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E*TRADE Financial Corporation (NASDAQ:ETFC)

Q1 2014 Earnings Conference Call

April 23, 2014 5:00 PM ET

Executives

Paul T. Idzik – Chief Executive Officer

Matthew J. Audette – Executive Vice President and Chief Financial Officer

Analysts

Richard H. Repetto – Sandler O’Neill & Partners LP

Steven J. Chubak – Nomura Securities International, Inc.

Christopher Harris – Wells Fargo Securities, LLC

Alex Blostein – Goldman Sachs & Co.

Michael R. Carrier – Bank of America Merrill Lynch

Devin Ryan – JMP Securities LLC

Chris J. Allen – Evercore Partners

Operator

Good evening, and thank you for joining E*TRADE’s First Quarter 2014 Earnings Conference Call. Joining the call today are Chief Executive Officer, Paul Idzik; and Chief Financial Officer, Matthew Audette.

Today’s call may include forward-looking statements, which reflect 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-Ks, 10-Qs and other documents the company has filed with the SEC. All of these documents are available at about.etrade.com.

This call will present information as of April 23, 2014. The company disclaims any duty to update forward-looking statements made during this call. This call is being recorded and a replay will be available via phone and webcast later this evening at about.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 distinguished, Mr. Idzik.

Paul T. Idzik

Thank you, Brett. Good evening. Thank you for joining us. We had a very positive first quarter with progress across multiple fronts; favorable economic conditions catalyzed retail engagement at levels not seen in years. And we see the opportunities to actively reduce legacy risks. This solid performance gave us the fuel to power our investment engine, as we continued sharpening our focus on the customer and on productivity.

To share some highlights from the quarter, our net income was the highest in nearly seven years. We posted company records across several retail performance metrics. we completed the sale of our market making unit. the team further curtailed our risk exposure capitalizing on opportunities to sell legacy assets and terminate costly liabilities. We continue to execute on our capital plan, recording our third consecutive quarterly dividend from the bank to the parent. and finally, we evolve the public phase of E*TRADE with a launch of a completely revamped platform, Type E*.

Needless to say, we’re quite pleased with how we preformed during the quarter, and more importantly, with the steps we took to improve the long-term positioning of the franchise for our owners. On the risk reduction front, after years of diligently managing down exposures to legacy risks, we capitalized on opportunities to accelerate those reductions. this included the land mark sale of $800 million of TDRs at a gain. We also sold the remaining balance of non-agency CMOs and eliminated $100 million of costly wholesale funding.

Matthew will provide more details on all of this shortly. But suffice it to say that any one of these items of loan would have represented good progress in reducing risk. Along the same lines, we also continue to sharpen our focus on the core business with the completion of the sale of our market making unit in February, adding $76 million to our parent cash position.

A key area of focus since my arrival has been the recasting of our marketing efforts to better reflect how we engage with our customers today. After lots of hard work, mountains of analysis and detailed customer research, we launched a completely new brand platform, which encapsulates our desire to build deeper with our customers, Type E*.

This launch is an important milestone in our ongoing evolution as we work to expand our presence as a trusted destination for advice and assets. This new campaign underscores E*TRADE’s commitment to do more for our customers and also leverages digital media in a way that resonates with these customers.

Additionally, we’ve added new capabilities to more actively track effectiveness, including the customer response. So while, it’s just a few weeks old, we’re encouraged by what we’ve seen thus far and we’re closely monitoring our progress.

Turning to our results, we’ve recorded earnings of $0.33 for the quarter, our net income of $97 million. Earnings benefited from the robust investor activity, better engagement with our customers and continued reductions in legacy costs. Trading activity was at its highest level in nearly five years with DARTs of 198,000, just below our 2009 company record when market volatility was more than double this quarter’s levels.

Our customers were overwhelming bullish with net buying activity of $3.9 billion in the quarter. The most we’ve seen in nearly two years. Just over 20% of customer trades were in options, a decrease in the past several quarters, where it approached one fourth of our trades.

This shift was driven by a significant ramp up in equity trading, consistent with past periods of Main Street re-engagement. We crossed into the double digits in terms of the portion of our trades executed through our mobile application at about 11% for the quarter. Worthy at note, trading activity is somewhat subsided since quarter-end with DARTs in April to date tracking down a little over 10% from March, but still at healthy levels.

Margin loan balances for the quarter averaged $6.9 billion and exited the quarter at $7.3 billion, the highest levels in more than six years. across growth metrics, we set a record with net new brokerage assets of $4.1 billion, representing annualized growth of 7.5% and we added 72,000 net new accounts, the highest in more than five years, while attrition was a company record-low at 7.1% annualized.

We also showed continued progress and hoping our customers with the retirement, investing and savings needs with the retirement assets up 21% from the prior year, and representing 22% of our net new brokerage assets in the quarter. We continue to see attractive growth in our managed products, which ended the quarter at $2.6 billion, up 11% during the quarter end, up more than 50% from a year-ago.

We also received external validation for the team’s hard work across the handful of recognized outlets. Barron’s awarded us four stars in their annual best of online brokerage feature, including very high marks for research amenities, customer service and education, as well as range of offerings. stockbrokers.com acknowledged our products and services with two first place ratings for No.1 Smartphone App and No. 1 Client Dashboard and five additional best-in-class ratings.

And finally, we were recognized the two Webby Awards for our website and mobile applications, a high distinction for all things Internet. Now well, it’s nice to be recognized for our hard work, the true proof is in what we’re hearing and seeing from our customers. And with retention at an all-time high and engagement at record levels, we feel quite gratified by our progress.

I’d now like to take a moment to briefly address topics that have garnered extensive media attention of late: high frequency trading, fairness of retail investors and the current market structure. E*TRADE was founded on the principle of fairness, with a determination to level the playing field for retail investors. This principle continues to govern our every decision and underscores the company’s commitment to our customers. As a trusted partner in helping retail investors navigate the markets and improve their financial well-being, we take our role quite seriously.

Ensuring best execution for our customers is and always has been top of mind for us. And almost any measure will indicate that it is a great time to be a retail investor, E*TRADE continues in its determination obtain price improvement for its customers. This means that we are helping our customers obtain a better price for their trades than the prevailing market and achieve it frequently.

Last quarter alone, we obtained more than $20 million of net price improvement across all equities and options trades – direct savings for us customers. Our ability to help our customers realize better pricing is predicated on the current market structure, where multiple trading venues, both on and off exchange attract business through incentive models, exchanging volume for improved prices, payment for order flow and rebates. This model helps reduce overall customer costs, delivering outstanding execution quality.

Internally, we apply great rigor to reviewing this process and conduct regular reviews to ensure our customers receive the best execution quality, including improved pricing. With this commitment to our customers as our top priority, we vehemently condemn efforts by any market participant – high-frequency or otherwise – that attempt to gain the system at the cost of the retail investor.

Now turning back to the quarter and before I hand the baton to Matthew, I’d like to say how pleased I am to start the year with such strong results and such impactful actions. On top of our solid performance, we took confident steps to better position in this company for the future. We have a talented group of colleagues and a sound financial strategy in place, and we are evolving our approach to better support our customers, and to me, that sounds like the right recipe.

And with that, I will turn the call over to our allegiant CFO, Matthew Barrick.

Matthew J. Audette

Matthew J. Audette.

Paul T. Idzik

Or Barrick, Audette.

Matthew J. Audette

Thank you, Paul.

Paul T. Idzik

Yes, okay.

Matthew J. Audette

I couldn’t agree more, I’ve been with the company nearly 15 years. And while I look at our resulted metrics, this feels like the best combined quarter we’ve ever had. And in conjunction with the actions we took to improve, the company’s risk profile and financial position, we are off to a great start to the year.

On the results, for the first quarter, we reported net income of $97 million or $0.33 per share, an improvement on net income of $0.58 per share in Q4 and also from $35 million or $0.12 per share in the year-ago quarter. Our first quarter net revenues were $475 million, up from $446 million the prior quarter and $420 million in the year-ago quarter.

Revenues included net interest income of $256 million, up 4% quarter-over-quarter, as Q1 net interest rate improved 7 basis points sequentially, or average balance sheet grew by $400 million. Spread exceeded our expectations as a result of more favorable stock lending results, higher margin balances and the lower prepayments on our securities portfolio.

Given the key drivers of our spread are becoming more and more business and macro-driven, with margin growth, stock loan and prepayment levels on securities becoming the key drivers of our spread changes of late, predicting this metrics is becoming more and more difficult, it can do predicting customer activity, which is nearly impossible to do.

So rather than a spread forecast, which requires predicting those things, I would just highlight the following. If we use the current four curves and assume margin, stock loan and prepayment stay at their current levels, spread would be in the low-to-mid 240s for 2014. Commissions, fees and service charges, principal transactions and other revenue in the first quarter were $194 million, up 10% from the prior quarter and up 18% from the same quarter of 2013.

Average commission per trade of $10.64 was down $0.33 from the prior quarter and $0.66 from the year-ago period. The decrease was primarily due to the mix shift of more equity trades relative to options. Principal transactions revenue was $10 million, which reflected the inclusion of G1X to February 10 when the sale closed. The pretax income on that revenue was less than less than $2 million. going forward, the principal transactions line will be zero and we will see an increase in the fees and service charges line, where we book payment received for volume right into third parties.

And given the recent focus on payment for order flow, I’d like to give a little more detail here. In the first quarter, we received $25 million in payment for order flow. The split was roughly even between equity and options. Net gains of loans and securities were $15 million this quarter, including $6 million related to the sale of the remaining balance of non-agency CMOs. During the quarter, we also terminated $100 million of high cost repo, resulting in an early extinguishment of debt charge of $12 million. We also had $90 million of natural runoff in wholesale obligations.

I would also point out that we have an additional $600 million of obligations set to expire during the remainder of 2014, all scheduled to roll off in Q2. Our operating expenses for the quarter were $290 million in line with our expectations. As a reminder, we expected Q1 to be above our range of $270 million to $280 million, due to seasonal factors and the inclusion of G1X for a portion of the quarter. With respect to investment spend, as we said last quarter, we will continue to be mindful of the operating environment and dynamic in our thinking, maintaining the ability to dial back should conditions warrant.

That said, with current market conditions putting the wind at our back, and with very clear plans, we still feel that now is the right time to invest in the business. Accordingly, we expect expenses for the remainder of the year to be near the high-end of the range.

One final point on the P&L, our effective tax rate in the quarter was 33%, which was reduced by a $7 million benefit related to a recently approved New York State Tax Reform. Excluding this benefit, our effective tax rate was 38%, which is our general expectation for a go-forward tax rate.

Moving onto the loan portfolio, I am quite pleased to report that we sold $800 million of our 1-4 family modified loans, that’s about 10% of the entire portfolio and the bulk of our 1-4 family modified portfolio. Thanks to recent market improvements, we were able to complete the transaction at a slight gain to where the loans were held, because these are TDRs, we’ve reserved for total expected losses through a combination of prior write-downs and reserves in the allowance.

Furthermore, the sale is accretive to earnings going forward, as the benefit from the associated reduction in servicing and FDIC insurance cost will outlay the corresponding reduction in net interest income. This represents the first sale of its kind since the portfolio transitioned to runoff in late 2007. The purchaser is the current servicer of those loans, making this a swift transaction for us and a smooth one for the borrowers. We actually closed on the transaction yesterday.

The TDR sale should indicate that we are always mindful of market opportunities to reduce our legacy risks. But I would note that we do not plan to sell anymore loans in the foreseeable future. This quarter’s provision for loan losses was $4 million, including in $11 million benefit from the third-party settlement. This settlement brings us to the end of a long road of put-back and recovery settlements, which we have actively pursued since 2007, accumulating a total of $450 million, while we continue to pursue one-off recoveries, there is nothing of this magnitude remaining on our radar.

Excluding the settlement, this quarter’s provision would have been $15 million, $2 million less than the prior quarter and at the bottom of our expected range. For the remainder of the year, we expect quarterly provisions within a range of $10 million to $30 million, which includes an expectation for a 4% improvement in home prices.

Charge-offs for the quarter of $54 million, were impacted by two unique items. First, they were increased by $42 million related to the TDR sale, as we charged off the full reserves related to these runs. Second, they were reduced by $11 million in the third-party settlement. Excluding these items, charge-offs for the quarter would have been $23 million, flat with the prior quarter and nearly zero for the 1-4 family portfolio, as impacts have improved term prices coupled with improved delinquency trends offset any new losses on this portfolio.

Specific to our portfolio, home prices improved 1.3% during the quarter, leading to continued improvement in our LTVs. The average CLTV for the home equity book improved slightly to 97%, while the average LTV for the 1-4 book improved 84% due in large part to the TDR sale. The portfolio ended the quarter at $7.4 billion, a reduction of $1.2 billion from the prior quarter.

Excluding the impact of the TDR sale, our portfolio contracted about $350 million during the quarter, which includes $330 million of pay-downs. For the remainder of this year, we expect runoff in the range of $300 million to $325 million per quarter.

Our allowance ended the quarter at $403 million, decreasing $50 million from the prior quarter, while the portfolio was clearly in a better position than it has been any very long time. We continue to be mindful of future conversions in the home equity portfolio.

Currently, there are $700 million of loans set to convert in 2015, and another $1.1 billion in 2016. As a reminder, these loans continue to voluntarily prepay, with the balances converting in 2014 and beyond, having come down by more than 40% over the past three years.

To date, $300 million of HELOCs have converted to amortizing payments. The performance of these loans has been encouraging, experiencing a spike in delinquency in the month, immediately following conversion, but then reducing to a manageable level in the following months, as borrowers adjust their payments to the updated amounts. Keep in mind that those loans that had converted to date represent a very small portion of convertible balance and may not be representative of the performance of loans that will convert in the future. The loans with balloon payments, the losses on conversion have been slightly better than our expectation. Recall that we reserve for our full loss expectation on these loans which is roughly half of the $220 million balance.

Moving to capital and our financial position, we ended the quarter with $525 million in corporate cash, approximately $300 million above our target of two years of debt service coverage. Corporate cash benefited during the quarter from both the $75 million dividend from the bank, as well as $76 million in proceeds from the sale of G1X. And importantly, we submitted our first ever OCC administered stress test at the end of the first quarter. We hope to receive feedback in our submission during the current quarter and it’s our objective to share more with you regarding our capital planning process later in the year. At that time, we also hope to be in a better position to give you some more specifics on our thinking around usage of corporate cash.

As for our capital ratios we posted improvement on our Tier 1 leverage ratios, with the bank ending the quarter at 9.7% with approximately $165 million of capital generation, funding a $75 million dividend and balance sheet growth of $150 million. The current leverage ratio ended the quarter at 7%, up from 6.7% in the prior quarter. We also remain well-positioned under the new Basel III capital rules, which would significantly improve our risk based capital ratios across the board, which are all currently more than double and triple current well-capitalized thresholds.

So in closing we had an enormously positive first quarter. Growth in our business was accompanied by many steps we took to reduce our risk profile. I'm proud of where we stand and look forward to continuing to execute on our strategy and capital plan throughout the year.

And with that, operator we’ll open the call for questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) And one moment please for the first question. And the first question comes from the line of Rich Repetto. Please proceed with your question.

Richard H. Repetto – Sandler O’Neill & Partners LP

Yes. Good evening this is – the question is for the allegiant and implacable CFO.

Matthew J. Audette

Thank you.

Richard H. Repetto – Sandler O’Neill & Partners LP

So the sale of the TDRs was impressive and I’m trying to get more color on the environment, you’ve sort of warned or implied that future sales warned in the making. But could you go through how this occurred and whether the environment, whether there’s any opportunities say even in the home equity or TDR portfolio to duplicate any of what you did this quarter?

Matthew J. Audette

Definitely, Rich. So the secondary market and being generic the troubled assets space, there has been a ton of buyer interest and demand. So that's the area where we really saw change and you can see that in the TDRs, now you can see in the sale of the remaining non-agency CMO portfolio. So two very good transactions from our standpoint, when I look at the rest of the portfolio, things have not changed.

Especially on the home equity side, the secondary market when we look at those values versus the value for shareholders to keep it and keep managing through it, that dynamic has not changed. The secondary market on the first liens sign just simply when compared to home equity is definitely better, but again that equation of it is, better to keep it or sell it has not changed, as well. So that’s why we don’t view any other sales in the foreseeable future. But I – from my chair, it does not take away to the positive nature and the power of getting the TDR sale done.

Richard H. Repetto – Sandler O’Neill & Partners LP

Okay. And then I had the follow-up would be backed in that is another bank today Flagstar up this reserve dramatic or significantly based on its I/O loan portfolio. and I guess I’m trying to see, you’ve been building reserve for several quarters now on the home equity I/O portfolio and just trying to see whether there’s any potential like, is this fully vetted whether the reserve policy you have for the home equity portfolio is fully vetted by the regulators and is what’s the chance of having to do a reserve bill like what happened at another bank today.

Matthew J. Audette

Yes. Rich, I mean I am quite comfortable with our reserves, as it is somewhat statement of the obvious. I mean we have a very good and active dialog with our regulators. So I think we – they understand our portfolio, they look at our portfolio a lot. I think the trends in reserves that you’ve highlighted the trends that we have seen for a while and I would expect going forward, which are slight increases on the home equity side where those I/Os are and improvements on the 1-4 side. So I think this is another quarter of validating our views that that’s occurring and nothing new from my standpoint that gives me concern about reserves from this quarter.

Richard H. Repetto – Sandler O’Neill & Partners LP

Okay, thank you and congrats on the quarter.

Matthew J. Audette

Thanks, Rich.

Operator

And the next question comes from the line of Steven Chubak. Please proceed with your question.

Steven J. Chubak – Nomura Securities International, Inc.

Thank you, good afternoon. I guess I wanted to start off with two questions pertaining to the regulatory landscape specifically. The first on balance sheet growth. We’ve seen that some of the tougher regulatory provisions are now being assessed on those banks, really specifically being targeted that those would exceed the $50 asset threshold and you manage to produce some fairly steady earning asset growth and you’re gradually building towards that $50 billion mark. and also if you can give us a sense, when you evaluate the risk reward proposition of tripping the $50 billion wire. does the increase in earnings power as you grow the balance sheet outweigh the more owners’ regulatory burden or vice versa?

Matthew J. Audette

Yes Steve. so before we think about the $50 billion mark, just going back to our objectives and getting our leverage ratio up to 9.5% and we’re now at that and above at a 9.7%, big way in a manner that we got there was through leveraging and having the balance sheet come down. So sitting at $46 billion, having a little over $5 billion of wholesale funding that’s going to roll off over time, I think the primary focus we have and that is getting comfortable with our leverage ratio, getting comfortable through this stress test and seeing where we go from there. I mean $50 billion is something obviously, we’re aware of and focus on, but it’s not the primary area focus for us right now, given that we’re below it.

Steven J. Chubak – Nomura Securities International, Inc.

Okay, fair enough, and then focusing on another area of regulation, the LCR, have you assessed your liquidity strength or calculated the LCR based on the latest proposal from the Fed and with achieving LCR compliance require any meaningful changes to how you’re currently managing your balance sheet or simply compare some smaller balance sheet adjustments, such as replacing Fannie and Freddie securities with more favorably treated Ginnie’s?

Matthew J. Audette

Yes. So I think in the bucket of a silver lining of our investing strategy is solely and incredibly liquid assets. so when we look at LCR, we look at that very close to what we’ve done, we do pro forma calculations. We don’t disclose that calculations, but I’ll say I’m quite comfortable with our positioning and where we stand on LCR, just given the liquid nature of our balance sheet.

Steven J. Chubak – Nomura Securities International, Inc.

Okay, thanks. And then just one more addition on capital management priorities, I may be jumping the gun here, I’m not given, you said you’re focused on the corporate cash discussion next quarter. But many of us on the call have gone through the exercise of modeling the path towards normalized and I suppose borrowing any negative surprises on credit, the level of capital accretion from returned earnings in DTA utilization over the long-term context is going to be very substantial.

And when we look at the various levers, they’re going to drive earnings accretion and some different capital deployment opportunities whether it’s reduction in corporate debt, on-boarding of the off balance sheet deposits, accelerated reduction in high cost repo or even share repurchase. when you look at all those in a long-term context, how do you prioritize each, and I suppose where considerations are influencing your current ranking.

Matthew J. Audette

Well made-up question, I mean I think that I’d put in the bucket of, if those things pan out the capital accretion that you highlighted. We’d be in a position to have in a pretty high quality problem of looking at a host of options all of which I feel like would be beneficial for shareholders. So I think the very first part of your question, I think is probably to take away here.

We are looking at all those options, and we hope to be in a position to give you more details on our thinking later in the year. And that’s really all we have to say – all I have to say today. The only other thing I would highlight is, one of the things that we have been at high on our list that we’re focused on is debt reduction. But again, that doesn’t mean we’ve decided anything. So we’re helpful later in the year, we’ll give you more details on the thinking.

Steven J. Chubak – Nomura Securities International, Inc.

Okay, fair enough. That’s it for me and congrats on a very strong quarter.

Matthew J. Audette

All right. Thanks.

Operator

And the next question comes from the line of Chris Harris. Please proceed with your question.

Christopher Harris – Wells Fargo Securities, LLC

Thank you. Hey guys, so a follow-up question on credits. Matt, you had talked about the HELOCs and that there has been some prior experiences of HELOCs that have converted to their amortization period. I know it’s a really small sample size, but can you give us an idea as to what those initial loss rates were and those are about $300 million bucket.

Matthew J. Audette

Yes. So it is the all very small numbers, right, it’s a few hundred million. I think that the main point I would make without getting into the details of the numbers is it’s managed or there are small amounts and we do see a spike in delinquency in that first month and then you see it come right back down to a manageable level, still a little bit higher than it was before it converted. but at a manageable level, which to us speaks to someone who has got a payment on automatic bill pay, just didn’t realize the payment was going well; once I noticed that, they corrected me in the vast majority come back down. So my standpoint, they’re manageable numbers, but it is a very small sample. and so it’s not necessarily indicative a much.

Christopher Harris – Wells Fargo Securities, LLC

Okay, yes, I understood. And then a follow-up question on a different topic, I guess payment for order flow, we appreciate you guys providing the level of detail that you do, it’s more than most. But I’m wondering, I know there’s a variety of sources of payment for order flow whether it’s selling the order flow wholesalers or whether it’s rebates from exchanges. Is there anyway you guys can give us a little clarity on what percentage of the payment for order flow falls in each of that buckets – each of those buckets and kind of reason I’m asking is that the selling of the order flow to wholesalers doesn’t seem to be that much of a focus, but there is some regulatory focus on say, doing something that may take.

So having that breakout would be really helpful for us to start and assess full kind of risk we could be looking at.

Matthew J. Audette

Yes, so Chris with given the amount in the breakout between equities and options is probably as helpful as I’m going to be, we’re not breaking anything up beyond that.

Christopher Harris – Wells Fargo Securities, LLC

Okay. Maybe one final question that on the business. You guys have been turning favorably for quite some time now. And really what’s sticking out and this isn’t really a new phenomenon but your attrition rate being kind of at record low. Do you guys think there’s any more upsides to this number, or do you think kind of where you have it now, is kind of a reasonable level to expect going forward, because it gets much lower than that and you guys are going to be looking at competing with some of the best-in-class numbers, I think.

Matthew J. Audette

Well, we certainly don’t hope to see an uptick in that number, we certainly hope that it stays steady or goes down a bit, right? I’ve given how reported. That’s very difficult for us to predict. I think we’re doing the right things to engage better with our customers. You see our net new account grows at attractive levels, net new assets. And important to us is not only keeping the attrition number at an attractive rate, but growing the existing customer relationship. So I think that’s all we can really say on this topic.

Christopher Harris – Wells Fargo Securities, LLC

Okay, got it. Thank you.

Operator

And the next question comes from the line of Alex Blostein. Please proceed with your question.

Alex Blostein – Goldman Sachs & Co.

Hey, good afternoon guys.

Matthew J. Audette

We know your name Alex?

Alex Blostein – Goldman Sachs & Co.

Thanks.

Matthew J. Audette

(Indiscernible) currently.

Alex Blostein – Goldman Sachs & Co.

I’m used to that. As Joe and I’ve heard worse. So on the leverage ratio you guys are at 9.7% at the banks, so clearly above your 9.5% target. I guess what needs to happen for you to kind of come back to the regulators to see if you could adjust the amount of capital you could dividend back to the bank. And then also – sorry back to the ALCO, and on the flip side do you need to actually get a regulatory approval if you decide to bring some of the deposits back or is it just a function of what we have access capital at the bank, we don’t want or we can’t dividend to the ALCO, we could bring some of these deposits back? How would that process work?

Matthew J. Audette

So it would all be part of the capital planning process and discussion Alex. So I would look at them together, we have a very good and active dialogue with our regulators on discussing a host of matters. And when we look at the short term nature of capital distribution, which includes the level of the leverage ratios at 9.7%, our short-term plans are still the same, in the prior quarter up to the amount of the prior quarter bank earnings. The longer-term plans are still the same to close down 50 basis points a year from the 9.5% per year beginning this year. But the big next step for the big next process for us is really focused around the stress testing.

So that is submitted, we really hope that this quarter is a good quarter of dialogue and back and forth putting us in a position to or putting us in a position to speak with more specificity later in the year on this exact topic, so that’s our goal to work towards that. So we’ll talk later in the year.

Alex Blostein – Goldman Sachs & Co.

Okay got you. And then shifting gears to the business for a second, clearly, really strong organic growth I think one of the best we’ve seeing from you guys in a while. Maybe you guys could spend a minute just talking about the sources of those net new assets coming in, whether that’s some of the existing clients, where you staring to gain a little bit more wallet share I know that’s been the strategic priority for you in the past or is it winning business from some of the competitors?

Matthew J. Audette

Yes. So I’ll take the first out and then sure Paul can carry on that. So net new assets at $4.1 billion, definitely it’s I mean the record quarter for us. I think the new verses existing roughly a fifty-fifty split and so nice $2 billion number on each. I think the general sources of this new assets really hasn’t changed, meaning there’s not a bunch of assets moving in back and forth within our sectors it’s really assets coming over from the traditional space to our space. We’ve seen that for a very long time I think this quarter just validated to us and that is continuing.

Paul T. Idzik

So that’s good.

Matthew J. Audette

All right.

Paul T. Idzik

Yeah.

Matthew J. Audette

And that’s good.

Paul T. Idzik

So that’s good.

Alex Blostein – Goldman Sachs & Co.

All right. Great, last quick number question to margin balances clearly strong for everybody really exiting the quarter, wondering if you could provide where things stood on margin balances in April.

Matthew J. Audette

Yes. So, as Paul covered in his prepared remarks trading has gone down in the month of April around 10% versus March. Without giving a number on margin, margin has largely held in where we ended the quarter.

Alex Blostein – Goldman Sachs & Co.

Got it, great. All right, thanks a lot guys.

Operator

(Indiscernible) that was Mr. Blostein. And the next question will come from the line of Mike Carrier. Please proceed with your question.

Michael R. Carrier – Bank of America Merrill Lynch

Hi, thanks guys. And then, may be first question just on the interest spread outlook and somewhat related to the sale and I understand your comments on with margins, stock loan, it is more volatile, in terms of the outlook. Just any color on what the impact on the prepay side was. And then when we think about sale and then also the reduction in wholesale funding and then, the reduction in FDIC and service cost. Can you just go through some of those items in terms of what the impact will be or the offsets to get to somewhat of a neutral impact or positive impact to this P&L.

Matthew J. Audette

Sure. So, in general on the TDR sale, I mean, it has three impacts, a little of a decline in net interest income going forward and a bit of an improvement meaning a decline on the expense side on both FDIC and servicing. All those three things together I’d characterize as a slight benefit going forward. On the prepay and security side, so prepayments and securities continue to be at incredibly low levels for us. So there were roughly a 7 CPR in Q4, which was incredibly low that came down even further in Q1 of a 6 CPR, a level at which you would even with really no rate incentive to refinance, a level at which you would expect to be higher.

So if those prepayments stay that’s part of my scenario, on spread going forward in the low to 240s. That’s one that is incredibly difficult to I predict, which is one doing it. But it is a very low number and was a low number in Q1.

Michael R. Carrier – Bank of America Merrill Lynch

Okay. and just a follow-up, in terms of the investment spend, we think about on the technology side on the head count side, just in terms of what that should be driving in terms of the revenues. So whether it’s net new assets in bringing money in, something on the trading side, whether it’s mobile or new strategies. Just I want to get a sense and then if you do start to get slippage on the revenue side, how quickly can some of that be pulled back.

Matthew J. Audette

Well, we are – I’d say our investment spending is in three broad categories. The first is in technologies you mentioned, that’s quite important for us to stay. At the right level of technological innovation and stability that our customers expect and I think you’re seeing us go over 11% for mobile trades this past quarter, it is indicative of the type of things we need to do to help our customers do the things they want to do. The second category is advertising spending year-over-year. We’ve launched a new platform, we’ve launched in the way that we think as quite smart. We’re engaging more robust in a digital frontier and that has meant an increase in there. And third is in talent, we’ve added teams and individuals in the marketing area and technology et cetera. And certainly, we had to add teams as we continue to improve our regulatory standing and respond to the request that regulators have for us as we go forward on our business.

Those costs are recently dirigible, the area that’s less controllable of course is the things we do to respond to regulators, but we certainly have the opportunity to use the term tabs on both technology spend and advertising spend as the revenues warrant what we do and drive what we do. The type of things you are starting to see that those drive are the net new accounts more growth from existing customers, lower iteration. So you should look that we certainly keep our eyes on those targets and those categories of indications that our customers are responding to what we are doing.

Michael R. Carrier – Bank of America Merrill Lynch

Okay. Thanks guys.

Operator

And the next question comes from the line of Devin Ryan. Please proceed with your question.

Devin Ryan – JMP Securities LLC

Thank you. Good afternoon. So, just want to follow-up on the trespassing, trying to get a little bit better sense around the timing and I guess the progression of dialogue with the regulators. It sounds like you are expecting feedback this quarter. But just given that they are already pretty incrementally familiar with the portfolio and capital plan. Do you expect that at that point where you get that feedback if you’re comfortable with the test that you will receive approval to move forward with that capital plan relatively short order or is that piece of feedback is part of the bigger process in your views with the back-and-forth carried on for some time thereafter.

Paul T. Idzik

We have closed and fairly continuous dialogues with our regulators including submitting a multi-year capital plan, which they are very intimate with and we submit our stress test in March. The requirement was we use Q3 2013 numbers for that. It’s the first time, we were required to officially submit a stress test, but it’s not the first time that we’ve shared stress test results with the regulators because we run that as a matter of being good business people.

So, as Matthew said, it’s our objective to share more with you regarding our capital planning process later in the year. We like to better tell you when we actually know better what we are going to be able to do and we look forward to having a constructive dialogue around that subsequently.

Devin Ryan – JMP Securities LLC

Fair enough, okay. And then, just also wanted to just circle back on the strength in DARTs that you have been experiencing recently and also the slight change in mix that you saw with higher cash at a derivative as a percentage, and I’m just trying to get a better sense of are you seeing that longer-term investor, we are engaging. It seems like the active trader has continued to be active, but I am just trying to think about that the engagement that we are seeing for long-term investor and do they feel more entrenched today with today with margin balances increasing or just still feel pretty fragile to the extent we saw some volatility. I know it’s difficult to predict, but while we get a little more color there from what you guys are seeing now from the actual investor basis within your customers.

Paul T. Idzik

Well, I would say the number that indicates how Main Street’s feeling is that increase in equity trades relative to absence trades and as we’ve been tracking and about 25% option trades in prior quarters and was down to 20% because the cash equity trades where much higher. I spent quite a bit of time with customers. And I would say they realize they really need to put their money to work, but the level of uncertainty with what’s happening around the world and still some of the economic indicators are leaving them bullish about needing to invest, but still really keeping their eye on the dashboards and paying probably more attention to what has been happening then, we might suspect otherwise.

Devin Ryan – JMP Securities LLC

Got it, okay. And then, just lastly with respect to the loss on the earlier extinguishment of debt to $12 million loss that resulted from the decision to terminate the $100 million in wholesale funding. Did that seem like a little bit large penalties of just curious would drove that decision whether we could expect there to be similar termination of contracts moving forward.

Paul T. Idzik

Sure. So, just looking at the wholesale book overall if you go back, before we started focusing on deleveraging, we had about $7 billion book. And we look at that from the perspective of overtime, we want that to run down, which it will also and if there is anything we can do to accelerate that, that makes sense economically. To make sense from a capital ratio standpoint we want to do that. And we did about $1.5 billion of that during our deleveraging focus. What we saw, we saw an opportunity this quarter on a specific charge of $100 million, the $12 million prepayment penalty should really indicate that was very high rate stuff, meaning while the penalty was high, the benefit going forward should also be high. So, it’s just something that we thought made sense to do, put in the bucket of accelerating balance sheet clean up. I was very happy to do it, very excited about it bring wholesale down to $5.2 billion, we’ve got another $600 million that are maturing on their own next quarter, bring it to the $4.6 million. So all in all I feel good about wholesale and I feel good about the transaction.

Devin Ryan – JMP Securities LLC

Great. I appreciate the color and congrats on a strong quarter.

Operator

(Operator Instructions) And next question is from the line of Chris Allen. Please proceed with your question.

Chris J. Allen – Evercore Partners

Hi, good morning guys.

Paul T. Idzik

Good morning.

Chris J. Allen – Evercore Partners

I just wanted to ask about the fees and service charges and their sequential increases, I’m assuming some of that’s driven by increased pay forward with the Q1, but I was wondering if you can give any color on that and just have to think about the run rate moving forward.

Paul T. Idzik

Yes. Chris, I mean, that there is two basic quarter for those by far the biggest item in net lines. The $25 million of payment quarter fall at $47 million. So, that line large are going to move with customer activity. And the second biggest item in there is really recurring fee income related to assets that we manage primarily the net. But, it is predominantly payment for quarter meaning it’s going to move the volume.

Chris J. Allen – Evercore Partners

Got it. If I mean assuming if there was a fourth quarter, the number would have been couple of million dollar above that in terms of payment for order flow of $25 million, would you (indiscernible).

Paul T. Idzik

Yes. I mean, I would put that in the bucket of noise. It’s only five weeks of the quarter and that we had UNX so it will be would be buyer stuff a little bit, but not meaningfully.

Chris J. Allen – Evercore Partners

Got it. And any thoughts in terms of what would happen if I mean, there restructuring and the quarter fall I mean, any thoughts in terms how you might monetize your order flow or how the impact of modification of the trade outlook if there was a implementation of a trade-off role would impact the payment for your guys.

Paul T. Idzik

First of all, we are committed offering our customers value beyond price through customers service, education professional guidance. And we believe are offering is really compelling and competitive. If anything happens in the competitive landscape we would evaluated at address it at that time, but I cannot really speculate on what is to happen in that space. I can just assure you that we are just going to continue to put the making sure we offer the best to our customers at the forefront of what we're doing.

Chris J. Allen – Evercore Partners

Thanks guys.

Operator

(Operator Instructions)

Paul T. Idzik

Thank you very much for joining us this evening. Matthew and I are happy you could spend the time with us we’re quite happy with the quarter and we will talk you to all of our three months. Thanks very much. All right.

Operator

Ladies and gentlemen, that does conclude today’s conference call. We thank you for your participation and ask that you please disconnect your lines.

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