eTrade 2007 Annual Report Download - page 65

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, 2007 were
designated as hedges. As of December 31, 2007, we had derivative assets of $133.1 million and derivative
liabilities of $200.3 million. As of December 31, 2006, we had derivative assets of $208.1 million and derivative
liabilities of $78.7 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
materially impact our financial results. If 10% of the fair value of derivatives classified in liabilities were
determined to relate to derivatives that do not qualify for hedge accounting treatment, the adjustment would
reduce income by $20.0 million before taxes. Similarly, if 10% of the fair value of derivatives included in assets
were determined to not qualify for hedge accounting treatment, the result would be $13.3 million in additional
pre-tax income. The most significant effect of not qualifying for hedge accounting treatment is the earnings
volatility that would be created by marking the derivatives to market as interest rates change.
Estimates of Effective Tax Rates, Deferred Taxes and Valuation Allowances
Description
In preparing our consolidated financial statements, we calculate our income tax expense based on our
interpretation of the tax laws in the various jurisdictions where we conduct business. This requires us to estimate
our current tax obligations and the realizability of uncertain tax positions and to assess temporary differences
between the financial statement carrying amounts and the tax bases of assets and liabilities. These differences
result in deferred tax assets and liabilities, the net amount of which we show as other assets or other liabilities on
our consolidated balance sheet. We must also assess the likelihood that each of our deferred tax assets will be
realized. To the extent we believe that realization is not more likely than not, we establish a valuation allowance.
When we establish a valuation allowance or increase this allowance in a reporting period, we generally record a
corresponding tax expense in our consolidated statement of income. Conversely, to the extent circumstances
indicate that a valuation allowance is no longer necessary, that portion of the valuation allowance is reversed,
which generally reduces our overall income tax expense. At December 31, 2007 we had a net deferred tax asset
of $550.2 million, net of a valuation allowance of $91.8 million. At December 31, 2006 we had a net deferred tax
liability of $58.5 million, net of a valuation allowance of $38.3 million.
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