Axos Financial, Inc.

Greetings and welcome to Axos Financial Inc. Third 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 AXIS. Joining us today for AXIS Financial Inc.' 's third 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 nine months ended March 31st, 2019, 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 AxiosFinancial.com for 30 days. Details of this call were provided on the conference call announcement in today's earnings press release. At this time, I'd like to turn the call over to Greg for opening remarks.

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 third quarter of fiscal 2019, ended March 31, 2019. I thank you for your interest in Axos Financial, Axos Bank, and Axos Securities. Axos announced net income of $38.8 million for the fiscal third quarter ended March 31, 2019, down from $51.3 million earned in the fiscal third quarter ended March 31, 2018, and unchanged when compared to the $38.8 million earned in the prior quarter. Earnings attributable to Axos' common stockholders were $38.7 million, or $0.63 per diluted share, for the quarter ended March 31, 2019, compared to $0.80 per diluted share for the quarter ended March 31, 2018, and $0.62 for diluted share for the quarter ended December 31, 2018. Excluding non-recurring expenses, non-GAAP adjusted earnings and earnings per share were $51.5 million or $0.84 respectively for the quarter ended March 31, 2019. Other highlights for the third quarter include ending loan and leases increased by approximately $1 billion, up 12.8% year-over-year, and 4% annualized from the second quarter of 2019. Strong originations in multifamily, small balance, CRE, and CNI were offset by lower production in jumbo single family and a few large payoffs in our commercial specialty real estate loan portfolio. Repayment of H&R Block franchise and Emerald Advance loans also accounted for $65 million of sequential decline in the ending loan balances at March 31, 2019. Total assets reached $10.9 billion in March 31, 2019, up by $1.1 billion compared to December 31, 2018, and up 0.9 billion from the third quarter of 2018. Net interest margin was 4.82 for the quarter ended March 31st, 2019, up 95 basis points from 3.87 in the second quarter of fiscal 2019. Average loan yields increased by seven basis points to 6.68% compared to 6.61% in the quarter ended March 31st, 2018. Excluding the impact from H&R Block seasonal loan products and excess liquidity, Bank-only net interest margin in the quarter ended March 31, 2019 would have been approximately 3.9%, up 8 basis points from 3.82% in the third quarter of 2018, and up 9 basis points from 3.81% in the second quarter of 2019. Capital levels remain strong with Tier 1 leverage of 8.68% at the bank and 9.25% at the holding company, both well above our regulatory requirements. Return on equity was 15.34% for the third quarter of 2018 compared to 22.84% in the corresponding period last year. Excluding one-time merger-related expenses, non-cast depreciation and amortization expenses, and a reverse of four potential trading losses related to a corresponding clearing client, our non-GAAP-adjusted return on equity would have been 20.37% in the third quarter of 2019. Our credit quality remained solid with four basis points of net charge-offs In a non-performing asset, the total asset ratio of 48 basis points this quarter. Our allowance for loan loss represents 161.1% coverage of our non-performing loans and leases. Our efficiency ratio was 52.7% for the third quarter of 2019 compared to 46.5% in the second quarter of fiscal 2019 and 32.4% for the third quarter of fiscal 2018. The primary driver of the year-over-year and sequential increases in our efficiency ratio were the addition of the core clearing and wide-spanning acquisitions and the reserve for potential losses related to a corresponding clearing client. Excluding the impact of the client loss and one-time expenses, the consolidated efficiency ratio would have been 41.2%. The bank business unit efficiency ratio was 35.3% this quarter. A number of relatively small items individually contributed to a more meaningful adverse impact collectively on our bank efficiency ratio this quarter. Increased professional services, mostly related to M&A and legal expenses, accounted for $1.2 million of the increase in uninsured expense. Depreciation and amortization expenses related to acquisitions in our software development increased to $4.4 million this quarter from $3.86 million in the prior quarter and $2 million in the third quarter of 2018. A non-cash mark related to the change in quarter end value of our mortgage loan servicing book reduced our mortgage banking income by approximately $1 million. Finally, we had an $821,000 non-cash OTTI charge in our security portfolio as rates dropped at the end of the quarter. Excluding these unusual items, some of which may reverse in the future, our bank efficiency ratio would have been 34.3% in the quarter ended March 31, 2019. Exos Clearing had an efficiency ratio of 86%, excluding one-time merger-related costs and the offers that mentioned client loss reserve. Although over the intermediate term, we will improve the efficiency of the clearing business as we bring them inside our process improvement framework and introduce automation in a variety of areas, as a fee-oriented business, the clearing business has the potential to run at significantly higher returns on capital as we grow the business, given that the business is focused primarily on fee income and suite balances that can be placed off balance sheet. We originated approximately $2.5 billion of gross loans in the quarter, up 1% year-over-year. Originations for investment decreased 0.2% year-over-year to $2.2 billion, and originations for sale increased 11.2% to $287.9 million, reflecting higher originations of refund advance and correspondent lending loans. Ending loan balances increased by 12.8% year-over-year to $9.1 billion. Our loan production for the third quarter ended March 31, 2019, consisted of $58 million of single-family agency-eligible gain-on-sale production, $285 million of single-family portfolio jumbo production, $143 million of multifamily and other commercial real estate portfolio production, and $584 million of CNI production. $1,164,000,000 of refund advance production, and $51 million of auto, consumer-unsecured loans, and seasonal H&R Block franchise loans. For the third quarter of 2019, originations are as follows. The average FICO for single-family agency-eligible production was 734, with an average loan-to-value ratio of 70.4%. The average FICO for the single-family jumbo production was 729, with an average loan-to-value ratio of 62.1%. The average loan-to-value ratio that originated multifamily loans was 53.5%, and the debt service coverage ratio was 1.32. The average loan-to-value ratio that originated small-balance commercial real estate loans was 64%, and the debt service coverage ratio was 1.17. The average FICO of the auto production was 757. At March 31, 2019, the weighted average loan-to-value ratio of the entire portfolio of real estate loans was 57%. Our jumbo single-family mortgage business had a disappointing quarter, originating $285 million of new loans compared to an average of $389 million per quarter for the past two years. Increased competition from non-bank lenders and a subdued appetite by high-net-worth individuals in the first two months of 2019 following the precipitous decline in the stock market at the end of last year resulted in weak jumbo mortgage production in January and February. While we saw better production in March as mortgage rates fell and the stock market rebounded, The improvement was not sufficient to offset the weakness in the first two months of the quarter. Prepayment rates in jumbo single-family loans remain elevated as some borrowers refinance away from us while we maintain our credit and LTV standards. We expect our jumbo mortgage production to rebound to $300 to $325 million per quarter starting in the fiscal fourth quarter ending June 30th. Given where we are in the housing cycle, we expect net growth in the jumbo single-family portfolio to be in the low-mid single digits approximately $150 to $200 million per year on a net basis. We had approximately $1.8 billion of multifamily loans outstanding on March 31, 2019, representing 20% of our total loan book. The portfolio grew by $45.8 million, or 2.7% lend quarter. The weighted 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 a less than one basis point of loans originated over the 18 years we've originated multifamily loans. Our C&I lending business posted another strong quarter with $548 million in loan originations. We continue to focus on well-secured, well-structured asset-based loans and lines of credit to creditworthy borrowers, financing high-quality projects in attractive markets in both our lender finance and commercial specialty real estate businesses. Our commercial lending team continues to grow in terms of relationships, product types, and expertise. Loan demand remains solid overall despite increased competition from non-bank lenders in certain segments of jumbo mortgage and consumer lending. Demand for single-family agency mortgages is down meaningfully across the industry with purchase transactions accounting for the vast majority of industry origination volume. Our loan pipeline was $1.22 billion on March 31, 2019, consisting of $476 million of single-family jumbo loans, $68 million of single-family agency loans, $163 million of income property loans, and $509 million of CNI loans. We continue to transition our portfolio away from single-family lending into CNI lending and commercial real estate. We have proactively eliminated higher-cost distribution and marketing channels for single-family agency mortgages and reassigned team members to other consumer lending and consumer deposit businesses. We continue to expand our distribution channels and refine our marketing strategies within our jumbo mortgage lending business, and expect origination volumes to rebound from levels we experienced this quarter, although production will not reach levels we had two or three years ago, given where we are in the housing cycle and our adherence to low LTV underwriting. We anticipate strong originations across our auto, small-balance commercial, and C&I lending groups as we identify new opportunities to meet or exceed our risk-adjusted return criteria. On an annual basis, we are targeting overall loan growth in the low teens which we believe is prudent given the competitive landscape for loans and deposits, the credit cycle, and the shape of the yield curve. Switching to funding, total deposits increased by $315 million quarter over quarter to $8.7 billion. Total non-interest-bearing deposit balances were approximately $1.8 billion on March 31, 2019, up by $762.9 million from December 31, 2018. The increase in non-interest-bearing deposits was driven by deposits related to tax-free funds for H&R Block loan customers primarily and by commercial bank and deposit vertical increases. At March 31, 2019, checking and savings deposits represented 71% of total deposits at March 31 compared to 67% at December 31, 2018. Of that, 71%, 30% of our deposit balances were business and consumer checking accounts, 20% money markets, 5% IRAs, 5% savings, and 11% prepaid accounts. We completed the acquisition of MWA Bank's deposits and successfully converted the clients to our bank last month. The MWA transaction added approximately $173 million of interest-bearing and non-interest-bearing deposits. We paid no deposit premium to the seller. In addition to the MWA deposit acquisition, we closed the core clearing and wide-spanning digital wealth acquisitions in the quarter ended March 31, 2019. The two combined businesses, as reflected in a new operating segment classified as securities on our SEC followings, provide us with a solid foundation from which we can expand our security servicing, wealth management, and private label of banking services to RIAs, independent broker-dealers, and their underlying retail clients. We've already made good initial progress in the first 60 days since closing the transaction, including rebranding Core Clearing to Axios Clearing, hosting productive meetings with team members, clients, and prospects, and establishing joint meetings to map out a comprehensive product and technology roadmap for the combined businesses. It's still early days, but we're extremely excited about the opportunity to serve small and medium-sized correspondent broker-dealers and RIAs a market with over $2 trillion of client assets and provide them and their clients with access to a comprehensive set of banking products and services through a platform and interface that is convenient and easy to use. What client and prospects have told us is that they're not receiving the type of technology and customer service they need from existing custodians, client firms, and third-party vendors in order to successfully manage and grow their practices. Industry consolidation continues to result in reduced services and increased costs for small and medium-sized RIAs and broker-dealers. With our existing presence in this industry through Axios Clearing, we are committed to investing alongside our clients to grow our assets, clients, deposit balances, and technology services in this space. On March 8, 2019, we disclosed in an 8K filed with the SEC that Axios Clearing, our newly acquired clearing broker-dealer, formerly known as Core Clearing, was due approximately $15.3 million from the trading activities of a correspondent broker-dealer, and that the collection of that receivable was uncertain. On March 8, 2019, Axios Clearing entered into an agreement with a trader who caused this loss, under which Axios Clearing was to be paid $10.5 million, $7.5 million immediately, and another $3 million over time secured by the trader's residential real estate. The initial payment was not received when due, and Axios Clearing filed a breach of contract lawsuit against this individual. On March 31, 2019, no amount has been collected. and we concluded that the timing of any repayment of the $15.3 million receivable from this individual or the responsible broker-dealer which has discontinued its trading activity remains uncertain. A loss provision was included in our consolidated operating expenses for this quarter for the full $15.3 million receivable. The correspondent broker-dealer is required to indemnify access clearing and has initiated a FINRA arbitration against its former trader seeking recovery for the entire loss and other damages. Our holding company's risk team, including the Axos clearing risk team, have conducted a detailed review of the circumstances under which the loss occurred and a comprehensive review of our internal risk systems. Design enhancements to our own systems and procedures to better detect subversion of risk controls have been implemented, and the risk controls of selected correspondent broker-dealer customers have been confirmed and tested. In addition to the work we have completed, we are making investments in further enhancements to risk systems, limits, and processes designed to limit similar events. we are actively building our client pipeline through targeted outreach and marketing of access clearing. When you consider the acceleration of investments we are making in risk and other systems, changes and enhancements to the management team, and lower projected fee income from slightly client rationalization, we considerably expect that the deal of creation we initially projected in year one for core will likely be neutral from an EPS perspective. With that being said, we have already achieved some early client success in the short term we have owned the business, including signing three corresponding clearing firms with over 8,000 client accounts and approximately $36 million in projected cash balances. While it typically takes two or three quarters for a new correspondent to transition all their client accounts to a new clearing firm, these client wins suggested opportunities to grow our securities, clearing, and custody clients and asset bases robust. The response to utilizing our front-end client interface to sell banking products to our correspondent clients' customers has been overwhelmingly positive, and delivery of technology that will enhance the client experience and expand our product offerings will be a top priority. Securities-based lines of credit and RIA custody represent meaningful long-term revenue opportunities and a source of incremental upside in the short term if client uptake ramps faster than we expect. Assuming flat fee income and sweep interest income, we expect to combine securities businesses, which include Axos Clearing and Wise Banyan, to operate at a high 80s and low 90s efficiency for the next year compared to the mid to high 70s efficiency target for the medium to long term for Axos Claring operating range. And Wise Banyan will operate at a loss of approximately $3 to $4 million in the first year as we incorporate their platform into our universal digital banking platform and scale the platform to spread the fixed cost of operations. With a successful deposit conversion behind us, We launched our relationship with Nationwide to offer co-branded banking and insurance products and services to Nationwide Associates, policyholders, and general market customers earlier this year. The agreement, with the initial term of five years, encompasses a variety of deposit and lending products to consumers and small businesses. Since our soft launch in February, we have taken over our mortgage relocation services for Nationwide Associates, executed a win-back campaign with Nationwide Associates, added a banking services tab on Nationwide's dedicated website for small business owners, and started building data and marketing strategies for specific consumer lending channels. We have also met with business unit leaders at Nationwide to discuss specific new opportunities to offer bundled banking, financial wellness, and benefits packages to target client segments such as pet owners and RIAs. We appreciate the collaborative and growing relationship with Nationwide. We continue to make good progress in our strategic initiatives to grow and expand our commercial banking business. Axos Fiduciary Services, the trustee and fiduciary services business we acquired from Epic in April 2018, continues to perform well. Last month, we successfully transitioned all our data and team members from Epic to our new office in Kansas City. The transition allows us to work more efficiently while maintaining a responsive and stable infrastructure from which we can serve our trustee clients. Our trusted relationship managers and senior business leaders continue to work alongside bankruptcy trustees and fiduciaries nationwide to provide the essential services they need to administer, track, and report on Chapter 7 bankruptcy and other non-Chapter 7 legal matters. Concurrently, we are actively exploring adjacent market opportunities to serve trustees in non-Chapter 7 cases. At March 31, 2019, dozens of trustees with approximately $300 million invested of noninterest-bearing balances have chosen to transition their banking services to our bank. As more trustees are able to provide testimonials to their peers about the responsive service and strong value proposition Axos Fiduciary Services provides, we are hopeful that we can add new trustees. A second component of our commercial banking strategy is expanding our geographic presence and industry expertise through selective additions of experienced bankers and banking teams. This started about two years ago when we hired a team and opened a commercial banking office in Orange County. Based on the profitability and success of that initial group, we added additional senior bankers from other community and regional banks in the past year. More recently, we hired an experienced team on the East Coast to target general middle market deposit and specialty deposit verticals. This group will work side by side with our existing commercial lending team and the significant existing lending book of business we have when we open our first East Coast office in New York later this quarter. We believe our regional center strategy is allowing us to attract the necessary talent in markets where we have a significant existing presence and will allow us to develop a balance between our consumer and commercial bank as we grow to become a $15 to $20 billion bank. Our net interest margins have held up well, expanding by five basis points year over year on a consolidated basis, including the security segment, and nine basis points at the bank, excluding H&R Block, even though we must focus on increasing loan growth coming out of the first quarter holiday season. Deposit competition remains high across the industry, and a flat yield curve has generally created downward pressure on net interest margin for many banks. We continue to work proactively on the asset and funding side to support an annual net interest margin in the 380 to 4 range, irrespective of what the Fed may do the rest of calendar 2019. 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 clients, and the second year that we are the exclusive provider of interest-free refund advance loans. In the quarter ended March 31, 2019, we originated approximately $1.16 billion of refund advance loans, up approximately 7% from the $1.08 billion we originated in the prior year. We received fees from H&R Block based on the principal amount of refund advance loans we originated while we recorded as net interest income in the quarter ended March 31st. As of last Wednesday, less than $20 million of refund advances were outstanding. Consistent with prior years, we will generate additional fee income in the June quarter for refund transfer and emerald cards. We are pleased with the execution of yet another successful tax season with H&R Block. Our capital ratios remain strong despite recent actions to deploy some of our excess capital into accretive M&A transactions. Our Tier 1 leverage ratio was 9.25% at the holding company and 8.68% at the bank on March 31, 2019, well above our required regulatory capital thresholds. Once the majority of the tax-related excess liquidity leaves our balance sheet, our capital levels will be even higher. Our priorities for excess capital have not changed. We will continue to fund organic growth and investments in our business and consider opportunistic share repurchase on the creative M&A. I'd like to close by discussing our overall strategic vision and operating model in light of recent acquisitions and strategic investments. We are committed to having a strong consumer and small business bank, a commercial bank, and a securities business. With respect to our consumer business, we have a variety of profitable niches that we continue to focus on growing individually. jumbo and agency mortgage lending, auto, unsecured lending, retention of servicing rights, small business and consumer banking. We also have a variety of unique sources of customer acquisition in each of these businesses, including our partnerships and affinity relationships. As each of these businesses individually grow, we will utilize our proprietary platform to centralize the vast majority of interactions with our customers and small business lending and deposit customers to enhance the customer experience and reduce operating costs. As this group of customers grow, we will utilize our evolving personalization engine to target this growing group of customers with an expanding product suite, which will include digital wealth management and eventually online trading. We launched this platform only a month before we closed the nationwide acquisition and then followed it with a second acquisition only a few months later. We are all working hard to bring this vision to fruition. This strategy provides the best way to monetize consumer and small business customer acquisition costs over time in a fully digital model that is not dependent upon fiscal presence. On the security side of the business, we will be primarily focused on serving small to medium-sized broker-dealers and RIAs with clearing and custody services, but integrate a best-in-class banking platform and account-opening platform to ensure these companies can remain competitive in the digital arms race. The development required to build a consumer platform overlaps significantly with the business to a business platform required for the in-client experience that access clearings clients. These firms will benefit from our technology, the customer attention derived from easy access to banking products, a clearing firm is responsive to their needs, and we will benefit from a cost-effective model for customer acquisition and capital-efficient fee revenue generation. Our commercial business is also technology and software-focused serving specific industry verticals that we have selected either for their risk return profile or their needs for specific technology. We have a number of industry verticals that we are excited about, which we believe will supplement our loan growth and reduce our deposit cost over time. We believe we can operate this model with the limited office locations we have discussed already to allow our team members, many of whom are already present in these locations, to better collaborate with one another. capital deployment to grow existing and new businesses, infrastructure and technology investments such as UDB, strategic partnerships like H&R Block and Nationwide, and acquisitions such as the addition of Axos Fiduciary Services and Core all go hand-in-hand with this long-term strategy to further diversify and expand our product capabilities, distribution channels, and revenue sources. As we become a larger institution and more traditional and nontraditional competitors, encouraged on various parts of the overall financial services value chain, or act for a period of time in an irrational manner, it will be even more important to have multiple levers and revenue streams from which we can generate good risk-adjusted returns and be able to monetize the cost of customer acquisition over a broader range of product sets in a fully digitally-enabled manner so that we can give customers a better value proposition. Not all of these businesses will have similar growth rates in different phases of the credit cycle, operating efficiency ratios and return profiles on a standalone basis, and various investments will reach optimal profitability levels faster than others. Ultimately, what is of utmost importance is that we continue to improve our products, capabilities, and customer experience so we will be able to create a sustainable competitive advantage in light of rapid changes in the competitive regulatory and economic landscape. We firmly believe we have the right model for success and are more excited than ever to execute on the incredible opportunities that are in front of us. Now I'll turn the call over to Andy, who will provide additional details on our financial results.