eTrade 2012 Annual Report Download - page 83

Judgments
Determining the adequacy of the allowance is complex and requires judgment by management about the
effect of matters that are inherently uncertain. Subsequent evaluations of the loan portfolio, in light of the factors
then prevailing, may result in significant changes in the allowance for loan losses in future periods. We evaluate
the adequacy of the allowance for loan losses by loan portfolio segment: one- to four-family, home equity and
consumer and other. The estimate of the allowance for loan losses is based on a variety of quantitative and
qualitative factors, including the composition and quality of the portfolio; delinquency levels and trends; current
and historical charge-off and loss experience; our historical loss mitigation experience; the condition of the real
estate market and geographic concentrations within the loan portfolio; the interest rate climate; the overall
availability of housing credit; and general economic conditions. The allowance for loan losses is typically equal
to management’s forecast of loan losses in the twelve months following the balance sheet date as well as the
forecasted losses, including economic concessions to borrowers, over the estimated remaining life of loans
modified as TDRs.
For loans that are not TDRs, we established a general allowance. The one- to four-family and home equity
loan portfolios are separated into risk segments based on key risk factors, which include but are not limited to
loan type, delinquency history, documentation type, LTV/CLTV ratio and borrowers’ credit scores. For home
equity loans in the second lien position, the original balance of the first lien loan at origination date and updated
valuations on the property underlying the loan are used to calculate CLTV. Both current CLTV and FICO scores
are among the factors utilized to categorize the risk associated with mortgage loans and assign a probability
assumption of future default. We utilize historical mortgage loan performance data to develop the forecast of
delinquency and default for these risk segments. The consumer and other loan portfolio is separated into risk
segments by product and delinquency status. We utilize historical performance data and historical recovery rates
on collateral liquidation to forecast delinquency and loss at the product level. The one- to four-family and home
equity loan portfolios represented 52% and 40%, respectively, of total loans receivable as of December 31, 2012.
The consumer and other loan portfolio represented 8% of total loans receivable as of December 31, 2012.
The general allowance for loan losses also included a qualitative component to account for a variety of
factors that are not directly considered in the quantitative loss model but are factors we believe may impact the
level of credit losses. Examples of these factors are: external factors, such as changes in the macro-economic,
legal and regulatory environment; internal factors, such as procedural changes and reliance on third parties; and
portfolio specific factors, such as the impact of payment resets and historical loan modification activity, which
impacts the historical performance data used to forecast delinquency and default in the general allowance for
loan losses.
The total qualitative component was $44 million and $124 million as of December 31, 2012 and 2011,
respectively. The qualitative component for the one- to four-family and home equity loan portfolios was 17% and
35% of the general allowance for loan losses at December 31, 2012 and 2011, respectively. The decrease in the
qualitative reserve in these loan portfolios from December 31, 2011 to December 31, 2012 reflects the
completion of our evaluation of certain programs and practices that were designed in accordance with guidance
from our former regulator, the OTS. This evaluation was initiated in connection with the transition from the OTS
to the OCC. As a result of the evaluation, loan modification policies and procedures were aligned with the
guidance from the OCC. The qualitative component was increased to 35% during the fourth quarter of 2011 to
reflect additional estimated losses due to this evaluation. The review resulted in a significant increase in charge-
offs during the year ended December 31, 2012 and a corresponding decrease in the qualitative component. The
qualitative component for the consumer and other loan portfolio was 17% and 15% of the general allowance at
December 31, 2012 and 2011, respectively.
For modified loans accounted for as TDRs that are valued using the discounted cash flow model, we
established a specific allowance. The specific allowance for TDRs factors in the historical default rate of an
individual loan before being modified as a TDR in the discounted cash flow analysis in order to determine that
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