Earnings Call Transcript - AX Q3 2020

Operator, Operator

Greetings, and welcome to the Axos Financial Third Quarter 2020 Earnings Results Conference Call. At this time, all participants are in listen-only mode. A question-and-answer session will follow the formal presentation. 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.

Johnny Lai, Vice President of Corporate Development and Investor Relations

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 that is contained in the Private Securities Litigation Reform Act of 1995. Forward-looking statements related to the business of Axos Financial Inc and its subsidiaries can be identified by common use 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.

Greg Garrabrants, President and 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 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 over the quarter, I will focus my discussion on three 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 mortgages, 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 stressfully 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, which we are a part of. 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 an abundance of caution and supported by a first lien on other collateral. Approximately 95% of our loans outstanding as of 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 the March 31, 2020 quarter, 60% of our single-family mortgages had loan-to-value ratios at or below 60%, 33% had loan-to-value ratios between 61% and 70%, 6% had loan-to-value ratios between 71% and 80%, and less than 2 basis points, or $860,000 of combined balances had 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 on 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 as of March 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 the March 31, 2020 quarter, 44% of our multifamily mortgages had loan-to-value ratios at or below 55% loan-to-value, 35% had loan-to-value ratios between 56% and 65%, 20% had loan-to-value ratios between 66% and 75%, and less than 1% had greater than 75% loan-to-value. The average debt service coverage ratio of our multifamily loans was 1.5 as of March 31, 2020. Our small balance commercial real estate loan portfolio of $410 million, representing approximately 4% of our total loans as of March 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 had loan-to-value ratios that were below 50%, 23% had loan-to-value ratios between 51% and 60%, 23% had loan-to-value ratios between 61% and 70%, 4% had loan-to-value ratios between 71% and 75%, and around 1% had loan-to-value ratios between 76% and 80%. Those higher loan-to-value loans are uniquely positioned. 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 49% loan-to-value for the hotel exposures. The average debt service coverage of our small balance commercial real estate loan book is 1.69 as of March 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 disruptions in the secondary market for non-agency mortgages. As of April 28, 2020, we had approximately $88 million in outstanding non-agency exposure on our mortgage warehouse book, or 19% of total current balances of $462 million. Our initial advance rate on non-agency loans varies 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 $87 million in non-agency loan balances outstanding, distributed among eight 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 on 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 at 27% of the outstanding receivable balances. These structures generally require rapid paydowns in the event of any significant collateral deterioration and the receivables 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, housing and 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 Aries, 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 sectors. In our equipment leasing portfolio, we had approximately $28 million of leases to four 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, 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 six equipment leases mentioned above was 2.87 times at the end of the third quarter. All of the above-mentioned 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 as of March 31, 2020, respectively. The vast majority of hotel loans are AB notes that we hold a senior position and with strong funds with a strong funded at junior position. The only two 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 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 our hotels are current in their loan payments. The average loan-to-value of the hotel and retail commercial specialty real estate loans was 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 allowance 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 three months ended March 31, 2019. We have received payments for all the $56 million of the principal balances for IRAs as of March 31, 2020, a pacing that is far ahead of the disclosed pacing of others in the industry. Given a 90-day extension in the Federal tax filing deadline by the IRAs, we anticipate a more extended repayment timeframe for IRAs this year compared to the prior year and cannot guarantee those extended pace will result in no incremental credit losses. In our securities business, we ended up the quarter with approximately $159 million of margin loans, down $67 million from December 31, 2019. Despite record price volatility in the stock market over the past few months, we successfully managed our 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 communication with clients through email, phone, and other channels over the past several weeks, and the tenor of the conversations has been productive. Other than as 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 we'll work with borrowers on a case-by-case basis on deferral requests while we help them manage through the negative impact from COVID-19. We believe this approach is more appropriate for our borrowers given the unique circumstances and uncertainty 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 one or two-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 two weeks late in the single-family, multifamily, and small balance commercial real estate groups. The number of those borrowers who have requested assistance that are 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, and on the unsecured lending side about 4.7% of the book have requested deferrals. These are currently short-term deferrals with 90% being no more than two months and around 10% receiving three months of 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 appealing 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 payments 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 up $8 million from $2.8 million in the prior quarter. The $69.4 million of loan loss reserves for the quarter ended March 31, 2020 represented approximately 105.7% of total nonperforming assets and 22.3 times our annualized net charge-offs. Approximately $4.2 million of the $10.8 million loan loss provision for 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 later implementation for CECL is that we'll 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 to 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 7A loans, but our technology, credit, 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 first quarter, compared to 4 basis points in the corresponding period last year. The non-performing asset to total asset ratio was 54 basis points for the quarter ended March 31, 2020, flat from December 31, 2019. The majority of our non-performing 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 a 150.7% coverage of our non-performing loans and leases at March 31, 2020. We continue to generate strong returns, as return on average common shareholders' equity was 18.65% and 15.34% in the three months and nine 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 quarter. Our capital ratios remain strong at 8.72% of the bank and 8.55% of 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 non-interest bearing deposits increased by almost $1 billion year-over-year, led by our Axos Fiduciary Services. Client cash deposits from AFS and Axos Securities currently held at other banks was approximately $455 million as of March 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 costs compared to three and six 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 non-banks 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 non-bank lenders. The purchase market has weakened due to the government 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. Supply constraints on housing and the relatively diverse nature of local economies on the West Coast make the multifamily and commercial real estate market 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 two loan categories. Also, we do not know whether governmental intervention in rent collection and eviction or foreclosure processes will impact our willingness to continue to lend, or impact our ability to manage our loan book. In our two 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, higher margins of safety, and better structures. With respect to auto and personal unsecured lending, we've temporarily suspended originations for all prime borrowers with a minimum FICO of 720, and significantly tightening 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 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 one-time 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 shifting competitive dynamics across 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 or single-family and multifamily mortgage as the underlying collateral. With a slowdown in prepayment 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 as of March 31, 2020, are term loans with fixed interest rates and staggered prepayment penalties through the first five years of the loans. Approximately 5% of our multifamily CRE loan portfolio is currently above their flow rates. With competitors pulling back from small balance CRE, we see opportunities to improve on low yields 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 raised just to the index. Of the $3.3 billion of lender finance commercial specialty real estate loans, approximately 70% are at their flow rates. Our equipment lending and leasing portfolio, which account for the remaining $162 million of C&I loan outstanding, is comprised of fixed-rate loans and leases. On the funding side, we're well positioned given the diversity of our consumer and commercial businesses and the optionality of our security-based deposits. Consumer deposits represent approximately 55% of our total deposits as of March 31, 2020 and are comprised of consumer direct checking, savings, money market, and non-interest bearing prepaid accounts. Excluding consumer time deposits, our consumer checking, savings, and money market balances increased by $916 million from December 31, 2019, with strong growth in our non-interest 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 271 and reissued a similar amount at 1.78 in the third quarter. Average non-interest bearing deposits were $2.6 billion in the quarter ended March 31, 2020, up by almost $1 billion compared to the same period a year ago. We're 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 new 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've 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 company's long-term outlook. Overall, we feel good about our ability to maintain an annual net interest margin towards the lower end of our 3.8 to 4.0 target. With loan growth likely 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.

Andrew Micheletti, CFO

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'll 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 include a one-time charge of $15.3 million for an uncollected receivable in our securities business. Increased quarterly net income was the result of operating expense efficiency improvements both year-over-year and on a linked quarter basis. The efficiency ratio was 39.85% for the quarter ended March 31, 2020, an improvement year-over-year of 292 basis points when compared to the 42.77% efficiency ratio calculated without the $15.3 million one-time 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, non-interest expense was $71.8 million, up $4.8 million compared to our last quarter ended December 31, 2019. Salaries and related costs increased by $2.3 million, primarily due to increased payroll taxes, 401(k) matching, and a small staffing increase. FDIC and regulatory fees increased by $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 by $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 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've created life-of-loan loss models based upon our portfolio characteristics. Using the 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 the 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 the COVID-19 pandemic and its future impact upon the economy. For regulatory capital purposes, when we adopt CECL, we expect to elect the two-year delay and the five-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.

Johnny Lai, Vice President of Corporate Development and Investor Relations

Thanks, Andy. Operator, we are ready to take questions.

Operator, Operator

Your first question comes from the line of Michael Perito with KBW. Please proceed with your question.

Michael Perito, Analyst

Hey, good afternoon, guys. I'm glad to hear it seems like everyone's doing well under the circumstances. Thanks for taking my questions. I want to start on just the 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 was just curious if you could maybe give us a little bit more 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 application to request you've received thus far?

Greg Garrabrants, President and CEO

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 auto and unsecured lending book, and those are current numbers. With respect to the real estate loan portfolio on the commercial real estate side, with respect to the transactions we work with sponsors on, essentially there's been no requests that are simply a deferral oriented in our requests. With respect to things, to the extent that someone wants to in the 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 really substantive there either. On the single and multifamily side, there are requests in the agency book that we're 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, never 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, 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.

Michael Perito, Analyst

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

Greg Garrabrants, President and CEO

It's definitely challenging to determine the situation right now. Initially, we allowed some individuals to skip one payment, but many thought they could defer six months without consequences, which was not the case, leading to prompt payments. It's hard to gauge how much of this behavior is opportunistic and how much is due to legitimate business disruptions. The concept is that deferring someone with little chance of recovery isn't useful, while deferring someone who is temporarily struggling makes more sense. Each asset class has unique characteristics, which may be affected by governmental regulations concerning lenders. For instance, if a multifamily borrower requests extensive long-term deferrals, many would still be interested in purchasing those properties despite default interest rates, suggesting that a different strategy might be needed, like securing a second lien. Overall, we're still in the early stages, with recent developments since March 31 leading to a fair amount of requests. We're currently figuring out how to assess these cases effectively.

Michael Perito, Analyst

Got it. And then on the PPP, I think it was $85 million that you guys approved, and you can get another $30 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 oscillating around that 3% mark. Do you think that's a reasonable assumption for you guys to evolve at this point from what you've seen?

Greg Garrabrants, President and CEO

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

Michael Perito, Analyst

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

Greg Garrabrants, President and CEO

Not at this time.

Michael Perito, Analyst

Okay. And then just lastly, can you remind us, to the extent that the COVID-19 pandemic rather has a material impact on small businesses? Can you just remind us a little bit about the 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 of Axos Financial?

Greg Garrabrants, President and CEO

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 a 40% of U.S. bankruptcy trustees roughly give or take a couple of percent 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 timeframe 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, and 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 activity there 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. And we have to remember this is a 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.

Michael Perito, Analyst

Yes. So, 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 counter to what traditional banking businesses how they would perform?

Greg Garrabrants, President and CEO

Yes, that's correct. In 2010, the deposits were twice what they are now. I would expect that trend to change. Sometimes a major bankruptcy can create significant opportunities. This is definitely a countercyclical business. I would be surprised if it didn't expand, and we are preparing for the increased activity that we anticipate. It's hard to imagine a scenario where Chapter 7 bankruptcies don't rise due to the lockdowns and other measures that have been implemented.

Operator, Operator

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

Steve Moss, Analyst

Good afternoon. I wanted to start with the disruption in the mortgage market and in particular, just on the non-QM and jumbo products that you guys offer. Just wondering, even with tightening standards, Greg, you mentioned that you're still seeing demand. What is that demand these days? And how are you thinking about that?

Greg Garrabrants, President and CEO

Sure. So, as you know, we previously had a robust growth business in jumbo mortgages. And over the last call it six quarters or almost two years that has had disappointing growth as a result of the market sort of running away from us and where we felt was prudent. 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 that competition. We lost a lot of business as a result of it. That business is now 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. In this case, holding six months of reserves and 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 tried 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's 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 we may be heading into recognizing that we always plan for home values to go down by a lot. And we're still going to make sure that we're doing loans that are safe and secure.

Steve Moss, Analyst

Okay, that's hopeful. 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 six months?

Andrew Micheletti, CFO

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 than 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 the 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 net interest margin. 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.

Operator, Operator

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

Andrew Liesch, Analyst

Just one follow-up question from me. You covered the rest of them. On expenses, I know there have been a lot of business development plans you guys have had through spending initiatives. What's the outlook for that in this environment? Are there any plans to slow them? And then just 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?

Andrew Micheletti, CFO

Sure. I think our increase this quarter, compared to the previous quarter, came from a couple of factors. There's $1.5 million in other general and administrative costs that we can eliminate for next quarter since that is solely related to the tax season. In terms of personnel costs, about half of the $2.3 million increase was due to FICA, which is a new expense for employees that employers pay. This accounts for about half of the increase. While that will persist, approximately $500,000 was a one-time cost associated with 401(k). Therefore, you can expect salary costs to remain similar or slightly lower for the next quarter, and everything else seems fairly stable. Currently, we are not planning any significant projects, but we are always preparing for changes in the future. Overall, the $69 million figure you are referencing is fairly accurate.

Greg Garrabrants, President and CEO

Yes. One clarification, as I said. I said the lender finance those costs on book had around 70%, it's actually 63%. 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, one or two 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 have developed over time. And those tools were really incredibly important in our ability to very seamlessly adapt to with the majority of people working from home and all these other things. So, there are a lot of really good technology that we have put in. And now, I think a lot of its really time to benefit from that and to try to start reaping some of the fruits of that hard labor that's happened and investments that have happened over the last couple of years.

Operator, Operator

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

David Chiaverini, Analyst

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

Greg Garrabrants, President and CEO

So, with respect to their 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 disclose that, they were around. Was it 7%?

Andrew Micheletti, CFO

Yes, it was 7%.

Greg Garrabrants, President and CEO

We’re currently seeing a 4% delay in payments compared to others who have a 7% delay. Generally, the others tend to perform slightly worse than us on credit. Although we seem to be in a better position pacing-wise, it doesn't ensure we won't face challenges. We have accounted for some loan losses in our projections. Analyzing the data reveals that slower payments are occurring, but the reasons for this remain uncertain. In terms of guarantees, we are protected up to a certain limit, ensuring we don't lose more than our fees. However, we expect to collect beyond that limit. Presently, requests for payment deferrals remain low. We've reviewed our loan portfolio and the employment status of borrowers, particularly in industries vulnerable to shutdowns, like restaurants. The situation seems manageable. However, even within the medical field, some professionals have been laid off due to a lack of patients, like radiologists in San Diego. These are the types of individuals we've lent to, as our underwriters assess employment stability. While some may require deferrals, we don't anticipate many defaults from those with strong credit histories. Regarding single and multifamily housing, the risk is minimal, though could relate to government actions affecting rent collection. Some tenants may find it more beneficial to rely on unemployment benefits rather than their jobs. If neighbors begin to delay payments due to eviction moratoriums, this can create a troubling downstream effect. Additionally, any state-level attempts to hinder foreclosures could extend our loan holding periods. Despite having favorable loan-to-value ratios in our commercial lending sector, banks typically shy away from prolonged holding due to associated complexities. Nevertheless, the potential to sell these notes exists should such situations arise. Specifically, in commercial real estate, most sponsors are deeply invested in their loans, facing dire consequences if they neglect property management. Without significant drops in property values, it's unlikely they will risk these investments. In scenarios where property values fall dramatically, we might see some losses, but not extensively. The market remains active, with funds seeking to acquire distressed notes. We’re closely monitoring possible risks, as previous crises demonstrated vulnerabilities like property damage from maintenance issues. We're vigilant for fraud, especially in agency mortgages and warehouse lending, which is thriving. A rational approach from governments could prevent irrational actions from occurring over time, and it remains to be seen if that rationality will be sustained.

David Chiaverini, Analyst

That's very helpful. Shifting gears, I wanted to ask about the next milestone for the universal digital bank, which was to allow a single integrated enrollment process. Given everything that's happening with COVID and remote work, has the timeline for building out that next phase been affected at all? Is there any disruption there?

Greg Garrabrants, President and CEO

In general, there hasn't been any significant impact. The work from home aspect has not affected our operations. To be direct, I expect everyone to work harder right now, not less. Our team is making efforts to support borrowers, adapt to changes, and uphold our vision of becoming a digital-first bank that leads in technology. I believe our focus hasn't shifted. Regarding your question about universal enrollment, it’s one of several goals for the Universal Digital Bank (UDB). While I understand what you mean, we are primarily concentrating on universal integration and servicing. This means we want to ensure that all interactions that customers have with us occur through our portal. We aim to create a self-service environment that enhances the customer experience so they do not have to rely on a call center, even though it's available, and to streamline that process. Additionally, we want to integrate UDB for small businesses. Currently, we have a platform for small businesses with multiple owners that does not utilize UDB, and that experience is lacking. We have a comprehensive roadmap, but we've postponed a few long-term goals to focus on enhancing the SBA PPP platform and addressing unique needs of the current environment, such as improving communication for customer requests through UDB and enabling document uploads. Overall, we still expect to launch the universal digital bank experience for our clearing clients by October. This will allow us to reach over 100,000 high-net-worth customers for whom we plan to offer banking products, and our clearing clients are enthusiastic about this development. We are also testing online trading capabilities with test accounts and will continue developing this area. Our plan is comprehensive and promising, although it's somewhat overshadowed by current events. It should bring long-term efficiency and revenue benefits in the near future.

Operator, Operator

The next question comes from the line of Mitch Hemmelgarn with Shaker Investment. Please proceed with your question.

Edward Hemmelgarn, Analyst

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

Andrew Micheletti, CFO

Yes. The process works in two stages. On the day you adopt the new rules, if you increase your allowance, you apply a tax rate to that increase and charge it directly to stockholders' equity according to GAAP. This means it doesn't go through the income statement but goes straight into equity. After this initial entry, your provisions will follow the usual process where they run through the income statement as they do currently. However, the significant change is that for regulatory capital, recent rule adjustments allow the entire day one charge to be added back to your regulatory capital for two years, after which it will be phased out over three additional years. Essentially, there is a five-year transition period before it has a real effect on your regulatory capital ratios.

Edward Hemmelgarn, Analyst

Okay, great. And Greg, one more question. 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 jumbo mortgage area. Any other areas that you think there might be some opportunities?

Greg Garrabrants, President and CEO

Yes. I believe many real estate lenders have moved towards high advance rates with gestation lines, leaving some banks in difficult positions that we managed to avoid. Those loans, which often included 12-month gestation facilities with securitization exits, are no longer available. It's surprising what has been placed on repo facilities. You wouldn't expect long-term commercial real estate loans with incremental funding structures to be included in those, yet it happened. We have retained the same team and playbook and know how to navigate through this. During the crisis, we capitalized on well-structured and conservative loan options. Currently, there seems to be an equity gap in the market, which funds can help address. Previously, our advance rates were around $0.45 on the dollar, and interest in that has resurfaced, which is promising. However, if anyone received $0.85 for a while, transitioning back will take time and can be challenging. Opportunities exist in the market, but we cannot always tackle them individually. Fortunately, we have partners who can assist more broadly. Nonetheless, there are specific situations where equity is necessary. I feel optimistic about this. It's still early, but there have been many constructive discussions, and I anticipate positive outcomes. It seems that some competition, which previously had loan books of $1 billion in certain categories that dropped to zero, will create new opportunities in those loan categories again.

Operator, Operator

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

David Feaster, Analyst

Good afternoon, everybody. I just wanted to start with the securities business. Volatility like this often creates pretty significant disruption. And I was just curious whether you've been able to add new broker-dealers or investment advisors given all the disruption?

Greg Garrabrants, President and CEO

Yes, we have a pipeline that I would like to see grow larger, and I believe it will. For instance, our business is based in Omaha, which makes it easier to attract talent now that the merger is approaching. This has allowed us to bring in talented individuals. We're having meaningful conversations with registered investment advisors who are concerned about their current situations. Many of them are reassessing their choices after moving from Schwab to TD and are now reconsidering. Additionally, individuals from recent acquisitions at E-Trade are seeking to find a firm where they feel valued and can receive personal attention rather than just interacting with a call center. This presents significant opportunities for us. Regarding our clearing operations, we are focused on integrating our technology into our processes to handle increased capacity. Our team has worked diligently to navigate liquidity issues without incurring losses. Although other firms have faced difficulties, we managed to address a specific issue last year. Despite the challenges, our team excelled this quarter, and we are continuing to enhance our operational efficiency. Progress is being made, and the culture is improving with a stronger emphasis on execution. Looking at the clearing side, we have a solid platform and ongoing interest. Building credibility with larger firms presents a challenge, as persuading them to switch is tough. On the RIA custody front, we are collaborating with committed individuals who are bringing us assets and helping us refine our onboarding process and platform. We are implementing new software, and while it will take time to fully develop, I believe that in three to five years, we will be proud of what we've created, providing a universal platform and excellent technology and service to our clients. As for our robo-advisory and managed portfolio services, I appreciate the no-fee model we've had, which has helped with client acquisition. I've emphasized to the team that it’s time to transition to a profitable model. They have a solid portfolio and deliver excellent service, so they will start generating revenue soon, especially because the clearing company is profitable. The segment's net loss stems from the managed portfolio side, which we anticipate will change. While we initially aimed for growth with the no-fee structure, we can continue to expand by adding value instead of solely competing on cost. We don’t need to be the lowest-cost provider to succeed.

David Feaster, Analyst

Got it. And then just maybe 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 your thoughts on this segment what you're hearing from your clients? And just your thoughts on that segment more broadly near-term.

Greg Garrabrants, President and CEO

Yes. I think that the nature of that segment 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 there is 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. And 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 their 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’ll be interesting to see how it goes. I think there’ll be selected projects to get off the ground. I think Junior Capital is working through what they want to do. I think there are a lot of discussions and a lot 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. 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.

David Feaster, Analyst

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 a disruption in being able to pick up a complementary business that you've been eyeing for a while?

Greg Garrabrants, President and CEO

Yes. Regarding dividends, I've addressed that. As for share repurchases, we've done a little but have been cautious with our capital. I won't impose strict guidelines or make definitive statements about it. However, there are many opportunities in the market, and we also face uncertainties about the future, so we have to consider all these factors. We want to ensure we have capital for growth, which is wise, and we aim to support our clients where there are promising opportunities. I believe there will be some strong yielding prospects with good credit profiles. It’s important for us to be available for those as we remain prudent about our capital. Concerning M&A, that hinges on what we can obtain from the platform. Unfortunately, many fintech companies are either managing their existing assets and debt levels or may need to pause and reassess their direction. There could be unique opportunities similar to the Robo advisory platform we acquired, which came with an asset base that poses no negative credit risk. We've worked diligently to make thoughtful decisions about our assets, ensuring strong credit evaluations for each one. Any M&A activity would have to be accompanied by a robust credit assessment, especially in the current environment.

Michael Perito, Analyst

Okay. That's helpful. Thank you.

Greg Garrabrants, President and CEO

Thank you.

Johnny Lai, Vice President of Corporate Development and Investor Relations

Alright, I guess that's it. So thank you very much. We'll talk to you next quarter.

Operator, Operator

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