eTrade 2008 Annual Report Download - page 68

SUMMARY OF CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Our discussion and analysis of our financial condition and results of operations are based on our
consolidated financial statements, which have been prepared in conformity with accounting principles generally
accepted in the United States of America. Note 1—Organization, Basis of Presentation and Summary of
Significant Accounting Policies to the consolidated financial statements contains a summary of our significant
accounting policies, many of which require the use of estimates and assumptions. We believe that of our
significant accounting policies, the following are noteworthy because they are based on estimates and
assumptions that require complex, subjective judgments by management, which can materially impact reported
results. Changes in these estimates or assumptions could materially impact our financial condition and results of
operation.
Allowance for Loan Losses
Description
The allowance for loan losses is management’s estimate of probable losses inherent in our loan portfolio as
of the balance sheet date. In determining the adequacy of the allowance, we perform periodic evaluations of the
loan portfolio and loss forecasting assumptions. At December 31, 2008, our allowance for loan losses was $1.1
billion on $25.3 billion of loans designated as held-for-investment.
Judgments
The estimate of the allowance 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. We
evaluate the adequacy of the allowance for loan losses by loan type: one- to four-family, home equity and
consumer and other loan portfolios.
Our one- to four-family and home equity loan portfolios are separated into risk segments based on key risk
factors, which include but are not limited to channel of loan origination, documentation type, loan product type
and LTV ratio. Based upon the segmentation, probable losses are determined with expected loss rates in each
segment. The additional protection provided by mortgage insurance and the credit default swap has been factored
into the expected loss on defaulted mortgage loans. The expected recovery from the liquidation of foreclosed real
estate and expected recoveries from loan sellers related to contractual guarantees are also factored into the
expected loss on defaulted mortgage loans. Our one- to four-family and home equity loan portfolios represented
51% and 40%, respectively, of the total gross loan portfolio as of December 31, 2008.
For the consumer and other loan portfolio, management establishes loss estimates for each consumer
portfolio based on credit characteristics and observation of the existing markets. The expected recoveries from
the sale of repossessed collateral are factored into the expected loss on defaulted consumer loans based on
current liquidation experience. Our consumer and other loan portfolio represented 9% of the total gross loan
portfolio as of December 31, 2008.
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.
Effects if Actual Results Differ
The crisis in the residential real estate and credit markets has substantially increased the complexity and
uncertainty involved in estimating the losses inherent in our loan portfolio. If our underlying assumptions and
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