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E*TRADE Financial (NASDAQ:ETFC)

Q4 2012 Earnings Call

January 24, 2013 5:00 pm ET

Executives

Paul Thomas Idzik - Chief Executive Officer

Matthew J. Audette - Chief Financial Officer, Principal Accounting Officer, Executive Vice President and Controller

Analysts

Howard Chen - Crédit Suisse AG, Research Division

Richard H. Repetto - Sandler O'Neill + Partners, L.P., Research Division

Alexander Blostein - Goldman Sachs Group Inc., Research Division

Jason Weyeneth - Sterne Agee & Leach Inc., Research Division

Joel Jeffrey - Keefe, Bruyette, & Woods, Inc., Research Division

Keith Murray - Nomura Securities Co. Ltd., Research Division

Christopher J. Allen - Evercore Partners Inc., Research Division

Patrick J. O'Shaughnessy - Raymond James & Associates, Inc., Research Division

Christopher Harris - Wells Fargo Securities, LLC, Research Division

Edward Ditmire - Macquarie Research

Brian Bedell - ISI Group Inc., Research Division

Operator

Good evening, and thank you for joining the E*TRADE Financial Fourth Quarter and Full Year 2012 Earnings Conference Call. Joining the call today are Paul Idzik, Chief Executive Officer; Matt Audette, Chief Financial Officer; and other members of E*TRADE's management team. Today's call may include forward-looking statements, which reflects management's current estimates or beliefs and are subject to risks and uncertainties that may cause actual results to differ materially. During the call, the company may also discuss non-GAAP financial measures. For a reconciliation of such non-GAAP measures to the comparable GAAP figures, and for a discussion of additional risks and uncertainties that may affect the future results of E*TRADE Financial, please refer to our earnings release furnished with Form 8-K and our 10-K, 10-Qs, and our other documents the company has filed with the SEC. All of these documents are available at investor.etrade.com. This call will present information as of January 24, 2013. The company disclaims any duty to update forward-looking statements made during the call. The call is being recorded, and a replay will be available via phone and webcast later this evening at investor.etrade.com. No other recordings or copies of this call are authorized or may be relied upon.

With that, I will now turn the call over to Paul Idzik. You may begin, sir.

Paul Thomas Idzik

Thank you. Good evening. It's a pleasure to be here for my first quarterly earnings call with E*TRADE. Given I've been here a total of 3 days, you won't hear much from me by way of commentary on our business and results. I would like to share a few thoughts on the attraction of E*TRADE. The moment I was contacted by the search committee of E*TRADE's board, I've been doing my own due diligence on the company. What really excites me about this company are: First, its iconic and enduring brand. This company has done an impressive job building a recognized name for itself and a reputation for great customer service. Second, it's a great business model, bouncing along in an unfavorable environment. As with any investment opportunity, the best time to enter is when things are well positioned for greatness, but not there yet. In the case of E*TRADE, the brokerage model and opportunity is vast, but suppressed by external factors. As you can tell, investor confidence is low, and so are volumes. And the interest rate environment has compressed the spread a depository can generate on customers' cash. While it's impossible to forecast macroeconomic normalization, and live through the ebbs and flows of past cycles, and while this one will likely last longer than most, I believe the economy will improve, confidence will return and this company will capitalize on those improvements. So I think it's a great time for E*TRADE and I'm extremely excited to be part of the team. I look forward to getting further up to speed on the company in the coming days and months, getting to know its employees, and speaking with you in more detail on future calls.

With that, I will turn the call over to our CFO, Matthew.

Matthew J. Audette

Thank you, Paul. 2012 was an important year for E*TRADE. We completed the transition to our new regulators. We formalized a strategic and capital plan centering on the most efficient path to unlocking value for shareholders. We refinanced our highest cost corporate debt, replacing it with the lowest coupons the company has ever issued. We advanced through an exhaustive efficiency and cost-cutting exercise, identifying over $100 million of cost reductions for implementation in 2013. We made significant investments and enhancements to our enterprise risk management capabilities. We made great progress on reducing our loan portfolio and the associated risks, further positioning ourselves for strong profitability and more normalized earnings. And the core brokerage franchise continue to grow and improve, outpacing the account and asset growth from the past several years.

I'll share additional details and thoughts on each of those items, but first I'd like to review the results of the brokerage business, the heart of this company. During a year characterized by global macro economic uncertainty, domestic political uncertainty and an ever-approaching fiscal cliff, we are proud of our successes in the core brokerage business. Our brokerage account growth outpaced our growth over the past 3 years, with more than 120,000 net new accounts. And we kept more of those accounts on board with account retention at an all-time high. A similar story in brokerage assets. Net new assets into the firm were at their highest annual level since we began tracking the metric in 2007. Not bad, and all during a year when the retail investor largely remained on the sidelines, as evidenced by lower trading activity than we have seen in 6 years. Waning investor confidence and a 5-year low in volatility contributed to the 12% decline to 138,000 Daily Average Revenue Trades for the full year. For the fourth quarter, in particular, DARTs of 128,000 were down 9% year-over-year, but were down less than 1% sequentially.

As of this afternoon, our January to-date trends are reflective of some rebound, though it's too early to tell if investors are truly returning to the market in a meaningful way. Month-to-date, our DARTs are tracking 17% above December levels. Net new brokerage assets for the year of $10.4 billion were up from $9.7 billion in 2011, and represent a growth rate of 7%. Our net new brokerage accounts for the year of 120,000 are also well above the 99,000 we recorded in 2011. This is partially a result of fewer accounts leaving us as we improved our attrition rate to a record low of 9% for 2012. Our successes in improving customer service and expanding awareness around our product offering are reflected in this metric. Considering attrition levels were historically in the mid-teens, this is an area of great pride, but also of continued focus for improvement. Beyond brokerage accounts, our Corporate Services group brought on more Stock Plan accounts than we have seen in any year of the company's history. With the acquisition of 65 new clients during the year, we added 77,000 net new accounts, more than triple the amount added during 2011. We have made a number of enhancements to our retirement and investing offering over the past year, including placing certified retirement planning counselors in nearly every branch, complementing our call center presence. We launched one-stop rollover, providing customers with a simple way to move their 401(k) savings into a professionally-managed portfolio at E*TRADE. This was an important launch for us, as rollover assets represented about half of our net new retirement flows in 2012 and were up 70% versus 2011.

Our professionally-managed account solutions, which offer accessible entry points with a minimum of just $25,000 are an essential component of our suite of retirement and investing products and services, as we work to deepen engagement with our customer base, focused on expanding our share of our customers' wallet. Launched in early 2010, we have grown managed account assets from 0 to $1.3 billion in a fairly short period and ending 2012 at nearly double 2011.

Our financial consultant sales force has also been a key factor in our early success in the retirement and investing segment and for our managed accounts in particular. This group of 270 individuals accounted for 1/3 of net new brokerage assets brought to E*TRADE during 2012, of which approximately 40% were retirement-based. Our net new retirement accounts of 26,000 in 2012 represented a 14% increase from last year, and is also a testament to the efforts of our FCs.

With respect to our customer offering, we made multiple improvements throughout the year, continuing our investment in the retail trading experience, including a complete revamp of our prospect and logged-in customer websites, a redesign of our bond resource center, the incorporation of new planning and education tools, as well as improvements to our active trader platform, to name a few. Mobile continues to be a crucial way to serve our customer base, as retail investors are increasingly disconnecting from desktop computing. During the year, we expanded our mobile offering to Windows Phone, bringing our total mobile platforms to 6. Within these 6 platforms, we made several upgrades and enhancements, including introducing mobile check deposit, voice-recognition, barcode scanning, educational videos and CNBC videos-on-demand. We just launched a redesigned platform for tablet users, which incorporates several new features, centered on research and analytics. The importance of having top-tier mobile access points is evidenced in our record mobile adoption rates, with 6.8% of our trades executed by a mobile in Q4, up from 5.3% a year ago. Our mobile platform was also featured as the #4 essential finance app in the Apple App Store this quarter, the only brokerage app to make the list.

A more sophisticated and educated customer, in conjunction with continued enhancements to our trading suite, is reflected in our mix of trades. Derivatives continue to be a growth part of our business in 2012, as our mix of option trades represented 24% of DARTs, up from 20% in 2011. This improvement was driven by complex option volume growth and success in short dated options. Derivatives as a percent of overall volume set a record in 2012.

All of these elements: the Service, the platform, the tools and the education drive at the heart of our focus to empower our customer base to achieve their financial objectives, whether in retirement, investing or trade. Giving our customers capabilities, knowledge and advice, when and where they need it, has not gone unnoticed. The hard work and commitment of our employees earned us the #1 ranking in Kiplinger's Annual Best of the Online Brokers survey, the only firm to receive 5-star ratings in both customer service and investment choice categories. Among the other third party recognition awards received in 2012, our customer offering was recognized by SmartMoney, receiving top marks in the trading tools and research categories, and by Barron's, earning top marks in portfolio analysis and research. Both firms also recognized our customer service as one of the best in the industry.

Turning to our financial results. For the fourth quarter, we reported a net loss of $186 million or a $0.65 loss per share. This included a couple unique items. First, a $257 million pretax charge related to our $1.3 billion refinance of corporate debt, equating to approximately $0.59 per share. Second, our tax benefit included approximately $38 million of expense, or $0.13 per share, related primarily to a recent change to the California Tax Code. For the full year, we reported a net loss of $113 million, a $0.39 loss per share, compared with net income of $157 million or $0.54 per share in 2011.

Our fourth quarter net revenues were $468 million, inclusive of deleveraging-related securities gains. Revenues were down from $490 million in the third quarter, which also included deleveraging-related gains, and down from $475 million in the fourth quarter of 2011. Revenues included net interest income of $260 million, a sequential decline of $0.5 million as a result of 10 basis points in net interest spread expansion, offset by a $2 billion reduction in the average balance sheet size. Net interest spread rose to 238 basis points for the quarter, leading to a full year spread of 239 basis points, consistent with our expectations. The improvement to our spread this quarter was driven primarily by deleveraging, as we reduced balance sheet cash held in Q3, commensurate with our targeted reduction of liabilities. We additionally benefited from lower wholesale funding cost and the full quarter impact of rate cuts made on customer deposits of 1 basis point for the majority of our cash products.

Assuming no changes to the current rate environment and our current balance sheet strategy, we continue to expect our average spread in 2013 to compress 10 basis points from 2012's average. Commissions, fees and service charges, principal transactions, and other revenue in the fourth quarter were $151 million, down 1% from the third quarter and down 3% from the same quarter of 2011. Average commission per trade was $11.10, down from $11.24 last quarter, as a result of more trades from active traders on a relative basis. For the full year, average commission per trade was flat at $11.01.

Revenue this quarter also included $62 million of net gains on loans and securities inclusive of deleveraging-related gains, as we sold securities to match a reduction in certain wholesale funding obligations. Our legacy loan portfolio ended the quarter at $10.6 billion, a contraction of $557 million during the quarter, and is now down 68% from its size at the peak. We expect that loan runoff will average approximately $450 million per quarter through 2013, generally consistent with the 4% to 5% quarterly decline we have experienced for quite some time.

Provision for loan losses for the quarter was $74 million, down from $141 million in the prior quarter. The sequential decline related primarily to the prior quarter's charge of $50 million related to charge-offs associated with newly-identified bankruptcy filings. We continue to expect provision to trend downward over the long term, though there can be variability in any given quarter.

Total net charge-offs in the quarter were $102 million, down from $158 million in the prior quarter, which again included $50 million related to newly-identified borrower bankruptcies. The total allowance for loan losses ended the quarter at $481 million, a sequential decline of $28 million. The $481 million reserve includes a specific reserve of $171 million for modified loans. Our coverage remains relatively constant for non-modified loans, with this quarter's allowance covering 76% of 90-plus day loans past due. This compares to 72% last quarter. For modified loans, our total expected losses remain flat from the prior quarter at 37%. Our specific allowance of $171 million for modified loans, plus prior write downs, continues to cover the total expected losses in this portfolio.

During the quarter, we modified $44 million of loans, down from $54 million in the prior quarter, and representing the lowest quarterly level of modifications since we began the program in 2009. We continue to expect quarterly modification volumes to trend downward as the population of delinquent loans continues to get smaller. One important note on our reported metrics. Starting in the fourth quarter, we began to report loans in the process of bankruptcy as TDRs, so the balances reflected in the tables are greater than the amount of modified loans. Delinquencies in the quarter were down on a total basis, but increased 5% sequentially in the 30 to 89 day category, driven by the 1-4 family portfolio. We attribute this largely to seasonality, as the fourth quarter is typically weaker with respect to borrower collections.

Based on data received to-date for January collection activity, we anticipate that the elevated 1-4 family delinquencies will improve in the near term. Operating expenses for the year were $1.2 billion, down 6% from the prior year, and in line with our expectations. Fourth quarter expenses of $285 million were down 1% sequentially and 6% from the prior year. Included in the quarter was approximately $7 million of professional services expenses related to utilizing outside consultants for our expense review.

Turning to our financial position. Corporate cash ended the quarter at $408 million, declining by only $23 million from Q3 levels, due to interest expense payments, partially offset by a $58 million dividend during the fourth quarter, equal to the capital associated with a bank charter that was liquidated as part of our deleveraging actions. I would note that corporate cash is often impacted by subsidiary tax payments and expense reimbursements, which can create volatility in individual quarters. However, over the long term, we expect corporate cash will decline in line with interest payments. Our current level of corporate cash represents more than 3.5 years' worth of debt service coverage, a ratio that was improved materially by our recently completed refinance. Our capital ratios improved at the bank across all measures during the quarter, with our constraining Tier 1 leverage ratio ending the year at 8.7%, up from last quarter's 7.9%, and progressing toward our plan of exceeding our target of 9.5% by the end of 2013.

For all other bank risk-based ratios, we were between 19% and 20%, well in excess of regulatory minimums. At the parent, our ratios declined slightly as a result of the loss related to our debt refinance. However, we ended the quarter with a Tier 1 leverage ratio of 5.5%, just 30 basis points below the prior quarter, despite the capital hit created by the refinance. Importantly, our capital generation at the parent will improve as a result of the refinance we completed. Our parent Tier 1 common ratio ended the quarter at 10.3%, and we estimate it will be approximately 50 basis points higher under the current Basel III proposed guidelines.

With regard to our strategic and capital plan, we made some important progress since its submission in Q2 of last year. This progress includes deleveraging our balance sheet, our $1.3 billion refinance of corporate debt, over $100 million of identified cost saves and the buildout of an enterprise risk management function. I'll now discuss each of these in more detail. First, on deleveraging. As we have stated in the past, we view this to be the most shareholder-friendly path toward growing our Tier 1 leverage ratio, which represents our most constraining ratio and is an important barometer in gauging our success against the plan we submitted to regulators. Given the nature of our balance sheet, in order to reduce assets, we must target reductions in our liabilities. And to that end, we completed a total of $4.9 billion in deleveraging actions in 2012. This includes $1.3 billion completed in the third quarter, and another $3.6 billion completed in the fourth quarter, which consisted of the following: $1.2 billion of sweep deposits transferred to a third-party, bringing our total sweep deposits transferred to date to $1.7 billion; approximately $1 billion of a reduction of FHLB advances, bringing the total amount of wholesale bonds actively reduced to date to $1.5 billion; $900 million of customer payables transferred to third-party money funds and $500 million of new customer cash directed to third-party money funds upon account opening, bringing the total to $800 million. Additionally, we have already completed another $1.4 billion in the first quarter of 2013, consisting of: Approximately $100 million of customer payables converted to third-party money funds; and $1.3 billion of sweep deposits transferred to third-parties. This brings the total to $6.3 billion in completed deleveraging actions, falling squarely within our original target of $5 billion to $10 billion. Recall that the target is a wide range due to the uncertainty of customer activity and the impact of customer selling and buying on our balance sheet size. Given our current position, our plans are for total deleveraging actions of $8.5 billion, though that may change if cash balances change meaningfully.

One last point about our deleveraging efforts. I want to emphasize that the actions we have taken, with respect to customer deposits moved off balance sheet, are near-term tactics to achieve longer term capital goals. We have taken great pains not to disrupt our brokerage customers with these actions, as we fully recognize the value of maintaining these relationships and ultimately, these balances. Finally, in today's rate environment, the risk reward for maintaining a larger balance sheet is not exactly in favor of maintaining ours above its natural size, given that returns are at historical lows. For example, the incremental spread on a $1 invested today, considering our strategy of agency-backed investments, is approximately 1%. So in all, it's not a bad time to deleverage.

Now turning to our recently completed $1.3 billion refinance of corporate debt. In December, we eliminated the entirety of our 12.5% Springing Lien Notes due 2017 and the entirety of our 7 7/8% notes due in 2015. I have to admit that feels really good to say. This was a major accomplishment and has been a priority for quite some time. The Springing Lien Notes had been issued at a point in time when our bank needed capital, which was reflected in the high coupon. They were also issued at a discount and carried unfavorable tax treatment, making the effective cost to us closer to 17%. The elimination of these notes on their first call date and the subsequent issuance of new notes with an effective cost of well under half that of the previous debt, marks an important progress for the company. We also took the opportunity in attractive credit market conditions to refinance our nearest maturity notes, removing a 2015 payment event at a 7 7/8% coupon from our capital structure. Upon completion of the refinance, we had extended the weighted average maturity of our interest-bearing debt from approximately 4.7 years to around 6 years, and reduced the average coupons from 10.25% to 6.4%. I would also note that along with the principal amounts, we refinanced the associated call premiums and deal-related expenses, such that we did not use any of our corporate cash to complete the transaction. As far as impact on the financials, we reduced our annual interest expense from approximately $185 million pretax to $115 million pretax, representing an after-tax savings of approximately $60 million or $0.21 per share.

Considering we have eliminated a significant amount of nondeductible interest expense, we expect our tax rate going forward to improve to around 40%. Beyond being incredibly positive for shareholders, the refi also addresses an important component of our strategic and capital plan, which calls for us to reduce our interest expense and eventually, our overall debt burden. The newly-issued notes were designed with this goal in mind, including callability as early as the end of 2014, as we continue to work toward our goal of distributing capital from the bank to the parent at the end of 2013. While we will weigh all options for parent capital management when the time comes, our optimal capital structure has less corporate debt than we carry today. Therefore, we structured our new debt to accommodate any such actions without being overly punitive. $505 million is callable at the end of 2014 at half its annual coupon, and $800 million is callable in 2015 at 3/4 its annual coupon. Moving to cost reductions. Last quarter, we raised our target for cost reductions to $100 million, at which point, $70 million had been identified. This quarter, we have identified the full $100 million and then some. Our target for cost reductions is now $110 million, and will be fully implemented by the end of the current calendar year. Within this $110 million, $30 million will come from marketing spend and the remaining $80 million will come predominantly through compensation and professional services. I would also note that we expect about half of this $80 million to come from technology and operations. We expect the cost of implementing these reductions to come in around $10 million in 2013.

For the fourth quarter, in addition to the $7 million in consultant fees that I highlighted earlier, we also recorded $4 million in restructuring cost, bringing the total onetime cost attributed to our cost save project to $11 million. Finally, regarding the buildout of our enterprise risk management capabilities, we are in the process of creating a structure that is appropriate for our size and complexity. We made significant progress on this front during 2012 and this will remain a top focus in 2013.

We expect the annual investment in this function to be $10 million, and we saw about $1 million of that flow through in 2012, with the vast majority expected in 2013. During the year, we made important new hires, including compliance personnel and internal auditors, and utilized external consultants. We also began engaging in systems upgrades. Just note this is incremental to our $110 million of identified cost saves, so you should think about the $100 million in net savings.

So to briefly summarize the year, we strengthened our financial position with a refinance of our highest cost debt and solid bank capital growth. We continued to reduce our legacy loan portfolio and the associated risk. We formalized and submitted a strategic and capital plan to the regulators and have made good progress executing against it. And we identified significant cost saves and efficiency gains to be realized over the current and coming quarters. And above all, our core brokerage business continues to execute well, growing accounts and assets at levels we haven't seen in quite some time, even in the face of a challenging environment. We still have much work to do, but I am proud of the things we accomplished in 2012 and look forward to building on those achievements this year. With that, operator, we are ready to take questions.

Question-and-Answer Session

Operator

[Operator Instructions] And our first question is from the line of Howard Chen from Credit Suisse.

Howard Chen - Crédit Suisse AG, Research Division

Matt, now that you have completed the refinancing actions and you're making meaningful progress on deleveraging, can you just outline for us what next steps the company has to take? And what we should expect to hear, if it's going to hit that timetable to achieve your goal of upstreaming bank capital by the end of the year?

Matthew J. Audette

Sure, sure, Howard. So the most measurable thing is going to be to continue to improve the Tier 1 leverage ratio at the bank, so our target is 9.5%, and to dividend capital above that towards the end of 2013. So that's the most visible thing you will see. But I think it's important to emphasize that a dividend is not something that you can simply do based on above 9.5%. All the things that are important and part of our plan, I think really need to come together for that to make sense. Meaning, we need to continue to build out enterprise risk management capabilities. We have to continue to mitigate and decrease the credit risk on the balance sheet. We need to implement the cost reductions. We need to do all those things. And I think from -- if we're able to execute on all of that, I feel like we would be in a good position for a dividend. But I'd be remiss if I didn't close with, I can't speculate on whether the regulators would agree with what I'm saying, but I feel confident, from our perspective, it's the right thing to focus on.

Howard Chen - Crédit Suisse AG, Research Division

Okay, great. And then you also noted in your comments, your outlook for provision expenses to decline over the longer term. But just given the loan book continues to burn down and you're pulling down reserves, why shouldn't provision expense be also down in 2013 versus what we just experienced in 2012?

Matthew J. Audette

Sure, Howard. So I think without getting precise on any individual quarter, which can be pretty choppy, I think our expectations are down over the long term. It's just something where, on a quarter-to-quarter basis, that may not be the case. So year-over-year, I certainly would expect a decline.

Operator

Our next question is from the line of Rich Repetto from Sandler O'Neill.

Richard H. Repetto - Sandler O'Neill + Partners, L.P., Research Division

I guess the first question is on brokerage attrition. I know you've made great strides, Matt, when you look at the year-over-year numbers. But 4Q, at least by our calculations, ticked up, almost close to 10%. Was there anything going on in 4Q that's peculiar from the 8.5% or so run rate you've been on?

Matthew J. Audette

Nothing in particular, Rich. I think focusing on the year is really where to ground it. So we're 9% for the year, which is a record low for us. If you go back to last quarter, at 8.5%, I mean, that's one of the lowest numbers we've ever seen. So I think it's almost like -- well, I was just talking to Howard about provision, right? Attrition can bounce up and down, but I think we're really focused on we had a record low year. And we're not going to rest on our laurels on that. We are focused on improving it going forward as well.

Richard H. Repetto - Sandler O'Neill + Partners, L.P., Research Division

Got it, got it. Okay. And then, Matt, the charges on the FHLB, paying down FHLB, the charges were much less than what we anticipated. You had charges, I think, it was around in the $50 million range and you only retired half of what you did this quarter. And this quarter, the charges were almost half. So I guess, can you explain, there's still $1.3 billion on the balance sheet, do you intend to pay more down and how would we think about the charges that you're going to have to offset through gains or whatever, on what's remaining, if you do that?

Matthew J. Audette

Sure, Rich. So for the $1.5 billion we've done to date, which is over the last 6 months, in our overall plans for deleveraging of $8.5 billion, we've completed the wholesale reductions that we were looking to do. So at this moment, we don't have any plans to further reduce that actively. Now over time, that roughly $5.5 billion, when you add in the repo that's left, will naturally decline over time. But we don't have any plans to actively -- to do anything else prepayment-wise, in that area.

Richard H. Repetto - Sandler O'Neill + Partners, L.P., Research Division

Okay. And just to step back, the $28 million charge versus the like, $50 million, I think it was $52 million last quarter, or $51 million?

Matthew J. Audette

Yes, so why the difference in numbers?

Richard H. Repetto - Sandler O'Neill + Partners, L.P., Research Division

Yes.

Matthew J. Audette

So it just all depends on which ones you prepay, right? So for the very same reason that the $5.5 billion that's left, if we were to do it all, would come with a charge of north of $700 million, so it just depends on exactly which items that we terminated. They just have a different cost based on their coupons and the tenor that's leftover on the borrowing. So it's not something that you would have been able to predict.

Richard H. Repetto - Sandler O'Neill + Partners, L.P., Research Division

Got it. Okay. And one last quick one, it'd be for Paul. What areas will you think your energy and your focus on, near term, as you get introduced to E*TRADE?

Paul Thomas Idzik

As I discussed with the board before I joined, my focus is going to be on ruthless execution of that strategic plan. That's what our shareholders are expecting. That's what the board is expecting, that's what we have the employees and my colleagues teed up to do. And it doesn't take a rocket scientist to figure it out, that, that's where I'm going to spend my time.

Operator

Our next question is from the line of Alex Blostein with Goldman Sachs.

Alexander Blostein - Goldman Sachs Group Inc., Research Division

A couple of follow-ups on the balance sheet, I guess. So $8.5 billion target total deleveraging, so I guess, I just want to double check, so for the rest of the year, we're looking at, I don't know, $2 billion to $3 billion of incremental deleveraging on top of, I guess, what you guys done in the first quarter, is that roughly the math?

Matthew J. Audette

That is, Alex, about $2 billion.

Alexander Blostein - Goldman Sachs Group Inc., Research Division

Okay. And then, I guess, when I think about...

Matthew J. Audette

Sorry, Alex. Sorry to jump in there. Alex, $2 billion beyond what I described that we have already done in Q1, so off of what we've done -- where we ended the year, is another $3 billion.

Alexander Blostein - Goldman Sachs Group Inc., Research Division

Got it. Okay. I just wanted to double check that. And then when I look at the quarter, the fourth quarter, was there any timing difference, I guess, between when you guys broke the FHLB funding and sold some of the securities, because it feels like there is, from just looking at the average balances, seems like there was a little bit of a mismatch, so I just wanted to double check whether or not there was any kind of positive carry that you saw in the fourth quarter from that?

Matthew J. Audette

Not really, Alex. You can imagine, especially this particular quarter, with all the deleveraging actions that were going on, and all the customer flows, if you saw the -- if you noticed, on the monthly metrics that we put out as well, the net customer buying and selling, in the first 2 months of the quarter, there was a bunch of buying and then big selling in the month of December. So there was a lot of different things going on in the quarter. There wasn't something specific to when securities were sold, and when the FHLB advances were prepaid.

Alexander Blostein - Goldman Sachs Group Inc., Research Division

Got you. Last one, on the balance sheet and then I'll move on. Do you guys have a sense of where the average earning assets actually ended the year? I know we know what the total balance is, but I was just hoping to get the earning assets?

Matthew J. Audette

Yes, I don't have that number for you, Alex. Sorry.

Alexander Blostein - Goldman Sachs Group Inc., Research Division

But is the, like the $3 billion swing that you saw in the ending balance sheet, is it kind of indicative for the average balances as well, then?

Matthew J. Audette

Sure. So the non-interest ones are not moving dramatically, so that's a good way to think about it.

Alexander Blostein - Goldman Sachs Group Inc., Research Division

Okay, great. And just moving on, I guess, to expenses. So it sounded like you guys identified a little bit more in expenses for 2013. When you think about the business, and I guess, in the opportunities and you clearly continue to see pretty decent new business momentum, what do you envision kind of like the core expense growth that you need to have in order to continue to drive organic growth? I guess, in other words, you guys did $285 million in expenses this quarter, at run rate, that leaves you at $260 million by the end of next year, but presumably, there's obviously some just core expense growth, how do you think about that for '13?

Matthew J. Audette

So in a short window like that, I think that taking that $290 million, which has historically been our run rate, which is a little bit above what we saw in the fourth quarter. And taking the $110 million of cost saves offset by the year-end investment of $10 million, so taking off $25 million per quarter, that $260 million to $265 million range, I think is a good way to think about it. Embedded in that number is still a continued amount of investment in the firm. So I talked about $110 million of cost saves and about $40 million of that coming from our tech and ops area. Keep in mind, that's one of our biggest areas where we spend money, so reducing it by $40 million, we're still doing a significant amount of investment, on an annual basis, in those reduced cost numbers. So in the short term, I wouldn't think that there's -- I wouldn't view it as an upward bias that we need to increase the expense base to invest. I think in our baseline numbers we're talking about, we're still investing.

Alexander Blostein - Goldman Sachs Group Inc., Research Division

Got you. And just a last one for me. I guess, when you look at net new assets for December, pretty big pickup, I was wondering if you could quantify how much was the dividends? And then, more broadly, I was wondering if you have any stats on, I guess, where you see the growth coming from, whether it's competitors, so are you winning some business from either one of the other online brokers, or some other trend that continues to kind of drive your net new asset growth?

Matthew J. Audette

So I don't have a breakout of the dividends for the month of December, Alex, other than, if you just look at the 3 months of the quarter, we saw nice improvement, October, November, December, the net new assets were growing throughout the quarter. So I think we saw a nice trend there. As far as where we're getting the new customers or new accounts from, it really hasn't changed. I don't think there's a dramatic change within our space of customers going from us to our competitors and back. I really think it's the secular shift from the wirehouses and the off-line to the online space. And I think that trend is what continued in the fourth quarter.

Operator

Our next question is from the line of Jason Weyeneth from Sterne Agee.

Jason Weyeneth - Sterne Agee & Leach Inc., Research Division

The home equity book continues to see pretty rapid principal paydowns. In thinking about the home equity conversions that are starting in 2015, you guys have talked about that $150 to $200 average increase in minimum payments? But can you give us any sense as to how that compares to what the average home equity borrower might currently be paying, given clearly, many are paying above the minimums?

Matthew J. Audette

Sure, Jason. So I don't have precise data what their normal monthly payments are. I think you see in the home equity book, you certainly see that the charge-offs that are driving that number down. And typically, the vast majority of principal payments are going to be prepayments of the loans themselves. I don't have anything, any specific breakout there for you.

Operator

Our next question is from the line of Joel Jeffrey with KBW.

Joel Jeffrey - Keefe, Bruyette, & Woods, Inc., Research Division

So just to go back to your ability to return capital. I know you've talked in the past about, when you get to that 9.5% level, being able to start to return some of this back from the bank. You're currently at 8.7%. If you were to achieve the 9.5% earlier than expected, is there anything that holds you back from beginning the capital return before 2014?

Matthew J. Audette

So Joel, we definitely need approval from our regulators. And I think the things that are important for us to even be comfortable going to ask for a dividend are more than just being above 9.5%. So they are executing on our risk -- enterprise risk management buildout, they're improving our credit quality, they're executing on the cost reductions. It's really the entire plan coming together to get us to a point where we think it would make sense to go and make that request. Our plans are towards the end of 2013 to do that. But it's incredibly important to make sure that we execute on that plan, and not just increase our Tier 1 leverage ratio. We need to do everything.

Joel Jeffrey - Keefe, Bruyette, & Woods, Inc., Research Division

Okay. Great. And then, you guys also mentioned that $8.5 billion was your target, sort of deleveraging number. Can you talk about any kind of circumstances that would cause you to vary off of that, whether taking it to $10 billion or actually reducing it in any way?

Matthew J. Audette

Sure. So the biggest factor is going to be customer activity. So when customers are big net sellers, they go from some positions that are off balance sheet into cash that's on balance sheet, which would naturally drive the balance sheet up, which would then necessitate us doing more deleveraging. So that's why we have that big range of $5 billion to $10 billion. So given where we are today, and assuming that customers don’t meaningfully move the balance sheet up or down, we're targeting $8.5 billion. Now if customers are big net sellers and put cash in the balance sheet, we have to do more than $8.5 billion. And the reverse is also true, if there are big net buyers, like we saw in the months of October and November, we probably don’t need $8.5 billion, so it really just depends on what the customers do.

Operator

Our next question is from the line of Keith Murray with Nomura.

Keith Murray - Nomura Securities Co. Ltd., Research Division

Just some color on the economics around the third-party deposits, meaning, what are the economics there? What do you lose on a net basis, when you do the sweep to the third-party?

Matthew J. Audette

Yes. So you can imagine the economics there are pretty small, right, everyone's flushed with deposits. So for us, it's more about a balance sheet strategy. And the fee that we get paid from those third-parties are pretty nominal or pretty small.

Keith Murray - Nomura Securities Co. Ltd., Research Division

Okay. And then, I guess, at a similar vein, given that deleveraging leads to sort of a reduced earnings profile, at least in the short term, is there any risk of your DTA needing to have a valuation allowance, in your mind?

Matthew J. Audette

So we're quite comfortable that we don't need a valuation allowance on the DTA. I think, specific to deleveraging, keep in mind that the marginal investment rates we have in this environment, with our investment strategy, we're talking about 100 basis points. So it's not a dramatic amount that we're giving up. Also keep in mind, certain deleveraging strategies, like the wholesale reduction and like the customer payables, to the extent we have those in excess of margin, those deposits are invested in segregated cash, where you earn single-digit basis points on it. And after FDIC insurance, we're, on that particular one, we're actually losing money. So there is actually some deleveraging that makes us money by deleveraging, there's some that's kind of neutral and then there's some like sweeps that are costly, but the cost is in that marginal investment range of 100 basis points. So it's not something that I'm concerned about from a valuation allowance perspective at all.

Keith Murray - Nomura Securities Co. Ltd., Research Division

And then just a final one on securities gains. Last couple of quarters, obviously, you've taken sizable gains to offset some of the impacts on the wholesale borrowing declines. How should we think about sort of the pipeline of potential securities gains going forward? I know you've talked about it coming down over time in the past, but do you see the pace of that increasing as a result of the recent actions?

Matthew J. Audette

So specific to Q3 and Q4, they were most certainly elevated. One thing I would do is I would look at the securities gains and impairments and also net of the losses on the retirement of FHLB advances which are reported in a different line. So when you look at all those things together, the net number for the last couple of quarters bounced around the $25 million -- the upper $20 million range, which is somewhat consistent with what we've seen throughout this year. I think, over the long term, even those numbers, in the mid to upper 20s, are going to come down. But I don't have a specific number for you.

Operator

Our next question from the line of Chris Allen with Evercore.

Christopher J. Allen - Evercore Partners Inc., Research Division

I might have missed this, but I was just wondering if you could give us an update in terms of what has already been realized in the expense reductions, because there's been a somewhat gradual decline in expenses, looking at the starting point for 2012. And if you could give us a kind of a framework in terms of how it's going to progress. I know you guys gave us the numbers, but is there gradual progression or are there some things that need to be executed for more of a stair step drop-down?

Matthew J. Audette

Yes. So you didn't miss it. I didn't give it. But I'll do that now. So Of the $110 million, we had about $15 million of it was in our fourth quarter results. And on the ER investment side, the $10 million investment, about $1 million of that was in our fourth quarter results. So about a small amount, net $14 million, were in the fourth quarter results. Our objective is to complete the majority of the actions to realize the $110 million by the end of the second quarter, meaning beginning in the third quarter of 2013, the majority of it would be embedded in our results. And then to complete all of it by the end of the year, meaning, in Q1 2014, all of it is in our results, so that's our plans on timing.

Operator

Our next question is from the line of Patrick O'Shaughnessy with Raymond James.

Patrick J. O'Shaughnessy - Raymond James & Associates, Inc., Research Division

So let's assume you have the happy situation where you reach your capital target at the bank and you're ready to upstream capital to the parent. What realistically can you do in the near term with the capital to parent? Is the thought that you'd just kind of stockpile it there until you're able to prepay the debt or are there kind of other options that you would consider using with that money?

Matthew J. Audette

So I'd definitely love to have that problem, Patrick. So I think we'd make the decision at that time, of what was the best use of that cash for our shareholders, right, so you can run the gamut of the obvious choices, is there anything we can do on the debt, even though it's not callable. Is there anything in our business that would make sense to invest in. Can and should we return it to shareholders. So I think we'd make the thing that was in the best interest of our shareholders at that time. Keeping in mind that certain of those options would need regulatory approval and others wouldn't. So there'd be a lot of things to consider when we're in that situation.

Patrick J. O'Shaughnessy - Raymond James & Associates, Inc., Research Division

Okay, that's fair. And then one for Paul. So Paul, obviously, you have a background at Barclays and then I think, more recently, at a brokerage firm over in the U.K. What's your background level on the online brokerage business? How familiar are you with it? And do you think there's a learning curve that you have to come up here? Or are you pretty much ready to go and you feel like you have a pretty good grasp of the competitive dynamics?

Paul Thomas Idzik

Well, as you might well imagine, with a degree from Our Lady's University, I'm pretty well prepared for anything.

Patrick J. O'Shaughnessy - Raymond James & Associates, Inc., Research Division

Yes, everything except for winning the ballgame.

Paul Thomas Idzik

Yes, I understand, but I thought you'd like that. But seriously, when I was at Barclays Capital, oversaw the installation of BARX, which is one of the most successful corporate side for electronic brokering platforms that you've seen and really helped us move the dial. When I went to Barclays, we made great strides in electronic brokerage at Barclays Stockbrokers, which is the leading execution-only stockbroker in the U.K. And so I think, with particular questions about the retail electronic brokerage space, there's also some real value having helped run a branch network of red-blooded retail customers. And so I think there's a number of things. And the other thing is, we have a great team here and I would say it's not a one-man band.

Operator

[Operator Instructions] Our next question is from the line of Chris Harris with Wells Fargo.

Christopher Harris - Wells Fargo Securities, LLC, Research Division

Another question on the deleveraging here. It sounds like pretty much all of it this year is going to come from customer deposits. I know we kind of danced around this a little bit, on a answer to an earlier question, but I wonder if you can be a little bit more precise on what the average yield you expect to lose on the asset side associated with these liabilities?

Matthew J. Audette

Sure, Chris. So we certainly are focused on doing customer deposits for the rest of the year. I think, if you look, just look at the balance sheet, the reduction of customer payables, which I said, we had already done about $100 million in the first quarter of this year, that's the type of stuff that comes out of the segregated cash, which, in effect, is an asset where we net lose money when you factor in the FDIC insurance that we have to pay. The rest of it would likely be sweep, and that's where our loss opportunity, if you will, is going to be the marginal investment rate of around 100 basis points. So that's the best way I can probably direct you on that stuff.

Christopher Harris - Wells Fargo Securities, LLC, Research Division

Okay, fair enough. And then with respect to customer activity, you guys aren't alone at seeing DARTs kind of being, I'm sure, below where you'd like to see them. What do you guys think it's really going to take to get the retail investor a little bit more active here? I mean, we'd heard in the past that the holdup being the election, and that's done. And then all of sudden, it was the fiscal cliff was the problem and that's over. Just wondering if you guys have any perspective on why now folks aren't trading more. I mean is it the situation with the debt, with the government. And I guess, if that's the case, we can be waiting for kind of a long time until we see a little bit more normal activity. Maybe if you can comment a little bit about that, it'd be great.

Matthew J. Audette

Sure. So I think it's the things that you just listed out. So the retail investor hates uncertainty, right? So certainty is something that we think would generally encourage more trading. And the things that you highlighted, the election, fiscal cliff, which is really, the can's been kicked down the road as opposed to solved, are things that we think make those folks nervous so they pull back and they don't trade. I'd reiterate what we've seen so far in January, which is up 17% over December, which puts us just north of 150,000 trades per day. Higher, in general, levels, that if they continue, which who knows if they will, are the highest levels we've seen in a year. So we're seeing some good things in the past few weeks, but we'll have to see how it plays out.

Christopher Harris - Wells Fargo Securities, LLC, Research Division

Okay. And then last question for me. On the dividend potential out of the bank, how do you guys get comfortable with persuading the regulators that you can really have that dividend when you have a lot of your HELOC portfolio that's going to be switching to amortizing? I mean, do you think they're going to be comfortable with a dividend out of the bank prior to seeing what kind of loss expectations happen in that portfolio once we start getting some amortization activity there?

Matthew J. Audette

I definitely can't speculate on what they think, but I think improving our credit quality is one of the key things that we need to do to be comfortable even asking for a dividend. So I think that focusing on non-amortizing to amortizing or not making any principal payments to having to make them is certainly something that we focus on. But I think I'd just go back to there are a lot of things that we need to do to get to a position to ask for a dividend, improving our credit quality is one of them, cost reduction is another, deleveraging is another. So I just think there's a lot of things to do and we'll eventually see what their reaction is.

Operator

Our next question is from the line of Ed Ditmire from Macquarie.

Edward Ditmire - Macquarie Research

I've got a question on the core brokerage business. You guys have talked about over the last couple of years becoming a better place for people to do their retirement savings and their long-term investing versus just trading stocks. And I wondered if you might have any detail about how that affects things like, obviously, the average account size, but also how much people trade per year? It's pretty obvious that the online brokers that are the best at serving the longest term investing in this space have the lowest trades per account. And so, I know that there was less trading in 2012 than the year before across all manner of categories and whatnot, but I do worry that, over time, that there's some secular pressures pushing the trading turnover down, such as people just generally owning less stocks and more ETFs and having more of a focus on their long-term. I wanted to hear what you guys thought about that.

Matthew J. Audette

So well, specific to trading, I think the one thing that we've seen for quite some time now is the growth in options, right? So people are not necessarily as much in equities, but they're in options. 24% of our trades this quarter were options, which is up significantly over the past couple of years. On the retirement investing side, I think it's definitely a different business model, it's not a model where they trade as much, they're in assets and the business model, the economics of that, are different. We've been -- we're very clear that it's a long-term strategy, you have to move things meaningfully for it to have a P&L effect. Like you would see in bringing in a lot of trading customers. So it's just a totally different business model. But we think it's one that's important for our customer base. So just as a simple example, the managed products that we launched a couple of years ago, we've gone from [indiscernible] to $1.3 billion. So incredible growth there, but we need and want to grow it much larger than that. So it's things like that we need to focus on and from an economics perspective, you'll see it over time.

Edward Ditmire - Macquarie Research

Just a follow-up. Are you saying that increased options usage will offset the trend towards more investor behavior, lowering the trades per account?

Matthew J. Audette

So my comment on options is more responding to your comment on people are trading in equities less, not going back and forth between retirement, investing and trading. It's just more that the customers that do trade are starting to trade more in options as opposed to equities.

Operator

Our next question is from the line of Brian Bedell with ISI Group.

Brian Bedell - ISI Group Inc., Research Division

A couple of questions. Just going back to the deleveraging. Just to make sure I sort of have this math right, I guess. If we're at around $42 billion in earning assets now and you're going to delever another $3 billion from where you were in 4Q, that would get you down to about $39 billion. And then with the mortgage runoff, you're down to around $37 billion. If we assume -- if we're excluding the factor of net new assets from customers and excluding the factor of either net buyers, so securities, should we continue your balance sheet at around $37 billion or so size coming into 2014, is that -- do I have that math about right?

Matthew J. Audette

Almost, except for the loan paydowns. So the strategy to delever the balance sheet is solely liability-focused. So the deleveraging we do there is going to drive the balance sheet size. Loan paydowns, everything else being equal, would just be reinvested in securities. So it's really the liabilities that will drive the balance sheet.

Brian Bedell - ISI Group Inc., Research Division

So more like a $39 billion then, based on that math?

Matthew J. Audette

Right.

Brian Bedell - ISI Group Inc., Research Division

Okay. And then just on the expense run rate. Do I have it right, in terms of being -- trying to be at around $265 million by, say, the fourth quarter of this year?

Matthew J. Audette

Correct. On a run rate basis, so just keep in mind, seasonality can impact individual quarters, but on a run rate perspective, that's a good way to think about it, yes.

Brian Bedell - ISI Group Inc., Research Division

Okay. And then a question for Paul. Just as you studied the online broker, online brokerage industry, I guess, so far, are there any broad thoughts about untapped areas of opportunity for E*TRADE, such as businesses that they're not in, in any major way?

Paul Thomas Idzik

This is Day 3, I've been working for Matt pretty much, but I think if you want to know my thoughts on that, my submission to the Nobel Prize Committee for Economics will be coming out in a week or 2 on that topic.

Operator

Mr. Audette, I'll be turning the call back to you, sir. You may continue with your presentation or closing remarks.

Matthew J. Audette

All right, thanks, everybody. We appreciate the time. We look forward to talking to you next quarter.

Operator

Ladies and gentlemen, this does conclude the conference call. We thank you all for your participation, have a great day.

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