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E*TRADE Financial (NASDAQ:ETFC)

Q2 2012 Earnings Call

July 19, 2012 5:00 pm ET

Executives

Steven J. Freiberg - Chief Executive Officer and Director

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

Analysts

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

Brian Bedell - ISI Group Inc., Research Division

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

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

Howard Chen - Crédit Suisse AG, Research Division

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

Alexander Blostein - Goldman Sachs Group Inc., Research Division

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

Michael Carrier - Deutsche Bank AG, Research Division

David J. Chiaverini - BMO Capital Markets U.S.

Faye Elliott-Gurney - BGB Securities, Inc., Research Division

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

Christopher Harris - Wells Fargo Securities, LLC, Research Division

Operator

Good afternoon, and thank you for joining us for E*TRADE Financial's Second Quarter 2012 Earnings Conference Call. Joining the call today are Steven Freiberg, E*TRADE's Chief Executive Officer; Matt Audette, Chief Financial Officer, and other members of E*TRADE's management team.

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

This call will present information as of July 19, 2012. Please note that E*TRADE Financial disclaims any duty to update any forward-looking statements made in the presentation.

During this call, E*TRADE Financial may also discuss some non-GAAP financial measures in talking about its performance. The company provides these measures due to its belief that they provide important information about its operating results. These measures will be reconciled to the most directly comparable GAAP financial measures either during the course of this call or in the company's press release, which can be found on its website at investor.etrade.com. These non-GAAP financial measures should be considered in conjunction with the comparable GAAP measures.

This call is being recorded and a replay of this call will be available via phone and webcast beginning this evening at approximately 8:00 P.M. The call is being webcast live at the investor.etrade.com. No other recordings or copies of this call are authorized or may be relied upon. Following management's comments, the call will be opened up for questions. [Operator Instructions] With that, I will now turn the call over to Steve Freiberg. Steve, the floor is yours.

Steven J. Freiberg

Thank you. Good afternoon, and thank you for joining today's call. The second quarter was another significant step forward for E*TRADE as we grew our 4 franchise in the face of macroeconomic challenges at a market-wide lull in retail investor engagement. We continue to derisk the company, submitted our strategic and capital plan to our regulators and completed our offer to purchase auction rate securities.

We reported earnings per share of $0.14 on revenue of $452 million, inclusive of a few unique items, which Matt will cover in more detail. On the brokerage front, starts were down 6% versus the year-ago quarter, reflective of a generally weak retail trading environment. That aside, we generated healthy growth in net new accounts and assets, comprising the key long-term growth drivers for the franchise. Net new brokerage accounts of 46,000 brings the total for the first half of the year to 92,000 accounts, nearly equaling the 99,000 that we brought in during the entirety of 2011, and well above the 54,000 in 2010. Similarly, the $2.2 billion in net new brokerage assets brings the year-to-date total to $6.2 billion and places us on track to exceed our full-year levels of $9.7 billion in 2011 and $8.1 billion in 2010. Additionally, customer margin receivables ended the period at $5.8 billion, a 4-year high and reflective of increases in both the number of accounts using margin and balances per account during the quarter.

We were also proud to post another quarterly franchise record for brokerage account attrition of 8.4% annualized during the second quarter. This represents an improvement of more than 200 basis points from a year ago and is a testament to our focus on an extraordinary customer experience.

Turning to credit. Our legacy loan portfolio ended the quarter at $11.8 billion, down 5% sequentially and 64% from its peak. Our overall delinquencies were down 11% during the quarter while special mention delinquencies were down 7%. Both are at their lowest levels in approximately 5 years. We are proud of our progress on the continued derisking of the company as we closely manage the runoff of this portfolio.

As for our customer offering, we made enhancements to our E*TRADE pro- platform and simplified the overall user experience on the customer website. We added new tools, including a trading ladder and strategy screeners, giving customers even more realtime market depth and information, including realtime quotes for all E*TRADE 360 users. We opened 2 new branches during the quarter, one in Cupertino, California and one in New York City, bringing our branch total to 30. Over half of our 270 financial consultants reside within our branches providing an important point of contact for our customers, particularly as we expand our activities in the retirement and long-term investing segments. With $33 billion in retirement assets across nearly 800,000 accounts, we have a meaningful base from which to grow. Additionally, we ended the quarter with just under $1 billion in managed assets, over half of which are retirement assets. We're encouraged by our progress and are focused on continuing to build out our brand as a trusted destination for rollover accounts and other retirement services by providing solutions, advice and guidance and client education. Educated investors are typically more engaged customers, so we remain committed to our education efforts across a broad spectrum of categories with over 300,000 interactions during the quarter comprising seminars, webinars and videos, both live and on-demand. We believe that a clear indication of the increasing sophistication of our customers is the steady increase of options as a percentage of DARTs.

Options were 24% of trades this quarter, up from 20% a year ago and 16% 2 years ago. We also continue to experience steady growth in our mobile application usage. During the quarter, 6.6% of our DARTs were executed through E*TRADE mobile, up from 4% a year ago. More than half of these trades are through our iPhone application.

We are executing well in our Corporate Services group and as we exit the quarter, we have a healthy pipeline of prospects. This remains an important strategic channel for new brokerage assets and accounts. The relentless pursuit to provide cutting-edge products and technology and a superior customer experience will continue to drive our core brokerage business strategy, priorities and execution.

I'll now hand the call over to Matt to walk you through the financial results, after which I will follow up with additional comments and then we'll take your questions.

Matthew J. Audette

Thank you, Steve. For the second quarter, we reported net income of $40 million or $0.14 per share. I'll cover this in more detail later but I wanted to highlight upfront that our results included a benefit of approximately $0.04 from a few unique items and other expense and taxes.

Our second quarter net revenues were $452 million, down from $489 million in the first quarter and $518 million in the second quarter of 2011. Revenues included net interest income of $279 million, a sequential decline of $6 million driven by a 5 basis point decline in net interest spread, which was 244 basis points for the quarter. Given the margin growth we observed this quarter, we estimate our spread for the full year of 2012 will average slightly above 240 basis points.

Commissions, fees and service charges, principal transactions and other revenue in the second quarter were $154 million, down 11% from the first quarter and down 12% from the same quarter of 2011. Average commission per trade was $10.68, down from $11.04 last quarter as a result of lower activity from stock plan accounts. Year-over-year average commission per trade was down from $11.14 on less favorable product and customer mix.

Revenue this quarter also included $19 million of net gains in loans and insecurities inclusive of a $5 million impairment.

Total operating expenses declined sequentially by $25 million, reflective of a seasonal decline in advertising and compensation, as well as $3 million related to legal settlements and reserves and a $10 million benefit related to our offer to purchase auction rate securities. As a reminder, we established a $55 million reserve in the third quarter of 2011 related to settlements and our offer to purchase eligible auction rate securities from customers.

In the fourth quarter of 2011, we refined our estimates and reduced this reserve down to $48 million. During the current quarter, we completed this program having purchased in approximately $145 million from eligible holders. The total losses we realized on liquidating those positions was approximately $10 million less than our reserves for this program. With the completion of the offer to purchase, we do not believe we have any remaining material exposure related to auction rate securities.

Our effective tax rate for the quarter was 35%, which included a benefit of $6.7 million primarily related to state tax credits generated from software development. Without these credits, our effective tax rate this quarter would've been approximately 45%, which is consistent with our expectations for the tax rate going forward. DARTs for the second quarter were 139,000, a 12% decrease from last quarter and down 6% from a year ago. I would note that July-to-date DARTs are tracking down 1% from June.

Net new brokerage accounts were 46,000 in the second quarter, flat with the prior quarter and up from 25,000 in the second quarter of 2011. Net new brokerage assets totaled $2.2 billion during the quarter, representing 5% annualized growth. This was down from $4 billion last quarter but up from $1.5 billion in the second quarter of 2011. We ended the quarter with $29.2 billion in brokerage-related cash, a decrease of $1.8 billion during the quarter, as customers were net buyers of $3.9 billion of securities.

Margin receivables ended the quarter at $5.8 billion, up 9% for the prior period with average balances of $5.6 billion, up 14% sequentially. Our legacy loan portfolio ended the quarter at $11.8 billion, a contraction of $624 million during the quarter and is now just 36% of its size at the peak. The average age of the loan within this well-seasoned portfolio is now approaching 6.5 years. We expect loan runoff will continue at a pace of approximately $600 million per quarter for the remainder of this year.

Total net charge-offs in the quarter were $121 million, down from $316 million the prior quarter. As a reminder, approximately half of the charge-offs in the first quarter related to our review of modification policies and procedures. If we exclude these charge-offs and look at Q1 on a more normalized basis, charge-offs declined by greater than 20% this quarter. Delinquency performance across the portfolio trended positively as the 30-to-89-day delinquent category improved 7% sequentially and 24% from a year ago. Total at-risk delinquencies are the 30- to 179-day delinquent category, improved by 6% in the period and 28% from a year ago.

Provision for the quarter of $67 million was down from $72 million in the prior quarter. I will also highlight that the provision for 1-4 family loans was relatively minor this quarter at just 250,000. This was driven by 2 factors. First, there are less newly delinquent loans. And second, we received $11 million in settlements from third-party mortgage originators, bringing our life-to-date total of putbacks and settlements to $370 million. We do not expect material feature benefit from settlements of this type as the majority are behind us.

The total allowance for loan losses for the quarter declined by $53 million to end the period at $526 million. We modified $125 million of loans during the quarter, which was down from previous quarters. We expect TDR volumes will continue to decline, partly due to the elimination of certain Home Equity modification programs, but also reflective of fewer loans to modify as the population of newly delinquent loans continues to shrink.

With regards to the performance of our existing modifications, the average regional delinquency rates 12 months after modification has improved slightly for 1-4 family loans to 25% and remain stable for home equity loans at 42%.

With respect to initial loan resets, we do not expect this to be a material driver of credit costs this year. During the second quarter, approximately $440 million of 1-4 family mortgages reset for the first time, bringing the year-to-date total of $920 million, with another $60 million in the second half of this year. Of all 1-4 family loans that were reset this year, approximately $27 million are expected to experience a payment increase of 10% or more.

On our home equity lines of credits, which represents 78% of the Home Equity portfolio, we have approximately $290 million of balances that are already amortizing, with an additional $50 million expected to begin amortizing in the remainder of the year. The vast majority of Home Equity lines do not begin to amortize until 2015 or beyond. With the limited data of a relatively small sample of amortizing loans, it is hard to call it a trend but generally the performance of these loans is consistent with the performance of loans that are not yet amortizing. As of the end of the second quarter, 4% of amortizing home-equity loans are 30- to 179-days delinquent, compared with 3.5% for home equity loans that are not yet amortizing.

Last quarter, we highlighted new supervisory guidance around the treatment of interest for performing junior liens behind nonperforming firsts. At the time of last quarter's call, we estimated the effective population of loans to be something less than 10% of our performing seconds liens. Having completed our analysis in the second quarter, the affected population is far less than our initial estimate, totaling approximately 4%, or $180 million, of performing second lanes. During the quarter, we placed these loans on nonaccrual status, reducing interest income by approximately $1.7 million, which was applied as a reduction to the loan balances. This exercise did not impact our reserves for loan losses as we already contemplate these factors on our loss modeling.

Turning to our financial position. Corporate cash ended the quarter at $437 million, representing over 2.5 years of debt service coverage. The decline of $47 million, related primarily to $82 million of interest payments, partially offset by other reimbursements and allocations from subsidiaries. As a reminder, our parent has approximately $400 million in deferred tax assets, which is a source of corporate cash in future periods.

On capital, we grew ratios at both the bank and parent during the quarter across all measures. This was a combination of capital generation along with a reduction in balance sheet assets driven by the decline in brokerage customer cash during the quarter. To highlight a nuance between the parent and bank ratios, parent capital calculation use average assets while the bank calculations are end of period. As such, this quarter's more pronounced improvement in the bank's ratios was indicative of a decrease in asset late in the quarter, which should benefit average assets at the parent in Q3.

Turning now to potential changes in capital requirements. Near quarter end, the Fed published a notice of proposed rule-making, or NPR for comment, regarding the implementation of Basel III capital calculations. We are still working through the details but I would like to highlight a few points we believe are relevant to E*TRADE. First, the Fed is seeking comment and an alternative method to include in Tier 1 capital the unrealized gains and losses related to government agencies' securities. If implemented, this would remove a substantial source of downside volatility from our ratios in future periods should rates eventually rise. Second, clarity was provided on proposed risk weightings, which we estimate could actually lead to an improvement to our ratios under the calculations laid out in the NPR. For the mortgage portfolio, which is currently risk-weighted between 50% and 100%, to average about 80%, we estimate risk weightings could increase to approximately 120%. Offsetting this is a likely reduction in the risk weighting of customer margin loans, which are currently risk-weighted at 100%. We estimate there could be a substantial reduction to as low as 0% for overcollateralized margin loans, which would more than offset the capital impact from the residential mortgage portfolio.

For our parents Tier 1 common ratio, which remains the central focus of the new guidelines, we estimate that our ratio of 10.2% under current Basel guidelines would improve by approximately 70 basis points should all elements of the NPR be implemented. I would just caution that we're not certain that will be the case and that some or all of the proposals are subject to change before implementation, which is not proposed to occur until 2015. Under these new guidelines, as well as current ones, Tier 1 leverage remains our constraining ratio. And as I discussed last quarter, we are working to address this ratio by reducing the overall size of the balance sheet.

The balance sheet declined by $2 billion during the quarter mostly as a result of a decline in brokerage customer cash due to customer purchase activity. While we don't have anything specific to announce today, we are working on several strategies to reduce the size of the balance sheets and we hope to have some specifics for you by next quarter. To highlight the liabilities we would target reducing in order of preference, first is wholesale funding, as it is expensive and not core to our strategy. However, because the costs associated with exiting these obligations have likely proved to be more punitive to capital than beneficial, we do not view this as a viable near-term option.

Second is banking deposits, specifically our complete savings account. We recently reduced the rate paid on this account to 5 basis points and the balances declined by nearly $500 million during the quarter. These deposits are also not core to our strategy and we are reviewing other options beyond just adjusting the rate. It is also important to note that a portion of these deposits are tied to valuable brokerage customers, so we would be mindful in targeting these deposits.

The third category is sweep deposits for our 4 brokerage customer cash. While moving sweep off balance sheet could be the easiest option to implement, it is also the option we would need to structure with maximum flexibility to recapture balances on our balance sheet and in a manner which would be seamless to customers.

On the regulatory front, we submitted our long-term capital plan to both the Fed and the OCC at the end of June. The plan we submitted forecasts our business and outlines capital distribution in currents and adverse operating conditions over the next 5 years, applying internally developed stress tests similar in nature to the recent CCAR test. The extensive work that went into creating this plan facilitated a valuable assessment of all elements of our strategy and facets of our business to ensure that we are focused appropriately in consideration of the operating environment, optimal capital generation and risk profile. While the plan was quite detailed and extensive, the core principles that will be our primary strategic guide in the near-term can be summed up simply as follows:

First, continue our focus on our core retail brokerage business, which is the heart of this company. Second, develop cost reduction targets and an enhanced focus on efficiencies. Third, strengthen our risk profile by reducing credit costs and the size of the balance sheet. And fourth, focus on enhancing our credit and risk management functions to ensure they meet the standards for the current regulatory environment.

Given this revision in our focus, we have realigned the bank organization to have an exclusive focus on derisking, deleveraging and bolstering our enterprise risk management functions. Accordingly, we have ceased any plans to offer new banking products to customers, including mortgages. With this organizational realignment, Steve has taken on the additional title of Bank President, while select responsibilities have been distributed among other members of the senior management team.

In closing, and to emphasize our top priority from a financial and franchise standpoint, we recognize that freeing up bank capital and reducing the cost of our corporate debt is one of the most accretive things we can accomplish in the near term. Therefore, improving our risk profile, capital position and regulatory relationships are the primary objectives behind all initiatives going forward.

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

Steven J. Freiberg

Thank you, Matt. In summary, although it's a challenging environment, we have continued to execute well and have grown our core business, strengthened our financial position and improved our risk profile. I am proud of our employees at what we have accomplished so far.

Our accountant asset growth, coupled with high levels of customer satisfaction and improved retention are a testament to the hard work and dedication of our team. While we generated capital, effectively boosting or bolstering key ratios in the period, we look to continually improve these measures. And finally, we have made significant and continuous progress in reducing our legacy credit exposure.

As we have discussed, the current environment presents many challenges although as a management team, it's incumbent upon us to focus on what we can directly control. As Matt mentioned, we are in the process of developing cost reduction targets with an enhanced focus on efficiencies. We are specifically targeting areas that are not core to our brokerage franchise or have a low potential return in the current environment. Therefore, we plan to reduce at least $40 million from our expense base. This includes targeting a reduction in costs of at least $50 million, offset by a $10 million investment as we build out our enterprise risk management function and fully address the heightened regulatory environment. We expect to have the cost reductions fully implemented by the end of 2013, although we're aiming to complete the majority of the reductions within the next 12 months. Throughout the remainder of this year, we will continue to focus on the initiatives that we began in the first half, including continued growth in our core brokerage franchise, deleveraging, derisking, expense reduction and dialogue with our regulators related to our strategic and capital plan.

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

Question-and-Answer Session

Operator

[Operator Instructions] And your first question comes from Chris Allen from Evercore.

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

I guess if you just touch on the spread outlook to start. 240 basis bps over the course of the remainder of the -- 240 for the full year. Does that account for margin balances remaining where they are right now?

Matthew J. Audette

Chris, it's Matt. It does. If you go back to the last quarter, our estimate for the year was around 240. And in my prepared remarks said I -- we estimate slightly above 240 and the increase in margin we saw in the quarter was one of the primary reasons for that. So if you have your own assumption of margins are going to increase dramatically, it would definitely improve our spread and the opposite would be true as well. If that goes down, it would certainly decrease spread.

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

Got it. And then just on the cost reduction efforts. I mean, can you give us any examples of the specific areas you will be looking to target?

Matthew J. Audette

Sure, Chris, at a high-level, everything. So there's no one big area that we would target other than having the philosophy of being more efficient. And then in everything we do getting an extreme focus on prioritization and making sure that everything that we do are the most important things we needed to do and things that are lower in the priority list, we would stop doing. So it's each and every area of the company that needs to get more efficient and more focused and that's -- so the costs will really come from everywhere.

Operator

And your next question comes from the line of Brian Bedell with ISI Group.

Brian Bedell - ISI Group Inc., Research Division

Just talk a little bit again about the arm repricing on the 1-4 family. How much is left to reprice over the next 1 to 2 years?

Matthew J. Audette

Sure. So on the 1-4 family portfolio, it's about $6 billion, about $5 billion of that overall adjusts. So far, about half of it has already adjust and the other half really isn't going to adjust in a meaningful way until 2015 and '16. So it's well off into the future.

Brian Bedell - ISI Group Inc., Research Division

Got it, got it. Okay. And then on the margin loan balances, I know they're up at quarter end. Is it your view that you have given the slowdown in retail trading we're seeing in the summer...

Steven J. Freiberg

Could you complete that, Brian? Operator?

Operator

Sorry, it looks like his line got disconnected [Operator Instructions].

Brian Bedell - ISI Group Inc., Research Division

Just on margin loans, just trying to get a sense of the direction obviously, good performance in the second quarter and into quarter end and just trying to get a sense of how you're seeing that play out over the summer, where do you see that pull forward?

Steven J. Freiberg

Yes. Brian, let me just give you some perspective. It's hard to be prospective on it, so maybe perspective is better. If you look at the first 6 months of the year, where we ended 2011 into the end of the second quarter, the expansion in margin balances was actually quite impressive, at approximately $1 billion from the $4.8 billion to $5.8 billion. The amount of net buying in the second quarter, even though the DART activity was somewhat depressed relative to a more normalized set of trends for industry-wide, the net buying was quite extensive by our customers, I think, approximately $3.9 billion of net buying. And so within that context, clearly, our customers have made more of a bullish view and have used leverage within that frame. What I can tell you is that we haven't really seen any change in the early going in the new quarter but it's very hard to predict out over the horizon so hopefully that puts the context to it. So this has not been a one-quarter phenomenon. We've seen the expansion over the first half of the year. We seen substantial net buying by our customers and it's hard to predict whether or not that trend will continue. But as Matt made the point, it's a trend that we like.

Operator

[Operator Instructions] Your next question comes from Rich Repetto with Sandler O'Neill.

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

I guess the question is on the provisioning, Matt. I didn't quite get what you said about the 1 to 4 being sold to 250,000 but -- and also adding on to that question, the Home Equity provision seems like it's going up and down. I'm just trying to see what's the sort of the run rate or normalized -- should it, rates should have been for the quarter or so amount?

Matthew J. Audette

Sure, Rich. So on the 1-4, a couple of things there. I was just trying to highlight why the provision was still low at 250,000 for the quarter. The primary item was we had some settlements with third parties during the quarter, so putbacks, which happen all the time in every quarter. This quarter, it just happened to be primarily focused on the 1-4 family books. So if you kind of look back to last quarter, when it was around at $16 million, that's one of the big reasons it was lower this quarter. From a more normalized perspective, I think that the comments and our thoughts on provision are really the same that they've been in the past -- for quite some time now, which is over the long-term, we expect it to decline. But in any given quarter, you can definitely see some volatility. And then when you look at it by products, so by 1-4 family and by Home Equity and by consumer, that volatility can be even higher. So it's going to be choppy but we think the long-term trend will -- down will continue.

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

Okay, okay. And then I guess, Steve, I know you did put a lot of time and effort and thought into the capital plan. And I know it's a very recently submitted at quarter end, but any feedback or any discussion with the regulators? And how is that affecting your planning when the Springing Lien Notes come due in December or can be called in September?

Steven J. Freiberg

Yes, very much the relevant question. Given both the OCC and the Fed really have possession of both the strategic and capital plans for a matter of weeks. We really had no tangible, I would say, conversations at this point, as they're digesting what we provided them. And we would expect over the coming, probably over the coming weeks and months, really on their schedule, to get good feedback on how they feel about our views. On the plan I submitted, it was, to Matt's point, a fairly comprehensive document, basically well in excess of 100 pages. We think it was, in our view, it made the relevant points from their level of interest but we're just not able at this point because we haven't had feedback to get into any detailed discussion.

Matthew J. Audette

Yes, and then, Rich, this is Matt. Just specific to the Springing Lien Notes. I think our thoughts there are similar to they've been for the past quarters, which is where -- if you look at where our existing notes trade today and you assume that's where we could issue new debt, the economics of refinancing would be incredibly positive but our gating factor remains the loss that would come along with our refinance, which if you just assume we called them at the first call date, which is at the year, the call premium would be something a little bit north of $100 million, or around $115 million. And then the discount on the existing debt's $150 million. So you got to put that together and even though the economics would be great, you'd have a P&L loss in the $260 million range, which would reduce our leverage ratio at the parent by about 60 basis points. So that's -- the gating factor for us is going to be really to get that ratio up to a point where we're comfortable with that after the refinance at a level where we're comfortable and the regulators are comfortable. So it makes the reduction of the balance sheet size incredibly important from my perspective.

Operator

[Operator Instructions] Your next question comes from the line of Patrick O'Shaughnessy with Raymond James.

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

A question for you on your net interest spread and I guess looking forward. Matt, are you at a point where you can kind of assess how the tenure has moved and interest rates have moved recently and the long-term impact of that on your net interest spread?

Matthew J. Audette

Well, long-term, so as far as next year I think if sitting in the environment we're in today, so being slightly above 240 for 2012, I think absent anything else, we'd probably drop another 10 basis points next year, but really no commentary beyond that, Patrick.

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

Okay. Well, that's helpful. And then I guess with my follow-up. There's obviously a lot of volatility in your commission for trade and you talked a little bit about it bouncing around. Kind of interesting there, you talked about how a derivatives are a larger percent to your trading volume. Now should we not be expecting to see some benefit of that derivative trading volume in your revenue per trade?

Steven J. Freiberg

When you look at the sort of the variance on the commissions in any particular given quarter, a number of factors, that's clearly one factor that tends to play to the positive, but if you look on a sequential basis, a more significant factor from quarter 1 to quarter 2 was a reduction in the number of Corporate Services group trades, which clearly come in at a substantially higher level of commissions. And it tends to be aseasonal as well as dependent upon the conditions of the market in any given period. And if we look on a year-on-year basis, what's interesting is, as we made the point, options and derivative trades are a higher percentage today than they were a year ago. But that said, because of the lull in, I would say, the broad-based retail trader, so even the trades coming in are stratified now more heavily towards the active trader, which tends to basically trade at a lower level of commission than the broad middle. It is essentially the composition of all those elements to get to the aggregation of what you see. So we see essentially on 7 or 8 different variables the ins and the outs. But when you take them in the aggregate, the particular quarter that you're seeing today has a heavy bias on the drop in Corporate Services group trades and they tend to be volatile and seasonal. But more importantly, as the broad middle has more or less retrenched at a higher rate then I would say the active trader, it's the level of commissions or the rate of commission that each of those pay.

Operator

And your next question comes from the line of Howard Chen with Credit Suisse.

Howard Chen - Crédit Suisse AG, Research Division

Your goal of alleviating leverage appears to be focused on shrinking the balance sheet. I guess given parts of the balance sheet growth are core to the retail brokerage franchise, are you ruling out, in a raising common or preferred to maybe alleviate that leverage faster, pay down that expense of debt, perhaps optimize the capital structure a bit faster?

Matthew J. Audette

Howard, it's Matt. So I would say we don't rule out anything. I think the -- any option that would improve our capital ratio that made sense for shareholders is something that we would look at. I think if you can tell by the area of our focus in over the past few quarters, in particular, and in our prepared remarks this quarter, that the avenue we think makes the most sense is through a reduction of the balance sheet size. So that's really where we're focused, but I think we would always consider anything that made sense for shareholders.

Howard Chen - Crédit Suisse AG, Research Division

Great. And then just my follow-up, sorry if I missed this in your prepared remarks, but is it still your view that provisioning expense will continue to trend lower from this quarter over the balance of this year?

Matthew J. Audette

So I didn't get that precise, Howard. I think that we certainly think the longer-term trend of going down will continue and there could be volatility in any given quarter. I mean, there could be volatility the next quarter compared to this quarter. So it's more of a longer-term comment than a precise comment to the next few quarters.

Steven J. Freiberg

But, Howard, broadly speaking, the primary driver will be the level of delinquencies. And if delinquencies have continued to basically move down, that should give you a good level of, I guess, inside as well as confidence in the direction but Matt's, I think, Matt's comments are important that on any particular quarter could have some volatility. But broadly speaking, as long as we can sustain a trend where the portfolio is dropping in size and the level of delinquency is dropping as well, that should be a good arbiter of what's to come.

Howard Chen - Crédit Suisse AG, Research Division

Great. And certainly, we've been seeing those trends over the past couple of quarters and years. I guess, just final one looking forward out on that. I was just hoping, Matt, can you just speak about some of the historical performance that you've seen on the loans that have reset?

Matthew J. Audette

On the 1-4 family books, so we -- we really don't have any specific date on that. I did give some commentary in the prepared remarks on the home equity size where they've gone from non-amortizing to amortizing. And the data there, it's really early days, and we haven't really seen any difference in performance there.

Operator

And your next question comes from the line of Keith Murray with Nomura.

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

On the pace of the decline in the servicing costs and clearing, it was down a little bit in the quarter. How should we think about the decline going forward? Should it sort of go down somewhat percentage-wise on par with the loan decline?

Matthew J. Audette

Sure. So if you break down the 2 parts on the clearing side of clearing and servicing is really going to move in line with trading activity. In the servicing side, in general, I think it will, yes, it will move down in line with the portfolio. The one caveat I'd have to that is keep in mind it can be a little bit lumpy and that the costs associated with default servicing and REO expenses and things like that can -- don't necessarily move in line with the size of the portfolio. But definitely over the long-term, that's the case.

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

Okay. And then back to the focus on capital. So thinking about the Tier 1 leverage ratio, do you guys have a target in mind? It's 5 to 7 now, do you think something in the mid-6 range is where you'd like to get to?

Matthew J. Audette

So for leverage ratio, in general, we want to get to a place where our regulators are comfortable with our capital ratios and we're at a point where we can efficiently distribute capital between the bank and the parent. So as you can imagine, we certainly put forth in our capital strategic plan what we thought those ratios should be. But really, the ultimate answer is we;ve got to get to a place where we're comfortable and our regulators are comfortable. So it's going to be something that evolves over time as opposed to something that we have today.

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

And then one final one, as I think about the Springing Lien Notes and the capital plan that you guys gave to the OCC and the Fed, is a partial refi or a partial retirement of the 12.5% notes included in that, or is that a thought that you guys might have?

Matthew J. Audette

So separate from the plan, I think it's absolutely a thought we would have. So we -- you could refinance the entire amount. You could certainly refinance the part. I think the most, given the economics of refinancing, any of it are so incredibly compelling. Our objective would be to get to a place where our balance sheet's small enough that we could refinance the whole thing. But certainly a partial refinance is a possibility.

Operator

And your next question comes from Alex Blostein with Goldman Sachs.

Alexander Blostein - Goldman Sachs Group Inc., Research Division

I had another follow-on to the Springing Liens, so there could be one more I guess. But do you have a view of how low, I guess, the regulators can allow you to go on a Tier 1 leverage given the fact that it is an immediate hit to capital, but it's really easy to see how economics will be very accretive. Basically the first quarter, you refinance that so -- and then I guess from there, there's other mitigating things you could do. So can you help us understand maybe a little bit more on the minimal level of Tier 1 leverage than I guess is still possible for you to be at in order to get this done?

Matthew J. Audette

Sure. So it's going to be very similar to our thoughts on having target leverage ratios overall. The most important thing is that we get to a place where our regulators are going to be comfortable with the ratios, in particular to our refinance here, will they be comfortable with a ratio subsequent or after that refinance? So it's something that hopefully we'll have some dialogue on and we'll get to that place. I can tell you personally, I wouldn't want to end, have a consolidated leverage ratio drop below 5.5% after a refinance, but that's just me and my feel.

Steven J. Freiberg

But -- and let me just add, clearly, our preference is to refinance this debt, and there's no equivocation on that point. I think Matt's point is that we need to have a level of comfort and are regulators need to have at least a level of comfort on the safety and the soundness of the institution. I can tell you a lot and clearly, the regulatory community, particularly at the parent, understands the economic value and merits of this transaction, and we just have to balance off all the elements. There's nothing that is unattainable here. But we haven't got to a definitive stage as of yet. And if you put it into full perspective, we ended the quarter as, I think, either you or Keith have made the point, at approximately a 5.7% leverage ratio at the parent. Clearly, that was based, that parent on the -- on basically on the averages, not the ending. You can call it maybe probably closer to 5.9% if you're using guide you to ending, but we still have to build a bit. But that said, the 5.5%, which is sort of a one-man's view, which I think is sort of a rational view, but the other side is the cost, if we took it all down at one particular point when they're callable, could cost us as much as, say, a 60 basis points on our leverage ratio. So we have to find the right level of balance working with our regulators, but the economics of the transaction are very compelling. The desire is there. We just -- we will find or need to find the balance.

Alexander Blostein - Goldman Sachs Group Inc., Research Division

Got it. The other thing I wanted to dig into a little bit more just looking at different rates on the balance sheet, if I look at the health and maturity securities, you guys are still earning closer to 3% yields on that. Matt, can you give us a little more granularity on the duration of that book? What kind of reinvestment yields you guys are seeing because it feels like things that are, I guess, somewhat of comfort if you will get the agency paper, 2-to-3-year duration, that's now yielding sub-2%. So I guess if we roll that forward, how should we think about the repricing risk on the securities books? I guess, how the maturities are always available for sale.

Matthew J. Audette

Yes. So I think the broad way to think about it is from an interest rate risk perspective, we're always managing to an overall balance sheet position. The buying and selling of securities is really the final thing that we do to get to an interest rate position that we're comparable with based on deposits that come in or pull out that quarter, the loan paydowns that happens. So looking at an individual line item always gets -- it's a little bit skewed because it's reflective of the purchases of the sales that we had to make to get to that overall interest rate risk position. So it's really from a management perspective, it's not something where the duration of a particular line item is something we focus on versus the broader view of the overall balance sheet of running a relatively matched book.

Alexander Blostein - Goldman Sachs Group Inc., Research Division

Got it. And this is the last one for me, could you guys, well, share a little bit more your comments around some of the deposit strategies you mentioned with potentially trying to reduce the size of the balance sheet. I don't know, anything around the size of how much you could potentially move or how the economics of that would work out for you.

Matthew J. Audette

Sure. So I think where the areas that we're targeting, as I covered a little bit earlier, are the wholesale funding, the bank-specific funding and then lastly, the brokerage-related cash or the sweep accounts. So from a sizing perspective, I think kind of back to the overall comments, from a regulatory perspective is the amount we would target is something that helps us get to a place where we're all comfortable with our capital ratios, particularly the leverage ratio. I can tell you my perspective, though, just given the core of the company and the deposits that it produces, I think a reduction of $5 billion to $10 billion from here is a place that I'd be much more comfortable.

Operator

And your next question comes from the line of Joel Jeffrey with KBW.

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

Just a follow-up on Alex's question a little bit. Can you talk about some of maybe the some of the specific strategies you're thinking about in terms of moving the deposits off the balance sheet?

Matthew J. Audette

Absolutely. So on the wholesale side, there's not a lot of strategies other than we can pick around the edges given that the cost of reducing that would be around, overall it would be around $700 million. On the bank side, on the primary item that we've done so far, is we reduced that rate on our complete savings account, which is the primary bank product, down to 5 basis points. We saw outflows of $500 million in the quarter in that. So it's something from a balance sheet perspective, we certainly hope to continue going forward. Well, we can also look at other strategies on that account, right? For accounts that are not closely connected to our valuable brokerage customers. You can look at a sale, so that's another thing we would look at. On the brokerage side, or the sweep side, that's the type of product where from an operational perspective, we even have some of those deposits off balance sheet today, where the customer relationship is with us but the funds are off-balance sheet. And so specific to that fund, that's what we would look to do. We would look to really set up sweep arrangements, where the sweep goes to a third-party bank as opposed to our bank. So those are probably the most notable things that we're working on.

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

Okay, great. And then just lastly, can you give a sense for how DARTs are tracking in July?

Matthew J. Audette

Sure, down 1% from June.

Operator

And your next question comes from Michael Carrier with Deutsche Bank.

Michael Carrier - Deutsche Bank AG, Research Division

First question, you guys pointed out the $0.01, the legal benefit in the release. But, Matt, I think you mentioned like $0.04. I just wanted to make sure the other $0.03, is it just the tax rate or are you including that, the provision, I don't know if you want to call it an adjustment, but the provision benefit?

Matthew J. Audette

Sure. So it's really just the tax and the operating expenses. I think when you add them together, it comes up to something like $0.0351 or something, very close to a round up to $0.04. And so it's really just those 2 items, the tax and the other expense.

David J. Chiaverini - BMO Capital Markets U.S.

Okay, got it. And then just on the expenses, when you're talking about that net number of $40 million, are you looking at like this quarter's run rate or like what run rate should we be taking because advertising in certain quarters are going to be higher or lower?

Matthew J. Audette

Sure. So we think from a -- when you take seasonality out, and a good run-rate quarterly expense for us is around $290 million, so once the costs are fully implemented, I would view our run rate at that point would be $280 million.

Michael Carrier - Deutsche Bank AG, Research Division

Okay, got it. And then last one, just on the NIM, got the near-term outlook. Just given the current rate environment, the balance sheet, the runoff and the reduction in any reinvestment, just any outlook for 2013?

Matthew J. Audette

Sure. I mean, in this environment, everything else being equal, I think around a 10 basis point reduction in 2013 is kind of how we think about it. The one thing I would keep in mind from a -- just from a pure spread metric perspective, the more successful we are in deleveraging, the smaller the balance sheet's going to be and the higher the spread would likely be, even though the overall balance sheet would be smaller, so it would produce less net interest income. But just keep in mind there could be some volatility there on that particular metric with the deleveraging.

Operator

Your next question comes from the Faye Elliott with BGB Securities.

Faye Elliott-Gurney - BGB Securities, Inc., Research Division

Have you outlined the amortization schedule of the HELOC, not when they start amortizing but what percent of them would have full principal repayment do?

Matthew J. Audette

So I'm not sure I follow, Faye. So meaning like a maturity once -- is that what you're looking for?

Faye Elliott-Gurney - BGB Securities, Inc., Research Division

Right. But once they start amortizing. And I know you've given that schedule out. What is the time to maturity after that or the average time to maturity? And, really, what I'm interested in is, if you have any bullets on there and if you do, what percent?

Matthew J. Audette

So the -- so your typical Home Equity is going to have a 7-to-10-year drop period that's going to amortize for 15 years after that roughly. But I think the most compelling thing, the most relevant thing we view is that data that we put out, which is how many of the loans have begun to amortize or not, because that's really going to be the credit event. And the key for us is very few of those have begun to amortize, and if we don't get to a point where a meaningful number of those are amortizing until 2015 and beyond, so it's something well off into the future.

Faye Elliott-Gurney - BGB Securities, Inc., Research Division

So all of yours are typical then?

Matthew J. Audette

Yes, I'm speaking to -- our portfolio is typical from an amortization perspective.

Operator

Your next question comes from Matt Fischer with CLSA.

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

Regarding back to the cost reductions. The -- you mentioned that it's coming out of every area and you're going to go through that, but what percent are we talking about in terms of people taking out headcount? And then also, how does this impact the expansion of branch network? Are you still going to do that?

Matthew J. Audette

So from a branch network, I think, as Steve covered, we opened 2 new branches. We're up to 30. We don't have really any commentary or plans for a big expansion beyond that, but we would stop or start. With respect to where the costs would come from, I -- probably the only -- the best color, the additional color I can provide you is from looking at a line item perspective, things like FDIC insurance, depreciation and amortization, amortization of other intangibles, those are really things from just a cost reduction strategy perspective you really can't control. So it's more coming out of the other areas. So I don't have a focus on anything beyond that other than it's going to -- all those other outlined items is where it would come from and from all areas of the company.

Steven J. Freiberg

Let me just add without getting to a level of specificity because we're, again, we're not prepared to have that dialogue today. We have a pretty good plan laid out at, internally, that is actionable. And when we basically have the opportunity to convey that we will, but we're serious about it. We believe we can do it with no harm to our core franchise and remain competitive in the marketplace, continue to basically do what we have been doing, which is derisking the franchise, growing basically the core and hopefully positioning ourselves well as we look forward to a more normalized environment. We just can't predict when.

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

Okay. And then back to the investor sentiment. So you've kind of have 2 things going on. You've got margin increasing. Customers are net buyers of securities. Yet, DARTs are down pretty considerably and we're in this weak summer period, so I don't know if maybe mix of securities purchases or how can you -- can you give us an idea of...

Matthew J. Audette

Yes, I think the best at least the way -- I think the best way to express it is similar to the question asked earlier on the reduction in commission rate or the basically commission per trade, that what we really see is that largely, the active traders have remained engaged. And what really have seen is the broad, and I would say the broad middle, has diminished activity. And so the more sophisticated, the more active investors, which tend to basically have more of a bias towards being contrarian and more of a bias towards using leverage remain very active within basically the market. But what you're seeing is the reduction, I think, on industry-wide as well as in E*TRADE, because essentially it's that broad middle has been more reluctant to trade, given the nature of the markets and the environment. Hopefully that gives you some perspective. We see it at a segmented, very detailed level but that is the, I think, the best way to view it and the best lens to view it through. And so when the level of confidence, which is what we were talking about, broadly speaking, consumer confidence, rises, hopefully then retail engagement will broadly will take hold and then what we'll see is an increase in overall trades. We'll see a change in the composition of the commissions and hopefully that will be a good story. But, again, there's been a lot of volatility around that at least for the 2 years or so that I've been here. And we have not seen, I think as an industry, a sustainable trend on that front. Just maybe just also to finish up. The one thing that we will continue to emphasize that we do believe at some point normal will return. We just can't predict one. And what we believe is most important to our franchise is continue to do what we're doing, particularly on the core franchise, which is to grow high-quality accounts; grow the asset base; position ourselves to do more for our customers than just trade; help them basically in their retirement needs, their long-term investing needs, and we'll basically be a much better position firm when normal returns.

Operator

Your next question comes from the line of Chris Harris.

Christopher Harris - Wells Fargo Securities, LLC, Research Division

So on the reduction of the balance sheet here. As far as the potential to move deposits to a third party. The number you're talking about here, the $5 billion to $10 billion, that's a quarter of your, a quarter or so of your deposits and it'd have a pretty big impact on your net interest revenue like you mentioned. Is there some way you guys can get some clarity from the regulators or maybe some guidance from the regulators that says, "hey, gee, if we do this, will we be able to kind of refinance or retire the Springing Lien Notes?" Or is there really just no way to do that, you guys just have to kind of go ahead and reduce the balance sheet and then wait and see what the regulators say?

Matthew J. Audette

So there is. I mean, it's one of the purposes of the key tenets of our plan. So we've got -- we submitted a 5-year strategic and capital plan. So it's got our forecast of things that we want to do and think makes sense to do. And I think that's really the form in the item that will help facilitate that dialogue. So I think that's how we'll get to that point.

Steven J. Freiberg

Let me just add just a couple of additional points. One, when you talk about the actual numbers, Matt's point of $5 billion to $10 billion, first it's aspirational all over an extended period of time. Secondarily, and I think Matt addressed it even in his first point. So for example, and I've said this and Matt has for quite a while, that the overall size of the balance sheet over time will be more reflective of our, basically, of our customers' deposits with us in the current composition of the balance sheet. So for example, there's a significant amount of balances that are on that balance sheet via wholesale funding that today are net drags, meaning they actually are eroding our margins, not improving our margins. And so when we think about this and you think about it broadly, it's not the average assets coming off, it's over time reconstructing the company in a much more compelling way, both in its size and its economics. And in the short-term, we have limited options. And in the longer-term, we have more degrees of freedom, and it's finding that right balance. Hopefully that helps.

Christopher Harris - Wells Fargo Securities, LLC, Research Division

Yes, it does. Just one follow-up on that. So can we assume the $5 billion to $10 billion number you're talking about, that was -- that number wasn't just pulled out of thin air, it was done in concert with the discussions with the regulators?

Matthew J. Audette

Well, I'd say it definitely wasn't pulled out of thin air. I think it's where I, from my perspective, where I think the core business of the company and the deposits it produces, I think that's where I'd be much more comfortable, and I'd leave it at that.

Christopher Harris - Wells Fargo Securities, LLC, Research Division

Okay. All right, that's fair enough. And along the same lines then, just wondering how you guys think about, I mean, clearly, you're getting great growth as a broker. I was just wondering if that's really the correct strategic course, given you're really trying to reduce or shrink your balance sheet. Just a little bit thoughts about how you managed the growth of the broker versus wanting to shrink the budget will be helpful.

Matthew J. Audette

Sure. So I think from a -- from the growth of the broker, I think, over the long term, it would -- is an incredibly valuable thing to do. I think the thing that we have to manage is growth of the broker with little to no growth of the balance sheet. So I think when you go to the strategies we're pursuing, that third strategy of brokerage cash, can we be in a place where we can grow the franchise but grow it with a cash on/off balance sheet? I think that's the trick to make that work quite well.

Christopher Harris - Wells Fargo Securities, LLC, Research Division

Would the incremental broker account you get without being able to manage the cash -- I'd assume then that that's going to be a much less profitable proposition for you than one if where you can manage the cash? I'm just trying to get a sense of incremental profitability of actually adding an account where you can't -- where you can't manage the client cash.

Matthew J. Audette

Yes. So from an income perspective, I think, generically, having the deposit on your balance sheet produces more income than on someone else, than the fee you get paid for being on somebody else's balance sheet. The key for us though is the return on equity, right. So the balance sheet size and the equity have, we have to be in the right -- in the place where our balance sheet size is the right size for the equity that we have, because if your capital ratios are too low, increasing the size of your balance sheet, that incremental return on equity may not be compelling. So it's really that balance that we need to find that makes the most sense.

Operator

And there are no further questions at this time. Mr. Freiberg, I'll turn the call back over to you.

Steven J. Freiberg

Thank you. So let me just say in closing, I'd like to reiterate our commitment to growing our core brokerage franchise and enhancing our competitive position, continue the derisking and the deleveraging of the balance sheet and ensuring full alignment with the expectations of our regulators. And with that, I want to thank you, and say, good evening.

Operator

Thank you again for joining us today. This does conclude today's web conference. You may now disconnect.

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