Axos Financial Inc (AX) 2010 Q3 法說會逐字稿

Good afternoon and welcome to the BofI Holdings conference call and for the third quarter ended March 31, 2010.

With us today are BofI's CEO, Greg Garrabrants, and CFO, Andrew Micheletti. Today's call will have the following format. Mr. Garrabrants will provide an overview of the highlights for the quarter. He will then turn over the call to Mr. Micheletti who will provide a more detailed discussion of BofI's financial results. Finally, Mr. Garrabrants will make some closing remarks and open the call up to any questions you may have.

Before I turn the call over to them please remember that in this called management's remarks contain forward-looking statements which are subject to risks and uncertainties and that management may make additional forward-looking statements in response to your questions. Therefore the Company claims the protection of the safe harbor for forward-looking statements that is contained in the Private Securities Litigation Reform Act of 1995.

These statements are subject to risks and uncertainties and may cause actual results to differ materially from those discussed today, including risks and uncertainties related to the economic environment, particularly in the market areas in which BofI operates; competitive products and pricing; fiscal and monetary policies of the US government; changes in government regulations affecting financial institutions including regulatory fees and capital requirements; changes in prevailing interest rates; risks associated with the conduct of the Company's business over the Internet; credit risk management; asset liability management; the financial and securities markets; and the availability of and costs associated with sources of liquidity.

Examples of forward-looking statements include statements related to BofI's anticipated or projected asset size, net interest income, net interest margin, projections of future delinquencies and impairment charges, loan originations, deposits and performance ratios like efficiency and return on equity. We would like to encourage all of our listeners to review a more detailed discussion of the risks and uncertainties related to these forward-looking statements that is contained in the Company's filings with the Securities and Exchange Commission.

Any forward-looking statement as to the Company's future financial performance represents management's estimates as of April 28, 2010. BofI assumes no obligation to update these forward-looking statements in the future due to changing market conditions or otherwise.

With those cautionary statements it is my pleasure to turn the call over to BofI's CEO, Gregory Garrabrants.

Thank you. I would like to welcome everyone to BofI Holdings' third-quarter conference call and I thank you for your interest in Bank of Internet USA.

I would like to start this afternoon by reviewing our third-quarter performance. BofI reported record earnings of $7.175 million for its third quarter ended March 31, 2010, compared to earnings of $2.594 million for the three months ended March 31, 2009.

Earnings attributable to the Company's common stockholders were $7.002 million or $0.77 per diluted share for the current quarter compared to earnings of $2.421 million or $0.29 per diluted share for the quarter ended March 31, 2009.

For the nine months ended March 31, 2010, net income totaled $16.431 million compared to $3.538 million for the nine months ended March 31, 2009. Diluted earnings per share were $1.79 compared to $0.37 for the nine months ended March 31, 2010 and 2009, respectively.

Net income for the third quarter ended March 31, 2010, increased 176.6% compared to net income for the third quarter ended March 31, 2009. Net income this quarter included an after-tax increase of $2.827 million for realized gains on sales of securities net of unrealized losses.

Excluding the net gain, net income would have been $4.348 million for the quarter ended March 31, 2010, an increase of 55.2% compared to adjusted net income for the third quarter of last year excluding unrealized losses on securities of $207,000 after tax.

Net income for the nine months ended March 31, 2010, increased $12.893 million compared to the nine months ended March 31, 2009. Earnings for the nine months ended March 31, 2009, were reduced by $4.710 million after-tax loss on the sale of Fannie Mae preferred stock after Fannie Mae was placed in government conservatorship in September of 2008.

The increase in quarterly and year-to-date net income was primarily due to higher net interest income resulting from the growth in the Bank's average earning assets and increases in the Company's net interest margin. While increasing the profitability of the Bank we have maintained a strong focus on credit quality. Our non-performing assets as a percentage of total assets was 97 basis points at March 31, 2010.

During the third quarter we sold $3.3 million of our foreclosed and repossessed property creating a benefit of $3 million which helped minimize the impact of our non-performing loans. The Bank's total non-performing loans increased by $4.2 million during the quarter due to the addition of two delinquent multifamily loans, one in Houston for $2.1 million and one in Knoxville, Tennessee, for $0.9 million.

Also included in the non-performing loans this quarter were 11 RV loans for an aggregate of $1 million which were not delinquent but considered troubled debt restructurings and temporarily placed on non-accrual. For the two multifamily non-performing loans the Bank is currently working with the borrowers and does not anticipate foreclosing on either of these properties.

The $1 million in RV loans are considered trouble debt restructuring will be eligible to be removed from the non-performing category if the borrowers continue to make timely payments over the next two quarters.

The Bank continues to build its allowance for loan losses which has grown 41.8% since March 31, 2009. This quarter we purchased $100.9 million of single-family mortgages at low LTVs. For our bank low LTV means a loan principal balance which is less than 60% of the fair value of the property.

For example, our most recent transaction of $70 million was selected from a pool of $1.2 billion of seasoned loans, many as old as 10 years old. The end result of the purchase was that we purchased loans with a weighted average LTV of about 48%.

Our loss experienced with low LTV single-family loans is excellent and this experience has reduced our general loan-loss reserve allowance. Our low loan-to-value pool purchases this quarter changed the loan-to-value allowance requirements at March 31, 2010, reducing the allowance as a percentage of total loan balance when compared to the last quarter ended December 31, 2009.

Other highlights of the quarter include total assets reached $1.401 billion at March 31, 2010, up 12.2% compared to the third quarter last year. Total deposits reached $970 million at March 31, 2010, up 39.8% compared to the third quarter of last year. Our efficiency ratio improved to 25.73% this quarter compared to 36.4% for the third quarter of 2009.

Our bank's capital position at March 31, 2010, is strong with 68.5% more Tier 1 capital than the amount required to be considered well-capitalized under government regulations.

Finishing the third-quarter financial highlights I would like to move on to some of our more recent business accomplishments and what they mean for our future. On April 5, 2010, with the assistance of B. Riley & Co. BofI raised a net $15.2 million from the public issuance of its common stock pricing the transaction at a discount to market value of less than 6%. Our offerings was oversubscribed sufficiently to allow us to price the deal tighter and upsize the deal a bit from the initial projected offering size.

In addition to this strong execution price we were able to increase our float and attract additional large institutional ownership.

The Bank will use the proceeds of the offering to continue the growth of its wholesale banking group and for continued multifamily and jumbo single-family lending. Although we did not raise capital for the purpose of any specific FDIC transaction, we believe that opportunities will exist if we find the right institution to acquire it in an assisted deal.

As an example of how this new capital could provide growth to our business, if we assume a static core capital ratio of 7.5% the proceeds of the offering will allow the bank to grow assets immediately by more than $350 million. However, when adding earnings consistent with this quarter's earnings the Bank should be able to grow assets by almost $550 million over the next 12 months without returning to the capital markets. The Bank will use the proceeds of the offering to grow our wholesale banking group and continue our origination efforts.

As I mentioned in my earlier discussion of the third quarter, the Bank purchased $100.9 million in single-family loans of which $68.9 million was purchased in the last several days of the quarter. The net interest income in the third quarter did not benefit from this purchase due to the limited number of days outstanding and due to the fact that these loan purchases were funded by a buildup of deposits with the proceeds temporarily invested in low-yielding Fed funds. Net interest income in the fourth quarter will earn the full benefit of our third-quarter pool purchases.

We have been highly sensitive to interest rate risk as we select assets. For example, of the approximately $100 million of loans added over the last two quarters more than 58% were loans that adjusted their interest rate in less than 12 months. Our transaction pipeline on the wholesale side continues to be robust and we expect continued asset growth from that franchise.

Turning now to our origination group to provide you an update there. As many of you who follow us know, during the depths of the credit crisis it was clear to us that allocation of capital to the wholesale banking operation was preferable to allocation of capital to the origination groups. Although this continues to be true, the balance continues to get even -- closer to even and this as a result the Bank has an increasing emphasis on growth of our origination businesses.

Our multifamily group continues to grow nicely with a current committed pipeline of about $17 million of loans. The loans are of very high quality with an average LTV of 55% and an average debt service coverage ratio of 1.3.

We have only recently turned on the marketing horsepower in the group and recently appeared on the cover of the Scotsman's Guide, one of the most widely recognized resources for the commercial real estate lending profession. Subsequent to the release of the magazine the Bank had approximately 160 calls from loan prospects in the few days after the release of the magazine.

Since relaunching the origination group in mid-January the Bank has received over $200 million in multifamily loan requests. We completed our team on the jumbo mortgage side by bringing on board the head of underwriting from Thornburgh's wholesale lending group -- Thornburg's former head of wholesale underwriting for their wholesale lending group. And we are now in the process of qualifying brokers for this group.

I expect it to be several quarters before this group has a meaningful impact but we believe the niche vacated by Thornburgh is attractive and we now have a team in place to pursue that opportunity.

We have also made progress on building our management team and added several top-quality executives this quarter. First, we added a new Head of Deposit Operations. She is a seasoned banking executive who ran customer service and call center operations for National Australia Bank, one of the big four banks in Australia, and also has experience running large call center operations for large US-based institutions.

We also added a sales manager in the single-family mortgage origination group to prepare for future growth at that business. He ran the purchase money call center operations for Bank of America and he is tasked with doubling our sales force when we actually have a place for the sales folks to sit.

Unfortunately, we have run out of space in our current building and this has slowed the expansion of that group. But we have an additional square footage, 5,000 square feet of space, that we are going to be taking. We will be getting into that in mid-June which will allow us to continue our growth in that area.

As many of you have seen in our recent press release, Mr. Evans, the Bank's Chief Operating Officer, has received a fantastic opportunity to become the CEO of another institution. I know that I speak for all of us at the Bank when I say that we will miss Gary and we have all enjoyed working with him. I have an offer out to an executive who will be replacing Mr. Evans as Chief Operating Officer and I expect that he will be accepting that offer.

We have made investments in our team for growth. Although there is some investments that will be further required, we have also yet to see the potential and the economic benefit from the current investments we have made. And we will continue to see that as we grow in the future.

So we remain excited about our prospects and look forward to continuing to execute on our strategy. And now I will turn the call over to Andy who will provide additional detail on our financial results.

Thanks, Greg. First I want to note that in addition to our press release our Form 10-Q was filed today and is available online through Edgar or through our website at BofIHolding.com.

First, I will discuss our quarterly results on a year-over-year basis as well as this quarter ended March 31, 2010, versus our last quarter ended December 31, 2009. For the quarter ended March 31, 2010, net income totaled $7.175 million, up 176.6% from the third quarter last year and up 29.3% from the last quarter ended December 31, 2009.

Diluted earnings per share were $0.77 this quarter, an the increase of 165.5% compared to the $0.29 in diluted earnings per share for the third quarter last year and up 26.2% compared to the $0.61 per share for last quarter. Excluding realized gains and unrealized losses on securities, core net income for this quarter would have been $4.348 million, up slightly from last quarter and up 55% year-over-year.

Net interest income increased $4.134 million during the third quarter of fiscal 2010 compared with the third quarter of 2009. And it decreased slightly compared to the second quarter -- last quarter, December 31, 2009. The increase in net interest income year-over-year was due to both a higher net interest margin resulting primarily from decreases in deposit rates and increases in investment security rates due to a higher level of earning assets.

This quarter the net interest margin was 381 basis points, 3.81%, up 99 basis points over the third quarter in fiscal 2009 and down 21 basis points compared to last quarter. As Greg mentioned, the timing of the large single-family pool purchase at the end of the third quarter had a negative impact on our third-quarter net interest margin.

Provisions for loan losses were $1.250 million this quarter versus $1.2 million in the third quarter of fiscal 2009 and $1.6 million for last quarter. The $350,000 decrease in our loan loss provision this quarter compared to the provision last quarter was primarily due to decreased write-offs and repossessions of recreational vehicles. RV write-offs declined $354,000 from $813,000 last quarter to $459,000 this quarter.

Non-interest income was $5.675 million this quarter primarily due to realize gains on the sale of mortgage-backed securities of $5.947 million and mortgage banking income of $662,000 reduced by unrealized losses from impairments and fair value write-downs of $1.089 million. Non-interest income increased $5.375 million year-over-year and increased by $2.924 million compared to last quarter reflecting higher realized gains on this quarter.

Non-interest expense or operating costs for the third quarter of fiscal 2010 was $4.705 million, 47% higher than $3.190 million in operating costs for the quarter ended March 31, 2009, and higher than the $4.492 million in operating costs for last quarter.

The increases in operating expenses, both year-over-year and compared to last quarter, were primarily the result of increased REO expense and increased FDIC premiums as well as increased salary and benefits related to staffing that has increased to 76 full-time employees, up from 51 full-time employees last year and 64 full-time employees at the end of last quarter.

Our efficiency ratio was 25.7% this quarter compared to 36.4% for the third quarter of 2009 and compared to 28.6% last quarter. The efficiency ratio is calculated by dividing our operating expenses by the sum of our net interest income and our non-interest income. This quarter improved due to the higher net interest income compared to the third quarter of fiscal 2009 and compared to last quarter.

Shifting to the balance sheet, the Company's total assets increased $98.9 million or 7.6% to $1.401 billion as of March 31, 2010, up from $1.302 billion at June 30, 2009. The increase in total assets was primarily due to purchases and originations of additional loans.

Net principal paydowns were $134 million reducing that amount and also partially offset by a decrease in investment securities of $36.9 million due to both principal paydowns and sales. Total liabilities increased $79.4 million primarily due to an increase of deposits of $321 million partially offset by a decrease of $160 million in borrowings at the Federal Reserve and $81 million in borrowings at the Federal Home Loan Bank.

At March 31, 2010, our Tier 1 core capital ratio for the Bank was 8.43%, up 22% from the 6.89% ratio at March 31, 2009.

With that summary I will turn the call back to Greg.

Thanks, Andy. And thank you all for taking the time to listen to our remarks. That concludes what we have prepared and we will now move to the question-and-answer session.

Operator, could you open the call for questions?

(Operator Instructions) Mitchell Saks, Grand Slam.

Congratulations on a really nice quarter. How do I think about the growth of assets over the next few quarters from the capital and the earnings you have? You have talked about possibly growing assets about a little bit over $0.5 billion.

How would I look to think about that over the next few quarters? Will it be a smooth growth or will it be more lumpy?

Well, the wholesale side by its nature tends to be lumpy. We have some very attractive prospects there that would allow for some fairly decent, relatively quick growth. But those transactions also tend to be ones that you have got to fully diligence them and get through them before you know whether they are going to occur.

So it's difficult to say but I think we have got enough going on that I am reasonably confident that you will have some of that asset growth occur relatively quickly.

On the origination side, particularly on the multifamily side and the jumbo side, those are going to continue to escalate and get larger as a proportion of asset growth over the next number of quarters. And so we are really seeing the acceleration, particularly on the multifamily side now.

Whenever you are coming back into the market your first -- you are sorting through a lot of stuff where people are basically sending you a lot of things that really don't work. So we have had an incredible volume of leads and we actually have quite a few LOIs out above and beyond the roughly $20 million that we have in the pipe right now.

And so I think that you are going to see -- so in summary, I think what you are going to see is you are going to see some lumpy acquisitions based on some wholesale side asset growth. You will see more steady growth on the origination side, but we don't expect nor do we think it's prudent to deploy the money quickly unless we really are certain that we are doing it in a prudent manner.

So it doesn't take a lot to blow up the extra earnings by quickly deploying capital if you do it poorly. So we always -- I walked away from a deal that we had fully diligenced last week because when we got through it we just didn't end up feeling comfortable with it. So you do have those sort of situations happen as well and that will be there.

But I am confident that we have the engines for asset growth to deploy this capital in a careful and profitable way.

On the mortgage banking side when do you expect we would start to see more growth in that model?

You know, the whole model right now -- so the way we started it out was we started it out in the time frame where I would say there was still -- it was sort of coming to the end of the rapid single-family home price decline. And the model started out as simply a call center-based model.

One of the impediments to our growth, and I am almost embarrassed to say this, is the fact that literally we have shrunk our cubes, cut our offices in half, and we don't have any place to put people anymore. And so we haven't been able to hire folks.

So we have a pipeline of loan officers and there is only so many transactions loan officers can handle. Our loan officers are handling -- we only have six of them and they are handling three, 3.5 pipe on conforming. That is a pretty good performance for a loan officer.

So on that side on June 15 we are taking over some space upstairs. They are charged with immediately doubling the sales force. I see no reason based on the lead volume that we are generating through all our Internet sources that we shouldn't be able to have our volume go up commensurate with that.

There is clearly an overhead associated with running that group that can be leveraged there, so that is good. So that is just on the direct-to-consumer side, that is just an issue of getting more butts in seats, doing calls and taking applications and dealing with getting the borrowers over the finish line.

But there is -- the other component that we have opened recently I think has a real potential for scalability and that is a channel that allows -- well, basically the correspondent channel. We have several large organizations that you would hear about.

I haven't gotten permission to use their name -- you would know -- I haven't got permission to use their name yet so I am not going to do it, but that we are working on the correspondent side that are interested in flowing loans to us. We would obviously underwrite those loans according to our guidelines and make sure that they were good from a credit perspective.

But that is something that we have recently launched. That has come out in the last several months. We are viewing their packages now related to their credit qualities and their ability to provide a nice equity backstop to reps and [warrants]. So that group will also start to grow and I think that will be significant.

Then, finally, on the wholesale -- and you really asked about the gain on sales side, the wholesale bank, the wholesale mortgage side what we are focusing on on the jumbo side, we have really just got -- we hired the two top sales people from Thornburg Mortgage. They came on last month. We have the guy who used to run their Southern California region. We moved their head underwriter from Mexico just this last week so that group is really just starting.

But I always admired their business model. It was a good business model. It didn't implode because of credit, it imploded because of financing so I think it's a great opportunity for us there.

We do need to see growth there and I think we will. The bigger question for us is really that it is a people intensive business and so the scalability element related to just physical facilities and things like that has been a bit of a challenge for us. And so we are going to have to address how we deal with that on a broader scale.

So certainly doubling volume is nice but the question is what you do to get it to 10 and 15 times where you are. And that is something that we are going to be addressing in our strategic plan over the next several quarters.

Super. Thank you very much.

Joe Gladue, B. Riley & Co.

Wanted to escape few questions about net interest margin and I guess there seems to be a lot of moving parts now. You talked about the $100 million loan purchase and the full impact of that will be felt in the fourth quarter.

I am sorry if I missed it, but did you say what sort of yields you are getting on that package of loans?

The impact we figure quarterly will be about $500,000 net --.

But he asked what was the gross rate.

What was the gross rate on that. On that particular loan pool, which were all basically floating-rate loans, it was about a 5% pool. So it's 5% on a floating-rate basis which from a net interest margin perspective is quite attractive, obviously, given the ability to finance that with savings accounts and short-term debt at very low rates.

It was an incredibly attractive pool from the standpoint of it's seasoning. We were able to extract it from a much larger group of loans and the interest rate characteristics and credit characteristics were highly positive.

But I think, Joe, with regard to interest rate, we had a small decline in our net interest margin this quarter versus last quarter. One of the things that has been happening is we have been having so much success on our deposit side that we have been just getting -- carrying a decent bit of excess liquidity.

We did that as well throughout the entire quarter so we carried over $50 million of excess liquidity at probably an inverted spread of maybe almost 110, 120 basis points recognizing that we knew that that transaction was going to close and we wanted to fund it with deposit.

So at different times we have not done that and we have funded the sort of lumpy asset growth with FHLB advances and then sort of back filled with deposits. So I think one of the real positive abilities that we have, frankly, is we have the ability to adjust deposit rates down.

We are looking at that now and now we will definitely have the ability to -- well, that will increase, obviously, net interest margin. And then also we continue to have high interest rate CDs that were long term rolling off so that is another aspect of it.

And then a lot of the pool purchases have really been -- we have really focused on keeping interest rate risk lower and so that has been very good. But that does come at the expense of a little bit of yield as well. So I can't say that we are going to stay at 4% but I do think that we had a few headwinds, particularly related to the negative carry on that excess liquidity that made a difference in the spread this quarter.

And I guess just one -- if the proceeds from the offering they initially will be deployed in some short-term stuff that might have a drag on the yield initially?

Yes, I think that is right. I think the other thing that is going on right now is we have -- we have really tried to position ourselves for interest rate increases.

One of the other drags that we have is we have over $50 million of agency short-term debt that is earning only 25, 35 basis points, whatever pitiful amount. Over time we will be able to deploy that. Even simply deploying it in pass-throughs would raise the margin on that by 350 or 400 basis points, but the issue is that we have just been waiting to see how the shakeout happened in the agency market.

Now with what is happening with some of the sovereign debt risk in Europe we think the flight to quality that we have seen is also negatively impacting rates there. So we just haven't felt like it's the right time to deploy that, to redeploy those funds that are invested in short-term agency debt.

So I think there is several things that are out there like that that can result in immediate improvements, but obviously we are not looking at this quarter by quarter. We don't want to buy pass-throughs and then end up -- buy on-the-run pass-throughs and have them trading at 88 in the year either. So those are some of the considerations that we are working through.

In addition, Joe, we are still looking at some decent repricing of our CDs. As you look at what we have in one year we have about $237 million coming off at a weighted average rate of 2.6%. If you look at our offering rate right now that offering rate is about 1.53%, 1.54% so assuming your rates stay low here we will continue to reprice into a nice deposit cost decline.

One interesting thing that we have been able to do too is one of the areas where I think that there is a real mispricing in the market is in 10-year brokered CDs. So we have been able to accumulate just by being in the market about $50 million of 10-year brokered CD money at about around a 3.8% or lower all-in cost. And that is just incredibly good for obviously for 10-year money given if you look at where 10-year treasuries are trading.

So there is an interesting anomaly in the market. The great thing about those deposits is that they don't have convexity associated with prepayments when people get sick of having -- getting a lower yield in the market would be if interest rates spike. And the only thing that lets them get out of those commitments is they have to die.

Although that has happened, that is certainly not as big a risk as the convexity associated with normal CDs. So obviously all this is involved in interest rate risk management but it's not all about maximizing short-term spread. We have got to look at what is going to happen over the longer term too.

Okay. You sold some OREO properties during the quarter. Just wondering how much -- are you taking additional markdowns on those or were they pretty close to where you had them marked down?

Well, I think that we didn't take any additional markdown.

We took about $0.5 million on OTTI.

No, no, no. I am talking about the -- he is asking you what was the carrying value of REO prior to the sale and what was the sale. And I think it was --

It was relatively close for the majority of the properties. One of the things that you are looking at when you look at REO expense is that we actually time the REO expense write-downs well before the sales, because every quarter we look at valuations and we bring those things down.

So for example, of the $3 million in REO that we have on the books right now there is -- we have already written that down $1 million and that is already included in the REO expense. So by the time we get to the sales point we have really written it down to what our offering rate is well before that.

I don't think there was any real difference in the carrying value and when we sold it.

There may have been small adjustments but certainly not that -- the sales doesn't represent the REO expense.

On the REO and the non-performing asset side there is really a couple -- I think it's interesting to think about this in a couple of buckets. One thing that has really, frankly, frustrated us is that some of the single-family delinquencies that we have are serviced by Countrywide.

And I don't know if I have said this before, but to say that they are doing a poor job would be discrediting the word poor in a positive fashion. So they just are not doing a good job servicing those loans. We have marked them down to the point where we know that they can sell and we are just interested in moving them out.

They are just not really focused or able to handle the volume that they have. And so although our volume is not great, we are looking to pull servicing from them and once we do that we believe we are just going to be much more efficient about getting those assets off the books.

What I don't like about it is, frankly, we are aggressive about marking our assets that are non-performing down to what their fair value is and I just want them off. And so when we are able to get control of those assets we move them off.

We have about $1 million of assets is one loan in Coto de Caza that we have offers for; it's ready to go. We have several offers on other REO properties so I am fairly confident that we are seeing interest at the values that we are holding the assets at. So it's just a matter of time to get those moving.

If we can get servicing back from Countrywide then I think we are going to be able to really manage that better than they can, I have no doubt.

Okay. I will ask one more question and then let somebody else have a chance. I know it's a moving target but on the operating expense side you had -- went through some of the new hires and talked about leasing new office space. Just wondering if you can give us any idea of what to expect on the expense line?

I think a lot of the additional expense that we have had is -- you are seeing. I think, obviously, the additional expense from the space you haven't seen yet.

That is not it -- it's about $15,000 a month.

$15,000 a month. Obviously we have people coming and going. We are also -- frankly, personnel are a better deal than they were a couple of years ago too so there is that benefit as well.

I think we have done a lot of growth and we have yet to realize the full benefit of that growth, as I have said. So, look, I don't want to give you a hard number but I don't think that having another $15 million, $20 million of operating expenses -- $15,000 to $20,000 of operating expenses a month would be something that wouldn't surprise me.

But we are always continually looking at savings and looking at ways to make sure that we keep our expenses in line. It depends somewhat on our marketing expense because we have found that, particularly on the multi-family side, that we are getting very high payoffs from our marketing dollars so we may do some increasing there. But I think you could use that number and run with it.

You also want to run FDIC costs at 16 bps annually on deposits. We are seeing some decent deposit growth so that is a factor too.

The interesting thing is that, frankly, although we have added some people and things like that what has really swamped -- those expenses have been expenses related to recreational vehicle write-offs ore REO write-downs and things like that given how lean we run.

One interesting -- and this is a small data point, but we actually didn't have a single RV loan write-off in April. Now obviously it's too soon to call the bottom of that but we have had progressive declines in write-offs over the last several quarters there. And we are seeing signs of reasonable moderation of any kind of delinquencies there.

So whether or not -- it doesn't take much moderation there for it to completely offset any incremental expenses associated with bringing a person on here and there.

Okay, thank you.

Edward Hemmelgarn, Shaker Investments.

Just a couple of questions. A little bit more of a follow-up on the investment securities. Your average interest earned on that -- let me see if I can find the number again -- fell off quite a little bit. I think it dropped from like the yield from 7.41% in the December quarter to 6.55%.

Was that just because you were holding the $100 million you said you had invested in Fed funds or what was that? Was there anything else?

No, I think that there were a couple of factors in there. Some of it was, frankly, that the prior quarter was just unusually favorable. Why? We had a number of mortgage pools, private mortgage pools, securities, nonagency where we had a high level of early payoffs.

And when you buy at a discount and you have payoffs that discount flows right to the interest income causing our rate to be slightly higher in the prior quarter. So we didn't have that recurrence this quarter so that did impact our investment securities rate.

In addition, prepay speeds and other factors did slow down slightly which will impact the accretion of interest in some of our bond categories. And that is the key factor.

Okay. Greg and Andy, even though you took some -- it was about $5.5 million in net securities gains -- your actual, you actually had an increase in your total amount of unrealized and unrecognized gains relative to what it was in the prior quarter. Do you expect to continue to -- that that is going to be part of your income stream at least perhaps not to the same extent but certainly on an ongoing basis at least for a while?

Well, one thing to make very clear is that the securities gains that we took were gains on mezzanine pieces that were held on an unlevered basis at the holding company. And so they were owned -- they were the sort of junior piece to anything we owned at the bank and they were not rated. They were the unrated pieces of those securities.

So clearly we have the -- obviously when you have that kind of gain in the subordinate pieces you have some very favorable gain in the senior pieces. Those also obviously give us a good deal. So we are continually looking at the value of those securities and if we see the market rally to a point where we think it may be a good opportunity to sell we might do that.

I think we view that portfolio very favorably. It's a great credit quality, highly rated, low risk-based capital portfolio and so we will continue to look at it. I don't think that we feel like we need that to drive our earnings growth. Obviously, if you had the opportunity and you were in a situation where you needed capital, it's always nice to be able to have the ability to organically create it.

But we don't have any specific plans associated with earning -- managing earnings to be sort of higher than they were this quarter. In fact I think that would be a prediction that I wouldn't want to make. So it really depended -- frankly, we just found we felt like a very aggressive buyer who we thought had pricing that we just couldn't refuse.

Okay. What about in terms of this new individual that you are hiring to replace Gary? Can you talk a little bit about the person's background without obviously disclosing who it is?

No, I haven't reached an agreement with him yet, although I have reached preliminary, let's say, oral agreement. And so I don't -- I can't say that we will ultimately come to terms.

I have several individuals that I am actually talking to; I have my eye on one in particular. But I will certainly be happy to talk about that with you next quarter.

Okay. What about just in terms of generally what are the types of things you -- since you haven't hired the person yet what do you intend for that person to be doing? Can you give that?

I think that is a reasonable and good question. One of the things that I think, frankly, would be beneficial to the Bank is I view one of my strengths -- well, I think one of my clear strength is on the business development side. At times I find myself pulled into utilizing the skill sets that I learned as a consultant dealing with operational matters.

What I mean by that is in ensuring that we have, let's say, that we have or we are now having our files go through the mortgage bank paperlessly from an image perspective. Those are things that you need to do as table stakes to grow a mortgage business effectively, but I can't be spending my time doing that when I have too many other things to do.

And so it would be a typical COO sort of role which would be able to be a guy who could take a strategy and push it forward and manage the more day-to-day operative elements of the business and make sure that they followed rigorous procedures, made sure that they were constantly thinking about how they were doing work and improving it. That is obviously a big part of what an Internet bank is, right?

It's about making sure that you are continually looking at your processes. You have a set of as-is process diagrams and you are continually looking for a way to improve them. And so, just for example, we had -- it's amazing, you would think that there would be automated check hold processing systems that you could just buy and you wouldn't have to deal with looking at individual checks to determine holds.

But the problem is branches, people do that at the point of sale and so there is no need to have -- unlike us we get big bunches of checks at one time so we have something we are very close to rolling out that will allow all our checks to be automatic holds placed on them except for specific ones that will be looked at individually.

But that is just a labor-saving device. There is so many of those projects going on at the Bank. It's one of the reasons why we have been able to keep our efficiently ratios so low and at the same time grow like we have with the number of people that we have, which is a multiple fewer than an average bank of our size.

Those projects just need a shepherd. They need someone to work through. We have always been a little bit undermanaged and I like everybody to -- all of our managers are working managers but we need a few more folks to really drive the next avenue for growth.

I think what we are really facing now is there is so many opportunities. We have the ability to raise capital, we have demonstrated that. So with the ability to raise capital deposits and then a lot of opportunities for assets we have a runway that I am not sure we had if you look 18 months ago and said would you have wanted to raise capital at $7 a share. I think the answer is obviously no.

It's just a great opportunity for us right now to grow. And he is going to do what a COO should do.

Okay, good. What is that -- lastly, you had how many employees at the end of the quarter?

76 FTEs.

And how much additional space are you getting relatively?

About 5,000 so we basically think there is going to be room for about 44, 45 additional folks. So obviously we are not going to -- just because we have the space we are not looking to fill that up. But there is a lot of -- we need to have double our sales force on the single-family side.

We have very clear metrics about how profitable each person is. We have clear ability to tell who is cutting it, who is making the grade, who isn't. We have the infrastructure in place, you have already got secondary marketing there. You have got everything you need and so obviously mortgage banking has an element of scale to it and we need to continue to push that.

So there will be space there. There is also going to be space for -- I had -- it's funny just the opportunities you get. I have a guy who was a $70 million-a-year-plus multi-family producer, one of the guys that everybody knows in San Diego, and he called me out of the blue the other day.

I had been trying to get him to come over for a long time and he said I am ready. I want a cube and I want a desk and I am ready to go with you. Those are the types of things that we are seeing in this market now.

This guy is just a great performer in the San Diego multi-family market, has an incredible direct borrower base, and our ability to get folks like that now is here. So we just have to make sure we are ready for that opportunity.

Okay, thanks.

Will Waller, M3 Funds.

What were your 30- to 89-days delinquent at the end of the quarter?

Sure. 30 to 89, which -- two groups was three -- $4.4 million. That was a total of 52 loans.

Okay, great. And how much did you have in accruing troubled debt restructurings?

In troubled debt restructurings we have about four to five -- well, I am not going to call them troubled. We have restructured ones where we are not -- we don't have them -- we have them on accrual, they are not in non-performing. And that is around $5 million.

Okay, great. And then my last question relates to on the cash flow statement in the 10-Q there is a line item that is accretion of discounts on securities. Is it safe to assume that is just related to the nonagency or mostly related to the nonagency mortgage-backed securities that you guys bought at a discount to their par value in that line item, which I think was about $6 million in the most recent quarter? Is the accretion of those discounts back?

That is correct. It's that and then we have a couple of transactions that we did where we worked with funds and we basically created private pieces where we basically funded top pieces of assets that have similar structure there. But between those two the answer is yes.

Okay, so I just want to make sure I understand it right. So say you bought a nonagency mortgage-backed security and you paid at a $100 par value and during the downturn you guys bought them at a big discount and you were able to get them for $60 per $100. You paid $60 and it was $100 of par value so there is a $40 discount there.

Is it safe to then say you would take whatever the period of time was until that matured, say it's 10 years? You would then basically divide that $40 by 10 years and it would be $4 a year of accretion that would kind of come back into the income statement? Is that how it works?

One thing you have got to remember is that a lot of what we did is we actually created (inaudible) off these so you have got to think of a lot of it that way. So try to think of it a little bit differently and that is where some of the gains in these mezz pieces came.

So take your security, use your $50 -- let's say use $50 price, so you bought it at that. You basically went to the rating agency and said, all right, if we add an additional 40% of credit support on this what would you rate it? We will rate it AAA.

So then you have the 40% piece becomes a locked-out C piece. The A piece then -- if you have the A piece at the bank and that is getting the accretion, that maybe out of the $90 price. So you have got that, you are accreting that.

The other piece is the mezz piece. That mezzanine piece may have been sold in the case that we sold some of those. So it depends, obviously, on that structure.

So in some cases, yes, we are accreting where we have -- where we haven't (inaudible) them and we own the whole piece. Then what we do is we look at what the accretion should be. Any accretion that is not going to be received from par actually has to be taken as OTTI immediately. So it's kind of an interesting point, right?

You buy a security at $50, you are going to get $90 back. When you are accreting it it looks like you are going to get $100 back. If it appears to have deterioration to the point where you are not going to get $100 back, you have to take that write-down immediately and then you are accreting it to $90.

So that is where it's sort of interesting in the sense that you actually have to take the OTTI loss now even if your investment was incredibly good and you are going to get an incredibly return from it. So I think that you are generally right but there is a couple subtleties there that I think are useful for you when you are thinking about this.

Okay. So it looked like there was about $6 million that was related to that this quarter and that is a non-cash item, right? There is not actually cash changing hands when that takes place?

The payment of principal -- when you are getting back a full $1 of principal rather than $0.60, in some respects it is. (multiple speakers)

But that would be at the end of the period when the loan matures, right?

Yes.

Okay. So when I look at it it's included then at interest income about $6 million. So when I look at your total interest income of $21 million, roughly $6 million of that would be related to the accretion of the discounts on the securities. Is that pretty accurate?

Yes, that is a fair analysis in isolation looking at that, yes.

Okay. So that is all fine. Where there would be a problem is if the value of those securities ever became questionable. Whether or not you were going to get whatever the par value or whatever the end value that you are looking at is, then you would have to potentially go back and basically recalculate all of those. And you could potentially lose that accretion that you kind of calculated based on what the end value of the security is determined to be?

And you have to do that every quarter so in fact -- yes, you have to do that every quarter. So, yes, if your calculation of what that is would be wrong, you would have to go back and do it. But remember the interesting thing is, again, you actually have to take all of that now.

So you buy the security, you are accreting it and if you are not going to get 100 cents on the $1 back now it's not as if you can say that is great, I am just going to adjust my yield and I will take, instead of a 6% yield I will take a 5% yield. You have to take a complete write-down in that quarter and then you will get a 6% yield from that to the maturity of the security.

So you are correct but what you have to do is you got to take that write-down immediately. And so sometimes when you see small OTTI hits what you are seeing is the calculation that you are not getting the full discount back.

Okay, that makes perfect sense. So that is actually -- when I look at your pretax income of like $12.3 million, half of it is actually coming from that category then. So that could actually be a huge number if you ever had to go back and adjust it, correct?

Again, I think as Greg pointed out, what you would also look at is what OTTI write-downs we have taken which are not running through the interest margin, they are running through --

And I think you have got to step back and say, okay, right. So literally sure, I mean, if you -- I don't think that that is -- you can say that but I could also say that you are accruing a loan and it goes delinquent and therefore you don't get the money back that you thought you would on your loan.

I think you got to look at it this way, think about this again, we are literally selling locked out mezz B pieces that bear 100% of the risk of loss, don't get paid until 100 cents on the dollar of the top side piece gets paid, and selling those for incredible gains. So yes, sure, you can have -- these securities is AAA rated so it's not -- sure, yes, you could have that. That certainly is true.

You would also have loss on loans and other assets too that you thought were going to perform for you. So I don't really think that that is necessarily something that I view as so much different. And I think when you are looking at this sort of income I think we have a very good way of looking at it and assessing it.

Okay, great. Perfect, thanks a lot for clarifying that. That makes a lot more sense to me now.

Evan VanDerveer, Aegis Financial.

This is actually David Shapiro. Just a question, you guys touched on the expense ramp up that is necessary a little bit over at least the next year. If you get $500 million of extra assets where we are approaching $2 billion in total assets here for the Company, what exactly do you guys estimate the noninterest expense is going to be at that point? What would a normalized run rate look like?

You know, look, it depends somewhat on the composition, right? Because the single-family gain on sale mortgage group has to self-fund and it currently does, so it makes money on a direct basis. So because it simply turns over assets on to some sort of fixed capital, the size of that related to the way you are thinking about a spread business is not as relevant as long as it's making money and it's literally creating fee income off of that.

But it depends on what you are looking at to build for the future. So if I wanted to completely maximize short-term income I can go out and find $500 million of assets to buy. I don't have to add another body to do that.

Now if I am thinking about five years down the road then obviously having a robust single- and multi-family origination group is going to be pretty important. So I think we -- it depends on the success of those groups and how I see them going and on their assessment. But those groups, each unit will have to stand on its own. We could basically go out and get those assets with our existing staff. Frankly, with even with a reduced staff.

So it really depends on our ability to make the single-family mortgage group work on a stand-alone basis. The multi-family group obviously as mostly a portfolio group competes with the wholesale group for balance sheet. And so depending on -- that level of competition depends on what size it will end up being.

So I know that is not a great answer for you but to some respect the answer is it depends. It depends on the success of those groups but they are going to self-fund themselves. But as far as actually if you are looking and you are saying what could we do, we don't have to add anybody to basically go get $500 million more of assets.

Wouldn't if you kept the breakout, sort of the allocation breakout to the various investment categories and business lines similar and just the ratios were increased accordingly, just pro rata?

Look, I think that keeping an efficiency ratio in the low 30s is a very feasible way to look at the business. I think that -- as you got beyond $2 billion of assets I think you could even get it lower. But I think that that is a reasonable way to look at the business.

That is very helpful. Thank you, gentlemen.

That concludes today's question-and-answer session. I would like to turn the conference back over to you gentlemen for any additional or closing remarks.

Thank you for your questions, everyone, and look forward to talking with you next quarter.

Thanks.

That concludes today's conference. We thank you for your participation. You may now disconnect.