eTrade 2011 Annual Report Download - page 150

The Company is required to establish a valuation allowance for deferred tax assets and record a charge to
income if it is determined, based on available evidence at the time the determination is made, that it is more
likely than not that some portion or all of the deferred tax assets will not be realized. If the Company did
conclude that a valuation allowance was required, the resulting loss could have a material adverse effect on its
financial condition and results of operations. The analysis of the need for a valuation allowance recognizes that
the Company is in a cumulative book loss position as of the three-year period ended December 31, 2011, which
is considered significant and objective evidence that it may not be able to realize some portion of the deferred tax
assets in the future. However, the Company did not establish a valuation allowance against its federal deferred
tax assets as of December 31, 2011 as it believes that it is more likely than not that all of these assets will be
realized. Approximately two-thirds of existing federal deferred tax assets are not related to net operating losses
and therefore, have no expiration date. The Company ended 2011 with $781 million of gross federal net
operating losses which will expire within the next 16 years.
The Company’s evaluation focused on identifying significant, objective evidence that it will be able to
realize its deferred tax assets in the future. The Company determined that its expectations regarding future
earnings are objectively verifiable due to various factors. One factor is the consistent profitability of the
Company’s core business, the trading and investing segment, which has generated substantial income for each of
the last eight years, including through uncertain economic and regulatory environments. The core business is
driven by brokerage customer activity and includes trading, brokerage cash, margin lending, long-term investing
and other brokerage related activities. These activities drive variable expenses that correlate to the volume of
customer activity, which has resulted in stable, ongoing profitability in this business.
Another factor is the mitigation of losses in the balance sheet management segment, which generated a large
net operating loss in 2007 caused by the crisis in the residential real estate and credit markets. Much of this loss
came from the sale of the asset-backed securities portfolio and credit losses from the mortgage loan portfolio.
The Company no longer holds any of those asset-backed securities and shut down mortgage loan acquisition
activities in 2007. In effect, the key business activities that led to the generation of the deferred tax assets were
shut down over four years ago. As a result, the losses in the balance sheet management segment have continued
to decline significantly. In addition, the Company continues to realize the benefit of various credit loss mitigation
activities for the mortgage loans purchased in 2007 and prior, most notably, actively reducing or closing unused
home equity lines of credit and aggressively exercising put-back clauses to sell back improperly documented
loans to the originators. As a result of these loss containment measures, provision for loan losses has declined for
three consecutive years, down 72% from its peak of $1.6 billion for the year ended December 31, 2008.
For certain of the Company’s state, foreign country and charitable contribution deferred tax assets, the
Company maintained a valuation allowance of $73.5 million and $76.0 million at December 31, 2011 and 2010,
respectively, as it is more likely than not that they will not be fully realized.
The principal components of the deferred tax assets for which a valuation allowance has been established
include the following state and foreign country net operating loss carry forwards and charitable contributions
which have a limited carry forward period:
• At December 31, 2011, the Company had certain gross foreign country net operating loss carry forwards and
other foreign country temporary differences of approximately $142.2 million for which a deferred tax asset
of approximately $35.6 million was established. The foreign net operating losses represent the foreign tax
loss carry forwards in numerous foreign countries, the vast majority of which are not subject to expiration. In
most of these foreign countries, the Company has historical tax losses; accordingly, the Company has
provided a valuation allowance of $35.6 million against such deferred tax assets at December 31, 2011.
• At December 31, 2011, the Company had gross state net operating loss carry forwards that expire by
2030 in several states of $2.3 billion, most of which are subject to reduction for apportionment when
utilized. A deferred tax asset of approximately $102.1 million has been established related to these
state net operating loss carry forwards and temporary differences with a valuation allowance of $28.7
million against such deferred tax assets at December 31, 2011.
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