Axos Financial Inc (AX) 2023 Q3 法說會逐字稿

Good afternoon, and welcome to the Axos Financial Third Quarter 2023 Earnings Call. (Operator Instructions)

I will now turn the conference over to our host, Johnny Lai, Senior Vice President, Corporate Development and Investor Relations. Thank you. You may begin.

Thanks, Diego. Good afternoon, everyone, and thanks for your interest in Axos. Joining us today for Axos Financial, Inc.'s Third Quarter 2023 Financial Results Conference Call are the company's President and Chief Executive Officer, Greg Garrabrants; and Executive Vice President and Chief Financial Officer, Derrick Walsh. Greg and Derrick will review and comment on the financial and operational results for the 3 and 9 months ended March 31, 2023, and will be available to answer questions after the prepared remarks. Before I begin, I would like to remind listeners that prepared remarks made on this call may contain forward-looking statements that are subject to risks and uncertainties and that management may make additional forward-looking statements in response to your questions. 

These forward-looking statements are made on the basis of current views and assumptions of management regarding future events and performance. Actual results could differ materially from those expressed or implied in such forward-looking statements as a result of risks and uncertainties. Therefore, the company claims the safe harbor protection pertaining to forward-looking statements contained in the Private Securities Litigation Reform Act of 1995. This call is being webcast, and there will be an audio replay in the Investor Relations section of the company's website located at axosfinancial.com for 30 days. Details for this call were provided on the conference call announcement and in today's earnings press release.

Now I'd like to hand the call over to Greg.

Thank you, Johnny, and good afternoon, everyone, and thank you for joining us. I'd like to welcome everyone to Axos Financial's conference call for the third fiscal quarter ended March 31, 2023. I thank you for your interest in Axos Financial and Axos Bank. We delivered double-digit year-over-year growth in earnings per share, book value per share, and ending loan and deposit balances. Our consistently strong results were broad-based with stable net interest margins and double-digit net income and noninterest income growth.

We grew deposits by approximately 32% year-over-year despite an expected normalization in cash sorting deposits from our custody business. The diversity and optionality of our deposit franchise is a valuable differentiator that will allow us to maintain a strong net interest margin in a highly competitive market for deposits. We reported net income of $80 million and earnings per share of $1.32 for the 3 months ended March 31, 2023, representing year-over-year growth of 29% and 28%, respectively.

Our book value per share was $31.7 at March 31, 2023, up 17% from March 31, 2022. The highlights for this quarter include the following: Ending deposits increased by approximately $1 billion linked quarter, driven primarily by consumer deposits. We took advantage of anxiety in the marketplace following the 3 bank failures in March and added new consumer and commercial banking clients. Excluding the reduction of Axos advisory service deposits ending period commercial and consumer noninterest-bearing deposits were flat from the end of the prior quarter.

Ending net loans for investment balances were $15.8 billion, up 2% linked quarter or 9% annualized. Loan growth was broad-based with growth in single-family mortgage, multifamily and C&I loans, partially offset by our deliberate pullback in auto, small balance CRE and leasing. Net interest margin was 4.42% for the third quarter, down 7 basis points from 4.49% in the quarter ended December 31, 2022, and up 40 basis points from 4.02% in the quarter ended March 31, 2022. 

The impact of excess liquidity on our net interest margin accounted for approximately 5 of the 7 basis points decline in net interest margin. Net interest margin for the banking business was 4.5% compared to 4.65% in the quarter ended December 31, 2022, and 4.21% in the quarter ended March 31, 2022. Higher loan yields partially offset the increased funding costs and negative impact from holding excess liquidity. Axos Securities comprised primarily of our custody and clearing business made positive contributions to our fee and net income.

Broker-dealer fees increased 40% linked quarter and 166% year-over-year due to higher interest rates and increased client activity. Quarterly pretax income for our securities business improved by $3.9 million linked quarter to $19.5 million. Our credit quality remains strong with annualized net charge-offs to average loans of 4 basis points versus 5 basis points in the third quarter of fiscal 2022. Of the 4 basis points of net charge-offs this quarter, 3 basis points were from auto loans that are covered by insurance policies and will be subject to subsequent recovery. 

Double-digit growth in net interest income and noninterest income resulted in a 29% year-over-year increase in our diluted earnings per share. We generated a 1.71% return on assets and a 7.4% return on equity for the quarter ended March 31, 2023. Our strong capital levels improved further with Tier 1 leverage ratio of 10.2% at the bank and 9.3% of the holding company, both well above our regulatory requirements. We repurchased approximately $32 million of common stock in the third quarter to take advantage of the unwarranted decline in our share price in reaction to the turmoil in the banking industry.

Given what has transpired in the banking industry since early March, I'd like to spend some time discussing what makes Axos different and why we believe we are operating from a position of stability and strength. From a liquidity and capital perspective, we emerged from the turmoil even stronger. We increased deposits by $1 billion this past quarter to $16.7 billion with approximately 90% of our total deposits being FDIC insured or collateralized. We had $2.5 billion of cash and cash equivalents as of 3/31, 2023, equal to 138% of our uninsured deposits. 

We had no outstanding borrowing from our Fed discount window or from the bank term funding program. We had no overnight borrowings from the Federal Home Loan Bank as of March 31, 2023, and we had $3.1 billion of undrawn capacity at the discount window and $2.5 billion of immediately available undrawn capacity with the FHLB at quarter end. The combined cash and undrawn liquidity available was $8.1 billion at quarter end, equal to 450% of our uninsured and uncollateralized deposits.

Unlike many other banks with significant unrealized losses on their securities and loan portfolio, we had a de minimis of $7 million of net unrealized losses on our $280 million available-for-sale security portfolio at 3/31 2023. The $7 million of unrealized loss represents less than 50 basis points of our shareholder equity at the end of the third quarter. 

Additionally, the fair value of our loans held for investment was a positive $30 million at the end of the quarter. Another way to say this is that if you mark our entire securities portfolio and loans held for sale and exclude entirely the positive mark on our entire deposit base, our equity would increase. Our favorable liquidity and capital position is a result of our deliberate decision not to extend maturity in our securities or loan portfolio and to reposition our loan max from hybrid single-family and multifamily mortgage loans to variable rate commercial and industrial loans when interest rates were near 0.

We have always maintained a disciplined policy of pricing our loans with the appropriate rate fee structure and terms commensurate with our risk and return objectives. We also proactively established channels where we can sell or pledge our loans quickly at or above par as a contingency plan should any unexpected adverse events arise. 

Shifting to interest rate risk management. We continue to generate an above-average net interest margin and grow deposits despite the Fed's aggressive rate increase and deposit outflows for the banking industry. This quarter, our consolidated net interest margin was 4.42%, while our bank-going net interest margin was 4.5%. We maintained a strong net interest margin despite the decline in AS sweep deposits and not holding excess liquidity during the quarter.

Our ability to maintain a net interest margin above our historical range is a function of the diverse lending and deposit franchises we have built over the past decade. We built our C&I lending verticals organically and scale them over time to ensure we have the appropriate operational compliance and risk management infrastructure and processes in place. We acquired the clearing, custody, and bankruptcy deposit businesses when rates were at or near 0 and deposit balances were near their cyclical lows.

Over time, we integrated systems and processes, added talent and relationships, and increased sales and marketing to grow these businesses profitably. The net result is our loan and deposit franchises are much more robust, diverse and aligned from a duration and margin perspective than they've ever been. At the end of the quarter, approximately 57% of our loans were floating rate, 36% were hybrid 5/1 arms and 7% were fixed. 

The average duration of our loan portfolio was 2 years with multifamily loans having an average of 2.6 years duration and the vast majority of our commercial real estate specialty loans and lender finance portfolios with a contractual maturity of less than 3 years. The average yield on our held for investment loans was 7.07% in the third fiscal quarter, up 45 basis points from 6.62% in the prior quarter. New loan yields were 10.1% for auto, 7.9% for multifamily, 7.2% for single-family jumbo mortgages, and 9.2% for commercial and industrial.

We continue to see bank and nonbank competitors pull back in many of our lending businesses, and we feel good about our ability to grow our loan portfolio in a secure way with pricing in terms that meet our risk-required return requirements. Our deposits at the quarter end were comprised of 43% demand deposits, 46% savings in money market, and 11% CDs. We issued more CDs this quarter to align the duration of our loans given the growth in net balances and the slowdown in prepayments in our single-family and multifamily loan portfolios.

Our deposits remain well diversified from a business mix perspective, with consumer and small business representing 48% of the total deposits, commercial treasury management and institutional representing 26% commercial specialty representing 7 Axos fiduciary services representing 7 Axos Securities, which is our custody and clearing represented another 7 and distribution partners representing 4%.

The granularity and diversity of our deposits, particularly consumer savings and money market accounts, provide us with tremendous flexibility to match the duration and cost of our funding to the duration and cost of our adjustable and hybrid loans. Ending noninterest-bearing deposits, excluding fluctuations in Access advisory services cash balances were approximately flat from December 31 to March 31, with the ending period balance up down approximately $269 million to $3.2 billion, reflecting almost entirely the reduction in the AAS cash. 

Total ending deposit balances at AAS, including those on and off Axos' balance sheet declined by approximately $380 million in the quarter, while noninterest-bearing commercial and specialty deposits were flat. We believe that the pace of cash sorting at AAS has stabilized at or near the bottom, representing 5.6% of assets under custody at the end of the quarter compared to the historical range of 6% to 7%.

Access Advisory Services has a healthy and growing pipeline of new advisory clients with 15 new deals signed with a combined assets under custody of $1 billion this quarter. In addition to the Axos Securities deposits on our balance sheet, we had $1.1 billion of deposits off balance sheet at partner banks and approximately $680 million of deposits held at other banks buy software clients in our ZF business management vertical. We continue to add new accounts across each of our deposit businesses, including consumer checking, consumer savings, money market and CDs, commercial and treasury management, AAS, and Axos Security. 

Since the banking failures in early March, we have aggressively increased our outreach to existing and prospective clients across every deposit vertical. With our experience with the IntraFi ICS product and a competitive set of treasury management offerings, we are seeing a lot of interest from clients who are moving deposits to us. Our low loan-to-value asset-based lending philosophy continues to serve us well from a credit perspective. Our single-family jumbo mortgages and multifamily loans, which represent 24% and 19% of our total loans outstanding at the end of the quarter have a weighted average loan-to-value of 57% and 53%, respectively.

Our jumbo single-family mortgages are concentrated along the coast in markets where housing inventories continue to be constrained. The lifetime loss in our originated single-family jumbo mortgages and multifamily mortgages are 4 basis points in less than 1 basis point, respectively. Our commercial real estate lending business comprised of low LTV lending to nonbank lenders and well-capitalized sponsors is secured by single-family, multifamily, and commercial real estate properties in attractive locations.

Of the $5 billion of commercial specialty real estate loans outstanding at the end of the quarter, multi-family was the largest segment, representing 31% of total loans, condominiums and single-family representing 23% with hotel, office, and retail representing 16%, 14% and 5%, respectively. We included a slide in our earnings supplement detailing the balances, loan to values, and nonperforming loans for our commercial specialty real estate portfolio. 

On a consolidated basis, the weighted average loan-to-value of our commercial real estate portfolio was 42%. For the retail and office segment of our commercial real estate book, the weighted average loan-to-value was 42% and 37%, respectively. Of the $673 million commercial specialty real estate loans secured by office properties at the end of the quarter, 77% are A notes while note-on-note loan structures with significant subordination from fund partners and mezzanine lenders resulting in a 37% loan-to-value ratio.

The office exposure that isn't in any note with a strong funding partner is almost entirely participation for One Madison in New York, one of the best office buildings in the city. This building is 57% pre-leased and has a 50% recourse guarantee for SSL grain subject to conditional leases based on certain leasing cash flow and other milestones, approximately $80 million of the commercial specialty real estate office book repaid after the end of the March 31 quarter. We have no lifetime losses in our entire commercial specialty real estate loan book.

Our lender finance lending is comprised of lines of credit to non-bank lenders. The total lender finance book outstanding was $2.4 billion at the end of the quarter with real estate lender finance accounting for approximately 35% of the total lender finance portfolio and non-real estate lender finance accounting for the other 65%. We have a direct and a fun business in lender finance and the weighted average loan-to-value for the lender finance portfolio was 54%.

We actively monitor the cash flow and credit performance of our lender finance borrowers. The loan structure and our senior position in the payment waterfall provides us with confidence that our lender finance portfolio can withstand significant stress and not result in material loss to the bank. We've never lost any money in the level finance portfolio.

Our auto lending business comprised of direct and indirect lending to prime and super prime lenders had an ending balance of $518 million at the end of the quarter, representing only 3% of our total loans outstanding. We have reduced originations meaningfully in the auto lending due to our cautious outlook on a broader economy and used car values, resulting in net auto loan balances falling by approximately $37 million in the third quarter of 2023. 

With an overwhelming majority of our total loans outstanding being secured by some form of collateral, we believe our credit will perform well through the cycle. One of the key differentiators that allows us to grow revenue, loans, and earnings in a consistent and safe way is that we operate a software-based high-touch service model for clients nationwide. Whether it's through our Universal Digital Bank online and mobile platform that provides consumers a convenient and secure way to access all deposit lending and securities trading and wealth management services digitally or our proprietary front and back-end custody platform that simplifies the trading, reporting, marketing and back-office functions for independent RIAs, we acquire onboard, underwriting service customers efficiently.

East deposit lending and fee-based business vertical is supported by a robust risk management infrastructure and the team of dedicated members with subject matter expertise in their business and functions. The diversity and in certain instances, the countercyclicality of our businesses allow us to shift capital and resources quickly and efficiently when competitive and economic conditions change. 

As we have demonstrated throughout our history, especially during periods of distress, such as the dot-com boom and bust, the great financial crisis, and most recently, the COVID pandemic being able to pivot quickly to capitalize on market dislocations in a significant competitive advantage, particularly in a highly cyclical industry such as banking. I'm excited about the strategic initiatives we have across our businesses. Our strong capital liquidity and profitability allows us to maintain investments in technology, people, and products while others pull back.

We see improved loan pricing that will help offset lower demand in some lending categories as rates continue to rise and the economy decelerates further. We will continue to execute and expand various operational efficiency initiatives, including business process automation, offshoring, low-value manual tasks. We have already seen significant opportunities to hire talented individuals and teams to help us incubate new businesses or augment existing businesses. We have also reviewed opportunities to purchase assets, loans, and businesses from sales or less well-capitalized institutions looking to exit noncore businesses in order to shrink their balance sheet. Lastly, we'll take advantage of opportunities to return capital to shareholders through share buybacks when our stock becomes irrationally undervalued.

I now I'll turn the call over to Derrick now.

Thanks, Greg. To begin, I'd like to highlight that in addition to our press release, an 8-K with supplemental schedules and our 10-Q were filed with the SEC today and are available online through EDGAR or through our website at axosfinancial.com. I will provide some brief comments on a few topics. Please refer to our press release, our SEC filings, and our website for additional details.

Loan originations for investment for the quarter ended March 31, 2023, were $1.8 billion, down from $2.4 billion in the comparable quarter a year ago. We tightened our pricing and underwriting guidelines in auto, unsecured consumer, and small-balance commercial real estate and had lower demand in single-family jumbo resulting in a decline in loan originations. Fiscal Q3 2023 originations were as follows: $178 million of single-family jumbo portfolio production, $148 million of multifamily production $797 million of commercial real estate production, $20 million of auto and unsecured consumer loan production, and $588 million of C&I loan production, resulting in a net increase in ending C&I loan balances of $246 million. 

Credit quality remains good with 4 basis points of net annualized charge-offs to average loans, 3 basis points of which were from auto loans that are covered by insurance policies. Our nonperforming loans and leases were 60 basis points at March 31, a basis point improvement from the December quarter. Single-family, multifamily, and small-balance commercial mortgages represented over 75% of our nonperforming assets at the end of the third quarter.

Given our low loan to values and our low historical losses in these lending categories, we do not anticipate material increases in our net credit losses. We added $5.5 million of provision for credit losses this quarter to support our loan growth. Total allowances for credit losses represented 168% of our nonperforming loans at March 31, 2023. The Non-interest income for the 3 months ended March 31, 2023, was $32.2 million, an increase of 12% compared to $28.8 million in the corresponding period a year ago.

Broker-dealer fee income increased by $8.6 million year-over-year to $13.7 million in Q3 2023 due to -- due primarily to higher interest rates. Mortgage banking income was down approximately $5 million year-over-year to $1.1 million as a result of the industry-wide downturn in single-family agency mortgage refinancing activity. Prepayment penalty fee income was down by $0.7 million to $2.1 million as the increased rate environment led to decreased levels of prepayments on multifamily and commercial loans. 

Lastly, on equity, our return on equity was 17.4% and our return on average assets was 1.7% for the 3 months ended March 31, 2023. Tier 1 capital, the risk-weighted assets for Axos Bank was 11.6% at 3/31, up from 11.3% in the prior quarter. Since June 30, 2022, net capital at Axos Clearing has increased by approximately $41 million to $79.5 million due primarily to higher profitability in our securities business. We have excess capital at the holding company available for opportunistic share repurchases and to contribute to our subsidiaries if needed.

After buying back approximately $32 million of common stock in the third quarter, we had $21.2 million remaining availability in the stock repurchase program. That was before yesterday when the Board of Directors approved an additional $100 million of availability for the stock repurchase program. This allows us further optionality in the management of our capital between internal investments, accretive acquisitions, and share buybacks. 

Additional commentary on our loan pipeline are that we had $33 million of single-family agency gain-on-sale mortgages, $273 million of jumbo single-family mortgages, $83 million of multifamily and small balance commercial real estate term loans. And then given the dynamics, we now expect loans to grow by high single digits to low teens year-over-year, and our net interest margin in the range of 4.25% to 4.35% for the next few quarters.

Our loan growth outlook is based on a gradual rebound in single-family jumbo mortgage originations, coupled with low prepayments in that business, double-digit growth in our CRE and lender finance businesses, and flat to declining auto and unsecured lending. We believe that moderating our pace of loan growth and building capital levels until the economy and the banking industry rebound is a prudent trade-off.

Our NIM guidance reflects loans repricing higher, offset by rising deposit costs. We also expect to maintain a higher average deposit balance for the next few quarters, which will have a 10 to 15 basis point drag on our consolidated NIM. We believe maintaining excess liquidity is prudent given the uncertain economy and industry environment. That said, we are excited about the opportunities ahead and feel that Axos is well-positioned to continue its strong financial performance. With that, I'll turn the call back over to Johnny.

Thanks, Derrick. Operator, we're ready to take questions.

(Operator Instructions) Our first question comes from Andrew Liesch with Piper Sandler.

Derrick, you just answered most of my questions. But on this liquidity that's on the balance sheet right now, the 10 to 15 basis point drag, how does that affect NII? Is that neutral right now?

Yes, I think it's fairly neutral because we just put that money with the Fed and there may be a slight benefit from it. But if you look at the average cost of the marginal cost of the highest cost deposit, I think a neutral assumption is roughly.

Correct, correct. Yes. Got it. And then just looking at the Q, it didn't look like there's too much change in substandard or special mentions. But are you seeing anything in those loans that's given you any pause right now? I mean, your commentary was that you're not expecting much material losses in the loan book. So I'm guessing no. I'm just curious if there's anything out there that you're looking at more closely.

No, we're not really seeing anything that we find concerning. And we're looking pretty carefully. And I think where we are in our attachment points are still very, very strong and -- so we're not really seeing anything that we feel we should be concerned about.

Got it. And then, Greg, you mentioned that you were able to take advantage of some of the turmoil in the markets here and add more consumer deposits and probably some commercial deposits, too. But are there any businesses that you think you might want to expand into or anything that you see attractive out there as you take advantage of some of what's going on with some other banks?

Yes, we think so. There is -- we've got some team hires that we're working on, some that have accepted in certain areas that we really like, we'll kind of let those materialize over the next few quarters before we make announcements given that they're kind of in process, and we don't want to have people getting ahead of us and things like that. But yes, no, I think there's not only a team acquisition, so let's talk about the opportunity set.

There's definitely team acquisitions on the deposit and lending side in areas that previously had been probably precluded by the nature of the competition in that area in those areas. And so those are clearly open. There's opportunities for bulk loan purchases in a few cases that we might be interested in. We'll have to see how that goes. Those are very bling, right? You either win them or you lose them. 

But that could change the loan growth prospects. So we would -- we gave you kind of organic loan growth views. And so if we buy a portfolio, that would be bigger. And then there's just simply the fact that customers are looking more than ever for diversity in their deposit relationships. And so we're seeing very high rates of increase in the applications on both consumer and commercial deposit categories, and we're having conversations with clients that previously had been in scans and other institutions fairly strongly and are now interested in either moving or diversifying.

So we think we actually feel really good about our deposit pipeline right now, too. It just looks very good. And the teams have been working weekends to open accounts, and they're sort of -- it's -- we've been adding personnel there. So we feel really good about those 3 areas.

Our next question comes from David Feaster with Raymond James.

Maybe just starting on the loan growth side. I appreciate the high single-digit guidance and that kind of drives with the slowdown in originations we saw. I'm just curious how much -- is this by design? Or is this a function of just less demand in the market? And just -- so just kind of curious some of the drivers of that.

And then maybe where are you still seeing good risk-adjusted returns at this point in the cycle? I mean, you alluded to some opportunities in Jumbo single-family and some in Cresson lender finance. But I'm just curious, as you dig into it, where are you still seeing good risk-adjusted returns as well?

So yes, with respect to the loan growth side, clearly, on the consumer side, it's intentional. We're just -- we don't really see anything particularly problematic happening in that book. The insured book has a little higher delinquency, but that's also well covered by the insurance, but it's still quite de minimis. We just really don't want to deal with the servicing-type issues there as much and are kind of pulling back a little bit there deliberately.

On the other side, I think it's just really a matter of more of us continuing to tighten what we're doing. And so as that happens, we're holding pricing terms and then often tightening those terms. And so that kind of lets itself fall out. But I really do think that I feel reasonably good about loan growth. I think we're being I think that's our best estimate that $500 million, $600 million a quarter of growth is, something like that, I think that's where we're forecasting next quarter. But could it be a little higher, a little bit lower, potentially? And we also start seeing some interesting opportunities that are arising in very low-risk areas as a result of some of the exits and movement that's been happening in the banking business.

So I actually think that there are good deals across the board. They just have to be structured properly. And I mean, when we're doing cresol deals now, we're looking at 12 and 13 debt yields, right, for attachments to RFPs. Those are good deals with great sponsors. So I think that the pullback in the market that we're seeing from a lot of other lenders is enabling us to get better sponsors, better borrowers, tighter credit, and better pricing. So it's really a good time in a lot of ways to be a lender because you can get ahead of what those value changes are in an environment where there's just reduced competition.

That makes a ton of sense. And then obviously, there's a hyper-focus on CRE with investors at this point. I'm just curious what you're seeing more broadly there. You touched on it a little bit. You're seeing other competition kind of pull back. And you've always -- you've always had extremely tight underwriting standards.

Obviously, there's low LTVs as you can see in the presentation, I appreciate that. But maybe just more broadly, as you look out, is there anything that you're watching from a market perspective or a segment maybe that you're avoiding or pulling back in? And how are you tightening standards? Just curious kind of what you're seeing more broadly there.

Sure. So let me talk about it in 2 ways. The first way would be how the cash flow of the property is doing and what's the underlying economic fundamentals of each of the property types, then just talk about the impact of interest rates or other valuation issues. So what's interesting about it is that the housing market just in general, including what you see on the condo sales side, even in places like New York, Miami, all these places, they've essentially held in or actually gotten better in some respect.

So right now, the single-family, our condo sort of issues that people thought might arise so far have been a big bust. Now again, when you're at 40-ish percent loan to values on those things, it doesn't really matter that much if you get some decline in value, but we're not seeing it. It's not there. And in fact, if it's a good product and it's well placed, it's in New York, it's flying off the shelves, actually.

So that's sort of interesting. The next office, it depends on what you have on the office side. To the extent we've ever done that, done office, there's -- if we're not doing it in an extremely structured way where we're 15% loan to value for an office conversion with a fund guarantee from Fortress or something like that, then we're looking at the best buildings. 

So that I gave that example, the One Madison building, which is pre-leased to all these Fortune 500 companies. It's the best building in New York. If you want to be in an office and you're going to have people come in to work, you want to be there. I think office, clearly in many cities in places that we stayed away from for a long time is doing terribly.

Obviously, in San Francisco, L.A., particularly markets that have been subject to the sort of the criminal negligence that you have associated with how those cities are run, right, from a prime perspective and whatever people don't want to be in those places. They don't want to be in L.A. downtown. Even our office, our team wants to move because the people can't walk around the building without being bothered, right? So it's just sort of that kind of stuff is causing in some of those markets, those problems. So I think you have to be obviously very careful there. 

On the hotel side, frankly, the hotels are doing incredibly well. I mean they are blowing out their projections, getting busters, et cetera, above, blah, blah, right? So it's just really good and industrial the same way. So the question is, so you've got cash flow and those sort of things, and we always cut these projections. So -- but they're even hitting their own projections, right?

So it's sort of interesting. That looks really good. Now so then the question is, so you've got those cash flows, they're looking good. Obviously, they might not stay that way forever. But right now, you're not seeing problems. Then the question is, what's the value? And so then the interesting question is, well, so cap rates clearly in asset classes that are performing well haven't increased from a trade perspective anywhere near the way interest rates have increased.

So then the question becomes, well, why is that? And one answer is that the yield curve is obviously inverted. When you buy these properties, you're buying them over extended periods of time, and there's maybe potentially over-optimism not only on that cap rate but also on the potential for increased cash flows. 

So what we've done in order to deal with that is basically say, we're making the assumption that all these cap rates have gone up by that and a lot more, and we're going to get a significant reduction in the cash flows, even though we're not seeing it, right? And so that results in new deals being written at 11 and 12 from a debt yield attachment perspective, which allows us to have a salable piece of paper at cap rates that are nearly double what the appraisals are, right?

And so -- and that comports with those loan-to-value ratios. So I think when you look at these sort of things, and then obviously, we cultivate a very robust set of folks that are interested in being able to buy those properties in whatever form they're at and are opportunistic. And so we have a very broad base of opportunistic clients that are always interested in taking advantage of those opportunities. And so how we deal with that is we just simply adjust what we expect target debt yields are. We adjust the advance rates and we look for recourse and all those other things that we can do. And in a market like this, you just have more market power to do that. 

So I think -- look, I think that the fundamental issue is if you went on a San Francisco office building and you were 70% nonrecourse, which is something that you could have easily gotten and you basically had tenants and you underwrite it at a 3.5% or 4% cap rate, which is what the appraisal is that's a tough loan, right? But that's a very different thing from the type of stuff that we did. So we were never really in that kind of market because we never really believe the cap rates, right? So we had to choose kind of a different approach. And I think that approach has turned out to ultimately be correct, and I believe it will turn out to be correct over the cycle.

Okay. That's extremely helpful color. And then maybe just switching gears, I was hoping to get a status update on the Security segment. I mean you guys -- it's nice to see really the earnings power of that business starting to shine. I'm just curious, where are we at in the build-out there and the kind of the process improvements and all those types of things? And kind of what's the road map near term for that business? And any other initiatives that you have on the horizon?

Yes, sure. So where we are in the build-out is it is going to see progress there, and there has been a lot of progress made, but it's still very early innings with the sets of opportunities we have there. So we kind of talked about this in a number of different calls and stuff, but I'll kind of summarize it to kind of give you my perspective on where we are.

First, on the clearing side, One of the impediments we have is we have a very expensive core processor that kind of charges us by transaction and that we pass all those transaction costs on to the clients. We're decently through the development of what we've called Access Universal Core, which is a system that would replace that securities core. And that would then give us the opportunity to basically partner with a variety of different clients, often larger clients in materially different ways. 

And so part of our pricing stops us really from going out and getting bigger clearing clients because -- we just -- we don't have the pricing to do it and a company why Pershing owns its own system. So we're looking to have much greater parity there on a modern system at the level of core. Then the other elements that are progressing nicely is that we're also taking the front-end application for consumers and integrating that fully with the systems that we have for the clearing and custody business so that there's one application that can be utilized for the end clients of the RIAs and the brokers.

And so those clients would then be incented to bank with us through a variety of different mechanisms, so that when we're boarding an RIA, we're boarding that account, not only on the security side, but we're also boarding it on the banking side. We're boarding it for a securities-based line of credit and then working to serve that entire customer's need. That's ongoing as far as development and doing well. We're projecting that around end of July, we'll have the white label platform built out entirely for the consumer, and that will have the white label account opening as well for the RIA. 

And then we do have -- we have some test clients on the white label enrollment for the broker side. But what we really need to do there is get UDB embedded in that. But the only problem is if we basically code that up to the old core, then that doesn't help that much. So we're kind of going to roll out the UDB platform to the clearing clients at the same time we rolled out the universal core.

So I think that there's some fundamental cost changes that can occur from the universal core and then a lot of opportunities on the cross-sell side for banking because we get very, very positive feedback with respect to RIAs that often left these bigger wirehouses, and they don't like their clients' banking at their old employer because it just generates a connectivity that then stops that hurts that potential retention of the client. 

On the op side, we've done a lot, but there's still a lot to do. The security segment is nowhere near as efficient as the banking segment. There's a ton of straight-through processing opportunities. Some of those are related to the ability to get access directly to the client because through the app, right, because when that happens, then all of a sudden communications are maybe easier, money movement is made easier and all of those things just sort of fall in place.

So those are somewhat connected, but not entirely so because there's plenty of back-office stuff that can be improved on that side. So yes, there's -- it's a lot of great opportunity. The client reception is extremely good. People want another choice other than Schwab. And with the merger, they've just been forced into Schwab entirely. So yes, there's a lot of opportunity on the custody side there for sure.

Our next question comes from Gary Tenner with D.A. Davidson.

Just wanted to follow up on the comment you made on the prepared remarks on the RIAs, 15 RIAs, I think, signed up, AUM of $1 billion. What's the timing for the onboarding of that period?

It's a little bit variable, but I think 6 months is a reasonable kind of view. But it's -- some of this depends on their own pace. And we're also building a better process to move that along. But I think a 6-month time frame is a fair kind of representation of the time. It usually takes from the time a contract is signed and the time that the clients get onboarded.

And I know in the past, you've talked about the ability to really attract larger individual RIAs once you kind of complete the integration of the full suite. So are those -- is that kind of still the perspective that there's going to be...

Yes. Well, so both on the clearing side, I think that the bigger fish. We're precluded from getting the bigger fish by the current cost structure we have. I think on the RIA side, we are having those discussions and getting decent traction with -- and we have $1 billion-plus RIAs signing up. Part of it is the question is they're often committing $100 million of maybe several billion that they have and they're sort of trying us out.

And some of it is we've sold them on not only what we're doing now, but what we're doing in the future. So this is they're multi custodial. They're coming over with a certain proportion of their business. They are larger. So we are winning those and then they're going to have us prove ourselves out, and that's what we have to do.

And then we can increase the market share from there. Because a lot of times, it isn't like clearing is different, you basically -- I mean, you can do all clear, but it's much -- it's more rare, particularly for firms in and around the size that we have. But for RIAs, they're often multi-custodians. So when we are winning where we are winning business, but we may be -- we're only counting the assets that they've allocated to us, not the entire firm if it isn't pledged to us.

Got you. And then just really one more question on the custody side. With the commentary about the cash balances kind of down to a low level at this point, which I know was expected to come off the high from a couple of quarters ago.

I'm curious to the degree you kind of see the numbers behind the numbers as were -- have RIAs put more client funds back into equities? Or are you seeing some of those cash balances invested into treasuries kind of the same way that we're seeing bank deposits move out of the bank system into treasuries or otherwise? You give a sense for kind of where those funds are going?

Some of it is that. But a lot of it is we have these -- we have some tactical allocators who move in and out of the market when they get different signals. And so that kind of makes that movement. But there clearly has been some allocations away from the cash side through -- and we control which money market funds they're allowed to use and things like that.

And so what we do monitor that, and there clearly is some of that. But frankly, a lot of what -- that isn't the majority of what it was. It really was much more market -- their market timing, frankly, I think they did a pretty good job of it. And when the market was really going down, they basically took their money out and sat on it, and then they put it back in then. So -- but look, it's -- we haven't seen this environment for some time.

So the question is, this would even in much higher rate environment, this percentage of cash to assets has been sort of the low. So I think it's unlikely to go lower given the tactical nature of the trading. And it isn't a perfect substitute, right, because you do end up having to wait to be able to allocate. And a lot of those RIAs are fairly active, so they don't like to wait to allocate. They've got to wait for those trades to clear in and out. There's costs associated with doing that. So it isn't a perfect substitute, but there's some of it but not most of it.

Our next question comes from David Chiaverini with Wedbush.

The first one is a follow-up on the CRE discussion. Have the rating agencies specifically Moody's, expressed any concerns about your CRE growth?

Yes. Moody's did mention that in their most recent report on us. And I think that was pretty much -- they've kind of taken that pretty much industry-wide. And yes, so that we went through that with them. And we had folks that were a little bit new to the business, that we were talking with. But yes, they did express something. And you can read that report that they had.

And have they been receptive to, for instance, your discussion around how conservative your underwriting standards are around Kressel and lender finance? And how receptive have they been to that conversation?

I think that it was -- I think they were receptive to it, but I think it was somewhat mixed. I mean, you never know exactly how they say it. The people that were close to us, said, yes, we completely understand we're going to talk to folks about it, then they go up and they say, "We don't care, we're treating all banks the same way with respect to this and whatever." So I mean, look, I don't put much faith in what rating agencies say or do in my investments or anything else. They move with the tide and the press and whatever else. But yes.

Understood. Shifting gears. On the deposit side, you guys have that nice lever of having off-balance sheet deposits that you could entice to bring on balance sheet. Can you remind me what the number was for comparing the fourth quarter to the first quarter in terms of off-balance sheet deposits?

So it was pretty consistent. It's been around $700 million or so for a couple of quarters, and that's specifically talking about the -- on the security side of the business. And then there's another $680 million connected to the Zenith business that's not necessarily off balance sheet, but it's not an access bank, but it's an opportunity for us as through 5he customer base for.

Right, right. I think it is important to differentiate between those 2 though. We control the securities off balance sheet, those deposits that are through our software are at other banks and it takes an affirmative set of movement and work to move those on balance sheet. And we've got some decent commitments for that, but those are more -- it's more of a commercial pipeline opportunity, as Derrick said.

Our next question comes from Edward Hemmelgarn with Shaker Investments.

Yes. Just a couple of questions. One is, what is the time frame again on finishing the improvements to the securities business and you indicated numerous times.

I mean, there are so many different things going on. I mean the Universal Core is a multiyear project. I mean, we'll start putting clients on -- well, hopefully, we'll start putting -- we'll put cost on it in 6 months, which will save money, but that's a massive, massive project. That's a multiyear project.

And then the -- and then we have to get a bunch of -- it's really a huge change management process because you've got to get everybody to adopt to new systems and all those kind of things. So it's a time of saying. I mean this -- and then I take Enbridge at any manager ever thinking they're done improving their operations either. So -- but I think just with respect to that, it's a multiyear project.

No. But I'm assuming that it's impacting sales if you are -- your costs are higher than your competitors.

Yes. Well, yes, well, the cost -- so let's just be clear. On the clearing company, it is impacting sales, but there's really not a lot you can do about it if you got to switch out your core because that's a really complex thing. So it is impacting sales. On the custody side, that's not impacting sales so much. The core side of it. We own the system there. I think with respect to -- if you're talking about gee, you have so many customers that you could onboard them faster, that soft sort of stuff will get worked out in a couple of months.

Yes. I mean -- and then -- look, we have a good system now. I just also -- it's also about profitability, right? Because each of these clients that get onboarded, you bought board an RIA and it will come with 1,000 high net worth clients, we may be able to bank almost all of them at a certain level. And I think -- and that time frame is the white label will be out in test data at the end of July. And then we'll start working on that. But then it will be easier to put new clients on it and then you got to get old clients to change. There has to be incentives there, all that kind of stuff.

But probably then we've also got to get integrated SBLOC. We're going to launch an SBLOC credit card into that platform as well. So RIA clients can utilize their securities book to have a very low rate, high reward credit card because it will essentially be -- it should be unless we make an operational error a 0 loss credit card, right? So those kind of things, those are long-term things. They are still multi-year initiatives. So -- but you know what, and you can -- you've hung out a long time, you can be patient in a couple of more years. I mean you're still a young fry guy, I mean, come on.

All right. The other thing is I'm a 2-problem question, but I've been -- I was curious about your comments about the -- it looks like there may be blocks of loans available for sale. I mean, that's interesting. Where is that really coming from ores from the like the likely suspects that have failed or...

Yes. Some of them have announced them. Some of them are the suspects that have failed. I mean there's some that are probably -- you could guess who they are, but they're not -- I don't think they've made them all public. So there's like 4 or 5 shooting around. I think a couple have some possibility, but yes, so that could change the loan growth projections a little bit if we did stuff there. But we'll see.

I mean, we bid for one loan pool and got smoked spot for -- I thought I was surprised. I whoever took it. I was happy they did at that price, we wouldn't have bought it. So look, I mean you don't know those things. You basically do your diligence, you put in your bid and it could be pulled away, you could win it. So...

And lastly, I mean in the past have been, I mean, very opportunistic at least in the -- your only other time we had the recession. I was in 709, and taking advantage of the opportunities that are out there, do you -- what's your curious about your economic outlook? I mean, are you assuming a recession? Or do you think the potential is or things can get to be a lot worse and maybe the opportunities getting to be a lot better? And if so, do you have the capital to really take advantage of all that is presented?

Yes. I mean, I think that clearly, with the profitability we have and the capital we have, I think we have the ability to take advantage of the personnel that are out on the street for the businesses that we want to grow because we want to grow them in a controlled and methodical manner. I have not really projecting that if we -- that we're going to go out and -- look, if somebody is willing to sell me signatures book of $10 billion of loans at $0.50 on the dollar, then we'll have to go raise capital on deposit and whatever else, but that's not on the table and that's not going to happen.

So I think we have -- we've had some funds and firms approach us and say, if you need equity we'd like to be a part of anything you're doing. So there are those kind of opportunities out there. I think that probably the right approach to this is to take things like we always do in reasonably digestible chunks without taking any one bet that's so large that a deviation from the plan is something that gets you into any kind of significant issue. So yes, I think we do. And if we don't, we'll be able to find capital to partner on those things. But as I kind of said before, I think of the items that I'm most excited about, I think that the opportunity of just the personnel who were looking to move around and the clients that are looking to move around are pretty good.

And then some of the loan kind of purchase things, there's a couple that are interesting, others that are not so much, and trying to see if you can couple those with people that would be interesting as these things kind of move around could be something there. But look, we have -- obviously, we have very strong earnings, and so that allows us to have the opportunity to grow or to look at these kinds of opportunities as they arise.

There are no further questions at this time. I'll hand the floor back to management for closing remarks.

Great. So before -- thanks again for everyone joining. I just wanted to kind of reiterate the loan pipeline numbers because I think we got cut off a little bit there when Derrick was talking. So the total loan pipeline was $1.1 billion at April 24, 2023, and that was comprised of $33 million of single-family agency gain on sale $273 million of jumbo single-family mortgage, $83 million of multifamily and small balance commercial, $709 million of C&I and CRE loans and $15 million of auto and unsecured. So that's it for this quarter. Thanks for your interest.

Thank you. This concludes today's conference. All parties may disconnect. Have a good day.