Axos Financial Inc (AX) 2014 Q2 法說會逐字稿

Good day, ladies and gentlemen. Thank you for standing by. Welcome to BofI Holding Inc.'s second-quarter fiscal 2014 earnings conference call. During today's presentation all parties will be in a listen-only mode. Following the presentation the call will be open for questions. (Operator Instructions). This conference is being recorded today, Wednesday, February 5, 2014.

I would like to turn the conference over to Johnny Lai from MZ Group.

Thank you, Farrah. Good afternoon, everyone. Joining us today for BofI Holding Inc.'s second-quarter financial results conference call are the Company's President and Chief Executive Officer, Greg Garrabrants, and its Executive Vice President and Chief Financial officer, Andy Micheletti. Greg and Andy will review and comment on financial and operating results for the second quarter and they will be available to answer questions after the prepared presentation.

Now before we begin, I would like to remind our listeners that on this call prepared remarks 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 protection from the Safe Harbor forward-looking statements that is contained in the Private Securities Litigation Reform Act of 1995.

Forward-looking statements related to the business of BofI Holding 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 in more detail 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 on the Company's investor relations website located at www.bofiholding.com. All the details of this call were provided on the conference call announcement and in the press release today.

At this time I would like to turn the call over to Mr. Greg Garrabrants, who will provide opening remarks. Greg, the floor is yours.

Thank you, Johnny. Good afternoon, everyone, and thank you for joining us. I'd like to welcome everyone to BofI Holdings conference call for the second quarter of fiscal 2014 ended December 31, 2013. I thank you for your interest in BofI Holdings and BofI Federal Bank.

BofI announced record net income for its second quarter ended December 31, 2013 of $13.140 million, up 34.7% when compared to the $9.768 million earned in the second quarter ended December 31, 2012 and up 8% when compared to the $12.182 million earned last quarter.

Earnings attributable to BofI's common stockholders were $13.077 million, or $0.91 per diluted share for the quarter ended December 31, 2013, compared to $0.70 per diluted share for the quarter ended December 31, 2012 and $0.85 per diluted share for the quarter ended September 30, 2013. Excluding the after-tax impact of net gains related to investment securities, core earnings for the second quarter ended December 31, 2013 increased $3.706 million, or 36.8% when compared to the prior fiscal year second quarter ended December 31, 2012.

Other highlights of the second quarter include total assets reached $3.568 billion at December 31, 2013, up $478 million compared to June 30, 2013 and up $694 million from the second quarter of fiscal 2013. Return on equity exceeded 17.4% for the second quarter.

Our net interest margin of 4.01% for the quarter ended December 31, 2013, a 15 basis point improvement over the quarter ended September 30, 2013 and a 20 basis point improvement over the quarter ended December 31, 2012. Total deposits reached $2.403 billion, up $550 million compared to September 30, 2013.

Our loan units had another great quarter with $788 million in gross loans originated in the fourth quarter. As a result, the bank achieved good quarterly loan growth growing loan balances by 14% over the linked quarter and at a 56% annualized rate. The excellent performance of our lending groups resulted in $361 million of net loan growth and a 112% increase over the growth in the prior quarter.

The $788 million of production consisted of $76 million of single-family agency eligible gain on sale production, $2 million of single-family non-agency eligible gain on sale production, $310 million of single-family jumbo portfolio production, $38 million of single-family jumbo gain on sale production, $31 million of multifamily nonagency gain on sale production, $92 million of multifamily portfolio production, and $238 million of C&I and special asset production.

Additionally, our warehouse lending division originated $382 million of single-family production in the second quarter. Taken together, the bank originated $735 million of loans in the single-family, multifamily, and C&I lending groups, an increase of $115 million over the linked quarter despite a drop off in single-family agency gain on sale production.

I am particularly pleased that our C&I lending businesses produced $186 million of production in the second quarter, an increase of 30% over the prior quarter.

Our lending pipelines as of January 31, 2014, are at record levels with $497 million of jumbo loans, $92 million of multifamily loans, and a C&I pipeline of $151 million of initial projected fundings on an estimated $270 million of line size solidifying the likelihood that the bank can continue to enjoy robust asset growth.

For this quarter, our noninterest income continues to show the diversity of our platform. This quarter our non-interest income excluding securities and mortgage prepayment penalties is $5.400 million consisting of $1.5 million of mortgage banking income from single family agency eligible mortgage loans, $300,000 of mortgage banking income from single-family jumbo mortgage loans, $1.4 million of mortgage banking income from the sale of multifamily mortgage loans, $1 million from the sale of structured settlement and other loans, $600,000 of prepaid currencies, and $600,000 of other fees.

We remain optimistic that we can grow our prepaid card fee income with new relationships and deeper penetration of existing relationships. We also believe that we can grow our deposit and other fee income outside of prepaid over the next year.

We continue to be pleased with the increase in the credit quality at the bank. Our nonperforming assets as a percentage of total assets are down from 79 basis points at the end of the December 2013 quarter to 49 basis points at the end of the quarter ended December 30, 2013.

We are often seeing gains on the sale of our REOs [versus] our portfolio marks on the relatively few nonperforming assets we have given the significant recovery in the housing market. Into the third quarter of our fiscal year, that trend appears to be continuing.

We continue to remain highly focused on credit quality at the bank and have not sacrificed credit quality to increase originations.

For the second quarter's fiscal originations, the average FICO for the single-family agency eligible production was 762 with an average loan-to-value ratio of 66%. The average FICO score for the single-family jumbo production was 718 with an average LTV of 61%. The average loan-to-value ratio of the originated multifamily loans was 57% and the depth service cover ratio was 1.56.

At December 31, 2013, the weighted average loan to value ratio of the entire portfolio of real estate loans was 55%.

We continue to make progress in growing and enhancing our deposit franchise. Our goal is to increase our share of transaction accounts and develop deeper customer relationships. We have made strong progress on changing the mix of our deposits to become more transaction focused.

From December 31, 2011 to December 31, 2013, we grew our checking account balances by 786%, our money market balances by 175%, while our certificate of deposit balances decreased by 57%. Transaction accounts now make up 71% of our deposit base, up from only 43% from a year ago.

Our business banking group had over $688 million of total deposits at the end of the quarter, up from $467 million in the prior quarter and at September 30, 2013. The business bank has over 2000 accounts with 74% of balances comprised of checking accounts. We continue to foresee robust growth in our business deposit balances.

Including the growth of both consumer and business checking, we have grown our checking account balances by over 105% this fiscal year. Although our efficiency ratio of 39.89% this quarter isn't quite where we think we can be when our model fully matures and our newer businesses and infrastructure investments reach scale, we feel very good about the cost management initiative we have undertaken over the past six months.

This was not an initiative to downsize our employee base in any respect and we continue to invest in our people, but one to ensure that we had the best in class management of our expenses. The impact of this initiative was evident in the reduction of our efficiency ratio from 41.37% to 39.89% this quarter. We have not accomplished this reduction by reducing our focus on scaling our operations. We continue to invest in the people and technology required for a scalable prudent growth.

We recently replaced our Chief Technology Officer with a Chief Information Officer and a Senior Operations leader both of whom have deep technology and process improvement experience at much larger institutions. We have also added senior leadership talent to our marketing team.

As we grow the bank, the expertise required to manage our operations continues to increase and we are pleased to be able to supplement our team with individuals who are better suited for the next phase of the bank's growth.

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

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 bofiholding.com.

Second, I will discuss our quarterly results on a year-over-year basis meaning fiscal 2014 versus fiscal 2013 as well as this quarter, the second quarter ended December 31, 2013, versus the first quarter ended September 30, 2013.

For the quarter ended December 31, 2013, net income totaled $13.154 million, up 34.7% from the second quarter of fiscal 2013. Diluted earnings were $0.91 per share this quarter, up $0.21 or 30% compared to the second quarter of fiscal 2013. Net income increased 8% compared to the first quarter ended September 30, 2013.

For the six months ended December 31, 2013, net income totaled $25.336 million, up 35.1% compared to the six months ended December 31, 2012. Diluted earnings were $1.77 per share for the six months ended December 31, 2013, up $0.40, or 29.2% compared to the six months ended December 31, 2012.

Excluding the after-tax impacts of gains and losses associated with our securities portfolio, core earnings were $13.786 million for the quarter ended December 31, 2013, up 36.8% year-over-year from the $10.080 million in core earnings for the second quarter of fiscal 2013 and up 13.6% from the $12.025 million in core earnings for the last quarter ended September 30, 2013.

Net interest income increased $7.891 million during the second quarter ended December 31, 2013 compared to the second quarter of fiscal 2013 and increased $4.717 million compared to the first quarter ended September 30, 2013. This was a result of increases in average interest earning assets combined with a decrease in the cost of funds resulting in a near record net interest margin of 4.01% this quarter compared to 3.81% in the second quarter of fiscal 2013.

The cost of funds decreased to 1%, 1.16%, down 28 basis points over the second quarter of fiscal 2013 and down 10 basis points compared to the quarter ended September 30, 2013.

Provisions for loan losses were $1 million this quarter. They were $1.95 million for the second quarter of last fiscal year and $500,000 for the first quarter ended September 30, 2013. The decrease in the loan-loss provision was the result of lower charge-offs which decreased by approximately $461,000 and improvements in nonperforming loans and delinquencies this quarter compared to the second quarter of fiscal 2013. The benefit of the decrease in charge-offs and improvements in the loan quality was partially offset by additional provisions needed for growth in the loan portfolio.

Noninterest income for the second quarter of fiscal 2014 was $5.543 million compared to $6.249 million in the second quarter of fiscal 2013 and $6.976 million for the first quarter ended September 30, 2013. The decline was primarily a result of industrywide decline in mortgage banking. As Greg noted earlier, we have mitigated the decline by selling structured settlements and increasing other fees.

Noninterest expense or operating costs for the second quarter ended December 31, 2013, was $15.304 million compared to $12.781 million in operating costs in the second quarter of fiscal 2013 and compared to $14.514 million in operating costs for the first quarter of fiscal 2014.

For the quarter, salaries and compensation was up year-over-year by $1.008 million. Additional staffing added since December 31, 2012 is the reason as well as professional services increased $516,000, data processing and Internet expenses were up $665,000 and depreciation and amortization expense was up $247,000. These increases are primarily due to the growth of the bank's lending and deposit operations.

For the second quarter ended December 31, 2013 compared to the first quarter ended September 30, 2013, salaries and compensation was up by $178,000, professional services declined $438,000, advertising and promotional was up $625,000 due to marketing promotions aimed at increasing deposits, and general and administrative expenses increased $519,000 due to increased loan processing expenses.

Our efficiency ratio was 39.89% for the second quarter of 2014 compared to 40.98% recorded in the second quarter of 2013 and compared to 41.37% for the first quarter of fiscal 2014.

The efficiency ratio is calculated by dividing our operating expenses by the sum of our net interest income and our non-interest income.

Shifting to the balance sheet, our total assets increased $477.5 million or 15.5% to $3.568 billion as of December 31, 2013, up from $3.091 billion at June 30, 2013. The increase in total assets was primarily due to an increase of $520.4 million in loans held for investments.

Total liabilities increased $434.1 million primarily due to an increase in deposits of $311.1 million in addition to an increase in borrowings of $138.6 million. Those borrowings were from the Federal Home Loan Bank.

Stockholders' equity increased by $43.4 million or 16.2% to $311.7 million at December 31, 2013, up from $268.3 million at June 30, 2013. The increase was primarily the result of our net income for the three months ended December 31, 2013 -- that's actually for six months -- of $25.3 million as well as the sale of common stock of $16.7 million as well as vesting of RSUs and exercise of stock options of $2.8 million less $1.2 million in unrealized losses and 0.2 associated with dividends.

At December 31, 2013, our Tier 1 core capital ratio for the bank was 9.01% with $143.5 million of capital in excess of the regulatory definition of well-capitalized.

With that, I will turn the call back over to Greg.

Thanks, Andy. Operator, if you can open the call for questions, we will take them now.

Certainly. (Operator Instructions). Hugh Miller, Sidoti.

Hi, good evening. One housekeeping question with regards to the pipeline data you guys are giving out. Just wanted to double check that it was $92 million of multifamily loans you had?

Yes, that's right.

Okay. Can you just talk -- it seems like some of the other line items were a little bit of a wash but that the multifamily was down somewhat meaningfully from, I think it was about $154 million as of October of last year. Can you just give us some color on what you are seeing with that category?

Yes, sure. And obviously jumbo is not a wash. If we looked at the pipeline in the fiscal first quarter, it was $344 million and is $497 million today. So that was up a significant amount. C&I was up. The jumbo -- the C&I -- I'm sorry, the multifamily side tends to in December and we have seen this historically, fall because many of the folks that would be in the market for these sorts of loans tend to postpone those. So we see really great indicators of future pipeline and those indicators generally are LOIs issued. We have fairly steady ratio of LOIs issued to pipeline commitments, which are defined as LOIs that have been accepted and the entire fee has been paid to the bank.

So I am not too concerned about multifamily production. I think that this is a fairly seasonal move and that it will come back up.

Okay. That's good color there. And then with regards to the increase that we saw in the loan yield portfolio on a linked-quarter basis, is that primarily just a function of seeing the higher-yielding C&I loans starting to come through? Or are you noticing an improvement in pricing with the yield curve moving around a bit for new production? Can you just give us some color there, Andy, on what's kind of driving the loan yield?

Sure. It's a little bit of both. Certainly our C&I production is coming in at rates that are higher than the average for that. But we continue to have strong pricing out there for our basic loans as far as jumbo and multifamily.

We haven't had to back off from jumbo and multifamily pricing in any respect but we haven't increased it either, so it may be here or there a little bit of movement. Clearly the C&I max is helpful.

Okay. As we look at the lower levels of structured settlement loan sales in this particular quarter, I know you guys had mentioned previously that it was kind of a strategic move to sell off some with the longer duration of those assets, with the yield curve adjustments we are seeing. But can you just talk about the lower levels of sales in this quarter and whether or not you have seen a change in the loan sale pricing for that type of loan?

Yes, we definitely sold those at the right time from a standpoint of the pricing we achieved. They are very sensitive to the long end of the curve and we generally -- there was a number of sales but we did significantly better than we would have if we waited, so that was generally good.

Obviously, when you have the type of loan production that we are having and you look at a 58% potential growth you have to do something with that and so obviously selling some of those loans depending upon geographic concentrations and those sorts of things continues to be something that we do.

So I think structured settlement definitely is more sensitive to the longer end of the yield curve and we've also been doing some other things to reduce our interest rate risk as well. We did a significant amount of borrowing extension towards the end of last quarter and more this quarter as well. So despite the fact that we have a number of good things happening on the margin side namely the loan yields continue at a minimum to be steady and potentially increasing on average and we have the reverse repos coming off to reduce deposit pricing, we have taken a little bit of that and extended to reduce some interest rate risk.

So coupled with the structured settlement sales and those sort of things, we've been able to reduce our NPV shocks. So those are all linked as far as the thought processes that we have. It's better to sell things at higher prices than lower prices, that's what Andy has taught me here.

If memory serves me correctly, I think you guys had commented previously that you still obviously maintain a substantial portfolio of structured settlements and so while you could at some point elect to sell them, is the thought process now to be a little bit more hesitant to sell at this point given where we are right now?

Yes, I think that's probably correct. We love that asset. It's an incredibly safe asset. But the right mix of that from a duration perspective and coupled with our matching off some of those assets with longer duration liabilities make us feel a little more comfortable about holding them and being able to keep them for the longer term.

Okay, and as we think about the margin, I believe you guys have some higher rate CDs and repos that could be potentially maturing in the near term. Can you just give us a sense of where that stands. Are there any larger sized repricing that we should be considering and where those are coming off of?

Yes, let me go ahead and jump in. I will start with our reverse repo category, which we have noted as being at a relatively high rate of in the 4s and if you are ready with a pen, starting in January, you've got 10 coming off at 4.45; 15 in February at 4.27; 10 in March at 4.38; five in April at 4.24; and 10 in May at 4.5. You add on another 10 out in August at 3.5 and that's $60 million at 4.2 -- of the 95, so obviously it would be great to get rid of all of it that this year it takes out two-thirds of it pretty much.

And so when you think about us extending, as Greg has mentioned, we extended about 200, and now is a perfect time to do that as we are dropping those off and extending others. We are obviously replacing a shorter duration expensive borrowing with a much longer duration cheaper borrowing.

Right, but we also did that this quarter, so that means that thinking about great margin -- another sort of great quarter of margin expansion I would be cautious about that. I would say I would expect maybe slight margin moderation this quarter from where we are and I certainly wouldn't forecast expansion at least this quarter.

But as those -- those are actually -- obviously when you have something in the 4s and you are financing yourself and its 70 basis points or lower at worst, there's obviously some nice impact that you get from that and it's significant that we are going to be able to get rid of $60 million of that.

Sure. Yes, it's very helpful, thank you. The last question I had was just with regards to you guys had kind of alluded to kind of the BIN sponsorship program, wasn't really able to pick on some of the commentary you were talking about there. But can you just give us a sense of where things stand there with the pipeline of discussions with potential partnerships and anything that seems like it could be a positive on the horizon?

Yes, we have great dialogue with our existing partnerships to expand the scope of what we do for them and we have robust and ongoing discussions with other significant programs that could make big meaningful differences but we have nothing specific to update right now.

Okay. Thank you for the --

Andrew Liesch, Sandler O'Neill and Partners.

Hi, guys. Just curious with the loan to deposit ratio running up where it is and I know you have taken on and extended some of the borrowings, as you said. But are you concerned at this level at 116 and climbing?

We actually had -- we've been working on a number of relationships and some deposit campaigns and we had a little bit of a timing difference with when some of our deposits arrived on the business banking side. So I would say if you looked at it in January, it would actually be significantly lower than that. So, no, I am not concerned but I do think that obviously we need to ensure that we are continuing to grow our deposits along with our loan growth and we need to continue to invest in that area and ensure that we are appropriate thinking about how we are going to fund ourselves.

And so if you looked at that ratio in January 30, 31, you wouldn't see it. You would've seen it gone down. I don't know if you had (technical difficulties), but it has gone down.

Got you. And then flipping to the asset side, I was curious compared to what you were originating a year ago, has there been much change in the size of the loans that you have been putting on the books?

No. Except on the C&I side. The loans are larger now. A lot of that is lender finance and so the actual exposure to an individual underlying asset is often smaller than it would be on a single -- what is uniformly smaller than it would be on the single-family jumbo side, but the overall size of the lines are larger and so they have diverse pools of collateral backing them but the lines are definitely larger and we intend to continue to increase those line sizes because there's significant overhead costs associated with monitoring those lines, with getting them scaled up and also we tend to like companies that are able to need larger lines. We tend to think that they have better infrastructure and other things that make us feel better about lending money to them.

Okay. And then just one question, just flipping through the Q here, it looked like the special mention category for C&I loans was up to about $15 million. I'm just curious what detail you can provide and what drove that increase and then what may not have caused a larger provision for that.

It's actually interesting you bring that up because -- this is a line of credit backed by lottery receivables and the lottery receivables are secured by the fees treasuries at the state. So I accidentally think that -- I'm actually I don't believe that should be special mention, frankly.

What it is is that under the terms of the loan agreement, it says that what happens is the state withholds tax and because it's a special purpose entity, the tax is not -- sometimes the state will delay the return of the tax. That puts the loan, at least on one definition, which the borrower is disputing into a technical default, and the fact is though that without technical default into a situation where there is a dispute over when that return money should come back into the trust. So this is a very technical thing and it is backed by lottery payments from states that the vast majority of which are the fees treasury.

So the chance of loss on that loan is in my view zero. And I am actually surprised that it ended up there. I didn't realize they had put it there. But honestly, I don't think it should be there. I will have to ask IR what they were thinking.

Thank you so much. That covers my questions.

Terry McEvoy, Oppenheimer & Company.

Hi, good afternoon. If I just look at the cost of your non-CD deposits, it looks to be about 20 to 30 basis points above the industry data. I understand the reasons why and the expense benefit that you guys have. Has that gap in closing? Do you monitor that data? And do you think going forward there is a continued opportunity to bring the deposit costs down more consistent with what you see out of a traditional brick-and-mortar bank?

We certainly think so over time. I think there's a couple of components that have to be thought about there. If I was growing my deposit base 5% I could bring down that gap very, very significantly immediately. I think if you took a brick-and-mortar bank and you asked them to grow their deposit base at 35% that would create a gap too. It is just inherently that that sort of pressure as you are growing your deposit base well and we are offering a value proposition to the customers that include not only the sets and services that branches offer but an additional boost whether it's a reduced fee from a business banking perspective, or an increased yield from a consumer perspective.

I think that our strategy overall, if you couple the affinity side with the business banking side and the push for operating accounts and the prepaid businesses that over time you'll see some of those things balance themselves out where prepaid card balances will come in at zero. There will be operating accounts that will come in because of lines on the C&I side and things like that that will start to balance out other components.

But when we're going out and attracting business banking customers, we are generally not providing them lines of credit. We don't think that's a great business for us right now and so we do need to provide them some value. That being said, I do think that we have the opportunity to take down our cost of funds primarily in the CD area and in the repo area. But there is a potential opportunity on the other side of it too.

I think that that involves us having to continue to be better at gaining and we've done a good job. We need to do an even better job at gaining checking account business and getting that checking account business to actively engage with us. And I think we probably could pay less on our checking accounts by offering free checking and our research shows we do market research. I wouldn't call it particularly sophisticated, but it shows that there is not as much demand or requirement that we offer higher rates on checking as long as the fee structure has a value proposition that is differentiated for the customers.

The C&I portfolio is over $100 million. Could you just give us a little color on that portfolio, average loan size, maybe targeted client base and are there any purchase loans or shared national credits or anything that is purchased in nature?

Yes, there's a very small amount of shared national credits in there. It would be well less than 10% and there's not much there.

We do have some loans where we have acted with other institutions on, but that is also a small percentage and those tend to be clubbed deals where, as you know, there will be one or two other banks involved and we have sometimes brought other banks in where we want to have exposures that are lower than the demand that the borrowers have.

And the vast majority of those loans are loans that have been self originated by the bank, sourced by our team and they are a significant portion of those are lender financed loans that are backed by hard collateral, receivables, real estate or other loans.

And just one last question. Would BofI need to make any meaningful investments if you were looking to grow the prepaid card business in a material way and how do you think about the risks and rewards for expanding that business or potentially expanding that business in light of what the CFPB could come out with later this year and other regulatory issues that could pop up and limit the profitability of that business in the future?

I think that our view is that we want to work with the winners in the industry and I think that the industry is viable. It's a necessary industry that has made a lot of advances in how they think about distribution and I think that those advances are important and I don't believe that the industry will be regulated to the point where it will be put out of business and so the key is to pick the winners and to focus on those winners.

And because we have a very diverse platform and we are not dependent upon any one of our businesses succeeding, we have the luxury of spending the time to find the right partners and work with those partners regardless of the timeframe in which those ultimate partnerships develop.

And so I think one of the problems is if you get sloppy and fast with that business, then very bad things can happen to you because you are somewhat dependent, not somewhat dependent, you are dependent on the skills of the third party and you are dependent upon their compliance mindset and you are also dependent on their financial stability and so you have to choose very wisely.

There are some other models that we have kicked around and are not things that I'm willing to share right now that can be adapted that could accommodate a different partnership model. But right now in the structure of the value chain where we are, you need to focus on partners that are long-lasting and can be significant because the costs associated with running those and monitoring those partnerships is going to be increasing. Not for us but for others.

Thanks, Greg. Thank you.

Julianna Balicka, KBW.

Good afternoon. I have a few follow-up questions. A good number of them have already been asked.

In terms of the deposit cost rates picked up this quarter, I presume in response to some of the deposit campaigns you've been putting on to keep up with loan growth. When in the quarter did you increase rates? Or more to point, where are the rates right now on your different products so that as we think about where this will shake out for next quarter or two?

You are going to love this answer. So we didn't change anything on consumer rates generally. And on business banking rates, if you will notice we are not publishing those rates and that's because we are really working on a lot of individual account analysis where depending upon the overall fee structure and utilization, we are really trying to analyze a lot of these accounts and work with our customers. And so there is a wide variety of rates that depend upon what fees that our customers are paying for cash management and other services, so I think it's not a simple answer.

What I would say is I wouldn't expect that you should -- I think you should assume from a modeling perspective relative stability in those costs. But you could I think take some benefits associated with the repurchase side if you are modeling that separately.

And on the repo side, you said you extended them -- some of them. So as opposed to thinking about those balances rolling off, we should be thinking about stable balances at lower rates and what rate are you extending them down to?

Yes, so the 200 is in roughly a 1.8% rate. By the way, it will show up in Federal Home Loan Bank advances, not in reverse repos.

Right. The repos aren't being extended there -- we are not engaging a new repurchase agreement. It's FHLB advances.

So it will be shifting lines but it's conceptually similar.

Right. Got it. And then in terms of loan growth and deposit growth in terms of actual loans deposit ratio, you've talked about the kind of loan growth -- asset growth that you -- to be comfortable with the business model, could you talk about the kind of deposit growth that you would like to achieve in order to kind of keep up with the loan growth? What's the goal here with all the different initiatives?

The nature of how you think about the deposit and borrowing max is one that depends upon what you want to do from an interest rate risk perspective and I firmly believe that borrowing is superior to locking in consumer CDs for interest rate protection for all sorts of reasons, even though we have good penalties on our consumer CDs.

So some component of loans will and should based on the fact that they are 5-1 ARMS, and not that we don't think that our deposits have good duration but we think that they should be funded by borrowings. Depending upon what interest rate characteristics are and things like that, we believe that there should be some sets of loans that are permanently funded by borrowings and because we are really not doing much in the securities market now because of what we view as relative value on the security side, you're not going to see some typical formula like you might see in other banks where loans equal deposits and securities equal borrowings.

We don't think that that formulation is sophisticated enough to encompass what we are attempting to achieve. So that being said, I am not going to tie myself down to specific ratios but that is conceptually how we think about it.

So as I think about your deposit costs and kind of growth in the next year or two, basically before -- until short-term interest rates start to rise, conceivably should we start thinking about higher rates on your CDs because you will have to push growth more aggressively, or are you basically going to try to avoid doing that as long as possible?

We are going to try to avoid doing that as long as possible and based on the continued success we've had in the business banking and other side, we are hopeful that we can permanently avoid it. That being said, we have been dramatically decreasing our CD balances over time and I suppose at some point we can't rule out the fact that we would put on consumer CDs. I think there is actually relatively little demand for consumer CDs that extend beyond a year or two and I think that those durations are pretty much useless from an interest rate risk perspective.

So I think that -- there is just -- and we have found that there is very little benefit from a standpoint of -- we've been able to do a really good job of cross-selling to our savings account holders other products and for whatever reason, the CD side really has not ever caught on that way. So I'm not a big fan of short-term retail CDs and I think long-term retail CDs are -- they are worse than medium-term borrowing in every respect -- from a rate perspective, from a [stock] perspective and from everything else and given the level of collateral that we have, I just don't think that it is helpful. I don't think they are helpful.

Understood.

And in comparing them to wholesale brokered CDs, 10-year brokered money, which we put on at incredibly good rates and have only [def] puts and give us optionality. So all of those things, I think retail CDs are inferior in every respect of that. That doesn't mean that -- I think maybe the only place they are not completely inferior is potentially regulatory perception but we haven't run into that because our regulators have been sophisticated enough to understand what we are doing and have been supportive of it.

Okay. Understood. Okay, and then in terms of your loan yields, the tick-up linked quarter other than just a shifting in your loan mix, is there anything in terms of loan fees in that interest in combined that contributed -- that contributed to the uptick in the yield from a mathematical perspective?

No, nothing from a material perspective. The C&I loans in general have a little more fee income that is amortized into the yield but there is no one large pop from a single loan that contributes to the uptick.

So it looks like -- because your loan yields have been volatile lined quarters, so should we continue to think about them kind of more or less -- they are fairly steady around 520, but plus or minus a few bps, so should we continue to think about them as that or should we think about them as now being on an upward shift because of your loan mix?

I would say that it is reasonable to keep them relatively steady.

Okay. And then final quick question, on the expenses side, advertising moved $600,000 linked quarter, which doesn't sound like a lot but it's a lot in your very efficient context and other G&A, so how should we think about that?

That quarter was very low from a prior quarter. If anything I would think the last quarter was -- that you are benchmarking against -- was lower. Part of that was transition agency mortgage banking, advertising being down as part of that and so we have upticked that a little bit since then looking at different opportunities including other deposit opportunities. So I think it was more that Q1 was the outlier.

Got it. All right, very good. Thank you very much for letting me ask so many questions.

Donald Worthington, Raymond James.

Good afternoon. I guess going back to the deposit question, do you see the opportunity for acquiring deposits like you did with the Principal Bank deal?

Yes, certainly there are sets of opportunities that are out there and we look at those and we do think that they are out there and available.

Okay. And then do you break out how much you have in that second chance checking product?

No, we don't. And right now what we have really focused on on that product is some small pilots with regard to some affinities that have natural characteristics of their customer bases that would be appropriate for that and then optimizing our own marketing spend so that when someone is declined from our other products that they have the opportunity for that product.

We haven't broken that out. But I think that clearly there is opportunities there. We've had that product running now for a while to make sure that there is a lot of things that you have to make sure you get right. It's a very different client base and there is a lot of different behavioral elements you need to make sure you have control over. And I think we've done a pretty good job of doing that.

There's some real interesting opportunities for distribution on that side and it's really been probably more of a capacity issue for us and a prioritization but there is definitely opportunity there.

Okay. And then are you still adding FTE and loan production or do you have the infrastructure in place to grow quite a bit more without adding more people?

I would say that on the agency side, we have moved some folks around in order to accommodate the increased jumbo production. On the op side on multifamily, the team was telling me based on how many LOI requests they were getting they were short a person here or there. But I think that just from a standpoint of the rapid growth in personnel that you saw over time and on our lending side, that definitely will now be focused in a different area. It will be focused on the expansion of different C&I lending niches, which will tend to have fewer people but those people will be more expensive. And so we intend to build out that business area and I don't think there will be a lot of costly additions to single and multifamily.

Okay. All right, thank you.

Edward Hemmelgarn, Shaker Investments.

I will first say great quarter, Greg and Andy. But could you talk a little bit more about -- you mentioned that you have added new people to lead your IT area, your work processes and marketing. Could you talk a little bit more about some of the things you are trying to gain there and how that will help you move on to the next step?

Yes, sure. I think that's a great question. Inevitably what happens in organizations is as they grow, they need different sorts of executives and I think that we've done a good job with two recent hires from a standpoint of the level of their skill sets that we're bringing in.

So we hired a CIO and we hired an SVP of Operations. In the case of the CIO, he had been a CIO of a large component of ABN Amro's business and just happens to really want to live in San Diego and is sick of the cold and sick of the travel and all those sort of things, so we feel really good about that.

And then the gentleman on the SVP of Operations side has a background with -- as leading operations and deposit operations for a large institution for a number of years and then also experience with core processors and high-level consulting engagements across the board on process improvement.

So what's happening to us now is that we are now on that flywheel of people who believe and so people want to work for successful businesses, so the types of resumes when we recruit and the things that we see now from the standpoint of just talent is vastly different than what we saw several years ago.

I don't know if it has been crossing the billion-dollar market cap side or whatever, but it's just a really great time to be looking for talent to bring us to the next level.

Are all of these people reporting to you, or do you have -- how is your structure now on the operations side of the bank business?

No, obviously they are not all reporting to me and we have a good second layer that will be reporting to the CIO and so I'm not going to belabor the entire organizational structure of the bank now. But we continue to ensure and think about how I can scale and spend the time that I need to spend, which should be on newer businesses and then external focus and make sure that we have a robust internal focus. But that is also done through our management framework, which is a very specific way of making sure that we have a great and robust set of as is process diagrams and we are developing a process mindset among all our employees so that they can continually think about what they're doing from a process perspective. And that's a big cultural element that we continue to push. So it's not only at the senior level.

Further example, we recently hired a Six Sigma black belt to run the process database internally at the bank and to teach and help develop the middle management team in thinking about how to reengineer processes. So a process oriented mindset has to run through the whole organization and excessive focus on reporting structures and things like that while useful, is an incomplete way of thinking about those sorts of things.

Okay. Great, thanks.

Gregg Hillman, First Wilshire Securities Management.

Yes, good afternoon. Greg, could you talk about jumbo a little bit. Whether there's things going on that you think will make it grow faster in terms of your new relationships, internal processes, regulatory changes? Can you talk about that a little bit?

Sure. Well, I will take the regulatory changes first. The QM side of things -- I think the potential impact could be interesting. We have been seeing continued growth in the demand for our product before QM came into being. And so I can't say right now that I can attribute any particular loans to QM per se but I do see continued growth in our customer base and in the demand for the product.

So I would like to give specific reasons as to why that is the case but I will tell you we spend a lot of time improving and expanding our internal sales operations, the way we market our products, the technology and the ease-of-use, the customer service responsiveness and all of those sorts of things.

So I think that people don't do business with people who don't do a good job for them particularly on the jumbo side because those customers tend to be used to being served in a particular manner and just like in wealth management or other things, if you don't serve them in that way you may permanently offend them.

So the idea that they're going to have to wait 60 days for an underwriting answer and things like that and then get an answer and not be able to talk with someone about the conclusions and those sorts of things are problematic. So I think we have a really good formula and a model and it involves continually looking at those operational elements and making them better and that has been reflected in what is happening in the pipelines.

And can you explain briefly what QM is?

Sure. The QM rule is two separate components. One component, which is commonly called the ATR rules is a set of rules that requires that an institution appropriately document the ability of a borrower to repay a loan. What that effectively does is it outlaws loans that had been made in certain respects that were problematic in the crisis which would include no income, no low doc loan types that were widely available in that 2006, 2007 timeframe. And it basically states that you have to document a borrower's ability to repay.

Now in our case, we never did no documentation loans. We always collected every piece of documentation that we possibly could including tax returns from the IRS and everything else, so that really didn't change anything that we did.

Then the next thing that it does is it it states that there is a particular way you need to compute income and that mechanism of computing income is essentially in accordance with what was historically FHA guidelines for the computation of income. So for example, a borrower that owned a -- we did a loan for a borrower who owned a significant piece of a multimillion dollar market capitalization insurance company, they own more than 50% of this insurance company. We did their loan. None of that income, none of those income or assets would have been able to be calculated as income for the utilization of the loan under the Appendix Q, to the QM rules because those rules were designed for thinking about a borrower with a day job who didn't own businesses, didn't have subchapter S corporations, didn't have an investment portfolio, didn't make a significant amount of variable bonus income.

So the attempt has been made to apply these FHA standards, which were always designed for a very different borrower to all borrowers and as a result of whether those loans pass through different characteristics, they receive different levels of legal benefit associated with those which include a presumption that you have appropriately calculated the ability to repay, a rebuttable presumption that you have the ability to repay, and no presumption that you have the ability to repay.

And in each instance there is an assortment of penalties that could arise if you have not calculated the ability to repay. But the precursor to all of those penalties is that you have to have not calculated the ability to repay, which we always do.

So for those of you who were on this phone and who feel tortured by that, I apologize, but there really isn't a quicker way to explain it because it's a bit complicated.

Okay. And just, Greg, two other points. Could you just comment on, one is noninterest income whether you think that will increase as a percentage of overall earnings for the Company on a go-forward basis? And then finally, just getting to $10 billion, can you talk about what will it take in terms of capital structure raises or dilution?

Right, well with regard to noninterest income and the ratio of that to interest income, that really depends on a variety of complex factors that I don't really want to speculate on. I think that obviously we have robust loan production. We can convert that loan production into fee income if we desire because we have buyers who would like to buy all of our loans. The question on of whether or not we do that depends on what I'm seeing on the deposit side, what I'm seeing on the capital side and all those things have to come together.

I would say that obviously even if you are selling a loan for a several point gain, you obviously are making that back at interest income very quickly. However, the capital efficiency is very different.

So I really can't give predictions about that because we are also working on a number of different fee income sources as well, some of which are not dependent upon loans and we need to continue to work on those. So I will have to pass on making a numerical prediction there.

And then with regard to the capital requirements to get to $10 billion, obviously if you make an ROE of 18 and you are growing at 25%, 30%, then you have a gap and that gap has to be filled with capital that either is on the balance sheet resulting in a reduction of capital, which we do have significant excess capital right now, or from a capital raise.

So the answer to that depends upon something that I have to operationally execute every day, which is going out and making sure that I am safely and soundly growing the business and doing all those sorts of things and if our ROE starts to equal our growth rates, and hopefully that is above 25%, then we will no longer need capital and we will permanently be organically funded. But I would say that those are always things you have to consider.

Now that being said, we raised a significant amount of our ATM, $17 million in this quarter, and we've raised an additional $11 million now, so we're certainly not in a position where we need to raise additional capital for a number of quarters to continue very robust growth.

So we are really in a good position and we have already done a lot of the capital raising that we need to do for a while and our capital ratio Tier 1 fits higher than -- I don't know if we've ever, maybe saying ever been, be able to get some lumpy capital raises, but certainly at a level that's above where we feel comfortable.

Okay. And then, Greg, the prepaid deposits -- for your prepaid card business, for those kinds of deposit as opposed to business checking deposits, will that require less capital as you grow?

They would be at a lower direct cost. The cost of prepay deposits are embedded directly in the cost of compliance of overseeing the program. So prepaid card programs generate fee income and they generate compliance costs and they generate deposits. And so those deposits are generally very low cost, as low or lower than anything we have but there is an operational cost associated with them and that is what makes the difference. They don't have a direct capital impact in the sense that they are calculated the same as any other deposit from a capital ratio perspective.

Okay. Thank you.

Well, thank you very much, everyone. Is that it, operator?

That will conclude our conference call for today. Thank you all for attending.

Okay, thank you very much. Bye.

Bye.