Business context and reporting period
Axos Financial, Inc. is a digital financial-services holding company with Banking and Securities businesses. Its banking operations offer nationwide deposits and consumer and commercial lending; the Securities business provides broker-dealer clearing, custody, margin lending and digital investment-advisory services. This Form 10-K covers the fiscal year ended June 30, 2019, not calendar-year 2018 or a standalone 2018 Q4. The filing also reports the quarter ended June 30, 2019.
During fiscal 2019, Axos acquired COR Clearing, WiseBanyan and deposits from MWA Bank, and acquired $2.4 billion of Nationwide Bank deposits in November 2018. The acquisitions expanded the company into securities clearing and digital wealth services and contributed to asset and deposit growth.
Financial performance and condition
| Metric | FY2019 | FY2018 |
|---|---|---|
| Total assets, period end | $11.22 billion | $9.54 billion |
| Total deposits, period end | $8.98 billion | $7.99 billion |
| Loans and leases held for investment, net | $9.38 billion | $8.43 billion |
| Net interest income | $408.6 million | $368.5 million |
| Non-interest income | $82.8 million | $70.9 million |
| Non-interest expense | $251.2 million | $173.9 million |
| Income before taxes | $212.8 million | $239.7 million |
| Net income | $155.1 million | $152.4 million |
| Diluted EPS | $2.48 | $2.37 |
Combined net interest and non-interest income was approximately $491.4 million, up from $439.4 million. Net interest income grew with loan growth and securities-brokerage activity; higher funding costs partly offset the increase. Net income rose modestly despite lower pretax income, primarily because the effective tax rate fell to 27.10% from 36.42%, including the effect of tax credits.
- Margins and returns: Net interest margin was 4.07%, versus 4.11%; Banking segment margin was 4.14% in both years. Return on average assets was 1.51%, versus 1.68%, and return on average common equity was 15.40%, versus 17.05%. The consolidated efficiency ratio rose to 51.12% from 39.58%; the Banking segment ratio rose to 40.51% from 34.55%.
- Credit costs: Provision for loan and lease losses was $27.4 million, compared with $25.8 million. The allowance was $57.1 million, or 0.60% of loans and leases, versus $49.2 million, or 0.58%. Non-performing loans and leases increased to $48.4 million from $31.2 million; non-performing assets were 0.50% of assets, versus 0.43%.
- Cash flow: Operating activities provided $204.4 million; investing activities used $931.7 million; financing activities provided $961.8 million. Cash, cash equivalents and regulatory-segregated cash totaled $857.4 million at year-end, compared with $622.9 million. Lending and securities activity, deposit flows and acquisitions affect comparability of these cash-flow figures.
- Debt and liquidity: Year-end FHLB advances were $458.5 million; borrowings, subordinated notes and debentures totaled $168.9 million. Axos Clearing had $106.8 million outstanding on secured bank lines. The Bank reported approximately $2.0 billion of immediately available FHLB capacity and $1.6 billion of FRB borrowing capacity, both subject to collateral. The company and Bank met regulatory capital requirements and were classified as well capitalized; company CET1 was 11.43% and Bank CET1 was 12.14%.
For the quarter ended June 30, 2019, net income was $40.6 million, net interest income was $100.4 million and provision for loan losses was $2.8 million. The filing’s quarterly table does not make that quarter comparable to a 2018 Q4 reporting period without using the fiscal-quarter dates.
Material changes versus the prior year
- Assets grew 17.6%; net loans and leases increased by approximately $949.8 million, and deposits grew by approximately $997.8 million. Loan growth was concentrated partly in C&I, income-property and warehouse lending.
- Interest expense increased 46.6% to $156.3 million, reflecting higher rates and greater time-deposit balances, including acquired Nationwide deposits. Average cost of interest-bearing liabilities increased to 1.97% from 1.51%.
- Non-interest expense increased $77.3 million. The filing attributes the rise to staffing, acquired-business costs, technology and infrastructure, regulatory compliance, amortization, and other general and administrative costs.
- Mortgage banking income declined to $5.3 million from $13.8 million, partly offset by new broker-dealer fees of $11.7 million and higher banking and service fees.
- The Securities business generated a $14.8 million pretax loss in its first reported year, including a $15.3 million bad-debt expense tied to a correspondent customer’s default after unauthorized securities trades by an employee. Adjusted earnings, a non-GAAP measure that excludes this and other specified items, were $172.0 million, or $2.75 per diluted share; GAAP net income was $155.1 million.
Outlook, risks and contingencies
Management’s stated long-term objectives are annualized return on average common equity of at least 17%, annual growth in average interest-earning assets of at least 12%, and a Banking segment efficiency ratio of 40% or lower. These are objectives, not specific near-term earnings guidance. Management identifies interest rates, deposit and loan competition, credit performance, regulation, strategic transactions and operating efficiency as important determinants of future results. The Federal Reserve cut rates in July 2019; management cautions that rate movements can affect funding costs, net interest income, refinancing activity and asset values.
- Credit risk includes growth in less-seasoned C&I and other business lending, rising non-performing loans, the adequacy of the loss allowance and exposure to real estate. Approximately 72.2% of the mortgage portfolio was secured by California property.
- Funding risks include deposit competition, repricing and maturities: $1.3 billion of time deposits were scheduled to mature within 12 months. The company relies primarily on deposits and FHLB advances.
- Assets exceeded $10 billion in 2019, bringing additional CFPB oversight and potential effects from the Durbin Amendment on interchange fees. The company also faces securities-industry regulatory and net-capital requirements following its acquisitions.
- Other disclosed risks include integration and retention challenges from acquisitions, cybersecurity and third-party technology dependence, LIBOR transition, regulatory changes, and possible goodwill or securities impairment.
- Shareholder securities and derivative lawsuits remained subject to appeal or other proceedings; the company disputes the allegations. Management said it could not reasonably estimate any eventual loss or range of loss.
- Management and the auditor reported effective internal control over financial reporting, but the 2019 acquisitions were excluded from the control assessment because of acquisition timing. The auditor issued unqualified opinions on the financial statements and controls.
Investor verification priorities
- Confirm the fiscal-year period and compare fiscal quarters on matching dates; the filing is for the year ended June 30, 2019, not a calendar 2018 Q4 10-K.
- Assess whether earnings growth is sustainable after separating the $15.3 million correspondent bad-debt charge, acquisition expenses and tax-rate effects from GAAP results.
- Review the acquired Securities business’s customer exposure, reserve adequacy, integration progress and capital requirements following the correspondent default.
- Track credit quality, especially rising non-performing residential loans, C&I portfolio growth and the allowance relative to losses and loan mix.
- Monitor deposit pricing and retention, upcoming time-deposit maturities, liquidity capacity, capital ratios and the effect of the $10 billion regulatory threshold.
- Follow the appeals and derivative litigation, as well as the control-integration work for the acquired businesses.