Axos Financial, Inc. — Form 10-Q Summary
Reporting period: Three months ended September 30, 2019. Although the request labels this “2019 Q1,” the filing reports Axos’s fiscal 2020 first quarter. The comparable period is the three months ended September 30, 2018. Amounts below are U.S. dollars; financial statement amounts are generally in millions unless stated otherwise.
Business context
Axos is a diversified financial services company operating through Banking and Securities businesses. Its banking operations include online consumer and business banking and lending; its Securities business provides brokerage clearing, securities lending and digital investment services. The prior-year comparison does not include the Securities business, which followed acquisitions completed in fiscal 2019.
Financial and operating highlights
| Metric | Q1 FY2020 | Comparable period / change |
|---|---|---|
| Interest and dividend income | $146.3 million | $122.8 million |
| Net interest income | $103.3 million | $86.3 million; up 19.7% |
| Net interest margin | 3.77% | 3.76% |
| Non-interest income | $21.5 million | $16.5 million |
| Non-interest expense | $65.5 million | $52.9 million |
| Provision for loan and lease losses | $2.7 million | $0.6 million |
| Net income | $40.8 million | $36.8 million |
| Diluted earnings per common share | $0.66 | $0.58 |
| Adjusted earnings / adjusted diluted EPS (non-GAAP) | $42.0 million / $0.68 | $38.4 million / $0.61 |
| Return on average assets | 1.44% | 1.57% |
| Efficiency ratio | 52.44% | 51.47% |
Management attributed higher net interest income mainly to loan growth and income from securities borrowed and margin lending. Non-interest income benefited from $5.7 million of broker-dealer fees, primarily following the Axos Clearing acquisition, and higher mortgage banking and other loan-sale gains. Expense growth reflected the Securities business, increased staffing, data processing, depreciation and amortization, and operating expansion. Management’s adjusted earnings and EPS are non-GAAP measures; the filing reconciles them to GAAP results.
Balance sheet, credit, cash flow and liquidity
- Assets and lending: Total assets were $11.77 billion at September 30, up 4.9% from June 30, 2019. Net loans and leases were $9.78 billion, up 4.3% quarter over quarter. Growth was concentrated in multifamily and commercial and industrial lending; quarterly originations for investment were $1.46 billion.
- Funding and debt: Deposits were $9.21 billion, up 2.6% from June 30. Total borrowings were $626.2 million, approximately 5.3% of assets, versus $2.63 billion a year earlier. Brokered deposits were $1.13 billion. The filing reports $1.37 billion of time deposits due within one year in its discussion and $1.42 billion in its contractual-obligations table; investors should verify the definitions and reconciliation.
- Cash and liquidity: Cash, cash equivalents and cash segregated for regulatory purposes totaled $702.3 million, compared with $857.4 million at June 30. Quarterly operating cash flow was $21.4 million, investing cash flow was negative $403.4 million and financing cash flow was positive $226.9 million. The filing cites $2.20 billion of FHLB capacity available immediately, $1.43 billion available from the Federal Reserve discount window, and additional bank and broker-dealer credit lines.
- Credit quality: Nonperforming loans were $55.9 million, or 0.57% of gross loans, versus 0.51% at June 30; nonperforming assets were $63.4 million, or 0.54% of assets. The allowance was $59.2 million, equal to 0.60% of loans and 105.89% of nonperforming loans. Provision expense rose to $2.7 million from $0.6 million.
- Unusual credit matter: A $4.1 million C&I factoring receivable became nonperforming after repayments stopped. Axos classified it as doubtful and recorded a specific allowance for the full balance, citing its belief that the underlying invoices were invalid; its recovery investigation was ongoing.
- Capital: Stockholders’ equity was $1.12 billion. Axos and the Bank met regulatory capital requirements and were classified as well capitalized. The Bank’s total risk-based capital ratio was 11.95%, above the 10.0% well-capitalized threshold.
Material changes, outlook and risks
- Compared with the prior year, average earning assets increased 19.5%; NIM improved by one basis point. Net income increased about 10.7%, while non-interest expense rose about 23.7% and credit-loss provision increased substantially. The Securities business contributed new fee and interest income but also added operating costs.
- No numerical earnings or growth guidance is provided. Axos renewed its agreement with H&R Block in October 2019 to be the exclusive provider of interest-free Refund Advance loans for the 2020 tax season. Management noted that H&R Block-related fee income is seasonal, typically peaking in the fiscal third quarter.
- Durbin Amendment/H&R Block exposure: If Axos’s assets exceed $10 billion on December 31, 2019, the filing says interchange-fee limits could apply beginning July 2020. Axos estimates potential compensation to H&R Block of approximately $25 million pretax annually, or $18 million after tax/$0.28 per diluted share, absent mitigating action or restructuring. Management has the option to compensate H&R Block to avoid early termination of the agreement. The filing also corrects a conference-call statement that had cited $0.18 per share; the corrected estimate is $0.28.
- Credit-loss accounting: Axos expects adoption of the expected-credit-loss standard (CECL), effective for its fiscal periods beginning July 1, 2020, to have a material impact; implementation and model development were underway.
- Legal matters: Securities class actions and derivative actions had been dismissed at trial level, but appeals were pending; other derivative cases were stayed. Axos disputes the allegations and states it cannot reasonably estimate any eventual loss or range of loss.
- Other changes: Adoption of the lease standard on July 1, 2019 added $77.8 million of right-of-use assets and $79.7 million of lease liabilities at transition. The board authorized an additional $100 million stock repurchase program; no shares were repurchased under the programs during the quarter.
Important facts for investors to verify
- Whether Axos exceeded the $10 billion asset threshold at December 31, 2019, and the resulting effect on H&R Block economics and interchange income.
- Developments and potential exposure in the pending litigation appeals, for which the filing provides no estimable loss range.
- Recovery prospects and subsequent status of the $4.1 million doubtful factoring receivable and its full specific reserve.
- Deposit retention and repricing needs, particularly the near-term time-deposit maturities and brokered-deposit reliance.
- Credit quality trends, provision adequacy and the expected material effect of CECL adoption.
- Reconciliation of the two disclosed amounts for time deposits due within one year, and the treatment of regulatory-segregated cash in liquidity comparisons.