Axos Financial, Inc. (NYSE:AX) Q1 2024 Earnings Call Transcript

Axos Financial, Inc. (NYSE:AX) Q1 2024 Earnings Call Transcript October 26, 2023

Axos Financial, Inc. beats earnings expectations. Reported EPS is $1.38, expectations were $1.35.

Operator: Greetings. Welcome to Axos Financial Incorporated’s First Quarter 2024 Earnings Call and Webcast. [Operator Instructions] Please note, this conference is being recorded. At this time, I’ll turn the conference over to Johnny Lai, Senior Vice President, Corporate Development and Investor Relations. Mr. Lai, you may begin.

Johnny Lai: Thanks, Rob. Good afternoon, everyone, and thanks for your interest in Axos. Joining us today for Axos Financial Inc’s first quarter 2024 financial results conference call are the company’s President and Chief Executive Officer, Greg Garrabrants; and Executive Vice President and Chief Financial Officer, Derrick Walsh. Greg and Derrick will review and comment on the financial and operational results for the three months ended September 30, 2023, and we 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.

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Please refer to the safe harbor statement found in today’s earnings press release and in our investor presentation for additional details. 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 axosfinancial.com for 30 days. Details for this call were provided on the conference call announcement and in today’s earnings press release. All of the documents including the earnings press release and 10-Q and earnings supplement can be found on the Axos Financial website. With that, I would like to turn the call over to Greg for opening remarks.

Greg Garrabrants: Thank you, Johnny, and good afternoon, everyone, and thank you for joining us. I’d like to welcome everyone to Axos Financial’s conference call for the first quarter of fiscal 2024 ended September 30, 2023. I thank you for your interest in Axos Financial and Axos Bank. We generated double-digit year-over-year growth in earnings per share, book value per share and ending loan and deposit balances for four consecutive quarters. Broad-based loan growth, coupled with net interest margin expansion, resulted in double-digit net income growth year-over-year than linked quarter annualized. We grew deposits by approximately $440 million linked quarter despite intense competition for deposits and the execution of our previously announced exit of approximately $235 million of deposits for cryptocurrency and digital asset companies.

We reported net income of $83 million and earnings per share of $1.38 for the three months ended September 30, 2023, representing year-over-year growth of 42% for each. Our book value per share was $33.78 September 30, 2023, up 19% from September 30, 2022. Other highlights this quarter include the following: Ending net loans for investment balances were $17 billion, up 3% linked quarter or 12% annualized. Growth was broad-based with growth in C&I loans, single-family jumbo mortgages and single-family warehouse, offsetting deliberate runoffs of auto, multifamily and small balance commercial real estate loans. The acquisition of the LV Marine Finance business added approximately $50 million of floor plan loans in the quarter ended September 30, 2023.

Net interest margin was 4.36% for the first quarter ended September 30, 2023, up 17 basis points from 4.19% in the quarter ended June 30, 2023, and up 10 basis points from 4.26% in the quarter ended September 30, 2022. We grew net interest margin despite holding excess liquidity for a third consecutive quarter. Axos Securities comprised primarily of our custody and clearing businesses had another strong contribution to our fee and net income. Broker-dealer fee income increased 36% year-over-year due to higher interest rates and increased client activity. Advisory fee income increased 18% year-over-year due to higher mutual fund fees and higher average assets under custody. Quarterly pretax income for our securities business was $12.6 million in the first quarter of 2024, up 41% from the corresponding period a year ago.

Our credit quality remains strong with net annualized charge-offs to average loans of 4 basis points in the three months ended September 30, 2023. Of the 4 basis points of charge-offs, 2 basis points were from auto loans that are covered by insurance policies. Nonperforming loans as a percentage of total loans improved from 0.78% in the comparable quarter ended September 30, 2022, to 0.62%, but up from 0.52% in the prior quarter. While a few loans in our jumbo single-family mortgage and commercial real estate portfolios resulted in a small sequential increase in our nonperforming assets, these nonperforming loans are reasonably well secured by the current adjusted value of the underlying properties. Our capital levels remain strong with Tier 1 leverage of 9.9% of the bank and 9.3% at the holding company, both well above our regulatory requirements.

We repurchased approximately $25 million of common stock in the first quarter in addition to the $18 million we repurchased in the prior quarter to take advantage of the warranted decline in our share price. This brings our total share repurchase through September 30 to $74 million at an average share price of $37.47 per share, representing 3.3% of the shares outstanding at 12/31/2022. From October 1 to October 20, we repurchased an additional $35.2 million of stock, representing 1.6% of the shares outstanding at September 30, 2023, at an average share price of $36.55. We have approximately $44 million remaining in our share repurchase authorization as of October 20, 2023. With our consistently high returns and strong capital position, we continue to believe that buying back our stock at these attractive valuations is a prudent use of excess capital generated by our strong earnings.

We grew ending loan balances 11% year-over-year in the first quarter. Loan growth was a bit back-end loaded this quarter as several large commercial deals closed in the last month of the quarter. We had strong originations in our real estate and non-real estate lender finance and asset-backed lending groups, including our capital call lines. Single-family mortgages grew net ending loan balances by $95 million despite a tough environment for purchase and refinance activity in the single-family mortgage market. We continue to reduce our multifamily, small balance commercial real estate and auto loan balances, given our preference for originating and retaining loans with lower durations, floating rates and a better risk-adjusted return in the current environment.

At September 30, 2023, approximately 61% of our loans were floating, 32% were hybrid 5/1 ARMs and 7% were fixed. The average duration of our commercial loan portfolio was only two years with multifamily being the longest at an average of less than three years and a vast majority of our commercial specialty real estate and lender finance portfolios floating rate with contractual maturities of less than three years. Average loan yields for the three months ended September 30, 2024, was 7.85%, up 34 basis points from 7.51% in the prior quarter and up 220 basis points from the corresponding period a year ago. We have successfully remaxed our loan portfolio as rates continue to rise by replacing lower yield hybrid loans with higher-yielding adjustable rate loans.

Our new loan yields this quarter were the following: single-family mortgages, 8.06%, multifamily 8.58%, C&I 9.09% and auto 10.34%. Our commercial real estate loans continue to perform well. The low loan-to-value and senior structures we have in place for an overwhelming majority of our commercial specialty real estate loans provides us with significant downside protection in the event of a significant deterioration in the borrower’s ability or willingness to repay the valuation of the underlying properties or cost overruns or project delays. Of the $5.5 billion of commercial specialty real estate loans outstanding as of September 30, 2023, multifamily was the largest segment, representing 33% of total loans, while hotel, office and retail represent 19%, 8% and 4%, respectively.

On a consolidated basis, the weighted average loan to value of our commercial specialty real estate portfolio was 41%. For the retail and office segment of the commercial real estate loan book, the weighted average loan to value was 43% and 38%, respectively. Total commercial real estate loans secured by office properties declined by $96 million linked quarter to $456 million. Two large office loans paid off this quarter totaling approximately $100 million. Of the $456 million commercial real estate specialty loans secured by office properties at the end of the quarter, 70% are A notes or note-on-note structures, all with significant subordination with some having recourse to funds a cross collateralization with other asset types from fund partners and mezzanine lenders.

These loans have an average loan-to-value ratio of 38%, excluding the recourse and cross collateralization. In the commercial specialty real estate portfolio, we had approximately $26 million of nonperforming loans at September 30, 2023, representing 42 basis points of the total CRE loans outstanding. Currently, with respect to these two loans, we are working with the borrowers and the mezzanine lenders who are either putting in new money currently or are in the process of working with the borrower to provide additional support. In both cases, we believe we will not incur significant losses, if we incur any at all given the current and expected commitments from the subordinated capital and the borrowers. Nonperforming loans in our multifamily and commercial mortgage portfolio increased by $3.7 million to $38.8 million in the September quarter.

The largest nonperforming loan in this category is a $25 million loan to an assisted living facility in Venice, California, that has been included in the nonperforming loans since the fourth quarter of 2022. We filed a notice to foreclose four months ago and recently filed a notice to sell. The property has an appraised value of $27 million, and we have over $5 million of unaccrued defaulted interest in this loan. We also have personal guarantees in the two principal owners of this property. One multifamily and commercial mortgage with an outstanding principal balance of $5 million became delinquent this quarter. The guarantor has provided $750,000 in principal curtailments since 8/31/23. The guarantor has a net worth of over $100 million. The only other meaningful new nonperforming loan in the multifamily and commercial category was a $1.3 million loan on a multi-tenant retail building in San Diego.

The loan to value was 34% and the debt service cover is 1.52. Although we cannot be certain, we do not expect to incur a material loss on any of these asset-backed loans currently categorized as nonperforming. We had another strong quarter of deposit growth, with ending balances increasing by $443 million from June 30, 2023, or 10% annualized. Checking and savings accounts represent 94% of total deposits at September 30, 2023, grew even faster at a 16% annualized pace. Our deposits remain well diversified from a business mix perspective with consumer and small business representing 59% of total deposits, commercial cash, treasury management and institutional representing 19%, commercial specialty 6%, Axos Fiduciary Services 6% and Axos Securities, including casting and clearing 5%.

Our total noninterest-bearing deposits were essentially flat quarter-over-quarter with ending balances of approximately $2.9 billion, while the number of accounts increased approximately 2% linked quarter, reflecting growth in various commercial deposit verticals. Excluding the divestiture of approximately $235 million of deposits related to operating and institutional accounts for digital asset companies, total noninterest-bearing deposits were up approximately $235 million from June 30, 2023, to September 30, 2023. Due to recent regulatory changes in the landscape for U.S. banks and digital asset companies, we completed our previously announced exit of our small incubator deposit gathering business that’s focused on selected digital asset companies such as exchanges, brokers and firms engaged in activities related to nonfungible tokens.

Given recent banter by known short sellers about our alleged exposure to cryptocurrency companies, particularly binance.com, I’ll provide a factual summary of our brief involvement in this business. Axos has never had any relationship or opened any accounts from binance.com, the Global Exchange. Between March 14, 2023 and August 10, 2023, Axos maintained limited purpose accounts from Binance U.S. and selected subsidiaries, wholly different entities than binance.com. The initial contact with Binance U.S. began after Silvergate and Signature Bank failed. During the entire period when Binance U.S. accounts were open, Axos maintained strict risk controls and transaction restrictions, including, but not limited to, controls to ensure that no transactions were processed between Binance U.S. and binance.com or its controlling shareholder.

All significant binance.com U.S. counterparties required preapproval from the bank’s risk and compliance teams prior to any transaction activity being processed. The approved activity within these accounts was primarily limited to payroll, rents and other similar routine business expenses and the types that any business would need to process. Individual retail customer funds were not permitted to be deposited into any of these accounts. Axos’ internal risk assessment of the digital asset business concluded that the regulatory treatment for retail accounts was indeterminable, and therefore, cannot meet the bank’s client acceptance criteria. Accordingly, Axos did not process retail customer accounts or process retail customer wallet transactions for Binance U.S. These restrictions have really limited the number of counterparties of Axos which required due diligence.

As previously stated, Axos processed no transactions between binance.com and Global Exchange and Binance U.S. Prior to opening the Binance U.S. accounts, Axos performed significant due diligence, including by way of example, on not limitation, a comprehensive review of corporate formation documents, prior bank statements, financial reports and transaction counterparties utilizing multiple BSA and AML OFAC and CFT tools, including chain analysis, blockchain surveillance software. Following the SEC’s action against Binance U.S., Axos reassessed the regulatory landscape for the cryptocurrency and digital asset businesses in the U.S. and exited our small incubator deposit gathering business for digital asset companies that included exchanges, brokers and firms engaged in activities related to digital coins, including all business with Binance U.S. Axos never extended credit to Binance U.S. or any other company involved in cryptocurrency or digital assets and never accepted digital assets or cryptocurrency as loan collateral for any credit or loan made.

As such, Axos never had and currently does not have any risk of loss in connection with digital assets and cryptocurrencies or NVs participating in cryptocurrency-related businesses. Within the bank’s long-standing trustee and fiduciary deposit verticals, Axos manages in a material amount of bankruptcy trustee deposits related to failed cryptocurrency and digital asset businesses that have filed for bankruptcy protection or some other form of corporate restructuring and are managed by trustees or fiduciaries. Axos had no deposits with Binance U.S. after it exited from the relationship on August 10, 2023. While Axos invested to build technologies related to its own stable client AXPay and real-time payment technologies, the products and service was never launched and no customers were allowed to access the network that was under construction.

No payments wherever process for any third party on such network. Axos never operated any real-time payment networks based on blockchain technologies or our own stable client or other crypto network. Axos also never offered any direct-to-consumer services related to cryptocurrency trading, nonfungible tokens or other digital assets. The granularity and diversity of our deposits, particularly consumer savings and money market accounts, provides us with flexibility to match the duration and cost of our funding to the duration and cost of our adjustable on hybrid loans. This quarter, our consolidated net interest margin was 4.36% while our bank-only net interest margin was 4.46%. Our consolidated bank-only net interest margins were above our guidance of 4.25% to 4.35% despite maintaining a higher level of excess liquidity than we have maintained historically.

Total ending deposit balances at Axos advisory services, including those on and off Axos’ balance sheet, declined by $50 million in the quarter, an improvement from $188 million decline in the prior quarter and the $383 million decline in the quarter ended March 30, 2023. We believe that the pace of cash sorting at Axos Advisory Services has stabilized at or near the bottom, representing 4.5% of assets under custody as of September 30, 2023, compared to the historic range of 6% to 7%. In addition to our Axos securities deposits on our balance sheet, we had approximately $550 million of deposits off balance sheet at partner banks and another $750 million of deposits held at other banks by software clients in our Zenith accounting and deposit business management vertical.

We are starting to see increased traction in deposit inflows from teams we hired over the past six months and from newer commercial deposit verticals. As we slowly unwind our excess liquidity and grow deposits from lower cost sources such as our commercial and treasury management, Axos Fiduciary Services, Axos advisory services and other sources, we feel confident in our ability to maintain our 4.25% to 4.35% net interest margin guidance for the next few quarters. Our profitability, liquidity, balance sheet positioning and growth outlook all remain favorable. We completed a strategic acquisition of the marine finance business named LaVictoire in the September quarter. This transaction added approximately $50 million of marine floor plan loans, a $500 million servicing portfolio of retail marine loans held by purchasers of those loans and a dedicated team with more than 15 years of experience in the marine finance industry.

This acquisition provides us with another specialty lending vertical with attractive risk-adjusted returns, particularly in the dealer floor plan line of credit segment. Our relationships with leading boat manufacturers and dealers and high net worth retail customers provide tremendous cross-sell opportunities for our consumer and commercial bank. We are excited to welcome the LV team to Axos. From a technology perspective, we continue to invest in front and back-end systems, infrastructure, IT security and other enterprise software and systems that will further optimize our business than functional units. We launched our Universal Digital Bank 2.0, the latest version of our consumer and mobile banking application in September. The platform has new features and functionality and a better, more integrated user experience across all consumer lending, deposit and securities products.

It’s only been a few months, but we are seeing good engagement with our new consumer banking application from new and existing customers. Our white label banking for registered investment advisers and introducing broker-dealers continues to make progress with a beta launch expected in the next three to six months. At our recent adviser event earlier this month, we received tremendous interest in our white label banking solution. Over time, we believe the ability to leverage our relationships with advisers and broker-dealers to cross-sell Axos’ consumer deposits and lending products will be a good source of incremental growth. Axos Clearing, which includes our correspondent clearing and RIA custody business continues to make steady progress.

Noninterest income from the securities business increased 18% year-over-year to $34.6 million. The primary drivers of growth in fee and pretax income for Axos Securities is higher interest rates. Total deposits at Axos Clearing was $1.6 billion as of September 30, 2023, essentially flat from $1.6 billion as of June 30, 2023. Of the $1.6 billion of deposits from Axos Clearing, approximately $1 billion was on our balance sheet and a $550 million were held at partner banks. Net new assets in our custody business increased by approximately $163 million in the three months ended September 30, 2023. The pipeline for new custody clients remains healthy comprised of 11 advisory firms with more than $700 million of combined assets under custody. We continue to see more RIAs considering an alternative custodian and moving some or all of their assets from Schwab TD Ameritrade to us.

We remain focused on executing our strategic and operational initiatives. We are in a better position today relative to others because we are more diverse, and we do not make critical mistakes that others have. With strong liquidity and capital, a de minimis unrealized loss on our small investment securities portfolio and solid growth prospects given the diverse nature of our banking and securities businesses, we are operating from a position of strength relative to our competitors. Our returns, credit and margin are best-in-class because we focus on asset-based lending opportunities with the best risk-adjusted returns, and we stress for deals with low leverage and credit enhancements. we continue to evaluate opportunistic asset and business purchases such as the LV Marine Finance acquisition we closed in the September quarter.

We will deploy our capital judiciously between internal investments, accretive acquisitions of businesses and talent and opportunistic share buybacks. We are well positioned to maintain strong profitability and EPS growth irrespective of the interest rate, regulatory or economic environment. Now I’ll turn the call over to Derrick who will provide additional details on our financial results.

Derrick Walsh: Thanks, Greg. To begin, I’d like to highlight that in addition to our press release, an 8-K with supplemental schedules and our 10-Q were filed with the SEC today and are available online through EDGAR or through our website at axosfinancial.com. I’ll provide some brief comments on a few topics. Please refer to our press release and our SEC filings for additional details. Following a strong start to our fiscal year, our outlook remains consistent with what we have guided to in recent quarters. We believe that we will be able to grow loans by high single digits to low teens year-over-year and maintain 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 broad-based increases in our asset-based lending, lender finance and capital call lines, partially offset by declines in single-family warehouse, multifamily, small balance commercial, auto and personal unsecured loan balances.

We continue to see banks and nonbanks pull back or exit many lending areas we are in, such as lender finance and note-on-note commercial lending. Our market share gains have been partially offset by higher levels of prepayments in our C&I book, given the shorter duration for these loans. We are also seeing a more pronounced pullback in loan demand as developers and borrowers reassess their return objectives in a higher rate environment and a slowing economy. That said, we continue to identify strong credits, and our loan pipeline remained solid at $1.6 billion as of October 20, 2023, consisting of $238 million of single-family residential jumbo mortgage, $20 million of agency gain on sale mortgage, $44.2 million of multifamily and small balance commercial mortgage, $63 million of auto and consumer and $1.28 billion across the commercial platform.

Our NIM guidance reflects higher yields from new loans replacing lower-yielding hybrid loans, offset by rising deposit costs. It also assumes that AES deposit balances bottom at current levels and grow gradually driven primarily by net new asset growth, not a material reversal in cash sorting. One factor that could impact our net interest margin in the December 2023 quarter is the timing of expected loan payoffs and new loan originations. Our base case assumes the majority of loan payoffs occur earlier in the quarter and new loan originations ramp throughout the quarter. We expect to maintain some excess liquidity given the uncertain economic, geopolitical and industry environment. Total noninterest expenses increased by $8 million or 7.2% to $120.5 million in the three months ended September 30, 2023, compared to the quarter ended June 30, 2023.

Professional services expenses were up by $3.8 million or 64% on a linked quarter basis as we return to a more normal run rate with additional seasonal impacts in Q1 tied to supporting fiscal year-end reporting activities. Advertising and promotional expenses were up by $2.3 million or 28% from the linked quarter due to an increase in deposit marketing expenses as competition remains strong for deposits. Salary and benefits expenses increased by $1.3 million, primarily as a result of new team member additions as we continue to take advantage of broader dislocations in the industry and attract top talent in key growth areas and in small part due to merit increases, which will have a full rate next quarter. We expect noninterest expenses to grow sequentially at our historical average growth rate as we continue to invest in people and growth engines of our business.

Our income tax rate was 30.05% for the first quarter ended September 30, 2023, up from 25.3% for the fourth quarter ended June 30, 2023, and up from 29.5% in the first quarter of 2022. As we discussed last quarter, our income tax expense in the fourth quarter of 2023 included $5.2 million of primarily onetime tax credits equal to approximately $0.08 per diluted share. Going forward, we continue to expect our annual income tax rate to be between 29% and 30%. Lastly, our return on equity was 16.9%, and our return on average assets was 1.64% for the three months ended September 30, 2023. Even amidst our share repurchases over the quarter, Tier 1 leverage capital to average assets was 9.27% at September 30 compared to 8.96% at June 30. Total capital to risk-weighted assets for Axos Financial was 14.06% at 9/30/2023, up from 13.82% at 6/30/2023.

We continue to hold excess capital at Axos Financial and Axos Bank even after our opportunistic share repurchases, solid loan growth and continued investments in our business. We are confident that our model of strong liquidity and high returns positions us well to generate consistent profitable loan growth. With that, I’ll turn the call back over to Johnny.

Johnny Lai: Thanks, Derrick. Operator, we’re ready to take questions.

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Q&A Session

Operator: [Operator Instructions] And the first question today comes from the line of Andrew Liesch with Piper Sandler. Please proceed with your question.

Andrew Liesch: Hi, guys. Good afternoon. Just on the expenses here, it sounds like you’re not going to see any cost saves or anything because the quarter consumed a little bit outsized, but I guess it’s kind of like the new run rate. The efficiency ratio did tick up to 49%. I guess how should we be looking at that going forward? I mean, is revenue going to be growing fast enough to get that back down to that maybe 48% number? Or is this kind of where we should be looking at going forward?

Greg Garrabrants: I think the efficiency ratio should generally be between kind of 48.5% to 50%, that’s the range that it will operate. And to your point, it will depend from quarter-to-quarter, as we referenced some of the loan growth and the timing of the interest income recognized related to that.

Derrick Walsh: We also have merit –

Greg Garrabrants: Our merit increases are in June. So that this quarter is –

Derrick Walsh: In late September, yes – so late September.

Greg Garrabrants: So late September, yes, we evaluate them as of June, but by the time they roll through they are late September.

Derrick Walsh: So that’s what I was referencing. And so that’s what’s going to kind of probably keep us towards that 49% end of the range, right? Is that salaries and benefits, we do expect to increase as the full merit increase comes in, in the second quarter.

Andrew Liesch: Got it. All right. Yes, that’s helpful. And then just looking into the 10-Q, like there was some credit migration with an increase in special mention and some standards. It looks like there were some in multifamily and commercial real estate and some C&I, any comments there on what might be causing this? And I’ll leave it there.

Greg Garrabrants: Yes. No, it’s not significant, but those things are often moving in and out. And any time we see anything that, for example, on some of the substandard side, it just may be if a project is slightly delayed or something like that. So there’s nothing really that we see that’s of any significant set of concerns with respect to any actual loss content. And as I said in the prepared remarks, we’re getting, on every CRESL loan that is, there’s two that are actually delinquent there. One, UBS O’Connor is the mezz and they’re still supporting it. And so we’ve decided to sit still and let them continue to support the property. It’s very close to being finished at some very nice condominiums in Greenwich Village in New York.

I don’t think we’ll have any loss there. Is it possible? No. Little maybe, but nothing much. And then the other one is also is being supported by the mezz and they’re going to put more money in and they’re working with the borrower at this time. And so we’re just kind of hanging out there. And so obviously, we could take more aggressive action in those cases. But given the fact that everybody is behaving nicely who has much more at risk than we do, we think it’s the right thing to sit on that. And so it just really depends because most of the time, our notes are quite sellable. So if we feel like we want to sell a note or something we usually can, but I don’t think that’s changed. So this is just nothing of any real significance or anything that I’m looking at and saying, wow, this may translate into some significant loss content.

Andrew Liesch: Got it. very helpful. Thanks for taking the questions here.

Operator: Our next question comes from the line of Tim Switzer with KBW. Please proceed with your question.

Tim Switzer: Hi, I’m on for Mike Perito. Thanks for taking my question.

Greg Garrabrants: Hi Tim.

Tim Switzer: I had a couple of questions about your asset sensitivity here at this stage of the cycle. I was looking at Slide 3 in your guys’ earnings presentation, and you guys did a good job putting out your maturities over the next few years. Are you able to like help us quantify maybe what the loan yields are on these maturing loans over the next year or so that you guys call out?

Greg Garrabrants: Yes. Well, I don’t know if you have the – I can give you generalized numbers. Do you have exact ones, Derrick, I mean to give sort of general – so there really are – so let’s talk about the loans that are hybrid loans, those consist of two primary categories. One is single family and the other is the sort of multifamily smaller balance commercial. We shorten those to multifamily and small balance commercial up from 5/1 ARMs to 3/1 ARMs several years ago. for new originations. So that book is really repricing relatively quickly. In general, you might take loans that are sort of in mid-5s, and you’re repricing them all the way up to 8, 8.5s or 9s. A lot of times, they’ll run off at that point in time and they simply pay off.

We’ve done an analysis of looking at those and where they’re coming through. So there is a net benefit to us that will accrue associated with that, particularly that portfolio repricing because I think we made the right moves to shorten those deals up. And generally, competitor banks were more in that 5% to 7% to 10% range, and we were more in that 3% range with a little creep to 5%, and that 5% was really kind of sunsetted more years ago. So I think that’s pretty good. And then on the single-family side, those were all 5/1 ARMs. I wanted to shorten them, but you actually can’t because if they’re not at least five years, you have to price them at the rate cap from a DTI perspective, which is kind of a regulatory thing that doesn’t make a lot of sense.

But in any event, it kind of precludes you from doing shorter than 5/1 ARMs. You can sort of see it in the chart there. But to give you some flavor of it, let’s say those would be like another 5.2%, 5.3% sort of thing, and they’re repricing and they’ll reprice into the 8s and 9s as well. And they’re a little bit heavier in out years, though, because we had so many prepays in that low rate environment in the COVID period that some of the new originations are a little more stacked. So you might make an argument that, let’s say, that 5/1 ARMs, there’s 20% repricing a year, every year, you can think of it, but that’s not right. It’s much more pushed towards those sort of out years. Now I think that being said, and then auto, the auto loans are a little bit longer duration, but they’re prepaying rapidly.

And those are prepaying at let’s say they’re 5-ish percent. And then we’re just letting that book drop and when we’re originating at above 10%. So I think what is good about this is that if sometimes there’s this worry that I hear analysts talk about that. that what happens is you end up at the end of the rate cycle where all your adjustable loans have repriced and the only thing that’s left is for your deposits to sort of creep up and sort of reduce your NIM. But that’s not what we have to look forward to, actually. We actually have something different to look forward to. We have to look forward to the fact that we’re going to get these hybrids to reprice pretty quickly because we made reasonably good decisions about the structure of those loans.

And so those will reprice. And then additionally, as we grow almost all the new loans that are coming on are adjustable rate loans. And so they do have floors often. Those floors sometimes are good and sometimes they’re not as good as far as for us, but they do have some floor usually embedded in them with respect to SOFR to limit our downside risk. So I think if where your question is going is for a little bit of flavor around are we going to have this sort of end of rate cycle compression in NIMs. I think we might, but I don’t think it’s going to be significant. And I think we have a lot of offsetting factors associated with that, that can aid us. And I think it’s going to really be more about credit spreads on new originations given that we have such a relatively quick cycle time for our existing commercial book.

Tim Switzer: Okay. Yes, that makes sense on your last point. And I was actually going to maybe take this a step further along the cycle if we get to where maybe the Fed begins to cut rates sometime in the next year or so, if that occurs, like how do you think you guys are positioned like what’s your sensitivity to rate cuts?

Greg Garrabrants: Well, it depends on the assets. So all single-family loans have a floor at the start rate that are originated. So if you originated in the 8s, they’re not going down. So let’s talk about floors for a second and then I’ll talk about borrower behavior. So we do put floors in certain things, but a cap call facility, for example, is going to have a 1% SOFR floor. Other loans, let’s say, certain CRESL deals might have a 4% or 3.5% SOFR floor. So there’s some compression that occurs immediately in a reduced short-term rate environment associated with those loans. We’ve kept our deposit base in a way that we can reprice it. The question is always what’s the demand for deposits at that time? And what does that repricing do to your ability to grow deposits, et cetera, right?

Now we’re a pretty diverse business. We did grow noninterest-bearing deposits by over $200 million this quarter, if you exclude the runoff that we pushed out on the digital asset side. So there is good stuff happening there, and that all blends together. And if you look at that and you say you grew that by that amount of money and you grew loans by 500, that’s kind of pretty good actually, right? So there’s good stuff happening there. So these things are all going to come together. But if somehow there was a massive demand for deposits, and we weren’t able to cut any deposit rates and still grow and rates came down on that short side, we might see a little compression. But I think the other issue that could arise is you have floors on these loans, if the market rate falls very much below the floor rate, then you could see prepayments, too, right?

So I mean, I think realistically, we’ve thought pretty hard about how to deal with this. Part of the issue is that I’ve had some different folks, of course, they kind of haven’t brought this up lately, but there were investment bankers and such approaching saying, hey, you should extend duration when they thought the long rate was sort of where it was going to be, which was about 100 basis points below where it was now. And we firmly didn’t do that, and their commentary was, well, you’re taking risk on the other side in a short-term environment. And I don’t really think so. Because the tough part is, unless you’re extending loans with absolutely hard lockouts where they can’t prepay, you’re really taking asymmetrical risk there. So I think we’ve positioned it about as best as we can and so if somebody who has a higher floor wants to prepay and the markets there for them, then that loan will have to be replaced.

And then it’s up to our origination engines, which are pretty good, and they’re continuing to grow with our cap call business with our floor plan business, et cetera, to be able to replace those assets. But for what it’s worth, I’m not saying rates are not ever going to come down, but I think all the folks that were so optimistic that we’re going to get rate cuts next year. We were not in that camp, and we’ve been right so far. And I don’t think it’s something imminent.

Tim Switzer: Great, thank you. That was good color. I’m done.

Greg Garrabrants: Thank you.

Operator: Our next question is from the line of David Chiaverini with Wedbush. Please proceed with your question.

David Chiaverini: Hi, thanks. I wanted to ask about the digital asset business and how you guys exited? I was curious, did your regulators bring up any concern with your involvement in the digital asset business? Or was this entirely voluntary? And has there been any legal action at all related to this?

Greg Garrabrants: No. No. We’ll answer all the questions. I’ll answer the last one first. No, there’s no legal action related to it at all and nothing pending or anything we’re aware of. The only reason I even mentioned it is because there’s been some short-seller tweets that have deliberately confused. Evidently, there were some transactions related to binance.com that were widely reported to be involved with the various characters and then there was an attempt to link us to binance.com, which was a false statement. So I just wanted to be able to get a statement out about that. So the short answer is no legal and regulatory action. We’re not involved in any elements of that. From a regulatory perspective, we spent a long time with the regulators seeking a variety of non-objections going through a bunch of different risk reviews associated with these assets.

And ultimately, the exit we decided to do was really based on when the SEC came out and essentially said that most cryptocurrencies were securities, and therefore, the exchanges would have to be licensed as securities exchanges. And so even though we were only doing operating accounts for these businesses, essentially allowing them to do payroll and whatever, and we weren’t doing any wallet transactions. We weren’t doing retail transactions. We just decided that it was, we wanted to pause until we got more regulatory clarity. And by the way, I don’t want what we did to disparage anyone particularly in the crypto business. There’s obviously good players and bad players in that business. And I would still retain the optionality at some point in time to look at some sort of involvement in the future.

But that would wait until we get better regulatory clarity around what the treatment of these exchanges are going to be and what’s the overall landscape so that there’s just more certainty associated with it. So we weren’t doing anything there until after Signature and Silvergate collapsed. We did some limited purpose accounts. The SEC kind of had their rulings. Obviously, they’ve been aggressive in that space, but then they’ve also kind of pushed back by courts in certain instances and things like that. But at the end, it was our own decision, and it was just in relation to what we saw, not anything particular with respect to us. And there’s nothing that’s impacting us with respect to this. This is just attempts by folks who are short at the stock to try to try to make something out of nothing.

And that’s why we said something about it.

David Chiaverini: Got it. Very helpful. And then I had a follow-up on the professional services expenses. You mentioned that it was related to the fiscal year-end process. I was curious, was any of it related to the latest release of UDB 2.0. Was there any capitalized software expenses in there? Anything of that nature? And is that being kind of amortized in and this is kind of a new run rate going forward?

Greg Garrabrants: There’s always some kind of level. But now the capitalization that will be amortized comes through the depreciation and amortization line. So that will be recognized going forward. I forget candidly, whether there was 1/3 of it in the September quarter. That wasn’t in the professional services line. The professional services had a couple of insurance reimbursements in prior quarters. related to legal matters. This quarter, the primary thing related to the year-end activities was that we have our audit that occurs over the July and August period. So there’s always not only the audit fees, but then there’s the tax work and the legal work that goes in mind with it. So it usually causes a slight blip up during that September quarter when you look at it kind of almost a slight seasonality to it.

David Chiaverini: Got it. Thanks for that. And then the last one for me is a follow-up on the credit quality questions on the special mention in the substandard. I was curious, any common themes that you’re observing? Is it that lease-ups are going slower than expected? Or is it really driven by higher rates and pressure on DSCR. Any common themes that you’re observing?

Greg Garrabrants: Not really. It’s fairly idiosyncratic. I mean I think it’s really pretty de minimis, and it’s nothing, it’s a very small amount. And frankly, if you look at it, it’s a little bit up from the prior quarter, but it’s down from a year ago, right? So if you look at NPLs, for example, single-family is down significantly from last year. And so they really are idiosyncratic with respect to just different elements. I mean I do think that I think the office sector is under pressure, but I think fundamentals in multifamily and industrial and lease-up activity in Industrial looks fantastic. Condos are still selling very, very well. Single-family is still holding up. So I think all of the fundamentals are, I think, definitely pretty good. We don’t really see some sort of deterioration on the operating or cash flow side of any significance, really.

David Chiaverini: Great. Thanks very much.

Greg Garrabrants: Thank you.

Operator: The next question comes from the line of Gary Tenner with D.A. Davidson. Please proceed with your question.

Gary Tenner: Thanks. Good afternoon. I want to ask a little bit about the Advisory Services business and the white label banking, I know you kind of mentioned it a bit in your prepared remarks, Greg. But I think during the quarter, there was a report of the sizable adviser network that was going to move over to Axos lease part of their business. And I know over the last couple of years, you’ve talked a lot about kind of going after some of these larger RIAs, et cetera. So just looking for any sort of thoughts around kind of how that pipeline and how that sales process is developing and as you look out over the next 12, 18 months or pick a time frame, any thoughts on how much growth you could see in that business?

Greg Garrabrants: Right. The pipeline of new advisers and those joining are very good. The net I would say was not magnificent this quarter in comparison with what it should have been given the amount of new clients we won. What happened in that is that the legacy business has some pretty significant TAMs in it. And those TAMs, we’re seeing them have net asset losses as advisers break away. And so what would have been, I think, a very nice quarter of asset growth in that AES business ended up being still a net growth, but I would say relatively mediocre in comparison with what I would like to see, but the pipeline is really good, and the activity is great. And so I think the question, which I have a hard time being able to be able to estimate is how much of the existing business on that TAM side is kind of moving around.

And that’s what’s kind of keeping growth down right now. What I’m hopeful happens is that, that there’s frankly, the performance on that side for a lot of those guys, that’s kind of driven certain things. It’s obviously idiosyncratic to each TAM, but that’s what’s really going on. So back to the question of what that looks like. I think conservatively, we ought to be able to do several billion dollars of growth in the remaining several quarters on a net basis, that probably looks more like four or five on a gross basis, which is nice. And if you could get four to five and getting to six on a net basis, then that would be a really nice kind of run rate. I’ve told the team that I’d like to see them and kind of staff the sales function to double that business in the next five years.

And the conversations are great. We had our client advisory board where we released our demo and our first operational white label platform that has on the app that has the advisory side of the banking together had great feedback on it. People are excited to get using that. So that will start happening in the first quarter of the next calendar year. So there’s a lot of good things happening. The activity is really good. And when I was sitting around with the head of that business, I said, well, gee, it looks like your sales are great, but you got to figure out how to deal with the back door. I think that will that on a turnaround hopefully. But it’s hard to say with respect to whether it will and how many more quarters that will go on.

Gary Tenner: I appreciate the color. And so you’re saying, though, on the white label banking side that you expect to have RIAs live on that in the first quarter of ’24?

Greg Garrabrants: Yes, I do. And then what will happen with that, as I say, by the end of first quarter of ’24, every new account will be offered a bank account, and that bank account will come with the advised account, and there will be significant benefits associated with having that account together such as the ability to immediately deposit a check and have it available that instant. Where we have other elements on the platform that are going to take a while longer, securities-based lines of credit, which we want to be one click securities based line of credit, securities-based credit cards, things like that. And those are in the works. But there’s a lot of wood to chop there.

Gary Tenner: Thank you.

Greg Garrabrants: Thank you. Thanks Gary.

Operator: Thank you. We’ve reached the end of the question-and-answer session. I’ll now turn the call over to Johnny Lai for any closing remarks.

Johnny Lai: Great. Thanks, everyone, for your interest, and we’ll talk to you next quarter. Thank you.

Operator: This concludes today’s conference. Thank you for your participation. You may now disconnect your lines at this time.