eTrade 2011 Annual Report Download - page 78

Our analysis of the need for a valuation allowance recognizes that we are in a cumulative book loss position
as of the three-year period ended December 31, 2011, which is considered significant and objective evidence that
we may not be able to realize some portion of the deferred tax assets in the future. However, we did not establish
a valuation allowance against federal deferred tax assets as of December 31, 2011 as we believe that it is more
likely than not that all of these assets will be realized. Approximately two-thirds of existing federal deferred tax
assets are not related to net operating losses and therefore, have no expiration date. We expect to utilize the vast
majority of the existing federal deferred tax assets over the next seven years, with a small balance remaining as a
result of the current limitation caused by the ownership change (which is expected to be fully utilized in advance
of the statutory carry forward period).
Our evaluation focused on identifying significant, objective evidence that we will be able to realize the
deferred tax assets in the future. We determined that our expectations regarding future earnings are objectively
verifiable due to various factors. One factor is the consistent profitability of the core business, the trading and
investing segment, which has generated substantial income for each of the last eight years, including through
uncertain economic and regulatory environments. The core business is driven by brokerage customer activity and
includes trading, brokerage cash, margin lending, long-term investing and other brokerage related activities.
These activities drive variable expenses that correlate to the volume of customer activity, which has resulted in
stable, ongoing profitability.
Another factor is the mitigation of losses in the balance sheet management segment, which generated a large
net operating loss in 2007 caused by the crisis in the residential real estate and credit markets. Much of this loss
came from the sale of the asset-backed securities portfolio and credit losses from the mortgage loan portfolio. We
no longer hold any of those asset-backed securities and shut down mortgage loan acquisition activities in 2007.
In effect, the key business activities that led to the generation of the deferred tax assets were shut down over four
years ago. As a result, the losses in the balance sheet management segment have continued to decline
significantly. In addition, we continue to realize the benefit of various credit loss mitigation activities for the
mortgage loans purchased in 2007 and prior, most notably, actively reducing or closing unused home equity lines
of credit and aggressively exercising put-back clauses to sell back improperly documented loans to the
originators. As a result of these loss containment measures, provision for loan losses has declined for three
consecutive years, down 72% from its peak of $1.6 billion for the year ended December 31, 2008.
We maintain a valuation allowance for certain of our state deferred tax assets as it is more likely than not
that they will not be realized. At December 31, 2011, we had state deferred tax assets of approximately $102.1
million that related to our state net operating loss carry forwards and temporary differences with a valuation
allowance of $28.7 million against such deferred tax assets.
Effects if Actual Results Differ
Changes in tax expense (benefit) due to the actual effective tax rates differing from our estimates affect
accrued taxes and could be material to results of operations for any particular reporting period. In evaluating the
need for a valuation allowance, we estimated future taxable income based on management approved forecasts.
This process required significant judgment by management about matters that are by nature uncertain. If future
events differ significantly from our current forecasts, a valuation allowance may need to be established, which
could have a material adverse effect on our financial condition and results of operations.
Classification and Valuation of Certain Investments
Description
The classification of an investment determines its accounting treatment. We classify our investments in
securities as trading, available-for-sale or held-to-maturity. Trading securities are carried at fair value and both
unrealized and realized gains and losses are recognized in the consolidated statement of income (loss). Securities
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