Axos Financial, Inc.

Ladies and gentlemen, greetings and welcome to the Axos Financial second quarter 2019 earnings call. At this time, all participants are in a listen-only mode. A brief question and answer session will follow the formal presentation. If anyone should require operator assistance during the program, please push star zero on your telephone keypad. As a reminder, this program is being recorded. It is now my pleasure to introduce your host, Johnny Lai, VP Corporate Development and IR. Thank you. You may begin.

Thanks, Adam. Good afternoon, everyone. Thanks for your interest in Axos Financial and Axos Bank. Joining us today for Axos Financial Inc.' 's second quarter 2019 financial results conference call are the company's president and chief executive officer, Greg Gerbrandt, 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 31st 2018, and they will be available to answer questions after the prepared remarks. Before I begin, I would like to remind listeners that prepared remarks made on this call may contain forward-looking statements that are subject to risks and uncertainties, and that management may make additional forward-looking statements in response to your questions. These forward-looking statements are made on the basis of current views and assumptions of management regarding future events and performance. Actual results could differ materially from those expressed or implied in such forward-looking statements as a result of risks and uncertainties. Therefore, the company claims to save harbor protection pertaining to forward-looking statements contained in the Private Security Litigation Reform Act of 1995. This call is being webcast, and there will be an audio replay available in the Investor Relations section of the company's website located at Axos Financial for 30 days. Details for this call were provided on the conference call announcement and in today's earnings press release. At this time, I would like to turn the call over to Greg for his opening remarks.

Thank you, Johnny. Good afternoon, everyone, and thank you for joining us. I'd like to welcome everyone to Axios Financial's conference call for the second quarter of fiscal 2019, ended December 31, 2018. I thank you for your interest in Axios Financial and Axios Bank. Axos announced record net income of $38.8 million for the fiscal second quarter ended December 31, 2018, up 22.7% from the $31.7 million earned in the fiscal second quarter ended December 31, 2017, and up 5.4% when compared to the $36.8 million earned in the prior quarter. Earnings attributable to Axos' common stockholders were $38.8 million, or $0.62 per diluted share, for the quarter ended December 31, 2018, a 26.5% increase from the $0.49 for diluted share for the quarter ended December 31, 2017, and $0.58 per diluted share for the quarter ended September 30, 2018. Excluding non-recurring expenses, non-GAAP adjusted earnings and earnings per share were $39.6 million and $0.63, respectively, for the quarter ended December 31st, 2018. Other highlights for the second quarter included ending loan and lease balances increasing by 363 million, up 4.2% on a linked quarter basis, or 17% annualized from the first quarter of 2019. Total assets remained unchanged from 9.8 billion in September 30th, 2018, and up 0.9 billion from the second quarter of 2018. Net interest margin was 3.87 percent for the quarter ended December 31st, 2018, up 11 basis points from 3.76 in the first quarter of fiscal 2019. Average loan yield increased by nine basis points to 5.6 percent compared to 5.51 percent in the quarter ended December 30th, 2018. Excluding the impact from H&R Block seasonal loan products and excess liquidity and our subordinated debt, Net interest margin in the quarter ended December 31, 2018 would have been approximately 3.83% compared to the 3.92% in the second quarter of 2018 and 3.76% in the first quarter of 2019. Capital levels remain strong with Tier 1 leverage ratio of 9.03% at the bank and 9.41% at the holding company, both well above our regulatory requirements. We took steps to redeploy some of our excess capital this quarter buying back $48 million of common stock at an average price of $28 per share. Return on equity was 15.29% for the second quarter of 2018, compared to 14.37% in the corresponding period last year, reflecting the bank's year-over-year increase in earnings. Our credit quality remains strong with six basis points of net charge-offs and a non-performing asset-to-total asset ratio of 53 basis points this quarter. We received approximately $1 million of payments in the quarter ended December 31st, 2018 for refund advance loans originated during the 2018 tax season, which offset the increase in our loan loss provision this quarter. Our allowance for loan loss represents 124.9% coverage of our non-performing loans and leases. While we have a small number of loans to borrowers secured by real estate properties located in areas affected by wildfires and mudslides in California, Our net exposure after insurance appears to minimize. Our efficiency ratio was 46.47% for the second quarter of 2019, compared to 51.47% in the first quarter of fiscal 2019, and 40.28% for the second quarter of fiscal 2018. We incurred one-time expenses related to mergers and acquisitions this quarter. Excluding $1 million of deal-related expenses, the efficiency ratio would have been 45.5% in the second quarter of 2019. We originated approximately $2.5 billion of gross loans in the second quarter, up 20% year over year. Originations for investment increased 35.6% year over year to $1.8 billion, and originations for sale decreased 11.1% to $610.2 million. Ending loan balances increased by 14.5% year-over-year to $9 billion, led by strong growth in single-family jumbo, multifamily, other commercial real estate, and C&I lender finance. Our loan production for the second quarter ended December 31, 2018, consisted of $81 million of single-family agency-eligible gain-on-sale production, $4 to $31 million of single-family jumbo portfolio production, 182 million of multifamily and other commercial real estate portfolio production, 1 billion 43 million of CNI production, 42 million of auto and consumer unsecured lending production, 401 million of Emerald Advance loan originations, and 30 million of seasonal H&R Block franchise loans. For the second quarter 2019 originations are as follows. The average FICO for single family agency eligible production was 744, with an average LTV of 69.3%. The average FICO for the single-family production was 730, with an average loan-to-value ratio of 64.1%. The average loan-to-value ratio of the originated multifamily loans was 51.5%, and the debt service coverage was 1.27%. The average loan-to-value ratio of the originated small balanced commercial real estate loans was 49.2%, and the debt service coverage was 1.31%. The average FICO score of our auto production was 763. At December 31, 2018, the weighted average loan-to-value ratio of our entire portfolio of real estate loans was 56%. We had approximately $4.3 billion of single-family loans, representing approximately 48% of our loan portfolio. Lifetime credit losses in our originated single-family loan portfolio is four basis points of loans originated. We had approximately $1.9 billion of multifamily loans outstanding at December 31, 2018, representing 21% of our total loan book. The rated average loan-to-value ratio of our multifamily loan book is 53%, based on the appraised value at the time of origination. The lifetime credit losses in our originated multifamily portfolio is less than one basis point of loans originated. We had no losses in our CNI business since inception, other than our equipment finance group with approximately 160 million of outstanding balances at December 31st, 2018, and 27 basis points of cumulative net charge-offs since we entered the business in March 2016 through acquisition. We had only 43 basis points of cumulative loss on our originated portfolio of auto loans since we entered the business approximately three and a half years ago. Loan demand remains solid overall and across most of our lending segments, with the exception of single-family agency mortgages, which are down from prior quarters as it is across the industry generally. Our loan pipeline was $1.12 billion at December 31, 2018, consisting of $420 million of single-family jumbo loans, $58 million of single-family agency-eligible mortgages, $116 million of income property loans, and $527 million of CNI loans. We continue to gradually rebalance our portfolio from jumbo single-family lending into CNI and commercial real estate lending. While we anticipate strong originations across most lending categories, our average and ending loan balances will fluctuate from quarter to quarter based on the pace of prepayments. Switching to funding, total deposits increased by $2.3 billion quarter over quarter as we repositioned our balance sheet in anticipation of the transfer of deposits we acquired from Nationwide in late November. Total not interest-bearing deposit balances were approximately $1 billion at December 31, 2018, up by $139.5 million from September 30, 2018. The increase in non-interest-bearing deposits was driven by the addition of Chapter 7 bankruptcy deposits and other commercial deposits. On December 31, 2018, approximately 30% of our deposit balances were business and consumer checking accounts, 24% money market accounts, 5% IRA accounts, 5% savings accounts, and 4% prepaid accounts. Checking and savings deposits represented 67% of total deposits at December 31, 2018, compared to 77% at September 30, 2018. The December 31, 2018 deposit max was impacted by the addition of approximately $1.7 billion in time deposits from Nationwide. We deployed some of our excess capital across a variety of businesses and initiatives in the past 12 months. We made significant progress in our ongoing efforts to diversify and grow our deposit franchise and seed-based businesses with four separate transactions. First, we completed the acquisition of approximately $2.4 billion of deposits from Nationwide Bank in November, adding approximately 80,000 new accounts and over 40,000 new relationships to access. These deposits, comprised of $1.7 billion of retail CDs and $700 million of checking, savings, and money market deposits when the transaction closed on November 16, 2018, helped increase our core deposits and reduce our cost of funds. With a successful nationwide deposit conversion behind us, we are excited to start our strategic partnership with Nationwide to offer co-branded banking and insurance products and services to Nationwide's associates, policyholders, and general market customers. The agreement, with an initial term of five years, focuses primarily on a variety of consumer lending and deposit products. We intend to leverage our flexible digital banking platform and our collective marketing expertise to make it easy and convenient for existing and new customers to purchase banking and insurance products from Axos and Nationwide. The collective teams are working through data and marketing strategies to prioritize products and channels. We see additional opportunities to offer banking products and services to Nationwide's over 600,000 small business customers that are included in the partnership scope. While we incur incremental marketing expense related to our partnership with Nationwide, the cost will be well controlled and largely success-based. We look forward to working with our partners at Nationwide to make this collaboration a success. The second strategic action we took was the acquisition of Core Clearing, a leading independent clearing firm that serves approximately 60 correspondent broker-dealers with over 90,000 underlying client accounts. The acquisition provides an experienced team, a profitable business, and an established technology platform from which we intend to build our securities business. Core generated approximately $47 million in revenue when their fiscal year ended June 30, 2018, including $34.7 million of fee-based revenue. On a pro forma basis, the addition of CORE would have increased our fiscal 2018 fee income from $70.9 million to $105.6 million, representing an increase of approximately 49%. They also earned about $12 million in margin lending and interest income from client deposits placed at other banks. The $470 million of low-cost off-balance sheet deposits provide us with the flexibility to reduce our cost of funds by bringing some or all deposits to our bank or keeping them at partner banks and earning high margin fee income streams that are tied to short-term interest rates. After spending the last four years researching the clearing, custody, and asset servicing marketplace, we see opportunities to provide a more holistic service offering to small and medium-sized independent broker-dealers that will help improve the efficiency of their back office and enable advisors and brokers to successfully transition from a commission-based to a fee-based model. We also believe that we can expand CORE's revenue and profitability by providing more capital enhancing their sales and marketing capabilities, and growing existing high-margin services such as securities and margin lending. We are evaluating opportunities to add new banking and non-banking services to CORE's existing clients and to expanding into adjacent markets such as RIA custody, securities-based lending, and robo-advisory services. Our projection is that the CORE acquisition will be accretive to our earnings per share by approximately 6% in the 2020 fiscal year beginning July 1st of 2019, assumes no benefit from entering new markets, cost synergies, or accelerated growth. The clearing business runs at a higher efficiency ratio than Axos Bank, but is significantly more capital efficient. For comparative purposes, Core generated approximately $47 million in revenue and $10.4 million of adjusted net income in the 12 months ended June 30, 2018. Core had $32.5 million of operating expenses, excluding non-recurring legal and regulatory costs, which translated into an efficiency ratio of approximately 70%. Given the capital-efficient nature of their clearing business, Core had a return on equity of approximately 40.5% for their fiscal 2018. Starting in the quarter ended March 31, 2019, we will provide consolidated and segment reporting for Axos and Core so that investors can better track the underlying financial metrics of Axos Financial's bank and securities segments. We received all required regulatory and shareholder approval and closed the core transaction yesterday. I'd like to welcome the 131 team members joining us from core. We intend to rebrand the firm to access clearing over the next three to six months. The third strategic action we made this year from an M&A perspective was the addition of the trustee and fiduciary service business from Epic in April 2018, adding a new source of low-cost core deposits. We added an experienced team with established relationships with bankruptcy trustees and fiduciaries nationwide and a technology platform that will integrate and improve over time to serve not only Chapter 7 bankruptcy trustees, but also non-7 trustees and fiduciaries. When the deal was announced, the acquired business had approximately $1 billion of Chapter 7 bankruptcy and non-7 deposit balances held at seven bank partners on behalf of clients serviced through approximately 400 trustees using Epic software. Through the hard work of our team members, we have transitioned dozens of trustees with over $200 million of deposit balances to our bank, with more slated to transition in the coming weeks and months. Axos Fiduciary Services fits our strategic vision of providing banking services to a specialized industry vertical through a low-cost, scalable software and service-enabled model. We're committed to serving trustees in this market and expanding our product and service offering over time. Our most recent transaction announced in December 2018 is the acquisition of approximately $225 million of deposits from MWA Bank. Similar to our prior deposit acquisitions from Principal, H&R Block, and Nationwide, the parent company of MWA Bank is looking to wind down their OCC charter and focus on their core business. We'll be adding approximately 25,000 new accounts with $225 million of low-cost deposits, including $194 million of checking, savings, and money market balances and $31 million of time deposits from MWA Bank. We will not pay a premium on the deposits we're acquiring and will not assume any assets, employees, or branches from MWA Bank. While the deposit balances are small relatively and compared to our $8.3 billion in deposits, the national branchless nature of these accounts are a terrific fit for us and help us improve our funding costs. The OCC approved our acquisition of MWA Bank deposits last week. we're excited to offer our full suite of banking and cash management services to MWA banks, retail and business customers, and fraternal chapters when the transaction closes in mid-March 2019. Our net interest margins have held up well, improving by 11 basis points from September 2018 to December 2018 quarter, even though we've only realized partial benefits from two of our four deposit-related acquisitions. Deposit betas continue to increase across the industry, and a flat yield curve has generally created downward pressure on net interest margin for many banks. We remain focused on closing the announced acquisitions, transitioning the acquired no- or low-cost deposits to our bank, and growing non-interest-bearing deposits through our commercial small business and specialty deposit verticals. From an asset perspective, we continue to grow our asset-backed commercial loan portfolios, which have premium yields relative to our multifamily and jumbo single-family mortgages, and look for opportunities to enhance the yield in our relatively modestly sized securities book. Since the Fed began raising interest rates, we have been able to maintain our core net interest margin in a relatively tight band of 3.8 to 4.0%. If you include the H&R Block-related businesses, our reported net interest margins have steadily increased since the Fed started raising rates, from 3.91 in fiscal year 2016 to 3.95 in fiscal year 2017, to 4.11 in fiscal year 2018. Our proactive actions to diversify both our funding and asset generation capabilities have held up well and should hold up well in the future irrespective of Fed actions. The 2018 and 2019 tax season marks the fourth year of our seven-year partnership to provide various banking and payment services to H&R Block's clients. In the quarter ended December 31st, 2018, We originated approximately $401 million of Emerald Advance unsecured consumer loans and $30 million of H&R Block franchisee loans. Since January 2nd, we started offering refund advance loans to H&R Block customers for the second consecutive year as Block's exclusive provider of refund advance loans. Refund advance loans are interest-free, no-fee advances secured by qualified taxpayers' refunds. We received fees from H&R Block Bank based on the principal amount of refund advance loans we originate. Similar to prior years, we expect a seasonal surge in refund advance loans, refund transfers, and ML cards to result in a significant quarter-over-quarter increase in our fee income and noninterest-bearing deposits in the quarter ended March 31st. While still very early in the tax season, we have not experienced any disruption in the tax-related businesses as a result of the partial government shutdown. We look forward to completing another successful tax season helping H&R Block Bank's customers. Our capital ratio remains strong, despite recent action to deploy some of our excess capital into accretive M&A transactions and share repurchases. We spent $48 million of excess capital in the December quarter to repurchase approximately $1.7 million of common stock. Our Tier 1 leverage ratio was 9.41 at the holding company, and 9.03 at the bank at December 31, 2018, more than sufficient to fund core and the Wise Banyan acquisition without raising capital. Our priorities for excess capital have not changed. We will continue to fund organic growth and investments in our business and consider opportunistic share repurchases, accretive M&A transactions, and potentially a dividend. Last quarter, we announced a small but strategic acquisition of a digital advisory and personal financial management platform Wise Banyan. Wise Banyan offers a comprehensive and user-friendly platform for individual investors to manage their finances and create custom investment portfolios tailored to meet their life goals. We diligence dozens of robo-advisory firms, business models, and third-party technology providers through the course of our evaluation. What we determined was the economic model that most fintechs currently have, limited asset-based revenue streams with high customer acquisition costs, and limited control over the technology stack, Utilization of a third-party clearing firm and a limited ability to monetize the deposit and lending relationship is an unsustainable one. The combination of Wise Banyan, which has a talented entrepreneurial team who built the entire technology stack, combined with CORE's back office platform, accelerates our time to market by one to two years and provides us with the essential components to add a profitable and scalable digital wealth management business to our consumer product offering. Over time, we will integrate the wealth advisory services into the Universal Digital Bank, providing an integrated banking and wealth management experience to our clients and to Wise Banyan's clients as well. We look forward to closing the Wise Banyan transaction in the next few months. In closing, we are seeing the tangible benefits from investments we are making in technology, personnel, infrastructure, and new businesses. The addition of low-cost deposits from Nationwide and Epic help keep our deposit costs essentially flat quarter over quarter, despite only a partial quarter's impact from Nationwide. Investments in our small, balanced commercial real estate and asset-based commercial lending groups resulted in $363 million of sequential growth in net loan balances this quarter. The deployment of our universal digital banking platform with additional features such as personal financial management, biometric authentication, personalization, and gamification slated for rollout in the next 12 months will allow us to continually improve our user experience and become more relevant to our customers and partners. With control of our platform, we will increase the value of our product offering through the addition of wealth management services to the Universal Digital Bank to differentiate our consumer product offering. The addition of Axos fiduciary services and core and our multi-year partnership with Nationwide further expands our product capabilities, distribution channels, and revenue sources. The opportunities we have are abundant. We will continue to prudently prioritize and allocate capital and resources with a focus on ensuring that we're building a technologically forward, customer-centric consumer and commercial bank, as well as developing our clearing business to better serve our existing customers and to expand beyond our current market. Now I'll turn the call over to Andy, who will provide additional details on our financial results.

Thanks, Greg. First, I wanted to note that in addition to our press release, our 10Q was filed with the SEC today and is available online through EDGAR or through our website, axosfinancial.com. Second, I will quickly highlight a few areas rather than go through every individual financial line item. Please refer to our press release or 10Q for additional details. As Greg noted earlier, for the quarter ended December 31, 2018, net interest margin was 3.87% up 11 basis points from the 3.76% from our last quarter ended September 30, 2018. This quarter, the net interest margin was favorably impacted by higher loan and investment rates on earning assets, as well as lower rates on interest-bearing deposits and time deposits. Our average yield on earning assets was 5.48% for the second quarter of fiscal 2019, compared to 5.35% for the first quarter of fiscal 2019, up 13 basis points. On the deposit side, our average cost of interest-bearing deposits and time deposits decreased nine basis points and 21 basis points, respectively, when compared to Q1 ended September 30, 2018. As noted earlier, we closed the nationwide bank deposit acquisition of $2.4 billion in deposits halfway through the second quarter. This included $1.7 billion of time deposits at a weighted average rate of 2.26 and $0.7 billion of checking, savings, and money market accounts at a weighted average rate of 81 bps. If you assume the benefit of nationwide deposit acquisition for a full quarter and you remove the average loan balances and the interest income associated with the short-term H&R Block, Emerald Advances, and franchisee loans, the net interest margin for the quarter ended December 31, 2018 would have been 3.83% up seven basis points from the 3.76 percent net interest margin for the quarter ended September 30, 2018. Moving to operating expenses, as noted earlier, our efficiency ratio improved to 46.5 percent this quarter, compared to 51.5 percent for the quarter ended September 30, 2018. Total non-interest expense for the second quarter ended December 31, 2018 decreased two million to 50.9 million compared to 52.9 million for the length quarter ended September 30, 2018. The decrease is primarily attributable to a 1.4 million savings associated with normalizing FDIC insurance costs this quarter compared to the higher than average FDIC costs last quarter associated with the temporary broker deposits used to prepare for the nationwide deposit acquisition. In addition, advertising and promotional costs this quarter declined by $1.1 million compared to last quarter, primarily due to lower deposit marketing costs, lower mortgage loan lead costs, and lower branding costs. Excluding the acquisition-related expenses and the aforementioned excess FDIC expense, our non-GAAP adjusted efficiency ratio would have been 45.5 percent in the second quarter ended December 31, 2018, compared to 49.42 percent in the first quarter ended September 30, 2018. Our depreciation and amortization expense was approximately 3.6 million in the second quarter of fiscal 2019, compared to 3 million in the first quarter of 2019, and compared to 1.9 million in the last year's second quarter, ended December 31, 2017. The primary drivers of the sequential and year-over-year increase in our depreciation and amortization expenses are amortization of intangibles associated with the EPIC and the nationwide deposit acquisitions, which were 900,000, 700,000, and zero for this quarter, for last quarter, and for last year, respectively. Also, software depreciation as a result of deploying the Universal Digital Bank and the related systems was 1.8 million $1.5 million and $1.1 million for this quarter, for last quarter, and for last year, respectively. With the core acquisition closing this month and the Wise Banyan acquisition expected to close sometime in our fiscal third quarter of 2019, we expect our depreciation and amortization expenses to increase over the next several quarters by an amount between $1.5 million and $2.2 million per quarter. With that, I'll turn the call over to Johnny Lott.

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

Thank you. Ladies and gentlemen, we will now be conducting our Q&A session. If you would like to ask a question, please push star 1 on your telephone keypad now. The confirmation tone will indicate your line is in the question queue. You may push star 2 if you'd like to remove your question from the queue. And for any participant using speaker equipment, it may be necessary to pick up your handset before pushing the star key. One moment while we poll for questions. Our first question comes from the line of Brad Burning from Craig Hallam. You are now live.

Good afternoon, guys. Congrats on the quarter. I wanted to follow up on the acquisition front a little bit, and I asked this question last quarter, and I wanted to follow up on it. Can you talk a little bit more about what you think about the ROE profile and the growth profile of the company after you get things all put together? How do you think about access in the out years as this gets put together?

Are you talking specifically about core or are you talking about the aggregation of all?

I'm talking the aggregation of all of it. You've got a lot of good moving parts here and just trying to think about how you're putting this whole picture together in your head.

Yeah, well, I think right now from a standpoint of thinking about intermediate term modeling, I think we've given enough information to allow you to see these parts separately and to make reasonable estimates with respect to how they would come together. Obviously, over time, we expect to grow core organically and The value of that growth will be partially dependent upon interest rates. Higher interest rates are better for this business. Lower interest rates are not as good. Obviously, we have other parts of the business that may operate differently, such as agency mortgage banking, so there's a lot of assumptions that have to be embedded into this. The question of how much growth or how much enablement of growth that the overall and eventual integration of digital wealth management through the universal digital banking platform to our customers will have is very difficult to ascertain because we obviously have growth projected in the out years that is fairly robust. So part of this and these acquisitions is to ensure that we're able to meet those objectives as they currently are. It's also difficult to know how pricing will be impacted and how retention will be impacted by the addition of these services. And we believe that clearly from the research that we've done that it will lower the cost of acquisition, increase retention, reduce the sensitivity of the checking accounts within our deposit base. But, look, I think it's very difficult, and I don't think you should be building those numbers into the out years of your model because we have to go and prove that we're going to be able to do that effectively.

No, understood. All fair points, and appreciate the thought process, and we'll continue to monitor things as they go. And then one other follow-up is, as you think about the IT investments to bring people the new acquisitions on board and you think about the opportunities to not just integrate, but expand the investments and the opportunities with those acquisitions. How are you thinking about efficiency ratios as we progress through the intermediate term here? Obviously, a lot of, you know, kind of a better than expected cost management this last quarter. And just want to make sure we understand how much of that to perpetuate in the models. But Also, just think about the opportunity set that you might want to invest in.

I think that from a bank perspective, thinking about modeling the banking efficiency ratio essentially where it is for the next year is the right approach. And then with respect to core, we gave the numbers with respect to that specific efficiency ratio for the purpose of being able to look at those segments separately and We will be breaking those out on a segment basis. Now, the reality is if core ends up growing well, it will grow in a way that will increase our ROE, but would increase the overall holding company's efficiency ratio. Obviously, that's a good thing given that efficiency ratio is just simply a proxy that's utilized both for banks and it's much less utilizable for essentially selling software as a service to clients in a very capital-efficient business. So it really depends on the mix of growth. I think right now, just for the next year, assuming that core essentially is at stasis, although we certainly hope to do better than that, is the right approach. And then thinking about the bank and its normal growth trajectory with the efficiency ratio that we have currently is the correct approach. And if you're asking, well, how are we going to do a lot of the things that we're doing, we've invested a lot On the technology side, we have a pretty big team now. That team has delivered a lot of product, although they have a pretty aggressive schedule for this year. So there may be some incremental investments, but I don't believe they'll be material. I think that we can work within the existing structure that we have reasonably well with, you know, a million dollars here, a million dollars there, in order to be able to deliver on the strategic vision we have.

It's good news to hear. Appreciate it. I'll get back in the queue.

Thank you. Our next question comes from the line of Austin Nicholas from Stevens. You are now live. Hey, guys. Good afternoon.

Hey, Austin. Hey, Austin. On the margin outlook, could you just remind us of what that is kind of heading into 2019 as you layer on these different deposit businesses kind of off that 383 number?

Yeah, I mean, I think that looking forward for the next 12 months, I think you should use the guidance that we've historically given. You know, the 380 to 4% range excluding block impact. And I think that's the reasonable level to look for in this next calendar year.

Got it. And then maybe just on the EPIC business, can you give us an update of maybe how many deposits have come over and just how to think about the trajectory of kind of the full opportunity of the deposits coming over in 19?

Yes. It's about 200 million has come over now. And we're continuing to make those transitions. And ultimately, it depends on several, the timing depends on several factors. But there's roughly $800 million. Some of those deposits are higher cost than some of the others. And remember, we also do lose some component of fee-based income as those deposits move from a third party bank to our bank. However, they are a net benefit to us because we are receiving less from the partner bank than the cost of the deposit that we are replacing on a marginal basis.

Right. That all makes sense. Okay. And then just maybe as you cross $10 billion, or I guess experience the effects of crossing $10 billion this year, can you maybe just give us your thoughts on the kind of interchange impact, the FDIC impact, and then kind of any color you can give on the H&R Block side of the business and any impact there? Sure.

So we have – so the H&R Block contract is a seven-year deal. This is our fourth year. H&R Block does not have a Durban termination, so our exclusivity continues with respect to those items, although we have to make sure Block is not financially impacted as a result of that. We're working on a variety of different ways, structuring mechanisms to allow that to happen in a way that minimizes that impact. So, the H&R Block deal will continue. Obviously, we have the contract. So, that's one component of that with respect to the H&R Block. With respect to our own deposit products, Some of the reward-type products, we've been looking at redesigning those a bit to try to minimize the impact because some of the rewards, checking products and those sorts of things, the profitability will be impacted by Durban. And remember the timing would be at the earliest that we would be impacted by this would be July 1, 2020, because we would have a measurement date at December 31st, 2019.

Understood. Thanks, Greg. And then maybe just one last one. Can you just remind us of how you view the excess capital at the company and then maybe just what your priorities are for deploying it? Obviously, you've done a great job with some of these acquisitions and have kind of tapped the buyback. Any thoughts on capital and where it goes from here?

Sure. I think with the acquisition of Core, and the buyback that we did this quarter, I think we've deployed a reasonable amount of excess capital. However, we still have excess and we will likely generate excess in this next year. So with respect to the acquisition side, we've done the type of deals from a strategic perspective that we needed to do for the wealth management side, I believe. But that doesn't mean that there won't be opportunities that will arise that you know fit well within that core strategy and it's always difficult to know about that. With the stock price where it is, it certainly is tempting to continue to look at deployment of capital into share purchases. But we also look at the dividend side of things too and watch our shareholder base, which has been creeping up with income investors. and think that it may be appropriate at some point in time to think about a dividend as well. So we're watching the excess capital. We want to make sure that we're being efficient with our capital, and we'll continue to deploy it in a way that we think is most effective at generating shareholder value over the longer term.

Got it. Thanks, Greg. Appreciate all the help there. I'll just hop off. Sure. Sure.

Thank you.

Thank you.

Our next question comes from the line of Michael Perito from KBW. You are now live.

Hey, good afternoon, guys. Thanks for taking the call. Hey, Mike. Hi, Mike. I wanted to start on the loan growth side. It seemed like the C&I book had some really strong growth in the quarter, and I was looking through the Q filing. It looks like most of that was in the... I believe you guys incorporated within your CNI portfolio the warehouse and other line. I don't know if that's wrong or right, but I believe that you were including that in your prepared remarks when you mentioned the CNI growth. And I'm just curious, do you know, it seems like there's a few things included in that bucket, including the lender finance. Do you have kind of the breakout or more detail about what drove kind of the big year-to-date, fiscal year-to-date growth in that line item?

Yeah, so the year-to-date growth was about I mean, it's talking about going back here. If we go back from the second quarter of 2018 and then this fiscal and then the second quarter of 2019 fiscal, there was about 24% loan growth. And that was really broken up across a variety of categories. We had growth in the lender finance side. We had growth in the real estate specialty lending group as well. And so I think that it was reasonably balanced, probably a little bit on the side of the real estate specialty lending business.

Right. So I can give you the components that make up that line item.

Just as a relative benchmark. Like $730 million out of the warehouse and other line as of December 31st. That would be helpful, Andy.

Right. So included in single-family lender finance is $172.8 million. Single-family secured bridge specialty is $120.2 million. And then when we look at the warehouse number, where is that on this? Warehouse is 220 million.

Okay. That's a helpful color. And then just as it relates to the loan yields, you know, they've done fairly well, obviously, over the last, few years, but the mix of the portfolio has kind of changed a little bit in that time as well. And I'm curious if you can kind of give us a sense of, you know, where you think some of the stronger loan yield performance has been coming from. Has it been being able to get increased incremental yields on new single-family production? Has it been kind of the addition of some of the CNI stuff? Any color there would be helpful.

Yeah, so for single-family, Pretty much we've been able to maintain originations and grow that book. And for every rate increase that the Federal Reserve has made, I think except for one, we raised our rates 12.5 basis points. So, obviously, it's, you know, call it a 50% loan beta, but that's not – that's loan beta on the incremental production, not loan beta on the actual, you know, the static loan book. For multifamily – I think it was the same thing, 12.5 basis points, I believe, except one that we did not raise rates. So that's roughly that. And then the vast majority of the CNI production and the CNI production other than the equipment leasing, which tends to be fixed over three to four years, is variable and floating rate. that would float 100% with an index, usually LIBOR. And then the equipment finance loans and the warehouse lines and the specialty real estate generally have higher loan yields than the single and multifamily. So any MEX shift benefits in two ways. It benefits not only the loan beta, but it also benefits just in general from a re-max of the product.

Okay. That's helpful. Thanks. And then, sorry, go ahead, Andy.

Yeah, Mike, I can just give you an example of really the largest driver. CNI and Lender Finance, June, the point-in-time yield was about 7.13%. At the end of this quarter, it was 7.69. So you can see that it's a good rate, plus it's moving with rate hikes, which is helping us, you know, manage our PIM.

Got it. That's a helpful example. And then just lastly, on the expense side, kind of a broader question, but Obviously, you guys have layered in a few different businesses here. There's some investments up front, it seems like, in some of these cases to kind of grow these relationships and businesses as we go forward. But they're also, given that they were in some cases newer partnerships or businesses, weren't a lot of cost savings or anything like that. And I just wonder, as you guys kind of look at these businesses you're bringing on, is there a point over the next couple years where there could be some synergy opportunities once you get a better handle of kind of what's required to operate these platforms and any redundancies that you can maybe automate or stuff like that? I mean, is that something that's starting to kind of be discussed internally or do you think that they're actually fairly efficiently run as they stand today and that it's more just growing the revenues longer term is the biggest opportunity?

Yeah, I think there are opportunities to get efficiencies from an operational perspective out of both Epic and Core, which are the largest investments in personnel. However, those efficiencies will essentially be put back into doing things a lot better and quicker associated with these businesses. So, for example, on Epic, We're going to spend a lot of time making sure that we are absolutely the best in class in that business so we can go win more trustees. And we've got to go and fix the – make sure the platforms are efficient, make sure our customer service is best in class, and then the growth will come from the trustees. And the core will be the same thing. We'll be looking to go upmarket. And in the process of going up market, the folks that are currently doing some things that are manual will be spending time on gap analysis with respect to how to go up market and win bigger business. So I don't think that it would be a good idea to put in your model some sort of, hey, we're going to be able to cut 10% of core's cost in year two or something. That's just not what it looks like. What it looks like is more that we'll create an API platform for robo-advisors, for third-party robo-advisors to be able to use the platform. And that will generate lots of synergies with respect to UDB. Maybe robo-advisors who are looking to do that will be interested in using a white-label version of UDB and things like that. So it's really going to be more about the deployment. This isn't some sort of traditional kind of, you know, bank acquisition where you go in and you cut the accounting department or something because Andy's wincing here. That's a very sensitive thing in this room, I guess. But that's not what's happening here. I would think about it, I wouldn't think about it that way.

Okay. No, that makes a lot of sense. I appreciate the color and for taking my questions, guys. Thank you. Thank you. Thank you.

Our next question comes from the line of Gary Tenner from D.A. Davidson & Co. You are now live.

Thanks. Greg, I have a question just regarding wise banning. I wonder if you could kind of walk through or talk through how your thoughts there are when it comes to monetizing that platform, you know, rather, you know, as opposed to just offering it as a value-add product for your existing customers as a way of customer acquisition, et cetera.

Sure.

No, that's a great question. So there's There's several ways of monetizing the platform. The first one you mentioned last, which is the customer acquisition side, their cost of acquisition has historically been lower than our cost of acquisition with respect to gaining a new customer for the platform. Now, they've been very attractive on the pricing side with respect to the platform, which has assisted them in that customer acquisition cost. So thinking about how to tie in the requirements for a checking account with direct deposit with the pricing strategy of that customer acquisition is an area that we've done a lot of modeling in and looking at. Next, there's opportunities to provide basic levels of services and then to have an add-on services associated with that. that you can charge a fee for. And so there's a base level service being offered at a certain value proposition and then incremental services being offered that allow the customer to choose where they'd like to play. And so that would be a fee income generator. I do think that there's also the ability to monetize the customer from a pricing perspective with respect to the checking side. The whole goal of the long play here is to be able to control the platform so that the services of the platform are sufficient enough from a value proposition that the checking customer becomes less rate sensitive. Clearly there are some competitors who have done an amazing job at this, right? Charles Schwab has done a really, really good job. We don't think about what Charles Schwab is paying for checking accounts because they're not paying much of anything and they're doing just fine with retaining customers. So as digital banking competition increases, It's increasing in this, call it the first wave way, which is what we helped pioneer, but the second wave way is the path forward. And so that path forward is about integration of services, it's about customer experience, personalization of the recommendations, and sufficient services such that the overall value proposition is more valuable than sort of picking it apart. And I think that's, you know, we've got those pieces in place. And it's, you know, part of the, we've been eyeing the robo-advisory business for a long time, but part of the problem is the value that we wanted to provide was hampered by our discussions with third-party clearing companies. who said, well, fantastic, we'll meet your pricing demands, but we want all the deposits. And that just doesn't work for us. And so now those pieces are in place, that vertical integration, and so therefore we can go and make that happen. Look, it's not straightforward, and it's not a next quarter exercise, but it's all in place to be able to make that happen over the next couple of years.

Okay, thanks for that detail. I just also wanted to ask to make sure I heard correctly the relatively modest increase in NPAs this quarter in the single-family portfolio. Did you say that those were in areas that were impacted by some of the wildfires and lost content looks pretty minimal? Did I hear that correctly?

No, there was primarily one loan for $7.5 million that went into non-performing single family. It's about a 55% LTV, no real long-term issues with it. There were no issues in non-performing associated with the fires of any significant nature.

All right, thank you.

Thank you. Our next question comes from the line of Andrew Leisch from San Lorenino. You are now live.

Hey, guys. Just a follow-up question here on the expenses. Some good cost control this quarter, but it sounds like amortization or depreciation might step up here in the first quarter and maybe with core closing a little bit earlier than you may have expected, what's the right expense run rate or number to build off here in your third quarter and then going into the rest of the calendar year?

Well, with respect to the core depreciation, that is included in the number that we provided with respect to the net income. So it's not that net income and that benefit associated with the accretion. We're including the expected increase in the depreciation cost. So that's an element that you have, but that is included. So it's not incremental. And with respect to what's happening with CORE, you'll still have that 6% annual accretion associated with that business. And so the closing of it early will, you know, sort of midway through a quarter. That obviously has to be prorated, but that's that piece of it. The other pieces of the increased depreciation, I mean, those are just simply increased costs that will flow through the P&L.

Sure. So, and Greg gave guidance on general overall efficiency for the full year. As you know, this quarter's efficiency will be significantly better because of the block income. But of the 1.5 million increase, about half of that will be core intangibles that we're estimating. And that's part of the reason I gave a range. from 1.5 to 2.2. We haven't done the final valuation analysis to come up with the exact intangibles. But about a million of that is core. So it's not a huge number, but the broader point was that depreciation has increased a little bit each quarter because of the amortization of the software. And so we are expecting that to continue to increase. We just wanted to be clear on that. But I think the overall guidance of looking at a full year on the banking side in the 40s range is the right way to think about it. And then take core separately, which will be more like a 70% number in efficiency.

That covers it. I'll step back.

Thanks, Andrew. Thank you. Ladies and gentlemen, as a reminder, if you'd like to ask any questions, please push star 1 on your telephone keypad now. Our next question comes from the line of Edward Hamilton from Shaker Investments. You are now live.

Yeah. Thanks, Greg. I just have an additional question regarding CORE. clearing, and also congratulations on your acquisitions and also on the opportunistic share repurchase. But with Core, you're going to get a benefit from having greater equity. What other opportunities or how much do you think that may help Core in getting new business versus other opportunities that you may have? I mean, within you know, to pick up business for core. I mean, if you could kind of elaborate on that a little bit more.

Sure. Well, I do think that's an important point, Ed. I do think at a certain point, right, having the backing of AXA's financial with respect to its capital base will certainly increase the conversation. There are also opportunities to optimize the business across, there's obviously a number of different ways that clearing companies make money. And we've been digging into the optimization of the existing customer base. We do think there's some upside there. So there's upside from just the, hey, we have capital. There's upside from some of the cross-pollination with banking services without, I think, having to do much infrastructure work. And I will say that there is an absolutely felt need within, let's call it the middle market, of the introducing broker-dealer segment that clearing companies are not particularly responsive. They're not attuned to the needs of what they would consider to be smaller customers but would be quite good customers for us. You know, I've been out doing some selling and, you know, you've got, I'd say that, you know, the doors are being swung open to some pretty big opportunities on one hand. On the other hand, the issue is that these contracts are longer term and that, the conversion element of these are significant. So the great part is that means you get to, it's hard to lose customers, and it takes a long time to get them as well because they're often subject to contractual obligations and have the burden of having to sometimes repaper accounts associated and end accounts associated with transfers. So I think there's opportunity there, absolutely, and we'll be working on it. It's not an overnight set of opportunities, but I was out at one conference just kind of ahead of the game, and the excitement was palatable. I mean, people are very interested in having a company that has the technology that we have. I mean, think about, for example, you've got an introducing broker-dealer, and the way they're opening accounts is paper-based, and all of a sudden they have an account opening system where they can take a driver's license and a picture of their face and open it, and that could be pushed through that network, right? I mean, there was a lot of interest in that. getting all those things done and getting them implemented and people using them is a different story, but there's a ton of opportunity here.

Okay. Thanks.

Sure.

Thank you. Our final question comes from the line of Steve Moss from B. Riley FBR. You are now live.

Hi. Good morning, or good afternoon.

Hi, Steve. Hey, Steve.

This is Zach Weiss filling in for Steve today. So on the upcoming tax season, is there any outlook or expectations for the refund advance product relative to last year?

We have an understanding of that, but that would be something that we would comment on. You know, just we've historically in any year never comment on the volumes associated with those elements, just frankly because they also, they impact what people would be able to derive about H&R Block and any kind of variance we don't think is material for us.

Okay, fair enough. In terms of credit, is there anything you all are seeing from the trenches that's worth noting? If there are certain areas that might be getting a little bit too frothy, if there's any notable things that you guys are seeing on that end?

In general, I think there's been some non-bank competitors that have entered certain mortgage spaces. And I think they're doing things that are well outside our credit box. They're doing them generally at significantly higher rates, but also higher loan value ratios. So yeah, that's one area where we see a little push on the credit side there. But I don't think we spend a lot of time If we do what we do well, then I think we can continue to have reasonable growth and continue to increase our assets and not have to follow that. So we haven't done anything differently, and I'm not seeing anything that raises any major panic.

Got it. Thanks for taking the questions.

Thank you. Thank you. Ladies and gentlemen, we have no further questions in queue at this time. I'd like to turn the floor back over to management for closing comments.

All right. Thank you, everyone. We'll talk to you next quarter.

Thank you, ladies and gentlemen. This does conclude our teleconference for today. You may now disconnect your line at this time. Thank you for your participation, and have a wonderful day.