Axos Financial Inc (AX) 2015 Q4 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to the BofI Holding, Inc. Fourth Quarter and Full-Year 2015 Earnings Call. Today's call is being recorded. At this time, I would like to turn this conference over to Johnny Lai, Vice President, Investor Relations. Please go ahead, sir.

Thank you, John. Thank you and good afternoon, everyone. Joining us today for BofI Holding, Inc.'s fourth quarter and full-year 2015 financial results conference call are the Company's President and Chief Executive Officer, Greg Garrabrants; and Executive Vice President and Chief Financial Officer, Andy Micheletti.

Greg and Andy will review and comment on financial and operational results for the fourth quarter and for the full year and they will be available to answer questions after the prepared presentation.

Before we begin, I would like to remind listeners on this call that prepared remarks made on this call may contain forward-looking statements that are subject to risks and uncertainties and that management may make additional forward-looking statements in response to your questions. Therefore, the Company claims the Safe Harbor protection for forward-looking statements 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 detailed in the Company's filings on Form 10-K, 10-Q and 8-K with the SEC.

This call is being webcast and there will be an audio replay available in the Investor Relations section of the Company's website located at www.bofiholdinginc.com. Details for this call were provided on the conference call announcement and in today's press release.

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 Holding's conference call for the fourth quarter of fiscal 2015 ended June 30, 2015. I thank you for your interest in BofI Holding and BofI Federal Bank.

BofI announced record net income for its fourth quarter ended June 30, 2015 of $24.4 million, up 52.4% when compared to the $16 million earned in the fourth quarter ended June 30, 2014 and up 15.8% when compared to the $21.1 million earned last quarter. Earnings attributable to BofI's common stockholders were $24.3 million or $1.54 per diluted share for the quarter ended June 30, 2015 compared to $1.09 per diluted share for the quarter ended June 30, 2014 and $1.35 per diluted share for the quarter ended March 31, 2015.

Excluding the after-tax impact of net gains related to investment securities and a one-time Federal Home Loan Bank dividend, adjusted earnings for the fourth quarter ended June 30, 2015, increased $7.4 million or 45.7% compared to the quarter ended June 30, 2014.

Other highlights for the fourth quarter include, total assets reached $5.8 billion at June 30, 2015, up $1.4 billion compared to June 30, 2014. Return on equity reached 18.86% for the fourth quarter. Our net interest margin was 3.97% for the quarter ended June 30, 2015, a 12 basis point improvement over the quarter ended March 31, 2015 and a 5 basis point decrease over the quarter ended June 30, 2014. The efficiency ratio was 31.65% for the fourth quarter of 2015 compared to 34.46% for the third quarter 2015 and 34.87% for the fourth quarter of 2014.

Total deposits reached $4.5 billion, up $1.4 billion compared to June 30, 2014. We continue to generate strong loan growth with $1.2 billion of loan originations in the fourth quarter compared to $1.1 billion of loan originations in the third quarter ended March 31, 2015. Gross loan balances increased 6% on a linked-quarter basis or 24% annualized in the fourth quarter ended June 30, 2015. The primary drivers of our loan production consisted of $121 million of single-family agency eligible gain on sale production, $452 million of single-family jumbo portfolio production, $32 million of single-family non-agency eligible gain on sale production, $64 million of multifamily portfolio production, $32 million of multifamily gain on sale production, $26 million of non-multifamily commercial real estate production and $325 million of C&I production.

We originated high-quality loans in the fourth fiscal quarter. The average FICO for a single-family agency eligible production was 765 with an average loan-to-value ratio of 66%. The average FICO for the single-family jumbo production was 708 with an average loan-to-value of 62%. The average loan-to-value of the originated multifamily loans was 56% and the debt service coverage ratio was 1.38. The average loan-to-value of the originated commercial real estate loans was 55% and the debt service coverage ratio was 1.53.

At June 30, 2015, the weighted average loan-to-value of our entire portfolio of real estate loans was 56%. The very low average loan-to-value ratios in our loan book are not obscuring risk in the tails of our portfolio. For example, in the bank's entire single-family loan portfolio, both jumbo size and below, excluding loans originated for sale for the government sponsored entities, there is only one loan that was originated at greater than 80% loan-to-value. We've had a direct pledge of liquid collateral that would reduce the collateral exposure levels below 80%.

That's exactly [4,000th of 1%] of the single-family portfolio. That loan has a current loan-to-value ratio of 62%. The credit quality of our loan book remains strong. We had de minimis charge-offs in the fourth quarter, such that our annualized net charge-offs to average loans outstanding was zero for the quarter and 3 basis points for the full year of 2015. Our non-performing asset ratio was 55 basis points in the fourth quarter, down from 65 basis points in the March quarter. We had very little direct exposure to energy and energy-related companies.

Less than 5% of our multifamily loans are in Texas and these loans continue to perform well and the market fundamentals for those loans are very strong as they are concentrated primarily in the Dallas-Fort Worth area. We are the sole agent for the vast majority of our C&I loans and we have no shared national credit exposure in any oil and gas or oil field service firms.

We ended the quarter with a loan pipeline near record levels. The $920 million loan pipeline consisted of $467 million of single-family jumbo mortgages, $136 million of single-family agency mortgages, $102 million of income property loans and $216 million of C&I loans. We had another strong quarter in agency mortgage banking. Our ability to source loans through digital marketing, data initiatives and through affinity partners such as Costco, provide us with a significant cost advantage relative to our competitors.

Our enhanced digital marketing efforts on the single-family agency side are bearing fruit, significantly reducing the acquisition cost of our agency loans, reducing our reliance on Costco and providing a template for future growth as we develop the operational capability to expand that business. Because we are able to offer and pass on lower cost to our borrowers and offer them a superior economic value proposition, we are well positioned to outperform the industry through this cycle.

We believe our diverse lending platforms will allow us to grow in a variety of interest rate environments. Our C&I business continues to mature nicely as we methodically continue to invest in automated systems, processes and people and gradually increased production through more diverse lending niches over the last four years. We will continue to invest in our capabilities across different C&I niches that offer well secured loans at attractive yields.

Our strong loan pipeline and the 63% year-over-year growth in our C&I loan portfolio in fiscal 2015 are indications that good risk-adjusted opportunities exist today. Since a number of our C&I loans came in during the last month of June, we will reap the benefit of this higher than average loan yield growth from a net interest and net interest margin perspective in the September quarter and beyond.

In a higher rate environment, we would expect absolute levels of loan yield to rise providing increased C&I lending opportunities that meet our spread target. Currently, the vast majority of our C&I loan book is sole sourced, originated and agented by us. We see current opportunities to continue growing our agency book and in a higher rate environment, we believe there will be opportunities to work more closely with other institutions to growing our C&I loan portfolio either through club deals on a shared national credit basis.

Although we have focused our small balance commercial real estate platform more on originating multifamily loans, our data and marketing platform, sales team and origination system has historically always been capable of originating commercial real estate loan types other than multifamily. Over the past 12 months, we have refined our systems and processes and added several underwriters to allow our small balance commercial real estate team to focus not only on multifamily loans, but also on other commercial real estate loan types.

This quarter we originated $26 million of non-multifamily commercial real estate loans through our small balance commercial lending platform with an average yield of 5.23% and average loan-to-value ratio of 55% and an average debt service coverage ratio of 1.53.

Within our single-family business, we have a diverse product platform and great channel diversity that will position us well for continued growth. For example, although we continue to originate primarily first mortgages on the Costco platform, we have the ability to originate second mortgages on that platform as well, something that we have not done in any scale due to the robustness of other lending platforms and our capital allocation strategy. We don't currently originate agency loans through our lending partners despite the ready availability of the technology to allow us to do so and we have significant opportunities to expand our data-oriented marketing strategies to source more jumbo loans through our expanding retail call center loan officers.

Our seasoned credit underwriting team and our product pricing and delivery portal allow us to efficiently serve high-quality borrowers nationwide. Our network of lending partners, our direct sales team, data initiatives and lead generation volume, all continue to grow. We have a strong reputation for exemplary customer service and fast turnaround times, which make us the preferred lender for purchase transactions. With purchase transactions accounting for around 70% of our single-family jumbo mortgage originations in fiscal 2015, we feel good about our ability to continue growing our low loan-to-value jumbo portfolio at attractive yields, given the size of our addressable market and our relatively small market share.

We believe in an improving economy, higher-end borrowers will continue to seek purchase money mortgages in sufficient quantities to generate growing loan volume as the bank expands its market reach. We are methodically incubating other lending businesses that will allow us to expand our relationships with our customers and reach new customers all the time. Although we approach these businesses in a slow and controlled fashion, we have found that they grow to be significant contributors over an extended period of time.

Now turning to right side of the balance sheet. We further improved the diversity and quality of our funding mix. Total deposits increased 46.4% in fiscal year 2015, outpacing loan growth of 39.5%. Checking and savings accounts grew at even faster rate of 62.5%, accounting for 82% of total deposits at June 30, 2015, compared to 74% a year ago.

Our business deposit growth has been one of the most important parts of our deposit diversification strategy. By employing data oriented direct marketing strategies targeted at specific industry segments, we were able to find and service business customers that are attracted to our high-service, low-cost, technologically-enabled branches delivery model. Because we strive to offer more responsive and tailored customer service, comparable cash and treasury management software functionality and lower fees than most branch-based banks, we have successfully grown our business deposits from a little over $300 million two years ago to $2.4 billion at June 30, 2015.

Business accounts now represent 55% of our total deposit base. We have only started to capitalize on this large and growing opportunity. As we improve our cash management software and data analytic capabilities, we will be able to compete for an even more sophisticated cash management client with larger deposits and cross-sell more services to our existing customers.

We feel very good about our interest rate risk profile in a rising rate environment. Approximately 88% of our loans are adjustable rate with single-family mortgages and multifamily mortgages accounting for 60% and 24% of our loan portfolio at June 30, 2015. The vast majority of the single family mortgages we retain on our balance sheet are purchase money 5/1 jumbo ARMs with a weighted average life of approximately three years. We don't portfolio any 15 or 30-year fixed rate mortgages.

Our securities portfolio is primarily comprised of floating rate assets that respond almost immediately to any increase in short-term interest rates. I believe we will maintain our net interest margin in the 3.8% to 4% range even as rates eventually move off the bottom. Most community and commercial banks continue to struggle with a combination of excess liquidity, shrinking net interest margins, low loan growth and high costs. I don't believe short-term rates increasing by 50 or 100 basis points will generate strong pricing pressure on the bank's deposits given that we are generally more competitive on deposit pricing already.

Our ability to grow loans and deposits is stronger than it has been at any point in the bank's history. Digital and organizational initiatives that are in various stages of implementation will further strengthen our value proposition from a service and user experience perspective. Our structural cost advantage, which has consistently been over 200 basis points on assets prior to, during and after the financial crisis, remains a significant tool that we can deploy if necessary.

As we grow our brands and further expand our low-cost distribution channels, I feel increasingly confident that we will grow profitably by offering a more balanced value proposition. We delivered another quarter of positive operating leverage with our efficiency ratio improving to 31.65% in the June quarter. Even adjusting for the one-time Federal Home Loan Bank dividend, our efficiency ratio came in at 32.5%, a significant improvement over the prior quarter. We continue to invest in systems, processes and people that improve the user experience and make it easier for our service team to interact with existing and prospective customers.

Our new account opening system is operational on one of our brands and is on track to be rolled out sequentially to various brands over the next several quarters. This system will significantly reduce the time and cost of opening a new consumer deposit account and enable more personalized real-time cross-selling. We are excited about the possibility of deploying this new system across all our deposit brands. We will continue to invest in our information technology development team and expand its capacity so that we can realize our vision of providing a best-in-class digital customer experience in our platforms by directly controlling more of our technology stack and improving our speed to market.

I am pleased with the strong growth and returns the bank has achieved, but I am even more excited about the opportunities ahead. We are working hard to maintain our culture of continuous improvement, strong risk management, process orientation and disciplined capital allocation. Our management team is more capable and higher performing than it has ever been. Our risk infrastructure is more mature and more capable and we will continue to invest to ensure that we maintain our strong regulatory relationships and ensure that we are operating the bank in a risk conscious manner.

Our organic growth will be the overwhelming driver of our future. We actively evaluate M&A opportunities that can potentially augment our growth, returns of strategic advantages. We are actively working toward completing the pending transaction with H&R Block. We have recent ongoing and positive communications with the OCC and H&R Block regarding the transaction and remain confident that we will reach a successful outcome in a timeframe that will allow us to perform the contemplated services for the coming tax season and to begin utilizing the deposits we will be acquiring on their loan growth.

Now, I'll 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 8-K containing unaudited financial schedules 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 2015 versus fiscal 2014 as well as this quarter ended June 30, 2015, versus the third quarter ended March 31, 2015. Then, I will briefly discuss the results for the fiscal year.

For the quarter ended June 30, 2015, net income totaled $24.395 million, up 52.4% from the fourth quarter of fiscal 2014. Diluted earnings were $1.54 per share this quarter, up $0.45 or 41.3% compared to the fourth quarter of fiscal 2014. Net income increased 15.8% compared to the third quarter ended March 31, 2015.

Excluding the after-tax impact of gains and losses associated with our securities portfolio and the one-time FHLB dividend of $1.7 million paid in Q4, adjusted earnings were $23.467 million for the quarter ended June 30, 2015, up 45.7% year-over-year from the $16.111 million of adjusted earnings for the fourth quarter of fiscal 2014 and up from the $21.564 million in adjusted earnings for the last quarter ended March 31, 2015.

Net interest income increased $14.798 million during the fourth quarter ended June 30, 2015, compared to the fourth quarter of fiscal 2014 and it increased $4.629 million compared to the third quarter ended March 31, 2015. This was primarily a result of the increases in average interest earning assets and average interest-bearing liabilities as well as a decrease in the cost of funds. The net interest margin was 3.97% this quarter compared to 4.02% in the fourth quarter of fiscal 2014 and 3.85% in the third quarter of fiscal 2015.

The cost of funds decreased to 1.03%, down 6 basis points from the fourth quarter of fiscal 2014 and down 4 basis points compared to the quarter ended March 31, 2015. Excluding the one-time FHLB dividend, our net interest margin would have been 3.85% for the fourth quarter of fiscal 2015. Provisions for loan losses were $2.9 million this quarter, $2.250 million for the fourth quarter of last year and $2.9 million for the third quarter ended March 31, 2015. The provision for loan losses is primarily the result of loan growth during the quarter.

Non-interest income for the fourth quarter of fiscal 2015 was $10.278 million compared to $4.723 million in the fourth quarter of fiscal 2014 and compared to $8.366 million for the third quarter of fiscal 2015. Year-over-year increased sales volumes resulted in higher mortgage banking gains and are the primary reason for the variance between the quarters. Compared to third quarter ended March 31, 2015, the increase is primarily the result of increased prepayment penalty fee income.

Non-interest expense or operating costs for the fourth quarter ended June 30, 2015 was $20.752 million compared to $15.766 million in operating costs for the quarter ended June 30, 2014 and compared to $20.343 million in operating costs for the third quarter of 2015. The year-over-year increase was mainly a result of an increase in compensation expense of $3.333 million generally related to additional staffing added during the year.

Advertising and commercial expense increased $592,000 and data processing and Internet expense increased $413,000. These increases are all primarily due to growth of the bank's lending and deposit operations. Our efficiency ratio was 31.65% for the fourth quarter of 2015 compared with 34.87% recorded in the fourth quarter of fiscal 2014 and compared to 34.46% for the third quarter of fiscal 2015. The efficiency ratio was calculated by dividing our operating expenses by the sum of our net interest income and our non-interest income. Excluding the one-time FHLB dividend paid in the fourth quarter of 2015, the efficiency ratio would have been 32.47%.

Now turning to the annual results. As Greg mentioned, net income was $82.682 million for the year ended June 30, 2015, up 47.8% over the $55.956 million earned for the year ended June 30, 2014. Earnings attributable to BofI's common stockholders were $82.373 million or $5.37 per diluted share earned for the fiscal year ended June 2015 and up 48% from the $55.647 million or $3.85 per diluted share earned for the year ended June 30, 2014.

Adjusted earnings are $82.887 million for the year ended June 30, 2015, up 45.6% year-over-year from the $56.9 million of adjusted earnings for the fiscal year of 2014. Net interest income increased $61.848 million during the year ended June 30, 2015 compared to fiscal 2014, primarily as a result of the increase in average interest earning assets. The net interest margin was 3.92% this year compared to 3.95% in fiscal 2014. A decreased yield on loans of approximately 16 basis points was partially offset by a decrease in the cost of funds of approximately 14 basis points.

Provisions for loan losses were $11.2 million this year compared to $5.350 million for the fiscal year ended June 30, 2014. The increase in the provision was the result of additional growth in the loan portfolio and changes in the loan mix. Non-interest income for the fiscal-year 2015 was $30.590 million compared to $22.455 million in fiscal 2014. Increased sales volume resulting in higher mortgage banking gains is the primary reason for the variance year-over-year.

Non-interest expense or operating costs for the fiscal year ended June 30, 2015 was $77.478 million compared to $59.933 million in operating costs for the year ended June 30, 2014. The increase was mainly a result of an increase in compensation expense of [$11,000,579] related to additional staffing added during the year as we increased our employees from 366 at June 30, 2014 to 467 at June 30, 2015. Other contributing factors to the non-interest expense increase were increases in advertising and promotional expense of $2.336 million and an increase in other general and administrative expenses of $1.384 million.

Shifting to the balance sheet, our total assets increased $1.420 billion or 32.3% to $5.823 billion as of June 30, 2015, up from $4.4 billion at June 30, 2014. The loan portfolio increased to net of $1.4 billion primarily from portfolio loan originations of $3.3 billion, less principal repayments and other adjustments of $1.9 billion. Total liabilities increased by $1.3 billion or 31% to $5.3 billion at June 30, 2015, up from $4 billion at June 30, 2014. The increase in total liabilities resulted primarily from growth in demand and savings deposits, which increased $1.4 billion, primarily offset by a decrease in Federal Home Loan Bank borrowings of $157 million.

Stockholders' equity increased $162.7 million or 43.9% to $533.5 million at June 30, 2015, up from $370.8 million at June 30, 2014. The increase was primarily the result of $82.7 million in net income for the fiscal year and the sale of common stock through our ATM offerings, which totaled $76 million. At June 30, 2015, our Tier 1 core capital ratio for the bank was 9.25% with $240 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 would open the call to questions, please.

(Operator Instructions) Andrew Liesch, Sandler O'Neill & Partners.

Greg, did I hear you correctly, I thought you said that you added $26 million of non-multifamily CRE and that the yield was 5.23%. Just curious if you can go into, sort of like what properties are those. That yield seems pretty high to me, like where are they located. Just any detail that you can provide would be helpful.

Sure. They are generally small balance commercial properties. So, under $5 million, generally on the loan amount [is one], slightly above that. They are only in our coastal California markets. Most of them are multi-tenanted and I think they are good loans. And frankly, it's a very common platform that runs with a lot of the multifamily platforms. So, if you look at most of the multifamily platforms, they also have a small balance commercial platform. So, very strong area, strong debt service covers, full personal guarantees.

I was looking back at the transcript from a quarter ago and I guess your tone was pretty optimistic that the Block deal will be closed relatively shortly after that or in a recent -- a soon time period anyway. Just curious like what's gone on over the last 90 days or so, but why we haven't heard anything? What can you tell us, like what the regulator has been saying? Just curious on update there?

Yes. We have been in conversations with the regulators as early as this week. We know exactly where we are. I think my comments retain that optimism and what I believe I said before was that we felt good about being able to get the deal done for this tax season. I still feel good about that, but we look at something that's not absolutely done till it's absolutely done. So, we also have to make sure that we are in a perfect alignment with Block as well and just ensuring that we're getting the cross-sell opportunities out of this that we need to get and getting the appropriate level of fee compensation and that sort of thing, but I feel good about it. It's all going to work its way through and I think we'll be ready to go for this tax season.

Julianna Balicka, KBW.

A few questions if I may. One, kind of picking up on the H&R Block Bank question -- topic. And then, in terms of the cross-sell opportunities for the IRA accounts, the H&R Block Bank will contribute to end growth of said accounts. Could you give us more color about your thoughts about growing that segment? And also, what is the profile of such customers? I mean why would they be keeping those monies in cash et cetera?

Yes. You know that we are getting about 300,000 IRA accounts, if and when that transaction closes. And then we believe we will have future opportunities that may not be able to come in to play from the tax season to have the tax advisors originate IRA products. And I think that just in general, I am not speaking particularly about Block customer demographics, but just speaking broadly about this, is that what happens is just based on the tax rules at a particular point in time where someone's doing their tax return and if they are not late and they are doing it before April 15, the ability to have an opportunity, to seamlessly open an IRA account and save immediate dollars on that funding is important.

I think that the level of return associated with that over some short [curated] period of time is probably less important than the ability to save on that tax side. Now that being said, I think you bring up an interesting point in one sense and that is what if they are not over time, that level of customer base might provide some basis for some sort of robo-advisor model or something that would provide an expanded set of investment options, but it's a nice source of customer acquisition. We've still got to get through all the little details, but we feel like we're pretty good about being able to cross-sell our customers on checking accounts and things like that, particularly given the quality of the checking account product. So, those entrees are helpful in that regard.

In terms of cross-selling to these customers over time, maybe eventually robo advisor, but more near-term the checking accounts. Are you able to cross-sell right away or is there like a waiting period before you can approach these customers for bank products?

Yes. I mean we haven't fully disclosed that, but on the IRA side, I have said publically before that we don't have any prohibitions of any kind. I think that just from a logical perspective, if we were going out and selling net bank accounts to Emerald card holders that there might be a conflict, but those things are things that will be well worked through and they'll be thoughtfully construed. And we believe, as I said, that we'll have nice cross-sell opportunities through this.

And one more topic on this, just a different question, then I'll step back into the queue. You have mentioned in your answer right now -- to Andrew just now, that you want to make sure that fee structures are well aligned for both of your shareholders. I think you just said that. So should we be thinking about there being some different kind of -- final agreement being different than what was initially inked or is that just simply, did I mishear you or misinterpreted?

No, look, I think you should think of these things as substantially in line and not read too much into it. We're confident that we'll get something done. Obviously, it still has to go through all these approvals. My only point was that there is the regulators involved, there is Block and us, and everybody have to get together and make sure everybody is aligned in every respect. And that's what it takes to get a deal done and that's all I have to say about it.

Okay. And then just another question and I will step back. Could you refresh our memory what the average size is of your retail deposit customers in transaction accounts and the average balance sizes of your business deposit accounts?

Yes, Andy is going to get that for you.

So, the average total across the entire deposit network is about $106,000. So that includes both CDs and checking and savings. On the checking and savings, because of the business, we're actually averaging about $100,000.

The consumer side is much, much lower though. On the consumer side, that's not a particularly helpful number. The consumer side is much lower. It depends on the brand, but it's generally more in the 10,000 range for Bank of Internet and then for NetBank it's 1,000-ish.

This 1.000-ish for NetBank, 10,000 for Bank of the Internet and about 100,000 for the business checking?

Yes. That's about right.

Bob Ramsey, FBR.

First question I have for you, I know, Greg, you sort of gave a margin outlook that's pretty consistent with where you are. Just curious if that applies sort of all of fiscal 2016 looking forward or if that's really more focused on the next quarter.

That's a target for us. That's an inspirational target and we hope to achieve it. We feel pretty good about way that looks, just looking at where we are from our current business perspective. The C&I side is robust, it's growing. It's accretive to that yield. Multifamily is very competitive. Single family is very stable. The small balance CRE can add a little top to that. Structured settlements and lotteries are a lot higher. We think that with all the stuff we are doing, we are seeing a real ability to continue to reduce our cost of funds as we provide other value to customer.

We just see more business customers coming in where we don't have to pay them anything on rate, we are able to just do these things on earnings credit or lower fees on cash management. So, we are seeing a lot of real benefits and when you look at our actual deposit cost, they've really really improved. In that cost of funds, we have lots of 10-year CDs and that's pushing up the overall cost of funds to around 1%.

So, we are obviously hopeful that all the things that we are doing on the deposit side, we'll be able to continue to lower any gap that we have with branch-based banks. And we think if we can execute our digital strategy, and this will be in the way that we want to, over multiple years, that we hope our goal to be right on top of the funding cost of branch-based banks because of the digital experience and because of the fee structure that we have and still maintain our efficiency ratio.

And obviously I think that -- I have articulated that internally for a long time and people thought I was pretty bold, but we've moved decently there. And with the growth in business, with the growth in the cash management side, the growth in checking, all those sort of things, prepaid, if we get Block done on the IRAs and all that kind of stuff, I think we will really come together. So, I'm not going to say that -- we don't give long-term predictions, but that's a target of ours and something that we are trying to achieve.

Along these lines, you talked about the funding. You had a nice pickup this quarter in the non-interest bearing demand deposits. I might have missed it if you mentioned it on the call, but what drove the growth there this quarter?

Cash management growth just and there's some nice fee income pickup in those businesses too. So there is some pretty significant cash management customers that I think are sort of reflective of the early success of effort we are putting there. And we are such in early innings with regard to what we are doing there, but there is just so much opportunity. We have more opportunity -- we have more customers than we can actually board. So, we have got to obviously develop enhanced capacity there. We have got a new cash management system that's much more robust coming on. And so, we are really -- we are pleased about that and we just have to keep it going.

When does the new cash management system come on?

It's being tested. I think, worse case, probably three months from now, October-ish, something like that. We are going to run it with only a few customers for probably a quarter just to avoid any kind of negative impacts, but it's close.

Makes sense. You said the yield on the traditional resi-mortgage business was stable. Is the yield so kind of -- I think 5% or so you all talked about, is that still the right level?

Yes. It's around there. So, maybe [$0.01 under, $0.01 over at] different times, but that's about it.

I think I missed (inaudible). Can you run through the pipeline numbers again as far as what the pipeline is on the different portfolios?

Sure. So the single family jumbo pipeline was $467 million, $136 was single family agency, $102 million for income property, which includes multi and small balance CRE, and $216 million for C&I. Now that was as of the end of the quarter. Right now single-family pipeline is very robust. That's lot better than that. I think every area is looking really quite good with one exception that is looking okay, but this is more stable, is multifamily. We are sort of plugging that with [the sum of some of the] small balance commercial there. And so, I think we will be able to grow that, but the mix might change a little bit between multifamily and small balance commercial.

Speaking of the strength in single family, you obviously had a good quarter for mortgage banking in this quarter. Is there anything unusual there and is it fair to sort of expect a little bit of a seasonal slowdown in the back half of the year?

It's a little bit hard to predict. I think that the seasonal slowdown -- some are -- you can start to have a little bit reduction in purchases towards certain parts of it and then it comes back. I think where you really get that seasonality is in the holiday season, our second quarter. And that shows up in third quarter, because you got your mortgages and your loans just in general, even on the C&I side, that people just don't what to be doing that stuff generally over the holidays. And so then that makes our third fiscal quarter, first calendar quarter, a little slower. We have usually seen that.

It's interesting, we are doing so much on the data analytics side and we are doing so much more on having some dedicated digital marketing folks on the mortgage side. That we are really seeing an incredible pickup in leads even in markets that are lower. And we are having very strong swings away from dependence on Costco to a lower-cost lead. The Costco leads are great, they are high-quality, they close well, but in general, they are not expensive relative to the market, but they're expensive relative to folks that find you organically. And so, there's really so much going on there, but our limitations in mortgage banking have been more capacity related.

And I've never wanted that business to get ahead of the other businesses because of its inherent volatility, but we need to probably have other locations outside of Southern California, where we can grow and just access different labor pools. We've done well here and we have good people, but we're going to obviously have a presence here. We have to add some capacity at other places. The limitations we have on mortgage banking, things like that are really more operational in nature than they are platform based.

And we also expect to have -- if Block gets done and obviously that will get approval, et cetera, et cetera, but we also expect to have a mortgage relationship with them and the strength and quality of that will have to be defined, but we do think that, just by the nature of that size, it should be something that would assist in that growth.

Don Worthington, Raymond James.

Any more color on -- you mentioned in the press release you're working on efficiencies as it pertained to vendor cost reduction. Just looking for a little bit of an idea of what you are doing there.

Yes. Sure. I think I outlined maybe a quarter ago our approach to cost management. In the first part of that cost management, what we did is we went through and we looked at -- we kind of did a typical like McKinsey PSM study and we looked at all purchases that we made. And we went through those and we took large vendors or consistent vendors where we had longer-term contracts with them. We took those and put them in a second phase. And we started in the first phase looking at all the little things that we spent money on and figuring out how to improve the efficiency in each of those areas.

And there are lots of things that came out from it, some funny and then others the people just got used to, like reading on two sides of the paper and not printing in color and things like that, right. Not all having printers at their desks where the cost of toner was a lot higher. So all that sort of stuff. Then, the next phase of this really has two prongs. One prong is the measurement of efficiency around repetitive procedures that operational personnel do to understand the time it takes, impediments to that. And then the prong, the second prong in our second phase is a systemic review of vendors and a process by which those vendor contacts get bid out.

So, a good example and I mean I guess I can kind of have a [major call for here], because we have such a great efficiency ratio, but here we just had our contract for personal computers, laptops and such go through the vendor management process. And there was a way that we were supposed to be buying in bulk and estimating needs and things like that. And the fact is that that wasn't a sufficiently competitive bidding process that was formalized, moving up rounds in order to go and do that and so the vendor management team, which is at office of the CEO consulting team that goes around, does some other things, they'll also tell you about it and they went through and they think that there is a very significant savings there.

From a better estimate on the demand side and then simply going through different enterprise purchasing groups rather than how we were purchasing things and storing a little bit of the inventory of those computers on site rather than getting them shipped regularly, those sort of things. So that's a simple example of that, but there is a variety of techniques that are embedded in these PSM sort of areas. That sort of saving was sort of a low-hanging fruit and things obviously we should be doing, but in some cases we were, some cases we weren't. Maybe not as consistent.

Then there is the process-oriented approach, which I don't think that's part of our cost management initiative so much as it is -- some of it [that I think give cadence] to the entire culture of the bank. And that is the focus on process diagrams and then continuous improvement initiatives associated with each of those process diagrams. There is very strong transparency around how we are doing things and then a series of centers of excellence that can then improve those processes. So if there is a system that doesn't tie to one another, there is a middleware center of excellence that will go in and fix that and eliminate the manual uploading of something or rather whatever it is, tax information, the address information, so you get good tax data for escrow, things like that.

So that's really the whole process. And what I really feel good about is we've invested a bit in that group. We've expanded that consulting team. We've just hired a very senior partner, who did ops consulting for about 20 years with a lot of the big firms. He is coming in to help the people who are running that now. And it's just amazing even in our organization how many great opportunities there are to improve process and get everybody involved in that. And I think it makes this place for the right people and exciting place to work, because they got the opportunity to participate in that and think about how they do things rather than just doing them.

And then any update on the private bank brand and also the auto lending product?

Yes, the [vertices are] continuing to grow. The product side there is a little slim right now. We haven't given exact numbers, but it's over $50 million in deposits. It's continuing to grow. We think that the broader and overall strategy there, we are going to need to add some products on the trust side and the IRA side, things like that. It's going to be a slow incubation, but we are absolutely seeing traction and getting customers who otherwise would not necessarily be comfortable working through an undifferentiated call center environment.

So that simple value proposition of providing a relationship manager via the call center in an efficient way is getting people over the hump and comfortable. Lot of CEOs in town, things like that. I mean, frankly, some of them are people I personally know, but others aren't. And so there is good growth there. We still need to do some work on the products and we haven't even done any marketing. We haven't indexed the site. It's been a very soft launch.

The auto side, I think that's sort of typical of how we like to start things. We do these things very methodically. They are doing well. Their systems are up and running pretty much. They are still manually boarding loans in the Jack Henry, which we are working through that. That's one of the projects where we are getting going. We are not expecting to do it on a volume there, but that is an example, getting that product ready as an example of what we need to do to be able to exploit cross-sell opportunities with large groups of customers.

So, just alone, if you have 300,000 IRA customers and you are able to use data to be able to figure out where auto lending opportunities are, having that platform there, having it integrated into the account opening engine, all those kinds of things are what we're looking to do there. So it's going to be a longer-term initiative, but I think it's important, because it represents our push into some of these more homogenized consumer products, where if you think about how banks typically use data, you've got those who are pretty good at using for sourcing and I think we are pretty good at that. And then, there are others whether they are non-bank or others that are getting better at using it for underwriting, and that's an area we need to improve. So this is the first push into that.

But I wouldn't be modeling big numbers there for this year. We have in our business plan something like $10 million to $20 million or something to give you a sense. It's not expected to be much. It's expected to be a platform basis to do other things in the future.

Gary Tenner, D.A. Davidson.

Greg, you had mentioned that in the multifamily portfolio you expected it to be a little more, I guess stable. Is that just given an increased level of pre-payments in that portfolio and was that a contributor to the higher pre-payment fee income here in the fiscal fourth quarter?

Yes. It was, but, frankly, it's not that many loans that contribute to the high level of pre-payments. So, if a guy gets to sell his apartment building at his 3% cap rate and he has got a loan with that he took out a year and a half ago, he might have a 4% prepay on it. And that starts to add up pretty quickly. So, I am not sure we are thinking that there is -- you know that portfolio was fairly well protected from prepays given that they all do have stiff prepayment penalties, but it's more just competition. And it's not only that, it's also that we kind of have a little bit less stomach for the belief that a property should trade at the 3% cap rate. And so then if people are chasing those from an LTV perspective, then you start to be debt service cover constrained on the loan amount. So some of those are just going to other banks.

And I think that's why we have such diversity in what we do. We are not going to chase stuff and if it goes somewhere then that's fine. I think there are things that we can do in that group though that will make it better and more efficient. I mean there is an opportunity to do more stuff on the direct marketing side, more stuff on the data side. Get better at that and push volume and we will be working on that. I don't want to use the market as an excuse, but I do think it is a reason.

Thank you. My other questions were asked.

Edward Hemmelgarn, Shaker Investments.

Couple of questions. One, Greg, can you talk a little bit about your equity levels? I know you've been opportunistic about taking advantage of the current market prices, but is there some level, kind of upper level, that you are, as a percentage basis, that you are interested in going to?

Yes, I mean one of the things that we've been thoughtful about is just making sure that we have the capital necessary for our growth. And then, we've looked forward and although, obviously, I am reasonably positive and I think about the Block transaction and then -- we've had to think about the seasonality of how those deposits come on and off too. So I think that -- assuming that transaction gets done, I think it's safe to assume that our capital levels probably would be more in the low-ish mid-9 range rather than in the high-8 range. So, I think that's something to think about, because there is some seasonality in those deposits.

Now frankly, the interesting thing is that as we have got a lot bigger that's gotten to be a little bit of an issue, but it is something that we have to think about. And what we didn't want to do was have to have some sort of big capital raise associated with the transaction. So, we've just been thoughtful about all those elements.

Maybe I am missing something here, but why would that necessarily impact your capital? I mean given the fact -- I mean unless you put on assets to -- or loans too to coincide with deposit --?

I think, well, in general the reason why is that some of that cash get into taxies and moves on and because it's going to move off quickly, it's not prudent to do anything with it, right. So if there is a movement in and a movement out, it's not prudent to put that in some sort of loan obviously. You need stable funding for that. So in that case you have to just consider that. And that still though, even cash does impact capital ratios.

Don't you have the flexibility to adjust like your borrowings at the said window though too?

Well, you do to some extent. I mean obviously there is liquidity that you need to have for the bank and liquidity you need to have for the payment of the tax refunds to customers and things like that. So it's a fairly complex calculation. And if and when we get all this stuff done, we will have a call that will go through a lot of that stuff.

And then lastly, I've noticed that you seem to be getting to be reasonably successful by putting the mortgage sourcing rights on from your agency gain on sale mortgage originations. I am assuming that basically the sourcing operation is combined with the servicing for your jumbo loans that you hold. So is that a pretty efficient operation right now?

It's a good operation. Whether it's as efficient as it should be, I would say that they have their -- it depends on who you are comparing them to. I mean I think they're pretty good for a bank of our size, but they are not where they need to be. They had the opportunity to go through an office of the CEO consulting review and they have got a lot of enhancement and continuous improvement opportunities to some of their processes that we are working on. But there is the scalability there that we are really focused on. I think that's an example of how we think about newer businesses. And we started retaining our first MSR for agency, is it almost two years ago or?

Yes.

Two years ago. And we built that slowly and just made sure we were doing it properly. And we got our (inaudible) ticket to issue securities too. So I think probably within next three months here we will issue our first security. And it is that broader part of capability building at the bank and there is an ancillary benefit obviously to it is as that portfolio of servicing rights would grow, there is a retention benefit associated with the origination side of the house where you can often make sure you get a shot at the refinance.

So there is an inherent limitation to that portfolio based on the capital rules, but we are very, very far away from that and I think even with the dramatic expansion of our mortgage banking operation, we could retain 100% of are servicing, which we think is very high quality based on our negligible to non-existent level of delinquencies in our sole loan book that we could keep 100% of our MSRs for a long period of time.

Okay. Congratulations. Thanks for a great year.

Thank you very much, Ed. Thanks for your support. All right. Thank you everybody and we will talk to you soon. Take care. Bye-bye.

That does conclude today's conference. We would like to thank you for your participation.