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TD Ameritrade Holding Corp. (NYSE:AMTD)

F1Q10 Earnings Call

January 19, 2010 8:30 am ET

Executives

Bill Murray - Managing Director of Investor Relations, Communications and Public Affairs

Fred Tomczyk - President and Chief Executive Officer

Bill Gerber - Chief Financial Officer

Analysts

Rich Repetto – Sandler O’Neill

Roger Freeman – Barclays Capital

Daniel Harris – Goldman Sachs

Howard Chen – Credit Suisse

Celeste Brown – Morgan Stanley

Patrick O'Shaughnessy – Raymond James

Mike Vinciquerra – BMO Capital Markets

Michael Hecht – JMP Securities

Michael Carrier – Deutsche Bank

Joel Jeffrey – KBW

Faye Elliott – Bank of America/Merrill Lynch

Operator

Welcome to the TD Ameritrade Holding Corporation December quarter 2010 earnings results conference call. With us today from the company is President and Chief Executive Officer, Fred Tomczyk and Chief Financial Officer, Bill Gerber. At this time, I would like to turn the call over to Bill Murray, Managing Director of Investor Relations, Communications and Public Affairs. Please go ahead, Sir.

Bill Murray

Thank you. Good morning everyone and welcome to the TD Ameritrade December quarter earnings call. Hopefully you have had a chance to get our press release and view our presentation. If not, they can be found on our website at www.AMTD.com.

Before we begin, I would like to refer you to our safe harbor statement which is on slide two of the presentation as we will be referring to forward looking statements in today’s presentation. We would also like to review our description of risk factors contained in our most recent annual and quarterly reports, forms 10-Q and 10-K. As usual the call is intended for investors and analysts and may not be reproduced in the media in whole or in part without prior consent of TD Ameritrade.

As we begin I will remind you that we have 20 covering analysts and we would like to get through as many as possible so we would appreciate your keeping your questions limited to two.

With that I will turn it over to Fred Tomczyk, President and CEO and Bill Gerber, our CFO here to review the December quarter results and our major accomplishments. Fred?

Fred Tomczyk

Thanks Bill and good morning everyone. Thank you for joining us today. I am pleased to report we had another solid quarter maintaining our focus on our clients and driving organic growth.

This focus has enabled us to take advantage of the markets to grow our business, strengthen our firm and position ourselves for the future. We feel very good about our business model, our strategy and our financial position and we remain positive about our ability to grow earnings over the longer term. On slide three you can see our highlights for the first quarter. EPS came in at $0.23 and reflects a $0.01 charge incurred on refinancing our debt, lower trading and continued investments in marketing which is working for us.

After a strong October, trades began dropping off in mid-November and December as you are well aware and as a result we averaged 379,000 trades per day for the quarter. So far in January trades are averaging 408,000 per day, up 19% from December’s trading levels. Retail investors have re-engaged in the New Year.

We ended the quarter with $34.6 billion in insured deposit account balances and this number increased to $39.1 billion January to date primarily due to the last step in our cash management strategy; moving $4.1 billion from free credits to the IDA in early January. When we started our cash management program we had a goal of moving between $10-14 billion into the IDA from money market mutual funds and client credits. We are very pleased that we were able to over-achieve on this effort and we have now migrated $20 billion. Our IDA balances have now doubled to close to $40 billion over the last year. This bodes well in helping mitigate the impact of a near zero interest rate environment and positions us well for a rising rate environment.

Margin lending has come back nicely as the market has turned around. We ended the quarter with $6.4 billion in margin loans. As I have been saying to you for some time, while quarterly results are important we are focused on delivering value over the longer term and we manage our business with a focus on what we can control and our priority on creating long-term shareholder value.

Our business fundamentals remain very strong with net new assets of close to $9 billion. This represents an annualized growth rate of 12%, another quarter with double digit growth in net new assets. If you think about it, in the first year of our asset gathering journey, 2007, we gathered just over $12 billion of assets. Here we are three years later and we gathered close to $9 billion in one quarter. We are very happy with our continued asset gathering momentum.

Gross new accounts came in at 180,000. Our client assets of $319 billion are now higher than they were when we entered the financial crisis as a result of our strong asset gathering results and the recovery in the markets and client cash at $58 billion is at record levels. As you can see on slide four, net new assets of $8.7 billion for the December quarter were up from $7.8 billion in the same quarter last year and $6.8 billion in the December 2007 quarter after excluding some one-time assets gathered from a competitor. Both our retail and institutional distribution channels continue their strong asset gathering momentum. In fact, we had record net new assets in our advisor channel in the quarter.

We attribute these strong results to a number of things including continued strong service levels in both retail and institutional. In retail our Business League Referral Program continues to provide a steady and strong flow of opportunities to the branch system and we are converting more of these leads into net new assets. One of our long-term goals is to increase our annuitized revenue stream. While still early in this process, sales of our Amerivest family of package products are well up year-over-year. This will not make much of an impact over the short-term but it is important over the longer term.

We are encouraged by positive results with our AdvisorLink Program which pairs breakaway brokers with existing RIAs to help them transition into their new businesses. Along those same lines we have more than 1,000 advisors already signed up to attend our National Conference next month in Florida and we expect that number to climb even higher. Advisors are increasingly looking to TD Ameritrade as a preferred custodian.

Another factor in our strong asset growth is the quality of new accounts we are attracting, nearly double the size this quarter over the same quarter last year. Finally, our continued investments in marketing continue to pay off for us. Keep in mind that our marketing expense includes both our traditional marketing spend and origination payments to partners. Our research last fall found that clients were re-examining their investment strategies in light of the market crash and they wanted alternatives. We took that idea and beginning last November we aggressively went after these opportunities with our new advertising.

We have been successful with our new campaign, Time for Fresh Thinking, Time for TD Ameritrade. It is resonating in the market and our brand and is just starting to be reflected in our account growth. Clients are continuing to respond positive to TD Ameritrade as a provider of value added services for investors; both long-term investors and active traders.

Slide five reflects our average number of trades per day; 379,000 for the December quarter up from 357,000 last year and 311,000 in 2007. This is a healthy increase driven primarily by the acquisition of thinkorswim. On a pro forma basis our funded account activity rate declined from 8.3% in the December 2008 quarter to 7.1% in the December 2009 quarter. The decrease was driven by lower volatility levels between the two quarters.

The S&P 500 grew by 2.5% intra-day on 90% of the days in the December 2008 quarter. In the December 2009 quarter the S&P moved by 2.5% on only 5% of the days. We have said many times that intra-day volatility and funded accounts are the key drivers of trade volumes. While market environments and volatility are ever-changing we will continue to focus on funded account growth to support our long-term growth and our trading levels. We believe this is working and we will continue to focus on what we can control. Funded accounts, which are now at $5.3 million, are up 15% from what they were two years ago.

Now let me give you an update on the thinkorswim integration. First, I think it is important to note the thinkorswim base business continues to perform at record levels on a standalone basis. They have record trades per day and record new accounts and in the midst of a major integration they have been able to maintain client retention levels at between 98% and 99%, well within our expectations. In fact, thinkorswim client retention levels have actually improved since the transaction was announced.

Beyond that, the integration is also going very well. Let me bring you up to date on two levels. First we are monitoring the more than 70,000 legacy TD Ameritrade clients who have taken advantage of the thinkorswim platform. These clients are operating at activity rate levels that are higher than they were on the legacy TD Ameritrade platform which validates our expected synergies. Secondly, we have been successfully incorporating new technology and functionality including thinkondemand, an innovative new back testing tool, market [caps], live running commentary on the S&P 500 from a professional trader throughout the trading day and MyTrade, a community tool that allows its members to share their trades with others within the community, on Facebook or Twitter.

The investor education business is already showing significant promise as a tool for client engagement. We had 1.6 million interactions with students during the first quarter over 300,000 of which were in person with coaching sessions, live workshops or online seminars. 1.3 million were clients engaging with web based tool box resources. These numbers are very encouraging. It is clear there is a strong demand for investor education in today’s markets.

Option trades accounted for 21% of total trading volumes in the December quarter. We will continue to work on the integration through 2010 with complex options, futures and ForEx capabilities being rolled out throughout the year and we expect to begin capturing further synergies in the second half.

On slide six you can see we have done a good job of positioning TD Ameritrade for the future. You can expect more of the same for the remainder of the year as we continue to manage our business with the goal of driving long-term organic growth and earnings. This includes continued investments to improve and expand our technology infrastructure to handle future growth and continued investments in marketing which have been successful in helping to produce strong asset gathering and new account growth.

Our efforts to mitigate the impact of the near zero interest rate environment and position the firm for rising interest rates has been successful. We have over-achieved on our cash management strategy which is now largely complete with over $20 billion moved from money market mutual funds and client credits to the IDA. In late December and early January we have taken advantage of the recently steepened yield curve by extending $10 billion from short-term investments to 1-5 year term assets with higher rates. The yield curve is now quite steep by historical standards and these extensions will clearly help earnings over the balance of the year and into 2011.

We are very well positioned over the longer-term in a rising rate environment. We haven’t lost sight of the fact we want to bring expenses down but we are committed to making investments in the business that will bring us long-term growth. We will continue to be diligent in managing core operating expenses. We are currently investing heavily in our technology infrastructure to handle future growth but we expect these expenses to taper off in early 2011 as we complete our data center migration strategy.

We are making excellent progress and will continue to focus on delivery of the thinkorswim integration and realize the expected synergies. We are very excited about what this integration brings to TD Ameritrade; world class technology and best in class investor education for our current and prospective clients. We have a strong balance sheet and strong cash generation capabilities. I cannot over-emphasize the long-term benefits of our recent debt refinancing which gave us access to the public market, favorable pricing and the flexibility that will allow us to take advantage of opportunities to increase shareholder value in the future.

Bill will give you more detail on this a little later, but we have swapped two of the three trenches of the debt from fixed rate to floating rate which will also help with earnings on a prospective basis. Before I turn the call over to Bill I want to just leave you with a couple of thoughts. As you know, the near zero interest rate environment has and will continue to affect us but we will stay very focused on maintaining strong business fundamentals and continuing to drive strong organic growth.

When the crises hit in the fall of 2008 we said we would not run the company to maximize quarterly earnings but rather we would manage for the longer-term and take advantage of the dislocation in the market. We executed on that. Last quarter end we said we would look to position ourselves to take advantage of various options. With our debt refinancing we have now done that by replacing secured bank debt with non-investment grade covenants with public unsecured debt with covenants more appropriate for an investment grade company. This gives us the flexibility to capitalize on opportunities we see in the market.

As we look forward from here with the cash management strategy largely complete, $10 billion of extensions, debt refinancing and the swap to floating complete, we feel very good about where we are and we will remain focused on executing our strategy, being opportunistic and driving long-term earnings growth.

Thank you. Now I will turn it over to Bill.

Bill Gerber

Thanks Fred. As we have said for many quarters now our strategy is to continue to operate the company with an eye on the future, most important to recognize is the fact that we continue to grow the key long-term revenue drivers and net new assets and new accounts despite the difficult environment. This strategy should result in significant revenue growth as the US economy improves.

Furthermore, we are doing what we can to mitigate the near-term headwinds; principally the interest rate environment. I will touch on all of these things this morning but for now let’s start with our financial results for the December quarter on slide seven.

This quarter we are providing year-over-year comparisons as we normally do but we also have a sequential quarter comparison since the September quarter was the first full quarter with thinkorswim in our results. We will start with the year-over-year comparisons. Virtually all of the variances are related to thinkorswim. Transaction base revenues for the quarter as seen on line one exceeded last year’s results primarily as a result of a 6% increase in trading activity year-over-year due to thinkorswim. Our commission rate was slightly up to $12.98 per trade from $12.76 last year. The primary drivers here were stronger payment for order flow and slightly lower promotional couponing costs.

This transaction growth offsets most of the decline we realized in asset based revenues on line two which continues to be driven by the near zero interest rate environment. More of this in a moment. Other revenues on line three are up as a result of the education business we acquired from thinkorswim. All in, revenues were up slightly year-over-year. On the expense side we are adjusting our income statement a bit starting this quarter. We are moving corporate interest expense out of our operating expenses. The logic is that our strategy on the use of debt is a part of our total capital plan is the separate and distinct decision from expenses necessary to run the company.

Thus, we believe the new metrics, operating expenses and operating margin are more representative of the efficiency with which we are running TD Ameritrade. So, operating expenses excluding advertising are up about $70 million from last year, virtually entirely due to thinkorswim. Advertising is up $18 million also due to thinkorswim.

Our interest expense for the quarter was $4 million lower than the same quarter last year, as lowered interest rates benefited us on our debt. In this quarter, as you know, we refinanced our debt. As such we had to write off the deferred costs of our original financing. This amounted to about $8 million that you can see on line 11. Obviously this will not occur again in future quarters which brings us to the net income for the quarter on line 14 of $136 million or $0.23 per share. A side note here for your models, there can be a tendency to annualize the quarter results to represent the whole year but we have a few items to be considered in your analysis.

First, the $8 million of deferred financing costs written off in the quarter which I just mentioned and second the extension of over $10 billion of IDA balances. These are key items to factor into the balance of 2010. Obviously trading levels, new accounts and net new assets are quite impactful as well.

So now let’s look at our results on a sequential basis. Sequentially you can see that our transaction revenues have dropped off due to the decrease in overall trading volumes that Fred referenced earlier as well as lower payment for order flow. Asset based revenues, on the other hand, are up as a result of balanced growth in our cash management strategy which are offsetting rate declines. I will discuss this in greater detail in the next few slides. Other revenues are essentially flat quarter-over-quarter.

Moving to expenses, our operating expenses before advertising on line 5 are down $20 million. If you exclude the $14 million auction rate securities charge from last quarter expenses are essentially flat. This run rate should be good for your models for at least the next couple of quarters as we work through the thinkorswim integration and the data center migration.

On line six you can see we spent $9 million more in advertising for the quarter which is due to seasonality and other opportunistic spending that helped translate into the healthy asset and account growth we delivered for the quarter. As Fred and I have said many times we will continue to focus on the things that we can control. Given the organic growth that we discussed earlier I think it is safe to say we continue to deliver on our strategy.

Now let’s turn to the current status of our net interest margin on slide eight. We are looking at both rates and balances in this top graph. As a reminder, net interest margin is a calculation of the aggregate rate earned on all spread based balances. As we have been saying for some time, until we get to an interest rate environment with a rate on new investments that exceeds the rate on maturing investments, all else being equal the NIM rate will continue to contract. However, if you can grow balances you can minimize or overcome the impact of the NIM rate contraction on spread based revenue.

While the NIM continues to drop our ability to increase our spread based balances has helped the increase in spread based revenue. As you can see here, this revenue was up $16 million or 7% from last quarter and up $10 million year-over-year. Balance growth primarily in margin loans and IDA balances which are our two highest margin asset categories contributed to the increase in spread based revenue and more than offset the continued rate contraction. I will get into more specifics on this topic on the next slide.

As we have said before, we believe the March 2009 quarter was the low water mark on our spread based revenue. As we continue to grow and interest rates increase we have a significant opportunity to grow our revenues. Our portfolio continues to be set up very nicely for a rising rate environment. For a closer look at our asset based revenue let’s turn to slide nine.

I would like for you to focus on three lines in this schedule; lines 3, 6 and 7. In comparing our total asset based revenues on line 7 year-over-year look at the variance box in the last three columns on the far right of the slide. Although our total asset based revenues were $30 million year-over-year the absolute result is masking two significant underlying causes; the effect of our asset growth actually increased our revenues by about $173 million in the quarter. Conversely, the effect of the near zero interest rate environment has negatively impacted our asset based revenues by $203 million in the quarter. Put another way, if we have the same interest rate structure in the December 2009 quarter that we had in the December 2008 quarter all else being equal our revenues would have been about $200 million higher for the quarter.

We know examples like this are not perfect representations of what would have happened but the point is still valid that we are set to significantly grow our revenues in a rising interest rate environment. You can see the rate and balance impact of each line item in the schedule.

Now let’s turn to slide ten to discuss our total interest sensitive assets. Our rate sensitive assets have grown steadily over the past few years. As you can see not only did the absolute dollars grow but more importantly the composition of the assets has changed as well. In 2007 about half of our clients’ interest sensitive assets were in money market funds, one of the lowest margin products we offer. In the best of times we make about 85 basis points on money market funds. Today approximately 85% of these assets are now in our higher margin, spread based assets, a dramatic shift in two short years. In the best of times here we could make in excess of 350 basis points.

When we say that we are well set up for a rising rate environment this is what we mean. If you assume 100 basis point Fed funds rate versus the zero we have today on $60 billion of interest sensitive assets this could mean about $600 million of incremental revenue before any share with our clients. We know that all the assets don’t reprice immediately but the key point here is our earnings power is very strong not only in the short-term but over the long-term as well. This is a key component in our revenue opportunities that we feel is very powerful for TD Ameritrade.

Let’s now take a moment to provide an update on another strategy we implemented over the course of the quarter, our inaugural public senior notes offering. On slide 11 we have laid out a summary of that offering which when combined with approximately $158 million in cash allowed us to pay off our bank debt of $1.4 billion which was due by the end of 2012. As we discussed last quarter given our update to investment grade by the rating agencies over the course of 2009 and with our strong cash position we felt it prudent to re-examine our capital structure.

We issued three trenches of notes; 250 million 3-year notes issued at 175 basis points over the 3-year treasury; 500 million of 5-year notes issued at 200 basis points over the 5-year treasure and 500 million of 10-year notes issued at 225 basis points over the 10-year treasury. Offering these notes in the public market with investment grade covenants allows us to stagger the maturity of our debt and ultimately provides us with a more flexible capital structure. We were very pleased with the results of this offering which was about four times over-subscribed.

Furthermore, given the continued favorable debt rate environment we recently entered into an interest rate swap agreement for the three and five-year trenches that is tied to 3-month LIBOR. As you can see our three and five-year notes will reprice every three months at 97 basis points and 125 basis points respectively over the three month LIBOR yield. The first repricing will be March 1, 2010. As you may recall our former debt floated at 150 basis points over the LIBOR curve. Our decision to float the interest rate on these two trenches came down to matching. Since the interest sensitive assets we just discussed also float it makes sense for our liabilities to float in order to be matched.

We have decided not to float the 10-year notes at this point but may consider doing so in the future. Lastly, we arranged a 3-year $300 million line of credit. All in our capital structure is very strong.

Now let’s turn to our liquid assets on slide 12. Liquid assets remain at a very healthy level. We have said in the past we would prefer to keep these assets in the $500 million to $1 billion range and we are pleased with where we stand today. The primary sources in the quarter were net income of $136 million and depreciation and amortization of $39 million.

In addition we had two primary uses of our cash. One, as we previewed on our October earnings call we bought back approximately $270 million in auction rate securities as part of the tender offer we initiated in July. This was 100% of the people who had tendered by the end of the first cut off period. As I mentioned a moment ago, we used approximately $158 million to pay down our debt.

On our auction rate securities we are pleased with the redemption activity by the issuer of the securities. All of the redemptions have been at par. We expect this trend to continue into 2010. As you know, the final phase of our auction rate buy back commitment extends through March 2010. As of today we have about another $13 million of buyback requests that we will fulfill by the end of March. We have strong cash generation capabilities and are confident that we will continue to increase our cash position over the course of the year providing us with even more flexibility to pursue our growth objectives in the current market environment.

In conclusion, the December quarter was a busy one for TD Ameritrade. We were once again able to deliver solid financial results and strengthened our position by being opportunistic with our marketing spend, continuing to invest in technology and infrastructure and refinancing our debt. Further we continue to achieve healthy business fundamentals. We grew our main long-term revenue drivers of net new assets and new accounts at a very strong pace. This is very significant for our future.

The integration of thinkorswim is on track and we continue to be pleased with the results we have seen from client engagement and retention to our education team and technology output. We have also created greater flexibility in our capital structure through refinancing our debt. The debt market was very impressed with our financial position and cash generating capabilities at TD Ameritrade and that allowed us to get very attractive pricing at the right time in these markets.

We have positioned ourselves quite well for a rising interest rate environment as we have said many times. At TD Ameritrade we continue to show the strength of our trading platform, our asset gathering efforts and our new account growth and we have the size and composition of our interest sensitive assets to make our long-term earnings growth story very strong. It is still unclear where the markets or the economy will go in 2010 but with our eyes firmly focused on the future we remain confident that our strategy is on the right track.

With that I will turn the call back over to the operator for Q&A.

Question and Answer Session

Operator

(Operator Instructions) The first question comes from the line of Rich Repetto – Sandler O’Neill.

Rich Repetto – Sandler O’Neill

I guess my first question is a little bit more on this earnings run rate and in regard to interest rate sensitivity. Because I am a little bit…on the back on page 15 you have $0.07 for every 25 basis points. That would be $0.28 for 100 but then on page 10 you talked about $565 million in interest rate sensitivity which would be a lot more. I know you have the LIBOR floating rate but I am trying to see what is the real…it is a big difference between being almost 50% sensitive in EPS upside rather than half of that. Also, trying to understand this $10 billion extension how that impacts the run rate going forward. The earnings run rate.

Bill Gerber

The 25 basis points and the 100 basis points is the impact on the first 12 months. The $565 million is after obviously the whole portfolio reprices. So that is the key. The $10 billion net of all the costs and what we pay the clients, etc. it was extended at about 125 basis points net to us.

Rich Repetto – Sandler O’Neill

So 125 above what was prior?

Bill Gerber

Correct.

Fred Tomczyk

In the quarter. The quarter a lot of it was sitting and floating.

Rich Repetto – Sandler O’Neill

On trading activity you talked about intraday volatility as well as account growth being the drivers but we have seen a big uptick so far in trading so far in January. I am wondering if you can explain that and maybe I know people are going to ask about the Schwab price change as well the impact on trading.

Fred Tomczyk

The first comment on what is happening in January versus what was going on in December I think to put that in perspective it is up about 60,000 trades per day. Keep in mind that every 3,000 is $0.01 on an annualized basis. What has caused that? I think it is too early for me to declare if it is intraday volatility or not. I think it is a little bit more volatile but definitely what happened in the middle of December and I think you have written on this, from all the people we have talked to whether it is in the institutional side or the more active traders on the retail side, it just seems like towards the middle of November they all decided to lock their positions, protect themselves and take a break. We saw that go all the way through to the end of December and it seems like they certainly have come back in January and have re-engaged in the market.

The second thing, with respect to Schwab, using a flat pricing structure is certainly something we can relate to. We have had that strategy for many years as you are aware. We have long believed in the value of having a very simple, straight forward and transparent pricing structure and that strategy was put in place based on a fair bit of client research. If you look at our growth over the last year I think that speaks well to that. It is not the only thing but it is one of the things that has worked for us.

Having taken that, and if you look at where we are versus other players including the one that changed their pricing recently, our research and our experience through time tells us that small differences in pricing, i.e. if you are within $1 or $2 or even $3 it doesn’t matter as much as the technology, the tools and your ability to get good execution. As long as you do that and you are within a reasonable price point of the other players people will not move to that. It will not sway them from which firm they choose based on all of our research and our experience. We don’t mind competing with anyone on the trading side based on the strength of our technology, platform and our experience. So at this point I would say while we will monitor things as we always will any time any competitor makes a change, we have no plans to change any of our pricing at this point.

Operator

The next question comes from the line of Roger Freeman – Barclays Capital.

Roger Freeman – Barclays Capital

On the commission rate can you help us understand the sequential decline a little bit better given options were 21% of the mix versus I think 18% last quarter. How much of the decline is due to lower payments per order flow? I think to fly in the face of what others are saying like [big bang].

Bill Gerber

Let me get the percentage for you. If you have another question go ahead and I will get you this.

Roger Freeman – Barclays Capital

The second question would be on the fixed for floating. It certainly makes sense on a near-term basis. I guess I am just thinking in terms of your leverage to higher rates and why you would term out or hedge out basically that exposure over a 3-5 year period when rates are going up over that time?

Bill Gerber

The idea is we are not sure exactly when rates are going to go up so people predict they are not even going to move until early 2011. So we are going to enjoy the short-term benefit of the lower rate environment and as the interest rates go up obviously the $750 million will be impacted but as you can see on the schedule the difference between the fixed rate we are paying and the floating rate where it is right now the [trim] with LIBOR is going to have to go up fairly dramatically in order to exceed those fixed income rates. As such, as the rates go up the IDA will be repricing. Our margin loans will be repricing and so you will have much more power on the interest rate side and the asset side. By the way, 90% of the change on the rate was due to payment for order flow.

Operator

The next question comes from the line of Daniel Harris – Goldman Sachs.

Daniel Harris – Goldman Sachs

I know we are only a couple of weeks into the New Year but I was wondering if you could talk about any trends that you have seen from the breakaway brokers that you have mentioned. It seems like the RIA channel has been attracting a lot of assets and I was wondering if you could talk about how that asset generation is going and whether that is coming from at all what you have seen over the last few quarters as brokers are signing onto the Ameritrade platform?

Fred Tomczyk

The breakaway broker market has been very active. I think a year ago we were very clear that there was a lot of activity. We had record activity levels but the close rate was very difficult because for a broker to breakaway in that environment was not easy. Obviously dealing with their revenues were lower, their clients were calling and probably their existing broker was giving them significant cash payments to stick around. I think what we have seen now is that now that things have stabilized we seem to have the worst of the recession behind us. They are starting to…the closing rate is starting to improve and the activity is still fairly high. I would say we have had success with the AdvisorLink program because when we thought about it was just something we started to push about six months ago. To break out on your own and put up all the expenses to start your own business is one thing. But to do that in that environment was very, very hard but the AdvisorLink program helps make that transition easier and our existing RIAs that do want to consolidate and grow their business it has been good for them. They have been very happy about it and the ones coming in it makes that transition that much easier.

Daniel Harris – Goldman Sachs

So is it safe to say that for this quarter when you think about the close to $9 billion of net new assets a big chunk of that was coming from the RIA channel versus the retail?

Fred Tomczyk

Both channels did very, very well. We don’t break it down between the two. I think it would be a stretch to say it was a big chunk. I think both channels continue to do very well on the asset gathering side.

Daniel Harris – Goldman Sachs

On the IDA balances, the 125 basis points of addition you are getting in terms of the extension what are the net new assets into the IDA being priced at? I think you had said previously it was about 175 basis points.

Bill Gerber

What are the net new assets being….

Daniel Harris – Goldman Sachs

Into new assets…

Bill Gerber

I see. On a gross basis that is right.

Daniel Harris – Goldman Sachs

So we should expect that annualized rate continues to cut down a little bit over the next few quarters?

Bill Gerber

Probably the rate will continue to trim down. Yes.

Operator

The next question comes from the line of Howard Chen – Credit Suisse.

Howard Chen – Credit Suisse

You alluded to in your prepared remarks and I was hoping you could provide some more details on the early returns of cross-selling that legacy swim education franchise and maybe give an update on the TD Bank cross-selling efforts as well?

Fred Tomczyk

On the education side we made a number of changes to the way we run that program and it has worked quite well. With respect to the ones that have gone to our client base it has been very well received and we have seen very, very good response rates. Certainly a very big interest. It has been very successful but again I would emphasize that it is still very, very early.

We have done some things with giving free education credits for transfers of assets to us from another broker and that has also worked well and shows some promise early. Both of those things continue to do well. I can tell you that particular channel, because we do look at investor education as a distribution channel, has been very busy and has a very busy spring. Their schedule is pretty hectic. So we continue to see very good appetite there.

On the TD Bank side we continue to work through the three things we said we were going to work through this year which was some connections and abilities with TD Waterhouse both in the U.K. and Canada in terms of giving their clients access to our trading platform in the US and we have seen an appetite in those markets for people wanting to trade in the US because they see it as the most robust and most efficient end market in the world.

On the TD Bank America’s Most Convenient Bank we have put in place a number of pilots. Again some of the early indications are very promising but it is still very, very early and so we have been up I think for a couple of months now and we have been pleasantly surprised by some of the early pilots. So we are regrouping right now, making sure we are learning and we will go from there.

Howard Chen – Credit Suisse

On the EPS sensitivity to higher Fed funds I understand it is timing based but I am a bit surprised that $0.07 didn’t go up after the sharp increase in margin balances, pretty good asset gathering you experienced. Are there offsets on the negative side I am missing?

Bill Gerber

The money market funds certainly went way down and the IDA is now more laddered so as money gets moved out you kind of have to recalibrate the money that is now going to be available to be re-laddered and ultimately it is still about $0.07.

Operator

The next question comes from the line of Celeste Brown – Morgan Stanley.

Celeste Brown – Morgan Stanley

You referred to your strong balance sheet and your free cash flow generation capabilities or that you expect over the course of 2010 and I know there is lots of discussion about big acquisitions that you can use your money for but how are you thinking about deploying cash in other ways? Either returning it to shareholders, building out a platform or doing something else to help drive MMA?

Fred Tomczyk

Now that we have done the debt refinancing I think that was a big step in the first quarter for us to position ourselves as I said last quarter for optionality. So we now have the flexibility to take advantage of whichever options we see in the market. I think where our thinking is right now is we are very much considering all of our various options. At this point in the year I think we very clearly said no, let’s just keep our powder dry. Let’s be patient here and see what opportunities come. We will continue to consider all trade options and share buybacks instituting a dividend and/or acquisitions. I think we can be a little bit patient here and keep all of those in front of us with our eyes wide open making sure we are in a very good position and we take advantage of any opportunity to drive shareholder value and add to our future earnings power.

Operator

The next question comes from the line of Patrick O'Shaughnessy – Raymond James.

Patrick O'Shaughnessy – Raymond James

I just have one question which is can you provide a little more detail on the extension of the insured deposit account assets? What type of products are you going to put them into and what type of rate do you expect to get on that? I guess the follow-up to that would be if you could talk about your level of comfort with the duration, I know you talked about it in the past about wanting to make sure those insured deposit account assets are kind of matching the duration of when people need to take money out of those accounts. If you could talk about that I would appreciate it.

Bill Gerber

First on the extension, the extension was probably on average of maybe 2-3 years and it was all in as I said earlier, just over 1.2% net yield to us. What we have been looking at is continuing to keep the portfolio shorter than I guess normal. We have normally said it should be closer to the 3-year range. We are certainly closer to the 2-year range right now. That is up by design because we do think the benefit or opportunity of rates going higher are certainly closer to us now than before. So the latter is by design getting a little bit shorter. We are continuing to do that but we don’t want to have all the money sitting overnight because of course the rates overnight are virtually zero. So we will be prudent on moving the money out. We have look at the money we know is coming in over the next 12 months including assessing new growth and new assets coming in. All those factors go into the determination of total liquidity. The bank is highly liquid so we feel very good about that.

Operator

The next question comes from the line of Mike Vinciquerra – BMO Capital Markets.

Mike Vinciquerra – BMO Capital Markets

I just want to set the starting point for the March quarter in terms of the interest yields here. On the $50 billion in spread based assets, $39 billion you said now is in the IDA and I assume the other $11 billion is in the interest earning asset category. Can you tell us what the yield today is, the starting yield for this current quarter based on all the changes you are going through so we can set our models up?

Bill Gerber

It is going to be pretty close to 2%.

Mike Vinciquerra – BMO Capital Markets

That is 2% on the IDA?

Bill Gerber

Right.

Mike Vinciquerra – BMO Capital Markets

And on the [IDA] side?

Bill Gerber

2% of the total NIM.

Mike Vinciquerra – BMO Capital Markets

I want to ask one question on the regulatory front. I know you have been participants with the ELP program over at Direct Edge and I also know that you probably are benefiting from the step up functionality at some of the exchanges like the CPOE and [inaudible] on the option side. If flashes essentially end up being banned in the coming months in both cases can you talk about the impact both to your ability to offer price improvement to your customers but also the potential for rising clearing costs or exchange costs if you start being [rotted] out to the make or take markets without the step ups in options?

Fred Tomczyk

That is a complicated subject. There are a couple of points we have made. We have been active, no question. Mainly it is not that we have a view one way or the other on flash orders or not which I think is part of what you are talking about. What we want to make sure of is if we are going to change any of the rules that it is done for the right reasons and we felt that early on in the debate there was some misinformation that was hurting retail investors. Based on all of our evidence that is in fact not true.

So that is the first point. The second point is we have been active and from all the submissions we have seen is that the make or take or the [market maker] model there are definitely differences between the options market versus the equity market. I think there is a developing consensus to treat them differently as a result. Only time will tell whether that actually happens or not. So I think at this point in the process any impact on us would not be significant and would be rather insignificant. We feel very comfortable with the way we see most of the participants trending at this point in their views.

Operator

The next question comes from the line of Michael Hecht – JMP Securities.

Michael Hecht – JMP Securities

I wanted to follow-up on the question about capital priorities in terms of the use of capital. With your ARS winding down pretty favorably with an otherwise low capital intense model the $1.1 billion of liquid assets on the balance sheet it sounds like you are weighing towards keeping the powder dry versus a potential cash dividend or buyback. Any specific thoughts I guess as it relates to the E-Trade and whether a deal there makes more or less sense today versus what you have said in the past because there has been a lot of speculation there.

Fred Tomczyk

There is always speculation there. I would say I am not going to provide any specific comments on any particular company. We have always said it has to make strategic and financial sense and any transaction we think makes strategic and financial sense we will work very, very hard at. We haven’t changed that view and we are not going to change that view at this time. I think right now we just continue to be patient and continue to try to execute our organic growth strategy and make sure we are aware of all opportunities in the market.

Michael Hecht – JMP Securities

A follow-up, housekeeping on interest expense specifically can you just help us with, I am sorry if I missed it but I am coming up with the impact of the swap somewhere in the $9-10 million range a quarter. Is that right?

Bill Gerber

I think we are going to be around $10 million. We are going to be close right there.

Operator

The next question comes from the line of Michael Carrier – Deutsche Bank.

Michael Carrier – Deutsche Bank

A question on the expenses. It looks like on the outlook statement the lower end of the expense range was taken down a bit. It could have been just due to some of the interest expense being shifted out into non-op. More importantly, when you look through the year on flexibility on expenses obviously you have advertising but anything additionally if you continue to see these, whether it is the activity rates come under pressure or the interest rate headwinds, how much more flexibility do you have on the expense side?

Bill Gerber

Some of those things that we have that we do hire professional services for temporary help and supplementing our regular staff. Those things we always look at. Obviously if there is pressure on the quarters then as you know a significant amount of our compensation expense is bonus based so the bonus would naturally shift down as well. There are a few items like that. We do think the data center when that eventually gets completed hopefully later this year that is going to bring down our expenses a little bit as well. Then of course the thinkorswim integration we are expecting to continue to have a small impact but a cut there. So there are areas we think naturally tend to have opportunity to be diminished if trading activity continued to be lower.

Michael Carrier – Deutsche Bank

On the inflows, the 12% obviously that is healthy specifically relative to other competitors. When you are looking at the money that is coming in, any granularity or color on where these assets are going? Meaning are they in some of the long-term products? Are they into cash? Are they into securities?

Fred Tomczyk

I think they continue to reflect our overall asset mix. Some of the things we have seen are particular clients that have been, as you are aware, more interested in equity than equities and unlike the market on the mutual fund side where it has been largely bond funds and other equities ours is roughly split between equities and fixed income mutual funds for the long-term investors are going. The second thing is they continue to see clients right now certainly interested in technology stocks and actually resort stocks, particularly mining companies and the mix to cash continues as you can see. We have record cash levels. They continue to have a fair bit sitting in client cash and that is why you are seeing some of the record client cash right now.

Operator

The next question comes from the line of Joel Jeffrey – KBW.

Joel Jeffrey – KBW

I apologize if I missed this earlier but just on the expense side the comp rate was up a little bit more than I was looking for. Is there any color on that or is that sort of moving around 23% or so. Is that right? Is that going to continue or is that something that is just a seasonal thing?

Bill Gerber

We had some unusual things in severance and relocation expenses and thinkorswim related. So that is probably, it should probably come down a little bit in future quarters in percentage.

Joel Jeffrey – KBW

In terms of comments you made about some of your customers that had switched over to the swim platform that actually increased activity, is there essentially a revenue neutral event given the lower commission rates of swim?

Fred Tomczyk

No it is not because they are going onto what we call the Think TDA which means they are going on the new pricing schedule not the old pricing schedule.

Joel Jeffrey – KBW

So it is actually beneficial from a revenue standpoint?

Fred Tomczyk

That is right.

Operator

The next question comes from the line of Faye Elliott – Bank of America/Merrill Lynch.

Faye Elliott – Bank of America/Merrill Lynch

Schwab just opened its prices down for its RIAs and I just wonder if you could give some color on how that compares to your price points for your RIA products and if you think that will affect business at all?

Fred Tomczyk

Actually I am not aware they have done anything specific to their RIA business. They did something quite awhile ago, 6-12 months ago, in the RIA channel which we haven’t seen any impact on our ability to gather assets in the RIA channel as a result.

Faye Elliott – Bank of America/Merrill Lynch

But just recently when they lowered some of their products I guess from an annual rate of about $15,000 to $12,000 does that affect your offerings or how you have priced your offerings?

Fred Tomczyk

I am not quite sure what you are referring to with the 15 and the 10? We can talk about that offline.

Faye Elliott – Bank of America/Merrill Lynch

That would be great. Also for modeling purposes if we could talk about the $10 billion moved out the curve did you say you do not plan to extend any more near-term?

Bill Gerber

As the cash comes in two things happen. New cash comes in the door every day with our net new asset gathering effort. Second, when items mature in the IDA and of course lastly is when clients sell securities and move cash to IDA. Those three of those could increase the cash there. Of course clients using their cash to buy securities or whatever or pull the money out for any reason would lower that cash. But what we looked at is trying to keep a certain amount liquid. We know what is coming in of course over each month, how much cash is going to come in, and as that happens then we roll the investments into the appropriate duration. So we will continue to look at durations. The $10 billion we just wanted to reference because it was obviously so significant that what happened is roughly 20% of the portfolio was rolled. So that we thought it was important to mention it.

Faye Elliott – Bank of America/Merrill Lynch

So on a percentage basis would you say you would keep the same laddering structure?

Bill Gerber

We would keep the same laddering structure. We would look at again as I mentioned we will probably tend to keep it a little bit shorter than what our normal duration would be. Normal duration would be closer to three years. We are keeping it a little closer to two years now.

Faye Elliott – Bank of America/Merrill Lynch

What are your thoughts for the market in terms of a little bit more active in terms of trading? Do you have any projections for out flow from your cash management accounts?

Bill Gerber

We look at that. We look at what happens when the clients start trading more actively. Normally, again in any particular period, you see clients who are buying and selling so the net/net there isn’t as much net cash moving as you might think. So you might be buying and I might be selling. So net/net we have done a pretty good job. We keep a good chunk of the cash very short to cover liquidity and we have multiple levels of liquidity within the bank. So we feel very good with our total levels within IDA.

Faye Elliott – Bank of America/Merrill Lynch

But you don’t think you would tap any additional sources of liquidity?

Bill Gerber

No. Not at all.

Fred Tomczyk

I think with that we will end the call. I just want to thank everybody for their time and attention today. As we said, we are very happy with our asset gathering. It continues to go very, very well. We are actually encouraged by the trading level picking back up in the first part of January and as we look out into the year the combination of the continued organic growth, the extensions we have talked about today, the debt swap and the debt refinance we think we are very, very well positioned for improving earnings and very, very well positioned to take advantage of opportunities we see in the market to increase shareholder value.

With that I will close the call and we will talk to you again next quarter. Thank you.

Operator

That does conclude today’s call. Thank you for your participation.

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Source: TD Ameritrade Holding Corp. F1Q10 (Qtr End 12/31/09) Earnings Call Transcript
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