E*TRADE Q1 Earnings Call Transcript

123jump.com Staff
27 May, 2010
New York City

Revenues rose 8% to $536.5 million and net loss was $47.8 million or 2 cents a share. Total operating expense declined from the prior quarter by $23 million to $295 million. Operating expense declined 4% compared with the first quarter of 2009. Customer margin receivables in the U.S. grew by 5%.

E*TRADE Financial Corporation ((ETFC))
Q1 2010 Earnings Conference Call
April 21, 2010 5:00 p.m. ET

Executives

Susan Hickey – Investor Relations
Steven J. Freiberg – Chief Executive Officer
Bruce P. Nolop – Executive Vice President and Chief Financial Officer
Paul Brandow – Chief Risk Officer
Robert V. Burton – Executive Vice President and President of E*TRADE Bank
Michael J. Curcio – Executive Vice President and President of E*TRADE Securities

Analysts

William Tanona – Collins Stewart
Roger Freeman – Barclays Capital
Richard Repetto – Sandler O’Neill
Keith Walsh – Citigroup
Matthew Snowling – FBR Capital Markets
Michael Carrier – Deutsche Bank
Michael Vinciquerra – BMO Capital Markets
Howard Chen – Credit Suisse
Joel Jeffrey – KBW
Daniel Harris – Goldman Sachs
Faye Elliot – Bank of America/Merrill Lynch

Presentation

Operator

Welcome to the E*TRADE Financial First Quarter 2010 Earnings Conference Call. At this time, all participants have been placed in a listen-only mode. Following the formal remarks, we will open the call for Q&A. At that time, if you have a question, please press star one on your touchtone phone. If your question has been answered or you wish to remove yourself from the queue, please press the pound key. Thank you. It is now my pleasure to turn the floor over to Susan Hickey from E*TRADE Financial. Please go ahead.

Susan Hickey

Good afternoon and thank you for joining us for E*TRADE Financial''s first quarter 2010 conference call. Joining me today are Steven Freiberg, E*TRADE''s Chief Executive Officer, Bruce Nolop, our Chief Financial Officer and other members of E*TRADE''s management team.

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

This call will present information as of April 21, 2010. 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. These measures will be reconciled to GAAP, either during the course of the call or in the company''s press release, which can be found on its website at investor.etrade.com.

This call will be recorded. Replay of this call will be available via phone, webcast and podcast beginning today at approximately 7 p.m. Eastern time. The call is being webcast live at investor.etrade.com and no other recordings or copies of this call are authorized or may be relied upon. And with that I will now turn the call over to Steve Freiberg.

Steven J. Freiberg

Thank you everyone for joining us this afternoon. I am pleased to be participating in my first call as E*TRADE''s Chief Executive Officer. To begin today''s call, I would like to share a few thoughts and then Bruce will take you through the first quarter results. From there, I will add a few closing comments before we take your questions.

I’ve had a very busy and exciting first few weeks at E*TRADE learning more about the company, our people, and our customers. This is a pivotal time for the company and I am energized by the opportunity to lead the organization through its next phase of growth and innovation. My predecessors, Bob Druskin and Don Layton, the senior management team and really the entire organization navigated the company through very challenging times. And today, with the solid brokerage business, complemented by an improving balance sheet and its strengthened capital structure, E*TRADE is well positioned for growth and profitability.

I was attracted to the CEO role at E*TRADE for a number of reasons. I am a builder of businesses and I look forward to working with the team to build on the company''s current momentum. In addition, I believe E*TRADE''s focus on expanding customer relationships, both with active traders and long-term investors, aligns well with my experience in building consumer franchises. Through enhanced value propositions, customer segmentation, product innovation and world class customer service.

E*TRADE remains a respected company with a powerful financial services brand and as I spend time with our company and our people, I am even more confident about E*TRADE''s opportunity to reach its full potential and I look forward to engaging with you on our progress.

As Bruce will describe, E*TRADE''s first quarter performance exhibits several positive trends. Earnings are headed in the right direction. Our retail brokerage business continues to compete effectively, balance levels in our loan portfolio declined at a consistent rate with improving delinquency metrics and for the first time in two years, E*TRADE Bank internally generated, rather than used, capital. These trends provide us with the flexibility to make investments that will drive our continued leadership as a trading and investing platform and our ongoing expansion in the long-term investor segment. And with that brief introduction, I will turn the call over to Bruce.

Bruce P. Nolop

Thank you, Steve. We are pleased with our quarterly financial performance and the progress we continue to make in building out a comprehensive product and service offering that supports the needs of a broad range of investors. Before summarizing our financial results, I will review a few highlights of the quarter.

On the product side, a number of new customer offerings and enhancements were introduced. For long-term investors, E*TRADE Capital Management introduced managed investment portfolios with a competitive fee structure and an accessible entry point of only $25,000. And Power E*TRADE Pro users now have access to an expanded feature set including streaming, CNBC broadcasts.

In addition, E*TRADE Mobile Pro for the new iPad was recently released and we are proud that Apple highlighted our application on its download site and during its media briefings throughout the launch. We continue to lead the industry with tools that support today''s increasingly mobile investor.

During the quarter, we also simplified our fee structure to enhance our value propositions to customers. We eliminated the $12.99 pricing tier as well as incremental commissions that applied to certain trades and effective in the second quarter, we are eliminating all of our account inactivity fees.

We expect that these changes will reduce our revenue by approximately $50 million in 2010. But view the changes as an investment in customer satisfaction that we believe will reduce attrition rates over the long term. We were gratified that Barron''s recognized our comprehensive customer experience in its 2010 annual online broker survey. Barron''s awarded E*TRADE Securities four out of five stars, described us as a one-stop shopping destination, highlighted our mobile trading technology and listed us among the best firms for long-term investing.

Turning to our financial results, the company had a net loss of $48 million or $0.02 per share during the quarter which compares with a net loss of $67 million or $0.04 per share in the prior quarter, and a loss of $233 million or $0.41 per share, in the first quarter of 2009. During the quarter, we generated $537 million of net revenue, which is an increase of $13 million from the prior quarter and an increase of $39 million or 8%, from the same quarter a year ago.

Our revenue this quarter included net interest income of $320 million, which was essentially flat compared with last quarter. This reflected a net interest spread of 2.96% on average interest-earning assets of $42.4 billion. Therefore, while average interest earning assets declined by $1.4 billion, a 10 basis point expansion in interest income spread allowed us to maintain a consistent level of net interest income.

Commissions, fees and service charges, principal transactions and other revenue in the first quarter were $196 million. This was a 5% sequential decline compared with our fourth quarter, which reflected lower retail trading activity as well as a $0.10 decline in the average commission per trade. The decline in the average commission included the impact of our recent pricing changes, which was partially offset by a more favorable customer mix this quarter.

We enjoyed increased principal transactions this quarter in our market-making business. They were up $3 million from the prior quarter and $9 million from the prior year. Our revenue this quarter also included $29 million of net gains on loans and securities. This net gain was greater than $9 million of impairments during the quarter.

Our total operating expense for the first quarter declined from the prior quarter by $23 million to $295 million. This included lower compensation, real estate owned bad debt and restructuring expenses, which more than offset higher seasonal spending for advertising and market development.

Our operating expense declined 4% compared with the first quarter of 2009, if we exclude FDIC insurance premiums and restructuring activities during both periods. We are well on the way toward completing our previously-announced plan to restructure our international operations. We are exiting local market trading operations, but will continue to offer customers residing outside of the U.S. the ability to trade in U.S. Securities.

We completed the sale of our German operation at the end of last year, and in April, we consummated the sales of our local Nordic and U.K. businesses. During the quarter, we recorded $3.4 million in international restructuring charges. Over the next two quarters, we expect to record approximately $1 million in restructuring charges including a $3 million credit during the second quarter and a $4 million charge during the third quarter.

The restructuring charges are lower than previously expected due to a gain on the sale of the U.K. business and lower-than-anticipated costs. With our restructuring largely completed, we will focus on U.S. metrics going forward, as the international local activity will be phasing out over the next few quarters.

Darts for our U.S. operations were $155,000 during the first quarter, which is down 2% from the prior quarter and 11% compared with the first quarter of 2009, a period of significant market volatility. Brokerage accounts were up 2,000 and we ended the quarter with 2.6 million accounts. Net new asset flows into our U.S. brokerage business were a positive $2.2 billion during the quarter. Therefore, while the total number of brokerage accounts remained relatively constant, we believe the generation of net new assets indicates higher quality customer accounts.

Customer assets in the U.S. were $159 billion at quarter end. Net new assets were a positive $400 million during the quarter, with the increase in brokerage assets more than offsetting the planned decline in customer bank assets. Brokerage customer cash increased by $1.4 billion to $21.8 billion, while bank customer cash declined by $1.8 billion, including the sale of approximately $1 billion of savings accounts to Discover.

Customer margin receivables in the U.S. grew by 5% during the quarter and ended at $3.8 billion. This represented a 67% increase from a year ago. Turning to the balance sheet, we made continued progress in the runoff of our loan portfolio with total loans declining by $1 billion during the quarter.

Our loan loss provision declined for the sixth consecutive quarter from $292 million in the prior quarter to $268 million this quarter. Net chargeoffs were $288 million, which was a $36 million decrease from the prior quarter. Because our provision was less than our chargeoffs this quarter, our loan loss allowance declined by $20 million. Our loan loss reserve continues to be approximately $1.2 billion which is equal to 6% of total loans.

Delinquency trends continued to improve with quarter over quarter total special mention delinquencies declining by 4% and total at-risk delinquencies declining by 8%. We continue to be pleased with the impact that our loan modification program is having on our credit exposure and comfortable with our provision.

As Steve highlighted earlier, we were extremely pleased that the bank generated $48 million in regulatory risk-based capital during the quarter. And while we may not generate capital in every quarter, we do expect that the bank will generate capital for the full year 2010, marking a key milestone in our return to financial strength.

Our bank capital ratios continue to be substantially in excess of regulatory well capitalized thresholds. As of March 31, the tier 1 capital ratio was 6.83% to total adjusted assets and 13.08% to risk-weighted assets. Our sale of the savings accounts in particular allowed us to free up approximately $50 million in tier 1 capital.

We also ended the quarter with $947 million of risk-based total capital in excess of the level that our regulators define as well capitalized. We ended the quarter with $418 million in corporate cash, an increase of approximately $25 million from the prior quarter.

We expect to receive during the second or third quarter a tax refund of approximately $100 million related to the legislation in 2009 that extended net operating loss carrybacks to five years. We expect that the parent company will retain $95 million of this cash with the remaining $5 million going to the bank.

Given our improving financial position, we plan to pay cash for the May coupon on our springing lien notes, although we will consider this decision more specifically as we approach the interest payment date. Finally, I would like to highlight a change that we are making in our financial reporting this quarter.

In addition to the trading and investing and the balance sheet management segments, we are now providing increased visibility into our corporate expenses with the introduction of a new corporate segment. This new corporate segment includes unallocated expenses for finance, legal, human resource and risk management functions as well as corporate interest expense.

In summary, we believe that our first quarter results demonstrate the strength in our core retail franchise and continued improvement in our overall financial condition. We welcome Steve to the organization and look forward to his leadership as we focus on growth and profitability. And with that, I will turn the call back to Steve for closing remarks.

Steven J. Freiberg

Thank you, Bruce. Before opening the call for questions, let me share a few additional comments. Clearly, we are on the right track in both our brokerage business and in our legacy loan portfolio and I am committed to continuing this positive trend. As we generate capital and move towards profitability, our challenge is to invest in and grow our core brokerage business, manage legacy risk and identify and prioritize opportunities for enhancing growth.

I welcome this challenge and I am certain that the rest of our management team does, too. And although it is still early days for me, I have several thoughts about E*TRADE''s future. These include that we build on our heritage and strength as a technology leader to develop and/or embrace the next set of disruptive innovations.

Further leverage raptly involving research, segmentation, and decision science tools to drive more effective customer acquisition and retention and to expand customer relationships, particularly in the long-term investor segment. Enhance our product suite and customer interaction models to better serve our active trader and long-term investor segments and continue to support our brand and extend it more fully.

Not surprisingly, these themes support our strategy to extend our leadership in the active trader segment, while continuing to expand our relationships with long-term investors. I look forward to the coming weeks and months as we develop and execute plans for E*TRADE''s next stage of growth and as I said earlier, I look forward to engaging with you on our progress. With that, operator, we are ready to take questions.

Question-and-Answer Session

Operator

As a reminder, to ask a question, please press star one on your touchtone phone. We do ask that while you pose your question, you pick up your handset to allow optimum sound quality. Thank you. Our first question comes from William Tanona of Collins Stewart.

William Tanona – Collins Stewart

Good morning, Steve. Good morning, Bruce, I should say, good evening. Question on delinquencies, particularly the one four, I was surprised to see that the early-stage delinquencies have actually stayed flat here for it looks like, the last two to three quarters. And I was also I guess surprised to see the later stage delinquencies increase here. It just seems like it''s a trend that is not necessarily consistent with some of the other financial services companies that we have seen report as of late.

Bruce P. Nolop

This is Bruce. And one thing to remind everyone is that for first lane delinquencies, we have a month lag and so it''s really, the statistics for us, it''s through February and some of the ones you may be comparing may be through March. Overall, we''re very happy with this stabilization we''re seeing in delinquencies and we expect the trends to continue and any additional information we have since the February time period would reinforce that belief.

William Tanona – Collins Stewart

Okay. And then, in terms of the $1 billion in terms of loan reductions there -- you mentioned that $700 million was, you know, principal reductions as well as prepayments, can you quantify the difference between prepayments and principal reductions? And specifically, how much of that is modifications?

Bruce P. Nolop

In terms of prepayments, it''s, it''s the lion''s share of the reduction that''s in the $700 million, very small amount of actual maturities.

William Tanona – Collins Stewart

Okay. And in terms of the $47 million of risk-based capital that was created as a result of changes that took place on the risk-weighted assets, can you help me understand exactly what changes took place to, to free up that capital?

Bruce P. Nolop

The primary change would be as the loan portfolio pays down, so that''s debt reduced. The money is reinvested in agency securities so it''s that difference in the risk weighting, which is a major part of it. In addition, we were able to use more of our deferred tax asset this, this quarter. And then just the relationship of the profitability of the bank versus the loan-loss provision is more favorable than it had been.

William Tanona – Collins Stewart

Okay. Thanks.

Operator

Your next question comes from Roger Freeman of Barclays.

Roger Freeman – Barclays Capital

Hi, thanks. I guess, first, your comment on the dropping the fees for inactive accounts, can you just help us think about that a little bit more? I understand you want to -- I guess you''re looking for those as positive sources of I guess re-engagement at a later point, but as you think about sort of your balance sheet, you know, shrinkage, objectives and the cash that is in those accounts, you have to hold capital against -- does that counter at all some of your near-term priorities?

Bruce P. Nolop

No. The inactivity fee, we found, was just one of the primary customer dissatisfiers and it was an irritant. And we wanted to make sure that we were doing everything we can to retain our accounts and not have anything that would be a dissatisfier to them. And that will be the lions share -- or not lion''s, but the majority of the $50 million will actually be that inactivity fee and so, you know, you will see that coming in starting the second quarter. But it''s part of our overall strategy to focus on our online brokerage business and to grow our customer accounts and the quality of accounts.

Roger Freeman – Barclays Capital

What''s the profitability of an inactive client that doesn''t, you know, doesn''t use any of your services, doesn''t trade? Is there -- and then will there be a specific action to re-engage them?

Bruce P. Nolop

Sure. And the tenancy is that often an account goes inactive for a period and they can be reactivated in terms of their level of engagement with us and it affects not only the inactive ones. It''s just a perception that we found that even some of our very best customers had a perception that we had something that was not consistent with the other competitors in the online industry. So just from a customer perception standpoint, that has the benefit as well.

Roger Freeman – Barclays Capital

Got it. Okay. And then on the provision for loan loss, you may have said this, I might have missed it -- why did it pick up in the HELOC portfolio so much in the quarter?

Bruce P. Nolop

Right. The way it works is that the provisioning is based on your actual experience and then you forecast on that basis and it so happens that this quarter, the loan modification program was more skewed toward home equity than toward our first lien -- I''m sorry, more for first lien and less for home equity. The home equity went down because we were putting in some operational changes and had the effect of reducing that activity during the quarter and first liens is an area we have been gradually increasing. So that effect creates a disproportion compared to what had been the experience and that flows through your loan provisioning. Since that time, we returned to more normalized mix of loan modification including an increase in home equity modifications and therefore, going forward, we fully expect starting with the second quarter to be back to a normalized provisioning and you will see home equity and first lien return to their more normal trends. And overall, we expect that the provisioning for the year will not differ from where we began with our expectations.

Roger Freeman – Barclays Capital

Okay. But I guess does that mean the last few quarters the decline in provisioning has really been more just a function of modifying loans and some pushing out…

Bruce P. Nolop

No. It''s really the function of the change, and we, in our analysis, conclude that although you have some differences in the absolute amounts of provisioning, in terms of the trends, that it doesn''t have an impact on provisioning or on the delinquencies.
Roger Freeman – Barclays Capital

Okay. Last point, last question, quickly, customer mix? You made a comment it was more favorable this quarter. What was that in reference to?

Bruce P. Nolop

Yes, the primary one was that we had more transactions in our corporate services group, which is in the stock plan administration. And it''s more exercises of restricted stock that they sell the stock into the market. And that''s a higher profitable trade.
Roger Freeman – Barclays Capital

Interesting. Do you think it’s kind of being a seasonal thing, particularly with more of restricted stock being…?

Bruce P. Nolop

Yes, that probably is something that more and more we''ll take into account that there does seems to be more restricted stock that best in the first quarter and people are tending to sell their stock when it''s best. The other one in the mix, I would mention is we have an uptick in options as well, which is another favorable.

Roger Freeman – Barclays Capital

Yeah. Okay. Great, thanks.

Bruce P. Nolop

Yes.

Operator

Your next question comes from Rich Repetto of Sandler O''Neill.

Richard Repetto – Sandler O’Neill

Yeah. Good evening and welcome, Steve. Hopefully you come in an up swing here, for sure.

Steven J. Freiberg

Thanks, rich.

Richard Repetto – Sandler O’Neill

I guess, to follow up on the question that Roger asked on the provisioning --to be blunt, I don''t fully understand because I see you overprovided, even though the chargeoffs in home equity have sort of continued down on a trend downward. So I guess -- would you expect chargeoffs late on, because these modifications to increase?

Bruce P. Nolop

Rich, what I''ll suggest is have Paul Brandow, our Chief Risk Officer, elaborate further and just see what color he can add.

Paul Brandow

I’ll give you an explanation now, and then maybe if you have some questions later on, perhaps we can handle them there. But this is really an effect of the interplay between the two different reserves that are involved with loans, the FAS 5 reserve and the one that’s specific to TDRs. The way we do a forecast, right, we need to make an assessment of the amount of modification that are going to be done which would in turn then create the FAS, both the FAS 5 and the TDR, and the FAS 114 reserve. Because modifications for home equity were lower in the first quarter and since our forecasting is based on our most recent experience, that tended to leave more of our loans in the non-modified state, which would be showing up in higher FAS 5 reserves. Since we now have returned to a much more normal level of home equity loans, we expect that in effect to dissolve over the next quarter or two. And so that by the end of the year, assuming again that the modification activity stays at what is now the return to higher pace, it should return to what we expected at the beginning of the year.

Richard Repetto – Sandler O’Neill

Okay. We certainly can spend some time offline going through that. But moving on, the expenses, you know, nice reduction quarterly sequentially in expenses, and Bruce, the other line came down dramatically from, I think, $40 -- $38 million to $21 million. Can you give us color what the -- what was going in that line and why it came down?

Bruce P. Nolop

Yes, there are a couple of things. One is, you had lower REO expense that occurred, and that''s because of stabilization of home prices, had a favorable impact on that expense line. And then bad debts that the fourth quarter of 2009, there was an abnormally high amount of charges that went through that line and we''re back to normal bad debt levels.

Richard Repetto – Sandler O’Neill

Got you. Okay. And the very last question, you know, the focus on the core brokerage, and everybody knows that has been the strength here with the company through the down swing, the economic down swing -- we did -- I guess the question is, there was, you know, sort of an uptick in attrition. There was a net, you know, net loss of accounts in March. I was just trying to see -- I''m also looking back at the prior quarter, and it looks like the accounts are different than in the last press release. Is there some accounting thing going on with the brokerage accounts or -- and what do you attribute the attrition in March to?

Bruce P. Nolop

Sure. In March, you have the inactivity fee comes in, so you typically would find that that would have an impact in the last month of the quarter. And as we discussed a little earlier, in some ways, this is getting rid of the less valuable accounts and so more and more, what we look at is the overall quality of the accounts and that''s from our point of view, the best metric is the $2.2 billion in net new assets that came in. So while we want to grow the number of accounts, we are probably even more focused on the net new assets. And because of things like inactivity fees and other factors, you''ll have changes that we should help going forward.

Richard Repetto – Sandler O’Neill

And just on the accounting, I''m looking at the last press release that said $2.7 million brokerage accounts. Was there a change…

Bruce P. Nolop

Yes, the change was that in, as I mentioned, we were going to focus on U.S. metrics going forward and so we were excluding the international local accounts.

Richard Repetto – Sandler O’Neill

Got you.

Bruce P. Nolop

So, we''re trying to be apples to apples. And, and going forward, it should get a little less confusing, but for a while we''re going through the transition.

Richard Repetto – Sandler O’Neill

Understood. Thanks, guys.

Operator

Your next question comes from Keith Walsh of Citi.

Keith Walsh – Citigroup

Good morning, everybody or good evening. Sorry. Getting a little confused here. First for Bruce, just opportunity for more loan sales and specifically, what''s the gap you''re seeing these days around the market value versus what you''ve marked these loans to? Then I''ve got a couple follow-ups.

Bruce P. Nolop

Yes, rather than quote specific prices, I would say that we continue to monitor the market. And what we see are the prices in the secondary market are still below the intrinsic value and so we do not see the potential to do anything material in terms of additional loan sales.

Keith Walsh – Citigroup

I mean, what''s the trend on that gap, though? What have we seeing over the last six to eight months? With that, I think, the additional color I''ll call on Bob Burton, who is the President of the E*TRADE Bank, to comment.

Robert V. Burton

We are seeing some narrowing of that difference between what we believe the intrinsic value is in the market and we are looking, for example, to take advantage of opportunities to potentially securitize some of the loans in the portfolio. But we still think there''s a ways before that gap narrows to the point where we would contemplate additional sales.

Keith Walsh – Citigroup

Okay. And then second question for Bruce, maybe if you could just remind us, you know, upward movement on short-term rates, why your two larger competitors has positive EPS leverage and for you guys it''s actually slightly negative?

Bruce P. Nolop

Yeah. I can''t comment on the balance sheet of the competitors, but for us, we manage the balance sheet to be neutral in terms of the impact of interest rate movement and even since last quarter, we have become more neutral. So with a change in short-term rates, at this point, we don''t see any effect on our interest income and that''s a combination of just the way that the mix of assets and liabilities are constructed as well as hedging activities, which the people in our bank treasury department manage.

Keith Walsh – Citigroup

Okay. And then the third question, just for Steve and just around, you know, strategy here -- what attracted you to this job specifically and what do you view as your immediate priorities as we move throughout 2010? Thanks.

Steven J. Freiberg

Just to frame it, one, the industry at large, which essentially is, the brokerage and financial services, has been an interest of mine and I''ve spent ten out of my 30 years on that side of the house and I''ve always basically enjoyed it and enjoyed basically building franchises within the category. Secondarily, E*TRADE in particular, as I said earlier, is at a pivotal point, and I spent also a good part of my career in turnarounds and I''m very optimistic at this point about the opportunity that E*TRADE specifically presents. I also enjoy consumer-oriented franchises. We''ve got a terrific brand, a very strong core business.

We have the potential to expand that core business into other segments that I think holds significant potential. And we have to work through as it is clearly evident, some of the challenges of the past, which is, in fact, the legacy asset book, and so we can''t lose sight or we can''t basically let up the vigilance around that. So, that in itself and again, just to remind the group, it''s been all of three weeks -- so that I''m beginning to get a better understanding of both the opportunity of the issues and the risks associated with the franchise. But on balance, I couldn''t think of a better company at a better time to join.

Keith Walsh – Citigroup

Great. Thank you.

Operator

Your next question comes from Matt Snowling of FBR Capital Markets.

Matthew Snowling – FBR Capital Markets

Hi, good evening. Just maybe a question on net interest margins, it came in a little higher than what we were looking for. Is that just simply the effect of redeploying the cash on the balance sheet at, in higher rates or higher rates security?

Bruce P. Nolop

Sure. There''s really three reasons. One is, as you mentioned, that we were able to put more cash into securities. Secondly, we have a higher margin balance, which is very much lucrative balance and third is the mix of our deposit. It became more skewed towards brokerage cash rather than bank cash and that, in turn, lowers our cost of funding, which gets translated into a higher margin.

Matthew Snowling – FBR Capital Markets

Okay. Maybe going back to your interest rate sensitivity, you mentioned you were neutral right now.

Bruce P. Nolop

Yes.

Matthew Snowling – FBR Capital Markets

To rates. But, is the model itself still asset sensitive in that you''ve just hedged out some of that sensitivity in the near term?

Bruce P. Nolop

I tell you, again, I think this is when I''ll call on Bob Burton, who this is the President of the bank, to explain further about how we manage that.

Robert V. Burton

Yes, in general, although we certainly engage in hedging activity to customize our position, the balance sheet is generally moving closer and closer to neutral as a loan portfolio pays off. And so we have the rift generated by the loan portfolio and by our securities portfolio, offset by the value creation as interest rates move from our large, you know, internal deposit banks. So, as a rule, it leans towards being basically neutral.

Matthew Snowling – FBR Capital Markets

Does that assume that you reprice your deposits in line with rising rates?

Robert V. Burton

Well, it certainly makes -- there''s certainly a series of assumptions we have to make about how sensitive our deposits are to moving and we just, we use historical numbers to look at, look at that.

Matthew Snowling – FBR Capital Markets

Okay. Thanks.

Operator

Your next question comes from Michael Carrier of Deutsche Bank.

Michael Carrier – Deutsche Bank

Thanks. Just a question on the, the net new brokerage accounts. You had this quarter, you know, a little less than 2,000. Last quarter was negative. Just trying to figure it out, because in the industry, when you look at some of your peers, they show two-year high in terms of net new brokerage accounts and organic growth. I know when I look at your, your spending on the marketing, it''s a little bit lower but trying to understand if there''s anything else going on there in terms of the new growth?

Bruce P. Nolop

Two comments I would make, one is that if you recall in January, we had some achievements [ph] and so 6,000 accounts were eliminated through that process and that was not something that was in prior quarters, if you compare. And secondly is that we find new that accounts are very largely correlated with volatility and so this is a period of lower volatility. And I just would comment that already when you have seen some increase in the market volatility that we can see the impact from that immediately and so that''s something that probably is a more telling factor in the slower growth.

Michael Carrier – Deutsche Bank

Okay. And then secondly, just on the outlook for the commissions and inactive fees, if I look at the $50 million that you''re, you''re projecting for the year, I''m just trying to understand how much of that was in the first quarter versus…?

Bruce P. Nolop

Sure. Yes, yes. First quarter, the impact was about $4 million. And for the next three quarters, it will be $15 million, about, per quarter, which gets you up to the $50 million.

Michael Carrier – Deutsche Bank

Thanks a lot.

Bruce P. Nolop

Yes.

Operator

Your next question comes from Mike Vinciquerra of BMO Capital Markets.

Michael Vinciquerra – BMO Capital Markets

Thank you. Just following up on Mike''s question there on the commission rate. You did say that the majority of the lost $50 million is going to come from the inactivity fees, right? So there''s not going to be that much of an impact on the commission rate itself.

Bruce P. Nolop

Yeah. I can give you a feel for that. For the quarter, we estimate that it was about a $0.33 impact and again, that was offset to a large degree by mix and going forward, that would be more in the range of about $0.50.

Michael Vinciquerra – BMO Capital Markets

Okay. Great. And the corporate services side, I mean, as stock prices have risen certainly more people have incentive to sell restricted stock if it''s vested. So, does that help to support potentially more activity from that segment?

Bruce P. Nolop

Sure. Yes. I''m going to have Mike Curcio, who is the head of our Brokerage Operations, and also Corporate Services reports to him. So, maybe he can add some color.

Michael J. Curcio

Yes, absolutely. As market have come up and individual stocks have come up, there''s become more and more value in, in options than we see a lift in, in DARTs through the corporate service channel because more options are exercised, more restricted stock is sold. And that''s a positive there and it''s on our commissions because the commissions are much higher than the rack rate.

Michael Vinciquerra – BMO Capital Markets

Great. Thank you, Mike. Just one other thing, Bruce, on the interest margin that you didn''t mention as far as the lift in the quarter. I notice your repo rates fell pretty substantially, is this reflective of tighter credit spreads in the market place? Or how did that kind of come about? It''s pretty significant quarter over quarter.

Bruce P. Nolop

Again, this is what I''m going to refer to Bob Burton.

Robert V. Burton

Certainly, some of it is related to the market. But in addition, early last year, we locked in a lot of longer-term repo arrangements that are expiring and as they expire, we have been able to reduce our cost of repo.

Michael Vinciquerra – BMO Capital Markets

Great. So that sound like it''s a sustainable level now with these in the low twos now.

Robert V. Burton

That''s what we would expect.

Michael Vinciquerra – BMO Capital Markets

Great. Thanks, guys.

Operator

Your next question comes from Howard Chen of Credit Suisse.

Howard Chen – Credit Suisse

Hi. Good afternoon, everyone.

Bruce P. Nolop

Hi.

Howard Chen – Credit Suisse

Steve, your commentary was pretty constructive on the outlook for the organic growth of the franchise. I''m just curious, as the new CEO, thoughts on the feasibility and appetite of a strategic sale of the franchise?

Steven J. Freiberg

We expected that question would come up. Let me just emphasize, Howard, and I do appreciate the question, that we have a thriving online brokerage business, we''ve strengthened our financial position and I believe we have the opportunity to grow and prosper as a stand-alone company. I think that sums it up.

Howard Chen – Credit Suisse

Okay. Thanks. Just wanted to hear it from you, and then, second, any latest thoughts on what the appropriate size of the balance sheet and balance sheet composition is for the longer term franchise?

Steven J. Freiberg

Again, you know, just to reiterate, it''s been all of three weeks. I think the trend that the business has followed to this point is correct, which essentially is a combination of reducing the legacy at-risk assets, de-risking the company on a whole host of fronts, and as we develop a broadened, longer-term strategic plan for the company, which is part of one of my year-end priorities, I think that will be a derivative of the plan overall. So it will be a combination of relative size, diversification of the franchise, level of risk that we''re willing to take on with an expectation of kind of earnings and returns. So it''s very early to give you an absolute outside the context of a broader set of strategies, but that is a high priority for all of us so that we can frame, essentially, the future of this company.

Howard Chen – Credit Suisse

Okay, great. Thanks. And then, final question, loan portfolio seems to be running off, credit behaving, as you expected, better than expected. I guess as the environment becomes more normal, just any broad thoughts on when that inflection point in franchise profitability happens?

Steven J. Freiberg

At this point, one, we’re not predicting it -- again, I also just emphasized that the trends have been positive and we expect, as you’ve described it, those broad macro trends to continue. And within that frame, we believe that we can continue to produce the positive results, the positive trend. But predicting precisely when we would cross to profitability is something we would not really provide at this point.

Howard Chen – Credit Suisse

Okay. Great. Thanks so much for taking my questions.

Operator

Your next question comes from Joel Jeffrey of KBW.

Joel Jeffrey – KBW

Just a question, I think you said earlier that most of the rundown in the loan portfolio was due to prepayments. Now, if we get into a higher rate environment, do you continue to see that trend as being sustainable?

Bruce P. Nolop

You want to comment on that, Bob? Bob Burton?

Robert V. Burton

Sure. Certainly we continue to expect that we will continue to see prepayments. Obviously, we''re going to move with the industry and to the extent of prepayments flow and expect to see that. However, remember that our portfolio is older. And we think that a constant benefit across the number of factors in that age are going to help us.

Joel Jeffrey – KBW

Okay. Great. And then it looks like advertising was up quarter-on-quarter and typically seasonally up in the first quarter of the year. But given your new heavy focus on the brokerage side of the business, is this an elevated trend we can continue to see or you think it will resort back to more traditional seasonal levels?

Bruce P. Nolop

Well, what we said at the beginning of the year is we expected the overall spending on advertising and market development to be roughly equal to modestly above 2009 and that continues to be what we expect. But we are having a more broadly spaced throughout the year than we did last year.

Joel Jeffrey – KBW

Okay. Great. And then just lastly, in terms of your working capital needs, how much sort of working capital do you guys need to run the business on an annual basis?

Bruce P. Nolop

Well, in terms of the brokerage company, it''s in connection with the bank as well and maybe I can answer it that way, that we look at $1 billion to $2 billion of cash that we would maintain in the bank and that would be the level. And we''re slightly above that amount right now.

Joel Jeffrey – KBW

Okay. Great. Thanks.

Operator

Your next question comes from Daniel Harris of Goldman Sachs.

Daniel Harris – Goldman Sachs

Hi, good evening, guys. One of the things I want to touch on was the market-making business. It looks like the shares that you''re trading are going well, way up and obviously it was a difficult market for market-making in the quarter with volatility declining. But, how do you see that part of your business moving -- going forward?

Bruce P. Nolop

This is a really good story. As I mentioned, transactions are up so with that, I will let Mike Curcio, who supervises this business as well, maybe elaborate on what is a real gem for us right now.

Michael J. Curcio

Sure, Bruce. We''re seeing some really good trends now that we''re past our crisis, and we invested in our business, making it more automation in all the NMS stocks. We''re getting a lot more external customers. So that''s really where you''re seeing the growth, especially in the bulletin boards. But we''ve also seen a nice lift in the NMS business as well and we feel that trend will continue as long as market conditions are the way they are. And they could even increase if we get more volatility. So we''re very excited about that

Daniel Harris – Goldman Sachs

Okay. And sort of on a similar vein, can you sort of remind us what are the obligations and opportunities you guys have to increase payment for order flow as we move further away from some of the things that occurred over the last few years?

Bruce P. Nolop

Well, as you know, the agreement that we have with Citadel expires at the end of the year and we will be looking at alternatives for the order flow. And we''ll be comparing different alternatives, and obviously need to make a decision before then but, at this point, don''t have anything to report.

Daniel Harris – Goldman Sachs

Okay. And then just lastly, I know that there was some moving parts in first mortgage in the HELOC book on the provision rates. But in terms of the first mortgage portfolio, we''re starting to see some stabilization in the chargeoffs. I don''t know where, obviously, the number goes next quarter but we were trending that you were building the reserves prior to this quarter. You said that probably flip-flops next quarter. At what point do you think you start releasing reserves in that first lien portfolio? And are you seeing any signs that would actually lead you to think that that''s sooner rather than later?

Bruce P. Nolop

Again, Paul Brandow, Chief Risk Officer, response?

Paul Brandow

I think actually you almost answered my question for me. We do -- we agree the trends in the home equity portfolio have been more favorable than the first lien but first lien also has declined quite consistently over the last 12 months, at a slower pace than home equity because, as we mentioned before, it''s a less seasoned portfolio, and furthermore we had first mortgages with relatively low LTVs and it''s taken a long time -- longer time for some of those to become delinquent.

Having said that, we would expect that the, the positive trend to continue, perhaps at the, this more moderate pace that we''ve seen over the past few months. But to the point that was mentioned before, in the quarter, sort of the, or of the special mention delinquencies were more or less flat, but there were improvements in the roll rates and other categories. And actually, we did see more significant declines in the later stage buckets. So, again, we won''t predict when exactly that means that we would flip, but we''re pretty confident that''s coming not too far away.

Daniel Harris – Goldman Sachs

But so the big provision bill that you -- or the big reserve bill that you had in the fourth quarter, that, you know, probably shouldn''t expect anything much more than that, given the trends we''re seeing and maybe getting better? As that''s for what I''m understanding you''re saying. So, thanks very much.

Paul Brandow

You''re welcome.

Operator

Your next question comes from Faye Elliott of Bank of America/Merrill Lynch.

Faye Elliot – Bank of America/Merrill Lynch

Hi, thank you. Good afternoon. I think I might be repeating the previous question, but I just wanted to make sure that for modeling sake I understand -- I guess, your philosophy on your provision and your reserve and it looks like your reserve to EOP loans and your reserves to EOP -- I''m sorry, to MPAs is going up across categories and actually as a whole. And I guess I''m still not clear whether you''re saying that you''re ready to lower that provision such that these numbers can start coming down, these ratios can start coming down a little bit.

Bruce P. Nolop

Yes. There is -- it’s interesting -- the one thing I would say at the outset is our philosophy, really, isn''t the governing factor. That we apply consistent procedures and a very rigorous modeling, and so I just don''t want you to think that this is a subjective process. And with that, I''ll let Paul respond.

Paul Brandow

The only thing I will add to what Bruce said was keep in mind that we have a steadily declining portfolio so other things being equal would drive the ratios up.

Faye Elliot – Bank of America/Merrill Lynch

Right, but, but -- and I expected that would be the reason but if you have a continually declining portfolio, then would you, provision less to drive those, to allow those ratios to start coming down, given the trend that we''re seeing?

Paul Brandow

I think the effect would be that, or the result would be that, but as Bruce alluded to before, our process for, for providing for loans, and reserving for loans is based on a consistent procedure, which start with an estimation of losses going forward, based on a number of factors including the loan level performance of our own portfolio. So yes, what you say is going to happen over time, but we get at with it a different set of analysis.

Faye Elliot – Bank of America/Merrill Lynch

Okay. Thank you.

Operator

Once again to ask a question, please press star one. Your next question comes from Roger Freeman of Barclays.

Roger Freeman – Barclays Capital

Hi, yes, just a couple follow ups. On the -- with respect to the wholesale funding, you know, I think it was a question earlier about where you''re putting sort of maturing loans and you''re buying MBS securities. What about further reduction of, say, FHLD loans since it has a higher cost to it?

Bruce P. Nolop

Yes. I think we''ve communicated before -- and I''ll just make sure everyone understands that the wholesale funding, we have a couple of constraints that limit our ability to reduce that amount of funding. First, on the home loan bank loans, any reduction there would require a prepayment penalty so essentially, pulls interest clause forward and that has a negative impact on capital. So it''s something we do when we can but it''s not something we can do regularly. And then, with respect to the repo financing, the constraint there is there are hedging arrangements that are associate and that would be a pretty significant financial impact if we try to reduce.

Roger Freeman – Barclays Capital

Just on that one -- I know you have talked about that in the past -- what is the, what''s the average duration of those swap hedges on the repo portfolio? At some point, do those sort of, you know, run off?

Bruce P. Nolop

Eventually, but it''s a long duration. My memory has been more four or five years, in the maturity.

Roger Freeman – Barclays Capital

Got it.

Bruce P. Nolop

Or 10.

Roger Freeman – Barclays Capital

Okay. Got it. But I just want -- one thing on repos, I think the balance actually went -- I''m sorry, FHLD actually when up in the quarter? 2.761 versus 2.749?

Bruce P. Nolop

$2 million.

Roger Freeman – Barclays Capital

Yeah. I mean, it wasn''t much.

Bruce P. Nolop

Yeah.

Roger Freeman – Barclays Capital

I was wondering why it went up at all.

Bruce P. Nolop

Our Bank Treasurer, any comment on that, Mike do you see?

Michael J. Curcio

The home loan bank line has a certain amount that''s just overnight. It''s a very small amount.

Roger Freeman – Barclays Capital

Okay.

Michael J. Curcio

Some intraday fluctuations there between the cash side of the balance sheet, on the asset side, and the funding side and so you will see some small amount of variability. There''s, there -- you shouldn''t expect to see any large curve.

Roger Freeman – Barclays Capital

Okay. All right.

Bruce P. Nolop

No change in strategy.

Roger Freeman – Barclays Capital

Got it. Okay. Makes sense. Just on a -- on a lighter note, would you say you got more advertising benefit out of this frivolous Lohan lawsuit than any expenses?

Bruce P. Nolop

Well, we won''t comment on that, but I would just say overall that we''ve got a lot of free media from the whole Super Bowl campaign that made that a very worthwhile. As the CFO, I appreciate that return on investment.

Roger Freeman – Barclays Capital

Got it.

Bruce P. Nolop

Yes.

Roger Freeman – Barclays Capital

Okay. Thanks.

Operator

This concludes the question and answer portion of today''s call. I will now turn the conference back over to Mr. Steven Freiberg for any closing remarks.

Steven J. Freiberg

Okay. Thank you for joining us tonight. We feel very good about the progress we made in the first quarter. We look forward to speaking with you again next quarter. Good evening.

Operator

Thank you. This concludes your conference. You may now disconnect.