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Executives

Paul Idzik - Chief Executive Officer

Analysts

Alexander Blostein - Goldman Sachs

E*TRADE Financial (ETFC) Goldman Sachs Financial Services Conference December 10, 2013 10:50 AM ET

Alexander Blostein - Goldman Sachs

Okay. Thanks everybody. We are going to start our next session. Next, I would like to welcome Paul Idzik, CEO of E*TRADE. Even though Paul has been with E*TRADE for a little less than a year, he has made a number of strategic changes to the business to refocus E*TRADE on top of its more of a core components of the business and clearly the fact that the financial conditions at E*TRADE continue to improve has not gone unnoticed with the stock up about 100% this year. But I think a lot of investors are eager to hear what is the next lag in the E*TRADE’s story going to be and how should we think about the company on a go forward basis. So there is no slides, so we will keep this as a fireside chat format. I will kick it off with a couple questions and then folks in the audience, just feel free to jump in.

But Paul, thanks again for agreeing to this stuff of format, I think it’s a little more refreshing and I also get to hear some of your thoughts on the business. The first one from me is as I mentioned you started less than a year ago. You made a number of important strategic changes. You added new folks to the board. You’re refocusing the business more on the core brokerage side. When you think about 2014, maybe talk about two or three strategic initiatives that are sort of within your control? We know credit is an important part of the story. We know capital could be an important part of the story. But as far as the business goes, what do you focus on for next year?

Paul Idzik

First of all, let me thank you for inviting me. I know this is – it’s a lot of work for you. And we appreciate it. So there is three things that I am spending a lot of time on now and intend to continue through 2014. And the first is really ruthless execution of our capital plan. That’s a plan we agreed with our board and our regulators. I mean there is a lot of value to extract for our shareholders as we continue to keep our leverage ratios where we want them to be, our tier 1 where we want them to be both at the bank and the holding company. I mean there is a lot of value to making sure that, that turns out the way we’ve been signalling it should turn out.

The second is I have been spending a lot of time and it’s just begun as we’ve got the team in place is converting the business from being very supply-led to demand-driven. And let me take a few moments to say what I mean by that. This business has traditionally and quite frankly across our industry has been traditionally aimed at putting product and technology out in front of customers and hoping that they adopt it and they like it. Now that was appropriate, I believe, in the earlier days of being an online company oriented towards direct investors. But the internet, the online or the cyber world has changed a great deal. It’s now part of people social fabric, it’s about how they live. I can almost guarantee you if we were to look out here, there is one or two people on their iPhone surfing as opposed to listening to these pearls of wisdom. And that’s actually – that’s how people live and we have to interact with them. And we need to do a better job at E*TRADE of following that demand, listening to our customers, analyzing the data not only within our own world and how they work with us but more broadly how they live their lives interactively and follow that demand to produce our products, to introduce new technology.

And then the third element is spending quite a bit of time improving the company’s focus on execution. Unsurprisingly if you look back over the recent history there has been a bit of drift in terms of real focus on execution in the core business. Both execution in terms of allocation of resources, pace of management and pace of change and making sure that those resources are as productive as we can. So those are the three areas where I have been spending a great deal of time in this latter half of 2013 and they tend to spend a great deal of time in 2014.

Alexander Blostein - Goldman Sachs

Great. Maybe focusing a little bit on the core brokerage business and I do want to spend some time on this topic as I don’t think it gets enough – enough traction with investors, from the competition that we are frankly having. But when you think about E*TRADE in the context of the online brokerage players, what do you see -- who is your key clients, what differentiates the business from the Ameritrade and Schwab world? So when you kind of think about the incremental market share that you can achieve in that business, what are the key drivers for you?

Paul Idzik

Well, in terms of differentiation we need to step back a bit and look at the structural advantages I believe E*TRADE has. So E*TRADE size means we are quite nimble and we are able to move fairly quickly, and that’s evidenced in the company’s heritage and innovation. We’ve quite frankly been a company that’s introduced new things not only to our clients but also in the industry. And we think we are able to continue to build on that, again as I said to being more demand-led. We have a workforce that has frankly a joy to work with – I mean it’s a great group of colleagues that I have a chance to work with who really take our goal of being customer oriented, customer advocates, product neutral solution driven with our customers, and they live that every day and quite frankly, it’s one of the reasons why the fourth point I am going to make a note of exists and that this brand functions above its weight. Customers like the E*TRADE brand, where we go out and do surveys and customer focused groups and focused groups of people who aren’t our customers, the brand functions above its weight and a lot of that is a result of our colleagues staying focused over the years.

Now in financial services if we look at what Goldman Sachs does versus JP Morgan or Morgan Stanley, or Chase does versus Citibank or Wells Fargo, when you look at the sub-atomic particles, the products, the channels, the regulatory environment, those things are all pretty much the same, right? When you take those sub-atomic particles and you start focusing on talent, consistency delivery, innovation, customer focus, and doing that in a way that’s very much oriented around what your customers really want, that matters, and that’s going to determine whether or not the business shines or collapses under its own weight. And we think we have some real structural advantages and we believe as we continue to cure the balance sheet, we’re going to have to continue to do more focus on our customers and driving more value for the shareholders.

Alexander Blostein - Goldman Sachs

One of the things I guess to measure that, that you guys have talked about in the past is think about the wallet share that you currently have with your clients. And I think it’s been around 12% for the last several years. When you think about the ultimate opportunity, do you look at your closest peers and say okay if they are in the 20% to 30% range, that’s where we could be, and if that’s the plan any particular products that you think you still need to develop to get there, or what I guess would drive that incremental wallet share?

Paul Idzik

Sure. We think about just our customers and that’s a good way to pick it up, Alex. We think we can more than double what we do with our existing customers. And frankly, we’ve had two impediments to moving there. The first has been – we haven’t really focused on it internally. While there has been quite a bit of talk over the years about it, the actual focus and attention has been over about the last 12 to 18 months, and if you look at our numbers in that period which you all have those numbers, it’s quite an impressive growth rate. Granted starting from small base, nevertheless quite an impressive growth rate.

The second is while our brand is quite iconic, we haven’t positioned our brand even with our existing customers to properly reflect the capabilities we have on investment, savings and retirement products. So I have been attending and listening to focused groups and what our customers are telling us is they are frankly surprised by the capabilities we have and the breadth and we just haven’t done a good job of getting there. When we do get our customers presented with those opportunities, when we get them with a financial consultant or when we convert an online chat into a live conversation with one of our financial consultants, we have very good results. So some good old fashion listening to the customer, presenting them the opportunities as real results, our financial consultants with the client are five times more productive than on unattached clients. So we have a lot of opportunity and what I feel good about is much of that is in our hands, much of its achievable without needing to spend a lot of money, and we just quite frankly have to do a much better job on expanding the brand and explaining to our customers what we do and really execute it.

Alexander Blostein - Goldman Sachs

I think one of the parts of your business that truly differentiates E*TRADE is the corporate business and the stock plan you have with number of fairly large corporations. I think in the past you said something like a third of your business comes – a third of our new accounts comes through this channel. Can you talk a little about what else you can do to better monetize that opportunity because that does feel like more of an advantage that others might not have, and that once you bring that account, what’s the characteristics, right? I mean is that somebody who will – who doesn’t trade who could start trading, how do you monetize that better, so maybe flush out –

Paul Idzik

Now let me first help the people in the audience size that. So we have 1.2 million customers in that business. We have over 1000 clients. We are the leading TPA in the United States of America in the stock plan business, both publicly traded and private. There is a 100 billion of assets attached to that book, a third of which or about are vested, two-thirds aren’t. So we are talking sizable numbers. And the first thing we have to do to monetize that business is there is a B2B component and we have to convince our customers who are executives, top HR executives, top legal executives or top finance executives which is where those stock plans are usually managed other companies to choose E*TRADE versus some other well-heeled sophisticated competitors. And we do very well or we wouldn’t have the leading market share.

So the first is making sure that our B2B activities are professional, they are on point, they stay up to date with tax law changes both in the United States and internationally. As a result, we’re able to have clients such as eBay and Yahoo! who are sophisticated, who have great demands on us, have put their faith in us because let me tell you something. It’s easy to sit here in this room and talk about it. When you are the head of HR and your stock plan isn’t working well because there is a problem with your provider, your employees are pretty unhappy. And that doesn’t bode well for one’s bonus at this time of the year.

And then what we need to do is we need to take that B2B relationship where those employees of the stock plan have a relationship with E*TRADE as a result of that stock plan and we need to do the same thing with those customers as we do with our core retail customers with one important difference – we very much know when life events are going to take place for those stock plan participants. We know when major tranches are going to vest. We know key employment dates that may keep things towards retirements, and our opportunity to take advantage of that data and that relationship and drive a more intimate supporting relationship for those customers is quite profound.

Today we only keep 15% of the assets that are invested after one year. We should be doing a much better job on that. Now you asked what type of clients are there. They are fairly representative of the rest of our E*TRADE clients in that they are from all over the country, they are from different levels within the organizations. They have different family requirements, different investing objectives, different stage of their life. But this is certainly an area where we can grow by focusing on the customer and taking advantage of what we know. But it all begins with superb professionalism at the B2B level and then being there for those customers as they mature as their stock plans mature, as they invest, and as they look to change their investment profile from being so dependent necessarily upon a particular equity to broadening what they need to do. So does that answer your question?

Alexander Blostein - Goldman Sachs

No, that’s helpful. I think one of the strategic initiatives you put in place is also growing the fee base out of the business. And we have seen that from some of the other players in the space as well. You guys have seen nice growth in that area over the last year albeit from a fairly small base. But when you think about what else you need to do to accelerate growth in the fee base business? Do you envision yourself partnering with manufacturers more like some other players have done, or are you already doing some of that and whether it’s the ETFs or the traditional mutual fund side of the business?

Paul Idzik

We have some very good partners across the business both in the mutual fund space and in ETF space. If you are asking do we think we should have proprietary product, should we perhaps have a JV or purchase and have a proprietary product? That’s not really the core of E*TRADE. Where the core of E*TRADE is aimed at customer advocacy, and being neutral for the solution being positive about helping the customer develop the right solution for them. Now one of the reasons we’ve really been focusing on the fee base is in trying to reshape the dynamics of the P&L. You know that earlier that our wallet share is much less and that’s an AUM of our customer base. We much more what we like to call them Saturday and Sunday money, much more investing savings and retirement products, in order to start changing the revenue side of our P&L to be less dependent upon the vicissitudes of DARTs.

On the other side of the P&L, we have been working very hard to change the cost base and restructure the cost base. We saw us take out and complete our $110 million cost reduction, and that’s important for two reasons. First of all, I think it’s more appropriately sized the business and cost base for 2013 as opposed to 2006, right? We’ve actually looked that’s the first real focus on reshaping the cost base.

Secondly, it provides the room on the canvas to start shaping the cost base where we want it to be for the business going forward and we have been investing in three areas. We have been investing in the control and risk environment and we have been investing that for really good reasons. We are investing because our customers expect us to have our business under control, they expect our books and records to be accurate. When they click the trade or click to invest, they expect that to work. So we are investing and making sure we have that under control because our customers expect it. In addition, our regulators expect it. Our regulators are pushing all financial institutions to develop much stronger enterprise risk management and control capabilities. We intend to not be at the back of that, we intend to be at the front of that. So that you can see things happen which are important to our shareholders, like two consecutive quarters of dividends, second place [ph] on the bank to the holding company.

The second place we have been investing is in talent. We’ve made some high profile and quite frankly I would say very superb higher up the senior level, hired an experienced very capable president, with his help we reshaped the executive committee and the type of people we have been trying to hire at the senior level are people who understand what E*TRADE needs to look like several years in the future, so the steps they take are [sure put it] in that learning on the job. And you are seeing the people that these people we have been hiring and reshaping both internally and from externally change, so we have been investing in talent because talent matters and if you don’t believe me, try running a business without talent around you.

And the third place we have been investing and are starting to invest is in our IT infrastructure. We want it to be scalable, we want to make sure we have the right resilience. We want it 24x7, not only an online business for financial services business, so our customers expect a certain level of performance from our infrastructure that’s twice as good as you would expect from a regular business, and we need to make sure we are staying ahead of that and not falling behind. So these are three areas we have been spending on. But to get back to your point, we are not only worried about shaping the income side of the P&L dynamics, we’ve also been very much focused on the cost side because we want to have that P&L dynamic make more sense to our owners and be more transparent, be clear what it’s focused on.

Alexander Blostein - Goldman Sachs

Shifting gears a little bit, I want to spend a minute on the operating environment that we have seen this year but also more recently it feels like this year we have seen sort of a bit of a decoupling between the more engaged retail investor and what we have seen maybe on the institutional side or just broader volume backdrop. Do you think -- I guess, a) are you seeing similar trends in your business, do you think [indiscernible] is financially starting to recover and I guess do you still there is lots more room to go, because I would argue there is probably some structural changes in the business that may not necessarily bring us all the way back to the level of activity we have seen in the last 10 years ago?

Paul Idzik

Well, I think it’s a malaise [ph]. I think when we look at it, we do monitor customer behavior. Number of factors have been driving it. Certainly improvements in home prices have helped, improvement in employee levels have helped. But yet when we listen to our customers and I listen to customer calls quite a bit. They are still hesitant, either they have someone in their family who is unemployed or a friend, and the economy doesn’t yet feel to the core retail customer the way it should. Does it feel better? Yes, but do they feel they are on really solid ground yet? I don’t think so. Certainly not what we hear when we are engaging with our customers. Now our business certainly will benefit from a more benevolent interest rate environment due to the way the P&L is geared. But it’s very difficult for me to predict which way this is going to go other than to say as the economy improves for lots of reasons, our business health looks much better, not only on the balance sheet side in terms of that curing, but also the core business.

Alexander Blostein - Goldman Sachs

So you mentioned the balance sheet and I promise I won’t spend the whole time on your balance sheet. I can help myself. So first I guess on the capital management front, you’ve highlighted the fact that you guys had a critical step in your future history sort of started with have some dividends of the bank and the holding company, we’ve seen two of those already this year, after the recent changes I guess that you made at the bank where it’s up 200% of the bank’s earnings start to flow through to the Holdco, if you just kind of assume current trends, it feels like you will be well above the 9.5% tier 1 leverage level at the bank over the next 12 months. So when you think about the opportunity of that capital potentially still being trapped at the bank, are there other things you could do to either start bringing the deposit sooner or is the plan still to execute on the plan that you have put in place for the next 12 months and then revisit?

Paul Idzik

As I said, one of my primary objectives is to really ruthlessly execute on that capital plan. Now can things alter that? Certainly things can alter that and business conditions can change, we will take a very careful look at our stress testing along with our regulators as we have in the past because we have done our own stress testing to mirror what they have reported of other banks and share that with the regulators as they look at our capital plan and as they look at our dividend requests. So we need to take that in the whole and we have a rise on the overall health of the holding company as well. So Alex, it’s very difficult to sit here today and talk about bringing liabilities back on and thinking about what we might do with the dividends that are upstream. What I am delighted by is I think if I were sitting here a year ago, we wouldn’t be talking about the options. We are now talking about what we might do, where then we would have been talking about if you ever get a dividend, and I feel just we are at a better spot but you have to keep paying attention to [inaudible].

Alexander Blostein - Goldman Sachs

Along the similar lines, when you think about the next steps in this process, you guys will be going through the stress test for the first time this year. I know you’ve run obviously a number of stress tests yourself and your regulators have been obviously running their own as to allow you the dividend capital. So maybe describe how you think this process will be different, what are you worried about because it feels like it’s the same set of regulators but the tests might be a little more challenging, maybe not, but how you think about the differences?

Paul Idzik

Well I want you to know, I actually think I have been going through a stress test since I joined January 20. I feel like I kind of stress test every day. But we are well – the team is well prepared and well attuned to not only the tests but what the dialogue with our regulators entails, right? Because we have done it for the past two years. And our regulators are very sophisticated and engaged with us on topics related to the business and the balance sheet every day, as they do at many large financial institutions. I don’t think we are going to be surprised by what the stress test reveals and I don’t believe that the regulators are going to be surprised with what our stress tests reveal because I am sure they are running on the back of an envelope for revenue. They are just smart people. I do think the signals of the dividends as a positive signal and I think we’re just going to have to wait and see until we run it and have that dialogue because one thing that I don’t intend to do is try and attempt to take a new account how the regulators are going to view things until we have a fulsome discussion with the regulators because they have a different set of perspectives and things they are concerned about the necessary item [ph] and when we get together that will be a good discussion and we will see what they have to say.

Alexander Blostein - Goldman Sachs

I guess longer term, you started this conversation by saying you guys will ultimately have lots of excess capital and it’s good to have that optionality.

Paul Idzik

Actually Alex, I did not say that.

Alexander Blostein - Goldman Sachs

But when you think about the longer term opportunities to deploy that capital, what are the things that you guys are going to be considered and again this is not next 12 months but longer term whether it’s dividends to buybacks or growing the balance sheet faster again, how do you – what are the things you will be considering to make those decisions?

Paul Idzik

Look, the first thing we are going to consider is what are we doing to promote the customer franchise, and as we grow the customer franchise, it’s going to mean growth in liabilities and we will have to figure out what we do with the balance sheet related to that. And that’s a high class problematic. Secondly, we will look at the balance sheet not only at the bank but at the holding company, do we like the capital structure, don’t we like the capital structure and that will be decisions about how the capital structure looks, what we might do with excess cash and – but today it’s a little premature, Alex, right? But those things again we are at a much better position sitting here today than we even were when I first sat down in my seat at E*TRADE in mid-January and certainly much better position than we were last year.

Alexander Blostein - Goldman Sachs

I want to shift gears a little bit and talk about the credit trends and clearly there has been nice tailings in your credit book over the last two years both from home price appreciation both from the fact that delinquencies continue to come down and the macro-economic state of your customers continue to get obviously better. Clearly 2015, ’16 will be an important couple years so that you [indiscernible] amortization percent, so when we as investors think about the path for provisioning I know there’s certainly things you can’t obviously do until you’re 12 months away from the event. But do you still anticipate that overall provisions will continue to decline again over time in that book or it could just be a little more lumpy given the fact that you are entering a bit of a different period?

Paul Idzik

Well, you know it’s hard to predict what provisions are going to do, because it’s very hard to predict what’s going to happen in the economy. And just as we have seen a run up in home prices, we can see the opposite take place and not that you and I could control that and quite frankly no one’s been tremendously great at predicting that over the last several years.

You mentioned the HELOC book, I think it’s important to keep that in context. The average loan size is about $75,000, 40% of the holders of those loans have made a voluntary principal payment of at least $500 over the last 12 months, half of that 40% -- 20% have made a principal payment of $2500, when these are clear signals that these people intend to stay on their own. So when these do start to amortize we will have even more data and a better understanding of what’s the likelihood of loss versus the likelihood of the payment. You mentioned the 12 months, so let me just give an example where it’s not necessarily always 12 months. Today we have about 250 of balloon payments, so loans that when they amortize there is a bullet payment required. For those loans we took our provisions to life of the loan and we assumed a 50% loss. So we feel we’ve got our arms around more the volatility and certainly the loans that if you were an investor – how do I predict what’s going to happen with this, we have taken a very conservative approach to the provisioning because we think that’s appropriate.

Alexander Blostein - Goldman Sachs

We have a couple minutes for one or two questions from the room if we have any.

Question-and-Answer Session

Unidentified Analyst

[Question Inaudible] next year.

Alexander Blostein - Goldman Sachs

Sorry, just wait for the mic, one second.

Unidentified Analyst

How do you see your NIM trending in 2014?

Paul Idzik

Well, as we move into more benevolent interest rate environment, I feel pretty good about that. But my CFO Matt Audette is very nervous [ph] and making no predictions, so you’re just going to have to listen to the fourth quarter results and hear what happens there.

Alexander Blostein - Goldman Sachs

Well, probably the last one from me I guess is, you guys continue to be a pretty idiosyncratic story, not just within capital markets but I think broadly within financials. And you’ve articulated quite well of what the earnings opportunity is for the company. And that’s again probably things that – if they continue to progress at current pace, you could see the visibility with every quarter. What do you think are the one or two things that the investors are still missing from the story given the fact that the sort of constructive pieces have been outlined for some time?

Paul Idzik

I think the first and clearly the major driver of value in the near term is the balance sheet issues. And I think the first is I believe people have been discounting the progress we were likely to have made. I think I would do the same thing if I were sitting some – in a different seat somewhere, right? But the team has delivered on what it said it would. We actually got dividends a quarter ahead of when we thought we might. And the balance sheet curing I think is somewhat ahead of where people thought they would be and I don’t think that’s necessarily reflected in how people are thinking and people [ph] are slow to catch up with the reality on that one.

The second is because of the miasma of all the balance sheet issues, the fact that this franchise has just tremendous intrinsic value, I mean just – discussed or thought about or written about very much quite frankly because it’s been not a secondary issue but tertiary issue. And I think that’s real value there. And the third is I was watching Fox Sports Sunday morning when I was at the gym. And Mike Ditka was on predicting who was going to win, sure number of games. And I was in Chicago in the mid-80s, so Mike Ditka talks I listened, and if Ditka was talking about the intangibles of a certain team and I have to tell you, I think the intangibles of a tremendously loyal employee base who wants E*TRADE to win or just don’t push the clock when they come to work. I am on an executive management team that knows what we have to do, what it has done it elsewhere before and works exceptionally well together. I think those intangibles while it’s difficult to put an EPS number on are something that investors should look for when they want to invest in a company, because if you don’t have the talent, if you don’t have engaged employees, [there is value in the structure].

Alexander Blostein - Goldman Sachs

Okay. We’ll wrap it up there. Thank you very much.

Paul Idzik

Thanks very much, Alex.

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