E*TRADE Financial Corporation (NASDAQ:ETFC) Q1 2017 Earnings Conference Call April 20, 2017 5:00 PM ET
Karl Roessner - CEO
Michael Pizzi - CFO
Steven Chubak - Nomura Instinet
Conor Fitzgerald - Goldman Sachs
Rich Repetto - Sandler O'Neill
Devon Ryan - JMP Securities
Chris Harris - Wells Fargo
Chris Allen - Buckingham
Michael Cyprys - Morgan Stanley
Patrick O'Shaughnessy - Raymond James
Brendon Hawking - UBS
Michael Carrier - Bank of America Merrill Lynch
Kyle Voigt - KBW
Brian Bedell - Deutsche Bank
Vincent Hung - Autonomous Research
Good evening and thank you for joining E*TRADE’s First Quarter 2017 Earnings Conference Call. Joining the call today are Chief Executive Officer, Karl Roessner and Chief Financial Officer, Michael Pizzi.
Today’s call may include forward-looking statements, including statements about E*TRADE’s future, operational, and financial performance and synergies related to the OptionsHouse acquisition, which reflect management’s current estimates or beliefs and are subject to risks and uncertainties that may cause actual results to differ materially.
During the call, the company will also discuss non-GAAP financial measures. For a reconciliation of such non-GAAP measures to the comparable GAAP figures, and for a discussion of additional risks and uncertainties that may affect the future results of E*TRADE Financial, please refer to the company’s earnings release furnished on Form 8-K along with Form 10-Ks, 10-Qs and other documents the company has filed with the SEC. All of these documents are also available at about.etrade.com.
Note that the company has not reconciled its forward-looking non-GAAP measures, including non-GAAP adjusted operating margin, to the most directly comparable GAAP measures, because material items that impact that measure are out of the company’s control, and cannot be reasonably predicted.
This call will present information as of April 20, 2017. The company disclaims any duty to update forward-looking statements made during the call. This call is being recorded, and a replay will be available via phone and webcast later this evening at about.etrade.com. No other recordings or copies of this call are authorized or may be relied upon.
With that, I will now turn the call over to Mr. Roessner.
Thanks very much, Ash. Good evening and thank you for joining. It’s a pleasure to expand on the quarter’s results and to update you on our progress. This quarter was one for the history books, as our industry attacked published commission pricing for the first time in many years. Meanwhile, we made progress on our path to deliver meaningful value to our shareholders, efficiently deploying capital and continuing in an undaunted fashion to position ourselves for improved growth.
Specifically, we on-boarded deposits to grow our balance sheet by $7 billion during the quarter, just shy of our mid-year goal. We lowered our bank Tier 1 leverage threshold to 7.5%, reflective of the regulatory progress we’ve made over the years. We returned to our full year operating margin target of 38% despite reducing commission pricing.
We began to see early benefits from several initiatives we put in play over the last six months in the form of strong brokerage metrics. We delivered on much of the necessary work around the OptionsHouse integration to ensure a Q3 completion. We concluded an exhaustive process to partner with the right creative agency as we reinvigorate our iconic brand. We made significant headway in energizing our HR efforts to better support internal business partners, while improving talent acquisition. And finally, we laid more legacy issues to rest with the effective completion of HELOC conversions from interest-only to fully amortizing loans.
Let’s start with the elephant in the room, commission pricing. The moves within the industry this quarter served as a stark reminder of how fiercely competitive our business is, and has been for quite some time. After three of our closest competitors lowered commission pricing within a relatively short window, we reacted swiftly and accordingly by lowering our own rates. This is not a decision we took lightly, as we truly obsess about shareholder value.
But throughout our history we have never rested in our quest to deliver an exceptional experience to our customers at a compelling value. And in an industry where pricing is the most transparent variable for customers choosing a platform, we didn’t like our long-term growth prospects at a premium price point, especially while the perceived disparity in value amongst competitors widened in a very public fashion. So we took the necessary steps to defend our customer franchise, which is far and away the most valuable asset we have.
Our new structure includes a standard rate of $6.95 plus $0.75 per options contract, and an active trader rate of $4.95 plus $0.50 per options contract. Lowering our standard rate was the necessary response to the industry moves, while the changes we made for active traders was the effective pull-forward of a planned post-OH integration pricing tier. We put significant thought into the right cutoff for our more active tier and ultimately set the threshold at 30 trades per quarter, down from our previous 150 trades.
This was born from customer insight. At this level, we capture customers who actively engage with the markets, as well as those who could be compelled to execute more trades, particularly in derivatives, at a more favorable price point. Beyond price, we are working to package a differentiated service and product experience for those who qualify for this tier, which we plan to deliver post integration. As we make a concerted push to reclaim our spot as the top home for derivatives traders, we believe this structure will prove compelling and competitive for this target segment.
To summarize, this recent price battle and our response presents a temporary bump on our road, from a revenue standpoint. But we are undeterred in our objectives as we continue to charge full steam ahead, focused on accelerating the growth of our franchise. Now, to update you on how we’re positioning ourselves to do just that. To reiterate, our targets are to increase our brokerage asset and account growth rates by 2 to 3 percentage points from Q3 2016 levels, grow derivatives to 35% of our trades and grow our managed assets to $6 billion. The things we are doing to achieve those goals are progressing as planned.
First, the integration of OptionsHouse. With the corporate integration largely complete, and the clearing conversion on track for Q3, we will deliver our synergy targets on schedule. Beyond that, there is more value for us to capture here as we fully capitalize on the acquisition to help us reclaim our space as the premier, undisputed home for options traders. We believe that delivering an integrated platform that combines the best of OptionsHouse’s derivatives capabilities with the best of our existing technology will move us forward with this valuable customer segment.
The vision we are working hard to deliver puts additional capabilities in the hands of our customers, and also addresses the growing demands for advanced trading capabilities on the go. And it bears repeating that this integration is about much more than producing a top-notch combined platform. It is also about adopting a mindset of efficiency in product development. The notion is simple, we are relatively small, and we must remain nimble, more agile, and be able to respond to customers' evolving demands faster than the competition.
Second is marketing. This is an initiative we absolutely must nail. We must revitalize the brand, the way our offerings are understood, and how they resonate with our customers and prospects.
We took a major step in this direction earlier this month when we tapped a new creative agency, MullenLowe. We went through an exhaustive process to select the right partner, and I am confident in the direction we are headed. Together we are developing brand messaging that will elevate our value proposition in the eyes of our current and prospective customers, while speaking to who we are as a company. Stay tuned as we look to make a splash in the next few months.
The final initiative we have in place is a bit more comprehensive. We’re working to address all of our customer pain points, which is no small task for any company. While we talk a lot about new assets and accounts, keep in mind these are net numbers. We must be equally conscious about making sure that once a customer chooses E*TRADE, they never have a reason to leave.
While phenomenal customer service will always be core to our offering, we are taking the approach of addressing the most common frustrations of our customers before they ever reach a service rep. Some changes will occur through the integration process, but we have also rolled out a host of new features and offerings on our current platforms including, simplified navigation, better organizing our pages and bringing key tools and products to the forefront of our site. Continued enhancements to our most heavily-trafficked pages such as the portfolios page. A redesign of the E*TRADE mobile app to provide stock plan participants access to popular benefits and tools and significant enhancements to the OptionsHouse mobile app to improve fast paced usability and execution for options traders.
Amid all this hard work, I am very pleased to say that we are starting to see early returns reflected in our Q1 metrics which represent a tremendous start to the year. We brought in a record $4.2 billion in net new brokerage assets during the period. These strong flows continued in March following the industry price changes, giving us confidence that we are doing what is right in the eyes of our customers and that we are still very competitive in our industry. Further, the annualized growth rate of 6.1% is comfortably within the goal we set six months ago for this metric of 5.8% to 6.8%.
Managed product also continued to grow steadily, ending the quarter at $4.3 billion, up 10% sequentially. We feel good about reaching our target of $6 billion. Part and parcel with our asset success is our account growth. We posted a multi-year high in net new brokerage accounts at 58,000, more than half of our full year 2016 total in just one quarter. The annualized growth rate of 6.7% is far in excess of the goal we set forth, which was 4.8% to 5.8%. We’re not claiming victory after just one quarter, especially as Q1 is a seasonally strong period, but I think these levels demonstrate just how achievable our growth goals are.
The strength of the equity markets undoubtedly boosted our metrics as strong performance instilled confidence in our customers that compelled them to meaningfully engage. DARTs of 207,000 were up 10% sequentially as broad market indices reached all-time highs. Derivatives represented a steady 29% of total DARTs, which is consistent with our expectations ahead of the launch of our fully integrated platform. In April to date, DARTs are tracking down 5% from March levels. Our customers were net buyers of $1.6 billion of securities during the quarter. This follows the prior two quarters’ heavy net selling during which customers reduced their securities positions by $3.2 billion, underlining the shift in customer confidence.
This was further supported by an increase in customer margin balances, to $7.3 billion from $7.1 billion at the end of Q4. Beyond the metrics, we recently received additional validation of our efforts, having just emerged from our industry’s awards season. Both OptionsHouse and E*TRADE received high marks and an assortment of accolades from Barron’s and StockBrokers.com, further substantiating our offerings as among the best in the business. Barron’s awarded E*TRADE and OptionsHouse each four out of five stars overall, earning a combined four Best of distinctions. StockBrokers.com also acknowledged our products and services with nine Best in Class distinctions across the two platforms. And for the second straight year, StockBrokers.com named OptionsHouse the top overall options platform in the industry. While it is nice to receive third-party validation, the true proof of our success will come after we deliver a fully integrated platform.
Turning now to our results, we reported net income of $145 million or $0.48 per diluted common share in the first quarter. Our results include a provision benefit of $14 million and one-time costs of $6 million related to the OptionsHouse integration and crossing $50 billion. Our results also reflect the power of our capital deployment strategy as net interest income was the strongest we’ve posted in six years. After lowering our bank Tier 1 leverage ratio threshold to 7.5% during the quarter, we took advantage of available capital plus a favorable interest rate environment and moved deposits on balance sheet. We ended the quarter just shy of $56 billion in consolidated assets, a $7 billion increase during the quarter, outpacing our growth goals. I will let Mike Pizzi provide more details but suffice it to say we are pleased with where we stand on this measure.
In summary, we had a great quarter. There was some unexpected turbulence in the industry, but we combatted it with fortitude, and we continue to take steps to reinvigorate the growth of our customer franchise. I believe our progress here reflects something I feel on a personal level, which is a singular source of strength, that we are a Company that can be counted on to achieve the goals we communicate. We are a Company that delivers on its promises. I’m excited about what we have in stored for the remainder of this year, and look forward to executing on our commitments to both our customers, and our shareholders.
With that I will turn the call over to Mike Pizzi.
Thanks Karl. For the quarter we reported net income of $145 million or $0.48 per diluted common share. Note that this includes a $14 million provision benefit and $6 million of one-time costs related to the OptionsHouse integration and crossing $50 billion. The bottom line also reflects our first semiannual preferred stock dividend, which equates to $0.05 per common share.
Our results compare to $127 million or $0.46 per share in the prior quarter and $153 million or $0.53 per share in the year-ago quarter, which included an income tax benefit related to the release of evaluation allowance against state deferred tax assets.
Revenues for the quarter were $553 million, up $44 million from the prior quarter, reflecting balance sheet growth, a better interest rate environment, and stronger customer trading activity. Year-over-year revenues were up 81 million primarily on balance sheet growth and the addition of OptionsHouse.
Net interest income increased 11% to 319 million during the quarter as we grew average interest earning assets by 4.4 billion. With a significant amount of capital available after lowering the Tier 1 leverage ratio threshold at the bank, against a backdrop of a more favorable interest rate environment, we grew the balance sheet in a purposeful manner. Net interest margin increased slightly to 263 basis points, reflecting the full impact of the December Fed rate hike, as well as a slight benefit from the March hike. I’ll expand on interest rate impact in a moment.
Commissions revenue of $127 million increased 4% quarter over quarter, driven by a 10% increase in DARTs, but partially offset by the impact of our commission reductions. While the new pricing schedule is only effective for the last three weeks of the quarter, it was the primary driver of the decline in average commission per trade, which was down $0.55 to $9.87. As a point of reference for you, pro forma for our new pricing, our Q1 commission per trade would have been $8.10. Keep in mind this includes a sequential increase related to corporate services, for which Q1 is typically the strongest quarter.
Fees and service charges increased $6 million quarter over quarter to $86 million, driven by a higher rate on off balance sheet deposits, reflecting the December increase in short-term rates. This was partially offset by a reduction in the amount of these off balance sheet deposits as we grew our balance sheet, a dynamic that should continue over the course of the year. As a reminder, OptionsHouse margin balances will no longer run through this line after conversion in Q3, as they will be reflected on our balance sheet and accordingly generate NII.
Gains increased to $10 million from $8 million last quarter, and included approximately $3 million of non-securities gains. We expect this line to return to the $5 million range next quarter. Other revenue was unchanged at 11 million for the quarter. Provision benefit was 14 million, compared to 18 million in Q4. The allowance reduced by 8 million to end the quarter at 213 million, as net charge offs were a recovery of $6 million. The loan portfolio now stands at $3.5 billion, or just 6% of total assets.
Importantly, we’ve put the last remaining credit risk overhang behind us, as 96% of our HELOC portfolio is now amortizing. Given the dwindling size, complexity and risk of this portfolio, we have eliminated much of the associated supplementary information in this release, particularly that related to the performance of modified loans or TDRs, and the breakout of reserves for that population. Further detail will be available in our 10-Q.
Non-interest expense for the quarter was $342 million, up $20 million sequentially, which primarily reflects seasonality in marketing spend and compensation. It also includes one-time expenses of approximately $6 million, primarily related to the OptionsHouse integration. Our operating margin was 41%. Excluding provision benefit, our adjusted operating margin was 38%, up slightly from the prior quarter and ahead of our expectations as a result of strong customer activity, a faster pace of balance sheet growth, and higher interest rates. As for our full year operating margin, during our last call we outlined a 38% target, which we subsequently revised down to 36% when we announced our commission reductions in late March.
Now, in the wake of the Fed’s March hike, our revenue forecast supports our initial 38% level. And for clarity in your modeling, achieving this target for the full year does not require targeting expenses beyond our ongoing commitment to be disciplined in our spending. Our operating margin in Q2 will be down from Q1 as a result of the commission price reduction, elevated expenses related to the OH integration, and the costs of crossing $50 billion.
As for tax, this quarter we posted an effective tax rate of 35.6% which includes a benefit related to the adoption of amended accounting guidance for employee share-based compensation. This item will likely have the greatest impact in the first quarter of each year, however there could be additional tax impact as shares vest throughout the year. We expect our full year tax rate to approximate 38%, assuming no further unique items. And finally on the P&L, I’ll give an update on the impact of rising interest rates on our expectations for the remainder of this year.
First on net interest margin. We benefitted from higher short-term rates following the Fed’s rate hike in March. And while the longest end [ph] of the curve didn’t show the same degree of upward movement, our average reinvestment rate was firmly in the 230 to 250 basis points range. This, coupled with accelerated timing of balance sheet growth, raises our expectation for full year NIM to the low 260s. This expectation assumes no changes to the rate environment, and that margin receivables are held constant.
However, we acknowledge that broad market expectations for at least one Fed hike, if not more. If the Fed does raise rates in June and there is a corresponding increase in term rates, holding all else equal, our NIM expectations would increase by approximately 10 basis points. However, considering the intense nature of the competitive environment, we remain conscious of the potential need to amend deposit pricing following future hikes, which would obviously temper some of the NIM benefit.
As for the yield on off balance sheet deposits, in Q1 we averaged a gross yield of 58 basis points, up from 45 basis points in Q4. Today that yield is around 80 basis points, and we expect it to average approximately 90 basis points for the full year.
There are a lot of moving pieces with respect to interest rates, and I want to be clear on how we think about OP margin in this context.
Shareholders bore the brunt of the extended, and unprecedented low rate environment, and so our intent is to allow as much of this upside to reach the bottom line as possible. We believe that an additional hike in June of this year could add up to 100 basis points to our full year operating margin target. But as I mentioned a moment ago, competition remains intense within our industry, and should competitive dynamics shift again we will do what it takes to defend our franchise.
Moving on to capital, we generated and put a significant amount to work for our shareholders during the quarter. We moved 70 million from the broker to the parent during the quarter, and plan to move another 50 million this quarter related to excess capital generation during Q1. We continued to utilize excess bank capital directly at that entity to fund balance sheet growth. After crossing 50 billion in the first days of January, the interest rate environment presented an opportunity to accelerate our growth plans, and with plenty of available capital, we took full advantage.
We ended Q1 just shy of our mid-year target at 56 billion, representing an increase of 7 billion during the quarter. This growth utilized the majority of our capital buffer, which widened after lowering the bank leverage ratio threshold during the quarter. Since we began managing to this ratio in 2012, we have been able to lower the threshold by a full 200 basis points to 7.5%, creating a substantial amount of capital for deployment, and putting us at a level we consider appropriate.
However, the bank ended the quarter well above that at 8.1%. This compares to our parent leverage ratio of 7.2%, versus our internal minimum of 7.0%. So clearly the parent has become the binding constraint. Given that we conservatively maintain a slight buffer to these capital thresholds, we expect the pace of balance sheet growth to be more measured from here and to be fully supported by organic capital generation. We now expect to be at 58 billion in consolidated assets by the end of this quarter and 63 billion by the end of this year, which is just shy of our fully-deployed balance sheet size of 65 billion, assuming all available deposits were brought on balance sheet today. Beyond that, our broad expectations are to direct all growth in customer deposits to our balance sheet, barring any abnormal patterns or net selling activity.
I want to reiterate that we are focused on putting capital to work in the ways that we believe will generate the most value. Share repurchases serve as our baseline return on capital when we consider a range of deployment strategies. We feel that, in conjunction with balance sheet growth, repurchases are our best path for long-term value generation for our shareholders.
Accordingly we continue to plan to resume share repurchases in the second half of the year, with the size dependent on the amount of capital in excess of the consolidated leverage ratio.
To close, overall this quarter, we posted solid results and we put a lot of capital to work for our shareholders. Despite the turbulence in commission pricing, our franchise didn’t skip a beat, and we remain positioned to deliver on the commitments we made with respect to our operating margin and capital deployment.
And with that, operator, we’ll open it up for questions.
Thank you, [Operator Instructions] and our first question comes from the line of Steven Chubak with Nomura Instinet, please proceed with your question.
So I want to just kick things off with a question on the competitive environment, you allude to this a little bit in some of your prepared remarks, but just given the strong growth in that new assets and accounts that we saw, it certainly appears like the latest round the price cuts had little impact in terms franchise performance. Mike, you noted that you guys really didn’t skip a beat and didn’t really hinder your ability to make progress towards this grow targets that you guys have outlined.
I’m just wondering, if you could just speak a little bit more in terms of how the competitive environment actually evolved over the course for the quarter following those actions, whether you saw any impact if it all. And if we do in fact seen another round in meaningful price cuts, you did note that you would look to defend the franchise. I’m hoping you can give some additional context in terms of what specific actions you might have to take?
Sure. Looking at what went on during the quarter around the price cuts initially, it was a lot of calls from our customers and a lot of interested parties trying to figure out what was going on in the space, that was certainly no large demand for lower pricing and there was no calls before that coming into us. So there are a lot of offers and ask in the marketplace to max pricing and see if we would sort of lower down to where they were.
So like I said before sort of the hand-to-hand combat on the hire into the book to make sure that we are providing pricing. But keep in mind that what we always say and it holds true today, the higher end of our book is on negotiated pricing and they provide a lot more to us than just commission for trade, they've large cash balances with us, they have large margin receivable with us.
So it was some pretty heavy sweating for our customer service reps and for our FCs on the ground working with customers. And our pricing changes I think resolved a lot of that, bringing it down to 675, because our offering overall provides a significant amount of value to our customers. That was true before the price cuts and it remains true after the price cuts. What they gave us the opportunity to do in the price cuts is really pull forward, what we were thinking about and looking at internally for post integration on the options outside. And also allowed us to redefine, we’ll be look at as an active account and looking at 30 trades per quarter as oppose to the 150 that we used to use. Which we believe is the right customer and the right type to go after with our improved options capabilities and derivatives trading capabilities, our service client, services team that we put in place on the active trader side, our derivative services guide.
So we think, we’re in the right place now. In terms of positioning the franchise for additional costs at the instance and take a step back. When I look at what when on and Mike hit it head on in his prepared remarks, in 2010 we went through this and we saw this price cut and matching and we collapsed in tears and there is really no reallocation among the larger players. There was a lot of lower pricing, a lot of revenue foregone and a lot of shareholder value that went out the door. But we didn’t really see a lot of reallocation among.
So in my view, I don’t really want to see additional price cuts come through, but Mike is right, we’ll do everything we can to defend the franchise and in terms of, if we’re have to go down lower, if we had to match, we’ll have to do what we need to do to keep our customers on our book, it's the most valuable asset we have. So it’s really move of the same should that happen, I don’t think it’s rational to think about additional price costs at this point in time, particularly given what we’re seeing in the early days, but we’ll see how it ends up and it’s not always necessarily within our control, but we’ll absolutely defend our franchise.
Thanks Karl. Certainly very helpful detail. And just switching over to the deposit growth side of the equation. The balance sheet growth itself is actually coming stronger than expected. You guys touched on some of the factors driving that faster growth. What do you believe is a reasonable pace of organic deposit growth that you can achieve, once the on boarding is completed? And what do you believe is that reasonable expectation in terms of deposit beta? Has your thinking there evolved a but given some increased competition we have already seen from one of your competitor actually passing on some of the benefits to clients this early on in terms of the rate tightening cycle?
I'll start with that I mean we did see pretty good growth in the quarter. If you measure it in terms of what we sort of size of the fully deployed balance sheet, last quarter we were at 62.5 this quarter we are showing at 65 from the pace of balance sheet growth, I think it disappointed, the pacing will be really in line with capital generation as we go forward. As we really deploy the buffer that we had at the start of the year. From an organic growth perspective I think you can expect deposit growth or cash growth really to stale with underlying account growth, asset growth that's within the business. And so from a cash perspective, we would expect cash to grow in line with accounts and assets, once we reach sort of that fully deployed stage. So you can mirror that directly to the underlying business forecast. With the only really caveat is that our corporate services business does generate some cash and that is a little bit more heavier around the seasonal vesting patterns that are in that business.
Then just one more in terms of efficiency targets that you guys have outlined. Then as you think about the long term profitability of your business just given your heavier gearing to on NII or spread revenue relative to some of your peers its about 60% of your revenue less than 50% with the peers stat. Now there is a case to be made that the operating margins that your moral supports should in fact be greater than that 46% that you've outlined in the earnings log slide. And in the environment where commission cuts aren’t accelerating and we continue to see some health growth in terms of balance sheet and some additional rate help, what do you believe is at least an achievable margin target longer term and is it reasonable to expect that it could, in fact grow beyond 46%?
So I'll start with [indiscernible] and then I'll hand over to Mike for some specific guidance, but I couldn't agree with you more, this business can absolutely generate higher margins, and we can absolutely get there, but I think what you described would be the perfect utopian state, where there is no additional pricing pressure, maybe there is no additional competition coming in for our account. Because remember before in that type of environment our competitors are benefiting just as much as we are. And it's probably extremely difficult out there to maintain and defend your book so you have to look at continuing to defend and continuing to invest in the best technology you can provide to your customers, you need to look at marketing how do we make sure that we keep out there and keep in the customer mindset and attract our fresher of new customers that come into the pipeline.
And what else do we need to do to continue to maintain, defend and then grow our book. So that’s why when you start getting out there you can come up with some pretty big numbers based on the current scheme we have if you don’t -- if you hold everything constant sure we can do better. Mike why don’t you?
Sure we put out really a long term target with 100 basis point normalization and achieving of our growth goals of about 46%. But if you do the math on what we are putting that’s going to give you a pretty high operating margin on both our additional growth as well as the additional moves in rates. And obviously it extends the rate move where you accelerate the growth even further and keep applying that you will get higher and higher out margins.
When we look at a model and we do that math we have to use an element of judgment as to how much we think the competitive environment is going to intensify, and how much of the -- are we going to be able to pass through of the rate hikes. So for today, we think sort of that mid 40s, 46% as we’re showing our long-term earnings slide is the appropriate target for how we’re thinking about the business today. But the competitive environment warrants it, there is no reason why, those operating margins could not be higher.
Very helpful color guys and congratulates on strong quarter.
Our next question comes from the line of Conor Fitzgerald with Goldman Sachs. Please proceed with your question.
Karl, I want to get your latest thoughts about the targets 200 to 300 basis points in fast organic growth and just how that feeds in the firm's strategy. The pricing cuts we saw this quarter highlight that the pick-up in organic growth improving can be pretty quickly overwhelmed by pricing pressure. Just given what you saw in 1Q, is it still your view that executing in your growth target is still in the best interest to shareholders, even with maybe more elevated risk of future pricing cuts?
Yes. I absolutely stand by the growth goals we put out and they are absolutely achievable within the timeframes that we've set forth. I've gone through this Mike a number of times in terms of where we are in the interest rate front, where we are on the balance sheet and where we are just as a franchise. I really like what I’m seeing around here, I like the initiatives that we have taken and I like the way we’ve gone through and restructured the company around the goals that we've set. So we had real ownership and real accountability throughout the organization to deliver on this and teams that really stepped up. So I’m excited about it and absolutely no change in timeframe and scope to the goals or what we promise to deliver.
And maybe building on that from a broader strategy perspective. You’re still confident that the improving growth is kind of in the best interest of shareholders. If you just think about it as a risk reward equation of faster growth versus maybe the risk of intense pressure. It's still your view that the reward of faster growth is the best half for shareholders?
It is absolutely they might be a color, it’s absolute a lot of thing.
Conor, when we look at sort of the revenue drivers in terms of how we general P&L from a net interest perspective, from a commission perspective, from fees and service charges from our margin book and from our stock lending position. As we look at all this revenue drivers, commission is one element of it, where there is certainly sensitivity to commissions and certainly we’ve seen what happen this quarter. You could see right in the quarterly results the power of all of the other drivers coming together. And then just look at how we illustrate the earnings power of that growth, it’s pretty clear to us that growth remains the right objective for the firm.
Thanks. That’s helpful. Just wanted to get the updated thoughts. And then Mike one for you, you mentioned, you’re bumping up again the 7% Tier 1 leverage target. I interpreted your comments about operating what the buffer, about the 7% target as meaning you wouldn’t drop below that number, even for a temporary period of time, but just wanted to confirm that? And then second do you have any appetite for additional prep issuances to help accelerate the balance sheet growth?
The 7% is the floor, so we have no intention to drop below it. We are aware of where things are in the preferred market, but right now we think the best course of action is to continue to build out from an organic capital generation standpoint.
Thanks for taking my questions.
Our next question comes from the line of Rich Repetto with Sandler O'Neill. Please proceed with your question.
Yes good evening guys. I guess the first question is just maybe an obvious. But I don’t know what happen on cash and cash equivalents. So it went down by 1 billion, is that, could you just explain that?
It’s the cash position at the bank Rich, if you look at the yield table, you’ll see it’s a little bit higher. It's just investing in securities really over the last few weeks and just positioning of the balance sheet in terms of what was settling and what was unsettled, you can see on average for the quarter it was higher, we continue to just sort of you know sweep cash over, it’s the movements that are coming on and off the balance sheet as we deploy them, it’s the record date really versus just the ongoing average.
Got it, okay, and then the next question is you know a peer, you know their average commission dropped -- will drop, they gave guidance or by around the low double digit percentage. If you take your 8-10 it’s going to be over, and you said it could even be less than 8-10 in the coming quarters, it's going to be more like in the low 20% compared to 4Q's average commission. So I'm just trying to understand you know what do you think the impact is it, they're doing more price discounting than you do, is it derivatives or is it the idea that you bought you know the act of [indiscernible] why is it that big a difference versus your peer, the drop in commission?
I think one rates we did bring the active traders here down, that's a lower price point than I think the peer you're referring to. In terms of where we are, that's a significant portion of our book, but then keep in mind we have a book of business we bought at OptionsHouse is already pricing Tier, so it's really not affected by that move in any way. So I mean it's just a dynamic, every book of business has evolved differently through past acquisitions, grandfathered acquisition rates through negotiated schedules that have been applied over time in terms of what the decision we made in terms of how we're going to offer pricing in the market versus theirs.
Our next question comes from the line of Devon Ryan with JMP Securities, please proceed with your question.
Would love to maybe just drill down a little bit more into the drivers of the strength in that negative quarter, maybe just set it a little more granular level if you can, how much is from the active traders sales efforts versus how much you think is coming from marketing, branding, or if you're going to attribute anything specifically to OptionsHouse momentum, and then just in your opinion how much do you feel like is really truly a direct result of the things that you're doing versus how much is seasonality as you mentioned or the Trump-bump, just looking to see if we could get a little more granular there.
Sure, so it’s -- when I look at how we proceeded and what we've done over the past couple of months. There is quite a bit of more directed marketing and more thoughtful marketing going in to our campaign, so a lot more on the digital side and we're being a little different in the way that we approach things around here, so there's a little bit of marketing. It has to do with some of the active trader sales and as I said in the prepared remarks we're not declaring victory and there was absolutely some of the environment behind some of the strength in our result.
We're just getting started, right. So the first quarter to me, is extremely encouraging in terms of what we are able to produce. We haven't rolled out our new brand campaign, we haven't put ourselves back on the map in terms of the irreverent challenger brand that we are. We haven't got through a fully integrated OptionsHouse and rolled out some of the top derivatives capabilities into our entire E-trade book. So the first quarter results are extremely encouraging given what we've been able to roll out to date and where we're headed.
Yes, absolutely, great result there, and then just maybe a follow up on some of the prior questions on some of the thinking after the price cuts, I mean obviously, one way to defend is to match on pricing, and another way is to add more value for clients over shift and mix of your business. So I am just curious after that are there any specific investments that have maybe been moved to the front burner for the firm or changes just within the priority list, as I'm sure you know that this cut wasn’t in the budget to start of the year and it doesn’t seem like obviously, the aggregate expense commentary is all that different, but just curious kind of mix of how you are thinking about spending and opportunities might be shifting a little bit?
Look when we set out our plans for the year and we worked on the budget and really those the corresponding strategic and capital plan we identified initiatives that really tie in very closely to the growth goals. Obviously, getting to $6 billion in managed assets or fee based assets as we would say managed products is an important goal, the derivate amounts are an important goal. Those projects remain high priorities of the company. And so really we don’t feel that we needed to really reprioritize much, overall from the project standpoint. On the expense side yes, the environment forces us to be disciplined, but that’s a culture that we are trying to instill and put in place every day, is to remain disciplined and focused in how we look at expenses.
Our next question comes from the line of Chris Harris with Wells Fargo. Please proceed with your question.
Clearly the commission cuts show the vulnerability of that revenue source. Can you guys give us an update about your longer-term plans to diversify the business away from that? And then how quickly do you think you can do that?
When I look at the way we are set up now, we have our stock plan business on one side and we've just acquired to finish the acquisition on the auctions outside. So it's really growing the derivatives traders and growing the percentage of our customers that exercise those trades and use the functionality in the tools that we have taken in. That’s one pieces, it's moving upstream in that. It will help us bringing the higher end of the book and help us bring in more value-added customers.
So it's not about reaching out and trying to find additional streams of revenue. We would like to be able to rollout additional managed product that’s one of the goals and one of the sets of people we have focused on moving up to $6 billion to make sure that we can provide the best possible global capabilities and best possible managed investment products to roll the amount to our customers and its more investment on that side. So that’s really part of our organic growth strategy Chris and those are right in line with goals that we've set out before any of these price cuts took place.
And then just unrelated question on branding. You guys had mentioned that you are really focused on that, and really I am just kind of wondering how do you guys want E*TRADE to be viewed by the market place perhaps -- versus perhaps how you being viewed today?
So what I would like to do when I believe what our new marketing agency MullenLowe and the fantastic marketing people we have here will be able to put out, is a campaign that puts us back on the map, in terms of the irreverent challenger brand that we are. And we will rollout additional branding and advertising around products and capabilities sets following the completion of the integration on the options outside. So it's really getting back to the roots that we came from an irreverent challenger brand with fantastic tools products and services to be offered to our customers looking particularly on the active trader side and on the derivatives and options capabilities.
Our next question comes from the line of Chris Allen with Buckingham. You may proceed with your question.
Just wanted to touch a little bit on the NIM guidance. So I’m just kind of reconcile that with the guidance you gave after fourth quarter, which for [indiscernible] from the full year was 250 to 255, was 10 basis points higher with the June hike, you got a hike sooner than expected, you were able to put on a lot of assets into security pretty decent, it looks like. So I’m just wondering why there wouldn’t be a little bit more upside relative to that guidance that you’re currently providing?
Yes. Chris, we said 255, we said a June hike would be -- mid-June hike would be work about 10 basis points. We’ve got that hike looking at sort of what that hike did is it flattened the curve a little bit, spreads a little bit tighter overall. So while we’re still optimistic below 260 is really sort of midpoint to midpoint, we’re getting to almost the same place to getting that 10. But we didn’t see that 25 basis points yield and we're completely across the curve, with spreads out cognitive. So we had to back it a little bit off of a level. But we still think that there is pretty strong NIM expansion with each within hike.
Our next question comes from the line of Michael Cyprys with Morgan Stanley. Please proceed with your question.
You spoke a lot about the active trader customer. Just curious how you’re prioritizing growing from longer term retirement last year. And what’s the opportunity set to see that more aggressively here and how you see that business, aspect of your business could look at, say five years?
Sure. I mean look growing the active trader is really about reclaim the roots of our business. In terms of the evolution of the company, as a brand and where we are today and really, really closing gap that emerged in the past few years in that market, that you can see is very much tied in with the OptionsHouse acquisition. But right along with that are initiatives to improve in the mange investment products space and to continue to try and be one of the best providers at offering digitally centric financial services and that goes directly into the retirement space.
We’ve been doing pretty well in growing retirement assets even though we were a bit late to get started. But as you can see, we are really at the beginning of a revolution in the digital distribution and financial services. And so it's a key priority for us over the next few years, especially the lower asset size customer were in digital distribution is going probably be the main stay of the market.
And you mentioned buyback in terms of not also margin targets generally taking longer term. Where you can operate, I guess why not just kind of put that aside adjust invest more aggressively going after the retirement in past set there. How do you skip kind of balancing the margin capital management versus investing more aggressively into the sales?
Well, when we layout or playing, you look at sort of what the capacity is sort of product development from an advertising standpoint from positioning. We think this is right plan that allows us to deliver and keep in those objectives while delivery and also those results to the bottom-line. I mean certainly, if there is more to investment opportunity and the value is there. We certainly have that option. But how we sort of think about that balance is really sort of the value of the investments we're making and the value of the next marginal investment versus letting it go, letting the additional earnings flow through to the bottom and become part of capital.
Our next question comes from the line of Patrick O'Shaughnessy with Raymond James, please proceed with your question.
Question for you on deposit beta. So prior to essential crisis, was the rate paid on customer brokerage ever used as a competitive lever, and if not, why is it the general assumption that the deposit beta on those assets is not something close to zero.
We've always taken the position that the deposit beta is a fairly low number, as you've heard me say many times the best evidence of that is when LIBOR rates were around 5% we were paying about 1% on sweep and growing the underlying sweep balance. If you want to go back that far in time. When we look at what customers are most sensitive to, obviously, they're sensitive to commission level, they're sensitive to margin rate, they're sensitive to a lot of things, but really the bottom of that list is really sort of the cash level overall in terms of these being relatively small transaction accounts. That may differ across the industry depending on the size of the account and the amount of cash, but when you look on average for our average account size as an average cash holding the betas are pretty low as you're suggesting and therefore it's not necessarily the most efficient place from a competitive differentiation. That said, there are customers who care deeply and you have to have the right product mix to address that need.
Got it, thanks and then follow up question, so we obviously saw very strong net new asset and account growth that you trade in, to be honest we saw a strong account and asset growth at your publicly traded competitors as well, so if your strong growth wasn't coming from mortgage or gains and same thing for your competitors, can you maybe provide us some color on where you think that was coming from, was it from the full service channel, was it from your existing customers, at least the net new assets. What was really driving those flows and the new account that you saw during the quarter.
I don't have the information on that front coming on or where they came from, but a lot of work going into what we're doing on the marketing side, what we're doing on the product side and what we're doing to move forward you know to continue to grow account. So I can't speak to our competitors, I can't speak to exactly where our accounts came from on the call.
Our next question comes from the line of Brendon Hawking with UBS, please proceed with your question.
So one, you made a reference earlier to the new pricing tier that you guys have rolled out. I know it's only been a few weeks, but curious whether or not you're actually noting any adjustments in client behavior with this new lowered tier and you know obviously adjusting for any calendar issues such as option expiration and the like, are you seeing some of your clients actually try to reach for this aspirational level, like you designed it?
It's early days in terms of what we rolled out and I think we'll start to see some more of this and we'll have some better data, when we get through the integration on the OptionsHouse and we start offering their tools into the completely trade population. It's a little bit early to make a judgment call on that one given where the pricing changes took place in the quarter.
Alright, maybe I'll give it a shot next quarter, and then apologies if you walked through this when you were running through the NIM outlook, Mike, but on the recent hike with March did you guys change your margin rates and was there any difference in the adjustment in margin depending on negotiated rate versus rack?
We did change our rates that included both negotiated and rack rates, and so the book essentially reset. There is still an ongoing movement of growth in negotiated versus rack. So that does cause a little bit deterioration that you can see on the period versus the full sort of 25 basis points that you would see coming out that December hike. But we move all accounts.
Our next question comes from the line of Michael Carrier with Bank of America Merrill Lynch. Please proceed with your question.
Just a question on capital allocation. You mentioned the balance sheet and I guess once you are to this steady state and then you are growing organically from inflows. Just wanted to get your sense, when you think about that versus the buybacks, is there a certain rate environment, one that makes the buyback option a bit more attractive as you get into the second half?
Right now when you look at sort of the differential between the on-balance sheet, off balance sheet rates, it still makes sense to continue to pursue the strategy of balance sheet growth. But I think more importantly in that is if we tried to place the large quantum of deposits that we have off balance sheet we would actually see some dilution in the rate as we would move through -- we would move from more aggressive to less aggressive banks in terms of what they would be willing pay to take those deposits overall in our sweep waterfall [ph] program. So from a balance standpoint, this remains the best use of capital and strategy. Sure we can come up with yield curve environment where that may not be the case and we're going adjust accordingly to do the right things for shareholders and get the best return on capital possible.
And then just quick follow up on the themes or services lines, just wanted to get a sense when you are basically done with the strategy on the off-balance sheet cash, is there a base level for that revenue line? I know there is a lot of other items in there, so maybe that's tough, but just wanted to get a sense.
Yes it is literally fees and service charges, so there is a lot of things that are in there other than just the off-balance sheet revenue that’s running through there. So you have any fee that customer might pay, other service charges, wire fees all things like that and then including payment for order flow. So overall we haven’t broken it out in terms of what percentage of it is from each area but we can probably think about giving a little bit more color on that as that goes down and is replaced by net interest income. I think you can get all that data in the Q.
Our next question comes from the line of Kyle Voigt with KBW. Please proceed with your question.
Most of my questions have been answered, but I guess a few housekeeping questions. Mike, sorry if I missed this, but did you say the average reinvestment rates in Q1 or 230 to 250 basis points, can you give us an update on the current reinvestment rates, are you still in that range?
We are still in that range. We have been moving about, spreads have been getting a little bit tighter, rate came down, but we're seeing rates moved back up a little bit. We are still in the 230 to 250 basis points range now.
And then Karl, just a follow up on the question earlier. I think you said there is bit of spike in the renegotiations and call volumes with those active traders right after the cut by one of your last competitors, before you made your cut. Can you give us a sense of what you are seeing today in terms of renegotiation versus what you were seeing prior to the cuts in the beginning of February, just trying to get a sense if it's more intense now still?
No. For the top end of the book, there is always competition. People are always trying to go after those folks with large balances, large margin balances and active traders in that front. So we see that kind of competition the call volume has decided we'd back down to sort of normal levels, if you will. But there is a lot of competition out in the marketplace and a lot of offers, unlike things that we’ve seen in the past, we continue to do what we’re doing to make sure we keep our customers and defend the book. But this call volume is definitely down from where we stared pre-our move .
Our next question comes from the line of Brian Bedell with Deutsche Bank. You may proceed with your question.
Just a little bit more in the time color, you were talking about obviously the rollout of the market and campaign in that and the branding along with technology enhancements with OptionsHouse, I think you were saying we're going to close that in the third quarter? Is that possible to be a little bit more precise about the exact timing of the close and then as for the rollout, I would think that would be in the fall?
So in terms of what we’re looking at, first of all, in the marketing campaign, we hope to by the end of June, beginning of July rollout our new marketing campaign. So that will be focused primarily around our rebranding and sort of some hard-hitting advertising we'll go out with. The integration itself is still planned for the third quarter, mid to end third quarter, and I guess sort of a safe assumption on where we are. And in connection with that you’ll see some additional advertising, some additional product rolls that will come out afterwards.
But the integration for us is the start of everything that we’re doing. So innovating and bringing the OH platforms that we acquired to the next level, something we're already working on and hope to rollout following integration. So I think you’ll see a lot more from us overtime, I'm pretty excited about what the future looks like. So I would just, if you would, just say June and we'll be there as soon as we can.
It sounds like there could be a little bit of soft patch in the organic growth in the spring depending I guess on the environment and then obviously you would expect that to reaccelerate upon all this -- working through these clients. Maybe just one last one on the commission rate, $8.10, any sense of what that would be pro forma for the seasonality, I think you mentioned the corporate stock plan, trades were affecting that rate. So for certain [Multiple Speakers].
Yes. If you go back and look you'll to see our Q1 is always strong due to corporate services. If you think around, right around $8 is going to be really -- is a good run rate going forward.
And our next question comes from the line of Vincent Hung with Autonomous Research. Please proceed with your question.
I just want to switch upon again on the strength of [indiscernible] growth. Is there any sense of the mix between the number of accounts you’re gaining from competitors versus customers versus accounts, never had brokerage accounts before, and how that compares historically?
I mean, we get accounts from lots of different places and we’ve done a lot to revamp the way that we go after accounts and in particular some of the reach out and call out campaigns we’ve had around our new active trader sales group and some of the other activities that have been taking place, and it’s not a breakdown that I have in front of me, but our accounts come from lots of different place and we're just happy with the growth we had in the quarter and we expect to see more.
Okay. And you noted that you’re going to be addressing the main customer endpoint. Can you touch upon what these are?
The way we look at it, the pain points and the list of dissatisfiers, if you will, changes on pretty much at daily basis. So there are always five or six things that our call reps are getting calls from customers on and it’s really trying to identify those before they hit that level and before they become a pain point for customers. So a minute you see that somebody in the call center needs to do a work around or deal with an issue on a repeated basis, you step in and fix it you raise your hand. So it’s really about changing culture and changing the way we think and the way that we act in the call centers with our reps.
If you see something, you raise your hand, you tell someone, it goes on the list and you knock it out. It’s a change in focus is really what’s driving that and I’m not going to aim for the specific list of dissatisfies, because it’s constantly changing and we’re doing everything we can to make sure our customers have the best experience possible and they never have the reason to leave E*TRADE.
And with that, I will now turn the call over to you Mr. Roessner for any concluding remarks.
Well, thank you all for joining and have a nice evening. We’ll talk to you next quarter.
Ladies and gentlemen, that does conclude the call for today. We thank you for your participation and ask that you please disconnect your lines. Have a great day everyone.
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