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E*TRADE Financial (NASDAQ:ETFC)

Q1 2012 Earnings Call

April 19, 2012 5:00 pm ET

Executives

Steven J. Freiberg - Chief Executive Officer, Director and Member of Finance & Risk Oversight Committee

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

Analysts

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

Michael Carrier - Deutsche Bank AG, Research Division

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

Alexander Blostein - Goldman Sachs Group Inc., Research Division

Christopher Harris - Wells Fargo Securities, LLC, Research Division

Howard Chen - Crédit Suisse AG, Research Division

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

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

Brian Bedell - ISI Group Inc., Research Division

Operator

Good afternoon, and thank you for joining us for E*TRADE Financial's First Quarter 2012 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 and 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 statements.

This call will present information as of April 19, 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. The Company provide these measures due to its belief that they provide important information about its operating results. These measures will be reconciled to the most directly comparable GAAP financial measures 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. These non-GAAP financial measure should be considered in conjunction with the comparable GAAP measure.

This call is recorded, and a replay of this call will be available via phone and webcast beginning this evening at approximately 8:00 p.m. The 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

Thank you, operator. Good afternoon, and thank you for joining today's call. I will begin by covering highlights 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. The first quarter was a solid one on several fronts as we generated some of the strongest customer metrics in the firm's history, made good progress in reducing risk on the legacy loan portfolio and grew revenue sequentially, despite a difficult interest rate environment.

We reported earnings per share of $0.22, which included a $0.09 per share income tax benefit on total net revenue of $489 million, representing a 3% sequential growth. Our Brokerage business was quite robust this quarter. DARTs grew by 12% sequentially while generating new record net new brokerage assets of $4 billion in the quarter, an 11% annualized growth rate and more than double the $1.7 billion in the prior quarter.

Net new brokerage accounts of 46,000 are well above last quarter's 10,000. Our brokerage account attrition rate hit a record low 8.7% annualized, marking the second consecutive quarter this metric has tracked below 10%. This is a significant improvement in the previous 3 years, which averaged 12%, and is a testament to our ongoing efforts to improve the customer experience. During the quarter, we are recognized by the American Customer Service Index with a first place score among online brokers, the result of a 4% improvement in our score, the largest in our peer group.

Brokerage-related cash also ended the quarter at the highest level on record, at $31 billion, enabling us to offset the maturity of net interest spread compression through volume. On the credit front, we made meaningful progress on our review of loan modification practices and procedures, which we discussed last quarter, and Matt will cover the details later in the call.

I would point out that our legacy loan portfolio ended the quarter at $12.4 billion, down 6% sequentially and down 62% from its peak.

Our overall delinquencies are down 56% from their peak and are at their lowest level in over 4 years. Meanwhile, special mentioned delinquencies are down 20% sequentially at their lowest level in 5 years. As for our customer offering, we launched several new products and enhancements during the quarter and unveiled 2 important websites redesigns, rebuilding our storefront through a comprehensive retooling of our public website and completing the rollout of E*TRADE 360, bringing a unique and streamlined experience to our customers.

Both sites have been well received, and we continue to make refinements and optimize based on feedback and in-market testing. We will further enhance the prospect experience this year with the incorporation of new planning tools and improvements to the Investor Education section of our site, with the goal of deepening engagement and strengthening E*TRADE's brand position as the place to receive the best investing experience.

We also integrated a retail FOREX offering into our product set for those more sophisticated active traders. In addition to these major launches, we rolled out a number of enhancements and upgrades to our existing platforms. We redesigned our bond resource center to offer streamlined access to news, unbiased education, intuitive screeners to select individual bonds and tools to help our customers quickly and easily build out the fixed income portion of their portfolio. We also made enhancements to E*TRADE Mobile on both iPhone and Android, including mobile check deposit capability, complex options trading and mutual fund trading. Yesterday, we announced voice recognition for the iPhone, allowing users to verbally prompt quotes and order tickets, as well as bar code scanning for iPhone and Android. We believe our mobile strategy is a highly differentiating element of our offering, and we have seen a steady increase in customer utilization, with 6% of our trades this quarter executed via mobile applications, up from 3% a year ago.

We continue to bolster our retirement offering and believe that we're on the right track to attain a meaningful presence in this category. The combination of our education and product offerings and our certified retirement planning counselors and financial consultants are helping us develop momentum in this area. Retirement assets now account for 16% of our total assets, and retirement accounts make up 28% of total brokerage accounts. During the quarter, we hosted our first ever all-day retirement education event with over 3,400 participants, comprised of both current and prospective customers. We continue to enhance our brand positioning, having used the Super Bowl to kick off a broad marketing campaign geared toward retirement and investing products and services.

In summary, we feel good about our performance during the quarter, both in terms of our customer value proposition, as well as our financial results, which Matt will now walk you through.

Matthew J. Audette

Thank you, Steve. For the first quarter, we reported net income of $63 million, or $0.22 per share, inclusive of a $0.09 per share tax benefit, which I will describe in more detail shortly.

We generated $489 million in net revenue, up from $475 million in the fourth quarter of 2011 but down from $537 million in the first quarter of 2011. Our first quarter revenue included net interest income of $285 million, a sequential decline of just $4 million, despite 17 basis points of net interest spread contraction. While this decline in spread was in line with our expectations, growth and brokerage cash to its current levels is well above what we expected for the quarter. While this growth drove an increase in net interest income, it's a negative for net interest spread as the marginal spread in the balance sheet that is increasing in size is lower, given our philosophy to maintain a modest level of interest rate risks. Last quarter, when we communicated expectations for net interest spread in 2012 to be slightly below 250, or 250 basis points, we had not predicted the significant growth in brokerage cash we experienced this quarter. Therefore, if our balance sheet remains at this elevated level, we expect that our net interest spread for the full year would be approximately 240 basis points. While we're incredibly pleased with the growth of the franchise and the customer cash that comes with it, our near-term priority is to improve our capital ratios through a reduction in our balance sheet size, with an eye on bolstering our leverage ratio. We are focused on reducing less-efficient or nonstrategic liabilities that are not core to our franchise. We do not have any specific actions to announce on this today, but we will provide an update when there's something specific to share.

Commissions, fees and service charges, principal transactions and other revenue in the first quarter were $173 million, up 11% from the fourth quarter, but down 14% from the same quarter of 2011. This sequential increase is driven by higher DARTs and a higher average commission. While the year-over-year change reflect a decline in both of those metrics. Revenue this quarter also included $31 million of net gains on loans and securities, inclusive of a $3.5 million impairment.

Total operating expenses rose sequentially by $2 million, mainly as a result of a seasonal increase in advertising and compensation, partially offset by the fact that the prior quarter included unique items of approximately $12.5 million. During the quarter, we recorded an income tax benefit of approximately $26 million related to certain losses in the 2009 Debt Exchange, previously considered nondeductible. In 2009, we exchanged $1.7 billion of interest-bearing debt for 0 coupon convertible debt, which generated a noncash loss of $968 million, with a portion of that loss being nondeductible for tax purposes. Through additional research completed this quarter, we identified a portion of these losses that are deductible for tax purposes over the life of the debt.

The result of this finding was a benefit to tax expense in the first quarter of approximately $26 million with a corresponding increase to our DTA, which now stands at $1.6 billion. Without this adjustment, our effective tax rate this quarter was 45%. We continue to estimate our effective tax rate would trend in the mid-40s, primarily driven from the nondeductible portion of our interest expense on the 12.5% notes, which impacts tax expense by approximately $15 million annually.

Our brokerage metrics this quarter reflected a better retail trading environment, as well as the strength of our franchise. DARTs for the first quarter were $157,000, a 12% increase from last quarter, but down 11% from a year ago. Net new brokerage accounts were $46,000 in the first quarter, up from $10,000 in the prior quarter, but down slightly from $51,000 in the first quarter of 2011.

Net new brokerage assets totaled $4 billion during the quarter, representing 11% annualized growth. This was up from $1.7 billion last quarter and $3.9 million in the first quarter of 2011. We ended the quarter with $31 billion in brokerage-related cash, an increase of $3.3 billion during the quarter. Meanwhile, customers were net buyers were $100 million of securities.

Margin receivables ended the quarter at $5.3 billion, up $500 million from year end and averaging $4.9 billion during the quarter, flat with the prior quarter. Our legacy loan portfolio ended the quarter at $12.4 billion, a contraction of $780 million during the quarter and is now down over 62% from its size at the peak. I will cover more in the quality of the book but first, I would like to address this quarter's provisions. During the quarter, we completed an evaluation of our portfolio of TDRs and certain modification policies and procedures to align with the guidance of our new primary banking regulator, the OCC. You may recall that we announced this evaluation last quarter and increased our reserves in anticipation of the results. Specific to existing modifications, the review resulted in a significant increase in charge-offs this quarter, which we believe address the key issues raised last quarter by our new regulator with respect to our TDRs. The majority of these charge-offs were previously reserved for us through our standard allowance process and the increase to the qualitative component of the reserve recorded last quarter. With respect to our modification programs going forward, we have discontinued the programs that we suspended last quarter, particularly in home equity. Also it's important to note that the level of loan modifications expected to occur through these programs in future periods was modest.

Turning now to the allowance for loan losses for the quarter. It declined by $244 million to end the period at $579 million, including a general reserve of $326 million, which represents a coverage ratio of 63% of non-modified, nonperforming loans. This coverage ratio is consistent with the trends reported in recent periods. The allowance also includes a reserve for TDRs of $205 million, which combined with prior write-offs and TDRs totaling $445 million, constitutes total expected loss of 37% of total TDRs. Also consistent with trends reported in recent periods. The last component of the allowance is a $48 million qualitative reserve, which accounts for factors not considered in the quantitative loss model.

Last quarter, we increased the qualitative component of the allowance by $67 million to $124 million, reflecting additional estimated losses due to reduced modification activity, as well as uncertainty around certain loans modified under previous programs.

During the first quarter, we completed our review and charged off loan balances as a result, decreasing the specific valuation allowance and the qualitative reserve. Based upon this review and the associated balances that were charged off this quarter, we have returned the qualitative component of our allowance to 15% of our general reserve, so it currently stands at $48 million. The consistency of the reserve metrics I just described provides additional comfort of the level of our current reserve is adequate.

Last quarter, we increased the qualitative component of the allowance by $67 million to $124 million, reflecting additional estimated losses due to reduced modification activity, as well as uncertainty around certain loans modified under previous programs. During the first quarter, we completed our review and charged off the loan balances as a result, decreasing the specific valuation allowance and qualitative reserve.

Based upon this review and the associated balance that was charged off this quarter, we have returned the qualitative component of 15% of our reserves, so it currently stands at $48 million. Total net charge-offs in the quarter were $316 million, with approximately half related to this review and the remainder from the standard process of charging off loans.

I gave a lot of numbers there and realize this may be a difficult to follow. So let me try and sum it up simply. Last quarter, we announced a review to align certain policies and procedures with the guidance for the new regulators. We increased our reserves in anticipation of the outcome of that review. During the first quarter, we completed this review and charged off the increased reserves as a result.

Now I just one final point to close out this topic, which is to stress that we expect our regulators to continue to review the treatment and performance of our TDR portfolio, which could have an impact on provision in future periods. And while we are confident that our current reserves are adequate, ultimately, we believe the actual performance of our loans, including those we have modified, will be the primary driver of our reserve levels.

With regards to the performance of our existing modifications, the average redelinquency rate 12 months after modification has remained stable at 28% for one-to-four family loans and 42% for home equity loans. Delinquency performance on all loans this quarter was quite positive, as the 30- to 89-day delinquent category improved 20% sequentially and 26% from a year ago. Total at-risk delinquencies of the 30- to 179-day delinquent category improved by 19% in the period and 33% from a year ago.

One additional point on home equity. New supervisory guidance on the treatment of second lien home equity loans has garnered a lot of attention in the last week and I'd like to address our status in implementing this guidance, specifically, on the treatment of performing second liens behind nonperforming first mortgages. Since the vast majority of our loans were purchased in the secondary market, situations where we hold both the first and second lien mortgage for the same borrower represent less than 1% of our portfolio. Given our lack of visibility into this population on loans, we rely on credit bureau data currently available to us to determine whether our borrower has a reported delinquency on any other debt obligations. Using this information, which is currently the best available to us, we estimate that less than 10% of our performing junior liens would be reclassified to nonaccrual status pursuant to this guidance. It is important to emphasize however that's in its current form, the credit bureau data that we used does that provided the specificity needed to determine whether the reported delinquency is tied directly to the corresponding first-lien mortgage underlying our home equity loan. Accordingly, we are working to enhance this reporting. We expect to be in a position to have the necessary information to implement this guidance within the next quarter and the final amount of junior liens ultimately impacted by this guidance should be considerably less than our current estimates.

Please note that interest payments received in nonperforming loans are recognized on a cash basis and operating interest income until it is doubtful the full payment will be collected. At which point, payments are applied to principal and not recognized as income. We do anticipate this updated guidance will have any meaningful impact on our allowance for loan losses as this credit bureau data is already a factor incorporated into our risk segmentation and provisioning process, so we do not anticipate this guidance will impact that. With respect to initial loan resets, as I mentioned last quarter, we do not expect these to be a material driver of credit cost this year. Thus far in 2012, we have seen approximately 560 million of one-to-four family mortgages reset for the first time, and we expect an additional 500 million to reset for the first time throughout the course of this year. Of the remaining balances which will reset this year, approximately 1%, or 6 million, is expected to experience a payment increase of 20% or more.

On our home equity lines of credit, which represents 3/4 of the home equity portfolio, we have approximately $285 million that are already amortizing, with an additional $80 million expected to begin amortizing in the remainder of this year. As we have previously stated, the maturities of this lines do not amortize until 2014 or later.

On capital. At both the bank and the parent, our absolute levels of capital grew slightly from the previous quarter on both Tier 1 and risk-based measures. However, as I previously mentioned, growth in brokerage, customer cash and the resulting increase to the size of our balance sheet drove a sequential decline in our leverage ratios. As for our progress in establishing a more comprehensive capital distribution plan with our regulators, our key next step is to submit a long-term capital forecast, including internally developed stress tests, by the end of the second quarter. And while we can't be certain of the timing or the nature of their response, our objective is to get feedback on the plan, including the dividend process, by the end of the current calendar year.

Corporate cash ended the quarter at $484 million or just under 3x our annual debt service. In general, we expect corporate cash to decline in line with our corporate interest expense, which is paid in the second and fourth quarters. I would also remind you that our parent houses roughly $0.5 billion 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'll turn the call back to Steve for closing remarks.

Steven J. Freiberg

Thank you, Matt. This was clearly a very positive partner for us, as we posted some of the best retail metrics in the firm's history. We exit the quarter with good momentum in the brokerage business and while trading has moderated in April, currently down 7% from March, we remain encouraged for 2012.

Although we are pleased with our progress this quarter as evidenced by our strong performance in retail brokerage, we will continue to aggressively focus on the retirement and investing category as this is a key component of our long-term growth strategy. We remain focused on ensuring current and prospective customers are aware of our extensive capabilities in this area through our enhanced marketing and advertising efforts, as well as our financial consultants and retirement specialists.

Our legacy risks are less of an overhang each day, and we expect continued runoff of the loan portfolio of approximately $600 million to $650 million per quarter in 2012. And provision, while uncertain in any given period, should continue to decline over time reflecting the long term trend of declining delinquencies.

One final note on our corporate governance, the board made significant enhancements this quarter with the addition of 3 new board members: our Nonexecutive Chairman, Frank Petrilli, Rodger Lawson and Rebecca Saeger. We feel honored to have Frank, Roger and Becky on our board and believe their industry experience with lead to valuable business insights and contributions.

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

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from Rich Repetto of Sandler O'Neil.

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

Let me get to my question. The retail net new assets were just up dramatically and just trying to get a little bit more color, what's driving -- what -- how you increased them, did it come from any single channel or how'd you more than double them? I believe they doubled from last quarter.

Steven J. Freiberg

Rich, just a few comments on that. At least to put it in perspective, about 1/2 of the volume has come from new customers to E*TRADE. And so clearly driving up higher levels of net new accounts, critically important to us and we've been on that trend now since really 2010 and it continues. About 1/2 the volume clearly has also come in from existing customers. Really benefiting from several, I think, from several items. One, over the last several years and basically beginning prior to my arrival here, a relentless focus on customer satisfaction and enhanced customer experience. And I said in the prepared remarks, the attrition rates, running now in the 8s, is substantially better than what this company has ever experienced before. So keeping our customers is critical and therefore keeping their assets and in addition to that, by providing better tools, better platform support products, we're seeing our customers engage more with us now than they have in the past. So it really was on several fronts. One, more high-quality new customers, better experience for our existing customers and, in addition, the Corporate Services group continues basically to perform extraordinarily well and it also it's usually a seasonally high period for them in addition to that. So I think it's sort of been the aggregation of all those very positive events that translated into an extraordinary, a record quarter for the company.

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

That's very helpful. And then Matt, the follow-up question would be the very helpful guidance or discussion on the performing second liens. And if I interpret you correctly, are you saying that you will implement this once you get certainty -- more certainty on the performance of the connected first liens? And the broader question is, as you talk with the regulators -- I got a sense that you've talk more about capital ratios this quarter and sale of non-core assets. Are the regulators encouraging you to improve the capital ratios specifically, or -- I guess that's the question.

Matthew J. Audette

Yes, well, I think Rich, every regulator on the planet would want your capital ratios to improve, of course, but I think that in the prepared remarks, our focus was on putting together a long-term capital forecast, which we are currently working on and plan to submit at the end of the second quarter. So really we would hope and expect to have some dialogue on that with them in the second half of the year and that's really where we are.

Steven J. Freiberg

Rich, let me just add to Matt's comments just a few points. And I think it picks up from the first quarter performance. One, as part of essentially growing the franchise at a quicker pace than we originally anticipated, the balance sheet clearly has grown faster as well. And obviously in the short term, you get the balances, you get some revenue, but you're basically, your capital is deployed immediately. That said, there are a number of actions that I can at least give you perspective on that should be helpful here. One, and using Corporate Services group is a good example. We typically high degree of seasonality in the first quarter with some reversion, meaning some of those balances will run off, the cash balances in the second and third. We're already experiencing that. And basically in a second point to that is we took Liberty given that there seems to be a low elasticity on basically deposit pricing starting April 1 to lower prices on certain of our savings products as well, albeit we don't see a lot of elasticity, so not sure we're going to see a lot of balance runoff, but regardless, it's the right thing to do. And just, finally, to sort of frame it on several fronts. One, even from my arrival here, we said over the long term, we would expect this balance sheet to reflect more of the customer deposit base than anything else. Well, the customer deposit base business today is closer to $30 billion, not $50 billion. There are a number of other items on the balance sheet that either less capital friendly on a number of measures and/or very much nonstrategic and to, I think Matt's point in his prepared remarks, even though we won't go to specificity right now, we are looking not only for basically more, I would say, more efficiency in our capital that are leveraged but basically fitting that into the strategic frame or the size of the balance sheet with the passage of time. So we're working across it. Some things are easy and some things are a bit more challenging as we trade-off capital income and risk.

Operator

Next question comes from Michael Carrier of Deutsche Bank.

Michael Carrier - Deutsche Bank AG, Research Division

Maybe, one follow-up on the net new assets. It does seem like every first quarter, you have a very strong quarter. And so like you mentioned there, some seasonality in that and it seems like in that Corporate business, it makes sense, meaning if money invests, then you have more cash that comes in. So I'm just wondering, if you can size that up just a bit, because it seems like easier when I look in the past that you get some moderation in the second or third quarter but obviously, the trend's having good just in terms of the core organic growth as well?

Steven J. Freiberg

Yes, I can put it in perspective for you by the numbers. So if you take the sequential, the $1.7 growing to $4 billion. Roughly, the incremental $2.3 billion of growth, we've seen -- it's almost evenly split between CSG and I would say non-CSG retail. So we've seen good growth on both fronts. And if you look at it in absolute terms, of the $4 billion, roughly about 2/3 of it is coming in from retail, X corporate services and about 1/3 coming in from the Corporate Services side, rough numbers. They'll round in either direction. So, we believe, again, the key here to sustain it is to continue to drive growth in the Corporate Services group. And if you look at it on a year-on-year basis, the business is getting larger and the quality of our accounts, our customers are basically improving as well. And then finally, and you have to look at it across the year, because any given quarter does have volatility. The number of net new accounts that we acquired in 2011 was twice what we acquired in 2010, and we're on basically, we believe, we're on a roll this year to do substantially better in 2012 versus 2011 and that would basically fall back to 2010. So, the question is can we sustain it? I do agree that we tend to get a seasonal high in the first quarter, but we think there's a core to this that should be sustainable and give us growth on a year-on-year basis throughout the remainder of the year.

Michael Carrier - Deutsche Bank AG, Research Division

Okay. That's helpful. And then maybe just on the regulatory side, you guys cover a lot in these comments. I think probably the 2 areas that tend to get focused on whether it's for the industry or for you guys is that leverage ratio and then probably, the HELOC portfolio. So I think on the leverage ratio, when you look at it this quarter, you benefit because you had so much cash come in, but at 5.5%, I'd say if some of the industry, the peers are at 6%, 6.5%, if you had to pair those -- the assets down by anywhere from, say, $3 billion to $6 billion to get around that range, like what types of assets would those be? Or said another way, what type of a yield would you be giving up there? And then just on the HELOCs, kind of the same thing. In terms of -- you mentioned that a lot of those don't reset or they're not going to be starting to pay the principal until 2014. So when you think about this like credit trends and how to kind of manage that risk, particularly on a new regulator, how are you thinking through that?

Matthew J. Audette

Sure. So on the first question, the leverage ratio, so the 5.5% for the parent, I think that kind of the point Steve made earlier said our balance sheet is really liability driven and, specifically, our core customer deposit driven, which is the brokerage-related cash around $30 billion. So the reason were up over $50 billion today is 2 broad buckets, the wholesale funding book, which is around $8 billion, and the bank cash or bank deposits, which is around $8 billion. So those are the 2 primary areas that we would look to from a de-leveraging standpoint. Now, kind of the comments I made in the prepared remarks, given the leverage ratio where it is, the incremental spread is actually pretty low when we're growing the balance sheet, so all the amounts of net interest income would likely be less on the smaller balance sheet, spread would actually -- could possibly improve. So those are 2 big buckets we are looking at. Specific to Home Equities, I think the key take away for us is they really don't start amortizing in a meaningful way for several years, until 2014 and beyond. The average home equity, the loan size is relatively small at $60,000. So the, actually, amount of pay increase that would occur once it begins to amortize is in the $150 to $200 per month range, so when you think about in the grand scheme of things from a credit perspective, the size of the portfolio that would likely be in 2015 and then the amount of payment that's increasing, it's from our perspective, it's not a huge credit risk.

Steven J. Freiberg

Just add one more point and there's no guarantee the trends sustain themselves but even using home equity, which is the highest risk profile of our legacy portfolios. If you look year-on-year, the portfolio contracted roughly 20%. As you think about '14, '15, '16, the absolute size of these portfolios, assuming trends continue, should be substantially smaller tomorrow than they are today and we've seen these trends or maintained these trends for quite a period of time. So again, it doesn't negate it. But what it does say is it becomes smaller, more manageable, more predictable with the passage of time all things considered.

Operator

Your next question comes from Chris Allen of Evercore.

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

Touch on some of the expense lines, particularly, the compensation line, which last quarter you had the software charge. The next thing it's about $11 million sequential increase. I know there's some seasonality there but that seems rather large. In the opposite direction, on the other operating expense is a fairly large decline, even after adjusting for last quarter, so if you could give us underlying trends in each should be helpful.

Matthew J. Audette

Sure, Chris. It's probably best to give an overall commentary on expenses. But specific to Q1 from a seasonality perspective, typically comp is pretty high in Q1. Taxes are highest during the year in Q1, as well as in the marketing side, typically Q1 is our higher marketing quarter. So broadly we think about good run rate for expenses on a normal quarter basis of around $290 million and that's still what we think today. So kind of thinking about the rest of the year $290 million is a good thought process from a run rate. Keep in mind each individual quarter could move slightly, but that's kind of how we see the rest of the year.

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

Okay. And then just following up on Mike's question in terms of taking down the balance sheet, I think you said one of the buckets you look at is the wholesale funding side, but I always understood it to be longer term in nature. Is that still the case? Or is there opportunities within that piece?

Matthew J. Audette

So it's still the case. So that $8 billion in wholesale funding, we estimate would run off over the next 10 years. So it's a rather long time frame. And the prepayment penalty if were just to get rid of it today are rather substantially, they're just under $700 million. So it's not an easy solution, kind of to Steve's earlier point. But when you think about de-leveraging, our primary focus is on the core of the company that brokerage-related cash and this wholesale funding of $8 billion and the bank funding of $8 billion is really where we're looking. We just don't have any answers or anything we decided upon on today.

Steven J. Freiberg

Again, I think it's an important just area to clarify. We will get reversion in basically the second quarter versus the first, which is sort of the natural seasonality of the Corporate Services group. And not to present numbers today, but it tends to be meaningful. The second is we just did reprice about $5 billion worth of savings. Again, we can't predict elasticity. In the good old days, you would think that people basically were price sensitive. They're less price sensitive today, so we'll take the spread, all things being equal, but we did basically bring prices down. And then to Matt's point, the wholesale funding is more of a challenge in the short-term because of the cost benefit. That is essentially the mitigating factor. But beyond that, we are looking at opportunities, potentially to move certain savings products off our books. We could if we want basically direct, for example, new customers to the off balance sheet suite versus the deposit product. We have a lot of degrees freedom and I think to Matt's point right now, what we're try to find the right mix of income, capital and profile. And that's what we're working on as we speak. We were, on one hand, pleasantly surprised that we grew much faster than we thought. On the other is we have to deal with the dynamic of that outcome, beyond just income. But we will basically have a tangible set of steps in very short order.

Operator

Your next question comes from Alex Blostein of Goldman Sachs.

Alexander Blostein - Goldman Sachs Group Inc., Research Division

I wanted to follow up again on just delinquency trends. So if you look at just the change quarter-on-quarter in delinquencies and if you adjust that for the charge-offs, it actually looks like there was a substantial pickup close to $130 million and that, again, that looks like one of the higher numbers over the last 2 years or so. So I guess the first question, is that -- is my math right on that and if it is a pickup, where are you guys seeing a deterioration in credit? And then as a follow-up to that, looks like your reserves to loans are now also at the lower level in the last since really early 2009. So is that kind of a 4.5% a comfortable level for us to think about going forward? Or there could be incremental buildup just to kind of refill that provision bucket?

Matthew J. Audette

Sure. So on the delinquencies, I think that the broad comments that we covered in the prepared remarks is we're quite pleased with the declined deliquencies. So that the primary area we focused on our special mention our 30 to 89 days delinquent because of the new loans that have gone delinquent this quarter, so kind of the indicator of where you're going. So we're down $375 million there, it's down 20% from last quarter. About 5 percentage points of that decline comes from the charge-offs that you referenced. So even when if you pull out a 15% decline, it's quite a good number from our perspective that. It's really as we talked about each quarter, the portfolio is quite seasoned. We haven't bought loans since early 2007 and each quarter and each year that goes by, it's more and more seasoned and we expect delinquencies to continue to trend downward. As far as the ratios the reserve to loans, the way we look at it given, we've got a combination of a qualitative factor, we've got modified loans that we've reserved for but we've charged off. We kind of look at it a little bit differently or a little bit deeper than the overall coverage ratio that you referenced and kind of looking at it in 2 buckets. First, the general reserve of non-modified loans, which is $327 million. We look at that as a coverage on non-modified, nonperforming loans and that's around 63% it's been pretty consistent for quite some time. On the modified said, we look at a combination of the amount of charge-offs we've taken on those loans, plus the amount of reserves we still have on the books together, and that's at 37% of that's actually been increasing over time. So from a coverage ratio perspective, we're most definitely comfortable. But that's the way we look at it from a management perspective.

Steven J. Freiberg

Alan, just adding one more point, I think we had -- I think your question started off with, I would say, a directional inconsistency. The delinquencies on a sequential basis showed substantial contraction, not expansion. If you look at it from home equity first, in the quarter, the 30 to 179, we're down 27%. Of the 90 to 179, we're down 20% and at 30 to basically 89, we're down 31%. Those are our reported statistics. The one-to-four family did not have as good but had on any basis, very good performance, 30 to 179, down 15%; 90 to 179, down 16%; and of 30 to 89, down 15%. And the way we report on the first versus the home equity, home equity is on a natural calendar. First lagged by one month. So even call or actual data. When you look at March debate, which we'll release in about a month or so from now, but directionally, it looks almost identical to home equity. So we feel extraordinary good about delinquency trends in the first quarter. I want to make sure nobody misinterprets that.

Alexander Blostein - Goldman Sachs Group Inc., Research Division

Got you. I appreciate the comment. I was basically just making observations that total delinquencies declined but adjusted for the charge-offs because...

Steven J. Freiberg

Yes. And even home equity, just to help you, because we've done the math, home equity was where the impacts would have been most evident. That -- basically that roughly 30% improvement, about 2/3 of that we would describe as organic, independent of the write-downs, so about 20% if you excluded them and 30% or so if you included them. So regardless, we do feel that the natural trend in the portfolio looks quite good and the reported trend looks extremely good, but you have to take into account that those write-downs did in fact have some positive impact, at least on the OpEx.

Alexander Blostein - Goldman Sachs Group Inc., Research Division

Got you. That's very helpful. And then the second question for you was just if you could just comment on trading activities so far in April. Feels like it's gotten a little bit softer, but curious to hear how you guys -- what you guys are seeing?

Matthew J. Audette

Yes. Again, you may have missed it. I think -- again, in my prepared remarks said that on a sequential basis, March into the first basically the first half or so of April, we've seen a sequential decline of approximately 7%. But as you know, it's a very volatile set of measures and 10 days or so or 10 business days really don't make up a quarter. But nonetheless, the trading is a bit subdued relative to what we have seen in March.

Operator

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

Christopher Harris - Wells Fargo Securities, LLC, Research Division

Just want to follow up on that last point there. Some of your peers have commented that in the retail investors starting to kind of disengage. They're decreasing their talents for risk and I kind of see what's happening with your trends here and see that margin lending, I guess, has kind of declined as percent of client assets. So really just wondering what you guys are seeing out there, whether you're seeing similar things happening within the retail investor landscape, whether folks are really starting to kind of de-risk or be cautious or whether you're not really seeing as much of that?

Steven J. Freiberg

I don't see precisely the same trends, let me just give you some statistics that maybe will help you draw your own set of conclusions. One, and Matt referred to it in his remarks, that even though average, on average our margin receivables were flat fourth quarter to first quarter. On a quarter end to quarter end basis, margin receivables are actually up about $0.5 billion, which is about 10%. And it's the first real significant positive movement we've seen in margins in probably close to a year, because the trend in 2011 was a downward trend largely and the trend basically has been an upward trend. In fact, if you look into the first basically, the first half of the month of April, margin is actually continuing to move in a very positive way. In addition to that, if you looked at the fourth quarter of 2011 for us, we basically had option activity in our DARTs running around 22% and that was up from about 19% a year ago in the first quarter and the first quarter of this year we're little bit above 23%. So from the standpoint of the type of instruments people are utilizing and the amounts of leverage they're taking on and obviously, there's leverage in options, there's leverage – really, basically, margin is leverage. We're not seeing the same but we do see a fair amount of volatility depending upon the information that's released in any given period into the market as to whether the retail investors are in or out. So we see a lot of volatility in that. It's hard to discern a real trend on DARTs in any given day or week, but the trends that we do see is option activity continues to rise and in addition to that, margin expansion continues to march on. So again, I don't want to take that and translate that into a consumer confidence metric. But at the same time, if you look at behavior, people are behaving in a way that manifests itself possibly as more confidence. But clearly, these trends are still over several quarters and I still think we did more data points to conclude anything. But I mean, it feels better, given that leverage is basically coming into play.

Christopher Harris - Wells Fargo Securities, LLC, Research Division

That's very helpful, Steve. And then just my follow-up question would be on the kind of the regulatory transition review period. I know it's obviously a fluid situation, but your commentary there I think you mentioned that you feel pretty confident that there won't be another qualitative reserve. Just wondering if you can expand a little bit more on that, what it is regulators are looking and what kind of gave you the confidence that do you think you won't have additional qualitative reserve going forward?

Matthew J. Audette

Sure. So just to clarify the comment. I think we are quite confident that our reserves in the quarter are adequate. But I think we're also quite confident that our regulators are going to review the performance of these modified loans and our reserve level is a very closely going forward. And there most certainly changes that could result -- that could happen as a result of that. From a management perspective we're quite comfortable with in but just keep in mind the allowance itself by its very nature is an estimate and it's inherently uncertain so it can always change based on future periods.

Steven J. Freiberg

Yes, and just let me finish up. Even in the press release, I think the best way to express it is that we're going to a regulatory transition from our bank regulator prior with the OTS to the OCC and at the parent, the Fed. And it's not just the point in time, it is clearly a journey. We think we're on the road. We think we have good relationship with our regulators to a match point. We feel confident that what we've done is in fact aligning and adequatel, but at the same time it's a dynamic process. The world changes, things change and we don't want to basically say definitively we started on X date and we finished on Y data. But that said, this is an important transition. We take it very seriously. We think we're executing well and we'll continue to basically march forward. But the primary focus or, I would say, one of the main areas we focused in on in Q1 was the ALLL and we worked through that, and we think we've come to our reasonable solution that. But again, processes are dynamics.

Operator

Your next question comes from Howard Chen of Credit Suisse.

Howard Chen - Crédit Suisse AG, Research Division

Just given the action in the HELOC TDRs to conform with your regulators standards, I'm curious what percentage of those $215 million of charge-offs are still cash flowing?

Matthew J. Audette

So, you mean total charge-offs on home equities? Is that what you're looking at?

Howard Chen - Crédit Suisse AG, Research Division

Yes, in Home Equities.

Matthew J. Audette

Yes. So I think if you think broadly of the total charge-offs for the quarter, which were $315 million, about half of that came from this review. I think, the amount of cash that cash flowing is not a number we have in front of us probably not the gating factor, separate and apart from the fact that we charged them off and we feel quite comfortable where our reserves are today. The cash flowing are not, from our perspective, a meaningful impact on those reserves going forward because the principal amounts as opposed to the interest that they would pay key driver of those losses.

Howard Chen - Crédit Suisse AG, Research Division

Okay. And then on your commentary regarding the reserving policy for HELOCs for the nonperforming first. If your current visibility isn't great and you don't have all of the enhanced tools that you want yet, what's driving your confidence that the ultimate figure will considerably less than the current estimate?

Steven J. Freiberg

Sure. So we kind of have 2 buckets there. One, the confidence of getting that clarity on data, specific to a borrower who is paying their second lien but delinquent on some other loans. And we have clarity that they're delinquent on something and that clarity is factored into our overall loss modeling. The clarity we don't have is whether that delinquency is specific to the first mortgage loan. So it could be on their mortgage, it could be on the auto loan payment, it could be on their Nordstrom card payment, it could be anything. So that's the clarity that we need to get to be able to factor in this regulatory guidance, but to the provisioning itself, that delinquency is factored in.

Steven J. Freiberg

Just to add going back to the numbers that were cited by Matt, if you think about it, sort of a superset, which we addressed the 10%, and I know Matt had just made the point but I think it's important again to just one more clarification, it's any product that could be delinquent it could be $100 delinquency on their credit card. Also from a logic standpoint, if you're paying your second, it's probably a low probability that you're not paying your first, not an absolute, but a lower. So when you think about it logically, if 10% is to superset the question is what you think the first mortgage behind our second would be. We think it will be a, relatively speaking, a considerably lower subset of that number. And that's what we'll get clarity out across the quarter and it does go to basically accrual of interest not so much basically provisioning because we incorporate that they data already from the standpoint of delinquency into our modeling. I would bet it's a very low number. But I could be wrong. But we know basically what the absolute top is and we'll have to see where we come out.

Howard Chen - Crédit Suisse AG, Research Division

Got it. And then last one for me. Earlier this year you struck an agreement with FXCM to offer foreign exchange. Could you just provide some early progress on that partnership and maybe as a baseline, what's FX as a percentage of your DARTs today?

Steven J. Freiberg

Yes, I'll give you a perspective. We think it's important from the standpoint of a service to provide to some of our more sophisticated active traders. From the standpoint of registering on DARTs at the moment, you wouldn't see it in an absolute term in our DARTs data. It's extremely small. It would round off. But again, we're in early stages. The partnership is good. We've executed it well. We have, I would say, maybe a couple of hundred of our basically of our customers engaged. But the numbers are not large at this point. So again, they're not material, they wouldn't register, although we are at the early stages.

Operator

The next question comes from Joel Jeffrey of KBW.

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

Just a quick clarification. I apologize if I missed this earlier. You talked about if the balance sheet remains at current levels, did you say the spread would be at 240 basis points of the year or average 240?

Matthew J. Audette

Average 240 for the year. So Q1 was 249 so something less than 240 for the rest of the year.

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

Okay, great. And then I think in the past you talk about sort of a more normalized spread of 3% and given your commentary about where the balance sheet is going in terms of size and some level of inflexibility in the wholesale funding side, I mean, would we have to wait until the wholesale funding basically runs off to see that kind of number or is there anything else you could do to get -- just to get an impact to that level?

Matthew J. Audette

So that 300 basis points, Joel, is what we think over the long-term the balance sheet would produce. On a customer-driven balance sheet, meaning primarily funded by a brokerage customer cash and in a more normalized environment. So in that customer-funded balance sheet, the wholesale funding would have run off, the investment strategy on the asset side would have continued. So it's a very long term thing. So I think at the odds of being in a normalized interest rate environment anytime soon are pretty slim, so our focus is more on where the spread is heading today.

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

Okay, great. And then just lastly, you guys look like another decent pick up in the held-to-maturity bucket on the balance sheet. Can you talk about how you think about putting something in either available-for-sale versus healthy maturity?

Steven J. Freiberg

Sure. So we've been growing the healthy maturity book in line with essentially the growth in customer cash rather the balance sheet gets bigger. We've been growing the healthy maturity book, but given where the balance sheet is right now, our target is to grow that to $10 billion and pause there.

Operator

Your next question comes from Keith Murray at Nomura.

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

Could you just spend a minute on the capital plan on the stress test? Do you have a sense yet of whether or not focusing on the risk-based ratios like the CCAR process for the large banks focused on Tier 1 common?

Matthew J. Audette

Well, I suspected any and all regulators is going to focus on what your constraining ratio is. So specific to the bank, our Tier 1 common ratio is just under 16%. So incredibly strong from our perspective versus the leverage ratio, which is much lower at 7.3%. So we suspect when we do all the work, which we haven't done yet, but our plans are to get it done and submit it at the end of the second quarter. But the leverage ratio is likely to be the most constraining ratio and that's where the focus would likely be.

Steven J. Freiberg

Let me just want to clarify that we're not going to a CCAR, a specific CCAR in the second quarter, but nonetheless, I think Matt's points are extremely relevant in that though most of our ratios are very strong, we always look at the constraining ratio, both at the parent and at the bank. It tends to be basically the leverage ratio.

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

And the thoughts around refinancing 12.5% notes. Do you feel like you'd rather wait to get clarity on the capital plan from the regulators before you move forward on that? Or is that independent of that?

Matthew J. Audette

They're most certainly connected. So the refinance of 12.5% notes. If you just look at the last time we issued last year, we issued at 6.75%. So the economics of a refinance would be incredibly positive. At the same time, they were issued a pretty large discounts and the premium that you have to pay to do that collectively, you'd have a rather large loss in the refinance driving down the capital ratio. So we really look at the balancing those 2 things together.

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

And the last one. You mentioned about 1/2 of that new money coming from new accounts. Can you talk about the quality of those new accounts versus existing?

Steven J. Freiberg

Yes, I mean, we keep a very, as you would expect, very close eye on quality of accounts. Without quality, they're not really worth much to us. And at least over the last several years, there has been a very focused effort of not just to basically to look at the accounts, but to look at the quality of accounts coming in and I would say on balance -- and I'll give you a perspective, on balance, our average new account brings to us somewhere in the neighborhood of about $25,000 and it kind of varies by channel and varies by type. We typically think if a new accounts opening on average is at least $20,000, that's a good thing. And that typically grows on average to about $60,000 over the course of an 18-month or so period of time. And the accounts that we've been bringing on at least for the 2 years that I've been here have more than met that criteria. And so we like the economics, economics and the payback of it, just to reassure the group, that we're not basically looking for accounts, we're looking for quality of accounts.

Operator

The next question comes from Brian Bedell of ISI Group.

Brian Bedell - ISI Group Inc., Research Division

Just to talk a little bit more on the balance sheet. Can you talk a little bit about what you think the stickiness of the deposit growth in the first quarter in terms of whether you think that will be deployed back into risk assets? Or whether the deposit pricing strategy that you're talking about for the savings rate will have any kind of a material impact on that? And can you kind of remind me what exactly you're doing with the deposit rates, I think you said, April 1?

Matthew J. Audette

Yes, so the deposit rate is specific to a bank product on April 1, from 15 basis points to 5. As far as the investment strategy goes, there's no change in the investment strategy, which is to allow the loan portfolio to run off and to invest in government-backed or agency-backed securities. So little credit risk on the asset side and no change there at all.

Brian Bedell - ISI Group Inc., Research Division

And then on the deposit base, in terms of the customers, I guess, the behavior if you could sort of characterize what you think customers might do in this environment in terms of redeploying the deposits into securities or kind of stay put?

Steven J. Freiberg

Yes, just to give you may be in a contextual frame. Typically, our experience has been that customers keep somewhere in the neighborhood of 15% to 20% of their financial assets with us in cash. We've trended closer to, I would say, 18%, 19% in this environment, let's say, speculating that they have a higher degree of conservatism. And so, I would expect as confidence levels rise, you would see it recede back toward 15%. And if people remain conservative, it probably stays on the higher side of that range. So trying to predict over the short term with any certainty sort of the psyche is tough. But the range of tends to basically give you a pretty good indication. Now, when you talk about the folks who carry today I think it's almost in excess of $200 billion of financial assets with us, percentage points really matter. But we're probably now in the higher end of the range, which is not unexpected. I don't know if that helps you to build a model from, but it sort of range bounds. We don't think, say, the 15% to 20% falls to 5% to 10%. And we don't think it rises to 30% or 40%. And we've gone back over long periods of time and the range tends to be a good indicator, but within that range, could be a lot of variation.

Brian Bedell - ISI Group Inc., Research Division

Got it. That's very helpful. And then just one more in the balance sheet. On the loan side, going down about 20 to 25 basis points per quarter, can you characterize on the armory [oh] pricing, what type of impact you think might have in the second, third and fourth quarters in terms of the rate?

Matthew J. Audette

Sure, Brian. Probably the best thing to reiterate is of the repricings of the reset that we expected this year, about half happen in the first quarter. That's a majority of the impact happened in the first quarter and we would expect that to subside a bit later in the year.

Brian Bedell - ISI Group Inc., Research Division

Okay. Great. And then just lastly, on the wholesale borrowing, that went up a little bit. On a net basis, do you expect that trend to continue through the year?

Matthew J. Audette

No. I mean, wholesale is a little bit choppy and you've got hedges applied to that book. I think the broad comment I would stick to in wholesale is it could move around a little bit here and there. Our expectation is something to run that portfolio off of over a long period of time and individual items or the individual yield per quarter could be a little bit choppy.

Operator

This concludes the Q&A portion of today's call. I would now like to turn the floor back over to Mr. Steve Freiberg for any closing remarks.

Steven J. Freiberg

Thank you again for joining us tonight. And we look forward to speaking with you again next quarter. Have a good evening.

Operator

Thank you. This concludes today's conference. You may disconnect.

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