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TD Ameritrade Holding Corporation (NYSE:AMTD)

Goldman Sachs US Financial Services Conference 2011

December 7, 2011; 11:30 am ET


Fred Tomczyk - Chief Executive Officer


Unidentified Participants

Unidentified Company Representative

I think we’ll go ahead and get started here to keep on track. So it’s my pleasure to introduce Fred Tomczyk, the CEO of TD Ameritrade. Fred’s been the CEO since 2008, the COO before that and Fred’s been a big part of the changes that Ameritrade’s undergone in the last few years, including overhauling a lot in the technology, extending the trading suite to include options, as well as other areas and really driving an asset gathering strategy at the firm, which has been very successful. As a matter of fact it’s been more successful in the industry over the last few years.

I think a lot of these are topics Fred’s going to touch on, so I’ll stop there and just turn it over to Fred.

Fred Tomczyk

Thanks Dan and I’ll be brief, because I guess you want this to be conversational. So I’m just going to talk to one slide and whenever I talk to asset managers, I think one of the more harder questions you know people always ask is give me five reasons why I should consider your stock or invest in your stock, so that’s what this page drives you to.

So I think the first one is that we have a unique and differentiated business model. We are probably (ph) the only broker that has truly open architecture and multi channel approach to the market, both product and channel and I think most other firms either have a channel they are biased to, even though they have all the channels.

Ours is all driven to be confident for you, just right from the client. We are not an asset manager and we are not a product manufacturer per say, so everything’s designed in everybody’s incentives to just gather assets, retain assets and deepen the relationships with clients. All of our sort of model is designed to line up with the security terms against certain types of the markets that we find are attractive and have a good opportunity, so that’s worked very well for us.

The second thing is we do have market leadership in trading. I think we processed more revenue trades everyday than the other players in the business. We had around 400,000 trades per day last year and you know on this side, we are clearly the leader in the derivative side, because about third of our trading volume are now derivatives. I’d say 25% out of 26% are options and another 5% or 6% in futures, 1% or so in forex. Well just mainly concentrated in options with to a less extent futures.

And we continue to innovate and we continue to – we’ve rolled out now our three tier trading platform which we’ll continue to enhance from there going forward, between our standard Ameritrade site and trading platform, what we call trade architect, which will have a lot of functionality as a mid tier platform and then I think a firm which is the high end, which is really for the more professional type of trader, the very active trader and the option trader and the new (ph) trader in particular.

On the asset gathering side, you know we started on this journey four years ago. We’ve done very well. We gathered assets at double digit rates, which is the highest in the industry for three years in a row now and that’s, if you think the way I think about that, in the last three years we have gathered a $100 billion of net new assets; that’s a quarter of the clients firm and size today and so we’ve done quite well here.

Last year being the best one, a record year for us at $41 billion or 12% organic growth rate, which I think is probably the best in the industry by probably double. I don’t think anybody’s even probably the next close is at half that rate.

I think also to understand our stock and our business model you have to understand the relationship we have with TDMA loans, 45% of TDMA trade. That plays out on a number of fronts, but primarily the one that I think is the most interest to investors is we sweep all of our client cash or most of our client cash through TDE, which was our money market funds, which is a very small part today, about $5 billion.

The bigger part is in the deposit account and so the way the arrangement works is we sweep it to TDE Bank. That is I guess $58 billion and that allows us because of the way the arrangement works is that we put it on essentially a bond ladder or a synthetic bond ladder that works off the LIBOR swap curve and so we basically are able to earn, the economics and the rewards, deposit banking and the duration extension, without taking the capital requirements or the credit risks of deposit banks, of banking in general.

So it’s a fairly conservative approach, but what that does is it gives us good economics for the cash management in an environment where it’s very hard to make money, at least a return on capital from your cash management and it also allows us the sense that our earnings and our free cash flow are essentially the same. So we’re not capital intensive at all and we take out a lot of free cash every year, which allowed us to be acquisitive. It also allowed us to have an aggressive return of capital strategy.

We are very well positioned for a rising rate environment that may not happen for the next couple of years and we are also sensitive to the yield curve. You know, that’s low right now, so that environment is not great for us right now, but you know that won’t last forever, but you know so I do think if your looking at our stock, you have to recognize that we are too sensitive and have a significant upside in a rising rate environment.

And the last part is really an extension of the relationship with TD. It was very strong cash generation, you know good earnings, good return on equity and you know if you look at it we’ve had our strategy here for the last couple of years. We are returning 40% to 60% of our earnings to our shareholders in this environment, roughly 20% in the dividend and the rest in share buybacks. We’ve done more on opportunity and so if you look, that last year we actually returned 80%, most of the coming in the fourth quarter as the market softened and the stock softened. In the fourth quarter we did buyback 2% of our stock.

So that basically is the six things I think you ought to think about it if you have invested or your thinking of investing in TD Ameritrade and I’ll stop there. I think we’ve done quite well in a very difficult environment and we’ll do very well in a rising rate environment.

Question-and-Answer Session

Unidentified Company Representative

Thanks Fred and I appreciate you keeping comments in this page, so we can go into some Q&A here. So look, you’ve highlighted the fact that from a asset gathering perspective your leading the industry and a lot of it has to do with changes that you guys have implemented and focused over the last few years, but a big part of that also is the sales culture you put into the call center.

So I was wondering, how do you think about the growth there? Sort of what innings are we in, in terms of monetizing all the investments you’ve made in training and technology and how do we think about that, you know helping to persist that new asset growth over the next few years.

Fred Tomczyk

I think that one is pretty disciplined now, so they on the retail side the sales and service culture and I’ll also say the same thing in the institutional business. Most of them have gotten very good at what they do and how they do it, so I mean I think you know, I don’t think there is another step up from that so to speak, other than expanding the size of the sales force and increasing the marketing budget to put more in and broadening our capabilities, which I think are a pretty wide range of products now, which was a important part of the asset gathering, because people used to leave us, because we didn’t have what they were looking for. That was the other reason we closed our – improved our retention quite a bit.

I do think you know as we look forward now, I think the way I think about it is to continue that engine going, continue to make any investments in distribution, technology and marketing and improving the effectiveness of that and we’re doing some things on that front in terms of new account flows and once we get somebody started, how do we pull – improve the pull through rate and deepen the relationship early in the account, which we think is important and will help further, so that’s kind of the next journey.

And then the other thing we think about is ways to open up new sources of accounts and assets, so one of those being TD Bank as an example and we’re looking at other possibilities of whether that’s an acquisition, whether that’s a partnership or a joint venture arrangement. That’s a mutual interest to the two parties that we can find another source of accounts and assets.

Unidentified Company Representative

So one of the other things for the last few years, you talked about investors and asked about is that relationship with TD Bank and how do you continue to monetize it. So 25 branches today have Ameritrade employee there. There is 1300 I believe you said in the past and all of those branches at some point have contributed at client Ameritrade. How big can that 25 get to and is that a meaningful driver of net new asset growth as well?

Fred Tomczyk

Well, we all heard, I mean if we’re in debt we’re for – what I did say earlier today, you know if we’re putting money and time and effort into it, we expect something to be $1 billion annual opportunity, otherwise its not worth our time, to focus the organization.

The 25, I wouldn’t think about it as 25 covering 25 branches, because that’s the hub and spoke model. I would think about 25 covering somewhere between 15 or 100 branches and those would be the branches that we would say have a bigger opportunity. They are in a market where we think you know there is a good wealth opportunity, that’s the way we work on it okay. So it’s much more we’ll cover more than one branch.

Unidentified Company Representative

So not to just jump to the institutional side, but to stay sort of on the net new asset side, Tom Bradley as Head of Institutional has said that the funnel for bringing in new assets, which is again going to be a driver view has never been larger and continues to grow. So (a) what’s the timeframe for actually getting those assets from the top of that funnel into TD Ameritrade? What’s the conversion rate that that’s been improving and you know what’s your view on the Board over the next two to three years on the institutional side?

Fred Tomczyk

In the next two or three, the institutional sales cycles can be a long cycle and sometimes it can be six months or it could be more. So the important thing is to keep your pipeline forward and keep working on the pull through rates, which is exactly the way we are going to start to focus in the marketing and retail side as how do we take that tunnel concept and then each step in that process pull more people through. So that’s going to be a bigger part of what we do in the next 12 to 18 months and that’s kind of one of our next themes.

On the institutional side, you know people always say when you see that break away broker trends ending and personally we have not seen that in our numbers or in our pipeline. I do think at the higher end of the broker market, like a $1 billion plus broker, that the wire houses have gotten much better at tightening that down and yet probably getting a break in service. That’s why we are targeted slightly under that and I think that’s one of the reasons we continue to do well.

Unidentified Company Representative

And when you think about the size of that funnel, has that increased 5%, 10%, 20%. It seems like there’s been a sizable increase each year, but any thought around that?

Fred Tomczyk

Yes, I think it’s just – I don’t know what the percentage is, Tom would know, but you know if you want to keep growing the way we are growing, you have to just keep filling that funnel and keep growing. I mean it’s all part of our marketing and sales strategy that basically says you attract as many as you can into your pipeline and then you work out all the things in the pipeline to improve your pull through rate, that’s the way you look at it.

So pull you know from marketing to get them on your website. Once they are on your website, pulling them through till you get a name, address, phone number and then you turn it over and then the sales forces take over and work it and just try to – every step of the way there is probably five or six steps, the way we look at it. You are trying to improve your pull through rate while keeping that pipeline full.

Unidentified Company Representative

And then as you bring in those assets, I think one of the challenges has been again, how do you convert those assets into revenue, so you have trading, you certainly have managed the income which has been hurt obviously by the interesting environment, but what other types of fee based strategies are you trying to do, whether it’s Amerivest or monetizing those assets in what are recurring or a stable way.

Fred Tomczyk

So we put a little bit more emphasis on that recently, because we’ve been very much just focused on growth and asset gathering, with some focus but a lesser degree, but we’ve upped it more recently in terms of what you might call annuitizing. We were to find that in the broader sense in terms of all assets that have an asset base fee, whether its interest sensitive or not.

But we are also setting specific goals around what we call Amerivest and Advisor Direct, which would be more market based annual fees. Amerivest we have broadened that out. We used to just have one version, now we have three versions of it and we’ve certainly upped the focus on it in the sales forces too, sell more of it and retain more of it to get that growing faster, such that we can you know build out that third source of revenue.

And also that the advisors versus the retail side focus at different parts of the market and so we’ve moved the advisor direct minimums up a bit to get back closer to where we want it and Advisor Direct has worked very well for us and we do good in that, because not only that goes into the RA space where there is more annual investment fees for the (inaudible), but on top of that the advisor pays you for it based on the assets and so you get you know your annuitizing two ways through that side.

Unidentified Company Representative

And what is that? Those have grown quite nicely? And what’s the opportunities out there in terms of what percentage of client assets do you think would be interested in having that type of relationship, whether its on the retail or the institutional side, in terms of having you know a broader ETF overlay or that Advisor Direct relationship?

Fred Tomczyk

I think that’s a fairly broad appeal and I think right now people are probably defiantly more interested in getting some help or some guidance. And we can give guidance, but getting it into a product that you package yourself, then you have greater fees and the market based fees I think is, there’s appeal for that. Our challenge is just having enough distribution power to really make a difference.

Unidentified Company Representative

So one of the other things you touched on earlier was the difficult environment that we’ve seen in net interest and I think it’s absolutely true. Its next to impossible to understand when rates will change, when the curve will move, and this is obviously impacted results right, because you are earning less name on a higher level of total assets.

But the question is, when do you think that just given the market you could just see stabilization in them versus when – you know because we can all say what will be 2013 or 14 when the fed will raise, but at some point just given the duration of your assets, you will hit a point where it then stabilizes. How do we think about that?

Fred Tomczyk

Well, it starts with your assumption of the yield curve, so I can give you different answers. I mean we would in our planning say fed funds isn’t going anywhere for the next two fiscal years. So we can’t bank on that and as for planning purposes, I have no ideal what it’s going to do.

With the NIM stabilization, just you know it’s easier to answer just on the idea, because it will depend on mix, the overall NIM. But if you just do it on the IDA, if you want to use the global insight it will stabilize sooner, sometime you know they are sort of in the 13. If it stays where it is today you are probably into 14, but you know somewhere in 13, you know maybe even 14, depending on your view of the yield curve, which I also said we can’t predict.

But if the global insights was right, you know it would be largely stipend as a question and even the forwards will tell you it will stipend. I think the question is whether you are – it just goes nowhere, because right now its flat or it even goes flatter, it becomes a pan and you know your answer will depend on how you answer that question.

Unidentified Company Representative

So lets say in the interest money fund area for a moment, there has been a lot of discussion in the market recently about potential changes to the money fund business. Now you guys don’t manufacture. You have roughly a $1 billion or so decline assets in money funds and there’s been a discussion about adding some sort of cap lift offer to the money fund business. So if you were to go on the assumption that that happens, what do you think happens to the money fund business, whether its prime or treasury and then what opportunity is there for Ameritrade there.

Fred Tomczyk

Well it depends what the buffer is and it depends whether it applies to all money funds or just some money funds, so I think it is a depend there, but I don’t think I see a logical from a regulatory point of view that there would be a capital buffer on a fixed NAV money market fund. I think many of them are sort of walking and talking and acting like a bank account, so its after the reserve fund went down and we saw what happened with Lehman and all that stuff, I think it was a little bit scary in terms of the funding markets, the short term finding markets. So I understand there is a lot of sense in why the regulators will want to do that.

I do think the way I think about it is it’s less of an impact to us than others, because others may have much bigger money market funds and that’s a capital application. It also changes the substation risk between the three versions of client cash, which is important in the brokerage business, because of the online brokerage business, but I would say full service brokerage too.

You make a lot of your money on cash management, I’m including marginal in there and I think even if you back that out, you still make a lot of your revenue on – if you are packed on margin loans, on cash management and your three available alternatives are broker cash, which has very strict restrictions on how you can invest it and has capital implications.

If you go to money market funds, you know that you presumably can give the client a better rate and historically hasn’t had much capital implications and then you have bank deposits which has capital implications, but you can actually earn a wider spread and you know to compensate for that, because you can take credit risk, you can interest rate, you can duration risk.

I do think that they have a capital buffer on the money market funds. I think that the killer would be on capital buffer plus short duration and no credit risk. The combination of those three has actually I think – makes the money market fund industry actually quite a problem for those providers, but I’m not sure all three of those will stay the way they are, so I think it’s a little bit more dynamic.

But I do think that what it does to you is that the risk that you might, the substitution risk of just intermediation risk from up the pot, historically deposit accounts have been just intermediate by money market funds, I think that goes down and you may even see some re-intermediation, which is probably not what banks want to hear right now, so and to flush with deposits already.

Unidentified Company Representative

Does that present an opportunity for you, especially given your relationship with TD as assets move from – I mean they only have $1 billion, but there could be money flowing in other places.

Fred Tomczyk

I think it gives us an economic advantage and a capital advantage, which means that you may be able to be more aggressive in the market. It allows you to earn higher margins. From a marketing point of view I think everyone will just adjust.

Unidentified Company Representative

Why don’t we go back to the audience and start taking some questions here.

Unidentified Participant

In the longer time that I remember (Inaudible) trading thing out there, we seem to have kind of stabilized. We have not had a lot of conversation about pressure on trading commissions. Do you – how are you guys thinking about it? Do you see competition coming from you know what are the banks going to do or the brokers going to do overtime.

Fred Tomczyk

Well I think well Merrill Lynch has you know sort of re-launched itself and my understanding is inside Bank of America its moved from Merrill Lynch into the retail bank, which I can understand why they are doing it and they are adding sales people. I forget their commission per trade there, but it was a little bit lower. What’s that? About 4 or 5 bucks a trade of something like that.

I think historically every time they did anything, you know Merrill Lynch will say okay we are re-launching Merrill Lynch with a new platform or say anything even if they weren’t or the whole industry stock traded and I think now that people realize that’s probably six months later it recovers, so you haven’t seen people as nervous about it.

I do think because of the impact of the interest rate environment and I think because of the threat of capital buffers in the money market fund industry, I would hope at least the peers in our business would now realize that this is not a time to get aggressive on pricing. In fact you can make an argument that the people should be increasing prices or raising their fees right now. I mean, I just don’t think anybody has the courage. To leave that charge would be one of the first times in the industry’s history.

You know I think in the past when the industry went through these types of environments, it went to maintenance fees for some example, but customers hate those things and given what Bank of American went through was the debt card fee. I’m not sure anybody has the courage to go there right now. But I do think there is – I think people are generally right now saying, I don’t think anybody is, any of us is thinking about cutting pricing here right now given what’s – because you have lost a fair source of your revenue.

The way I describe it our board is and if you just think about it, you know four years ago our net interest margin was 450 basis points, today its under 200. That’s 50% of your revenue has some degree of interest sensitivity if you include money market funds and that means you’ve lost a third of your revenue. And so you know the economics to your business has been impacted. We’ve been fortunately enough to grow through that and change our cash strategy because of the arrangement with TD to hold ourselves even, but no one else has been able to do that.

Unidentified Company Representative

Question at the back.

Unidentified Participant

Just going back to the question to who your customer is, I would believe that the number of people out there with a million dollars that want some kind of a – they want some kind of assistance at a fair price in terms of what they are paying for investment management would be an infinitely lager audience, for you ultimately then the number of people that have a million dollars and what to go out there and trade their own account. And yet I get the sense that you are not as enthusiastic about trying to either solicit that client or convert your existing clients to that mode as I would think that you would be and I’m just trying to get a sense. Is it (a) is that the case and (b) just it just have a lot more expense attached to it than I’m thinking that it does, because I would just think this would be the number one, two and three opportunity for you guys.

Fred Tomczyk

Yes, I will explain that in a couple of ways. Its not that we are not interested and I just – let me start with one thing. So when we went down the asset-gathering journey and it was much more about growth and you know eventually you do turn to annuitizing around what you are talking about and there is a question of when you do that and how you do that.

I think a couple of things; we wanted to do it in a way that didn’t kill our trading business, because if you work the math you could argue, well yes you will get a higher multiple. If you chase the multiple and destroy the economics of your trading business, it actually would be value distractive.

The part that most people don’t recognize about the trading business is, yes they trade a lot, but they keep a lot in cash and so an actual trader is going to keep probably 30% to 40% in cash. So you wind up that that’s the part that most people miss about that business and so that’s why we don’t want to kill it, so we are trying to do both.

Whereas our retail model is more targeted at the I’ll call it the 50,000 to 750,000 post holder asset or account and that’s deliberate to keep it down and then we get to the bigger, the million dollar client, if you want advice, we are probably going to send you to the RA and the way we set it up here, that the branch person is indifferent between selling Amerivest or referring it to an RA and our economics you know, they are different but not as material, because the RA is paying us a trailer on those assets.

So I think we do focus on that. I think the part and we are trying to up our game on that, the hard part is we just haven’t found a way yet and we made some tweaks this year to try and drive that harder and we will continue to do that. It is just we haven’t seen the evidence that we have the distribution power to do it as fast as we would like and so we definitely have added sales people and we have adjusted the compensation to try and glide more of that going forward and the organization is getting more focused on it.

Like we have, like my pay is set – our pay is set, you know next year its going to be 60% EPS and 40% on what we call CE, goals and initiatives which are agreed to with the board, that have a set of strategic either metrics or projects or initiatives that actually drive long term value and that would be one of them.

Unidentified Company Representative

Any questions up front?

Unidentified Participant

Thank you. Do you think there is a maximum appetite that TD Bank would have for deposits and would it be possible to have an agreement, a similar kind of agreement with another bank if you reached the point where TD Bank said we’ve got enough deposits.

Fred Tomczyk

I don’t know about that in today’s world. The first question is I think TD is showing no interest in backing away from the IDA deal and in fact you know whatsoever and you know it has a two year rout and its already at the five year renewal point and that’s past, so its with us for a while here as a way we would interpret the agreement and I think they would interpret the agreement, so we are pretty much with each other for another five years anyway, which you know is fine with us and I think its fine with them.

And I think they look at it and this is going to get a little complicated, but you know they do make money on it, because they basically invested with Barclays Financials, so doing that there is still long deposits and short loans, but they look at that as changing what they focus their acquisition strategy on.

The second thing is you know I think with Basel III everybody talks about capital requirements. The reality is probably the harder argument in Basel III is about liquidity and term funding, so I think this is going to be interesting how that plays out. Its not written about as much, because it’s a hard subject to explain, but in the banking community that’s very much the focus of most banks right now and the regulators. So deposits could become very valuable in the long term.

And I think the other thing, the last point, which is, you know in the real world, the way they look at the world is they split the balance sheet on both sides. The 25 basis points, plus they keep using the swap curve means, basically that they keep the liquidity premium on top, which in their model, their models are the way they look at their economics, probably gives them another 40 to 60 basis points, so they do, they sit on it. The real advantage for them is that they could put it out in loans.

But they have always had a long view that the real economics, if you focus on economic profit of the banks, you know deposit gathering and stable deposits is where you make most of your economic profit in the retail bank. So you know, yes it could be a short term problem, but its not a longer term problem.

With the respect of whether other banks are doing it or not, I think you get in the temporary conditions if you do that you know and I’ve heard of one broker that you know does have a capital to do those that are trying to have a surplus, go elsewhere and that’s not uncommon, the people that are capital constrain, but you know I think some of the banks are saying I’m not sure I want it now.

But in that world, that bank is going to look at it as a not a stable deposit, its going to be a broker deposit that’s probably fluid, because it’s a broker deal that’s going to get you to move it the second they have the comp. So I think the banks take a different view of that than what they would have asked. So it’s established a long-term relationship; that’s a stable source of longer term deposit funding.

Unidentified Company Representative

Questions. All right, I have one more. So historical you’ve looked at your consolidation acquisition strategy that’s been focused on the retail side and there is a few entities out there that may or may not be interesting, but the institutional side, there is maybe potentially more interesting opportunities. How do you think about retail versus institutional, essentially where you get your bang for the buck and where you see you can grow within the overall organizations via acquisitions.

Fred Tomczyk

I think just generally speaking when we think of acquisitions right now, I mean (a) it has to make strategic and financial sense, which I think is a given; (b) I think when you think about acquisitions right now, you want to make such you are not picking up asset problems unless you can you know cap your downside and you can price that in and then number three is you want to make sure you are not just making an interest rate that you back out the effective interest rates, which makes you know, because you just don’t want to make an interest rate, you don’t want to give it away, so I think you have to think of all those three things.

With respect to retail and institutional, the cost synergies are greater in retail. The institutional side you get growth in assets, you know different revenue stream. We’ve done institutional acquisitions, we did by (inaudible) RA business a few years ago, I think four years ago now and they are harder and you can’t price them the same, because you won’t have the same cost synergies and you can’t have many gaps, because the RA will move and so you have to, you just have to be more careful. You know one thing to be very careful about the attrition on those types of things, but we look at both. Its just that the retail side is more economically compelling, the obvious ones.

Unidentified Company Representative

Okay, thanks very much. I appreciate your time.

Fred Tomczyk

Okay. Thank you.

Unidentified Company Representative

Thanks very much. Have a great one.

Fred Tomczyk

You too.

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