ETFC-2014.09.30-10Q
Table of Contents    

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 September 30, 2014
or
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from              to             .
Commission File Number 1-11921
 
 
E*TRADE Financial Corporation
(Exact Name of Registrant as Specified in its Charter)
 
 
Delaware
 
94-2844166
(State or other jurisdiction
of incorporation or organization)
 
(I.R.S. Employer
Identification Number)
1271 Avenue of the Americas, 14th 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 Website, 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 October 31, 2014, there were 289,161,187 shares of common stock outstanding.
 


Table of Contents    

E*TRADE FINANCIAL CORPORATION
FORM 10-Q QUARTERLY REPORT
For the Quarter Ended September 30, 2014
TABLE OF CONTENTS
PART I
FINANCIAL INFORMATION
 
Item 1.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
 
 
 
 
 
 
 
 
Item 3.
Item 4.
PART II
OTHER INFORMATION
 
Item 1.
Item 1A.
Item 2.
Item 3.
Item 4.
Item 5.
Item 6.
 
Unless otherwise indicated, references to "the Company," "we," "us," "our" and "E*TRADE" mean E*TRADE Financial Corporation and its subsidiaries.

i

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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.

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FORWARD-LOOKING STATEMENTS
This report contains forward-looking statements, within the meaning of the Private Securities Litigation Reform Act of 1995, that involve risks and uncertainties. These statements relate to our future plans, objectives, expectations and intentions based on certain assumptions and include any statement that is not historical in nature. These statements may be identified by the use of words such as "assume," "expect," "believe," "may," "will," "should," "anticipate," "intend," "plan," "estimate," "continue" and similar expressions. We caution that actual results could differ materially from those discussed in these forward-looking statements. Important factors that could contribute to our actual results differing materially from any forward-looking statements include, but are not limited to, those discussed under Part 1. Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations of this Form 10-Q; and Part 1. Item 1A. Risk Factors of our Annual Report on Form 10-K for the year ended December 31, 2013, filed with the SEC, which are incorporated herein by reference. By their nature forward-looking statements are not guarantees of future performance or results and are subject to risks, uncertainties and assumptions that are difficult to predict or quantify. Actual future results may vary materially from expectations expressed or implied in this report or any of our prior communications. The forward-looking statements contained in this report reflect our expectations only as of the date of this report. You should not place undue reliance on forward-looking statements, as we do not undertake to update or revise forward-looking statements to reflect the impact of circumstances or events that arise after the date the forward-looking statements were made, except as required by law.

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 and with the Annual Report on Form 10-K for the year ended December 31, 2013.
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 business strategy is centered on two core objectives: accelerating the growth of our core brokerage business to improve market share, and strengthening our overall financial and franchise position.
Accelerate Growth of Core Brokerage Business
Enhance digital and offline customer experience.
We are focused on maintaining our competitive position in trading, margin lending and cash management, while expanding our customer share of wallet in retirement, investing and savings. Through these offerings, we aim to continue acquiring new customers while deepening engagement with both new and existing ones.
Capitalize on value of corporate services business.
This includes leveraging our industry-leading position to improve client acquisition, and bolstering awareness among plan participants of our full suite of offerings. This channel is a strategically important driver of brokerage account growth for us.
Maximize value of deposits through the Company's bank.
Our brokerage business generates a significant amount of deposits, which we monetize through the bank by investing primarily in low-risk, agency mortgage-backed securities.
Strengthen Overall Financial and Franchise Position
Manage down legacy investments and mitigate credit losses.
We continue to manage down the size and risks associated with our legacy loan portfolio, while mitigating credit losses where possible.

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Execute on our capital plan.
The core components of our capital plan include bolstering our capital levels through earnings and de-risking and building out best-in-class enterprise risk management capabilities. A key goal of this plan is to distribute capital from the bank to the parent.
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;
the level and volatility of interest rates;
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 brokerage customers;
generate meaningful growth in our retirement, investing and savings customer products;
enhance our risk management capabilities;
mitigate credit costs;
achieve the capital ratios stated in our capital plan, with a particular focus on the Tier 1 leverage ratio at E*TRADE Bank;
generate capital sufficient to meet our operating needs at both our bank and our parent company;
assess and manage interest rate risk; and
maintain disciplined expense control and improved operational efficiency.

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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: 
  
Three Months Ended September 30,
 
Variance
 
Nine Months Ended September 30,
 
Variance
 
2014
 
2013
 
2014 vs. 2013
 
2014
 
2013
 
2014 vs. 2013
Customer Activity Metrics:
 
 
 
 
 
 
 
 
 
 
 
Daily average revenue trades ("DARTs")
153,494

 
145,150

 
6
 %
 
168,526

 
147,777

 
14
 %
Average commission per trade
$
11.05

 
$
11.15

 
(1
)%
 
$
10.79

 
$
11.18

 
(3
)%
Margin receivables (dollars in billions)
$
8.1

 
$
6.2

 
31
 %
 
$
8.1

 
$
6.2

 
31
 %
End of period brokerage accounts
3,126,476

 
2,975,842

 
5
 %
 
3,126,476

 
2,975,842

 
5
 %
Net new brokerage accounts
23,510

 
13,111

 
79
 %
 
128,417

 
72,651

 
77
 %
Annualized brokerage account attrition rate
9.1
%
 
9.0
%
 
*
 
8.5
%
 
8.7
%
 
*
Customer assets (dollars in billions)
$
281.7

 
$
240.6

 
17
 %
 
$
281.7

 
$
240.6

 
17
 %
Net new brokerage assets (dollars in billions)
$
2.3

 
$
2.4

 
(4
)%
 
$
7.4

 
$
7.2

 
3
 %
Brokerage related cash (dollars in billions)
$
40.4

 
$
38.2

 
6
 %
 
$
40.4

 
$
38.2

 
6
 %
Company Financial Metrics:
 
 
 
 
 
 
 
 
 
 
 
Corporate cash (dollars in millions)
$
610

 
$
373

 
64
 %
 
$
610

 
$
373

 
64
 %
E*TRADE Financial Tier 1 leverage ratio
7.7
%
 
6.6
%
 
1.1
 %
 
7.7
%
 
6.6
%
 
1.1
 %
E*TRADE Financial Tier 1 common ratio
16.1
%
 
12.9
%
 
3.2
 %
 
16.1
%
 
12.9
%
 
3.2
 %
E*TRADE Bank Tier 1 leverage ratio
10.4
%
 
9.5
%
 
0.9
 %
 
10.4
%
 
9.5
%
 
0.9
 %
Special mention loan delinquencies (dollars in millions)
$
159

 
$
278

 
(43
)%
 
$
159

 
$
278

 
(43
)%
Allowance for loan losses (dollars in millions)
$
401

 
$
459

 
(13
)%
 
$
401

 
$
459

 
(13
)%
Enterprise net interest spread
2.54
%
 
2.30
%
 
0.24
 %
 
2.52
%
 
2.32
%
 
0.20
 %
Enterprise interest-earning assets (average dollars in billions)
$
41.3

 
$
40.8

 
1
 %
 
$
41.6

 
$
40.6

 
2
 %
*
Percentage not meaningful.
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 and are a key driver of net operating interest income.
End of period brokerage accounts, net new brokerage accounts and brokerage account attrition rate are indicators of our ability to attract and retain brokerage customers. The brokerage account attrition rate is calculated by dividing attriting brokerage accounts, which are gross new brokerage accounts less net new brokerage accounts, by total brokerage accounts at the previous period end. This rate is presented on an annualized basis.
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.

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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 new and existing brokerage customers.
Brokerage related cash is an indicator of the level of 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. See Liquidity and Capital Resources for a reconciliation of this non-GAAP measure to the comparable GAAP measure.
E*TRADE Financial Tier 1 leverage ratio is Tier 1 capital divided by average total assets for leverage capital purposes for the parent company. 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 parent 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").
Enterprise interest-earning assets, in conjunction with our enterprise net interest spread, are indicators of our ability to generate net operating interest income.
Significant Events in the Third Quarter of 2014
$75 Million Dividend Issued from E*TRADE Bank to the Parent Company
We received approval from our regulators for a $75 million dividend from E*TRADE Bank to the parent company, totaling $400 million in dividends over the last five quarters, continuing to reflect significant progress on our capital plan.
Enhancements to Our Trading and Investing Products and Services
We launched several mobile enhancements, including a new iPhone® application for iOS 8, with touch ID fingerprint authentication, and a home screen widget containing market and watch list information, as well as an app for the Amazon Fire Phone.
We made improvements to our website, including revamping the Fixed Income Solutions Center with updated tools and resources.
We enhanced and added more functionality to our active trader platform, most prominently a more fulsome integration of FX trading.
We evolved our offering suite through launching browser-based trading, enabling real-time monitoring and execution.
Market Recognition
Our corporate services business was rated #1 for client satisfaction and loyalty for the third consecutive year by Group Five, an independent consulting and research firm, in their 2014 Stock Plan Administration Study Industry Report.

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EARNINGS OVERVIEW
We generated net income of $86 million and $252 million, or $0.29 and $0.86 per diluted share, on total net revenue of $440 million and $1.4 billion for the three and nine months ended September 30, 2014, respectively. Net operating interest income increased 12% to $269 million and 11% to $805 million for the three and nine months ended September 30, 2014, respectively, compared to the same periods in 2013, which were driven primarily by the size and mix of the balance sheet as well as increases in net interest spread. Commissions, fees and service charges and other revenue increased 7% to $163 million and 13% to $508 million for the three and nine months ended September 30, 2014, respectively, compared to the same periods in 2013, which were driven primarily by increased order flow revenue and advisor management fees, in addition to increased trading activity.
Provision for loan losses decreased 73% to $10 million and 79% to $26 million for the three and nine months ended September 30, 2014, respectively, compared to the same periods in 2013. The decreases were driven primarily by improving economic conditions, as evidenced by the lower levels of delinquent loans in the one- to four-family and home equity loan portfolios, lower net charge-offs, home price improvement and loan portfolio run-off. Total operating expenses increased 2% to $277 million for the three months ended September 30, 2014 compared to the same period in 2013, primarily due to an increase in compensation and benefits expense. Total operating expenses decreased 13% to $851 million for the nine months ended September 30, 2014, compared to the same period in 2013 driven primarily by $142 million in impairment of goodwill that was recognized in the second quarter of 2013 which increased operating expenses for the same period in 2013.
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 September 30,
 
Variance
 
Nine Months Ended September 30,
 
Variance
 
 
2014 vs. 2013
 
 
2014 vs. 2013
 
2014
 
2013
 
Amount
 
%
 
2014
 
2013
 
Amount
 
%
Net operating interest income
$
269

 
$
241

 
$
28

 
12
 %
 
$
805

 
$
725

 
$
80

 
11
 %
Commissions
108

 
103

 
5

 
5
 %
 
341

 
310

 
31

 
10
 %
Fees and service charges
45

 
40

 
5

 
13
 %
 
138

 
113

 
25

 
22
 %
Principal transactions

 
13

 
(13
)
 
*
 
10

 
56

 
(46
)
 
(82
)%
Gains on loans and securities, net
8

 
12

 
(4
)
 
(33
)%
 
30

 
49

 
(19
)
 
(39
)%
Net impairment

 
(1
)
 
1

 
*
 

 
(3
)
 
3

 
*
Other revenues
10

 
9

 
1

 
11
 %
 
29

 
27

 
2

 
7
 %
Total non-interest income
171

 
176

 
(5
)
 
(3
)%
 
548

 
552

 
(4
)
 
(1
)%
Total net revenue
$
440

 
$
417

 
$
23

 
6
 %
 
$
1,353

 
$
1,277

 
$
76

 
6
 %
 
*
Percentage not meaningful.
Net Operating Interest Income
Net operating interest income increased 12% to $269 million and 11% to $805 million for the three and nine months ended September 30, 2014, respectively, compared to the same periods in 2013. Net operating interest income is earned primarily through investing deposits and customer payables in enterprise interest-earning assets, which include: available-for-sale securities, held-to-maturity securities, margin receivables and real estate loans.
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 have been prepared on the basis required by the SEC’s Industry Guide 3, "Statistical Disclosure by Bank Holding Companies" (dollars in millions): 

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Three Months Ended September 30,
 
2014
 
2013
 
 
Average Balance
 
Operating Interest Inc./Exp.
 
Average Yield/Cost
 
Average Balance
 
Operating Interest Inc./Exp.
 
Average Yield/Cost
 
Enterprise interest-earning assets:
 
 
 
 
 
 
 
 
 
 
 
 
Loans(1)
$
6,871

 
$
70

 
4.05
%
 
$
9,288

 
$
96

 
4.15
%
 
Available-for-sale securities
12,595

 
70

 
2.23
%
 
13,011

 
69

 
2.11
%
 
Held-to-maturity securities
11,366

 
81

 
2.84
%
 
9,853

 
65

 
2.62
%
 
Margin receivables
7,645

 
67

 
3.47
%
 
5,938

 
56

 
3.75
%
 
Cash and equivalents
1,316

 

 
0.15
%
 
1,544

 
1

 
0.20
%
 
Segregated cash
904

 

 
0.06
%
 
517

 

 
0.09
%
 
Securities borrowed and other
649

 
28

 
16.89
%
 
661

 
12

 
7.08
%
 
Total enterprise interest-earning assets
41,346

 
316

 
3.04
%
 
40,812

 
299

 
2.92
%
 
Non-operating interest-earning and non-interest earning assets(2)
4,523

 
 
 
 
 
4,312

 
 
 
 
 
Total assets
$
45,869

 
 
 
 
 
$
45,124

 
 
 
 
 
Enterprise interest-bearing liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
Deposits
$
25,068

 
2

 
0.03
%
 
$
25,804

 
4

 
0.05
%
 
Customer payables
6,624

 
2

 
0.13
%
 
5,548

 
2

 
0.15
%
 
Securities sold under agreements to repurchase
3,753

 
30

 
3.07
%
 
4,446

 
37

 
3.29
%
 
Federal Home Loan Bank ("FHLB") advances and other borrowings
1,290

 
16

 
4.75
%
 
1,292

 
17

 
5.20
%
 
Securities loaned and other
1,634

 

 
0.03
%
 
874

 

 
0.01
%
 
Total enterprise interest-bearing liabilities
38,369

 
50

 
0.50
%
 
37,964

 
60

 
0.62
%
 
Non-operating interest-bearing and non-interest bearing liabilities(3)
2,270

 
 
 
 
 
2,383

 
 
 
 
 
Total liabilities
40,639

 
 
 
 
 
40,347

 
 
 
 
 
Total shareholders’ equity
5,230

 
 
 
 
 
4,777

 
 
 
 
 
Total liabilities and shareholders’ equity
$
45,869

 
 
 
 
 
$
45,124

 
 
 
 
 
Excess of enterprise interest-earning assets over enterprise interest-bearing liabilities/Enterprise net interest income/Spread
$
2,977

 
$
266

 
2.54
%
 
$
2,848

 
$
239

 
2.30
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Enterprise net interest margin (net yield on enterprise interest-earning assets)
 
 
 
2.57
%
 
 
 
 
 
2.34
%
 
Ratio of enterprise interest-earning assets to enterprise interest-bearing liabilities
 
 
 
107.76
%
 
 
 
 
 
107.50
%
 
Return on average:
 
 
 
 
 
 
 
 
 
 
 
 
     Total assets
 
 
 
 
0.75
%
 
 
 
 
 
0.42
%
 
     Total shareholders' equity
 
 
 
 
6.59
%
 
 
 
 
 
3.97
%
 
Average equity to average total assets
 
 
 
 
11.40
%
 
 
 
 
 
10.59
%
 
 
Reconciliation from enterprise net interest income to net operating interest income (dollars in millions): 
 
Three Months Ended September 30,
 
2014
 
2013
Enterprise net interest income
$
266

 
$
239

Taxable equivalent interest adjustment
(1
)
 
(1
)
Customer assets held by third parties(4)
4

 
3

Net operating interest income
$
269

 
$
241


(1)
Nonaccrual loans are included in the 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 revenue earned on average customer assets of $14.6 billion and $12.0 billion for the three months ended September 30, 2014 and 2013, respectively, held by third parties outside the Company, including money market funds and sweep deposit accounts at unaffiliated financial institutions. Fees earned on the customer assets are based on the federal funds rate plus a negotiated spread or other contractual arrangement with the third party institutions.


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Nine Months Ended September 30,
 
2014
 
2013
 
 
Average Balance
 
Operating Interest Inc./Exp.
 
Average Yield/Cost
 
Average Balance
 
Operating Interest Inc./Exp.
 
Average Yield/Cost
 
Enterprise interest-earning assets:
 
 
 
 
 
 
 
 
 
 
 
 
Loans(1)
$
7,556

 
$
231

 
4.07
%
 
$
9,828

 
$
305

 
4.14
%
 
Available-for-sale securities
12,940

 
221

 
2.28
%
 
12,800

 
200

 
2.08
%
 
Held-to-maturity securities
11,075

 
240

 
2.88
%
 
9,709

 
184

 
2.52
%
 
Margin receivables
7,307

 
194

 
3.56
%
 
5,761

 
164

 
3.82
%
 
Cash and equivalents
1,258

 
1

 
0.15
%
 
1,501

 
3

 
0.21
%
 
Segregated cash
847

 
1

 
0.09
%
 
382

 

 
0.10
%
 
Securities borrowed and other
633

 
66

 
13.84
%
 
644

 
38

 
7.89
%
 
Total enterprise interest-earning assets
41,616

 
954

 
3.06
%
 
40,625

 
894

 
2.94
%
 
Non-operating interest-earning and non-interest earning assets(2)
4,331

 
 
 
 
 
4,715

 
 
 
 
 
Total assets
$
45,947

 
 
 
 
 
$
45,340

 
 
 
 
 
Enterprise interest-bearing liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
Deposits
$
25,331

 
6

 
0.03
%
 
$
26,113

 
10

 
0.05
%
 
Customer payables
6,416

 
7

 
0.15
%
 
5,302

 
6

 
0.14
%
 
Securities sold under agreements to repurchase
4,071

 
95

 
3.07
%
 
4,455

 
111

 
3.29
%
 
Federal Home Loan Bank ("FHLB") advances and other borrowings
1,285

 
50

 
5.09
%
 
1,280

 
51

 
5.27
%
 
Securities loaned and other
1,457

 

 
0.03
%
 
827

 

 
0.01
%
 
Total enterprise interest-bearing liabilities
38,560

 
158

 
0.54
%
 
37,977

 
178

 
0.62
%
 
Non-operating interest-bearing and non-interest bearing liabilities(3)
2,285

 
 
 
 
 
2,490

 
 
 
 
 
Total liabilities
40,845

 
 
 
 
 
40,467

 
 
 
 
 
Total shareholders’ equity
5,102

 
 
 
 
 
4,873

 
 
 
 
 
Total liabilities and shareholders’ equity
$
45,947

 
 
 
 
 
$
45,340

 
 
 
 
 
Excess of enterprise interest-earning assets over enterprise interest-bearing liabilities/Enterprise net interest income/Spread
$
3,056

 
$
796

 
2.52
%
 
$
2,648

 
$
716

 
2.32
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Enterprise net interest margin (net yield on enterprise interest-earning assets)
 
 
 
2.55
%
 
 
 
 
 
2.35
%
 
Ratio of enterprise interest-earning assets to enterprise interest-bearing liabilities
 
 
 
107.93
%
 
 
 
 
 
106.97
%
 
Return on average:
 
 
 
 
 
 
 
 
 
 
 
 
     Total assets
 
 
 
 
0.73
%
 
 
 
 
 
0.08
%
 
     Total shareholders' equity
 
 
 
 
6.58
%
 
 
 
 
 
0.77
%
 
Average equity to average total assets
 
 
 
 
11.10
%
 
 
 
 
 
10.75
%
 
 
Reconciliation from enterprise net interest income to net operating interest income (dollars in millions): 
 
Nine Months Ended September 30,
 
2014
 
2013
Enterprise net interest income
$
796

 
$
716

Taxable equivalent interest adjustment
(1
)
 
(1
)
Customer assets held by third parties(4)
10

 
10

Net operating interest income
$
805

 
$
725


(1)
Nonaccrual loans are included in the 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 revenue earned on average customer assets of $14.2 billion and $10.9 billion for the nine months ended September 30, 2014 and 2013, respectively, held by third parties outside the Company, including money market funds and sweep deposit accounts at unaffiliated financial

7

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institutions. Fees earned on the customer assets are based on the federal funds rate plus a negotiated spread or other contractual arrangement with the third party institutions.
The fluctuation in enterprise interest-earning assets is driven primarily by changes in enterprise interest-bearing liabilities, specifically deposits and customer payables. Average enterprise interest-earning assets increased 1% to $41.3 billion and 2% to $41.6 billion for the three and nine months ended September 30, 2014, respectively, compared to the same periods in 2013. The increases in average enterprise interest-earning assets were primarily a result of increases in average held-to-maturity securities and margin receivables, which were partially offset by decreases in average loans compared to the same periods in 2013.
Average enterprise interest-bearing liabilities increased 1% to $38.4 billion and 2% to $38.6 billion for the three and nine months ended September 30, 2014, respectively, compared to the same periods in 2013. The increases in average enterprise interest-bearing liabilities were primarily due to increases in average customer payables and securities loaned and other, partially offset by decreases in average deposits and securities sold under agreements to repurchase.
As part of our strategy to strengthen our overall financial and franchise position, we have been focused on improving our capital ratios by reducing risk and deleveraging the balance sheet. Our deleveraging strategy included transferring customer deposits to third party institutions. At September 30, 2014, $14.8 billion of our customers' assets were held at third party institutions, including third party banks and money market funds. Approximately 71% of these off-balance sheet assets resulted from our deleveraging efforts. We estimate the impact of our deleveraging efforts on net operating interest income to be approximately 135 basis points based on the estimated current re-investment rates on these assets, less approximately 30 basis points of cost associated with holding these assets on our balance sheet, primarily FDIC insurance premiums. While we may take some tactical actions in future periods, we consider this deleveraging initiative to be complete.
Enterprise net interest spread increased by 24 basis points and 20 basis points to 2.54% and 2.52% for the three and nine months ended September 30, 2014, respectively, compared to the same periods in 2013. Enterprise net interest spread is driven by changes in average balances and average interest rates earned or paid on those balances. During the three and nine months ended September 30, 2014, the increases in enterprise net interest spread were driven primarily by the growth in margin receivables and securities loaned coupled with higher yields on the securities lending business, and lower wholesale borrowing costs due to a decrease in securities sold under agreements to repurchase. These increases were partially offset by the decrease in loans and lower rates earned on margin receivables. Enterprise net interest spread may further fluctuate based on the size and mix of the balance sheet, as well as the impact from the level of interest rates.
Commissions
Commissions revenue increased 5% to $108 million and 10% to $341 million for the three and nine months ended September 30, 2014, respectively, compared to the same periods in 2013. The main factors that affect commissions are DARTs, average commission per trade and the number of trading days.
DART volume increased 6% to 153,494 and 14% to 168,526 for the three and nine months ended September 30, 2014, respectively, compared to the same periods in 2013. Option-related DARTs as a percentage of total DARTs represented 23% and 22% of trading volume for the three and nine months ended September 30, 2014, respectively, compared to 24% for both the same periods in 2013.
Average commission per trade decreased 1% to $11.05 and 3% to $10.79 for the three and nine months ended September 30, 2014, respectively, compared to the same periods in 2013. Average commission per trade is impacted by customer mix and the different commission rates on various trade types (e.g. equities, options, fixed income, stock plan, exchange-traded funds, mutual funds, forex and cross border). Accordingly, changes in the mix of trade types will impact average commission per trade.

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Table of Contents    

Fees and Service Charges
Fees and service charges increased 13% to $45 million and 22% to $138 million for the three and nine months ended September 30, 2014, respectively, compared to the same periods in 2013. The table below shows the components of fees and service charges and the resulting variances (dollars in millions):
 
 
Three Months Ended September 30,
 
Variance
 
Nine Months Ended September 30,
 
Variance
 
 
2014 vs. 2013
 
 
2014 vs. 2013
 
2014
 
2013
 
Amount
 
%
 
2014
 
2013
 
Amount
 
%
Order flow revenue
$
22

 
$
19

 
$
3

 
16
 %
 
$
69

 
$
52

 
$
17

 
33
 %
Mutual fund service fees
6

 
5

 
1

 
20
 %
 
17

 
16

 
1

 
6
 %
Advisor management fees
6

 
3

 
3

 
100
 %
 
17

 
9

 
8

 
89
 %
Foreign exchange revenue
4

 
4

 

 
0
 %
 
12

 
11

 
1

 
9
 %
Reorganization fees
1

 
3

 
(2
)
 
(67
)%
 
5

 
6

 
(1
)
 
(17
)%
Other fees and service charges
6

 
6

 

 
0
 %
 
18

 
19

 
(1
)
 
(5
)%
Total fees and service charges
$
45

 
$
40

 
$
5

 
13
 %
 
$
138

 
$
113

 
$
25

 
22
 %
The increases in fees and services charges for the three and nine months ended September 30, 2014, compared to the same periods in 2013, were driven primarily by increased order flow revenue as a result of increased trading volumes and as E*TRADE Securities began routing all of its order flow to third parties following the sale of G1 Execution Services, LLC which was completed on February 10, 2014. In addition, advisor management fees increased, driven by assets in managed accounts within our retirement, investing and savings products, which were $3.0 billion at September 30, 2014, compared to $2.1 billion at September 30, 2013.
Principal Transactions
Principal transactions decreased 82% to $10 million for the nine months ended September 30, 2014 compared to the same period in 2013. There was no principal transactions revenue for the three months ended September 30, 2014. Principal transactions were derived from our market making business in which we acted as a market-maker for our brokerage customers’ orders as well as orders from third party customers. On February 10, 2014, we completed the sale of the market making business to an affiliate of Susquehanna International Group, LLP ("Susquehanna") and no longer generate principal transactions revenue.
Gains on Loans and Securities, Net
Gains on loans and securities, net decreased 33% to $8 million and 39% to $30 million for the three and nine months ended September 30, 2014, respectively, compared to the same periods in 2013. The table below shows the activity and resulting variances (dollars in millions):
 
Three Months Ended September 30,
 
Variance
 
Nine Months Ended September 30,
 
Variance
 
 
2014 vs. 2013
 
 
2014 vs. 2013
 
2014
 
2013
 
Amount
 
%
 
2014
 
2013
 
Amount
 
%
Gains (losses) on loans, net
$
(3
)
 
$
(1
)
 
$
(2
)
 
200
 %
 
$
4

 
$
(1
)
 
$
5

 
*
Gains on available-for-sale securities, net
12

 
16

 
(4
)
 
(25
)%
 
34

 
50

 
(16
)
 
(32
)%
Hedge ineffectiveness
(1
)
 
(3
)
 
2

 
(67
)%
 
(8
)
 

 
(8
)
 
*
Gains on securities, net
11

 
13

 
(2
)
 
(15
)%
 
26

 
50

 
(24
)
 
(48
)%
Gains on loans and securities, net
$
8

 
$
12

 
$
(4
)
 
(33
)%
 
$
30

 
$
49

 
$
(19
)
 
(39
)%
 
*
Percentage not meaningful.

Gains on loans and securities, net for the nine months ended September 30, 2014 included a $7 million gain recognized on the sale of one- to four-family loans modified as TDRs during the second quarter of 2014, and a $6 million gain recognized on the sale of our remaining $17 million in amortized cost of available-for-sale non-agency CMOs in the first quarter of 2014.
Provision for Loan Losses
Provision for loan losses decreased 73% to $10 million and 79% to $26 million for the three and nine months ended

9

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September 30, 2014, respectively, compared to the same periods in 2013. The decrease in provision for loan losses was driven primarily by improving economic conditions, as evidenced by the lower levels of delinquent loans in the one- to four-family and home equity loan portfolios, lower net charge-offs, home price improvement and loan portfolio run-off for the nine months ended September 30, 2014. Provision for loan losses also included $11 million and $13 million of benefits recognized from settlements with third party mortgage originators during the nine months ended September 30, 2014 and 2013, respectively. The timing and magnitude of the provision for loan losses is affected by many factors and we anticipate variability from quarter to quarter, particularly as home equity lines of credit begin converting to amortizing loans.
Operating Expense
The components of operating expense and the resulting variances are as follows (dollars in millions):
 
 
Three Months Ended September 30,
 
Variance
 
Nine Months Ended September 30,
 
Variance
 
 
2014 vs. 2013
 
 
2014 vs. 2013
 
2014
 
2013
 
Amount
 
%
 
2014
 
2013
 
Amount
 
%
Compensation and benefits
$
108

 
$
88

 
$
20

 
23
 %
 
$
305

 
$
270

 
$
35

 
13
 %
Advertising and market development
21

 
21

 

 
0
 %
 
88

 
81

 
7

 
9
 %
Clearing and servicing
21

 
31

 
(10
)
 
(32
)%
 
72

 
94

 
(22
)
 
(23
)%
FDIC insurance premiums
18

 
25

 
(7
)
 
(28
)%
 
61

 
79

 
(18
)
 
(23
)%
Professional services
27

 
23

 
4

 
17
 %
 
79

 
59

 
20

 
34
 %
Occupancy and equipment
22

 
17

 
5

 
29
 %
 
59

 
53

 
6

 
11
 %
Communications
17

 
16

 
1

 
6
 %
 
53

 
53

 

 
0
 %
Depreciation and amortization
19

 
22

 
(3
)
 
(14
)%
 
60

 
68

 
(8
)
 
(12
)%
Amortization of other intangibles
5

 
6

 
(1
)
 
(17
)%
 
16

 
18

 
(2
)
 
(11
)%
Impairment of goodwill

 

 

 
*
 

 
142

 
(142
)
 
*
Facility restructuring and other exit activities
2

 
6

 
(4
)
 
(67
)%
 
6

 
23

 
(17
)
 
(74
)%
Other operating expenses
17

 
16

 
1

 
6
 %
 
52

 
40

 
12

 
30
 %
Total operating expense
$
277

 
$
271

 
$
6

 
2
 %
 
$
851

 
$
980

 
$
(129
)
 
(13
)%
 
*
Percentage not meaningful.
Compensation and Benefits
Compensation and benefits increased 23% to $108 million and 13% to $305 million for the three and nine months ended September 30, 2014, respectively, compared to the same periods in 2013. The increase resulted primarily from increased salaries expense due to increased headcount and increased incentive compensation when compared to the same periods in 2013.
Clearing and Servicing
Clearing and servicing decreased 32% to $21 million and 23% to $72 million for the three and nine months ended September 30, 2014, respectively, compared to the same periods in 2013. The decrease resulted primarily from a decrease in clearing fees as a result of the sale of the market making business which was partially offset by costs associated with an increase in trading volumes, when compared to the same periods in 2013. Additionally, servicing fees decreased when compared to the same periods in 2013 as the loan portfolio continues to run off.
FDIC Insurance Premiums
FDIC insurance premiums decreased 28% to $18 million and 23% to $61 million for the three and nine months ended September 30, 2014, respectively, compared to the same periods in 2013. The decrease for the nine months ended September 30, 2014 was due to the sale of $0.8 billion of our one- to four-family loans modified as TDRs during the second quarter of 2014 as well as continued improvement and quality of our balance sheet, improving capital ratios and overall risk profile when compared to the same periods in 2013. TDRs are considered underperforming assets and are assessed at a higher rate in the FDIC insurance calculation. We expect sustained savings as a result of the sale, and as we continue to improve the quality of the balance sheet and capital ratios in future periods.

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Table of Contents    

Professional Services
Professional services increased 17% to $27 million and 34% to $79 million for the three and nine months ended September 30, 2014, respectively, compared to the same periods in 2013, primarily driven by professional services engagements focused on improving the customer experience and overall product offering, as well as our continued enterprise risk management build-out.
Impairment of Goodwill
Impairment of goodwill was $142 million for the nine months ended September 30, 2013. This impairment represented the entire amount of goodwill associated with the market making business, which was sold in the first quarter of 2014. There were no similar charges during the nine months ended September 30, 2014.
Facility Restructuring and Other Exit Activities
Facility restructuring and other exit activities were $2 million and $6 million for the three and nine months ended September 30, 2014, respectively, compared to $6 million and $23 million for the same periods in 2013. The costs in 2014 were driven by severance costs incurred primarily related to our exit of the market making business and were partially offset by the $4 million gain on the sale of that business, which was completed on February 10, 2014. The costs in 2013 were driven primarily by severance costs incurred as part of the expense reduction initiatives in the prior periods.
Other Operating Expenses
Other operating expenses increased 6% to $17 million and 30% to $52 million for the three and nine months ended September 30, 2014, respectively, compared to the same periods in 2013. The increases were driven primarily by increased expenses related to real estate owned compared to the same periods in 2013. In addition, a legal accrual reversal of $3 million in the second quarter of 2013 offset the other operating expenses for the nine months ended September 30, 2013.
Other Income (Expense)
Other income (expense) decreased 3% to $28 million and increased 17% to $95 million for the three and nine months ended September 30, 2014, respectively, compared to the same periods in 2013 as shown in the following table (dollars in millions):
 
 
Three Months Ended September 30,
 
Variance
 
Nine Months Ended September 30,
 
Variance
 
 
2014 vs. 2013
 
 
2014 vs. 2013
 
2014
 
2013
 
Amount
 
%
 
2014
 
2013
 
Amount
 
%
Corporate interest expense
$
(29
)
 
$
(29
)
 
$

 
0
 %
 
$
(86
)
 
$
(86
)
 
$

 
0
 %
Losses on early extinguishment of debt

 

 

 
*
 
(12
)
 

 
(12
)
 
*
Equity in income of investments and other
1

 

 
1

 
*
 
3

 
5

 
(2
)
 
(40
)%
Total other income (expense)
$
(28
)
 
$
(29
)
 
$
1

 
(3
)%
 
$
(95
)
 
$
(81
)
 
$
(14
)
 
17
 %
*
Percentage not meaningful.
Total other income (expense) primarily consisted of corporate interest expense of $29 million for both the three months ended September 30, 2014 and 2013 and $86 million for both the nine months ended September 30, 2014 and 2013. In addition, during the nine months ended September 30, 2014 we recognized $12 million of losses on early extinguishment of debt as a result of the early extinguishment of $100 million in repurchase agreements.
Income Tax Expense
Income tax expense was $39 million and $129 million for the three and nine months ended September 30, 2014, respectively, compared to income tax expense of $33 million and $62 million for the same periods in 2013. The effective tax rate was 31% and 34% for the three and nine months ended September 30, 2014, respectively, compared to 41% and 69% for the same periods in 2013. Income tax expense for the three and nine months ended September 30, 2014 included $8 million of benefit primarily related to the settlement of a state tax audit. Income tax expense for the nine months ended September 30, 2014 also included $5 million of benefit related to a recent change to the New York state tax code and its impact on state deferred taxes. Excluding the impact of the recent change to the New York state tax code and the settlement of the state tax audit, our effective tax rate for the three and nine months ended September 30, 2014 would have been 38% and 37%, respectively calculated in the following table (dollars in millions):

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Table of Contents    

 
 
For the Three Months Ended September 30, 2014
 
For the Nine Months Ended September 30, 2014
 
 
Pre-tax Income
 
Tax Expense (Benefit)
 
Tax Rate
 
Pre-tax Income
 
Tax Expense (Benefit)
 
Tax Rate
Taxes and tax rate before the impact of the change in New York state tax code and settlement of a state tax audit
 
$
125

 
$
47

 
38
%
 
$
381

 
$
142

 
37
%
Impact of the change in the New York State tax code
 

 

 
 
 

 
(5
)
 
 
Impact primarily related to the settlement of a state tax audit
 

 
(8
)
 
 
 

 
(8
)
 
 
Income taxes and tax rate as reported
 
$
125

 
$
39

 
31
%
 
$
381

 
$
129

 
34
%

At the end of June 2013, we decided to exit the market making business, and as a result recorded $142 million in goodwill impairment during the nine months ended September 30, 2013. The $142 million goodwill impairment charge associated with the market making business was non-deductible for tax purposes. In addition, the overall state apportionment increased significantly as a result of the exit of the market making business and we expected our state taxable income to increase in future periods. We expected to utilize net operating losses in California; therefore we recognized a tax benefit of $26 million during the nine months ended September 30, 2013, the majority of which consisted of releasing valuation allowances for net operating losses, research and development credits and revaluation of other deferred tax assets relating to California. Without the exit of the market making business, the effective tax rate for the nine months ended September 30, 2013 would have been 38%, calculated in the following table (dollars in millions):
 
 
For the Nine Months Ended September 30, 2013
 
 
Pre-tax Income
 
Tax Expense
 
Tax Rate
Taxes and tax rate before impact of exit of market making business
 
$
232

 
$
88

 
38
%
Impact of exit of market making business:
 
 
 
 
 
 
Goodwill impairment charge
 
(142
)
 

 
 
State apportionment change
 

 
(26
)
 
 
Income taxes and tax rate as reported
 
$
90

 
$
62

 
69
%
Valuation Allowance
We are required to establish a valuation allowance for deferred tax assets and record a corresponding charge to income tax expense if it is determined, based on evaluation of available evidence at the time the determination is made, that it is more likely than not that some or all of the deferred tax assets will not be realized. If we were to conclude that a valuation allowance was required, the resulting loss could have a material adverse effect on our financial condition and results of operations. As of September 30, 2014, we did not establish a valuation allowance against our federal deferred tax assets as we believe that it is more likely than not that all of these assets will be realized. Slightly less than half of our existing federal deferred tax assets are not related to net operating losses and therefore, have no expiration date. We expect to utilize the majority of our existing federal deferred tax assets within the next five years.
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; and corporate services. Balance sheet management includes the management of asset allocation; loans previously originated by the Company or purchased from third parties; deposits and customer payables; and credit, liquidity and interest rate risk for the Company as described in the Risk Management section. Costs associated with certain functions that are centrally-managed are separately reported in a corporate/other category. For more information on our segments, see Note 14—Segment Information in Item 1. Consolidated Financial Statements (Unaudited).

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Table of Contents    

Trading and Investing
The following table summarizes trading and investing financial information and key customer activity metrics as of and for the three and nine months ended September 30, 2014 and 2013 (dollars in millions, except for key metrics): 
 
Three Months Ended September 30,
 
Variance
 
Nine Months Ended September 30,
 
Variance
 
 
2014 vs. 2013
 
 
2014 vs. 2013
 
2014
 
2013
 
Amount
 
%
 
2014
 
2013
 
Amount
 
%
Net operating interest income
$
165

 
$
134

 
$
31

 
23
 %
 
$
459

 
$
401

 
$
58

 
14
 %
Commissions
108

 
103

 
5

 
5
 %
 
341

 
310

 
31

 
10
 %
Fees and service charges
45

 
39

 
6

 
15
 %
 
137

 
111

 
26

 
23
 %
Principal transactions

 
13

 
(13
)
 
*
 
10

 
56

 
(46
)
 
(82
)%
Other revenues
9

 
8

 
1

 
13
 %
 
25

 
24

 
1

 
4
 %
Total net revenue
327

 
297

 
30

 
10
 %
 
972

 
902

 
70

 
8
 %
Total operating expense
183

 
171

 
12

 
7
 %
 
574

 
688

 
(114
)
 
(17
)%
Trading and investing income
$
144

 
$
126

 
$
18

 
14
 %
 
$
398

 
$
214

 
$
184

 
86
 %
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Key Customer Activity Metrics:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
DARTs
153,494

 
145,150

 
8,344

 
6
 %
 
168,526

 
147,777

 
20,749

 
14
 %
Average commission per trade
$
11.05

 
$
11.15

 
$
(0.10
)
 
(1
)%
 
$
10.79

 
$
11.18

 
$
(0.39
)
 
(3
)%
Margin receivables (dollars in billions)
$
8.1

 
$
6.2

 
$
1.9

 
31
 %
 
$
8.1

 
$
6.2

 
$
1.9

 
31
 %
End of period brokerage accounts
3,126,476

 
2,975,842

 
150,634

 
5
 %
 
3,126,476

 
2,975,842

 
150,634

 
5
 %
Net new brokerage accounts
23,510

 
13,111

 
10,399

 
79
 %
 
128,417

 
72,651

 
55,766

 
77
 %
Annualized brokerage account attrition rate
9.1
%
 
9.0
%
 
0.1
%
 
*
 
8.5
%
 
8.7
%
 
(0.2
)%
 
*
Customer assets (dollars in billions)
$
281.7

 
$
240.6

 
$
41.1

 
17
 %
 
$
281.7

 
$
240.6

 
$
41.1

 
17
 %
Net new brokerage assets (dollars in billions)
$
2.3

 
$
2.4

 
$
(0.1
)
 
(4
)%
 
$
7.4

 
$
7.2

 
$
0.2

 
3
 %
Brokerage related cash (dollars in billions)
$
40.4

 
$
38.2

 
$
2.2

 
6
 %
 
$
40.4

 
$
38.2

 
$
2.2

 
6
 %
*
Percentage not meaningful.
The trading and investing segment offers products and services to individual retail investors, generating revenue from these customer relationships and from corporate services activities. This segment currently generates four main sources of revenue: net operating interest income; commissions; fees and service charges; and other revenues. Net operating interest income is generated primarily from margin receivables and from a deposit transfer pricing arrangement with the balance sheet management segment. The balance sheet management segment utilizes deposits and customer payables and compensates the trading and investing segment via a market-based transfer pricing arrangement. This compensation is reflected in segment results as operating interest income for the trading and investing segment and operating interest expense for the balance sheet management segment, and is eliminated in consolidation. 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 increased 14% to $144 million and 86% to $398 million for the three and nine months ended September 30, 2014, respectively, compared to the same periods in 2013. We continued to generate net new brokerage accounts, ending the third quarter of 2014 with 3.1 million accounts. Brokerage related cash, which is one of our most profitable sources of funding, increased by $2.2 billion to $40.4 billion when compared to the same period in 2013.
Trading and investing, net operating interest income increased 23% to $165 million and 14% to $459 million for the three and nine months ended September 30, 2014, respectively, driven primarily by the growth in margin receivables coupled with higher yields on securities borrowed balances when compared to the same periods in 2013.

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Table of Contents    

Trading and investing commissions revenue increased 5% to $108 million and 10% to $341 million for the three and nine months ended September 30, 2014, respectively, compared to the same periods in 2013. The increases were primarily due to increases in DARTs of 6% to 153,494 and 14% to 168,526 for the three and nine months ended September 30, 2014, respectively, partially offset by decreases in average commission per trade of 1% to $11.05 and 3% to $10.79, compared to the same periods in 2013.
Trading and investing fees and service charges increased 15% to $45 million and 23% to $137 million for the three and nine months ended September 30, 2014, respectively, compared to the same periods in 2013. The increases in fees and services charges were driven primarily by increased order flow revenue as a result of increased trading volumes and as E*TRADE Securities began routing all of its order flow to third parties following the sale of G1 Execution Services, LLC which was completed on February 10, 2014. In addition, advisor management fees increased driven by assets in managed accounts within our retirement, investing and savings products, which were $3.0 billion at September 30, 2014, compared to $2.1 billion at September 30, 2013.
Trading and investing principal transactions decreased 82% to $10 million for the nine months ended September 30, 2014 compared to the same period in 2013. There was no principal transactions revenue for the three months ended September 30, 2014. Principal transactions were derived from our market making business in which we acted as a market-maker for our brokerage customers’ orders as well as orders from third party customers. On February 10, 2014, we completed the sale of the market making business to an affiliate of Susquehanna and no longer generate principal transactions revenue.
Trading and investing operating expense increased 7% to $183 million and decreased 17% to $574 million for the three and nine months ended September 30, 2014 compared to the same periods in 2013. The increase for the three months ended September 30, 2014, was driven by increased compensation and benefits primarily as a result of increased incentive compensation, and increased professional services expense as a result of our focus on improving the customer experience and overall product offering. The decrease for the nine months ended September 30, 2014, compared to the same period in 2013 was driven by higher operating expenses in the prior period as a result of $142 million in impairment of goodwill associated with the market making business, which was recognized in the second quarter of 2013.
As of September 30, 2014, we had approximately 3.1 million brokerage accounts, 1.3 million stock plan accounts and 0.4 million banking accounts. For the three months ended September 30, 2014 and 2013, our brokerage products contributed 79% and 78%, respectively, and our banking products contributed 21% and 22%, respectively, of total trading and investing net revenue. For the nine months ended September 30, 2014 and 2013, our brokerage products contributed 80% and 78%, respectively, and our banking products contributed 20% and 22%, respectively, of total trading and investing net revenue.
Balance Sheet Management
The following table summarizes balance sheet management financial information and key financial metrics as of and for the three and nine months ended September 30, 2014 and 2013 (dollars in millions):
 
Three Months Ended September 30,
 
Variance
 
Nine Months Ended September 30,
 
Variance
 
 
2014 vs. 2013
 
 
2014 vs. 2013
 
2014
 
2013
 
Amount
 
%
 
2014
 
2013
 
Amount
 
%
Net operating interest income
$
104

 
$
107

 
$
(3
)
 
(3
)%
 
$
346

 
$
324

 
$
22

 
7
 %
Fees and service charges

 
1

 
(1
)
 
*
 
1

 
2

 
(1
)
 
(50
)%
Gains on loans and securities, net
8

 
12

 
(4
)
 
(33
)%
 
30

 
49

 
(19
)
 
(39
)%
Net impairment

 
(1
)
 
1

 
*
 

 
(3
)
 
3

 
*
Other revenues
1

 
1

 

 
0
 %
 
4

 
3

 
1

 
33
 %
Total net revenue
113

 
120

 
(7
)
 
(6
)%
 
381

 
375

 
6

 
2
 %
Provision for loan losses
10

 
37

 
(27
)
 
(73
)%
 
26

 
126

 
(100
)
 
(79
)%
Total operating expense
36

 
43

 
(7
)
 
(16
)%
 
113

 
135

 
(22
)
 
(16
)%
Balance sheet management income
$
67

 
$
40

 
$
27

 
68
 %
 
$
242

 
$
114

 
$
128

 
112
 %
Key Financial Metrics:
 
 
 
 
 
 
 
 
 
 
 
 
 
 


Special mention loan delinquencies
$
159

 
$
278

 
$
(119
)
 
(43
)%
 
$
159

 
$
278

 
$
(119
)
 
(43
)%
Allowance for loan losses
$
401

 
$
459

 
$
(58
)
 
(13
)%
 
$
401

 
$
459

 
$
(58
)
 
(13
)%
*
Percentage not meaningful.

14

Table of Contents    

The balance sheet management segment generates revenue from managing loans previously originated by the Company or purchased from third parties, as well as utilizing deposits and customer payables to generate additional net operating interest income. The balance sheet management segment utilizes deposits and customer payables from the trading and investing segment, wholesale borrowings and proceeds from loan pay-downs to invest in available-for-sale and held-to-maturity securities. Net operating interest income is generated from interest earned on available-for-sale and held-to-maturity securities and loans receivable, net of interest paid on wholesale borrowings and on a deposit transfer pricing arrangement with the trading and investing segment. The balance sheet management segment utilizes deposits and customer payables and compensates the trading and investing segment via a market-based transfer pricing arrangement. This compensation is reflected in segment results as operating interest income for the trading and investing segment and operating interest expense for the balance sheet management segment and is eliminated in consolidation.
The balance sheet management segment income increased 68% to $67 million and 112% to $242 million for the three and nine months ended September 30, 2014, respectively, compared to the same periods in 2013. The increases in balance sheet management income were primarily due to decreases in provision for loan losses of 73% to $10 million and 79% to $26 million for the three and nine months ended September 30, 2014, respectively, compared to the same periods in 2013.
The balance sheet management net operating interest income decreased 3% to $104 million and increased 7% to $346 million for the three and nine months ended September 30, 2014, respectively, compared to the same periods in 2013. The decrease for the three months ended September 30, 2014 was driven by the decrease in interest earned on the loan portfolio as it continues to pay down, partially offset by an increase in interest earned on our securities portfolio, compared to the same period in 2013. The increase for the nine months ended September 30, 2014 was driven by the growth in average balances and increased yields of our securities portfolio, which more than offset the decrease in the interest earned on the loan portfolio, compared to the same period in 2013.
Gains on loans and securities, net decreased 33% to $8 million and 39% to $30 million for the three and nine months ended September 30, 2014, respectively, compared to the same periods in 2013. Gains on loans and securities, net for the nine months ended September 30, 2014 included a $7 million gain on the sale of one- to four-family loans modified as TDRs during the second quarter of 2014, and a $6 million gain recognized on the sale of our remaining $17 million in amortized cost of available-for-sale non-agency CMOs in the first quarter of 2014.
Provision for loan losses decreased 73% to $10 million and 79% to $26 million for the three and nine months ended September 30, 2014, respectively, compared to the same periods in 2013. The decreases in provision for loan losses were driven primarily by improving economic conditions, as evidenced by the lower levels of delinquent loans in the one- to four-family and home equity loan portfolios, lower net charge-offs, home price improvement and loan portfolio run-off. The timing and magnitude of the provision for loan losses is affected by many factors and we anticipate variability from quarter to quarter, particularly as home equity lines of credit begin converting to amortizing loans.
Total balance sheet management operating expense decreased 16% for both the three and nine months ended September 30, 2014 to $36 million and to $113 million, respectively, compared to the same periods in 2013. The decrease in operating expense for the three and nine months ended September 30, 2014 resulted primarily from lower FDIC insurance premiums and reduced servicing expenses due to lower loan balances, partially offset by increased expense related to real estate owned when compared to the same periods in 2013.
Corporate/Other
The following table summarizes corporate/other financial information for the three and nine months ended September 30, 2014 and 2013 (dollars in millions):
 

15

Table of Contents    

 
Three Months Ended September 30,
 
Variance
 
Nine Months Ended September 30,
 
Variance
 
 
2014 vs. 2013
 
 
2014 vs. 2013
 
2014
 
2013
 
Amount
 
%
 
2014
 
2013
 
Amount
 
%
Total net revenue
$

 
$

 
$

 
*
 
$

 
$

 
$