Axos Financial Inc (AX) 2016 Q3 法說會逐字稿

Greetings and welcome to the BofI Holding, Inc., third-quarter 2016 earnings conference call. (Operator Instructions) As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Johnny Lai, Vice President of Corporate Development and Investor Relations for BofI Holding. Please go ahead, sir.

Thank you, Kevin. Good afternoon, everyone. Joining us today for BofI Holding, Inc.'s third-quarter 2016 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 the financial and operational results for the three and nine months ended March 31, 2016, and they will be available to answer questions after the prepared remarks.

Before I begin, I would like to remind listeners that prepared remarks made on this call may contain forward-looking statements that are subject to risks and uncertainties and that management may make additional forward-looking statements in response to your questions. These forward-looking statements are made on the basis of current views and assumptions of management regarding future events and performance. Actual results could differ materially from those expressed or implied in such forward-looking statements as a result of risks and uncertainties. Therefore, the Company claims the Safe Harbor protection pertaining to forward-looking statements contained in the Private Securities Litigation Reform Act of 1995.

This call is being webcast, and there will be an audio replay available in the Investor Relations section of the Company's website located at BofIHolding.com for 90 days. Details for this call were provided on the conference call announcement and in today's earnings 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 third quarter of fiscal 2016, ended March 31, 2016. I thank you for your interest in BofI Holding and BofI Federal Bank.

BofI announced record net income for its third quarter ended 2016 of $35.914 million, up 70.4% when compared to the $21.074 million earned in the third quarter ended March 31, 2015, and up 27.6% when compared to the $28.149 million earned last quarter. Earnings attributable to BofI's common stockholders were $35.837 million or $0.56 per diluted share for the quarter ended March 31, 2016, compared to $0.34 per diluted share for the quarter ended March 31, 2015, and $0.44 per diluted share for the quarter ended December 31, 2015.

Excluding the impact of after-tax net gains related to investment securities, adjusted earnings for the third quarter ended March 31, 2016, increased $14.4 million or 66.9% when compared to the quarter ended March 31, 2015.

Other highlights for the third quarter include total assets reaching $7.7 billion at March 31, 2016, up $1 billion compared to December 31, 2015, and up $2.2 billion for the third quarter in 2015. Excluding H&R Block temporary seasonal cash assets, linked-quarter asset growth would have been $491 million and year-over-year growth $1.6 billion.

Noninterest income was $23.3 million, up almost $15 million year-over-year, primarily due to the strong fee revenue from our H&R Block partnership. Return on equity reached 22.59% for the third quarter, well above our long-term target of 15% or better. Efficiency ratio was 31.66% for the third quarter of fiscal 2016, compared to 34.57% in the second quarter of fiscal 2016, and 34.46% for the third quarter of fiscal 2015.

Net interest margin was 3.85%, compared to 4.1% in the second fiscal quarter, and 3.85% in the third quarter of the last fiscal year. Excluding the seasonal deposits and loan products related to our H&R Block partnership, net interest margin would have been 4.02% in the third quarter of 2016, an increase of 17 basis points over the third fiscal quarter of 2015.

Our loan units had another solid quarter, with $1.1 billion in gross loans originated in the third fiscal quarter. Ending loan balances grew by 6.9% over the second quarter of fiscal 2016, which equates to a 27.6% annualized growth rate.

The performance of our lending groups is reflected in $389.4 million of loan growth this quarter, a 30% increase over the third quarter of fiscal 2015. The primary drivers of our organic loan production consist of: $93 million of single-family agency-eligible gain on sale production; $404 million of single-family jumbo portfolio production; $29 million of single-family non-agency-eligible gain on sale production; $90 million of multifamily and small balance commercial real estate secured production; $331 million of C&I production; $18 million of auto production; and $17 million of Emerald Advance originations.

Additionally, we acquired approximately $140 million of equipment leases at an average rate of approximately 7% from Pacific Western Bank. The transaction closed on March 31, 2016.

Our outlook for loan growth remains positive, with a loan pipeline of approximately $979 million consisting of: $540 million of single-family jumbo loans; $149 million of single-family agency mortgages; $77 million of income property loans; and $213 million of C&I loans, including the newly purchased equipment finance business.

For the third fiscal quarter's originations, the average FICO for the single-family agency-eligible production was 756, with an average of loan-to-value ratio of 66.4%. The average FICO score for the single-family jumbo production was 708, with an average loan-to-value ratio of 60.5%.

The average loan-to-value ratio of the originated multifamily loans was 58%, and the debt service coverage ratio was 1.36%. The average LTV of the originated small balance commercial real estate loans was 55.1%, and the debt service coverage was 1.44%. The average FICO of the auto production was 763.

Our asset quality remains excellent, with 1 basis point of annualized net charge-offs and 31 basis points of nonperforming assets of total assets.

At March 31, 2016, the weighted average loan-to-value ratio of our entire portfolio of real estate loans was 57%. Given that these loan-to-value ratios use origination date appraisals over current amortizes balances in a generally appreciating housing market, these historic LTVs generally overstate the true loan-to-value ratios in the portfolio, providing a further margin of collateral security.

In single-family jumbo mortgages, representing 58% of our gross loans outstanding at March 31, 2016, the average loan-to-value ratio was 58%. At the March 31, 2016, quarter 55% of the single-family loans have loan-to-value ratios at or below 60%; 38% have loan-to-value ratios between 61% and 70%; only 6% have loan-to-value ratios between 71% and 75%; and approximately 1% between 75% and 80%; and less than 1% have a greater than 80% loan-to-value ratio.

The LTV is calculated by using the current principal balance, divided by the original appraised value of the property securing the loan. Our lifetime credit losses in our originated single-family loan portfolio represent less than 2 basis points of loans originated.

We had approximately $1.3 billion of multifamily loans outstanding at March 31, 2016, representing approximately 21% of our total loan book. The weighted average loan-to-value ratio was 55%, based on the appraised value at the time of origination. Since multifamily properties have generally appreciated in the majority of the markets where we lend, we believe these reported LTVs are overstated.

We do not have risks hidden in the tails of our portfolio. Approximately 60% of our multifamily loans are under 60% loan-to-value; 32% are between 60% and 70%; 7% are between 70% and 75%; and less than 1% of our multifamily loans have a loan-to-value ratio above 75%. Our lifetime credit losses in our originated multifamily portfolio is less than 2 basis points of loans originated.

The credit quality in our C&I lending book remains pristine. We have no direct energy exposure and no shared National Credit exposure to any oil, gas, or oilfield services firms in our loan portfolio.

Our commercial and single-family lender finance loans are first liens on pools of financial assets at low leverage points. These lines of credit to non-bank financial services companies are fully reflected on our balance sheet.

The underlying collateral of these lender finance facilities, which is residential or commercial real estate properties or non-real estate-related loans or receivables, is contributed to a Bank co-promote special purpose entity owned by the non-bank financial services company to ensure that the Bank has collateral that is segregated from a legal perspective in the unlikely event of a bankruptcy. The use of special purpose entities by the Bank in this business is usual and customary in the industry and represents prudent practice.

Our credit team monitors the borrowing base and the underlying collateral values of loans securing our lender finance facilities to ensure that our borrowers maintain the required significant equity cushion in the underlying collateral. In the event loans or receivables in the collateral pool fail to perform as required by the loan documents, we require our borrowers to replace the delinquent loan with a different loan that meets our eligibility criteria, reduce the loan balance to comply with the current borrowing base calculation, or provide additional cash collateral.

These borrowing base restrictions ensure that the collateral which the Bank is attaching at a loan loan-to-value ratio does not deteriorate in quality. These protections, coupled with our low effective advance rates on these performing loans have resulted in no losses in our C&I lender finance book since its inception. We have also not had a charge-off in our C&I lending portfolio to date.

On March 31, we closed the purchase of approximately $140 million of equipment leases and the assumption of 25 employees of Pacific Western Equipment Finance, headquartered in Salt Lake City, off from Pacific Western Bank. We paid a purchase price premium of approximately 2.5% on a net book value of approximately $140 million of equipment leases, with a weighted average rate of approximately 7%, and paid no additional premium for the business.

The addition of the Pac West Equipment Finance team gives us a strong credit underwriting team and a direct nationwide sales platform in the equipment leasing space, a market we believe offers good risk-adjusted return opportunities. The team has robust direct sales origination capabilities through a team of seasoned salespeople with strong relationships, and an indirect sales origination capability through a trusted third-party referral network.

The strong credit underwriting processes that exist in the leasing business are consistent with BofI's disciplined risk management culture. We cherry-picked through the equipment leasing portfolio prior to purchase to remove any energy exposure or other credits that we do not wish to assume. This business has a long history of operating with low credit losses, including through the last credit cycle, where loss rates did not exceed 90 basis points annually in the worst performing year.

Operating under the regulatory framework of a publicly traded FDIC regulated bank for the last four years, the group understands how to comply with bank standards and guidelines. Their expertise in underwriting and restructuring credits, developed and refined over decades of lending through a full range of credit cycles, will help ensure we properly manage our risks. We will leverage the platform and the personnel from this group and develop more advanced marketing and data analytics capabilities to grow this business in an efficient manner.

Unlike some other banks, we do not have commercial real estate loan concentration issues. We have grown our commercial real estate loan book in a controlled manner by identifying attractive properties with a strong cash flow profile. With the personnel and infrastructure investments we have made over the past years, we have sufficient capability and capacity to generate organic growth in our commercial real estate loan portfolio over the next several years.

We originated $18 million of prime auto loans of the quarter ended March 31, 2016, up 50% from the $12 million in the prior quarter. Our strategy in our auto lending business is consistent with that of all our other new lending products: expand slowly and deliberately; build a solid operations and risk and compliance infrastructure; anticipate product needs of our low-cost distribution partners; identify niche lending opportunities; and create flexibility as to whether we balance sheet, securitize, or sell in whole loan form our production. We believe our risk selection in this new business is prudent, with an average FICO score of 763.

Our loan losses remain healthy, at 154% of nonperforming loans at the end of the third quarter. We had 1 basis point of net charge-off to average loans in the third quarter, and 2 basis points of net recoveries for the nine months ended March 31, 2016, making our 61 basis point loan loss reserve to total loans and leases sufficiently strong.

Turning to the funding side, total deposits increased 38.4% year-over-year and 16.3% on a sequential basis, with growth across a variety of consumer and business deposit categories. Checking and savings deposits grew even faster, increasing 44.8% year-over-year. Checking and saving deposits increased by approximately $1.6 billion to $5.1 billion at March 31, 2016, representing 85% of total deposits, an improvement from 81% a year ago.

The strong deposit growth this quarter reflects continued success diversifying our funding sources and improvements in various marketing and data analytics initiatives. Of the Bank's overall deposit base, we have approximately 33% business and consumer checking, 30% money market accounts, 5% IRA accounts, 7% savings accounts, and 9% prepaid accounts.

We had particular success growing our BofI Advisor and small business deposits this quarter. As we test new cross-marketing initiatives across various consumer and business banking brands, we see lots of opportunities to further solidify our relationships with our customers.

Furthermore, we are expanding our commercial banking group to continue to attract commercial cash management customers and expand into new specialty deposit categories.

We've completed a very successful first tax season of our long-term strategic partnership with H&R Block. The fee income related to the Refund Transfer and Emerald card businesses provided a significant boost to our noninterest income this quarter.

We are the BIN spon issuer for H&R Block's Emerald card, a general-purpose, reloadable prepaid card offered through H&R Block stores and online channels. In addition to the fee income from this business, we also hold deposits for each Emerald card holder in an FDIC-insured account, providing us with no-cost deposits.

As we previously mentioned, the Emerald card deposits searched surged in April and March due to a certain percentage of Emerald cardholders choosing to have their tax refunds loaded onto an Emerald prepaid card. Because the majority of the Emerald card deposits are transitory in nature, we only use the non-transitory component of these deposits to fund our loan growth.

We have engaged in some early discussions with H&R Block about ways we can increase the usage and longevity of the Emerald card, which is the third largest prepaid card in the United States. We continue to expect that the three initial products in the H&R Block program management agreement will generate close to $34 million of annual revenue and approximately $16 million of annual net income after incremental expenses.

While the timing of that revenue and the earnings contributed shifted slightly from our initial expectations, we are extremely pleased with the results in our relationship with H&R Block. We are currently working on software integration with H&R Block so that we can execute seamlessly on our exclusive right to cross-sell Individual Retirement Accounts through H&R Block tax offices and through H&R Block's digital channel next season.

H&R Block has success offering IRAs through their retail channel for a number of years, generating upwards of 100,000 new accounts per year. By making the process seamless to the customer and tax advisor at the point-of-sale, we see this as another great opportunity to add new deposit customers through a low-cost acquisition channel.

Our efficiency ratio was 31.7% in the third quarter, well below our long-term target of 35%. Our corporate management framework is deeply embedded in our culture and built on the pillars of operational excellence, management accountability, prudent risk management, and a culture of continuous improvement that enables us to remain efficient and nimble.

Our scale and operating leverage has allowed us to maintain industry-leading efficiency ratios while continuing to invest in existing businesses and customer segments and incubate a number of new lending, fee, and deposit businesses. We are also continuing to ensure that our risk management infrastructure and personnel are sufficient for us to maintain our excellent regulatory standing and ensure that our regulators continue to believe that our risk management infrastructure is commensurate and appropriate for our growth.

To provide some context to our level of commitment to risk management and compliance, we have over 130 professionals in our credit, credit administration, enterprise risk management, compliance, BSA, internal audit, and quality control functions. We continue to focus on providing our risk management professionals with enhanced tools to perform their roles.

Our data-driven compliance framework allows us to automate a number of compliance review functions that are more repetitive in nature, which frees up more time for our compliance staff to focus on more complex tasks. The compliance framework also streamlines our monitoring and review processes in order to analyze and filter more data faster.

We are almost done implementing a process-based enterprise risk management system normally utilized by much larger banks that will provide us a strong core infrastructure to scale our operations significantly and ensure continued strong regulatory compliance and maintain our excellent regulatory relationships.

We have made good progress in our multiyear investments in our universal digital banking model. Our vision is that by building systems, processes, and partnerships that allow BofI to offer a seamless user experience and access to multiple services offered by us, or by potential third-party providers through an integrated software platform, we will differentiate our value and proposition, personalize the user experience, and encourage more customers to use BofI as their primary banking platform.

The virtuous cycle of convenience leading to higher client engagement and the Bank gaining more intelligence about customer wants and needs is the formula that companies such as Amazon and Google have already exploited successfully. This concept, still in its infancy for the banking industry, provides opportunities for companies with the business model, commitment, and flexibility to establish a competitive advantage through consumer and business software systems.

We incurred incremental costs related to investments in our next-generation retail banking platform the last two quarters. We firmly believe these investments will generate significant long-term returns as we build our next-generation digital banking platform, our personalization engine, and expand our digital product set. By way of example, we increased our software development capability by adding 46 software architects, UX designers, and programmers over the last six months.

Before I turn the call over to Andy to discuss our financial results, I'll provide some brief commentary on the recently filed amended complaint and the recent anonymous short-seller hit piece that appeared, coordinated with the legal filing, and the timing of the recent options expiration. On April 11, 2016, the strike suit lawyers filed an amendment to the existing class action filed against the Company on October 15, 2015. The strike suit lawyers' revised complaint is riddled with numerous misrepresentations, outright fabrications, factual inaccuracies, out-of-context statements, and mistaken application of regulatory guidance and law.

We will address the multitudinous deficiencies with this frivolous lawsuit in court.

The amended complaint is unimpressive as legal work, but had some share price impact when incorporated into a short-seller hit piece timed around the recent option expiration deadline. Despite the capital markets impact, there has been no impact on the performance of the business, as today's outstanding results and our growth plans demonstrate.

The Bank is in a strong regulatory standing with no enforcement actions; has not been fined a single dollar by any regulatory agency; and has not been required to modify its products or business practices. Additionally, we do not foresee any future impact to the underlying business as a result either of the frivolous lawsuits or the short-seller hit pieces.

We have a proven track record of managing our Company through a variety of competitive, economic, credit, and regulatory environments while maintaining industry-leading returns and efficiencies. The fact that we completed a $50 million debt offering, received an investment-grade rating from Kroll, closed the Pacific Western Equipment Finance acquisition, and remain in excellent regulatory standing is clear evidence that the Bank has never been healthier.

We remain focused on serving all our stakeholders, including customers, employees, business partners, shareholders, and regulators. I want to thank all of our employees for their hard work and dedication, and congratulate them on SNL naming BofI the top-performing large thrift for the fourth straight year. Now I'll turn the call over to Andy, who will provide additional detail 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, BofIHolding.com.

Second, I will highlight a few areas rather than go through every individual financial line item. Please refer to our press release or 10-Q for additional details.

This quarter ended March 31, 2016, was the Bank's first income tax preparation season since it entered into its August 2015 long-term agreement with H&R Block, Inc., to offer cobranded financial products to H&R Block customers. The seasonal impact of income tax refunds received by H&R Block customers this quarter caused an expected increase in the Bank's fee income for the three months ended March 31, 2016, and an expected temporary increase in assets and deposits included in the balance sheet of the Bank at March 31, 2016.

Excluding the H&R Block temporary seasonal growth, consolidated assets and consolidated deposits at March 31, 2016, would have been $7.2 billion and $5.5 billion, respectively.

BofI had a strong balance sheet growth even after excluding the seasonal asset and deposits from the H&R Block agreement. Asset growth, excluding the seasonal growth this quarter, was 29.4% year-over-year and 29.5% annualized, compared to the last quarter ended December 31, 2015. Similarly, deposit growth this quarter was 25.9% year-over-year and 23.2% annualized growth, compared to the last quarter ended December 31, 2015, after excluding seasonal deposit growth.

As Greg mentioned, net loan portfolio growth was $389 million, comparing March 31, 2016, to December 31, 2015. This includes the acquisition of Pacific Western Bank's equipment leasing portfolio of approximately $140 million; but it also reflects a seasonal decline in H&R Block-related loans, which decreased $55 million between March 31, 2016, and December 31, 2015.

For the quarter ended March 31, 2016, our net interest margin was 3.85%, compared to 4.10% for the quarter ended December 31, 2015, and compared to 3.85% in the quarter ended March 31, 2015. The net interest margin would have been 4.02% when excluding the average balances associated with lower-yielding excess cash and the average balances in the yield earned on H&R Block-related loan products during the quarter, which is consistent with our strong net interest margins reported in previous quarters.

Our average loan yield was 5.31% for the third quarter of fiscal 2016, compared to 5.14% in the second quarter of fiscal 2016, and 5.03% in the third quarter of fiscal 2015. After excluding the impact of the H&R Block-related loans, our average loan yield would have been 5.10% for the quarter ended March 31, 2016, and 5.03% for the quarter ended December 31, 2015, which is net growth of 7 basis points. And that's even before adding the impact of the new $140 million of equipment leases that are added at about 7%, which will impact next quarter.

We also expect the new leasing team to originate between $80 million and $100 million in new leases annually at an efficiency ratio of approximately 40%, improving to 35% within the next year.

With regard to H&R Block-related income and expenses, we expect our results for the full fiscal year of 2016 to be in line with our high end of our original guidance of $16 million in net income for the year. We expect to realize approximately 18% of the total net income in the quarter ended June 30, 2016, reflecting an expected decrease in fee income next quarter compared to the peak this quarter.

As Greg mentioned, we're investing significantly in our future with increased staffing, systems, and software development. This cost should keep our efficiency ratio around 35% in the next couple of quarters.

The Bank is very well positioned from a capital perspective. The Tier 1 capital was 8.99% at the Holding Company and 8.62% for the Bank at March 31, 2016. Including the proceeds from our recent $51 million 6.25% subordinated notes offering, the Holding Company has more than $70 million in cash at March 31, 2016, that is available to be used for general corporate purposes, possible future acquisitions and growth opportunities, possible common stock repurchases, and to provide new capital to the Bank to support future growth.

For example, if we push down the entire $70 million as capital to the Bank, the Tier 1 leverage ratio would increase at the Bank from 8.62% to 9.57%.

With that I'll turn the call over to Johnny Lai.

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

(Operator Instructions) Bob Ramsey, FBR.

Hey, good evening, guys. I wanted to talk about the core margin and loan yields. Core margin came in better than we expected, and it looks like it's from those better yields on loans. Can you just talk about what drove that increase and what the outlook looks like?

Sure. In a nutshell, single-family is flat, multifamily is flat. C&I as a bigger percentage is higher, and the equipment finance business will generally be higher as well.

That's offset a little bit by some -- we had a benefit on the deposit side in the prior quarters from the H&R Block acquisition, which was very low-cost funds. So as we grow, there may be some slight increase in deposit costs that would somewhat offset that; but I do think that the loan yields outlook is reasonably strong.

Okay. Could you maybe touch on, with the new equipment finance business, what the loan yields look like in that business, and then also what losses or charge-offs look like over a cycle?

Sure. On the low end you'll see some 5%s; on the higher end, you'll see 7%s and 8%s. Their worst year was a 90 basis point hit. It tends to be somewhat sporadic, and they've had a lot of years that have been in the 20, 30 basis point range.

They don't have no charge-offs like we often do, but they do have some. But I think they do a really good job and I think it's a very good risk-adjusted return.

They have a nice pipeline. I think we're being conservative about what they can do and how we can help them grow. So I think it's a really nice addition and definitely will be accretive to margin, even after taking into account their relatively small losses they have historically had.

Okay, great. I guess putting it all together, next quarter you'll have less Block liquidity; sounds like your loan yields are stable-ish; plus you have some lift from the equipment finance; and deposit costs maybe tick up with a little growth.

Does that put you somewhere in the ballpark of 4%? Or what is the right range for next quarter?

Yes, Bob, I think we're still in that 3.80% to 4% range. I would lean to the higher end of that, given where we're coming out, without the Block impact. But certainly in the 3.90%s would be fair.

Great. Thank you very much.

Gary Tenner, D.A. Davidson.

Thanks; good afternoon. I just wanted to ask about the sequential-quarter increase in interest-bearing deposit costs, 89 bps to 1.02% from the December quarter to the March quarter. Was some degree of that pass-through of the December rate hike? Or what were the moving parts that drove up the interest-bearing deposit costs?

Yes, so that also includes the CD costs, correct, in terms of looking at total deposits? Or are you just looking at checking and savings?

No, total interest-bearing deposits.

Yes. We continue to build in the brokered CD area an additional duration in our project or in that portfolio. So last year we had about $300 million of long-term brokered CDs, and this quarter we have about $500 million with a weighted average life of seven years.

So we've we been slowly but surely building that CD piece. Of the CDs, $500 million really are longer-term seven-year CDs. That's what's influencing the cost as part of it. Then the rest would be just incremental growth, growing at a slightly higher rate.

Some of it is -- and that's -- some of it is pass-through some of the Fed hike as well.

And, Andy, what's the average rate on that $500 million of brokered CDs?

It is approximately -- I don't have that number right here for you. I'll see if I can get it for you.

Okay, appreciate that. Then I did the miss -- Greg, I think it was your comment in terms of your expectation for what -- the first-year production in the leasing division. What was that number?

We think conservatively it's $80 million to $100 million.

Okay. Great; thank you very much.

Brad Berning, Craig-Hallum.

Good afternoon. On the H&R Block transaction for the IRAs, I just wondered if you could expand a little bit more on the vision for that. I wasn't sure if you could clarify the 100,000 accounts that you were talking about.

Is that your business? Or are you looking for incremental business beyond what they are doing on their current existing product?

No. Well, we have an agreement with H&R Block whereby they will incorporate our IRA product into their do-it-yourself software system and into their tax preparation interview process. So that when appropriate, based on a tax customer's needs and whether or not they would benefit from an IRA, allow them to automate the opening of them IRA during the tax preparation process.

That is what we're talking about. That starts this next tax season.

The 100,000 was simply commenting on the fact that they've been able to historically generate a lot of IRA accounts as a result of that process. So the way we view that is a great source of customer acquisition, not only obviously for the IRA balances, which we believe are nice, long-term, sticky and relatively low-cost deposits; but also because we think that if we catch the customers at the time they're coming in then we have other good products to sell them, like our checking account which has no overdrafts, no NSS, unlimited ATM reimbursements, things like that.

So that's what we're hoping to do, and we have a path for that. That systems integration is ongoing. So the operational teams at the Bank and H&R Block are working together to bring that to fruition for the next tax season.

Okay. Then on the longer-term CDs that you've been adding, can you talk about the interest rate strategic view that you're taking? How much are you pushing your liability sensitivity?

Sure, sure. Like I say, we've moved the weighted average life of about $300 million, and we've increased that balance to $500 million. In that increase year-over-year we have extended from a five-year weighted average life to a seven-year weighted average life.

I think the basic philosophy is, of course, we do expect rate hikes to continue to march upward. It's important for us to fix some rate as rates rise, and we like using the brokered deposit mechanism.

$500 million is only a portion of our $900 million in CDs and is really not a huge piece of our $6 billion in deposits at the end of the period, but it allows us to help manage our interest rate sensitivity. And what's great about it, it doesn't require collateral. Other types of borrowings require collateral. Brokered CDs can't be prepaid and are effective tools for extending liabilities.

Understood. Real quickly on the universal digital banking model that you've talked about, the investments you've been making for the last couple quarters, can you talk a little bit more about what you are seeing from an opportunity set? What kind of time frames should we be thinking about, that you're thinking about going to market per se on bringing that model to vision?

Sure. We'll talk a little bit about what the model is and its components, and I'll talk about the timing. Our view is that we need to control our technology stack that faces to the consumer; and then in that technology stack, we want to be able to personalize the banking experience for those customers by providing value-added products inside the online banking experience.

That might mean, by way of a use case, that parents would be able to have debit cards issued to their children where they'd be able to have special control over those debit cards that would be available through their mobile phones, right? The idea is that we're able to develop that type of software quickly, deploy it quickly, test it, see if it gets traction, and give the customer a choice of whether or not they want to use that particular application at the Bank.

So what that -- so there is a platform that has to be developed, the online banking platform. there's one for business that has to be developed. And then there is also a set of products.

I would say that maybe the best way to think about what those products would be is to look at externally to a lot of the fintech companies and look at a lot of the monoline products that they've developed, whether it's roboadvisor, consumer installment lending, those sort of products. We see those products as being most suited for cross-sell personalization opportunities where the ability to sell a consumer installment product would be based on an understanding of the customer's history of direct deposits with the Bank, as well as an understanding of what the credit bureau said about their credit card balances.

We think that a lot of the fintech companies that are more monoline ultimately will have acquisition costs that are too high in order to sustain their models. So as part of what we're doing, we're building the verticals that allow us to have those products.

Right now the auto group is developing those processes to be able to produce auto loans. But over time that will be a product that will be delivered through a personalization engine, inside and behind the password, when we see that we can generate a cost savings for all those customers that we're going to have that we've generated and received through H&R Block and our other low-cost distribution channels.

So, it's a fairly ambitious project, but it's one that's going very well. We have a great prototype for one of the product verticals that I'm not going to talk about yet, but it looks fantastic. The UI is beautiful; the back-end processing engine looks really good.

Then we're working on a lot of interesting aspects and architectures related to the consumer online platform as well. This is a multiyear project.

There will be pieces of it that will be rolled out that would be beneficial to the Bank. We replaced our consumer online enrollment system as one of the first projects that we developed through this new team, and it reduced our cost -- even after amortization of the software cost -- by 50% to open a consumer account.

We then will be able to do something that we've not been able to do in the past, which is completely control that account opening process to allow us to personalize cross-sell or to add different features that arise over time. So if there is biometric authentication that suddenly gets popular on the iPhone or something, we'll be able to add that immediately to our software in a way that, when we didn't have control of that, we had to go to outside parties and it just took too long.

We're already seeing results of that software team, and then there's a lot of internal results, too, because the ability to have that kind of team present can assist in all the internal aspects of getting systems to work together and those sorts of things as well. So that's the vision.

That number I gave includes folks that work for us and contractors that are working for us on specific projects. So there is some flexibility there depending on our needs.

But it's really exciting. I think it's an incredible opportunity, and we've got a lot of enthusiasm ongoing related to it at the Bank.

Just to be clear, you're already seeing tangible benefits, on the expense side more so than the revenue side at this point, but looking for over time to drive more on the revenue side?

That's right. I think the only thing that's so far from a software perspective has been the online enrollment piece, which is a significant benefit. But that -- and that benefit comes from a reduced cost associated with the software acquisition -- the cost associated with the spend on an outside provider to process those accounts.

But yes, you will -- obviously the end result is you sell more loans of different types to your customers. You get greater deposit stickiness, because those customers engage with you because they have strong value to your platform. They like your platform and they stay with you.

Then over time we actually think that we have a strong ability to reduce cost by doing this as well. For example, we sign -- there's a lot of sub agreements, for example, for things like bill pay. Our bill pay cost with the sub agreement we signed is about 40% lower per bill pay than we're currently paying, which is a significant savings.

So over time at scale I do think you get savings out of this. But you have expenditures and investment over the next several years that -- we feel comfortable with the 35%, but we would be able to drive that down much lower if we weren't focused on the future as much as we are.

Brad, if I can interrupt, I did get the number since you asked and both -- I believe Gary asked on the brokered CDs, what the rate was for the seven-year weighted average life. It's actually a 3% number.

So of the average balance in the quarter, which was approximately a grand total of $847 million, $500 million is at 3%.

Thank you.

Edward Hemmelgarn, Shaker Investments.

Yes, hi, Greg and Andy. Could you talk a little bit about what your intentions are to grow some of the existing loan origination areas? I noticed as your balance and your overall size of the Bank has increased, some of these have stabilized at a certain level, like mortgage originations and multifamily.

Do you -- how can you develop these areas to add more people and to grow the businesses in a way that will keep pace with the overall size of the Bank?

Right. No, that's a great question, Ed. In each of those areas, they have strategic plans that are focused on continuing to scale those operations. In each business unit there is a unique answer to each question. I do think that in some cases -- I'll take each business unit and provide a commentary on each one.

On the single-family agency side, our primary issue with growing more quickly has been capacity. We've been more circumspect about having that capacity because there is some variation in demand. So we have plans to open a location in another state that will give us access to a greater number of individuals who can work with us.

There is some really neat software that we think we'll have in by next year on the single-family side that's going to make the process from a retail perspective a lot better. We also have opened the wholesale agency channel and are just starting to get that going. So from the agency perspective, we do have opportunities there.

Also we still haven't really gotten -- just given everything that we've been doing -- really cracked the H&R Block cross-sell area on the mortgage side. So we think that that on the agency side will make a difference.

The jumbo business is about growing both the retail and the wholesale component of that. We added someone to focus on that retail side and they've been doing a good job there. We have a number of data initiatives that are going on there that we think will bear fruit.

The multifamily side, partly it's geographic expansion on that side. It also is a reflection -- our numbers there are a reflection of a conscious choice that the yields and the risk profiles there have gotten to the point where we view those -- that business as a little less desirable from a growth perspective.

We're not going to follow everyone where they're going, and so I don't really know where that will go. I think it may have to go through maybe a little bit of a -- it seems like basically prices are leveling out. But it's been a very robust market for a long time and there's a lot of competition there competing in ways that we're not always 100% comfortable.

So I think that the reality from the growth perspective is that, as we get bigger, I think that it is natural that our assets and loan growth will not be as large from a percentage basis as it was in the past. Now I think that there is plenty of great stuff going on that will allow us to continue to grow at a rate that's very robust and much better than industry average.

But I don't think it would be prudent to put it in your models that we're going to grow, absent acquisitions, loans by 25% to 30% over the next three years. I just don't project that sort of loan growth.

Now, that being said, we have a lot of great stuff going on and we could have upside surprises there. But I think that there will be some natural attenuation of growth, although it will still be very good, as the size of the asset base grows.

Are there any areas that might -- that you are looking at where you can make investments in that offer opportunities to capture appropriate returns but also outsized growth? Similar to what you've done in the jumbo mortgage area by offering more -- being willing to look at the more detail of the borrower. Or a specialized niche like, let's say, something like Bank of the Ozarks has done in their commercial construction area over a long -- it took over a long period of time, but --

Yes, definitely. The growth area that -- when you're talking about C&I I guess now, we've been at it for long enough that you can put it in that category, there is an incredible set of growth opportunities there from a standpoint of just working on the bridge lending group, the lender finance group, the factoring business, the equipment leasing business. That business will have lots of verticals that will be able to grow assets in a very productive way.

We actually do end up seeing Bank of the Ozarks in the cities in which we're comfortable, so we'll see them every now and then competing on deals in Los Angeles and those sorts of things. So we do have a group that does some of that, where we're not as broadly spread as they are in the markets that they're in.

But -- so yes, there is great opportunity there. I also don't mean to say that there is not strong opportunity in the single-family side or in the small-balance commercial real estate side. I think we do have robust growth plans there, and I think we'll be able to continue to grow those originations over time.

But what we've really done is we've made sure that we don't sacrifice yield or credit quality, and we let the origination volumes fall where they need to in order to have both of those two primary goals met. Sometimes what that means is we're expanding in other product sets to make sure that we're keeping our yields and that we're also maintaining credit quality.

Okay, great. Thanks for another good quarter. Thanks.

Julianna Balicka, KBW.

Good afternoon. I had a few follow-ups. Some of the topics have already been raised.

One, in terms of the brokered CDs that you have been layering on, how should we think about additional growth in that line from maybe additional extension of duration and/or just more five-year, seven-years CDs in the next few quarters? Is there a target mix that you're looking for?

Yes, we're layering on about $30 million a quarter is probably the going-forward from this period, is about the way to look at it.

Is there a way to think about what is your expectation for how much of the -- to the cost of deposits that would have? A couple basis points a quarter? 5 basis points? How should we be thinking about the expansion in the rate there?

Right. I think it's going to be relatively small in terms of the incremental impact going forward from here for that piece. Because $30 million at 3% on average isn't going to move it all that much in terms of a basis point or two.

But as we look at all the deposits movements across our board as the Block deposits leave and we look at growth in those other opportunities, I don't see us necessarily doing an outsized portion of that. But I would just use $30 million at 3% for the next couple of quarters.

Got it; okay. Then skipping over to expenses, in terms of the expenses this quarter, what was the dollar amount that you can directly associate with the H&R Block bank products and business line?

What we tried to do is guide very specifically toward the forward number, Julianna, so that people can get right to what we're thinking the remainder of the fee income will be in the quarter coming up. We're thinking $16 million is the net income; 18% of that will be realized in the next quarter.

So that's about $2.9 million after-tax. Before tax, that's around $5 million of fee income.

You layer on about another $2 million of our regular Bank fee income and you're looking at Bank fee income with that coming out at about $7 million for next quarter.

There was a quite significant amount of cost in the other G&A line that was attributable directly to our share of origination expenses of the Emerald Advance loans.

So for example, in other G&A it was about $1.2 million of expense, was one of the elements of that. Now we don't expect that going forward because that related to the Emerald Advance, and we expect the expenses to be light going forward.

But I think if you're looking at what's left on the Block agreement for the balance of the quarter for June 30, I would guide you that way.

Well, but looking at it from the expense side, if I were to try to think about what were the components of your expenses this quarter, some component is your regular operating expenses of both the ex-H&R Block. Some of those are directly related to H&R Block, so something to think about for next year. What is the dollars amount associated with the fee income that you are generating?

And thirdly, what I was hoping to get at was also in terms of the investment spending that you've been talking about, what is the dollars that you have going on this quarter that you could pinpoint as infrastructure investments, growing the business? Because I'm trying to think about your efficiency ratio dropping back down to 34%, 35%, back up to your regular long-term efficiency rate with a higher investment spending yet no fee income from H&R Block. So I'm trying to reconcile those two.

Yes, I would say that I think the best way to reconcile it is to utilize the guidance that we have that we think without -- it's not without H&R Block -- but you should -- with the fee income that we expect to get from H&R Block next quarter and then in successive quarters, based on the fact that we've made a lot of these investments already, and we just -- and frankly there's a lot of opportunity for those investments and all the people that we have to get more efficient, do more projects, you should utilize 35% as the efficiency ratio; take the guidance that we provided on the revenue; and that will provide you the numbers that you require to understand what the approximate costs are from the investments that we're making in IT infrastructure and those sort of things.

The good part of that is a lot of that is already here. Now it doesn't mean that we don't need -- that we won't continue to grow. But we've done a lot of work in bringing people on and working on the sort of things that we need to do to make our vision come alive.

I see; so a lot of the costs are already in the run rate. Okay; that makes sense.

And one more question -- a couple more questions real quick. One, in terms of the markets in which you're originating and growing your loans, any particular areas where you are getting incrementally more cautious or pulling back?

This earnings season there have been a number of banks that have talked a bit more cautiously about loan growth. So given your national footprint, maybe you can talk about what you are noticing as the good points and the low points of the marketplace.

Sure. I think that in the areas that we originate single-family loans, which are really gateway-city-type markets, we are seeing in some of those markets a little flattening out of home prices. At our loan-to-value ratios and where we are, we're not seeing anything at all that would be remotely troubling.

And frankly, we like to see that, because we don't want to see continued price appreciation like we've seen as we look at our values in our portfolio and continue to see the collateral increasing in value so much.

Then on the other side, the multifamily side has just gotten very competitive in some cases. We see some banks from a structuring perspective moving to some I-O products and some things like that.

There's a lot of nonrecourse out there in the market. We generally don't do much, if any, nonrecourse multifamily loans.

So those are some areas that we see a little bit. Clearly there are some areas where the capital markets have foreclosed opportunities for certain companies. Obviously, the energy sector is one of them; but there's others that have fallen a little bit out of favor, and there's some securities opportunities that have arisen in some cases as a result of that.

But I think on the C&I side for us, we don't see anything that is troubling. In the equipment leasing platform that we have, we're obviously not going to be doing deals in the energy sector unless there is something special, like a fully collateralized Letter of Credit or something that would completely mitigate any risk that we would have associated with that. So that's really what we see right now.

Okay; that makes sense. A final question and I'll step back. In terms of -- and this goes partly to your lawsuit situation, and I apologize if you addressed this in your remarks. But one area of questions that we've received was about the one appraising firm that you were using.

So could you clarify for us on the conference call about the scope of this one appraiser firm? It's got multiple employees and subcontractors, etc., so can you just give us some clarification, if you are able to, please?

Sure, sure. Yes, there was this comment about one of the appraisal management companies we use. Yes, the gentleman that was mentioned and incorrectly stated as having done the majority of our appraisals or some drivel like that, that's not close to being correct.

We use appraisal management companies to perform our appraisals. After those appraisal management companies perform the appraisals, the appraisals are subject to a review by another qualified appraiser who reviews that appraiser's work.

And in the case of The Flynn Group, The Flynn Group is a group. He does appraisals on his own; he has appraisers who work for him; and he has a software that gives him access to thousands of appraisers.

He is well known in the market as an incredibly conservative appraiser. And the appraisals that were mentioned that in that frivolous suit are demonstrative -- I'm not going to give out confidential information, but it is public information that that property that they were quibbling about the appraisal value there and put in the lawsuit, sold for $33 million. And you can look that up.

I guess, that was within 18 months of an appraisal that was 60% lower than that value. And then the other property sold within 18 months for about 40% more than that allegedly high appraisal that was made.

So our appraisal management practices are very strong. There's nothing unusual about our practices.

In many cases, banks have their own appraisal panels where appraisers actually are employees of the bank. That would be the way Chase performs their multifamily appraisals using their own employees.

So in this case, it's just an appraisal management firm. We use a different appraisal management firm for single-family. That's just -- and I would be cautious in assuming that, even if something is in that lawsuit, that that is actually what someone actually said.

I just think -- I'm not going to say more than that, except to say that when I said the statement about it being riddled with fabrications, inconsistencies, etc., that was an understatement of just how inaccurate that is. Those stories are complete fabrications and leave out so many facts that render them to be completely -- render the reader to have a completely different impression of those transactions than they otherwise would have.

I would also note that if the best you've got after harassing our employees for all this time is that you're picking on a property that sold for 40% more than what they're arguing was what the value was, and then another one that sold for the $33 million, where they gave out the borrower's address, that that is in itself demonstrative of the credit quality that we have -- if you needed further evidence of that, by obviously all the charge-off ratios and all that stuff.

No, there's nothing unusual about any of that. It's all standard, and we have very strong appraisal practices and very strong appraisal review practices.

Very good. Thank you for that clarification.

Andrew Liesch, Sandler O'Neill.

Hey, guys. Just one follow-up from me on these brokereds. Greg, do these have a similar or the same breakage penalty as the brokereds that you had in prior years?

Are you talking about the brokered CDs?

Brokered CDs?

The brokered CDs, yes.

Yes, they have a -- they are actually --

They can't be broken.

They have a death put. So if you -- unless you're actually willing to pass away you don't get to take your money out, which is one of the benefits of those, because it's impossible to charge a consumer that sort of prepayment penalty and get that kind of duration. So they really are almost a substitute for borrowing from a standpoint of the certainty around their duration.

Without the collateral.

Right. All right; that was my only question. You covered the rest. Thank you.

Gary Tenner, D.A. Davidson.

Thanks. I had one quick follow-up on the Emerald unsecured -- or excuse me, Emerald Advance loans. What was the balance that you guys had left as of March 31?

We had about $4 million, a little over $4 million.

Okay, so almost paid all the way down. What was the loss experience like in that book relative to your expectations?

Right, so the loss experience we booked for reserve was 2.5, based on Block data and their history. It looks very close -- like it's going to come in right at that over time. So we'll see over the next quarter how that works.

All right. Thanks, Andy.

Thank you. We've reached the end of our question-and-answer session. I'd like to turn the floor back over to Johnny Lai for any further or closing comments.

Well, great. Appreciate everyone's interest in BofI. If you have any follow-up questions, please contact me. And we will speak to you next quarter. Thank you.

Thank you. That does conclude today's teleconference. You may disconnect your line at this time and have a wonderful day. We thank you for your participation today.