eTrade 2009 Annual Report Download - page 78

was applied by loan type, reflects our estimate of credit losses inherent in the loan portfolio due to environmental
factors which are not directly considered in our quantitative loss model but are factors we believe will have an
impact on credit losses (e.g. the current level of unemployment).
In addition to the general allowance, we also established a specific allowance for loans modified as TDRs.
The impairment of a loan is measured using a discounted cash flow analysis. A specific allowance is established
to the extent that the recorded investment exceeds the discounted cash flows of a TDR with a corresponding
charge to the provision for loan losses. The specific allowance for these individually impaired loans represents
the expected loss over the remaining life of the loan, including the economic concession to the borrower.
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
judgments prove to be inaccurate, the allowance for loan losses could be insufficient to cover actual losses. We
may be required under such circumstances to further increase our provision for loan losses, which could have an
adverse effect on our regulatory capital position and our results of operations in future periods.
Fair Value Measurements
Description
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an
orderly transaction between market participants at the measurement date. As of December 31, 2009, 30% and
less than 1% of our total assets and total liabilities, respectively, represented instruments measured at fair value
on a recurring basis. During the year ended December 31, 2009, fair value was also used for certain other
nonrecurring measurements, including the Debt Exchange. The fair value measurement accounting guidance
describes the following three levels used to classify fair value measurements:
• Level 1—Quoted prices in active markets for identical assets or liabilities.
• Level 2—Quoted prices in markets that are not active or for which all significant inputs are observable,
either directly or indirectly.
• Level 3—Unobservable inputs that are significant to the fair value of the assets or liabilities.
In determining fair value, we use various valuation approaches, including market, income and/or cost
approaches. The fair value hierarchy requires an entity to maximize the use of observable inputs and minimize
the use of unobservable inputs when measuring fair value. Fair value is a market-based measure considered from
the perspective of a market participant. As such, even when market assumptions are not readily available, our
own assumptions reflect those that market participants would use in pricing the asset or liability at the
measurement date. The availability of observable inputs can vary and in certain cases, the inputs used to measure
fair value may fall into different levels of the fair value hierarchy. In such cases, the level within the fair value
hierarchy is based on the lowest level of input that is significant to the fair value measurement. Our assessment of
the significance of a particular input to a fair value measurement requires judgment and consideration of factors
specific to the asset or liability.
Recurring Fair Value Measurements
Judgments
Of assets measured at fair value on a recurring basis, 66% were available-for-sale residential mortgage-
backed securities as of December 31, 2009. Our residential mortgage-backed securities portfolio is composed of:
1) agency mortgage-backed securities and CMOs; and 2) non-agency CMOs and other. The fair value of agency
mortgage-backed securities and CMOs is determined using quoted market prices, recent market transactions and
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