Axos Financial Inc (AX) 2017 Q2 法說會逐字稿

Greetings and welcome to BofI's Holdings second-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, Mr. Johnny Lai, Vice President of Corporate Development and Investor Relations. Thank you, Johnny, please go ahead.

Thanks, Chris. Good afternoon, everyone. Thanks for you interest in BofI.

Joining us today for Bofl Holding Inc's second 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 operating results for the three and six months ended December 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 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 Privacy 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 BofIHoldingInc.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, please go begin.

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 second quarter of FY17 ended December 31, 2016. I thank you for your interest in Bofl Holding and Bofl Federal Bank.

Bofl announced net income for its second quarter ended December 31, 2016, up $32.3 million, up 14.7%. When compared to the $28.1 million earned in the second quarter ended December 31, 2015, and up 11.8% when compared to the $28.9 million earned in the prior quarter. Our results are even more impressive when you consider that our second quarter 2007 growth was on top of the 45.3% growth in net income during the second quarter of 2016, our first tax season with H&R Block.

Earnings attributable to BofI's common stockholders were $32.2 million, or $0.50 per diluted share for the quarter ended December 31, 2016, compared to $0.44 per diluted share for the quarter ended December 31, 2015, and $0.45 per diluted share for the quarter ended September 30, 2016. Excluding the after-tax impact of net gain related to investment securities, adjusted earnings for the second quarter ended December 31, 2016 increased $4.1 million, or 14.9% when compared to the quarter ended December 31, 2015.

Other highlights for the second quarter include total assets reached $8.2 billion at December 31, 2016, up $313 million compared to September 30, 2016 and up $1.5 billion for the second quarter of 2016. Return on equity reached 17.49% for the second quarter, up from 16.59% in the first quarter of 2017, and well above our long-term target of 15% or greater. The efficiency ratio was 35.8% for the second quarter of FY17, compared to 38.9% in the first quarter of FY17 and 34.6% for the second quarter of FY16.

Net income increased 20.9% year over year and 9.4% from the prior quarter, up $76.4 million. Net interest margin was 4%, an increase of 22 basis points over the first quarter of 2017 and at the top end of our 3.8% to 4% range we target a full-year basis.

Our net interest margin was benefited this quarter by 2 basis points from H&R Block's seasonal loan products, and around 10 basis points due to the Federal Home Loan Bank special dividend and reduced by our subordinated debt offering of 5 basis points. Without the effect of H&R Block's seasonal loans, the undeployed subordinated debt offering and the Federal Home Loan Bank dividend, net interest margin would be approximately 3.93%.

Capital levels remained strong, with tier 1 leverage ratio at 9.36% at the Bank and 9.71% at the Holding Company. Credit quality continues to be strong, with 5 basis points of net charge-offs and only 43 basis points of non-performing assets to total assets.

We originated approximately $1.7 billion in gross loans in the second quarter, a 45% increase over the last quarter ended September 30, 2016, and a 4% increase over the second quarter of last year. We generated $262 million of net loan growth this quarter, including Emerald Advance and H&R Block franchise loans.

The primary drivers of our loan production this quarter consist of $139 million of single-family agency eligible gain on sale production, $348 million of single-family jumbo production, $28 million of single-family non-agency eligible gain on sale production. $118 million of multi-family and other commercial real estate portfolio production, $504 million of C&I production for net growth of $166 million when compared to September 30, 2016. $21 million of auto production, $293 million of Emerald Advance originations for an on balance sheet increase of approximately $40 million, and $23 million of seasonal H&R Block franchise loans.

Loan growth in our C&I group accelerated this quarter, with ending balances increasing $166 million sequentially and $539 million year over year. We continue to see good risk adjusted opportunities and robust demands across our C&I lending businesses, which include equipment leasing, commercial real estate specialty lending, and lender finance. Our equipment leasing group had a great quarter, originating $60 million for the first three months ended December 31, 2016 and adding net portfolio growth of $40 million, a 32% increase in the portfolio balance in just one quarter.

Yields for existing and new equipment leases are accretive to the Bank, as are yields in all C&I product categories. The leasing loan pipeline remains healthy, and credit quality remained strong with no downgrades during the second quarter and no non accruals at December 31, 2016.

Our commercial real estate specialty lending business originated $138 million during the quarter for net portfolio growth of $111 million, a 45% increase in three months. Our lender finance business experienced net portfolio growth of $14 million.

Our C&I business has had no losses since its inception, and our credit quality in all segments of this group remained strong. Our C&I loans in our commercial real estate specialty lending group are secured by lower leverage first positions in real estate in generally attractive urban markets. Our lender finance business loans are backstopped by borrowing bases of performing collateral at low leverage ratios with significant excess spread.

Our leasing segment secures critical-use equipment on relatively short amortization schedules of 3 to 5 years, resulting in relatively quick pay down of our lease schedules. We have only a couple of enterprise cash flow loans, one shared national credit for around $4 million that we share with a number of money center banks and a roughly $2.5 million loan that is personally guaranteed by a business owner with around $50 million in net worth. Both of these loans are performing well.

Our multi-family and small balance commercial portfolios also had a good growth this quarter. Our multi-family and small balance commercial groups originated $118 million, for a net increase of $64 million and an 18% annualized increase in the entire portfolio.

Our small balance commercial production has been effective at supplementing our multi-family originations, and producing reasonable net portfolio growth in this segment. The outlook for our multi-family and small balance commercial groups remained positive going into 2017.

In our single-family jumbo mortgage business, demand for purchase and refinance tractions look healthy with this quarter's production of $348 million. Despite solid production, our single-family jumbo portfolio growth was impacted by higher prepayment rates. We believe the outlook is positive for our jumbo lending originations with good pipelines, and we believe that the prepayment rate may slow as the market adjusts the recent and subsequent rate hikes.

In our single-family agency business, we had a good quarter with $139 million in originations. Recent increases in long-term interest rates may negatively impact mortgage banking gain on sale production and revenue in the next several quarters, given the decline in mortgage activity in the broader market.

We benefit from the fact that we are not dependent upon mortgage banking income, given its relatively modest contribution to our profitability. Nor do we have a high fixed cost of infrastructure that requires a robust mortgage market to be profitable. However, our goal is to gain share to offset any decline in overall mortgage market volume.

We believe we have the right mortgage banking business model to gain market share in comparison with high fixed cost branch based competitors with expensive outside sales people. In cycles like we may be entering, there's a significant exit of competitors reducing supply over time.

We have affinity relationships and a focus on direct marketing, driven by data analytics rather than expensive outside sales people. Plans to continue to improve our digital mortgage processing software to enhance customer experience and further drive down costs. Our mortgage banking cost structure is highly variable and lower than most bricks-and-mortar competitors, supporting physical end market origination offices.

We've also recently segmented our mortgage banking sales team into a specific purchase-oriented team that is building capability to more effectively manage the longer sales cycle inherent in the purchase money mortgage business. We've also hired a builder group focused on forming relationships with homebuilders. Over time, we believe this initiatives may allow us to increase mortgage banking market share.

The details of our second quarter 2017 originations are as follows. The average FICO for single-family agency eligible production was 759 with an average LTV of 64%. The average FICO for the single-family jumbo production was 707, with an average loan-to-value ratio of 61.9%.

The average loan-to-value ratio of the originated multi-family loans was 55.3%, and the debt service coverage ratio was 1.31%. The average loan-to-value ratio of the originated small balance commercial real loans was 60.1%, and the debt service coverage ratio was 1.34%. The average FICO of the auto production was 784.

This quarter is the official start of the income tax season, and as a result of our program management agreement with H&R Block we added several specialty loan types in our portfolio. At December 31, 2016, we had $40 million in Emerald Advance lines of credit and $23 million in franchisee operating loans, for a total of $63 million.

The loan total is up from $61 million at December 31, 2015, which included $42 million in Emerald Advance lines of credit and $19 million in franchisee operating loss. These loan types have high interest rates that are repaid by the end of the tax season. Our net interest margin of 4% for the quarter ended December 31, 2016 would have been slightly lower at 3.98% when you adjust out the impact of the seasonal loans and the excess tax season liquidity.

Our outlook for loan growth remains positive, with a $960 million loan pipeline at December 31, 2016, consisting of $635 million of single-family jumbo loans, $75 million of single-family agency mortgages, $105 million of income property loans and $145 million of C&I loans. Our C&I loan pipeline is projected based on initial funding, rather than line size.

Our loan portfolio credit quality remains very strong. Our strong credit discipline and low loan-to-value loans have resulted in consistently low credit losses and servicing costs. Our lifetime loss in our originated single-family loan portfolio represents less than 3 basis points of loans originated.

We remain disciplined in our multi-family credit underwriting, and continue to originate loans with low loan-to-value ratios and attractive debt service coverage ratios. We do not have risks hidden in the tails of our multi-family portfolio.

Approximately 63% of our multi-family loans are under 60% loan to value, 31% are between 60% and 70%, 5% are between 70% and 75%, and less than 1% of our multi-family loans have loan-to-value ratio above 75%. The increase in the loan loss provision to $4.1 million this quarter was due only to seasonal additions to the Emerald Advance loans of $40 million, which increased the provision $2.2 million, about the same amount as last year, except last year the Emerald Advance increase was partially offset by unrelated commercial mortgage loss recoveries.

Total non-performing assets as a percentage of total assets was 43 basis points at December 31, 2016, up from 42 and 40 basis points of non-performing assets at June 30, 2016 and December 31, 2015, respectively, but down from last quarter's rate of 55 basis points. The decrease since last quarter was primarily the result of improvements in non-performing single-family loans.

Our loan-loss reserve to non-performing loans is 118.4%. As reflected in our historically low charge-off rates, a very small percentage of our non performers result in a loss to the Bank, because we have a granular portfolio secured by primarily real estate collateral with readily ascertainable market values to ensure we receive repayment on problem loans.

The bank has only one REO property, with a total carrying value of $908,000. All of the Bank's REO properties are held in special purpose entities to isolate the Bank from any potential issues associated with direct ownership, and these entities are consolidated at the Bank.

At December 31, 2016, the weighted average loan-to-value ratio of the entire portfolio of real estate loans was 57%. Given that these loan-to-value ratios used currently amortized balance over originated date appraisals in a generally appreciating housing market, these historical loan-to-value ratios generally overstate the true loan-to-value ratio in the portfolio, providing a further margin of collateral security.

Our deposit growth continues to be strong and diversified, outpacing loan growth and providing favorable funding in an environment where Federal Reserve rate hikes may become more frequent. Net growth in deposits was 27.1% year over year, and 4.5% above the balance at September 30, 2016. Of the Bank's overall deposit base at the end of this quarter, we have approximately 39% business and consumer checking, 29% money market accounts, 4% IRA, 10% savings, 4% prepaid accounts.

Time deposits or CDs have declined to 14% of total deposits. Our increased level of checking, savings and money market deposits will help reduce our reduce our interest-rate sensitivity should rates rise further in 2017, and in fact RMX has already helped mitigate the 25 basis Federal Reserve rate rise we experienced in December of 2015.

Our cost of interest-bearing demand and savings was 62 basis points for the quarter ended December 31, 2015, and 69 basis points for the quarter ended December 31, 2016. So only 7 basis points of the 25 basis point increase, or 28%, was realized even with a 32.2% growth in average balances.

Our time deposits have an average cost of approximately 2.28%, because we have an average duration of approximately four years compared to 3.6 years in the comparable period a year ago. With a diverse deposit base across a wide range of consumer and business categories, we have a variety of opportunities to continue growing our deposits to support our loan growth.

Overall, excluding the impact of the 6.25% subordinated debt funding we have yet to deploy, our total cost of funds has grown from 97 basis points for the quarter ended December 31, 2015 to 108 basis points this quarter or 11 basis points. In addition to minimizing our funding cost increase, we have recently increased our loan rates on single-family and multi-family loans in order to continue to support our net interest margin guidance of the 3.8% to 4%.

As I noted earlier, we have started our second tax season offering co-branded financial products with H&R Block. In addition to the three products we offered to H&R Block customers last year, Emerald Advance which is a line of credit, Emerald Card, a general-purpose reloadable prepaid card, and Refund Transfer, a temporary bank account to receive a tax refund, we are also offering new IRA accounts and will provide funding for the new Refund Advance and interest free loan to customers expecting a tax refund.

We continue to expect that on an annual basis, the H&R Block program management agreement will generate $31 million to $34 million of revenue and $13 million to $16 million of net income on par with results reported for the 2016 tax season. As a reminder, we anticipate that approximately 70% of the net income from the program management agreement will be generated in the quarter ending March 31.

We're making good progress in several of our incubator businesses, which we will provide growing contribution over time. In auto lending, we have methodically grown our loan book from approximately $20 million in the second quarter of 2016 to over $99 million in the second quarter of 2017. We focus on prime borrowers with an average FICO of 760, and an average loan size of roughly $36,000 for purchase transactions.

Our credit quality in this book remains very strong, with delinquencies over 60 days under 20 basis points of loans outstanding. The development of our direct auto lending platform, which will be one of the products we offer through our personalization engine to our customers through the Universal Digital Bank, is slated for a soft launch in the second half of FY17. We will grow our auto lending business in a controlled fashion, while we refine our sales and data analytics capabilities and explore low-cost distribution partnership opportunities.

We're moving closer to being able to offer robo-advisory services through our new consumer online platform, just one example of the services that we'll provide to our customers to enhance retention and reduce rate sensitivity. We originated H&R Block franchise's loans this season through our unsecured lending platform that we developed with our in-house software development team. The seamless rollout allowed us to improve the process for H&R Block franchisees.

We soft launched our consumer installment lending product that utilizes our internal developed software and made our first consumer installment loan this week. This platform will focus on prime borrowers.

Consistent with what we have done with our prior product launches, we intend to grow our unsecured consumer lending business very slowly in order to optimize our marketing, on boarding, underwriting, systems procedures and servicing. Over time, these loans should be accretive to margin. Where there's likely that more than one year will pass before there's a measurable impact, given the modest volume goals we have in the first year of launch.

Despite significant investments in future growth opportunities and compliance and risk infrastructure to support a dynamic growing bank, we continue to generate best-in-class returns in margins. Our 17.49% return on average common equity and 35.8% efficiency ratio this quarter, represents the healthy balance between maximizing shareholder returns and prudent investment.

Our track record of managing capital and credit in a variety of interest rate, competitive and regulatory cycles makes us excited about the opportunities to sustain profitable growth going forward. Our ongoing strategic emphasis to diversify our lending and deposit businesses across multiple consumer and commercial verticals is bearing fruit.

As evidenced by the growth in our C&I and small balance commercial real businesses in the first half of FY17, we are well-positioned to maintain double-digit loan growth by opportunistically deploying capital where we see the best risk-adjusted return. We believe the investments we're making in our Universal Digital Bank through our new consumer banking platform, new products, personalization and customer experience will enhance our value proposition to our customers and enable us to drive continued growth and profitability.

I will now provide a brief update on our litigation. As I said last quarter, I will not spend much time on this because these lawsuits are old news. The events alleged by disgruntled and apparently from his latest court filing now chronically unemployed former Junior employee Erhart happened almost 2 years ago by his account. One of the world's largest law firms conducted an independent investigation of his allegations, and found his allegations to be without factual basis and cleared Management of the alleged wrongdoing.

Subsequently, the Bank has completed two record-setting fiscal years, two successful quarters after the close of our most recent record-setting fiscal year, closed two deposit acquisitions that both required regulatory approval. Successfully completed three mid-cycle examinations, two full annual examinations, multiple Federal Reserve regulatory examinations, and received regulatory non objection in the last six months to launch a Refund Advance product with H&R Block.

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

Our Management Team and employees remain focused on running the business. However, despite all the time that has passed and all the positive results in our business since these outright fabrications have been published in the lawsuits and internet troll fake news hit pieces, we still see activity from at least one of the trolls.

Recently, an attorney who represents one of the trolls who wrote many defamatory fake news blogs over the last couple of years called, under false pretenses, one of our largest shareholders, pretending to be a mutual fund interested in investment in investing in Bofl and asking for information about that shareholder's current ownership.

I raise this issue to note that the short-selling conspiracy is likely still active. All shareholders should be alert for suspicious activity and report this activity to us. We are dedicated to holding these individuals and funds accountable for their actions, and each report of their misbehavior will assist us in holding them accountable.

With that, I'll make no further comments on our litigation, and will be focusing questions in the Q&A portion of this call on our business update. Now I'll turn the call over to Andy who will provide more details on our financial results.

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

The net interest income for the second quarter ended December 31, 2016 increased $13.2 million year over year, and increased $6.6 million over the first quarter ended September 30, 2016. The net interest margin was 4% this quarter, up 22 basis points from 3.78% in the last quarter ended September 30, 2016 and down 10 basis points compared to the 4.10% for the quarter ended December 31, 2015.

As Greg mentioned, we continued to maintain our net interest margin within our range of 3.80% to 4%. The positive impact of higher rates on our H&R Block Emerald Advances this quarter and the negative impact of excess balance liquidity when adjusted out of the 4% margin, results in a relatively small adjustment downward of 2 basis points to 3.98% for the second quarter ended December 31, 2016.

Also impacting our margin this quarter was a special dividend from the Federal Home Loan Bank, which added a favorable impact of 10 basis points. Which, if adjusted out of our margin, would leave us at 3.88% for the second quarter.

We have some benefit next quarter from our loan growth this quarter, which was driven by C&I lending, where the average rates are above our average loan portfolio yield of 5.14%. And early in Q3, we increased our single-family jumbo rates by 12.5 basis points and increased our multi-family loan rates by approximately 25 basis points. So new loan production will be at a higher rate to help offset any potential increase in deposit costs.

Our net interest income parallel shock analysis with a 200 basis point increase assumed at December 31, 2016 shows us being asset sensitive, and generates increased net interest income of 7.6% for the first 12 months and a 1.2% increase for the second 12 months. Our asset sensitivity improved this quarter due to a number of factors, including the higher prepay rates on single-family jumbo loans or shortening the duration of our single-family loan portfolio.

Number two, we have increased the duration of our long-term CD portfolio, as Greg noted, it moved to 4%, up from 3.4 years up from 3.6 years. This quarter, we sold long-duration securities, including muni bonds which decreased our interest rate risk in our securities portfolio.

Our average rate paid on interest-bearing demand checking and savings decreased this quarter compared to last quarter by 3 basis points. Our ability to maintain our annual net interest margin in the guided range of 3.80% to 4% will be determined by market competition on deposits, and our ability to maintain loan volumes as we increase loan rates.

Moving now to non-interest expense or operating expenses. Our efficiency ratio for the quarter was 35.78%, a significant improvement over the first quarter ended September 30, 2016, which was 38.90%.

The modest growth in operating expenses of $0.4 million was primarily the result of growth in salaries and compensation. Our net change in employee headcount this quarter was an additional five employees, for a Company total of 631.

We also benefited from lower FDIC insurance costs that were the result of favorable changes in the FDIC-based assessment calculations. With regard to occupancy expense, we've opened our new office in Las Vegas, Nevada in December 2016, which adds space for 190 people and will cost an additional $176,000 of expense per quarter starting in Q3.

Finally, our tier 1 leverage ratio to average assets at December 31, 2016 was 9.71% and 9.36% for the Holding Company and the Bank respectively. We believe that the cash we have in reserve at the Holding Company will be sufficient to support our organic growth for the next 12 months.

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

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

(Operator Instructions)

Our first question comes the line of Mr. Bob Ramsey with FBR. Please proceed with your question.

Hey, good afternoon, guys. Want to talk a little bit about margin. I know you highlighted seasonality in Block, the HLB dividend and sub debt drag. But even stripping those factors out, the margin rose nicely quarter over quarter.

What was the biggest factors in that move? Was it the growth in the higher yielding commercial loans, or was it simply putting loans on at a little bit higher rate or what drove that expansion?

It was a little bit of all of that, including decrease in the lower yielding liquidity on an average-balance basis. So if you go to our rate volume table in the queue and you look at our non-interest or the interest-bearing deposits at banks, that actually declined on the linked-quarter basis. As well as the fact that we continue to have growth on the C&I side that adds to the margin. And this quarter -- I'm sorry, go ahead, Bob.

I was just going to say, it looks like the loan yields were up maybe 16 bps quarter over quarter. Is that mix or was there any element of prepayments or anything unusual in there?

Well, there's the H&R Block loans in there which we are separating out for that. So you have some H&R Block impact there because you have the Emerald Advance loans and you have the franchise loans.

And we did raise loan rates around mid-January. We raised them about 15 basis points on single-family, and on average around 25 basis points in multi-family. There's some different tiering and that sort of thing, some a little bit less than that, so much more than that.

But that will start to come through. We're not seeing impacts on volume there, we have seen competitors follow. But I think that said, that's a good start there to ensuring we maintain or can even increase margins.

And then obviously the mix changes too. If we have more C&I production, you're going to see loan rates come up a bit. The unsecured consumer side should increase margins over time.

But as I said on my prepared remarks, it's going to be a while before we have any significant volume in there that makes much of a difference. But it doesn't really take that much volume. You see there's some significant movement even from $40 million of Emerald Advance loans and those sorts of things you can get a nice updraft.

So I think we've got a lot of good opportunities going to maintain margins. And I don't think we're going to have to pass along all our LIBOR-based increases, and we have got some interesting things we're doing on the deposit side to try to reduce elasticity as well. So hopefully that'll all work out to be able to allow us to maintain our margins.

You mentioned the increase in the loan yields in January. Have you had much movement on the deposit side of things since the Fed moved rates in December?

Not a ton, no. There's different segments that have some elements of rate sensitivity, and we've had some calls from some customers. But it wouldn't be pervasive, but I also don't think that's necessarily indicative of everything that will happen in the sense that it's really still pretty recent.

And so we have to obviously grow -- it's one thing to retain deposits and then you have to grow them. Now frankly, the pipeline looks very, very good with some very nice low-cost deposit sources coming. And if those all work their way through, we could -- we have a significant amount of non-interest-bearing deposits in our pipeline, but we have to see if we can get those deposits closed and get them on board and we'll see if we can do that.

And then we have a good cash management pipeline too, and those deposits come in at a much lower blended rate. So we'll need to shift mix as well, hopefully if we can do that.

Okay, great. And last question and I'll hop out. You may have given it and I might have missed. But did you quantify the mix of business versus non-business deposits this quarter?

I didn't put it in my prepared remarks.

Yes, so it is of the $6.6 billion, $3.7 billion is business and $2.9 billion is consumer.

Great. Thank you, guys.

And our next question comes from the line of Brad Berning with Craig-Hallum. Please go ahead.

Good afternoon. On the H&R Block side, maybe you could give a little bit more thoughts on the initial new products in the traction that you are seeing there early in the tax season. And then also talk about aggregate -- earnings expectations from that now that you'll have your first comp from a year-over-year basis, and where your thoughts are on that.

Sure. Well obviously given the sensitivity related to our revenue tie to H&R Block's volumes, I'm not going to comment at all on the tax season. Except to say that -- and we are projecting, and this is just more of a way of providing some guidance that we are going to have roughly equal revenue.

And then on the IRA side, the product is out there. I think that the franchisee and the tax preparers are finding value in it. We're getting positive feedback about it.

The systems and processes are working. The API structure into the software is working for the automated opening. So I think all of that is very positive. It's our biggest test of our API.

But I don't want to get into any attempts to look like I'm forecasting something when frankly at this stage, even if I was willing to give you information, that tax season is really, really early. It's a very early timeframe. People are just getting their W-2s.

So it's really too early to comment. We're trying to keep with our guidance that we're going to basically make about the same amount of money as we did last quarter, I mean last year for the H&R Block Partnership.

Understood. Can you update us on efforts on the universal banking as far as progress of making traction with other clients, new opportunities? Can you just give us an update on your thoughts on those efforts?

Sure. So we think about -- what we're talking about during through the Universal Digital Bank is the creation of a flexible, online platform that allows us to use a personalization engine to place services behind the password for the customer that are most useful to them. And so the development on the consumer side is going very, very well. It's on track for a soft launch in one of the brands and testing around the July-August timeframe. It looks great.

The services component, which will allow us to offer like an app store inside behind the password is very good. We are working on the content behind that. I mentioned robo advisor is one of those that we're working through the process of offering, and we intend to be very, very competitive on that offering to be able to offer it for people who keep large balances with us potentially for free.

So those are -- that's part of the broader strategy to create stickiness with our increasing customer base so that they can focus on a service value proposition, as well as the fee and rate value proposition that we have. So everything is working very well there.

We are obviously adding new products that we are creating in house to be able to offer those products in a cross-sell basis. Our Salesforce 2.0 initiative is moving along, which is basically a methodology of tying some of the rules associated with our different CRM engines together so that we can do a better job of cross selling. And all those things are coming along, and it's really about driving us to being the next -- to driving us to the next phase of where we think digital banking is going.

On the business side, we will be developing a small business platform next and we are working through some of the services with some potential fintech partnerships and things like that. I'm not going to go into too much more detail there. But the idea is to have a robust platform for small business that offers value-added services behind the password that allow utilization of the data to do things like cash flow forecasting, bookkeeping, things like that.

So these are long-term initiatives. But the immediate impact of these is as we launch the products, we'll end up with increased loan volume from those products. And then over time, tying this altogether, we are really excited about it and it's working very well.

One last follow up on the NIM from the prior question. Any moving parts in the next quarter or two that you just want to make sure we are aware of?

Yes, there's a lot of moving parts. So obviously, we will have a massive influx of cash as we go through and process all of the tax refunds that H&R Block does. The number of refund transfers that we have, all of those things will impact how much excess liquidity we have.

Obviously, we don't need any more capital for that excess liquidity. So with the Fed rate move, we actually make more money on that. But from a net interest margin perspective, we can't use that liquidity for any investment obviously because of its temporary nature.

So that liquidity just sits with the Federal Reserve, gets paid Fed funds. And then when it comes out, the margin goes up. So obviously although net interest income will increase, margin will move. But it really is just a result of that temporary liquidity.

Then we also obviously have the loans that will roll over, the seasonal tax loans, will roll over, and those will start to get repaid in the next quarter as well. So that repayment makes something of a difference as well.

Andy mentioned that the C&I production being a little more robust and being accretive to our overall loan yield is helpful. So this is the quarter where there's a lot of movement.

And if you go back and look what we said last quarter, the last comparable quarter so the third quarter of our FY16, you can see the extent to which there was movement. We tried to break that down for you, and will try to do that again. But it's a pretty noisy margin quarter.

But obviously it's a great thing to have -- we're not passing on any of that benefit from the excess liquidity. We are keeping it all. But it does -- and we are holding the capital every quarter in order to absorb the -- on a leverage ratio basis, the extra cash.

So this is the payback for that in the next quarter. We're holding this excess capital for the whole year, but we get this tax revenue in this quarter. So it's always a good quarter for us, well at least it has been over the last year and it will be a good one this year, we hope.

Thank you.

And our next question comes from the line of Gary Tenner with D.A. Davidson. Please go ahead.

Good afternoon. Two quick questions. First, was there any change in the valuation on MSR this quarter that went through the income statement, was it through the mortgage line or anything?

Yes. There was. It did go through the mortgage line. It was about $600,000.

Okay. Small number. And then -- I'm sorry.

Our end is not that big, but it's obviously a little bit of a hedge against production decline. But ours is not large enough to make a significant difference.

And then the other question I had was, Andy, on the new location in Nevada or the new facility, I think you mentioned it could seat up to 190 or so people. Can you talk about plans for timing of staffing it up, how much of that headcount would be pure variable cost versus any addition -- any additional fixed cost headcount?

Well so we're not obviously pushing or forcing our employees to move, but there are a set of folks who are interested in moving. The cost of living is lower, the ability to afford homes is better.

We also have turnover, and as we have turnover having a secondary location to source talent for a variety of functions. But particularly call-center functions which are very prevalent out there is something that's meaningful.

So this is a strategic move on our part to look over the longer term, and as we grow, where we're going to need to place individuals. So I'm not going to get into what specific departments are being built out there and that sort of thing. But there obviously are reasons to place certain departments there, and to allow us to have a good mix of locations to be able to source employees.

So it's a beautiful office, it's a very desirable one. I think we'll become a desirable employer there just like we are here, and I think it will be successful. But it will be a little bit of drag right now, because we're it's not going to be some rush to fill it.

So you shouldn't expect that headcounts are going to all of a sudden shoot up as a result of having empty seats, it's going to be a methodical process and we'll add employees as we need for growth. And as we have turnover, we'll move some positions out there.

Very good. Thank you.

Our next question comes from the line of Andrew Liesch with Sandler O'Neill. Please go ahead.

Hey, guys. So just a question here on credit, so good to see non performers and it looks like classifieds declined as well. But special mention loans increased, looks like some of those were just mortgages. Just curious what might be driving that? And then in general, do you see any concerns on the horizon for credit?

No, I think the special mention is driven by a temporary lag on getting property tax reports for those loans that don't show the property taxes fulfilled. We will temporarily show them as a special mention, and that's what created that small surge. And there's nothing that we're seeing that systematically concerns us.

Okay. And then the banking service fees and other line in the income statement, that was a pretty nice increase. Was that from a higher level of Emerald Advance origination fees? And then also curious, is it higher year over year as well and were you getting a better -- were you just better at originating these and that's why the fees are better, curious what drove it?

No, the increase isn't from the increased Emerald Advance fees, it's from other deposit fees. But some of those fees just by the nature of their structure are annual rather than quarterly. So I think it's important not to assume that they're recurring quarterly, but rather they are annual in nature. So those are not from Emerald Advance.

Okay. Those are my questions, thanks.

Our next question comes from the line of Scott Valentin with Compass Point. Please proceed.

Thanks for taking my question. This is Jesus Bueno for Scott Valentin. Just very quickly on the tax rate.

You have one of the higher tax rates among regional banks. Have you looked at what the impact would be of any tax reform? I know it's early in the game, but I know you have a small deferred tax asset.

But in terms of your operating tax rate going forward, how much of that of the benefit would you capture? Say we were going to see a decrease from say 35% to 25% call it.

Why don't you answer that.

Obviously, yes, banks are one of the most penalized institutions that exist. Here in California, we have the highest corporate rate that exists. So and ultimately, as we talked about, our Nevada office part of our strategy ultimately is to be able to allocate some away to Nevada.

But that's longer term. Shorter term, there is a discussion of cutting federal rates from 35% down to 25%. That full impact would be felt by us on an ongoing basis.

There might be a small one-time adjustment in deferred tax asset rate that's mostly related to loan loss. But actually this quarter when we sold securities, we actually also realized some OTTI that we had set out aside and we actually lowered our deferred tax assets on a linked-quarter basis. Partially with the idea that we're going to be able to better to take those now while the deduction is high rather than wait when federal rates become lower.

But obviously, if you look at a point in time basis, we went from, pursuant to what Andy said, we went from $39 million of deferred income tax to $32 million over the last six months. But if you take -- if it's $32 million and it's a 10% reduction in rate, then you can do the math on what that would do.

But obviously, that's definitely looking the gift horse in the mouth. The obvious benefit is that we do have this incredibly high tax rate, we should be able to immediately benefit from that. And we're not hoping for 25%, I was hoping for 15%. But who knows, that might -- that probably changes on a regular basis.

So that 10%, that would fall right through to the bottom line with the exception that the single small adjustment of 10% times $30 million or $3 million that we would have the quarter of adoption.

That's helpful, appreciate the color there. And just jumping to consumer unsecured product, obviously you're building that out. And I guess how are you thinking of that product going forward? Is this going to be something where it's all on balance sheet or is there going to be an opportunity for gain on sale?

And we've seen some other banks, large regionals and even a large investment bank go into this industry. So how do you view the environment competition wise, and how are you going to differentiate your offering going forward?

So first off, so from the perspective the first question of where the loans end up going. Like all the new products that we have, we really make sure that we're going into them with a very deliberate process that allows us to look at their performance over an extended period of time. And that allows us to really avoid making mistakes, and I think we've done a pretty good job of doing that to date.

So early on, these loans will be held on balance sheet. Now at a certain point in time, there's a variety of options that we can look at to determine what we do with them. Whole loan sales we have a whole loan sales that obviously knows how to do those sales. We could work on some forms of securitization, depending on what the cost of that would be and how it would compare to putting the loans on balance sheet.

With respect to the differentiation side, there really are several opportunities we have. We know that some of the distribution partners we currently have are interested in these products. And I can't guarantee that we get those products out through those channels, but there's interest. And that's obviously having distribution is an advantage.

Next, we're interested in offering this product to our growing customer base, and we have an advantage understanding their data. So if we have a customer where we understand what their spending and payment patterns are for their checking accounts, obviously, that allows us to have a ability to differentiate our offering. We think that hopefully we can extend that to being able to utilize an underwriting engine that's able to take that data and process it in a unique way.

Right now, what we're doing is we're simply asking for more documentation. The process takes a little bit longer from the standpoint that -- but it's very smooth in the sense that these documents can all be submitted in an efficient online process.

But we are asking for more documentation, so you are not going to get approved in an hour. But if you really need your loan in an hour versus a day, maybe we are not the right bank for you. But we are going to work through it, and we have a lot of interesting advantages that we are going to explore and we're going to do it in a very conservative way.

With respect to the competitive environment, I think the competitive environment is moving around a lot. Our thesis is that they'll be a variety of exit/pulling back in the business.

We've already seen it, and so we think that there will be more of that because a lot of the structures and the largest players in this business really haven't been making any money. So the way they're going about it to us seems like it's going to create an opportunity over time.

Got it. Thanks.

And I'm not talking about Goldman, I'm talking about the other players.

I didn't want to name any names.

Yes, I'm not talking about Goldman. I'm not saying what Goldman is doing is good or bad, I don't know. I'm aware of it and I'm following it, but I think it's still too early.

Fair enough. And if I could just ask one more clarification. I know you added some color around the impact of H&R Block in your balance sheet and your liquidity. But in terms of the fees, just a reminder about the differences in the banking services fee line in the third quarter, I'm sorry, your March quarter, I should say.

Sure. So we make between 60% and 70% of our entire earnings under the Block relationship in that third quarter. So in Greg's comments, he gave guidance of revenue of $31 million to $34 million and net income around $16 million. So think about between 60% and 70% of that being earned in the third quarter.

Got it. Thank you for taking my questions.

Thank you.

And our next question comes from the line of Edward Hemmelgarn with Shaker Investments. Please proceed.

Hello, Greg. Just a couple of questions. One, on the refund loan that you are participating in with H&R Block that funds the tax credits that can't pay out yet, where will that show up in your average loans?

It will show up in fee income for the income side -- the loan side will show up in average balance in loans.

And what category will it be? Will it stay in the Emerald Advance or --?

Yes, we'll likely put it in that category.

Are you going to be able to -- I know you restricted some of -- I'm assuming that you can fund that out of your cash balances?

Yes. And these are -- they're very short-term loans. So we'll be able to afford (multiple speakers).

Short term, okay. The commercial industrial, that's where you're showing a lot stronger growth there than obviously anyplace else. What, in addition to the equipment leases, what are you getting -- because I calculate you're up $212 million just in the last quarter and $482 million year over year. So what categories are you hitting other than the equipment loans or leases?

Right, so really there are three segments there right now that are active. The first is the equipment leasing, which you've already -- you mentioned, so we won't discuss that.

The next is the lender finance business, which didn't have a fantastic quarter from a growth perspective. But the pipelines in that business are good. And so that just to refresh is a line of credit to a non-bank lender, either back leveraging real estate collateral or consumer business loans.

And those are done at very low leverage, they're done with borrowing basis. And so as the underlying -- as long as the underlying collateral is performing, the institution that's our borrower gets for those loans. If those loans go delinquent, they have to be pulled out of that pool or there's a variety of events of default that would turbo the structure down and that sort of thing.

So that business has a bright future, and we had some pay downs in the quarter. But the pipeline looks good there.

And then real estate specialty lending segment is one that we are also focused on. I know there's a bank that you are a fan of discussing that does that as well, and we think there's a lot of opportunity there. And we have growth plans in that area, and there's a lot of interesting things to do there that we think could be nice yielding at very low loan-to-value ratios, really good projects.

So really we have an incredible pipeline in the real estate specialty lending segment. The pipeline is so much bigger than what we can go through. The deals are ones that you have to be very thoughtful about, look at very carefully.

And so expansion of personnel in that area will allow us to take advantage of demand. Because it is a -- it's not demand that is limiting growth in that area, it's simply the ability to get through and do all the work and process those loans.

Okay, that's good. Lastly, what's really hit you the last couple of quarters has been these -- you cited in your release was the repayments in terms of loan growth. Can you talk about what's giving you a little bit more confidence that, that may decrease in coming quarters?

Yes, I don't have really a ton of confidence that it will decrease. I think that the single-family pipeline is very, very strong. It's very good, and I think we have to increase our originations also commensurate with the increase in the portfolio side.

I think that we have really good borrowers that have low loan-to-value ratios, and the speed that we offer on purchase transactions and those sorts of things, we have a lot of advantages in our execution. But over time, we're having some of the prepays.

Now, if logic would dictate that if rates go up, there would be some borrowers at whatever marginal basis would have less incentive to prepay and therefore not do that. There are some things that we are doing to do that.

We're looking at some relationships and making sure we are not being churned and some things like that. I'm not going to go into those in great detail. There may be a few little things on the edge there, but I can't tell you that prepays will not continue to be relatively high.

I think we just have to make sure that we are originating in a manner that allows us to grow that business, and I think we can do that. But obviously, that depends on us executing. Our think our execution on the single-family side just from a perspective of getting loans through the pipeline which I discussed is something I was a little concerned about last quarter, is very much [peered].

So the operational side of the house was looking good there, and I think that, that hopefully will allow us to get greater volume through. But we also raised prices too. So all of that has to come into play when we try to look at what loan growth will be in that segment.

Okay, great. Thanks for a good quarter.

Thank you.

Our next question comes from the line of Austin Nicholas with Stephens. Please proceed with your question.

Hey, guys, good afternoon. Could you just -- I noticed the real estate owned and repossessed vehicle line on the expenses ticked up a little bit this quarter. Is there anything going on there or is that related to any specific business line?

No, it is a single-family property, right, guys, that caused it to tick up a little bit, and there's nothing that's going on that would cause that to be of a general concern. As you know, it came out of non performing and then simply went into REO. So this isn't something that all of a sudden hit us.

We only have one REO, right?

Yes, it's only one single-family REO.

Under $1 million?

Yes.

Got it. And I think the rest of my questions have been answered. So thanks a lot, guys.

Thank you.

And our final question comes from the line of Don Worthington with Raymond James. Please proceed.

Good afternoon. Greg, when you were talking about loan growth, or I'm sorry double digit, would it be safe to say that would be somewhere in the mid-teens range that you've had in the fiscal year to date continuing on?

Yes, I think that's a reasonably safe bet. We had stated before that we were targeting $1 billion to $1.2 billion of loan growth in this fiscal year, I think we want to try to push towards that and I think we have definitely opportunities to do that. And if we fell a little bit, I think that's -- when you look at that and you do the math on that, it's in those ranges. And so, yes, I think that's a fair statement.

Okay. And then in terms of the gains on structured settlements, where do you see that going over the next quarter or two?

The structured settlement line item on the balance sheet side has been growing. I don't think we're looking at much on the gain side there really.

I know we've had some in the comparable quarter last year, and we were able to not only not realize the gains in those assets this quarter and still grow nicely. But I don't really foresee us doing a lot of sale there in the next couple quarters.

Okay. All right, thanks.

Thank you.

Ladies and gentlemen, we've reach the end of our question-and-answer session. I will turn the call back over to management for any final remarks.

All right. Thank you, everyone. Appreciate your interest, and we'll talk to you next quarter. Take care.

Thank you, ladies and gentlemen. This does conclude our conference for today. We thank you for your time and participation and you may disconnect at this time. Have a wonderful rest of the day.