eTrade 2010 Annual Report Download - page 75

For loans that are not TDRs, we established a general allowance that is assessed in accordance with the loss
contingencies accounting guidance. Our one- to four-family and home equity loan portfolios are separated into
risk segments based on key risk factors, which include but are not limited to loan type, loan acquisition channel,
documentation type, LTV/CLTV ratio and borrowers’ credit scores. Based upon the segmentation, probable
losses are determined with expected loss rates in each segment. The additional protection provided by mortgage
insurance has been factored into the expected loss on defaulted mortgage loans. The expected recovery from the
liquidation of foreclosed real estate and expected recoveries from loan sellers related to contractual guarantees
are also factored into the expected loss on defaulted mortgage loans. Our one- to four-family and home equity
loan portfolios represented 51% and 40%, respectively, of total loans receivable as of December 31, 2010. For
the consumer and other loan portfolio, management establishes loss estimates for each consumer portfolio based
on credit characteristics and observation of the existing markets. The expected recoveries from the sale of
repossessed collateral are factored into the expected loss on defaulted consumer loans based on current
liquidation experience. Our consumer and other loan portfolio represented 9% of total loans receivable as of
December 31, 2010.
The general allowance for loan losses also included a specific qualitative component to account for a variety
of economic and operational factors that are not directly considered in our quantitative loss model but are factors
we believe may impact our level of credit losses. Examples of these economic and operational factors are current
level of unemployment and the limited historical charge-off and loss experience on modified loans. As of
December 31, 2010, this qualitative component increased from 5% to 15% of the general allowance for loan
losses, resulting in an increase of $58.1 million to $87.2 million, and was applied by loan portfolio segment. The
increase in the qualitative component was a result of a higher concentration of modified loans in our portfolio
and the uncertainty of how modified loans will perform over the long term.
In addition to the general allowance, we also established a specific allowance for loans modified as TDRs.
Impairment of the loans is measured using a discounted cash flow analysis. A specific allowance is established to
the extent that the recorded investment exceeds the discounted cash flows of a TDR with a corresponding charge
to the provision for loan losses. The specific allowance for these individually impaired loans represents the
expected loss over the remaining life of the loan, including the economic concession to the borrower.
Effects if Actual Results Differ
The crisis in the residential real estate and credit markets has substantially increased the complexity and
uncertainty involved in estimating the losses inherent in our loan portfolio. In the current market it is difficult to
estimate how potential changes in the quantitative and qualitative factors might impact the allowance for loan
losses. If our underlying assumptions and judgments prove to be inaccurate, the allowance for loan losses could
be insufficient to cover actual losses. We may be required under such circumstances to further increase our
provision for loan losses, which could have an adverse effect on our regulatory capital position and our results of
operations in future periods.
Fair Value Measurements
Description
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an
orderly transaction between market participants at the measurement date. As of December 31, 2010, 33% and
less than 1% of our total assets and total liabilities, respectively, represented instruments measured at fair value
on a recurring basis. The fair value measurement accounting guidance describes the following three levels used
to classify fair value measurements:
• Level 1—Quoted prices in active markets for identical assets or liabilities.
• Level 2—Quoted prices in markets that are not active or for which all significant inputs are observable,
either directly or indirectly.
• Level 3—Unobservable inputs that are significant to the fair value of the assets or liabilities.
72