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E*TRADE Financial (NASDAQ:ETFC)

Q4 2011 Earnings Call

January 25, 2012 5:00 pm ET

Executives

Steven J. Freiberg - Interim Chairman, Chief Executive officer and Member of Finance & Risk Oversight Committee

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

Analysts

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

Eric Bertrand - Barclays Capital, Research Division

Brian Bedell - ISI Group Inc., Research Division

Michael Carrier - Deutsche Bank AG, Research Division

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

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

Daniel F. Harris - Goldman Sachs Group Inc., Research Division

Howard Chen - Crédit Suisse AG, Research Division

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

Matt Fischer - Credit Agricole Securities (NYSE:USA) Inc., Research Division

Christopher Harris - Wells Fargo Securities, LLC, Research Division

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

Operator

Good afternoon, and thank you for joining us for E*TRADE Financial Fourth Quarter 2011 Earnings Conference Call. Joining me today are Steven Freiberg, E*TRADE's Chief Executive Officer; Matt Audette, Chief Financial Officer; and other members of E*TRADE's management team.

Before turning the call over to Steve, I'd like to remind everyone that during this conference call, the company will be sharing with you certain projections or other forward-looking statements regarding future events or its future performance. E*TRADE Financial cautions you that certain factors, including risks and uncertainties referred to in the 10-Ks, 10-Qs and other documents E*TRADE files with the Securities and Exchange Commission could cause the company's actual results to differ materially from those indicated by its projections or forward-looking statement.

This call will present information as of January 25, 2012. Please note that E*TRADE Financial disclaims any duty to update any forward-looking statements made in the presentation.

During this call, E*TRADE Financial may also discuss some non-GAAP financial measures in talking about its performance. These measures will be reconciled to GAAP either during the course of this call or in the company's press release, which can be found on its website at investor.etrade.com.

This call is being recorded, and a replay of this call will be available via phone and webcast beginning this evening at approximately 7 p.m. This call is being webcast live at investor.etrade.com. No other recordings or copies of this call are authorized or may be relied upon.

With that, I will now turn the call over to Steve Freiberg.

Steven J. Freiberg

Operator, thank you. Good afternoon, and thank you for joining today's call. I will begin by covering highlights from the year, adress a few items from the quarter, and then Matt will take you through the results. I will follow with additional comments, after which, we'll open up the call for questions.

Let me begin by saying I am pleased to report that 2011 was the company's first profitable year since 2006. It wasn't an easy year by any measure, but we maintained a focus on the business and on our customers, and are proud of the way our team executed. We faced challenging headwinds during 2011, including a near-0 interest rate environment, which pressured our spread and net interest income. Global macroeconomic uncertainty, leaving many retail investors less engaged than they otherwise would have been. And continued stress in real estate. However, we proactively worked to mitigate these environmental pressures as we grew broker-related cash by 13% during the year, offsetting the majority of spread compression at the 12 basis points contraction in spread only led to a $6 million decline in net interest income.

Despite the macroeconomic challenges, we grew DARTs by 5% during the year as we continue to increase accounts and assets. And we continue to aggressively focus our loss-mitigation strategies, including short sales, loan modifications and transfers to higher touch servicers.

Separately, the company transitioned regulators during the second half of the year from the OTS to the OCC and the Fed. Throughout 2011, we focused our efforts on strengthening our core business and in addition, have made significant strides in de-risking the company.

I will now highlight several key accomplishments that have enhanced our strategic position. First and foremost, we remained focused on strengthening the financial position of the company. We moved forward on many fronts as we progressed from significant losses in 2007 to profitability in 2011. In addition, we increased our capital levels and ratios. And with the exception of a slight dip in Q4, our capital levels, at both the bank and the parent, are the strongest in the firm's history. Finally, we continued to improve our risk profile as the legacy loan portfolio declined another $3 billion during the year, while delinquencies improved double digits. The portfolio ended the year at $13.2 billion, down 60% from its peak.

With regards to our core brokerage franchise, we made solid progress on improving our competitive position. During 2011, we nearly doubled the amount of net new brokerage accounts over last year's levels and broadened net new assets of $9.7 billion, up from $8.1 billion in the prior year. Additionally, our attrition rate decreased nearly 200 basis points through a firm record 10%. We continue to grow our institutional businesses. Our Corporate Services group brought on 46 new clients in 2011 and starts the year off well with a pipeline of 33 clients. Our market making business grew revenue in a tough environment and increased its external NMS order flow. Finally, we remained committed to enhancing our market position in the long-term investor segment. While this is a relatively new focus for us, we continue to grow balances and accounts, and we are building a solid foundation for this business. Our sales force initiative is a very important element of this strategy.

In 2011, we grew our team of financial consultants by 42% and remained committed to this effort. We also announced the number of enhancements in new products during the year. We launched E*TRADE Pro Elite for our most valuable active traders, Portfolio Margin, expanded CNBC contact, algorithmic charts, a number of options tools, and we introduced the E*TRADE Community. We launched a number of enhancements for E*TRADE mobile, including mobile check deposit capability for the iPhone, we expect to launch on the Android very early this year. Finally, we continue to expand our investor education offerings across a number of channels, including online videos, live and on-demand web seminars and live events. Total interactions with our education platform increased 63% from last year, to over 1 million.

Finally, as it relates to fourth quarter results, several unique items impacted business performance. And in a moment, Matt will take you through the details.

It is noteworthy to emphasize that for the quarter and year, our franchise metrics were relatively solid as we continue to grow the key business drivers.

I will now turn the call over to Matt.

Matthew J. Audette

Thank you, Steve. For the fourth quarter, we reported a net loss of $6 million or $0.02 per share on a revenue of $475 million.

These results included a few items unique to the quarter: First, we recorded a $46 million recovery to charge-offs, resulting from a settlement with a third-party mortgage originator; second, we increased the qualitative portion of our allowance and made an adjustment to our valuation methodology for certain homes in the process of foreclosure; Third, we recorded a $10.8 million expense related to the settlement of class-action lawsuits; fourth, a $7 million reduction to the ARS reserve established in the third quarter; and finally, we expensed $8.7 million related to internally developed software costs, which were previously capitalized.

For the full year, we recorded net income of $157 million or $0.54 per share compared with a net loss of $28 million or $0.13 per share in 2010. In addition to the unique items from the fourth quarter, our full year results included a $48 million reserve for settlements and repurchases related to auction rate securities and a $62 million tax benefit related to the taxable liquidation of a European subsidiary.

In the fourth quarter, we generated $475 million of net revenue, down from $507 million in the third quarter and $518 million in the fourth quarter of 2010. Our fourth quarter revenue included net interest income of $289 million, a sequential decline of $16 million as our net interest spread declined to 266 basis points from 281 in the prior quarter, reflecting lower loan yields, a decrease in margin balances and the current rate environment.

We continue to expect spread to compress during 2012. And given the continued challenges of the interest rate environment, we expect that our spread could average slightly less than 250 basis points for the full year 2012. Again, I would highlight that this assumes no change to our current balance sheet strategy.

Commissions, fees and service charges, principal transactions and other revenue in the fourth quarter were $156 million, down 14% from both the third quarter and the same quarter of 2010. This decrease is driven by lower DART volumes versus both periods and a decline in the average commission relative to the fourth quarter of 2010. Revenue in this quarter also included $30 million of net gains in loans and securities, including a net impairment of $3 million.

Expenses fell by $37 million in the prior quarter, largely as a result of the auction rate securities reserve and the true-up to FDIC charges included in the prior quarter. Included within the fourth quarter is a seasonal increase in advertising spend, as well as an $8.7 million expense related to a review and the resulting adjustment of costs associated with internally developed software. The adjustment resulted in increases to operating expenses of $7.4 million to compensation and benefits, $3 million to professional services and a $1.7 million reduction to depreciation and amortization. Finally, we reported a $10.8 million expense related to the settlement of class-action lawsuits.

Turning now to the metrics. DARTs for the fourth quarter were 140,000, a 15% decline from last quarter and down 7% from a year ago. For the full year, DARTs were 157,000, up 5% from 2010 and represented quite a volatile year in retail trade.

During 2011, we experienced an all-time record high for trading volumes as we executed nearly 360,000 trades in one day following the U.S. debt downgrade. Net new brokerage accounts were 10,000 in the fourth quarter, down from 13,000 in the prior quarter and 28,000 in the fourth quarter of 2010. For the full year, net new brokerage accounts were 99,000, nearly double the 54,000 we recorded in 2010. I would also note that brokerage account attrition was a record low of 10% for the full year, down from 12% in 2010 and 13% in 2009. While we constantly aim to improve customer retention, we are quite pleased with this improvement, and it's a testament to our investments in sales and service.

Net new brokerage assets totaled $9.7 billion for the full year, up 20% from last year and inclusive of $1.7 billion in the fourth quarter. We ended the year with $28 billion in brokerage-related cash, an increase of $3 billion during the year. Meanwhile, customers were net buyers of $3.8 million of securities. Margin receivables ended the year at $4.8 billion and averaged $4.9 billion during the quarter, down from $5.4 billion during the prior quarter and flat with the year-ago quarter. Our legacy loan portfolio ended the year at $13.2 billion, a contraction of $664 million during the quarter and is now down 60% from its size at the peak. For the full year, the portfolio contracted $3 billion, largely reflecting $2.3 billion in paydowns.

I will cover more in the quality of the book in a moment. But first, I would like to address this quarter's provisions. During the quarter, we booked a provision for loan losses of $123 million, which included a recovery of $46 million related to a mortgage repurchase settlement, a $15 million collateral valuation write-down for certain loans in the process of foreclosure and a $67 million increased to the qualitative component of the allowance, which now stands at $124 million.

The $46 million repurchase settlement, which was disclosed in our most recent 10-Q, was the largest single settlement we have received to date and brings a total to just over $335 million during the life of the put back program.

The $15 million collateral valuation write-down relates to a change to our processes of using automated valuation models, or AVMs, to estimate the value of the property in cases where we haven't obtained the full appraisal or other property-specific information.

The increase write-downs are intended to refine the estimate for property conditions not fully captured in the AVM method of valuation. While this change resulted in an increase to our current provision, we do not expect it to have a material impact on the losses we will openly incur.

Turning now to the $67 million increase in the qualitative reserve. As we transition bank regulators from the OTS to the OCC, we are evaluating programs and practices that were designed in accordance with guidance from our prior regulator. While we were to align certain policies and procedures with the guidance of our new regulators, we have suspended certain modification programs that will require changes.

We anticipate this retooling process will take some time to complete. And as a result, we expect to execute fewer modifications in 2012. Therefore, we increase the qualitative reserve to reflect additional estimated losses during this period of reduced activity in our modification programs, as well as uncertainty around certain loans modified under our previous programs. Once the necessary changes to these programs have been implemented, we will reassess the overall qualitative reserve to ensure it’s at the appropriate level, always keeping in mind the guidance of our new regulators and Generally Accepted Accounting Principles. As a reminder, the overall qualitative reserve also accounts for uncertainty in the performance of modified loans, as well as a variety of economic and operational factors not directly considered in the quantitative loss model.

So to summarize, prior to the including the items I just described, net charge-offs for the quarter were $151 million and provision was $87 million, which compares favorably to last quarter's charge-offs of $157 million and provision of $98 million. Turning back to the performance of the portfolio. Loan charge-offs for the full year were $649 million, down 30% from 2010. The performance of our legacy loan portfolio continues to benefit from aggressive loss-mitigation strategies, including the use of servicers that specialize in troubled assets. Through 2011, we transferred a total of $3.2 billion of loans to higher touch servicers, including $850 million during the fourth quarter, completing the majority of plan transfers. These special servicers have historically been effective in reducing delinquencies through loan modifications and more aggressive outreach to borrowers.

With regards to the performance of our existing modifications, we saw stability during the fourth quarter in the average re-delinquency rate 12 months after modification, which was 29% for 1-4 Family loans and 42% for Home Equity loans. Additionally, we do not expect loan resets to be a material driver of credit costs as less than 1% of the 1-4 Family mortgage portfolio is expected to experience a payment increase of more than 10% during the year. And more importantly, nearly 70% are expected to reset to a lower payment. In total, we expect approximately $3.2 billion in 1-4 Family mortgages to reset in 2012, of which $1 billion are resetting for the first time.

With respect to capital, our position remains flat to last quarter's levels. For the year as a whole, the bank generated $411 million of regulatory risk-based capital and $228 million of Tier 1 capital. As of December 31, 2011, the bank's Tier 1 capital ratio is 7.8% and its risk-based capital ratio is 17.3%. In addition, our consolidated Tier 1 common ratio is 9.4%. Under Basel III in its current form, we estimate this ratio will also be approximately 9.4%, which is well above the 2019 fully phased in requirements. The primary difference in the Tier 1 calculation under Basel III is the capital treatment of unrealized gains and losses on available for sale securities, which will also make this ratio inherently more volatile than other capital ratios.

Turning now to dividends of excess capital out of our bank. As we stated last quarter, we have begun the process of requesting a more comprehensive dividend from the bank to the parent. Our thinking on the timing of this process has not changed, and our objective is to complete this dialogue sometime in 2012, after which, we should have a better idea on the timing of the dividend. However, we reiterate that the relationship with our primary regulator is very new, and we cannot predict the timing or likelihood of approval for any such dividends.

Corporate cash ended the year at $484 million or just under 3x our annual debt service. This increase of $46 million from the prior quarter related to settlements between the parent and subsidiaries for overhead cost-sharing arrangements, dividends from nonregulated subsidiaries and year-end tax settlements. Going forward, we would expect corporate cash to decline generally in line with our corporate interest expense. However, I would also point out that our parent houses roughly $500 million of deferred tax assets, which will ultimately become sources of parent cash as the company subsidiaries will reimburse the parent for the use of its DTA.

With that, I will turn the call back to Steve for closing remarks.

Steven J. Freiberg

Thank you, Matt. Before taking questions, I would like to share a few additional comments. As I said earlier, I feel positive about our franchise and headwinds, be as they may, we will continue to enhance our franchise position.

In addition to several new products in the pipeline for launch in early 2012, we are enhancing the way we position E*TRADE by broadening our advertising and platforms to better address both the trading and long-term investing needs of consumers. To that end, we have several new platforms and products ready or near ready for launch, including a completely new public website experience, our store front for prospects. Launched just weeks ago, we are currently directing just under 50% of visitors to the new site, and we expect it to be fully rolled out within weeks. In addition to a new look and feel, the site features streamlined information and digital design, clear pathing and differentiated experiences for distinct customer segments, plus tools for investment decision-making and guidance.

Our new customer site, E*TRADE 360, is in the final phase of testing with select new customers and is scheduled for a full franchise launch within a few weeks. We are very excited about this website, which makes online trading and investing faster, easier and more powerful by giving customers everything they need on one dashboard, the ability to choose and customize favorite features and a graphical view of accounts and the markets.

Retirement planning is a key priority for E*TRADE. And during the past couple of years, we have significantly enhanced our suite of products in our retirement planning center. And we are currently featuring this subject in our client education center. Our commitment to delivering best-in-class retirement experience was reinforced by Kiplinger's The Best of Everything 2011, where E*TRADE was recognized as having the best retirement planning calculator.

Additionally, we have refocused our advertising messages beyond trading and extended our brand position to align with the needs of long-term investors. The advertising has evolved to showcase the full range of investing solutions available at E*TRADE. In addition to tallying the latest enhancements to our already robust online offering, we've expanded our messaging to highlight investment professionals and retirement solutions.

From a financial standpoint, we are cautiously optimistic that customer-activity levels will increase, albeit modestly, from 2011 levels. Thus far in January, we have experienced an 18% sequential increase in DARTs compared to December. With respect to the loan portfolio, we believe it will continue to climb at roughly $600 million to $650 million per quarter. We expect delinquency trends to continue to improve, although the pause and certain modification efforts will likely impact net charge-offs in the near term.

We will continue to focus on executing our strategic plan, building on the progress and momentum we have generated over the past year. Specifically, we expect to increase the growth rate of net new brokerage accounts and customer assets, which in turn should drive growth in DARTs margin and brokerage cash.

Finally, given the macroeconomic uncertainty and the near-0 interest rate environment, we believe it is prudent to target expenses to be down mildly from 2011.

With that, operator, we are ready to take questions.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Daniel Harris of Goldman Sachs.

Daniel F. Harris - Goldman Sachs Group Inc., Research Division

I wanted to touch back here on the NIM. So I think that you said you expect that the average NIM for the year would be 200 -- it could be below 250 basis points. So as you see the 10-year -- or the yield curve as it stands today, how should we think about the progression of that through the course of the year, assuming that margin loans hold roughly in line here, around $5 billion?

Matthew J. Audette

Dan, it's Matt. So I think that -- you're correct, slightly below 250 for the year. And I think the best color, incremental color I can have is it's going to happen pretty quickly, so meaning Q1.

Daniel F. Harris - Goldman Sachs Group Inc., Research Division

Okay, that's helpful. And then I wanted to talk a little bit about -- you gave some color around the ability to upstream capital to the parent. But as we think about the year and the debt that you have outstanding, specifically the 12.5s, what's the thought process around retiring those towards year-end, whether that's retiring or refinancing them in the market?

Matthew J. Audette

So we're absolutely focused on those, Dan. I think if you go back to last year, just looking at our ability to issue a refinance, we issued -- that 6 and 3 quarters back in May. The markets have definitely increased since then, but we feel like sitting here today, that refinancing those notes at the end of the year is absolutely something that we can do. It would mostly be our preference to upstream capital out of the bank and pay those off. But as they said in their prepared remarks, they had some dialogue that they were having with the regulators throughout this year. It's not something that we would have any additional color on today. But from a refinance perspective, we are absolutely focused on that.

Daniel F. Harris - Goldman Sachs Group Inc., Research Division

Okay, great. And then just lastly, I just want to talk to the expense guidance. So it sounds like what you're saying is all else equal, we should expect that the expense number in 2012, excluding any onetime items, would be below what we saw in 2011?

Steven J. Freiberg

That's correct.

Operator

You're next question comes from the line of Eric Bertrand of Barclays Capital.

Eric Bertrand - Barclays Capital, Research Division

The earnings release commented on the additional reserves and write-down being an important step, which from my seat would suggest that this is actually an evolutionary ongoing process. Do you frame the magnitude of potential further write-offs or valuation allowance that are under review? Or is this actually done and was just kind of a conservative statement?

Matthew J. Audette

Sure. Eric, it's Matt. So I think just a high level when we discussed in the release and the prepared remarks, so we were early in the stages of our transition from the OTS to the OCC. And as part of that transition, we were going through policies and procedures to make sure that we conform anything that under the OCC is that they either have either different guidance or different focus in the OTS side. And loan modifications is one of those areas. So as we discussed, we're working through making changes to those programs to make sure they're in line with what our regulators expect. But I think the key thing that I would highlight here is that's ongoing. So where we sit today, we expect that the $67 million increase to the qualitative reserve is appropriate for this quarter. But keep in mind the allowance itself is inherently uncertain and it's an estimate. And as we finish these changes, as we work through these discussions with our regulators, it could change in the future. But where we sit today, the $67 million increase is absolutely our best estimate.

Eric Bertrand - Barclays Capital, Research Division

Okay, that's helpful. Also in the prepared remarks, I believe Steve commented on a whole bunch of new products and services that are coming online over the next couple of weeks and seemingly needing advertising support. With that in mind, how do you envision at your ad spending footprint and geography over the course of the year?

Steven J. Freiberg

Yes. Let me comment on a few points. One, which I think I addressed in the prepared remarks, that it's the evolution of our advertising and hopefully in the playoff games and actually we'll kick off in the Super Bowl a new advertising. And you should see not only interesting advertising but advertising that covers both investing, as well as trading as we try to broaden out successfully the firm. That said, from the standpoint of spend, I would say our spend levels will more or less be in line in 2012 with roughly what we spent in 2011. Although what we do believe is that we learn and get smarter, and so the effectiveness and the efficiency of our spend should improve with the passage of time, but we don't see a material change. You may see some restratification of the change between media, between online and other promotion. But largely speaking, I would say, the spend in 2012 will be similar to the spend in 2011.

Operator

Next question comes from the line of Rich Repetto of Sandler O'Neil.

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

I guess the first question is obviously talking about expenses and the guidance of lower expenses. But if you looked at this quarter, Steve and Matt, the comp was higher than it's been in the couple of years. I know you've been adding people; I think that's probably what it is. But when you get pre-provision revenue at the lowest, you have to comp at the highest. Is that because of the added headcount? Or...

Steven J. Freiberg

I mean I think largely, it's one of the unique factors that Matt had addressed. If -- and it was in the prepared remarks that the expenses -- the onetime expenses, I'll let Matt go through it in detail, that had been advertised. But to review, the expectation was -- to the expend, these are development of expenses, the majority of what was ultimately a $9 million expense showed up in comp and bend [ph] for this particular quarter. So it distorted it. And Matt, you may want to share just another -- a different point on that?

Matthew J. Audette

Yes, sure. So Rich, the IDS [ph] items that I talked about in the prepared remarks, actually hit 3 different line items on the income statement. To Steve's point, the hit complement the most of $7 million but also increase professional services $3 million and it reduced depreciation and amortization by $1 million. So you take all those together, I think that's the $9 million that Steve commented on. And then ARS, Freudenberg reserve and the other items that I speak to, when you put all those together, it increase expenses in the $15 million to $16 million range. So if you exclude those, Q4 expenses are around $290 million, which I think for some time now we've talked about, we think that's about the right run rate for each quarter's expenses, and broadly, $1.2 billion for the year. And I think that's the focus we'll continue to have with the philosophy of get more efficient and save on noncustomer facing areas and invest in the customer facing areas, but keep things net flat to down.

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

Got it, that's very helpful. The -- and then Matt, you gave some, what do you call it, detailed guidance on the NIM for 2012. And I'm just going back, it was -- but you did -- the previous statement was 250 basis points over time, and we never really knew where the NIM reach that point. And you correctly pointed out that other people have a lot of brokerage, say, cash sitting on their balance sheets, that weigh down their NIMs, and that's why yours was 250 and someone else's was 180. But I guess the question is, if you strip out the, say, cash effects of some of these other guys, like that big competitor, now they're down to a run rate of more like 220. So your longer-term run rate in this kind of environment, where would that stand now?

Matthew J. Audette

Sure, Rich. So 250, the slightly below 250 was for 2012. I think if you -- especially given the Fed's comments today of keeping rates at near 0 through the end of 2014, when you get in, I won't be too precise to each year, but when you get beyond 2012 in that rate environment, it will definitely float down some more. And I think being very broad, I'd say 10 more basis points is probably as good an idea as any, but we don't see it being meaningfully below that.

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

Okay. And then a very last question, Steve, I guess, bigger picture, given the Fed announcement today, when you gave your presentation at -- in conferences around year end, you talked about what a normalized -- the pretax could be in a better environment, higher interest environment, above $1 billion in pretax. Now the interest rate environment, this sort of pushes us back. Is there any modifications to your plan besides just it being pushed back by an outside force? Does the Fed impact any other plans as you march towards higher earnings rate?

Steven J. Freiberg

Let me try to answer the question if I fully understand. Just a couple of points, which I think help recognize your frame. One is spread is important, no doubt about it. Half of our revenues is net interest income more or less. I did say actually in my prepared remarks that even in 2011, where we did see, roughly speaking, on a full year basis 12 basis points of spread compression, we almost completely covered it with growing the franchise. So these are in aggregates. So absolute begets absolutes. But part of what we want to do, and it goes back to launching new prospect webs, new customer sites, smarter about our advertising is grow your business faster, so the volume basically offsets some of the rate compression, which by its very nature is likely, I think, to Matt's point. The second is if the environment were rough less challenging, let's talk about spread, we probably would be investing more to grow the franchise more rapidly, but we're constraining basically our expenditures in light of understanding the dynamics of expense revenue and provisioning. So what we're trying to do is to manage the business smartly and de-risk it in the context of the environment that we're facing, which is the same environment that our competitors are facing. And you'll see with the passage of time that if the environment shifts, if basically Europe gets some degree of buoyancy, maybe we see a different set of activity in trading, that will also generate typically an expansion of margin, that will change spread. We have over the next several years a fairly large book, which is clearly disclosed, a very expensive wholesale funding, which will roll off our balance sheet. We're repaying 4% and 5% for that money. So there's a lot of dynamics that run through, Rich. And part of what we think we do reasonably well is to understand those dynamics and try to find the best mix of that given the environment. But that said, if rates were going to stay absolutely low and flattish for 3 or 4 years, it will pressure the overall spread. And the question is how fast can you grow to get a volume offset or how smart can you be on changing somewhat of your balance sheet's strategy when you look out over the horizon. But that's -- I think, what we're trying to do here, which we haven't really done in the past, we started, I think, a quarter so back, is to give you a better sense of what we think the broad-based spread would be in an environment that stays relatively constant. And I think when Matt said in his prepared remarks, it said, "assuming no change in balance sheet strategy and more or less the rate environment that we see at the moment."

Operator

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

Howard Chen - Crédit Suisse AG, Research Division

So besides the treatment of modifications, so what are some of the other programs and policies we should be watching that could be treated differently between the OCC and OTS?

Matthew J. Audette

This is Matt. So I think the comment I made earlier, it's early in the transition. And I think one of the key things that highlight the differences between the OTS and the OCC and the Fed is the OTS was more of an annual review program versus the OCC and the Fed are more in-residence, so the dialogue is more active. So we don't have anything additional to highlight today, other than to say that it's early in the transition, and we do have active dialogue with them.

Howard Chen - Crédit Suisse AG, Research Division

Is this sequential in the sense that like you have to -- your OCC is your primary regulator today, and you need to conform with everything of theirs before you go to the Fed? Or is it all happening at the same time?

Matthew J. Audette

I think the OCC and the Fed work with each other quite well. So it's a in parallel thing.

Howard Chen - Crédit Suisse AG, Research Division

Okay, great. And then just one more on this. During the prepared remarks, I thought I heard you say this quarter's reserve actions wouldn't affect your view on losses, but then I thought I heard Steve say at the end, it could impact charge-offs a bit. So did I miss something in all that?

Matthew J. Audette

So I think you might be focusing on the AVM comment, so to add a little bit more clarity there, the changes there was in our process to estimate the losses on loans when they're 180 days past due. So we added a refinement to that process, but we don't expect it -- any change to the ultimate losses we have once we foreclosed on the property and sell it. Meaning the ultimate severity is the 1-4, which we cover in the low 40%. We don't have a different view on that. We just had a refinement to the process that are 180 days delinquent.

Howard Chen - Crédit Suisse AG, Research Division

Okay. And then I know your overall philosophy on securities gains vis-à-vis the provision expense, and that makes sense to me. I'm just hoping you could give us a flavor for what you continue to sell in this type of environment on the securities book and maybe how that's evolved over the last couple of quarters?

Matthew J. Audette

So there's really been no change. I mean the securities book, it's pretty much plain vanilla agency securities, so there's nothing different in there. And there's an active program to manage in this interest rate environment. I think the key theme, I think, we would leave you with is as we go back to 2009 and '10 where the gains overall were in the $150 million to $160 million range, our expectation is that floats down over time. And we saw that in 2011 that come down to $120 million. We would expect that trend of coming down to continue.

Howard Chen - Crédit Suisse AG, Research Division

Okay. And then just final one for me, Matt. I mean just -- not to beat a dead horse, but on the spread guidance, not to look too far forward, but if you're saying another 10 basis points. I guess with the loan book burning down and assuming no change in the shape of the yield curve or rates going up, I just -- I still struggle a bit with why, like let's just say 240 is the floor in your mind. Can you just help kind of expand on that a little bit?

Matthew J. Audette

Sure. So I think Steve probably hit on the key item for us, and that we've got a rather large wholesale funding book, roughly $1 billion that we -- let's put in place back in '06 and '07, so it's got extremely high rates. So as that portfolio runs off, it is the big offset. So I think the headwinds that you're probably -- that have in your mind that would drive it below 240. So that's the big item, and that's our estimate. But of course as you know, as we go through -- time will tell, we'll see. But our best estimate is slightly below 250 for this year. And there could be another 10 basis points beyond that.

Operator

Next question comes from the line of Patrick O'Shaughnessy of Raymond James.

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

So I wanted to chat a little bit about the brokerage side of the business. What are you looking at on the brokerage side in terms of you're hiring for the Corporate Services group or some of the trends that you're seeing in your customers that maybe gives you some optimism that trade is going to be a little bit higher in 2012 than 2011? And what sort of traction do you think you're basically getting with the Corporate Services group? And how soon is that going to be reflected, do you think, in some of your performance?

Steven J. Freiberg

Yes, just a couple of points. One, we think the Corporate Services group had an extraordinary year in 2011. And we'll see in majority the fruits of that labor more in 2012 as the majority of those customers get boarded, it's basically [ph] a period between when you sign contracts and you actually bring them on. The volumes themselves, year-on-year going from '10 to '11, meaning new customer assets were probably close to double. And the pipeline, as I said earlier, is extremely thick. And so that business has just been on a tear. And the volume, though, we actually see trading volume. In a bullish market, remember what underlies this, are largely employees that have options and equity that will vest. And so that if the markets have been muted as they have been, you don't see a lot of option exercise. But once the markets move in a direction that is positive, we'd expect to see both the base, as well as the overlay of new client or new customers perform extraordinarily well. These are terrific companies with great prospects overall. So very optimistic, the volumes keep growing, meaning they sign contracts, new customers coming on. We keep enhancing the platform. We already believe it's the best platform in the industry. And I would say that business in '12, '13 should continue to basically contribute quite smartly. And the added benefit is, I think you all know, that the average commission per trade that we get out of that business is far superior to what we get out of basically the traditional retail business, so it helps mix in addition. So it's sort of a win-win. But that's been, again, nothing short of extraordinary.

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

Great, that's helpful. And then my follow-up question, switching gears to your market making business. There has been an announcement by a couple of a relatively large investment banks that they're going to be entering the wholesale trading business. What sort of threat do you see that to your market making business? Because obviously, every little bit matters at this point. So how do you view the competitive environment in that area?

Steven J. Freiberg

We always respect any new competitors entering the industry. I've had a number of conversations with the people that run the market making side. I would say on a balance, we are confident that we will actually maintain or improve our share with the passage of time. We invested a fair amount in 2011, particularly in areas like colocation, where we moved essentially side-by-side with a number of our key clients to increase speed and execution, and we're seeing actually not only good takeup of that, but we think it's a good path for us to continue to grow. And again I'd never discount new competitors moving in. But we think by and large, we have scale, we have basically stated our capability and we'll continue to push on that. We also have the advantage of about half our flow onto that business is our own. And now about half our flow is third-party or external, and we're continuing to leverage both our own flow as well as scale. So I can't predict. We've seen this happened before. But I would say by and large, we prevailed and we continue to basically pick up share where we think it's important to pick up share. Just as you would also know, this is a business where not all volume is either effective and are good volume.

Operator

Your next question comes from the line of Keith Murray of Nomura.

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

Can you just touch on the tax rate in the quarter? I mean it looks like you have $7 million of taxes on roughly $800,000 income?

Steven J. Freiberg

Well I'm going to let Matt take that one but obviously, we're good Americans. We pay more than our fair share.

Matthew J. Audette

Keith, it's Matt. The key reason there is our taxable income is slightly higher than our book income, and the key reason for that is there's a decent size portion of our corporate interest expense, specifically on the Springing Lien Notes. It's not deductible for tax. So while we have pretax income of just around $1 million, the amount of income we actually have to accrue taxes on is a much larger number. I think the best way to think about taxes over the long term is in the range of 40% to 44%. But anytime we're relatively close to breakeven. That nondeductibility in the Springing Lien Notes is going to make the reported rate look pretty interesting, like it did this quarter.

Steven J. Freiberg

And it just goes to the point that we -- or the question we answered earlier, clearly it's compelling for us when the opportunity arises, either to refinance a paydown, or some combination there, the Springing Lien Notes. Because not only does it carry 12.5% coupons and almost $1 billion of debt, but largely, they're tax inefficient in addition, so we get to pay twice. One is very high coupons, and the other is we don't basically get the benefit of tax deductibility, which is really not helpful. So for those of you who weren't aware, it's clearly the challenge of that legacy that we'd like to reduce or eliminate.

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

And then on the E*TRADE Bank's Tier 1 leverage ratio, it went down slightly in the quarter. And I noticed in one of the footnotes that mentions that other risk-weighted assets increased. Could you provide any color on that?

Matthew J. Audette

Sure. So specifically the Tier 1, so the risk-weighted asset change should really be on the risk-weighted ratio. And I think the key thing on the leverage ratio for the bank is that the overall amount of capital in the bank, that didn't change. It's roughly $3.4 billion. But our assets increased during the quarter, and that was driven by the increase in deposits through brokerage-related cash. So from a leverage ratio perspective, it comes down. We think that's a good thing in that perspective because we generated more brokerage cash. So that's the reason for the decline there.

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

And then last one. The 5% increase in the early stage delinquencies in Home Equity, I mean what's the key factor driving that? Is it a certain geography? Or what specifically have you guys seen?

Matthew J. Audette

Yes. We would classify just even the overall increase and special mentioned delinquencies for the quarter at 2%, 5% of the Home Equity book. Q4 is typically a seasonally challenging quarter. So from our perspective, that 2% increase overall and then the 5% on Home Equity, keep in mind, it's less than $10 million, is a relatively good performance for Q4.

Steven J. Freiberg

Actually, just before we finish up the question, looking at -- basically coming off the same data, I think the context here is important across the year as well and notwithstanding that the fourth quarter tends to be a more seasonally challenged period, and we didn't see a lot of seasonality, which was positive. That if you look at the 1-4 Family, the actual current balances over the year came down about 15%. The delinquencies, though, 30.79 days, came down 30%. And if you look at the Home Equity book, the book is basically shrunk by 17% on the current across the year, but the delinquencies came down by 20%. And given these are liquidating portfolios, overall, that's not bad performance, if you'd expect typically liquidating performance on a relative basis to see a higher concentration of delinquencies with the passage of time. And we actually have experienced something of significantly less than that. I can't predict that's going to be the trend forever but nonetheless, it's not a bad trend when you look at your good volume coming down at a slower pace than your bad volume.

Operator

Your next question comes from the line of Chris Harris of Wells Fargo Securities.

Christopher Harris - Wells Fargo Securities, LLC, Research Division

So in your prepared commentary there, you talked about the improved environment for the brokerage this year, at least relative to last overall performance. I know in the past you guys have talked about increasing your hit rates on converting web prospects to customers. Have you guys made any progress in this area? I know it seems like a pretty big opportunity for you, and really any data you can share on this would be helpful.

Steven J. Freiberg

Yes, just a couple of points. Just to confirm, we had 3 good weeks relative to December. So directionally, not so bad. But I get it, it's hard to predict with any degree of certainty of how much improved 2012 will be, but with that regarded optimistic, we're looking for some mild improvements. From the standpoint of statistics around conversion rates off the web, I don't have that at my fingertips. We can help you potentially offline with that. But I do want to emphasize one of the main reasons we've completely rebuilt our prospect or our public website is to maximize the throughput from gross to net prospects coming through that channel. We think if you go online -- now again we're only directing 50% of the visits to that, next several weeks we'll be up to 100%. What we're doing right now is a lot of basically testing, learning and refining, so that we optimize against essentially the new web. But that is the aim of years’ worth of work. And maybe offline, we can get Brett to provide information that is in the public domain, but that's what we aim to do.

Christopher Harris - Wells Fargo Securities, LLC, Research Division

Okay, great, I'll follow-up after the call. And then I guess my second question here, just thinking about strategic opportunity for you guys, I know this always seems to come up. But any thought or progress about creating an RIA custodian business? Didn't know where that ranked in your strategic priorities, if at all, for the next year or so.

Steven J. Freiberg

Yes. I would say that it clearly is something that's on our radar. Today, we serve probably 200 or so RIAs. But it hasn't been, what I would say, the most strategic of the priorities for us. And so we understand the industry, we understand the growth in the industry. Clearly it's an area that over time we think to be important. But the world of prioritization, it's just not risen to the top of the priority list for '11 into '12. But I wouldn't discount in the period that would look out several more years that we wouldn't take a more aggressive stance there. But at this point in time, I wouldn't expect that to be a strategic high-priority focus for 2012. We have other things that we think provide us more income, more leverage, more opportunity, at least for the short term.

Operator

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

Michael Carrier - Deutsche Bank AG, Research Division

Just maybe one more on expenses. If I look throughout the year, your net new assets, your account growth, like everything has been turning in the right direction. Headcount is up. And so when you say, like flat year-over-year, I'm just wondering, the areas that you're investing versus where you can pull back, like where should we look for that? Because it seems like the trends are good and it seems like the expenses are already pretty low. So there should be some investment.

Steven J. Freiberg

Yes. I think what you'd expect to see, which is what Matt and I have said now consistently, we'll continue to invest in, I'll say, sales and marketing, although as I said earlier I think marketing will be more stable year-on-year given that we up some spend between '10 in '11 on the marketing front. And I would expect to continue to increase our sales capability both in our international sales centers, as well as in our physical approximate branches. But again we're not talking about substantial amounts of investment. And obviously the complement to that is if we're going to decrease expenses overall, again to Matt's comments earlier, it's going to come from areas that have less customer impact or less strategic value to us, and we're squeezing on it. I think we run a reasonably efficient model at this point. There could be some big opportunities for us on the expense side, but probably not going to be realized in 2012. Obviously as the legacy loan portfolio goes down, we probably spend $75 million to $100 million in that area that today is necessary but tomorrow would not be. We know we pay very high FDIC insurance premiums. So as basically the company continues to de-risk and it improves its overall financial position on a whole bunch of metrics, I would expect that expense to come down substantially, again, with the passage of time. I know that Matt's going through that in excruciating detail. But that could be another $50 million, $60 million, $70 million as well. That's where the big opportunities are on the expenditure side, from the standpoint of either restructure and/or efficiencies. But in the short term, we have to basically be, what I would say, we have to be in weeds and squeeze out expense that's not going to contribute, but reinvest it regardless of the environment in areas that we want to grow. And so -- but it's almost a full-time career for a lot of us, which is to continue to funnel it back into opportunity areas, and it's basically taken from where we think we get less value. It is a bit frustrating, though, there is some very large pockets that will take time likely to what I've just addressed, and I'm not sure if we can accelerate that in any material way.

Christopher Harris - Wells Fargo Securities, LLC, Research Division

Okay, that's helpful. And Matt, maybe just one more in the balance sheet. You mentioned on the wholesale funding that some of that rolling off. I guess any help there just on the timing of that, because obviously we can look at the environment and look at rates and how much that pressures your net interest margin. But on the funding side, when we think about -- as we're heading into 2013, like what portion of that can be replaced with cheaper funding?

Matthew J. Audette

Sure. It's not -- it's going to slowly trickle down in the coming years. When we put this funding back in '06 and '07, it was fairly long term, and it ended roughly 10-year range back then. So it's going to be years for it to flow down with little chunks here and there in the coming years. So it's going to be a long time.

Operator

You're next question comes from the line of Joel Jeffrey of KBW.

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

I think we've been through most of my questions out here, so I think I'll just ask a couple of housekeeping ones. Can you just talk a little bit about the decline in fees and service charge line? Is that just trading related?

Matthew J. Audette

It is. And that commissions, fees and service charges and principal transactions, all of those generally move in line with trading activity.

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

Okay, great. And then I apologize if I missed this earlier, but can you give a breakdown of the DART's options, futures, that type of thing?

Steven J. Freiberg

Yes. I mean I think the simple breakdown in the quarter, roughly 22% of the trades were in either options or futures, obviously, heavily skewed to options. And the remainder were in either equities with a very small portion of the final complement in probably package products like funds.

Operator

Your next question comes from the line of Chris Allen of Evercore.

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

Just wanted to ask quickly on the FDI insurance premium. Adjusting for the change in methodology, if those are running about $30 million a quarter for 2Q and 3Q and then obviously you dipped down $25 million this quarter. Was there any change there? Or is this just a function of the loan book going down?

Matthew J. Audette

A little bit of both. So the quarterly FDIC insurance is always going to be our estimate for that quarter and a little bit of true up from the actual versus the prior quarter's estimate. We had a little bit of that in the fourth quarter as a credit or reduction. And then one of the things that drove the increase in the FDIC insurance premiums under its asset-based methodology was, call it, a surcharge, if you will, for certain types of loans. So as those loans come down, the FDIC insurance will come down as well. So I think that where we sit today at $25 million, it's not the run rate, it's a little bit higher, but it's a little bit less than $30 million.

Operator

Your next question comes from the line of Brian Bedell of ISI Group.

Brian Bedell - ISI Group Inc., Research Division

Most of my questions have been answered, but just a couple. Just one, you talked about refinancing the Springing Lien Notes obviously as sort of a primary target. Do you require regulator approval for upstreaming dividends from the bank in order to do that? Or is that -- can you possibly do it without up streaming capital from the bank?

Steven J. Freiberg

So 2 separate questions, right? One is absolutely we're require regulatory approval to move dividends between the bank and the parent. And from the standpoint of could we, would we refinance without basically upstreaming the dividends from one to the other, the answer is we believe that the market, this is in conversations with a number of our investment banks and relations, we believe that we would refinance regardless. Clearly we'd like flexibility, but to Matt's point earlier, this is a process that we cannot predict, meaning essentially the dividend process, we cannot predict timing with any degree of certainty.

Matthew J. Audette

And I would just to add, just look back at what -- our refinancing looking back in last May, there was no dividend approved for that. And so I think refinance is something we can do at the parent.

Brian Bedell - ISI Group Inc., Research Division

Okay, great. And then the second question I had is just, Steve, if you could talk about sort of what your organic growth targets are? I don't know if you have sort of an official view of where you like them to be, if you look at your competitors over, let's say, maybe the next 1 to 2 years? And considering the momentum that you've got in the corporate client business and also overlaying the productivity of the new financial consultants that you've added this year and plan to add in 2012?

Steven J. Freiberg

Yes. I don't think we have a precise number. But what I would say is this year, 2011 -- this past year, 2011, we grew on a net basis, x-ing any market volatility or change, we grew net customer assets by approximately 7%, which was below Ameritrade and above Schwab, which we kind of look at when we have public data in as core competitors. And I would say, our goal would be to be at the top of the market, and we're not there yet. We're better than we were, and we're moving in the right direction. But I would say, the competitor in that was at the top of the market this year, probably grew in the low double digits, probably in the number around 11%, and we grew at 7%. I would say there's nothing wrong basically with our capacity over time to grow. One of the issues or challenges we have is that historically, we've been deemed to be more of an area to come to trade. So if you come to trade, you're going to bring a lot of assets, you bring your trading assets. We've been retooling, as I said, platforms, positioning, advertising, bringing in sales folks in order to essentially broaden out E*TRADE to be a great place to not only trade but to invest. If you come here to trade and invest, you bring more assets. We're already seeing, for example, new accounts generated from our financial consultants are about 6x larger than those that are coming through basically on their own. And so we're optimistic but this is -- I don't think you change the frame, we need to get to the top of the market in 6 or 12 months. So we're on a journey, but we're -- essentially we're not sitting here growing at once, hoping to grow in '11. We're in actually a decent position. And as we execute, we think it'll actually basically move higher, and that's our goal. But I don't have a number saying I wish we have 10% or 12% or 14%, I just think we have to be competitive to the point where we're as good as anybody we compete with.

Brian Bedell - ISI Group Inc., Research Division

Right. So it sounds like obviously the fourth quarter was subdued because of the trading activity that you mentioned, and as we move into your better season of seasons coming into the year and some momentum from the corporate client business and the FCs, we should see that sort of mid-4% to 5% rate that you've had in the fourth quarter, could that move up to the high single digits during the year, would you say?

Steven J. Freiberg

And that's what we would expect, and as I said in 3 weeks, it wouldn't make a trend. But not only our DARTs basically up sequentially, the way we described it at 18%. But all the other metrics are moving more or less in concert with that. So you look at new accounts coming through on a net basis, you look at asset growth, if we can sustain this, and no guarantee can, things, will feel like, are reasonably good.

Operator

Your next question comes from the line of Matt Fischer of CLSA.

Matt Fischer - Credit Agricole Securities (USA) Inc., Research Division

First off, when I look at -- in your Qs, you published the carry value versus fair value of your loans on a net basis. Do you -- in the third quarter it was like $1.3 billion, do you have that for the fourth quarter?

Matthew J. Audette

Sure. So I think if you convert that to a price in the loan during the low 90%, so we'll have that in the 10-K, but it improved slightly.

Matt Fischer - Credit Agricole Securities (USA) Inc., Research Division

Okay. And when you say improved, it's shrinking?

Matthew J. Audette

Well, so the portfolio itself is shrinking every quarter but the price of the portfolio, so the fair market value versus the book value, that price has improved slightly in the fourth quarter versus the third.

Matt Fischer - Credit Agricole Securities (USA) Inc., Research Division

Okay. So slightly over 90%?

Matthew J. Audette

Yes, correct.

Matt Fischer - Credit Agricole Securities (USA) Inc., Research Division

And as -- I guess there's some government programs to try to keep people at homes longer and with the extended period of lower -- period of lower rates. Do you -- obviously as the loan book shrinks, but also how do you look at that in terms of over time, how small -- how you close that gap and if you kind of see what you got in 2012 at least?

Steven J. Freiberg

So I think the question is the impact of any government programs on the loan portfolio. I think as a general statement, if we're doing anything there, it would certainly help us. But that's not something that we're counting on. We're managing the portfolio the way we have for the past several years, which is to minimize the credit losses associated with it as it pays down.

Matt Fischer - Credit Agricole Securities (USA) Inc., Research Division

Okay, great. And then with the -- you mentioned I believe the $600 million to $650 million per quarter in runoff on the loan book?

Matthew J. Audette

Yes.

Matt Fischer - Credit Agricole Securities (USA) Inc., Research Division

Okay. And that's kind of -- you started $650 million and gradually work your way down? Or from the first quarter through the end of the year?

Matthew J. Audette

It's a range. I wouldn't be as precise as that. I think $600 million to $650 million is a good estimate for the quarters and the year.

Matt Fischer - Credit Agricole Securities (USA) Inc., Research Division

And lastly, with you net new assets, any -- could you give some color in terms of new versus existing clients and where the accounts that are coming in your new accounts, just where are you getting this traction from?

Steven J. Freiberg

So as far as the mix, we don't break it out. It definitely comes from both, both new customers and existing customers. And I think where we're getting those customers from, I think it's the broad trend of investors movement from the traditional offline space to the online space is where we see our growth from.

Steven J. Freiberg

I mean just to add a little bit more color, and this is and it clearly changes, probably about 1/3 of our accounts are coming from brand new customers, about 2/3 are coming from existing customers. Obviously, our focus is expanding relationships with customers, and that's basically playing through the system. Clearly it's stratified differently. If it's coming through the sales channel, it tends to be a much larger account. If it's coming through, what I'd say, the marketing channel tends to be a smaller account but typically grows with the passage of time. And for your last question, how does Corporate Services group work through that? It is very important because broadly speaking about 25% to 30% of our new customers over the course of time come through that channel at a very low cost per account, although you tend not to get your very active traders out of the channel. By varied definitions, hopefully that kind of gives you more or less a frame.

Operator

This concludes the allotted time for today's question-and-answer session. I will now turn the floor back over to Mr. Steven Freiberg for any closing remarks.

Steven J. Freiberg

Operator, thank you very much. And all I want to say then is thank you again for joining us tonight, and we look forward to speaking with you again next quarter, and have a good evening.

Operator

Thank you. This concludes your conference. You may now disconnect.

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