Earnings Call Transcript - AX Q4 2022

Operator, Operator

Good day, ladies and gentlemen, and welcome to your Axos Financial Inc. Fiscal Fourth Quarter 2022 Conference Call. As a reminder, today's call is being recorded. At this time, it is my pleasure to turn the floor over to your host, Johnny Lai, Corporate Development and IR. Sir, the floor is yours.

Johnny Lai, Corporate Development and IR

Thanks, Melinda. Good afternoon everyone, and thanks for your interest in Axos. Joining us today for Axos Financial Inc's fourth quarter 2022 financial results conference call are the company's President and Chief Executive Officer, Greg Garrabrants; Executive Vice President and Chief Financial Officer, Derrick Walsh; and Executive Vice President of Finance, Andrew Micheletti. Greg, Derrick, and Andy will review and comment on the financial and operational results for the three and 12 months ended June 30, 2022, and we will be available to answer your 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 Security 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. We also issued an earnings supplement in conjunction with this call. All of these documents can be found on the Axos Financial website. With that, I would like to turn the call over to Greg.

Greg Garrabrants, CEO

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 fourth quarter of fiscal year 2022 ended June 30, 2022. I thank you for your interest in Axos Financial and Axos Bank. We had another excellent quarter with double-digit growth in loan originations for our fourth consecutive quarter. Our strong results were broad based with net interest margins exceeding the high end of our target and double-digit net interest income growth on a sequential and year-over-year basis. We grew deposits by 9.5% linked quarter and almost 29% year-over-year, led by strong growth in deposits from Axos Securities. We reported net income of $57.9 million and $240.7 million for the three and 12 months ended June 30, 2022, representing year-over-year growth of 6.7% and 11.6% respectively. Our book value per share was $27.48 per share at June 30, 2022, up 16.3% from June 30, 2021. The highlights this quarter include the following; ending net loans for investment balances were $14.1 billion, up 7.6% linked quarter or 30.4% annualized. Excluding single-family mortgage warehouse ending loan balances increased by 9% linked quarter. Net interest margin was 4.21% for the fourth quarter, up 19 basis points from 4.02% in the quarter ended March 31, 2022 and up 29 basis points from 3.90% in the quarter ended June 30, 2021. Net interest margin for the banking business unit was 4.45% compared to 4.21% in the quarter ended March 31, 2022 and 4.16% in the quarter ended June 30, 2021. In contrast to most of our peers, we have successfully maintained a strong net interest margin and generated loan growth from the high end of our annual target through the fiscal year 2022. We continue to make steady improvements in our funding mix with non-interest bearing deposits, increasing by approximately $900 million from March 31, 2022. Non-interest bearing deposits represented approximately 36% of our total deposits at June 30, 2022, a significant improvement from approximately 23% in the corresponding period a year ago. The steady growth of non-interest bearing deposits positions us well in a rising rate environment. Deposits from Axos Securities, our clearing and custody business was $3.5 billion at June 30, 2022, up by approximately $600 million from March 31, 2022. Our efficiency ratio for the first three months ended June 30, 2022, was 54.44% compared to 51.3% in the third quarter of 2022. The efficiency ratio for the banking business segment was 46.7% for the fourth quarter of 2022, first 3.98% in the third quarter of 2022. Operating expenses for the bank for the fourth quarter included an $11 million charge, primarily for a one-time resolution of a contractual claim. Excluding the $11 million charge, our banking efficiency ratio for the fourth quarter would have been 40.6%. Diluted earnings per share were at $0.96, up 6.7% from $0.90 in the year ago quarter. We continue to generate strong returns while we maintain excess capital. We generated a return on equity of 14.14% in the fourth quarter and a return on assets of 1.4%. Capital levels remained strong with Tier 1 leverage of 10.65% of the Bank and 9.29% of the holding company, both well above our regulatory requirements. Our credit quality remains strong, with net annualized charge-offs to average loans of 2 basis points versus 22 basis points in the fourth quarter of fiscal 2021. We added $6 million to our loan loss provision this quarter to support our loan growth. Total allowance for credit losses was $148.6 million at June 30, 2022, representing 49 times our annualized net charge-offs and 1.04% of total ending loans. Our total loan originations for the fourth quarter ended June 30, 2022, were $3.2 billion, representing an increase of approximately 41% from $2.3 billion in the year ago period. Loan originations for investment were approximately $3.2 billion, an increase of 55% from the corresponding quarter a year ago. Q4 2022 originations were as follows; $57.6 million of single-family agency gain on sale production, $545 million of single-family jumbo portfolio production, $148.6 million of multifamily production, $230.6 million of commercial real estate production, $105.6 million of auto and unsecured consumer loan production, and $2.1 billion of C&I loan production. This resulted in a net increase in ending C&I loan balances of $737 million. We generated $3.4 million of mortgage banking income, compared to $5.7 million in the quarter ended March 31, 2022, and $2.9 million in the corresponding quarter last year. The single-family agency origination decreased by approximately $57.6 million linked quarter to $57.6 million as a result of industry-wide declines in refinancing activity, while margins were down due to normalization in single-family mortgage gain on sale across the industry. Our MSR valuation generated a $1.5 million gain this quarter, benefiting from a rapid increase in mortgage rates since the end of 2021. We anticipate lower mortgage banking gain on sale in the foreseeable future, partially offset by MSR valuation gains as rising interest rates further reduce demand for mortgage refinancing. Our pipeline of single-family agency mortgages was $33 million as of August 1, 2022. Ending loan balances in our jumbo single-family mortgage business increased by $158 million to $3.7 billion, the strongest quarterly net loan growth we've had in the past three years. We generated $545 million of loan production in the fourth quarter of 2022 benefiting from dislocation in the jumbo SFR mortgage-securitization market. Prepayments in our jumbo single-family business were down where they were $390.4 million in the three months ended June 30, 2022, down from $455.6 million of prepayments in the prior quarter. While rising interest rates and economic uncertainty remain headwinds for our jumbo refi and purchase transactions, we are better positioned than most of our competitors given our efficient operations and established track record of execution. Our jumbo single-family mortgage pipeline was approximately $475 million as of August 1, 2022. Based on this pipeline and our expectations for continued decline in prepayments, we anticipate modest growth in our jumbo single-family loan balances in the next few quarters. C&I lending had another tremendous quarter. Loan originations were $2.1 billion, reflecting strong growth across CRESL asset-backed lending and construction lending. Our strong relationships, knowledge, structuring capabilities, and track record of execution have resulted in steady expansion and loan production in that area. Demand remains strong across loan types and geographies with a backlog of approximately $970 million as of August 1, 2022. We have positive momentum across multiple C&I lending verticals and we remain confident that we'll be able to sustain strong growth in our net balances while maintaining credit and loan yields. Auto lending had a good quarter with ending loan balances increasing by $39 million or 8.7% linked quarter. We are achieving good risk-adjusted returns in our auto lending business, focusing on prime borrowers with a strong mix of used vehicles and both rate and indirect channels. Our auto loan pipeline was approximately $105.9 million at August 1, 2022. Strong underlying profitability in our banking business was partially offset by ongoing growth investments at the bank and in our securities business. Our banking efficiency ratio was 47% and 42% for the three and 12 months ended June 30, 2022. As noted earlier, non-interest expenses this quarter included a one-time charge of $9.5 million for the resolution of a contractual claim and an accrual for an unrelated non-final derivative of $1.5 million. The $11 million aggregate charge was included in other general and administrative expenses for the fourth quarter. The contractual claim underlying the $9.5 million payment was based upon an indemnification obligation related to an acquisition. The settlement fully and finally resolved any claim that might be made under that provision. Representation and warranty insurance was purchased as part of this acquisition with the policy limit of $6.5 million, but the present collection of those proceeds under that policy remains uncertain. The $1.5 million legal accrual was made in connection with employment litigation initiated in 2015 by a former employee. We have a series of operational efficiencies across business units that will result in cost savings as we grow. Excluding the $11 million of discrete contractual and legal charges, the efficiency ratio on our banking business unit would have been 40.58% and 39.94% in the three and 12 months ended June 30, 2022, respectively. Axos Securities, which includes our securities clearing and custody, self-directed trading, and managed portfolio businesses generated $0.8 million of pre-tax income excluding non-cash amortization expenses in the fourth quarter of 2022, an improvement from a loss of $0.1 million in the prior quarter. Our securities business is starting to benefit from rising rates, partially offset by declines in custody and clearing fees as a result of a decline in overall stock market activity. Additionally, we continue to incur incremental expenses related to growth initiatives such as crypto trading, tech infrastructure upgrades for the bank and our securities business, and our new Axos Clearing core system. We believe these investments are appropriately scaled relative to future growth and cost savings they will generate from a fee income deposit and customer service perspective. We grew deposits by 9.5% linked quarter to $13.9 billion, with broad-based growth across our small business commercial securities deposits. Checking and savings accounts represent 92% of total deposits at June 30, 2022. Consumer deposits representing 54% of our total deposits at June 30, 2022, are comprised of consumer direct checking, savings, and money market accounts. The weighted average demand and savings deposit costs were 29 basis points for the three months ended June 30, 2022, compared to 14 basis points for the three months ended March 31, 2022. We continue to make steady progress cross-selling deposit products to our lending customers. Non-interest bearing deposits increased by $900 million quarter-over-quarter to $5 billion. Total client deposits from our custody and clearing business were approximately $3.5 billion at June 30, 2022, as advisors increased their cash holdings as a percentage of client assets in reaction to elevated stock market activity. We kept $2.5 billion of the $3.5 billion on Axos Bank's balance sheet. The optionality of deploying these low to no cost deposits to fund our bank's loan growth, or earning fee income from partner banks, is a significant competitive advantage relative to other banks our size. Continued growth in our non-interest bearing deposits has been instrumental in our ability to fund our strong organic loan growth while maintaining a net interest margin above our target range for the past three quarters. Our diverse lending and deposit businesses, along with a modest security portfolio, position us well for a rising rate environment. Our securities book, with approximately $264 million in lending balances, is less than 2% of total assets as of June 30, 2022. About half of our securities are floating rate, and the average duration of our securities portfolio was 2.4 years. Our single-family jumbo mortgage and multifamily loan portfolios were $3.7 billion and $2.1 billion of loan principal outstanding as of June 30, 2022, representing approximately 26% and 15% of our total loans outstanding, much lower than they were in prior upgrade cycles. With the exception of a small portfolio of prime jumbo mortgages, we have no other 30-year fixed-rate jumbo single-family or multifamily loans on our balance sheet. The weighted average duration of the jumbo single-family mortgages and multifamily mortgages on our balance sheet was approximately 2.3 and 3.8 years, respectively. Note rates on loans originated in our single-family jumbo multifamily and C&I loans were 5.01%, 4.75%, and 5.16% respectively in the three months ended June 30, 2022, up 89 basis points, 58 basis points, and 42 basis points respectively from the prior quarter. We have raised rates for our newly originated 5.1 jumbo single-family and multifamily loans in addition to the amount in July, and demand remains solid. C&I loans have been the biggest contributor to our overall loan growth over the past several years. For the quarter ended June 30, 2022, C&I loans increased by $700 million linked quarter to $6.8 billion, representing nearly half of our gross loans outstanding. With the exception of our $114.7 million equipment finance portfolio, all of our other C&I loans are adjustable rate. At June 30, 2022, approximately 79% of our variable rate C&I loans were above their floors, and following the rate increase announced on July 27th, 86% or above their floors. With another additional 75 basis points increase, 95% of C&I loans will be above their floor. Demand for our commercial specialty real estate and other C&I loans remains strong, as reflected in the $970 million of C&I loans in our pipeline as of August 1, 2022. We believe our balance sheet remains asset sensitive, with floor rates reaching those effectively on the vast majority of C&I loans, with the next rate increase, and with aggressive repricing of newly originated single-family and multifamily mortgages, and continued, although slower, levels of prepayment of lower yielding single-family and multifamily hybrid mortgages, our asset yields will continue to increase. Furthermore, the approximately $0.9 billion of deposits at partner banks will generate higher fees for Axos as rates rise. While we expect deposit betas to rise as competition for deposits increases in the back half of calendar 2022 and beyond, particularly for new deposits, our deposit betas will be meaningfully lower than they were in prior Fed tightening cycles due to the granularity and diversity of our tech-enabled customer-centric deposit servicing model. One of the key strategic benefits of being a bank like Axos, owning an RIA custodians, is having access to low cost deposits that we can use to fund our loan growth. Historically, the cash deposit balances held by our advisory clients fluctuated between 6% to 8% of assets under custody. In the quarter ended June 30, 2022, advisors held more cash in reaction to elevated levels of market volatility. The additional $670 million of no cost deposits, which represent the difference between the 9% average cash balance held by advisory clients and the 6% that we typically expect, boosted our net interest margin by approximately 12 basis points in this quarter. Our net interest margin in the fourth quarter of 2022 also benefited from non-recurring interest income from two loans that were previously categorized as non-performing; they were paid off in full. We received full interest in principal on both loans, including default interest. These two loans combined added approximately $3.5 million of net interest income, boosting our net interest margin by approximately 9 basis points. Excluding these two aforementioned items, our net interest margin would have been 4.2 in the three months ended June 30, 2022, up 6 basis points year-over-year. Looking forward, our outlook is that our net interest margin for the fiscal year-end June 30, 2023, will remain at or above our long-term target of 3.8 to 4. The biggest factors impacting our net interest margin will be how fast our loan portfolio grows and where our Axos advisory deposit balances are relative to the June 30, 2022 levels. As we stated previously, our expectation is that net loans will grow in the mid-teens in fiscal 2023, having grown net loans by nearly $1 billion in this quarter, representing an annualized growth of over 30%. If we continue to grow net loans at that rate or above our mid-teens base case target, then the incremental cost of fund or loan growth will be on the higher end of expectations. With respect to our advisory deposits, we have a healthy pipeline of new advisors looking to transition their custody assets to us. However, relative to the size of our existing $22.4 billion of assets under custody at the end of this quarter, the biggest source of incremental low cost deposits will come from our existing RIA clients. The amount of cash held by RIAs and their client accounts, commonly described as cash sorting, fluctuates based on advisors' risk appetite, which can change quickly. For example, when we closed the advisory acquisition last August, advisors and clients held a record low of 4.8% of assets they manage in cash. Fast forward to this quarter, the cash percentage dramatically increased to 11.9% by the end of the quarter due to the Fed's aggressive monetary tightening significantly reducing advisors' risk tolerance. Our baseline assumption is that the percentage of cash held by advisory clients will normalize to 7% of assets under custody in fiscal 2023. If clients become more risk-averse and continue to hold a higher cash balance, then our full year net interest margin would be higher than our baseline targets. However, if clients reduce their cash percentage and we had to replace those low-cost deposits with relatively higher cost deposits, then our full year net interest margin would be reduced depending on the percentage of cash sorting. Our credit quality remains healthy; net charge-offs to total loans remained low, and our asset base and low LTV lending make us extremely comfortable about our credit outlook even in adverse economic scenarios. Non-performing assets to total assets were 68 basis points for this quarter, an increase from 87 basis points for the quarter ended March 31, 2022. Other non-performing loans, 56% of our single-family first mortgages, where we've had historically very low realized losses. Of our nonperforming single-family mortgages, at the end of this quarter, approximately 84.3% had an estimated current loan-to-value ratio below 70, and approximately 90.5% are below 80% of our best estimates of current loan to value. The property of our largest nonperforming single-family mortgages was sold in the fourth quarter of 2022, and we were paid back 100% of our principal and interest, including our default interest. Given the low loan-to-values of our asset-backed loans, we remain confident that we will incur minimal credit losses, even if our asset values decline. A loan loss provision this quarter was $6 million, which is up by $1.5 million from the last quarter and up $4.7 million year-over-year. The increase and loan loss provision primarily reflects a record quarter of loan originations for investments and changes in loan portfolio mix with C&I and auto accounting for a greater percentage of our total loans. Our total allowance for loan losses was $148.6 million at June 30, 2022, approximately 1.04% of our total loans and approximately 49 times our total annualized net charge-offs in the three months ended June 30, 2022. Our loan pipeline remains solid with approximately $1.9 billion of consolidated loans in our pipeline of August 1, 2022, consisting of $33 million of single-family agency gain on sale mortgages, $475 million of single-family jumbo mortgages, $273 million of multifamily and small balance commercial real estate loans, $970 million of C&I and CRESL loans, and $109 million of auto and consumer unsecured loans. With healthy demand for loans across multiple loan categories, we are confident in achieving the mid-teens loan growth target we established at our Investor Day for fiscal 2023. We are making good progress with the integration of the Axos Advisory services business, which is the RIA custody business we acquired from Morgan Stanley a year ago. Overall profitability for Axos Securities in this quarter improved from the prior quarter primarily due to an increase in broker-dealer fee income. We see meaningful opportunities to grow assets under custody, fee income, and deposit balances and advisory services by adding new clients and rolling out new products and services. We've opportunistically added a few seasoned team members to our advisory sales team to take advantage of advisors looking to move some or all of their custody business. We signed five new deals this quarter that will increase our assets under custody by approximately $200 million once they're fully on-boarded. Our pipeline of custody clients is healthy and growing, and market volatility provides opportunities for a nimble and client-centric organization such as ours. Our capital ratios remain strong with Tier 1 leverage to adjusted asset leverage of 9.29% at the holding company and 10.65% of Axos Bank. We have access to approximately $2 billion of Federal Home Loan Bank borrowings and $1.9 billion in excess of $117 million we had outstanding at the end of the fourth quarter. Furthermore, we had $2.8 billion of liquidity available at the Fed discount window as of the end of this quarter. Our capital priorities remain unchanged, focusing on using our capital to support our organic loan growth, investing in our existing and emerging businesses, and deploying excess capital for opportunistic buybacks and accretive M&A. Our securities business had a solid quarter with higher client deposit balances and lower custody and clearing fees due to an overall decline in equity markets. Broker-dealer fee income increased 105% in the fourth quarter compared to the corresponding period last year due to the addition of fee income from the Axos Advisory Services acquisition. Excluding one-time merger-related expenses and non-cash depreciation and amortization costs, Axos Clearing generated $2.1 million of pre-tax income for the quarter ended June 30, 2022. Axos Clearing ended the fourth quarter of 2022 with approximately $32 billion of assets under custody and administration, including $22 billion of assets under custody and $10 billion of assets under administration in the clearing business. Total RIA and IDB relationships increased from $254 at March 31, 2022, to $263 at the end of this quarter. Revenue from clearing activity was relatively flat, with an increase in stock borrower balances being offset by a decline in ending margin balances. The increase in broker-dealer fee income of $3.4 million was primarily driven by multiple Fed rate hikes, resulting in FDI suite sweep fee income growing from $2.9 million to $6.69 million. We continue to make good progress in our ongoing effort to streamline the operations and infrastructure at Axos Clearing and advisory services. We have automated certain manual processes and eliminated redundant reconciliations and other internal workflows. As we discussed at our Investor Day in May, Axos Clearing is transitioning to a modern SaaS-based platform that will reduce our operating costs, increase the flexibility to introduce new products and features quickly and cost-effectively, and allow us to serve fintechs that we are not able to serve today. This multiyear transition started last quarter, and the incremental costs associated with the development and implementation are in the run rate today. The rollout will occur in several stages, and we do not expect any meaningful one-time expenses associated with any one specific stage. The consistency in our gross margins and profitability is a testament to the diversity and efficiency of our model and the solid execution by our team. We have a long track record of managing through changes in competition, interest rates, partnerships, and business mix while increasing our earnings and book value per share. Our strong loan growth and net interest margin support continued net income growth and growth in our broker-dealer fee, while offsetting declines in mortgage banking gain on sale revenue. While the uncertain environment presents short-term challenges, we will continue to invest in initiatives such as our universal digital bank 2.0, retail crypto trading, and commercial real-time payments in a modern core that will make us more competitive from a cost, product, technology, and scale perspective. Our strong profitability, excess capital, and ability to be nimble position us well to take advantage of market dislocations. We remain focused on generating strong organic growth that will translate into excess returns for our shareholders over time. Now I'll turn the call over to Derrick, who will provide additional detail on our financial results.

Derrick Walsh, CFO

Thanks, Greg. First, I want to remind investors that in addition to our press release and 8 K supplemental schedules, our quarterly earnings supplement was also filed with the SEC today and is available online through EDGAR or through our website at AxosFinancial.com. I will provide some brief comments on several topics. Please refer to our press release and supplements for additional details. To begin, I'd like to congratulate all of the team members of the Axos Enterprise on another fantastic year. We achieved record earnings of $240.7 million and diluted earnings per share of $3.97 for our fiscal year ended June 30, 2022 compared to $215.7 million and $3.56 for fiscal year ended June 30, 2021. Our fiscal 2022 return on equity was 15.61%, and our tangible book value increased from $21.36 to $24.45. Our bank efficiency ratio continues to be top of class at 41.61% for the fiscal year ended June 30, 2022. Shifting to our quarterly performance, I'll cover a few areas like we touched on by Greg in a bit more detail. Starting with our loan loss provision which were $6 million for the quarter ended June 30, 2022 compared to $4.5 million for the quarter ended March 31, 2022 and $1.25 million for the quarter ended June 30, 2021. The increase in the provision for the three months ended June 30, 2022 was primarily due to strong loan growth, specifically in our commercial real estate and C&I lending portfolios. It is worth noting that on July 1, 2022, we reached the two-year anniversary of our adoption of CECL, as well as our election to implement the five-year CECL transition option for calculating regulatory capital ratios. This guidance allowed an entity to add back to capital, 100% of the capital impact from the day one CECL transition adjustment and 25% of subsequent increases to the allowance for credit losses through June 30, 2022. The cumulative amount will now be phased out of our regulatory capital over the next three years. Based on our June 30, 2022 balance sheet, we expect this transition to be modestly dilutive or less than 10 basis points to our capital ratios in fiscal '23. Lastly, I'd like to touch on our non-interest expenses. For the quarter ended June 30, 2022, non-interest expenses were $104.8 million, up $18 million from the linked quarter ended March 31, 2022 and up $22.9 million from the quarter ended June 30, 2021. Excluding the $11 million contractual and legal charges, non-interest expenses were $93.8 million for the quarter ended June 30, 2022, up $7 million on the linked quarter. Data processing and professional services were the primary drivers of the sequential increase in our non-interest expenses. Data processing for the quarter ended June 30, 2022, was $13.6 million, an increase of $1.3 million from the $12.3 million for the three months ended March 31. And a $0.7 million increase from the $12.9 million for the quarter ended June 30, 2021. The increases are a reflection of the growth of our business as well as our ongoing investment in systems and personnel. Professional services for the quarter ended June 30, 2022 was $7.6 million, an increase of $3.3 million from the $4.3 million for the three months ended March 2022 and a $2.7 million increase from the $4.9 million for the quarter ended June 30, 2021. The primary drivers of the increases were legal expenses for matters Greg discussed earlier. As we look ahead into our fiscal 2023, we expect to maintain our banking efficiency ratio between 41% and 42%. Based on our continued growth in our headcount, merit-based increases and compensation for existing staff at or above our historical range of 5% to 7%, and a higher level of spending on marketing to generate growth in our consumer and commercial banking businesses. With that, I'll turn the call back over to Johnny.

Johnny Lai, Corporate Development and IR

Thanks, Derrick. Melinda we are ready to take questions.

Operator, Operator

Thank you. And we'll go right into our first question from David Feaster with Raymond James. Please go ahead.

David Feaster, Analyst

Hi, good afternoon everybody.

Greg Garrabrants, CEO

Hi David.

David Feaster, Analyst

Maybe just touching on growth, growth was phenomenal, it was extremely diversified, but let me just touching about the pipelines and how they're shaping up, have you, is there anything notable any notable changes to the competition. And then just curious on the demand you've seen today. I mean you talked in your prepared remarks about improving new volume yields. Have you seen any change in customer appetite or folks may be getting some sticker shock and if so, maybe what segments are you seeing that are more price inelastic or price elastic than others.

Greg Garrabrants, CEO

That's a great question. It's a multipart question, so I'll try to address each part. Pipelines remain strong, although we don't anticipate the same level of growth in the next quarter as we experienced this quarter. While growth will still be healthy, there has been some reduction in market activity, which is accompanied by decreased competition. This reduced competition stems from a pullback in the securitization market and increased spreads due to various financial tightening conditions, particularly affecting the non-bank sector. This situation is beneficial and significant for our single-family business. Although single-family volumes have decreased significantly, our pipelines remain solid despite our aggressive pricing strategy. Many competitors are facing challenges, which has worked in our favor. Regarding multifamily products, we've been a bit more aggressive with pricing on certain duration-oriented products, but we've seen a decline in demand, which seems to be influenced more by pricing shock than market conditions. To respond to this, we’ve shifted to more variable rate pricing for some assets, and we’ve also hired an individual skilled in derivatives. As the yield curve inverts, we have yet to see the full implications of this change, but for those willing to lock in rates for a period during an inverted yield curve, we can offer more attractive deals and convert those loans entirely to floating rates. In summary, financial tightening has increased credit spreads and reduced non-bank competition, allowing us to be more aggressive with rate increases while maintaining volumes. While this quarter was somewhat unusual, we are optimistic about loan growth in the coming year.

David Feaster, Analyst

That's great. And that makes a lot of sense. Maybe turning to the deposit discussion on the securities business. It sounds like a large majority of that might be from increased cash held in client accounts. But curious maybe how much you would attribute to client growth and it sounds like there is a good backlog of RIA that are looking to convert over. We've hired two new sales folks, maybe just curious about the potential deposit growth that you could see from new clients coming over and how you think about the deposit growth out of that business, exclusive of some of those cash balance dynamics that you talked about.

Greg Garrabrants, CEO

We have a target of about $1 billion growth in assets under custody. We believe we can exceed that target by leveraging cash percentages. Our focus is primarily on smaller Registered Investment Advisors (RIAs), although we are also engaging with some larger ones. We are currently looking to onboard more smaller RIAs, which tends to lead to growth, but we also have some very large RIAs in our pipeline that are converting only a portion of their assets at this stage. We are still acclimating to this process. Our sales team has significantly expanded and our pipelines have grown tremendously, but the time it takes for conversions can be lengthy. The positive aspect is that this business is quite resilient, yet the process can be slow. We are observing good increases in our pipelines; however, it’s uncertain how quickly this will impact us, especially in the coming year. While we expect meaningful growth, it won’t completely resolve our current situation, though it would certainly help.

David Feaster, Analyst

Yes. Okay. And then just maybe curious how you think about maintaining the off-balance sheet deposits in the contribution to fee income this quarter there. Just when would you consider bringing some of those back on? At what point or is just the arbitrage opportunity still too great there? And then just curious whether you're starting to see any inflection in the bankruptcy trustee business at all and deposit growth from that.

Greg Garrabrants, CEO

We are seeing some; we do expect to that to get a little better there is, if you go to these bankruptcy trustee conferences, they've been sitting there in every conference over the last number of years has been, it's just around the corner right and given that they have a countercyclical business, they have depositors of certain morbidity to it, but they do, we do expect that they do see some precursors to the filings, it's really hard to estimate, but I do expect that there would be some benefit there associated with an economic downturn to the extent that becomes obviously severe enough to drive that sort of activity. And then you had another part of your question.

David Feaster, Analyst

On-balance sheet.

Greg Garrabrants, CEO

So there are a few important points to keep in mind regarding certain limitations related to specific components of cash. Not all cash is treated equally, and having it on the balance sheet can be less advantageous from a regulatory capital standpoint in some cases. There are restrictions on certain types of cash and the amount that can be held in an affiliate. This situation is likely to persist, although there is some potential to move cash to different accounts to bypass these restrictions, which would require operational adjustments. I anticipate that the cash levels will likely fluctuate in line with the average. There seems to be some arbitrage opportunities right now, but it's worth considering whether the strong loan growth we are experiencing might lead us to sacrifice fee income in exchange for lower-cost deposits. This is a key trade-off that we will need to evaluate as we proceed.

David Feaster, Analyst

That makes sense. Thanks everybody.

Greg Garrabrants, CEO

Thank you.

Operator, Operator

Next, we go to the line of Gary Tenner with D.A. Davidson. Please go ahead.

Gary Tenner, Analyst

Thanks, good afternoon. Just follow up on that securities deposit-related question and I was curious is there separate from what you just noted Greg in terms of some of the kind of regulatory provisions on some use. Is there a need to maintain some level at third-party banks just to kind of have those banks to go back to over time in terms of totally turning the spigot off or do you risk losing the ability to have them out over time.

Greg Garrabrants, CEO

Yes, the short answer is yes. Additionally, we are aware that some customers have deposits exceeding $500,000, and we want to ensure they have the benefit of FDIC insurance. To support this, we collaborate with over 20 partner banks and are continuously building a pipeline to enhance our options for finding the best rate arbitrage with these partners.

Gary Tenner, Analyst

That makes sense. And then, make sure I caught the numbers correctly, is it $3.5 billion that are the securities deposit balances at other banks, or is that including the 2.5, I think you said that's on your best?

Greg Garrabrants, CEO

So that's the entire cash sorting balance. So $2.5 billion and change was on balance sheet at Axos Bank.

Gary Tenner, Analyst

Is that the level you would see at other banks, or is there still some flexibility to adjust that without causing any issues?

Greg Garrabrants, CEO

It's going to vary in the range of around $800 million, give or take $100 million or $200 million, and that will be the general low point. We could certainly see different opportunities and more off-balance sheet potential, especially in a higher rate environment, but that's likely where we will stand.

Gary Tenner, Analyst

Okay. Thanks. And then in terms of just overall balance sheet management. As you think of kind of cash and equivalents and AFS portfolio. You're right around 10% of total assets right now as we think about modeling the parts of the kind of earning asset mix over time. Is that 10% of total assets, kind of the ballpark you would you would kind of look to maintain over time.

Greg Garrabrants, CEO

I'm sorry, what was the question? What does the 10% refer to specifically?

Gary Tenner, Analyst

The cash and equivalents and available for sale portfolio is approximately 10% of the total assets.

Greg Garrabrants, CEO

Yes, there are different factors at play. Much of the cash is tied to regulatory requirements, as we need to hold cash against certain customer accounts in our clearing business. Additionally, we maintain a liquidity balance at the bank. I believe the cash increased slightly at the end of the quarter, partially due to balancing loan growth; we had several opportunities, some of which were realized and some were not by quarter-end. We want to ensure we have enough cash available to support these opportunities. Looking ahead, I would expect our cash balance to be slightly below 10%.

Gary Tenner, Analyst

Thanks. And last question from me, on the expense side. Derrick, I appreciate the kind of the guide you gave on the efficiency ratio at the bank segment as you think it maybe I've just broader consolidated expense levels using the kind of core June 30 run rate of what $92 million $93 million. What kind of growth rate would you expect overall consolidated basis off of that number.

Derrick Walsh, CFO

I believe I provided the range for the bank side. I don't anticipate a significant difference between our bank side and our Axos Financial efficiency ratio compared to historical levels.

Gary Tenner, Analyst

All right, thank you.

Operator, Operator

Our next question or comment comes from the line of Andrew Liesch with Piper Sandler. Please go ahead.

Andrew Liesch, Analyst

Hi, everyone. Thanks for taking the questions here. Just following up on the expense run rate question here, it looks like they were just the two compliance or the contractual claim and the legal claim. So expenses were up about $6 million or so, about $92 million. I mean is that the run rate we should be using. Are you looking at it more at an efficiency ratio target for the consolidated company as you just mentioned, or is this $92 million a good run rate with some growth expenses added on there.

Derrick Walsh, CFO

Yes, the expectation is that there will be growth, and that's why we're giving kind of that 41% to 42% range of the efficiency ratio because certainly will have some variability from quarter to quarter depending on things we do are been, for example, we do the merit increases for staff at the end of September. So there will be increases expected in our fiscal Q2 and that December quarter compared to September quarter. So I'd point you again back to the 41% to 42% of the bank efficiency ratio and playing or using that for your various models.

Greg Garrabrants, CEO

And then, I also think that as rates rise, the investment in deposit personnel and systems and work on the deposit side becomes more valuable; that obviously shows up in expenses. But it's very valuable from a margin protection and expansion perspective. And so we are adding a number of people and more salespeople on the deposit side. We're adding some teams with respect to some particular verticals in the deposit side and thus growing that. So that's where some of that guidance comes from.

Andrew Liesch, Analyst

Got it. That's helpful. And I'm sorry if I missed it, did you say what the MSR write-up was, or if there was one in the quarter.

Derrick Walsh, CFO

$1.5 million.

Andrew Liesch, Analyst

Okay. So then if I take that out of the mortgage banking still little under $2 million of gain in revenue for the quarter from the mortgage side, is that correct?

Derrick Walsh, CFO

Correct.

Andrew Liesch, Analyst

All right, that's helpful. You covered all other questions, I'll step back. Thanks guys.

Greg Garrabrants, CEO

Thank you.

Operator, Operator

And we take our final question from the line of Michael Perito with KBW. Please go ahead.

Michael Perito, Analyst

Hi everyone, good afternoon. I appreciate you taking my questions. I have a couple of quick clarification questions. First, regarding the $200 million of assets under custody that I believe you either added at the end of the quarter or will be bringing in next quarter from new clients, is that correct? Also, I recall on a previous Analyst Day you mentioned a $2.5 million annual revenue run rate for every billion of assets under custody. Is that still a reasonable estimate to keep in mind as you add assets under custody in terms of funds and the broker-dealer fee income once the full impact is realized?

Greg Garrabrants, CEO

Yes, I think that's a reasonable number. However, on an avoided cost basis, it would be higher due to increased rates. This would be more favorable depending on the cash balances associated with those assets. One of the challenges is that these opportunities come in various forms. For instance, some may rely heavily on mutual funds, resulting in lower cash balances due to more aggressive management, while others might have higher cash balances but are more ETF-oriented. Thus, there are differences in approach. Nevertheless, I believe that number is good to use and is conservative compared to the typical cash inflow and the avoided costs linked to lower-cost deposits that don't need to be raised when expanding loans.

Michael Perito, Analyst

Got it. Great, helpful. And then just lastly, obviously a fairly kind of volatile and dynamic macro environment right here, just curious how do you guys, how are you thinking about there is good commercial real estate and multifamily growth in the quarter, any views on how kind of changes in cap rates could impact LTVs in the portfolio. And just any context or additional thoughts you guys are kind of looking at or contemplating internally around credit on those books with just given everything that's going on in the macro currently.

Greg Garrabrants, CEO

Yes, we are being very careful to account for significant stress on cap rates. We analyze those factors, and although you haven’t seen these reflected in market transactions where pricing is, we are aware of the situation. Most of our operations involve working with funds, which means our loan-to-value ratios are much lower than the average financial institution. I believe there is considerable risk capital in front of us from both lending and equity perspectives. We've observed more cautious behavior from banks and non-banks, partly due to the securitization markets. This is a fascinating time with good opportunities, and we have strong niches that we concentrate on. Our partnerships are robust, and we have a clear direction with them. There are real benefits for our partners to collaborate with us, and this has been evident. However, it’s essential to pause and reflect, especially regarding multifamily investments, where cap rates have been historically low and seem poised to increase. It’s important to note that rent increases in the market have been unexpectedly high, which have supported these investments. I’ve expressed concern about how difficult it is for investors to remain profitable at the cap rates for multifamily properties. However, despite my concerns, the current situation has shown that they might be seeing favorable outcomes. Still, we must remain cautious, as this trend cannot continue indefinitely.

Michael Perito, Analyst

Yes. That makes sense. All my other questions have been answered, thank you, guys. Appreciate it.

Greg Garrabrants, CEO

Thank you.

Operator, Operator

This concludes our question-and-answer session. We return to Johnny Lai for closing remarks.

Johnny Lai, Corporate Development and IR

Thanks everyone for joining us. If you have any follow-ups, please contact me, and we will talk to you next quarter.

Operator, Operator

This concludes our teleconference. So we thank you for your participation. You may disconnect your lines at this time. Have a great day.