eTrade 2007 Annual Report Download - page 57

Allowance for Loan Losses
The allowance for loan losses is management’s estimate of credit losses inherent in our loan portfolio as of
the balance sheet date. The estimate of the allowance for loan losses is based on a variety of factors, including the
composition and quality of the portfolio; delinquency levels and trends; probable expected losses for the next
twelve months; current and historical charge-off and loss experience; current industry charge-off and loss
experience; the condition of the real estate market and geographic concentrations within the loan portfolio; the
interest rate climate; the overall availability of housing credit; and general economic conditions. Determining the
adequacy of the allowance is complex and requires judgment by management about the effect of matters that are
inherently uncertain. Subsequent evaluations of the loan portfolio, in light of the factors then prevailing, may
result in significant changes in the allowance for loan losses in future periods. We believe our allowance for loan
losses at December 31, 2007 is representative of probable losses inherent in the loan portfolio at the balance
sheet date.
In determining the allowance for loan losses, we allocate a portion of the allowance to various loan products
based on an analysis of individual loans and pools of loans. However, the entire allowance is available to absorb
credit losses inherent in the total loan portfolio as of the balance sheet date.
The following table presents the allowance for loan losses by major loan category (dollars in thousands):
One- to Four-Family Home Equity Consumer and Other Total
Allowance
Allowance
as a %
of Loans
Receivable(1) Allowance
Allowance
as a %
of Loans
Receivable(1) Allowance
Allowance
as a %
of Loans
Receivable(1) Allowance
Allowance
as a %
of Loans
Receivable(1)
December 31, 2007 $18,831 0.12% $459,167 3.79% $30,166 1.05% $508,164 1.66%
December 31, 2006 $ 7,760 0.07% $ 31,671 0.26% $28,197 0.82% $ 67,628 0.26%
(1) Allowance as a percentage of loans receivable is calculated based on the gross loans receivable for each respective category.
During the year ended December 31, 2007, the allowance for loan losses increased by $440.5 million from
the level at December 31, 2006. This increase was driven primarily by the increase in the allowance allocated to
the home equity loan portfolio, which deteriorated significantly during the second half of 2007. We believe this
deterioration was caused by several factors, which are described below. First, the combined impact of rising
mortgage interest rates and home price depreciation in key markets contributed to the declining performance of
our home equity loan portfolio. Second, concerns that began in the sub-prime mortgage loan market spread to the
broader credit markets beginning in the second half of 2007, resulting in a significant deterioration in the overall
credit markets. This deterioration led to a dramatic tightening of lending standards across the industry, and
general liquidity pressure for many mortgage lenders, some of whom ultimately ceased operations as a result.
The factors described above dramatically reduced the ability of borrowers to refinance their mortgage loans,
specifically their home equity loans, therefore drastically increasing the risk of loss once a loan becomes
delinquent. During the second half of 2007, we also observed a decline in the percentage of delinquent loans that
cure prior to charge-off or foreclosure once they have become delinquent. We attribute this change in behavior to
the factors described above, which have significantly limited borrowers’ alternatives to avoid defaulting on their
loans. In addition, because of the likely decline in value of the homes collateralizing our home equity loans, our
ability to recover our investment by foreclosing on the underlying properties has diminished as well.
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