eTrade 2012 Annual Report Download - page 89

statement of income (loss) in the period in which this determination was made. This loss would have a material
adverse effect on our regulatory capital position and results of operations.
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, 2012, 29% and 1%
of total assets and total liabilities, respectively, represented instruments measured at fair value on a recurring
basis. The fair value measurement accounting guidance describes the following three levels used to classify fair
value measurements:
• Level 1—Unadjusted quoted prices in active markets for identical assets or liabilities that are
accessible by the Company.
• 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 may use various valuation approaches, including market, income and/or cost
approaches. The fair value hierarchy requires us 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. Accordingly, 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.
Judgments
Of assets measured at fair value on a recurring basis, 91% were available-for-sale residential mortgage-
backed securities as of December 31, 2012. Our available-for-sale residential mortgage-backed securities
portfolio was composed of: 1) agency mortgage-backed securities and CMOs; and 2) non-agency CMOs. The
fair value of agency mortgage-backed securities and CMOs was determined using quoted market prices, recent
market transactions, spread data and our own trading activities for identical or similar instruments and were
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. We also utilized a
pricing service to corroborate the market observability of our inputs used in the fair value measurements of non-
agency CMOs. The valuations of non-agency CMOs reflect our best estimate of what market participants would
consider in pricing the financial instruments. We consider the price transparency for these financial instruments
to be a key determinant of the degree of judgment involved in determining the fair value. As of December 31,
2012, the non-agency CMOs were categorized in Level 2 and Level 3 of the fair value hierarchy.
Effects if Actual Results Differ
The use of different methodologies or assumptions to determine the fair value of certain financial
instruments could result in a different estimate of fair value. As of December 31, 2012, less than 1% of total
assets and none of total liabilities represented instruments measured at fair value on a recurring basis categorized
as Level 3. While our recurring fair value estimates of Level 3 instruments utilized observable inputs where
available, the valuations included significant management judgment in determining the relevance and reliability
of market information considered.
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