eTrade 2007 Annual Report Download - page 55

Underwriting Standards—Purchased Loans
Our underwriting policies for purchased loans focus primarily on ensuring (i) adherence to the underwriting
policies of the originator of the loan and (ii) that the loans meet certain minimum credit criteria.
In order to confirm adherence to the underwriting policies of the originator, we obtain a copy of the
underwriting guidelines used to originate the loans prior to purchase. We perform an analysis on a sample of the
loans to ensure compliance with these guidelines, with a focus on: appraisal methodology and type; equity
methodology and calculation; debt-to-income methodology and calculation; credit characteristics, including
documentation type and credit score; employment and income requirements; and the exception policy of the
originator. To the extent loans do not adhere to the underwriting policies of the originator, they are excluded
from the purchase.
When purchasing a portfolio of loans, primarily in the first half of 2007, our strategy was to attempt to
exclude loans that we believe have a higher risk of credit loss. We review a detailed listing of the credit
characteristics of the portfolio prior to purchase and attempt to identify higher risk loans. Our review criteria are
not static and vary by purchase, but typically focus on excluding loans in the following categories: FICO scores
below 640; combined loan-to-value ratios above 100%; debt-to-income ratios above 50%; and investor property
loans. Even though our strategy focuses on excluding loans with a lower credit quality, we invariably end up
purchasing an insignificant amount of loans that do not meet the credit criteria. This typically occurs in a
portfolio purchase where the seller of the loans requires the purchaser of the loans to buy all loans in the pool.
In the second half of 2007, we altered our business strategy and halted the focus on growing the balance
sheet. As a result, we do not anticipate purchasing a significant amount of loans in future periods. However, we
have significantly tightened our underwriting policies for any future loan purchases that do occur. These criteria
focus on limiting the acquisition of loans with a high risk of credit loss and require the exclusion of loans with
the following attributes: second lien; home equity line of credit; combined loan-to-value ratio above 80%; FICO
score below 700 at time of origination; and documentation type is not full documentation.
Loan Portfolio
We track and review many factors to predict and monitor credit risk in our loan portfolios, which are
primarily made up of loans secured by residential real estate. These factors include, but are not limited to:
borrowers’ debt-to income ratio when loans are made, borrowers’ credit scores when loans are made,
loan-to-value ratios, housing prices, documentation type, occupancy type, and loan type. In economic conditions
in which housing prices generally appreciate, we believe that loan type, loan-to-value ratios and credit scores are
the key factors in determining future loan performance. In a deteriorating housing market with declining home
prices and less credit available for refinance, we believe the loan-to-value ratio becomes a more important factor
in predicting and monitoring credit risk.
We believe certain categories of loans inherently have a higher level of credit risk due to characteristics of
the borrower and/or features of the loan. Two of these categories are sub-prime and option ARM loans. As a
general matter, we do not originate or purchase these loans to hold on our balance sheet; however, in the normal
course of purchasing large pools of real estate loans, we invariably end up acquiring a de minimis amount of
sub-prime loans. As of December 31, 2007, sub-prime real estate loans represented less than one-fifth of one
percent of our total real estate loan portfolio and we held no option ARM loans.
As noted above, we believe loan type, loan-to-value ratios and borrowers’ credit scores are key determinates
of future loan performance. Our home equity loan portfolio is primarily second lien loans(1) on residential real
estate properties, which have a higher level of credit risk than first lien mortgage loans. We believe home equity
loans with a combined loan-to-value ratio (“CLTV”) of 90% or higher or a FICO score below 700 are the loans
with the highest levels of credit risk in our portfolios.
(1) Approximately 14% of the home equity portfolio is in the first lien position. For home equity loans that are in a second lien position, we
also hold the first lien position on the same residential real estate property for less than 1% of the loans in this portfolio.
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