eTrade 2006 Annual Report Download - page 86

Available-for-sale securities consist of mortgage-backed securities, asset-backed securities, corporate bonds,
municipal bonds, publicly traded equity securities, investment in FHLB stock, retained interests from
securitizations and other debt securities. Securities classified as available-for-sale are carried at fair value, with
the unrealized gains and losses reflected as a component of accumulated other comprehensive income (“AOCI”),
net of tax. Fair value is based on quoted market prices, when available. For illiquid securities, fair value is
estimated by obtaining market price quotes on similar liquid securities and adjusting the price to reflect
differences between the two securities, such as credit risk, liquidity, term, coupon, payment characteristics and
other information. Realized and unrealized gains or losses on available-for-sale securities, except for publicly
traded equity securities, are computed using the specific identification cost method. Amortization or accretion of
premiums and discounts are recognized in interest income using the interest method over the life of the security.
Realized and unrealized gains or losses on publicly traded equity securities are computed using the average cost
method. Realized gains and losses and declines in fair value judged to be other-than-temporary are included in
gain on sales of loans and securities, net; other amounts relating to corporate investments are included in gain on
sales and impairment of investments. Interest earned is included in interest income for banking operations or
corporate interest income for corporate investments.
The Company regularly analyzes certain available-for-sale investments for other-than-temporary
impairment when the fair value of the investment is lower than its book value. The Company’s methodology for
determining impairment involves projecting cash flows relating to each investment and using assumptions as to
future prepayment speeds, losses and loss severities over the life of the underlying collateral pool. Assumptions
about future performance are derived from actual performance to date and the Company’s view on how the
collateral will perform in the future. In projecting future performance, the Company incorporates the views of
industry analysts, rating agencies and the management of the issuer, along with its own independent analysis of
the issuer of the securities, the servicer, the economy and the relevant sector as a whole. If the Company
determines impairment is other-than-temporary, it reduces the recorded book value of the investment by the
amount of the impairment and recognizes a realized loss on the investment. The Company does not, however,
adjust the recorded book value for declines in fair value that it believes are temporary. Management continues to
monitor and evaluate these securities closely for impairment that is other-than-temporary.
Mortgage- and asset-backed securities that both have an unrealized loss and are rated below “AA” by at
least half of the agencies that rate the securities, as well as interest-only securities that have unrealized losses, are
evaluated for impairment in accordance with Emerging Issues Task Force (“EITF”) 99-20, Recognition of
Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets.
Accordingly, when the present value of a security’s anticipated cash flows declines below the last periodic
estimate, the Company recognizes an impairment charge in the gain on sales of loans and securities, net line item
in the consolidated statement of income.
Asset Securitization and Retained Interests—An asset securitization involves the transfer of financial assets
to another entity in exchange for cash and/or beneficial interests in the assets transferred. Asset transfers in which
the Company surrenders control over the financial assets are accounted for as sales to the extent that
consideration, other than beneficial interests in the transferred assets, is received in the exchange in accordance
with SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities. The carrying amount of the assets transferred is allocated between the assets sold in these transactions
and the retained beneficial interests, based on their relative fair values at the date of the transfer. The Company
records gains or losses for the difference between the allocated carrying amount of the assets sold and the net
cash proceeds received. These gains or losses are recorded in the gain on sales of loans and securities, net line
item in the consolidated statement of income. Fair value is determined based on quoted market prices, if
available. Generally, quoted market prices are not available for beneficial interests; therefore, the Company
estimates the fair value based on the present value of the associated expected future cash flows. In determining
the present value of the associated expected future cash flows, management is required to make estimates and
assumptions. Key estimates and assumptions include future default rates, credit losses, discount rates,
prepayment speeds and collateral repayment rates. Retained beneficial interests are accounted for in accordance
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