eTrade 2005 Annual Report Download - page 82

Table of Contents
losses based on market conditions and other factors. Other-than-temporary impartment is recorded based on management judgment.
Management evaluates securities based on market conditions and all available information about the issuer or underlying collateral.
This information is used to determine if impairment is other-than-temporary. The determination that impairment is other-than-temporary
is judgmental. Based on the facts and circumstances, companies could have different conclusions regarding when securities are
other-than-temporarily impaired. Impairment of mortgage-backed or asset-backed securities is recognized when management estimates
the fair value of a security 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 meets both criterion, we write the security down to fair value in the current period. We assess
securities for impairment at each reported balance sheet date.
Effects if Actual Results Differ
Earnings could be influenced by the timing of management’s decisions to recognize a security as other-than-temporarily impaired. Our
estimates are based on the best available information. Over time additional information may become available and may influence future
write-downs. If all securities with fair values lower than amortized book were written-down, a $302.4 million charge would occur.
Management believes that its estimates of other-than-temporary impairment are supportable and reasonable. See Note 6 to the
Consolidated Financial Statements for additional information regarding securities.
Valuation and Accounting for Financial Derivatives
Description
The Bank’s principal assets are residential mortgages and mortgage-backed securities, which typically pay a fixed interest rate over an
extended period of time. However, the principal sources of funds for the Bank are customer deposits and other short-term borrowings
with interest rates that are fixed for a shorter period of time, if at all. The Bank purchases interest rate derivatives, including interest rate
swaps, caps and floors, to manage this difference between long-term and short-term interest rates and to convert fixed-rate assets or
liabilities to variable rates.
Accounting for derivatives differs significantly depending on whether a derivative is designated as a “hedge,” which is a transaction
intended to reduce a risk associated with a specific balance sheet item or future expected cash flow. In order to qualify for hedge
accounting treatment, documentation must indicate the intention to designate the derivative as a hedge of a specific asset or liability or
a future cash flow. Effectiveness of the hedge must be monitored over the life of the derivative. Substantially all derivatives held on
December31, 2005 were designated as hedges. As of December31, 2005, we had derivative assets of $152.5 million and derivative
liabilities of $38.1 million. As of December31, 2004, we had derivative assets of $115.9 million and derivative liabilities of $52.2 million.
Judgments
Hedge accounting is very complex and involves the interpretation of a vast amount of accounting literature. From time to time, new
interpretations are issued, which result in new accounting methods applied to existing and new transactions. The implementation of
SFAS No.133 involves numerous judgments and Company-level interpretations. We must make assumptions and judgments about the
continued effectiveness of our hedging strategies and the nature and timing of forecasted transactions. Judgment is necessary to
determine the accounting for our hedging strategies.
Effects if Actual Results Differ
If our hedging strategies were to become significantly ineffective or our assumptions about the nature and timing of forecasted
transactions were to be inaccurate, we could no longer apply hedge accounting and our
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