E*TRADE Financial (ETFC) Paul Thomas Idzik on Q1 2016 Results - Earnings Call Transcript

| About: E*TRADE Financial (ETFC)

E*TRADE Financial Corp. (NASDAQ:ETFC)

Q1 2016 Earnings Call

April 21, 2016 5:00 pm ET

Executives

Paul Thomas Idzik - Chief Executive Officer & Director

Michael A. Pizzi - Chief Financial Officer & Executive Vice President

Analysts

Richard H. Repetto - Sandler O'Neill & Partners LP

Conor Fitzgerald - Goldman Sachs & Co.

Christopher M. Harris - Wells Fargo Securities LLC

Steven J. Chubak - Nomura Securities International, Inc.

Daniel Thomas Fannon - Jefferies LLC

Devin P. Ryan - JMP Securities LLC

Christian Bolu - Credit Suisse Securities (NYSE:USA) LLC (Broker)

Brian B. Bedell - Deutsche Bank Securities, Inc.

Michael Roger Carrier - Bank of America/Merrill Lynch

Operator

Good evening, and thank you for joining E*TRADE's First Quarter 2016 Earnings Conference Call. Joining the call today are Chief Executive Officer, Mr. Paul Idzik; and Chief Financial Officer, Mr. Michael Pizzi.

Today's call may include forward-looking statements, which reflect management's current estimates or beliefs, and are subject to risks and uncertainties that may cause actual results to differ materially.

During the call, the company may also discuss non-GAAP financial measures. For a reconciliation of such non-GAAP measures to the comparable GAAP figures, and for a discussion of additional risks and uncertainties that may affect the future results of E*TRADE Financial, please refer to our earnings release, furnished with Form 8-K, and our 10-Ks, 10-Qs, and other documents the company has filed with the SEC. All of these documents are available at about.etrade.com. This call will present information as of April 21, 2016. The company disclaims any duty to update forward-looking statements made during the call.

This call is being recorded, and a replay will be available via phone and webcast later this evening at about.etrade.com. No other recordings or copies of this call are authorized or may be relied upon.

With that, I will now turn the call over to Mr. Idzik.

Paul Thomas Idzik - Chief Executive Officer & Director

Thank you, Ashwin. Good evening and thank you for joining us to reflect on what has been a meaningful quarter for E*TRADE. We kicked off the year with solid play by all our lines, as we posted strong results, continued to roll out enhancements to our customer offering, and deployed a considerable quantum of capital to shareholders.

Amidst a market environment characterized by trepidation and unease, we posted respectable growth in the business as our customers remained relatively active. Our results again benefited from the dwindling size and better-than-expected performance of our legacy loan portfolio, and we made significant progress on our premeditated march toward a $50 billion balance sheet. Meanwhile, we began managing the bank to a lower Tier 1 leverage ratio, distributed a considerable amount of capital to the parent, and continued to put capital to work for our owners.

Starting with our results. We reported net income of $153 million, or $0.53 per share for the quarter. On the metrics, customer activity increased sequentially, a trend that is typical in Q1. We also traditionally expect an uptick in activity from our corporate services customers in Q1 and that trend was less pronounced, attributable to the underperformance of the market. Options contributed a steady 23% of total DARTs. Additionally, the portion of trades executed via mobile platforms held steady at 16%. In April to date, DARTs are tracking down 1% from March.

In terms of sentiment, Q1 presented a bleak opening for our customers as the markets kicked off January with one of the worst starts in history. Confidence in activity improved through the quarter, and by March end, it seemed the Cimmerian curtain had lifted. The sum total of this quarter's activity was solid, with our customers being net buyers of $1.2 billion of securities, while exhibiting some purposeful de-risking behavior. Margin balances were dialed back by slightly over $1 billion with balances averaging $6.7 billion and ending the period at $6.3 billion. In April to-date, balances are flat where they ended the quarter.

Meanwhile, we continued to post solid growth. Excluding the impact of shuttering our Hong Kong and Singapore operations, we added 45,000 net new brokerage accounts during the quarter, while our adjusted attrition rate improved to 7.3%, both of which represent our best quarterly marks in two years.

We added $2.9 billion of net new brokerage assets during the quarter, healthy for Q1, but down from $3.5 billion a year ago primarily due to lower activity from our stock plan customers. Our focus on retirement, investing, and savings is present in this metric as one-quarter of these flows were into retirement accounts.

Q1's results also included a $0.10 per share income tax benefit, and some important changes to our reporting and segments. And Mr. Pizzi will elegantly walk you through each of those. There is one element I will highlight, however, which is the impact of these changes on our operating margin calculation, reducing it by about 2 percentage points, making our equivalent target 37% for this year.

Also, you'll find that we present this metric both straight up, and adjusted, which excludes provision for loan losses this quarter, the latter being the measure to which we manage our spending. While we are ever-mindful of the impact that provision can have on our bottom line and our capital, we don't view it as a key factor governing our investments in the business. That said, a large benefit is not a license to spend, nor would we ignore any meaningful charges.

And with that context out of the way, we posted an adjusted operating margin of 34% in Q1, below our full year target of 37%, yet broadly in line with our expectations given the timing of balance sheet growth and seasonality in comp and advertising.

The performance of the loan portfolio exceeded our expectations, and our results included a net benefit in the charge-off line, a first for the company. We continue to benefit from recoveries, along with better-than-expected performance of HELOC conversions, which we are now more than halfway through. This diminishing portfolio ended the quarter at just $4.7 billion.

On to capital, where we delivered some remarkable numbers and progress this quarter, across each stage of the capital lifecycle: generation, distribution, and deployment. Talking about our generation of capital, we've done a lot, both from an earnings standpoint as well as through lower capital thresholds. The progress we've made acutely reflects our improved financial position and regulatory progress, which are proof positive of all the work the entire team has done on the enterprise risk management front, the enhancements we've made to our operations and leadership team, as well as the continued and marked improvement to our overall risk profile.

Concordant with our much improved stature is the freedom we've earned to internally distribute the capital we generate, continuing to benefit from improved flexibility at the bank and companywide. This quarter we distributed a hefty $400 million to the parent, well above our typical contribution. This included capital from the bank, both formed through earnings, and liberated through the 100 basis points drop in our target leverage ratio, and capital from our brokers, from the earnings of our introducing broker and the extraction of excess capital from our dealing broker.

One related element of note: while we achieved a reduction in our bank leverage ratio to 8%, well ahead of our original plan, we have our sights set on continued improvement to our capital efficiency there, and aim to manage closer to 7.5% in early 2017. This, of course, is our aspiration, and would require regulatory approval.

On capital deployment, we exceeded $350 million in cumulative share repurchases during the quarter, putting us nearly halfway through our current authorization, just a few months after embarking on the program.

While market dislocations during the quarter presented us with opportunities to be aggressive buyers of our stock, we aim to continue buybacks at a more modest pace, with an eye on completing the current $800 million program by year-end. We are devotees of buybacks, as they allow us to return capital to shareholders efficiently and with low risk.

With regard to additional capital deployment, we're progressing on growing our balance sheet to $49.5 billion, adding $2.5 billion during the period. We intend to reach our target size this quarter.

In exploring other avenues to put capital to work, we continue to focus on growth, with acquisition as one method to achieve that goal. This quarter, we sharpened our focus, and I'd like to walk through our current thinking.

We believe scaled acquisitions in the brokerage space make the most sense. We also look for opportunities to bolster our capabilities through acquisition and consideration of our retirement, investing and savings vertical, as well as our corporate services channel. However, we continually evaluate build versus buy on this front.

Specific to acquisitions in the banking space, our areas of focus include innovative financial technology within custody and payment services; and trust and wealth management offerings, to the extent we find a logical fit in support of our current strategy.

Now, we certainly understand there has been significant investor interest around acquisitions that could result in credit exposure, and I'd like to summarize our present thinking on this. To the extent we would consider taking on credit exposure through acquisition, it would have to exceed a substantially higher hurdle for returns, to ensure the benefits and associated risks would truly be worthy of our owners' capital and management's time.

To make this point very clear, we will not explore acquisitions in a traditional banking model unless it is overwhelmingly compelling for shareholders. We have come too far as a company to go round the bend by assuming unwarranted risk through an injudicious acquisition. We also continue to evaluate other options for capital deployment, including share repurchases beyond our current program, and balance sheet growth beyond $50 billion. Mr. Pizzi will provide color on how we measure these options.

With respect to enhancements and rollouts, Q1 was a busy quarter. To cover a few of the highlights. We continued to expand our industry-leading mobile offerings as we incorporated customer feedback to increase customization capabilities on the mobile dashboard. As mobile continues to become a channel for long-term investors as much as for active traders, we also introduced a mobile retirement center, helping customers plan their retirement savings with a calculator tool, and easily open an IRA or rollover an existing 401(k) account.

On our website, we upgraded our income estimator tool, which now provides an improved logic that can be applied to securities within a watch list and can seamlessly send any stock, ETF, or mutual fund through for execution. Most recently, we rolled out a new dashboard in E*TRADE Pro, creating a home base for our most active traders to track the markets, manage their portfolios, and much more, in a consolidated manner.

We have a pipeline of great tools, features, and new experiences in store for our customers this year. So stay tuned. I look forward to sharing more with you.

We've just emerged from our industry's awards season with an ample assortment of accolades, receiving high marks from Barron's and NerdWallet, nine best-in-class distinctions from StockBrokers.com, which includes earning the number one mobile app, three Gold awards from Corporate Insight, and an honoree designation from the Webby Awards.

Our industry also witnessed one of the more impactful pieces of overreaching regulation seen in recent history. The Department of Labor's ruling on the applicability of the Fiduciary Standard. First, I want to state unequivocally that we support efforts to advance the best interests of retail investors, and will work within the new regulatory guidelines to continue to deliver guidance on our customers' terms, and provide services that help investors take control of their financial health.

We're also pleased that the DoL heeded many of the industry's concerns regarding the initial draft, delivering a final rule that is less burdensome than originally proposed. We believe as a matter of principle that all who serve the retail investor should be held to the highest standards when it comes to working in their best interest. At the same time, we believe this pursuit must be balanced against ensuring investors continue to have seamless access to investment support, and the greatest variety of financial choices at their disposal, to help them trade, invest, and save.

We're still working through the ruling's significance, but are confident it'll have minimal impact on our ability to properly serve our customers.

On the leadership front, I'm very pleased to welcome an addition to our executive suite, as we concluded our comprehensive search for a new Chief Risk Officer earlier this month, appointing Ms. Ellen Koebler to the post. With a risk management career spanning nearly two decades at a handful of large and complex financial institutions, Ellen brings considerable fire power to this crucial function and to our Executive Committee.

As Ellen comes on board, our unassailable Acting CRO and the original architect of E*TRADE's Risk organization, Mr. Paul Brandow, has graciously agreed to stay on in an advisory capacity to me and the entire executive management team. I'm happy to know we'll continue to benefit from his sage perspective and consummate insight.

In closing, as I think about 2016, we have a lot of exciting things in the works on the customer experience front, and we'll continue to ruthlessly pursue the best path forward on capital deployment. I look forward to keeping you apprised.

And with that I'll turn it over to our sedulous CFO, Mr. Pizzi.

Michael A. Pizzi - Chief Financial Officer & Executive Vice President

Thank you Mr. Idzik. For the quarter, we reported adjusted net income of $122 million or $0.43 per share. This excludes $31 million, or a $0.10 per share tax benefit related to the release of a valuation allowance against state deferred tax assets.

Our results compare to $89 million or $0.30 per share in the prior quarter. It also compares to adjusted net income of $85 million or $0.29 per share in the year-ago quarter, which excludes the loss on early extinguishment of corporate debt.

Before I delve into the details of our income statement, I'd like to review the changes we made to our reporting this quarter. For those of you following along, these changes are laid out graphically in our quarterly financial supplement on about.etrade.com under the quarterly earnings section. There, you will also find realigned financials going back through 2014. I'll refer to those during this call.

We consolidated our business segments and realigned both our income statement and yield table, all of which are reflective of how we currently manage the business. As for the specifics, beginning with segment reporting, we collapsed our operating segments and are now presenting only consolidated financial results.

With the vast majority of our legacy costs in the rearview mirror, and the management of our balance sheet now focused solely on maximizing the value of customer deposits, we thought it was the right time to wave goodbye to the balance sheet management segment as well as the corporate category.

We also realigned our income statement, moving our below-the-line items into revenue and expenses. Most notable among those changes is that corporate interest expense is now included in net interest income. Additionally, other income and expense was moved into the gains and losses on securities and other revenue line. And losses on early extinguishment of debt are now included within the non-interest expense section.

Taking a deeper dive into net interest income, we are now reporting net interest margin, as opposed to spread. After all, most of you already call it NIM. Now onto the result.

Revenue for the quarter were $472 million, up from $439 million in the prior quarter attributable to higher net interest income as both net interest margin and balance sheet size increased sequentially, and up from $441 million in the year-ago quarter as a result of the termination of wholesale borrowings, the Fed rate hike, and the corporate debt reduction and refinance.

Net interest income of $287 million improved $17 million from the prior quarter driven by a 7 basis point improvement in the net interest margin on a $1.4 billion larger average interest earning balance sheet. Our net interest margin of 281 basis points increased as a result of the full quarter impact of the Fed rate hike coupled with slower prepayment speeds on the securities portfolio, but was partially offset by lower margin balances. Because we guided to spread on our last call, I'll tell you that based on our prior reporting, our spread for the quarter would have been 294 basis points. Meaning, we significantly outperformed our expectations of high 270 basis points.

As for our expectations for the full year, holding the Fed Funds rate constant, and doing the same to margin balances, we expect our net interest margin for the full year to be in the 260 basis points to 265 basis points range. Adjusted for the reporting changes, this is consistent with our previous guidance. Note that our significant outperformance in Q1 is offsetting our expectation for NIM to contract in the remainder of the year. For Q2 specifically, we expect it to land in the mid-260 basis points.

Commissions, fees and service charges, and other revenues were $175 million, up $15 million from the prior quarter and down just modestly versus the year-ago quarter. Two main factors contributed to the fluctuations. First, customer activity increased 12% versus Q4, but decreased 3% versus the year-ago period. And second, improved rates on off-balance sheet cash helped drive increases in fees and service charges relative to both periods.

On the latter, the average rate earned on off-balance sheet cash was 30 basis points in Q1, up 17 basis points from Q4 as a result of the full quarter impact of the December rate hike. Keep in mind, this is a gross number. So net of the fees paid to our third party platform administrator, we earned 24 basis points on average in the period.

Average commission per trade of $10.64 declined $0.02 from the prior quarter and $0.30 from the year-ago quarter. The year-over-year decline was driven by a lower contribution from stock plan customer trades and fewer options contracts per trade. Securities and other gains were $10 million, flat with the prior quarter. For the full year, we expect gains to be in the $30 million to $40 million range.

Non-interest expense for the quarter was $312 million, up $7 million from the prior quarter, which included $14 million in non-recurring charges. Excluding those items, the $21 million sequential increase was driven primarily by compensation and benefits, which reflect the full quarter impact of the hires we made in Q4 as well as seasonality related to compensation.

We remain highly attuned to the operating environment, and the impact it has on how we manage our expenses. As Paul mentioned, for the quarter, our adjusted operating margin was 34%. Our target for the year remains 37%, the equivalent of 39% prior to our reporting changes. For Q2 specifically, we expect expenses to decrease approximately $10 million sequentially, primarily related to lower marketing spend.

Provision for the quarter was a benefit of $34 million, needless to say, better than we expected. Net charge-offs were also positive at $3 million of recoveries, resulting in a $31 million reduction in the allowance to $322 million. Meanwhile, the overall portfolio itself reduced by $284 million, or 6%, to $4.7 billion.

In addition to the positive impact of recoveries, our provision benefit also reflected better-than-expected performance of converted HELOCs that were previously classified as high risk and had been reserved for using the full life of loan loss expectation. This includes balloon loans, of which there are just $25 million remaining, the vast majority of which will convert in the current quarter.

In total, we had $213 million of HELOCs convert to amortizing loans during Q1, which puts us more than halfway through the conversions. Performance in Q1 was consistent with the observations we discussed last quarter where the default rate of the converting loan is about twice that of the non-converting loan, at approximately 12%.

So while we have been pleasantly surprised by performance to-date, please keep in mind that we have a sizeable pipeline of conversions through Q1 of next year. For this reason, we expect our provision to be approximately zero, with the caveat that recoveries of a greater than expected magnitude could again result in a provision benefit.

One final note on the P&L regarding the tax benefit we recorded this quarter. With the move of our broker dealers behind us, we took a hard look at our organizational alignment and found an opportunity to reinstate the tax treatment of our broker dealers prior to moving them under the bank. The tax election resulted in a release of valuation allowance against the associated state deferred tax assets. We are always looking for ways to deliver for shareholders and were pleased to uncover additional value in this pursuit.

Moving on to capital, we distributed nearly $400 million up to the parent during the quarter, comprising the following. $248 million from the bank, which included $97 million from the prior quarter's net income, and $151 million as a result of our reduced bank leverage ratio; and $148 million from the brokers, which included $24 million of excess capital generation at the introducing broker, as well as $124 million from the clearing broker.

In the second quarter, we expect total dividends to the parent of approximately $190 million from the bank and brokers. Starting with the bank, since balance sheet growth consumes bank capital and directly impacts our leverage ratio, in Q2, we will request an $85 million dividend to the parent, which is below the prior quarter bank net income of $108 million.

From the introducing broker, we anticipate $27 million to the parent, as part of the standard quarterly distribution. And from the clearing broker, we plan to move $75 million. We continually assess the capital position of the entity, and based on the business environment, we may periodically move surplus capital.

We remain in the midst of two capital deployment initiatives, balance sheet growth and share repurchases. On the former, we expect to reach our targeted balance sheet size by the end of the current quarter. At that point, based on Q1 deposits, we would have $2 billion in off-balance sheet deposits available to onboard.

With respect to the cost of exceeding $50 billion, we completed additional work during the quarter, and our initial estimate remains intact, which is $50 million over two years related to the build-out, with an annual recurring component of roughly $15 million. So to justify these expenses, along with the capital required to be held against the assets, we need some combination of higher rates and an abundance of customer cash. So for the time being, we plan to hold steady under the $50 billion mark.

On share repurchases, as Paul highlighted, we are nearly halfway through the $800 million program, having picked up nearly 15 million shares at an average price of $23.81. To elaborate on our internal parameters regarding utilizing capital for repurchases, while corporate cash is a clear measure of our dry powder, we are also mindful of our consolidated Tier 1 leverage ratio, which we manage to a floor of 7.0%, meaning we would not utilize capital to the extent it would put us below this level. We ended the quarter with corporate cash of $482 million and consolidated Tier 1 leverage of 7.8%, which provides the ability to make substantial progress on our program.

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

Question-and-Answer Session

Operator

And our first question comes from the line of Rich Repetto with Sandler O'Neill. You may proceed with your question.

Richard H. Repetto - Sandler O'Neill & Partners LP

Yeah. Good evening, Paul. Good evening, Mike.

Paul Thomas Idzik - Chief Executive Officer & Director

Hello, Rich. Always nice to hear from the doyen of the industry.

Richard H. Repetto - Sandler O'Neill & Partners LP

Thank you. The checking line definitely contributed here with the provision. I'm just trying to see – you don't expect it to contribute like it did. And is the performance that you're seeing there, I know we still got half the amortization portfolio to go, but are we still – it just feels like we're conservative given the last couple of quarters and the amount of reversals we've seen in that line.

Paul Thomas Idzik - Chief Executive Officer & Director

Well, Mike is going to talk to it in more detail. But Rich, our models and what we have set aside goes through a tremendous amount of scrutiny, not only from our own people, but from our accountancy firm and also from our regulators. So, I just think we just need to keep that in context as we think about it. But Mike, I know you have stuff to add here.

Michael A. Pizzi - Chief Financial Officer & Executive Vice President

Yeah, Rich, I would keep in mind that as we move through time, we're moving into later vintage loans, with the loans this year being really converting 2006 vintage, next year would be 2007. So, the remaining 50% is of vintages that are largely thought to be of lower quality. So that may help put this in perspective a little bit.

The other point I would call-out is, while we did have $3 million of recoveries through the charge-off line, they are not coming from the current loan population. And so that elevated recovery number that we see that's really been really very influential in the last few quarters is very difficult to forecast on a go-forward basis. And that's what contributes to coming out where we are on the current allowance.

Richard H. Repetto - Sandler O'Neill & Partners LP

Got it. Okay, helpful. Thank you. And then just – I'm going to ask about interest rate sensitivity, and we looked at the presentation and it's hard to compare given the new – the adjustments to the NII. But is there incremental – like the spread in your presentation is wider. Has anything changed in regards to interest rate sensitivity?

Michael A. Pizzi - Chief Financial Officer & Executive Vice President

Very little change in regards to interest rate sensitivity. What I will say is given the movement in margin and the movements in cash, and you'll see a higher amount of segregated cash. Those are the items that are directly influencing the small change in the delta in net interest income that you see.

Richard H. Repetto - Sandler O'Neill & Partners LP

Got it. Okay. And then I guess my last question is on, great quarter, it seem like you beat on every revenue line, but margin loans did drop, it appears a little bit more than peers. Anything going on – I know you mentioned Paul deleveraging of the consumer, but can you give us some more color on I guess it was – I think 15% quarter-to-quarter?

Paul Thomas Idzik - Chief Executive Officer & Director

Yeah. Rich, if you go back in history, you will see that while margin balances were building up, ours were building a little faster. And as our customer base decided to derisk, they derisked a little faster and a little more steeply than the competition. So I think it's just a question of the makeup of the relative customer books.

Richard H. Repetto - Sandler O'Neill & Partners LP

Got it. Okay. That's all I had and congrats on a good quarter.

Paul Thomas Idzik - Chief Executive Officer & Director

Thank you, Rich.

Operator

Our next question comes from the line of Conor Fitzgerald with Goldman Sachs. You may proceed with your question.

Conor Fitzgerald - Goldman Sachs & Co.

Good evening.

Paul Thomas Idzik - Chief Executive Officer & Director

Hey, Conor.

Conor Fitzgerald - Goldman Sachs & Co.

Hey. So, Paul, I just want to go back to your comments on I think managing the business to be adjusted pre-tax margin. So excluding the reserve release, I think on the last quarter call, you kind of left the door open for maybe you're reinvesting reserve release if they were stronger than you expected back in the business. Should we kind of interpret your comments today as reserve release is totally divorced from your expenses?

Paul Thomas Idzik - Chief Executive Officer & Director

No. I think what we said is we don't see it as a license to just spend it without regard to our other targets and other obligations we have both to our owners and other things we're trying to accomplish. So that's what we're trying to point to as well as saying if we have worse than expected charges that we would try and still keep to our target. So that's I think what you're hearing us talk about, Conor, is just trying to continue to be as disciplined as we can in managing for the type of results that we think our owners deserve.

Conor Fitzgerald - Goldman Sachs & Co.

Got it. Okay.

Paul Thomas Idzik - Chief Executive Officer & Director

If we thought we could put some additional cash to work wisely, we'd be happy to tell you about that.

Conor Fitzgerald - Goldman Sachs & Co.

Got it. And then again on the buyback, I appreciate the comments around the timing and the 7% floor. But if you were to get kind of more aggressive, is it more in your mind you just want to be more deliberate from here on out or are you kind of trying to maybe respond to share price movements when you think about kind of the pace and the timing. Is it more steady or are you going to try to be a little more dynamic?

Paul Thomas Idzik - Chief Executive Officer & Director

Well, I think you saw an acceleration in the quarter that was definitely in response to the market. I think we will remain as dynamic as we can be within the confines of our capital and corporate cash to respond to the overall market environment. But as we said on the call, we see finishing this really within the year really one quarter ahead of the authorization timing.

Conor Fitzgerald - Goldman Sachs & Co.

All right. Very helpful. Thank you.

Operator

Our next question comes the line of Chris Harris with Wells Fargo. You may proceed with your question.

Christopher M. Harris - Wells Fargo Securities LLC

Thanks, guys. Just wanted to come back to the NIM for a second, the 290-basis points-or-so that you talked about – 294 basis points, I guess, it was for the quarter. What was it that happened that really surprised on the upside. Was it the flow through on rates, the Fed rate hike being a little bit stronger than maybe you guys had anticipated? Is that what drove a lot of it? Just trying to square that relative to the original guidance?

Michael A. Pizzi - Chief Financial Officer & Executive Vice President

Well, the Fed rate hike did drive some of it but that was contemplated within the guidance. The main driver of outperformance versus the guidance really had to do with lower than expected pre – substantially lower than expected prepayment fees on the securities portfolio. And then you will see that even though the margin balance declined, the rate is up more than what the Fed – more than what the Fed would suggest, meaning the balances that left were at a much lower rate than the average for the portfolio.

Christopher M. Harris - Wells Fargo Securities LLC

Got you. Okay. I was going to ask a question on the margin loan, so that's good. All right. Ameritrade, on their call, they talked a little bit about some expenses for DOL. Any thoughts there guys whether you've kind of taken a look at that? I mean, I know we've really just gotten the final ruling out, but anything you could help us there as far as perhaps magnitude or anything qualitatively as well?

Paul Thomas Idzik - Chief Executive Officer & Director

I didn't listen to the TD Ameritrade call. But we anticipate being on the meet at our DOL obligations within the target guidance we've given for operating margin. As we've gone through and seen what's occurring out of the regs, we feel our model stands up very well with us not having proprietary product, us having compensation practices that are close to what's desired as it is. And so we're pretty confident we're going to be able to continue to try and drive towards our target operating margin.

Christopher M. Harris - Wells Fargo Securities LLC

Helpful. Thank you.

Operator

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

Steven J. Chubak - Nomura Securities International, Inc.

Hi, good evening.

Paul Thomas Idzik - Chief Executive Officer & Director

Hey, Steven.

Steven J. Chubak - Nomura Securities International, Inc.

So, I figure will kick it off with a question on capital ratios. You noted that you intend to request an incremental 50 basis point reduction in your targeted bank leverage to 7.5% next year. I just wanted to get a sense as whether 7% is a reasonable end game target that you guys are still contemplating, which from your remarks is consistent with what you're managing to at the parent today?

Paul Thomas Idzik - Chief Executive Officer & Director

Well, Steven, we do see others in the industry have a target – have a 7% handle. And when Mike and I wistfully look across the horizon as the sunsets, our eyes do twinkle thinking about the ability to get down to 7%. We think it's probably a reasonable aspiration we have. And we'll just continue doing what we have been doing in terms of improving our risk profile, taking regulatory guidance seriously, working hard to keep strengthening our enterprise risk management. And with all those things and with the close supervision of our regulators, we're hopeful that we'll be able to get down more towards where we see other competitors in a reasonable period of time.

Steven J. Chubak - Nomura Securities International, Inc.

Understood. Well, thinking about that pro forma balance sheet always brings a twinkle in your eye, I know in the past, you had spoken about some potential benefits linked to a portfolio sales and recognizing there's some different puts and takes. But given the favorable credit performance we've seen and now that you're halfway through, the amortizing HELOCs, is that still an attractive avenue worth pursuing? And does the secondary market actually accommodate that at the moment?

Paul Thomas Idzik - Chief Executive Officer & Director

Well, right now, we still think that holding those assets is in our shareholders' best interest. We, of course, continue to take soundings in the market, and if we felt a better solution would be to sell those to other people. We would certainly do so. And you have my phone number and if you want to buy them, Steven, you just give us a call and we'll talk about it at some point.

Steven J. Chubak - Nomura Securities International, Inc.

Unfortunately I don't think I have deep enough pockets, Paul, but thank you for the offer. And maybe just one more quick one for me. I was hoping you can just give an update on any plans you might have to extinguish the $400 million or so troughs just given that the securities as of the end of this year now fully disallowed from Tier 1 capital?

Michael A. Pizzi - Chief Financial Officer & Executive Vice President

Yes, Steven, if we look at the securities, they remain reasonably attractive from a debt spread perspective in terms of issuance. So we view them as really just liabilities at this point. To the extent that because they are somewhat illiquid, we see secondary trading in them, if someone's looking to move them, we will from time to time participate there as they can be purchased at a discount, but we have no intent to exercise the regulatory call.

Paul Thomas Idzik - Chief Executive Officer & Director

Steven, that's an order of magnitude less than the loan. So we also take a call from you on the troughs.

Steven J. Chubak - Nomura Securities International, Inc.

That's very kind. I have to take a pass for the moment, but appreciate the offer, and thanks for taking my questions.

Operator

Our next question comes from the line of Dan Fannon with Jefferies. You may proceed with your question.

Daniel Thomas Fannon - Jefferies LLC

Thanks. Paul, I appreciate the additional color around the M&A strategy in the outlook. I guess, if you could give us some additional commentary maybe around just the current environment. There was some activity in the market and the industry this quarter. I guess, how would you characterize the opportunity set in terms of pricing or actual available properties today?

Paul Thomas Idzik - Chief Executive Officer & Director

You guys are as aware as – I mean, more aware than almost anyone else regarding what kind of things might fit into each of those categories. But I'll take this opportunity to say that neither Michael nor I, nor our board is going to have us overpay for any property. And I think that's about all we need to say.

Daniel Thomas Fannon - Jefferies LLC

Okay. And I guess, Mike, a question on NIM, the guidance going to next quarter, margin balances are down, but I think in the previous answer to a question, you highlighted that the rates are up. So just curious as to kind of the outlook and the decline, I guess roughly 15-basis points-or-so quarter-over-quarter and the drivers of that?

Michael A. Pizzi - Chief Financial Officer & Executive Vice President

Yeah. I mean, we're anticipating some normalization in the overall security speeds from the very low level that they were in the first quarter of the year. That's going to be the primary driver of the decline in securities yield that we're expecting to get to the guidance range for next quarter and for the full year.

Daniel Thomas Fannon - Jefferies LLC

Got it. Thank you.

Operator

Our next question comes from the line of Devin Ryan with JMP Securities. Your may proceed with your question.

Devin P. Ryan - JMP Securities LLC

Hey, thanks. Good afternoon. Congratulations on the nice quarter.

Paul Thomas Idzik - Chief Executive Officer & Director

Thank you.

Devin P. Ryan - JMP Securities LLC

Maybe just a follow-up here on just DOL considerations, definitely appreciate you guys don't anticipate big implications around the ability to provide services for clients. But I'm just trying to think in the near-term, are there any considerations that you guys are thinking about? I'm not sure if we see a slowdown in rollover activity just for some period as the final rule is being digested, or maybe – or even on the positive side, some evidence that more money is moving towards self-directed just as it's falling through the cracks of the brokerage firms on the retail side. I'm just curious if there's any other considerations we're not talking about?

Paul Thomas Idzik - Chief Executive Officer & Director

Well, I think there's a whole host of – irrespective of what firm you are, there's a host of internal operational factors that all of us across the industry are going to have to deal with, even if it's just how you script telephone conversations regarding IRAs. So there is definitely work to be done. And I'm convinced our team is going to be able to do that. I think that this is just another indication that E*TRADE's model within the self-directed industry is going to hold up pretty well and has the right secular trends supporting its continued growth. We see continued movement to digital, continued movement to self-directed. We think those things show up well for what we're trying to do.

Devin P. Ryan - JMP Securities LLC

Okay. Got it. That's helpful. And then just following-up here on M&A thoughts, another hypothetical, but just curious how you guys would think about the utilization of stock in a deal? Obviously, it's pulled back here a little bit in recent months, but if you're thinking about anything on the brokerage or bank side, how would you think about that? Or just the things that we're kind of talking about or even thinking about, just not of the size that stock would even be necessary?

Paul Thomas Idzik - Chief Executive Officer & Director

Devin, it's just really hard to talk about theoreticals, and I don't want to sound like former government officials. But it's really difficult to just comment about theoreticals. So, if we had anything to talk about, we'll be really clear and explain our rational, how we decided to fund it or anything, but we – it's just difficult to talk theoretically.

Devin P. Ryan - JMP Securities LLC

Got it. Okay. No, that's fair enough. And just last on the NIM, just follow-up here again. On reinvestment rates, where are you guys seeing them right now on the securities portfolio as you're building it out a little bit further and as some are rolling off? And within that outlook, what is implied in sec lending? Just curious where you see that with the lower margin balances.

Michael A. Pizzi - Chief Financial Officer & Executive Vice President

Reinvestment rate is about 175 basis point to 200 basis point range. We've been pretty much in that range over the quarter. We're seeing a lot of volatility in rates, but also seeing a lot of volatility in agency spread. So, even on the days where rates moved pretty low, we were still able to purchase at some attractive overall spread levels.

Within securities lending, securities lending did move down with margin, although it's going to ebb and flow both with the size of the margin book as well as the amount of hard to borrows within the book. So, even with the size of the book coming down, you can still see that we did fairly well overall in securities lending this quarter. And I think as the market more normalizes, we'll see the hard to borrow activity pick back up again.

Devin P. Ryan - JMP Securities LLC

Got it. Great. That's helpful. Thank you.

Operator

Our next question comes from the line of Christian Bolu with Credit Suisse. You may proceed with your question.

Christian Bolu - Credit Suisse Securities (USA) LLC (Broker)

Good evening, Paul. Good evening, Mike. I have a question unfortunately on M&A. I hear you loud and clear on the high bar to take on credit risk. So, just curious, first of all, what kind of returns you would need to take on said (41:49) credit risk?

And then more broadly, what is the strategic rationale of even considering any current credit risk? I don't know, do you believe you have some sort of competitive edge on evaluating credit, or is there some other kind of strategic rationale that I'm missing?

Paul Thomas Idzik - Chief Executive Officer & Director

I think, Christian, I think we talked about some of this in some of the public comments we made at some of the conferences. Some of the areas we would look that have wealth management and other areas within that fall within a banking space may come with some credit assets. The return hurdle we're going to apply to any credit asset is going to be well in excess of our cost of capital in terms of putting the appropriate valuation on those businesses, given they come with considerable risk. They are therefore tangential really in overall strategic fit to something that, they come along with something that has a much broader strategic fit.

Christian Bolu - Credit Suisse Securities (USA) LLC (Broker)

Okay. Got it. And then, pardon if I missed this one in the prepared remarks, but do you have an estimate for the impact of increased FDIC rates in the back half?

Paul Thomas Idzik - Chief Executive Officer & Director

If the FDIC raises its threshold amount in Q3, which our sources lead us to believe they will, it's going to be about $1 million per quarter in increased assessment.

Christian Bolu - Credit Suisse Securities (USA) LLC (Broker)

Okay. Great. Thank you.

Operator

Our next question comes from the line of Brian Bedell with Deutsche Bank. You may proceed with your question.

Brian B. Bedell - Deutsche Bank Securities, Inc.

Thanks, good evening, folks. Paul, maybe just talk a little bit more about the DOL and your IRA rollover business. Retirement assets I think are close to $50 billion; I guess, first of all, how much of that is in IRAs? And then more strategically, with the DOL rules, how does that impact the stock plan administration business and the strategy of converting those users over to your platform?

Paul Thomas Idzik - Chief Executive Officer & Director

We don't break out what portion of retirement assets are IRA versus other. With regard to stock plan business, it shouldn't impact our opportunities of continuing to make those participants great customers of E*TRADE. And in fact may give us some opportunities to have some discussions along the way they may not be getting as well served by some other providers as a result of this.

Brian B. Bedell - Deutsche Bank Securities, Inc.

You view it as an opportunity essentially more than something that could be burdensome?

Paul Thomas Idzik - Chief Executive Officer & Director

Well, it's definitely burdensome, but I think it's an opportunity for our model relative to others.

Brian B. Bedell - Deutsche Bank Securities, Inc.

Okay. Okay, great. And then just in longer term plan of accelerating organic growth, can you talk a little bit about, from the acquisition side, I guess from a capability perspective, what do you think you need to accelerate that client organic growth. What types of – is it largely wealth management or do you feel you need more technology like a robo-advisory capability?

Paul Thomas Idzik - Chief Executive Officer & Director

Well, we already do have a robo-advisory capability, we've had it for some time. We have a new version coming out later this year and something I look forward to talking more about on a subsequent call. I'd say, there's several fronts for us on this accelerating organic growth.

One, is you will have seen us do some significant hiring over the last year. And that's primarily across hiring more financial consultants, also it has to do with adding along with the account growth, additional customer service people that we're providing the service, and adding some professionals into the corporate services participant experience area where some of our nascent efforts there are actually turning up very nicely.

The second is we interact with every one of our customers digitally, and you're seeing us do things to continue to improve our edge in mobile, and to make our overall web experience and mobile experience the type of experience that makes people want to engage more fulsomely with us and with improving their financial health. So it's a bit of doing a lot of little things better and continuing down the path.

Brian B. Bedell - Deutsche Bank Securities, Inc.

And just lastly on the – how do you feel your transactional banking capabilities are now. And again, is that something that looks attractive from an acquisition perspective again to cross-sell to your customers and accelerate their organic growth?

Paul Thomas Idzik - Chief Executive Officer & Director

Well, one of the things we are as we said in the prepared comments looking at is more along if you think about the excitement that's taking place in the payments space across some of the Fintech areas, are the type of things that we are starting to look at analytically with regard to that's something we should build, something we want to consider acquiring. But there are definitely ways we can improve some of the capabilities of our banking and banking like activities.

Brian B. Bedell - Deutsche Bank Securities, Inc.

Okay. Great. That's helpful

Paul Thomas Idzik - Chief Executive Officer & Director

Specifically in the payments area.

Brian B. Bedell - Deutsche Bank Securities, Inc.

Payments area. Okay. Thank you very much.

Paul Thomas Idzik - Chief Executive Officer & Director

Thank you.

Operator

Our next question comes from the line of Michael Carrier with Bank of America/Merrill Lynch. You may proceed with your question.

Michael Roger Carrier - Bank of America/Merrill Lynch

Hi, thanks, guys. Mike just a quick one, just on the commission rate, I think you mentioned that the activity in the corporate area was a bit lighter in the first quarter. Have you seen some of that improve with stability in the markets? And would you expect some improvement kind of going into 2Q, which is maybe less seasonal than what's typical?

Michael A. Pizzi - Chief Financial Officer & Executive Vice President

Well, I can tell you over the course of the quarter, we saw less initial activity in the early months and it did pick-up a little bit in the later months, but not meaningful enough to have an effect on the commission per trade being down $0.02 from Q4. But if you look back to last year, you'll see that typically there's a pretty powerful effect on commission per trade that we didn't see directly come directly through this quarter. Whether we see some of that come through this quarter or not, I think we're going to have to wait and see how things progress.

Michael Roger Carrier - Bank of America/Merrill Lynch

Okay. Thanks. And then Paul just one quick one on the M&A or the growth side, I think on one hand when you look at getting through or growing to the $50 billion, you mentioned in a different rate environment maybe if the cash generation was stronger, then you would potentially pursue that. Just wanted to get your sense of what environment that might be?

And then on the strategic side, it seems like there's a ton going on in financials and the tech area, Fintech. On one hand, it seems like that's the pricier area, but on the other hand, it's obviously where the industry is going. And so I just wanted to get your thoughts on how quickly can you build something versus having to acquire something and vice versa? Is there a lot of demand out there for a financial services company for – on the tech side – tech firms looking for financial service firms to kind of grow in that space?

Paul Thomas Idzik - Chief Executive Officer & Director

Let me try and take those in turn. I'd say, the jumping over the $50 billion mark is impacted by two things. I mean, clearly, you want to have a quantum of cash that makes it worth your while to earn on that cash because the costs are the same whether you're at $51 billion or $61 billion.

And the rate environment obviously makes it easier to jump more quickly just do the math. With regard to looking at Fintech opportunities, I think the question for us continues to be how quickly can we deploy something across our customer base and would it bring incremental revenues, would it strengthen the customer tie with our company.

And so we're continuing to look. I do think the valuations make certain deals difficult. And so, we have evaluate that, but speed to market is important. And I'm not all that familiar, I presume some of you guys would be more familiar than I am with a lot of Fintech firms looking at actually acquiring something that's going to get them nicely regulated to the degree, in fact, I don't think they can even possibly imagine. So that would be my way of looking at it.

Michael Roger Carrier - Bank of America/Merrill Lynch

Yes. All right. Thanks a lot.

Operator

There are no further questions at this time. I will now turn the call back over to you.

Paul Thomas Idzik - Chief Executive Officer & Director

Thank you, Ashwin, and I again want to thank everyone for joining us for this quarter. I'm particularly proud of the team this quarter and look forward to talking to you in a few months. Thank you. Goodbye.

Operator

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

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!