Q209
Earnings Conference Call Script
Welcome to E*TRADE
FINANCIAL Corporation’s second quarter 2009 business update call. At
this time, all participants have been placed on a listen-only
mode. Following the presentation, the floor will be opened for
questions.
I’ve been asked to
begin this call with the following “Safe Harbor” statement: During
this conference call, the Company will be sharing with you certain projections
or other forward-looking statements regarding future events or its future
performance. E*TRADE FINANCIAL cautions you that certain factors,
including risks and uncertainties referred to in the 10-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
projections or forward-looking statements. This call will present
information as of July 22, 2009. 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 this call or in the Company’s press release, which can be found on
its website at investor.etrade.com. E*TRADE has filed a definitive
proxy statement with the SEC. Shareholders are advised to read that
document and related proxy materials before voting at the Special Shareholders
Meeting scheduled for August 19th.
This call is being
recorded. Replays of this call will be available via phone, webcast
and podcast beginning today at approximately 7:00 p.m. Eastern
Time. The call is being webcast live at
investor.etrade.com. No other recordings or copies of this call are
authorized or may be relied upon.
I’ll now turn the
call over to Don Layton, Chairman and Chief Executive Officer of E*TRADE
FINANCIAL Corporation, who is joined by Bruce Nolop, Chief Financial Officer,
and other members of the E*TRADE management team.
–
Mr. Layton please go ahead.
Don:
Thank you all for
joining us this afternoon. This quarter marked several important
milestones for the Company, and we appreciate the opportunity to discuss with
you the progress we have made.
Bruce will take you
through our financial results for the quarter, but first I want to address three
topics with respect to the quarter’s strong results:
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Growing our
core franchise,
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Managing our
credit portfolio, and
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Executing
against our comprehensive capital
plan.
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First let me touch
upon our core franchise, which continues to perform exceptionally
well. Our online brokerage business is, quite simply,
thriving. We continue to take market share from traditional brokerage
firms and to benefit from favorable market conditions, with increases in
transactions, new customer accounts and both commission and interest income
revenue.
Second quarter
trading activity was robust. We set a new quarterly record at 221,000
daily average revenue trades or DARTs — our second such trading volume record in
the last three quarters. This represents a 14 percent increase over
the prior quarter and a 28 percent increase over the same period in 2008, as we
continued to benefit from our enhanced focus on the investing customer and
favorable market conditions. And, as customer buying power and
confidence improved with the markets, margin receivables increased 29 percent to
$3.1 billion at the end of the quarter.
We
also saw significant growth in brokerage accounts this quarter, reporting a
record 2.7 million accounts – a net increase of 54,000. With our
emphasis on growth in brokerage accounts, we now have added more than 200,000
net new accounts during the last 12 months, far higher than historical
averages. I should also point out that
brokerage account
attrition continues to trend lower – attrition was just 12.6 percent annualized,
versus 15.4 percent annualized for the same quarter a year ago. In
addition, we averaged 1.65 brokerage accounts opened for each one closed – a
33
percent increase over the year ago period. The improvement in both of
these metrics reflects our focus on the brokerage customer, especially in terms
of improved service quality.
Total
customer cash and deposits decreased $700 million. This net
reduction reflected a
$1 billion increase in brokerage cash, our most advantageous source of funding,
offset by a decrease in non-sweep deposits of $1.7
billion. As a reminder, we are decreasing our non-sweep deposits to
accommodate the reduction of our balance sheet due to the fact that
our
loan portfolio is in full run-off mode. We were able to achieve the
reduction in non-sweep deposits chiefly by reducing the yield on the
Complete Savings Account – or CSA – by more than 200 basis
points. This CSA yield began the year at 301 basis points, which was
reduced to 145 basis points as of March 31st, and stands at 95 basis points
today.
Still, we added
$900 million in net new customer assets this quarter, even with the impact of
the planned reduction of non-sweep deposits.
Our focus on the
investor franchise and our back-to-basics approach is producing strong customer
performance metrics quarter after quarter. This approach
emphasizes:
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Excellence
and discipline in execution;
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Continuously
improving service quality and addressing customer dissatisfiers; along
with
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A full
product development pipeline for long-term investors as well as for our
active trader client base.
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As
a result, our vibrant and profitable online brokerage business is providing an
excellent foundation from which to build future growth.
Let me now turn to
credit. For the second consecutive quarter, our loan portfolio has
shown improving delinquency trends. Our delinquency numbers clearly
suggest that our loan portfolio is further advanced in the credit cycle than the
broader industry.
In
the home equity portfolio, which represents the Company’s greatest exposure to
loan losses, special-mention delinquencies, that is 30 to 89 days delinquent,
declined by 12 percent; and at-risk delinquencies, that is 30 to 179 days
delinquent, declined by 19 percent from the end of March. These
declines seem to be indicative of both the advanced seasoning in our home equity
portfolio, which carried an average seasoning of 43 months at quarter end; and
our aggressive actions in 2008 to reduce open lines.
Our 1 to 4 family
loan portfolio has begun to show encouraging signs of reduced delinquencies this
quarter. Specifically, special-mention delinquencies are down four
percent from March 31st and total at-risk delinquencies are similarly down three
percent from March 31st. Roll rates are stable overall, although
there was a modest increase in severity at the 180 day charge-off point, from 21
percent to 24 percent.
For the total loan
portfolio, the decline in special mention and at-risk delinquencies resulted in
another significant quarterly reduction in provision expense.
Before I move on
from credit, I wish to mention that our increasingly successful loan
modification program is contributing to the meaningful improvement in the
quality of the loan portfolio. We have completed over $250 million in
loan modifications primarily via permanent or temporary rate reductions and we
are pleased with the performance of this program and its success in allowing
more Americans to stay in their homes.
Finally, let me
turn to the very significant progress we recently have made in executing our
capital plan to strengthen our
financial health and position the Company for long-term growth and
profitability.
During the quarter
we raised gross
proceeds of more than $600 million of cash equity, materially strengthening our
balance sheet. Our capital ratios, which Bruce will take you through
in detail, are now clearly stronger than they were at the beginning of the year
and will help to ensure that we remain significantly above the
“well-capitalized” threshold as defined by our regulators – even under weaker
economic conditions than are expected.
Equally important,
assuming completion, our pending debt exchange for $1.7 billion – which was more
heavily subscribed than anticipated – will cut our cash interest payments at the
Parent company by more than half. We will hold a special shareholders
meeting on August 19th to seek approval of the exchange of the irrevocably
tendered bonds. Assuming we receive shareholder and regulatory
approval, we would expect to close the debt transactions by the end of the third
quarter.
Needless to say, we
are thrilled with the results of our recapitalization to date. The
success of the equity and debt transactions, we believe, demonstrate that
investors see the strong franchise value and growth potential of our online
brokerage business, that they see credit issues declining and becoming
manageable, and that they see that our recapitalization gives our Bank a balance
sheet strong enough to carry it nicely through the rest of the credit
cycle.
With that, I’ll
turn the call over to Bruce for more on the quarter’s financials.
Bruce:
Thank you,
Don.
During the quarter,
we generated a net loss of $143 million, or 22 cents per share, on net revenue
of $621 million. The loss was due primarily to the loan loss
provision of $405 million. While the provision remains high, we are
pleased that it has decreased for
the third straight
quarter. It is more than $100 million off its peak – and is nearly
converging with quarterly charge-offs.
Our second quarter
revenue included net interest income of $340 million, a 22 percent increase over
the first quarter, which resulted from a 57 basis point expansion in the
interest income spread to 291 basis points. The largest contributor
to this significant spread expansion was the 50 basis point reduction in the
annual percentage yield on our Complete Savings Account – from 145 basis points
to 95 basis points. We expect to see a continuation of favorable
interest rate spreads, but on a gradually declining balance sheet.
Commissions, fees
and service charges, principal transactions, and other revenue were up 18
percent over last quarter — which reflected higher commission revenue from the
record trading volume in the quarter and an increase in the average commission
per trade by 46 cents to $11.05, which was due to a more favorable
mix.
We
continued to practice disciplined expense management, keeping down the costs
that are within our control. However, operating expenses increased
$35 million sequentially due to FDIC fees being higher by $29 million, which
included a one-time $22 million special assessment, and $10 million in increased
reserves for legal matters.
Therefore, the additional volume-related costs were more than offset by our
ongoing expense productivity programs.
Our loan loss
provision of $405 million was slightly above the $386 million of net charge-offs
during the quarter. The total allowance for loan losses thus was
essentially flat at $1.2 billion as of June 30th. This allowance was
equal to 5.3 percent of gross loans receivable, which compares with 2.3 percent
a year ago.
Total special
mention delinquencies were down eight percent from March 31st,
and total at-risk delinquencies were down nine percent.
The movement during
the quarter included:
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For the home
equity portfolio, at-risk delinquencies were down 19
percent.
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For the 1 to
4 family portfolio, at-risk delinquencies were down three
percent.
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And for the
consumer and other portfolio, at-risk delinquencies were down 10
percent.
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The allowance for
loan losses as a percentage of nonperforming loans — or the coverage ratio —
ended the quarter at 83 percent, which was down from 92 percent last
quarter. However, excluding the nonperforming loans at least 180 days
past due, as they have been written down to their expected recovery value, the
coverage ratio was 169 percent, up from 149 percent last quarter.
To
summarize, at-risk delinquencies declined across the portfolio, reflecting a
consistent decline in special mention delinquencies that began at the beginning
of the year for home equity loans and more recently for the remainder of the
portfolio.
We
increased the 1 to 4 family reserve, but reduced the reserves for home equity
and consumer and other loans.
In terms of
liquidity, we had $527 million of corporate cash at quarter end, the Bank had
$4.5 billion of cash, and we had unused Federal Home Loan Bank credit lines of
$6.7
billion. I should note that the decrease in unused lines this quarter
reflect the Atlanta Home Loan Bank’s revised rules that increase haircuts on
pledged collateral.
Finally, I want to
provide more insight concerning our comprehensive capital plan to bolster the
Bank’s capital cushion and strengthen the Company’s capital
structure. We successfully raised $586 million of net cash equity in
the second quarter. In total, we injected $500 million as equity into
the Bank during the quarter.
The $500 million of
new capital was much greater than our net usage of $28 million of risk-weighted
capital during the quarter. We generated $333 million of organic
capital
during the quarter
through $232 million of Bank earnings before taxes and credit losses, and $101
million of freed up capital through a reduction in the loan
portfolio. Other sources and uses were a net contributor of $44
million. These positive amounts were then offset by the credit
provision of $405 million, resulting in the net usage number of $28
million.
Thus, we realized a
$472 million increase in the Bank’s capital cushion during the quarter, ending
with $916 million in excess risk-based capital over the well-capitalized
threshold. We also reported Bank Tier 1 capital on total adjusted
assets of 6.79 percent and Tier 1 capital on risk-weighted assets of 12.65
percent.
At
the same time, we are well on our way to materially reducing the Parent
company’s debt service burden. Assuming we receive shareholder and
regulatory approval, we will exchange approximately $1.7 billion of non-interest
bearing Convertible Debentures for an equal principal amount of our existing
high-yield debt.
Bondholder response
to the exchange offer exceeded our expectations, with Citadel tendering the
maximum amount of $1.23 billion, and with virtually all other holders
participating at their maximum levels as well. Assuming completion,
this exchange will reduce the Parent company’s annual cash interest payments by
approximately $200 million to an annual total of approximately $160
million.
Our $527 million of
corporate cash is up $121 million from the end of the prior
quarter. Assuming the debt exchange is approved by shareholders and
regulators, this should
be sufficient to meet the Parent company’s cash debt servicing requirements
through 2011.
I
will now turn the call back over to Don for his closing comments.
DON:
Let me wrap up with
some forward-looking comments in the same order as my introductory
comments: the customer franchise, credit exposure and our capital
position.
First, the customer
franchise:
The business is
firing on all cylinders and we are extremely happy about how well the franchise
is performing. We continue to get our fair share of volumes and
revenue versus our online competitors and are clearly gaining share against
traditional brokerages. Our focus on the investor customer and the
basics of the online brokerage business are really paying off.
Nevertheless,
despite the high volumes in the first half of the year, and the record DARTs
this quarter, we will continue to manage the business to a conservative outlook
for the second half of the year, just as we did for the first
half. We will continue to manage expenses closely. And, as
we did in the first half, we will be positioning the company to more likely be
surprised to the upside and to produce strong operating income.
Second, credit
exposure:
Loan delinquencies,
which are the precursor to losses, are declining nicely with special mention
delinquencies down 17 percent from the end of 2008. As a result, we
believe we are likely to have a material reduction in quarterly charge-offs
during the remainder of the year.
We
believe that this past quarter marked the cyclical peak for charge-offs and that
likely we will soon reach the stage where the loan loss provision is less than
the charge-offs during the quarter. We expect that this crossover
probably will occur sometime later this year — which will mark a significant
watershed event in our eventual return to profitability.
And third, our
capital position:
We
have strengthened the Bank’s capital position considerably, and we are
continuing to generate Bank capital organically — both through consistent
pre-credit provision profitability and with our deliberate efforts to reduce the
size and risk of the Bank’s balance sheet. We estimate that the
break-even credit loss provision for a quarter is about $250 to $300
million. Therefore, with the expected decline in the loan loss
provision, we anticipate that the Bank will be a net generator of regulatory
capital in the foreseeable future, possibly even later this year.
Assuming the debt
exchange receives shareholder and regulatory approval, which we fully expect to
occur, we also will have enhanced the Parent company’s liquidity and reduced its
debt service burden — especially through the end of 2011. As a
result, we will be in a position to be flexible and opportunistic in response to
market conditions with regard to our capital planning actions, such as further
debt-for-equity exchanges, additional open market equity offerings or sales of
any non-core assets.
In
summary, we believe we are now much better positioned — both to cope with any
unforeseen problems and to seize the opportunities that we see for our online
brokerage franchise.
With that,
operator, you may open the line for questions.
Forward-Looking
Statements. The
statements contained in this investor
conference call script that are forward looking are based on current
expectations that are subject to a number of uncertainties and risks, and actual
results may differ materially. Such statements include those relating
to balance sheet trends, loan
portfolio and delinquency trends, the Company’s
expectation that the amount of its quarterly provision will drop below quarterly
charge-offs later this year and the belief that quarterly charge-offs peaked
this quarter, and the ability of the Company to complete
the Exchange Offer and reduce annual interest expense. The
uncertainties and risks include, but are not limited to, potential negative
regulatory consequences resulting from actions by the Office of Thrift
Supervision or other regulators, potential
failure to obtain regulatory and shareholder approval for the Exchange Offer and
related matters. Additional uncertainties and risks affecting the
business, financial condition, results of operations and prospects of the
Company include, but are not limited
to, potential changes in market activity, anticipated changes in the rate of new
customer acquisition, the conversion of new visitors to the site to customers,
the activity of customers and assets held at the institution, seasonality, macro
trends of the
economy in general and the residential real estate market, instability in the
consumer credit markets and credit trends, rising mortgage interest rates,
tighter mortgage lending guidelines across the industry, increased mortgage loan
delinquency and default
rates, portfolio growth, portfolio seasoning and resolution through collections,
sales or charge-offs, the development and enhancement of products and services,
competitive pressures (including price competition), system failures, economic
and political
conditions, including changes to the U.S. Treasury’s
Troubled Asset Relief Program, changes in consumer behavior and the introduction
of competing products having technological and/or other
advantages. Further information about these risks and
uncertainties
can be found in the “Risk
Factors” section
of our prospectus supplements dated June 18 and July 2, 2009, and in the
information included or incorporated in the annual, quarterly and current
reports on Form 10-K, Form 10-Q and Form 8-K previously filed
by E*TRADE FINANCIAL Corporation with the SEC (including information under the
caption “Risk
Factors”). Any
forward-looking statement included in this investor conference call script
speaks only as of the date of this communication; the Company disclaims
any obligation to update any information.
Proxy
Statement. In
connection with the Special Meeting of Shareholders, E*TRADE FINANCIAL
Corporation filed a definitive proxy statement with the Securities and Exchange
Commission (the “SEC”). Shareholders
are
advised to read the definitive proxy statement because it contains important
information about the proposals to be presented and voted
upon. Shareholders may also obtain a copy of the definitive proxy
statement and any other relevant documents filed by
E*TRADE FINANCIAL Corporation for free at the SEC web site at
www.sec.gov. The definitive proxy statement and other documents also
may be obtained for free from E*TRADE FINANCIAL Corporation, Attn: Corporate
Secretary, 135
East 57th Street,
New
York,
New
York,
10022.
E*TRADE
FINANCIAL Corporation and its directors, executive officers and other members of
management
and employees may be deemed participants in the solicitation of proxies and
voting instructions for the 2009 Special Meeting of
Shareholders. Information concerning the interests of these persons,
if any, in the matters to be voted upon is set forth
in the proxy statement.
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