etfc initiation

RBC Capital Markets, LLCBulent Ozcan, CFA (Analyst)(212) [email protected]

Sector: Brokers, Asset Managers & Exchanges

OutperformNASDAQ: ETFC; USD 27.05

Price Target USD 35.00Scenario Analysis*

DownsideScenario

23.0015%

CurrentPrice

27.05

PriceTarget

35.0029%

UpsideScenario

42.0055%

*Implied Total Returns

Key StatisticsShares O/S (MM): 289.2Dividend: 0.00

Market Cap (MM): 7,822Yield: 0.0%Avg. Daily Volume: 3,072,501

RBC EstimatesFY Dec 2014A 2015E 2016E 2017EEPS, Rpt Diluted 1.00 1.29 1.55 2.09P/Rpt EPS 27.2x 21.0x 17.4x 12.9xEBITDA 665.0 766.4 880.1 1,114.7DPS 0.00 0.00 0.28 0.48Div Yield 0.0% 0.0% 1.0% 1.8%BVPS Basic 18.59 20.00 21.80 23.97P/BVPS 1.46x 1.35x 1.24x 1.13x

EPS, Rpt Diluted Q1 Q2 Q3 Q42014 0.33A 0.24A 0.29A 0.14A2015 0.28E 0.30E 0.35E 0.35E2016 0.38E 0.36E 0.40E 0.41EEBITDA2014 198.0A 167.0A 178.0A 122.0A2015 173.0E 182.4E 206.0E 204.9E2016 218.1E 208.5E 226.7E 226.7EAll values in USD unless otherwise noted.

March 26, 2015

E*TRADE Financial CorporationInitiating at Outperform: We Expect Excess Capitalto Grow MateriallyOur view: E*TRADE Financial is a special situations story with significantupside. Having realigned its legal entities, we expect excess capital at theparent company to grow from $310 million today to close to $2 billion overthe next two years. We expect balance sheet growth to accelerate, as weview the $50B size limitation as a temporary constraint.

Key points:Our detailed analysis on the firm's excess capital position leads us tobelieve that parent company liquidity could increase significantly over thenext two years. Moreover, we believe that the market underestimatesearnings growth, which could exceed a CAGR of 26% over the next threeyears. We think that investors stand to reap the benefits of a restructuringstory that is still in the early innings:

• Capacity to upstream dividends improved significantly: Realignment oflegal entity structure provides the firm with financial flexibility, whichcould accelerate efforts to return capital to its shareholders. We expectshare buybacks of $40 million in 2015 and $200 million in 2016.

• Excess capital to grow significantly: We expect earnings growth to addover $1 billion to excess capital. Furthermore, we expect phasing in ofBasel III and running the bank at a Tier 1 leverage ratio of 8% to add$599 million to excess capital. In addition, we believe that FDIC expensereductions and deferred tax assets could contribute to excess capitalover time.

• Asset sensitivity to drive earnings growth: We believe that E*TRADEFinancial continues to be meaningfully interest-rate sensitive despitethe firm's hedging program. We estimate that earnings per share couldbenefit by approximately 24 cents (21% accretive relative to 2014 EPS)for a 50 basis points increase in interest rates.

• Sweep account optimization to boost balance sheet: A reduction in thesafety buffer needed to not exceed a targeted balance sheet size limit of$50 billion could add approximately $3 billion to assets and $60 millionto net interest income. We expect this project to be completed in 1H/15.

• Over the longer term, expect balance sheet growth to accelerate asthe management team could abandon its $50B size limit: We believethat the opportunity cost of remaining below $50B is going to increasewith rising interest rates. We estimate earnings could be 16 cents (14percent) higher if the company managed approximately $15B of clientassets on its own balance sheet. We expect the opportunity cost to morethan double over the next three years. Furthermore, there seems to bebipartisan support to revisit the $50B limit above which banks qualify as“systemically important” under the Dodd-Frank Act. We think we couldsee an upward revision of this threshold.

We arrive at our above consensus $35 price target by applying a 23x P/Emultiple on earnings of $1.55 and valuing deferred tax assets separatelyat $2.

Priced as of prior trading day's market close, EST (unless otherwise noted).For Required Conflicts Disclosures, see Page 48.

Target/Upside/Downside Scenarios

Exhibit 1: E*TRADE Financial Corporation

80m60m40m20m

N2012

D J F M A M J J A S O N2013

D J F M A M J J A S O N2014

D J F2015

M

UPSIDE 42.00TARGET 35.00CURRENT 27.05DOWNSIDE 23.00

Mar 2016

37.5

27.522.5

17.5

12.5

7.50

125 Weeks 02NOV12 - 25MAR15

ETFC Rel. S&P 500 COMPOSITE MA 40 weeks

Source: Bloomberg and RBC Capital Markets estimates for Upside/Downside/Target

Target price/base caseOur 12-month price target for E*TRADE is $35. We arrive atour price target using a price-to-earnings multiple of 23.0x onour 2016 calendar year earnings estimate of $1.55 per dilutedweighted average shares. We then discount the resultingvaluation using a cost of equity of 11.0%, before adding anestimated value of $2 for the DTA to our valuation to arrive atour price target.

These are our assumptions: Net interest margins of 283basis points by the year 2016; average enterprise interest-earning assets of $47.8 billion; daily average revenue trades of175,776; average revenue per revenue trade of $11.00.

Upside scenarioOur valuation is $42. We arrive at our price target using aprice-to-earnings multiple of 25.0x on our 2016 calendar yearearnings estimate of $1.71. We then add $2 to our price targetfor the DTA.


Downside scenarioOur valuation is $23. We arrive at our price target using aprice-to-earnings multiple of 16.0x on our 2016 calendar yearearnings estimate of $1.39. We then add $2 to our price targetfor the DTA.


Investment summaryWe think of E*TRADE Financial Corporation as a specialsituations story that is still to play out. Investors stand toreap the benefits of management's efforts to restructure thecompany to unlock value.

Potential Catalysts• Capacity to upstream dividends improved post the

realignment of legal entities and we expect excess capitalto grow significantly: Realignment of legal entity structurecould accelerate efforts to return capital to its shareholders.We expect earnings growth to add over $1 billion to excesscapital over the next two years and phasing in of Basel III& running the bank at a Tier 1 leverage ratio of 8% to addanother $599 million to excess capital.

• Asset sensitivity to drive earnings growth: We estimatethat earnings per share could benefit by approximately 24cents (21% accretive to 2014 EPS) for a 50 basis pointsincrease in interest rates.

• We expect the firm to grow its balance sheet beyondthe $50 billion threshold: We estimate sweep accountoptimization could boost balance sheet by approximately $3billion in the near term. Furthermore, we would expect themanagement team to abandon its $50 billion size limit ashigher interest rates add to the opportunity cost of havingthird-party financial institutions manage the firm's assets.

Risks• Drop in consumer confidence & commissions could

negatively impact commission revenues and earnings.• Prolonged period of low interest rates could compress net

interest margins.• Unforeseen regulatory constraints could impact valuation.• Balance sheet growth below our expectation could lead to

an earnings miss.• Changes in average balances, especially client margin, could

impact operating results. Revenues could fall short of ourexpectation were balance sheet growth to slow significantlyor decline.

• The company has significant exposure to mortgageloans which could result in losses due to deterioratingperformance.

• Sharp decline in securities markets & deterioration in creditmarkets/housing which could lead to a sharp increase inprovisions and a decline in earnings.

• Deferred tax assets might not be realized. The firm has about$1 billion of deferred tax assets. E*TRADE might have toestablish a valuation allowance against these reserves if itdetermines that not all of these assets will be realized. Thiscould negatively impact earnings and valuation.

E*TRADE Financial CorporationBrokers, Asset Managers & Exchanges

March 26, 2015 Bulent Ozcan, CFA (212) 863-4818; [email protected] 2

Key questions Our view

1. Given the recent announcement on the upcoming realignment of its legal entities, what are the likely options for returning capital to shareholders?

The firm’s January announcement that its regulators have approved plans to modify the corporate structure is a significant positive development. This should enable the firm to upstream dividends and excess capital of $509 million in 1Q/15. Furthermore, it should become meaningfully less burdensome to get regulatory approval to upstream quarterly dividends to the parent company in the future. However, we believe that investors should not expect dividend payments in 2015. We believe that the management team is done de-levering the balance sheet. We view balance sheet growth, de-risking legacy assets, and share buybacks as the most likely use of excess capital. We expect dividend payments to commence in 2016 at the earliest. We estimate that excess capital could approach $2 billion by the end of 2016.

2. Are there any catalysts that could drive the share price even higher given recent performance?

We believe that the firm is in its 4th

inning. The realignment of its legal entities has put the firm in a position to return capital. We believe that excess capital will grow significantly from here on. We expect earnings growth, phasing in of Basel III, running E*TRADE Bank at a Tier 1 leverage ratio, reduction in FDIC charges, and usage of deferred tax assets to add significantly to excess capital. We provide the details in the note.

3. How should investors think about asset growth as the company approaches the $50 billion SIFI mark?

While one could argue that growth could be limited given the company’s current desire to limit the size of its balance sheet, we believe that the firm’s balance sheet will exceed $50 billion in 2016. Certainly, right now, it makes sense to avoid more stringent regulatory capital requirements and adherence to enhanced prudential standards under the Dodd-Frank Act. However, there seems to be bipartisan support to raise the $50 billion threshold to be considered systemically important. Furthermore, we believe that the opportunity cost of using third-party financial institutions to manage the firm’s assets will grow with rising interest rates. We believe that a sweep account optimization will allow the firm to approach $50 billion quickly. We also think that the firm will start managing the $10.5 billion of non-money market client assets at third parties on its balance sheet with rising interest rates. We estimate that earnings could be boosted by $0.36/share by 2017 by managing the assets on E*TRADE’s balance sheet.

4. How asset sensitive is the firm and should investors buy ETFC’s shares to position themselves for rising rates?

We estimate that a 50 basis points move in interest rates would impact earnings per share to the tune of 24 cents (21% accretive relative to 2014 EPS). In comparison, we would expect TD Ameritrade’s earnings to be impacted by around 12 cents to 14 cents (9% accretive based on 2014 EPS) and Charles Schwab’s earnings by about 31 cents (33% accretive based on 2014 EPS). Despite generating about 60% of its revenues through spread-based revenues, earnings are not as interest rate sensitive as one would expect. We believe that the company has taken a defensive posture and hedged its interest rate exposure meaningfully. Management could decide to reduce its hedging efforts with rising interest rates, potentially picking up incremental earnings beyond our estimate.

5. What risks remain on the balance sheet post the company’s efforts to de-risk it?

While the company’s management has done a tremendous job de-risking the company’s balance sheet, E*TRADE Financial’s balance sheet continues to remain meaningfully more risky than that of its peers, in our view. The company maintains a sizeable exposure to mortgage loans. Whereas we are not as concerned about the HELOC portfolio, as the allowance for loan losses seems adequate, we have seen a significant decline in provisions for loan losses for one- to four-family home loans. About $1.3 billion of a total of $3.1 billion of one- to four-family home loans will convert from interest only to amortizing loans over the coming three years. An increase in frequency or severity of losses could lead to the need to add to reserves as the company has been releasing provisions for loan losses.



Table of contents

We expect excess capital at the parent company to grow significantly over next two years .................................................................................................................................... 5

Realignment of legal entity structure now puts E*TRADE Financial in a position to return capital to its shareholders ........................................................................................ 5

We expect E*TRADE Financial to grow excess capital meaningfully over the next two years ............................................................................................................................. 7

We anticipate earnings to increase significantly with rising interest rates ........................ 9

Sweep account optimization could lead to accelerated balance sheet growth ............... 11

We think that the firm’s $50 billion size limit is increasingly becoming a “soft target” ....... 14

Bringing back assets held by third-party financial institutions could boost earnings ....... 14

We are modeling a meaningful improvement in operating margins and cash generation starting in 2016 ............................................................................................... 15

Items management needs to address over the coming years ............................................. 20

E*TRADE’s business model is too transactional ................................................................ 20

Balance sheet continues to be the most risky among peers ............................................ 23

Ban on payment for order flow practices could impact earnings ..................................... 25

Sharp increase in short-term interest rates could negatively impact the firm given the duration of its balance sheet ...................................................................................... 26

Valuation framework ......................................................................................................... 27

Risks and price target impediments ................................................................................... 30

Quick overview of E*TRADE Financial Corp. ....................................................................... 31

Products ............................................................................................................................. 33

Revenue break-down ......................................................................................................... 35

Business segments ............................................................................................................. 39

Products ............................................................................................................................. 40

Distribution ........................................................................................................................ 41

Competitors ....................................................................................................................... 42

History ................................................................................................................................ 43

Management team ............................................................................................................. 44



We expect excess capital at the parent company to grow significantly over next two years

Realignment of legal entity structure now puts E*TRADE Financial in a position to return capital to its shareholders We believe that the recent regulatory approval to realign E*TRADE Financial Corporation’s legal entities puts the firm in a situation to buy back shares in 2015. We are estimating that the firm could repurchase shares worth approximately $40 million in 2015 and $200 million in 2016.

In 2009, E*TRADE Financial was required to move its introducing broker–dealer entity (E*TRADE Securities) under E*TRADE Bank at the request of its regulators where the firm’s clearing broker–dealer (E*TRADE Clearing) was already residing. Consequently, the company turned both broker–dealers into a subsidiary of E*TRADE Bank as part of an attempt to strengthen the bank’s capital. Under this structure, management had to get approval from its regulators before it was able to “dividend-up” any excess capital to the parent company.

More recently, the firm proposed a new “simplified” structure to its regulators in order to create a direct source of capital to the parent. Furthermore, E*TRADE Financial requested permission to operate its bank at a Tier 1 leverage ratio of 9%. This was a 50 basis points reduction from its previous target.

The recent regulatory permission to realign its corporate structure and operate the bank at a lower tier 1 leverage ratio has significant positive implications. Access to excess capital generated by the broker–dealers has been simplified. The income and capital generated by the broker–dealers is now housed directly below the parent company. Previously, the earnings generated by the firm’s broker–dealers were generated within the bank and thus subject to bank regulatory approvals before any capital could be moved to the parent company.

The company provided some context on what these changes imply during its 4Q/14 earnings call. Under the previous structure, E*TRADE Financial was able to pay quarterly dividends of $75 million in 2014, or $300 million for the entire year. Under the new structure, the firm would have been able to dividend-up $225 million of earnings from the bank in 2014. In addition, the broker–dealers would have generated excess capital of about $200 million, for a total of $425 million for 2014. The chart below shows this:

Exhibit 2: E*TRADE Financial should be able to dividend-up significantly more capital post regulatory approval & realignment

Current structure

2014

E*TRADE Bank

E*TRADE Financial

E*TRADE Securities E*TRADE Clearing

$300M dividends

Proposed new structure

2014 pro forma for realignment

E*TRADE Financial

E*TRADE Bank E*TRADE Securities E*TRADE Clearing

$225M dividends $200M dividends

Source: Company reports; RBC Capital Markets



The company indicated that it will dividend-up $434 million to the parent company in 1Q/15. Furthermore, the company will also ask to dividend-up $75 million from the bank in 1Q/15. Beginning in 2Q/15, it will request the full amount of the previous quarter’s earnings generated by the bank as dividends.

The company has also provided a timeline for the realignment. E*TRADE Securities is expected to be moved closer to the parent in early February, while E*TRADE Clearing will be moved in late 2015. This proposed realignment of legal entities should improve the company’s liquidity and cash position considerably. The exhibit below shows this.

Exhibit 3: Parent liquidity will be over $500 million post the realignment of entities and reduction in debt ($M)

$233 $310

$560

$434

$75

( $432 )

$250

$-

$100

$200

$300

$400

$500

$600

$700

$800

4Q/14Corporate

cash

Legal entityrealignment

Planned Q1dividend from

bank

Debtreduction and

refinance

4Q/14 Pro-forma

corporate cash

Revolver 4Q/14 Pro-forma parent

liquidity

Source: Company filings; RBC Capital Markets

What are E*TRADE Financial’s options now that it is in a strong position to have access to excess capital at the parent company? We do not expect the firm to pay dividends in 2015, nor to pay down more debt. It has now achieved its long-term goal of having $1 billion of debt outstanding. We believe that the incremental benefits of reducing debt would be small from here on as the debt burden is manageable. The firm’s stated target is to hold a minimum of twice the annual debt service. Applying a weighted average cost of debt of 5.0%, we arrive at a minimum cash balance of $100 million.

Clearly, E*TRADE Financial will enjoy some financial flexibility following the realignment of its legal entities and the reduction in debt burden. We believe that there are three likely options to deploy excess capital, namely buying back shares, reducing wholesale financing needs, and growing the firm’s balance sheet. The company’s capital plan could include a combination of all of the above. After all, we do not believe that the current shareholder base invested in E*TRADE is expecting dividend payments. Thus, we would not expect current shareholders to be disappointed should E*TRADE choose a different mode of creating shareholder value.



We expect E*TRADE Financial to grow excess capital meaningfully over the next two years We believe that excess capital could reach $2 billion, as the company reduces its bank’s targeted Tier 1 leverage ratio to 8 percent and phases in Basel III. In addition, FDIC expenses could potentially decline due to management’s efforts to reduce debt and de-risk the loan portfolio.

A) We anticipate earnings growth to add approximately $1.2 billion to excess capital at the parent company over the next two years Assuming that we are correct with our $550 million of excess capital generation figure for 2015, excess capital could stand at $810 million by the end of this year. Assuming that net income grows another 18% in 2016, excess capital could stand at $1.4 billion should E*TRADE Financial’s management decide not to return capital to its shareholders over the next two years. This scenario assumes that the firm will incur $50 million of interest expense on its debt each year and that it will not deploy excess capital for share buybacks or pay dividends.

Exhibit 4: Excess capital could grow to $1.4 billion by 2016 ($ in million)

$310

$810

$1,410 $1,660

$550

$50

$650

$50

$250

$0

$200

$400

$600

$800

$1,000

$1,200

$1,400

$1,600

$1,800

4Q/14 Pro-forma

corporatecash

2015Excesscapital

generated

2015 int.expense

4Q/15 pro-formaexcesscapital

2016Excesscapital

generated

2016 int.expense

4Q/16 pro-formaexcesscapital

Revolver Pro-formaparent

liquidity


However, there are additional factors beyond earnings growth that could add to excess capital.

B) We believe that phasing-in Basel III and reducing the bank’s targeted Tier 1 leverage ratio could add another $432 million to $599 million to excess capital over time The table below shows E*TRADE Bank’s pro-forma Tier 1 leverage ratio assuming that the broker–dealers had been moved from below the bank at the end of the December quarter. The ratio also reflects a dividend payment of $75 million to the parent company, which is scheduled for 1Q/15. Thus, the resulting pro-forma leverage ratio of 9% would be in line with the firm’s current target of running the bank at a Tier 1 leverage ratio of 9%. Were we to include the deferred tax assets that are currently not being accounted for in Tier 1 capital, we would estimate the Tier 1 leverage ratio to be 9.8% under Basel III. This provides the firm with incremental excess capital. Moreover, we would expect excess capital to increase further, as E*TRADE Financial approaches its target of operating at a Tier 1 leverage ratio of 8% by 2016. The table below shows our calculation.

Excess capital could grow to $1.4 billion over the next two years



Exhibit 5: We think phasing in Basel III and reducing the firm’s Tier 1 leverage ratio target to 8% could add about $599 million to excess capital

($ in million)

E*TRADE

Bank

E*TRADE

Securities

E*TRADE

Clearing

Pro-forma

Bank

Pro-forma

for 1Q/15

div.

Basel III DTA

adjustment

Pro-forma

Bank

Tier 1 capital $4,548 ($625) ($883) $3,040 $2,965 +$300 $3,265

Tier 1 assets $42,876 ($743) ($9,031) $33,102 $33,027 +$300 $33,327

Tier 1 leverage ratio 10.6% 84.1% 9.8% 9.2% 9.0% 9.8%

Excess capital at targeted:

Tier 1 leverage ratio 8.5% $158 $432

Tier 1 leverage ratio 8.0% $323 $599

Source: Company filings; RBC Capital Markets estimates

The management team indicated that it would like to run the bank at a targeted Tier 1 leverage ratio of 8% over the next two years. Thus, we would expect this to add about $323 million to excess capital, which could be streamed-up to the parent company with the approval of the bank’s regulator. Furthermore, we would expect the addition of deferred tax assets in the definition of Tier 1 capital under Basel III to add another $300 million to excess capital. Thus, at a Tier 1 leverage ratio of 8%, the bank’s excess capital would grow to $599 million without the firm having to grow its balance sheet. Consequently, with the approval of OCC, we would expect the parent company’s liquidity position to grow by an incremental $599 million excluding the impact of earnings. Combining this with our earnings growth estimate, we would expect excess capital to grow to approximately $2.0 billion.

C) Reduction in FDIC charges could add further to excess capital The company is clearly in a better position to utilize its excess capital after its regulators gave the management team their seal of approval to move the broker–dealers closer to the parent company. Having de-levered the balance sheet further in March and with continued de-risking of its loan portfolio, one could expect Federal Deposit Insurance Corporation (FDIC) insurance expenses to decline. The firm provided its own internal model during a recent presentation. Management assumed that it could reduce FDIC charges from about 19 basis points today to around 11 basis points over time. The lower FDIC premium would translate into savings of about $35 million on a pre-tax basis ($22 million after tax). This would equate to 7 cents per diluted share based on 2014 assets and a 38% tax rate.

Overall, the company seems to be in a solid capital position. We believe that the Fed could have a more favorable view of the company post management’s strong execution on its capital plan. We believe that implementation of Basel III could provide management with additional capital buffer. We show this below. On a consolidated basis, we estimate that Tier 1 leverage ratio would have increased by 90 basis points under Basel III had the company removed 75% of its trust preferred securities from and added about $718 million of deferred tax assets to the definition of Tier 1 capital.

E*TRADE could add 7 cents to earnings and $22m to excess capital were the firm to be successful in reducing FDIC expenses



Exhibit 6: Tier 1 leverage ratio would have been 8.9% phasing out 75% of trust preferred securities

Consolidated($ in million) Reported TRUPs DTA Pro-Forma

Tier 1 capital $3,463 ($325) $651 $3,789Tier 1 assets $42,845 ($325) $651 $42,520

Tier 1 leverage ratio 8.1% 8.9%

TRUPs 75% phased out

Source: RBC Capital Markets estimates

Were the company to phase out 100% of the trust preferred securities right away, Tier 1 leverage ratio would increase by 60 basis points. However, the company is required to phase out 75% of the trust preferred securities in 2015 and the remaining 25% in 2016. Thus, we would expect the firm to generate additional capital, which would add to the above estimates.

Exhibit 7: Tier 1 leverage ratio would have been 8.7% phasing out 100% of trust preferred securities

Consolidated($ in million) Reported TRUPs DTA Pro-Forma

Tier 1 capital $3,463 ($433) $651 $3,681Tier 1 assets $42,845 ($433) $651 $42,412

Tier 1 leverage ratio 8.1% 8.7%

TRUPs 100% phased out


Our key point is this: E*TRADE Financial seems well capitalized. The management team will have to think hard about how to unlock value over the coming quarters and years. Options include paying dividends, buying back shares, growing the balance sheet, or running off legacy assets at an accelerated rate. We believe that any of these options could be a catalyst for E*TRADE’s shares. We would rank addressing legacy issues and buybacks a top priority.

While we have demonstrated that excess capital at the parent company will increase meaningfully, we also need to address why we believe that E*TRADE Financial could generate earnings growth in excess of consensus figures. We show this below.

We anticipate earnings to increase significantly with rising interest rates E*TRADE Financial’s earnings could increase by about 24 cents (or 21% based on 2014 earnings) for a 50 basis point move in interest rates.

While not as asset sensitive as Charles Schwab, E*TRADE Financial is nonetheless meaningfully asset sensitive. We estimate that a 50 basis points increase in interest rates could add about $0.24 to earnings. This would be 21% accretive to normalized earnings of $1.12 per share, which the company reported in 2014. As a comparison, we estimate that Charles Schwab’s 2014 earnings per share would have been 33% higher, and TD Ameritrade’s 2014 earnings about 9% higher had we had higher interest rates.

This should not come as a surprise as the largest component of the firm’s net revenues is spread-based revenues. The exhibit below provides a revenue bridge for 2014.

We estimate a pro-forma Tier 1 leverage ratio of 9% post implementation of Basel III guidelines



Exhibit 8: Spread-based revenues comprised 60% of total net revenues in 2014 ($M)

$456

$1,814 $1,088

$186

$84

$-

$200

$400

$600

$800

$1,000

$1,200

$1,400

$1,600

$1,800

$2,000

Commissionrevenues

Spread revenues Fee revenues Other Total net revenue


Given the firm’s large dependency on interest-earning assets in order to generate revenues, one would expect E*TRADE Financial to be the most interest rate sensitive among its peers. However, this does not seem to be the case. One reason for this could be that the company has hedged its interest rate sensitivity. Over time, management could decide to roll off these hedges as interest rates start rising.

While E*TRADE Financial does not provide its own sensitivity to interest rates, we believe that we were able to come up with a workable approach. We have arrived at our conclusion using the company’s financial model as presented during a competitor’s conference earlier this year. E*TRADE Financial provided an estimate of the impact of lower interest rates on its revenues. The company pointed out that revenues would have been higher to the tune of $182 million based on its 2014 balance sheet had net interest spreads been 300 basis points. This is what the company would expect net interest margins to be in a normalized rate environment.

As a reference, net interest margins were 255 basis points in 2014. Thus, the company’s model would imply that a 45 basis points rise in net interest margins would impact net revenues by the aforementioned $182 million. Consequently, it appears that each basis point increase in net interest margin would result in a $4 million boost to net interest revenues.

We then tried to figure out what by how much net interest margins would expand for a 50 basis point move in interest rates. Looking at historical data, we estimated that funding costs would increase by about 12 basis points should interest-earning yields improve by 50 basis points. Consequently, we would expect an increase in interest rates of 50 basis points to impact net interest margins by 38 basis points.

A 38 basis points expansion in net interest margins would result in incremental net interest income revenue of $153 million. The next point is up for debate. We assumed an incremental margin of 75% on these earnings, similar to our approach for its peers. We then arrived at the EPS impact by using a 38% tax rate and 294 million of diluted shares.

The exhibit below provides a sensitivity table showing the impact on EPS using various assumptions for interest rate movements and pre-tax margins.



Exhibit 9: We estimate that a 50 bps move in interest rates would impact EPS by about 24 cents

40 43 45 48 50 53 55

40.0% $0.10 $0.11 $0.12 $0.12 $0.13 $0.14 $0.1442.5% $0.11 $0.12 $0.12 $0.13 $0.14 $0.14 $0.1545.0% $0.12 $0.12 $0.13 $0.14 $0.15 $0.15 $0.1647.5% $0.12 $0.13 $0.14 $0.15 $0.15 $0.16 $0.1750.0% $0.13 $0.14 $0.15 $0.15 $0.16 $0.17 $0.1852.5% $0.14 $0.14 $0.15 $0.16 $0.17 $0.18 $0.1955.0% $0.14 $0.15 $0.16 $0.17 $0.18 $0.19 $0.2057.5% $0.15 $0.16 $0.17 $0.18 $0.19 $0.20 $0.2060.0% $0.16 $0.17 $0.17 $0.18 $0.19 $0.20 $0.2162.5% $0.16 $0.17 $0.18 $0.19 $0.20 $0.21 $0.2265.0% $0.17 $0.18 $0.19 $0.20 $0.21 $0.22 $0.2367.5% $0.17 $0.19 $0.20 $0.21 $0.22 $0.23 $0.2470.0% $0.18 $0.19 $0.20 $0.22 $0.23 $0.24 $0.25

72.5% $0.19 $0.20 $0.21 $0.22 $0.23 $0.25 $0.2675.0% $0.19 $0.21 $0.22 $0.23 $0.24 $0.26 $0.2777.5% $0.20 $0.21 $0.23 $0.24 $0.25 $0.26 $0.28

Move in interest rates (bps)

Ass

um

ed in

crem

enta

l mar

gin

s


Thus, we would expect a move of 50 basis points in interest rates to impact earnings by about 24 cents (21% of normalized 2014 EPS). As a comparison, we estimated an impact of 31 cents on EPS for Charles Schwab (or 33% of 2014 EPS) and about 12 cents to 14 cents at TD Ameritrade (9% of 2014 EPS using midpoint).

As mentioned earlier, we believe that the company has taken a defensive posture and hedged its interest rate exposure meaningfully, which contributes to the current asset sensitivity. This would make sense as its regulators need to be comfortable about the firm’s risk profile in order to allow it to move up its broker–dealers, which have been a “source of strength” post the financial crisis. Furthermore, the firm’s balance sheet has a three-year duration. This compares to about two years for TD Ameritrade and Charles Schwab. This longer duration would impact the company more than its peers if interest rates increased sharply. Thus, hedging the company from sudden moves in interest rates is the prudent thing to do as net interest margins could decline were funding costs to re-price faster than the yield on the firm’s investment portfolio.

However, there is the possibility that the firm’s interest rate sensitivity could increase above our expectation as the firm’s capital position strengthens and management decides not to roll over all hedges. We view this as an optionality.

Sweep account optimization could lead to accelerated balance sheet growth Assuming that E*TRADE Financial holds an incremental $3 billion of assets on its balance sheet and earns a 200 basis point spread, we would expect net operating income to increase by about $60 million (or 5 cents per share).

Currently, E*TRADE Financial’s management team has set itself a limit of keeping the firm’s balance sheet below $50 billion. The goal is to avoid additional regulatory burdens. E*TRADE Financial’s balance sheet is currently at $45.5 billion. Considering that it needs to hold a buffer to avoid crossing the $50 billion mark, we think that balance sheet growth would have to be decelerated significantly once the firm gets to the $48 billion range. We believe that

We expect EPS to be impacted by about 24 cents based on a 50 basis points movement in interest rates



the firm would have to maintain a buffer in order not to exceed the $50 billion target. Our call is that there will not be a need for a large buffer once the firm has optimized its sweep account processes over the coming months. We think that management will provide its treasury function with additional flexibility and allow it to nightly move its clients’ assets quickly to and from third-party financial institutions. This will add to balance sheet growth and earnings.

Today, E*TRADE Financial is forced to route client cash to third-party financial institutions if assets on its balance sheet approach a certain level. Whereas cash can be swept overnight to third-party financial institutions, it can take E*TRADE Financial several months before it gains access to this capital given the current structure. It is difficult to maximize profits under today’s structure as the firm needs to maintain a sufficient buffer for unforeseen growth in the balance sheet.

Consider this: While adding clients could lead to growth, there are other reasons beyond client growth that could result in a larger balance sheet. For instance, the balance sheet could grow as consumer engagement declines. Here is why: If customers reduced their market engagement, buying fewer shares, and keeping their assets in cash and cash equivalents, then the balance sheet grows. This poses a real risk to the company’s target of limiting the size of its balance sheet. This is not a hypothetical, but real risk. The firm disclosed for its fiscal year 2014 that net buying activity was $7.7 billion. Management estimates normalized levels to be in the $2 billion to $3 billion range. Thus, the balance sheet could grow by $4 billion to $5 billion if clients decided to reduce their equity market exposure.

The exhibit below shows assets held by these third parties, i.e., outside of E*TRADE Financial. These include money market funds and sweep deposit accounts at unaffiliated financial institutions. Were these assets included on the company’s balance sheet, it would be safe to assume that E*TRADE Financial would have to comply with additional regulatory burdens, given that its own balance sheet is about $45.5 billion—excluding $15 billion of assets held by third parties.

Exhibit 10: Assets held by unaffiliated financial institutions have grown to over $15 billion

$-

$2.0

$4.0

$6.0

$8.0

$10.0

$12.0

$14.0

$16.0

$18.0

Jan

-10

Ap

r-1

0

Jul-

10

Oct

-10

Jan

-11

Ap

r-1

1

Jul-

11

Oct

-11

Jan

-12

Ap

r-1

2

Jul-

12

Oct

-12

Jan

-13

Ap

r-1

3

Jul-

13

Oct

-13

Jan

-14

Ap

r-1

4

Jul-

14

Oct

-14


While there still will be a need to sweep money to third parties in the near term, we believe that E*TRADE Financial should be able to approach the $50 billion limit once it has optimized its sweep account procedures without the risk of exceeding this size limit.



The impact of increasing its balance sheet on revenues should not be ignored. Assuming that E*TRADE Financial could hold an incremental $3 billion of assets on its balance sheet and earn spread of 200 basis points, we would expect net operating interest income to increase by about $60 million. Assuming a 40% margin and a 38% tax rate, we estimate earnings could increase by 5 cents per share by optimizing sweep account procedures. The exhibit below provides a sensitivity analysis.

Exhibit 11: Adding $3 billion to interest-earning assets could increase EPS by 5 cents

25% 30% 35% 40% 45% 50%

150 $0.02 $0.03 $0.03 $0.04 $0.04 $0.05175 $0.03 $0.03 $0.04 $0.04 $0.05 $0.06200 $0.03 $0.04 $0.04 $0.05 $0.06 $0.06225 $0.04 $0.04 $0.05 $0.06 $0.06 $0.07250 $0.04 $0.05 $0.06 $0.06 $0.07 $0.08275 $0.04 $0.05 $0.06 $0.07 $0.08 $0.09300 $0.05 $0.06 $0.07 $0.08 $0.09 $0.09325 $0.05 $0.06 $0.07 $0.08 $0.09 $0.10

Pre-tax margins

Inte

rest

sp

read

s (b

ps)




We think that the firm’s $50 billion size limit is increasingly becoming a “soft target”

Bringing back assets held by third-party financial institutions could boost earnings Management’s current limit on the balance sheet size is not sustainable over time, as we expect the opportunity cost to increase with rising interest rates. Furthermore, there seems to be growing support to reconsider the $50 billion bright line test to be considered systemically important. We estimate that earnings could increase by 16 cents were the company to move assets held by third-party financial institutions on its balance sheet today.

We think that the $50 billion threshold to be considered a systemically important financial institution could potentially change. There seems to be growing bipartisan support to reconsider this bright line $50 billion assets test. The threshold for triggering systemic risk worthy of enhanced prudential standards could be lifted to a higher number such as $100 billion or $200 billion. This could be combined with qualitative assessments of risk. The Bipartisan Policy Center, a non-profit organization focused on promoting bipartisan solutions, has endorsed a hybrid approach that would raise the threshold to $250 billion. It would also establish more of a “dashed line” versus the brightline-test that would give regulators discretion to add firms based on risk factors other than size and exclude business deemed less systemically imporantant. Former Rep. Barney Frank, D-Mass., a key author of the financial reform law, also testified before the House banking panel in July that lawmakers should revisit the $50 billion threshold. Several other regulators, including Federal Reserve Gov. Daniel Tarullo and Comptroller of the Curry Thomas Curry, have made similar statements.

Here we provide a sensitivity analysis around incremental earnings potential.

Bringing back assets held by third-party financial institutions could boost earnings It should not come as a surprise that E*TRADE Financial’s decision to sweep client assets to third-party financial institutions costs the firm a significant amount of earnings. The firm reported earnings of only $14 million in 2014 on assets held by these third-party institutions. We estimate that the average assets routed off the balance sheet were approximately $14.5 billion, resulting in a meager 10 basis points yield on these assets. As a comparison, E*TRADE Finanical’s net interest margins were 255 basis points in 2014. Thus, the decision to have third parties manage clients’ assets costs the firm $236 million in incremental revenues. Assuming that one-third of the assets are in money market funds earning 10 basis points and a 254 basis points net interest margin on the remaining assets, plus a 25% pre-tax margin, a 38% tax rate, and 294.1 million shares outstanding, earnings per diluted share could have been 13 cents higher than the $1.00 reported for 2014 were the company not forced to route cash to unaffiliated financial institutions. We should note that the above calculation does not assume that assets are being brought back today, but is intended to provide a “what if” analysis. Certainly, new investment rates would be around 200 basis points today. At 200 basis points and 40% of incremental pre-tax margins, EPS would have been 16 cents higher. The table below provides various scenarios.

We estimate that managing client assets on its balance sheet would have been 12% accretive to 2014 earnings



Exhibit 12: At an incremental margin of 40% and 200 bps of net interest margin, EPS could have been 16 cents higher

20% 25% 30% 35% 40% 45% 50%

100 $0.04 $0.05 $0.06 $0.07 $0.08 $0.09 $0.10125 $0.05 $0.06 $0.07 $0.09 $0.10 $0.11 $0.12150 $0.06 $0.07 $0.09 $0.10 $0.12 $0.13 $0.15175 $0.07 $0.09 $0.11 $0.12 $0.14 $0.16 $0.18200 $0.08 $0.10 $0.12 $0.14 $0.16 $0.18 $0.20225 $0.09 $0.11 $0.14 $0.16 $0.18 $0.21 $0.23250 $0.10 $0.13 $0.15 $0.18 $0.20 $0.23 $0.26275 $0.11 $0.14 $0.17 $0.20 $0.23 $0.25 $0.28300 $0.12 $0.15 $0.19 $0.22 $0.25 $0.28 $0.31325 $0.13 $0.17 $0.20 $0.23 $0.27 $0.30 $0.34

Pre-tax margins

Inte

rest

sp

read

s (b

ps)


There is more. Assets held by third parties have grown at a compound average growth rate of 46% over the past four years. This growth rate has declined to 12.3% year over year in 2014. Assuming that assets continue to grow at 12.3% over the next three years, those could reach $22 billion by 2017. Were we correct with our pre-tax margin projection of 40% by 2017 and assuming net interest spread assumption of 275 basis points (or 24 basis points below our overall portfolio yield projection for 2017) , earnings per share would be lifted by 36 cents by managing these client assets on the E*TRADE Financial’s balance sheet instead. To us, this pickup in earnings seems compelling and we believe that management will have to ponder whether the opportunity cost incurred justifies trying to avoid incremental regulatory scrutiny.

We do believe that the firm has the compliance and regulatory systems already in place to operate a much larger balance sheet. After all, regulators needed to be comfortable with the existing enterprise risk management at E*TRADE Financial before allowing the firm to realign its legal entities. It is just a question of time until the benefits of a larger balance sheet exceed the incremental cost associated with having to comply with modified liquidity coverage ratio requirements. We believe that management could make a decision relatively quickly once interest rates start rising.

We are modeling a meaningful improvement in operating margins and cash generation starting in 2016 We believe that there are encouraging signs that management will grow its balance sheet beyond $50 billion, resulting in operating leverage and margin expansion.

We have already seen a significant improvement in operating margins and cash generation since Mr. Paul T. Idzik was appointed CEO on January 17, 2013, joining E*TRADE Financial after having worked as Group Chief Executive of DTZ Holdings PLC in London and having served 10 years at Barclays PLC.

While one could argue that all discount brokers have benefited from improving margins, we would point out that margin expansion was not simply a case of the “tide lifting all the boats”. In fact, E*TRADE Financial’s management team has been working hard on its turnaround story. The exhibit below shows the improvement in the firm’s opreating margins and cash generation capacity. We use the EBITDA to net revenues ratio as a proxy for cash generation.

Having gone through a number of changes at the top level, we believe that the current E*TRADE management team has the needed qualities to position the firm for growth over time

Were the company to deploy $14.5 billion of client assets at a 200 basis points yield today, we would expect EPS to increase by 16 cents assuming 40% incremental margins on these earnings



Our call is that we are not done yet and could see continued improvement over the next three years.

Exhibit 13: Operating margins have been expanding significantly since 2013

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

50%

2010 2011 2012 2013 2014 2015E 2016E 2017E

AMTD SCHW ETFC


In fact, we belive that E*TRADE Finanical could add 7.9 percentage points to its pre-tax operating margin from 2014 to 2017. This, in turn, would improve the company’s ability to generate excess capital. The exhibit below depicts the EBITDA to revenue ratio over time.

Exhibit 14: E*TRADE Financial has improved its EBITDA/revenue ratios meaningfully

0%

10%

20%

30%

40%

50%

60%

2010 2011 2012 2013 2014 2015E 2016E 2017E

AMTD SCHW ETFC


We believe that there are encouraging signs that management will grow its balance sheet, resulting in operating leverage. Management has done a remarkable job de-risking its loan

EBITDA to total net revenues has improved significantly at E*TRADE since 2012



portfolio and de-levering the balance sheet. This in turn, has resulted in fewer clients leaving E*TRADE Financial. In fact, client attrition has declined significantly over time. This positions the firm for growth. The next two sub-sections provide specifics on what the management team has done to make E*TRADE Financial a better fiduciary of its clients’ capital.

Management de-risked its loan portfolio The company has been continuously reducing the risk embedded in the loan portfolio. The firm had about $6.4 billion of gross loan receivables as of 4Q/14. This was comprised of $3.1 billion in one- to four-family home loans, $2.8 billion of home equity loans, and $461 million of consumer and other loans. This compares to a loan portfolio of $2.7 billion of consumer loans, $16.9 billion of one- to four-family home loans, and $12.4 billion of home equity loans as of 3Q/07. In addition, there were about $17 billion of securities on its balance sheet including MBS securities, bonds, and asset-backed securities that management had to address.

The exhibit below shows the progress the company has made. The chart depicts delinquent loans as a percentage of total gross loans. Clearly, the trend has been improving since 2010.

Exhibit 15: Delinquent loans as % of gross loans have been declining since 2010

0%

2%

4%

6%

8%

10%

12%

14%

1Q

08

3Q

08

1Q

09

3Q

09

1Q

10

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10

1Q

11

3Q

11

1Q

12

3Q

12

1Q

13

3Q

13

1Q

14

3Q

14


A slow but steady ecomomic recovery in combination with better risk management has helped the firm improve the performance of its loan portfolio. In order to test how well management had anticipated expected losses, and more importantly, reserved for it, we aggregated the charge-offs for four quarters and compared the result to the beginning allowance for loan losses at the start of the four-quarter period (Exhibit 16). While management had to set up large provisions for loan losses in 2009, it seems that it had built enough cushion to absorb losses starting in 2013. In fact, E*TRADE Financial started releasing some provisions it had set up for its one- to four-family home loan portfolio over the past eight quarters.

E*TRADE’s loan portfolio of $32 billion in 2007, has been reduced to its current size and risk of about $6.4 billion of gross loans outstanding



Exhibit 16: Provisions for loan losses have stabilized starting in 2014

0%

50%

100%

150%

200%

250%

4Q

09

1Q

10

2Q

10

3Q

10

4Q

10

1Q

11

2Q

11

3Q

11

4Q

11

1Q

12

2Q

12

3Q

12

4Q

12

1Q

13

2Q

13

3Q

13

4Q

13

1Q

14

2Q

14

3Q

14

4Q

14

One-to-four-family Home equity Consumer and other


Consequently, the firm has regained the trust of clients such that client attrition has declined to historical levels.

Client attrition rate has declined significantly The company’s efforts to strengthen its capital position and reduce the risk of its investment portfolio is yielding results, positioning the firm to grow client accounts and its balance sheet. It is undeniable that management has been able to restore confidence after the events of 2007. The exhibit below shows the decline in the attrition rate for the period from 2008 to 2014. Clearly, the trend has been positive.

Exhibit 17: Fewer clients are leaving E*TRADE today than in the past

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

2008 2009 2010 2011 2012 2013 2014


The attrition rate, which the company defines as closed accounts as a percentage of previous quarter’s total brokerage accounts, has declined from 16.9% in 2008 to 8.7% as of 2014. Consequently, the firm was able to grow the total number of accounts starting in 2011.

Client attrition has declined from 16.9% in 2008 to 8.7% as of 2014



Exhibit 18: Total account growth commenced in 2011

3,900,000

4,000,000

4,100,000

4,200,000

4,300,000

4,400,000

4,500,000

4,600,000

4,700,000

4,800,000

4,900,000

1Q

09

3Q

09

1Q

10

3Q

10

1Q

11

3Q

11

1Q

12

3Q

12

1Q

13

3Q

13

1Q

14

3Q

14


This bodes well for revenue growth as we expect the firm to continue to add to its client base—as long as the number of gross new brokerage accounts exceeds closures. This seems to be the case since 2011.

Exhibit 19: E*TRADE Financial added 155,981 net new client accounts in 2014

28,439

(213,903)

69,162

163,063

133,713 155,981

(250,000)

(200,000)

(150,000)

(100,000)

(50,000)

0

50,000

100,000

150,000

200,000

2009 2010 2011 2012 2013 2014


Net new brokerage accounts were the main contributors to total net new accounts in 2014, with net new stock plans and net new banking accounts contributing marginally to growth. In fact, net new brokerage accounts of 146,000 in 2014 was the highest addition in over a decade at E*TRADE Financial. It seems that management has been able to restore confidence among retail clients, as it is able to retain more existing clients while adding new accounts.

The improvement we have seen in fixing the business and being able to add to the client base gives us confidence that E*TRADE Financial will be able to grow its assets. We would argue that balance sheet growth could accelerate once the management team determines that the limit on its balance sheet size of $50 billion is too costly to maintain. We expect the opportunity cost to do so to increase with higher interest rates.



Items management needs to address over the coming years

E*TRADE’s business model is too transactional We believe that the firm might not able to participate in certain growth opportunities including growth in independent RIAs as management has been too focused on fixing legacy issues.

While E*TRADE Financial has done a great job restructuring its balance sheet and repositioning the firm for growth, we are concerned that the business model has not changed much. Rather, the management team has focused on unwinding the errors made by the previous management teams and refocusing on its core franchise—which has been providing the best trading platform for its retail client. The exhibit below shows the firm’s product offerings versus peers.

Exhibit 20: ETFC’s product offering is limited versus peers

ETFC AMTD SCHW

Brokerage

Full range of investment products

Third-party research

In-house research

Mutual funds

Proprietary funds

Third-party funds

Exchange Traded Funds

Proprietary funds

Third-party funds

Advice - In-House

Investment advice

Tailored portfolio construction

Portfolio management

Separately managed accounts

Financial consultants 300 ~700 1,200

RIA relationships ~5,000 7,000

Number of branches 30 105 300+

Corporate services

Retirement plans (401k)

Equity compensation plans

Banking services

Full service bank

Trust services

Custody services

Administrative trustee services

Average retail client assets -estimate $65,000 $100,000 $250,000

Average age of retail client Mid 40s Mid 40s Mid 50s


E*TRADE’s competitors have taken advantage of regulatory limitations on its growth and management’s decision to refocus on its core franchise



Still, there have simply been too many fires to fight, which in our view, might have put the firm at a competitive disadvantage versus its peers. The firm has not been able to expand its product offering to the same degree as its competitors. The management team did the best it could given the opportunity set. One can assume that its regulators would not have been approachable had the management team been discussing paths to aggressively grow its business. The firm missed opportunities to grow and keep up with its evolving competitors while it was fully engaged with its regulators.

The exhibit below shows the average organic growth rate for client assets, growth in average fee based investment assets, and growth in interest-earning assets. While E*TRADE Financial was able to add to its client assets, we estimate that the average organic growth rate to be the lowest with 4.6%. This compares with 5.1% for Charles Schwab, and 10.5% for TD Ameritrade. As for interest rate sensitive assets, there has been a decline in average interest-earning assets since 2009. The firm’s peers grew their assets at a compounded annual growth rate of 16% to 17% since 2009.

Exhibit 21: ETFC’s five-year compound annual growth rate versus peers (2009 to 2014)

5%

11%

5%

24%

20%

n/m

16% 17%

-2%-5%

0%

5%

10%

15%

20%

25%

30%

35%

40%

SCHW AMTD ETFC

Client assets organic growth Avg. fee based investment balances Avg. Interest rate sensitive assets


Looking at the data over a three-year period, we come to a similar conclusion. The average organic growth rate for client assets is 4.2%, which is lower than over the five-year period. As for interest rate sensitive assets, the firm has slowed down running off its balance sheet. However, growth remained negative to the tune of 1.4% over the past three years.

E*TRADE seems to have fallen behind while its peers have evolved. A good example would be TD Ameritrade. The firm’s effort to build out its RIA network and capitalize on the “breakaway advisor” trend is paying dividends, in our view. While still lagging Charles Schwab, we have seen a tremendous effort and some success in closing the gap. Charles Schwab, on the other hand, has now evolved to a full-service brokerage firm.

Our point is this: E*TRADE Financial’s business model is too transactional. Certainly, the firm has grown its corporate services business. At the end of 2009, there were about 1 million stock plan accounts. This number increased to approximately 1.3 million by the end of 2014. However, there has been a slowdown in growth, as evidenced by net new accounts added. The exhibit below shows this. The decline could be due to mergers or an attempt to focus on more profitable segments of the market. However, a decline of over 50 percent is material and difficult to ignore.



Exhibit 22: Net new stock plan account growth has been declining since 2012

7,083

22,711 21,890

77,180 71,979

28,407

0

10,000

20,000

30,000

40,000

50,000

60,000

70,000

80,000

90,000

2009 2010 2011 2012 2013 2014


Given a lack of growth, it should not come as a surprise that the company’s revenue mix is not as diversified as that of its peers. Spread-based revenues are the major contributor to net revenues. Unlike its competitors, the firm has not grown its fee-based revenue stream. Based on the competitive landscape as of today, we believe that—absent of any acquisition—it will be difficult for the firm to catch up to its competitors if it attempted to transition to an asset gathering business model. Thus, we would expect the firm to continue to rely heavily on its balance sheet and commission revenues to grow the top line.

Exhibit 23: Spread-based revenues contribute about 60% to net revenues (2014)

15%

43%

25%

38%

19% 60%

42%36%

10%6% 2% 5%

0%

20%

40%

60%

80%

100%

120%

SCHW AMTD ETFC

Commission revenues Spread revenues Fee revenues Other


Revenues will be significantly impacted by the company’s ability to grow its interest-earning assets. While we believe that the firm will be able to grow its balance sheet, a lack of growth in interest-earning assets could lead to earnings growth below our expectation.



Balance sheet continues to be the most risky among peers While HELOC provisions seem adequate, investors need to be cognizant of the fact that there are about $3.2 billion of loans that will convert from interest only to amortizing loans, and that provisions for 1- to 4-family home loans have declined to $27 million. We would expect an increase in loan loss provisions over the coming years.

While E*TRADE Financial has done a tremendous job in reducing its risk exposure, there is still significantly more risk associated with investing in the company’s shares versus that of its peers.

Consider this: The loan portfolio was at $32 billion at its height. Today, this portfolio has been reduced to about $6.4 billion, and the quality of its loans has improved. Provisions for loan losses of $36 million in 2014 were down 75% relative to 2013.

However, the company has still not turned the corner in our view. As the company pointed out, it believes that provision for loan losses will remain in the $10–$30 million range per quarter in 2015 and 2016. It expects the provisions to be at the lower end of that range in 2015, and at the higher end of the range of 2016. So, what is happening?

There are about $3.1 billion of one- to four-family home loans and $2.8 billion of home equity loans on E*TRADE Financial’s balance sheet. About 42% of the one- to four-family home loans are going to convert from interest only to amortizing loans, while this ratio will be 68% for home equity line of credit loans (HELOC). The exhibit below shows the timing and amount of loan balances that are going to convert.

Exhibit 24: A total of $3.2 billion of loans will convert from interest only to amortizing loans over the next three years ($ in billion)

$0.8

$0.1 $0.1

$0.5

$0.7

$0.2

$0.1

$0.6

$1.0

$0.3

$-

$0.2

$0.4

$0.6

$0.8

$1.0

$1.2

2013 and priod 2014 2015 2016 2017

1-4 family I/O to amortizing conversions HELOC I/O to amortizing conversions


What is going to happen is that borrowers will move from paying a minimum monthly payment to paying based on a loan amortization schedule, which should increase the amount paid by the borrowers. Certainly, some of the borrowers have already started paying principal voluntarily. The company reported that 15% of the one- to four-family home borrowers paid back at least $2,500 in principal during 2014, while 6% reduced their principal amount by at least $10,000. These are positive developments. However, the average loan size is $496,000. As for the HELOC portfolio, 38% of borrowers have returned at

Management expects provisions for loan losses to be in the $10 million to $30 million per quarter range.



least $500 of the principal while 17% have returned at least $2,500. Again, the average loan amount of $73,000 is meaningful.

It is difficult to forecast potential loan losses over the next three years. Our point is that investors should consider this risk. It appears that E*TRADE Financial has been strengthening its allowance for loan losses for HELOC loans, but has been reducing it for one- to four-family home loans. The exhibit below shows this.

Exhibit 25: Company expects increasing losses on HELOC loans, but lower losses on the one-to four-family home loan portfolio (allowance for loan losses as % of outstanding balances)

0%

2%

4%

6%

8%

10%

12%

14%

1Q

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3Q

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One-to-four-family Home equity


There are many variables that could lead to better or worse than expected loan losses. We believe that the severity and frequency of the losses will be determined by the borrowers’ financial situation, which is a function of the economy.

Certainly, the trend has been good. The exhibit below shows delinquent loans as a percentage of gross loans receivable. We have seen a decline in total delinquent loans, especially for one- to four-family home loans.

Exhibit 26: Delinquent loans as percentage of gross loans receivable have been declining

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

20%

1Q

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1Q

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1Q

11

3Q

11

1Q

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3Q

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1Q

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13

1Q

14

3Q

14





Nonetheless, it is difficult to determine whether current reserves will be enough to absorb future losses. While the firm seems to be adequately reserved for losses on HELOC loans, we have seen reserve releases from allowances for losses on one- to four-family home loans. The exhibit below shows the current allowance as a percentage of the balances that are expected to convert over the next three years.

Exhibit 27: It would take losses of 2.1 percent of the upcoming one- to four-family home loan conversion balances to wipe out the current allowance

2.1%

19.3%

0%

5%

10%

15%

20%

25%



Ban on payment for order flow practices could impact earnings While we do not expect a ban on payment for order flow practices, we estimate that an adverse outcome could impact EPS to the tune of 13 cents.

In order to attract trades, exchanges pay brokers for routing a trade through them. This is called “payment for order flow”. According to current SEC rules, all that the brokers have to do now is disclose whether they receive payment for order flows and provide details of this arrangement.

The Securities and Exchange Commission is currently reviewing whether brokers act in their clients’ best interest when they “sell the orders” to a trading firm or an exchange for a fee. While we think that there is a low probability of this changing, the SEC could decide to eliminate this practice. The UK Financial Conduct Authority has already changed its policies in 2014 and prohibits brokers from taking payments for orders routed to other firms. Their view is that there is a “clear conflict” of interest caused by these payments.

So far, it does not seem likely that the SEC will follow suite. Mary Jo White, The SEC’s Chairwoman, said in her market structure reform speech that fees and payments for orders create a conflict of interest if these payments are not passed through to customers. However, she did not call for an end of such practices. There is a very high likelihood that the outcome of the SEC’s inquiry into this topic could simply be better disclosures instead of banning this practice.

However, if this practice was banned, we believe E*TRADE and TD Ameritrade would be impacted the most. We estimate that the firm generated about $90 million in order routing revenues in 2014. This figure compares to about $100 million at Schwab and $300 million at

While “Payment for Order Flow” is being reviewed by the SEC, we do not anticipate an elimination of these fees, but rather expect additional disclosures around fees



TD Ameritrade. While the absolute dollar revenue generated is the lowest among peers, the impact on EPS in percentage term appears to be the highest. This is how we arrived at our conclusion:

The firm did not disclose the percentage of its order routing revenues from equity transactions. We estimate this to be around 70%. As a note, the SEC is not reviewing transactions in other types of securities. Assuming 70% of the $90 million is from equity trades, a 100% margin on these revenues, and a 38% tax rate, we estimate that earnings per share could be impacted to the tune of $0.13. This compares to an estimated impact of $0.17 per share at TD Ameritrade and less than a nickel at Schwab. This calculation is based on an average share count of 294.1 million diluted shares. To put this figure into perspective, the firm’s earnings were $1.00 per diluted share in 2014. The exhibit below shows our calculation.

Exhibit 28: We estimate the impact from a ban on payment for order flow practices to impact EPS by about 13 cents

($ in million) FY 2014Order routing revenue $89.0Assumed equity transactions 70%Revenues at risk $62.3

Assumed margin 100%Impact on pre-tax earnings 62.3 Tax rate 38%Impact on earnings $38.6

Sharecount 294.1

EPS Impact $0.13


We believe that a ban is unlikely. However, if there should be one on payment for order flows, then we believe E*TRADE Financial would stand out to be impacted slightly more than TD Ameritrade. The impact is equal to 13% of earnings per share reported in 2014. While TD Ameritrade would be impacted more in dollar terms, with 17 cents, earnings per share would decline by about 12%. Over time, however, we would expect both firms to find ways to make up for the lost revenues through other fees and charges.

Sharp increase in short-term interest rates could negatively impact the firm given the duration of its balance sheet E*TRADE Financial’s assets have a duration of about three years, longer than the 2 years for its peers.

While a slow increase in rates would be a “tailwind”, as shown above, a sharp increase in rates could impact the firm negatively. This would result in net interest spread compression as yields paid on interest-bearing client balances would rise faster than what the firm earns on interest-earning assets.

The consolidated duration of the firm’s assets are about three years as of the end of fiscal year 2014. Although we assume a gradual increase in interest rates in our model, we also appreciate the fact that it is difficult to predict interest rate movements. Thus, while this is not a major issue from our perspective, we still think that investors ought to be cognizant of

Ban of “Payment for Order Flow” practices could impact E*TRADE’s EPS by approximately 13 cents, which would be significant

While increases in interest rates are a positive development, sharp increases in rates could impact E*TRADE more than peers given the duration of its assets



the risks of sharply increasing rates on earnings. We estimate that Charles Schwab’s duration is about 1.9 years while TD Ameritrade’s is 2.2 years.



Valuation framework We value E*TRADE Financial Corporation using a forward-looking P/E multiple approach. We understand that there are biases to this approach as P/E multiples can be overly high during bull markets and depressed during bear markets. We are trying to compensate for this by taking an average P/E multiple over an extended period. In addition, we are adding the present value of the deferred tax assets to arrive at our price target.

Our 12-month price target for E*TRADE is $35. We arrive at our price target using a price-to-earnings multiple of 23.0x on our 2016 calendar year earnings estimate of $1.55 per diluted weighted average shares. We then discount the resulting valuation using a cost of equity of 11.0%. The discount rate is based on a beta of 1.9x, a risk free rate of 4%, and a market premium of 4%. The discount period is 0.8 years.

Furthermore, we discount the $1 billion of deferred tax assets (DTAs) assuming that these will be realized over a four-year period. We discount the DTAs using a cost of equity of 11.0%. Furthermore, we take a 10% haircut to compensate for a margin of error in respect to the timing. We estimate that the DTAs could be worth approximately $2. This leads us to our price target of $35.

Exhibit 29: Price target based on one-plus-a-half-methodology

Valuation

CY 2016 EPS $1.55P/E Multiple 23.0x

Valuation $36

Valuation - PV $33Value of DTA 2

Price target - PV $35

Source: Company reports; RBC Capital Markets estimates

Our $35 base case scenario valuation is based on these assumptions for 2016: Net interest margins of 283 basis points by the year 2016; average enterprise interest-earning assets of $47.8 billion; daily average revenue trades of 175,776; average revenue per revenue trade of $11.00; a pre-tax margin of 33.9%. We believe a 23x P/E multiple is justified given historical valuation.

Deferred tax assets valuation E*TRADE Financial Corporation had $951 billion of deferred tax assets (DTAs) as of 4Q/14. DTAs were driven by the losses the company had to take on its investment portfolio, which had peaked at $32 billion in 2007, and a debt exchange of zero coupon convertible debentures for interest bearing debt in 2009. Today, about $323 million of the approximate $1 billion of DTAs are at the parent company. E*TRADE Financial expects its subsidiaries to reimburse the parent for the use of its deferred tax assets. There is value to the DTAs as these can be used to offset income.

The company has not established an allowance against its federal deferred tax assets, which in our view is an indication that management believes the full DTA amount is available for use. In fact, the firm expects to realize the majority of its existing federal deferred tax assets within the next four years.

We estimate that deferred tax assets (DTAs), which we have incorporated into our valuation, should be worth about $2 per share



DTAs are a source of future cash that, ultimately, will be held at the parent company, as subsidiaries will have to reimburse the parent for using the DTA. The following shows the impact of the DTAs on cash tax expenses. The company showed GAAP tax expenses of $159 million for 2014. However, cash outlays to meet the tax liabilities were only about $4 million for this period. We expect the firm to fully utilize the deferred tax assets by 2018. Thus, we estimate the value of the DTAs to be about $2 per share.

Exhibit 30: We estimate the present value of DTAs per share to be around $2

Valuation of Potential Deferred Tax Assets

DTA, net ($ mm) $951Assumed discount rate (cost of equity): 11.0%Assumed utilization period 4.0 years

($ in million) 1 2 3 4

Est DTA usage $233.3 $275.9 $363.7 $78.1Discount factor 0.90 0.81 0.73 0.66 Discounted cash flow $210.2 $224.0 $266.0 $51.5

PV of cash flows ($ mn): $751.6Haircut: 10%Estimated DTA value: $676.4Shares outstanding (in million): 294 PV of DTA assets per share $2.30

Years


To arrive at our valuation, we assumed that the firm would be able to use up the deferred tax assets of $951 million over a period of four years. In addition, to be conservative, we used a 10% haircut in order to adjust for any timing errors. We discounted the resulting cash savings by the company’s cost of equity, which we estimate to be around 11.0%.

Why we choose a PE multiple of 23.0x We have looked at P/E multiples going back to April 2003. On average, shares of ETFC have traded at a 23.1x P/E multiple since April 2003. The average P/E multiple prior to 2008 was 15.9x. As for the period post the financial crisis, our data shows that ETFC has been trading at an average P/E multiple of 32.9x. However, P/E multiples have been elevated recently given weak earnings and investor expectations that there could be some positive catalysts regarding the firm’s capital management plans. The shares of ETFC have been trading at an average P/E multiple of 23.1x since the beginning of this year. More recently, we have seen an uptick in the P/E multiple, which stands at 27.3x as of March 24

th. However, we are taking

a longer term view and believe that the 23.0x P/E multiple is appropriate.



Exhibit 31: ETFC’s current P/E multiples seem elevated relative to the period leading to the financial crisis

0.0x

10.0x

20.0x

30.0x

40.0x

50.0x

60.0x

70.0x

80.0x

90.0x

04/2

1/2

003

11/1

2/2

003

06/1

0/2

004

01/0

5/2

005

08/0

2/2

005

02/2

8/2

006

09/2

2/2

006

04/2

3/2

007

11/1

4/2

007

06/1

2/2

008

01/0

7/2

009

08/0

4/2

009

03/0

2/2

010

09/2

4/2

010

04/2

0/2

011

11/1

4/2

011

06/1

2/2

012

01/0

9/2

013

08/0

6/2

013

03/0

4/2

014

09/2

6/2

014

P/E

Multip

le

Priced as of market close ET, March 24, 2015. Source: FactSet; RBC Capital Markets



Risks and price target impediments Drop in consumer confidence & commissions A decline in trading volume and commission rates could negatively impact commission revenues and earnings. Trading volume is, to a high degree, dependent on market volatility. Usually, higher volatility would contribute to higher trading volume. However, a prolonged period of market volatility in declining markets could lead to a decrease in consumer confidence and thus trading activity. E*TRADE could be forced to reduce commission rates for its most active customers. Furthermore, margin borrowing/lending could decline significantly, leading to earnings shortfall.

Prolonged period of low interest rates A prolonged low interest rate environment could compress net interest margins. We are assuming a gradual increase in interest rates over the coming years. A sharp increase in short-term interest rates could be detrimental to the firm, as its assets seem to have a longer duration than its liabilities. This could lead to a net interest margin compression and earnings below our estimate.

Unforeseen regulatory constraints could impact valuation E*TRADE is a highly regulated entity. The holding company depends on dividend payments from its subsidiaries to pay for its debt obligations. Any regulatory action that could limit the company’s ability to “dividend-up” capital to the holding company could negatively impact the firm’s financial condition and have a direct impact on the firm’s ability to buy back shares or pay dividends. While the firm does not pay dividends at this time, we are assuming that the firm will commence paying dividends in 2016.

Balance sheet growth below our expectation could lead to an earnings miss Changes in average balances, especially client margin, could impact operating results. Revenues could fall short of our expectation were balance sheet growth to slow significantly or decline.

The company has significant exposure to mortgage loans which could result in losses E*TRADE had a loan portfolio of $6.4 billion as of the end of 2014. This figure includes a home equity loan portfolio of about $2.8 billion and a one-to-four-family loan portfolio of about $3.1 billion. Performance of the loan portfolio can vary and the provisions for loan losses might not be adequate. Deteriorating performance could impact customer retention, earnings, book value and valuations of the company’s common shares.

Sharp decline in securities markets & deterioration in credit markets/housing A sharp decline in securities markets could lead to losses as the value of collateral held in connection with margin receivables would decline. This could create collection issues with the margin receivable accounts, which could lead to an earnings shortfall. Likewise, the company continues to have sizeable exposure to the housing market via its portfolio of one- to four-family loans, home equity loans, and consumer loans. Deteriorating credit/housing markets could lead to a sharp increase in provisions and a decline in earnings.

Deferred tax assets might not be realized The firm has about $1.2 billion of deferred tax assets. E*TRADE might have to establish a valuation allowance against these reserves if it determines that not all of these assets will be realized. This could negatively impact earnings and valuation.



Quick overview of E*TRADE Financial Corp. Headquartered at New York, NY, E*Trade Financial Corp. operates as a financial services company that provides brokerage and related products and services primarily to individual retail investors. Incorporated in California in 1982, the company was reincorporated in Delaware in July 1996.

Quick history The firm’s story is not dissimilar to AIG’s in that bad investment decisions almost resulted in a disastrous outcome. Here is a summary of how the second largest discount broker very nearly became extinct as management teams took on too much risk for the sake of earnings growth. It starts with Mitchell Caplan taking over as the CEO of Financial in 2003 after his precessor Christos Cotsakos had to step down. Through various articles it became known that Mr. Cotsakos had been living a lavish lifestyle—at the expense of E*TRADE’s shareholders. Mr. Caplan had joined E*TRADE Finanical with a retail banking background after E*TRADE Financial had acquired Telebanc Financial Corporation in 2000, where he had served as President and CEO.

Mitchell Caplan’s view of the future was different than his predecessors. He wanted to position the firm as an electronic financial supermarket, away from generating revenues largely based on trading volumes. After all, E*TRADE Financial managed to generate positive earnings in only 4 quarters out of 12 quarters from 1999 to 2001. He wanted the bank to play a more dominant part in generating earnings.

This led to a culture of risk taking—excessive risk taking. The management team’s focus shifted from discount brokerage services to banking—specifically mortgages and home equity loans. Initially, management relied on loans originated by the firm to grow the balance sheet. Then, the company started purchasing mortgage pools from subprime lenders.

This worked for some time, with revenues growing at a steep pace. In fact, E*TRADE Financial reported four consecutive years of record revenues and earnings from 2003 to 2006.

The firm was chasing yields, making investments in mortgages, mortgage-backed securties, and various asset-backed securities—until the mortgage meltdown of 2007. By early 2007, investors became concerned about the mortgage market and the company’s mortgage portfolio started to show signs of deterioration. Understanding the severity of the situation in which it found itself, the management team started looking for options with two potential bidders emerging for E*TRADE Financial’s business. One was Citadel, the other a group consisting of TD Ameritrade and J.C. Flowers.

The firm announced in September 2007 its strategic plan to transition towards a “retail-driven” plain vanilla balance sheet. Put differently, it decided to de-risk its balance sheet after years of taking excessive risk in order to grow earnings. At this point, the firm’s mortgage portfolio had already deteriorated significantly andE*TRADE Financial’s shares had lost 35%. The company’s longer-term vision was to structure the balance sheet such that 80% to 85% of liabilities would be deposits from customers (instead of relying on wholesale funding sources) and 80% to 85% of assets would be loans to customers. The firm wanted to eliminate second lien mortgage exposure and shift its loan portfolio to first lien mortgages. The goal was to improve net interest spreads over time and improve the performance of its loan portfolio by allowing borrowers to prepay their debt and letting loans mature.

However, time was a luxury E*TRADE Finacial did not have. The firm was bailed out with a $2.5 billion of cash infusion the same day CEO Mitchell Caplan resigned. On November 29,

After years of management changes and uncertainty, E*TRADE seems to have a leadership team in place that focuses on unlocking shareholder value while paying attention to risk management



2007, Citadel LLC purchased E*TRADE Financial’s securitized subprime mortgage investments for approximately $800 million in cash—or at 27% of book value. This transaction effectively removed $3 billion of asset-backed securities (ABS portfolio), collateralized debt obligations, and second lien loans from the firm’s balance. Citadel also provided $1.75 billion of capital in exchange for 12.5% senior unsecured notes and a 20% ownership of the firm. Furthermore, Citadel received a seat on the board of directors. The firm had to take a $2.2 billion pre-tax charge related to the ABS portfolio. The firm also increased its allowance for loan losses by $285 million, bringing the total allowance to $400 million.

In March 2008, E*TRADE Finanical named Donald Layton, who had been Chairman of the board since November 2007, as its new CEO. He replaced Jarrett Lilien as the interim CEO. However, Mr. Layton retired at the end of 2009, and was replaced by interim CEO and chairman Robert Druskin—until a permanent CEO was found.

Steven Freiberg, who had held multiple senior positions as Citigroup, was appointed the new CEO of E*TRADE Financial on April 1, 2010. In August 2012, just two years into his four-year contract, he stepped down as the firm went through a strategic review. While E*TRADE Financial had been exploring the sale of its business, as Citadel had suggested earlier, it abandoned the effort of selling itself. Instead, management embarked on a turnaround strategy.

Frank Petrilli, the company’s chairman, replaced Mr. Freiberg as an interim CEO until the current CEO was announced. Mr. Paul T. Idzik was appointed CEO on January 17, 2013. Mr. Idzik joined the firm after having worked as Group Chief Executive of DTZ Holdings PLC in London and having served 10 years at Barclays PLC. We have a favorable view of the current management team as it able to put E*TRADE in a position that could lead to dividend payments in the not so distant future.

The new management was well received by the markets. As the exhibit below shows, ETFC’s shares have outperformed its peers since Mr. Idzik took over.

Exhibit 32: Shares of E*TRADE Financial have appreciated over 150% since January 17, 2013

0%

50%

100%

150%

200%

250%

300%

17

/01

/20

13

17

/03

/20

13

17

/05

/20

13

17

/07

/20

13

17

/09

/20

13

17

/11

/20

13

17

/01

/20

14

17

/03

/20

14

17

/05

/20

14

17

/07

/20

14

17

/09

/20

14

17

/11

/20

14

17

/01

/20

15

ETFC S&P 500 AMTD SCHW

Priced as of market close ET, March 24, 2015. Source: FactSet; RBC Capital Markets

The shares of E*TRADE Financial are up 174.6% from January 17, 2013 to March 24, 2015. This compares with 40.0% for the S&P 500, 102.8% for TD Ameritrade, and 2.3% for Charles Schwab.



Products The company also provides investor-focused banking products, primarily sweep deposits and savings products, to retail investors. The company provides services to customers in the U.S. through mobile applications and its website. It also provide services through its network of customer service representatives and financial consultants, over the phone or in person through its 30 E*TRADE branches.

Exhibit 33: DARTs (in thousands) Total customer assets (in billions)

151157

138151

168

0

45

90

135

180

2010 2011 2012 2013 2014

176.2 172.4201.2

260.8

290.3

$0

$50

$100

$150

$200

$250

$300

2010 2011 2012 2013 2014

DART - Daily average revenue trades Source: Company reports; RBC Capital Markets

E*TRADE reported daily average revenue trades (DARTs) of 168,000 during the Q4’14, an increase of 10% from the prior quarter and an increase of 5% from the same quarter a year ago. DARTs for the full year were 168,000, up from 151,000 in 2013.

In FY’14, the Company added 146,000 net new brokerage accounts. Brokerage account attrition for FY’14 was 8.7%, representing a slight improvement from 8.8% in 2013.

Key products/services and client offerings are:

Trading – Equities, Options, ETFs, Futures & forex, fixed income, Mutual funds

Margin lending – Enables customers to borrow against their securities

Customer Support – The Company provides the help of experienced financial consultants, independent research and analytics, education resources, and screeners and tools

E*TRADE’s digital platforms are listed below:

E*TRADE.com – The Company website provides customers with tools, guidance, actionable ideas, research, and education to take control of their finances

E*TRADE Mobile – Powerful trading applications for the most popular smart phones and tablets, delivering the same core functionality as E*TRADE’s desktop platforms

E*TRADE Pro – Trading platform for active and elite traders, with sophisticated tools



Exhibit 34: ETFC snapshot

Snapshot

Founded 1982

Headquarters New York, NY, USA

President and CEO Paul T. Idzik

Employees 3,377 (as of December 31, 2014)

Business Segments Trading & Investing, Balance sheet management

Total Revenue US$1.814 Billion (as of December 31, 2014)

Total Client Assets US$290.3 Billion (as of December 31, 2014)


Key subsidiaries through which ETFC conducts its business include:

E*TRADE Bank is a federally chartered savings bank that provides investor-focused banking products to retail customers nationwide and deposit accounts insured by the Federal Deposit Insurance Corporation (“FDIC”).

E*TRADE Securities LLC is a registered broker–dealer and is a wholly owned operating subsidiary of E*TRADE Bank. It is the primary provider of brokerage products and services to its customers.

E*TRADE Clearing LLC is the clearing firm for its brokerage subsidiaries and is a wholly owned operating subsidiary of E*TRADE Bank. Its main purpose is to clear and settle securities transactions for customers of E*TRADE Securities LLC.



Revenue break-down

Sources of revenue The Company’s major sources of revenues are Net Operating Interest income; Commissions; Fees and service charges; and Gains and losses on securities & Principal transactions.

A) Net Operating Interest income Net operating interest income is earned primarily through investing customer payables and deposits in enterprise interest-earning assets, which include: real estate loans, margin receivables, available-for-sale securities, and held-to-maturity securities. It represents what is traditionally known as the net interest margin or spread-related revenue, and accounts for ~61% of the total revenues earned during FY’14. This revenue head is largely driven by investment yield and average balances. This also includes gains and losses on the legacy mortgage portfolio. At the end of quarter ended December 2014, net interest spread stood at 2.69%, up from 2.40% in Q4 2013.

Exhibit 35: Enterprise interest-earnings assets | yield ($ in billion)

$6.5,407 bps

$24.8, 256bps

$1.7, 13bps

$7.9,449 bps

Q4 14 Enterprise Interest Earnings Assets | yield

Legacy Loan Agency Securities Cash Margin receivables & other

Source: Company reports; RBC Capital Market

Exhibit 36: Enterprise interest-bearing liabilities | cost ($ in billion)

$5.1,360bps

$24.7, -5bps

$1.7, -69bps

$6.4, 38bps

Q4 14 Enterprise interest bearing liabilities | cost

Wholesale Funding Customer deposits Other Customer assets held by third parties




Prior to the 2008 crisis, the company took on additional debt to invest in mortgage-backed securities. In 2007, the value of these investments deteriorated resulting in substantial write-downs and additional capital requirement for ETFC, which in turn were provided by hedge fund Citadel. ETFC has been able to refinance some of its high cost debt and now has ~$1.3 billion in corporate debt at an average cost of 5.97%. ETFC has since discontinued its mortgage-backed program and has no asset-backed securities in its portfolio. The write-downs resulted in a deferred tax asset of $1.2 billion, which is used to offset tax liability against current income. The legacy loan portfolio currently stands at $6 billion down from $31 billion in 2007. This holding is among the highest yielding assets in the portfolio, carrying a yield of 4.07%.

Exhibit 37: Average interest-earning assets ($ in billion)

$44.5 $41.1 $42.7 $44.3 $40.9 $41.4

2.72%2.91%

2.79%

2.39% 2.33%

2.55%

0.00%

0.50%

1.00%

1.50%

2.00%

2.50%

3.00%

3.50%

$39.0

$40.0

$41.0

$42.0

$43.0

$44.0

$45.0

2009 2010 2011 2012 2013 2014

Average interest earning assets Net Interest Spread


B) Commissions Commissions are a function of daily average revenue trades (DARTs), average commission per trade, and the number of trading days. Average commission per trade is determined by customer mix and the different commission rates on various trade types (e.g., equities, options, fixed income, stock plan, exchange-traded funds, mutual funds, forex, and cross border). DARTs for the quarter ended 2014 stood at 168,000, up from 153,000 in the last quarter. Average commission per trade for the quarter was $10.84, compared with $11.05 in the prior quarter, and $10.97 in the fourth quarter of 2013. Option DARTs represent 22% of 2014 of total DARTs, given that options represent recurring revenue as options expire and need to be renewed. ETFC charges an extra $0.75 per contract for options.



Exhibit 38: DARTs chart with option trading

179 151 157 138 151 169

13%

17%

20%

24% 24%

22%

0%

5%

10%

15%

20%

25%

30%

0

20

40

60

80

100

120

140

160

180

200

2009 2010 2011 2012 2013 2014

DARTs (000’s) Options DARTs


C) Fees and services charges Fees and services charges comprise payment for order flow, which is the largest component for this revenue stream. This also includes mutual fund service fees, foreign exchange revenue, and advisor management fees. ETFC has 1% of customer assets in retirement accounts and 27% of their brokerage accounts are retirement accounts. As of December 2014, the Company has $47.9 billion in retirement assets and $3.1 billion in managed accounts.

Exhibit 39: Retirement assets Managed accounts

$23 $28 $30 $35 $43 $48$0

$10

$20

$30

$40

$50

$60

2009 2010 2011 2012 2013 2014

Retirement assets ($B)

$0.3 $0.7 $1.3 $2.4 $3.1$0.00

$0.50

$1.00

$1.50

$2.00

$2.50

$3.00

$3.50

2009 2010 2011 2012 2013 2014

Assets in managed accounts ($B)




Exhibit 40: Total customer assets

$151 $176 $172 $201 $261 $290$0

$50

$100

$150

$200

$250

$300

$350

2009 2010 2011 2012 2013 2014

Total customer assets ($B)


D) Gains on loans and securities & Principal transactions Gains on loans and securities is driven by gains or losses resulting from the sale of available-for-sale securities, trading securities, sales of loans, hedge ineffectiveness, and derivative instruments, which are not accounted as hedging instruments.

Exhibit 41: Segment revenue break-up FY’14 vs. FY’10 ($M)

FY '14 Revenues

($1,776M)

61%

1%

26%

10%

2%

FY '10 Revenues

($2,069M)

59%

5%

21%7%

8%

Net operating interest income Commissions

Fees and service charges Principal transactions

Gains on loans and securities, net


Net operating interest income, which is earned through investing deposits and customer payables in enterprise interest-earning assets, is the biggest source of revenue for the company. As depicted in the chart, during FY’14, the majority of revenues were generated from Net Operating Interest income (61%), followed by Commissions (26%), Fees and service charges (10%), Gains on loans and securities (2%), and Principal transactions (1%). During FY’10, the majority of revenues were generated through Net Operating Interest income (59%), followed by Commissions (21%), and Gains on loans and securities (7%).



Business segments The Company primarily operates in two segments: Trading and investing, and Balance sheet management

Trading and investing Trading and investing includes retail brokerage products and services; investor-focused banking products; market making; and corporate services.

Balance sheet management Balance sheet management includes the management of asset allocation; loans previously originated by the Company or purchased from third parties; deposits and customer payables; and credit, liquidity, and interest rate risk for the Company.

Exhibit 42: Revenue break-up of business segments

Net Operating

interest income

46%

Commissions35%

Fees & service charges

14%Principal

transactions2%

Other revenues

3%

Trading & Investing LTM Sep'14 revenues (in $M)

Net Operating interest income

91%

Gains on loans and securities

8%

Other revenues

1%

Balance Sheet Management LTM Sep'14 revenues(in $M)




Products Exhibit 43: Trading products and services

Etrade.com Web

Platform

Access to website, etrade.com, including E*TRADE 360, a fully customizable

account page

E*TRADE Mobile Allows customers to securely trade, monitor real-time investment, market and

account information, access educational videos and other content, pay bills

and transfer funds between accounts via iPhone, iPad, Android phones and

tablets, Windows Phone or Kindle Fire

E*TRADE Pro Desktop trading software for qualified active traders, which provides

customers with customizable trading technology, continuous market visibil ity,

news and information, plus l ive streaming news via CNBC TV

Margin Trading Margin accounts allowing customers to borrow against their securities,

complete with margin analysis tools to help customers manage their account

and risk

Cross-border

Trading

Allows customers residing outside of the U.S. to trade in U.S. securities

International

Trading

Access to 77 international markets with American depositary receipts (ADRs),

exchange-traded funds (ETFs), and mutual funds, plus online equity trading in

local currencies in Canada, France, Germany, Hong Kong, Japan and the United

Kingdom

Idea generation

tools

Research and investing idea generation tools that assist customers with

identifying investment opportunities including analyst and technical research,

consensus ratings, and market commentary from Morningstar, Dreyfus and

Bond Desk Group

OneStop Rollover A simplified, online rollover program that enables investors to invest their

401(k) savings from a previous employer into a professionally managed

portfolio

Commission-free

ETFs

Access to all ETFs sold, including over 80 commission-free ETFs from leading

independent providers, and over 7,700 non-proprietary mutual funds

Managed

Investment

Portfolio advisory

services

One-on-one professional portfolio management service by an affil iated

registered investment advisor

Online Portfolio

Advisor

Helps customers identify the right asset allocation and provides a range of

solutions including a one-time investment portfolio or a managed investment

account

Retirement

center

Offers easy-to-use tools, calculators, education, retirement solutions, and

access to Chartered Retirement Planning Counselors who can provide

customers with one-on-one portfolio evaluations and personalized plans

Investor

education center

~400 educational articles and videos from over 10 independent sources and

E*TRADE’s financial experts, along with live events, web casts, web seminars,

and tutorials and demos

FDIC insured

deposit accounts

Checking, savings, and money market accounts, including those that transfer

funds to and from customer brokerage accounts

Source: Company presentation; RBC Capital Markets

Corporate Services – Software and services for managing equity compensation plans for

corporate customers.

Equity Edge Online platform facilitates the management of employee stock option plans, employee stock purchase plans and restricted stock plans, including necessary accounting and reporting functions.



Distribution The company strives to maintain a high standard of customer service by staffing the customer support team with appropriately trained personnel who are equipped to handle customer inquiries in a prompt yet thorough manner.

Branches — The Company operates ~30 branches in the U.S. where retail investors can go

to receive face-to-face customer support in meeting their needs. Financial consultants are also available on-site to help customers assess their current asset allocation and develop plans to help them achieve their investment goals.

Customers can also contact financial consultants via phone or e-mail.

Online — Online Advisor tools provides asset allocation and a range of investment solutions

that can be managed online or through a dedicated investment professional.

The company also has an Online Service Center where customers can request services on their accounts and obtain answers to frequently asked questions. The online service center also provides customers with the ability to send a secure message and/or engage in Live Chat with customer service representatives.

The Investor Education Center, providing customers with access to a variety of live and on-demand courses, is also offered.

Telephonic — A toll-free number connects customers to an automated phone system that

directs customers to the appropriate department where a financial consultant or licensed customer service representative can assist with their inquiry.



Competitors E*TRADE’s trading and investing segment competes with full commission brokerage firms, discount brokerage firms, online brokerage firms, Internet banks and traditional “brick & mortar” retail banks and thrifts. Some of these competitors provide Internet trading and banking services, investment advisor services, touchtone telephone and voice response banking services, electronic bill payment services, and a host of other financial products.

Exhibit 44: Growth in client assets ($ in billion)

$2,498

$2,025

$672

$290

$2,464

$-

$500

$1,000

$1,500

$2,000

$2,500

$3,000

1Q10 3Q10 1Q11 3Q11 1Q12 3Q12 1Q13 3Q13 1Q14 3Q14Bank of America Merrill Lynch Morgan Stanley

Ameritrade E*Trade

Charles Schwab

Note: TD Ameritrade assets as of December 31, 2014.

Source: Publicly available company reports for each period; RBC Capital Markets



History Exhibit 45: ETFC history

Year Highlights

1982 William Porter founded TradePlus

1983 Launches its first online trade over a network of via CompuServe

1991 William Porter establishes E*Trade Securities with startup capital from TradePlus

1992 Begins offering online brokerage services directly to individual investors

Launches E*trade.com Website

Launches an IPO and lists on NASDAQ

Christos Cotsakos named President and CEO of the Company

1999 Revenue increases by 134.2%

2000 Acquires Telebanc financial corp. and Electronic Investing Corp

2001 Listed on NYSE under the ticker "ET"

2002 Acquires Tradescape Corp

2003 Changes its name to E*Trade Financial Corporation

2004 Moves its headquarter from California to New York

2005 Acquires online broker Harrisdirect and Brown Co

2006 Moved to NASDAQ under the ticker "ETFC"

2007 Hedge Fund Citadel makes a $2.5 billion cash infusion

2008 Sells its Canadian division to Scotia Bank

Appoints Steven Freiberg as new Chief Executive Officer

Changes its Ticker to "ETFCD" on NASDAQ

Revises its Ticker to "ETFC" on NASDAQ

2013 Appoints Paul T. Idzik as new Chief Executive Officer

2010

1996

Source: Company reports and presentations; RBC Capital Markets



Management team Exhibit 46: Management team

Name Title Background

Paul T. Idzik Chief Executive Officer and Director

Paul T. Idzik, 53, has been Chief Executive Officer since January 2013. He is also a member of the Board of Directors and is President of E*TRADE Bank, as well as a member of its Board of Directors.

Prior to joining E*TRADE, Mr. Idzik was Group Chief Executive of DTZ Holdings PLC in London. He also served 10 years at Barclays PLC, most recently as Group Chief Operating Officer and before that as Chief Operating Officer of Barclays Capital. Mr. Idzik began his career as a consultant, and spent more than a decade with Booz Allen Hamilton.

Mr. Idzik holds BAs in Economics and Computer Applications from the University of Notre Dame and an MBA in Finance from the University of Chicago.

Rodger Lawson Chairman and Director Rodger Lawson, 67, has been the director of the Company since February 2012 and Chairman of the Board since May 2013. He also served as Lead Independent Director from August 2012 to January 2013. He is a retired financial services executive who most recently served as President and Chief Executive Officer of Fidelity Investments – Financial Services from 2007 through 2010.

Prior to joining Fidelity, Mr. Lawson served in several senior executive roles with Prudential Financial including Vice Chairman of Prudential Financial. He has held numerous other executive positions in financial services, including President and Chief Executive Officer of Van Eck Global, and Chief Executive Officer and Partner of Global Private Banking at Bankers Trust Company. Previously, Mr. Lawson was President and Chief Executive Officer of Fidelity Investments Retail Group and Chief Executive Officer of the Dreyfus Service Corporation. He is currently on the board of directors of UnitedHealth Group, Inc. He is also a member of the E*TRADE Bank board and the Governance Committee.

Navtej S. Nandra President Navtej S. Nandra, 47, is the President of E*TRADE Financial Corporation who is responsible for overseeing management of E*TRADE Financial’s core businesses. He joined E*TRADE from Morgan Stanley where he was Head of International for Morgan Stanley Investment Management and Chief Strategy Officer for Real Estate Investing and Merchant Banking. In addition, he served on the Boards of Directors of Morgan Stanley Huaxin Fund Management Company, Morgan Stanley International Ltd., and Morgan Stanley & Co. International plc.

Prior to Morgan Stanley, Mr. Nandra served on the Boards of Directors of Edelweiss Financial Services Ltd., and Edelweiss Tokio Life Insurance Co. Ltd., and as Senior Advisor to DTZ Holdings plc. Before that, he was at Merrill Lynch, where he was Head of Diversified Financial Services, and was Chief Operating Officer of Global Wealth Management. Before joining Wealth Management, he was the Chief Operating Officer of Global Investment Banking at Merrill Lynch.

Mr. Nandra holds a PGDM (MBA) from the Indian Institute of Management, Ahmedabad, and a Bachelor’s degree in Commerce (honors) from the University of Delhi.

Matthew J. Audette Chief Financial Officer Matthew Audette, 39, is the Chief Financial Officer of E*TRADE Financial and is responsible for all finance and accounting functions for the company. He joined E*TRADE in 2000, when the company acquired Telebank, where he served as Controller in the Capital Markets department. In E*TRADE, he served from 2005 through 2010 as Senior Vice President, Corporate Controller. Prior to 2005, he served as Controller of E*TRADE Bank and Chief Financial Officer of E*TRADE Bank, a position he continues to hold. He also supported the company as interim Chief Financial Officer in 2008. He began his career in public accounting at KPMG.

Michael E. Foley Executive Vice President and Chief Administrative Officer

Michael E. Foley, age 62, is Executive Vice President and Chief Administrative Officer of the Company, since June 2013. He oversees the Company’s technology infrastructure, operations, human resources, facilities management and procurement functions. Prior to joining the Company, he worked as a consultant at Foley & Cunningham from April 2009 to February 2013. He also held several roles at Barclays Bank PLC from January 2005 to April 2009, including Interim Chief Information Officer and Chief Administrative Officer.

Mr. Foley studied at Hatfield Polytechnic, in Hertfordshire, England.



Exhibit 46: Management team (continued)

Name Title Background

Liza K. Landsman Chief Marketing Officer Liza K. Landsman is the Chief Marketing Officer of the Company who is responsible for E*TRADE Financial's marketing initiatives, including customer engagement, analytics and insights, advertising, direct online and offline marketing programs and branding campaigns.

Prior to joining E*TRADE, Ms. Landsman held the position of Global Head of Digital at BlackRock. Before that, she was an Operating Partner at Bravas Partners followed by 10 years in senior management positions at Citigroup. She serves on the Board of Directors of GO! Project, a New York City based foundation that provides education opportunities for children in need, as well as on the Board of Directors of Choice Hotels International.

Ms. Landsman graduated magna cum laude with a BA from Cornell University.

Michael A. Pizzi Chief Risk Officer Michael Pizzi is the Chief Risk Officer of the company and directs E*TRADE Financial’s enterprise risk management function. He has been with E*TRADE since 2003. Before joining E*TRADE, he worked in asset/liability management at both Lehman Brothers and First Maryland Bank, as well as in capital markets research for the Federal Reserve Board.

Mr. Pizzi earned a BA in Economics from Ursinus College, and holds Chartered Financial Analyst (CFA) and Financial Risk Manager (FRM) designations.

Karl A. Roessner General Counsel Karl A. Roessner, age 46, is the General Counsel of E*TRADE Financial Corporation, he manages the legal, compliance and regulatory functions for the company and its bank and brokerage subsidiaries. He also serves as Corporate Secretary to the Company's Board of Directors. Prior to joining E*TRADE in 2009, he was a partner in the Corporate Practice group of Clifford Chance US LLP.

Mr. Roessner earned his undergraduate degree in business administration cum laude from Siena College and his J.D. cum laude from St. Johns University School of Law where he was a member of the St. John’s University Law Review.




Scenario shown: Base caseSource: Company filings; RBC Capital Markets estimates($ in million) Fiscal Year

1QA 2QA 3QA 4QA 1QE 2QE 3QE 4QE 2013A 2014A 2015E 2016E 2017EIncome Statement Mar-14 Jun-14 Sep-14 Dec-14 Mar-15 Jun-15 Sep-15 Dec-15 Dec-13 Dec-14 Dec-15 Dec-16 Dec-17

Net operating interest incomeOperating interest income $322 $322 $319 $330 $315 $336 $358 $365 $1,220 $1,293 $1,375 $1,573 $1,765

Operating interest expense (56) (52) (50) (47) (46) (46) (46) (46) (238) (205) (186) (192) (196) Net operating interest income $266 $270 $269 $283 $268 $290 $312 $319 $982 $1,088 $1,189 $1,381 $1,569

Total non-interest incomeCommissions $128 $105 $108 $115 $121 $112 $114 $125 $420 $456 $472 $487 $511

Fees and service charges 47 46 45 48 48 48 49 49 155 186 195 201 207 Principal transactions 10 - - - - - - - 73 10 - - - Gains on loans and securities, net 15 7 8 6 6 6 6 6 61 36 24 24 24

Net Impairment - - - - - - - - (2) - - - - Other revenues 9 10 10 9 9 9 9 9 36 38 36 36 36

Total non-interest income $209 $168 $171 $178 $184 $176 $178 $189 $742 $726 $726 $748 $778

Total net revenue $475 $438 $440 $461 $452 $466 $489 $507 $1,724 $1,814 $1,915 $2,129 $2,348

Provision for loan losses 4 12 10 10 15 15 15 15 144 36 60 100 20

Operating expense:Compensation and benefits 98 99 108 $107 $100 $101 $110 $109 $363 $412 $420 $429 $437

Advertising and market development 34 33 21 32 35 34 22 33 109 120 125 130 135 Clearing and servicing 28 23 21 22 24 22 23 25 124 94 94 97 102

FDIC insurance premiums 24 19 18 18 20 21 22 23 103 79 87 100 113

Professional services 24 28 27 33 26 29 28 34 85 112 116 125 135

Occupancy and amortization 18 19 22 20 19 21 24 22 73 79 85 92 100

Communications 18 18 17 18 19 19 18 19 69 71 77 83 89 Depreciation and amortization 21 20 19 18 20 20 20 20 89 78 80 84 88

Amortization of other intangibles 5 6 5 6 6 6 6 6 23 22 24 24 24

Impairment of goodwill - - - - - - - - 142 - - - -

Facility restructuring and other exit activities 3 1 2 2 2 2 2 2 28 8 8 8 8

Other operating expenses 17 18 17 18 18 19 20 20 66 70 77 85 94 Total operating expense $290 $284 $277 $294 $290 $294 $294 $314 $1,275 $1,145 $1,193 $1,257 $1,325

Income before other inc. (exp.) and inc. tax exp. $181 $142 $153 $157 $147 $156 $180 $179 $305 $633 $662 $772 $1,003

Other income (expense)

Total other income (expense) ($37) ($30) ($28) ($86) ($15) ($13) ($13) ($13) ($111) ($181) ($53) ($50) ($50)

Income before income tax expense $144 $112 $125 $71 $132 $144 $167 $166 $195 $452 $610 $722 $952

Income tax expense 47 43 39 30 50 55 64 63 109 159 232 274 362

Net income $97 $69 $86 $41 $82 $89 $104 $103 $86 $293 $378 $447 $591

EBITDA $198 $167 $178 $122 $173 $182 $206 $205 $423 $665 $766 $880 $1,115

Earnings per share - basic $0.34 $0.24 $0.30 $0.14 $0.28 $0.31 $0.36 $0.36 $0.30 $1.02 $1.31 $1.58 $2.130 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00Earnings per share - diluted $0.33 $0.24 $0.29 $0.14 $0.28 $0.30 $0.35 $0.35 $0.29 $1.00 $1.29 $1.55 $2.09

Dividends declared per share - diluted $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.28 $0.48

Weighted average share count - basic ('000) $288,051 $288,705 $288,843 289,209 288,824 288,447 288,078 287,715 286,991 288,705 288,266 283,360 276,791

Dilution ('000) 5,768 5,121 5,276 5,155 5,155 5,155 5,155 5,155 5,598 5,398 5,155 5,155 5,155

Weighted average share count - diluted ('000) $293,819 $293,826 $294,119 294,364 293,979 293,602 293,233 292,870 292,589 294,103 293,421 288,515 281,946

Profitability metrics

Operating margin 38.1% 32.4% 34.8% 34.1% 32.5% 33.6% 36.8% 35.2% 17.7% 34.9% 34.6% 36.3% 42.7%Enterprise net interest spread (basis points) 247bps 255bps 254bps 269bps 257bps 256bps 269bps 270bps 233bps 255bps 263bps 283bps 299bps

Pre-tax margin 30.3% 25.6% 28.4% 15.4% 29.2% 30.9% 34.2% 32.8% 11.3% 24.9% 31.8% 33.9% 40.6%

Return on average stockholders' equity 7.8% 5.4% 6.5% 3.1% 6.1% 6.5% 7.4% 7.2% 1.8% 5.7% 6.8% 7.5% 9.3%

ROTE 5.9% 4.1% 5.0% 2.4% 4.7% 5.0% 5.7% 5.6% 1.3% 4.4% 5.3% 5.9% 7.4%

EBITDA as a percentage of revenues 41.7% 38.1% 40.5% 26.5% 38.3% 39.2% 42.1% 40.4% 24.5% 36.7% 40.0% 41.3% 47.5%

Fiscal Year

Balance Sheet 1QA 2QA 3QA 4QA 1QE 2QE 3QE 4QE 2013A 2014A 2015E 2016E 2017E

Cash and cash equivalents $1,585 $1,807 $1,809 $1,783 $1,540 $809 $1,427 $2,132 $1,838 $1,783 $2,132 $3,769 $5,396Cash required to be segregated 981 1,215 608 555 555 555 555 555 1,066 555 555 555 555 Trading securities - - - - - - - - - - - - - Available for sale securities 12,766 12,837 12,516 12,388 12,266 14,687 14,833 14,979 13,592 12,388 14,979 15,581 16,208

Held-to-maturity securities 11,248 11,356 11,847 12,248 12,486 12,730 12,978 13,231 10,181 12,248 13,231 14,294 15,446 Margin receivables 7,346 7,340 8,117 7,675 8,068 8,481 8,914 9,369 6,353 7,675 9,369 11,427 13,930

Loans held for sale 795 - - - - - - - - - - - - Loans receivables, net 6,982 6,656 6,302 5,979 5,652 5,466 5,286 5,111 8,123 5,979 5,111 4,461 3,886 Investment in FHLB stock 56 56 77 88 88 88 88 88 61 88 88 88 88

Property and equipment, net 224 227 240 245 245 245 245 245 237 245 245 245 245 Goodwill 1,792 1,792 1,792 1,792 1,792 1,792 1,792 1,792 1,792 1,792 1,792 1,792 1,792

Other intangibles, net 210 205 199 194 194 194 194 194 216 194 194 194 194

Other assets 2,453 2,257 2,312 2,583 2,583 2,583 2,583 2,583 2,821 2,583 2,583 2,583 2,583 Total Assets $46,438 $45,748 $45,819 $45,530 $45,470 $47,630 $48,894 $50,278 $46,280 $45,530 $50,278 $54,990 $60,322

Deposits $25,749 $25,084 $24,927 $24,890 $25,063 $27,052 $28,126 $29,244 $25,971 $24,890 $29,244 $32,889 $36,993Securities sold under agreements to repurchase 4,345 3,742 3,917 3,672 3,634 3,597 3,560 3,597 4,543 3,672 3,597 3,746 3,902

Customer payables 6,260 6,626 6,526 6,455 6,583 6,714 6,848 6,984 6,310 6,455 6,984 7,557 8,177 FHLB advances and other borrowings 1,287 1,291 1,294 1,299 1,234 1,197 1,162 1,127 1,279 1,299 1,127 998 884

Corporate debt 1,769 1,770 1,771 1,366 1,000 1,000 1,000 1,000 1,769 1,366 1,000 1,000 1,000 Other liabilities 1,996 2,047 2,110 2,473 2,498 2,523 2,548 2,573 1,553 2,473 2,573 2,678 2,787 Total Liabilities $41,406 $40,560 $40,545 $40,155 $40,013 $42,084 $43,244 $44,525 $41,424 $40,155 $44,525 $48,869 $53,743

Common stock 3 3 3 3 3 3 3 3 3 3 3 3 3

Additional paid-in-capital 7,333 7,336 7,340 7,350 7,350 7,350 7,350 7,350 7,328 7,350 7,350 7,350 7,350 Accumulated deficit (1,925) (1,856) (1,770) (1,729) (1,647) (1,558) (1,454) (1,351) (2,022) (1,729) (1,351) (983) (525)

Accumulated other comprehensive loss (379) (295) (299) (249) (249) (249) (249) (249) (453) (249) (249) (249) (249) Total Shareholders' Equity $5,032 $5,188 $5,274 $5,375 $5,457 $5,546 $5,650 $5,753 $4,856 $5,375 $5,753 $6,121 $6,579

Total Liabilities & Shareholders' Equity $46,438 $45,748 $45,819 $45,530 $45,470 $47,630 $48,894 $50,278 $46,280 $45,530 $50,278 $54,990 $60,322

Balance sheet and debt ratiosInterest coverage ratio 7.1x 5.8x 6.1x 4.5x 11.7x 14.5x 16.4x 16.3x 3.7x 5.9x 14.6x 17.5x 22.2x

Debt to EBITDA 4.7x 5.7x 5.5x 7.9x 5.0x 4.8x 4.3x 4.4x 7.9x 5.8x 4.7x 4.2x 3.4xLong-term debt to capitalization ratio 26.0% 25.4% 25.1% 20.3% 15.5% 15.3% 15.0% 14.8% 26.7% 20.3% 14.8% 14.0% 13.2%

Book value per share - basic weighted average $17.44 $17.97 $18.26 $18.59 $18.89 $19.23 $19.61 $20.00 $16.90 $18.59 $20.00 $21.80 $23.97Tangible equity per share $11.76 $12.34 $12.69 $13.08 $13.38 $13.71 $14.09 $14.46 $11.14 $13.08 $14.46 $16.13 $18.17

FY 2015FY 2014

FY 2014 FY 2015



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Please note that current conflicts disclosures may differ from those as of the publication date on, and as set forth in,this report. To access current conflicts disclosures, clients should refer to https://www.rbccm.com/GLDisclosure/PublicWeb/DisclosureLookup.aspx?entityId=1 or send a request to RBC CM Research Publishing, P.O. Box 50, 200 Bay Street, Royal Bank Plaza,29th Floor, South Tower, Toronto, Ontario M5J 2W7.

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Distribution of ratingsFor the purpose of ratings distributions, regulatory rules require member firms to assign ratings to one of three rating categories- Buy, Hold/Neutral, or Sell - regardless of a firm's own rating categories. Although RBC Capital Markets' ratings of Top Pick(TP)/Outperform (O), Sector Perform (SP), and Underperform (U) most closely correspond to Buy, Hold/Neutral and Sell, respectively,the meanings are not the same because our ratings are determined on a relative basis (as described below).

Distribution of ratings

RBC Capital Markets, Equity Research

As of 31-Dec-2014

Investment Banking

Serv./Past 12 Mos.

Rating Count Percent Count Percent

BUY [Top Pick & Outperform] 897 52.92 290 32.33

HOLD [Sector Perform] 686 40.47 137 19.97

SELL [Underperform] 112 6.61 6 5.36



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The Global Industry Classification Standard (“GICS”) was developed by and is the exclusive property and a service mark of MSCI Inc. (“MSCI”) and Standard & Poor’s Financial ServicesLLC (“S&P”) and is licensed for use by RBC. Neither MSCI, S&P, nor any other party involved in making or compiling the GICS or any GICS classifications makes any express or impliedwarranties or representations with respect to such standard or classification (or the results to be obtained by the use thereof), and all such parties hereby expressly disclaim all warrantiesof originality, accuracy, completeness, merchantability and fitness for a particular purpose with respect to any of such standard or classification. Without limiting any of the foregoing,in no event shall MSCI, S&P, any of their affiliates or any third party involved in making or compiling the GICS or any GICS classifications have any liability for any direct, indirect, special,punitive, consequential or any other damages (including lost profits) even if notified of the possibility of such damages.

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RBC Capital Markets is the business name used by certain branches and subsidiaries of the Royal Bank of Canada, including RBC Dominion Securities Inc., RBCCapital Markets, LLC, RBC Europe Limited, RBC Capital Markets (Hong Kong) Limited, Royal Bank of Canada, Hong Kong Branch and Royal Bank of Canada, SydneyBranch. The information contained in this report has been compiled by RBC Capital Markets from sources believed to be reliable, but no representation or warranty,express or implied, is made by Royal Bank of Canada, RBC Capital Markets, its affiliates or any other person as to its accuracy, completeness or correctness. Allopinions and estimates contained in this report constitute RBC Capital Markets' judgement as of the date of this report, are subject to change without notice andare provided in good faith but without legal responsibility. Nothing in this report constitutes legal, accounting or tax advice or individually tailored investmentadvice. This material is prepared for general circulation to clients and has been prepared without regard to the individual financial circumstances and objectives ofpersons who receive it. The investments or services contained in this report may not be suitable for you and it is recommended that you consult an independentinvestment advisor if you are in doubt about the suitability of such investments or services. This report is not an offer to sell or a solicitation of an offer to buyany securities. Past performance is not a guide to future performance, future returns are not guaranteed, and a loss of original capital may occur. RBC CapitalMarkets research analyst compensation is based in part on the overall profitability of RBC Capital Markets, which includes profits attributable to investment bankingrevenues. Every province in Canada, state in the U.S., and most countries throughout the world have their own laws regulating the types of securities and otherinvestment products which may be offered to their residents, as well as the process for doing so. As a result, the securities discussed in this report may not beeligible for sale in some jurisdictions. RBC Capital Markets may be restricted from publishing research reports, from time to time, due to regulatory restrictions and/or internal compliance policies. If this is the case, the latest published research reports available to clients may not reflect recent material changes in the applicableindustry and/or applicable subject companies. RBC Capital Markets research reports are current only as of the date set forth on the research reports. This report isnot, and under no circumstances should be construed as, a solicitation to act as securities broker or dealer in any jurisdiction by any person or company that is notlegally permitted to carry on the business of a securities broker or dealer in that jurisdiction. To the full extent permitted by law neither RBC Capital Markets norany of its affiliates, nor any other person, accepts any liability whatsoever for any direct or consequential loss arising from any use of this report or the informationcontained herein. No matter contained in this document may be reproduced or copied by any means without the prior consent of RBC Capital Markets.

Additional information is available on request.

To U.S. Residents:This publication has been approved by RBC Capital Markets, LLC (member FINRA, NYSE, SIPC), which is a U.S. registered broker-dealer and which acceptsresponsibility for this report and its dissemination in the United States. Any U.S. recipient of this report that is not a registered broker-dealer or a bank acting ina broker or dealer capacity and that wishes further information regarding, or to effect any transaction in, any of the securities discussed in this report, shouldcontact and place orders with RBC Capital Markets, LLC.To Canadian Residents:This publication has been approved by RBC Dominion Securities Inc.(member IIROC). Any Canadian recipient of this report that is not a Designated Institution inOntario, an Accredited Investor in British Columbia or Alberta or a Sophisticated Purchaser in Quebec (or similar permitted purchaser in any other province) andthat wishes further information regarding, or to effect any transaction in, any of the securities discussed in this report should contact and place orders with RBCDominion Securities Inc., which, without in any way limiting the foregoing, accepts responsibility for this report and its dissemination in Canada.To U.K. Residents:This publication has been approved by RBC Europe Limited ('RBCEL') which is authorized by the Prudential Regulation Authority and regulated by the FinancialConduct Authority ('FCA') and the Prudential Regulation Authority, in connection with its distribution in the United Kingdom. This material is not for generaldistribution in the United Kingdom to retail clients, as defined under the rules of the FCA. However, targeted distribution may be made to selected retail clients ofRBC and its affiliates. RBCEL accepts responsibility for this report and its dissemination in the United Kingdom.To Persons Receiving This Advice in Australia:This material has been distributed in Australia by Royal Bank of Canada - Sydney Branch (ABN 86 076 940 880, AFSL No. 246521). This material has been preparedfor general circulation and does not take into account the objectives, financial situation or needs of any recipient. Accordingly, any recipient should, before acting onthis material, consider the appropriateness of this material having regard to their objectives, financial situation and needs. If this material relates to the acquisition



or possible acquisition of a particular financial product, a recipient in Australia should obtain any relevant disclosure document prepared in respect of that productand consider that document before making any decision about whether to acquire the product. This research report is not for retail investors as defined in section761G of the Corporations Act.To Hong Kong Residents:This publication is distributed in Hong Kong by RBC Capital Markets (Hong Kong) Limited and Royal Bank of Canada, Hong Kong Branch (both entities which areregulated by the Hong Kong Monetary Authority ('HKMA') and the Securities and Futures Commission ('SFC')). Financial Services provided to Australia: Financialservices may be provided in Australia in accordance with applicable law. Financial services provided by the Royal Bank of Canada, Hong Kong Branch are providedpursuant to the Royal Bank of Canada's Australian Financial Services Licence ('AFSL') (No. 246521). RBC Capital Markets (Hong Kong) Limited is exempt from therequirement to hold an AFSL under the Corporations Act 2001 in respect of the provision of such financial services. RBC Capital Markets (Hong Kong) Limited isregulated by the HKMA and the SFC under the laws of Hong Kong, which differ from Australian laws.To Singapore Residents:This publication is distributed in Singapore by the Royal Bank of Canada, Singapore Branch, a registered entity granted offshore bank licence by the MonetaryAuthority of Singapore. This material has been prepared for general circulation and does not take into account the objectives, financial situation, or needs of anyrecipient. You are advised to seek independent advice from a financial adviser before purchasing any product. If you do not obtain independent advice, you shouldconsider whether the product is suitable for you. Past performance is not indicative of future performance. If you have any questions related to this publication,please contact the Royal Bank of Canada, Singapore Branch. Royal Bank of Canada, Singapore Branch accepts responsibility for this report and its disseminationin Singapore.To Japanese Residents:Unless otherwise exempted by Japanese law, this publication is distributed in Japan by or through RBC Capital Markets (Japan) Ltd., a registered type one financialinstruments firm and/or Royal Bank of Canada, Tokyo Branch, a licensed foreign bank.

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