BofI Holding's CEO Discusses F2Q 2014 Results - Earnings Call Transcript

Feb. 5.14 | About: BofI Holding, (BOFI)

BofI Holding, Inc. (NASDAQ:BOFI)

F2Q 2014 (Qtr End 12/31/2013) Earnings Call

February 5, 2014, 4:30 PM ET

Executives

Johnny Lai - MZ Group, Inc.

Gregory Garrabrants - President and Chief Executive Officer

Andrew Micheletti - Executive Vice President and Chief Financial Officer

Analysts

Hugh Miller - Sidoti

Andrew Liesch - Sandler O'Neill & Partners

Terry McEvoy - Oppenheimer & Co.

Julianna Balicka - KBW

Don Worthington - Raymond James

Edward Hemmelgarn - Shaker Investments

Gregg Hillman - First Wilshire Securities Management

Operator

Good day, ladies and gentlemen. Welcome to BofI Holding, Inc.'s second quarter fiscal 2014 earnings conference call. (Operator Instructions) And now, I would like to turn the conference over to Johnny Lai from MZ Group. Please go ahead, sir.

Johnny Lai

Thank you, Sara, and good afternoon, everyone. Joining us today for BofI Holding Inc. second quarter 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 financial and operating results for the second quarter, and they will be available to answer the questions after the prepared presentation.

Now, before we begin, I would like to remind our listeners that on this call, prepared remarks may contain forward-looking statements that are subject to risks and uncertainties and that management may make additional statements in response to your questions. Therefore, the company claims the protection from the Safe Harbor forward-looking statements that is contained in the Private Securities Litigation Reform Act of 1995.

Forward-looking statements related to the business of BofI Holding, Inc. and its subsidiaries can be identified by common-used, forward-looking terminology and those statements involve unknown risks and uncertainties, including all business-related risks that are more detailed in the company's filings on Form 10-K, 10-Q and 8-K with the SEC.

This call is being webcast and there will be an audio replay available on the company's Investor Relations website located at www.bofiholding.com. All the details of this call were provided on the conference call announcement and in the press release today.

At this time, I would like to turn the call over to Mr. Greg Garrabrants, who will provide opening remarks. Greg, the floor is yours.

Gregory Garrabrants

Thank you, Johnny. Good afternoon, everyone, and thank you for joining us. I'd like to welcome everyone at BofI Holding's conference call for the second quarter of fiscal 2014, ended December 31, 2013. I thank you for your interest in BofI Holdings and BofI Federal Bank.

BofI announced record net income for its second quarter ended December 31, 2013, of $13,154,000, up 34.7% when compared to the $9,768,000 earned in the second quarter ended December 31, 2012, and up 8% when compared to the $12,182,000 earned last quarter.

Earnings attributable to BofI's common stockholders were $13,077,000 or $0.91 per diluted share for the quarter ended December 31, 2013, compared to $0.70 per diluted share for the quarter ended December 31, 2012, and $0.85 per diluted share for the quarter ended September 30, 2013.

Excluding the after-tax impact of net gains related to investment securities, core earnings for the second quarter ended December 31, 2013, increased $3,706,000 or 36.8% when compared to the prior fiscal year's second quarter ended December 31, 2012.

Other highlights for the second quarter include, total assets reached $3,568,000,000 at December 31, 2013, up $478 million compared to June 30, 2013, and up $694 million from the second quarter of fiscal 2013. Return on equity exceeded 17.4% for the second quarter.

Our net interest margin was $4.01% for the quarter ended December 31, 2013, a 15 basis point improvement over the quarter ended September 30, 2013, and a 20 basis point improvement over the quarter ended December 31, 2012. Total deposits reached $2,403,000,000, up $550 million compared to September 30, 2013.

Our loan units had another great quarter with $788 million in gross loans originated in the fourth quarter. As a result, the Bank achieved good quarterly loan growth, growing loan balances by 14% over the linked quarter and at a 56% annualized rate. The excellent performance of our lending group's resulted in $361 million of net loan growth and a 112% increase over the growth in the prior quarter.

The $788 million of production consisted of, $76 million of single-family agency eligible gain on sale production; $2 million of single-family non-agency eligible gain on sale production; $310 million of single-family jumbo portfolio production; $38 million of single-family jumbo gain on sale production; $31 million of multi-family non-agency gain on sale production; $92 million of multi-family portfolio production; and $238 million of C&I and special asset production.

Additionally, our warehouse lending division originated $382 million of single-family production in the second quarter. Taking together, the Bank originated $735 million of loans in the single-family, multifamily and C&I lending groups, an increase of $115 million over the linked quarter, despite a drop off for the single-family agency gain on sale production.

I am particularly pleased with our C&I lending businesses, produced $186 million of production in the second quarter, an increase of 30% over the prior quarter. Our lending pipelines as of January 31, 2014, are at record levels with $497 million of jumbo loans; $92 million of multifamily loans; and a C&I pipeline of $151 million of initial projected funding on an estimated $270 million of line size, solidifying the likelihood of the Bank and continue to enjoy robust asset growth.

For this quarter, our non-interest income continues to serve a diversity of our platform. This quarter our non-interest income, excluding securities and mortgage prepayment penalties is $5,400,000 consisting of, $1.5 million of mortgage banking income from single-family agency eligible mortgage loans; $300,000 of mortgage banking income from single-family jumbo mortgage loans; $1.4 million of mortgage banking income from the sale of multi-family mortgage loans; $1 million from the sale of structured settlements and other loans; $600,000 of prepaid card fees; and $600,000 of other fees.

We remain optimistic that we can grow our prepaid card fee income with new relationships and deeper penetration of existing relationships. We also believe that we can grow our deposit and other fee income outside of prepaid over the next year.

We continue to be pleased with the increase in the credit quality at the Bank. Our non-performing assets as a percentage of total assets are down from 79 basis points at the end of the December 2013 quarter to 49 basis points at the end of the quarter ended December 30, 2013. We are often seeing gains on the sale of our OREOs versus our portfolio marks on the relatively few non-performing assets we have, given the significant recovery in the housing market.

Into the third quarter of our fiscal year, that trend appears to be continuing. We continue to remain highly focused on credit quality at the Bank and have not sacrificed credit quality to increase originations. For the second quarter's fiscal originations, the average FICO for the single-family agency eligible production was 762 with an average loan-to-value ratio of 66%.

The average FICO score for the single-family jumbo production was 718 with an average LTV of 61%. The average loan-to-value ratio of the originated multifamily loans was 57% and the debt service coverage ratio was 1.56%. At December 31, 2013, the weighted average loan-to-value ratio of the entire portfolio of real estate loans was 55%.

We continue to make progress in growing and enhancing our deposit franchise. Our goal is to increase our share transaction accounts and develop deeper customer relationships. We have made strong progress on changing the mix of our deposits to become more transaction focused.

In December 31, 2011, to December 31, 2013, we grew our checking account balances by 786%, our money market balances by 175%, while our certificate of deposit balances decreased by 57%. Transaction accounts now make up 71% of our deposit base, up from only 43% from a year ago.

Our business banking group had over $688 million of total deposits at the end of the quarter, up from $467 million in the prior quarter ended September 30, 2013. The business Bank has over 2,000 accounts with 74% of balances comprised of checking accounts. We continue to foresee a robust growth in our business deposit balances. Including the growth of both consumer and business checking, we have grown our checking account balances by over 105% this fiscal year.

Although, our efficiency ratio at 39.89% this quarter, isn't quite where we think we can be, when our model fully matures and our newer businesses and infrastructure investments reach scale. We feel very good about the cost management initiative we have undertaken over the past six months.

This was not an initiative to downsize our employee base in any respect and we continue to invest in our people, but one, to ensure that we have the best-in-class management of our expenses. The impact of this initiative was evident in the reduction of our efficiency ratio from 41.37% to 39.89% this quarter. We have not accomplished this reduction by reducing our focus on scaling our operations, but we continue to invest in the people and technology required for a scalable prudent growth.

We recently replaced our Chief Technology Officer with the Chief Information Officer and a senior operations leader, both of whom have deep technology and process improvement experience at much larger institutions. We have also added senior leadership talent to our marketing team.

As we grow the Bank, the expertise required to manage our operations continues to increase, and we are pleased to be able to supplement our team with individual, who are better suited for the next phase of the Banks growth.

Now, I'll turn the call over to Andy, who will provide additional details on our financial results.

Andrew Micheletti

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 at bofiholding.com.

Second, I will discuss our quarterly results on a year-over-year basis, meaning fiscal 2014 versus fiscal 2013, as well as this quarter, the second quarter ended December 31, 2013, versus the first quarter ended September 30, 2013.

For the quarter ended December 31, 2013, net income totaled $13,154,000, up 34.7% from the second quarter of fiscal 2013. Diluted earnings were $0.91 per share this quarter, up $0.21 or 30% compared to the second quarter of fiscal 2013. Net income increased 8% compared to the first quarter ended September 30, 2013.

For the six months ended December 31, 2013, net income totaled $25,336,000, up 35.1% compared to the six months ended December 31, 2012. Diluted earnings were $1.77 per share for the six months ended December 31, 2013, up $0.40 or 29.2% compared to the six months ended December 31, 2012.

Excluding the after-tax impacts of gains and losses associated with our securities portfolio, our core earnings were $13,786,000 for the quarter ended December 31, 2013, up 36.8% year-over-year from the $10,080,000 in core earnings for the second quarter of fiscal 2013 and up 13.6% from the $12,025,000 in core earnings for the last quarter ended September 30, 2013.

Net interest income increased $7,891,000 during the second quarter ended December 31, 2013, compared to the second quarter of fiscal 2013 and increased $4,717,000 compared to the first quarter ended September 30, 2013. This was a result of increases in average interest earning assets combined with the decrease in the cost of funds resulting in a new record net interest margin of 4.01% this quarter compared to 3.81% in the second quarter of fiscal 2013. The cost of funds decreased to 1.16% down 28 basis points over the second quarter of fiscal 2013 and down 10 basis points compared to the quarter ended September 30, 2013.

Provisions for loan losses were $1 million this quarter; they were $1.95 million for the second quarter of last fiscal year; and $500,000 for the first quarter ended September 30, 2013. The decrease in the loan loss provision was a result of lower charge-offs, which decreased by approximately $461,000 and improvements in non-performing loans in delinquencies this quarter compared to the second quarter of fiscal 2013. The benefit of the decrease in charge-offs and improvements in the loan quality was partially offset by additional provisions needed for growth in the loan portfolio

Non-interest income for the second quarter of fiscal 2014 was $5,543,000 compared to $6,249,000 in the second quarter of fiscal 2013 and $6,976,000 for the first quarter ended September 30, 2013. The decline was primarily a result of industry-wide decline in mortgage banking. As Greg noted earlier, we have mitigated the decline by selling structured settlements and increasing other fees.

Non-interest expense or operating costs for the second quarter ended December 31, 2013, was $15,304,000 compared to $12,781, 000 in operating costs in the second quarter of fiscal 2013 and compared to $14,514,000 in operating costs for the first quarter of fiscal 2014.

For the quarter, salaries and compensation was up year-over-year by $1,008,000, additional staffing added since December 31, 2012, is the reason as well as professional services increased $516,000; data processing and internet expenses were up $665,000 and depreciation and amortization expense was up $247,000. These increases are primarily due to the growth of the Bank's lending and deposit operations.

For the second quarter ended December 31, 2013, compared to the first quarter ended September 30, 2013, stocks and compensation was up by $178,000. Professional services declined $438,000. Advertising and promotional was up $625,000 due to marketing promotions and increasing deposits. And general and administrative expenses increased $519,000 due to increased loan processing expenses.

Our efficiency ratio was 39.89% for the second quarter of 2014 compared to 40.98% recorded in the second quarter of the 2013 and compared to 41.37% for the first quarter of fiscal 2014. The efficiency ratio is calculated by dividing our operating expenses by the sum of our net interest income, and our non-interest income.

Shifting to the balance sheet, our total assets increased $477.5 million or 15.5% to $3,568 million as of December 31, 2013, up from $3.91 million at June 30, 2013. The increase in total assets was primarily due to an increase of $520.4 million in loans held for investments. Total liabilities increased $434.1 million primarily due to an increase in deposits of $311.1 million, in addition to an increase in borrowings of $138.6 million. Those borrowings were from the Federal Home Loan Bank.

Stockholders equity increased by $43.4 million or 16.2% to $311.7 million at December 31, 2013, up from $268.3 million at June 30, 2013. The increase was primarily the result of our net income for the three months ended December 31, 2013, that's actually for six months of $25.3 million, as well as the sale of common stock of $16.7 million, as well as vesting of RSUs and exercise of stock options of $2.8 million, less $1.2 million in unrealized losses and $0.2 million with dividends.

At December 31, 2013, our Tier-1 core capital ratio for the Bank was 9.01% with $143.5 million of capital in excess of the regulatory definition of well-capitalized.

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

Gregory Garrabrants

Thanks, Andy. Operator, you can open the call for questions. We will take them now.

Question-and-Answer Session

Operator

(Operator Instructions) We'll hear first from Hugh Miller with Sidoti.

Hugh Miller - Sidoti

One housekeeping question with regards to the pipeline data you guys have given out. I just wanted to double check that it was $92 million of multifamily loans you had?

Gregory Garrabrants

Yes, that's right.

Hugh Miller - Sidoti

And can you just talk, it seems like some of the other line items were kind of a little bit of a wash, but the multifamily was down somewhat meaningfully from, I think it was about a $154 million as of October of last year. Can you just give us some color on what you are seeing with that category?

Gregory Garrabrants

Yes, sure. Obviously jumbo is not a wash, right. I mean, if we look at the pipeline in the fiscal first quarter it was $3.44 and its $4.97 today. So that was up a significant amount. C&I was up. The multifamily side tends to, in December, and we've seen this historically, fall because many of the folks that would be in the market for these sorts of loans tend to pose upon those.

So we see really great indicators of future pipeline. And those indicators generally are LOIs issued. We have a fairly steady ratio of LOIs issued to pipeline commitments, which are defined as LOIs that have been accepted, and the entire fee has been paid to the Bank. So I'm not too concerned about our multifamily production. I think that this is a fairly seasonal move and it will come back up.

Hugh Miller - Sidoti

And then with regards to the increase that we saw in the loan yield portfolio on a linked-quarter basis, is that primarily just a function of seeing kind of the higher yielding C&I loans starting to come through or are you noticing an improvement in kind of pricing with the yield curve moving around a bit for new production. Can you just give us some color there, Andy, on what's kind of to driving the loan yield.

Andrew Micheletti

It's a little bit of both. Certainly, our C&I production is coming in at rates that are higher than the average for that, but we continue to have strong pricing out there for basic loans as far as jumbo and multifamily.

Gregory Garrabrants

And we haven't had to back off from jumbo and multifamily pricing in any respect, but we haven't increased it either. So still, it maybe here or there, a little bit of move, but clearly the C&I mix is helpful.

Hugh Miller - Sidoti

And then as we look at kind of the lower levels of structured settlement loans sales in this particular quarter, I know you guys had mentioned previously that it was kind of a strategic move to sell-off some with the longer duration of those assets, with the yield curve adjustments that we're seeing. But can you just talk about kind of the lower levels of sales in this quarter and whether or not you've seen a change in kind of the loan sale pricing for that type of loan?

Gregory Garrabrants

Yes. We definitely sold those at the right time from a standpoint of the pricing we achieved. They are very sensitive to the long end of the curve. There is a number of sales that we did significantly better than we would have, if we waited. So that was generally good. Obviously, when you have the type of loan production that we're having and you look at 58% potential growth, you have to do something with that. And so obviously selling some of those loans depending upon geographic concentration and those sorts of things continue to be something that we do.

So I think the structured settlement definitely is more sensitive to the longer end of the yield curve. And we've also been doing some other things to reduce our interest rate risk as well. We did a significant amount of borrowing expansion towards the end of last quarter and more this quarter as well. So despite the fact that we have a number of good things happening on the margin side, namely the loan yields continue at a minimum to be steady and potentially increasing on average. And we have the reverse repos coming off to reduced deposit pricing. We have taken a little bit of that and extended to reduce some interest rate risk.

So coupled with the structured settlement sales and those sort of things, we've been able to reduce our NPV stock. So those are all linked as far as the thought processes that we have, it's better to sell things at higher prices than lower prices, that's what Andy's taught me here.

Hugh Miller - Sidoti

If memory serves me correctly, I think you guys had commented previously that you still obviously maintain a substantial portfolio structured settlements. And so while you could at some point elect to sell them, is the thought process now to be a little bit more hesitant to sale at this point, given where we are right now?

Gregory Garrabrants

I think that's probably correct. We love that asset. It's incredibly safe outside. But the right mix of that from a duration perspective and coupled with our matching off some of those assets with longer duration liabilities, make us feel a little more comfortable about holding them and being able to keep them for the longer term.

Hugh Miller - Sidoti

And as we think about the margin, I believe you guys have some higher rate CDs and repos that could be potentially maturing in the near term. Can you just give us a sense of kind of where that stands, any larger size re-pricing that we should be considering and where those are coming off of?

Andrew Micheletti

No, let me go ahead and jump in. I'll start with our reverse repo category, which we've noted as being at relatively high rate of in the 4s. And if you're ready with a pen, starting in January you've got 10 coming off at 4.45, 15 in February at 4.27, 10 in March at 4.38, 5 in April at 4.24 and 10 in May at 4.5. You add on another 10 out in August at 3.5, and that's $60 million at 4.2 of the $95 million.

And obviously I'd be great to get rid of all of it, but this year it takes out two-thirds of it pretty much. And so when you think about us extending, as Greg has mentioned, we extended about 200, and now is the perfect time to do that, as we're dropping those off and extending others. Obviously, we're replacing a shorter duration expensive borrowing with a much longer duration cheaper borrowing.

Gregory Garrabrants

Right, but we also did that this quarter. So that means that thinking about another sort of great quarter of margin expansion, I would be cautious about that, I would say, I would expect maybe a slight margin moderation this quarter from where we are. And I certainly wouldn't forecast expansion, at least this quarter. Obviously, when you have something in the 4s, and you're financing yourself at 70 basis points or lower at worst, there is obviously some nice impact that you get from that and it's significant that we're going to be able to get rid of $60 million of that.

Hugh Miller - Sidoti

And then, the last question I had was just with regards to, you guys had kind of alluded to kind of the BIN sponsorship program, wasn't really able to pick up on some of the commentary you were talking about there. But can you just give us a sense of where things stand there with the pipeline of discussions with potential partnerships and anything seem like it could be a positive on the horizon?

Gregory Garrabrants

We have great dialogue with our existing partnerships to expand the scope of what we do for them, and we have robust ongoing discussions with other significant programs that could make big meaningful differences, but we have nothing specific to update right now.

Operator

Our next question comes from Andrew Liesch with Sandler O'Neill & Partners.

Andrew Liesch - Sandler O'Neill & Partners

Just curious with the loan to deposit ratio running up, where it is? I know you've taken and extended some of the borrowings as you said. But are you concerned at this level 1.16 and climbing?

Gregory Garrabrants

We've been working on a number of relationships and some deposit campaigns, and we had a little bit of a timing difference with when some of our deposits arrived on the business banking side. So I would say if you look at it in January, and January would actually be significantly lower than that. So no, I'm not concerned.

But I do think that, obviously, we need to ensure that we're continuing to grow our deposits along with our loan growth. And we need to continue to invest in that area and ensure that we're appropriately thinking about how we're going to fund ourselves. So if you look at that ratio at January 31, you will see it gone down -- but it's gone down.

Andrew Liesch - Sandler O'Neill & Partners

And then flipping to the asset side, I was curious like compared to what you were originating a year ago, has there been much change in like the size of the loans that you've been putting on the books?

Gregory Garrabrants

No, except on the C&I side. The loans are larger now. A lot of that is lender finance, and so the actual exposure to an individual underlying asset is often smaller than it would be on the single-family, what is uniformly smaller than it would be on the single-family jumbo side, but the overall size for the lines are larger.

And so they have diverse pools of collateral backing them, but the lines are definitely larger. And we intent to continue to increase those line sizes, because they are significant overhead cost associated with monitoring those lines, with getting them scaled up. And also we tend to like companies that are able to need larger lines. We tend to think that they have better infrastructure and other things that make us feel better about lending money to them.

Andrew Liesch - Sandler O'Neill & Partners

And then just one question, just flipping through the Q here, it looked like the special mentioned category for C&I loans is up to about $50 million. I am just curious what detail you can provide and what drove that increase? And then if what may now have caused like a larger provision for that?

Gregory Garrabrants

It's actually interesting, you bring that up. So this is a line of credit backed by lottery receivables. And the lottery receivables are secured by the fees treasuries of the state. So I don't believe that should be special mentioned frankly. And what it is, is that under the terms of the loan agreement, it says that what happens is the state withholds tax, and because of the special purpose entity, some times the state will delay the return of the tax.

That puts the loan, at least on one definition, which the borrowers are disputing into a technical defaults, and the fact is though that with technical default into a situation where there is a dispute over when that return money should come back into the trust. So this is a very technical thing and its backed by lottery payments from states, that the vast majority of which are fees treasury. So the chance of loss on that loan is in my view is zero. And I am actually surprised that it ended up there. I didn't realize they imposed there. But honestly I don't think it should be there. I'll have to ask IR, what they were thinking.

Operator

Next up we'll hear from Terry McEvoy with Oppenheimer & Co.

Terry McEvoy - Oppenheimer & Co.

If I just look at the cost of your non-CD deposits, it looks to be about 20 basis points to 30 basis points above the industry data. I understand the reasons why and the expense benefit that you guys have. Has that gap been closing? Do you monitor that data? And do you think going forward there is a continued opportunity to bring the deposit cost down more consistent with what you see out of a traditional brick-and-mortar bank?

Gregory Garrabrants

We certainly think so over time. I think there is a couple of components that have to thought about there. If I was growing my deposit base 5%, I could bring down that gap very, very significantly, immediately. I think if you took a brick-and-mortar bank and you ask them to grow their deposit base to 35% that would create a gap too. It's just inherently that sort of pressures you are growing your deposit base well.

And we are offering a value proposition to customers that include not only the sets of services that branches offer, but an additional boost, whether it's a reduced fees from a business banking perspective or an increased yield from a consumer perspective. I think that our strategy overall, if you couple the affinity side with the business banking side, and then push for operating accounts and the prepaid businesses that over time you'll see some of those things bounce and some of that were prepaid card, balances will come in at zero.

The operating accounts will come in because of lines on the C&I side and things like that, that it will start to balance out other components. And we're going out and attracting business banking customers. We generally are not providing them lines of credit. We don't think that's a great business for us right now. And so we do need to provide them some value.

That being said, I do think that we have the opportunities to take down our cost of funds, primarily in the CD area and in the repo area, but there is potential opportunity on the other side of it too. I think that that involves us having to continue to be better at gaining and we've done a good job. We need to do even better job at gaining checking account business and getting that checking account business to actively engage with us.

And I think we probably could pay less on our checking accounts by offering free checking. And our research shows, we do market research, I wouldn't call it particularly sophisticated, but shows that there is not as much demand or requirement that we offer higher rates on checking as long as the fee structure has a value preposition that's differentiated for the customers.

Terry McEvoy - Oppenheimer & Co.

The C&I portfolio is over a $100 million, could you just give us little color on that portfolio, average loan size, maybe your targeted client base and other any purchase loans or shared national credits or anything that is purchased in nature?

Andrew Micheletti

There is very small amount of shared national credits in there and it would be well less than 10%, and there is not much there. We do have some loans, where we've acted with other institutions on, but that is also a small percentage. And those tend to be clubbed deals where as you know there will be one or two other banks involved.

And we've sometimes brought other banks in where we want to have exposures that are lower than the demand that the borrowers have. And the vast majority of those loans, the loans that have been self-originated by the bank are sourced by our team and they are a significant portion of those lender financed loans that are backed by hard collateral receivables, real estate or other loans.

Terry McEvoy - Oppenheimer & Co.

Then just one last question. Would BofI need to make any meaningful investments if you were looking to grow the prepaid card business in a material way? And how do you think about the risks and rewards for expanding that business or potentially expanding that business in light of what the CFPB could come out with later this year and other regulatory issues that could pop-up in and limit the profitability of that business in the future?

Andrew Micheletti

I think that our view is that we want to work with the winners in the industry. And I think that the industry is viable, it's a necessary, and industry that has made a lot of advances and how they think about distribution. And I think that those advances are important, and I don't believe that the industry will be regulated to the point where it will be put out of business.

And so the key is to pick the winners and to focus on those winners. And because we have a very diverse platform and we are not dependent upon any one of our businesses succeeding, we have the luxury of spending the time to find the right partners and work with those partners, regardless of the timeframe in which those ultimate partnerships develop.

And so I think one of the problems is if you get sloppy and fast with that business, then very bad things can happen to you, because you are somewhat dependent, not somewhat dependent, you are dependent on the skills of the third-party. And you're dependent upon their compliance mindset and you're also dependent on their financial stability. And so you have to choose very wisely.

And there is some other models that we've kicked around are not things that I'm willing to share right now, that can be adapted, that could accommodate a different partnership model. But right now in the structure of the value chain where we are, you need to focus on partners that are long lasting and can be significant because the cost associated with running those and monitoring those partnerships is going to be increasing, not for us but for others.

Operator

Next will here from Julianna Balicka with KBW.

Julianna Balicka - KBW

I have a few follow-up questions and a good number of them have already been asked. In terms of the deposit costs, rates ticked up this quarter, I presume in response to some of the deposit campaign you've been putting on to kind of keep up with loan growth. When in the quarter did you increased rates, or more to point, where are the rates right now on your different products as we think about where this will shake out for next quarter or two?

Gregory Garrabrants

You're going to love this answer. So we didn't change anything on consumer rates generally. And on business banking rates, if you'll notice we're not publishing those rates, and that's because we're really working on a lot of individual account analysis, where depending upon the overall fee structure and utilization we are really trying to analyze a lot of these accounts. And work with our customers.

And so there is a wide variety of rates that depend upon what fees and that that our customers are paying for cash management and other services. So I think it's not a simple answer. What I would say is I wouldn't expect that you should -- I think you should assume from a modeling perspective relative stability in those costs, but you could I think take some benefits associated with the repurchase side, if you're modeling that separately.

Julianna Balicka - KBW

And on the repos side, I thought you extended them, some of them, so I suppose just thinking about those balances rolling up, you should be thinking about stable balances and lower rates and what rate are you extending them down to?

Andrew Micheletti

So the 200 is in a roughly a 1.8% rate. By the way it will show up in Federal Home Loan Bank advances, not in reverse repos.

Gregory Garrabrants

The repos aren't being extended there. We're not engaging a new repurchase agreements if FHLB advances, got to be shifting lines, but it's conceptually similar.

Julianna Balicka - KBW

And then in terms of loan growth and deposit growth and kind of going back to the loan to deposit ratio, you've talked about the kind of loan growth, asset growth that you'd be comfortable with the business model. Could you talk about the kind of deposit growth that you would like to achieve or would you going keep up with the loan growth, like what's the goal here with all the different initiatives?

Gregory Garrabrants

Well, the nature of how you think about the deposits and borrowing mix is one that depends upon what you want to do from an interest rate risk perspective. And I firmly believe that borrowing is superior to locking in consumer CDs for interest rate protection, for all sorts of reasons, even though we have good penalties on our consumer CDs. So some component of loans will and should, based on the fact that they are 5/1 ARMs and not that we don't think that are deposits have good duration, but we think that they should be funded by borrowings.

Depending upon what interest rate characteristics are and things like that, we believe that there should be some sets of loans that are permanently funded by borrowings and because we're really not doing much in the securities market now, because of what we view is relative value on the securities side, you're not going to see some typical formula like you might see another banks where loans equal deposits and securities equal borrowings. We don't think that that formulation is sophisticated enough to encompass what we're attempting to achieve. So that being said, I'm not going to tie myself down to specific ratios, but that's conceptually how we think about it.

Julianna Balicka - KBW

So as we think about your deposit costs and kind of growth in the next year or two or basically before, until short-term interest rate starts to rise. Conceivably should we start thinking about higher rates on your CDs, because you'll have to push growth more aggressively or are you basically going to try to avoid doing that as long as possible?

Gregory Garrabrants

We are going to try to avoid doing that as long as possible. And based on the continued success we've had in the business banking and other side, we're hopeful that we can permanently avoid it. That being said, we've been dramatically decreasing our CD balances overtime, and I suppose at some point, we can't rollout the fact that we would put on consumer CDs. I think there is actually relatively little demand for consumer CDs to the extent beyond the year or two. And I think that those durations are pretty much useless from an interest rate risk perspective.

And there is really, we found that there is very little benefit from the standpoint of -- we've been able to do a really good job of cross-selling to our savings account holders, other products. And for whatever reason the CD side really hasn't have record on that way. So I am not a big fan of short-term retail CDs and I think long-term retail CDs, they're worse than medium term borrowing in every respect, from a rate perspective, from a stock perspective and from everything else and given the level of collateral that we have, I just don't think that it's helpful. I don't think they are helpful.

And in comparing them to wholesale brokerage CDs, 10 year brokerage money, which we put on had incredibly good rates and have only debt puts and it give us optionality. So all of those things, I think retail CDs are inferior in every respect to that, that doesn't mean that -- I think maybe the only place they're not completely inferior is potentially regulatory perception, but we haven't run into that, because our regulators have been sophisticated enough to understand what we're doing and have been supportive of it.

Julianna Balicka - KBW

And then in terms of your loan yields, the tick up linked-quarter other than just a shifting in you loan mix, is there anything in terms of loan fees in that interest income line contributed to the uptick in the yield from a mathematical perspective?

Gregory Garrabrants

No, no, nothing from a material perspective. The C&I loans in general have a little more fee income that's amortize into the yield. But there is no one large pop from the single loan that it contributes to the uptick.

Julianna Balicka - KBW

So it looks like, was your loan yields to kind of involved to linked quarter, so should we continue to think about them kind of more or less -- I mean they're fairly steady around 520, but plus or minus a few bps. So should we continue to think about them as that or should we think about them as now being on an upward shift, because of your loan rates uptick?

Andrew Micheletti

I would say that it's reasonable to keep them relatively steady.

Julianna Balicka - KBW

And then a final quick question, on the expenses side, advertising moved $600,000 linked quarter, which doesn't sound like a lot, but it's a lot in your very efficient context and others too may, so how should we think about that?

Andrew Micheletti

I mean that quarter was very low from a prior quarter. If anything I would think, the last quarter was at your benchmark and again was lower. Part of that was transition agency mortgage banking advertising being down as part of that, and so we've uptick that a little bit. Since then, looking at different opportunities, including other deposit opportunities. So I think it was more that Q1 was the outliner.

Operator

Up next, we'll hear from Don Worthington with Raymond James.

Don Worthington - Raymond James

I guess going back to the deposit question. Do you see the opportunity for acquiring deposits like you did with the Principal Bank deal?

Gregory Garrabrants

Yes. Certainly, there are sets of opportunities that are out there, and we look at those and we do things that they are out there and available.

Don Worthington - Raymond James

And then do you breakout how much you have in that second chance checking product?

Gregory Garrabrants

No, we don't. And right now what we're really focused on that product is some small pilots with regard to some affinities that have natural characteristics of their customer bases and would be appropriate for that. And then optimizing our own marketing spend, so that when someone has decline from our other products that they have the opportunity for that product. We haven't broken that out, but I think that clearly there is opportunities there.

We've had that product running now for a while to make sure that there is a lot of things, but you have to make sure you get it right. It's a very different client base and there is lot of different behavior elements, you need to make sure you have control over. And I think we've done a pretty good job of doing that. There is some real interesting opportunities for distribution on that side. And it's really probably been more of a capacity issue for us and a prioritization, but there is definitely opportunity there.

Don Worthington - Raymond James

And then are you still adding FTE in loan production or do you have kind of the infrastructure in place to grow quite a bit more without adding more people?

Gregory Garrabrants

I would say that on the agency side, we've moved some folks around in order to accommodate the increased jumbo production. Beyond the upside on multifamily, the team was telling me based on how many LOI request they were getting, they were showed a person here there.

But I think that this from a standpoint of a rapid growth in personnel that you saw over time in loan and on a lending side, that definitely will now be focused in a different area. It will be focused on the expansion of different C&I lending niches, which will tend to have fewer people, but those people will be more expensive. And so we intend to build out that business area. And I don't think there'll be a lot of costly additions to single and multifamily.

Operator

Our next question comes from Edward Hemmelgarn with Shaker Investments.

Edward Hemmelgarn - Shaker Investments

But could you and Greg could talk a little bit more about your -- you mentioned that you've added new people to lead the your IT area, your both processes and marketing. Can you just talk a little bit more about some of the things you're trying to game in there and how that will help you move on to the next step?

Gregory Garrabrants

I think that's a great question. So inevitably what happens in organization is, as they grow they need different sorts of executives. And I think is that we've done a good job with two recent hires from a standpoint of the level of their skill sets that we're bringing in. So we hired a CIO and we hired an SVP of Operations.

In the case of the CIO, he had been a CIO of a large component of ABN AMRO's business, and just happens to really want to live in San Diego and sick of the cold and sick of the travel, and all those sort of thing. And so we feel really good about that. And then, the gentleman on the SVP of Operation side has a background, as leading operations and deposit operations for a large institution for a number of years. And then, also experienced with core processors and high-level consulting engagements across the Board on Process Improvement.

So what's happening to us now is that we are now on that flywheel of people who believe, and so people want to work for successful businesses. So the types of resumes, when we recruit and the things that we see now from a standpoint of just talent, is definitely different than what we saw several years ago. I don't know if it's been crossing the billion dollar modern cap side or whatever. But it's just a really great time to be looking for talent to bring us to the next level.

Edward Hemmelgarn - Shaker Investments

Are all of these people reporting to you or how is your structure now on kind of the operation side of the bank business?

Gregory Garrabrants

No. I mean, obviously, they are all not reporting to me, and we have a good second layer that will be reporting to the CIO. And so I'm not going to belabor the entire organizational structure of the Bank now. But we continue to ensure and think about how I can scale and spend the time that I need to spend, which should be on newer businesses and an external focus, and make sure that we have a robust internal focus.

But that's also done through our management framework, which is a very specific way of making sure that we have a great robust setup as is process diagrams, and we're developing a process mindset among all our employees. So that they can continually think about what they're doing from a process perspective, and that's a big cultural element that we continue to push.

So it's not only at the senior levels. For example, we've recently hired a Six Sigma Black Belt to run the process database internally at the Bank and to teach and help develop the middle management team in thinking about how to reengineer processes. So process oriented minds that have to run through the whole organization, and excessive focus on reporting structures and things like that, while useful; it is in incomplete way of thinking about those sorts of things.

Operator

And our last question today will come from Gregg Hillman with First Wilshire Securities Management.

Gregg Hillman - First Wilshire Securities Management

Greg, could you talk about the jumbo a little bit, whether there is things going on that you think will make it growth faster in terms of your new relationships, internal processes, regulatory changes. Can you talk about that a little bit?

Gregory Garrabrants

Well, I'll take the regulatory changes first. The QM side of things, I think the potential impact could be interesting. We've been seeing continued growth and the demand for our product before QM came into being. And so I can't say right now that I can attribute any particular loans to QM per se. But I do see continued growth in our customer base and in the demand for the product.

So I would like to give specific reasons as to why that's the case, but I will tell you we've spend a lot of time improving and expanding our internal sales operations, the way we market our products, the technology and the ease-of-use, the customer service responsiveness and all of those sorts of things.

So I think that there are people going to do business with people who don't do a good job for them, particularly on the jumbo side, because those customers tend to be use to being served in a particular manner. And just like in wealth management or other things, if you don't serve them in that way, you may permanently offend them.

So the idea that they're going to have to wait 60 days for an underwriting answer and things like that, and then get an answer and not be able to talk with someone about the conclusion, the no sorts of things, they're problematic. So I think we have a really good formula and a model and it involves continually looking at those operational elements and making them better. And that's been reflected in what's happening in the pipelines.

Gregg Hillman - First Wilshire Securities Management

And can you explain briefly what QM is?

Gregory Garrabrants

Sure. The QM rule has two separate components. One component, which is commonly called the ATR rules, is a set of rules that requires that an institution appropriately document the ability of a borrower to repay a loan. And what that effectively does, it outlaws loans that had been made in certain respects that were problematic in the crisis, which would include no income, no doc loan types, that were widely available during that 2006, 2007 timeframe. And it basically states that you have to document a borrower's ability to repay.

Now in our case, we never did no documentation loans. We always requested every piece of documentation that we possibly could, including tax returns from the IRS and everything else. So that really didn't changed anything that we did. Then the next thing that it does is it states that there is a particular way you need to compute income and that mechanism of computing income is essentially in accordance with what was historically FHA guidelines for the computation of income.

So for example, we did a loan for a borrower who owned a significant piece of a multimillion dollar market capitalization insurance company. They owned more than 50% of this insurance company, we did their loan. None of that income, none of those income or assets would have been able to be calculated as income for the utilization of the loan under the Appendix Q to the QM rules, because those rules were designed for thinking about a borrower with a day job, who didn't owned businesses, didn't have subchapter S corporations, didn't have an investment portfolio, didn't make a significant amount of variable bonus income.

So the attempt has been made to apply these FHA standards, which were always designed for a very different borrower to all borrowers and as a result of whether those loans pass through different characteristics, they received different levels of legal benefits associated with those, which include a presumption that you've appropriately calculated the ability to repay, a repayable presumption that you have the ability to repay, and no presumption that you have the ability to repay.

And in each instance there is as an assortment of penalties that could arise if you have not calculated the ability to repay, but the precursor to all those penalties is that you have to have not calculated the ability to repay, which we always do. So for those of you who are on this phone and who have felt tortured by that, I apologize, but there really isn't a quicker way to explain it, because it's a bit complicated.

Gregg Hillman - First Wilshire Securities Management

And, Greg, just two other points. Could you just comment on, one, is non-interest income, whether you think that will increase it's percentage of your overall earnings for the company on a go forward basis? And then finally, just getting to $10 billion, can you talk about what will it take in terms of capital structure, raises or dilution?

Gregory Garrabrants

With regard to non-interest income and the ratio of that interest income, that really depends on a variety of complex factors that I don't really want to speculate on. I think that obviously we have robust loan production. We can convert that loan production into fee income, if we desire, because we have buyers who would like to buy all of our loans.

On the question of whether or not we do that depends on what I am seeing on the deposit side, what I am seeing on the capital side and all those things have to come together. I would say that obviously even if you're selling a loan for a several point gain, you obviously are making that backed at interest income very quickly, however, the capital efficiencies are very different.

So I really can't give predictions about that, because we're also working on a number of different fee income sources as well. Some of which were not dependent upon loans, so we need to continue to work on those. So I left the path, I am making a numerical prediction there.

And then with regard to the capital requirements to get the $10 billion, obviously, if you make an ROE of 18%, and if you're growing at 25% to 30% then you have a gap. And that gap has to be filled with capital that either is on the balance sheet resulting in a reduction of capital, which we do have significant excess capital right now or from a capital raise.

So the answer to that depends upon some thing that I have to operationally execute every day, which is going out and making sure that I am safely and soundly growing the business and doing all those sorts of things. And if our ROE starts to equal our growth rates and hopefully that's above 25%, then we will no longer need capital and we will permanently be organically funded. But I would say that those are all these things you have to consider.

Now, that being said, we raised a significant amount of our ATM. 17 million in this quarter and we've raised an additional 11 million now. So we are certainly not in a position where we need to raise additional capital for a number of quarters to continue very robust growth.

So we're really in a good position and we've already done a lot of that capital raise that we need to do for a while and our capital ratio, Tier 1 sits at higher than -- I don't know if we've ever, maybe saying ever been to be able to get some lumpy capital raises, but certainly at a level that's above where we feel comfortable.

Gregg Hillman - First Wilshire Securities Management

And then, Greg, for your prepaid card business, for those kinds of deposits, I suppose can say business checking deposits, will that require less capital as you grow?

Gregory Garrabrants

Well, no. I mean they would be at a lower direct cost. The costs in prepaid deposits are embedded directly in the cost of compliance of overseeing the program. So prepaid card programs generate fee income, and they generate compliance cost and they generate deposits. And so those deposits are generally very low cost as lower, lower than anything we have. But there is a operational cost associated with them and that is what makes them have a direct capital impact in the sense that they are calculated the same as any other deposit from a capital ratio perspective.

Gregory Garrabrants

Well, thank you very much, everyone. Is that it operator?

Operator

Yes. That does conclude our conference call for today. Thank you all for attending.

Gregory Garrabrants

Thank you very much. Bye.

Andrew Micheletti

Bye.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!