Earnings Call Transcript - AX Q3 2022

Operator, Operator

Greetings. Welcome to the Axos Financial, Inc. Q3 2022 earnings call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. Please note this conference is being recorded. I will now turn the conference over to your host Senior Vice President of Corporate Development and Investor Relations, Johnny Lai. You may begin.

Johnny Lai, Senior Vice President of Corporate Development and Investor Relations

Thanks, Kyle. Good afternoon, everyone, and thanks for your interest in Axos. Joining us today for Axos Financial, Inc's third-quarter 2022 financial results conference call are the company's President and Chief Executive Officer, Greg Garrabrants; and Executive Vice President and Chief Financial Officer, Derrick Walsh; and Executive Vice President of Finance, Andy Micheletti. Greg and Derrick will review and comment on the financial and operational results for the three and nine months ended March 31, 2022, and they will be available to answer questions after the prepared remarks. Before I begin, I would like to remind listeners that prepared remarks made on this call may contain forward-looking statements that are subject to risks and uncertainties and that management may make additional forward-looking statements in response to your questions. These forward-looking statements are made on the basis of current views and assumptions of management regarding future events and performance. Actual results could differ materially from those expressed or implied in such forward-looking statements as a result of risks and uncertainties. Therefore, the company claims the safe harbor protection pertaining to forward-looking statements contained in the Private Securities Litigation Reform Act of 1995. This call is being webcast, and there will be an audio replay available in the Investor Relations section of the company's website located at axosfinancial.com for 30 days. Details for this call were provided on the conference call announcement and in today's earnings press release. All of these documents can be found on the Axos Financial website. With that, I would like to turn the call over to Greg for his opening remarks.

Greg Garrabrants, President and Chief Executive Officer

Thank you, Johnny, and good afternoon, everyone, and thank you for joining us. I'd like to welcome everyone to Axos Financial’s conference call for the third quarter of fiscal year 2022 ended March 31, 2022. I thank you for your interest in Axos Financial and Axos Bank. We had an excellent quarter with double-digit growth in loan originations, net income, book value per share, and earnings per share for the third consecutive quarter. Our strong results were broad-based with net interest margins exceeding the high end of our target and balanced net interest income and fee income growth across our consumer and banking segments. Axos Securities increased client accounts and deposit balances despite a challenging quarter for the industry due to headwinds caused by macroeconomic and geopolitical turmoil. Axos reported third-quarter net income of $61.8 million for the three months ended March 31, 2022. Earnings per diluted share were $1.02, representing year-over-year growth of 15.3% and 14.6% respectively. Our book value per share was $26.58 at March 31, 2022, up 17% from March 31, 2021. The highlights for this quarter include pending loan balances of $13.1 billion, up 3.9% linked-quarter or 15.4% annualized. Strong ending loan originations in our auto, commercial real estate, and various C&I lending loan types more than offset an expected decline in our single-family mortgage warehouse loans. Excluding single-family jumbo and single-family mortgage warehouse, ending loan balances increased by 9.5% linked-quarter. Net interest margin was 4.02% for the third quarter, down from 4.10% in the quarter ended December 31, 2021, and up six basis points from 3.96% in the quarter ended March 31, 2021. The efficiency ratio for the three months ended March 31, 2022, was 51.21% compared to 48.78% in the second quarter of 2022. The efficiency ratio for the Banking Business segment was 39.79% for the third quarter of 2022 versus 39.39% in the second quarter of 2022, which reflects positive operating leverage in our Banking Business as a result of strong net interest income growth year-over-year, and continuous focus on managing our operating costs. Diluted earnings per share were $1.02, up 15% from $0.89 in the year-ago quarter. We continue to generate strong returns while maintaining excess capital. We generated a return on equity of 15.89% in the third quarter and a return on assets of 1.59%. Capital levels remain strong with a Tier 1 leverage ratio of 10.51% at the bank and 9.43% at the holding company, both well above our regulatory requirements. Our credit quality remains strong with net annualized charge-offs to average loans of 5 basis points versus 3 basis points in the third quarter of fiscal 2021. We added $4.5 million to our loan loss provision this quarter to support our strong loan growth. Factoring in these developments, I would say the overall sentiment reflects stability and growth potential across our operations.

Derrick Walsh, Chief Financial Officer

Thanks, Greg. To begin, I’d like to highlight that in addition to our press release an 8-K with supplemental schedules and our 10-Q were filed with the SEC today and are available online through EDGAR or through our website at axosfinancial.com. I will provide some brief comments on a few topics. Please refer to our press release and our SEC filings for additional details. Turning to our quarterly performance. Overall non-interest income for Q3 fiscal 2022 was consistent with Q2 fiscal 2022 when removing the annual fees of $1.9 million for certain bank IRA products recognized once per year in the December quarter, and up $4.9 million from Q3 fiscal 2021, primarily due to the addition of custody and mutual fund fees from our AAS Division, which was acquired this past summer. Our bank efficiency ratio was 39.79% for the three months ended March 31, 2022 significantly improved when compared to 42.33% for the three months ended in March 31, 2021 and a small change when compared to 39.39% for the last quarter ended December 31, 2021. The strong efficiency ratio is a reflection of loan growth, prudent expense management and our scalable business model. Our non-interest expense for the quarter ended March, 2022 was $86.8 million up $0.8 million from the linked-quarter ended December, 2021 and up $6 million from the quarter ended March 31, 2021. We closely monitor our capital levels in conjunction with market data and various other key performance indicators, including our return on average equity. With that, I’ll turn the call back over to Johnny.

Johnny Lai, Senior Vice President of Corporate Development and Investor Relations

Thanks Derrick. Kyle, we’re ready to take questions.

David Feaster, Analyst

Hi, good afternoon, everybody.

Greg Garrabrants, President and Chief Executive Officer

Hi, David.

David Feaster, Analyst

You guys have been able to take a ton of expenses out of that AAS business. I would’ve thought most of the savings would’ve been realized just given what you guys have done, but it sounds like there’s still more to come. Just curious, the scalability of this business and the expense growth that we might see as you continue to onboard new clients and activity increases and just, how you think about what a good efficiency ratio for this business is as you continue to operate that.

Greg Garrabrants, President and Chief Executive Officer

Right. So first of all, thank you. I think you’re right, the team has done a good job working on process improvement and increasing its efficiency. There is still so much opportunity. We’ve been at it for a long time at the bank and there’s a lot of opportunity in clearing and there’s a lot of opportunity in custody as well. I think with respect to what the efficiencies should look like over the longer term, it’s bound up a little bit and I’ll try to disaggregate it with respect to interest rates. So if you just take the securities business as a whole, and you have $3 billion and you have a 100 basis point increase, that’s $30 million of extra pre-tax income that goes to that business. Obviously impacting the efficiency ratio, but that’s not really the way I’d like to look at it. I think we should target having positive income, assuming that the deposits don’t generate anything. There’s a lot of benefit to be gained, but it’ll take a little time to realize that opportunity.

Derrick Walsh, Chief Financial Officer

Right. You’d have to say that as of today, the efficiency ratio won’t be as good as it would be up 200 basis points. But regardless, we’re carving out a lot of expenses there and have a lot of strategic plans to make the business much more efficient.

David Feaster, Analyst

Yes. No, that is hopeful color. And then just curious on the conversation with new clients within the securities business, how are they going? Where are your clients seeing, AES as, what are the key differentiators?

Greg Garrabrants, President and Chief Executive Officer

Yes, I think from a catalyst to make change, I think the TD acquisition is really weighing heavily on folks because a lot of the advisors are multi custodial. They sort of wanted some choices with respect to their custodial relationships. So, if you look at the history of AAS, they often brought in smaller firms that over time grew and the businesses grew together. The key differentiator right now is that the system itself allows an RIA to run their full business effectively. There’s other sub-elements that some folks are really excited about. You can run multiple models in a single account. There’s a bunch of functionality that is unique and others haven’t caught up in the industry. So, I think we’re doing well. There are exciting times ahead. The interesting thing is that you see folks that are traditional brokers becoming hybrid, and you also see the rise of FinTechs who want not only securities APIs, but also banking APIs. We are in a position to deliver that and that’s something we’re working on right now. So those are some potential growth areas.

David Feaster, Analyst

That’s exciting. That’s great color. I appreciate it.

Greg Garrabrants, President and Chief Executive Officer

Thanks, David.

Andrew Liesch, Analyst

Hey guys. Good afternoon.

Greg Garrabrants, President and Chief Executive Officer

Hey Andrew, good afternoon.

Andrew Liesch, Analyst

Thanks for the commentary there on the jumbo outlook. But on the commercial side, it seems like things are firing on all cylinders. So, I guess the question is what can disrupt this momentum right now?

Greg Garrabrants, President and Chief Executive Officer

Look, things are looking pretty good on the lending side. It’s a question of how the economy reacts to the rate increases and what individual decisions are made with respect to aggregate loan demand. We are seeing some positive signs where banks are getting ahead of stuff, so that’s good, but we want to be cautious about duration. I think things are on the loan growth side are looking pretty good.

Andrew Liesch, Analyst

And then just a quick question on credit quality. Are you seeing anything concerning out there at all the numbers are great, but does anything concern you right now?

Greg Garrabrants, President and Chief Executive Officer

No, there’s nothing that concerns me specifically in our portfolio, but every lender should always just be concerned. It’s a disposition. I think we’ve had a lot of years of lowering of cap rates based on low interest rates. We are cautious about our loan to values and we are always focused on that. But I feel we are in a strong position.

Gary Tanner, Analyst

Thanks. Good afternoon. Hey, I just want to ask a clarifying question on the security segment. I think Greg, you had mentioned a process that will lower annual expenses by about $1 million. Did I hear that correctly?

Greg Garrabrants, President and Chief Executive Officer

Yes, that was the JPM conversion. When we brought AAS over, part of the deal was we converted from JPM to self clearing for the AAS side of the business, which should save about $1 million pre-tax going forward. That was completed at the end of March.

Johnny Lai, Senior Vice President of Corporate Development and Investor Relations

Great. Well, thanks for your interest in Axos. We are hosting our Investor Day in our Axos Advisor Services office in Centennial, Colorado next Wednesday, May 4th. If you have any questions or are interested in attending, please contact me directly. Thank you.

Operator, Operator

This concludes today’s conference, and you may disconnect your lines at this time. Thank you for your participation.