eTrade 2008 Annual Report Download - page 71

market information considered and the financial instruments were therefore classified as Level 3. The Company
recorded a $118.8 million loss in other comprehensive loss during the year ended December 31, 2008 on CMOs
classified as Level 3 as of December 31, 2008. The Company recorded a $1.0 million loss in other
comprehensive loss during the year ended December 31, 2008 related to CMOs classified as Level 2 on
January 1, 2008 and Level 3 as of December 31, 2008. Of the $95.0 million impairment recorded for the year
ended December 31, 2008 related to the CMO portfolio, $93.6 million related to CMOs classified as Level 3 as
of January 1, 2008 and December 31, 2008.
Determining if a security is other-than-temporarily impaired is complex and requires judgment by
management about circumstances that are inherently uncertain. In particular, these estimates require management
to estimate the amount and timing of credit losses on the underlying loans supporting the security. Subsequent
evaluations of these securities, in light of factors then prevailing, may result in additional impairment in future
periods. If all securities with fair values lower than amortized cost were impaired, we would record a pre-tax loss
of $439.9 million.
Accounting for Financial Derivatives
Description
We enter into derivative transactions to reduce the risk of market price or interest rate movements on the
value of certain assets, liabilities and future cash flows. Accounting for derivatives differs significantly
depending on whether a derivative is designated as a hedge. 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.
The majority of derivative transactions we entered into as of December 31, 2008 were cash flow hedges.
These hedges, which include a combination of interest rate swaps, forward-starting swaps and purchased options
on caps and floors, are used primarily to reduce the variability of future cash flows associated with existing
variable-rate liabilities and assets and forecasted issuances of liabilities.
These cash flow hedge relationships are treated as effective hedges as long as the future issuances of
liabilities remain probable and the hedges continue to meet the requirements of SFAS No. 133, as amended.
Changes in the fair value of derivatives that hedge cash flows associated with repurchase agreements, FHLB
advances and home equity lines of credit are reported in accumulated other comprehensive loss as unrealized
gains or losses, for both active and terminated hedges. As of December 31, 2008, we had an unrealized pre-tax
loss reported in accumulated other comprehensive loss of $671.3 million related to cash flow hedges.
Judgments
If the derivatives in these cash flow hedge relationships are determined to be effective hedges, the amounts
in accumulated other comprehensive loss are included in operating interest expense or operating interest income
as a yield adjustment during the same periods in which the related interest on the hedged item affects earnings. If
the derivatives are determined not to be effective hedges, the amount recorded in accumulated other
comprehensive loss would be reclassified into the gain (loss) on loans and securities, net line item in the
consolidated statement of income (loss).
The majority of cash flow hedge relationships are hedges of the potential change in cash flows associated
with the forecasted issuance of debt. In order to be considered an effective hedge, the forecasted issuance of debt
must be considered probable as of the balance sheet date. The future issuance of this debt, including repurchase
agreements, is largely dependent on the market demand and liquidity in the wholesale borrowings market.
As of December 31, 2008, we believe the forecasted issuance of all debt in cash flow hedge relationships is
probable. However, unexpected changes in market conditions in future periods could impact our ability to issue
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