BofI Holding's (BOFI) CEO Greg Garrabrants on Q2 2016 Results - Earnings Call Transcript

| About: BofI Holding, (BOFI)

BofI Holding, Inc. (NASDAQ:BOFI)

Q2 2016 Earnings Conference Call

August 02, 2016 16:30 PM ET


Johnny Lai - VP, IR

Greg Garrabrants - President and CEO

Andy Micheletti - EVP and CFO


Bob Ramsey - FBR

Brad Berning - Craig-Hallum Capital Group

Gary Tenner - D.A. Davidson

Andrew Liesch - Sandler O'Neill

Donald Worthington - Raymond James


Greetings and welcome to the BofI Holding, Inc. Fourth Quarter and Fiscal Year Financial Results Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host, Mr. Johnny Lai. Thank you. You may begin.

Johnny Lai

Thanks, Michelle. Good afternoon, everyone. Joining us today for BofI Holding, Inc.'s fourth quarter 2016 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 the financial and operational results for the three and 12 months ended June 30, 2016 and they will be available to answer questions after the prepared presentation.

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 risk 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 available in the Investor Relations section of the Company's website located at for 30 days. Details for this call were provided on the conference call announcement and in today's earnings press release.

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

Greg Garrabrants

Thank you, Johnny. Good afternoon, everyone, and thank you for joining us. I'd like to welcome everyone to BofI Holding's conference call for our 2016 fiscal year-end ended June 30, 2016. I thank you for your interest in BofI Holding and BofI Federal Bank.

BofI announced record net income for the fiscal year ended June 30, 2016 of $119,291,000, up 44.3% over the $82,682,000 earned for the fiscal year ended June 30, 2015. BofI’s return on average equity over the fiscal year was 19.43% and the Bank's 2016 fiscal year efficiency ratio was 34.4% Fiscal year 2016 earnings per share increased 38.1% from $1.85 per diluted share compared to $1.34 in the fiscal year ended June 2015.

Net income for BofI’s fourth quarter ended June 30, 2016 was $29,727,000, up 21.9% when compared to the $24,395,000 earned in the fourth quarter ended June 30, 2015.

Earnings attributable to BofI’s common stockholders were $29,650,000 or $0.46 per diluted share for the quarter ended June 30, 2016, compared to $0.39 per diluted share for the quarter ended June 30, 2015 and $0.56 per diluted share for the linked-quarter ended March 31, 2016, in which we recognized the vast majority of our tax season-related revenue.

Excluding the after-tax impact of net gains related to investment securities, adjusted earnings for the fourth quarter ended June 30, 2016 increased by $6.2 million or 26.5% when compared to the quarter ended June 30, 2015.

Other highlights for the 2016 fiscal year and the fourth quarter include; net loans and leases grew by 29% in the fiscal year and average balances grew by $471 million in the fourth quarter, a quarterly growth rate of 8.1% and an annualized growth rate of 32.4%.

The fourth quarter average growth was increased by $140 million of average balances of purchased leases and reduced by $35 million of short-term H&R Block’s loans outstanding in the June 2016 versus March 2016 quarters, resulting in adjusted average net organic loan growth of $366 million, a quarterly growth rate of 6.1% and an annualized growth rate of 24.3%.

Total assets reached $7.6 billion at June 30, 2016, up $1.8 billion or 30.5% when compared with June 30, 2015. Excluding the impact of H&R Block seasonal liquidity, assets grew 28.4% over the prior fiscal year and by an annualized 18.2% in the fourth quarter. Average rates on loans and leases increased from 5.02% in fiscal 2015 to 5.12% in fiscal 2016. Average loan rates in the fourth quarter of fiscal 2016 were 5.02%.

Interest-bearing savings and demand deposit costs fell to 67 basis points in fiscal 2016 from 72 basis points in fiscal 2015. Non-interest income increased by 117% from fiscal 2016 to fiscal 2015, and fiscal year fourth quarter non-interest income grew by 65.5% over the fourth quarter of fiscal 2015.

Return on equity reached 19.43% for the fiscal year and declined to 17.91% for the fourth quarter, as a result of less H&R Block fee income being realized in the fourth quarter.

Net interest margin was 3.70% for the quarter ended June 30, 2016, compared to 3.85% in the quarter ended March 31, 2016. Excluding average balances associated with short-term H&R Block lending products and excess H&R Block liquidity, net interest margin was 3.87% in the fourth quarter of 2016, within our target 3.8% to 4.0% range.

The reduction over the prior quarters resulted from payoffs of short-term higher yielding H&R Block lending products, additional seasonal liquidity and increase in pre-pay rates on single-family loans and the carrying cost of our subordinated debt offering. The increased cost of our subordinated debt offering, which has not currently been contributed to the Bank as capital, or utilized for share repurchases as of today, resulted in a reduction of net interest margin by 4 basis points. For the fiscal year ended June 30, 2016, our net interest margin was 3.91%, essentially unchanged from 3.92% in the prior fiscal year.

Our efficiency ratio was 34.44% for the full fiscal year 2016 and our efficiency ratio was 38.28% for the fourth quarter of fiscal 2016. As our quarterly fee income varies, we expect to see some variation in our efficiency ratio as our expense base will be more consistent than our seasonal tax product-related revenue.

Additionally, we continue to make significant strategic investments in our next-generation online and mobile banking infrastructure, as well as in incubating new growth businesses. We believe these long-term strategic investments are controlled, reasonably sized and will augment our organic growth and competitive position in the near future.

Our credit quality remains strong. The Bank experienced a small net recovery rather than a net charge-off in fiscal year 2016 and ended the year with only 50 basis points of non-performing loans to total loans. Our allowance for loan loss represents 112.5% coverage of our non-performing loans.

We originated approximately $1.2 billion of gross loans in the fourth quarter. As a result, ending loan balances increased by 5.3% linked-quarter, representing a 21.2% annualized growth rate. Our loan production for the fourth quarter ended June 30, 2016 consisted of $141 million of single-family agency and non-agency eligible gain on sale production, $416 million of single-family jumbo portfolio production, $173 million of multi-family and small balance commercial real estate secured production, a net increase in C&I and warehouse lending of $97 million, and $33 million of auto production.

We experienced what we believe to be a higher level of pre-payment in our single-family portfolio this quarter, which negatively impacted our loan yields. The increased prepayments resulted in an increase in recognition of costs, associated with the origination of the loans, thereby reducing the loan yield of the single-family portfolio. We did not reduce market rates this quarter in any of our loan portfolios.

For the fourth fiscal quarter originations, the average FICO for single-family agency eligible production was 758, with an average loan-to-value ratio of 68%. The average FICO for the single-family jumbo production was 710, with an average LTV of 62.7%. The average LTV of the originated multi-family loans was 57% and the debt service coverage ratio was 1.42%. The average LTV of the originated small balance commercial real estate loans was 52.2% and the debt service coverage ratio was 1.51%. The average FICO of the auto production was 761.

At June 30, 2016, the weighted average loan-to-value ratio of our entire portfolio of real estate loans was 57%. These loan-to-value ratios use historic origination date appraisals over current amortized balances, making this historic loan-to-value ratios even more conservative when you consider that real estate values have generally risen.

In single-family jumbo mortgages, representing 57% of our gross loans outstanding at June 30, 2016, the average loan-to-value ratio was 58%. As of the June 30, 2016 quarter, 55% of the single-family loans have loan-to-value ratios at or below 60%. 37% have loan-to-value ratios between 61% and 70%. 6% of single-family loans have loan-to-value ratios between 71% and 75%. And approximately 1% have loan-to-value ratios between 75% and 80%. And approximately 1% have loan-to-value ratios greater than 80%.

The LTV is calculated using the current principal balance divided by the original price value of the property securing the loan. We have a proven track record as a conservative lender in jumbo single-family mortgage lending, with lifetime credit losses in our originated single-family loan portfolio of less than 2 basis points of loans originated. Disciplined underwriting and strong asset appreciation have resulted in excellent asset quality across our entire portfolio, with 1 basis point of recoveries over the 12 months ended June 30, 2016, and 42 basis points of non-performing assets to total assets.

Although our level of delinquencies remains well below those of average banks at only 42 basis points of non-performing assets to total assets and 50 basis points of non-performing loans to total loans, we will have delinquencies from time-to-time. However, we believe that our strong collateral protection limits the severity of our loss in the event of a delinquency, because the borrower can either sell the property or we will recover substantially all our principal on the event we ultimately have to foreclose on a property.

The increase in non-performing loans this quarter of around $8 million is primarily comprised of three loans that became non-performing this quarter. One $5 million loan is a single-family first mortgage secured by well-located beach house that is currently for sale for $20 million. The other two loans are well secured single-family properties in coastal areas, one with a loan of $2.2 million on a property with a value of $3.7 million; and the other, a loan of $1.2 million on a property worth $2.6 million.

We had approximately $1.4 billion of multi-family loans outstanding at June 30, 2016, representing approximately 21% of our total loan book. We focus on smaller dollar multi-family properties in Northern and Southern California, Florida, Texas, Illinois, and certain markets in Washington and New York. The weighted average loan-to-value ratio of our multi-family loan book is 55% based on the appraised value at the time of originations. We do not have risks hidden in tails of our portfolio. Approximately 59% of our multi-family loans are under 60% LTV, 34% are between 60% and 70%, and 6% are between 70% and 75%, and less than 1% of our multi-family loans have a loan-to-value ratio above 75%.

We conducted CCAR stress testing on our multi-family portfolio, showing very manageable projected losses in adverse and severe scenarios even without the benefit of support from guarantors. The lifetime credit losses in our originated multi-family portfolio, lifetime loss rates are also less than 2 basis points of loans originated over the entire 15 years we've originated multifamily loans.

Our C&I lending group, which includes lender finance, real estate secured bridge lending, equipment leasing and other asset base lending, continues to generate good risk adjusted returns for the Bank.

Our ability to find good credits and credit structures with significant collateral production are competitive advantage as we believe can be extended to other C&I lending categories. Despite growing our C&I loan book from less than 10% of our total loans outstanding three years ago to almost 15% at the end of fiscal 2016, our commercial loan portfolio continues to perform extremely well from a credit perspective. We have no direct energy exposure and no shared national credit exposure to any oil and gas or oil field services firms in our loan book.

Our lender finance group has been a key driver of our C&I loan growth. These lines of credits and non-bank lenders backed by residential or commercial real estate assets or non-real estate related loans and receivables, provide good risk-adjusted returns with a large margin of safety. By conducting thorough credit analysis of our non-bank borrowers and creating sound structures, putting the Bank at the top of the credit stack in the majority of instances, we've been able to avoid losses that cash flow wise commercial lenders incur when their borrowers experience deterioration in their underlying business. We use special purpose entities in this business to ring-fence the collateral. This practice is usual and customary in the industry and represents prudent practice.

On March 31, we closed the purchase of approximately $140 million of equipment leases and added 25 employees from Pacific Western Equipment Finance, headquartered in Salt Lake City, from Pacific Western Bank. We paid a purchase premium of approximately 2.5% on a net book value of approximately $140 million of equipment lease with an average rate of approximately 7% and paid no additional premium for the business. The addition of a seasoned equipment leasing team augments our lending capabilities and provides another commercial lending vertical that we intend to broaden on an opportunistic basis.

We continue to expect the leasing team to originate between $80 million and $100 million in new leases annually and an efficiency ratio of approximately 40% improving to 35% within the next year. The operational integration of this business has been smooth. We originated $33 million of prime model loans in the quarter ended June 30, 2016, up 81% from the $18 million in the prior quarter. Our strategy in auto lending is to build a strong operational risk and compliance infrastructure, identify niche lending opportunities and create flexibility as to whether we balance sheet, securitize or selling whole loan form of production. Over the past six months, we've expanded our indirect distribution while investing in direct marketing and strategic partnership opportunities.

We continue to target high-quality borrowers in auto lending, with an average FICO score of 758 in our existing loan book. Our outlook for loan growth remains positive, with a loan pipeline of approximately $954 million, consisting of $522 million of single-family jumbo loans, $122 million of single-family agency mortgages, $82 million of income property loans, and $228 million of C&I loans including the newly purchased Equipment Finance business.

We had another strong quarter of deposit funding growth. Total deposits increased by $1.6 billion, or 35.8% year-over-year, with growth across a variety of consumer and business deposit categories. Checking and savings deposits increased by $1.3 billion, compared to June 30, 2015, representing year-over-year growth of 36.4%.

Checking and savings deposits represent 83% of total deposits. We continue to expand and develop our cross-sell initiatives between our lending and deposit groups. We're developing additional cross-sell initiatives in consumer and business banking that should generate new deposits accounts over time.

Of the Bank's overall deposit base, we have approximately 38% business and consumer checking accounts, 27% money market accounts, 5% IRA accounts, 9% savings accounts and 3% prepaid accounts. We had a particular success growing our business banking and consumer online deposits this quarter. As we test new cross-marketing initiatives across various consumer and business banking brands, we see lots of opportunity to further solidify our relationships with our customers. Our commercial banking group continues to focus on attracting treasury management customers and expanding with the new specialty deposit categories.

We are pleased with the smooth operational transition and the financial results in the first year of our long-term strategic partnership with H&R Block. We thank H&R Block and their team members for making this a smooth transition.

While the timing of the revenue and earnings contributions and the amount of excess liquidity that stays on our balance sheet after the tax season created some volatility in our fee income, loan growth, net interest income and net interest margins, we are extremely pleased with the results and our relationship with H&R Block. We are currently working on software integration with H&R Block so that we can execute seamlessly on our exclusive right to cross-sell individual retirement accounts through H&R Block tax offices and through H&R Block digital channel for this coming tax season. We are investing in more strategic projects today than we have any time in the 16-year history of the Bank.

These investments cut across every function and business unit, from refining retention analytics and outbound call center strategies in our consumer deposit franchise to implementing an enterprise-wide business intelligence to enhance the efficiency of our data analysts, to automating process, testing and compliance and fully implementing our enterprise risk management system, establishing new C&I and consumer lending verticals and building our new consumer online banking platform. We have been able to accelerate the pace and scale of the initiatives as we grow our revenue and strengthen our management team.

We have made good progress in our multi-year investments in our universal digital banking model. The rationale behind the universal digital banking model is several-fold.

First, we believe we must have the ability over time to control and own our user experience. This is an important competitive advantage because it allows us to rapidly integrate new technologies and services as they develop and partner more seamlessly with third-parties for customer acquisition, as well as to offer complementary products.

We believe that the future of banking will still require the ability to be a low-cost provider and offer a great value to customers. But the strong user experience will also be compelling value proposition that will increase retention and reduce customer acquisition cost.

Second, customer and third-party data can provide useful guidance as to how to integrate sales efforts that involve marketing automation, outbound sales center and behind the password cross-selling. We've a team dedicated to building a personalization engine that we believe will increase our ability to cross-sell our customers’ relevant products and increase their retention through customized user experience.

Third, increasing the scope of our digitally enabled products will allow us to develop more lending niches, but also provide a wider variety of digitally delivered products to our customers. We've been making progress. We've completed our development of our consumer account opening software, eliminating significant third-party software costs per account opening. We've developed an API stack that allows us to work seamlessly with partners to allow us to open deposit accounts. This API stack will be utilized to integrate into H&R Block's tax software for IRA account opening this tax season. We have a prototype of our next generation online consumer banking platform. We've made significant progress and are within a few months of completing our first in-house developed retail consumer loan origination software system. We've mapped out and begun to develop our personalization and alerts engine. We've a much improved in-house user experience and software development capability that will serve to power this ambitious project.

By building systems, processes and partnerships should allow BofI to offer a seamless user experience and access multiple services, either offered by us or potentially third-party providers through an integrated software platform. We believe we will differentiate our value proposition, personalize the user experience and encourage more customers to use BofI as their primary banking platform. The virtuous cycle of convenience leading to higher client engagement and the bank gaining more intelligence about customers' wants and needs, is a formula that we believe will be successful in banking over the next decade.

Of course, we incurred incremental costs related to these investments. However we firmly believe that these investments will generate significant long-term returns as we build our next generation digital banking platform, our personalization engine and expand our digital product set.

Before I turn the call over to Andy to discuss our financial results, I'll provide a brief update on our ongoing litigation. I’ll not spend much time on this because these lawsuits are old news. The events alleged by former junior employee, Erhart, happened almost 1.5 year ago, by his account. One of the world's largest law firms conducted an independent investigation and found his allegations to be without factual basis and cleared management of the alleged wrong-doing. Subsequently, the bank has completed two record-setting fiscal years, closed two acquisitions that both required regulatory approval and successfully completed multiple OCC and Federal Reserve Regulatory examinations.

We’ve generally been successful on court. The court issued a temporary restraining order against Erhart, while the bank sanctioned against Erhart for damages proceeding towards a trial, Erhart's case against the bank has not moved forward because our motion to dismiss is under consideration.

In a decisive victory, one of motion requiring Erhart's attorney Gillam to disclose her communications with short sellers, the media and other third parties. The shocking evidence shows Gillam providing BofI confidential information she apparently obtained from Erhart's in the New York Times as well as communicating with a number of short seller hedge funds and sending celebratory e-mails about the stock price decline following the filing of Erhart's complaint.

With regard to the class action, I previously stated, the strike suite lawyers revised complaint as riddled with numerous misrepresentations, outright fabrications, factual inaccuracies, out-of-context statements and mistaken application of regulatory guidance and law. During our investigation, we obtained declarations signed under penalty of perjury by two former employees, indicating that the lead plan of counsel misrepresented witness allegations, attributed to them in an effort to bolster his complaint. This is egregious and we're weighing on our options to seek sanctions at the appropriate time to help defray some of our shareholder losses.

The performance of our business has not been impacted based on today's outstanding results. The bank is in strong regulatory standing with no enforcement actions, has not been fined a single dollar by any regulatory agency, and has not been required to modify its products or business practices. Additionally, we do not foresee any further impact to the underlying business as a result of the frivolous lawsuit and the short seller hit pieces. Our management team and employees remain focused on running the business. Due to the nature of the ongoing litigation, I will not answer any questions regarding our legal matters on this call, and the question-and-answer session.

The fourth quarter was a culmination of an extremely successful year that included record earnings of $119 million, nearly $5 billion in total loan originations, completion of a $51 million subordinated note offering, a first successful tax season with our new partner H&R Block and the acquisition of Pac West Equipment Financing team based in Salt Lake City, Utah. We are extremely proud to be recognized by SNL Financial as the top-performing large trust in the U.S. for a fourth consecutive year as well as by Bank Director Magazine as a top 5 performing bank with assets between $5 billion and $50 billion for the second consecutive year.

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

Andy Micheletti

Thanks, Greg. Our 8-K was filed today with the SEC and is available online through EDGAR or through our website at In addition to our press release, the 8-K includes unaudited financial schedules. I will highlight a few areas rather than go through every financial line item. Please refer to our press release and our 8-K for additional details.

First, looking at our results for the fiscal year compared to the last fiscal year, net income increased 44.3% to a record $119.3 million. Return on average common equity was 19.43%, up from 18.34% last year. This is the fifth consecutive year we have increased our average ROE, starting from 15.17% in the fiscal year ended June 30, 2011.

Our earnings growth has been generated from both strong growth in our net interest income and in our fee income year-over-year. With primarily organic loan growth, our average loan portfolio balance grew $1.3 billion this year or 29.4%, while our net interest margin was stable coming in at 3.91% for the fiscal year compared to 3.92% for the last fiscal year. Our fee income this year was increased by the ongoing program management agreement with H&R Block as final revenue for the fiscal year came in slightly above the high end of the range of $34 million.

Finally, including the cost of our increased size and our new products and technology, our efficiency ratio for the year was 34.4%, changed slightly from our 33.8% ratio for the last fiscal year.

Looking at our results for this quarter ended June 30, 2016, compared to our results for the quarter ended March 31, 2016, average portfolio loan balances increased $471 million between linked quarters. The net interest margin for this quarter was 3.72%, but when you subtract about $321 million of average balance related to the program management agreement for H&R Block at 44 basis points, the net interest margin increases to 3.87%. We expect the entire excess liquidity from H&R Block to be gone next quarter and the net interest margin to increase between 3.8% and 4%.

Regarding asset quality, we had 2 basis points of net charge-off to average loans in the fourth quarter compared to 1 basis point of net charge-offs for the quarter ended March 31, 2016. Our allowance as a percentage of loans at June 30, 2016, was 56 basis points, down from 61 basis points at March 31, 2016, primarily due to the reduction of the Emerald Advance loans at June 30, 2016, which had a significantly higher allowance, which is no longer necessary.

Nonperforming loans, as a percentage of total loans increased slightly to 50 basis points at June 30, 2016, primarily due to the 3 single-family loans totaling $8.3 million, which Greg had previously discussed. Overall, our loan loss allowance as a percentage of our total nonperforming was 112.5% at June 30, 2016.

The bank is very well positioned from a capital perspective. The Tier 1 capital was 9.12% from the holding company and 8.78% for the bank at June 30, 2016. The holding company has more than $70 million in cash at June 30, 2016, that is available to be used for general corporate purposes, possible future acquisitions and growth opportunities, possible common stock buybacks and repurchases and to provide new capital to the bank to support future growth. For example, if we push down $70 million as capital to the bank, our Tier 1 leverage ratio would increase from 8.78% to 9.71%.

With that, I will turn the call back over to Johnny.

Johnny Lai

Thanks, Michelle. We are ready to take questions.

Question-and-Answer Session


[Operator Instructions] Our first question comes from the line of Bob Ramsey with FBR.

Bob Ramsey

Hi, good afternoon. I wanted to touch quickly on expenses, if we could. They ran a little bit higher than I was looking for, and I just note if there was anything variable comp related to mortgage banking that was unusual or anything around some of the Block, quarterly volatility or just sort of how we should think about the expense run rate?

Andy Micheletti

Sure. Well, when you look at the overall increase in compensation, the primary reason for the increase is 70 headcounts were added between March 31 and June 30. When you break that down, the largest increase is associated with C&I and leasing. As Greg mentioned, there are about 23 to 25 people that were added for the C&I Salt Lake City office for the leasing and then another 10 people were added to C&I on top of that.

The next largest growth category came out of single-family residential, where about 9 headcounts were added during the quarter. The next largest increase came out of IT, where we had 14 headcounts added in connection with our technology projects and overall growth. The balance of the headcounts are spread across a number of the groups, including an additional 5 headcounts for compliance and audit that were added in this period. So, the probably single largest factor to growth in comp comes from the addition of the leasing unit.

Greg Garrabrants

I think that with regard to whether we expect that kind of growth of personnel in subsequent quarters, I think the answer is no. But with everything we're doing, I think that we're more likely to be at 35% to 36% ratio over the entire year, but because the block income is moving so much, we will see spikes in our efficiency ratio based on what we're doing. So, I don't think it's -- it would be good to expect that we have a 35% efficiency ratio every quarter. But we hope to achieve that over the entire year, although we're not going to slow down our ambitious growth agenda, or technology agenda for couple of hundred efficiency -- couple of hundred basis points of efficiency ratio. So, I hope that's helpful from that perspective.

Bob Ramsey

That is helpful. That's great. Shifting to net interest margin, I know you guys said, excluding Block you were at 3.87%. Next quarter you expect to still be in 3.80% to 4% range. I heard that there will be no Block impact, I guess, next quarter. Where are you -- I guess, are you expecting it to be down from where we're today, up from where we're today. Just want to get a little bit of more sort of directional vision on where you are seeing margin pressure or not in the environment today with history about that Block volatility?

Greg Garrabrants

I think, I'd say that rough stability. We didn't change loan rates at all. We did have a prepaid quarter on single-family that impacted the single-family loan rate a little bit. We also have the sub-debt, which impacted our margin by about 4 basis points this quarter. So that -- we didn't use it yet. So it essentially is sitting there just as excess capital and creating a drag because it hasn't been deployed yet and our capital ratios are above what they normally are. So I think relative stability, taking away the Block number, I mean, deposit costs were reasonably stable and loan rates were stable, at least the offer rates were stable. We didn't have to cut rates in order to attract volume and we don't intend to do that.

Bob Ramsey

Okay. Then last question, I’ll hop out. But what do you thinking of is the priorities for that sub-debt. I mean, I know you mentioned it so far is not being used on the balance sheet and if you push it down to the bank, it brings us ratios up very significantly. What is the priority for using that capital?

Greg Garrabrants

Well, clearly with where the share price is, that makes share repurchases more attractive, that's a decision that I and the Board make, but that's obviously something that after -- frankly after announcing the year that we have, and that was a good quarter, we're obviously disappointed by that reaction. But that also provides us opportunity and so we have to take advantage of that opportunity. And if we are doing that, then that will allow us to obviously increase EPS because we certainly are in a lot more on an ROE basis than we do pay on interest. So there is a lot of considerations. We have some interesting opportunities going forward from a lending perspective too. So it's a balance, but those are all considerations, whether to use it for organic growth over time or to utilize it for some form of share repurchase.


Our next question comes from the line of Brad Berning with Craig-Hallum Capital Group. Please proceed with your question.

Brad Berning

Good afternoon. Could you just start with going through each of the lending sectors, talk about market environment, talk about competition, talk about your interest to growth, growth outlook? Just kind of give of the lay of the land of each one of the sectors?

Andy Micheletti

Sure. For a single-family jumbo business, I think has good growth potential. It's probably our more mature segment, but I still believe there's lots of opportunity there. And we don't really see any significant increased competition. There is a few lenders here and there, but we don't really see too much there from increased competition. I think that frankly as we continue to grow, a lot of the limitations that we have in our growth opportunities are related more to our own operational infrastructure in growing it. We have a office, we're opening in different states, it has 140 people, who has the capacity for 140 people.

There is just some of those elements of operation -- of operational infrastructure build that I think are more limiting to growth in any market segment or sector. And we have really good plans on the data strategy side there and things like that, to be able to, to move that business forward. On the single-family agency side, there is a lot of opportunity to grow that business. And frankly, we probably have been a little too cost conscious with regard to always maintaining an operational infrastructure that was very cost focused and so at times it hasn't allowed us to take advantage of what the market opportunities are out there. So I feel very good about that. Multifamily is a lot more competitive. There's a lot of banks focused on it. I think they've -- we've seen them sort of pushing credit, long IO periods, higher LTVs, nonrecourse. So that's made that segment a lot more difficult and growth has been more challenging there. So that's that something that we've been compensating for with smaller balance commercial production a little bit, which we think there is some more opportunities with some different niches there although that's relatively competitive, but less so than multifamily, which is really, I think the most competitive component of it. In the C&I side, we have our lender finance businesses. There is lots of opportunity there.

The production can be lumpy. The deals are long. There is lots of negotiation. It takes a lot of time. But we have good established niches there. We have a lot of great partners from a B lender perspective and from a hedge fund perspective. We work with a lot of largest private equity firms in the world in those deals, and I think we're important partners for them and they know we can execute. So that's good. The leasing business, we clearly have plans for them to enhance their growth. We hired a leasing executives, who not only focuses on the type of growth that the Pac West Group does, but another leasing growth. And so we think there are other opportunities in the C&I side to find good risk-adjusted returns. We'll have to -- we have our view what the markets are, but we'll have to see how well we can execute there, and I think that's still to be determined. The auto side has lots of opportunity. We've intentionally kept our credit quality extremely high.

They have done a very good job of building a very high quality book. The yields are only okay. And so there is some lending niches there that we need to explore to increase the yield there. But certainly they have done a good job in building that business. And we've got some other initiatives that I'm not prepared to announce here that we're continuing to work on. Overall, part of the universal digital banking initiatives to be able to have a broad suite of consumer products on the retail side, which would include auto, personal loans and others to sell our customers and to have a broad spectrum of business products, but probably not the sort of small business cash flow lending products, at least, owned by us. So I think, all in all, things are pretty good. We're not going to, I think as we grow, as I've said before, we've had typically 30%-ish loan growth and I'd try to guide people more down into the 20s and if you look at where we were organically after you separate the H&R Block, short-term balance decrease, that's where we were and obviously we have the acquisition, which boosted that more into the 30 range. But that's not something obviously that's going to be repetitive.

Bradley Berning

Understood. We'll follow up more details on those later. But just wanted you to make sure, you had a chance to reecho a comment that I think I heard you say. But I think you did say in your prepared remarks that the regulatory exams for the year are all completed. And I just wanted to give you a chance to, given all the questions on that topic; give me a chance to kind of reecho what you said there.

Greg Garrabrants

Oh, sure. Well, so. Yes. The regulatory exams are always completed, but as I've said on past calls, the nature of being a regulated entity is that we've constant dialogue with regulators, including the OCC, SEC, FDIC and the Fed. I know that you got involved and a little sped over what the term investigation is and how it's defined and that sort of thing. And it's interesting because the term investigation isn't defined in Securities Law and you can characterize any question or one question as investigation, and the nature of regulatory dialogue is there's constant questions in the inquiry. And so, I think the important thing to note and what's the most important is if there is any event that's occurred that would require disclosure, the answer is absolutely no.

So we've not been asked any question or received any inquiry from any agency, including the SEC that would suggest concerns regarding financial misrepresentation, financial results, estimates, or other matters that would require an 8-K. And so, we have with regard to the OCC, obviously, our primary regulator, we have 2 -- we have a full scope exam and an in-term exam. Our full scope exam for this year is complete. We know where that is. Obviously, we cannot talk about the specific results, but I was very clear that we have no constraints on our business. We have no enforcement actions and we frankly don't have any issues that would lead me to think that we have to change any single thing about what we're doing. So while the amount of noise that the short-sellers have been able to generate is impressive, the actual impact on the operations of the business is nothing. And so allow me to repeat. We have not been asked any questions that or received any inquiry that would suggest any concerns about our financials, financial misrepresentations, financial results estimates or anything else that would require the filing of an 8-K, meaning that would be material.


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

Gary Tenner

Couple of quick questions. First on your comments on the prepayment speeds, impacting loan yields this quarter. Could you be a little more specific on what the actual impact was, on average loan yields for the quarter?

Andrew Micheletti

Yes, it was like 3 to 5 basis points something like that. So it's not -- it was an -- I mean, it's enough to make a difference, right, when you're looking at a few basis point. And that's on single-family yield, not on the entire yield. Single-family yield.

Gary Tenner

Okay. And just what you've seen through the first month of this quarter and based on where rates are you seeing as similar sort of pace of prepayments this quarter?

Andrew Micheletti

It's tough to say because we're only a third through it on that item, but we do believe the quarter was outsized.

Gary Tenner

Okay. And then just a follow-up on the expense piece. You discussed it in terms of the outlook for the efficiency ratio, et cetera, but just trying to understand, so the leasing company came in, you said that's around 40% efficiency ratio that you should be able to get down from there. And I guess how efficiency ratio would be higher this quarter than it was in the March quarter obviously with H&R Block impact. I was surprised that it was actually well above where it was through the first half of the year or at least in the counter fourth quarter last year when H&R Block was in there. So can you talk about specifically the sequential increase in professional services cost this quarter. It was $2 million versus $2.7 million for the first 3 quarters and then advertising $2.2 million versus $4.6 million for the first 3 quarters. So just in terms of any seasonal fluctuations or impacts there?

Greg Garrabrants

Sure. Yes, let me first cover professional services, and we'll look at the linked quarter change where it went up about $1 million so -- for that piece. So when you break that down, only $400,000 of that increase is connected to the litigation. The rest of that increase, so $600,000 is items outside of that. When you break that down, the $600,000, about $100,000 relates to the accounting. So that's audit and tax work. About $200,000 relates to contract legal, that's legal work for a variety of different business contracts, unrelated to the litigation. And then about $300,000 is increased primarily for third-party consultants that we bring in from time to time for audits and other items. So for example, BSA exam we engage Crow, which is part of our routine. That's around $200,000 for the period. So that kind of rounds out the increase in professional services.

Gary Tenner

Okay. And just on the advertising front because I was about only half of what it was in the first 3 quarters.

Greg Garrabrants

Yes, the advertising is a little bit more of a max, but there certainly is -- part of that is lead fees as Costco gets bigger and it's mortgage banking moves, that's a little bit of that. But the issue is that we also have developed the capacity there. So sometimes they've gotten a lot of capacity constraint in mortgage banking, and I think some of the efficacy of some of those leads really weren't where they should be. So that's a little bit -- a little bit of that there. But otherwise, it's just there is -- we're working on a lot of interesting marketing initiatives constantly testing things. And so there is an element of that, too. I would say, more broadly, is that and obviously it's -- you guys have to make models and that's important. But what I've seen in the business as we've grown is that, you go through slight stair-step waves where you bring on people, you do new things, you have a little bit of a cost increase and then you are able to get productivity out of those individuals and those initiatives, that kind of levels things out a little bit. And I think we've had a little bit of that with regard to personnel. We've really worked hard to really upgrade talent in the organization, and there is a lots of new talent here that are working on a lot of new things and all those new things aren't yet at fruition. So it maybe more of a little bit of an extended time frame in order to get all those things working, but people will be happy in 2 to 3 years. But there will be -- we're not absolutely bounded in any 1 quarter by that 35% efficiency ratio. We're going to work hard to be cost conscious, but we're not going to sacrifice the future.

Gary Tenner

Yes, and I think I'll get there from the headcount perspective just was 1 and understand some of the other line items.


Our next question comes from the line of Andrew Liesch with Sandler O'Neill.

Andrew Liesch

Sorry, if I missed it. Did you guys say what the balance of deposits from H&R Block is on the balance sheet at the end of June?

Andrew Micheletti

We did not, but I can give that to you. So that's going to be approximately $203 million in total at the end of the period, included in noninterest-bearing deposits.

Greg Garrabrants

And we don't think that, that much above low really. I mean, [indiscernible]

Andrew Micheletti

That might be 100 roughly. So we're close. That's why we're expecting with that excess liquidity gone, to have better margin.

Andrew Liesch

Got it, just a little bit of excess liquidity remains now?

Greg Garrabrants


Andrew Liesch

Okay. And then just curious if now with the first year of Block in there and just looking out to next year, have you had any discussions with them about any changes in tax laws that might affect the income tax credit and the IRS not paying out refunds until February 15? Is that -- have you had any discussions with them on how that might affect your results?

Andrew Micheletti

Well, we have lots of discussions with them about things like that, about new products, about opportunities. And we're in constant dialogue with them. I don't think that any of those things would probably move where that revenue occurs to push it out in a quarter. But if it did, we certainly know far enough in advance so we could talk about that. But I don't think that's anything right now to be worrying about modeling. And we have a lot of exciting potential opportunities with them. Obviously, we've got the base products that we're excited about, but there is always other things to look out and maybe we'll get some of those and there will be some opportunities for more than organic customer growth that they have. So we will see. But I don't think there is anything to try to put in your model right now in that regard.

Andrew Liesch

Okay. And then similar to that or somewhat related, I think it might be possible that H&R Block launches or relaunches the refund anticipation loan product next year. Does your existing program management agreement allow for you to be the issuing bank under that? Or just kind of curious if you would be willing to do that product as well, if Block is offering that product?

Greg Garrabrants

That's something that we're certainly looking at and obviously thinking about, and I really don't have any further comment on it.


Our final question comes from the line of Donald Worthington with Raymond James.

Donald Worthington

In terms of the gain on sale other, what's the composition of that? Is that primarily structured settlements?

Greg Garrabrants

Yes. It's primarily structured settlements. So when you look at the $5.2 million gain, approximately $4.3 million of that roughly is structured settlements.

Donald Worthington

Okay. And then in terms of -- is this deposits, I think, Greg, you mentioned, a balance of business plus transaction or something like that. But do you have a balance for the business deposits, I think, has been running kind of North of $2 billion in the past?

Greg Garrabrants

Yes, hang on a second and if you go to your next question, I'll have it for you.

Andrew Micheletti

Do you have anything else you want to talk about?

Donald Worthington

The last question was -- this is a small part of what you do, but just looking for an update on kind of the high net worth brand, how that's progressing?

Greg Garrabrants

Yes, that's going well. It's -- I think it's around $70 million of deposit. The -- it's providing us a good place to test the cross-selling and the relationship management model for our jumbo mortgage customers. So for somebody who -- the guy who has his $20 million house for sale and although he is the $5 million delinquency guy, doesn't want to go and call into the call center. And so that model is allowing us to test that cross-sell. It's working, it's not. It's one of the many initiatives we have, and we think there is real opportunity there to continue to grow it. We think that the -- I think we think the name Bank of Internet, at times, may be an obstacle to attracting certain high net worth customers. And so I think the branding and the structure around that and the service delivery method is something that has legs, and we'll be continuing to work on it in the future.

Andrew Micheletti

So I've got your numbers for you. It's about 50-50 split. $2,976,000,000 in consumer and $3,067,000,000 in business. So nearly about 50-50.


There are no further questions at this time. I'd like to turn the call back over to Mr. Greg Garrabrants for any closing remarks.

Greg Garrabrants

Well, thanks, everyone. I appreciate your time today and your attention. And to my knowledge, the 10-Q should be forthcoming. So we all look forward to that, and we look forward to talking with you next quarter. Thank you.


This concludes today's conference. Thank you for your participation. You may disconnect your lines at this time, and have a wonderful day.

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