Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

E*TRADE Financial Corporation (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

Welcome to E*TRADE Financial Corporation Fourth Quarter 2007 business update call.

(Operator instructions)

I have been asked to begin this call with the following safe harbor statement. 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-K, 10-Q and other reports if periodically filed 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 January 24, 2008.

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

This call is being recorded. Replays of this call will be available via phone, webcast and podcast, beginning today at approximately 7 p.m. Eastern time. This call is being webcast live at etrade.com. No other recordings or copies of this call are authorized or maybe relied upon.

I will turn the call over to Mr. Jarrett Lilien, acting Robert Jarrett Lilien – Acting Chief Executive Officer of E*TRADE Financial Corporation, who is joined by Robert Simmons – Chief Financial Officer.

Robert Jarrett Lilien

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

Our plan builds on the steps we have already taken and establishes a roadmap to remove risk in the bank balance sheet, reduce leverage of the parent company and reduce non-court expenses to reinvest in the business. The combination of these actions will significantly diminish the financial risk to the company and address the primary overhang of the perceived quality of the franchise.

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

Robert Simmons

On Slide 4 you can see that the performance of our retail and institutional segments deviated significantly from each other last year. The retail portion of the business delivered very strong financial results. Due to exceptional growth across all of the key drivers of the business, for the full year, retail segment net revenue totaled the record 1.8 billion with the record pre-tax segment income of $789 million. Unfortunately, the institutional portion of the business which includes balancing management faced significant challenges as a result of industry wide deterioration in the performance of mortgage related assets.

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

As a result of the well documented balance sheet related challenges in the institutional segment, the company reported that consolidated net loss of $3.40 per share for the year, the first annual loss since the repositioning of the business in 2002.

Turning specifically to the Fourth Quarter we reported a net loss per share of $3.98. These results were the net effect of major losses in the institutional segment despite a continued strong performance in retail.

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

This transaction generated a net loss of 2.2 billion dollars. At the time of the announcement, we also indicated that we expected to end the year with an allowance from loan __ that is approximately $400 million. We increased our provision in excess of charged offs in the Fourth Quarter and increased the ending allowance, finishing the year with a total allowance for lone office as $508 million. The increase to our provision and allowance levels in the Fourth Quarter reflects our view on the timing of losses, rather than a change to our expectation for accumulates of losses.

Through this additional reserves, we ended the year with a 200% coverage against non-performing home equity loans, 116% coverage in Q3. Both the real life loss from the ABF sale 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 worth noting. We are required to evaluate the book value of goodwill carried on the balance sheet for impairment. As a result of the decline in fair value of the balance sheet management business, the goodwill associated with this business was impaired resulting in the write-down of $101 million in the quarter.

While this goodwill write-down increased the per share loss for the quarter by $0.21, it is important to keep in mind that it is a non-cash item with no impact to potential equity. In addition, professional service fees and expenses increased by $14.5 million, driven by higher legal consulting and outsourcing fees. We did not expect these expenses to recur at this 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 previously announced. Other expenses increased in the quarter by $9 million and about half of this increase was non recurring item related to regulatory fees and TNE expense. Expect other expense to return to the run rate that is more consistent with the first and second quarters 2007.

Advertising increased $15 million quarter-over-quarter. However, most of this increase was planned in advance of the quarter. A portion of the increase is about $4 million. It was due to our decision to increase our customer communication and presence in the market 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. Clearing or servicing expenses declined by $ 13 million, a direct benefit of the aggregate from our institutional brokerage operation. The action taken this quarter to sell our ABF portfolio and simultaneously to replenish the related bank capital did result in a large loss. But it addressed our primary financial risks and allowed us to begin the process of restoring customer confidence.

This transaction provided timely stability for the business and helped 12 customer concerns by providing us with three primary benefits. It stabilized customers by instilling confidence and the viability of a company. It provided additional funds with the parents to enable the bank to address potential losses in the home equity portfolio and its strengthened excess capital level.

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

Robert Jarrett Lilien

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

On Slide-7, you can see that through the Third Quarter, the retail business was on a steep growth trajectory. This growth was driven by our success in attracting, retaining, and migrating customers into our highest value segments. The quarter drivers of the business including net new accounts darts cash and assets were all on pace to end of the year at record levels. As of 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% annualized growth in customer cash to a record $40 billion. We also generated the strongest organic account growth we have seen in over seven years including a 23% annualized increase in our target segment accounts. As a result of the financial challenges in the bank’s balance sheet. Confidence was shaking in November.

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

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

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

This was apparent this past Tuesday, when saw two times the two times the normal level of cash inflow through our quick transfer product from external sources, while at least one of our competitors had platform issues and difficulty handling the high market volumes of the day.

Overall, the pathway back for us, started with the Citadel capital infusion. And now continues with our turn around plan. The plan addresses the companies financial challenges and in doing so, allows us to get past the concerns that we have been facing. Restore our confidence and return our franchise to growth. Turning to the plan into Slide 8, our rigorous assessment of the company evaluated all of our operations and resources. The plan we have created aggressively addresses the factors that lead to the concerns.

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

Slide 9 shows the home equity performance matrix and where we have already began to address this issue with the increase in loan loss allowance in Q4, current reserved levels, provides for annualized in this portfolio of nearly 4%. This compares in the annualized charge operate of just under 3% that we experienced in the Fourth Quarter. The combination of increased loan loss allowance and a growing base of excess bank capital provided additional 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 next three years. And this, expectation is consistent with evaluations performed by independent third parties. As a further example, on Slide 11, we show our home equity portfolio and cumulative loss outlook in its context of the Wells Fargo Liquidating home equity portfolio, while the Wells Fargo portfolio is similar to ours in terms of size, the underlying credit characteristics, firs lean position, exposure to California and origination channels in our portfolio are better. Despite these differences our forecast of losses in reserved levels are in a similar range.

In 2008, we expect provision expenses to be between 400 and 600 million; we entered the year with reserves of 508 million and expect to exit 2008 with strong reserves and excess regulatory capital approaching $1 billion in building overtime.

In our view, this positions us to withstand our forecasted losses over the next three years while remaining well capitalized at all times. If market conditions change dramatically in 2008, clearly we would need to make adjustments to our reserved level but given the information we have today and the independent third party credit analysis of our portfolio, we believe our reserve levels are appropriate and reasonable, we expect home equity loans to decline by approximately 15% front current balances over the course of the year, as this portfolio runs off.

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

This includes potential loan modifications and aggressive efforts to reduce open, were undrawn credit lines. We are already making progress in this front, open home equity line commitments have declined in the past several months by a billion dollars, returning to the capital levels at the bank, we plan to build up excess capital through a combination of retained earnings and further the leveraging. Our plan calls for us to end 2008 with capital in excess of well capitalized standards of nearly a billion dollars at both the tier one leverage and risk based measurements.

Progress towards reaching these targets is already underway and it has benefited from $150 million received from Citadel 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 earned at the holding company is the second element of the turnaround plan. We will improve capital and liquidity at the holding company overtime through a combination of asset sales and potential capital markets transaction. Decisions to sell assets are focused on none core businesses and investments and actions here are already in the works as well.

We generated $10 million in asset sales in the fourth quarter and we see an opportunity for 250 to 300 million for all of 2008. We expect about 2/3rd of this amount to come in the first half of the year. We have also identified a number of other potential capital raising activities and these could further benefit the second half of the year. We will be both disciplined and opportunistic in selecting the action we will take, our objective to reduce leverage at the holding company of DOD’s initiatives if there are down payment towards improving our credit ratings over time.

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

Fortunately, the core business and the strength of our valued proposition remain intact. Even as we experience the spike in nutrition from our retail base in November and into December, we continue to generate strong new account opening demonstrating the continued attractiveness of the E*TRADE brand. The same competitive advantages that existed before the crisis continued to exist today. As we take the steps, I have outlined to improve the financial stability of the company and restore confidence; it is of paramount importance that we continue to invest to remain an industry leader. As part of the plan, we expect to increase total marketing spend in 2008 by approximately 30% of over 2007, which amounts to about $ 45 million.

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

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

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

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

The second phase of expense reduction includes exploring further organizational streamlining including additional operations in technology integrations between the bank and broker and the benefit of the second phase actions, they are not currently budgeted for 2008 but could represent an opportunity to take another 40 to 50 million dollars in cost out of the business overtime.

Through and increased focus on expense discipline we can do investments to keep the core franchise on track for growth while we address the financial concerns of investors. It is important that we work to restore investor confidence; we do not loose our focus on delivering a world class experience for our customers.

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

We think this is more constructive than providing what would have otherwise then a wide range of potential bottom line results. In addition, we are reinstating monthly metrics to help you gauge the trends of the business over time. Through the combination of monthly and quarterly reporting, you will get a good view for the progress we were making on a turn around plan in the overall performance of the business. While we expect to return the company to profitability in 2008, we are anticipating a net loss in the First Quarter.

The expected loss in the first quarter is the result of timing differences between the benefits of our plan versus higher provision levels and greater charge up, expected in the early part of the year. In addition, we expect investments in marketing and new products to pay off later in the year with expense sitting in the first quarter. The head win from these loaded expenses will ease as the year progresses. Our expected ranges and levels for the key drivers of the business are affected by two factors.

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

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

We expect average interest earning assets of between 45 and 49 billion, which is down from 52 billion at year end. This decline is the result of continued prepayments and pay downs but does not assume any capital market actions. I have already covered provision 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 CEO and we expect to have a resolution on this topic by the end of February as the board originally committed. In closing, I just like to reiterate a few points, our core retail franchise remains strong and stable as a result of the actions we have already taken, through the plan we have outlined today, we will continue to address concerns about the business by strengthening our capital position, managing future loan losses in an orderly fashion and restoring growth to our core retail business.

E*TRADE is an industry leader for a reason. The value of proposition we offer plus our ability to develop innovative products and provide quality service to our customers is what built this company, it is our core competency and it is what we will return the franchise to growth.

With that, let me open it up for questions.

Question and answer session

Operator

(Operator instructions)

Your first question is coming from Richard Repetto with Sandler O'Neill

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

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

Robert Jarrett Lilien

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

Basically, if you looked at the Fourth 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, before they get better. And our expectation is that they will get worst in the first half of the year and then we will start to see some improvement on the second half of the year.

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

Okay and I guess that my one follow up is a little bit of more on than. It does not have to do with deterioration that you have seen or an increase deterioration of the portfolio. And let me tack on. Can you also talk about the 101 impairment a little 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 in the allowance was not because of further deterioration versus expectation. I wanted to stay that we do expect things to get worst. We expect the slowing of economy. We expected that there would be more defaults. We expected that housing prices will continue to decline.

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

Robert Simmons

Rich, on the question of the impairment of good will, it is really a year on our product this year on which we go through and evaluate your will for impairment to make sure that it still represents the value that is should on your balance 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, the goodwill related to balance sheet management was determined to be impaired so we took that charge in the fourth quarter, which again is the none cash charge and does not impact regulatory capital but did big impact our EPF as we have said.

Operator

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

Matt Snowling - FBR Capital Market

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

Robert Jarrett Lilien

We adequately lost some high value customers and that goes without question. As we have said in the prepared 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 not see but, but we actually had growth in the quarter overall in our active trader segment. And in our active segment, that also qualifies as high asset customers which we call the ideal segment where we saw in that lost is overall wherein the balance customers, the people holding really, buying the whole or cash only customers. To that, that is a little bit on the profile.

Matt Snowling - FBR Capital Market

Okay. This is a real quick follow up. Can you give in the sense 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 an interesting one for us. We expect 75 basis points more to come. On one level, fed cuts can only be good news. We would hope that they would improve credit and help on some of our portfolios performed better than expectation in terms of spread. It actually works against you because you will have some spread compression because of what will happen on the cash side of the balance sheet. Offsetting that spread compression though would be the fact that we are de-levering in the part of the balance sheet that we are de-levering which have to be more of the carriage trade or low spread trade. So, overall, even with more fed cuts building to our plan, we do expect some modest spread expansion, but basically, the rest is built into the plan.

Operator

Your next question is coming from William Tanona with Goldman Sachs

William Tanona - Goldman Sachs

I apologize if you guys already talked about this earlier. I came on a little bit late. But you are looking at 84 cents in terms of tangible value. Offset does not give you a much in a way of flexibility and you have mentioned additional capital raises. And so, why do you not give us a sense to how much you think you may need to raise and what forms you kind thinking about rising? And, how do you think about using that? Would that be something to rise just to try to unload some of that home equity portfolio or like we have seen some of that larger investment banks? Or what would be something that you would just want give yourself a little bit of additional cushion to try to work through some of the mortgage loan that are on the balance sheet?

Robert Jarrett Lilien

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

The topic that you bring up is one that is essential to our recovery plan. It is very much of a focus for us. We have reopened the potential of, in addition of asset sales, capital market related transaction opportunistically potentially later in the year. But, one of our key objectives to this is to increase capital and de-lever the holding company from here.

William Tanona - Goldman Sachs

Okay. Were you able to sell any of the home equity portfolios in the quarter or was that all kind of 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 to it. We are still in an irrational market. The way we looked at it, the capital markets are more or less closed right now and selling would not be an option. So, we are holding those securities that are those loaned, that is our intention. Ad again, as we want to which you might have missed in the prepared remarks. Because from here, it is about making sure that we have an appropriate reserves and that we are building excess capital to withstand in the ordinary course of business and any lawsuits that come our way.

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

Operator

Your next question is coming from Roger Freeman with Lehman Brothers

Roger Freeman - Lehman Brothers

I wanted to come back to the timing issue of losses that you have talked about before. I guess, as the 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 of the press release. The charge off rate increased significantly there. And I guess that if you really look over the last two quarters now, both of on to four family portfolio and the Hemlock Portfolio have seen delinquencies increase in $100 million range. So it seems like they are both performing similarly. I know that one to four family portfolios is bigger but can you talk about 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 home equity portfolio and that is the one where we expect the majority of losses for 2008. You are right. We did see an up check in losses coming out of the one to four family. But they are still at a very low level. We still have a portfolio that is better than the industry average in terms of credit quality. But even so, as said, it is not immune to what is going on and so there is an expected up check in some of the charge offs there and that is included in our allowance forecast for this year.

Roger Freeman - Lehman Brothers

Okay. My second question would be around the nature of the cash that is coming in the door. So your cash balance is not enough and the answer here provides a current customer cash balance. But it has been fairly stable since the end of November yet. Obviously, Ameritrade because they are still seeing their heightened levels to cash coming out of E*TRADE to them.

And so, is the cash replacing coming in mainly through CDs here which I think we look on bankrate.com, which is the highest in the industry, 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% of them were really concentrated on the two week period at the end of November.

Things are pretty much stabilized since then. Also, we have seen some of the reverse. We did see a big day on Tuesday. The market’s activity was very busy. We had a record number of users logged on to the E*TRADE system. And at other places, that cost slowness and outages and we saw some of that money come back. So that is the nature of the whole transfer of assets. Some goes on one day and some comes back. The majority of who went to a Ameritrade though was really in that crisis period.

As to the money that is coming in to cash products, first of all, you would want to look at the cash that is left. And a significant portion of cash that is left was actually in our highest rate product being the complete savings account. And likewise on the return, it has 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 the bank product with was 3.8%.

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

Operator

Next question is coming from Howard Chen of Credit Suisse.

Howard Chen - Credit Suisse

I just wanted to follow up on the one to four family portfolio, what is the specific deterioration that you are making into your assumptions? Is it a 10% reserve coverage for 2008? And, can you update us on the state of any insurance or CDS that you might have against that one to four family portfolio.

Robert Jarrett Lilien

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

Howard Chen - Credit Suisse

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

Robert Jarrett Lilien

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

Howard Chen - Credit Suisse

And then the second question I have, what is the current state 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 had going into the federal transaction, we canceled. As you know, there was nothing outstanding on it at the time of the cancellation. And we are currently working to establish a new revolver that would be at a holding company level again that would be part of our on-going liquidity program and we will give more detail as appropriate. But we would expect to have some more to say in the not so different future.

Operator

Your next question is coming from Michael Vinciquerra with BMO Capital Markets

Michael Vinciquerra - BMO Capital Markets

What is the available draw for you client? You said that you expected to drop the balances of about 15% from pure run off this year. But your clients, I presume have ability to make additional withdraws. Is there anyway 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 the mitigation networks and some of that as I did mention in the prepared remarks that is around trying to reduce those undrawn balances.

Robert Simmons

A major part of the work that we are doing in our mitigation for the portfolio would include looking very heavily at draws. We have drawn elimination plans and play for their services now for customers who become delinquent. We are also looking at our ability to put hold on those potential draws based on changes in house value and changes in the 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 have somewhere around 90 million a quarters assuming the borrow from CDL, is that in the 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 win them all.

Operator

The next question is coming from Prashant Bhatia with Citigroup

Prashant Bhatia - Citigroup

The repos of about $9 billion at the end of the year, it looks like they are down about $2 billion during the quarter. Could you us the feel for how much of those mature 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 the auditors, is that something that you have had discussion about or that is something 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 for loss 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 $20 million 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 understand the capital impact, can you just give me a condition, Hillock markets continued to deteriorate. Let us just assumed, this is a bad case scenario and let us just say that given that lot of the Hillocks where ‘06, ’07 vintages, let us say that either the $1 to $1.5 billion accelerate, then maybe two year or maybe the losses end up being a little bit higher. What I am just trying to understand is, if you end up, let just say operating a lost for a little longer, how much of a capital caution do you have and in particular. But, when you look at the equity at the broker risk, the equity at the bank, like how negative can the tangible equity or the equity of the broker in order to maintain the equity capital at the bank to be like well capitalized. You guys are not different, I mean lot of the growth online broker has a negative equity at 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 in at the end but when we announce the federal bill, we trap about at that time having $364 million of excess capital above the well-capitalized levels. We had risk ratio tier line risk based of 590 and 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 excess capital of $417 million. We have talked about the extra Citadel money coming in January. We have talked about the business. I think reasonable expectations for the growth in the business are not incredible and yet we expect to be through retain earnings and delivering.

We expect to end the year with a billion dollars of excess capital at the bank and again risk rations well an access of well-capitalized. So, if you have take it and you say, could charge house be worsen, we are expecting and if we have to had probation be hire, already we can stomach a lot of that in 2008. And, clearly if we get in 2008 as we plan to you 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 can reasonably address it and one of our real goals through our 2008 is to get everybody comfortable with that so that we really take off the table as an issue or as an ongoing topic of discussion.

Mike Carrier – UBS

Michael as you know the broker have stand, their own stand along capital requirement. So, obviously they cannot be negative and we would not expect them to be negative. I am not sure where that question was going but with respect to and to something a parenthetical to what Jarrett said, that when we talk about our ending AO capital, excess capital approaching the billion dollars and excess of well capitalized standard, that is not just necessary, that does an include potential equity that we have at the holding company level. It does not include other potential equinity that could come from other assets sales. So, there are a lot of different ways in addition to the capital that we have model and layout for you today, that we can still be comfortable with our capital edition even in worst case scenario than we are laying out for you today.

Operator

You next question is coming from Michael Hecht with Banc of America Securities

Michael Hecht - Banc of America Securities

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

Robert Jarrett Lilien

Yes, we did talk about in the prepared remarks, the board is always committed from the very start of the process that effectively they have completed the process by the end of February and they are still on tract to meet that commitment.

Michael Hecht - Banc of America Securities

I just wanted also to clarify something I thought, I heard you say, so you guys expect the enterprise wide spread to increase next year from 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 the answer is yes, but modestly and again a big reason for that is a smaller balance sheet where you gotten read of some of the narrow spread carry tree but clearly lower rates are working against us and create some spread compression on the cast set.

Michael Hecht - Banc of America Securities

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

Robert Jarrett Lilien

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

And just adding to that, if you look if something new that comes out at some point in the Proxy but of the top five officers in the group that would be in the proxy, those directly responsible connected to the balance sheet issue are gone and showing up in severance here. The remaining proxy officers are certainly accountable 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 - Mary Lynch

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

Robert Jarrett Lilien

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

Brian Midell - Mary Lynch

You got 10% home price deep appreciation in 2008 and another 5% in 2009.

Robert Jarrett Lilien

For those area that we do not have specific market data form.

Brian Midell - Mary Lynch

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

Robert Jarrett Lilien

But we have got 75 more baked into 2008 and that is in the plan so far. I would say a nice about where we are with this numbers versus where everybody was, let us say five or six months ago, is that it was hard to take your assumption and validate them or verify them anywhere. What we have been able to do and again November and December and now is through third parties to get another look through additional internal model that we have added, adding our own assumptions, take a look but also again as we talked about and prepared remarks, we have been able to see what other banks are doing and 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 is something that is different than what it was, again five to six months ago to really verify and validate some of your assumptions and your numbers. So, we feel we have been responsible and that these are reasonable estimates.

Robert Simmons

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

Brian Midell - Mary Lynch

Now, there is one other question that I expected someone to asked but since they did not, I am going to asked it, so Rob can you answer it, there are going to be some interesting thins 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 expect a 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 20 million. The addition tax expenses, I talked about release primarily to the fact that we have got a portion of out interest expenses on our new spring ling note that are nondeductible for tax purposes as well as some of the tax contributable, the earning of our foreign operation. So, again the overall effective tax rate is going to be base on the number of doctors that we think a pro-form effective rate of 37% to 38% plus $15 to $20 million an additional expense.

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 to put behind us. We do have now a clear plan and that plan included execution and then includes retail growth, things that we are good at and things that we have done before. So, we look forward to the coming quarters to report on our progress and success around the plan and thanks for joining us tonight.

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

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

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

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