Axos Financial, Inc. quarterly report, Q3 FY2018

Business context and reporting period

Filing mismatch: The request identifies Axos Financial, Inc. and “2017 Q3,” but the supplied filing is BofI Holding, Inc.’s unaudited Form 10-Q for the quarter ended March 31, 2018 (fiscal 2018 third quarter), filed April 26, 2018. The summary below reflects the supplied filing, not an Axos filing. Unless stated otherwise, amounts are U.S. dollars.

BofI Holding was the parent of BofI Federal Bank, a branchless financial services company with approximately $10.0 billion in assets. It offered consumer and business banking, residential and commercial lending, specialty finance, and partner products, including H&R Block-branded services.

Financial and operating results

• Growth and margins: Quarterly net interest income rose 31.8% year over year, principally on loan growth and H&R Block Refund Advance activity. Net interest margin was 4.77%, up 53 basis points. For the nine months, net interest income rose 19.9% and margin was 4.25%, up 23 basis points.
• Profitability: Quarterly return on average assets was 2.08% and return on average common equity was 22.84%; the nine-month figures were 1.72% and 17.55%. The quarterly efficiency ratio was 32.40%, versus 31.73% a year earlier.
• Balance sheet and funding: At March 31, 2018, assets were $9.98 billion, up 17.4% from June 30, 2017. Net loans and leases were $8.06 billion, up 9.4%; deposits were $7.96 billion, up 15.4%. Cash and cash equivalents were $1.49 billion. Borrowings totaled $1.02 billion, including $968 million of FHLB advances and $54.5 million of subordinated notes and other debt; repurchase-agreement balances were zero.
• Cash flow: For the nine months, operating activities provided $118.6 million, investing activities used $603.9 million, and financing activities provided $1.33 billion. Cash and cash equivalents increased $847.5 million to $1.49 billion, largely alongside deposit growth and loan originations.
• Credit and capital: Non-performing loans and leases were $30.4 million, or 0.37% of gross loans, versus 0.38% at June 30, 2017. Non-performing assets were $38.7 million, or 0.39% of assets, up from 0.35%. The allowance was $62.1 million, 0.76% of gross loans, versus $40.8 million and 0.65% at June 2017. The company and bank reported well-capitalized status; company total risk-based capital was 16.74% and bank total risk-based capital was 15.98%.

Material changes and management commentary

• Growth in average earning assets, especially commercial and industrial lending, and higher Refund Advance-related income drove much of the increase in net interest income. Higher deposit and borrowing costs partly offset that growth; quarterly interest expense increased 53.2% year over year.
• The quarterly loan-loss provision more than tripled. Management attributed the increase mainly to Refund Advance loan funding rising from approximately $0.3 billion to $1.1 billion year over year, as well as overall portfolio growth. The “other” loan category’s quarterly provision increased from $4.5 million to $14.1 million.
• Operating expenses increased 28.2% for the quarter. Management cited staffing to support growth, technology and core-processing investments, deposit marketing and rebranding, and costs supporting loan and deposit production.
• H&R Block products create material seasonality, with activity typically peaking in the fiscal third quarter. For the 2018 tax season, the bank exclusively originated and funded H&R Block’s interest-free Refund Advance loans and received fees from H&R Block; borrowers had no repayment recourse if tax refunds were insufficient.
• The Tax Cuts and Jobs Act reduced the federal corporate tax rate beginning January 1, 2018. The company recorded an $8.0 million reduction in net deferred tax assets and related discrete tax expense in the December 2017 quarter. The filing reports a 34.18% effective tax rate for the March quarter and 39.08% for the nine months.

Outlook, risks, contingencies and unusual items

• Guidance: The filing provides no specific earnings or balance-sheet guidance. Management said it believed liquidity sources were stable and adequate for anticipated needs and that it could increase deposits and borrowings as needed.
• Liquidity and rate exposure: Available immediately, the bank reported $562.3 million of FHLB borrowing capacity, $35.0 million in unused unsecured federal funds lines, and $916.5 million available from the Federal Reserve discount window. Brokered deposits were $1.59 billion. The filing cautions that modeled interest-rate sensitivities rely on assumptions; its one-year net interest income model showed a 13.7% increase under an immediate 200-basis-point increase and a 13.0% decrease under a 200-basis-point decrease.
• Funding risk: Contractual time deposits due within one year were reported as $691.8 million in the obligations table; management separately cited $669.7 million. The filing says replacement funding could cost more if maturing deposits do not remain. Verify the difference between these disclosed values.
• Legal matters: A securities class action was dismissed on March 21, 2018, and the plaintiff appealed. A separate securities class action and shareholder derivative actions remained pending. The company disputed the allegations; it said potential losses could not be reasonably estimated.
• Other notable items: In April 2018, after quarter-end, a bank subsidiary acquired Epiq’s bankruptcy trustee and fiduciary services business; no deposits were acquired. The company had repurchased $35.2 million of its shares under a $100 million authorization, with $64.8 million remaining. Management expected the forthcoming expected-credit-loss standard (ASU 2016-13) to have a material financial-statement impact.
• Management reported effective disclosure controls and no material quarter-end change in internal control over financial reporting. Results for the nine-month period were not necessarily indicative of full-year results.

Important facts for investors to verify

1. Confirm the issuer and reporting period: the supplied filing is BofI Holding, Inc., quarter ended March 31, 2018, not Axos Financial or 2017 Q3.
2. Track credit performance and reserve needs, especially the seasonal Refund Advance portfolio, the higher provision, and the increase in non-performing assets.
3. Assess deposit retention, brokered-deposit reliance, upcoming maturities, and the cost and availability of alternative funding.
4. Review the impact of the Tax Act and the expected-credit-loss accounting standard on future earnings, capital, and reserves.
5. Monitor the securities litigation appeal, other pending legal matters, and the integration and financial contribution of the post-quarter Epiq acquisition.