Axos Financial Inc (AX) 2017 Q1 法說會逐字稿

Greetings and welcome to BofI Holding, Incorporated, first quarter 2017 earnings conference call. (Operator Instructions) As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Johnny Lai, Vice President of Corporate Development and Investor Relations. Mr. Lai, you may begin.

Thanks, Rob. Good afternoon, everyone.

Joining us today for BofI Holding, Inc.'s first quarter 2017 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 months ended September 30, 2016, and they will be available to answer questions after the prepared presentation.

Before I begin, I'd like to remind listeners that prepared remarks made on this call may contain forward-looking statements that are subject to risk 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 30 days. Details for this call were provided on the conference call announcement and in today's earnings press release.

At this time, I'd 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 first quarter of fiscal year 2017 ended September 30, 2016. I thank you for your interest in BofI Holding and BofI Federal Bank.

BofI announced net income for its first quarter ended September 30, 2016 of $28,897,000, up 13.3% when compared to the $25,501,000 earned in the first quarter ended September 30, 2015. Earnings attributable to BofI's common stockholders were $28,820,000 or $0.45 per diluted share for the quarter ended September 30, 2016 compared to $0.40 per diluted share for the quarter ended September 30, 2015 and $0.46 per diluted share for the quarter ended June 30, 2016.

Excluding the after tax impact of net gains related to investment securities, adjusted earnings for the first quarter ended September 30, 2016 increased $2.8 million or 11% when compared to the quarter ended September 30, 2015. Other highlights of the first quarter include total assets reached $7.86 billion at September 30, 2016, up $254 million compared to June 30, 2016 and up $1.6 billion from the first quarter in 2016.

Total deposits increased $1.57 billion from $4.76 billion at September 30, 2015 to $6.32 billion. Return on equity was 16.59% for the first quarter, above our long-term target of 15% or better. Our efficiency ratio was 38.9% for the first quarter of fiscal 2017 compared to 38.28% in the fourth quarter of fiscal 2016 and 33.25% for the first quarter of fiscal 2016.

Net interest margin was 3.78%, an increase of 6 basis points over the fourth fiscal quarter of 2016. Non-interest income increased by 50.5% as a result of strong mortgage banking fee income, higher prepayment fees, and a 66% increase in banking service fees and other income.

The primary drivers of our loan production this quarter consisted of $122 million of single-family agency eligible gain on sale production, $383 million of single-family jumbo portfolio production, $43 million of single-family non-agency eligible gain on sale production, $104 million of multi-family and other small balance commercial real estate portfolio production, $27 million of auto production, and a net increase in loan balances outstanding at the end of the quarter in C&I lending, factoring, and warehouse lending of approximately $105 million in the quarter.

We experienced a higher rate of prepayment in our single-family mortgage, multi-family and single-family lender financed loans this quarter compared with last quarter. We believe part of the acceleration of these prepayments was a byproduct of a reduction in interest rates in the quarter. Prepayments on loans held for investment in the portfolio this quarter were approximately $130 million higher than the fourth quarter of 2016 and we sold approximately $20 million more single-family jumbo loans than in the fourth quarter of 2016.

As a result, held for investment balances grew by $203 million and net loan balances grew this quarter by $195 million over the fourth quarter of 2016. Despite the higher than expected headwinds from higher loan prepayments, we ended the quarter with $6.5 billion of net loans outstanding, a 25.3% increase over the September 30, 2015 quarter balance of loans outstanding.

This quarter's results demonstrate the diversity of our lending businesses with broad growth in C&I, warehouse, auto, and small balance CRE lending. Our outlook for loan growth remains positive with a loan pipeline of approximately $970 million consisting of $545 million of single-family jumbo loans, $132 million of single-family agency mortgages, $113 million of income property loans, and $180 million of C&I loans.

Net interest margin was 3.78%, up from 3.72% last quarter and down from 4.02% in the first quarter of 2016. We had higher average cash balances, which resulted in us holding more excess liquidity during the quarter ended September 30, 2016 then we initially anticipated, which reduced net interest income margin by 6 basis points. The increased cost of our subordinated debt offering, which has not been either contributed to the bank as capital or utilized for share repurchases as of today also resulted in a reduction of our net interest margin by 4 basis points.

Excluding the impact of H&R Block related excess liquidity and the impact of the subordinated debt, our net interest margin was 3.88% in the first quarter of 2017, within our target 3.8% to 4.0% annual range. Average loan yields for the first quarter of 2017 were 4.98%, essentially unchanged from 5.02% in the prior quarter and 5.02% in the first quarter of 2016.

Our loan yields in our largest business, single-family jumbo lending and multi-family lending, are stable and impacted only slightly by changes in prepayment speed. Our C&I lending businesses, including equipment leasing, generates higher than average loan yields. Our auto and warehouse lending loans carry a lower than average yield relative to other portfolio loans.

In this current quarter, we will, as we did last year, originate loans to H&R Block franchise owners as well as start originating Emerald Advance loans. Both the franchise loans and the Emerald Advance loans carry higher yields than our average loan yield. Other than a similar seasonal increase in our loan yield to that which occurred last year from the H&R Block loan products, the overall loan yield at the bank will be determined by the mix of our incremental C&I loan balances vis-a-vis our auto or warehouse lending business.

Our credit quality remains strong. The bank had 1 basis points of net charge offs in the first quarter of fiscal 2017 compared to 3 basis points of net recoveries in the corresponding year ago period, which reflects a favorable credit cycle and our strong underwriting and monitoring.

Non-performing loans were a modest 64 basis points of total loans and leases compared to 57 basis points in the first quarter of fiscal 2016. We believe that our strong collateral position protects and limits the severity of our losses in the event of default because the borrower can either sell the property or we will recover substantially all our principal in the event we ultimately have to foreclose on the property.

The primary drivers of the increase in non-performing loans were $6.8 million of single-family jumbo mortgages and a $3.5 million multi-family loan. The four loans with current LTVs between 62% and 75% account for $6.1 million in single-family jumbo delinquencies over the prior quarter. Two of these four single-family mortgages that went delinquent this quarter are under contract to be sold at prices above our loan amount. One $3 million loan for the multi-family property located in Laguna Beach has a 55% LTV and accounts for the bulk of the increase in the multi-family delinquencies.

The cause of the delinquency in each of these instances is unique to the family circumstances of the borrower. Because these borrowers have significant equity and their properties are located in attractive locations, we believe our risk of loss is minimal.

For the first fiscal quarter's originations, the average FICO for single-family agency eligible production was 758 with an average loan to value ratio of 67%. The average FICO score for the single-family jumbo production was 709 with an average loan to value ratio of 61.5%. The average loan to value ratio of the originated multi-family loans was 55.3% and the debt service coverage ratio was 1.44%.

The average loan to value ratio of the originated small balance commercial real estate loans was 45.5% and the debt service coverage ratio was 1.35%. The average FICO of the auto production was 768.

At September 30, 2016, the weighted average loan to value ratio of our entire portfolio of real estate loans is 57%. These loan to value ratios use historic origination date appraisals over current amortized balances, making these historic loan to value ratios even more conservative when you consider that real estate values have generally risen in the markets in which we lend.

In single-family jumbo mortgages, representing 56% of our gross loans outstanding at September 30, 2016, the average loan to value ratio is 58%. As of the September 30, 2016 quarter, 55% of the single-family loans have loan to value ratios at or below 60%; 37% have loan to value ratios between 61% and 70%; 6% of single-family loans have loan to value ratios between 71% and 75%; and approximately 1% have loan to value ratios between 75% and 80%; and approximately 1% have loan to value ratios greater than 80%.

We have approximately $1.4 billion of multi-family loans outstanding at September 30, 2016 representing approximately 21% of the total loan book. We have maintained our low loan to value and strong debt service coverage across all our markets. The average loan to value ratio on a weighted basis in the multi-family book is 55% based on the appraised value at the time of the origination.

We do not have risks hidden in the tails of our multi-family portfolio. Approximately 61% of our multi-family loans are under 60% loan to value; 33% are between 60% and 70%. Only 5% are between 70% and 75% and less than 1% of our multi-family loans have a loan to value ratio above 75%.

Our C&I lending group, which includes lender finance, real estate secured bridge lending, equipment finance, and other asset based lending, continues to generate good risk adjusted returns for the bank with no delinquencies and no credit losses. We have a seasoned C&I team focused on finding good credits, creating favorable structures with significant collateral protection, and monitoring our borrowing base and underlying collateral values.

Our borrowers' concentration and industry exposures are well managed and the majority of our approximately $1 billion of C&I loan portfolio are backed by hard assets with readily ascertainable market values. We see good opportunities to grow our C&I loan portfolio in existing niches and new verticals without compromising credit standards, yields, or structure. Our C&I lending group continues to have strong pipelines.

Our equipment leasing group, based in Salt Lake, was formed when we individually selected and purchased approximately $140 million of loans and leases and hired a team of 25 seasoned members from the Pac West equipment leasing and financing group in March of this year. Our opportunistic asset purchase and lift-out provided us with an accelerated point of entry into a new C&I lending business with accretive yields and good growth potential.

Based on the first two quarters of operation, we feel more confident that we will be able to execute upon our leasing business plan. The group has a nationwide focus with a commitment to grow the business over the next few years, as a result of both the bank's expertise and recent investments in lead generation resources, alternative marketing strategies, a transition to a more robust customer relationship management system, expanding product offerings, and inter-bank cross-sell initiatives, all of which we believe will accelerate production over time.

We continue to expect the leasing group to originate between $80 million and $100 million of new leases in the first year. While we are focusing on implementing our management framework, a process improvement and workflow integration in the first two quarters, to build the business for future success, the equipment leasing team has successfully increased the pipeline in the equipment leasing business during the quarter ended September 30, 2016. The equipment finance business typically experiences its highest lease production in the fourth calendar quarter. We have no non-performing assets either that we purchased or that we originated in the equipment leasing book.

We had another strong quarter of deposit funding growth. Total deposits increased by $1.6 billion or 33% year-over-year with growth across a variety of consumer and business deposit categories. Checking and savings deposits increased by $1.3 billion compared to September 30, 2015 representing year-over-year growth of 33.5%. Checking and savings deposits represent 83% of total deposits.

We have a diversified deposit base comprised of approximately 41% business and consumer checking accounts, 27% money market accounts, 5% IRA accounts, 6% savings accounts, and 4% prepaid accounts. Our small business and specialty deposit groups generated strong growth this quarter. We continue to focus on improving our marketing efforts to attract small business customers and improve the effectiveness of our inside sales team.

Since the launch of our more sophisticated cash management platform last year, our commercial banking group continues to grow and gain traction, focusing on attracting more sophisticated treasury management customers and expanding into new specialty deposit verticals. On the consumer side, we were pleased to be recently recognized by Money Magazine as the best consumer online bank because of our easy to use web and mobile tools and our strong consumer value proposition.

We are having success cross-selling deposit products to our mortgage customers and utilizing the Virtus brand for those jumbo mortgage customers.

We're excited to expand the product set that we're offering through H&R Block during this upcoming tax season. This year, BofI will be the provider of individual retirement accounts offered to H&R Block tax clients through Block's approximately 10,000 company owned and franchise retail locations in the United States.

Additionally, we announced in a press release yesterday that we were working with H&R Block, MetaBank, and SCS to perform certain disbursement and repayment services and provide $700 million of funding for H&R Block's interest free Refund Advance product. The two new H&R Block branded products, IRAs, and the Refund Advance will be offered for the 2017 tax season in addition to the three existing financial services products, Emerald prepaid MasterCards, Refund Transfer, and Emerald Advance all offered by us during the 2016 tax season.

We hope that the Refund Advance product will drive incremental tax return volume to H&R Block, and as a result increase usage of BofI's current H&R Block branded product suite. We will receive revenue from fees earned funding the Refund Advance product and from potential incremental volume derived from usage of the bank's Refund Transfer and Emerald Card products.

As we have previously stated, the revenue we receive from our H&R Block relationship is primarily dependent upon the volume of BofI products sold through H&R Block channels. With respect to our funding commitment for the Refund Advance product, we believe that this funding commitment is very well secured from a credit risk perspective with sufficient fee income earned to offset the relatively low level of projected credit loss. In order to protect from principal loss above the projected credit loss, H&R Block has provided BofI with limited guarantees up to $34 million in the aggregate. BofI expects that only an immaterial amount of the guarantees will be called upon under anticipated loss scenarios.

After a smooth acquisition and integration of H&R Block Bank and the first tax season with H&R Block, we believe we are well prepared for our second tax season with H&R Block. We have completed the software integration with H&R Block using our account enrollment API capability that enables our bank to offer individual retirement accounts through Block's approximately 10,000 tax offices and through Block's digital channel for this upcoming tax season.

I'm pleased with the progress we're making across the dozens of strategic and operational initiatives we are currently undertaking. In auto lending, we've methodically grown originations from approximately $10 million in the first quarter of 2016 to over $25 million in the first quarter of 2017. We focus on prime borrowers with an average FICO of 760 for purchase transactions. Our direct auto lending platform, which will target high quality borrowers nationwide through direct and wholesale channels, and will be a component of the product we offer through the universal digital bank is slated for a soft launch in the second half of 2017.

We intend to expand our auto lending business methodically, while we perfect our data analytics and marketing capabilities to generate new customers and allow us to cross sell our products to our existing customers, particularly with our online platform.

We continue to make good progress in our next generation digital banking infrastructure initiative, the universal digital bank. With the consumer online banking platform prototype and consumer online opening software completed, we are focusing our efforts on building the production ready consumer online banking platform and expanding our API toolkit and micro services architecture to allow us to seamlessly integrate with third parties and offer new financial services developed by us or third parties to our clients through our core consumer banking platform.

These investments have already started to pay dividends as evidenced by the API integration into our custom consumer enrollment system we have completed with H&R Block for new IRA accounts this tax season and the custom integration with a large commercial banking client to significantly streamline their payment processing functions, resulting in dramatic cost savings for the client and significant deposit balances and recurring fee income for the bank.

Once the universal digital bank is fully developed, we will be able to provide more personalized and targeted products and services delivered in a more seamless way across the channels by which we interact with our clients.

We are making significant progress on implementation of our next generation retail mortgage origination platform that will automate and streamline the mortgage origination process for the retail client. We believe this software will allow us to automate time consuming paper based interactions with customers by integrating with third party providers of tax returns, pay stubs, and bank statements thereby improving the customer experience and further reducing our closing times.

We believe that one key to realizing our long-term growth plan is to geographically diversify where we attract our future team members. In order to expand the geographies from which we can attract talent, we will significantly expand our existing operations in Nevada by the end of calendar year 2016.

We are having continued success in making progress in our data driven compliance initiatives. Our data driven compliance initiative works to digitize the inputs to the compliance process and automate compliance rules in real time rather than rely on after the fact sample testing. We believe this reg tech approach to compliance is not only more efficient but it is also more effective. As we roll out more modules available to RSA Archer, our enterprise risk management system, we are focusing on continuing our success in meeting the enhanced regulatory requirements that will accrue as we grow.

Our unsecured lending platform is currently being used to originate loans to H&R Block franchisees and we're going to launch this software platform in the third fiscal quarter of 2017. The speed and efficiency achieved in building this platform is another indication of how our investment in software development and user experience will be monetized in the future. We expect to start this business off slowly and conservatively so we can ensure we originate loans that perform in accordance with our loss expectations.

Our 38% efficiency ratio is higher than the annual efficiency ratio that we expect to achieve in the fiscal year because of the seasonality of our tax related revenue. Our efficiency ratio will be significantly lower in quarters when we receive the bulk of our seasonal tax related fee income streams, specifically our fiscal third quarter of 2017.

We will continue to invest in new businesses and new technologies that will help us sustain diverse and profitable growth. These investments have included expanding our software development team, user experience team, and project management group to approximately 70 people. We also have staff dedicated to better linking our CRM systems across the enterprise to improve cross-sell, the launch of retail auto and consumer installment lending, new systems and software in our risk and compliance group to support organic growth, and other new incubator businesses.

While our investment in the future is significant, we believe these long-term strategic investments are controlled, reasonably sized, and will augment our organic growth and future competitive position. I believe the Company is better positioned from a financial, operational, personnel, and leadership perspective than we've ever been in the past. The investments we are making are well controlled with clear and measurable risk and return objectives.

As we have proven in the past, by methodically developing new businesses and scaling them in a cost effective and controlled manner, after we perfected the operational, regulatory, and system functions, we can further diversify our funding and fee income streams without taking undue credit risk.

Before I turn the call over to Andy to discuss our financial results, I wanted to comment briefly on another rambling and absurd short seller hit piece that was published two days ago. As this amateurish short seller hit piece rambled through its laughably silly innuendo, it appeared to allege that BofI has a financial interest or some sort of economic and legal exposure to a loan either to or guaranteed by Jason Galanis. I wanted to clarify, BofI has no interest, credit exposure, or ownership of any loan -- any kind of loan to Jason Galanis or any loan on which Jason Galanis is a guarantor, including the $7 million loan mentioned in this hit piece.

I'll provide a brief update on our litigation. As I said last quarter, I'll not be spending much time on this because these lawsuits are old news. The events alleged by disgruntled former junior employee Erhart happened almost a year and nine months ago by his account. One of the world's largest law firms conducted an independent investigation of his allegation and found his allegations to be without factual basis and cleared management of any alleged wrongdoing.

Subsequently, the bank has completed two record setting fiscal years, closed two acquisitions that both required regulatory approval, successfully completed two full annual examinations, two mid-cycle examinations, and multiple Federal Reserve regulatory examinations. The bank remains in strong regulatory standing with no enforcement actions, has not been fined a single dollar by any regulatory agency, 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 of the frivolous lawsuits and short seller hit pieces. Our management team and employees remain focused on running the business. Due to the nature of the ongoing litigation, I'll not answer any question regarding our legal matters on this call in the question and answer session.

With that, I'll turn the call over to Andy.

Thanks, Greg. First, I wanted to note that in addition to our press release, our 10-Q was filed with the SEC today and it's available online through EDGAR or through our website at 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.

For the quarter ended September 30, 2016, net income attributable to common stockholders was $28.8 million compared to $25.4 million in the corresponding year ago period. Diluted earnings per share and tangible book value per share for the first quarter of fiscal 2017 were $0.45 and $11.25, up 12.5% and up 23.9% respectively compared to the first quarter of fiscal 2016.

Turning to the balance sheet, net loans outstanding were $6.55 billion, up 25.3% year-over-year. Deposits were $6.32 billion, up 33% from $4.76 billion in the first quarter of fiscal 2016. Our average loan yield for the quarter ended September 30, 2016 was 4.98%, essentially flat from the 5.02% for the fourth quarter of fiscal 2016 and from the 5.02% for the first quarter ended September 30, 2015.

Our average cost of funds this quarter was 113 basis points, up from 112 basis points last quarter, and up from 96 basis points at September 30, 2015. The increased cost from the $51 million subordinated debt we issued in March of 2016 was the primary driver of the year-to-year -- year-over-year increase in our funding costs. Our average deposit cost for our interest bearing demand and savings accounts for the first quarter of fiscal 2017 were 72 basis points compared with 70 basis points for the fourth quarter of fiscal 2016.

Without the impact of higher than expected seasonal liquidity of approximately $125 million from our H&R Block programs, our net interest margin would have been 3.4% in the first quarter of fiscal 2017. Non-interest expense was $32.9 million for the quarter ended September 30, 2016 down approximately $107,000 from the $33 million for the quarter ended June 30, 2016 and up from the $22.9 million for the quarter ended September 30, 2015.

Salaries and benefits expense increased from $14.3 million in the first quarter of fiscal 2016 to $19.4 million in the first quarter of fiscal 2017. The primary driver of the year-over-year increase in salaries and benefits was staffing to support our organic growth in our new business and strategic initiatives, as well as approximately 25 employees that were added for our leasing group. We had 626 total employees at September 30, 2016, a 24% increase from the 503 in total employees for the corresponding period a year ago.

Professional services expense was $1.4 million compared to $0.4 million in the corresponding period last year. The year-over-year increase in professional services was due to the timing of reimbursements for legal expenses and other insurance received in the quarter ended September 30, 2015. Advertising and promotional expenses increased to $2.5 million from $1.6 million a year ago. We made strategic marketing investments and launched commercial campaigns in several of our lending and deposit businesses this quarter.

Stockholders equity increased by $38.3 million or 5.6% to $721.9 million at September 30, 2016, up from $683.6 million at June 30, 2016. The increase was primarily the result of our net income for the three months ended September 30, 2016, of $28.9 million, as well vesting an issuance of RSUs for $1.5 million, a $7.9 million unrealized gain in our other comprehensive income, net of income taxes, as well as a small $0.1 million reduction for dividends on our preferred stock.

The bank is very well positioned from a capital perspective. The Tier 1 capital was 9.55% for the holding company and 9.2% for the bank at September 30, 2016. Return on equity was 16.59% for the first quarter of fiscal 2017, down from 17.91% in the fourth quarter but still above our 15% long-term target. We expect fee income from the H&R Block related services to provide a boost to our return on equity for the quarters ended December and March.

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

Thanks, Andy. Rob, we're ready to take questions.

Thank you, Johnny. (Operator Instructions) Our first question is from the line of Bob Ramsey with FBR. Please proceed with your question.

I wanted to talk first about loan growth. The pace seemed to slow a little bit this quarter. I know you guys highlighted the increase in loan repayments this quarter. Is there anything else that's a factor in there?

Well, I don't think that there's anything that we think is a secular trend. The -- our C&I business didn't pull through as many loans as we thought we would and some of them got kicked to this quarter. Pipelines are generally good. I do think though that when you look at the difference in prepayments and if you had steady prepayments from the prior quarter, I think loan growth would have been where we would expect it to be.

So I'm not seeing anything that is significantly concerning, although single-family jumbo loan production is not growing like it had in the -- in prior years. And we have a lot of different sources of loan growth but that is an engine of loan growth that we've depended upon and we haven't been successful in growing that production over the last several quarters.

And do you think that's a reflection of sort of gaining more market share where it's tougher to continue to take it higher? Do you think it's a reflection of market demand? Do you think it's a reflection of the competition or some other factor?

No, I think it's none of those things. It actually is our own execution. Our turn times, particularly for purchase transactions, have always been a real factor in people sending us business. And those turn times, for a variety of relatively minor reasons related to personnel turnover, things like that, increased. And we know from feedback from our customers that that was impactful for them in sending us loans.

So I don't really see -- there's not some significant competitor there. Demand may be falling a little bit in certain markets at least from a price perspective anyway. We don't see prices increasing as much as they have in those markets, but there's still decent volume.

This has really been something that is our own execution challenges as we've grown. We had a very good quarter on the agency side. That also tends to be distracting for a lot of the originators who also are originating jumbo mortgages. And so we do see sometimes there's a substitution effect there.

So I don't think there's anything systemic but I do think we have to work on just some of those operational components to make sure that we're delivering the service that we've historically been known for.

Got it. And how are you thinking about loan growth for the full year?

I gave guidance of $1 billion to $1.2 billion and I don't think that's something that we should change right now. We have a lot of opportunities and obviously, if single-family fell off or if we started to see continuation of very high prepay trends, we'd have to revise that. But right now, I don't think that's the case and I think we'll be able to deliver for the full year the $1 billion to $1.2 billion growth.

Okay. Great. Shifting gears a little bit to talk about efficiency, I know you guys have said 38% this quarter is not a good run rate for the full year because of the benefits in the fiscal third quarter. Is 38% the right level for the other quarters when you don't have that sort of increase from Block?

That's not a bad estimate. It's a little bit difficult to say. We have a lot of moving pieces but I don't think it's a bad estimate.

The nature of a lot of the things we're doing right now are that they're in process and they're not necessarily going to be generating the revenue that they will. It also will depend partly on what happens with the tax season and what the product take rates we have there are as well. I know you're talking about the other seasons but I don't think 38% is bad.

Okay. Great. And then thinking about the new products that you've added at Block, are those -- what's the best way to think about their impact? I mean is that just sort of marginal, you've got some more products, some more options. It helps at the margin or are there benefits in those new products that can be quantified?

Right. Well, on the IRA side, that's new customer deposit relationships. We hope that over time that becomes a significant source of new customer accounts that then we're cross-selling in checking accounts and other products to those individuals. But that doesn't have a fee income or an immediate impact. It's really just a component of our overall deposit growth.

On the IFL product, we are receiving fees for the origination of that product. And then there are some reasons to believe that the take rate on certain of our other three products or other two products, the Refund Transfer and Emerald Card, will increase as a result of H&R Block's offering of the interest free -- the Refund Advance product.

So those are two sources of incremental revenue that will be received by us in this year. I think the difficulty is in projecting exactly how much. What we have to know in order to do that, as I stated in the prepared remarks, we have to know what the volume of tax preparation business is for H&R Block, what the attach rates are for our existing products and how those attach rates are changed by the new products.

So H&R Block, I think that the best way to think about this would be to say that we think that it's going to ensure that we maintain the revenue that we received in the prior year and there certainly is upside depending upon the performance of those products. But it's a very new process and it's difficult to be able to forecast what that is.

And I can't give you exactly because I'm under a confidentiality agreement, the nature of how the economic arrangement works. But in our case, there is a fixed minimum fee for an origination fee -- or I guess an origination fee is probably the best way to put it. And then there's potential upside, not significant but potential upside if the loans perform better than they do. We're protected on the down side and then we're protected through a guarantee all through very significant losses that would be much in excess of what anybody has ever experienced on the product.

So I know that's not exactly what you want but that's about the best I can do.

Okay. No, that's helpful. Thank you.

Our next question is from the line of Jefferson Harralson with KBW. Please proceed with your question.

Thanks. I was going to follow-up on that H&R Block question. So from the press release, it sounded like there might be interest income as well coming to you from H&R Block, I guess, since it's an interest rate free loan. Or is your economics basically the fee plus or minus your losses and your losses are capped at a certain level?

Well, we're working with MetaBank on this. H&R Block is paying MetaBank a certain amount of money. We are funding a certain proportion of the loans from MetaBank, which is detailed in all the press releases. We're paid a fee for that.

There is no interest, because the loan doesn't have any interest associated with it, not does it have any fees associated with it. The payment is really a form of this compensation that's coming from H&R Block.

The other area where we would potentially receive incremental fees is that we're facilitating payment processing services for all the loans, whether we own them or MetaBank owns them and we receive transaction fees on those payment facilitations. And there is a potential that those fees go up depending upon the usage of the product and the overall level of the business that flows through H&R Block.

All right. And this shows up as a loan on your books at 0%?

Yes, it's a very, very short-term loan. Well, I'm not going to get into the specific -- there's specific accounting of how the fees are -- we'll get into that when we do this in the quarter. But that's basically -- it's a very short-term loan. It might be out there for a couple weeks. That's just the nature of it because it's secured by the e-filed tax return and the e-filed tax return settles the loan.

All right. Got you. I'll let someone else go at it.

Our next question comes from the line of Brad Berning with Craig-Hallum. Please go ahead with your questions.

Good afternoon. You touched upon the digital universal bank platform on a couple different areas. I was wondering if you could expand upon it just a little bit further. You mentioned something about a soft launch in the second half of 2017. On the online retail side of it, I wish you could just expand upon a little bit about what your thoughts are.

And secondly, for the first time I think you talked about actually generating business out of the efforts there and you talked a little bit about the large commercial payment product side.

Can you expand upon what kind of payment product area are you in? Is that a new business area for you in payment processing or is it just an expansion of an existing business line?

Sure, so I'll take those -- there's really two separate questions there. One of them is about what we're calling our API Bank and the extensibility of our API architecture to the operating platforms of our businesses. And I'll talk more about that and then the first one is about what we're doing on the retail side.

So this is a pretty long-term initiative, but all the software developers, and UI developers, and project managers that we've been hiring is designed to create a platform that will allow us to have a personalization engine that will cross-sell different retail products only at the point in time where we see a demonstrated need to the customer and that will be done through this personalization engine.

So the retail auto side of that will be a component of that cross sell, as well as the consumer installment lending. And those will be run based on algorithms through the personalization engine that will determine when those offers are made. So that -- those are cards within a structure of the universal digital bank, which can include third party products as well that will be also offered through the decision making that will occur through the personalization engine.

So that's what we're building on the retail side and then on the API side, what we believe and what we've shown -- this customer that we're talking about is simply a customer of our cash management services. They're just a very, very large customer and they do a lot of ACH originations. And when they are done with those, there's lots of outcomes associated with them. They want reporting and they need intelligent routing of where the results of those transactions go.

They can get those results by going into our online platform but that's less efficient than by us connecting with their operating platform and pushing results to where they need to go to be able to facilitate reporting and operations in what they're doing. And so this is just an example of all the things that you can do when you have an API structure to your products. You can allow different services to exist in the user experience, the operating platforms of your customers.

And obviously, how big somebody has to be in order to spend this effort depends on how automated that process is right now. So right now, we have -- we're developing this API Bank. Eventually, it will have the published APIs and people will be able to go get them and they'll be able to integrate those processes. We think there's real value to business banking clients from that.

But it's a pretty long-term initiative and we have to work through a lot of hopeful partnerships there and those sort of things. But it really is real value because it really does make a business banking relationship I think very sticky and very value added.

Does that help?

Yes, it does, absolutely. I've run actual ACH platforms myself in the past so I get it. On the retail side of it, from a marketing perspective, does this necessarily mean you need to go build a retail brand or is this to push through existing partners where you already have the connectivity from a marketing standpoint to take advantage of the relationships and increase just the amount of lending that you can make on that?

And do you plan to sell a lot of this production or do you plan to retain a lot of the production?

Well, so with respect to a retail brand, we have multiple retail brands now that you can argue about what their unaided awareness is and those sort of things. But this is -- the initial component of the initial part of this platform is a retail platform.

And then with respect to the way -- whether we're going to hold or sell these assets, that depends upon a variety of factors. But what I would say is that these are very controlled and frankly, relatively smaller, say, commitments from a loan production perspective until we can make sure that we're appropriately seasoning the loans.

Frankly, we have some great niches that I think have proven themselves over extended periods of time, through cycles, that they're very low loss. Obviously when we're entering into the auto lending business, particularly at the time we're doing it, we have concerns that we have to make sure we're doing it the right way.

So far, we've done extraordinarily well with that. The yields are okay but the credit performance has been very, very good and we've had very good prime book develop.

I think when we enter the consumer installment lending space given the players that are out there, some of whom I think have been less careful than we would hope to be, we have to be thoughtful about what size chunk we take there.

What I don't think though is that that question of how big that business gets is going to impact what we're doing with our own customers. Because the idea is that somebody who comes in for an IRA product through H&R Block then realizes like Money Magazine has that we have the best checking account in the country and so they want that. At that point in time, we are taking the data aggregated and figuring out that their auto loan rate is 200 basis points higher than we could offer them and because of the data we have, we understand what the financial situation is. So we're able to offer that loan inside the platform.

And that's really the idea there. And obviously, there's a lot of complexity to build this and so it's a very long-term thing. But that's what we're spending the money on to do that.

We think there will be real value in that. We think that everybody eventually has to get on board to doing those things and it really is a reengineering of the value chain of the way things are -- items are sold. On the other hand, we will also from a retail -- an auto lending platform and a retail consumer installment lending platform be marketing outside our customer base as well to the extent that we can find good credit quality loans and we can bring customers into the fold that way and then cross-sell them checking accounts.

So that's really the idea of it.

That's very helpful. If I can ask one more follow-up and then I'll get back in the queue, on the reg tech side of the equation. Can you give us an update where you're at in your roadmap for digitalizing all of the compliance functions, and what's next on the map, and just judge how far you are into that process. Obviously it makes a lot of sense from a compliance standpoint to do 100% testing live rather than sample testing after, right. So if you can give us a thought on where you're at in that roadmap?

Sure, I think we are -- I don't have it directly in front of me. We have a report on it but it's going very well on most of the reg side. And then the only hold up is in some cases, certain components of the information we get come to us via the loan files in PDF, and things like that. So we have to go through and make sure that that digitization process is occurring upfront.

So I'd say, and this is a rough estimate, I'd say we're probably 50%, 50%, 60% of the regs have some form of at least a component of those that are being tested through some automated process that's doing 100% testing and then can fix any issue usually before the transaction actually occurs. And in certain cases, certain of those have components that are easier to digitize because of the nature of the information required and others are a little more difficult.

But we're working on it and I think -- we're absolutely seeing a benefit from what otherwise would be the cost of compliance. It's still higher and we still have more people and all that, but it is bending that compliance cost curve and we can definitely see that. And allowing compliance folks to frankly do things that are a little more interesting, a little more forward looking, and a little more thoughtful about risk rather than spending time looking at items that are more simplistic and can be done more efficiently.

Thanks a lot.

Our next question is from the line of Andrew Liesch with Sandler O'Neill. Please proceed with your question.

Just a question on the margin here. It sounds like you've kept your expectation for that 3.8% to 4% range but is that still -- is that truly a good area to look at? I mean just with the sub-debt it seems like it might be coming in near the lower end of that or even below it. So on a full year basis, is 3.8% to 4% really the right way to think about it?

I think it still is. I think that this next quarter we will obviously have an uptick in the short-term seasonal loans. That uptick occurs also partially to a lesser extent in the third quarter but that benefit is swamped by the excess liquidity that we have in that third quarter.

So I think that when we're talking about that, if you're adding all the excess Block liquidity in, it definitely is going to be coming in at the lower end of that range and maybe even slightly below it. It just depends on really what you're looking at.

And I think we can maintain loan yields and our deposit cost. Andy gave the deposit cost on an interest bearing only, but we've also been able to increase our non-interest bearing deposits as well. So deposit cost has been relatively flat. Loan yields have been relatively flat but we have all this noise associated with a lot of the liquidity issues and we also have noise associated with higher yielding seasonal products.

So all that kind of meshed together with the excess liquidity might be a little bit on the lower end, but it's not -- it doesn't have anything to do with the loan yields or the deposit costs.

Got you. And then just curious if you guys have thought on what might happen to the margin and the fees based -- the Refund Transfer fees based on the IRS not funding earned income tax credit or other tax credit returns until after February 15.

Yes, that could increase the average balance on the excess liquidity, which isn't bad for us from an actual earnings perspective because we are earning something on that excess liquidity. We don't need additional capital for that because of the capital that we have, which we have not utilized through the sub-debt offering and through other monies at the holding company.

But that could increase the average balance of those liquid funds in the third quarter, which would thereby reduce the margin, which is why I'm reticent to say -- it's absolutely going to be 3.80% or bust because those are the sort of things that could increase the impact from the excess liquidity, even though loan yields and deposit, sort of what we would call a core margin if we can invent that word, would be relatively stable within the range that we believe we can maintain it.

Okay, and then do you think -- would that cause the fees -- maybe some fees be pushed into your fourth quarter from the third quarter with that delay?

It's possible. I don't think so right now but that's something that -- I generally don't think so but it is possible. I don't think it'd do much on the Refund Transfer side but it could push a little bit of the Emerald Card fees out a little bit.

Okay, thanks for taking my questions.

Thank you. Our next question is from the line of Gary Tenner with D.A. Davidson. Please proceed with your questions.

Thanks. Good afternoon. Two questions, one on the expansion of the Nevada operation. You did say by the end of calendar 2016; is that correct?

Yes, that is correct; yes, that is.

And does that go at all towards addressing maybe some of the bottlenecks, if you will, on the production issues that you mentioned earlier? Or what else (multiple speakers)?

That is absolutely what it's designed to do and we hope it will do that. We've been recruiting. We have a small -- we've been recruiting processors there. We've been starting a purchase money sales team out there and the office is quite a good size and it's an investment. It's not going to be filled up right away but it certainly is something that we need to be focused on in order to access a different talent pool.

Quite frankly, there's ten mortgage companies in San Diego. Everybody knows each other. We want good seasoned people and there's also -- it's also a high cost of living here so we think there's over time a variety of benefits to having that secondary location and we need to -- we believe we have a lot of opportunity to grow our agency business and to grow our jumbo business.

And Bob listed off a set of things that I'm not concerned about, which is good because the things that I am concerned about, I can fix by just doing a better job executing.

Okay, thanks. And then I saw in the Q, it looks like you reclassified your held to maturity securities to available for sale. Can you just talk about kind of what the thought is and the flexibility that maybe you're looking for in doing that?

Sure. Andy, are you -- do you want to take that one?

Yes, I can go ahead and take that point. Yes, it's not our intent at September 30 to sell those securities but we looked at in September a variety of factors. The presidential race, ultimately what that will mean for regulation. We're interested also in what the Fed is going to think about on rate hikes after the presidential election. And the other impact was CECL where we're, as you know, CECL is looking at the cumulative loss.

That does apply to held to maturity securities and there's going to be additional guidance coming out on that over the next couple of years. So for all of those uncertainties, we just thought, hey, now's a good time to transfer them all into available for sale so that if we do change our intent, we're good to go on that.

Okay.

We haven't used the held to maturity bucket for a long time at the bank. It's been, I don't know, how many years before we put anything in there. So it's been a long time.

It's been three years since we put anything in the held to maturity bucket. And because of the transfer, we won't be able to use it for at least a year. But we think it's a good time to do it.

All right. Thanks, guys.

Thank you. Our next question is from the line of Jesus Bueno with Compass Point. Please proceed with your questions.

Just quickly if I could delve into the mortgage banking income line, it looked fairly strong for the quarter and I don't know if I'm reading this right. It looks like you actually marked the MSR down during the quarter. Could you go into some of the puts and takes of that? Was it hedging gains or gain on sale? What exactly drove that number?

Yes, let me give you the components of the mortgage banking number. When you look at our mortgage banking line, there's really two key drivers. First is how much do we make on gain on sale of agency mortgages.

As you know, everything we originate for Fannie and Freddie, we sell. So this quarter, the gain on agency was $3.9 million, which was -- it's certainly stronger than where we've been in other quarters for that. But we also have non-agency loans, both single-family and multi-family that we sell and that gain was about $1.2 million.

So the $3.9 million and the $1.2 million rolled up to make your mortgage banking gain. So the real strength is coming from a very good agency gain on sale quarter.

That's great, I appreciate it. And thank you for sharing the color on the efficiency ratio. I guess other than on the revenue side, is there I guess any opportunity on the cost side for any improvement there to perhaps get that down over the next year?

I think that what will likely occur on the cost side is that as we launch newer initiatives, those initiatives begin to increase revenue and the cost then is spread over that. But outside the seasonality associated with that, I think we run a pretty tight ship. To give you a sense because you're sort of new to the bank, we have a very comprehensive cost management program that -- we have a vendor management group that looks very carefully at those items.

We do have some things that are coming on that might help us manage productivity and personnel a little more carefully but I don't think there's a ton of cost opportunities here, given all the newer things we're doing. Unless we stop doing some of those things, I don't think that there's a lot of opportunity there. It doesn't mean there's none. It just doesn't mean there's anything that I think would be significant.

Great, thank you. And if I can slip one more in, just back to loan growth and obviously, we've heard from other banks that prepayment rates have been very high and that impacted their numbers for this quarter. Just as it relates to loan growth going forward, obviously you focused on auto is an area where you're pushing. But you were able to grow multi-family CRE and commercial real estate. We've heard a lot about regulators focusing on certain banks in terms of concerns over growth.

I guess do you see any opportunities there for you just given the size of your book relative to peers?

Yes, I do think that we do not have those concentrations that some of the other banks do, partially because I think we are more diverse particularly related to the size of our single-family book, what we're doing on the C& I side, some of the consumer things. So I do think and particularly because we have most of our commercial real estate is in multi-family, our concentrations in non-multi-family CRE are very, very low relative to what they could be before they would raise any significant regulatory scrutiny.

So I do think that we do have opportunity there. We are doing more of that and we just want to be cautious but we do need to -- I think we need to -- if we could execute better there I think there will be opportunity. I think there is market. The market is available and I think if we execute in that, there will be opportunity.

Thanks for the color. That's my question. Thank you.

Thank you. We have time for one additional question today and that question is from the line of Don Worthington with Raymond James. Please proceed with your questions.

The other piece of the gain on sale, the other category, that's almost exclusively the structured settlements; is that correct?

There was also some of our correspondent lending gain that runs through that but the variance from quarter-to-quarter is mostly the change in structured settlement and watery sales, yes.

Okay, and what's the current balance of that? Is it still around the $100 million level?

Yes (multiple speakers).

Yes. It's $120 million. They had a good quarter. They originated $24 million. It was $100 million in the beginning of the -- roughly $100 million. It was $98 million at the beginning of the quarter and it was up to $120 million at the end.

And then what's your current thoughts on the multi-family market? I've heard others talk about that that's one segment where it seems like it's a little frothy. Are you seeing that or I guess what's your take on it?

If you look back at our originations, we've had a relatively flat multi-family origination book for quite a few years despite a lot of effort to grow that and a lot of improvements in a variety of areas that would normally lead to greater growth. And I think partly it is due to very intense competition on the rate side and also very -- I think a little bit of looser underwriting guidelines from some of our competitors that focus on those, start doing IOs, seven years and things like that.

But what's interesting about it is, is that there's been continual prediction that the NOIs of these properties would start to level off, and be reduced, and when we look at -- we monitor every one of our multi-family loans by getting rent rolls and operating statements every year. We do a bunch of other monitoring as well, but what we see is we see very strong rent growth and high occupancy in the markets in which we're in.

So things are still working but it is -- it's something to keep an eye on and I do think that you're starting to see at least reports of reduced ability to raise rents if not outright reductions in rents. But yes, I mean we're -- a lot of our properties, we're not in the most glamorous areas all the time. We're in areas in Los Angeles and places like that where there's a lot of demand for housing. There's a need for it but we're not doing the 2.5% cap rate Santa Monica deals on a regular basis. So those are where really I've seen the most froth.

Okay, great. Thank you.

Thank you. At this time, I will turn the floor back to management for closing remarks.

Well, thank you everyone for your time and we'll talk to you next quarter. Appreciate your interest.

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