Axos Financial, Inc.
Q2 2021 Earnings Call Transcript

Published: 28 Jan 2021

[Operator:]

Greetings, and welcome to Axos Financial's Second Quarter 2021 Earnings Results Conference Call. At this time, all participants are in listen-only mode. A question-and-answer session will follow the formal presentation. Please note, this conference is being recorded. I would now like to turn the conference over to your host, Johnny Lai, Vice President of Corporate Development and Investor Relations. Thank you. You may begin.

[Johnny Lai:]

Thank you, Devin. Good afternoon, everyone. Thanks for your interest in Axos. Joining us today for Axos Financial, Inc.'s second quarter 2020 financial results conference call, are the company's President and Chief Executive Officer, Greg Garrabrants; and Executive Vice President and Chief Financial Officer, Andy Micheletti. Greg and Andy will review and comment on the financial and operational results for the three and six months ended December 31, 2020, and they will be available to answer questions after prepared remarks.

[Greg Garrabrants:]

Thank you, Johnny. Good afternoon, everyone, and thank you for joining us. I'd like to welcome everyone to Axos Financial's conference call for the second quarter of fiscal year 2021 ended December 31, 2020. I thank you for your interest in Axos Financial and Axos Bank. We had an outstanding quarter with higher net interest margins, double-digit growth in net interest income and non-interest income and positive operating leverage year-over-year; we combine that with solid credit performance. Axos announced record second fiscal quarter net income of $54.8 million for the three months ended December 31, 2020, up 32.7% compared to the $41.3 million earned for the quarter ended December 31, 2019, despite a $3.5 million increase in our provision for loan losses, increasing to $8 million from $4.5 million in the comparable period. Our pre-tax pre-provision income was $86.5 million, an increase of 38.1% compared to the $62.7 million in the quarter ended December 31, 2019. Axos' return on average equity for Q2, 2021, was 17.3%, and the bank's efficiency ratio was 40.45%. Q2, 2021, diluted earnings per share increased 35.8% to $0.91 per diluted share compared to $0.67 per diluted share in Q2, 2020. Our tangible book value per share was $19.51 at December 31, 2021, up 18% from December 30, 2019.

[Andy Micheletti:]

Thanks Greg. First, I wanted to note that in addition to our press release, an 8-K with supplemental schedules and our 10-Q were filed with the SEC today and are available online through EDGAR or through our website at axosfinancial.com. I will provide some very brief comments. Please refer to our press release or the SEC filings for additional details. As Greg mentioned, our provision for credit losses was $8 million for this quarter ended December 31, 2020, down from $11 million for the last quarter ended September 30, 2020, and up from $4.5 million for the second quarter last year, ending December 31, 2019. Also this quarter, we decreased our unfunded loan commitment liability by $1 million due to an overall decrease in the amount of unfunded loan commitments. This $1 million pre-tax benefit was included as a reduction to our other G&A in our non-interest expense for this quarter ended December 31, 2020. The $8 million provision for credit losses this quarter can be summarized as a net $4.1 million related to loan growth and loan mix and $3.9 million related to specific allowances. Of that $3.9 million specific allowance, $3.5 million relates to the condo rehab loan project Greg discussed earlier. Last quarter, we provided $6.5 million specific allowance related to the H&R Block refund advance loans, RAs that were made in 2020. Although, we have exited the H&R Block relationship, they agreed to continue to pass-through RA payments through April 30th, 2021 due to IRS return processing delays. This quarter, we continue to collect RIA payments such that we were able to reallocate $3.5 million of our RA allowance to cover loan growth this quarter. As of December 31, 2020, there was $7.2 million of RA loans left, a 100% of which are covered by our allowance for credit losses. With that, I will turn the call back over to Johnny Lai.

[Johnny Lai:]

Thanks, Andy. Devin, we're ready to take questions.

[Operator:]

Our first question comes from the line of Andrew Liesch with Piper Sandler. Proceed with your question.

[Andrew Liesch:]

Hi, guys. Thanks for the color early in the call. I just wanted to cover your loan growth outlook, similar comment before is like high single digit, low double digits, but you're kind of already there in this fiscal year. I think I heard you say calendar year. So, I mean, is there any -- are there any headwinds ahead that could maybe slow this pace of growth, because the pipeline looks great. You've had great growth this quarter. What's giving you some pause right now?

[Greg Garrabrants:]

Well, we don't know how quickly warehouse lending has been a strong contributor the last couple of quarters. It's uncertain how that will continue. It looks pretty good right now. We actually have a good pipeline of new lines. But, obviously, that's dependent on overall mortgage banking volume. And then single-family declined this quarter. The pipeline is okay. It usually comes through the holiday season, and we always have -- if you look back over time, we do have these seasonal lows. But it's just uncertain how that will pick up. Frankly, we're being very conservative in New York. That was a market for us that we had previously done more business in on the single-family side, and we're doing a lot less now. So those would be the caveats with respect to that. But as you said, I'm looking forward in the calendar year. And I'm also, frankly, trying to moderate growth expectations that they're not going to be what this quarter's loan growth was in subsequent quarters. So that's more of a way to think about it. So that's -- Andy, do you have anything to add there?

[Andy Micheletti:]

No. No, it's a great summary. Again, Andrew, it partially depends on where warehouse ends up. It's entirely possible that it will pull back, but it could be dramatically by the time we get to June 30, 2021.

[Andrew Liesch:]

Got it. Okay. That's helpful. And then, just if you look at the entire credit quality bucket, it seems like a lot of the issues that you've mentioned, they are more unique situations to some of these borrowers. It seems like your strategy of forcing people to pay you rather than grant them deferral is working out really well. Are there any areas that you have concern on credit beyond what you may have mentioned? Are you seeing any weakness in the economy beyond what we would have expected as a result of the pandemic?

[Greg Garrabrants:]

Well, not in the asset classes that we generally work with. Obviously, the two hotels that were there. Frankly, the only reason they weren't solved or were gone was simply because of this Oregon foreclosure moratorium. And we had an agreement to sell those loans at par plus a crude and when the moratorium came in place, the fund that was going to buy those loans backed out. So I think, obviously, to the extent there are hotels there, on the multifamily side mostly we had taken some of the multi-family loans we have. We have ready buyers for all these multifamily loans at par plus accrued. And the thing of it is we've been selling them and then they've been curing in 15 or 30 days. So sometimes somebody is a little late with the payment and they're 35 days late and they cure. So not really. I don't see anything particular there. This New York project is actually a nice building in a great area, but some interesting sort of legislative things came up. The retail tenant was supposed to be moved out. There was a moratorium on moving that tenant out, that tenant stopped paying. So some of the governmental interference in the private markets is clearly, I'd say, thematically something that could happen. But we don't see it really impacting our book, given that we're so focused on asset classes that are really doing pretty well overall.

[Andrew Liesch:]

Got it. And it sounds like, I mean, with these LTVs, if there was one, it sounds like you -- for any ones that may have given you some trouble or consternation, you at least have willing buyers at low LTVs. So it doesn't really seem like lost content is going to be all that meaningful?

[Greg Garrabrants:]

Yes. I think that's right. I certainly don't think lost content. I mean, the type of assets that we generally have there. You're talking about a little clips at the top end of the range, not some kind of total loss on a company that just is no longer viable or something. So I think that's right. So we're in -- we feel quite good about credit and feel very well reserved.

[Andrew Liesch:]

So I will step back. Thanks for taking the question.

[Greg Garrabrants:]

Thank you.

[Operator:]

Our next question comes from the line of Gary Tenner with D.A. Davidson. Proceed with your question.

[Gary Tenner:]

Thanks. I just wanted to ask about mortgage, you actually partially addressed this. But I'm just wondering, given the pace of growth that you've seen, and obviously, you're looking to continue to expand those relationships. It looks like its right at about 10% of loans today, and that may cure itself, as you pointed out over the next 6 months or 12 months. But do you have an internal limit generally for that segment?

[Greg Garrabrants:]

With respect to an overall limit, we do have one, but it certainly allows us to exceed where we are. From a risk perspective, I think the right way to think about the risk associated with those loans is absent loans that we're purchasing ourselves or loans to very secured conduit relationships. They're all government mortgages. We're doing the work to make sure that those loans qualify for sale. We're a Fannie Mae direct seller. So to the extent there was ever any underlying issue with any of those mortgage companies, we would simply be able to take that collateral and sell it. The issue in mortgage warehouse is generally fraud, and there's a variety of mechanisms, including the systems that we have that are widely shared with other mortgage lenders to make sure that, that dual pledging issue doesn't occur. So frankly, it's one of the asset classes that from a safety perspective, is a very good asset class to grow in. It exhibits, obviously very high levels of liquidity. It -- essentially, the mortgages are almost entirely guaranteed by the government. The weakness in the product, as I'm sure you know, is that the rate is lower than the average rate in our loans and there's higher levels of volatility associated with those loans. And so in the event that mortgage lending pulls back, the calls you get are, well, would you like to be -- I have four lines, and would you like to be used or not. And if you would like to be used, then you need to be in this range. So you can have interest rate compression on those lines if there's a pullback in mortgage lending.

[Gary Tenner:]

Great. I appreciate the detail there. And then just as a follow-up. You've mentioned the 0 commission product, self-directed training getting ready to be launched pretty soon. Just wondering what all the noise going on with Robinhood the last couple of days. Any thoughts or ramifications positively or negatively from kind of what's going on?

[Greg Garrabrants:]

Well, so it's interesting because Axos Clearing has always had retail brokerage accounts. And those retail brokerage accounts arose and then that they trade directly with clients on. But this is -- so this is really taking this Axos Clearing product and bringing it through the platform in a way that would expand the service. So it's -- I think with respect to the question of the nature of what's going on with Robinhood, I would say -- I'll address this at 2 levels. One level is more broadly. Individuals are looking for a consolidated relationship between a trading and investing account and a banking account. And we see the massive growth of the Robinhoods and their attempts to add checking accounts even if it didn't exactly work out right away, right? And the they'll be back at it. So the strategic moves we've been taking, in my opinion, are absolutely validated by what's happening in the market with respect to the growth in online trading. Now -- and then that required also the clearing company, given the margins in that business to make sure that you own all the value stream from a revenue perspective. Now the question with respect to these, the utilization of social media to drive trading is something that because we own our own platform, we're going to be looking at and considering in the event that some of these types of activities occur -- that have occurred over the last several days and thinking about how to deal with those, whether it's a speed bump that requires somebody to go through a warning and a review of whether they're interested in trading on a regulative basis, or are there other remedies associated with that are things that a compliance group would consistently review and make determinations on. So I think -- is -- I don't want to comment on whether any of the events would somehow hurt a reputation of one firm, and therefore, make us more likely to get clients or something. And given that this product is six months away, I think those things are just too speculative. But I do think, overall, it's demonstrative of the fact that digital financial services and the bundling of them is a strategy that's really important.

[Gary Tenner:]

Great. Appreciate it guys.

[Greg Garrabrants:]

Thank you.

[Operator:]

Our next question comes from the line of Michael Perito with KBW. Please proceed with your question.

[Michael Perito:]

Hey, good afternoon guys. Thanks for taking the question. Greg, I was wondering on the lender finance portfolio. I think if we look back, it was over a couple of billion, nine plus months ago, obviously, came down another $34 million quarter-over-quarter here. Just -- is that -- do you expect that trend? Will that continue to work against your growth for your near-term? Do you think that's close to bottoming out? And can you maybe just give us a quick update of your view on that portfolio as you guys clearly have made an effort to run it down here over the last year or so?

[Greg Garrabrants:]

I think that the asset class will probably shift and it will become more real estate, hard asset focused. I think the -- really, the reduction, I think where we attached ourselves and the structure that we had even given a very severe recession, much more severe than it appears, the consumer recession is going to be in the U.S., I think we were safe. I think the reality is that the market demand and our underlying customers have simply reduced originations or the demand for those originations are such that the market really isn't there right now. However, there are other lender finance areas that are the result of different -- the more real estate oriented lender finance opportunities that are there. So I think that that portfolio will stabilize just overall, and probably grow a bit as well. So I think we're probably done with it being a drag on loan growth.

[Michael Perito:]

Helpful. And then in your prepared remarks, I think you mentioned there was three pretty sizable clients on the clearing side that you guys are either brought on board or bringing on board. I was curious if you could maybe give us an update on where, kind of, the efficiency and the margin of that business is today? I mean, are these clients and growth from the prior couple of quarters, I mean, are you starting to really see it go through to the scalability of the platform you've built? Or are we still maybe six months away from that? Any updated thoughts there.

[Greg Garrabrants:]

Yes. I think we're away from that, whether it's only six months or not, I think our goal with respect to what we're doing in clearing is the creation of a platform, both on the custody side for RIAs and on the clearing side for IBDs. The goal then is to take the software that we've developed and utilize that software for the end clients from an acquisition perspective, as well as to build on the existing trading platforms for retail that the firm has and bring those through in a very cohesive and user experience friendly way. And so that's just a lot of stuff to do. That's new businesses to build where the competitors are large and have big head-starts. So Axos clearing is about a month away from launching a really very nice RIA custody platform. It's quite comprehensive. And so those are the type of things that are going on. And so -- I am just not particularly focused on -- and whether they make $1 million on the segment or make -- lose $1 million or make $2 million right now. What I'm focused on is the long-term benefits that, that will generate. And what I hope to do is in a couple of years instead of being sitting on 750 or 770 of zero cost deposits, so I want to be sitting on $3 billion and $4 billion of zero cost deposits. And that's really the overall goal. And even if right now, the deposit rate that clearing gets in those deposits is very low and clearing would be very profitable right now at a 2.5% rate. If Fed funds were 2.5%, Clearing would be super profitable. So you say, well, it's not right now, but the reality of this is that the deposit businesses have to be built over half decades and decades. And so the investment is really about that. And we're going to continue to invest in it and not be bothered by little drips and drabs there. Now look, I'm not saying that I wanted to increase, and I think they are doing a really good job of driving the profitability. It's just not -- that's not the immediate goal.

[Michael Perito:]

No. That's absolutely helpful. It makes a lot of sense. And I guess on that point, as we think about kind of deposit platform that you guys are building, I'm just curious, obviously, calendar 2020 thematically seem to be a big proof-of-concept for a lot of kind of digital consumer banks. And just curious if maybe you can give us a quick recap of how the digital consumer bank kind of grew over the past 12 months? And do you -- I imagine it was fairly robust. Do you think that can continue into this year? Is there some momentum in the market on that side, just to kind of continue to grow the consumer digital bank at a meaningful --

[Greg Garrabrants:]

Yes. We're seeing tremendous growth in accounts. And pretty much every month is a record account opening quarter for consumer checking accounts for the utilization of the direct deposit switch kits. We're also obviously shifting -- I think we're improving the max of that business a lot because we have the UFB brand, which is more focused on savings accounts and kind of attracts yield focused folks, and that's sitting at about 20 basis points now. And so we really are, I think, we're in the range of the next couple of years getting to the point where we have the checking accounts we're bringing on, the average cost is in the 20, 25 basis, 28 basis point range, something like that. So all in. So I think it's really working. The small business side is really working. The platform is getting a lot of complements the -- all the work that's being done internally on the risk engines to make the transactions more seamless. The work that is being done to add product is really paying off. And so -- yes. We have a -- all that work that was done on the UDB side is really paying off, and it's paying off in the efficiency ratio because we can take activities that are coming through call centers, analyze them and then push them through automated fulfillment. And so efficiency ratio work is never glamorous, it's always a grinded out sort of deal. But with this platform, we're able to just digitize so much, and it helps with everything. It else with compliance, it helps with cost and it helps with customer experience. So yes, we're really excited about where we are, and we're really pleased we made the investments we did, even though they were kind of painful in the efficiency ratio as it look, over the long term, it kind of ran up and now it's starting to come back down.

[Michael Perito:]

And just -- sorry, if I can just sneak one last one in on that point, and that was a great rundown. Just the -- when you think about your kind of target consumer for that platform. I mean, I think a lot of the names generating the headlines clearly have an under bank and unbanked kind of focus. But I'm just curious how you kind of view the target consumer? Or is it -- are you really seeing kind of a broad range of people adopt the platform at this point? Any other additional color there would be helpful.

[Greg Garrabrants:]

Yes. Our consumers do tend to be higher end than those other platforms. They carry larger balances. And those platforms are largely trying to drive Durbin Exempt transaction revenue. And that's where they make a significant majority of their money, as you know. So, that's a little bit different for us and also, obviously, with what we're trying to do on the advisory side, with the RA platforms and then the customers of our introducing broker-dealers. Those are going to tend to be different customer segments. So, the platform is built to accommodate everyone and that's open to everyone, and we do get a mix of customers. I think that the trading side will actually shift some to the millennial groups. You have to be thoughtful about that. My 15-year-old wanted to know how to trade crypto-currencies the other day. So, -- but it's an interesting set of products that I think we'll end up with. And we do have a different demographic, though, than a chime or something.

[Michael Perito:]

Yes. No, that makes sense. And the direction everything is going, you're probably going to have to start offering cryptos on the UDB at some point in the near future.

[Greg Garrabrants:]

So, yes, it's interesting. There's a lot of work being done in that space, for sure.

[Michael Perito:]

Yes, great. Well, thank you guys. Appreciate it.

[Greg Garrabrants:]

Thank you.

[Andy Micheletti:]

Thanks Mike.

[Operator:]

Our next question comes from the line of David Chiaverini with Wedbush Securities. Please proceed with your question.

[Greg Garrabrants:]

Hi David.

[David Chiaverini:]

Hi, a couple of questions. And actually, I'll start with -- on that last point and discussion about your target market and I saw the press release today from N26 and the growth that they're generating in the U.S. And I was curious if you're able to disclose how big this relationship is? And what your expectations are going forward?

[Greg Garrabrants:]

We don't generally trying to talk about our partner relationships too much, except to say that it's public information that we're their issuer and they hold their deposits with us. And we like working with them. We think they're an innovative business. And they -- you can say that, well, we have a competitive platform, but the reality is that the market for consumer banking is dominated by large banks and whatever collaboration that we have, it certainly -- we don't feel like it runs into them. And they -- I think they feel the same way.

[David Chiaverini:]

Got it. Thanks for that. And then I had some questions on the outlook. In terms of net interest income and net interest margin and clearly, on the margin front, given the strong deposit growth we're kind of gravitating towards a discussion around net interest income. Are you able to provide any sort of outlook commentary on what you're expecting over the next a couple of quarters or for the full year in 2021?

[Greg Garrabrants:]

Well, an aggressive analyst might be inclined to revise their NIM targets very far up. And I would advise not to do that. And I think the reason why that would be the case is that, obviously, warehouse growth is lower. We are continually looking at loan rates. And as banks sort of adjust to this new environment, we can't tell whether we'll have loan rate compression. So, that's there. We talked about how we're not going to have a lot of compression on the existing book because we're all at floors. So, that's that issue. And then also, we're looking to continue to do things like draw customers in through getting them into the transaction platform on the checking side, things like that and what kind of incentives and what sort of things we're offering to them. So, I don't know, Andy, do you have other comments?

[Andy Micheletti:]

No, I think our guidance is kind of Greg stated it is still 3.8% to 4%. You could pick somewhere between 3.8% and 3.9% kind of where we would be in the long run. So -- and again, I think the only caution here is we're in an environment where rates are really low. Competitive rates are coming down. We've done a great job maintaining our margin, but we're also interested obviously in trying to keep loan volume. And so it's a blend between both. So, for that reason we're at between 3.8% and 4%.

[Greg Garrabrants:]

Yes. And also, some of that now that we have the securities subsidiary, getting this blended rate, and some margin and those type of loans and things like that, sometimes are not quite at the rates that others are. And so you end up with is that, they end up with a max question with respect to the overall.

[Andy Micheletti:]

Right. Probably, most importantly, I mean, we upped the bank NIM a little bit to compensate for our sub debt. So as you know, we added $175 million of sub debt, which was a big increase. But we still improved our NIM a little bit. So it's a balancing act, but we're still targeting between that range.

[David Chiaverini:]

Got it. Thanks for that. And I think I heard in your prepared comments about the loan loss provision being stable. And I wanted to clarify is -- and I may have just misheard all the detail around it. But was that kind of stable with the December quarter for the next couple of quarters? Or could you just kind of reiterate what you were saying in your prepared comments about the loan loss provision outlook?

[Andy Micheletti:]

Sure. I mean, I think basically, we're not seeing any kind of trend that's worrying us that we would expect any kind of prolonged increase in provisions for that piece.

[Greg Garrabrants:]

You've also seen, the comment that, frankly, my view of that, I think that's -- I agree with Andy. And then the other comment, I would make is, I saw there are a lot of banks that released reserves, with respect to this quarter. And I guess my comment, the way I meant it was directed and don't expect us to release reserves. So I don't -- that might mean that I'm not saying, we're going to have the same reserves for -- in these quarters, we'll see, obviously, how things turn out, look at loan volume, that's going to drive that, those sort of things. But I just wouldn't be expecting some reserve release. That's something you've seen some other banks do.

[David Chiaverini:]

Got it. Got it. That's helpful. And then your comment about self-clearing for Axos Invest perhaps a midyear, how much in savings could that generate for you guys?

[Greg Garrabrants:]

It was in -- is it around $600,000 or something like that?

[Andy Micheletti:]

It's modest, relative to the entire finance.

[Greg Garrabrants:]

Yes. I mean, the truth of the matter is that, it's interesting because what, of course, we're doing is we're turning right around, and we're adding products and services into the business, and adding people there to hit our growth objectives. So I think it isn't something that's so overwhelming. It is helpful from a cost perspective, and it also ensures that we have all those capabilities From an API perspective. So that, it also makes us a viable alternative for third-party investment platforms that would like to use us as a custodian to hold their securities and their deposits so.

[Andy Micheletti:]

I think what it really speaks to is the scalability, because now that we've got the pipes in place at a base level charge, now we can scale it at a minimal cost.

[Greg Garrabrants:]

Right. And then there's a lot of product advantages from that, too, because if we want to add something, we want to have the communication, it doesn't have to be a work order to a third-party firm. It's something we can work through.

[David Chiaverini:]

Great. That's really helpful. And then the last one, just PPP round two, do you have an expectation as to how much you plan to do there?

[Greg Garrabrants:]

As little as possible, we're not really going to do -- we're going to take care of selected clients and folks that have strong TM relationships with us. And it's just the nature of having a one -- a potential 1% loan on your balance sheet. They've extended this. It was fine. And we kind of did it, frankly, more for the purposes of trying to add capacity to a system that needed it and things like that. We never really -- it was useful for getting some deposit accounts for when the big banks were clogged up. But I feel like the systems have kind of worked through. So, we're taking care of our clients. I wouldn't expect it to be something significant for us.

[David Chiaverini:]

Got it. Thanks very much.

[Greg Garrabrants:]

Thank you.

[Operator:]

And with that, this concludes our question-and-answer session. And I would like to turn the call back over to our management team for any closing remarks.

[Greg Garrabrants:]

Thank you, everyone. I appreciate your interest, and we'll talk to you next quarter.

[Andy Micheletti:]

Thank you.

[Operator:]

This concludes today's teleconference. You may now disconnect your lines at this time. Thank you for your participation, and have a wonderful day.