eTrade 2008 Annual Report Download - page 70

Classification and Valuation of Certain Investments
Description
We generally classify our investments in mortgage-backed securities, debt securities and marketable equity
securities as either available-for-sale or trading. We have not classified any investments as held-to-maturity. The
classification of an investment determines its accounting treatment. Both unrealized and realized gains and losses
on trading securities held by our banking subsidiaries are recognized in gain (loss) on loans and securities, net.
Securities held by our brokerage subsidiaries are for market-making purposes and gains and losses are recorded
as principal transactions revenue. Unrealized gains and losses on available-for-sale securities are included in
accumulated other comprehensive loss. Declines in fair value that we believe to be other-than-temporary are
included in gain (loss) on loans and securities, net for our banking and brokerage investments and gain (loss) on
sales of investments, net for our corporate investments. We have investments in certain publicly-traded and
privately-held companies, which we evaluate for other-than-temporary declines in market value. For the years
ended December 31, 2008, 2007 and 2006, we recognized $96.2 million, $168.7 million and $2.8 million,
respectively, of losses from other-than-temporary declines in market value related to our investments.
Judgments
The fair value hierarchy established in SFAS No. 157 requires us to maximize the use of observable inputs
and minimize the use of unobservable inputs when measuring fair value.
Mortgage-backed securities backed by U.S. Government sponsored and federal agencies include to be
announced (“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.
CMOs, generally non-agency mortgage-backed securities, are typically valued using market observable
data, when available, including recent external market transactions for similar instruments. We also utilized a
pricing service to corroborate the market observability of our inputs used in the fair value measurements. The
valuations of CMOs reflect our best estimate of what market participants would consider in pricing the financial
instruments. We consider 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
we believe that Level 2 inputs could likely be obtainable in a more active market.
We also make estimates about the timing for recognizing losses in the consolidated statement of income
(loss) based on market conditions and other factors. Management uses judgment to estimate the future cash flows
associated with each security held at a loss and to assess the probability of collecting those cash flows.
Management uses a qualitative and quantitative risk approach to evaluate each security held at a loss, which
includes assessing underlying collateral characteristics to determine if there has been an adverse change in the
amount or timing of the estimated future cash flows, which would indicate other-than-temporary impairment.
The Company recognizes an impairment charge by writing the amortized cost basis of the security down to its
fair market value when the Company believes that there has been a probable adverse change in the estimated
future cash flows of the security. We assess securities for impairment at each reported balance sheet date.
Effects if Actual Results Differ
In general, level classification transfers in and out of Level 3 during the year ended December 31, 2008
were driven by changes in price transparency in the CMO market throughout the year. Level 3 assets as of
December 31, 2008 include $3.9 million of CMOs classified as Level 2 on January 1, 2008. While the
Company’s fair value estimates of Level 3 instruments as of December 31, 2008 utilized observable inputs where
available, the valuation included significant management judgment in determining the relevance and reliability of
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