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Edited Transcript of BOFI earnings conference call or presentation 29-Apr-20 9:00pm GMT

Q3 2020 Axos Financial Inc Earnings Call

SAN DIEGO Jun 17, 2020 (Thomson StreetEvents) -- Edited Transcript of Axos Financial Inc earnings conference call or presentation Wednesday, April 29, 2020 at 9:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Andrew J. Micheletti

Axos Financial, Inc. - Executive VP & CFO

* Gregory Garrabrants

Axos Financial, Inc. - President, CEO & Director

* Johnny Y. Lai

Axos Financial, Inc. - VP of Corporate Development & IR

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Conference Call Participants

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* Andrew Brian Liesch

Piper Sandler & Co., Research Division - MD & Senior Research Analyst

* David John Chiaverini

Wedbush Securities Inc., Research Division - Senior Analyst

* David Pipkin Feaster

Raymond James & Associates, Inc., Research Division - Research Analyst

* Edward Paul Hemmelgarn

Shaker Investments, L.L.C. - Founder, President, CIO, Portfolio Manager & Director

* Michael Perito

Keefe, Bruyette, & Woods, Inc., Research Division - Analyst

* Stephen M. Moss

B. Riley FBR, Inc., Research Division - Analyst

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Presentation

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Operator [1]

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Greeting, and welcome to the Axos Financial Third Quarter 2020 Earnings Results Conference Call. (Operator Instructions) As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host, Mr. Johnny Lai, Vice President of Corporate Development and Investor Relations. Please go ahead, sir.

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Johnny Y. Lai, Axos Financial, Inc. - VP of Corporate Development & IR [2]

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Thank you, and good afternoon, everyone. Thanks for joining us for Axos Financial, Inc.'s third quarter financial results conference call. With me today 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 for the third quarter, and they will be available to answer questions after the prepared remarks.

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 as contained in the Private Securities Litigation Reform Act of 1995. Forward-looking statements related to the business of Axos Financial, Inc. and its subsidiaries can be identified by commonly used forward-looking terminology. And those statements involve unknown risks and uncertainties, including all business-related risks that are more detailed in the company's filings on Form 10-K, 10-Q and 8-K with the SEC.

This call is being webcast, and there will be an audio replay available for 30 days in the Investor Relations section of the company's website located at www.axosfinancial.com. All the details of this call were provided on the conference call announcement and in the press release today.

At this time, I'd like to turn the call over to Greg, who will provide opening remarks.

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Gregory Garrabrants, Axos Financial, Inc. - President, CEO & Director [3]

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Thank you, Johnny. Good afternoon, everyone, and thank you for joining us. I'd like to welcome everyone to Axos Financial's conference call for the third quarter of fiscal 2020 ended March 31, 2020. I thank you for your interest in Axos Financial and Axos Bank.

We had an excellent quarter with annualized double-digit loan growth, stable net interest margins, strong fee income and very low credit losses. Rather than go through the typical rundown of the quarter, I will focus my discussion on 3 topics: credit, capital and near-term business outlook.

We have a consistent track record of maintaining low credit losses through multiple economic cycles given our conservative underwriting guidelines, senior structures in our commercial lines and loans and the collateralized nature of our loan book. During the great financial crisis, our peak annual net charge-offs for loans we originated was less than 1 basis point for single-family and multifamily mortgages. The vast majority of our credit losses incurred between 2008 and 2012 were for recreational vehicle loans that were discontinued in 2007.

We are confident that we will be able to weather the current economic downturn for several reasons. The vast majority of our loan portfolio is collateralized by hard assets at conservative attachment points. Our single-family mortgage, multifamily and commercial real estate mortgages have low loan-to-values, low loan-to-costs and are located in markets with historically strong demand. The vast majority of our larger real estate exposures are structurally protected by relationships with large funds that are structurally subordinated to us. Our direct exposure to unsecured consumer loans represents approximately 50 basis points of our loan portfolio. We have no exposure to credit cards and approximately $3 million of home equity lines. Although some of our asset-backed facilities and a real estate loan or two are technically classified as shared national credits because of the nature of the syndication in which we are a part, we do not have exposure to cash flow-based shared national credits. We lend exclusively to prime and super prime borrowers across each of our consumer lending categories: auto, single-family mortgages and personal unsecured lending. We have minimal credit exposure to airlines, malls, casinos, retailers, theme parks, hotels, oil and gas, restaurants and small businesses. We do not have mezzanine or subordinated tranches of securities in our portfolio. We do not have collateralized loans in our portfolio that are junior in rights to other loans other than the previously mentioned $3 million of home equity loans. If we take additional collateral in a second position, it is in an abundance of caution and supported by a first lien on other collateral.

Approximately 95% of our loans outstanding at March 31, 2020, were collateralized by hard assets with a loan-to-value ratio in the 50s, including $9.1 billion of real estate assets and $787 million of primarily consumer receivables. Single-family mortgages, representing 40% of our total loan portfolio, had a weighted average loan-to-value ratio of 57%. At the end of March 31, 2020, quarter, 60% of our single-family mortgages have loan-to-value ratios at or below 60%. 33% have loan-to-value ratios between 61% and 70%. 6% have loan-to-value ratios between 71% and 80%, and less than 2 basis points or $860,000 of combined balances have greater than 80% loan-to-value. We have an established track record of strong credit performance in our jumbo single-family mortgage lending book with lifetime credit losses of originated single-family loans of less than 3 basis points of loans originated. While we do not foresee a sharp decline in home prices nationwide on par with levels we experienced in the 2007 and 2008 financial crisis, we believe that any potential losses in our single-family real estate secured loan book will be manageable even in a sharp economic and housing downturn given the desirability and low attachment points of our underlying collateral.

Multifamily loans, representing 21% of our total loan portfolio at 3/31/2020, had an average loan-to-value ratio of 51%. The lifetime credit losses in our originated multifamily portfolio are less than 1 basis point of loans originated over the 18 years we have originated multifamily loans. At the end of March 31, 2020, quarter, 44% of our multifamily mortgages have loan-to-value ratios at or below 55% loan-to-value. 35% have loan-to-value ratios between 56% and 65%. 20% have loan-to-value ratios between 66% and 75% and less than 1% greater than 75% loan-to-value. The average debt service cover ratio of our multifamily loans was 150 -- was 1.5 at 3/31/2020.

Our small balance commercial real estate loan portfolio of $410 million, representing approximately 4% of our total loans at 3/31/2020, had a weighted average loan-to-value ratio of 52%. At the end of the March 2020 quarter, 49% of our small balance commercial real estate loans have loan-to-value ratios at or below 50%. 23% have loan-to-value ratios between 51% and 60%. 23% have loan-to-value ratios between 61% and 70%. 4% have loan-to-value ratios between 71% and 75%, and around 1% between 76% and 80% loan-to-value. Those higher loan-to-value loans are uniquely positioned. One of the largest loan-to-values -- one of the largest loans is secured by a state-level guarantee under a special program, and all loans at that level have strong personal guarantors.

In our small balance commercial real estate portfolio, we had approximately $80 million of loans to hotels and resorts, representing less than 1% of our total outstanding loans. We have an active dialogue with each of our CRE borrowers, and the weighted average loan-to-value of this book is approximately 52%, including a 49% loan-to-value for the hotel exposures. The average debt service cover of our small balance commercial real estate loan book is 1.69 at 3/31/2020.

Our mortgage warehouse loan book with March 31 balances of $380 million is secured by single-family mortgages that can be sold if the borrower is unable to turn the book. We temporarily suspended accepting non-agency mortgages, other than those that we intend to fund, as collateral for our mortgage warehouse facilities in mid-March due to dislocations in the secondary market for non-agency mortgages. As of April 28, 2020, we had approximately $88 million in outstanding non-agency exposure in our mortgage warehouse book or 19% of total current balances of $462 million. Our initial advance rate on non-agency loans vary between 90% and 95% of the note amount, and we typically curtail an additional 15% on day 45. Our weighted average exposure on a loan-to-value basis on the $87 million in non-agency loan balances outstanding distributed among 8 different warehouse clients was 58%.

Our borrowers have been actively reducing their non-agency exposure, and we have ongoing discussions to sell their remaining non-agency loans and reduce their draw on our line. We do not currently project losses from any non-agency exposure in our warehouse lending book, particularly given that the current market execution of trades is higher than our adjusted and curtailed advance rates. Our warehouse clients are benefiting from elevated levels of refinancing activity and higher margins across the industry due to capacity constraints.

Our commercial loan book, including lender finance and commercial specialty real estate, is comprised of loans and lines of credit secured by single-family, multifamily, commercial real estate, land and consumer receivables. The lender finance book is comprised of real estate and non-real estate transactions. The weighted average advance rate on the real estate lender finance book is 27.2% with no transaction with an advance rate greater than 50%. The non-real estate lender finance book, backed primarily by consumer loans, is approximately $732 million with an average advance rate of 27% of the outstanding receivable balances. These structures generally require rapid paydowns in the event of any significant collateral deterioration in the receivables and are also paid down rapidly in the event originations decline. We have sole and absolute discretion to approve or deny draws on all of our real estate secured lender finance and mortgage warehouse lines.

The weighted average loan-to-cost on our commercial specialty real estate portfolio is 44%, with strong junior partners supporting the capital structure. We hold a senior position in all of our lender finance and commercial specialty real estate loans, and every deal has significant capital support from borrowers and/or sponsors. We monitor the performance of the underlying collateral housed in a bankruptcy remote special purpose vehicle, allowing us to identify credit deterioration and take swift action to protect our principal and interest.

In our commercial bridge and construction portfolios, we work with experienced developers and well-capitalized sponsors, such as Ares, Fortress, Madison and Blackstone. The projects are located in gateway cities such as Los Angeles, New York, San Diego and Denver. The average loan size is approximately $18 million. The average remaining term is 14 months, and the average loan-to-cost is 44%. We have no direct credit exposure to airlines, casinos, theme parks, oil and gas exploration companies, retailers or movie theaters. Our equipment leasing portfolio represents our entire exposure to the oil and gas, aircraft and restaurant sector. In our equipment leasing portfolio, we had approximately $28 million of leases to 4 borrowers who provide services to the oil and gas and mining industries, a $13 million lease to the largest provider of emergency medical transportation services in the United States backed by a fleet of helicopters and $5 million of leases to a large fast-casual restaurant operator that finances countertop kiosks. The average debt service coverage ratio for the 6 equipment leases mentioned above was 2.87x at the end of the third quarter. All of the abovementioned credits were current as of March 31, 2020. Although some of our leases to companies have cash flow-based leverage on their balance sheet, we have no cash flow-based leverage loans.

We had approximately $263 million of hotel and $97 million of retail mixed-use exposure in our commercial specialty real estate loan portfolio, representing 2.5% and less than 1% of our total loans outstanding at March 31, 2020, respectively. The vast majority of hotel loans are A-, B-notes that we hold a senior position in with strong funds -- with a strong funded and junior position. The only 2 direct hotel deals we have are one in Manhattan at a 55% loan-to-value at origination with 97% ownership by the son of a Saudi billionaire, and the other is a -- also in the New York area for $12.5 million with a full guarantee from an individual with a net worth of over $50 million. The hotel properties are completed, and all hotels are current in their loan payments. The average loan-to-value of the hotel and retail commercial specialty real estate loans were 48%.

Our non-real estate consumer lending is comprised of approximately $312 million of auto loans, $55 million of personal unsecured loans and $56 million of H&R Block Refund Advance loans. We source our auto loans primarily from dealers located in 10 states and lend to prime borrowers with an average FICO score of 772. We fully underwrite and service every auto loan we hold on our balance sheet, and the portfolio continues to perform in line with expectations. We have managed the credit risk of our personal unsecured loan book by focusing on prime borrowers with an average FICO score of 765 and an average loan size of $20,000.

Given the rapid deterioration in the economy and the rise in unemployment nationwide, we have temporarily suspended originations of new personal unsecured loans. We originated approximately $1.36 billion of Refund Advance loans this quarter, up 17% from the $1.16 billion in the 3 months ended March 31, 2019. We have received payments for all but $56 million of the principal balances for RAs as of March 31, 2020, a pacing that is far ahead of the disclosed pacing of others in the industry. Given the 90-day extension on the federal tax filing deadline by the IRS, we anticipate a more extended repayment time frame for RAs this year compared to the prior year and cannot guarantee this extended pace will result in no incremental credit losses.

In our securities business, we ended the quarter with approximately $159 million of margin loans, down $67 million from December 31, 2019. And despite record price volatility in the stock market over the past few months, we successfully managed our mortgage -- margin lending business with no incurred losses. Our overall credit risk management approach is to engage in frequent communications with individual borrowers and lending partners and determine the optimal set of actions by each individual credit based on borrower, sponsor, project cash flow and liquidity. Business unit leaders have been working with our Chief Credit Officer and his underwriting and portfolio management teams to evaluate and monitor clients that have requested forbearance and/or become delinquent in their loan payments.

We have maintained an elevated cadence of communications with clients through e-mail, phone and other channels over the past several weeks, and the tenor of the conversations have been productive. Other than those directed by Fannie and Freddie, with respect to agency mortgages that we service and hold no other economic interest, we have not and will not make extended blanket loan forbearances or modifications on real estate loans but will work with borrowers on a case-by-case basis on deferral requests while we help them manage through the negative impacts from COVID-19. We believe this approach is more appropriate for our borrowers given the unique circumstance and uncertainties surrounding the near- to immediate-term outlook on the economy and various government restrictions that have been implemented.

For single and multifamily real estate loans, we have not yet granted any deferrals or long-term modifications but rather provided 1- or 2-month forbearances to allow us to have more time to review individual circumstances. With respect to borrowers who did not make their payment for April 1, which would have been late on April 15, meaning that they would be currently about 2 weeks late, in the single-family, multifamily and small balance commercial real estate groups and the number of those borrowers who have requested assistance that had greater than 65% loan-to-value ratios at origination, represents 2.6% of the total single-family portfolio and 76 basis points of the combined multifamily and small balance commercial real estate portfolios. Since many borrowers have been told by some banks that a simple phone call is enough to obtain relatively long-term deferrals, there are customers who are calling, expecting to be granted long-term assistance for no legitimate reason.

With respect to the auto lending side, deferral requests were granted for 8.7% of the portfolio. In the unsecured lending side, about 4.7% of the book have requested deferrals. These are currently short-term deferrals with 90% no more than 2 months and around 10% receiving 3-month deferrals. We are still developing how we will formulate our policies for each asset class in this regard given that each asset class has its own dynamic. For example, given the level of protective equity as well as the high default rate on our notes of 18% in our multifamily and small balance real estate book, we believe our loans will be salable quickly to opportunistic buyers if we have borrowers who simply wish to utilize loan deferrals as a temporary liquidity buffer rather than ensuring they prioritize their payment on their first mortgage.

Provisions for loan losses were approximately $28.5 million in the quarter ended March 31, 2020, up $9.5 million compared to the same period a year ago. Excluding loan loss provisions for H&R Block-related loans in both periods, our loan loss provision was $10.8 million or $8 million for up -- or up $8 million from $2.8 million in the prior quarter. The $69.4 million of loan loss reserves ex RAs for the quarter ended March 31, 2020, represented approximately 105.7% of total nonperforming assets and 22.3x our annualized net charge-offs. Approximately $4.2 million of the $10.8 million of loan loss provision ex RAs in the quarter ended March 31, 2020, was attributed to loan growth, and $6.6 million was attributed to the rapid and sharp deterioration in the economy. Our provisions for the March quarter were not impacted by CECL because our CECL adoption will occur by June 1, 2020. Andy will provide more detail with respect to how we are thinking about the CECL impact in his prepared remarks. One of the benefits of a later implementation for CECL is that we will be able to incorporate more updated information in our projections.

We are encouraged by the speed and size of various fiscal and monetary actions taken by the Federal Reserve, treasury and other government agencies and believe that some of these actions will help mitigate the negative ramifications of COVID-19 on our borrowers. We participated in the SBA's Paycheck Protection Program, originating approximately $85 million of loans for 149 existing and new clients. Even though we were an approved SBA lender, we had not previously been an originator of SBA 7(a) loans. But our technology, current and deposit team worked quickly to stand up a loan portal and streamline a set of processes to quickly open deposit accounts and underwrite and fund PPP loans. In addition to providing much needed capital for a subset of our borrowers, participation in the PPP program also helped generate incremental relationships and deposits for our small business and commercial banking groups.

Our credit quality remains good. Our annualized net charge-offs to average loans and leases was 3 basis points this quarter compared to 4 basis points in the corresponding period last year. Nonperforming assets-to-total asset ratio was 54 basis points for the quarter ended March 31, 2020, flat from December 31, 2019. The majority of our nonperforming assets are comprised of single-family and multifamily loans with low loan-to-values. We remain well reserved, with our allowance for loan loss representing 150.7% coverage of our nonperforming loans and leases at March 31, 2020.

We continue to generate strong returns with return on average common shareholders' equity of 18.65% and 15.34% (sic) [15.99%] in the 3 months and 9 months ended March 31, 2020, respectively. Our efficiency ratio for the banking business segment was 33.2% for the quarter ended March 31, 2020, down over 200 basis points from 35.26% in the year ago. Our capital ratios remained strong at 8.72% at the bank and 8.55% at the holding company. Despite a higher provision for loan loss reserves and buying back approximately $39 million of common stock at an average price of $19.74 per share this quarter, our tangible common equity-to-total asset ratio remains healthy at 8.66% at March 31, 2020.

Given that we believe there will be tighter credit standards coming out of these times, our top priority for capital will be to fund growth in our existing businesses. Although we had discussed in previous calls starting to pay a modest dividend, given the uncertainty surrounding the economy, the global pandemic and impact on various government actions on consumer and corporate behavior, we've decided not to pay a dividend until we get better clarity on the depth and duration of economic and business disruptions.

We have a healthy liquidity position and a diverse set of funding. Our balance sheet deposits increased by 10.5% year-over-year, with checking and savings deposits increasing by 16.4%. Our commercial cash and treasury management, small business banking and specialty deposits continue to show positive growth. Average noninterest-bearing deposits increased by almost $1 billion year-over-year, led by our Axos Fiduciary Services group. Client cash deposits from AFS and Axos Securities currently held at other banks was approximately $455 million at 3/31/2020. We have the ability to bring back a good portion of our off-balance-sheet deposits if it's economically advantageous to do so. We also have access to $3.8 billion of FHLB borrowing, $3 billion in excess of the $771 million we had outstanding at the end of the third quarter. Furthermore, we have $1.4 billion of liquidity available at the Federal Reserve discount window as of March 31, 2020. With many banks and fintechs reducing rates on their consumer online savings and money market deposit products, we have more flexibility to raise consumer online deposits at relatively lower all-in costs compared to 3 and 6 months ago.

We have a relatively stable outlook with respect to loan growth and net interest margin. In jumbo single-family mortgages, many banks and nonbanks have pulled back on the aggressive lending terms and conditions they offered in the prior 12 to 18 months. Pricing on new jumbo mortgages has tightened due to dislocation in the secondary market for non-agency mortgages and liquidity constraints for most nonbank lenders. The purchase market has weakened due to the government's stay-at-home and forbearance measures. We have tightened our credit underwriting standards with respect to all of our lending products. We continue to see demand for our lending products at our tightened credit standards.

The multifamily and small balance CRE dynamics vary by geographic market and property type. Rent payments in our primary markets where we lend held up relatively well in March and April. The stimulus checks, forbearance programs, federal subsidies on unemployment insurance and the SBA Paycheck Protection Program should provide short-term cash flow for renters and borrowers who are unable to work voluntarily or involuntarily. Supply constraints on housing and the relatively diverse nature of local economies on the West Coast make multifamily and commercial real estate markets attractive in the medium to long term. How quickly economies are able to resume normal levels of production and productivity will dictate the short-term dynamics in these 2 loan categories. Also, we do not know whether governmental intervention in rent collection/eviction/foreclosure processes will impact our willingness to continue to lend or impact our ability to manage our loan book.

In our 2 largest C&I lending categories, lender finance and commercial specialty real estate, we continue to evaluate new opportunities but are pivoting to leverage real estate assets at even more conservative advance rates than previous. Given the current environment, we will be able to deploy capital senior to our funding partners where we can obtain better economics on loans and obtaining higher margins with safety and better structures.

With respect to auto and personal unsecured lending, we have temporarily suspended originations for all but prime borrowers with a minimum FICO of 720 and significantly tightened credit standards until we have more information about when employees will be allowed to go back to work and what restrictions on commerce and travel may remain in place and before we look to grow either of these consumer lending portfolios.

We're actively originating and funding PPP loans for existing and new Axos customers. These forgivable loans, which are 100% guaranteed by the SBA and carry a 0% risk weighting, will remain on our books until we sell them back to the SBA or utilize the Federal Reserve's funding facility. Through April 27, we have originated and funded approximately $85 million of PPP loans and have a backlog of $38 million in various stages of processing. We will receive a onetime processing fee between 1% and 5% of the principal amount of PPP loans we originated based on the size of each loan. We are delighted to be able to help small businesses nationwide stay open and pay their employees during these challenging times.

We continue to maintain stable net interest margins despite significant flattening of the yield curve and the shift in competitive dynamics across our various lending and deposit categories. Excluding the impact from H&R Block-related loans and deposits, our net interest margin for the banking business was 3.85% compared to 3.87% in the prior quarter and 3.9% in the third quarter of 2019.

On the asset side, approximately 61% of our loans are 5/1 ARMs with single-family and multifamily mortgages as the underlying collateral. With a slowdown on prepay activity and stability in new jumbo mortgage and multifamily loan yields, we expect to maintain overall yields in our jumbo single-family mortgage loan book and our multifamily loan book. The majority of our small balance commercial real estate portfolio, which represents another 4% of our loan balances at 3/31/2020, are term loans with fixed interest rates and staggered prepayment penalties through the first 5 years of the loan. Approximately 5% of our multifamily and CR loan -- CRE loan portfolio is currently above their floor rates. With competitors pulling back from small balance CRE, we see opportunities to improve all -- loan yield while maintaining low loan-to-values and high debt service coverage.

In our C&I loan book, our asset-based lender finance and commercial specialty real estate portfolios have rates that adjust to the index. Of the $3.3 billion of lender finance and commercial specialty real estate loans, approximately 70% are at their floor rates. Our equipment lending -- leasing portfolio, which accounted for the remaining $162 million of C&I loan outstanding, is comprised of fixed-rate loans and leases.

On the funding side, we are well positioned given the diversity of our consumer and commercial businesses and the optionality of our security-based deposits. Consumer deposits, representing approximately 55% of our total deposits at 3/31/2020, is comprised of consumer direct checking, savings, money market and noninterest-bearing prepaid accounts. Excluding consumer time deposits, our consumer checking, savings and money market balances increased by $916 million from 12/31/2019 with strong growth in our noninterest-bearing prepaid and other interest-bearing demand deposit balances. We reduced our high-yield savings and money market deposit rates in March following the Fed's actions. We prepaid $200 million of brokered CDs with an average cost of funds of 2.71% and reissued a similar amount at 1.78% in the third quarter. Average noninterest-bearing deposits was $2.6 billion in the quarter ended March 31, 2020, up by almost $1 billion compared to the same period a year ago. We are making good progress in our specialty commercial and treasury management businesses, and our involvement with the SBA PPP program will provide additional momentum for small business and commercial deposits.

Axos Clearing benefited from a flight to safety this quarter, with ending deposits increasing by approximately 16% linked quarter to $413 million. These client deposits held in approximately 90,000 individual brokerage accounts provide a stable, low-cost source of funding. We have chosen to keep the majority of the $413 million in other banks, earning interest income for the securities business. We have the ability to bring these deposits back to our bank on relatively short notice to fund our loan growth. With the impact of consolidation in this industry, we continue to be bullish on the clearing company's long-term outlook.

Overall, we feel good about our ability to maintain an annual net interest margin toward the lower end of our 3.8% to 4.0% target. With the loan growth likely to be slowing in the short term and some additional downward pricing flexibility in some of our deposit categories, we look to hold margins relatively stable.

Now I'll turn the call over to Andy, who will provide additional details on our financial results.

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Andrew J. Micheletti, Axos Financial, Inc. - Executive VP & CFO [4]

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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 at axosfinancial.com. Second, I will provide brief comments on several topics. Please refer to our press release or 10-Q for additional details.

Axos' net income for the third quarter ended March 31, 2020, was $56.1 million, up 44.4% year-over-year and up 35.7% compared to our last quarter ended December 31, 2019. The increase in net income this quarter compared to the last quarter ended December 31, 2019, is primarily due to growth in the loan portfolio of 2.3% and additional income from seasonal income tax products, partially offset by our higher loan loss provisions and higher operating expenses. The growth in net income year-over-year is primarily due to loan portfolio growth of 14% and increased mortgage banking revenue and lower operating expenses. Operating expenses for Q3 of 2019 includes a onetime charge of $15.3 million for an uncollected receivable in our securities business.

Increased quarterly net income was the result of operating expense efficiency improvement both year-over-year and on a linked-quarter basis. The efficiency ratio was 39.85% for the quarter ended March 31, 2020 and an improvement year-over-year of 292 basis points when compared to the 42.77% efficiency ratio, calculating without the $15.3 million onetime charge recognized in expense last year. For the quarter ended December 31, 2019, the efficiency ratio was 51.66%, improving to 39.85% for the quarter ended March 31, 2020, primarily due to income from seasonal tax products.

Mortgage banking income for the quarter ended March 31, 2020, was $3 million, up from $0.4 million last year and up from $2.2 million for the last quarter ended December 31, 2019. The $3 million mortgage banking income for this quarter was net of a write-down of the fair value of our mortgage servicing rights of $1.7 million generally due to the decline in long-term U.S. Treasury interest rates. While future declines in long-term U.S. Treasury rates are possible, given the low level of interest rates today, additional large declines in the value of our mortgage servicing rights are not likely.

For the third quarter of fiscal 2020, noninterest expense was $71.8 million, up $4.8 million compared to our last quarter ended December 31, 2019. Salaries and related costs increased $2.3 million primarily due to increased payroll taxes, 401(k) matching and a small staffing increase. FDIC and regulatory fees increased $1 million due to a small bank assessment credit that had been received from the FDIC in the prior quarter. Also, general and administrative expenses increased $2 million, of which $1.5 million of that increase related to processing costs associated with the seasonal tax products.

As Greg noted earlier, we did not adopt CECL this quarter ended March 31, 2020, and therefore we recorded our loan loss provisions this quarter using the incurred loss method. The FASB's original timetable for adoption for public companies with accounting year-ends at June 30 was on or before July 1, 2020. We currently expect to meet that deadline rather than extend the adoption date as recently permitted in the CARES Act in response to COVID-19.

To prepare for CECL implementation, we have created "life of loan loss" models based upon our portfolio characteristics. Using industry-forecasted macroeconomic data, these models produce low-level probabilities of default and loss-given defaults to estimate loss over the entire life of the loan. We are currently making modifications to these models based upon recommendations of our third-party consultants.

Upon the adoption of CECL, we expect a material increase in our allowance for credit losses and likely increases in future loss provisions. The amount of the increase will depend in part on changes to forecasted macroeconomic inputs resulting from COVID-19 pandemic and its future impact upon the economy. For regulatory capital purposes, when we adopt CECL, we expect to elect the 2-year delay and the 5-year total transition period to minimize the impact of the increase in our allowance for credit losses on our capital ratios.

With that, I'll turn the call back over to Johnny Lai.

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Johnny Y. Lai, Axos Financial, Inc. - VP of Corporate Development & IR [5]

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

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from the line of Michael Perito with KBW.

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Michael Perito, Keefe, Bruyette, & Woods, Inc., Research Division - Analyst [2]

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I wanted to start on kind of the COVID-19 response that you guys laid out in your prepared remarks. I was curious. I mean it didn't seem like through the quarter end, based on the numbers you laid out, Greg, that there was much deferral activity. And I know you guys said you're kind of working through it here, it sounds like, in the near term, but I'm just curious if you can maybe give us a little bit more kind of context around what the decision-making process kind of looks like and where you ultimately expect the deferral rate to kind of move to based on the applications or requests you've received thus far.

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Gregory Garrabrants, Axos Financial, Inc. - President, CEO & Director [3]

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So as of the end of the quarter, there really wasn't much of anything at all. Subsequent to that, there have been requests coming in. I gave the numbers for the -- to the auto and unsecured lending book, and those are current numbers. With respect to the real estate loan portfolio on the CRESL side with respect to the transactions we work with sponsors on, essentially there's been no requests that are simply deferral-oriented requests with respect to things. To the extent that someone wants to, in a normal course, extend a loan or that sort of thing, they may be paying something down or working with us to do that, but nothing is really substantive there either. On the single and multifamily side, there's been requests in the agency book that we are following government guidelines on. And then for the remainders of the loans with respect to this, we're not really doing some maybe very short-term deferrals, and then we're going to go back and create a process to really look at each underlying asset and decide exactly what to do. So I think in most cases, these are very desirable properties. They're low loan-to-values. We expect people in general -- but obviously each one is going to have its own dynamic, but we expect them to be working hard to make their payments. It doesn't mean we're not going to defer or grant some modifications or deferrals. We just haven't really had a lot of time right now to assess the individual circumstances of the borrowers. And so that's what we intend to do. And the level that we actually do this assessment is going to be dependent upon the type of request that they have.

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Michael Perito, Keefe, Bruyette, & Woods, Inc., Research Division - Analyst [4]

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No, that's helpful. So I mean it sounds like there is some expectation from you guys that the deferrals will increase, but it doesn't seem like it's anything really very significant at this point, I guess, to just put broad terms around this.

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Gregory Garrabrants, Axos Financial, Inc. - President, CEO & Director [5]

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Yes. Look, I think that it's certainly hard to tell because, at times, you get the first -- what we did at first was to say that we would grant somebody the ability to skip one payment. And a lot of the folks just said, "Well, I thought I was going to get 6 months for nothing," and we told them no and they just paid. So it's a little bit difficult to tell because, as you're kind of working through this, it's really too early to tell because you don't know how much of this is simply opportunistic behavior and how much of it is a legitimate disruption from a business that will come back, right? I mean obviously the intellectual framework for this is that deferring someone who has no chance of coming back is probably not that useful. Deferring somebody who you want to maintain as a customer who is simply suffering from some temporary impact probably makes more sense. So an assessment is required in order to understand how that works. And as I said, each individual asset class has its own dynamic, and that dynamic might be influenced by the nature of government rules with respect to actual execution of remedies with respect to lenders. So for example, if you're a multifamily borrower and you just decided to ask for a blanket set of long-term deferrals, there's a lot of people who want those properties. And a lot of people are willing to buy notes that have 18% default interest, so that might not be the right approach. Maybe you'll go get a second lien on that property or something. And we'll help facilitate that for you so that you have someone that has an interest in that property and can help you through that. But those are the type of things that are just -- it's just too early right now. I mean really it -- this is very recent. As of March 31, there really wasn't much. And then there has been -- there have been folks who have come in and there has been a decent number of requests, and we've been working on what we're going to do to evaluate them.

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Michael Perito, Keefe, Bruyette, & Woods, Inc., Research Division - Analyst [6]

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Got it. And then on the PPP, I think it was $85 million that you guys have approved, and you said you had another $30-something million in the pipeline. I think you mentioned in your remarks that the fee rate can range from 1% to 5%, but it seems like a lot of your peers are kind of oscillating around that 3% mark. Do you think that's a reasonable assumption for you guys involved at this point given what you've seen?

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Gregory Garrabrants, Axos Financial, Inc. - President, CEO & Director [7]

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Yes, 3% to 3.5%, I think, is probably reasonable.

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Michael Perito, Keefe, Bruyette, & Woods, Inc., Research Division - Analyst [8]

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Okay. A couple other questions. On H&R Block, I was just curious. It seemed like they had a pretty productive quarter actually. Revenues were off like -- I mean refund advances were up rather, as you guys mentioned, but I know there's still some uncertainty about kind of the duration and the status of that relationship. Is there any update there that you guys can provide?

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Gregory Garrabrants, Axos Financial, Inc. - President, CEO & Director [9]

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Not at this time.

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Michael Perito, Keefe, Bruyette, & Woods, Inc., Research Division - Analyst [10]

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Okay. And then just lastly, can you remind us? To the extent that the COVID-19 pandemic rather has a material impact on small business, can you just remind us a little bit about the Epiq bankruptcy business? And if there is an increase in bankruptcies in the United States, how that necessarily would benefit that business and, as a result, Axos Financial?

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Gregory Garrabrants, Axos Financial, Inc. - President, CEO & Director [11]

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Yes, certainly. So that business has about 40% of the U.S. bankruptcy trustee market that runs through -- and that's the Chapter 7 side only. 40% of U.S. bankruptcy trustees, roughly, give or take a couple percent, are -- use our software. Everyone who uses our software is required to hold their liquidity at Axos Bank right now. And so to the extent that Chapter 7 bankruptcies increase and those bankruptcies have significant assets and those assets are subject to liquidations or other types of dispositions, and then there's a time frame often that is significant in which those distributions need to occur as part of that entire bankruptcy process, those deposits will be held at our institution. That's the Chapter 7 part of the business. Now the non-Chapter 7 part of the business utilizes the software and all its services to deal with a variety of other issues and types of clients, SEC receivers, other types of receiverships, potentially other types of bankruptcies that don't have the more formulaic process of Chapter 7 bankruptcies. And often, those firms that deal with the Chapter 7 side have other businesses that they're also working through that are related to the types of things -- the types of activity that would likely be expected to increase in the market. So right now, it's obviously too early. I know that everybody feels like each day is a week now. I mean you have to remember this is relatively short period of time into this. So obviously we do expect bankruptcy filings to increase, but that's going to be something. And that will lead to enhanced business. It's just we don't have a great visibility into that right now. It really is still early.

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Michael Perito, Keefe, Bruyette, & Woods, Inc., Research Division - Analyst [12]

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Yes. I mean it is fair to think about that business as kind of a countercyclical banking business that in a period of economic stress could theoretically give you guys some more liquidity and revenue opportunities that would be kind of contrary to what traditional banking businesses would -- how they would perform?

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Gregory Garrabrants, Axos Financial, Inc. - President, CEO & Director [13]

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Yes, that's correct. I mean it's -- in 2010, the deposits were twice what they are now. I would expect that's, I mean -- and look, sometimes it's interesting, right, because sometimes you have a -- if you have a big bankruptcy and it's put on the wheel, meaning who gets it, it could be massive, right? So there's -- but it definitely is a countercyclical business. I would be shocked if it didn't get bigger. And we're preparing for the throughput that we think we'll have. I think it's very difficult to see a situation where Chapter 7 bankruptcies don't increase as a result of all of these lockdowns and various mitigating measures that have been taken.

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Operator [14]

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Your next question comes from the line of Steve Moss with B. Riley FBR.

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Stephen M. Moss, B. Riley FBR, Inc., Research Division - Analyst [15]

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I want to start with the disruption in the mortgage market and in particular just on the non-QM and jumbo product that you guys offer. Just wondering, even with tightening standards, Greg, you mentioned that you're still seeing demand. Kind of what is that demand these days and how you're thinking about that?

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Gregory Garrabrants, Axos Financial, Inc. - President, CEO & Director [16]

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Sure. So as you know, we previously had a robust growth business in jumbo mortgages. And over the last, I'll call it, 6 quarters or almost 2 years, that has had disappointing growth as a result of the market sort of running away from us in what we felt was an imprudent manner, and that has completely and totally reversed. So all of those competitors are gone and not just a little gone, all the way gone. And so we had not compromised our credit standards in order to meet those -- that competition. We lost a lot of business as a result of it. That business is now all flowing back, but the reality of it is we've tightened our credit standards across all products, including liquidity standards, holding 12 months of reserves, 6 months. In this case, we're holding 6 months of reserves, a bunch of other things, tightened LTV standards, so we are getting obviously lots of calls. The pipeline is very large. I think the question is going to be -- obviously, we try to screen that pipeline before it comes in, but I would also expect that pipeline to have a larger fallout than it otherwise would as the market adjusts to the reality that these loans are going to be lower LTVs. There is going to be adjustments to the appraisals as a result of the market circumstance. There's going to be much more stringent liquidity requirements and standards. There's going to be escrows for taxes and insurance. And there's just going to be a bunch of things that are appropriate for the environment that may -- we may be heading into, recognizing that we always plan for home values to go down by a lot. And we are still going to make sure that we're doing loans that are safe and secure.

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Stephen M. Moss, B. Riley FBR, Inc., Research Division - Analyst [17]

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Okay. That's helpful. And then in terms of the margin here, just want to get some color on funding costs. Curious as to what you're seeing as of March 31 and where funding costs could go over the next 6 months.

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Andrew J. Micheletti, Axos Financial, Inc. - Executive VP & CFO [18]

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Yes. There's a couple of just general points I can give you, particularly when you look at our CD side. We have approximately $300 million more in CDs that have callable options on them, which means I can retire them and reprice them at significantly lower rates, typically at least 100 basis points lower, for the same duration that we had them on. So that's a key opportunity when you look at reducing it. And in fact, also in the CD costs for this quarter, there was $1.1 million of early amortization of brokered CDs premiums. So when we call these CDs, obviously any unamortized commission has to be recognized. So just by taking that $1 million out of this quarter, that should reduce the cost by at least 10 basis points that you see in the rate/volume table in the 10-Q. So I think we've got plenty of opportunities in the CDs to reprice. Obviously, on just traditional deposits, we're growing both consumer and business. Our rates are attractive. The PPP program is also adding deposit accounts because we are requiring deposit accounts. So all of that is being added at lower rates, and we expect that to continue to drive our costs lower. In the end, I think Greg's guidance was we expect to continue to maintain our traditional non-block rate of between 4% and 3.8% on our NIM. And his guidance, we're a little bit closer to the lower end of that, and we don't see why we can't continue to maintain that going forward.

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Operator [19]

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Your next question comes from the line of Andrew Liesch with Piper Sandler.

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Andrew Brian Liesch, Piper Sandler & Co., Research Division - MD & Senior Research Analyst [20]

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Just one follow-up question for me because you've covered the rest of them. On expenses, I know there have been a lot of business development plans that you guys have had and some spending initiatives out there. Like what's the outlook for that in this environment? Are there any plans to slow them? And then just then at a high level, recognizing that there are some seasonal costs from the tax business, should we expect to see operating costs fall below, say, $69 million for the quarter?

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Andrew J. Micheletti, Axos Financial, Inc. - Executive VP & CFO [21]

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Sure -- no. I mean I think the -- our increase this quarter on a linked-quarter basis really came in a couple of ways. I think, as you noted, there's $1.5 million in other general and administrative costs that you can take out for next quarter since that's exclusively related to the tax season. In our personnel costs, the majority, about half of the $2.3 million increase, was simply due to FICA. This is a brand-new quarter for FICA expense for employees that the employer pays, and that's about half the increase. So that will continue, but maybe $500,000 of it was more onetime associated with 401(k). So you can probably look at salaries costs being similar to slightly lower for next quarter. And everything else in there is fairly normalized. We at this point aren't looking at too many huge projects, so I think -- but we'll -- we're always planning, and that could change down the road. But in the end, the $69 million you're using is pretty close.

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Gregory Garrabrants, Axos Financial, Inc. - President, CEO & Director [22]

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Right. Yes, one clarification: As -- I said that the lender finance plus CRESL book had around 70% of the floor. It's actually 63%, so -- and then with respect to your question, Andrew, I think Andy had it exactly right. We basically have everyone that we need now to do all the things that we need to do pretty much with 1 or 2 other folks. So the improvements in UDB are going well. We've got a lot of opportunities to improve our operating efficiency with respect to a lot of different tools that we've developed over time, and those tools were really incredibly important in our ability to very seamlessly adapt to the majority of people working from home and all these other things. So they're everything from ticketing systems throughout the organization, robotic process automations, the ability to have a large -- a team of developers who can develop portals to communicate with borrowers, to enhance our abilities to be able to respond quickly to our customers and all those things. And so there's a lot of really good technology that we've put in. And now I think a lot of it's really time to benefit from that and to try to start reaping some of the fruits of that hard labor that's happened over the -- and investments that's happened over the last couple of years.

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Operator [23]

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Your next question comes from the line of David Chiaverini with Wedbush.

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David John Chiaverini, Wedbush Securities Inc., Research Division - Senior Analyst [24]

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I wanted to start with a question on credit. It seems most of your loan portfolio is very well secured. I was curious, what loan exposures do you consider the most at risk? Is it the Refund Advance loans, hotel, other unsecured consumer? Just curious as to what you're considering the most at risk.

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Gregory Garrabrants, Axos Financial, Inc. - President, CEO & Director [25]

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Right. So with respect to the Refund Advance loans, they did pay at a slower level than they had in the past. Now when we compare that to the other large players who publicly disclosed that, they were around, was it, 7%...

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Andrew J. Micheletti, Axos Financial, Inc. - Executive VP & CFO [26]

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It was 7%...

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Gregory Garrabrants, Axos Financial, Inc. - President, CEO & Director [27]

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7% out, and we're 4% out. And they typically, I think, do a little bit worse than we do on the credit side, but they're basically in line. So from a pacing perspective, we're better. But that doesn't mean that we're both not going to be worse, right? So I think we put a little loan loss into that. We're looking at that. We have -- when we look at it, we -- and we dissect the data, it appears to be that simply it's just slower payments, but that's unknown. So that's out there. There is a guarantee. After our fee, there's a guarantee from H&R Block, so we never lose more than our fee, but obviously we like -- we want to get paid for this. We didn't do this really on mandatory purposes. So we can't lose more than what we earned on this, but well, at least at the level that it's at now, H&R Block guarantees that after that amount, up to a certain amount, which we will collect. So that's that piece. So the fee could be at risk, although we don't think so. This is a -- this is something different. From an unsecured perspective, it's interesting. Right now there has been a relatively low level of request for deferrals. We've gone through the book and we've looked at where people work. And we've looked at our exposure to individuals that work in restaurants and work in areas that we think could be negatively impacted or shut down that would be a sort of a first-line effect of this, and it didn't look too bad. Now -- right. The impact of this is interesting, though. I've known -- I know some people in the medical profession here, radiologists, who have been laid off because in San Diego there aren't really any COVID-19 patients and so the hospitals are empty. And so our government has decided that elective surgeries are bad, so we're laying off medical professionals, right? So those are the type of folks that we lent to because we looked at each individual loan and there was an actual underwriter who made a decision about it based on employment stability and things like that. So depending upon how that works, you don't expect medical professionals to -- they might need a deferral, but you don't expect them to actually default over time when they had prime credit scores. So that is -- that's that book.

With respect to the single and multifamily side, I think the exposure is low, but it will relate to the potential that government action interferes in 2 places. First will be in the ability to collect rents, where a lot of the folks that, frankly, are in our housing are going to get more money from unemployment than they would from working. However, if their neighbor is not paying the bill and they look at the neighbor and they say, "Gee, I can wait 12 months. And I have an eviction moratorium that I may be opportunistic and take advantage of that," that flows downhill. The other would be if there's an attempt to have a state-level interference with the ability to foreclose, thereby rendering the time frame you have to hold loans longer. Now the reality of that is that our loan-to-value ratios and at the default rates we have in the commercial lending book, that could be a very profitable enterprise, but that's also not something that generally banks like to do just because it causes noise, right? And so I think there's obviously the opportunity to sell those notes if that ever came about. These are -- again, these are all hypothetical situations that aren't currently happening, but they're there.

The other book, the CRESL book, and those elements are most of these sponsors are very embedded in these loans. So if you look at a typical loan and you use it as an example, you have about -- whatever our capital stack is, they've got about half above us, maybe a little bit less. And if they don't take care of that property, they get wiped out on day 1. That is a very, very harsh remedy and one that I don't believe that they're going to be interested in partaking in absent dramatic reductions in values in property. I -- if there is 50% long-term reductions in property with little hope of recovery, then you might see people start to do things like that. However, then what is our loss rate going to be when we're at a 50% attachment point? We might lose a little money here or there but probably not. And the other element is each of these funds want to buy the other's paper, right? So they all want -- if you have one from another fund and they say, "Wait. If I get the opportunity to buy a note where I can take advantage of this," they want that note, right? So that market is very active. And these are some of the world's biggest funds. They're -- I just do not foresee them deciding that they're going to take massive losses at that level. So where does it come from? It comes in dribs and drabs in the areas where you get a -- you get someone that you're trying to work through something and maybe there's a maintenance challenge or they're overwhelmed and there's some sort of issue with the property.

In the last crisis, we had one where we were in at a pretty good loan-to-value ratio, but there was -- it was a borrower had a maintenance challenge. The maintenance person had an issue and there was significant property damage. Insurance was problematic with respect to how they wanted to pay, and there was some damage that was problematic. And then there were some vandalism. And there was -- we ultimately didn't take a loss on that, but it was close, closer than I thought it would be. So there's those idiosyncrasies. You have to watch fraud in these markets. We're watching the agency mortgages very carefully in the warehouse lending group. That business is going very well and expanding, but people are always -- when there's economic pressure in other places, you have to be careful with that. I think it's really more about, if you get some irrationality from governments or regulators, then you can force things to happen in ways that don't make any sense. And the reality of things are is everybody is acting like they're going to be rational right now, and that question is does that last over an extended period of time. And I think that's really the question that you have to look at and you have to be prepared for.

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David John Chiaverini, Wedbush Securities Inc., Research Division - Senior Analyst [28]

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That's very helpful. And then shifting gears, I wanted to ask about I think the next milestone for the Universal Digital Bank was to get it to allow a single integrated enrollment process. And I was curious, with everything that's happening with COVID and work from home, has the time line been impacted at all in terms of building out that next phase? Any disruption there?

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Gregory Garrabrants, Axos Financial, Inc. - President, CEO & Director [29]

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In general, not in any material way. The -- certainly the work-from-home element has not impacted anything. In fact, I've been -- just being perfectly blunt, I've been very clear with everyone, and I hold myself to this standard, this is the time that everyone works harder. This is not a time when everyone works less. So everyone is working harder now than they have for the right reasons, to take care of the borrowers, to make sure that we're adapting, to make sure that we are living up to our vision of being a truly digital-first bank that's a leader in technology. I don't think that that's changed. I think with respect to the question of your categorization of the goal of universal enrollment, I would say that there really are a variety of goals that UDB had. I would say that, that goal of universal enrollment is, frankly, one, I understand what you mean by it, but what we've really been trying to focus most on is, I would say, universal integration and servicing, meaning that what we're trying to do is ensure that all of the elements that -- the reasons why someone would contact us in banking are going through our portal. So from a servicing perspective, if there is an insurance update or need or an individual who wants to tell us about their travel ex-plans -- maybe less so now, but they would like a temporary increase and they're -- and managing their debit card in a more productive way. The goal is to take and create this self-service environment that allows individuals to have a better experience, not have to go through a call center, even though it is available, and to make that process more efficient. And so that's very important. The other is to integrate UDB for small business. We have a set -- we have a small business platform right now that -- for enterprises that are -- that have more than one owner. And those don't go through the UDB right now, and that experience is nowhere near as good. There's a very robust road map. We have put off a couple of long-term goals just intermittently to focus on building out the SBA PPP platform and a few other items that are unique to this environment, such as better communications with respect to customer requests through UDB and the ability to upload documents and things like that. But in general, I think, by October, we still expect to have the Universal Digital Bank experience available to our clearing clients. And that, we think, is going to be nice because it's going to enable us to get access to more than 100,000 high-net-worth customers that we intend to sell banking products to and our clearing company clients are very excited about. And then we will have online trading capacity available. And we're testing that in -- with test accounts and those sort of things, and we'll be working on that as well. So it's a very robust plan. It's very exciting. It gets overshadowed by obviously all the current circumstances. And I think it has a lot of long-term benefits for efficiency and for revenue over the intermediate term.

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Operator [30]

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The next question comes from the line of Mitch Hemmelgarn (sic) [Edward Hemmelgarn] with Shaker Investments.

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Edward Paul Hemmelgarn, Shaker Investments, L.L.C. - Founder, President, CIO, Portfolio Manager & Director [31]

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That's Edward Hemmelgarn. But Andy, just one question for you is just with the CECL implementation at the next quarter, at the end of the year, will that -- the original provision, will that go through retained earnings or income?

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Andrew J. Micheletti, Axos Financial, Inc. - Executive VP & CFO [32]

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Yes. So the way it works -- and it's called generally day 1 and day 2. You were -- on the day you adopt it, you make a direct. And assuming you're increasing your allowance, you would apply a tax rate to that increase, and then you charge it directly against stockholders' equity on a GAAP basis. So it doesn't run through the income statement. It goes straight into equity. After that day 1 entry, it becomes -- your provisions become normal, i.e., all your provisions run through the income statement as they do today, so -- but the big difference is that for regulatory capital purposes, the rules were changed recently such that, that day 1 charge, 100% of it, is actually added back to your regulatory capital for a period of 2 years and then phased out for another 3 years, so you have 5 years of so-called transition before it really impacts your regulatory capital ratios.

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Edward Paul Hemmelgarn, Shaker Investments, L.L.C. - Founder, President, CIO, Portfolio Manager & Director [33]

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Okay. Great. And Greg, one more question. Just you've always been very opportunistic about when opportunities present themselves. In terms of lending, you mentioned that the competition is going away -- or the aggressive competition is going away in the first jumbo mortgage area. Any other areas that you think there might be some opportunities?

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Gregory Garrabrants, Axos Financial, Inc. - President, CEO & Director [34]

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Yes. So I think that a lot of real estate lender finance had moved away to these gestation lines at very high advance rates that some banks are stuck with now that we never did. And those loans were -- sometimes they would do these 12-month gestation facilities with securitization exits. Those are all gone. A lot of -- it's amazing what people put on repo facilities without going into detail on it. It would surprise you. You wouldn't expect that you should put long-term, let's say, commercial real estate loans with incremental funding structures on a repo facility, yet it was done. So I think there's -- we have the same team. We have the playbook. We know how to do this. We know how to -- in that crisis, what we took advantage of on all those loan structures are very well developed here. They're very conservative. I think that there's a little bit of an equity gap in the market right now. Funds can fill that equity gap, but if you had an advance rate -- our old advance rates were $0.45 on the dollar, let's say, and people are interested in that again, which is great. The problem is, if you had gotten $0.85 for a while, you have a transition, and that transition is a difficult one and it's one that takes some time. So there are opportunities in the market, but we are not always able to sell those opportunities individually. But we do have partners that can assist more globally with that, but obviously in certain cases there's need for equity. So I feel good about that. It's early, but there's been a lot of productive discussions. And I think they'll be -- coming out of this, it should be the case that some of the competition which essentially -- we had $1 billion loan books in certain categories that essentially went to 0. And there'll be opportunities in those loan categories again.

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Operator [35]

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Your next question comes from the line of David Feaster with Raymond James.

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David Pipkin Feaster, Raymond James & Associates, Inc., Research Division - Research Analyst [36]

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I just want to start on the securities business. Volatility like this often creates pretty significant disruptions. And I'm just curious whether you've been able to add new broker-dealers or investment advisers given all the disruption.

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Gregory Garrabrants, Axos Financial, Inc. - President, CEO & Director [37]

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We have a pipeline. Candidly, I'd like that pipeline to be bigger. I think that it's coming. For example, that business is in Omaha. And TD is in Omaha. And so getting talent to Omaha has become a lot easier now that obviously you have this merger on the horizon, and that has really helped us. And we've been able to pick off opportunistic talent. There's lots of good discussions with RIAs from a custody perspective, who are very worried. Often, they didn't want to be at Schwab or they left Schwab for TD, and now they're being pulled back in. There's obviously folks who were part of some acquisitions that E*TRADE made that are looking at and trying to figure out exactly how to be part of an organization where they matter and where someone will return their calls other than through a call center. So I think there is a lot of opportunity there.

With respect to what we're doing on that business, on the clearing side, we are trying to bring all the technology that we have into the operational environment to make sure that we can handle additional capacity. So the people, they work very hard. They've done an amazing job managing through this liquidity without losses. I mean obviously you've seen there has been interactive broker and other things have made -- that have had some interesting disclosures that they've had to make. A lot of companies had issues. Obviously, we had one, which was a one-off last year. So I'm not -- there's never any rest, but they did a great job this quarter. And so we're working a lot on the operational efficiency side there, making good progress. They're learning to adopt a culture of execution that is a lot sharper than they've had before. And I think there's really great long-term opportunities because the disruption in this -- these markets are massive and we're just beginning to see the results of that disruption. So on the clearing side, I think we have a pretty good platform, and we have interest. We have to get more credibility with larger firms. We've had some looks, but it's a tough thing to get somebody to switch. And then on the RIA custody side, we are currently working with some hardy folks who are bringing us assets and, frankly, helping us make sure that we're working out the kinks with both the onboarding and the platform overall. We have a new software that we're implementing that is going well, and that platform will develop over time. It's not going to be immediate. It's a longer-term initiative, but I think it's -- you look out 3 to 5 years. I think everybody is going to be very happy that we spent the time to do something unique on bringing a universal platform to the end client and bringing a great -- a technology and servicing system to that business.

On the robo advisory, the managed portfolio side, as we're calling it, we are -- I've appreciated the no-fee model. That's been great for a while. It's useful for acquisition. I also -- frankly, I've told the team, "You've had some opportunities, and now you're going to go make money." So we're going to be working on what that model looks like, but they will be making money shortly. They have a nice portfolio of assets and they provide a great service, and so they're going to go make money on that pretty soon. I'm -- I've had -- because the clearing company makes money. And the issue is the net loss that you see in the segment is from the managed portfolio side, and that's going to end. So we were -- they had a view that they wanted to try to grow the business with that model. I think we had a nice run at that, had some growth, but we can grow it by adding value rather than absolutely being -- we'd still be the lowest-cost provider. We just don't have to be the lowest-cost provider by that amount.

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David Pipkin Feaster, Raymond James & Associates, Inc., Research Division - Research Analyst [38]

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Got it. And then just what are you seeing in the specialty CRE segment? I mean I know you deal with premier developers that are very well capitalized but just curious on your thoughts on this segment, what you're hearing from your clients and just your thoughts on that segment more broadly near term.

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Gregory Garrabrants, Axos Financial, Inc. - President, CEO & Director [39]

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Yes. I think that the nature of that segment is going to be -- and its activity is going to be determined by junior capital. And so if you think about, let's say, a funding structure for a project, and these obviously are just rough numbers, but if you have a situation where, let's say, there's a $100 million project, equity was going to put in $20 million. The junior was going to put in $40 million, and we were going to put in $40 million, right? So -- and what -- our $40 million is going to come after all of that $60 million, and it's going to come in only after all that is already there. And so that does a couple of things and obviously makes the hurdle rates with respect to the project higher because the junior capital is looking around saying, "Gee, I have a lot of interesting opportunities," and there's a lot of current developments. So it will be interesting to see how it goes. I think there will be selected projects that get off the ground. I think junior capital is working through what they want to do. I think there's lots of discussions and lots of asking for what term sheets would look like and not a lot of movement. I think the market is really trying to figure out exactly where things are. There clearly are good projects. There clearly are folks that have a lot invested and are going to deliver, and I think that's good. It's going to be interesting, though, to see how that develops. And my inclination is that I think the junior capital is going to look for opportunities, some of which they may find more attractive in existing assets and helping others through their problems rather than going after new things. But that's speculation. It's still too early, yes.

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David Pipkin Feaster, Raymond James & Associates, Inc., Research Division - Research Analyst [40]

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Yes, that makes sense. Last one from me. Just wanted to get your thoughts on your capital priorities near term. I mean, dividend, it sounds like it's on hold for now. But just thoughts on repurchases or any other opportunistic investments or even potential M&A maybe in the fintech side, given the disruption and being able to pick up a complementary business that you've been eyeing for a while.

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Gregory Garrabrants, Axos Financial, Inc. - President, CEO & Director [41]

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Right. Yes. I think with respect to the dividend side, I talked about that. The share repurchase side, I think -- look, I think that's something that we've been -- we haven't -- we did a little bit. We never -- we're very thoughtful about our capital. I'm not going to make any prophylactic rules on that, but -- or make any statement of absolution in either way there. But clearly, there's a lot of opportunities in the market. We also have uncertainty with respect to what happens in the future. And so you're weighing all those different elements. Clearly we want to have capital for growth that's prudent when there. We want to support our clients where we have good opportunities. I think there will be good-yielding opportunities at very good credit profiles here, so we want to make sure that we're there for that and also make sure obviously that we're thoughtful about our capital. So the -- with respect to the M&A side, that depends upon what you're getting with the platform. So I think, unfortunately, a lot of the fintechs, with respect to the platform, they're either going to work through it with respect to their existing assets and their debt levels or things like that. Or they're kind of have to wind down for a while and see where they go. There may be one-off opportunities like there were with respect to the robo advisory platform that we purchased, where it comes with an asset base that is -- that has no negative credit, potential credit consequences or not. But obviously, I think we've tried very hard to be thoughtful about we -- what we put on the books, and there were strong credit thesis for each one. So there'd have to be a very strong credit thesis that would have to accompany anything that would involve taking on any credit risk in an M&A right now.

All right. I guess that's it, so thank you very much. We'll talk to you next quarter.

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Operator [42]

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This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.