Axos Financial, Inc. (AX) Q3 2023 Earnings Report, Transcript and Summary

Good afternoon. And welcome to the Axos 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. [Operator Instructions] Please note that this conference is being recorded. I will now turn the conference over to our host, Johnny Lai, Senior Vice President, Corporate Development and Investor Relations. Thank you. You may begin.

Thanks, Diego. And good afternoon, everyone. Thanks for your interest in Axos. Joining us today Axos Financial Inc’s third quarter 2023 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 and nine months ended March 31, 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. 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 the safe harbor protection pertaining to forward-looking statements contained in the Private Securities Litigation Reform Act of 1995. This call is being webcast, and there will be an audio replay available in the Investor Relations section of the company's website located at axosfinancial.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 Axos Financial's conference call for the third fiscal quarter ended March 31, 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 noninterest 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, up 17% from March 31, 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 Axos Advisory Service deposits, ending period commercial and consumer noninterest bearing deposits were flat from the end of the prior quarter. Ending net loans for investment balances were $15.8 billion, up 2% linked quarter or 9% annualized. Loan growth was broad based with growth in single family mortgage, multifamily and C&I 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 seven 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. Axos Securities, comprised primarily of our custody and clearing business, made positive contributions to our fee and net income. Broker-dealer fees increased 40% linked quarter and 166% year-over-year due to higher interest rates and increased client activity. Quarterly pretax income for our securities business improved by $3.9 million linked 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 noninterest income resulted in a 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 31, 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 a $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 and 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 mix 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 by 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 C&I 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 the clearing, custody and bankruptcy deposit businesses when rates were at or near zero and deposit balances were near the 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 deposits 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 ARM 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 on 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 nonbank 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 mix perspective with consumer and small business, representing 48% of total deposits. Commercial and 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 noninterest bearing deposits excluding fluctuations in Axos Advisory Services cash balances were approximately flat from December 31 to March 31 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 noninterest bearing, commercial and specialty deposits were flat. We believe that the pace of cash sorting at AAS has 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 Axos 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 Axos Security. Since the banking failure in early March, we have aggressively increased our outreach to existing and prospective clients across every deposit vertical. With our experience with the IntraFi 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% of our total loans outstanding at the end of the quarter, have a weighted average loan to value of 57% and 53%, respectively. Our jumbo single family mortgages are concentrated along the coast in markets where housing inventories continue to be constrained. The lifetime loss on 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 nonbank 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 nonperforming 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 parry participation for One Madison in New York, one of the best office buildings in the city. This building is 57% preleased and has a 50% recourse guarantee from SL 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 31 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 finance portfolio and non-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 to value 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 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.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 significant competitive advantage, particularly in a highly cyclical industry such as banking. I'm excited about the strategic initiatives we have across our businesses. Our strong capital, liquidity and profitability allows 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 succeeded 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 noncore 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 Derrick now.

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@axosfinancial.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 and ending C&I loan balances of $246 million Credit quality remains good with four basis points of net annualized charge-offs to average loans three basis points of which were from auto loans that are covered by insurance policies. Our nonperforming loans and leases were 60 basis points at March 31, 8 basis point improvement from the December quarter. Single family, multifamily and small balance commercial mortgages represented over 75% of our nonperforming 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 nonperforming loans at March 31, 2023. Noninterest 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 industrywide 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. Tier1 capital to risk weighted assets for Axos 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 is 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 CRESL 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 NIM. 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, Derrick. Operator, we're ready to take questions.

[Operator Instructions] Our first question comes from Andrew Liesch with Piper Sandler.

Thanks, Derrick. 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?

Yes, 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 a neutral assumption is roughly correct.

Got it. And then just looking at the Q, it didn't look like there's too much change in sub standards 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 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. And then, 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 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, yes, I think there's not only team acquisitions. So let's talk about the opportunity set. There are 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 are 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 Boolean, right? You either win them or you lose them, but that could change the loan growth prospects. So we would, we gave you kind of organic loan growth 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 they're sort of. We've been adding personnel there, so we feel really good about those three areas.

Our next question comes from David Feaster with Raymond James.

Hey, good afternoon, everybody. Maybe just starting on the loan growth side. Appreciate the high single digit guidance and that kind of jives with the slowdown in originations we saw. I'm just curious, how much is this by design or is this a function of just less demand in the market? 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 CRESL 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, yes, 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, 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. I feel reasonably good about loan growth. I think we are being, I that's product our best estimate, 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 when we're doing CRESL deals now, we're looking at 12 and 13 debt yields right for attachments to RPS. Those are good deals right with great sponsors. So 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. I'm just curious what you're seeing more broadly there. You touched on it a little bit. 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's the cash flow of the properties 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% loan to values on those things, 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 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. So that I gave that example, the One Madison Building, which is pre lease 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 into 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, LA, particularly markets that have been subject to the sort of 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 LA downtown, even our office, our team wants to move because the 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 sorts 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 so that comports with those loan to value ratios. So I think when you look at these sorts of things and then obviously, we cultivate a very robust set of folks that are interested in being able to buy those properties in whatever form they are at and 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 adjust what we expect target debt yields are, we adjust the advance rates and 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 look, I think that the fundamental issue is if you lent on a San Francisco office building and you were 70% non-recourse, which was something that you could have easily gotten, and you basically had tenants and you underwrote at a 3.5% or 4% cap rate, which is what the appraisal is, that's a tough loan, right? But that's a very different thing from the type of stuff that we did. So 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 turned out to ultimately be correct. And I believe it will turn out to be correct over the cycle.

Okay, that's extremely helpful color. 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?

Yes, 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 Purging 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 systems 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 security based line of credit and then working to serve that entire customer's need. That's ongoing as far as development and doing well. We are 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 there's some fundamental cost 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 stops, 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 view processing opportunities. Some of those are related to the ability to get access directly to the client because through the app, right. Because when that happens, then all of 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, yes, there is a lot of great opportunity. The client reception is extremely good. People want another choice other than Schwab, and with the merge, they've just been forced into Schwab entirely. So, yes, there's a lot of opportunity on the custody side there, for sure.

Our next question comes from Gary Tenner with D.A. Davidson.

Thanks. Just wanted to follow up on the comment you made on the prepared remarks on the RIAs, 15 RIAs I think, signed up AUM of $1 billion. What's the timing for the onboarding of that group?

Yes, it's a little bit variable, but I think six months is a reasonable kind of view. But some of this depends on their own pace and we're also building better processes to move that along. But I think a six month time frame 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 on boarded.

Yes. I know in the past you've talked about the ability to really attract larger individual RIAs once you kind of complete the integration of the full sweep, is that kind of still the perspective that there's going to be delays, some --?

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 billion dollars plus RIA signing up. Part of it is the question is they're often committing $100 million of maybe several billion that they have, and they're sort of trying us out. And some of it is we've sold them on not only what we're doing now but what we're doing in the future so they're multi 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 we have to do. And then 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.

Got you. Thank you. And then just really one more question on the custody side with the commentary about the cash sorting balances kind of down to 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 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 treasuries kind of in the same way that we're seeing 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?

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 that kind of makes that movement. But there clearly has been some allocations away 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 that so, but it, look, we haven't seen this environment for some time, so the question is, even in much higher rate environments, this percentage 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 are costs associated with doing that. So it isn't a perfect substitute, but there's some of it, but not most of it.

Our next question comes from David Chiaverini with Wedbush.

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?

Yes, Moody’s did mention that in their most recent report on us, and I think that was pretty much they've kind of taken that pretty much industry wide. And yes, so we went through that with them, and we had folks that were a little bit new to the business that we were talking with. But, yes, 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 CRESL and Lender Finance and how receptive have they been to that conversation?

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, look, I don't put much faith in what rating agencies say or do in my investments or anything else. They basically move with the tide and the press and whatever else but yes so.

Understood. Thanks for that. Shifting gears on the deposit side, you guys have that nice lever of having off balance sheet deposits that you could entice to bring on balance sheet. Can you remind me what the number was for 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 of 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 not necessarily off balance sheet, but it's not an Axos Bank, but is an opportunity for us as well. We have the customer base for.

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 Derrick said.

Our next question comes from Edward Hemmelgarn with Shaker Investments.

Yes, just a couple of questions. One is, what is the time frame again on finishing the improvements to the securities business? You indicated numerous times.

Ed, I mean there's so many different things going on. I mean, the universal core is a multiyear 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 multiyear project. 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 kinds of things. So it's a multiyear kind of thing. I mean then I take, umbrage at any manager ever thinking they're done improving their operations either. So but I think just with respect to that, it's a multiyear project.

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

Yes, 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 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 of months. But, yes, I mean and then, 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 got to get old clients to change. There's have 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 those kinds of things, those are long term things. They are still multiyear 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, you're still a young spry guy, I mean you are much.

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

Yes, 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 are 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 yes. So that could change the loan growth projections a little bit if we did stuff there, but we'll see. I mean we bid for one loan pool and got smoked spot for and I thought it was I was surprised that whoever took it I was happy they did at that price, we wouldn't have bought it. So, look, I mean that you don't know those things, you basically do your diligence you put in your bid and it could be pulled away you could win it so.

And lastly, I mean in the past have been very opportunistic at least in your only other time we had the recession that was in ’07, ‘09 and taking advantage of the opportunities that are out there. Do you or what's your curious about your economic outlook? I mean are you assuming a recession or do you think the potential is that things 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?

Yes, 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 we're going to go out and, look, if somebody's willing to sell me signatures book at of $10 billion of loans at $0.50 of a $1.00, 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 kinds 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 yes, 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 kind of purchase things 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. It could be something there. But look we have, obviously, we have very strong earnings. And so that allows us to have the opportunity to grow or to look at these kinds of opportunities as they arise.

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

Great. So 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 Derrick 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 C&I and Crestal Loans and $15 million of auto and in secured. 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.