eTrade 2004 Annual Report Download - page 48

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Table of Contents
Index to Financial Statements
SUMMARY OF CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Our discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements, which
have been prepared in conformity with accounting principles generally accepted in the United States of America. Note 2 to the consolidated
financial statements contains a summary of our significant accounting policies, many of which require the use of estimates and assumptions.
We believe that of our significant accounting policies, the following are noteworthy because they are based on estimates and assumptions that
require complex, subjective judgments by management, which can materially impact reported results. Changes in these estimates or
assumptions could materially impact our financial condition and results of operation.
Allowances for loan losses and uncollectible margin loans
Management evaluates the Bank’s loan portfolio and establishes an allowance that it believes is at least equal to the probable losses
inherent in its loan portfolio. When establishing this allowance, management considers a number of factors including historical and industry
loss rates, estimated cash flows and collateral values. In addition, management also considers numerous quantitative factors that may influence
the overall credit performance of the Bank’s loans, such as adjustments to policies and procedures, changes affecting third-party service
providers and other market factors. This analysis is performed both for individual loans with large balances, as well as for groups of loans with
similar risk characteristics. Although the Company has considerable experience in performing these reviews, if management’s underlying
assumptions prove to be inaccurate or significant unanticipated changes to the national or regional economies occur, the allowance for loan
losses would have to be adjusted. If the loan losses that we actually incur are significantly different from our estimates, it may be necessary to
increase or decrease the allowance for loan losses in the future. At December 31, 2004, our allowance for loan losses was $47.7 million on
$11.6 billion of loans we intend to hold for investment.
In addition to our banking loans, we extend credit to brokerage customers in the form of margin loans. At December 31, 2004, margin
accounts had approximately $2.2 billion in outstanding margin loans for which we provided an allowance for uncollectible margin loans of
$2.0 million based on historical experience, as well as the review of certain individual customer accounts and the specific identification of
uncollectible amounts.
Classification and valuation of certain investments
The classification of an investment determines its accounting treatment. We generally classify our investments in debt instruments
(including corporate, government and municipal bonds), mortgage-backed securities, asset-backed securities and marketable equity securities
as either available-for-sale or trading. We have not classified any investments as held-to-maturity. Investment classifications are subject to
ongoing review and change. When possible, the fair value of securities is determined by obtaining quoted market prices. We also make
estimates about the fair value of investments and the timing for recognizing losses based on market conditions and other factors. If our
estimates change, we may recognize additional losses. Both unrealized and realized gains and losses on trading securities held by our Bank are
recognized in gain on sales of loans held-for-sale and securities, net. Our brokerage operations hold trading securities for market-making
purposes and record the net gains in revenues as principal transactions. Unrealized gains and losses on available-for-
sale securities are included
in accumulated other comprehensive income. Declines in fair value that we believe to be other-than-temporary are included in gain on sales of
loans held-for-sale and securities, net for our banking investments and gain (loss) on sale and impairment of investments for our brokerage and
corporate investments.
Impairment of mortgage-backed or asset-backed securities is recognized when management estimates the fair value of a security is less
than its amortized cost and if the current present value of estimated cash flows has decreased since the last periodic estimate. If the security
fails both tests, the Company writes the security down to fair value in the current period. The Company assesses securities for impairment at
each reported balance sheet date.
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