eTrade 2002 Annual Report Download - page 45

Table of Contents
Index to Financial Statements
Corporation. These securities are backed by loans and receivables from multiple underlying obligors and are not direct obligations of Metris
Companies or Conseco Incorporated. As of December 31, 2002, the market values of these securities were $4.7 million and $21.3 million,
respectively. We performed a detailed credit and cash flow analysis of the underlying assets in each of these securities and do not believe this
decline in market value represents an other-than-temporary impairment. We intend to hold these securities for the foreseeable future and
continue to monitor any developments related to the cash flows associated with these securities.
We have investments in several publicly-traded and privately-held companies. Generally accepted accounting principles require that we
evaluate our investments in these companies for declines in market value which we believe are other-than-temporary. Our policy is to recognize
such declines when the market value of a company’ s stock remains below our cost for a period of six months, unless recognized sooner based
on other indicators. During fiscal 2002, we recognized losses of $12.5 million from declines in market value which we determined to be
other-than-temporary related to investments in privately-held companies. See Note7 to the Consolidated Financial Statements for further
information. As of December 31, 2002, certain of the publicly-traded equity securities which we held had unrecognized losses of $0.7 million,
which we believe to be temporary and consequently, we have not included these losses in the computation of our earnings.
We have made significant investments in venture capital funds, which invest in privately-held companies. Generally accepted accounting
principles require venture capital funds to adjust their investments in publicly-traded and privately-held companies to reflect current market
values each period. Because we account for our investments in these funds under the equity method, our earnings are impacted by the portion of
market value changes allocated to us. The determination of market value for privately-held companies requires significant judgment on the part
of the fund managers. The general practice in the venture capital industry is to record an increase in fair value only when it is supported by a
third-party transaction, such as a sale of stock to an unrelated investor. Decreases in fair value are generally recognized upon a similar event, or
sooner if general market conditions or company-specific events indicate there has been a decline in value. During fiscal 2002, we recorded
losses of $9.7million on our venture fund investments.
Valuation and accounting for financial derivatives
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. One of the most significant risks arises because the principal investments of the Bank are residential mortgages
and mortgage-backed securities, which often pay a fixed interest rate over an extended period of time; however, the principal source of funds
used to make these investments are customer deposits and other short-term borrowings whose interest rates are fixed for a much shorter period
of time, if at all. In order to manage this difference in short-term and long-term interest rates, the Bank purchases interest rate derivatives,
including interest rate swaps, caps and floors.
Under generally accepted accounting principles, all derivatives must be reflected in the balance sheet at their estimated fair market value.
Accounting for derivatives differs significantly depending on whether or not a derivative is designated as a “hedge.” In order to qualify as a
hedge, management must designate a derivative as a hedge or a transaction intended to reduce a risk associated with a specific balance sheet
item or future expected cash flow at the time it is purchased, as well as continue to demonstrate that the instrument effectively hedges or reduces
a risk associated with that item. We designated substantially all of our derivatives held as of December31, 2002 as hedges. By doing so, the
balance sheet items that we determine are hedged in fair value hedge relationships are adjusted to market value as well as the derivative itself,
resulting in a net offset in the statements of operations to the extent that the hedge is effective. The effective portion of the gains and losses on
cash flow hedges are recognized initially as a component of accumulated other comprehensive income and are recognized in earnings as a yield
adjustment as the hedged forecasted transactions affect earnings. The assessment as to whether a derivative instrument will continue to meet the
effectiveness requirements of generally accepted accounting principles requires assumptions and judgment about the continued effectiveness of
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2003. EDGAR Online, Inc.