Greetings, and welcome to the Axos Financial Second Quarter 2020 Earnings Results Conference Call. At this time, all participants are in listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instruction] As a reminder, this conference is being recorded. It's now my pleasure to introduce our host, Johnny Lai. Please go ahead.

Thank you and good afternoon everyone. Joining us today for Axos Financial Inc's second quarter financial results conference call are the Company's President and Chief Executive Officer, Greg Garrabrants; and Executive Vice President and Chief Financial Officer, Andy Micheletti. Greg and Andy will review and comment on our financial and operational results with the second quarter, and they will be available to answer questions after the prepare presentation. Before we 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 statements in response to your questions. Therefore, the Company claims the protection from the Safe Harbor for forward-looking statements that is contained in the Private Securities Litigation Reform Act of 1995. Forward-looking statements related to the business of Axos Financial Inc and its subsidiary can be identified by common use forward-looking terminology and those statements involve unknown risks and uncertainties, including all business related risks. There are more detailed in the Company's filings on form 10-K, 10-Q, 8-K with the SEC. This call is being webcast and there'll be an audio replay available with 30 days in the Investor Relations section of the Company's website located at axosfinancial.com. All the details of this call were provided on the conference call announcement and today's press release. At the time, I'd like to turn the call over to our CEO, Greg Garrabrants, who will provide opening remarks. Greg, please begin.

Thank you, Johnny. Good afternoon everyone, and thank you for joining us. I'd like to welcome everyone to the Axos Financials conference call for the second quarter of fiscal year 2020, end of December 31, 2019. I thank you for your interest in Axos Financial and Axos Bank. Axos announced record quarterly second quarter net income of $41.3 million for the fiscal second quarter ended December 31, 2019, up 6.3% from the $38.8 million earned in the fiscal second quarter ended December 31, 2018, and up 1.2% compared to the $40.7 million earned in the prior quarter. Earnings attributable to Axos' common stockholders were $41.2 million, or $0. 67 per diluted share for the quarter ended December 31, 2019, compared to $0.61 per diluted share for the quarter ended December 31, 2018, and $0.66 per diluted share for the quarter ended December -- September 30, 2019. Excluding non-recurring expenses, non-GAAP adjusted earnings and earnings per share were $42.9 million and $0.69 respectively for the quarter ended December 31, 2019. Other highlights of the second quarter include ending loan and leases increased by approximately $1.1 billion, up 14.8% annualized from the first quarter of 2020, and up 12.5% year-over-year. Strong originations in commercial real estate specialty lending, small bowels commercial real estate lending, mortgage warehouse in equipment leasing or offset by lower production in jumbo single-family and IR payoffs in multi-family uncertain C&I loan portfolios. Total assets reached $12.3 billion at September 31st -- December 31, 2019 up by $1 billion compared to September 30, 2019, and up $2.5 billion from the second quarter of 2019. Net interest margin was 3.87% for the quarter ended December 31, 2019, up 10 basis points from the 3.7% in the first quarter of fiscal 2020, and unchanged from 3.87% in the second quarter of…

Thanks Greg. First, I wanted to note that in addition to our press release, our 10-Q was filed with the SEC today and is available online through EDGAR or through our website, axosfinancial.com. Second, I will highlight a few areas rather than go through every individual financial line item. Please refer to our press release or 10-Q for additional details. As Greg indicated earlier, Axos' net income for the second quarter ended December 31, 2019, goes 41.3 million, up 8.46% year-over-year and up 1.2% compared to our last quarter ended September 30, 2019, both due to primarily loan growth and the maintenance of our net interest margin. Net interest income grew 5.1 million or 5% for the second quarter ended December 31, 2019, compared to our first quarter ended September 30, 2019. Breaking down the linked quarter growth of net interest income by segment, the banking business had net growth of 5.8 million, the securities business had a net decline of 1.1 million, and the corporate segment had a net benefit of 0.4 million. That net interest margin for the banking business grew to 3.94% of 11 basis points compared to 3.83% last quarter and up 4 basis points compared to the prior year. The linked quarter improvement in the banking net interest margin is primarily the result of first shifting more average deposit balances to non-interest bearing. Second, reducing our interest bearing deposit rates; third, adding the seasonal H&R Block Emerald Advance loans; and finally fourth, overall growth in our average interest earning assets. As a result, interest in dividend income grew 2.7 million, while the cost of funding declined 3.1 million on a linked quarter basis. Average loan balances increased 240 million, while average non-interest bearing deposit grew 302 million this quarter, providing the opportunity to redeploy existing…

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

Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] Our first question today is coming from Steve Moss from B. Riley FBR. Your line is now live.

Good afternoon guys. This is Nick Dufala, stepping in for Steve Moss. I have a question regarding expenses and if you guys could kind of walk us through operating expenses for 1Q, '20. How they escalate to the remaining part of the year?

Let me give you a high level overview and then Andy can jump in with any particular specifics you might have. So, let's talk about the banking segment first. I'll divide that into sort of sales and production oriented personnel and then infrastructure personnel. I think that we are in a place with respect to our technology investments where I feel relatively good that barring relatively small changes. We're going to be able to complete the objectives we have with respect to those technological goals that we have without adding substantially to our expense base. So, that I think is good news. There's been an incredible amount of investment over the last number of years. And we have a large staff now that has a good pipeline of activities, and they're accomplishing items and checking them off the list and moving on to new ones. So I think that's one piece of it. The next piece of it is that we continue to expand sales team, commercial bankers. Some of those bankers perform well. Some of those bankers perform less well. So that is a management issue there, but as we grow the bank and we increase the asset deposit base then there would be a commensurate increase in that banking talent. With respect to how much that costs? I said before and I think it's important to reiterate that, obviously as you continue to blend, let's say a more retail online banking business with a more traditional commercial business, what you end up with is different levels of operating costs with respect to the business. So in other words, we have a higher level of non-interest bearing deposits, but that comes with a commensurate increase in cost of personnel. And in more automated businesses, you'll have lower levels of…

Yes, I'll just comment on probably three or just one grade items. Looking at this quarter's operating expense and thinking about operating expense going forward, the one area where we have had a benefit has been FDIC insurance, where frankly all banks, generally a smaller banks have been getting a credit from the FDIC. So, it's a net result when you look at our year-to-date numbers. Last year, we were at $4.4 million in FDIC insurance. This year on a six month basis, where 1.1, I would expect us to approach the $4 million on a run rate, as the credit start to diminish, which that program is starting to end. So, you'll have a small uptick in FDIC insurance. And looking at linked quarter depreciation and amortization increased about $1 million. That is exclusively for our software that we deployed in the unity software that's being deployed in our fiduciary business. That's an accounting, purchase amortization entry. I don't expect, best the largest of the incremental growth items there. We will continue to have some increase in a depreciation of for capitalized software as we continue to capitalize some of the software costs, and they get deployed and they get amortized. But I don't expect of the million, tap growth larger than the million we have this quarter. Looking at salaries and wages, they were down on a linked quarter basis. Part of that reason is this quarter we happen to have a little more capitalization of labor. So that was $1 million benefit on a linked quarter. I don't think we can count on having that benefit, frankly, every quarter. It completely depends on what happens with the development team and how that looks. So overall, I think we're happy with the small increase this quarter, but we do expect expenses to increase. We will have seasonal increases, the normal seasonal increases next quarter, meaning the March quarter for block. So, we think overall, expenses should increase but not large.

Okay. And thanks for all that information. It sounds like on a technology front at least in near term you guys are pretty well equipped there. I also was thinking about how you guys are thinking on resi mortgage balances given the lower rate environment that kind of what you're seeing on that side of the business?

We continue to be hopeful for some stabilization in that portfolio. We do have some slight upticks in the pipeline. Unfortunately, I think that we're really, really shooting for some stabilization there, not a lot of ongoing growth, but we continue to have that as a focus and we continue to work on mechanisms of stabilizing that business. And I think that we did see a little bit -- we're seeing a little bit lower prepayment indications, but I don't think we can expect that business to be a significant grower in the next several quarters. But it's interesting businesses just given some increased competition in certain areas that we're paying attention to it, and in some cases where we're simply letting business go, that we don't really think we want to participate in. So, that's going to be something we have to watch on an ongoing basis.

Our next question is coming from Andrew Liesch from Piper Sandler.

The non-interest bearing deposit growth here. I know you walk through some of it, but $2.6 billion at that quarter end. What was the big driver -- suddenly you move some interest bearing accounts and non-interest bearing. You had some epic departments come over in maybe you had another larger commercial balance. Is this a good level of non-interest bearing accounting? Or is there going to be some outflows from here? What where do you see this moving going forward?

Yes. I think we've always had a look at seasonal differences. So this next quarter, of course, we have block where we have seasonal increases in non-interest bearing, but the bottom-line majority that growth was due to two fiduciary balances that came in. And we don't necessarily expect that to stay at that same level, because it does depend upon, basically settlements and when settlements get paid. So we can't tell you how fast you would advertise off. But there's a chance that it's going to be come down faster than our normal Chapter 7 balances.

And then, but it does sound like you're having some pretty good success bringing in non-interest bearing account reclassifying others. I mean, the 3% to 4% margin range is, it's pretty wide, especially with some of the success you have this quarter. And before I think you'd said like towards the lower end of that. I mean, is there -- what the success you've had on the funding side? I mean, are we creeping up closer to the middle part of the range is a better place to be forecasting?

Yes, I think that might be a bit premature, but obviously, we always tried to do that. I think also, you have to bear in mind that there is just more broadly, with respect to our loan growth target, there may be pressure on the asset side. And with respect to the ability, if we're able to maintain sustain some of these non-interest bearing balances, but with respect to these just given the nature of different various elements they can occur at different times and things like that. I just think it's a little premature to do that, given the steadiness of the inflows and the outflows are not always predictable enough to make that conclusion right now.

Our next question is coming from Michael Perito from KBW. Your line is now live.

Thanks for taking my questions. I want to just start on core. If I'm looking at the broker dealer fees, they've been a pretty tight range last couple quarters. But -- and I apologize I did jump on the call seamlessly, but it sounds like you guys added a couple of new clients there. And I think if I recall at the Analyst Day, you guys were talking about opportunity for efficiency improvements specifically in that business. So I guess my question, is it mostly revenue driven at this point? I mean, I know you're answering an earlier question, it sounded like there wasn't anything material on the expense side. There is more kind of growing into what you've already done. And I guess if that's the case, what's the update on kind of time line for adding more clients and growing that revenue stream going forward?

I think you stated it reasonably accurately. There certainly is lots of manual processing and opportunities to utilize a lot of the tools that we've utilized in other businesses of ours to improve efficiency and to create I think a much better and resilient operation. I think that the reality of the business though is its relative size. I think it's just a little bit rough to forecast that you're going to cut your way to any significant growth. So, the way this is going to work is severalfold. We have a reasonable pipeline right now of new clients, and those clients take multiple quarters to come on board and generate revenues. So, there's that component of that immediate business there. Then there are other clients that, that we're talking with that are, they're substantive, they're large, but some of the strategic items that we have to do need to get done before we're actually a viable player. So for example, there's one player that has $700 million of reasonably low cost deposits, just one single broker dealer. The reality of that is that we have some technological, elements that will put us in a very good place to compete for those sort of clients. Not guaranteeing we can get them. And that's probably about a year to 15 months off before all that technology will be deployed. But once it does get deployed, some of it will truly be best in class in the industry and others will put us more at table stakes. So I think when we have a good proposition for a certain size broker dealer and we have a good group of folks there who are interested in joining us. We're weeding out some of the ones that are not within our core strategy. And then for the long-term future of the business, we're investing in the capabilities, using some of the consolidated platforms that we have in other businesses to really create a great product. And I don't think there are a lot of companies including the largest providers that have a great product for their clients here.

So, is it fair to say that, if we're trying to think about what kind of the base case expectation is for this business that we should see some revenue lift this year, but there should be kind of a much bigger pickup next year when a lot of those items that you just discussed kind of are full force in terms of your abilities to...

Yes, I think that's right. I think the reality of both these businesses is that they are longer term businesses and I wouldn't expect much in the way of lift throughout the rest of this year. They're much more strategic to the long-term as a long term needs to serve clients in a holistic way than they are in next couple quarters lift sort of items, I basically forecast flattish with respect to them.

Got it. That's helpful. Thank you. And then I was wondering, if you could -- the commercial specialty real estate segment has seen some nice growth. And I was wondering, if you could just give us kind of a flavor of what like some of the typical opportunities that you've been capitalizing on, in that businesses within? And what you think kind of the actual value proposition is there, that's really made a difference been able to drive growth some of that growth over the last 12 to 18 months?

I think we have a lot of institutional relationships with very strong partners who have grown to trust us over time. And so, our ability to take risk positions that we feel comfortable and with partners that we've have longstanding relationships with allow us to be the first call, essentially. And so, those partnerships are many of the largest funds and private equity shops in the world. And we've cultivated those relationships over extended periods of time. And now, I think we're reaping the benefits of those of those relationships.

Got it. And then just lastly on, any updated thoughts Greg on kind of capital levels? And what some of the priorities outside of organic growth might look like for fiscal 2020?

Well, with respect to the capital side, obviously, I mean, we continue to grow our Tier 1 leverage ratios. And as the business sort of next moves in 50%, 100% risk weighted, I do think that thinking about the max capital given are relatively low double leverage ratio or are much lower double leverage ratio than the industry average will be something we continue to look at. I don't have anything definitive to update you on there, but that will be something. And then with respect to just more global outlook, I think only items that we outlined an investor day stay on track. And so, we're continuing to execute against the strategic plan that we have and don't really have any substantive update there to share.

Okay. So, from a timing perspective, is it fair to think that the capital will probably build the next couple quarters, and as you reach the end of fiscal 2020, that there might be more to communicate?

Yes, I think that might be a fair statement. We certainly are in a pretty good position now and obviously we continue to accumulate capital and have our leverage ratio grow. And obviously, I don't think -- clearly, we don't need equity sort of common equity, so the fee options are obviously other than that.

Thank you [Operator Instructions] Our next question today's coming from David Chiaverini from Wedbush Securities. Your line is now live.

Hi thanks, a couple of questions for you. So first, a follow-up on clearing, you mentioned the significant opportunity given the merger between Schwab and TD Ameritrade. Have you considered actually accelerating investment in the clearing business take advantage of this?

I think that it probably is the case that there is a justification for doing that. However, what we're trying to do because there's a number of elements that are kind of running on a simultaneously through the items that we have to do. So for example, a lot of the retail platform elements that we're working on aren't very valuable. And when they're seen by RIAs or independent broker dealers, they truly are unique whether it's the account opening features or the robustness of the banking platform. And those banks kind of all have to move together. So, we're working hard on it. And I think that there is a case for that, and if you can reincarnate my investor base as a set of fintech investors or have softbank come in and invest in me, then we'll really be able to build a much more robust custody and clearing business more quickly. But I do think that, there's a lot of market opportunity here. And then, you get a sense of from client discussions how frustrated they are with existing players, how unhappy they are. A lot of those kinds of things and you can kind of feel that and that's the sort of thing we've always had around here before, often years before opportunities show up, right. So I remember, when I first started talking to people about the C&I lending 5 to 6 years ago, and then I would get comments. You hired some people and two quarters later, I don't know what's going on. I don't see it like tick, tick, tick, tick, right? And then years later, obviously, you see the tremendous results from it. So, I mean, I think that's sort of my job to be long term. And I think it's an industry job these days to be short term. And so, that kind of yin and yang sort of ends up in a place that you've got a balance, so, yes, I do think that there is a lot of opportunity. I think that's a really insightful question because I think, maybe any given your, where you're from, you understand the opportunities.

And then shifting gears on, in jumbo lending, you mentioned how it won't be much of a contributor to loan growth in the near term. What is it that's holding you back? Is it pricing getting too tight? Or competitors offering underwriting terms they're too loose? Or is it simply not enough supply in your niche to generate growth?

I think that it's the emergence of a variety of conduit style opportunities, they're creating an alternative outlook for outlet for products that we're not necessarily inclined a balance sheet. We've always had a very conservative perspective with respect to what we balance, which is why our credit performance has been so strong over such an extended period of time. And we are doing some work to engage in some of that conduit business, and we're going to dip our toe in that and see how it goes. But that's not going to be through the bank, that's going to be through the securities, subsidiary and through actually a special subsidiary of the securities subsidiary. So, there may be some ability to participate in that, but I don't -- that would then result in some fee income. That would be generated, but it would -- it's just a fundamentally different business than what we have been historically doing on the portfolio sign.

We've reached end of our question-and-answer session. I'd like to turn the floor back over for any further or closing comments.

Thank you everyone for your attention and support and we'll talk to you next quarter.

Thank you. This does conclude today's teleconference. You may disconnect your lines at this time and have a wonderful day. We thank you for your participation today.