)

Corporate cash is the primary source of liquidity at the parent company. 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. We believe corporate cash is a useful measure of the parent company’s liquidity as it is the primary source of capital above and beyond the capital deployed in our regulated subsidiaries. Corporate cash can fluctuate in any given quarter and is impacted primarily by tax settlements, approval and timing of subsidiary dividends, debt service costs and other overhead cost sharing arrangements. We target corporate cash to be two times our annual debt service, or approximately $330 million. From the level of corporate cash at March 31, 2012, we expect that it will decline generally in line with our corporate interest expense. However, the parent company has approximately $0.5 billion in deferred tax assets, which will ultimately become sources of corporate cash as the parent’s subsidiaries reimburse the parent for the use of its deferred tax assets.

Liquidity Available from Subsidiaries

Liquidity available to the Company from its subsidiaries is limited by regulatory requirements. In addition, neither E*TRADE Bank nor its subsidiaries may pay dividends to the parent company without approval from its regulators. 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.

E*TRADE Bank is subject to capital requirements determined by its primary regulator. At March 31, 2012 and December 31, 2011, E*TRADE Bank had $1.1 billion and $1.2 billion, respectively, of Tier 1 capital in excess of the regulatory minimum level required to be considered “well capitalized.” Historically, the Company had requested and received the approval of its primary regulators to send quarterly dividends from E*TRADE Bank to the parent. The dividend had been equal to profits from the previous quarter of E*TRADE Securities LLC, which is a subsidiary of E*TRADE Bank. We believe our former regulator, the OTS, viewed these dividend requests as distinct from a more comprehensive request to release a portion of E*TRADE Bank’s excess capital. During the third quarter of 2011, the Company transitioned regulators from the OTS to the OCC and the Federal Reserve. We believe our new regulators would subject all dividend requests to an equal level of scrutiny; therefore, rather than request a dividend from E*TRADE Bank in an amount equal to the profits of E*TRADE Securities LLC in the prior quarter, we believe the best path for the Company’s shareholders is to work on a comprehensive dividend plan that efficiently distributes capital among our regulated entities and parent company. The Company is in dialogue with the regulators regarding our ability to implement a comprehensive capital distribution plan and expects to submit a long-term capital forecast, including internally developed stress tests, by the end of the second quarter of 2012. Our objective is to have a better understanding of the timing of any future dividends by the end of 2012; however, we cannot predict the likelihood or the timing of regulatory approval for any such dividends.

The Company’s broker-dealer subsidiaries are subject to capital requirements determined by their respective regulators. At March 31, 2012 and December 31, 2011, all of our brokerage subsidiaries met their minimum net

capital requirements. Our broker-dealer subsidiaries had excess net capital of $703.7 million at March 31, 2012, an increase of $28.6 million from $675.1 million at December 31, 2011. The excess net capital of the broker-dealer subsidiaries at March 31, 2012 included $493.6 million and $162.8 million of excess net capital at E*TRADE Clearing LLC and E*TRADE Securities LLC, respectively, which are subsidiaries of E*TRADE Bank and are also included in the excess capital of E*TRADE Bank. While we cannot assure that we would obtain regulatory approval in the future to withdraw any of this excess net capital, $524.5 million is available for dividend while still maintaining a capital level above regulatory “early warning” guidelines.

Financial Regulatory Reform Legislation and Basel III Accords

Under the Dodd-Frank Act, our primary regulator, the OTS, was abolished during July 2011 and its functions and personnel distributed among the OCC, the FDIC and the Federal Reserve. Although the Dodd-Frank Act maintains the federal thrift charter, it eliminates certain benefits of the charter and imposes new penalties for failure to comply with the qualified thrift lender test. The Dodd-Frank Act also requires all companies, including savings and loan holding companies, that directly or indirectly control an insured depository institution to serve as a source of strength for the institution.

The implementation of holding company capital requirements will impact us as the parent company was not previously subject to regulatory capital requirements. These requirements are expected to become effective within the next three years. We believe these requirements are an important measure of our capital strength and we have begun to track these ratios, using the current capital ratios that apply to bank holding companies, as we plan for this future requirement. The Tier 1 leverage, Tier 1 risk-based capital and total risk-based capital ratios are non-GAAP measures as the parent company is not yet held to these regulatory capital requirements and are calculated as follows (dollars in millions):


	March 31, 2012			December 31, 2011			March 31, 2011
Shareholders’ equity	$	5,035.9		$	4,928.0		$	4,397.8
Deduct:
Losses in other comprehensive income on available-for-sale debt securities and cash flow hedges, net of tax		(345.3	)		(389.6	)		(422.1	)
Goodwill and other intangible assets, net of deferred tax liabilities		1,930.6			1,947.5			2,009.8
Add:
Qualifying restricted core capital elements		433.0			433.0			433.0

Subtotal		3,883.6			3,803.1			3,243.1
Deduct:
Disallowed servicing assets and deferred tax assets		1,353.2			1,331.0			1,289.1

Tier 1 capital		2,530.4			2,472.1			1,954.0

Add:
Allowable allowance for loan losses		282.5			277.6			301.2

Total capital	$	2,812.9		$	2,749.7		$	2,255.2

Total average assets	$	49,331.4		$	46,964.2		$	47,214.8
Deduct:
Goodwill and other intangible assets, net of deferred tax liabilities		1,930.6			1,947.5			2,009.8

Subtotal		47,400.8			45,016.7			45,205.0
Deduct:
Disallowed servicing assets and deferred tax assets		1,353.2			1,331.0			1,289.1

Average total assets for leverage capital purposes	$	46,047.6		$	43,685.7		$	43,915.9

Total risk-weighted assets⁽¹⁾	$	22,244.0		$	21,668.1		$	23,442.8
Tier 1 leverage ratio (Tier 1 capital / Average total assets for leverage capital purposes)		5.5	%		5.7	%		4.4	%
Tier 1 capital / Total risk-weighted assets		11.4	%		11.4	%		8.3	%
Total capital / Total risk-weighted assets		12.6	%		12.7	%		9.6	%

⁽¹⁾

Under the regulatory guidelines for risk-based capital, on-balance sheet assets and credit equivalent amounts of derivatives and off-balance sheet items are assigned to one of several broad risk categories according to the obligor or, if relevant, the guarantor or the nature of any collateral. The aggregate dollar amount in each risk category is then multiplied by the risk weight associated with that category. The resulting weighted values from each of the risk categories are aggregated for determining total risk-weighted assets.

As of March 31, 2012, the parent company Tier 1 leverage ratio was approximately 5.5% compared to the minimum ratio required to be “well capitalized” of 5%, the Tier 1 risk-based capital ratio was approximately 11.4% compared to the minimum ratio required to be “well capitalized” of 6%, and the total risk-based capital ratio was approximately 12.6% compared to the minimum ratio required to be “well capitalized” of 10%.

Our Tier 1 common ratio, which is a non-GAAP measure and currently has no mandated minimum or “well capitalized” standard, was 9.4% as of March 31, 2012. We believe this ratio is an important measure of our capital strength. The Tier 1 common ratio is defined as the Tier 1 capital less elements of Tier 1 capital that are not in the form of common equity, such as trust preferred securities, divided by total risk-weighted assets. The following table shows the calculation of Tier 1 common ratio (dollars in millions):


	March 31, 2012			December 31, 2011			March 31, 2011
Shareholders’ equity	$	5,035.9		$	4,928.0		$	4,397.8
Deduct:
Losses in other comprehensive income on available-for-sale debt securities and cash flow hedges, net of tax		(345.3	)		(389.6	)		(422.1	)
Goodwill and other intangible assets, net of deferred tax liabilities		1,930.6			1,947.5			2,009.8

Subtotal		3,450.6			3,370.1			2,810.1
Deduct:
Disallowed servicing assets and deferred tax assets		1,353.2			1,331.0			1,289.1

Tier 1 common	$	2,097.4		$	2,039.1		$	1,521.0

Total risk-weighted assets	$	22,244.0		$	21,668.1		$	23,442.8
Tier 1 common ratio (Tier 1 common / Total risk-weighted assets)		9.4	%		9.4	%		6.5	%

The full impact of the Basel III Accords on regulatory requirements will remain unknown for at least some time until capital regulations are proposed and adopted for U.S. institutions. We will continue to monitor the ongoing rule-making process to assess both the timing and the impact of the Dodd-Frank Act and Basel III Accords on our business.

Other Sources of Liquidity

We also maintain uncommitted lines of credit with unaffiliated banks to finance margin lending, with available balances subject to approval when utilized. At March 31, 2012, there were no outstanding balances.

We rely on borrowed funds, from sources such as securities sold under agreements to repurchase and FHLB advances, to provide liquidity for E*TRADE Bank. Our ability to borrow these funds is dependent upon the continued availability of funding in the wholesale borrowings market. In addition, we can also borrow from the Federal Reserve Bank’s discount window to meet short-term liquidity requirements, although it is not viewed as the primary source of funding. At March 31, 2012, E*TRADE Bank had approximately $2.9 billion and $1.3 billion in additional collateralized borrowing capacity with the FHLB and the Federal Reserve Bank, respectively. We also have the ability to generate liquidity in the form of additional deposits by raising the yield on our customer deposit account products.

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 (Unaudited).

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 supports decision-making, improves the success rate for new initiatives and strengthens 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 four major categories of risk that often overlap:

•

Credit Risk—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.

•

Liquidity Risk—the risk of loss resulting from the inability to meet current and future cash flow and collateral needs.

•

Interest Rate Risk—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—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.

For additional information on liquidity risk, see Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources. For additional information about our interest rate risk, see Item 3. Quantitative and Qualitative Disclosures about Market Risk. Operational risk and the management of risk are more fully described in Item 7. 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, 2011. We are also subject to other risks that could impact our business, financial condition, results of operations or cash flows in future periods. See Item 1A. Risk Factors in the Annual Report on Form 10-K for the year ended December 31, 2011, and as updated in this report.

Credit Risk Management

Our primary sources of credit risk are our loan and securities portfolios, where risk 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, whose objective is to monitor current and expected market conditions and the associated probable impact on the Company’s credit risk. The Credit Risk Committee establishes credit risk guidelines in accordance with the Company’s strategic objectives and existing policies. The Credit Risk Committee reviews investment and lending activities involving credit risk to ensure consistency with those established guidelines. These reviews involve an analysis of portfolio balances, delinquencies, losses, recoveries, default management and collateral liquidation performance, as well as any credit risk mitigation efforts relating to the portfolios. In addition, the Credit Risk Committee reviews and approves credit related counterparties engaged in financial transactions with the Company.

Loss Mitigation

We have a credit management team that focuses on the mitigation of potential losses in the loan portfolio. 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 our exposure to open home equity lines from a high of over $7 billion in 2007 to $0.4 billion as of March 31, 2012.

We have an initiative to assess our servicing relationships and where appropriate transfer certain mortgage loans to servicers that specialize in managing troubled assets. We believe this initiative will improve the credit performance of the loans transferred in future periods when compared to the expected credit performance of these same loans if they had not been transferred. A total of $2.9 billion of our mortgage loans were held at servicers that specialize in managing troubled assets as of March 31, 2012.

We have a loan modification program that focuses on the mitigation of potential losses in the loan portfolio. We consider modifications in which we make an economic concession to a borrower experiencing financial difficulty a TDR. During the three months ended March 31, 2012, we modified $146.9 million and $31.6 million of one- to four-family and home equity loans, respectively, in which the modification was considered a TDR. During the first quarter of 2012, we completed an evaluation of certain programs and practices that were designed in accordance with guidance from our former regulator, the OTS. This evaluation was initiated in connection with our transition from the OTS to the OCC, our new primary banking regulator. As a result of our evaluation, loan modification policies and procedures were aligned with the guidance from the OCC. During the fourth quarter of 2011, we suspended certain home equity loan modification programs that required changes. These suspended programs were discontinued in the first quarter of 2012, which we expect to result in a decrease in the volume of TDRs in 2012.

Trial modifications are classified immediately as TDRs and continue to be reported as delinquent until the successful completion of the trial period, which is typically 90 days. The loan is then classified as current and becomes a permanent modification.

We also processed minor modifications on a number of loans through traditional collections actions taken in the normal course of servicing delinquent accounts. These actions typically result in an insignificant delay in the timing of payments; therefore, we do not consider such activities to be economic concessions to the borrowers. As of March 31, 2012 and December 31, 2011, we had $42.7 million and $44.7 million of mortgage loans, respectively, in which the modification was not considered a TDR due to the insignificant delay in the timing of payments. Approximately 6% and 8% of these loans were classified as nonperforming as of March 31, 2012 and December 31, 2011, respectively.

We continue to review the mortgage loan portfolio in order to identify loans to be repurchased by the originator. Our review is primarily focused on identifying loans with 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. Approximately $13.1 million of loans were repurchased by the original sellers for the three months ended March 31, 2012. A total of $348.6 million of loans were repurchased by the original sellers since we actively started reviewing our purchased loan portfolio beginning in 2008.

CONCENTRATIONS OF CREDIT RISK

Loans

We track and review factors to predict and monitor credit risk in the mortgage loan portfolio on an ongoing basis. These factors include: loan type, estimated current loan-to-value (“LTV”)/combined loan-to-value (“CLTV”) ratios, delinquency history, documentation type, borrowers’ current credit scores, housing prices, loan acquisition channel, loan vintage and geographic location of the property. In economic conditions in which housing prices generally appreciate, we believe that loan type, LTV/CLTV ratios, documentation type and credit scores are the key factors in determining future loan performance. In a housing market with declining home prices and less credit available for refinance, we believe the LTV/CLTV ratio becomes a more important factor in predicting and monitoring credit risk. The factors are updated on at least a quarterly basis. We track and review delinquency status to predict and monitor credit risk in the consumer and other loan portfolio on an ongoing basis.

The home equity loan portfolio is primarily second lien loans on residential real estate properties, which have a higher level of credit risk than first lien mortgage loans. Approximately 15% of the home equity portfolio was in the first lien position as of March 31, 2012. We hold both the first and second lien positions in less than 1% of the home equity loan portfolio. The home equity loan portfolio consists of home equity installment loans and home equity lines of credit.

Home equity installment loans are primarily fixed rate and fixed term, fully amortizing loans that do not offer the option of an interest-only payment. Home equity lines of credit convert to amortizing loans at the end of the draw period, which ranges from five to ten years. At March 31, 2012, the vast majority of the home equity line of credit portfolio had not converted from the interest-only draw period to an amortizing loan. In addition, approximately 78% of the home equity line of credit portfolio will not begin amortizing until after 2014. The following table outlines when home equity lines of credit convert to amortizing for the home equity line of credit portfolio as of March 31, 2012:


Period of Conversion to Amortizing Loan	% of Home Equity Line of Credit Portfolio
Already amortizing		8	%
Through December 31, 2012		2	%
Year ending December 31, 2013		5	%
Year ending December 31, 2014		7	%
Year ending December 31, 2015		24	%
Year ending December 31, 2016		41	%
Year ending December 31, 2017		13	%

The following tables show the distribution of the mortgage loan portfolios by credit quality indicator (dollars in millions):


	One- to Four-Family						Home Equity
Current LTV/CLTV ⁽¹⁾	March 31, 2012			December 31, 2011			March 31, 2012			December 31, 2011
<=80%	$	1,473.1		$	1,596.3		$	1,056.5		$	1,168.9
80% - 100%		1,604.1			1,716.8			881.2			967.9
100% - 120%		1,471.5			1,527.3			1,089.2			1,191.9
>120%		1,745.4			1,775.4			1,933.6			2,000.0

Total mortgage loans receivable	$	6,294.1		$	6,615.8		$	4,960.5		$	5,328.7

Average estimated current LTV/CLTV⁽²⁾		107.8	%		106.7	%		113.2	%		112.1	%
Average LTV/CLTV at loan origination⁽³⁾		71.0	%		71.0	%		79.2	%		79.2	%

⁽¹⁾

Current CLTV calculations for home equity loans are based on the maximum available line for home equity lines of credit and outstanding principal balance for home equity installment loans. Current property values are updated on a quarterly basis using the most recent property value data available to us. For properties in which we did not have an updated valuation, we utilized home price indices to estimate the current property value.

⁽²⁾

The average estimated current LTV/CLTV ratio reflects the outstanding balance at the balance sheet date, divided by the estimated current value of the underlying property.

⁽³⁾

Average LTV/CLTV at loan origination calculations are based on LTV/CLTV at time of purchase for one- to four-family purchased loans and undrawn balances for home equity loans.


	One- to Four-Family				Home Equity
Documentation Type	March 31, 2012		December 31, 2011		March 31, 2012		December 31, 2011
Full documentation	$	2,709.7	$	2,845.6	$	2,536.2	$	2,699.2
Low/no documentation		3,584.4		3,770.2		2,424.3		2,629.5

Total mortgage loans receivable	$	6,294.1	$	6,615.8	$	4,960.5	$	5,328.7


	One- to Four-Family				Home Equity
	March 31,		December 31,		March 31,		December 31,
Current FICO⁽¹⁾	2012		2011		2012		2011
>=720	$	3,367.2	$	3,557.6	$	2,599.1	$	2,780.2
719 - 700		538.0		585.2		483.8		497.7
699 - 680		475.9		448.6		399.1		408.8
679 - 660		376.1		385.0		308.5		325.8
659 - 620		500.7		525.9		433.5		447.9
<620		1,036.2		1,113.5		736.5		868.3

Total mortgage loans receivable	$	6,294.1	$	6,615.8	$	4,960.5	$	5,328.7

⁽¹⁾

FICO scores are updated on a quarterly basis; however, as of March 31, 2012 and December 31, 2011, there were some loans for which the updated FICO scores were not available. The current FICO distribution as of March 31, 2012 included original FICO scores for approximately $145 million and $25 million of one- to four-family and home equity loans, respectively. The current FICO distribution as of December 31, 2011 included original FICO scores for approximately $153 million and $30 million of one- to four-family and home equity loans, respectively.


	One- to Four-Family				Home Equity
Acquisition Channel	March 31, 2012		December 31, 2011		March 31, 2012		December 31, 2011
Purchased from a third party	$	5,154.2	$	5,420.8	$	4,345.3	$	4,669.6
Originated by the Company		1,139.9		1,195.0		615.2		659.1

Total mortgage loans receivable	$	6,294.1	$	6,615.8	$	4,960.5	$	5,328.7


	One- to Four-Family				Home Equity
Vintage Year	March 31, 2012		December 31, 2011		March 31, 2012		December 31, 2011
2003 and prior	$	225.1	$	239.9	$	278.8	$	302.6
2004		595.0		620.5		438.2		472.9
2005		1,307.8		1,377.7		1,312.1		1,387.0
2006		2,420.2		2,528.5		2,289.5		2,480.0
2007		1,738.5		1,841.1		630.7		674.8
2008		7.5		8.1		11.2		11.4

Total mortgage loans receivable	$	6,294.1	$	6,615.8	$	4,960.5	$	5,328.7


	One- to Four-Family				Home Equity
Geographic Location	March 31, 2012		December 31, 2011		March 31, 2012		December 31, 2011
California	$	2,950.3	$	3,096.0	$	1,570.4	$	1,690.3
New York		459.5		488.2		361.2		387.0
Florida		431.2		458.2		349.1		377.8
Virginia		266.5		280.8		222.8		234.1
Other states		2,186.6		2,292.6		2,457.0		2,639.5

Total mortgage loans receivable	$	6,294.1	$	6,615.8	$	4,960.5	$	5,328.7

Approximately 40% of the Company’s real estate loans were concentrated in California at both March 31, 2012 and December 31, 2011. No other state had concentrations of real estate loans that represented 10% or more of the Company’s real estate portfolio.

Additionally, in the current and anticipated interest rate environment, we do not expect interest rate resets to be a material driver of credit costs in the future. A total of $6.0 billion of one- to four-family loans have reset or are expected to reset for the first time in the next six years. We expect approximately $2.6 billion in one- to four-family loans to reset in the remainder of 2012 of which $0.5 billion are resetting for the first time. Less than 1% of these one- to four-family loans are expected to experience a payment increase of more than 20% and nearly 80% are expected to reset to a lower payment in 2012. The following table outlines the percentage of one- to four-family loans that have reset and are expected to reset for the first time as of March 31, 2012:


Period of First Interest Rate Reset	% of Total One- to Four- Family First Resets
Already reset		44	%
Through December 31, 2012		8	%
Year ending December 31, 2013		4	%
Year ending December 31, 2014		4	%
Year ending December 31, 2015		5	%
Year ending December 31, 2016		14	%
Year ending December 31, 2017		21	%

Allowance for Loan Losses

The allowance for loan losses is management’s estimate of probable losses inherent in the loan portfolio as of the balance sheet date. The estimate of the allowance for loan losses is based on a variety of quantitative and qualitative factors, including the composition and quality of the portfolio; delinquency levels and trends; current and historical charge-off and loss experience; our historical loss mitigation 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. The allowance for loan losses is typically equal to management’s forecast of loan losses in the twelve months following the balance sheet date as well as the forecasted losses, including economic concessions to borrowers, over the estimated remaining life of loans modified as TDRs.

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


	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⁾
March 31, 2012	$	239.6		3.79	%	$	291.0		5.81	%	$	48.6		4.66	%	$	579.2		4.68	%
December 31, 2011	$	314.2		4.73	%	$	463.3		8.60	%	$	45.3		4.02	%	$	822.8		6.25	%

⁽¹⁾

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

During the three months ended March 31, 2012, the allowance for loan losses decreased by $243.6 million from the level at December 31, 2011. During the first quarter of 2012, we completed an evaluation of certain programs and practices that were designed in accordance with guidance from our former regulator, the OTS. This evaluation was initiated in connection with our transition from the OTS to the OCC, our new primary banking regulator. As a result of our evaluation, loan modification policies and procedures were aligned with the guidance from the OCC. The review resulted in a significant increase in charge-offs during the three months ended March 31, 2012. The majority of the losses associated with these charge-offs were previously reflected in the specific valuation allowance and qualitative component of the general allowance for loan losses. See Summary of Critical Accounting Policies and Estimates for a discussion of the estimates and assumptions used in the allowance for loan losses, including the qualitative reserve. The following table shows the trend of the ratio of the general allowance for loan losses, excluding the qualitative component, to non-TDR nonperforming loans (dollars in millions):


	Total Nonperforming Loans, Excluding TDRs		General Allowance for Loan Losses		Coverage Ratio
March 31, 2012	$	520.9	$	326.6		63	%
December 31, 2011	$	595.9	$	378.6		64	%
September 30, 2011	$	680.6	$	429.6		63	%
June 30, 2011	$	881.2	$	478.7		54	%
March 31, 2011	$	1,037.6	$	535.8		52	%

Troubled Debt Restructurings

Included in allowance for loan losses was a specific valuation allowance of $204.6 million and $320.1 million that was established for TDRs at March 31, 2012 and December 31, 2011, respectively. The specific valuation allowance for these individually impaired loans represents the forecasted losses over the remaining life of the loan, including the economic concession to the borrower. The following table shows loans that have been modified in a TDR and the specific valuation allowance by loan portfolio as well as the percentage of total expected losses as of March 31, 2012 and December 31, 2011 (dollars in millions):


	Recorded Investment in TDRs		Specific Valuation Allowance		Net Investment in TDRs		Specific Valuation Allowance as a % of TDR Loans			Total Expected Losses
March 31, 2012
One- to four-family	$	993.9	$	90.1	$	903.8		9	%		30	%
Home equity		310.9		114.5		196.4		37	%		58	%

Total	$	1,304.8	$	204.6	$	1,100.2		16	%		37	%

December 31, 2011
One- to four-family	$	973.0	$	101.2	$	871.8		10	%		28	%
Home equity		445.9		218.9		227.0		49	%		55	%

Total	$	1,418.9	$	320.1	$	1,098.8		23	%		35	%

The recorded investment in TDRs includes the charge-offs related to certain loans that were written down to the estimated current value of the underlying property less estimated costs to sell. These charge-offs were recorded on loans that were delinquent in excess of 180 days or in bankruptcy and on TDRs when certain characteristics of the loan, including CLTV, borrower’s credit and type of modification, cast substantial doubt on the borrower’s ability to repay the loan. The total expected loss on TDRs includes both the previously recorded charge-offs and the specific valuation allowance. Total expected losses on TDRs increased slightly from 35% at December 31, 2011 to 37% at March 31, 2012.

The following table shows the TDRs by delinquency category as of March 31, 2012 and December 31, 2011 (dollars in millions):


	TDRs Current		TDRs 30-89 Days Delinquent		TDRs 90-179 Days Delinquent		TDRs 180+ Days Delinquent		Total Recorded Investment in TDRs
March 31, 2012
One- to four-family	$	782.0	$	90.8	$	38.1	$	83.0	$	993.9
Home equity		272.0		20.4		13.3		5.2		310.9

Total	$	1,054.0	$	111.2	$	51.4	$	88.2	$	1,304.8

December 31, 2011
One- to four-family	$	774.0	$	85.7	$	31.3	$	82.0	$	973.0
Home equity		351.6		51.4		34.5		8.4		445.9

Total	$	1,125.6	$	137.1	$	65.8	$	90.4	$	1,418.9

TDRs on accrual status, which are current and have made six or more consecutive payments, were $799.1 million and $795.3 million at March 31, 2012 and December 31, 2011, respectively.

We evaluate the re-delinquency rates in order to monitor TDR performance. We also monitor the average re-delinquency rates for TDRs twelve months after the modification occurred, which are based on cumulative performance since the modification program began. The following table shows the average re-delinquency rates for TDRs twelve months after the modification occurred:


	One- to Four- Family			Home Equity
March 31, 2012		28	%		42	%
December 31, 2011		29	%		42	%
September 30, 2011		28	%		42	%
June 30, 2011		31	%		43	%
March 31, 2011		36	%		44	%

Net Charge-offs

The following table provides an analysis of the allowance for loan losses and net charge-offs for the three months ended March 31, 2012 and 2011 (dollars in millions):


	Charge-offs			Recoveries		Net Charge-offs
Three Months Ended March 31, 2012
One- to four-family	$	(90.5	)	$	—	$	(90.5	)
Home equity		(225.0	)		9.8		(215.2	)
Consumer and other		(12.9	)		3.0		(9.9	)

Total	$	(328.4	)	$	12.8	$	(315.6	)

Three Months Ended March 31, 2011
One- to four-family	$	(54.3	)	$	—	$	(54.3	)
Home equity		(134.1	)		6.8		(127.3	)
Consumer and other		(17.5	)		5.5		(12.0	)

Total	$	(205.9	)	$	12.3	$	(193.6	)

Loan losses are recognized when it is probable that a loss has been incurred. The charge-off 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 or is in bankruptcy, 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 value of the underlying property less estimated costs to sell. TDRs are charged-off when certain characteristics of the loan, including CLTV, borrower’s credit and type of modification, cast substantial doubt on the borrower’s ability to repay the loan. Closed-end consumer loans are charged-off when the loan has been 120 days delinquent or when it is determined that collection is not probable.

Net charge-offs for the three months ended March 31, 2012 compared to 2011 increased by $122.5 million. During the first quarter of 2012 we completed an evaluation of certain programs and practices that were designed in accordance with guidance from our former regulator, the OTS. This evaluation was initiated in connection with our transition from the OTS to the OCC, our new primary banking regulator. As a result of our evaluation, loan modification policies and procedures were aligned with the guidance from the OCC. The review resulted in a significant increase in charge-offs during the three months ended March 31, 2012. The timing and magnitude of the charge-offs is affected by many factors and we anticipate variability from quarter to quarter while continuing to see a downward trend over the long term. The following graph illustrates the net charge-offs by quarter:

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Nonperforming Assets

We classify loans as nonperforming when they are no longer accruing interest, which includes loans that are 90 days and greater past due and TDRs that are on nonaccrual status for all classes of loans. The following table shows the comparative data for nonperforming loans and assets (dollars in millions):


	March 31, 2012			December 31, 2011
One- to four-family	$	829.6		$	930.2
Home equity		190.6			281.4
Consumer and other		4.7			4.5

Total nonperforming loans		1,024.9			1,216.1
Real estate owned (“REO”) and other repossessed assets, net		69.1			87.6

Total nonperforming assets, net	$	1,094.0		$	1,303.7

Nonperforming loans receivable as a percentage of gross loans receivable		8.28	%		9.24	%
One- to four-family allowance for loan losses as a percentage of one- to four-family nonperforming loans		28.88	%		33.78	%
Home equity allowance for loan losses as a percentage of home equity nonperforming loans		152.68	%		164.64	%
Consumer and other allowance for loan losses as a percentage of consumer and other nonperforming loans		1034.04	%		1000.46	%
Total allowance for loan losses as a percentage of total nonperforming loans		56.51	%		67.66	%

During the three months ended March 31, 2012, nonperforming assets, net decreased $209.7 million to $1.1 billion when compared to December 31, 2011. This decrease was due to both improving credit trends and the additional charge-offs recorded as a result of the completion of the evaluation of certain programs and practices that were designed in accordance with guidance from our former regulator, the OTS. This evaluation was initiated in connection with our transition from the OTS to the OCC, our new primary banking regulator. As a result of our evaluation, loan modification policies and procedures were aligned with the guidance from the OCC. The review resulted in a significant increase in charge-offs during the three months ended March 31, 2012, which also decreased the loans receivable balance.

During the first quarter of 2012, interagency supervisory guidance related to practices associated with loans and lines of credit secured by junior liens on one- to four-family residential properties was issued. The guidance provided clarification on when junior liens with a delinquent first lien should be placed on nonaccrual status. The vast majority of our home equity loans were purchased in the secondary market; therefore, we hold both the first and second lien positions in less than 1% of the home equity loan portfolio. We do not directly service our loans and as a result, rely on third party vendors and servicers to provide information on our home equity portfolio, including data on the first lien positions related to our second lien home equity loans. We are working with third parties to clarify the credit bureau data currently available to us, which in its current form is data on a borrower’s reported delinquency for all debt obligations. Using this information, we estimate that less than 10% of our performing second lien home equity loans would be placed on nonaccrual status. We are working to enhance the reporting specific to first lien delinquencies associated with our second lien home equity borrowers and we expect to be able to implement this guidance in the second quarter of 2012. We do not anticipate this guidance to have a meaningful impact on our allowance for loan losses upon implementation, as we already factor this information into our risk segmentation process when determining the allowance for loan losses.

The following graph illustrates the nonperforming loans by quarter:

LOGO

Delinquent Loans

We believe the distinction between loans delinquent 90 to 179 days and loans delinquent 180 days and greater 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 (unless they are in process of bankruptcy or are TDRs that have substantial doubt as to the borrower’s ability to repay the loan). We believe loans delinquent 90 to 179 days is an important measure because these loans are expected to drive the vast majority of future charge-offs. Additional charge-offs on loans delinquent 180 days and greater are possible if home prices decline beyond 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 expect the balances of one- to four-family loans delinquent 180 days and greater to decline over time; however, we expect the balances to remain at high levels in the near term 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 comparative data for loans delinquent 90 to 179 days (dollars in millions):


	March 31, 2012			December 31, 2011
One- to four-family	$	113.6		$	136.2
Home equity		80.2			99.7
Consumer and other loans		4.4			4.1

Total loans delinquent 90-179 days⁽¹⁾	$	198.2		$	240.0

Loans delinquent 90-179 days as a percentage of gross loans receivable		1.60	%		1.82	%

⁽¹⁾

The decrease in loans delinquent 90-179 days includes the impact of loan modification programs in which borrowers who were 90-179 days past due were made current. Loans modified as TDRs are accounted for as nonaccrual loans at the time of modification and return to accrual status after six consecutive payments are made in accordance with the modified terms.

One- to four-family loans delinquent 90-179 days declined $22.6 million to $113.6 million and home equity loans delinquent 90-179 days declined $19.5 million to $80.2 million due to both improving credit trends and the additional charge-offs recorded as a result of the completion of the evaluation of certain programs and practices, as previously discussed. The review resulted in a significant increase in charge-offs during the three months ended March 31, 2012, which also decreased the loans receivable balance.

The following graph shows the loans delinquent 90 to 179 days for each of our major loan categories:

LOGO

In addition to nonperforming assets, we monitor loans in which a borrower’s past credit history casts doubt on their ability to repay a loan. 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 millions):


	March 31, 2012			December 31, 2011
One- to four-family	$	252.3		$	294.8
Home equity		105.4			154.6
Consumer and other loans		17.3			17.7

Total special mention loans⁽¹⁾	$	375.0		$	467.1

Special mention loans receivable as a percentage of gross loans receivable		3.03	%		3.55	%

⁽¹⁾

The decrease in special mention loans includes the impact of loan modification programs in which borrowers who were 30 to 89 days past due were made current. Loans modified as TDRs are accounted for as nonaccrual loans at the time of modification and return to accrual status after six consecutive payments are made in accordance with the modified terms.

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. 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 loss severity of our second lien home equity loans is approximately 95%.

During the three months ended March 31, 2012, special mention loans decreased by $92.1 million to $375.0 million and are down 63% from their peak of $1.0 billion as of December 31, 2008. This decrease was largely due to both improving credit trends and the additional charge-offs recorded as a result of the completion of the evaluation of certain programs and practices, as previously discussed. The review resulted in a significant increase in charge-offs during the three months ended March 31, 2012, which also decreased the loans receivable balance. While the level of special mention loans can fluctuate significantly in any given period, we believe the continued decrease is an encouraging sign regarding the future credit performance of the mortgage loan portfolio.

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 highest concentration of credit risk within this portfolio is the non-agency CMO portfolio. The table below details the amortized cost of non-agency debt securities and FHLB stock by average credit ratings and type of asset as of March 31, 2012 and December 31, 2011 (dollars in millions):


March 31, 2012	AAA		AA		A		BBB		Below Investment Grade and Non-Rated		Total
Non-agency CMOs	$	5.1	$	9.7	$	7.9	$	13.5	$	368.9	$	405.1
Municipal bonds, corporate bonds and FHLB stock		150.6		20.0		2.5		15.0		19.9		208.0

Total	$	155.7	$	29.7	$	10.4	$	28.5	$	388.8	$	613.1


December 31, 2011	AAA		AA		A		BBB		Below Investment Grade and Non-Rated		Total
Non-agency CMOs	$	5.6	$	9.9	$	8.0	$	16.1	$	383.0	$	422.6
Municipal bonds, corporate bonds and FHLB stock		150.8		20.0		8.0		9.5		19.9		208.2

Total	$	156.4	$	29.9	$	16.0	$	25.6	$	402.9	$	630.8

We also held $24.6 billion and $21.1 billion of agency mortgage-backed securities and CMOs, agency debentures and other agency debt securities at March 31, 2012 and December 31, 2011, respectively. We consider securities backed by the U.S. government or its agencies to have low credit risk as the long-term debt rating of the U.S. government is AA+ by S&P and AAA by Moody’s and Fitch.

Certain non-agency CMOs were other-than-temporarily impaired as a result of the deterioration in the expected credit performance of the underlying loans in those specific securities. As of March 31, 2012, we held approximately $313.9 million in amortized cost of non-agency CMOs that had been other-than-temporarily impaired. We recorded $3.5 million and $6.1 million of net impairment for the three months ended March 31, 2012 and 2011, respectively, related to other-than-temporarily impaired non-agency CMOs. Further declines in the performance of our non-agency CMO portfolio could result in additional impairments in future periods.

SUMMARY OF CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Our discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements, which have been prepared in conformity with GAAP. Note 1–Organization, Basis of Presentation and Summary of Significant Accounting Policies of Item 8. Financial Statements and Supplementary Data in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011, as updated in this report, contains a summary of our significant accounting policies, many of which require the use of estimates and assumptions. We believe that of our significant accounting policies, the following are noteworthy because they are based on estimates and assumptions that require complex and subjective judgments by management: allowance for loan losses; estimates of effective tax rates, deferred taxes and valuation allowances; classification and valuation of certain investments; accounting for derivative instruments; fair value measurements; and valuation of goodwill and other intangibles. Changes in these estimates or assumptions could materially impact our financial condition and results of operations. The accounting policy for allowance for loan losses has been updated for the period ended March 31, 2012 to reflect the change in the qualitative component of the general allowance for loan losses.

Allowance for Loan Losses

Description

The allowance for loan losses is management’s estimate of probable losses inherent in the loan portfolio as of the balance sheet date. In determining the adequacy of the allowance, we perform periodic evaluations of the loan portfolio and loss forecasting assumptions. As of March 31, 2012, the allowance for loan losses was $579.2 million on $12.3 billion of total loans receivable designated as held-for-investment.

Judgments

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 evaluate the adequacy of the allowance for loan losses by loan portfolio segment: one- to four-family, home equity and consumer and other. The estimate of the allowance for loan losses is based on a variety of quantitative and qualitative factors, including the composition and quality of the portfolio; delinquency levels and trends; current and historical charge-off and loss experience; our historical loss mitigation 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. The allowance for loan losses is typically equal to management’s forecast of loan losses in the twelve months following the balance sheet date as well as the forecasted losses, including economic concessions to borrowers, over the estimated remaining life of loans modified as TDRs.

For loans that are not TDRs, we established a general allowance. The one- to four-family and home equity loan portfolios are separated into risk segments based on key risk factors, which include but are not limited to loan type, loan acquisition channel, delinquency history, documentation type, LTV/CLTV ratio and borrowers’ credit scores. For home equity loans in the second lien position, the original balance of the first lien loan at origination date and updated valuations on the property underlying the loan are used to calculate CLTV. Both current CLTV and FICO scores are among the factors utilized to categorize the risk associated with mortgage loans and assign a probability assumption of future default. We utilize historical mortgage loan performance data to calibrate the forecast of future delinquency and default for these risk segments. The consumer and other loan portfolio is separated into risk segments by product and delinquency status. We utilize historical performance data and historical recovery rates on collateral liquidation to forecast future delinquency and loss at the product level. The one- to four-family and home equity loan portfolios represented 51% and 41%, respectively, of total loans receivable as of March 31, 2012. The consumer and other loan portfolio represented 8% of total loans receivable as of March 31, 2012.

The general allowance for loan losses also included a qualitative component to account for a variety of economic and operational factors that are not directly considered in the quantitative loss model but are factors we believe may impact the level of credit losses. Examples of these economic and operational factors are changes in the level of unemployment and the impact of historical loan modification activity, which impacts the historical performance data used to forecast future delinquency and default in the general allowance for loan losses. In connection with the transition from the OTS to the OCC, during the fourth quarter of 2011, we suspended certain home equity loan modification programs that required changes to be aligned with the guidance from the OCC, our new primary banking regulator. These suspended programs were discontinued in the first quarter of 2012 which we expect to result in a decrease in the volume of TDRs in 2012. A portion of the qualitative component captures estimated losses associated with the impact of the historical loan modification activity assumed in the quantitative general allowance for loan losses. As a result, we do not anticipate a material impact to provision for loan losses in future periods.

The qualitative component for the consumer and other loan portfolio was 15% of the general allowance at March 31, 2012 and December 31, 2011. The qualitative component for the one- to four-family and home equity loan portfolios decreased from 35% of the general allowance for loan losses at December 31, 2011 to 15% at March 31, 2012. The total qualitative component was $48 million as of March 31, 2012. The decrease in the qualitative reserve from December 31, 2011 to March 31, 2012 reflects the completion of our evaluation of certain programs and practices that were designed in accordance with guidance from our former regulator, the OTS. This evaluation was initiated in connection with the transition from the OTS to the OCC. As a result of the evaluation, loan modification policies and procedures were aligned with the guidance from the OCC. The qualitative component was increased to 35% during the fourth quarter of 2011 to reflect additional estimated losses due to this evaluation. The review resulted in a significant increase in charge-offs during the three months ended March 31, 2012 and a corresponding decrease in the qualitative component.

For modified loans accounted for as TDRs, we established a specific allowance. The specific allowance for TDRs factors in the historical default rate of an individual loan before being modified as a TDR in the discounted cash flow analysis in order to determine that specific loan’s expected impairment. For both of the one- to four-family and home equity loan portfolio segments, each loan’s individual default experience is analyzed in addition to the performance observed in similar seasoned TDRs in our overall TDR program when calculating the specific allowance. A specific allowance is established to the extent that the recorded investment exceeds the discounted cash flows of a TDR with a corresponding charge to provision for loan losses. The specific allowance for these individually impaired loans represents the forecasted losses over the estimated remaining life of the loan, including the economic concession to the borrower.

Effects if Actual Results Differ

The crisis in the residential real estate and credit markets has substantially increased the complexity and uncertainty involved in estimating the losses inherent in the loan portfolio. In the current market it is difficult to

estimate how potential changes in the quantitative and qualitative factors might impact the allowance for loan losses. If our underlying assumptions and judgments prove to be inaccurate, the allowance for loan losses could be insufficient to cover actual losses. We may be required under such circumstances to further increase the provision for loan losses, which could have an adverse effect on the regulatory capital position and our results of operations in future periods.

As we progress in our transition to the OCC and Federal Reserve, a key focus is to align all of our policies and procedures with the guidance of our new regulators. While our regulators are in the process of completing their initial review of our business and practices, the process itself is dynamic and ongoing and we cannot be certain that additional changes or actions will not result from their continuing review.

GLOSSARY OF TERMS

Active accounts—Accounts with a balance of $25 or more or a trade in the last six months.

Active customers—Customers that have an account with a balance of $25 or more or a trade in the last six months.

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

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

Agency—U.S. Government sponsored and federal agencies, such as Federal National Mortgage Association, Federal Home Loan Mortgage Corporation, Government National Mortgage Association, the Small Business Administration and the Federal Home Loan Bank.

ALCO—Asset Liability Committee.

AML—Anti-Money Laundering.

APIC—Additional paid-in capital.

Average commission per trade—Total trading and investing segment commissions revenue divided by total number of 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.

BCBS—International Basel Committee on Banking Supervision.

BOLI—Bank-Owned Life Insurance.

CAMELS rating—A U.S. supervisory rating of a bank’s overall condition. The components of the rating consist of Capital adequacy, Asset quality, Management, Earnings, Liquidity and Sensitivity to market risk.

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

CFPB—Consumer Financial Protection Bureau.

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.

CLTV—Combined loan-to-value.

CMOs—Collateralized mortgage obligations.

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.

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

Customer cash and deposits—Customer cash, deposits, 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.

Debt Exchange—In the third quarter of 2009, we exchanged $1.7 billion aggregate principal amount of our corporate debt, including $1.3 billion principal amount of the 2017 Notes and $0.4 billion principal amount of the 2011 Notes, for an equal principal amount of newly-issued non-interest-bearing convertible debentures due 2019.

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.

DIF—Deposit Insurance Fund.

Economic Value of Equity (“EVE”)—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.

Enterprise interest-bearing liabilities—Liabilities such as customer deposits, repurchase agreements, FHLB advances and other borrowings, certain customer credit balances and securities loaned 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, available-for-sale securities, held-to-maturity securities, margin receivables, trading securities, securities borrowed balances and cash and investments 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 and interest earned on customer cash held by third parties.

Enterprise net interest margin—The enterprise net operating interest income divided by total enterprise interest-earning assets.

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 and customer 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 price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.

Fair value hedge—A 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.

Fannie Mae—Federal National Mortgage Association.

FASB—Financial Accounting Standards Board.

FDIC—Federal Deposit Insurance Corporation.

FHLB—Federal Home Loan Bank.

FICO—Fair Isaac Credit Organization.

FINRA—Financial Industry Regulatory Authority.

Fixed Charge Coverage Ratio—Net income before taxes, depreciation and amortization and corporate interest expense divided by corporate interest expense. This ratio indicates the Company’s ability to satisfy fixed financing expenses.

Forex—A type of trade that involves buying one currency while simultaneously selling another. Currencies are traded in pairs consisting of a “base currency” and a “quote currency.”

Freddie Mac—Federal Home Loan Mortgage Corporation.

FSA—United Kingdom Financial Services Authority.

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

Ginnie Mae—Government National Mortgage Association.

IFRS—International Financial Reporting Standards.

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.

LIBOR—London Interbank Offered Rate. LIBOR is the interest rate at which banks borrow funds from other banks in the London wholesale money market (or interbank market).

Long-term investor—The customer group that includes those who invest for the long term.

LTV—Loan-to-value.

NASAA—North American Securities Administrators Association.

NASDAQ—National Association of Securities Dealers Automated Quotations.

Net new customer asset flows—The total inflows to all new and existing customer accounts less total outflows from all closed and existing customer accounts, excluding the effects of market movements in the value of customer assets.

NOLs—Net operating losses.

Nonperforming assets—Assets that do not earn income, including those originally acquired to earn income (nonperforming loans) and those not intended to earn income (REO). Loans are classified as nonperforming when they are no longer accruing interest, which includes loans that are 90 days and greater past due and TDRs that are on nonaccrual status for all classes of loans.

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

NYSE—New York Stock Exchange.

OCC—Office of the Comptroller of the Currency.

Operating margin—Income before other income (expense), income tax expense and discontinued operations, if applicable.

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.

OTTI—Other-than-temporary impairment.

OTS—Office of Thrift Supervision.

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

Recovery—Cash proceeds received on a loan that had been previously charged off.

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

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

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

Risk-weighted assets—Primarily computed by the assignment of specific risk-weightings assigned by the regulators to assets and off-balance sheet instruments for capital adequacy calculations.

S&P—Standard & Poor’s.

SEC—U.S. Securities and Exchange Commission.

Special mention loans—Loans where a borrower’s past credit history casts doubt on their ability to repay a loan. Loans are classified as special mention when loans are between 30 and 89 days past due.

Stock plan trades—Trades that originate from our corporate services business, which provides software and services to assist corporate customers in managing their equity compensation plans. The trades typically occur when an employee of a corporate customer exercises a stock option or sells restricted stock.

Sweep deposit accounts—Accounts with the functionality to transfer brokerage cash balances to and from a FDIC insured account at the banking subsidiaries.

Sub-prime—Defined as borrowers with FICO scores less than 620 at the time of origination.

Taxable equivalent interest adjustment—The operating interest income earned on certain assets is completely or partially exempt from federal and/or state income tax. 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, as that is not permitted under GAAP.

Tier 1 capital—Adjusted equity capital used in the calculation of capital adequacy ratios. Tier 1 capital equals: total shareholders’ equity, plus/(less) unrealized losses (gains) on available-for-sale securities and cash flow hedges and qualifying restricted core capital elements, less disallowed servicing and deferred tax assets, goodwill and certain other intangible assets.

Troubled Debt Restructuring (“TDR”)—A loan modification that involves granting an economic concession to a borrower who is experiencing financial difficulty.

ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The following discussion about 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 the Annual Report on Form 10-K for the year ended December 31, 2011, and as updated in this report. Market risk is exposure to changes in interest rates, foreign exchange rates and equity and commodity prices. 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 exposure to changes in interest rates. In general, we manage interest rate risk by balancing variable-rate and fixed-rate assets and liabilities and we utilize derivatives in a way that reduces overall exposure to changes in interest rates. In recent years, we have managed interest rate risk to the board-approved limits, as outlined in the scenario analysis below, and 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 steepen, 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 March 31, 2012, 90% of our total assets were enterprise interest-earning assets.

At March 31, 2012, approximately 66% of total assets were residential real estate loans and available-for-sale and held-to-maturity 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 Asset Liability Committee (“ALCO”) reviews estimates of the impact of changing market rates on prepayments. This information is incorporated into our interest rate risk management strategy.

Our liability structure consists of two central sources of funding: deposits and wholesale borrowings. Cash provided to us through deposits is the primary source of funding. Key deposit products include sweep accounts, complete savings accounts and other money market and savings accounts. Wholesale borrowings include securities sold under agreements to repurchase and FHLB advances. Other sources of funding include customer payables, which is customer cash contained within our broker-dealers, and corporate debt issued by the parent company.

Deposit accounts and customer payables tend to be less rate-sensitive than wholesale borrowings. Agreements to repurchase securities re-price as agreements reset. Sweep accounts, complete savings accounts and other money market and savings accounts re-price at management’s discretion. FHLB advances and corporate debt generally have fixed rates.

Derivative Instruments

We use derivative instruments to help manage 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”), 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 instruments discussion at Note 6—Accounting for Derivative Instruments and Hedging Activities in Item 1. Consolidated Financial Statements (Unaudited).

Scenario Analysis

Scenario analysis is an advanced approach to estimating interest rate risk exposure. Under the Economic Value of Equity (“EVE”) approach, the present value of all existing assets, liabilities, derivatives and forward commitments are estimated and then combined to produce a EVE 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 basis points. The EVE method is used at the E*TRADE Bank level and not for the Company. E*TRADE Bank had 99% of enterprise interest-earning assets at both March 31, 2012 and December 31, 2011 and held 98% of enterprise interest-bearing liabilities at both March 31, 2012 and December 31, 2011. The sensitivity of EVE at March 31, 2012 and December 31, 2011 and the limits established by E*TRADE Bank’s Board of Directors are listed below (dollars in millions):


Parallel Change in Interest Rates (basis points)⁽¹⁾	Change in EVE
	March 31, 2012						December 31, 2011
	Amount			Percentage			Amount			Percentage			Board Limit
+300	$	(257.7	)		(6.7	)%	$	(18.7	)		(0.5	)%		(25	)%
+200	$	(43.8	)		(1.1	)%	$	120.2			3.4	%		(15	)%
+100	$	82.3			2.1	%	$	153.6			4.4	%		(10	)%
-100	$	(279.0	)		(7.3	)%	$	(324.0	)		(9.2	)%		(10	)%

⁽¹⁾

On March 31, 2012 and December 31, 2011, the yield for the three-month treasury bill was 0.07% and 0.02%, respectively. As a result, the requirements of the EVE model were temporarily modified, resulting in the removal of the minus 200 and 300 basis points scenarios for the periods ended March 31, 2012 and December 31, 2011.

We actively manage 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.

PART I–FINANCIAL INFORMATION

ITEM 1.

CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

E*TRADE FINANCIAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF INCOME

(In thousands, except per share amounts)

(Unaudited)


	Three Months Ended March 31,
	2012			2011
Revenue:
Operating interest income	$	362,261		$	387,466
Operating interest expense		(77,409	)		(77,764	)

Net operating interest income		284,852			309,702

Commissions		107,431			124,433
Fees and service charges		31,998			37,245
Principal transactions		24,146			29,576
Gains on loans and securities, net		34,906			32,334
Other-than-temporary impairment (“OTTI”)		(12,634	)		(4,874	)
Less: noncredit portion of OTTI recognized into (out of) other comprehensive income (before tax)		9,102			(1,188	)

Net impairment		(3,532	)		(6,062	)
Other revenues		9,596			9,467

Total non-interest income		204,545			226,993

Total net revenue		489,397			536,695

Provision for loan losses		71,947			116,058
Operating expense:
Compensation and benefits		92,278			84,003
Clearing and servicing		34,555			39,155
Advertising and market development		47,588			44,365
FDIC insurance premiums		28,362			20,567
Professional services		20,335			23,468
Occupancy and equipment		17,854			16,814
Communications		19,120			15,555
Depreciation and amortization		22,239			22,047
Amortization of other intangibles		6,296			6,538
Facility restructuring and other exit activities		(424	)		3,552
Other operating expenses		18,036			21,950

Total operating expense		306,239			298,014

Income before other income (expense) and income tax expense		111,211			122,623
Other income (expense):
Corporate interest income		14			616
Corporate interest expense		(45,125	)		(43,277	)
Losses on sales of investments, net		(1	)		—
Equity in loss of investments and venture funds		(105	)		(998	)

Total other income (expense)		(45,217	)		(43,659	)

Income before income tax expense		65,994			78,964
Income tax expense		3,403			33,731

Net income	$	62,591		$	45,233

Basic earnings per share	$	0.22		$	0.20
Diluted earnings per share	$	0.22		$	0.16
Shares used in computation of per share data:
Basic		285,478			230,301
Diluted		290,017			289,677

See accompanying notes to consolidated financial statements

E*TRADE FINANCIAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME

(In thousands)

(Unaudited)


	Three Months Ended March 31,
	2012			2011
Net income	$	62,591		$	45,233
Other comprehensive income
Available-for-sale securities:
OTTI, net⁽¹⁾		7,889			2,988
Noncredit portion of OTTI reclassification (into) out of other comprehensive income, net⁽²⁾		(5,684	)		728
Unrealized gains, net⁽³⁾		36,175			12,887
Reclassification into earnings, net⁽⁴⁾		(21,816	)		(21,959	)

Net change from available-for-sale securities		16,564			(5,356	)

Cash flow hedging instruments:
Unrealized gains, net⁽⁵⁾		8,396			6,801
Reclassification into earnings, net⁽⁶⁾		19,327			16,263

Net change from cash flow hedging instruments		27,723			23,064

Foreign currency translation gains, net		725			2,035

Other comprehensive income		45,012			19,743

Comprehensive income	$	107,603		$	64,976

⁽¹⁾

Amounts are net of benefit from income taxes of $4.7 million and $1.9 million for the three months ended March 31, 2012 and 2011, respectively.

⁽²⁾

Amounts are net of benefit from income taxes of $3.4 million and $0.5 million for the three months ended March 31, 2012 and 2011, respectively.

⁽³⁾

Amounts are net of provision for income taxes of $21.8 million and $8.1 million for the three months ended March 31, 2012 and 2011, respectively.

⁽⁴⁾

Amounts are net of provision for income taxes of $13.1 million and $13.9 million for the three months ended March 31, 2012 and 2011, respectively.

⁽⁵⁾

Amounts are net of a provision for income taxes of $5.2 million and $4.0 million for the three months ended March 31, 2012 and 2011, respectively.

⁽⁶⁾

Amounts are net of benefit from income taxes of $11.9 million and $9.6 million for the three months ended March 31, 2012 and 2011, respectively.

See accompanying notes to the consolidated financial statements

E*TRADE FINANCIAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEET

(In thousands, except share data)

(Unaudited)


	March 31, 2012			December 31, 2011
ASSETS
Cash and equivalents	$	2,018,438		$	2,099,839
Cash required to be segregated under federal or other regulations		1,411,678			1,275,587
Trading securities		58,830			54,372
Available-for-sale securities (includes securities pledged to creditors with the right to sell or repledge of $3,649,181 at March 31, 2012 and $3,916,927 at December 31, 2011)		17,496,733			15,651,493
Held-to-maturity securities (fair value of $7,859,298 at March 31, 2012 and $6,282,989 at December 31, 2011; includes securities pledged to creditors with the right to sell or repledge of $2,316,389 at March 31, 2012 and $2,092,570 at December 31, 2011)		7,640,118			6,079,512
Margin receivables		5,285,791			4,826,256
Loans receivable, net (net of allowance for loan losses of $579,175 at March 31, 2012 and $822,816 at December 31, 2011)		11,796,468			12,332,807
Investment in FHLB stock		140,330			140,183
Property and equipment, net		298,425			299,693
Goodwill		1,934,232			1,934,232
Other intangibles, net		279,509			285,805
Other assets		2,931,192			2,960,673

Total assets	$	51,291,744		$	47,940,452

LIABILITIES AND SHAREHOLDERS’ EQUITY
Liabilities:
Deposits	$	29,581,388		$	26,459,985
Securities sold under agreements to repurchase		5,022,253			5,015,499
Customer payables		5,706,213			5,590,858
FHLB advances and other borrowings		2,732,900			2,736,935
Corporate debt		1,497,376			1,493,552
Other liabilities		1,715,713			1,715,673

Total liabilities		46,255,843			43,012,502

Commitments and contingencies (see Note 12)
Shareholders’ equity:
Common stock, $0.01 par value, shares authorized: 400,000,000 at March 31, 2012 and December 31, 2011; shares issued and outstanding: 285,676,131 at March 31, 2012 and 285,368,075 at December 31, 2011		2,857			2,854
Additional paid-in-capital (“APIC”)		7,307,207			7,306,862
Accumulated deficit		(1,932,546	)		(1,995,137	)
Accumulated other comprehensive loss		(341,617	)		(386,629	)

Total shareholders’ equity		5,035,901			4,927,950

Total liabilities and shareholders’ equity