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E*TRADE FinancialCorporation (NASDAQ:ETFC)

Q4 2007 Earnings Call

January 24, 2008 05:00 pm

Executives

Robert Jarrett Lilien – Acting CEO and President

Robert Simmons – CFO

Analysts

Richard Repetto - Sandler O'Neill & Partners L.P.

Matt Snowling - FBR Capital Market

William Tanona - Goldman Sachs

Roger Freeman - Lehman Brothers

Howard Chen - Credit Suisse

Michael Vinciquerra - BMO Capital Markets

Prashant Bhatia - Citigroup

Mike Carrier – UBS

Michael Hecht - Banc of America Securities

Brian Midell - Mary Lynch

Operator

Welcometo E*TRADE FinancialCorporation Fourth Quarter 2007 business update call.

(Operator instructions)

I have been asked to begin this call with the following safe harborstatement. During this conference callthe company will be sharing with you certain projections or other forwardlooking statements regarding future events or its future performance. E*TRADEFinancial cautions you that certain factors, including risks anduncertainties referred to in the 10-K, 10-Q and other reports if periodicallyfiled with the Securities and Exchange Commission, could cause the company’sactual results to differ materially from those indicated by its projections orforward looking statements. This callwill present information as of January 24, 2008.

Please note that E*TRADE Financialdisclaims any duty to update any forward looking statements made in thepresentation. In this call E*TRADEFinancial may also discuss some non-GAAP Financial measures in talking aboutits performance. If measures will bereconciled to GAAP either during the course of this call or in the company’spress release, which can be found on its website at etrade.com.

This call is being recorded. Replays of this call will be available viaphone, webcast and podcast, beginning today at approximately 7 p.m. Easterntime. This call is being webcast live atetrade.com. No other recordings orcopies of this call are authorized or maybe relied upon.

I will turn the callover to Mr. Jarrett Lilien, acting Robert Jarrett Lilien – ActingChief Executive Officer of E*TRADEFinancial Corporation, who is joined by Robert Simmons – Chief FinancialOfficer.

Robert Jarrett Lilien

Welcome everyone to our Year End 2007 Conference Call. On today’s call, we are going to provide anoverview of our Fourth Quarter and Full Year Financial Results and then spendthe bulk of the time on our action plan that addresses the financial issuesfacing the company to restore customer confidence.

Our plan builds on the steps we have already taken andestablishes a roadmap to remove risk in the bank balance sheet, reduce leverage of the parent company and reduce non-court expenses to reinvest in thebusiness. The combination of theseactions will significantly diminish the financial risk to the company andaddress the primary overhang of the perceivedquality of the franchise.

By restoring customer and investor confidence, we willaccelerate our recovery, and return the core business to growth. At this point I would like to turn the callover to Rob, to discuss the Fourth Quarter and Full Year Financials. I will then dive deeper into the details ofour 2008 turn-around plan and provide our outlook for the year.

Robert Simmons

On Slide 4 you can see that the performance of our retailand institutional segments deviated significantlyfrom each other last year. The retailportion of the business deliveredvery strong financial results. Due toexceptional growth across all of the key drivers of the business, for the fullyear, retail segment net revenue totaledthe record 1.8 billion with the record pre-tax segment income of $789million. Unfortunately, theinstitutional portion of the business which includes balancing management faced significant challenges as a result of industrywide deterioration in the performance of mortgage relatedassets.

The institutional segment sustained a pre-tax loss for theyear of $2.8 billion do largely to $2.5 billion in loss on loans and securitiesand $640 in provision expense, which is at $595 million increase from the prioryear.

As a result of the well documented balance sheet relatedchallenges in the institutional segment, the company reported that consolidatednet loss of $3.40 per share for the year, the first annual loss since therepositioning of the business in 2002.

Turning specifically to the Fourth Quarter we reported a netloss per share of $3.98. These resultswere the net effect of major losses in the institutional segment despite acontinued strong performance in retail.

To put some additional contacts to round the contributors tothe lap in the quarter, I would like to highlight a few specific items onSlide-5. As you know, on November 29, wewill announce the sale of our asset taxed Securities Portfolio in conjunctionwith an investment in the company from Citadel.

This transaction generateda net loss of 2.2 billion dollars. Atthe time of the announcement, we also indicatedthat we expected to end the yearwith an allowance from loan __ that is approximately $400 million. We increasedour provision in excess of chargedoffs in the Fourth Quarter and increasedthe ending allowance, finishing the year with a total allowance for lone officeas $508 million. The increase to ourprovision and allowance levels in the Fourth Quarter reflects our view on thetiming of losses, rather than a change to our expectation for accumulates oflosses.

Through this additional reserves, we ended the year with a200% coverage against non-performing home equity loans, 116% coverage inQ3. Both the real life loss from the ABFsale and the increase provision expense or reductions to reported revenue,which resulted in a $2-billion net negative revenue in the quarter.

On the expense side, we had a couple of items also worthnoting. We are required to evaluate thebook value of goodwill carried on the balance sheet for impairment. As a result of the decline in fair value ofthe balance sheet management business, the goodwill associated with thisbusiness was impaired resulting in the write-down of $101 million in thequarter.

While this goodwill write-down increased the per share lossfor the quarter by $0.21, it is important to keep in mind that it is a non-cashitem with no impact to potential equity. In addition, professional service fees and expenses increased by $14.5million, driven by higher legal consulting and outsourcing fees. We did not expect these expenses to recur atthis level in 2008.

Restructuring expense totaled$28 million as a result of decisions to exit non-core, low margin business,such as institutional brokerage and wholesome mortgage as we have previouslyannounced. Other expenses increasedin the quarter by $9 million and about half of this increase was non recurringitem related to regulatory fees andTNE expense. Expect other expense toreturn to the run rate that is more consistent with the first and secondquarters 2007.

Advertising increased$15 million quarter-over-quarter. However, most of this increase was plannedin advance of the quarter. A portion ofthe increase is about $4 million. It wasdue to our decision to increase our customer communication and presence in themarket place in November and December to help stabilize our customer bets.

Beside from these items, quarter operating expenses declined in the quarter. Compensation and benefits declined$2.9 million, net of approximately $6 million and $7 million to related expenses. Clearingor servicing expenses declined by $13 million, a direct benefit of the aggregate from our institutional brokerageoperation. The action taken this quarterto sell our ABF portfolio and simultaneously to replenish the related bank capital did result in a large loss. But it addressedour primary financial risks and allowedus to begin the process of restoring customer confidence.

This transaction provided timely stability for the businessand helped 12 customer concerns by providing us with three primarybenefits. It stabilized customers by instillingconfidence and the viability of a company. It provided additional funds with the parents to enable the bank toaddress potential losses in the home equity portfolio and its strengthenedexcess capital level.

The Citadel transaction represents one of several tangiblesteps we took in the Fourth Quarter to remove risk, strengthen the balancesheet and restore confidence and restore confidence in our franchise. While we recognize that much work remains tobe done, we have made solid progress already. Last for your reference, an updated version of our supplementalportfolio disclosure will be available this evening and can be found on theinvestor relation portion of our website. Now, to go to the highlights of our 2008 turn around plan, I will turnthe call back over to Jarret.

Robert Jarrett Lilien

Setting aside for a moment thefinancial challenges that stem from the balance sheet issues last year, 2007was a pretty remarkable year for our retail franchise. As rob mentioned,the quarter retail segment deliveredrecord results despite the disruption we facedin November. It is important tounderstand the momentum that was building in our retail business to assess ourability to get the franchise back on track. The disruption was the result of a broken balance sheet not a brokenbusiness.

On Slide-7, you can see thatthrough the Third Quarter, the retail business was on a steep growthtrajectory. This growth was driven by oursuccess in attracting, retaining, and migrating customers into our highestvalue segments. The quarter drivers ofthe business including net new accounts darts cash and assets were all on paceto end of the year at record levels. Asof the third quarter, total client asset reached the record $218 billion,representing a 16% analyzed growth rate from the beginning of the year.

This growth included 24% annualizedgrowth in customer cash to a record $40 billion. We also generated the strongest organicaccount growth we have seen in over seven years including a 23% annualizedincrease in our target segment accounts. As a result of the financial challenges in the bank’s balancesheet. Confidence was shaking inNovember.

This confidence issue lead to adisruption to our customer based, which resulted in an 8% decline in totalassets, which included a 17% decline in customer cash balances. In dollar terms, this translates into $16.5billion of total assets, including $6.8 billion in cash.

With the announcements of theCitadel transaction on November 29, we were able to stabilize the outflows andbegan to restore customer confidence, as we indicated in December and againearlier this month, customer cash balances that remains stable at about $33billion since the deal was announced.

At the account level, thedisruption was significantly less material. From November 11 to the year end, actual account closures attributableto the disruption were only about $70,000 or just 1.5% of our total accountbase. This makes an importantpoint. Most customers maintain theirrelationship with us, even if they decided some assets else where in Novemberand December during the peak of concern. This is encouraging and we believe it gives us a greater likelihood ofsuccess in winning back assets as we address concerns.

This was apparent this pastTuesday, when saw two times the two times the normal level of cash inflowthrough our quick transfer product from external sources, while at least one ofour competitors had platform issues and difficulty handling the high marketvolumes of the day.

Overall, the pathway back for us,started with the Citadel capitalinfusion. And now continues with ourturn around plan. The plan addresses thecompanies financial challenges and in doing so, allows us to get past theconcerns that we have been facing. Restore our confidence and return our franchise to growth. Turning to the plan into Slide 8, our rigorousassessment of the company evaluatedall of our operations and resources. Theplan we have created aggressivelyaddresses the factors that lead to the concerns.

There are three quarter goals toour plan. Reduce risk in the bankbalance sheet, reduce leverage of the parent company, and reduce expenses tofund investments in the core business. Taking those one at a time, first, the primary concern around thestrength of the bank will wait at the capital levels and our ability towithstand losses from the home equity portfolio.

Slide 9 shows the home equityperformance matrix and where we have already began to address this issue withthe increase in loan loss allowance in Q4, current reservedlevels, provides for annualized inthis portfolio of nearly 4%. Thiscompares in the annualized chargeoperate of just under 3% that we experiencedin the Fourth Quarter. The combinationof increased loan loss allowance anda growing base of excess bank capital providedadditional capacity to withstand deterioration in this portfolio.

We estimate between $1 billion and$1.5 billion in cumulative losses in our home equity portfolio over the nextthree years. And this, expectation isconsistent with evaluations performed by independent third parties. As a further example, on Slide 11, we showour home equity portfolio and cumulative loss outlook in its context of the WellsFargo Liquidating home equity portfolio, while the Wells Fargo portfolio issimilar to ours in terms of size, the underlying credit characteristics, firslean position, exposure to Californiaand origination channels in our portfolio are better. Despite these differences our forecast oflosses in reserved levels are in a similar range.

In 2008, we expect provisionexpenses to be between 400 and 600 million; we enteredthe year with reserves of 508 million and expect to exit 2008 with strongreserves and excess regulatory capital approaching $1 billion in buildingovertime.

In our view, this positions us towithstand our forecasted losses over the next three years while remaining wellcapitalized at all times. If marketconditions change dramatically in 2008, clearly we would need to make adjustmentsto our reserved level but given the information we have today and theindependent third party credit analysis of our portfolio, we believe ourreserve levels are appropriate and reasonable, we expect home equity loans todecline by approximately 15% front current balances over the course of theyear, as this portfolio runs off.

Giving current market conditions,and liquidity discounts for these types of assets, our plan is to hold andaggressively manage these loans overtime. Should markets recover significantly, which we are not expecting, wewill evaluate opportunities at that time to the lever at a faster pace and inan orderly fashion. In the mean time, wehave formed a special credit management team to focus on home equity lossmedication.

This includes potential loanmodifications and aggressive efforts to reduce open, were undrawn creditlines. We are already making progress inthis front, open home equity line commitments have declined in the past severalmonths by a billion dollars, returning to the capital levels at the bank, weplan to build up excess capital through a combination of retained earnings andfurther the leveraging. Our plan callsfor us to end 2008 with capital in excess of well capitalized standards ofnearly a billion dollars at both the tier one leverage and risk basedmeasurements.

Progress towards reaching thesetargets is already underway and it has benefitedfrom $150 million received fromCitadel in mid January, by year end, we expect that tier one and risk based capital ratios will clime to roughly 7% and 12%respectively, addressing the leverage and total debt earnedat the holding company is the second element of the turnaround plan. We will improve capital and liquidity at theholding company overtime through a combination of asset sales and potentialcapital markets transaction. Decisionsto sell assets are focused on nonecore businesses and investments and actions here are already in the works aswell.

We generated$10 million in asset sales in the fourth quarter and we see an opportunity for250 to 300 million for all of 2008. Weexpect about 2/3rd of this amount to come in the first half of theyear. We have also identified a number of other potential capital raisingactivities and these could further benefit the second half of the year. We will be both disciplined and opportunistic in selecting the action we willtake, our objective to reduceleverage at the holding company of DOD’s initiatives if there are down paymenttowards improving our credit ratingsover time.

The third element of the plan is toreduce operating expense to fund growth investments in the core franchise.There is no doubt that the Fourth Quarter issue has created a setback in ourgrowth trends.

Fortunately, the core business andthe strength of our valuedproposition remain intact. Even as weexperience the spike in nutrition from our retail base in November and intoDecember, we continue to generate strong new account opening demonstrating thecontinued attractiveness of the E*TRADEbrand. The same competitive advantagesthat existed before the crisiscontinued to exist today. As we take the steps, I have outlined to improve the financial stability of the companyand restore confidence; it is of paramount importance that we continue toinvest to remain an industry leader. Aspart of the plan, we expect to increase total marketing spend in 2008 byapproximately 30% of over 2007, which amounts to about $ 45 million.

We also plan to expand ourrelationship manager group to increase the personal coverage of our mostvaluable customers, a service that many of these customers would find difficultto match elsewhere with the value we offer. Our overall customer outreach programs will work in concert with keyproduct launches to continue the show that E*TRADE is an industry leader ininnovation with the world class customer experience.

Our 2008 plan includes a launch ofa series of new products and services such as a new mobile trading platform, ahome deposit solution and expansion of our industry leading global tradingoffering for US customers. In ourinternational retail business we will further leverage our global technologyplatform to increase efficiencies, improve operating leverage and strengthenour product set to gain market share.

Reducing expenses is another coreelement to our plan. We have created aseries of cost cutting initiatives that include two phases. The first phase is already underway and it reducesour core operating base by about a hundred million by cutting non essential andgeneral overhead expenses. Our totalexpense based in 2008 relative to 2007 also benefits from the exit of ourinstitutional brokerage operation and the elimination of non recurring items. This represents $260 million of expenses fromlast year that will not run through to 2008.

The combination of direct expensecuts and a non-recurring items will reduce the total expense phase in 2008 byroughly $360 million. We then plan totake approximately $85 million of this forecasted savings to fund strategicinvestments in marketing service and product in both our US and international operations.

The second phase of expensereduction includes exploring further organizational streamlining includingadditional operations in technology integrations between the bank and brokerand the benefit of the second phase actions, they are not currently budgetedfor 2008 but could represent an opportunity to take another 40 to 50 milliondollars in cost out of the business overtime.

Through and increased focus on expense discipline we can do investmentsto keep the core franchise on track for growth while we address the financialconcerns of investors. It is importantthat we work to restore investor confidence; we do not loose our focus ondelivering a world class experience for our customers.

I like to now turn to slide 14 tospend a few minutes on our outlook for 2008. This year we are approaching our annual guidance a bit differently givenso much uncertainty around interest rates, the economy and the stock market, wewill provide you with a range of expectations for a set of key business driversrather than revenue and earning’s expectations.

We think this is more constructivethan providing what would have otherwise then a wide range of potential bottomline results. In addition, we arereinstating monthly metrics to help you gauge the trends of the business overtime. Through the combination of monthlyand quarterly reporting, you will get a good view for the progress we weremaking on a turn around plan in the overall performance of the business. While we expect to return the company toprofitability in 2008, we are anticipating a net loss in the First Quarter.

The expected loss in the firstquarter is the result of timing differences between the benefits of our planversus higher provision levels and greater charge up, expected in the earlypart of the year. In addition, we expectinvestments in marketing and new products to pay off later in the year withexpense sitting in the first quarter. The head win from these loaded expenses will ease as the yearprogresses. Our expected ranges andlevels for the key drivers of the business are affected by two factors.

The economic backdrops for 2008 andthe impact to our driver run rates as a result of the November customerdisruption. With respect to the economy,we have assumed to slow down in 2008but not a recession. For the drivers, weare clearly working off a different base, given what happened in November, to give context; we estimate thatthe run rate impact on darts and margin was about 8% on each and 17% forcash. On an economic basis, this resultsin a 10% reduction in annualized retail segment net revenue.

So, with that as a backdrop, I willgive some color on a few of the key drivers, for darts, we expect to rangebetween 170,000 and 200,000 for the year. For total customer cash, our expectation is for 33 and 37 billion atyear end. At the low end, it isrelatively flat with current levels and at the high end we have modest growththat is the function of both new account growth and customer win backs. If we are able to win back just 30% of thecash, we lost in November; it would provide $2 billion dollars worth of growthor half of what we expect for the full year at the high end of the range.

We expect average interest earningassets of between 45 and 49 billion, which is down from 52 billion at yearend. This decline is the result ofcontinued prepayments and pay downs but does not assume any capital marketactions. I have already coveredprovision levels and capital ratio, so I would not spend anymore time on that,finally the board is making progress in their work to announce a permanent CEOand we expect to have a resolution on this topic by the end of February as theboard originally committed. In closing,I just like to reiterate a few points, our core retail franchise remains strongand stable as a result of the actions we have already taken, through the planwe have outlined today, we will continue to address concerns about the businessby strengthening our capital position, managing future loan losses in anorderly fashion and restoring growth to our core retail business.

E*TRADE is an industry leader for areason. The value of proposition weoffer plus our ability to develop innovative products and provide qualityservice to our customers is what built this company, it is our core competencyand it is what we will return the franchise to growth.

With that, let me open it up forquestions.

Question and answer session

Operator

(Operator instructions)

Your first question is coming from Richard Repetto withSandler O'Neill

Richard Repetto -Sandler O'Neill & Partners L.P.

I guess the first question comes onthe reserve, because we have talked about the provision expense and can you, Iknow you said it was based on timing, can you go a little bit deeper tounderstand what you expect as far as losses and why it is 500 versus 400 thatwe were looking at before?

Robert Jarrett Lilien

Sure, I will give a little color and then we are going tolet some others try and add on about some of the plans that we have but again, we have not changed our expectation for cumulativeloss. That was a $1 billion to a $1.5 billionover three years, it remains a $1 billion to a $1.5 billion over threeyears. What has changed is in our own conservativemodeling we have chosen to change a couple of assumptions, which impacts thetiming of those losses. So we expectsome of those to come earlier rather than later. That was the reason for taking the allowanceup 400 to 500 million.

Basically, if you looked at theFourth Quarter we had about $100 million of charge offs there. If you look at a $500 million allowance,clearly what we are saying is, is that we expect things to get worse, beforethey get better. And our expectation is that they will get worst in the first half of theyear and then we will start to see some improvement on the second half of theyear.

Richard Repetto -Sandler O'Neill & Partners L.P.

Okay andI guess that my one follow up is a little bit of more on than. It does not have to do with deteriorationthat you have seen or an increase deterioration of the portfolio. And let me tack on. Can you also talk about the 101 impairment alittle more deeper and detail on that as well. That is all I got.

Robert Jarrett Lilien

Well, on the first question again, first is our expectation, the change inthe allowance was not because of further deterioration versus expectation. I wanted to stay that we do expect things toget worst. We expect the slowing ofeconomy. We expected that there would bemore defaults. We expected that housingprices will continue to decline.

So, all of that are in the numbers and again the change in the allowance wasbased on timing and nothing else.

Robert Simmons

Rich, on the question of the impairment of good will, it is really a year onour product this year on which we go through and evaluate your will forimpairment to make sure that it still represents the value that is should on yourbalance sheet. As part of that product,the goodwill that was contributable to our balance sheet management business,as a result of the challenges that we have had in the credit front, thegoodwill related to balance sheet management was determined to be impaired sowe took that charge in the fourth quarter, which again is the none cash chargeand does not impact regulatory capital but did big impact our EPF as we havesaid.

Operator

Your next question is coming from Matt Snowling with FBR Capital Market.

Matt Snowling - FBRCapital Market

Can you talk a little bit about the type of customer thatyou may have lost during the quarter, I guess what I am get out of this is moreof an active trader that you may have lost or a balance customer?

Robert Jarrett Lilien

We adequately lost some high value customers and that goeswithout question. As we have said in theprepared remarks, attributable to crisis, we feel that we lost 70,000 accounts,the average at that price per account at about $236,000. So that is a good customer. But if you look deeper into it, you can notsee but, but we actually had growth in the quarter overall in our active tradersegment. And in our active segment, thatalso qualifies as high asset customers which we call the ideal segment where wesaw in that lost is overall wherein the balance customers, the people holdingreally, buying the whole or cash only customers. To that, that is a little bit on the profile.

Matt Snowling - FBRCapital Market

Okay. This is a realquick follow up. Can you give in thesense way your position from a balance sheet perspective relative to that cut?

Robert Jarrett Lilien

On the balance sheet, on the fed cut, that is going to be aninteresting one for us. We expect 75basis points more to come. On one level,fed cuts can only be good news. We wouldhope that they would improve credit and help on some of our portfoliosperformed better than expectation in terms of spread. It actually works against you because youwill have some spread compression because of what will happen on the cash sideof the balance sheet. Offsetting thatspread compression though would be the fact that we are de-levering in the partof the balance sheet that we are de-levering which have to be more of thecarriage trade or low spread trade. So,overall, even with more fed cuts building to our plan, we do expect some modestspread expansion, but basically, the rest is built into the plan.

Operator

Your next question is coming from William Tanona withGoldman Sachs

William Tanona -Goldman Sachs

I apologize if you guys already talked about thisearlier. I came on a little bitlate. But you are looking at 84 cents interms of tangible value. Offset does notgive you a much in a way of flexibility and you have mentioned additionalcapital raises. And so, why do you notgive us a sense to how much you think you may need to raise and what forms youkind thinking about rising? And, how doyou think about using that? Would thatbe something to rise just to try to unload some of that home equity portfolioor like we have seen some of that larger investment banks? Or what would be something that you wouldjust want give yourself a little bit of additional cushion to try to work throughsome of the mortgage loan that are on the balance sheet?

Robert Jarrett Lilien

One of the things that you might have missed earlier if youhave joined late was that the plan around that that built that we have gotthese signals somewhere in the neighborhood of 250 to 300 million of potentialasset sales in the works.

The topic that you bring up is one that is essential to ourrecovery plan. It is very much of afocus for us. We have reopened thepotential of, in addition of asset sales, capital market related transactionopportunistically potentially later in the year. But, one of our key objectives to this is toincrease capital and de-lever the holding company from here.

William Tanona -Goldman Sachs

Okay. Were you ableto sell any of the home equity portfolios in the quarter or was that all kindof a run offs in terms of what had the balance is terms of their decline?

Robert Jarrett Lilien

Our plan for the home equity portfolio is to hold on toit. We are still in an irrationalmarket. The way we looked at it, thecapital markets are more or less closed right now and selling would not be anoption. So, we are holding thosesecurities that are those loaned, that is our intention. Ad again, as we want to which you might havemissed in the prepared remarks. Becausefrom here, it is about making sure that we have an appropriate reserves andthat we are building excess capital to withstand in the ordinary course ofbusiness and any lawsuits that come our way.

We feel we are in that position. If the market recovers significantly then wewould look potentially de-leverage faster, but that is not the market that weare expecting and that is not the market that we are in today.

Operator

Your next question is coming from Roger Freeman with LehmanBrothers

Roger Freeman -Lehman Brothers

I wanted to come back to the timing issue of losses that youhave talked about before. I guess, asthe accelerated speed of losses coming out of the one to four family portfolio,that was the one thing that sort of struck me in the disclosures at the end ofthe press release. The charge off rateincreased significantly there. And Iguess that if you really look over the last two quarters now, both of on tofour family portfolio and the Hemlock Portfolio have seen delinquenciesincrease in $100 million range. So itseems like they are both performing similarly. I know that one to four family portfolios is bigger but can you talkabout as one to four is sort of the issue here?

Robert Jarrett Lilien

Yes, and again, to let others jumped in. But really the issue for us is in that homeequity portfolio and that is the one where we expect the majority of losses for2008. You are right. We did see an up check in losses coming outof the one to four family. But they arestill at a very low level. We still havea portfolio that is better than the industry average in terms of creditquality. But even so, as said, it is notimmune to what is going on and so there is an expected up check in some of thecharge offs there and that is included in our allowance forecast for this year.

Roger Freeman -Lehman Brothers

Okay. My secondquestion would be around the nature of the cash that is coming in thedoor. So your cash balance is not enoughand the answer here provides a current customer cash balance. But it has been fairly stable since the endof November yet. Obviously, Ameritradebecause they are still seeing their heightenedlevels to cash coming out of E*TRADE to them.

And so, is the cash replacing coming in mainly through CDshere which I think we look on bankrate.com, which is the highest in theindustry, so, is that where most of this cash coming from? Do you think that that is stable cash? And do you plan to remain at the top?

Robert Jarrett Lilien

I guess two things on it. First on the Ameritrade, they certainly took some assets from us. But I will tell you that __uploads, 75% ofthem were really concentrated on thetwo week period at the end of November.

Things are pretty much stabilizedsince then. Also, we have seen some ofthe reverse. We did see a big day onTuesday. The market’s activity was verybusy. We had a record number of userslogged on to the E*TRADEsystem. And at other places, that costslowness and outages and we saw some of that money come back. So that is the nature of the whole transferof assets. Some goes on one day and somecomes back. The majority of who went toa Ameritrade though was really in that crisis period.

As to the money that is coming in to cash products, first ofall, you would want to look at the cash that is left. And a significant portion of cash that isleft was actually in our highest rate product being the complete savingsaccount. And likewise on the return, ithas not been one of hot money. Actually,71% of the new deposits in the fourth quarter came from brokerage customers,existing customers and the average costs to funds on that incoming cash in thebank product with was 3.8%.

So, obviously, it was the balance of some of the higher rateproducts but also, some of the lower rate products.

Operator

Next question is coming from Howard Chen of Credit Suisse.

Howard Chen - CreditSuisse

I just wanted to follow up on the one to four familyportfolio, what is the specific deterioration that you are making into yourassumptions? Is it a 10% reservecoverage for 2008? And, can you updateus on the state of any insurance or CDS that you might have against that one tofour family portfolio.

Robert Jarrett Lilien

If you look at our reserve division for 2008, we areassuming that less than 5% of that reserve will be needed by the first portfolio. We look at that portfolio and compare veryfavorably to other lenders primarily because of a very limited top prime exposure, only about seven basis pointin the first portfolio with that prime. And secondly, we do not have any exotic products, no pay option while orother type of loan

Howard Chen - CreditSuisse

And in the state, any insurance or CDF that you have againstthat portfolio?

Robert Jarrett Lilien

I think that we said previously that we have creditprotection of about $4 billion for that portfolio.

Howard Chen - CreditSuisse

And then the second question I have, what is the currentstate of the revolver for the holding company? When should we expect an update there?

Robert Jarrett Lilien

The revolver as you know, the prior revolver that we hadgoing into the federal transaction, we canceled. As you know, there was nothing outstanding onit at the time of the cancellation. Andwe are currently working to establish a new revolver that would be at a holdingcompany level again that would be part of our on-going liquidity program and wewill give more detail as appropriate. But we would expect to have some more to say in the not so differentfuture.

Operator

Your next question is coming from Michael Vinciquerra withBMO Capital Markets

Michael Vinciquerra -BMO Capital Markets

What is the available draw for you client? You said that you expected to drop thebalances of about 15% from pure run off this year. But your clients, I presume have ability tomake additional withdraws. Is thereanyway to mitigate the risk on those available lines that are outstanding?

Robert Jarrett Lilien

The draw potential is about $6 billion. And again, I will let Bob go into some of themitigation networks and some of that as I did mention in the prepared remarksthat is around trying to reduce those undrawn balances.

Robert Simmons

A major part of the work that we are doing in our mitigationfor the portfolio would include looking very heavily at draws. We have drawn elimination plans and play fortheir services now for customers who become delinquent. We are also looking at our ability to puthold on those potential draws based on changes in house value and changes inthe ability to cut for pay.

Michael Vinciquerra -BMO Capital Markets

Okay and just one question, corporate interest extent expectation for OA,just as when we are modeling. I havesomewhere around 90 million a quarters assuming the borrow from CDL, is that inthe right range or can you give us an approximate number?

Robert Jarrett Lilien

Yes, that is in the right range. Yes, all the numbers are out there so this should be pretty if you winthem all.

Operator

The next question is coming from Prashant Bhatia withCitigroup

Prashant Bhatia -Citigroup

The repos of about $9 billion at the end of the year, itlooks like they are down about $2 billion during the quarter. Could you us the feel for how much of thosemature in the next 90 days?

Robert Jarrett Lilien

It is a little over a billion dollars.

Prashant Bhatia -Citigroup

You are just going to replace that type of thing with FHLB,is that that plan go on court?

Robert Jarrett Lilien

No, we continue to roll our repos as they can do.

Prashant Bhatia -Citigroup

In terms of getting a nonqualified opinion from theauditors, is that something that you have had discussion about or that issomething that you will get that you think?

Robert Jarrett Lilien

We do not expect that to be an issue.

Prashant Bhatia -Citigroup

Just finally on the first lean, what you have assumed forloss there as well as the RV and the consumer loan portfolio as well?

Robert Jarrett Lilien

On the first lean, we are expecting about just under $20million on losses in 2008.

Operator

Your next question is coming from Mike Carrier with UBS,please go ahead.

Mike Carrier – UBS

I just have question on loses and in trying to understandthe capital impact, can you just give me a condition, Hillock markets continuedto deteriorate. Let us just assumed,this is a bad case scenario and let us just say that given that lot of theHillocks where ‘06, ’07 vintages, let us say that either the $1 to $1.5 billionaccelerate, then maybe two year or maybe the losses end up being a little bithigher. What I am just trying tounderstand is, if you end up, let just say operating a lost for a littlelonger, how much of a capital caution do you have and in particular. But, when you look at the equity at thebroker risk, the equity at the bank, like how negative can the tangible equityor the equity of the broker in order to maintain the equity capital at the bankto be like well capitalized. You guysare not different, I mean lot of the growth online broker has a negative equityat the broker because of the good will, but I just wanted to under stand that.

Robert Jarrett Lilien

I will take the first part of the question that Rob jump inat the end but when we announce the federal bill, we trap about at that timehaving $364 million of excess capital above the well-capitalized levels. We had risk ratio tier line risk based of 590and 11/10 was the target that we were saying for the end of the year. We have already come in better than that. We come in at 618 and 1131 with excesscapital of $417 million. We have talkedabout the extra Citadel money coming in January. We have talked about the business. I think reasonable expectations for thegrowth in the business are not incredible and yet we expect to be throughretain earnings and delivering.

We expect to end the year with a billion dollars of excesscapital at the bank and again risk rations well an access ofwell-capitalized. So, if you have takeit and you say, could charge house be worsen, we are expecting and if we haveto had probation be hire, already we can stomach a lot of that in 2008. And, clearly if we get in 2008 as we plan toyou are clearly in a very strong position to take what comes in 2009 and 2010.

So, we think we have this portfolio and a place where we canreasonably address it and one of our real goals through our 2008 is to geteverybody comfortable with that so that we really take off the table as anissue or as an ongoing topic of discussion.

Mike Carrier – UBS

Michael as you know the broker have stand, their own standalong capital requirement. So, obviouslythey cannot be negative and we would not expect them to be negative. I am not sure where that question was goingbut with respect to and to something a parenthetical to what Jarrett said, thatwhen we talk about our ending AO capital, excess capital approaching thebillion dollars and excess of well capitalized standard, that is not justnecessary, that does an include potential equity that we have at the holdingcompany level. It does not include otherpotential equinity that could come from other assets sales. So, there are a lot of different ways inaddition to the capital that we have model and layout for you today, that wecan still be comfortable with our capital edition even in worst case scenariothan we are laying out for you today.

Operator

You next question is coming from Michael Hecht with Banc ofAmerica Securities

Michael Hecht - Bancof AmericaSecurities

Any update on the CEO search in terms of timing and when theboard expects to make a decision.

Robert Jarrett Lilien

Yes, we did talk about in the prepared remarks, the board isalways committed from the very start of the process that effectively they havecompleted the process by the end of February and they are still on tract tomeet that commitment.

Michael Hecht - Bancof AmericaSecurities

I just wanted also to clarify something I thought, I heardyou say, so you guys expect the enterprise wide spread to increase next yearfrom the 285 that you have average for 2007 and when it ended the year at 255.

Robert Jarrett Lilien

We expected to increase from 255 where we ended and theanswer is yes, but modestly and again a big reason for that is a smallerbalance sheet where you gotten read of some of the narrow spread carry tree butclearly lower rates are working against us and create some spread compressionon the cast set.

Michael Hecht - Bancof AmericaSecurities

I was a little surprised at how expenses, despite thenegative revenue, you only have about a 1% drop in income expense versus, Ithink it was a 9% drop in your head count. Can you give a little more color on I guess how much on the $360 milliongrowth expenses to the client and I guess 30 to 35 million net in overallexpensive kind of Comp versus non-Comp.

Robert Jarrett Lilien

Let me talk about Q4 because that is probably morerelevant. If you look at the overallcomp expense quarter over quarter, now you are down about 5% or so or about $12million. Now, that is including,remember the effective of severance in the fourth quarter that wouldartificially pump that up but would not necessary be recurring. So, the overall expense decrease that we hadin the quarter was despite some unusual several in there as well.

And just adding to that, if you look if something new thatcomes out at some point in the Proxy but of the top five officers in the groupthat would be in the proxy, those directly responsible connected to the balancesheet issue are gone and showing up in severance here. The remaining proxy officers are certainlyaccountable and it will have zero bonus for this year.

Operator

Your next question is coming from Brian Midell with Mary Lynch, please go ahead.

Brian Midell - MaryLynch

Just a couple of questions, can you talk about a littleabout the economic assumptions from the third parties on the Home EquityPortfolio and when they concluded that analysis. In terms of that kind of assumptions,assumptions for home prices, whether they think of recession or not onappointment rate, things like that.

Robert Jarrett Lilien

The third part analysis were all done in the November, earlyDecember time frame. They took a look atvarious economic outcomes that they run in models. In our modeling, we use the Case-Shiller datafor home price which gives us not only a estimated loses of about 10% next yearbut about 5% more in the following year in terms the home pricedeterioration. That data also allows usto look at home price deterioration by market. So, we can tool at the various pieces of portfolio and apply appropriatemarket appreciation for those people.

Brian Midell - MaryLynch

You got 10% home price deep appreciation in 2008 and another5% in 2009.

Robert Jarrett Lilien

For those area that we do not have specific market dataform.

Brian Midell - MaryLynch

For interest grade assumptions, you guys set another 75basis points of that coming, do you expect that would stop after 75 or do youactually go from there?

Robert Jarrett Lilien

But we have got 75 more baked into 2008 and that is in theplan so far. I would say a nice aboutwhere we are with this numbers versus where everybody was, let us say five orsix months ago, is that it was hard to take your assumption and validate themor verify them anywhere. What we havebeen able to do and again November and December and now is through thirdparties to get another look through additional internal model that we haveadded, adding our own assumptions, take a look but also again as we talkedabout and prepared remarks, we have been able to see what other banks are doingand Wells Fargo portfolio as if for instance. I may not even look a coverage ratio. If you look at our coverage ratio for the home equity portfolio at 200%,it is hard to fine anybody with a higher coverage ration than that. So, you do have the ability now which issomething that is different than what it was, again five to six months ago toreally verify and validate some of your assumptions and your numbers. So, we feel we have been responsible and thatthese are reasonable estimates.

Robert Simmons

In terms of looking at the impact of lower rate in the modeland into our estimate, there is very little benefit from any rate loweringbuilt in for the estimate where you are been right now. So, the expensive rate continues to dropfurther and the benefit in the market from that. That is potential outline.

Brian Midell - MaryLynch

Now, there is one other question that I expected someone toasked but since they did not, I am going to asked it, so Rob can you answerit, there are going to be some interestingthins around tax next year and so Rob what is your tax …

Robert Jarrett Lilien

To hopefully be a little helpful for model and we do expecta 2008 tax expense. It could be based on a pro-form effective tax rate of about,somewhere in the range of 37% to 38% plus additional tax expenses of 15 to 20million. The addition tax expenses, Italked about release primarily tothe fact that we have got a portion of out interest expenses on our new springling note that are nondeductible fortax purposes as well as some of the tax contributable, the earning of ourforeign operation. So, again the overalleffective tax rate is going to be base on the number of doctors that we think apro-form effective rate of 37% to 38% plus $15 to $20 million an additionalexpense.

Operator

Thank you, at this time, there are no further question. I like to turn the floor back over to Mr.Jarrett Lilien for closing comment.

Robert Jarrett Lilien

Certainly 2007 was a difficult year and one we would like toput behind us. We do have now a clearplan and that plan included execution and then includes retail growth, thingsthat we are good at and things that we have done before. So, we look forward to the coming quarters toreport on our progress and success around the plan and thanks for joining ustonight.

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Source: E*TRADE Financial Corporation Q4 2007 Earnings Call Transcript
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