eTrade 2010 Annual Report Download - page 117

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. The Company’s 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 Measurement Techniques
U.S. Treasury Securities and Agency Debentures
The fair value measurements of U.S. Treasury securities were classified as Level 1 of the fair value
hierarchy as they were based on quoted market prices in active markets. The fair value measurements of agency
debentures were classified as Level 2 of the fair value hierarchy as they were based on quoted market prices that
can be derived from assumptions observable in the marketplace.
Residential Mortgage-backed Securities
The Company’s residential mortgage-backed securities portfolio was composed of agency mortgage-backed
securities and CMOs, which represented the majority of the portfolio, and non-agency CMOs. As agency
mortgage-backed securities and CMOs were guaranteed by U.S. government sponsored and federal agencies,
these securities were AAA-rated as of December 31, 2010. The majority of the Company’s non-agency CMOs
were backed by first lien mortgages and were below investment grade or non-rated as of December 31, 2010. The
weighted average coupon rates for the residential mortgage-backed securities as of December 31, 2010 are shown
in the following table:
Weighted
Average
Coupon Rate
Agency mortgage-backed securities 3.68%
Agency CMOs 4.21%
Non-agency CMOs 4.43%
The fair value of agency mortgage-backed securities was determined using market and income approaches
with quoted market prices, recent market transactions and spread data for similar instruments. The fair value of
agency CMOs was determined using market and income approaches with the Company’s own trading activities
for identical or similar instruments. Agency mortgage-backed securities and CMOs were generally categorized in
Level 2 of the fair value hierarchy.
Non-agency CMOs were valued using market and income approaches with market observable data,
including recent market transactions when available. 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
non-agency CMOs reflect the Company’s best estimate of what market participants would consider in pricing the
financial instruments. The following table presents additional information about the underlying loans and
significant inputs for the valuation of non-agency CMOs as of December 31, 2010:
Weighted
Average Range
Underlying loans:
Coupon rate 4.45% 2.55% - 6.83%
Maturity (years) 24 12 - 26
Significant inputs:
Yield 4% 0% -10%
Default rate(1) 15% 0% -100%
Loss severity 43% 0% -103%
Prepayment rate 9% 0% -60%
(1) The default rate reflects the implied rate necessary to equate market price to the book yield given the market credit assumption.
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