eTrade 2008 Annual Report Download - page 113

• Level 3—Unobservable inputs that are significant to the fair value of the assets or liabilities. Examples
of assets and liabilities utilizing significant Level 3 inputs or those that require significant management
judgment as of December 31, 2008 include certain CMOs, servicing rights and certain derivatives. In
certain securities, including a portion of the CMO portfolio, where there has been limited activity or
less transparency around inputs to the valuation, securities are classified as Level 3 even though the
Company believes that Level 2 inputs could likely be obtainable in a more active market.
The availability of observable inputs can vary from instrument to instrument and in certain cases, the inputs
used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, an instrument’s
level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value
measurement. The Company’s assessment of the significance of a particular input to the fair value measurement
of an instrument requires judgment and consideration of factors specific to the instrument.
Recurring Fair Value Measurement Valuation Techniques
The fair value for certain financial instruments is derived using pricing models and other valuation
techniques that involve significant management judgment. The price transparency of financial instruments is a
key determinant of the degree of judgment involved in determining the fair value of the Company’s financial
instruments. Financial instruments for which actively quoted prices or pricing parameters are available will
generally have a higher degree of price transparency than financial instruments that are thinly traded or not
quoted. In accordance with SFAS No. 157, the criteria used to determine whether the market for a financial
instrument is active or inactive is based on the particular asset or liability. For equity securities, the Company’s
definition of actively traded was based on average daily volume and other market trading statistics. The
Company considered the market for other types of financial instruments, including certain CMOs, to be inactive
as of December 31, 2008. As a result, the valuation of these financial instruments included significant
management judgment in determining the relevance and reliability of market information available. The
Company considered the inactivity of the market to be evidenced by several factors, including decreased price
transparency caused by decreased volume of trades relative to historical levels.
Mortgage-backed Securities Backed by U.S. Government Sponsored and Federal Agencies
Mortgage-backed securities backed by U.S. Government sponsored and federal agencies include TBA
securities and mortgage pass-through certificates. The fair value of mortgage-backed securities backed by U.S.
Government sponsored and federal agencies is determined using quoted market prices, recent market transactions
and spread data for similar instruments. Mortgage-backed securities backed by U.S. Government sponsored and
federal agencies are generally categorized in Level 2 of the fair value hierarchy.
Collateralized Mortgage Obligations
CMOs, generally non-agency mortgage-backed securities, are typically valued using market observable
data, when available, including recent external market transactions for similar instruments. The Company also
utilized a pricing service to corroborate the market observability of the Company’s inputs used in the fair value
measurements. The valuations of CMOs reflect the Company’s best estimate of what market participants would
consider in pricing the financial instruments. The Company considers the price transparency for these financial
instruments to be a key determinant of the degree of judgment involved in determining the fair value. Due to the
limited activity and low level of transparency around inputs to their valuation, a portion of these securities are
classified as Level 3 even though the Company believes that Level 2 inputs could likely be obtainable in a more
active market.
Investment Securities
As of December 31, 2008, investment securities include municipal bonds and corporate bonds. For
municipal bonds, the Company utilized recent market transactions for identical or similar bonds to corroborate
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