Axos Financial, Inc.

And thank you for your patience. This conference will begin momentarily. Please continue to hold. Thank you. Thank you for watching. Good afternoon and welcome to the Axios Financial third quarter 2023 earnings call. At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. Please note that this conference is being recorded. I will now turn the conference over to our host, Johnny Lai, Senior Vice President and corporate development, and investor relations. Thank you. You may begin.

Thanks, Diego. Good afternoon, everyone, and thanks for your interest in Axos. Joining us today for Axos Financial Inc.' 's third quarter 2023 financial results conference call are the company's president and chief executive officer, Greg Garabrantz, and executive vice president and chief financial officer, Derek Walsh. Greg and Eric will review and comment on the financial and operational results for the three and nine months ended March 31st, 2023, and 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 a safe 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 in the investor relations section of the company's website located at accessfinancial.com for 30 days. Details for this call were provided on the conference call announcement and in today's earnings press release. Now I'd like to hand the call over to Greg. Thank you, Johnny.

Good afternoon, everyone, and thank you for joining us. I'd like to welcome everyone to Access Financial's conference call for the third fiscal quarter ended March 31st, 2023. I thank you for your interest in Axos Financial and Axos Bank. We delivered double-digit year-over-year growth in earnings per share, book value per share, and ending loan and deposit balances. Our consistently strong results were broad-based with stable net interest margins and double-digit net income and non-interest income growth. We grew deposits by approximately 32% year-over-year despite an expected normalization in cash-sorting deposits from our custody business. The diversity and optionality of our deposit franchise is a valuable differentiator that will allow us to maintain a strong net interest margin in a highly competitive market for deposits. We reported net income of $80 million and earnings per share of $1.32 for the three months ended March 31, 2023, representing year-over-year growth of 29% and 28%, respectively. Our book value per share was $31.07 at March 31, 2023, from March 31st, 2022. The highlights for this quarter include the following. Ending deposits increased by approximately $1 billion linked quarter, driven primarily by consumer deposits. We took advantage of anxiety in the marketplace following the three bank failures in March and added new consumer and commercial banking clients. Excluding the reduction of access advisory service deposits, ending period commercial and consumer non-interest bearing deposits were flat from the end of the prior quarter. Ending net loans for investment balances were $15.8 billion, up 2% in the quarter, or 9% annualized. Loan growth was broad-based with growth in single-family mortgage, multifamily, and CNI loans, partially offset by our deliberate pullback in auto, small balance, CRE, and leasing. Net interest margin was 4.42% for the third quarter, down 7 basis points from 4.49% in the quarter ended December 31, 2022, and up 40 basis points from 4.02% in the quarter ended March 31, 2022. The impact of excess liquidity on our net interest margin accounted for approximately five of the seven basis points declined in net interest margin. Net interest margin for the banking business was 4.5% compared to 4.65% in the quarter ended December 31, 2022, and 4.21% in the quarter ended March 31, 2022. Higher loan yields partially offset the increased funding costs and negative impact from holding excess liquidity. Axo Securities, comprised primarily of our custody and clearing business, made positive contributions to our fee and net income. Broker-dealer fees increased 40% link quarter and 166% year-over-year due to higher interest rates and increased client activity. Quarterly pre-tax income for our securities business improved by $3.9 million link quarter to $19.5 million. Our credit quality remains strong with annualized net charge-offs to average loans of four basis points versus five basis points in the third quarter of fiscal 2022. Of the four basis points of net charge-offs this quarter, three basis points were from auto loans that are covered by insurance policies and will be subject to subsequent recovery. Double-digit growth in net interest income and non-interest income resulted in the 29% year-over-year increase in our diluted earnings per share. We generated a 1.71 return on assets and a 7.4% return on equity for the quarter ended March 31st, 2023. Our strong capital levels improved further with Tier 1 leverage ratio of 10.2% at the bank and 9.3% at the holding company, both well above our regulatory requirements. We repurchased approximately $32 million of common stock in the third quarter to take advantage of the unwarranted decline in our share price in reaction to the turmoil in the banking industry. Given what has transpired in the banking industry since early March, I'd like to spend some time discussing what makes Axos different and why we believe we are operating from a position of stability and strength. From a liquidity and capital perspective, we emerged from the turmoil even stronger. We increased deposits by $1 billion this past quarter to $16.7 billion, with approximately 90% of our total deposits being FDIC-insured or collateralized. We had $2.5 billion of cash in cash equivalents as of 3-31-2023, equal to 138% of our uninsured deposits. We had no outstanding borrowing from our Fed discount window or from the bank term funding program. We had no overnight borrowings from the Federal Home Loan Bank as of March 31, 2023, and we had $3.1 billion of undrawn capacity at the discount window and $2.5 billion of immediately available undrawn capacity with the FHLB at quarter end. The combined cash and undrawn liquidity available was $8.1 billion at quarter end, equal to 450% of our uninsured and uncollateralized deposits. Unlike many other banks with significant unrealized losses on their securities and loan portfolio, we had a de minimis $7 million of net unrealized losses on our $280 million available for sale security portfolio at 3-31-2023. The $7 million of unrealized loss represents less than 50 basis points of our shareholder equity at the end of the third quarter. Additionally, the fair value of our loans held for investment was a positive $30 million at the end of the quarter. Another way to say this is that if you mark our entire securities portfolio and loans held for sale and exclude entirely the positive mark on our entire deposit base, our equity would increase. Our favorable liquidity and capital position is the result of our deliberate decision not to extend maturity in our securities or loan portfolio and to reposition our loan max from hybrid single-family and multifamily mortgage loans to variable rate commercial and industrial loans when interest rates were near zero. We have always maintained a disciplined policy of pricing our loans with the appropriate rate, fee structure, and terms commensurate with our risk and return objectives. We also proactively establish channels where we can sell or pledge our loans quickly, at or above par, as a contingency plan should any unexpected adverse events arise. Shifting to interest rate risk management, we continue to generate an above-average net interest margin and grow deposits despite the Fed's aggressive rate increase and deposit outflows for the banking industry. This quarter, our consolidated net interest margin was 4.42%, while our bank-only net interest margin was 4.5%. We maintained a strong net interest margin despite the decline in AAS sweep deposits and us holding excess liquidity during the quarter. Our ability to maintain a net interest margin above our historical range is a function of the diverse lending and deposit franchises we have built over the past decade. We built our CNI lending verticals organically and scaled them over time to ensure we had the appropriate operational compliance and risk management infrastructure and processes in place. We acquired declaring custody and bankruptcy deposit businesses when rates were at or near zero and deposit balances were near their cyclical lows. Over time, we integrated systems and processes, added talents and relationships, and increased sales and marketing to grow these businesses profitably. The net result is our loan and deposit franchises are much more robust, diverse, and aligned from a duration and margin perspective than they've ever been. At the end of the quarter, approximately 57% of our loans were floating rate, 36% were hybrid 5-1 arms, and 7% were fixed. The average duration of our loan portfolio was two years, with multifamily loans having an average of 2.6 years duration, and the vast majority of our commercial real estate specialty loans and lender finance portfolios with a contractual maturity of less than three years. The average yield in our held for investment loans was 7.07% in the third fiscal quarter, up 45 basis points from 6.62% in the prior quarter. New loan yields were 10.1% for auto, 7.9% for multifamily, 7.2% for single-family jumbo mortgages, and 9.2% for commercial and industrial. We continue to see bank and non-bank competitors pull back in many of our lending businesses, and we feel good about our ability to grow our loan portfolio in a secure way with pricing and terms that meet our risk and return requirements. Our deposits at the quarter end were comprised of 43% demand deposits, 46% savings and money market, and 11% CDs. We issued more CDs this quarter to align the duration of our loans, given the growth in net balances and the slowdown in prepayments in our single-family and multifamily loan portfolios. Our deposits remain well diversified from a business max perspective, with consumer and small business representing 48% of total deposits, commercial, treasury, management, and institutional representing 26%, commercial specialty representing 7%, Axos fiduciary services representing 7%, Axos securities, which is our custody and clearing, represented another 7%, and distribution partners representing 4%. The granularity and diversity of our deposits, particularly consumer savings and money market accounts, provide us with tremendous flexibility to match the duration and cost of our funding to the duration and cost of our adjustable and hybrid loans. Ending not interest-bearing deposits excluding fluctuations in access advisory services cash balances were approximately flat from December 31st to March 31st, with the ending period balance down approximately $269 million to $3.2 billion, reflecting almost entirely the reduction in the AAS cash. Total ending deposit balances at AAS, including those on and off Axos balance sheet, declined by approximately $380 million in the quarter, while non-interest-bearing commercial and specialty deposits were flat. We believe that the pace of cash sorting at AAS is stabilized at or near the bottom, representing 5.6% of assets under custody at the end of the quarter compared to the historical range of 6% to 7%. Axos Advisory Services has a healthy and growing pipeline of new advisory clients with 15 new deals signed with a combined assets under custody of $1 billion this quarter. In addition to the Exos Securities deposits on our balance sheet, we had $1.1 billion of deposits off balance sheet at partner banks and approximately $680 million of deposits held at other banks by software clients in our Zenith business management vertical. We continue to add new accounts across each of our deposit businesses, including consumer checking, consumer savings, money market, and CDs, commercial and treasury management, AFS, and Axel Security. Since the banking failures in early March, we have aggressively increased our outreach to existing and prospective clients across every deposit vertical. With our experience with the Intrify ICS product and a competitive set of treasury management offerings, we are seeing a lot of interest from clients who are moving deposits to us. Our low loan-to-value asset-based lending philosophy continues to serve us well from a credit perspective. Our single-family jumbo mortgages and multifamily loans, which represent 24 and 19 percent of our total loans outstanding at the end of the quarter, have a weighted average loan-to-value of 57 percent and 53 percent, respectively. Our jumbo single-family mortgages are concentrated along the coast in markets where housing inventories continue to be constrained. The lifetime loss in our originated single-family jumbo mortgages and multifamily mortgages are four basis points and less than one basis point, respectively. Our commercial real estate lending business, comprised of low LTV lending to non-bank lenders and well-capitalized sponsors, is secured by single-family, multifamily, and commercial real estate properties in attractive locations. Of the $5 billion of commercial specialty real estate loans outstanding at the end of the quarter, multifamily was the largest segment, representing 31% of total loans, condominiums and single-family representing 23%, with hotel, office, and retail representing 16%, 14%, and 5% respectively. We included a slide in our earnings supplement detailing the balances, loan-to-values, and non-performing loans for our commercial specialty real estate portfolio. On a consolidated basis, the weighted average loan-to-value of our commercial real estate portfolio was 42%. For the retail and office segment of our commercial real estate book, the weighted average loan-to-value was 42% and 37% respectively. Of the $673 million commercial specialty real estate loans secured by office properties at the end of the quarter, 77% are A-notes or note-on-note loan structures with significant subordination from fund partners and mezzanine lenders, resulting in the 37% loan-to-value ratio. The office exposure that isn't an A note with a strong funding partner is almost entirely a pari-pursuit participation for One Madison in New York, one of the best office buildings in the city. This building is 57% pre-lease and has a 50% recourse guarantee from S.L. Grain, subject to conditional releases based on certain leasing, cash flow, and other milestones. Approximately $80 million of the commercial specialty real estate office book repaid after the end of the March 31st quarter. We have no lifetime losses in our entire commercial specialty real estate loan book. Our lender finance lending is comprised of lines of credit to non-bank lenders. The total lender finance book outstanding was $2.4 billion at the end of the quarter, with real estate lender finance accounting for approximately 35% of the total lender's real estate lender finance accounting for the other 65%. We have a direct and a fund business in lender finance, and the weighted average loan devaluer for the lender finance portfolio was 54%. We actively monitor the cash flow and credit performance of our lender finance borrowers. The loan structure and our senior position in the payment waterfall provides us with confidence that our lender finance portfolio can withstand significant stress and not result in material loss to the bank. We've never lost any money in the lender finance portfolio. Our auto lending business comprised of direct and indirect lending to prime and super prime lenders had an ending balance of $518 million at the end of the quarter, representing only 3% of our total loans outstanding. We have reduced originations meaningfully in the auto lending due to our cautious outlook on the broader economy and used car values, resulting in net auto loan balances falling by approximately $37 million in the third quarter of 2023. With an overwhelming majority of our total loans outstanding being secured by some form of collateral, we believe our credit will perform well through the cycle. One of the key differentiators that allows us to grow revenue loans and earnings in a consistent and safe way is that we operate a software-based, high-touch service model for clients nationwide. Whether it's through our universal digital bank online and mobile platform that provides consumers a convenient and secure way to access all deposit lending and securities trading and wealth management services digitally, or our proprietary front and back end custody platform that simplifies the trading, reporting, marketing, and back office functions for independent RIAs, we acquire onboard, underwriting service customers efficiently. Each deposit lending and fee-based business vertical is supported by a robust risk management infrastructure and a team of dedicated members who with subject matter expertise in their business and functions. The diversity and, in certain instances, the countercyclicality of our businesses allow us to shift capital and resources quickly and efficiently when competitive and economic conditions change. As we have demonstrated throughout our history, especially during periods of distress, such as the dot-com boom and bust, the great financial crisis, and most recently the COVID pandemic, being able to pivot quickly to capitalize on market dislocations is a significant competitive advantage. Our strong capital liquidity and profitability allows us to maintain investments in technology, people, and products while others pull back. We see improved loan pricing that will help offset lower demand in some lending categories as rates continue to rise and the economy decelerates further. We will continue to execute and expand various operational efficiency initiatives, including business process automation, offshoring, low-value manual tasks. We have already seen significant opportunities to hire talented individuals and teams to help us incubate new businesses or augment existing businesses. We have also reviewed opportunities to purchase assets, loans, and businesses from failed or less well-capitalized institutions looking to exit non-core businesses and or to shrink their balance sheet. Lastly, we'll take advantage of opportunities to return capital to shareholders through share buybacks when our stock becomes irrationally undervalued. And I'll turn the call over to Derek now.

Thanks, Greg. To begin, I'd like to highlight that in addition to our press release, an 8K with supplemental schedules and our 10Q were filed with the SEC today and are available online through EDGAR or through our website at AxiosFinancial.com. I will provide some brief comments on a few topics. Please refer to our press release, our SEC filings, and our website for additional details. Loan originations for investment for the quarter ended March 31, 2023, were $1.8 billion, down from $2.4 billion in the comparable quarter a year ago. We tightened our pricing and underwriting guidelines in auto, unsecured consumer, and small-balance commercial real estate and had lower demand in single-family jumbo, resulting in a decline in loan originations. Fiscal Q3 2023 originations were as follows. $178 million of single-family jumbo portfolio production, $148 million of multifamily production, $797 million of commercial real estate production, $20 million of auto and unsecured consumer loan production, and $588 million of C&I loan production, resulting in a net increase in ending C&I loan balances of $246 million. Credit quality remains good, with four basis points of net annualized charge-off to average loans, three basis points of which were from auto loans that are covered by insurance policies. Our non-performing loans and leases were 60 basis points at March 31, a basis point improvement from the December quarter. Single-family, multifamily, and small-balance commercial mortgages represented over 75% of our non-performing assets at the end of the third quarter. Given our low loan-to-values and our low historical losses in these lending categories, we do not anticipate material increases in our net credit losses. We added $5.5 million of provision for credit losses this quarter to support our loan growth. Total allowances for credit losses represented 168% of our non-performing loans at March 31, 2023. Non-interest income for the three months ended March 31, 2023 was $32.2 million, an increase of 12% compared to $28.8 million in the corresponding period a year ago. Broker-dealer fee income increased by $8.6 million year-over-year to $13.7 million in Q3, 2023. due primarily to higher interest rates. Mortgage banking income was down approximately $5 million year-over-year to $1.1 million as a result of the industry-wide downturn in single-family agency mortgage refinancing activity. Prepayment penalty fee income was down by $0.7 million to $2.1 million as the increased rate environment led to decreased levels of prepayments on multifamily and commercial loans. Lastly, on equity, our return on equity was 17.4%, and our return on average assets was 1.7% for the three months ended March 31, 2023. Tier 1 capital, the risk-weighted assets for Axios Bank, was 11.6% at 3.31%, up from 11.3% in the prior quarter. Since June 30, 2022, net capital at Axos Clearing has increased by approximately $41 million to $79.5 million, due primarily to higher profitability in our securities business. We have excess capital at the holding company, available for opportunistic share repurchases and to contribute to our subsidiaries if needed. After buying back approximately $32 million of common stock in the third quarter, we had $21.2 million remaining availability in the stock repurchase program. That was before yesterday when the Board of Directors approved an additional $100 million of availability for the stock repurchase program. This allows us further optionality in the management of our capital between internal investments, accretive acquisitions, and share buybacks. Additional commentary on our loan pipeline are that we had $33 million of single-family agency gain-on-sale mortgages, $273 million of jumbo single-family mortgages, $83 million of multifamily and small-balance commercial real estate term loans. And then, given the dynamics, We now expect loans to grow by high single digits to low teens year over year, and our net interest margin in the range of 4.25% to 4.35% for the next few quarters. Our loan growth outlook is based on a gradual rebound in single-family jumbo mortgage originations coupled with low prepayments in that business, double-digit growth in our Crestle and lender finance businesses, and flat to declining auto and unsecured lending. We believe that moderating our pace of loan growth and building capital levels until the economy and the banking industry rebound is a prudent tradeoff. Our NIM guidance reflects loans repricing higher, offset by rising deposit costs. We also expect to maintain a higher average deposit balance for the next few quarters, which will have a 10 to 15 basis point drag on our consolidated NIMs. We believe maintaining excess liquidity is prudent given the uncertain economy and industry environment. That said, we are excited about the opportunities ahead and feel that Axos is well positioned to continue its strong financial performance. With that, I'll turn the call back over to Johnny.

Thanks, Derek. Operator, we're ready to take questions.

Thank you. And ladies and gentlemen, at this time, we'll conduct our question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate that your line is in the question queue. You may press star 2 if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. Our first question comes from Andrew Leash with Piper Sandler. Please state your question.

Thanks. Derek, you just answered a bunch of my questions. But on this liquidity that's on the balance sheet right now, the 10 to 15 basis point drag, how does that affect NII? Is that neutral right now?

Yeah, I think it's fairly neutral because we just put that money with the Fed. There may be a slight benefit from it, but if you look at the average cost of the marginal cost of the highest cost deposit, I think I think a neutral assumption is roughly correct. Got it.

And then just looking at the queue, it didn't look like there was too much change in substandards or special mentions, but are you seeing anything in those loans that's giving you any pause right now? I mean, your commentary was that you're not expecting much material losses in the loan book, so I'm guessing no. I'm just curious if there's anything out there that you're looking at more closely.

No, we're not really seeing anything that – that we find concerning and we're looking pretty carefully and I think where we are in our attachment points are still very, very strong and so we're not really seeing anything that we feel we should be concerned about.

Got it. Greg, you mentioned that you were able to take advantage of some of the turmoil in the markets here and add more consumer deposits and probably some commercial deposits too. But are there any businesses that you think you might want to expand into or anything that you see attractive out there as you take advantage of some of what's gone on with some other banks?

Yes, we think so. We've got some team hires that we're working on, some that have accepted in certain areas that we really like. We'll kind of let those materialize over the next few quarters before we make announcements, given that they're kind of in process and we don't want to have people getting ahead of us and things like that. But yeah, I think there's not only team acquisitions. Let's talk about the opportunity set. There's definitely team acquisitions on the deposit and lending side in areas that previously had been probably precluded by the nature of the competition in that area, in those areas. And so those are clearly open. There's opportunities for bulk loan purchases in a few cases that we might be interested in. We'll have to see how that goes. Those are very, you know, Boolean, right? You either win them or you lose them. But that could change the loan growth prospects. So we would – you know, we gave you kind of organic loan growth, you know, views. And so if we buy a portfolio, that would be bigger. And then there's just simply the fact that customers are looking more than ever for diversity in their deposit relationships. And so we're seeing very high – rates of increase in the applications on both consumer and commercial deposit categories, and we're having conversations with clients that previously had been ensconced in other institutions fairly strongly and are now interested in either moving or diversifying. So we think we actually feel really good about our deposit pipeline right now, too. It just looks very good. And the teams have been working weekends to open accounts, and we've been adding personnel there. So we feel really good about those three areas.

Got it. That's good to hear. Thanks for taking the questions. I will step back.

Thanks, Andrew.

Our next question comes from David Feaster with Raymond James. Please state your question.

Hey, good afternoon, everybody. hey david um maybe just starting on the loan growth side appreciate the the high single digit guidance you know and that kind of jives with the the slowdown and originations we saw i'm just curious how much is this by design or is this you know a function of just less demand in the market and just so just kind of curious some of the drivers of that and then maybe where are you still seeing good risk-adjusted returns at this point in the cycle? I mean, you alluded to some opportunities in Jumbo Single Family and in Crestle and Lender Finance. But I'm just curious, as you dig into it, where are you still seeing good risk-adjusted returns as well?

So yeah, with respect to the loan growth side, clearly on the consumer side, it's intentional. We don't really see anything particularly problematic happening in that book. The insured book has a little higher delinquency, but that's also well covered by the insurance, but it's still quite de minimis. We just really don't want to deal with the servicing type issues there as much and are kind of pulling back a little bit there deliberately. On the other side, I think it's just really a matter of more of us continuing to tighten what we're doing. And so as that happens, you know, we're holding pricing terms and then often tightening those terms. And so that kind of lets itself fall out. But I really do think that what I feel reasonably good about loan growth, I think we're being, you know, I think that's our best estimate, you know, that $500 million, $600 million, a quarter of growth-ish, something like that. I think that's where we're forecasting next quarter, but could it be a little higher, a little bit lower, potentially? And we also are seeing some interesting opportunities that are arising in very low-risk areas as a result of some of the exits and movement that's been happening in the banking business. So I actually think that there are good deals across the board. They just have to be structured properly. And You know, I mean, when we're doing Crestle deals now, we're looking at 12 and 13 debt yields, right, for attachments to our piece. Those are good deals, right, with great sponsors. So, you know, I think that the pullback in the market that we're seeing from a lot of other lenders is enabling us to get better sponsors, better borrowers, tighter credit, and better pricing. So it's really a good time in a lot of ways to be a lender because you can get ahead of what those value changes are in an environment where there's just reduced competition.

That makes a ton of sense. And then obviously there's a hyper focus on CRE with investors at this point. You know, I'm just curious what you're seeing more broadly there. You touched on it a little bit. You know, you're seeing other competition kind of pull back. And you've always had extremely tight underwriting standards. Obviously, there's low LTVs, as you can see in the presentation. Appreciate that. But maybe just more broadly as you look out, is there anything that you're watching from a market perspective or a segment maybe that you're avoiding or pulling back in? And how are you tightening standards? Just curious kind of what you're seeing more broadly there.

Sure. So let me talk about it in two ways. The first way would be how the cash flow of the property is doing and what's the underlying economic fundamentals of each of the property types. Then just talk about the impact of interest rates or other valuation issues. So what's interesting about it is that the housing market just in generally, including what you see on the condo sales side, even in places like New York, Miami, all these places, they've essentially held in or actually gotten better in some respects. So right now, the single-family or condo sort of issues that people thought might arise so far have been a big bust. Now, again, when you're at 40-ish percent loan-to-values, on those things, you know, it doesn't really matter that much if you get some decline in value, but we're not seeing it. It's not there. And, in fact, if it's a good product and it's well-placed, it's in New York, it's flying off the shelves, actually. So that's sort of interesting. The next, office, it depends on what you have on the office side. To the extent we've ever done that, done office, If we're not doing it in an extremely structured way where we're 15% loan to value for an office conversion with a fund guarantee from Fortress or something like that, then we're looking at the best building. I gave that example, the one Madison building, which is pre-leased to all these Fortune 500 companies. It's the best building in New York. If you want to be in an office and you're going to have people come in to work, you want to be there. I think office clearly in many cities and places that we stayed away from for a long time is doing terribly. Obviously in San Francisco, L.A., particularly markets that have been subject to the sort of, you know, the criminal negligence that you have associated with how those cities are run, right, from a crime perspective and whatever. People don't want to be in those places. They don't want to be in L.A. downtown. You know, even our office, our team wants to move because, you that people can't walk around the building without being bothered, right? So it's just sort of that kind of stuff is causing in some of those markets those problems. So I think you have to be obviously very careful there. On the hotel side, frankly, the hotels are doing incredibly well. I mean, they are blowing out their projections, gangbusters, et cetera, blah, blah, blah, right? So it's just really good, and industrial the same way. So the question is, so you've got cash flow and those sort of things, and we always cut these projections, but they're even hitting their own projections, right? So it's sort of interesting. That looks really good. So then the question is, so you've got those cash flows. They're looking good. Obviously, they might not stay that way forever, but right now you're not seeing problems. Then the question is, what's the value? And so then the interesting question is, Well, so cap rates clearly in asset classes that are performing well haven't increased from a trade perspective anywhere near the way interest rates have increased. So then the question becomes, well, why is that? And one answer is that the yield curve is obviously inverted. When you buy these properties, you're buying them over extended periods of time, and there's maybe potentially over-optimism not only on that cap rate but also on the potential for increased cash flows. So what we've done in order to deal with that is basically say we're making the assumption that all these cap rates have gone up by that and a lot more, and we're going to get a significant reduction in the cash flows even though we're not seeing it, right? And so that results in new deals being written at 11s and 12s from a debt yield attachment perspective, which allows us to have a saleable piece of paper at cap rates that are nearly double what the appraisals are, right? And that comports with those loan-to-value ratios. So I think when you look at these sort of things, and then obviously we cultivate a very robust set of folks that are interested in being able to buy loans those properties in whatever form they're at and, you know, are opportunistic. And so we have a very broad base of opportunistic clients that are always interested in taking advantage of those opportunities. And so how we deal with that is we just simply, you know, adjust what we expect target debt yields are. We adjust the advance rates and, you know, we look for recourse and all those other things that we can do. And in a market like this, you just have more market power to do that. So, you know, I think, look, I think that the fundamental issue is if you, like if you went on a San Francisco office building and you were 70% non-recourse, which is something that you could have easily gotten, and you basically had tenants and you, you know, underwrote it at a 3.5% or 4% cap rate, which is what the appraisal is, that's, That's a tough loan, right? But that's a very different thing from the type of stuff that we did. So, you know, we were never really in that kind of market because we never really believed the cap rates, right? So we had to choose kind of a different approach. And I think that approach has turned out to ultimately be correct, and I believe it will continue. turn out to be correct over the cycle.

Okay, that's an extremely helpful caller. And then maybe just switching gears, I was hoping to get a status update on the security segment. I mean, you guys, it's nice to see really the earnings power of that business starting to shine. I'm just curious, where are we at in the build out there and kind of the process improvements and all those types of things? And kind of what's the roadmap near term for that business and any other initiatives that you have on the horizon?

Yeah, sure. So where we are in the build-out is it is great to see progress there, and there has been a lot of progress made, but it's still very early innings with the sets of opportunities we have there. So we kind of talked about this in a number of different calls and stuff, but I'll kind of summarize it to kind of, give you my perspective on where we are. First, on the clearing side, one of the impediments we have is we have a very expensive core processor that kind of charges us by transaction, and then we pass all those transaction costs on to the clients. We're a decent way through the development of what we've called Axos Universal Core, which is a system that would replace that securities core. And that would then give us the opportunity to basically partner with a variety of different clients, often larger clients, in materially different ways. And so part of our pricing stops us really from going out and getting bigger clearing clients because we don't have the pricing to do it. And a company like Pershing owns its own system, so we're looking to have much greater parity there on a modern system at the level of the core. Then the other elements that are progressing nicely is that we're also taking the front-end application for consumers and integrating that fully with the system's that we have for the clearing and custody business so that there's one application that can be utilized for the end clients of the RIAs and the brokers. And so those clients would then be incented to bank with us through a variety of different mechanisms so that when we're boarding an RIA. We're boarding that account not only on the security side, but we're also boarding it on the banking side. We're boarding it for a securities baseline and credit, and then working to serve that entire customer's need. That's ongoing as far as development and doing well. We're projecting that around end of July we'll have the white label platform built out entirely for the consumer and that will have the white label account opening as well for the RIA and then we do have we have some test clients on the white label enrollment for the broker side but what we really need to do there is get a UDB embedded in that but The only problem is if we basically code that up to the old core, then that doesn't help that much. So we're kind of going to roll out the UDB platform to the clearing clients at the same time we roll out the universal core. So I think that, you know, there's some fundamental costs changes that can occur from the universal core and then a lot of opportunities on the cross-sell side for banking because we get very, very positive feedback with respect to RIAs that often left these bigger wire houses and they don't like their clients banking at their old employer because it just generates a connectivity that then that then stops that – that hurts that potential retention of the client. On the op side, we've done a lot, but there's still a lot to do. The security segment is nowhere near as efficient as the banking segment. There's a ton of straight-through processing opportunities. Some of those are related to – to the ability to get access directly to the client because through the app, right? Because when that happens, then all of a sudden communications are made easier, money movement is made easier, and all of those things just sort of fall in place. So those are somewhat connected but not entirely so because there's plenty of back office stuff that can be improved on that side. So... Yeah, so there's a lot of great opportunity. The client reception is extremely good. People want another choice other than Schwab, and with the merger they've just been forced into Schwab entirely. So, yeah, there's a lot of opportunity on the custody side there for sure.

That's terrific. That's a great caller and excited to see this all play out. Thanks. Thank you.

Our next question comes from Gary Tanner with DA Davidson. Please go ahead.

Thanks. I just wanted to follow up on the comment you made on the prepared remarks on the RIAs. Fifteen RIAs, I think, signed up, AUM of a billion. What's the timing for the onboarding of that group?

You know, it's a little bit variable, but I think six months is a reasonable kind of view. But, you know, some of this depends on their own pace. And, you know, we're also, you know, building better processes to move that along. But I think a six-month timeframe is a fair kind of representation of the time it usually takes from the time a contract is signed to the time that the clients get onboarded.

And I know, you know, in the past you've talked about the ability to really attract larger clients. individual RIAs once you kind of complete the integration of the full suite. So are those, is that kind of still the perspective that there's going to be?

Yeah, I think it is. Yes. Well, so both on the clearing side, I think that the bigger fish, we're precluded from getting the bigger fish by the current cost structure we have. I think on the RIA side, we are having those discussions and getting decent traction with, and we have, you know, billion-dollar-plus RIAs signing up. Part of it is the question is they're often committing $100 million of maybe several billion that they have and are sort of trying us out. And some of it is, you know, we've sold them. on not only what we're doing now, but what we're doing in the future. So, you know, this is – they're mostly custodial. They're coming over with a certain proportion of their business. They are larger. So we are winning those, and then they're going to have us prove ourselves out, and that's what we have to do. And then, you know, we can increase the market share from there. Because a lot of times it isn't – like, clearing is different. You basically – I mean, you can dual clear, but it's more rare, particularly for firms in and around the size that we have. But for RIAs, they're often multi-custodial. So when we are winning, we are winning business, but we're only counting the assets that they've allocated to us, not the entire firm if it isn't pledged to us.

Gotcha. Thank you. And then just really one more question on the custody side. You know, the commentary about the cash starting balance is kind of down to, you know, a low level at this point, which I know was expected to come off the high from a couple of quarters ago. I'm curious, to the degree you kind of see the numbers, you know, behind the numbers, as it were, have RIAs put more client funds back into equities, or are you seeing some of those cash balances invested into, you know, treasuries kind of in the same way that we're seeing, you know, bank bank deposits move out of the bank system into treasuries or otherwise. Do you have a sense for kind of where those funds are going?

You know, some of it is that, but a lot of it is we have some tactical allocators who move in and out of the market when they get different signals. And so, you know, that kind of makes that movement. But there clearly has been some allocations away from from the cash side through and we control which money market funds they're allowed to use and things like that but we do monitor that and there clearly is some of that but frankly a lot of what that isn't the majority of what it was it really was much more market their market timing frankly I think they did a pretty good job of it and when the market was really going down, they basically took their money out and sat on it, and then they put it back in then. We haven't seen this environment for some time, so the question is, even in much higher rate environments, this percentage of the of cash to assets has been sort of the low. So I think it's unlikely to go lower given the tactical nature of the trading. And it isn't a perfect substitute, right, because you do end up having to wait to be able to allocate. And a lot of those RIAs are fairly active, so they don't like to wait to allocate. They've got to wait for those trades to clear in and out. There's costs associated with doing that. You know, it isn't a perfect substitute, but there's some of it, but not most of it.

Thank you.

Thank you. Our next question comes from David Chiaverini with Web Bush. Please state your question.

Hi. Thanks for taking the questions. The first one is a follow-up on the CRE discussion. Have the rating agencies, specifically Moody's, expressed any concerns about your CRE growth?

Yeah, you know, Moody's did mention that in their most recent report on us. And, you know, I think that was pretty much – they've kind of taken that pretty much industry-wide. And, yeah, so we went through that. We went through that with them. And, you know, we had folks that were – that were a little bit new to the business that we were talking with. But yeah, they did express something. And you can read that report that they had.

And have they been receptive to, for instance, your discussion around how conservative your underwriting standards are around Crestle and lender finance? And how receptive have they been to that conversation?

You know, I think that it was – I think they were receptive to it, but I think it was somewhat mixed. I mean, you never know exactly how they say it. The people that were close to us said, yes, we completely understand. We're going to talk to folks about it. Then they go up and they say, we don't care. We're treating all banks the same way with respect to this and whatever. So, I mean, you know, look, I don't put much faith in what rating agencies say or do in my investments or anything else. You know, they basically move with the tide and the press and whatever else, but yeah.

Understood. Thanks for that. Shifting gears, on the deposit side, you guys have that nice lever of having, you know, off-balance sheet deposits that you could, you know, entice to bring on-balance sheet. Can you remind me what the number was for you know, comparing the fourth quarter to the first quarter in terms of off-balance sheet deposits?

It was pretty consistent. It's been around $700 million or so for a couple quarters, and that's specifically talking about on the security side of the business. And then there's another $680 million connected to the Zenith business that's Not necessarily off-balance sheet, but it's not an access bank, but it's an opportunity for us as well that we're at the customer base for.

Right, right. I think it is important to differentiate between those two, though. We control the securities off-balance sheet. Those deposits that are through our software are at other banks, and it takes an affirmative set of movement and work to move those on-balance sheet. And we've got some decent commitments for that. But those are more, it's more of a commercial pipeline opportunity, as Derek said.

Great. Thanks very much.

Thank you.

Our next question comes from Edward Hemmelgarm with Shaker Investments. Please state your question.

Yeah, just a couple of questions. One is, when does the time frame begin on finishing the improvements to the securities business? And you mentioned Indicated numerous times. Oh, gee.

I mean, there's so many different things going on. I mean, the Universal Core is a multi-year project. I mean, we'll start putting clients on. Well, hopefully we'll start putting – we'll put custody on it in six months, which will save money. But that's a massive, massive project. That's a multi-year project. And then – And then we have to get a bunch of – it's really a huge change management process because you've got to get everybody to adopt the new systems and all those kind of things. So it's a multi-year kind of thing. And then I take umbrage at any manager ever thinking they're done improving their operations either. But I think just with respect to that, it's a multi-year project.

No, but I'm assuming that it's impacting sales if your costs are higher than your competitors.

Oh, yeah. Well, the cost – so let's just be clear. On the clearing company, it is impacting sales. But there's really not a lot you can do about it if you've got to switch out your core. because that's a really complex thing. So it is impacting sales. On the custody side, that's not impacting sales so much, the core side of it. We own the system there. I think with respect to, if you're talking about, gee, you have so many customers that you could onboard them faster, that sort of stuff will get worked out in a couple months. But Yeah, I mean, and then, you know, look, we have a good system now. It's also about profitability, right, because each of these clients that get on board, if you board an RIA and it'll come with 1,000 high net worth clients, we may be able to bank almost all of them at a certain level, and that time frame is the white label will be out in test, beta, at the end of July, and then we'll start working on that. But then it'll be easier to put new clients on it, and then you've got to get old clients to change. There's got to be incentives there, all that kind of stuff. But probably then we've also got to get integrated S-Block. We're going to launch an S-Block credit card into that platform as well, so ARIA clients can – utilize their securities book to have a very low-rate, high-reward credit card because it'll essentially be, it should be, unless we make an operational error, a zero-loss credit card, right? So, you know, those kind of things, those are long-term things. They are still multi-year initiatives. So, but you know what, Ed? You can hang out. You've hung out a long time. You can be patient a couple more years. I mean, you're still a young spry guy. I mean, come on.

All right. The other thing is, it's a two-part question, but I've been, I was curious by your comments about the, it looks like there may be blocks of loans available for sale. I mean, that's interesting. Where is it really coming from? Or is it from the likely suspects that have failed? Yep. Yeah.

Some of them have announced them. Some of them are the suspects that have failed. I mean, There's some that are probably – you could guess who they are, but they're not – I don't think they've made them all public. So there's like four or five shooting around. I think a couple have some possibility. But, yeah, so that could, you know, change the loan growth projections a little bit if we did stuff there. But, you know, we'll see. I mean, we bid – We bid for one lone pool and got smoked. I thought it was – I was surprised. Whoever took it, I was happy they did at that price. We wouldn't have bought it. So, you know, so look, I mean, you don't know those things. You basically do your diligence. You put in your bid, and, you know, it could be pulled away. You could win it, so.

And lastly, I mean, you know, in the past have been – I mean – very opportunistic, at least in the only other time we had the recession. I was in 07, 09. In taking advantage of the opportunities that are out there, what you're curious about your economic outlook, I mean, are you assuming a recession or do you think the potential is that things can get to be a lot worse and maybe the opportunities getting to be a lot better. And if so, do you have the capital to really take advantage of all that is presented?

Yeah. I mean, I think that clearly with the profitability we have and the capital we have, I think we have the ability to take advantage of the personnel that are out on the street for the businesses that we want to grow because we want to grow them in a controlled and methodical manner. I am not really projecting that, you know, if we, you know, that we're going to go out and, you know, like if somebody's willing to sell me, you know, signatures book at, you know, $10 billion of loans at 50 cents on the dollar, then we'll have to go raise capital and deposits and whatever else. But that's not on the table and that's not going to happen. So I think, we've had some funds and firms approach us and say, if you need equity, we'd like to be a part of anything you're doing. So there are those kind of opportunities out there. I think that probably the right approach to this is to take things like we always do in reasonably digestible chunks without taking any one bet that's so large that a deviation from the plan is something that gets you into any kind of significant issue. So yeah, I think we do. And if we don't, we'll be able to find capital to partner on those things. But as I kind of said before, I think of the items that I'm most excited about, I think that the opportunity of just the personnel who are looking to move around and the clients that are looking to move around are pretty good. And then some of the loan, the loan kind of purchase things. You know, there's a couple that are interesting, others that are not so much, and trying to see if you can couple those with people that would be interesting as these things kind of move around. You know, it could be something there. But, you know, look, we have, obviously we have very, strong earnings, and so that allows us to have, you know, the opportunity to grow or to look at these kinds of opportunities as they arise.

Okay, and once again, congratulations on a good job.

Thank you. Thanks, Ed.

Thank you. There are no further questions at this time. I'll hand the floor back to management for closing remarks.

Great. So before... Thanks again for everyone joining. I just wanted to kind of reiterate the loan pipeline numbers because I think we got cut off a little bit there when Derek was talking. So the total loan pipeline was $1.1 billion at April 24, 2023, and that was comprised of $33 million of single-family agency gain on sale, $273 million of jumbo single-family mortgage, $83 million of multifamily and small-balance commercial, $709 million of CNI and Crestle loans, and $15 million of auto and insured. So that's it for this quarter. Thanks for your interest.

Thank you. This concludes today's conference. All parties may disconnect. Have a good day.