Current Report

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 8-K

CURRENT REPORT PURSUANT

TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

Date of report (Date of earliest event reported): October 17, 2005

E*TRADE Financial Corporation

(Exact Name of Registrant as Specified in Its Charter)

Delaware

1-11921

94-2844166

(State or other Jurisdiction

of incorporation)

(Commission File Number)

(IRS Employer

Identification No.)

135 East 57th Street

New York, New York

10022

(Address of Principal Executive Offices)

(Zip Code)

(646) 521-4300

(Registrant’s Telephone Number, Including Area Code)

Not Applicable

(Former Name or Former Address, if Changed Since Last Report)

Check the appropriate box below if the Form 8-K filing is intended to simultaneously satisfy the filing obligation of the registrant under any of the following provisions:

Written communications pursuant to Rule 425 under the Securities Act (17 CFR 230.425)

Soliciting material pursuant to Rule 14a-12 under the Exchange act (17 CFR 240.14a-12)

Pre-commencement communications pursuant to Rule 14d-2(b) under the Exchange Act (17 CFR 240.14d-2(b))

Pre-commencement communications pursuant to Rule 13e-4(c) under the Exchange Act (17 CFR 240.13e-4(c))

Item 8.01 Other Events

E*TRADE Financial Corporation (the “Company”) is filing this Current Report on Form 8-K to update the historical financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2004 (the “2004 Form 10-K”) for discontinued operations and change in reporting segments from Brokerage and Banking to Retail and Institutional. The discontinued operations relates to the closure of our E*TRADE Professional unit responsible for both proprietary and hybrid proprietary trading models; and our decision to sell our recreational vehicle and marine loan origination business. Both of these events met the requirements under Statement of Financial Accounting Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (“SFAS No. 144”) for classification as discontinued operations.

Under requirements of the Securities and Exchange Commission (the “SEC”), the same classification as discontinued operations required by SFAS No. 144 is also required for previously issued financial statements included in the Company’s currently filed 2004 Form 10-K, if those financial statements are incorporated by reference in filings with the SEC made under the Securities Act of 1933, as amended, even though those financial statements relate to periods prior to these businesses’ operations being classified as discontinued operations.

On August 5, 2005, the Company filed its Quarterly Report on Form 10-Q for the quarter ended June 30, 2005 (“June 2005 10-Q”) with the SEC. In the June 2005 10-Q, the Company presented its results to reflect the discontinued operations and new segments.

This reclassification has no effect on the Company’s reported net income for any reporting period and has no material effect on the Company’s results of operations or financial condition.

This report includes our reclassified audited Consolidated Financial Statements for the years ended December 31, 2004, 2003 and 2002.

The reclassified consolidated financial information is attached to this current report on Form 8-K as Exhibit 99.1. Because we are reclassifying certain financial information in the 2004 Form 10-K for discontinued operations and segment reporting, the revised sections of our 2004 Form 10-K included in this report have not been otherwise updated for events occurring after the date of our Consolidated Financial Statements, which were originally presented in the 2004 Form 10-K filed on March 10, 2005. All other information in the 2004 Form 10-K remains unchanged. This report should be read in conjunction with our 2004 Form 10-K (except for Item 8 of Part II, which is contained in this report).

Item 9.01 Exhibits


23.1		Consent of Independent Registered Public Accounting Firm

99.1		Revised Consolidated Financial Statements and Supplementary Data for the years ended December 31, 2004, 2003 and 2002 (Part II—Item 8 of the Company’s Annual Report on Form 10-K for the year ended December 31, 2004, filed with the SEC on March 10, 2005).

SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized.


	*ETRADE F INANCIAL C ORPORATION**

Date: October 17, 2005	By:	/s/ Russell S. Elmer
		Russell S. Elmer *Corporate Secretary*

Exhibit 23.1

CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

We consent to the incorporation by reference in the following Registration Statements of E*TRADE Financial Corporation of our report dated March 10, 2005 (October 17, 2005 as to the effects of discontinued operations and segment classification discussed in Note 31), included in this Current Report on Form 8-K of E*TRADE Financial Corporation.

Filed on Form S-3:


Registration Statement Nos.:		333-98417, 333-100185, 333-104903, 333-41628, 333-98419, 333-124673

Filed on Form S-4:


Registration Statement Nos.:		333-91467, 333-62230, 333-117080

Filed on Form S-8:


Registration Statement Nos.:		333-12503, 333-52631, 333-62333, 333-72149, 333-35068, 333-35074, 333-37892, 333-44608, 333-44610, 333-54904, 333-56002, 333-113558, 333-91534, 333-125351

/s/ Deloitte & Touche LLP

McLean, Virginia

October 17, 2005

Exhibit 99.1

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS


		Page
Report of Independent Registered Public Accounting Firm		2
Consolidated Balance Sheets as of December 31, 2004 and 2003		3
Consolidated Statements of Operations for the Years Ended December 31, 2004, 2003 and 2002		4
Consolidated Statements of Comprehensive Income (Loss) for the Years Ended December 31, 2004, 2003 and 2002		5
Consolidated Statements of Shareholders’ Equity for the Years Ended December 31, 2004, 2003 and 2002		6
Consolidated Statements of Cash Flows for the Years Ended December 31, 2004, 2003 and 2002		8
Notes to Consolidated Financial Statements:
Note 1—Organization and Basis of Presentation		10
Note 2—Summary of Significant Accounting Policies		11
Note 3—Discontinued Operations		19
Note 4—Business Combinations		21
Note 5—Brokerage Receivables, Net and Brokerage Payables		23
Note 6—Available-for-Sale Mortgage-Backed and Investment Securities		24
Note 7—Other Investments		27
Note 8—Loans Receivable, Net		29
Note 9—Servicing Rights		32
Note 10—Property and Equipment, Net		33
Note 11—Goodwill and Other Intangibles, Net		33
Note 12—Other Assets		35
Note 13—Asset Securitization		35
Note 14—Related Party Transactions		39
Note 15—Deposits		40
Note 16—Securities Sold Under Agreements to Repurchase and Other Borrowings by Bank Subsidiary		42
Note 17—Senior Notes and Convertible Subordinated Notes		43
Note 18—Accounts Payable, Accrued and Other Liabilities		44
Note 19—Income Taxes		45
Note 20—Shareholders’ Equity		47
Note 21—Employee Benefit Plans		48
Note 22—Facility Restructuring and Other Exit Charges		51
Note 23—Income (Loss) Per Share		55
Note 24—Regulatory Requirements		56
Note 25—Lease Arrangements		57
Note 26—Commitments, Contingencies and Other Regulatory Matters		58
Note 27—Accounting for Derivative Financial Instruments and Hedging Activities		61
Note 28—Fair Value Disclosure of Financial Instruments		65
Note 29—Segment and Geographic Information		66
Note 30—Condensed Financial Information (Parent Company Only)		69
Note 31—Subsequent Events		72
Note 32—Quarterly Data (Unaudited)		73

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of

E*TRADE Financial Corporation

Arlington, Virginia

We have audited the accompanying consolidated balance sheets of E*TRADE Financial Corporation and subsidiaries (the “Company”) as of December 31, 2004 and 2003, and the related consolidated statements of operations, comprehensive income (loss), shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2004. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of E*TRADE Financial Corporation and subsidiaries as of December 31, 2004 and 2003, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2004, in conformity with accounting principles generally accepted in the United States of America.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company’s internal control over financial reporting as of December 31, 2004, based on the criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 10, 2005 expressed an unqualified opinion on management’s assessment of the effectiveness of the Company’s internal control over financial reporting and an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.

/s/ Deloitte & Touche LLP

McLean, Virginia

March 10, 2005 (October 17, 2005 as to the effects of discontinued operations and segment classification discussed in Note 31).

E*TRADE FINANCIAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(in thousands, except share amounts)


	December 31,
	2004			2003
ASSETS
Cash and equivalents	$	939,906		$	921,364
Cash and investments required to be segregated under Federal or other regulations (includes repurchase agreements of $0 at December 31, 2004 and $875,800 at December 31, 2003)		724,026			1,644,605
Brokerage receivables, net		3,034,548			2,297,778
Trading securities		593,245			832,889
Available-for-sale mortgage-backed and investment securities (includes securities pledged to creditors with the right to sell or repledge of $10,113,049 at December 31, 2004 and $5,706,325 at December 31, 2003)		12,543,818			9,826,940
Other investments		46,269			49,272
Loans receivable (net of allowance for loan losses of $47,681 at December 31, 2004 and $37,847 at December 31, 2003)		11,505,755			8,130,906
Loans held-for-sale, net		279,280			1,000,487
Property and equipment, net		302,291			287,097
Derivative assets		115,867			59,990
Accrued interest receivable		117,131			92,565
Investment in Federal Home Loan Bank Stock		92,005			79,236
Goodwill		395,043			392,845
Other intangibles, net		134,121			126,032
Other assets		209,278			307,210

Total assets	$	31,032,583		$	26,049,216

LIABILITIES AND SHAREHOLDERS’ EQUITY
Brokerage payables	$	3,618,892		$	3,696,225
Deposits		12,302,974			12,514,486
Securities sold under agreements to repurchase		9,896,872			5,283,609
Other borrowings by Bank subsidiary		1,760,732			1,203,554
Derivative liabilities		52,208			79,303
Senior notes		400,452			—
Convertible subordinated notes		185,165			695,330
Accounts payable, accrued and other liabilities		587,086			658,415

Total liabilities		28,804,381			24,130,922

Commitments and contingencies		—			—
Shareholders’ equity:
Preferred stock, shares authorized: 1,000,000; issued and outstanding: none at December 31, 2004 and 2003		—			—
Shares exchangeable into common stock, $0.01 par value, shares authorized: 10,644,223; issued and outstanding: 1,302,801 at December 31, 2004 and 1,386,125 at December 31 2003		13			14
Common stock, $0.01 par value, shares authorized: 600,000,000; issued and outstanding: 369,623,604 at December 31, 2004 and 366,636,406 at December 31, 2003		3,696			3,666
Additional paid-in capital		2,234,093			2,247,930
Deferred stock compensation		(18,419	)		(12,874	)
Retained earnings (deficit)		150,018			(230,465	)
Accumulated other comprehensive loss		(141,199	)		(89,977	)

Total shareholders’ equity		2,228,202			1,918,294

Total liabilities and shareholders’ equity	$	31,032,583		$	26,049,216

See accompanying notes to consolidated financial statements

E*TRADE FINANCIAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share amounts)


	Year Ended December 31,
	2004			2003			2002
Revenues:
Commissions	$	452,288		$	444,084		$	398,546
Principal transactions		126,893			107,601			111,281
Gain on sales of loans and securities, net		140,718			247,654			208,762
Service charges and fees		97,915			110,147			113,231
Other revenues		94,460			96,317			72,907
Interest income		1,145,744			892,906			949,690
Interest expense		(510,455	)		(486,129	)		(561,174	)

Net interest income		635,289			406,777			388,516
Provision for loan losses		(38,121	)		(38,523	)		(14,664	)

Net interest income after provision for loan losses		597,168			368,254			373,852

Total net revenues		1,509,442			1,374,057			1,278,579

Expenses excluding interest
Compensation and benefits		355,862			369,270			318,527
Occupancy and equipment		72,854			80,735			82,015
Communications		72,119			77,586			83,548
Professional services		68,330			56,079			52,977
Commissions, clearance and floor brokerage		145,639			144,052			157,802
Advertising and marketing development		62,158			57,935			70,191
Servicing and other banking expenses		35,971			37,575			45,424
Fair value adjustments of financial derivatives		(2,299	)		15,338			11,662
Depreciation and amortization		79,603			87,397			104,709
Amortization of other intangibles		20,493			25,808			20,186
Facility restructuring and other exit charges		15,688			134,191			15,357
Acquisition-related expenses		248			1,499			11,473
Executive agreement		—			—			(23,485	)
Other		91,543			100,606			69,748

Total expenses excluding interest		1,018,209			1,188,071			1,020,134

Income before other income (loss), income taxes, discontinued operations and cumulative effect of accounting change		491,233			185,986			258,445

Other income (loss)
Corporate interest income		6,692			6,550			12,612
Corporate interest (expense)		(47,525	)		(45,592	)		(47,716	)
Gain (loss) on sale and impairment of investments		128,103			147,874			(20,302	)
Gain (loss) on early extinguishment of debt, net		(22,972	)		—			5,346
Equity in income (losses) of investments and venture funds		4,382			9,132			(682	)

Total other income (loss)		68,680			117,964			(50,742	)

Income before income taxes and discontinued operations		559,913			303,950			207,703
Income tax expense		180,278			110,250			90,922
Minority interest in subsidiaries		893			(5,061	)		1,555

Net income from continuing operations		378,742			198,761			115,226

Discontinued operations, net of tax
Gain (loss) from discontinued operations, net		(29,667	)		4,266			(7,962	)
Gain on disposal of discontinued operations, net		31,408			—			—

Net income (loss) from discontinued operations		1,741			4,266			(7,962	)

Cumulative effect of accounting change, net of tax		—			—			(293,669	)

Net income (loss)	$	380,483		$	203,027		$	(186,405	)

Basic income per share
Basic income per share from continuing operations	$	1.03		$	0.56		$	0.32
Basic income (loss) per share from discontinued operations		0.01			0.01			(0.02	)
Basic loss per share from cumulative effect of accounting change		—			—			(0.82	)

Basic net income (loss) per share	$	1.04		$	0.57		$	(0.52	)

Diluted income per share
Diluted income per share from continuing operations	$	0.98		$	0.54		$	0.32
Diluted income (loss) per share from discontinued operations		0.01			0.01			(0.02	)
Diluted loss per share from cumulative effect of accounting change		—			—			(0.82	)

Diluted net income (loss) per share	$	0.99		$	0.55		$	(0.52	)


Share used in computation of per share data
Basic		366,586			358,320			355,090
Diluted		405,389			367,361			361,051

See accompanying notes to consolidated financial statements

E*TRADE FINANCIAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(in thousands)


	Year Ended December 31,
	2004			2003			2002
Net income (loss)	$	380,483		$	203,027		$	(186,405	)
Other comprehensive income (loss):
Available-for-sale securities:
Unrealized gains		94,900			301,634			48,672
Less impact of realized gains (transferred out of AOCI) and included in net income (loss)		(187,663	)		(223,086	)		(54,340	)
Tax effect		37,015			(33,552	)		2,918

Net change from available-for-sale securities		(55,748	)		44,996			(2,750	)

Cash flow hedging instruments:
Unrealized losses		(84,050	)		(15,375	)		(137,143	)
Amortization of losses into interest expense related to de-designated cash flow hedges deferred in AOCI		95,614			121,414			67,937
Tax effect		(5,828	)		(41,513	)		29,266

Net change from cash flow hedging instruments		5,736			64,526			(39,940	)

Foreign currency translation gains (losses)		(1,210	)		31,958			8,610

Other comprehensive income (loss)		(51,222	)		141,480			(34,080	)

Comprehensive income (loss)	$	329,261		$	344,507		$	(220,485	)

See accompanying notes to consolidated financial statements.

E*TRADE FINANCIAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

(in thousands)


	Preferred Stock			Shares Exchangeable into Common Stock					Common Stock					Additional Paid-in-Capital			Shareholders’ Notes Receivable			Deferred Stock Compensation			Retained Earnings (Deficit)			Accumulated Other Comprehensive Loss			Total Shareholders’ Equity
	Shares	Amount		Shares		Amount			Shares		Amount			Additional Paid-in-Capital			Shareholders’ Notes Receivable			Deferred Stock Compensation			Retained Earnings (Deficit)			Accumulated Other Comprehensive Loss			Total Shareholders’ Equity
Balance, December 31, 2001	—	$	—	1,826		$	18		347,592		$	3,476		$	2,072,701		$	(32,707	)	$	(28,110	)	$	(247,087	)	$	(197,377	)	$	1,570,914
Income before cumulative effect of accounting change																								107,264						107,264
Cumulative effect of accounting change																								(293,669	)					(293,669	)
Other comprehensive loss																											(34,080	)		(34,080	)
Exercise of stock options and warrants, including tax benefit									2,568			26			14,811															14,837
Employee stock purchase plan									454			4			2,449															2,453
Repurchases of common stock									(10,171	)		(102	)		(43,379	)														(43,481	)
Issuance of common stock in exchange for retirements of convertible subordinated notes									6,452			64			55,284															55,348
Collection of shareholders’ notes receivable									(5,021	)		(50	)		(28,740	)		32,707												3,917
Amortization of deferred stock compensation, net of cancellations and retirements									(1,002	)		(10	)		(6,127	)					8,712									2,575
Ascribed value of restricted stock contributed to Rabbi Trust																					(3,660	)								(3,660	)
Issuance of common stock for purchase acquisitions and equity investments									16,973			170			123,201															123,371
Conversion of Exchangeable Shares to common stock				(199	)		(2	)	199			2																		—

Balance, December 31, 2002	—	$	—	1,627		$	16		358,044		$	3,580		$	2,190,200		$	—		$	(23,058	)	$	(433,492	)	$	(231,457	)	$	1,505,789

See accompanying notes to consolidated financial statements.

E*TRADE FINANCIAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY—(Continued)

(in thousands)


	Preferred Stock			Shares Exchangeable into Common Stock					Common Stock					Additional Paid-in-Capital			Shareholders’ Notes Receivable		Deferred Stock Compensation			Retained Earnings (Deficit)			Accumulated Other Comprehensive Loss			Total Shareholders’ Equity
	Shares	Amount		Shares		Amount			Shares		Amount			Additional Paid-in-Capital			Shareholders’ Notes Receivable		Deferred Stock Compensation			Retained Earnings (Deficit)			Accumulated Other Comprehensive Loss			Total Shareholders’ Equity
Balance, December 31, 2002	—	$	—	1,627		$	16		358,044		$	3,580		$	2,190,200		$	—	$	(23,058	)	$	(433,492	)	$	(231,457	)	$	1,505,789
Net income																							203,027						203,027
Other comprehensive income																										141,480			141,480
Exercise of stock options and warrants, including tax benefit									8,543			85			58,917														59,002
Employee stock purchase plan									1,572			16			5,908														5,924
Adjustment related to change in original option grants															954														954
Cancellation of unvested restricted stock									(3,447	)		(34	)		(21,271	)				21,305									—
Issuance of restricted stock									1,733			17			13,491					(13,408	)								100
Amortization of deferred stock compensation, net of cancellations and retirements									(50	)					(269	)				2,287									2,018
Conversion of Exchangeable Shares to common stock				(241	)		(2	)	241			2																	—

Balance, December 31, 2003	—		—	1,386			14		366,636			3,666			2,247,930			—		(12,874	)		(230,465	)		(89,977	)		1,918,294
Net income																							380,483						380,483
Other comprehensive loss																										(51,222	)		(51,222	)
Exercise of stock options and purchase plans, including tax benefit									6,757			68			57,686														57,754
Employee stock purchase plan									1,443			14			8,640														8,654
Adjustment related to change in original option grants															224														224
Repurchases of common stock									(13,664	)		(137	)		(175,639	)													(175,776	)
Cancellation of restricted stock									(113	)		(1	)		(858	)				859									—
Issuance of restricted stock									908			9			11,149					(11,058	)								100
Shares issued upon debt conversion									7,438			74			79,889														79,963
Amortization of deferred stock compensation, net of cancellations and retirements									(25	)					(325	)				4,654									4,329
Conversion of Exchangeable Shares to common stock				(83	)		(1	)	83			1																	—
Other									161			2			5,397														5,399

Balance, December 31, 2004	—	$	—	1,303		$	13		369,624		$	3,696		$	2,234,093		$	—	$	(18,419	)	$	150,018		$	(141,199	)	$	2,228,202

See accompanying notes to consolidated financial statements

E*TRADE FINANCIAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)


	Year Ended December 31,
	2004			2003			2002
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)	$	380,483		$	203,027		$	(186,405	)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Cumulative effect of accounting change		—			—			293,669
Provision for loan losses		38,121			38,523			14,664
Depreciation, amortization and discount accretion		398,297			443,746			325,980
Net realized gains on available-for-sale securities, loans held-for-sale and trading securities		(275,795	)		(445,552	)		(223,159	)
Gain on disposition of assets		(57,451	)		—			—
Realized loss on impairment of investments		18,330			10,406			24,972
Minority interest and equity in income of subsidiaries and investments		(9,882	)		(14,834	)		(9,040	)
Unrealized loss on venture funds		5,413			5,640			9,683
Noncash restructuring costs and other exit charges		15,029			70,811			11,880
Executive agreement		—			—			(23,485	)
Amortization of deferred stock compensation		4,654			2,287			8,712
Deferred income taxes		79,787			3,556			84,138
Gain on early extinguishment of debt		—			—			(8,669	)
Other		11,503			16,033			(35,368	)
Net effect of changes in brokerage-related assets and liabilities:
(Increase) decrease in cash and investments required to be segregated under Federal or other regulations		936,492			(171,287	)		(675,514	)
(Increase) decrease in brokerage receivables		(713,656	)		(856,359	)		646,240
Increase (decrease) in brokerage payables		(117,567	)		924,051			132,270
Net effect of changes in banking-related assets and liabilities:
Proceeds from sales, repayments and maturities of loans held-for-sale		6,857,431			13,662,209			12,794,746
Purchases of loans held-for-sale		(6,063,974	)		(12,951,831	)		(10,261,694	)
Proceeds from sales, repayments and maturities of trading securities		9,354,027			14,749,315			12,892,384
Purchases of trading securities		(9,122,071	)		(15,204,220	)		(13,246,949	)
Other changes, net:
(Increase) decrease in other assets		(69,810	)		75,329			(325,223	)
Accrued interest receivable and payable, net		(13,207	)		12,814			(8,452	)
Increase (decrease) in accounts payable, accrued and other liabilities		(27,183	)		144,311			9,665
Decrease in restructuring liabilities		(11,564	)		(30,626	)		(18,846	)

Net cash provided by operating activities		1,617,407			687,349			2,226,199

CASH FLOWS FROM INVESTING ACTIVITIES:
Net (increase) decrease in loans receivable, net of loans received in business acquisition		(3,487,941	)		(2,426,789	)		165,488
Purchases of mortgage-backed and investment securities, available-for-sale		(20,701,412	)		(21,516,669	)		(17,151,373	)
Proceeds from sales, maturities of and principal payments on mortgage-backed and investment securities, available-for-sale		17,995,471			20,271,822			13,646,716
Purchases of property and equipment, net of property and equipment received in business acquisition		(108,887	)		(60,121	)		(117,599	)
Proceeds from sale of property and equipment		5,957			3,846			—
Restricted deposits		—			—			71,888
Cash used in business acquisitions, net		(19,025	)		(3,466	)		(1,853,188	)
Proceeds from escrow settlement		—			—			3,513
Net cash flow from derivatives designated in a fair value hedge relationship		(33,354	)		(59,607	)		(331,321	)
Proceeds from sale of E*TRADE Access		106,868			—			—
Other		(11,156	)		(1,908	)		11,015

Net cash used in investing activities	$	(6,253,479	)	$	(3,792,892	)	$	(5,554,861	)

See accompanying notes to consolidated financial statements

E*TRADE FINANCIAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS—(Continued)

(in thousands)


	Year Ended December 31,
	2004			2003			2002
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase (decrease) in banking deposits, net of deposits received in acquisitions	$	(202,544	)	$	4,113,280		$	317,474
Advances from the Federal Home Loan Bank		7,041,000			1,634,700			2,068,945
Payments on advances from the Federal Home Loan Bank		(6,472,000	)		(2,025,000	)		(1,664,945	)
Net increase (decrease) in securities sold under agreements to repurchase		4,603,641			(343,324	)		2,608,477
Net decrease in other borrowed funds		(64,215	)		(208,479	)		—
Proceeds from bank loans and lines of credit, net of transaction costs		23,500			—			18,500
Payments on bank loans and lines of credit		(753	)		(5,090	)		(23,283	)
Net proceeds from 8.00% Notes		394,000			—			—
Payments on call of convertible subordinated notes		(428,902	)		—			—
Proceeds from issuance of common stock from employee stock transactions		43,974			51,740			13,746
Repayment of capital lease obligations		(734	)		(6,031	)		(14,431	)
Proceeds from related party loan		500			—			—
Issuance of loans to related parties		(250	)		(1,507	)		(11,299	)
Proceeds from repayments of principal and interest on loans to related parties		509			15,719			14,013
Repurchases of common stock		(175,776	)		—			(43,481	)
Collection on shareholders’ notes receivable		—			—			3,073
Proceeds from issuance of subordinated debentures and trust preferred securities		75,630			58,210			73,836
Payments on trust preferred securities		(23,375	)		—			—
Net cash flow from derivatives in a cash flow hedge relationship		(159,591	)		(30,916	)		(89,799	)
Other		—			—			(4,760	)

Net cash provided by financing activities		4,654,614			3,253,302			3,266,066

INCREASE (DECREASE) IN CASH AND EQUIVALENTS		18,542			147,759			(62,596	)
CASH AND EQUIVALENTS, Beginning of year		921,364			773,605			836,201

CASH AND EQUIVALENTS, End of year	$	939,906		$	921,364		$	773,605

SUPPLEMENTAL DISCLOSURES:
Cash paid for interest	$	437,714		$	430,855		$	621,140
Cash paid for income taxes	$	101,309		$	42,555		$	6,111
Non-cash investing and financing activities:
Tax benefit on exercise of stock options	$	22,441		$	13,186		$	3,145
Transfers from loans to other real estate owned and repossessed assets	$	47,080		$	48,947		$	38,897
Reclassification of loans held-for-sale to loans held-for-investment	$	—		$	289,592		$	104,348
Deconsolidation of trust preferreds to other borrowings	$	—		$	201,665		$	—
Reclassification of loans held-for-investment to loans held-for-sale	$	—		$	—		$	2,622,126
Issuance of shares in exchange for increased ownership in E*TRADE Japan K.K.	$	—		$	—		$	30,698
Notes receivable repaid with common stock	$	—		$	—		$	28,790
Issuance of common stock to retire debentures	$	79,963		$	—		$	55,348
Acquisitions, net of cash acquired:
Common stock issued and stock options assumed	$	—		$	—		$	91,943
Cash paid, less acquired		19,025			3,466			1,854,910
Net deferred tax (asset) liability		—			(4,956	)		36,200
Net liabilities assumed		—			—			56,346

Fair value of assets acquired including goodwill	$	19,025		$	(1,490	)	$	2,039,399

See accompanying notes to consolidated financial statements

E*TRADE FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1—ORGANIZATION AND BASIS OF PRESENTATION

Organization

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

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

•

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

•

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

•

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

•

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

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

•

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

•

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

Basis of Presentation

The Company’s consolidated financial statements include the accounts of the Parent and its majority-owned subsidiaries. Intercompany accounts and transactions are eliminated in consolidation. Entities in which the Company holds at least a 20% ownership or in which there are other indicators of significant influence are generally accounted for by the equity method. Entities in which the Company holds less than 20% ownership and does not have the ability to exercise significant influence are generally carried at cost. Because the Company operates in the financial services industry, it follows certain accounting guidance used by the brokerage and banking industries.

Certain prior period items in these consolidated financial statements have been reclassified to conform to the current period presentation. As discussed in Notes 3 and 31, certain operations of the Company have been accounted for as discontinued operations in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets . Accordingly, prior period amounts have been reclassified to reflect the operations as a discontinued operation. Unless noted, discussions herein pertain to the Company’s continuing operations.

New Expense Reporting Format

On January 1, 2004, the Company began reporting its expenses within its consolidated statements of operations in a format more consistent with common presentation in the financial services industry. Under this new format, expenses are presented in the consolidated statements of operations under the following new captions:

•

Compensation and benefits —includes employee salary, bonus, sales and trading commissions, temporary employee services and other related benefit costs;

•

Occupancy and equipment —includes building and equipment rent and lease costs;

•

Communications —includes customer statements, confirmations, website content, data communications and internal communication costs;

•

Professional services —includes fees for legal, accounting, tax, public relations and other consulting services;

•

Commissions, clearance and floor brokerage —includes costs for exchange and clearing brokerage costs and third-party research costs provided to institutional customers;

•

Advertising and market development —includes television, print, mailing and website advertising and promotion costs;

•

Servicing and other banking expenses —includes loan servicing costs and other banking related costs;

•

Depreciation and amortization —includes depreciation on property and equipment; and

•

Other —includes regulatory-related costs, insurance, employee travel expenses and other general corporate administration costs.

Previously these expenses were reported under the following captions:

•

Cost of services —included employee salary, bonus, brokerage and banking costs for its customer transactions, customer communications and overhead costs to provide service to customers;

•

Selling and marketing —included costs for advertising campaigns, independent research provided to institutional customers and fees paid to outside market makers for orders received for execution;

•

Technology development —included costs for technology design and development; and

•

General and administrative —included compensation and benefits, overhead for executive and administrative personnel and other corporate costs.

Previously, these costs were recorded based on a company-department level, whereas, now these costs are reported based on their type. For example compensation and benefits was included in each of cost of services, selling and marketing, technology development and general and administrative.

Use of Estimates

The consolidated financial statements were prepared in accordance with accounting principles generally accepted in the United States of America, which require management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and related notes for the periods presented. Actual results could differ from management’s estimates. Material estimates that management believes near-term changes could reasonably occur include: allowances for loan losses and uncollectible margin loans; classification and valuation of certain investments; valuation and accounting for financial derivatives; estimates of effective tax rates, deferred taxes and valuation allowances; and valuation of goodwill and intangibles. The Company’s investments in venture funds reflect changes in the fair value of their portfolio investments, including estimated values of non-public companies, which may be subject to adjustments. The Company also estimates the value of real estate and repossessed assets acquired in connection with foreclosures and repossessions.

NOTE 2—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Cash and Equivalents —For the purpose of reporting cash flows, the Company considers all highly liquid investments with original or remaining maturities of three months or less at the time of purchase that are not required to be segregated under Federal or other regulations to be cash equivalents. Cash and equivalents are composed of interest-bearing and non-interest-bearing deposits, certificates of deposit, commercial paper, funds

due from banks and Federal funds. Cash and equivalents included $23.7 million and $11.1 million at December 31, 2004 and 2003, respectively, of overnight cash deposits that the Company is required to maintain with the Federal Reserve Bank.

Cash and Investments Required to be Segregated Under Federal or Other Regulations —Cash and investments required to be segregated under Federal or other regulations consist primarily of interest-bearing cash accounts. At December 31, 2003, amounts also included government-backed securities purchased under agreements to resell (“Resale Agreements”). Resale Agreements are accounted for as collateralized financing transactions and are recorded at their contractual amounts, which approximate fair value. The Company obtains possession of collateral with a market value equal to or in excess of the principal amount loaned under Resale Agreements. These balances, held by our broker-dealer subsidiaries, are maintained in a special reserve bank account for the exclusive benefit of brokerage customers in accordance with Securities and Exchange Commission (“SEC”) Rule 15c 3-3.

Securities Borrowed and Securities Loaned —Deposits paid for securities borrowed and deposits received for securities loaned are recorded at the amount of cash collateral advanced or received. Deposits paid for securities borrowed transactions require the Company to deposit cash with the lender. With respect to deposits received for securities loaned, the Company receives collateral in the form of cash in an amount generally in excess of the market value of the securities loaned. Interest income and interest expense are recorded on an accrual basis. The Company monitors the market value of the securities borrowed and loaned on a daily basis, with additional collateral obtained or refunded, as necessary.

Trading Securities —Certain trading securities and financial derivative instruments, that are not designated for hedge accounting, are bought and held principally for the purpose of selling them in the near term and are carried at estimated fair value based on quoted market prices. Realized and unrealized gains and losses on securities classified as trading and held by the Bank are included in gain on sales of loans and securities, net and are derived using the specific identification cost method. Realized and unrealized gains and losses on trading securities are recorded in principal transactions for brokerage activities and are also derived by the specific identification method.

During 2004 and 2003, the Bank realized losses from the sales of trading securities of $0.7 million and $21.5 million, respectively, and recognized a $3.9 million gain in 2002. In addition, the Bank had unrealized trading asset appreciation of $2.5 million and $4.8 million in 2004 and 2003, respectively, and $0.9 million unrealized depreciation on these assets in 2002. The Company’s brokerage operations realized gains of $102.0 million, $102.8 million and $94.4 million in 2004, 2003 and 2002, respectively. During 2004 and 2003, the brokerage’s trading assets did not appreciate or depreciate significantly. However, the trading assets held by our brokerage operations resulted in a $0.1 million depreciation loss in 2002.

Available-for-Sale Mortgage-Backed and Investment Securities —The Company classified its debt, mortgage-backed securities and marketable equity securities as either trading or available-for-sale. None of the Company’s mortgage-backed or investment securities were classified as held-to-maturity at December 31, 2004 or 2003.

Available-for-sale securities consist of mortgage-backed securities, asset-backed securities, corporate bonds, municipal bonds, publicly traded equity securities, retained interests from securitizations and other debt securities. Securities classified as available-for-sale are carried at fair value, with the unrealized gains and losses reflected as a component of accumulated other comprehensive income (“AOCI”), net of tax. Fair value is based on quoted market prices, when available. For illiquid securities, fair value is estimated by obtaining market price quotes on similar liquid securities and adjusting the price to reflect differences between the two securities, such as credit risk, liquidity, term, coupon, payment characteristics and other information. Realized and unrealized gains or losses on available-for-sale securities, except for publicly traded equity securities, are computed using the specific identification cost method. Amortization or accretion of premiums and discounts are recognized in

interest income using the interest method over the expected life of the security. Realized and unrealized gains or losses on publicly traded equity securities are computed using the average cost method. Realized gains and losses and declines in fair value judged to be other-than-temporary are included in gain on sales of loans and securities, net for the Company’s banking operations; other amounts are included in gain (loss) on sale and impairment of investments. Interest earned is included in interest income for banking operations or corporate interest income for corporate investments.

The Company reviews all securities with unrealized losses for other-than-temporary impairment at each balance sheet date. The Company considers market value of equity securities below the Company’s cost basis, for a period of greater than six months, an indication of other-than-temporary impairment, unless there are other indicators that would cause us to consider an impairment sooner. The Company conducts a detailed credit review of any security with potential for other-than-temporary impairment. In addition, the Company reviews any security in which publicly available information indicates a significant credit concern with the issuer.

In addition, impairment of mortgage-backed and asset-backed securities is evaluated in accordance with the Consensus of the Emerging Issues Task Force (“EITF”) 99-20, Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets which requires a two-step test on certain mortgage-backed and asset-backed securities to determine if other-than-temporary impairment has occurred. Specifically, impairment is recognized when the security’s fair value is less than its amortized cost and if the current present value of estimated cash flows has decreased since the last periodic estimate. If the security fails both tests, other-than-temporary impairment has occurred and the Company writes the security down to fair value.

Asset Securitization and Retained Interests —An asset securitization involves the transfer of financial assets to another entity in exchange for cash and/or beneficial interests in the assets transferred. Asset transfers in which the Company surrenders control over the financial assets are accounted for as sales to the extent that consideration, other than beneficial interests in the transferred assets, is received in the exchange in accordance with SFAS No. 140 Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities . The carrying amount of the assets transferred is allocated between the assets sold in these transactions and the retained beneficial interests, based on their relative fair values at the date of the transfer. For transactions managed by the Bank, the Company records gain or loss for the difference between the allocated carrying amount of the asset sold and the net cash proceeds received. These gains or losses are recorded in gain on sales of loans and securities, net. Fair value is determined based on quoted market prices, if available. Generally quoted market prices are not available for beneficial interests; therefore, the Company estimates the fair value based on the present value of the associated expected future cash flows. In determining the present value of the associated expected future cash flows, management is required to make estimates and assumptions. The key estimates and assumptions include future default rates, credit losses, discount rates, prepayment speeds and collateral repayment rates. Retained beneficial interests are accounted for in accordance with SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities and EITF 99-20.

Loans Receivable, net —Loans receivable, net consists of real estate and consumer loans that management has the intent and ability to hold for the foreseeable future or until maturity. These loans are carried at amortized cost adjusted for charge-offs, net allowance for loan losses, deferred fees or costs on originated loans and unamortized premiums or discounts on purchased loans. Loan fees and certain direct loan origination costs are deferred and the net fee or cost is recognized in interest income using the interest method over the contractual life of the loans. Premiums and discounts on purchased loans are amortized or accreted into income using the interest method over the remaining period to contractual maturity and adjusted for anticipated prepayments. Nonperforming loans consist of loans for which interest is no longer being accrued and troubled loans that have been restructured in order to increase the opportunity to collect amounts due on the loan. All loans at least 90 days past due and other loans considered uncollectible are placed on nonaccrual status and are considered nonperforming. Interest previously accrued, but not collected, on nonperforming loans is reversed against current income when a loan is placed on nonaccrual status and is considered nonperforming. Accretion of deferred fees is discontinued for nonperforming loans. Payments received on nonperforming loans are recognized as interest

income when the loan is considered collectible and applied to principal when it is doubtful that full payment will be collected. Real estate loans are generally charged off to the extent that the carrying value of the loan exceeds the estimated net realizable value of the underlying collateral at 180 days past due. Consumer loans are charged off to the extent the carrying value of the loan exceeds the estimated net realizable value of the underlying collateral when the loan becomes 120 days past due.

Allowance for Loan Losses —The allowance for loan losses is maintained at a level that management believes is at least equal to the probable losses inherent in the Bank’s held-for-investment loan portfolio. Loan losses are charged and recoveries are credited to the allowance for loan losses. In determining the level of the allowance, the Company evaluates its real estate and consumer loans using expected loss ratios. The expected loss ratios are determined based on historical charge-off experience, industry loss experience and current market and economic conditions. Management evaluates these factors each month and adjusts the allowance for loan losses, as necessary. Inherently, the determination of the allowance for losses is subjective, as such management must make significant estimates, including the amounts and timing of losses and current market and economic conditions.

Loans Held-for-Sale, net —Loans held-for-sale, net consists of mortgages acquired by the Bank and loans originated by both E*TRADE Consumer Finance and E*TRADE Mortgage that are intended for sale in the secondary market. These loans are carried at the lower of cost or estimated fair value, as determined on an aggregate basis, based on quoted market price for loans with similar characteristics. Net unrealized losses are recognized in a valuation allowance by charges to income. Premiums and discounts on loans held-for-sale are deferred and recognized as part of loss or gain on sale and are not accreted or amortized.

Property and Equipment, net —Property and equipment are carried at cost and depreciated on a straight-line basis over their estimated useful lives, generally three to ten years. Leasehold improvements are stated at cost and are amortized over the lesser of their estimated useful lives or lease terms. Buildings are depreciated over forty years. Land is carried at cost.

In accordance with Statement of Position (“SOP”) 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use , the cost of internally developed software is capitalized and included in property and equipment at the point at which the conceptual formulation, design and testing of possible software project alternatives are complete and management authorizes and commits to funding the project. The Company does not capitalize pilot projects and projects where it believes that future economic benefits are less than probable. Internally developed software costs include the cost of software tools and licenses used in the development of the Company’s systems, as well as payroll and consulting costs.

Investment in Federal Home Loan Bank (“FHLB”) Stock —Investment in FHLB stock is carried at its amortized cost, which approximates fair value.

Goodwill and Other Intangibles, net —Goodwill and other intangibles, net represents the excess of the purchase price over the fair value of net tangible assets acquired through the Company’s business combinations. The Company tests goodwill and intangible assets with indefinite lives for impairment on at least an annual basis or when certain events occur. The Company evaluates the remaining useful lives of other intangible assets each reporting period to determine whether events and circumstances warrant a revision to the remaining period of amortization.

Servicing Rights —The Company recognizes servicing assets when it sells loans and retains the related servicing rights. Servicing rights are initially recorded at allocated cost based on the relative fair value of the loans sold and servicing retained at the date of sale in accordance with SFAS No. 140. Servicing assets are amortized in proportion to and over the period of estimated net servicing income. A valuation allowance, if required, is adjusted to reflect the excess of the carrying value of the servicing assets over fair value.

Real Estate Owned and Repossessed Assets —Included in other assets is real estate acquired through foreclosure and repossessed consumer assets. Real estate properties acquired through foreclosures, commonly referred to as real estate owned (“REO”) and repossessed assets, are recorded at fair value, less estimated selling costs at acquisition.

Income Taxes —The Company accounts for income taxes in accordance with SFAS No. 109, Accounting for Income Taxes, which prescribes the use of the asset and liability method whereby deferred tax asset or liability account balances are calculated at the balance sheet date using current tax laws and rates in effect. Valuation allowances are established when necessary to reduce deferred tax assets when it is more likely than not that a portion or all of the deferred tax assets will not be realized. In accordance with SFAS No. 109, income tax expense includes (i) deferred tax expense, which generally represents the net change in the deferred tax asset or liability balance during the year plus any change in valuation allowances and (ii) current tax expense, which represents the amount of tax currently payable to or receivable from a taxing authority plus amounts accrued for expected tax deficiencies (including both tax and interest). Accruals for expected tax deficiencies are recorded in accordance with SFAS No. 5, Accounting for Contingencies , when management determines that a tax deficiency is both probable and reasonably estimable.

Foreign Currency Translation —Assets and liabilities of consolidated subsidiaries outside of the United States are translated into U.S. dollars using the exchange rate in effect at each period end. Revenues and expenses are translated at the average exchange rate during the period. The effects of foreign currency translation adjustments arising from differences in exchange rates from period to period are deferred and included in AOCI as the functional currency of our subsidiaries is their local currency. Currency transaction gains or losses, derived on monetary assets and liabilities stated in a currency other than the functional currency, are recognized in current operations and have not been significant to the Company’s operating results in any period.

Deferred Stock Compensation —On the date restricted common stock is granted to an employee, the Company records the shares granted as common stock issued and additional paid-in capital at the fair market value. An equal and offsetting amount is recorded in shareholders’ equity as deferred stock compensation. Deferred stock compensation is amortized to compensation expense over the vesting period of the restricted common stock.

Advertising Costs —Advertising production costs are expensed when the initial advertisement is run. Costs of communicating advertising are expensed as the services are received.

Technology Development Costs —Technology development costs are charged to operations as incurred. Technology development costs include costs incurred in the development and enhancement of software used in connection with services provided by the Company that do not otherwise qualify for capitalization treatment as internally developed software costs in accordance with SOP 98-1 .

Stock-Based Compensation —The Company has stock-based employee compensation plans, which are described more fully in Note 21. The Company accounts for the plans under Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees , and related Interpretations which requires compensation expense to be recognized for any intrinsic value in stock options at the grant date.

The following table illustrates the effect on the Company’s reported net income (loss) and earnings per share if the Company had applied the fair value recognition provisions of SFAS No. 123, Accounting for Stock-Based Compensation , as amended by SFAS No. 148, Accounting for Stock-Based Compensation—Transition and Disclosure, to stock-based employee compensation (in thousands, except per share amounts):


	Year Ended December 31,
	2004			2003			2002
Net income (loss), as reported	$	380,483		$	203,027		$	(186,405	)
Add back: Stock-based employee compensation expense, net of tax included in reported net income (loss), net of tax		3,081			2,033			5,522
Deduct: Total stock-based employee compensation expense determined under fair value-based method for all awards, net of tax		(22,640	)		(17,561	)		(19,737	)

Pro forma net income (loss)	$	360,924		$	187,499		$	(200,620	)

Income (loss) per share:
Basic—as reported	$	1.04		$	0.57		$	(0.52	)

Basic—pro forma	$	0.98		$	0.52		$	(0.56	)

Diluted—as reported	$	0.99		$	0.55		$	(0.52	)

Diluted—pro forma	$	0.94		$	0.51		$	(0.56	)

The underlying assumptions to these fair value calculations are discussed in Note 21.

Comprehensive Income —The Company’s comprehensive income is comprised of net income (loss), foreign currency cumulative translation adjustments, unrealized gains (losses) on available-for-sale mortgage-backed and investment securities and the effective portion of the unrealized gains (losses) on financial derivatives in cash flow hedge relationships, net of reclassification adjustments and related taxes.

Earnings Per Share —Basic earnings per share (“EPS”) is computed by dividing net income (loss) by the weighted-average common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock.

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

Each derivative is recorded on the balance sheet at fair value as a freestanding asset or liability. Financial derivative instruments in hedging relationships that mitigate exposure to changes in the fair value of assets are considered fair value hedges under SFAS No. 133. Financial derivative instruments designated in hedging relationships that mitigate the exposure to the variability in expected future cash flows or other forecasted transactions are considered cash flow hedges. The Company formally documents all relationships between hedging instruments and hedged items and the risk management objective and strategy for each hedge transaction.

Fair value hedges are accounted for by recording the fair value of the financial derivative instrument and the change in fair value of the asset being hedged on the consolidated balance sheets with the net difference reported as fair value adjustments of financial derivatives in the consolidated statements of operations. Accordingly, any net difference, or hedge ineffectiveness, is recognized currently in the consolidated statements of operations as

fair value adjustments of financial derivatives. Cash payments or receipts and related accruals during the reporting period on derivatives included in fair value hedge relationships are recorded as an adjustment to interest income on the hedged asset. If a financial derivative in a fair value hedging relationship is no longer effective, de-designated from its hedging relationship or terminated, the Company discontinues fair value hedge accounting for the derivative and the hedged item. Changes in the fair value of these derivative instruments after the discontinuance of fair value hedge accounting are recorded in gain on sales of loans and securities, net, in the consolidated statements of operations. The accumulated adjustment of the carrying amount of the hedged interest-earning asset is recognized in earnings as an adjustment to interest income over the expected remaining life of the asset using the effective interest method.

Cash flow hedges are accounted for by recording the fair value of the financial derivative instrument as either a freestanding asset or a freestanding liability in the consolidated balance sheets, with the effective portion of the change in fair value of the financial derivative recorded in AOCI, net of tax in the consolidated balance sheet. Amounts are then included in interest expense as a yield adjustment in the same period the hedged forecasted transaction affects earnings. The ineffective portion of the change in fair value of the financial derivative is reported as fair value adjustments of financial derivatives in the consolidated statements of operations. If it becomes probable that a hedged forecasted transaction will not occur, amounts included in AOCI related to the specific hedging instruments are reported as gain on sales of loans and securities, net in the consolidated statements of operations.

Derivative gains and losses that are not considered highly effective in hedging the change in fair value or expected cash flows of the hedged item are recognized as gain on sales of loans and securities, net in the consolidated statements of operations as these derivatives do not qualify for hedge accounting under SFAS No. 133. If a financial derivative ceases to be highly effective as a hedge, hedge accounting is discontinued prospectively and the financial derivative instrument continues to be recorded at fair value with changes in fair value being reported as gain on sales of loans and securities, net in the consolidated statements of operations.

Commissions —The Company derives commission revenues from its retail customers and its commission-based portion of its global execution and settlement service business. Commission revenues from securities transactions are recognized on a trade date basis. E*TRADE Securities receives commissions for providing certain institutional customers with market research and other information, which is a common industry practice. These commission revenues contributed less than 10% of the Company’s net revenues for all periods presented. Direct costs from these arrangements are expensed as the commissions are received, in proportion to the cost of the total arrangement. As a result, payments for independent research are deferred or accrued to properly match expenses at the time commission revenue is earned. For these arrangements, payments for independent research of $6.3 million were deferred and costs of $18.6 million were accrued at December 31, 2004 and payments of $7.7 million were deferred and costs of $17.6 million were accrued at December 31, 2003.

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

Gain on Sales of Loans and Securities, net —Gain on sales of originated loans are recognized at the date of settlement and are based on the difference between the cash received and the carrying value of the related loans sold, less related transaction costs. In cases where the Company retains the servicing rights associated with loans sold, the gain recognized is the difference between cash received and the allocated basis of the loans sold, less the related transaction costs. In accordance with SFAS No. 140, the allocated basis of the loans, which is determined at the sale date, is the result of the allocation of basis between the loans sold and the associated servicing right, based on the relative fair values of the loans at the date of transfer. Nonrefundable fees and direct costs associated with the origination of mortgage loans are deferred and recognized when the related loans are sold.

Gain on sales of loans held-for-sale and securities includes gains or losses resulting from sales of loans, which the Bank purchased for resale; the sale or impairment of the Bank’s available-for-sale mortgage-backed

and investment securities; and gains or losses on financial derivatives that are not accounted for as hedging instruments under SFAS No. 133. Gains or losses resulting from the sale of Bank loans held-for-sale are recognized at the date of settlement and are based on the difference between the cash received and the carrying value of the related loans, less related transaction costs. Nonrefundable fees and direct costs associated with the origination of mortgage loans are deferred and recognized when the related loans are sold. Gains or losses resulting from the sale of available-for-sale securities are recognized at the trade date, based on the difference between the cash received and the amortized cost of the specific securities sold.

Service Charges and Fees —Service charges and fees consist of account maintenance fees, servicing fee income and other customer service fees. Account maintenance fees are charged to the customer either quarterly or annually and accrued as earned.

Other Revenues —Other revenues consists of stock plan administration services, payments for order flow from third party market makers, foreign exchange margin revenue and electronic communication network (“ECN”) rebate fees. Stock plan administration services are recognized in accordance with applicable accounting guidance, including SOP 97-2, Software Revenue Recognition . Payments for order flow revenues are accrued in the same period in which the related securities transactions are completed or related services are rendered. ECN rebate fees, which represent payments from ECNs for initiating order flow are recorded as earned.

Interest Income —Interest income is recognized as earned and consists of interest earned on interest-earning assets, customer margin loan balances, stock borrow balances and cash required to be segregated under regulatory guidelines and fees on customer assets invested in money market funds. Interest income includes the effect of hedges on interest-earning assets.

Interest Expense —Interest expense is recognized as incurred and consists of interest paid on interest-bearing liabilities, customer credit balances, interest paid to banks and interest paid to other broker-dealers through a subsidiary’s stock loan program. Interest expense includes the effect of hedges on interest-bearing liabilities.

New Accounting Standards

SFAS No. 123R—Share-Based Payment

In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123 (Revised 2004), Share-Based Payment. This statement supersedes APB Opinion No. 25, and its related implementation guidance. The statement establishes standards for the accounting for transactions in which an entity exchanges its equity instruments for goods and services. This statement focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. The most significant change resulting from this statement is the requirement for public companies to expense employee share-based payments under fair value as originally introduced in SFAS No. 123. This statement is effective for public companies as of the beginning of the first interim or annual reporting period that begins after June 15, 2005. The Company will adopt this statement effective July 1, 2005. The Company will adopt this statement effective July 1, 2005, and is currently evaluating the impact it will have on net income for the last half of 2005. Note 2 contains the pro forma effect on net income had the Company adopted the provisions of SFAS No. 123, for each year presented.

EITF 03-01—The Meaning of Other-Than-Temporary Impairment and its Application to Certain Issues

In March 2004, the EITF amended and ratified previous consensus reached on EITF 03-01, The Meaning of Other-Than-Temporary Impairment . This amendment, which was originally effective for financial periods beginning after June 15, 2004, introduced qualitative and quantitative guidance for determining whether securities are other-than-temporarily impaired. In September 2004, the FASB’s staff issued a number of Financial Staff Positions (“FSP”) that focused primarily upon the application of EITF 03-01 to debt securities that are impaired solely due to interest rates and/or sector spreads. Subsequently, the FASB suspended the effective date of the application of the majority of EITF 03-01 for an unspecified period, pending additional

review. In the interim, the Company continues to apply earlier authoritative accounting guidance, primarily SFAS No. 115 and EITF 99-20, to the measurement and recognition of other-than-temporary impairments of its debt and equity securities.

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

In December 2003, the Accounting Standards Executive Committee of the American Institute of Certified Public Accountants issued SOP No. 03-3, Accounting for Certain Loans or Debt Securities Acquired in a Transfer to address accounting for differences between the contractual cash flows of certain loans and debt securities and the cash flows expected to be collected when loans or debt securities are acquired in a transfer and those cash flow differences are attributable, at least in part, to credit quality. As such, SOP No. 03-3 applies to loans and debt securities purchased or acquired in purchase business combinations and does not apply to originated loans. The application of SOP No. 03-3 limits the interest income, including accretion of purchase price discounts, that may be recognized for certain loans and debt securities. Additionally, SOP No. 03-3 requires that the excess of contractual cash flows over cash flows expected to be collected (nonaccretable difference) not be recognized as an adjustment of yield or valuation allowance, such as the allowance for credit losses. Subsequent to the initial investment, increases in expected cash flows generally should be recognized prospectively through adjustment of the yield on the loan or debt security over its remaining life. Decreases in expected cash flows should be recognized as impairment. SOP No. 03-3 is effective for loans and debt securities acquired in fiscal years beginning after December 15, 2004, with early application encouraged. The impact of this new pronouncement is not expected to be material to the Company’s financial condition, results of operations, or cash flows.

NOTE 3—DISCONTINUED OPERATIONS

On June 30, 2004, the Company’s retail segment completed the sale of substantially all of the assets and liabilities of E*TRADE Access, Inc. (“E*TRADE Access”), a subsidiary of the Bank, to Cardtronics, LP and Cardtronics, Inc., for $107.0 million cash. Although the Company believes that an ATM network is an important distribution channel for its customers, it determined that its continued ownership and direct operation of the ATM network was not essential to providing this customer benefit and that the capital it had invested in this endeavor could be better applied to other operations.

The sale resulted in a $57.5 million pre-tax gain ($31.4 million after taxes). As part of the sales agreement, Cardtronics assumed substantially all of the liabilities of E*TRADE Access, including contingent liabilities that could result from litigation that was pending final resolution as of June 30, 2004. Under the sales agreement, the Company continues to retain the obligation for certain unasserted contingent liabilities that may have existed prior to the sale, primarily employment-related claims. The Company has reflected E*TRADE Access’ results of operations and financial position as discontinued operations in the consolidated financial statements for all periods reported herein.

The following table summarizes the results of discontinued operations for the periods presented (in thousands):


	Year Ended December 31,
	2004			2003			2002
Net revenues	$	20,029		$	44,909		$	38,659


Loss from discontinued operations before income taxes	$	(3,085	)	$	(2,700	)	$	(3,597	)
Income tax benefit		1,230			1,035			1,387

Loss from discontinued operations	$	(1,855	)	$	(1,665	)	$	(2,210	)

Proprietary Trading

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

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

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


	Year Ended December 31,
	2004			2003			2002
Net revenues	$	24,442		$	17,424		$	8,626


Loss from discontinued operations before income taxes	$	(9,277	)	$	(9,808	)	$	(10,165	)
Income tax benefit		(3,013	)		(4,259	)		(4,413	)

Net loss from discontinued operations	$	(6,264	)	$	(5,549	)	$	(5,752	)

Consumer Lending

On August 16, 2005, the Company’s retail segment signed an agreement to sell its recreational vehicle and marine loan origination and servicing businesses.

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

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

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


	Year Ended December 31,
	2004			2003
Net revenues	$	(5,898	)	$	47,318


Income (loss) from discontinued operations before income taxes	$	(36,630	)	$	18,912
Income tax expense (benefit)		(15,082	)		7,432

Net income (loss) from discontinued operations	$	(21,548	)	$	11,480

NOTE 4—BUSINESS COMBINATIONS

During the past three years, the Company completed several business combinations and asset acquisitions which were all accounted for under the purchase method of accounting. The results of operations of each are included in the Company’s consolidated statements of operations from the date of each acquisition.


Acquisition	Segment(s)	Purchase Consideration	Goodwill at December 31, 2004
2004
Active Accounts	Institutional	$ 17.0 million	—

2003
ETCF Asset Funding Corporation	Retail	$ 59.7 million	$ 18.9 million
Trading Relationships	Institutional	$ 11.7 million	$ 4.5 million

2002
E*TRADE Consumer Finance	Retail & Institutional	$ 1.9 billion	$ 26.7 million
Engelman	Institutional	$ 7.5 million ⁽¹⁾	—
E*TRADE Professional	Retail & Institutional	$ 96.2 million	$ 88.6 million

⁽¹⁾	Includes 1.3 million shares of common stock, $0.5 million of cash and $0.5 million of acquisitions costs.

Active Accounts

In October 2004, the Company acquired certain active accounts from a brokerage company. The Company paid $17.0 million in cash and recorded an intangible asset of $17.0 million which will be amortized over 10 years.

ETCF Asset Funding Corporation

In October 2003, the Company completed the acquisition of all of the issued and outstanding capital stock of ETCF Asset Funding Corporation, formerly Deutsche Recreational Asset Funding Corporation. This acquisition included the purchase of residual cash flow interests related to certain marine and Recreational Vehicle (“RV”) loan securitizations. The transaction was completed in connection with the E*TRADE Consumer

Finance acquisition in December 2002 (see caption titled E*TRADE Consumer Finance). The Company paid $59.7 million for ETCF Asset Funding Corporation, including $10.5 million prepaid by the Company in December 2002. This acquisition completes the final transaction contemplated under the E*TRADE Consumer Finance acquisition.

Purchase of Trading Relationships

In June 2003, the Company entered into an agreement with Tanzman, Rock and Kaban, LLC (“TRK”) whereby the Company agreed to purchase the remaining rights of TRK in the net trading profits of E*TRADE Professional Trading, LLC and TRK agreed to waive and release the Company from all claims arising out of certain actions and arrangements that occurred on or prior to the date of the Company’s purchase of E*TRADE Professional Trading, LLC in June 2002. The agreement called for the Company to make payments totaling $11.7 million, comprised of cash and common stock, over a 3-year period: $7.0 million for the release of pre-acquisition claims which the Company recorded as goodwill, $1.4 million for the return of capital that represented the remaining minority interest of TRK and $3.4 million for the purchase of TRK’s rights in the net trading profits of the business, non-compete clauses and other agreements. Additionally, the Company entered into employment agreements with Tanzman, Rock and Kaban, individually, wherein they further agreed not to compete for a period of the greater of 22 months or the term of their employment with the Company. The June 2003 agreement consummated the Company’s “step” acquisition of the proprietary trading business previously between Momentum Securities, LLC and TRK. In accordance with the “step” acquisition, the Company finalized the purchase price valuation recording $12.5 million in intangible assets, which includes the carrying value of the TRK non-compete intangible from the June 2002 purchase price valuation, and $4.5 million of additional goodwill.

E*TRADE Consumer Finance

In December 2002, the Company acquired 100% of the issued and outstanding capital stock of E*TRADE Consumer Finance, a recreational vehicle, marine and other consumer loan originator and servicer, for an aggregate of $1.9 billion. As part of this acquisition, the Company also acquired consumer loans totaling $1.9 billion. During 2003, the Company finalized its purchase price valuation with respect to its intangible assets, and recorded a $1.6 million increase in the distribution intangible asset to $7.8 million. The Company reduced goodwill by $10.5 million to reflect the refund of a prepayment made to E*TRADE Consumer Finance. This prepayment was included previously in the Company’s goodwill estimate. The Company also increased goodwill by $4.7 million, related to the relocation of the E*TRADE Consumer Finance facility, which primarily represents the tax-effected present value of the contractual lease payments for the current facility, less any projected sublease income. Using the purchase accounting method, the purchase price was allocated to the assets acquired and liabilities assumed in the E*TRADE Consumer Finance acquisition based on the estimated fair value on the purchase date.

E*TRADE Professional

In June 2002, the Company acquired Tradescape Securities, LLC, together with Tradescape Technologies, LLC, a provider of high-speed direct access trading software, technology and network services and Momentum Securities, LLC (renamed “E*TRADE Professional Trading, LLC”), a brokerage firm for professional traders (collectively, “E*TRADE Professional”). In total, the Company originally paid an aggregate of $96.2 million for these companies, composed of approximately 11.8 million shares of the Company’s common stock valued at $83.1 million, $8.2 million for the fair value of operating lease liabilities assumed by the Company and other charges of approximately $4.9 million. During the first half of 2003, the Company adjusted its purchase price allocation which resulted in an increase in the amount of goodwill of $11.9 million related to certain additional liabilities, including $7.0 million in claims that were resolved upon the 2003 purchase of trading relationships, as well as, the finalization of the valuation of certain intangibles resulting in an additional increase in goodwill of $3.1 million. Further, in 2003, the Company incurred approximately $5.5 million of non-capitalizable rebranding costs, which are included in acquisition-related costs.

NOTE 5—BROKERAGE RECEIVABLES, NET AND BROKERAGE PAYABLES

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


	December 31,
	2004		2003
Receivable from customers and non-customers (less allowance for doubtful accounts of $1,970 and $1,082)	$	2,214,210	$	1,820,161
Receivable from brokers, dealers and clearing organizations:
Net settlement and deposits with clearing organizations		158,780		128,419
Deposits paid for securities borrowed		613,546		315,789
Securities failed to deliver		11,762		2,592
Other		36,250		30,817

Total brokerage receivables, net	$	3,034,548	$	2,297,778

Payable to customers and non-customers	$	2,805,662	$	3,123,478
Payable to brokers, dealers and clearing organizations:
Deposits received for securities loaned		735,622		521,454
Securities failed to receive		10,604		4,978
Other		67,004		46,315

Total brokerage payables	$	3,618,892	$	3,696,225

Receivable from customers primarily represents credit extended to customers to finance their purchases of securities on margin, as well as commission receivables from customers upon settlement of their trades. Receivable from non-customers primarily represent credit extended to principal officers and directors of the Company to finance their purchase of securities on margin. Securities owned by customers and non-customers are held as collateral for amounts due on margin balances, the value of which is not reflected in the consolidated balance sheets. In many cases, the Company is permitted to sell or repledge these securities held as collateral and use the securities to enter into securities lending transactions, to collateralize borrowings or for delivery to counterparties to cover customer short positions. At December 31, 2004, the fair value of securities that the Company has received as collateral, where the Company is permitted to sell or repledge the securities is approximately $3,572 million. Of this amount, $1,126 million has been pledged or sold at December 31, 2004 in connection with securities loans, bank borrowings and deposits with clearing organizations.

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

NOTE 6—AVAILABLE-FOR-SALE MORTGAGE-BACKED AND INVESTMENT SECURITIES

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


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

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

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

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

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

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

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

December 31, 2003:
Mortgage-backed securities:
U.S. Government sponsored enterprise obligations:
Federal National Mortgage Association	$	2,860,218	$	453	$	(70,945	)	$	2,789,726
Government National Mortgage Association		2,339,066		—		(69,779	)		2,269,287
Federal Home Loan Mortgage Corporation		138,229		565		(3,087	)		135,707

Total U.S. government sponsored enterprise		5,337,513		1,018		(143,811	)		5,194,720
Collateralized mortgage obligations		1,965,930		4,992		(18,885	)		1,952,037
Private issuer and other		10,465		461		(294	)		10,632

Total mortgage-backed securities		7,313,908		6,471		(162,990	)		7,157,389

Investment securities:
Debt securities:
Asset-backed securities		2,000,239		26,031		(15,541	)		2,010,729
Municipal bonds		44,906		740		—			45,646
Corporate bonds		122,583		67		(6,620	)		116,030
Other debt securities		89,944		18		(6,590	)		83,372

Total debt securities		2,257,672		26,856		(28,751	)		2,255,777
Publicly traded equity securities		201,777		182,737		(1,533	)		382,981
Retained interests from securitizations		30,793		—		—			30,793

Total investment securities		2,490,242		209,593		(30,284	)		2,669,551

Total available-for-sale securities	$	9,804,150	$	216,064	$	(193,274	)	$	9,826,940

Other-Than-Temporary Impairment of Investments

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


	December 31, 2004
	Less than 12 Months					12 Months or More					Total
	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses			Fair Value		Unrealized Losses
Mortgage-backed securities:
Backed by Federal agencies	$	5,504,676	$	(85,020	)	$	2,135,727	$	(60,460	)	$	7,640,403	$	(145,480	)
Other		704,369		(6,715	)		175,678		(6,167	)		880,047		(12,882	)
Asset-backed securities		771,250		(5,851	)		20,769		(8,853	)		792,019		(14,704	)
Municipal bonds		72,146		(1,082	)		—		—			72,146		(1,082	)
Corporate bonds		—		—			84,515		(3,444	)		84,515		(3,444	)
Other debt-securities		—		—			74,700		(4,767	)		74,700		(4,767	)
Publicly traded equity securities		52,717		(2,055	)		—		—			52,717		(2,055	)

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


	December 31, 2003
	Less than 12 Months				12 Months or More				Total
	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
Mortgage-backed securities:
Backed by Federal agencies	$	4,936,947	$	137,227	$	205,167	$	6,584	$	5,142,114	$	143,811
Other		1,140,248		13,448		215,459		5,731		1,355,707		19,179
Asset-backed securities		239,808		3,387		63,585		12,154		303,393		15,541
Corporate bonds		429		39		104,755		6,581		105,184		6,620
Publicly traded equity securities		19,467		1,533		—		—		19,467		1,533
Other investments		78,730		6,581		1,644		9		80,374		6,590

Total temporarily impaired securities	$	6,415,629	$	162,215	$	590,610	$	31,059	$	7,006,239	$	193,274

The Company regularly analyzes certain available-for-sale investments for other-than-temporary impairment when the fair value of the investment is lower than its book value. The Company’s methodology for determining impairment involves projecting cash flows relating to each investment and using assumptions as to future prepayment speeds, losses and loss severities over the life of the underlying collateral pool. Assumptions about future performance are derived from the actual performance to date and the Company’s view on how the collateral will perform in the future. In projecting future performance, the Company incorporates the views of industry analysts, rating agencies and the management of the issuer, along with its own independent analysis of the issuer of the securities, the servicer, the economy and the relevant sector as a whole. If the Company determines impairment is other-than-temporary, it reduces the recorded book value of the investment by the amount of the impairment and recognizes a realized loss on the investment. The Company does not, however, adjust the recorded book value for declines in fair value that it believes are temporary. The Company has the intent and ability to hold these securities for the foreseeable future and has not made the decision to dispose of these securities as of December 31, 2004. Management continues to monitor and evaluate these securities closely for impairment that is other-than-temporary.

Mortgage- and asset-backed securities that both have an unrealized loss and are rated below “AA” by at least half of the agencies that rate the securities, as well as interest-only securities that have unrealized losses, are evaluated for impairment in accordance with EITF 99-20. Accordingly, when the present value of a security’s anticipated cash flows declines below the last periodic estimate, the Company recognizes an impairment charge in gain on sales of loans and securities, net in the consolidated statements of operations.

Based on its evaluation, the Company recorded an other-than-temporary charge of $14.0 million for 2004, for its asset- and mortgage-backed securities and interest-only securities. The Company also recognized $4.4 million of other-than-temporary impairments for 2004, from retained beneficial interests in securitized receivables held by a subsidiary, ETCF Asset Funding Corporation.

Publicly Traded Equity Securities

Publicly traded equity securities include investments in preferred stock of Fannie Mae, Freddie Mac, Softbank investment Corporation (“SBI”) and Archipelago Holdings, Incorporated (“Archipelago”). Fair value of Fannie Mae was $187.6 million and $136.3 million at December 31, 2004 and 2003, respectively, with an unrealized loss of $0.7 million and an unrealized gain of $1.3 million, in 2004 and 2003, respectively. Fair value of Freddie Mac was $87.0 million and $24.6 million at December 31, 2004 and 2003, respectively, with an unrealized gain of $1.1 million and an unrealized loss of $1.4 million, in 2004 and 2003, respectively. Fair value of SBI was $78.6 million and $216.8 million at December 31, 2004 and 2003, with unrealized gains of $66.3 million and $178.4 million respectively. Fair value of Archipelago was $11.3 million at December 31, 2004 with unrealized gain of $5.6 million. During 2004 and 2003, the Company recognized gains of $130.6 million and $151.7 million, respectively on sales of SBI, reducing its ownership from 9.07% to 2.93%.

Contractual Maturities

The contractual maturities of available-for-sale debt securities, including mortgage-backed securities, at December 31, 2004 are shown below (in thousands):


	Amortized Cost		Estimated Fair Values
Due within one year	$	61	$	56
Due within one to five years		47,695		47,824
Due within five to ten years		235,653		231,702
Due after ten years		12,015,443		11,865,524

Total	$	12,298,852	$	12,145,106

The Company pledged $10.1 billion at December 31, 2004 and $5.7 billion at December 31, 2003 of mortgage-backed securities as collateral for repurchase agreements, short-term borrowings, derivative instruments and FHLB advances.

Realized Gains (Losses)

Realized gains and losses from the sales and other-than-temporary impairment of available-for-sale investment securities, including mortgage-backed securities, are as follows (in thousands):


	Year Ended December 31,
	2004			2003			2002
Mortgage-backed securities:
Realized gains	$	105,876		$	138,781		$	90,693
Realized losses		(47,785	)		(47,046	)		(24,014	)
Impairment on purchased interest-only securities		(12,400	)		—			(16,603	)

Net realized gains on mortgage-backed securities included in gain on sales of loans and securities, net	$	45,691		$	91,735		$	50,076

Other bank investments:
Realized gains	$	17,801		$	22,951		$	6,586
Realized losses		(4,459	)		(6,300	)		(1,827	)
Impairment on asset-backed securities		(1,558	)		(2,198	)		—

Net realized gains included in gain on sales of loans and securities, net	$	11,784		$	14,453		$	4,759

Corporate investments:
Realized gains ⁽¹⁾	$	134,679		$	171,653		$	144
Realized losses		(2,145	)		(15,471	)		(3,582	)
Impairment charges ⁽²⁾		—			(209	)		—

Net realized gains (losses) included in gain (loss) on sale and impairment of investments	$	132,534		$	155,973		$	(3,438	)

⁽¹⁾	The 2004 amount includes dividend income of $2.3 million.

⁽²⁾	The 2003 amount represents other-than-temporary declines in the value of certain available-for-sale corporate investments.

NOTE 7—OTHER INVESTMENTS

Other investments are composed of equity method and other investments. Investments in entities in which the Company owns between 20% and 50% or has the ability to exercise significant influence are generally accounted for using the equity method. Investments in securities in which there is a less than 20% ownership and the Company does not exercise significant influence are carried at cost.

The carrying amounts of other investments are shown below (in thousands):


	December 31,
	2004		2003
Joint ventures	$	17,573	$	16,386
Venture capital funds		23,901		20,168
Other investments		4,795		12,718

Total other investments	$	46,269	$	49,272

Equity Method Investments

Equity in the net income (losses) of investments and venture funds were as follows (in thousands):


	Year Ended December 31,
	2004			2003			2002
Joint Ventures:
KAP Group	$	10,272		$	14,584		$	9,934
E*TRADE Japan K.K.		—			203			(869	)
Other		(156	)		(15	)		(64	)

Total joint ventures		10,116			14,772			9,001

Venture Capital Funds:
E*TRADE eCommerce Fund I		268			(756	)		(4,053	)
ArrowPath Fund II		(1,314	)		(1,348	)		272
Other funds		(4,602	)		(3,536	)		(5,902	)

Total venture capital funds		(5,648	)		(5,640	)		(9,683	)

Total recognized in equity in income (losses) of investments and venture funds	$	4,468		$	9,132		$	(682	)

Losses from the sales and other-than-temporary impairment of equity method and other investments were as follows (in thousands):


	Year Ended December 31,
	2004			2003			2002
Impairment of privately held equity investments	$	(60	)	$	(8,006	)	$	(12,549	)
Other		(4,371	)		—			(4,315	)

Net recognized losses included in gain (loss) on sale and impairment of investments	$	(4,431	)	$	(8,006	)	$	(16,864	)

Joint Venture

KAP Group — At December 31, 2004 , the Company has a 31% ownership in KAP Group with a carrying amount of $8.5 million that is accounted for under the equity method. KAP Group has invested substantially all of its assets in two other entities, which were formed for the purpose of engaging in electronic options trading. KAP Group investors include two members of the Company’s Board of Directors. Beginning in 2002, the Company has received distributions from KAP Group in proportion to its ownership of shares totaling $13.8 million in 2004, $4.7 million in 2003 and $8.2 million in 2002.

Venture Capital Funds

The Company has investments in E*TRADE eCommerce Fund I (“Fund I”) and ArrowPath Fund II (“Fund II”). The Company is a non-managing member of each fund and their general partners. The Company’s former CEO and former Chief Strategic Investment Officer are managing members of the general partner of each fund. At December 31, 2004, the Company’s remaining capital commitment was $0.4 million to Fund I and $29.8 million to Fund II.

The Company also has limited partnership interests in three other unrelated venture capital funds, including one sponsored by SOFTBANK Corp. (“SOFTBANK”). At December 31, 2004, the Company had funding commitments to these funds totaling $1.1 million.

Other Investments

The Company has also made investments in non-public, venture capital-backed, high technology companies. These investments represent less than 20% of the outstanding shares of these companies and are accounted for under the cost method. The Company does not have the ability to exercise significant influence over these companies. The Company recorded no other-than-temporary impairments for 2004, $8.0 million for 2003 and $12.5 million for 2002, associated with these privately held equity investments. These impairments are recorded in gain (loss) on sale and impairment of investments in the consolidated statements of operations. Each quarter, the Company evaluates its privately held investments using factors that aid in the identification of possible other-than-temporary impairments. These factors include evaluating, as available, the cash flows and profitability of the investee, general economic conditions, trends in the investee’s industry and trends in publicly traded peers of the investee.

NOTE 8—LOANS RECEIVABLE, NET

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


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

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

Consumer and other loans:
Recreational vehicle		2,542,645			23,284		2,565,929
Marine		720,513			3,612		724,125
Automobile		583,354			35		583,389
Credit card		203,169			—		203,169
Other		19,493			1,962		21,455

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

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

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


	December 31, 2003
	Held-for- Investment			Held-for- Sale		Total Loans
Real estate loans:
One- to four-family	$	2,289,196		$	966,334	$	3,255,530
Home equity lines of credit and second mortgage		1,511,452			315		1,511,767
Other		12,351			97		12,448

Total real estate loans		3,812,999			966,746		4,779,745

Consumer and other loans:
Recreational vehicle		2,263,606			21,845		2,285,451
Marine		625,484			2,491		627,975
Automobile		1,162,339			—		1,162,339
Credit card		113,434			—		113,434
Other		15,956			262		16,218

Total consumer and other loans		4,180,819			24,598		4,205,417

Total loans		7,993,818			991,344		8,985,162
Unamortized premiums, net		174,935			9,143		184,078
Allowance for loan losses		(37,847	)		—		(37,847	)

Total	$	8,130,906		$	1,000,487	$	9,131,393

In addition to these loans receivable, net, the Company had commitments to originate, buy and sell loans at December 31, 2004 (see Note 26).

Approximately 45% and 42% of the Company’s real estate loans were concentrated in California at December 31, 2004 and 2003, respectively. No other state had concentrations of real estate loans that represented 10% or more of the Company’s real estate portfolio.

The following table shows the percentage of adjustable and fixed-rate loans in the Company’s portfolio (dollars in thousands):


	December 31, 2004				December 31, 2003
	$ Amount		% of Loans		$ Amount		% of Loans
Adjustable rate loans:
Real estate	$	6,839,796	58.79	%	$	3,317,262	36.92	%
Credit card and other		206,039	1.77			113,434	1.26

Total adjustable rate loans		7,045,835	60.56			3,430,696	38.18
Fixed rate loans		4,588,254	39.44			5,554,466	61.82

Total loans	$	11,634,089	100.00	%	$	8,985,162	100.00	%

The weighted-average remaining maturity of mortgage loans secured by one- to four-family residences was 340 months and 334 months at December 31, 2004 and 2003, respectively. Additionally, all mortgage loans outstanding at December 31, 2004 and 2003 in the held-for-investment portfolio were serviced by other companies.

The Company actively sells loans originated by the Bank and correspondents. From time-to-time, the Company also sells loans that it originally purchased from others. A summary of these activities is presented below (in thousands):


	Year Ended December 31,
	2004			2003		2002
Loans sold:
Correspondent	$	2,395,886		$	4,114,563	$	6,011,964
Origination	$	4,339,901		$	9,401,248	$	5,999,900
Gain (loss) on sales of loans:
Correspondent loan sales	$	(3,447	)	$	186	$	26,104
Origination loan sales	$	71,561		$	192,467	$	128,506

The following is the relative breakout of nonperforming loans (in thousands):


	December 31,
	2004		2003
First mortgage loans, secured by one- to four-family residences	$	11,029	$	18,094
Home equity lines of credit and second mortgage		2,755		269
Recreational vehicle		1,416		1,399
Marine		908		1,067
Automobile		826		1,602
Credit card		2,999		2,147
Other		22		16

Total nonperforming loans	$	19,955	$	24,594

Interest income is not accrued for loans classified as nonperforming and any income accrued through the initial 90-day delinquency is reversed. We classify loans as nonperforming whenever principal or interest payments are more than 90 days past due or when we have reason to believe the loan is uncollectible. Had these loans been current at December 31, 2004, the Company would have recognized $1.0 million, $1.1 million and $1.4 million of additional income in 2004, 2003 and 2002, respectively. During 2004, the Company recognized $1.3 million of interest on loans that were in nonperforming status at December 31, 2004. At December 31, 2004, there were no commitments to lend additional funds to any of these borrowers.

Activity in the allowance for loan losses is summarized as follows (in thousands):


	Year Ended December 31,
	2004			2003			2002
Allowance for loan losses, beginning of year	$	37,847		$	27,666		$	19,874
Provision for loan losses		38,121			38,523			14,664
Acquired through acquisitions		1,547			2,748			14,428
Charge-offs		(50,341	)		(53,734	)		(31,962	)
Recoveries		20,507			22,644			10,662

Allowance for loan losses, end of year	$	47,681		$	37,847		$	27,666

At December 31, 2004 and 2003, the Company had $15.3 million and $3.0 million of impaired loans, respectively, which consist primarily of loans secured by one- to four-family residences. The average recorded investment was $15.4 million for 2004 and $2.5 million for 2003.

NOTE 9—SERVICING RIGHTS

Included in other assets, in the consolidated balance sheets are servicing assets which are recognized when the Company sells a loan and retains the related servicing rights. The servicing right is initially recorded at its allocated cost basis based on the relative fair value of the loan sold and the servicing retained at the date of the sale in accordance with SFAS No. 140. The fair value of the servicing retained is estimated based on market quotes for similar servicing assets. Servicing assets are amortized in proportion to and over the period of estimated net servicing income. The Company measures impairment by stratifying the servicing assets, based on the characteristics of the underlying loans and by interest rates. Impairment is recognized through a valuation allowance for each stratum. The valuation allowance is adjusted to reflect the excess of the servicing assets’ cost basis for a given stratum over its fair value. Any fair value in excess of the cost basis of servicing assets for a given stratum is not recognized. The Company estimates the fair value of each stratum based on an industry standard present value of cash flows model. The Company recognizes both amortization of servicing rights and impairment charges in service charges and fees in the consolidated statements of operations.

The following table shows the net amortized cost of the Company’s servicing rights (in thousands):


	December 31,
	2004			2003
Servicing assets:
Balance beginning of period	$	32,773		$	27,235
Additions resulting from acquisition		4,614			16,010
Amortization of servicing rights		(7,728	)		(10,472	)

Balance end of period		29,659			32,773

Valuation allowance for impairment:
Balance beginning of period		(5,379	)		(583	)
Valuation adjustment		(2,767	)		(4,796	)

Balance end of period		(8,146	)		(5,379	)

Servicing rights, end of period	$	21,513		$	27,394

The most important assumptions used in determining the estimated fair value are anticipated loan prepayments and discount rates. The Company uses market-based assumptions and confirms the reasonableness of the Company’s valuation model through management’s quarterly review, analyses of market quotes and independent broker valuations of the fair value of the servicing rights.

The following summarizes the estimated fair values of the Company’s servicing assets and significant assumptions (dollars in thousands):


	December 31,
	2004	2003
Mortgage servicing assets:
Fair value	$14,761	$21,111
Constant prepayment rate	23%	18%
Discount rate	1.0% - 1.5%	4.0% - 4.5%

Consumer servicing assets:
Fair value	$6,752	$6,283
Constant prepayment rate	21% - 24%	26% - 27%
Discount rate	8%	8%

NOTE 10—PROPERTY AND EQUIPMENT, NET

Property and equipment, net consists of the following (in thousands):


	December 31,
	2004			2003
Equipment and transportation	$	240,517		$	193,723
Software		331,774			293,618
Leasehold improvements		88,066			77,991
Buildings		71,927			73,827
Land		3,428			7,233
Furniture and fixtures		14,340			9,080

Total property and equipment, gross		750,052			655,472
Less accumulated depreciation and amortization		(447,761	)		(368,375	)

Total property and equipment, net	$	302,291		$	287,097

Depreciation and amortization expense related to property and equipment was $82.9 million for 2004, $89.5 million for 2003 and $104.8 million for 2002.

Included in equipment and transportation, software, buildings and furniture and fixtures, are capital leases (gross), of $3.6 million at December 31, 2004 and $13.5 million December 31, 2003. Total accumulated amortization of these leases was $3.5 million at December 31, 2004 and $7.4 million at December 31, 2003.

Software includes capitalized internally developed software costs. These costs were $31.8 million for 2004, $41.8 million for 2003 and $34.0 million for 2002. Completed projects are carried at cost and are amortized on a straight-line basis over their estimated useful lives, generally four years. Amortization expense for the capitalized amounts was $33.7 million for 2004, $29.3 million for 2003 and $30.1 million for 2002. Also included in software is $15.1 million of internally developed software in the process of development for which amortization has not begun.

NOTE 11—GOODWILL AND OTHER INTANGIBLES, NET

On January 1, 2002, the Company adopted SFAS No. 142, Goodwill and Other Intangible Assets . Upon initial adoption, the Company stopped amortizing goodwill, identified its reporting units based on its current segment reporting structure and allocated all recorded goodwill, as well as other assets and liabilities, to the reporting units. The Company then determined the fair value of its reporting units using discounted cash flow models and relative market multiples for comparable businesses. The Company compared each reporting unit’s fair value to its carrying value. This initial evaluation indicated that goodwill was impaired, resulting in a non-cash charge totaling $293.7 million ($(0.82) per share). This charge was recorded as a cumulative effect of accounting change. In November 2003 and 2004, the Company performed its annual impairment tests, resulting in no additional impairment.

The following table discloses the changes in the carrying value of goodwill and intangibles with indefinite lives that occurred in the brokerage and banking segments subsequent to the initial impairment (in thousands):


	Brokerage ⁽¹⁾			Banking ⁽¹⁾			Total
Balance at December 31, 2001	$	149,116		$	114,554		$	263,670
Additions from 2002 acquisitions		87,483			33,991			121,474

Balance at December 31, 2002		236,599			148,545			385,144
Additions from 2003 acquisitions		—			9,394			9,394
Write-offs related to the 2003 Restructuring Plan		(1,433	)		—			(1,433	)
Adjustments to 2002 acquisitions		14,997			(5,606	)		9,391

Balance at December 31, 2003		250,163			152,333			402,496
Write-offs related to disposition of E*TRADE Access		—			(9,651	)		(9,651	)

Adjusted balance at December 31, 2003		250,163			142,682			392,845
Adjustments to 2002 acquisitions		(9,409	)		(2,451	)		(11,860	)
Adjustments to 2003 acquisitions		—			15,490			15,490
Other adjustments		(1,432	)		—			(1,432	)

Balance at December 31, 2004	$	239,322		$	155,721		$	395,043

⁽¹⁾

The presentation of Brokerage and Banking segments are based on the Company’s reporting unit structure that was used to evaluate goodwill impairment as of December 31, 2004. As a result of change in segments in 2005, discussed in Note 31, the Company will revise its reporting units for its 2005 annual impairment evaluation.

During 2004, the Company finalized certain contingencies related to its acquisition of ETCF Asset Funding Corporation. When this business was acquired, the Company recorded deferred tax assets based on management’s best estimate of the tax basis that would be accepted by the tax authority upon ultimate settlement. In 2004, management’s best estimate of the ultimate tax basis was modified and the Company recorded a $15.8 million adjustment to deferred tax assets to reflect the revised tax basis. In accordance with EITF 93-7, Uncertainties Related to Income Taxes in a Purchase Business Combination , the adjustment was applied as an increase to the balance of goodwill attributable to that acquisition. Adjustments to goodwill in 2004 relating to the Company’s 2002 and 2003 acquisitions, were primarily related to changes in effective tax rates resulting in a corresponding adjustment to their related deferred tax liabilities.

Other intangible assets with finite lives, which are primarily amortized on a straight-line basis, consist of the following (dollars in thousands):


	Weighted- Average Useful Life (Years)	December 31, 2004							December 31, 2003
	Weighted- Average Useful Life (Years)	Gross Amount		Accumulated Amortization			Net Amount		Gross Amount		Accumulated Amortization			Net Amount
Specialist books	28	$	61,820	$	(8,522	)	$	53,298	$	59,800	$	(5,891	)	$	53,909
Active accounts ⁽¹⁾	8		69,023		(36,121	)		32,902		53,077		(30,027	)		23,050
Credit cards ⁽¹⁾	15		32,672		(4,981	)		27,691		16,006		(1,817	)		14,189
Deposit intangibles ⁽¹⁾	3		15,188		(14,411	)		777		15,188		(9,898	)		5,290
Proprietary agreements ⁽²⁾	7		11,600		(9,806	)		1,794		11,600		(4,967	)		6,633
Customer list ⁽¹⁾	7		10,248		(5,189	)		5,059		10,464		(3,079	)		7,385
Distribution ⁽²⁾	9		7,800		(1,486	)		6,314		7,800		(798	)		7,002
Agency relationships	6		6,300		(2,713	)		3,587		6,300		(1,663	)		4,637
Trader relationships ⁽¹⁾⁽²⁾	4		3,300		(1,653	)		1,647		3,300		(763	)		2,537
Other	2		2,671		(1,619	)		1,052		2,616		(1,216	)		1,400

Total		$	220,622	$	(86,501	)	$	134,121	$	186,151	$	(60,119	)	$	126,032

⁽¹⁾	Amortized using an accelerated method.

⁽²⁾	Some of these intangibles are associated with discontinued operations discussed in Notes 3 and 31.

Amortization expense of other intangible assets was $26.9 million for 2004, $30.1 million for 2003 and $22.2 million for 2002. Assuming no future impairments of these assets or additional acquisitions, annual amortization expense will be as follows (in thousands):


Years ending December 31,
2005	$	22,152
2006		15,698
2007		13,928
2008		10,464
2009		7,196
Thereafter		64,683

Total future amortization expense	$	134,121

NOTE 12—OTHER ASSETS

Other assets consist of the following (in thousands):


	December 31,
	2004		2003
Securities sold collateral not delivered	$	53,152	$	46,514
Deferred tax assets		41,119		84,544
Servicing rights		21,513		27,394
Deferred compensation plan		11,974		7,929
Other		81,520		140,829

Total other assets	$	209,278	$	307,210

Receivables for Bank Securities Sold, Collateral Not Delivered

The Bank has receivables for mortgage-backed securities from third-party brokers that the Bank committed to sell, but did not deliver to the brokers by the settlement date. The Bank was unable to deliver the securities primarily because other parties failed to deliver similar securities to the Bank, which the Bank had committed to buy.

NOTE 13—ASSET SECURITIZATION

Collateralized Debt Obligations

In 2004, 2003 and 2002, E*TRADE Global Asset Management (“ETGAM”) transferred asset-backed securities to E*TRADE ABS CDO III, Ltd. (“CDO III”), E*TRADE ABS CDO II, Ltd. (“CDO II”) and E*TRADE ABS CDO I, Ltd. (“CDO I”), respectively. The Bank also transferred asset-backed securities to CDO II and an unrelated financial advisor transferred asset-backed securities to CDO I and CDO III. Concurrent with these transfers, the respective CDOs sold beneficial interests to independent investors in the form of senior and subordinated notes and preference shares, collateralized by the asset-backed securities. Neither the CDOs themselves nor the investors in the beneficial interests sold by the CDOs have recourse to ETGAM or the Company. Each of the CDOs are qualifying special purpose entities, as defined in SFAS No. 140, and, as such, are not required to be consolidated in the Company’s consolidated financial statements. ETGAM purchased preference shares in each of the CDOs. ETGAM’s retained interests are subordinate to the notes sold by each CDO and on an equal standing with the preference shares purchased by other preference share investors in CDO I, CDO II and CDO III.

The following table summarizes the asset-backed securities transferred to each CDO, the amount of the cash proceeds, the preference shares purchased by ETGAM and the current rating for those preference shares (dollars in millions):

Transaction Date

Asset-Backed Securities

Transferred to CDO

Proceeds