eTrade 2006 Annual Report Download - page 56

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losses based on market conditions and other factors. Other-than-temporary impairment is recorded based on
management judgment. Management evaluates securities based on market conditions and all available information
about the issuer or underlying collateral. This information is used to determine if impairment is other-than-
temporary. The determination that impairment is other-than-temporary is judgmental. Based on the facts and
circumstances, companies could have different conclusions regarding when securities are other-than-temporarily
impaired. 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 meets both criterion, we write the security down to
fair value in the current period. We assess securities for impairment at each reported balance sheet date.
Effects if Actual Results Differ
Earnings could be influenced by the timing of management’s decisions to recognize a security as other-than-
temporarily impaired. Our estimates are based on the best available information. Over time additional
information may become available and may influence future write-downs. If all securities with fair values lower
than amortized book were written-down, a $310.0 million charge would occur. Management believes that its
estimates of other-than-temporary impairment are supportable and reasonable. See Note 6–Available-For-Sale
Mortgage-Backed and Investment Securities to the consolidated financial statements for additional information
regarding securities.
Valuation and Accounting for Financial Derivatives
Description
The Bank’s principal assets are residential mortgages and mortgage-backed securities, which typically pay a
fixed interest rate over an extended period of time. However, the principal sources of funds for the Bank are
customer deposits and other short-term borrowings with interest rates that are fixed for a shorter period of time, if
at all. The Bank purchases interest rate derivatives, including interest rate swaps, caps and floors, to manage this
difference between long-term and short-term interest rates and to convert fixed-rate assets or liabilities to
variable rates.
Accounting for derivatives differs significantly depending on whether a derivative is designated as a hedge,
which is a transaction intended to reduce a risk associated with a specific balance sheet item or future expected
cash flow. In order to qualify for hedge accounting treatment, documentation must indicate the intention to
designate the derivative as a hedge of a specific asset or liability or a future cash flow. Effectiveness of the hedge
must be monitored over the life of the derivative. Substantially all derivatives held on December 31, 2006 were
designated as hedges. As of December 31, 2006, we had derivative assets of $208.1 million and derivative
liabilities of $78.7 million. As of December 31, 2005, we had derivative assets of $152.5 million and derivative
liabilities of $38.1 million.
Judgments
Hedge accounting is complex and involves the interpretation of a significant amount of accounting
literature. From time to time, new interpretations are issued, which result in new accounting methods applied to
existing and new transactions. The implementation of SFAS No. 133, as amended, involves numerous judgments
and Company-level interpretations. We must make assumptions and judgments about the continued effectiveness
of our hedging strategies and the nature and timing of forecasted transactions. Judgment is necessary to
determine the accounting for our hedging strategies.
Effects if Actual Results Differ
If our hedging strategies were to become significantly ineffective or our assumptions about the nature and
timing of forecasted transactions were to be inaccurate, we could no longer apply hedge accounting and our
reported results would be significantly affected. Revised accounting interpretations of existing literature could
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