Axos Financial Inc

NYSE:AX

Earnings Call Transcript 2023-Q1

[Operator]

Greetings. Welcome to the Axos Financial, Inc. Q1 2023 Earnings Call. [Operator Instructions] Please note, this conference is being recorded.

I will now turn the conference over to Johnny Lai. You may begin.

[Johnny Lai, Corporate Development & Investor Relations]

Thank you and good afternoon, everyone. Thanks for your interest in Axos. Joining us today for Axos Financial, Inc.'s first quarter 2023 financial results conference call are the company's President and Chief Executive Officer, Greg Garrabrants; and Executive Vice President, Chief Financial Officer; Derek Walsh; and Executive Vice President of Finance, Andy Nicoletti. Greg and Derek will review and comment on the financial and operational results for the 3 months ended September 30, 2022, and we will be available to answer questions after the prepared remarks.

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 risks 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 axosfinancial.com for 30 days. Details for this call were provided on the conference call announcement and in today's earnings press release. Before handing over the call to Greg, I'd like to remind our listeners that in addition to the earnings press release, we also issued an earnings supplement for this call. All of these documents can be found on Axos Financial website.

With that, I'd like to turn the call over to Greg.

[Greg Garrabrants, President & Chief Executive Officer]

Thank you, Johnny. Good afternoon, everyone, and thank you for joining us. I'd like to welcome everyone to Axos Financial's conference call for the first fiscal quarter ended September 30, 2022. I thank you for your interest in Axos Financial and Axos Bank.

We had another excellent quarter with double-digit growth year-over-year in book value per share and ending loan and deposit balances. Our strong results were broad-based with net interest margins exceeding the high end of our target and double-digit net interest income growth year-over-year. We grew deposits by approximately 29% year-over-year led by strong growth in consumer deposits and deposits from Axos Securities. Excluding a onetime weekly reserve, which I'll discuss later, we reported adjusted net income of $69.6 million for the 3 months ended September 30, 2022, representing year-over-year growth of 15.6%. Our book value per share was $28.35 at September 30, 2022, and also up 15.6% for September 30, 2021. Highlights for this quarter include the following. Deposits increased 8.8% linked quarter and 29.2% year-over-year to $15.2 billion.

We continue to make steady improvements in our funding max with noninterest-bearing deposits increasing by approximately $1 billion from September 30, 2021. Noninterest-bearing deposits represented approximately 30% of our total deposits at September 2022. The diversity of our funding mix compared to the last rate cycle positions us well to maintain our best-in-class net interest margin. Ending net loans for investment balances were $15.2 billion, up 8% linked quarter or 28.1% annualized. Despite rating increases rapidly since the start of the year, we continue to see good demand for well-secured C&I and commercial real estate loans.

Net interest margin was 4.26% for the fourth quarter, up 7 basis points from 4.19% in the quarter ended June 30, 2022, and up 4 basis points from 4.22% in the quarter ended September 30, 2021. Net interest margin for the banking business unit was 4.5% compared to 4.45% in the quarter ended June 30, 2022, and 4.48% in the quarter ended September 30, 2021. Higher loan yields more than offset the increase in funding costs. Axos Securities comprised primarily of our custody and clearing businesses made positive contributions to our fee income, deposits and net income. Total deposits from Axos Securities were approximately $3.3 billion as adviser and broker-dealer clients continue to hold higher cash balances in light of elevated market volatility and Quarterly pretax income improved by $9 million year-over-year to $8.9 million due primarily to higher interest rates.

Adjusted diluted earnings per share was $1.18, up 15% from $1.03 in the year ago quarter. Capital levels remained strong with Tier 1 leverage ratio of 10.3% at the bank and 8.98% of the holding company, well above our regulatory requirements. Our credit quality remains strong with annualized net charge-off to average loans of 5 basis points versus 1 basis point in the first quarter of fiscal 2022. The slight uptick in our net charge-offs was from very low levels, solely due to losses in our personal unsecured and auto loan portfolios, some of which are later offset on the auto side by collection of credit insurance we have purchased on certain auto FICO bands. We added $8.75 million to our loan loss provision this quarter to support our strong loan growth.

Total allowance for credit losses was $155.5 million at September 30, 2022, representing 21x our annualized net charge-offs and 1% of our ending loan total loans. Loan originations for investments for the quarter ended September 30, 2022, were $2.5 billion, up approximately 19% from $2.1 billion in the comparable quarter 1 year ago.

The first quarter 2023 fiscal year originations were as follows: $312 million of single-family jumbo production, $129 million of multifamily production, $59 million of commercial real estate production, $125 million of auto and unsecured consumer loan production and $1.9 billion of C&I loan production, resulting in a net increase in ending C&I loan balances of $960 million. Ending loan balances in our jumbo single-family business increased by $124 million to $3.8 billion, marking the second consecutive quarter of over $100 million of net growth in our jumbo single-family mortgage portfolio. We generated $313 million of loan production in the first quarter of 2023, benefiting from dislocation of jumbo single-family mortgage securitization market.

Prepayments in our jumbo single-family mortgage business were $184.3 million in the 3 months ended September 30, 2022, down from $390 million of prepayments in the prior quarter. While rising interest rates have resulted in reduced overall market demand for jumbo refinances and purchase transactions, we are better positioned than most of our competitors to capture a greater share of the available market given our efficient operations and established track record of execution. Our jumbo single-family mortgage pipeline was approximately $311 million as of October 24, 2022. C&I lending had another tremendous quarter. Demand remained strong across loan types and geographies with a backlog of approximately $790 million at October 24, 2022. We have positive momentum across multiple C&I lending verticals, and we remain confident that we'll be able to sustain strong growth in our net balances while maintaining our credit quality and loan yields.

Our loan pipeline remains solid with approximately $1.4 billion of consolidated loans in our pipeline at October 24, 2022, consisting approximately of $20 million of single-family agency gain on sale mortgages, $11 million of jumbo single-family mortgages, $155 million of multifamily and small balance commercial real estate term loans million of C&I and commercial real estate specialty loans and $170 million of auto and unsecured loans. We are off to a strong start to our fiscal year with over $1 million of net loan growth in the first quarter of fiscal 2023. While the near-term outlook remains good, we expect loan growth to moderate from the elevated pace we've seen in the past 2 quarters as the impact of higher interest rates begin to have a more pronounced effect on loan demand in the first half of calendar 2023. Nevertheless, we remain confident that we will achieve the mid-teens loan growth target for our fiscal 2023.

Deposits increased 8.8% linked quarter and 29.2% year-over-year. Growth in small business and consumer deposits were offset by declines in certain commercial banking and clearing and custody deposits from elevated levels at the end of the prior quarter. Competition for deposits has increased across most of our deposit categories. We have been successfully retaining and growing consumer checking, savings and money market deposits through cross-sell and relationship pricing initiatives.

In Commercial Banking, our low-cost nationwide deposit gathering and specialized servicing approach has allowed us to be more competitive in maintaining and growing deposits from existing clients. Our investments in cash and treasury management capabilities and teams have increased the pipeline of prospective new treasury management clients. In Axos Fiduciary Services, our bankruptcy trustee business, total deposits were approximately $1.1 billion at the end of the first quarter. We expect a gradual pickup in Chapter 7 and non-chapter 7 cases and deposits over the next 12 months as the economy decelerates and bankruptcy filings rebound from multi-decade lows.

Axos Clearing continues to generate a significant source of low-cost deposits. We had approximately $3.3 billion of clearing and custody deposits at September 30, 2022, including $2.4 billion that was on our balance sheet and $0.9 billion that was placed at partner banks. While the level of cash sorting by advisers and brokerage or clients has increased, the cash held at Axos Clearing remains elevated at approximately 11% of total assets under custody and administration. The weighted average cost of our clearing and custody deposits remain very low, even with a rapid rise in the fed fund rates. We have a healthy pipeline of new custody and Caron clients that will help offset the eventual normalization in cash holdings if and when advisers and broker-dealers become less risk averse. We maintained a net interest margin well above our long-term annual target of 3.8% to 4% once again this quarter, with consolidated and bank-only NIM of 4.26% and 4.5%, respectively.

New loan yields during the quarter were as follows: single-family jumbo mortgages, 6.03%, multifamily mortgages, 5.92%, auto, 6.5%, C&I 7.33%. We remain slightly asset sensitive with 38% of our loans comprised of 5/1 hybrid arms in the jumbo single-family and multifamily portfolio and 53% of our loans comprised primarily of floating rate C&I loans. With the exception of a small portfolio of prime jumbo mortgages, we have no other 30-year fixed-rate jumbo single-family loans or multifamily loans on our balance sheet. The overwhelming majority of our C&I loans are variable rate, excluding the $138 million equipment leasing portfolio. 58% of our variable rate C&I loans just to LIBOR and the other 42% of just SOFR Ameribor or other indexes. At September 30, 2022, approximately 93% of our C&I loans were above their floors, with another 75 basis point increase in Fed funds expected in November. All the C&I loans will be above their floor rates. Demand for our commercial specialty real estate and other C&I loans remain strong as reflected in the $790 million C&I loan pipeline as of October 24, 2022. Akzo Securities, which includes our securities clearing and custody, self-directed trading and managed portfolio businesses generated $10 million of pretax income, excluding noncash amortization expense in the first quarter of fiscal 2023, an improvement from adjusted pretax income of $0.8 million in the linked quarter.

Our securities businesses are benefiting from rising interest rates, partially offset by declines in asset-based cheese as a result of market depreciation. Axles Advisor Services held its first in-person adviser conference since 2019 and then for last month. Over 100 existing and prospective advisers attended, reflecting strong interest from independent RIAs seeking an alternative noncompetitive tech-forward custodian that can help them grow their practice. Access Advisory Services is seeing good momentum, adding approximately $200 million of net new assets in the quarter ended September 30, 2022, and a pipeline of 10 new advisers with those of $500 million of new client assets that is committed to transfer to Axos over the next 12 months.

The pipeline for AES remains robust with active discussions with several multibillion-dollar firms who are looking to move portions of their assets from their existing custody. We are making good progress with various operational and infrastructure initiatives in our clearing and custody businesses. We continue to make progress on the build-out of our proprietary securities core that will reduce operational costs in our securities business by reducing third-party vendor costs allow greater levels of straight-through processing and enable us to pursue more cost-competitive business opportunities. Higher fee income from access securities was instrumental in helping offset expected declines in mortgage banking gain on sale. As rates continue to rise, we expect this dynamic to continue with higher fee income from off-balance sheet deposits offsetting lower mortgage banking income.

We expect higher margin businesses such as stock borrowings, margin lending to rebound from current levels when market conditions improve. Additionally, we have several initiatives at AES and Axos Clearing that will optimize and grow the fee income from new and existing sources such as mutual funds, ETFs, our model management marketplace and alternative assets. Our efficiency ratio was 55.9% for the 3 months ended September 30, 2022, up from 54.4% in the prior quarter. Excluding a $16 million onetime legal reserve, our efficiency ratio was 48.2% in the first fiscal quarter of 2023. Yesterday, we received an unfavorable outcome in the litigation initiated by Union Bank related to our purchase of our Axos Fiduciary Services business. This litigation pertained to issues related to the sale of the business to access by Epic Systems and the termination of a prior contract between Union Bank and Axis. Axos' relationship with Union Bank ended a number of years ago, and this matter has no impact on any aspect of the AxoFiduciary services business going forward. The jury award of the Union Bank jury awards Union Bank demos is totaling $18.3 million, which is offset by a prior amount received by union of approximately $8 million for a net amount of $10.3 million plus estimates of prejudgment interest. While the company strongly disagrees with the verdict and plans to appeal the decision in the damage awarded, Axos took a $16 million pretax reserve in the quarter ended September 30, 2022.

Our diverse lending and deposit businesses and modest support securities portfolio position us well for a rising interest rate environment. Our securities book with approximately $258 million in ending balances is less than 2% of the total assets as of 9/30, 2022. About half of our securities are floating rate and the average duration of our securities portfolio was 2.1 years. Unlike other banks, we are not and do not anticipate having material AOCI marks for our securities portfolio. Our single-family jumbo mortgages and multifamily loan portfolios with $4 billion and $3 billion of loan principal outstanding as of September 30, 2022, represent approximately 26% and 19% of our total loans outstanding, much lower than they were in prior upgrade cycles. While we expect deposit betas to rise to the end of the Fed tightening cycle, we have more tools from a loan and deposit perspective to help alleviate some of the expected funding pressure.

Looking forward, our outlook is that our net interest margin for the fiscal year ended June 30, 2023, will remain above our long-term target of 3.8% to 4%. The biggest factors impacting our net interest margin will be how fast our loan portfolio grows and where our access advisory services deposit balances are relative to their September 30, 2022 levels. As we stated previously, our expectation is that net loan growth will moderate from the high levels seen in the prior 2 quarters and grow by mid-teens in fiscal 2023. If loan growth exceeds our mid-teens based target, then the incremental cost to fund our loan growth will be on the higher end of expectations. With respect to our Axis advisory service deposits, the biggest source of incremental low-cost deposits will come from our existing RIA clients. The amount of cash held by RIAs and their client accounts fluctuate based on adviser risk appetite, which can change quickly.

Another factor impacting Axos Advisories clearing cash balances is the relative rates paid by money market funds and other liquid cash alternatives. Historically, advisers and broker-dealers have not viewed cash sweeps as an asset class and have not actively looked to maximize the return on that cash. However, given the Fed's aggressive tightening, some advisers are starting to evaluate higher-yielding cash alternatives. We have started to engage in productive discussions with custody and clearing clients to come up with solutions that are mutually beneficial for the RIAs and their clients' needs. We are also actively exploring relationship-based pricing that could accelerate the transfer of new custody assets to Axos. Our baseline assumption is that the percent of cash held by Access Advisory Services clients will normalize to 7% of our assets under custody in fiscal 2023 from 11% at September 30, 2022. If clients become more risk-averse and continue holding a higher cash balance, then our full year NIM will be higher than our baseline target. However, if clients reduce their cash percentages, and we had to replace those low-cost deposits with relatively higher cost deposits than our full year net interest margin will come in to the lower end of our target of 4% or higher.

Our credit quality remains healthy, and we're not seeing any signs that our borrowers are struggling to finance their debt obligations with us. Net charge-offs to total loans remains low, and our asset-based lower TV lending makes us extremely comfortable about our credit outlook even in adverse economic scenarios. Nonperforming assets of total assets was 68 basis points for the quarter ended September 30, 2022, no change from 68 basis points for the quarter ended June 30, 2022. Of our nonperforming loans, approximately 55% are single-family mortgages, where we've had historically very low realized losses. Of our nonperforming single-family mortgage loans at September 30, approximately 95% had an estimated current loan-to-value at or below 70% and approximately 97% or below 80% of our best estimates of current loan to value. Given the low loan-to-value of our asset-backed loans, we remain confident that our incurred credit losses will remain manageable even if asset values decline.

We had an excellent start to our fiscal 2023 with loan growth and net interest margin well above our full year guidance. While the uncertain environment presents short-term challenges, we will continue to manage the aspects of our business that we have direct control over, credit, operational efficiencies, capital liquidity and strategic investments. Our strong profitability, excess capital and ability to be nimble positions us well to take advantage of market dislocations similar to what we've done in prior cycles. I'm excited to execute on the various strategic initiatives we have in place across each of our businesses.

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

[Derrick Walsh]

Thanks, Greg. To begin, I'd like to highlight that in addition to our press release, an 8-K with supplemental schedules was filed with the SEC today and is available online through EDGAR or through our website at axosfinancial.com. I will provide some brief comments on a few topics. Please refer to our press release, our SEC filings and our website for additional details. I'll lead off with an overview of our deposits at September 30 compared to June 30.

Our noninterest-bearing deposits declined $407 million from $5 billion at June 30 to $4.6 billion at September 30. The -- our total interest-bearing demand and savings deposits increased $1.4 billion from $7.9 billion at June 30 to $9.3 billion at September 30. Our time deposits increased $187 million from $1.1 billion at June 30 to $1.2 billion at September 30. Our weighted average interest rate at the end of the period for our total deposits increased 60 basis points from 0.54% at June 30 to 1.14% at September 30. We Next, I'll turn to our noninterest expense, which for the quarter ended September 2022 was $116 million, up $11 million in the linked quarter ended June 2022 and up $32 million from the quarter ended September 2021.

As Greg discussed, the primary reason for the increase was a $16 million accrual for an adverse legal judgment that has not been finalized. I'll provide some additional information on a few specific expense areas. Salaries and related expenses for the quarter were $47 million, up $3.5 million from the linked quarter and $6.3 million from the year ago quarter. The $3.5 million linked quarter increase is primarily attributable to our annual salary compensation increases, taxes for semiannual bonuses and increased headcount. Professional services for the quarter ended September 30, 2022, were $8.1 million, an increase of $0.5 million from the $7.6 million for the 3 months ended June 30 and $3.5 million increase from the $4.5 million for the quarter ended September 30, 2021. The primary drivers of the increases were legal expenses and fiscal year-end audit expenses.

Advertising and promotional expenses increased to $6.4 million from $3.4 million in both the June and prior year September quarters to support growth in our deposit businesses. Given the competitive landscape for deposits, we expect to maintain a higher level of spending on marketing to grow our consumer and commercial deposits. Lastly, despite strong asset growth, our capital ratios remain in a strong position with our total risk-weighted capital ratio at Axos Financial ending the period at 12.9%. Net capital at Axos Clearing increased 26% on a linked quarter due primarily to higher profitability in our securities business. We continue to maintain additional cash reserves at the holding company available to contribute to our subsidiaries. And with an expected moderation of asset growth, we expect to organically grow our capital throughout the enterprise.

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

[Johnny Lai, Corporate Development & Investor Relations]

Thanks, Derek. Operator, we're ready to take questions.

[Operator]

And at this time, we'll be conducting a question-and-answer session. [Operator Instructions] And our first question comes from the line of Gary Tenner with D.A. Davidson.

[Gary Tenner, D.A. Davidson]

A couple of questions. On the segment reporting section of the supplement, just looking at the fee income at the securities business and the corporate eliminations, it strikes me as they took really large delta there, certainly much more than the year ago period. So I'm just wondering, Derrek, if you could kind of walk us through the moving parts there and how to think about it on a segment basis or...

[Derrick Walsh]

Yes, certainly. That's the cash sorting deposits. So we did try to add some language above the table that covers that the vast majority of that are those deposits from the Axos Clearing and AAS cash sorting deposits that are held at the bank. So obviously, we have a portion of those held off balance sheet as a portion that are held on the bank's balance sheet. And so the elimination is that the bank pays the securities business for those transactions for those deposits at a roughly market interest rate, and that's what's getting eliminated in that noninterest income line item and in the noninterest expense line item.

[Gary Tenner, D.A. Davidson]

Okay. In Rose [ph], I went through the fee side. Okay, that helps. And then just in terms of the loan deposit ratio increased this quarter. Obviously, a lot of banks are running a little bit higher than typical on that metric right now. I was just wondering how you're kind of monitoring that and thinking about that going forward.

[Derrick Walsh]

Yes, certainly. We always, as you know, run a little bit north of 1. Given the diversity of our deposit sourcing opportunities, we feel comfortable in and around kind of a 1.05, give or take a few percentage points there. But I don't think that's -- when you go back in our history, we're not necessarily outside our normal kind of band of where we live within that. We feel good about our capabilities to continue. We're seeing a lot of strong demand on our consumer deposit business lines as well as making some inroads, as Greg highlighted, with regards to some customer-based relationship-based sourcing with regards to the AAS new customers. And so it's pretty overall, I think we feel good about where we can go with the deposit franchise. And -- but we will certainly get the best bang for the buck because we know we have these different areas, different levers that we can pull and source deposits from that we will run slightly at that or slightly above.

[Gary Tenner, D.A. Davidson]

Thank you very much.

[Operator]

Our next question comes from the line of Andrew Liesch with Piper Sandler.

[Andrew Liesch, Piper Sandler]

Derrick and I was taking some notes. Did you give what a good run rate would be for expenses here? It sounds like it could be a little bit higher, but did you give like a total number of where we should build off going forward?

[Derrick Walsh]

Yes. I think not too dissimilar from what we provided last quarter. Obviously, there's a little bit of noise with the legal charge. But when we think about 42% as the -- what we previously provided the bank efficiency ratio in and around that by a percentage point would be, I think, the best way to pencil out the expenses. And that usually equates to from a consolidated ratio from kind of a band of 48% to 50% in the consolidated ratio.

[Andrew Liesch, Piper Sandler]

Got it. All right. That's really helpful. Is that just on the margin guide in the range, the $3.80 to $4, -- it sounds like to get below that high end, you need to have a natural the cash level at and Axos Securities come down to a normal level. And maybe if the fed stops raising rates, then funding costs catch up, but even so, it's still probably going to be at the high end of that range at worse. I mean, is it time to update your range just given all the different in the deposit base over the last several years?

[Greg Garrabrants, President & Chief Executive Officer]

Yes. It's a reasonable question, given we're sitting so far above it. So it's not without merit. Look, I think that there's a couple of things going on. Obviously, the loan side is a lot more variable than it ever was, but there's still a set of loans that although they are 5/1 arms and they've been originated in different periods, given the level of prepays that we had previously, that tends to skew towards relatively recent vintages. Nobody's going anywhere really with respect to those. Also, prepay is lower. So as opposed to the regular 2.9 average year weighted life. I think that's pushing out longer. So obviously, we are -- the new assets are coming on at higher rates. But even though they're coming on, let's say, on the jumbo side in the low to mid-7s if, let's say, the Fed fund rate goes up 5 and above, then that obviously squeezes that net interest margin on a couple of those portfolios, you have the potential that there could be more cash sorting associated with that or the deposit betas pick up.

So look, but I do think that it's -- I don't think it's reasonable to assume in the fiscal year that we're going to have some massive collapse of NIM to 4% either that I don't think that makes sense. So yes, look, I think that those are long-term targets that may be a little low on the 3.8% to 4% side. But we do get a lot of benefit from the security side and that segment does have variability with respect to what happens with cash balances based on risk tolerances in the market. So I think that we definitely shouldn't be modeling a lot of upside from here on those really high NIMs. And I think we kind of outlined what we were thinking about with respect to what could happen with the cash percentages, given the differences between the 11% and 7% and where we are; and so you can see where those ranges are.

And frankly, we don't really have a lot of control or that it really depends on what happens with the market and what views are with respect to those individual advisers what they do with those balances.

[Andrew Liesch, Piper Sandler]

Got it. All right. That's really helpful. I will step back. Thanks, Greg.

[Operator]

Our next question comes from the line of David Feaster with Raymond James.

[David Feaster, Raymond James]

Just I wanted to touch on AAS for a second. And just maybe something you could talk about the competitive landscape. You talked about a pretty good pipeline there. Just curious, I guess, first, whether a volatile or uncertain environment like this, is that conducive for you guys to continue to take market share and expand? And then I guess, could you just help us -- where are we on the road map for the growth there? And I guess, what's on docket in terms of the build-out of your capabilities?

[Greg Garrabrants, President & Chief Executive Officer]

Sure. Those are all really good questions. So with respect to the competitive dynamic, obviously, I think the biggest dynamic going on there is the purchase of TV by Schwab and that conversion, which is going to happen, I believe, towards the end of the 2023 calendar year. And so a lot of the discussion is that folks wanted to be multi-custodial or they are concerned about Schwab's sort of footprint from a competitive standpoint. And so they're looking for alternatives. So I think that there's a real opportunity there and the level of conversations and discussions we have and the enthusiasm is very, very high. And the capabilities of the business are not -- are certainly fairly strong. And so there's not a lot of capabilities that we often run into. There's a few, and I'll talk about those in a minute. But that's -- so that's pretty good. So that's driving it.

I think the question of the switch and the volatility, I think on balance, it's probably countervail to some extent, the otherwise very favorable dynamic with respect to the acquisition of TV because I think advisers really don't want to approach sometimes for a repapering when they've got to talk to their clients about how far the markets down or whatnot. But I don't think that, that's really something that anywhere near outweighs the otherwise favorable dynamic. With respect to the question of road maps, we have a very robust technology road map one element on the backside of the operation is that we have built our own securities core, which actually has been something that has taken a lot of effort, but the potential reward is massive from a standpoint of a $10 million-plus expense that we expect to essentially go to 0 in about 3 years, and we'll start migrating folks off of that next year, and that will reduce the volumes. There's obviously -- I think we've already borne the expenses associated with that, but there's a lot of real benefit from that because there's no incremental cost of transactions and things like that. So it allows us to sort of price everything that we're doing with clients in a way that is helpful and can win more business; so that's ongoing. That's on the back side.

And then on the front side of it, the real integration of UDB at that conference, we presented a tech vision that involved integration of banking into every client that opens their account so that they can eliminate the check processing work associated with having advisers take checks and all of the different elements of this. And universally, we didn't have one adviser tell us that they wouldn't be absolutely happy to just have deposit paperwork coming with the paperwork to move the client over so that every client would get a deposit account and that, that would facilitate the operational complexities that are associated with getting money in and out and all those other sort of things. So the -- we call that the white label UDB component, which is essentially allowing the adviser to be able to interact with our system, and there's a lot of resources being spent on that right now, and that's going well. So that should be rolled out sometime in its first version by June of 2023.

So that's a very exciting vision that the RIAs are very excited about and believe it's really additive to their clients. And we also believe it's additive to the overall banking franchise we have. So there's a lot of really good stuff going on in the capabilities build as we can basically take all of the technology that we have that we've built at Axos with respect to customer service, straight-through processing and really bring that through to the securities firm. The securities firms have gotten more efficient, but they still have both of them clearing and custody, both have a long way to go to be able to meet the sort of standards that we've established for ourselves from an operational excellence perspective at the bank. And it just takes time because some of the movements are really system related.

So yes, I think -- look, the good news is that these client relationships are very sticky. So what that means on the other side is that they take a little bit of time to move. But the market demand for an alternative custodian, I don't think has ever been better right now. I mean there really is incredible excitement across the board about having an alternative provider that also can be responsive because at a certain point, right, it's not -- it's just -- if you're as big as a Schwab, even $1 billion firm kind of as far as how you're going to be serviced, it's going to be in relationship to the overall portfolio that they have. But for us, that's a very important client and they're going to have access to senior leaders and things like that. And so I think that makes a difference.

[David Feaster, Raymond James]

That's great color. And I was hoping maybe you could touch on the specialty CRE market. You talked about higher rates impacting demand a bit. I'm just curious where you're still seeing demand both by product and geography and just your outlook and how to appetite for growth in the specialty CRE segment.

[Greg Garrabrants, President & Chief Executive Officer]

So we're still seeing demand for multifamily construction projects. And I think that aligns well with where our appetite is. Remember, we're in the sub 50% loan-to-cost range with respect to these products with the partners that we're working with, the funds that we're working with. So that, I think, still remains quite robust. I think the question is demand is good now. I think this is really more about our forecast with respect to people are now -- they're going out and doing financings for projects that had been in the pipeline for extended periods of time. And so I think the question really will be more in and around what happens with respect to newer projects as they look at an interest rate and a cap rate environment that has changed significantly from 12 months ago and then look at what they're interested in going forward with. I will say though that frankly, with the securitization markets generally in a state that's lacking dependability that really does tend to benefit banks and other companies with more stable funding sources.

So for example, we had really good growth in our real estate lender finance business. Those loans typically were securitized and because they got much higher advance rates and frankly, better pricing. Some of those loans are ending up now on our lines. And we like that. They're discretionary. We get to look at every loan. But that kind of movement, I think, is going to allow us to continue to have good loan growth. We're also seeing, in certain cases, certain types of loans that just we would kind of not focus on as much due to spreads, maybe asset back lines, things like the straight ABL, things like that, widening out in ways that make them things that we would be more likely to be a part of. So I actually think that the asset side, obviously, I think really from our perspective, we aren't in a position where we want to go out and sort of overrun -- we don't want to go raise capital, right?

So we've grown a little faster in the last couple of quarters, then we will sustainably do just given our ROE, which really has to essentially match asset growth within a range over some reasonable period of time. And so that is really where we're targeting. But I think we feel pretty good given the massive diversity that we have across our asset businesses that we're not going to be in a situation where we're going to be without asset growth. It's -- I think even though certain markets have gone down, the competition has also disappeared, let's say, on a single family, for example, conduit operations that were kind of messing with the credit side of things and messing with pricing of just they've just blown up left and right and are not there anymore.

[David Feaster, Raymond James]

That makes a lot of land. And then just last one for me. You've done a great job proving out your rate sensitivity and driving margin expansion. And you talked about the more floating rate loans than you've ever had. I'm just curious how you think about managing rate sensitivity going forward. Obviously, we're about to get another 75 probably next week, another 75 next month. But just curious whether you're considering locking in some rate sensitivity and how you'd approach that, whether it's through for more fixed rate lending or even potential synthetic opportunities?

[Greg Garrabrants, President & Chief Executive Officer]

Yes. No, I think those are really interesting questions, and we are looking at some of those things. I don't want to kind of make any firm comments right now. I think one element that I would say is that we are not utilizing deposits to go out and make and go out along from a CD perspective. So I think to the extent that we're going through these different elements, we have to make sure they match up, and we don't want to obviously be locking in long-term funding if we don't have long-term assets associated with that. So there's a lot of different opportunities that exist there, and we are looking at those actively. And -- but I don't really have anything further on that right now, specifically.

[David Feaster, Raymond James]

All right. That's fair. All right. Thanks, everybody.

[Greg Garrabrants, President & Chief Executive Officer]

Thank you.

[Operator]

Our next question comes from the line of Michael Perito with KBW.

[Michael Perito, KBW]

We've kind of run through a lot of it. I just had a couple of kind of credit-oriented questions more just kind of talking through some of the book, if you guys don't mind. First, I want to kind of start high level as we look at the ACL today, it's just a hair over 1%. The book -- the mix of the loan book has changed quite a bit over the last few years to, right? I mean, jumbo today is only maybe 26-ish percent versus almost 53 years ago. And obviously, we went to the pandemic. And I'm just curious how you guys kind of think about that level of reserve for the mix of business we have today? And maybe you could we've seen some other banks increase their qualitative assumptions around the economy and their ACL to this quarter. I was wondering if you could quickly run through what you guys are assuming there today generally.

[Derrick Walsh]

Yes, certainly. And I'll also refer you to the supplement that was filed with the SEC earlier. Slide 4 gives a good 3 and 4, give a good summary of the additions we've made to the allowance 8.8% during this current quarter. And where we sit, as you referenced, the 1%, just above 1% of total loans. But obviously, that's -- when you break that apart amongst the things like single-family warehouse, single-family mortgage, multifamily and commercial mortgage where we have LTVs that are at 57% and 52% on a weighted average across those portfolios, respectively, that you're going to see a lower percentage of ACL of 45 bps and 49 bps, respectively. But as you look at the commercial real estate, which contains some of the construction loans, the C&I non-real estate that you're going to be well above 1% there. And as you go to the auto and consumer, you're well above 2%.

So it's really a dynamic across the when you look at each slice of the loan portfolio. But the one theme across the entire loan portfolio, as a reminder, is the low loan-to-value approach, the structured AB, no-no type of approach that brings us to extremely low sub-50 in many of the commercial products, LTV, LTC ratio. And so that's considered as part of that allowance analysis and when we stress the portfolio as part of that process that really comes into plant takes some extreme -- some pretty significant stress to result in losses given those loan -- those low collateral values.

[Greg Garrabrants, President & Chief Executive Officer]

Yes. I think that if you looked at the average as we -- typically, what we're doing is we're competing with a bank and we're competing with a partner. And if we had loan-to-value ratios like those banks, our matrices and our loan loss models would result in significantly higher loan loss levels as well. So if we were taking 70% or 65% loan-to-value risks on construction lending or something that we would have a lot higher loss rates in there. We're just not loan loss provisions against that. We're just not really doing that. But I think if you look at it and break it down, you're in the 150s and above range with respect to those portfolios essentially zero losses in history with none foreseeable. So obviously, these things are always forward-looking. And so that you have to -- but we've been at this a long time.

Obviously, COVID kind of went away quickly. It's been a while since we've had a long-term deep recession. But I mean when you look at these products, I mean there our loans are breakeven at 10, 11, 12 cap rate type valuation. So it's a long way to go before you're starting to get into where we are.

[Michael Perito, KBW]

Got it. And that kind of -- that's helpful. And kind of dovetails into my second question here, which is a follow-up to an earlier question. But just if we look at in the supplemental slide, I guess it's like 1 technically, the loan breakout. Most of the growth this quarter was CRE specialty and lender finance. I was wondering if you could just remind us, I know you discussed the LTVs, but can you remind us a little bit more about how loans in those buckets are structured? And what the typical collateral like physically looks like? Is it developed properties? Is it sites? Is it a mix? Just would love a little refresh there as those buckets kind of continue to grow here at a nice clip.

[Greg Garrabrants, President & Chief Executive Officer]

Yes, sure. So the commercial specialty real estate business consists of several types of products. So one would be completed buildings that are either cash flowing or involved in some sort of repositioning or sellout. So completed condominiums, for example, that are being involved in the sellout. The structure would be, typically, there would be a total debt stack of 70% of cost with around 65% to 70% of that stack taken by us with a fund that would be solely subordinate to us, that fund may have certain levels of recourse with respect to that matter, and they would be required to cure any deficiencies, whether interest or any kind of principal and interest efficiencies, any kind of cost efficiencies if the borrower was unable to do so and have to do so quickly. And -- if they don't, they would essentially forfeit their loan to us. They could turn over that piece to us if they had to. But so if that would involve is essentially a 50% plus a loss of -- on a loan-to-cost basis, and that is also -- would be also capped at the estimated value associated with the property as well on a stressed basis.

So that's kind of the way these loans look that each of them have a strong partner that bears the risk of loss. And even in the time frame, the COVA time frames and whatnot, it's been extremely rare that even the partner has any loss whatsoever. Every now and then, if there's some stress, they may not get a full default interest rate, they may waive some of the default interest of a borrower kind of waivers and that has to get back on track. But yes, you really do have -- you have -- what's great about the structures that you have partners that you can spend time with collaboratively talking about things. And they generally also we look at their liquidity very carefully. And so their funds often have very significant liquidity. So they're able to kind of work on these projects to the extent there's any issues that occur. And there really haven't been many, but to the extent there are there, it's good to have the structure there. So that's really what that looks like.

And we actually think that's one of the -- we think that's a lot, frankly, safer than straight multifamily right now because even if you're at low levels on multifamily on loan to value, I think part of the issue is that cap rates have been so low for so long and rents have increased for so long that some of these individual borrowers may have extended themselves a little bit at low cap rates. And so we feel good about that too, but it doesn't have the protection associated with having these large institutional sponsor partners. And those loans, by the way, the Series specialty loans often have really, really strong underlying sponsors. So those sponsors also have significant liquidity. And obviously, they have to be ready to forfeit an interest, significant economic interest in the property as well. So that's really why you end up with a sort of no loss portfolio there.

[Michael Perito, KBW]

Thanks. Great, I appreciate you spending some time on that.

[Greg Garrabrants, President & Chief Executive Officer]

Thanks, Mike.

[Operator]

Our next question comes Edward Hemmelgarn with Shaker Investments.

[Edward Hemmelgarn, Shaker Investments]

It's just a couple of things. Could you talk a little bit more about the legal judgment. I was a little surprised by that. I'm just trying to understand it a little bit better. And then lastly, the other thing is just about how -- I know you're running into some limits now. without raising additional capital, you can grow to as you mentioned at your ROA. But do you have any cushion left in the balance sheet that you can kind of go over that

[Greg Garrabrants, President & Chief Executive Officer]

Well, so I'll take the last question first. Yes, I mean, obviously, there is some cushion. We still -- we've raised capital, we still have excess capital in a number of respects, depending upon the nature of the risk weighting of certain assets, the 50% and 100%. So it's not -- there's obviously excess capital right now, but the ability to use that in a systemic way to grow above our return on equity, this isn't something that I think investors should count on. So yes, of course, there'll be quarters where we will outgrow that return on equity, but they won't be -- it won't systemically be above that at this time. And I think that it makes sense. Look, I think it's a good growth rate, and I think it's okay. And obviously, it's -- we do have excess capital right now and it kind of depends exactly on how the lung mix is between the 50% and 100% risk-weighted assets.

And then with respect to the first question, I think I'd just say, in general, that we've had some of these things -- some of the legal matters sitting out for a long time. There was that the years ago class action suit related to that kind of stuff and that ultimately got settled within the insurance limits. There's really no other substantive business disputes we have. This one kind of arose out of a pretty idiosyncratic element where essentially the complaint was mostly against EPIC. And I think there was -- there was -- the complaint was against the seller of the business, and we ended up getting caught up in that complaint through a variety of complex machinations. And that we don't think that, that is an appropriate outcome. But nevertheless, we are accruing for it. And -- but I think this ends that particular matter, at least with respect to our exposure on it in most substantive ways. I can't ever say that with absolute certainty in the sense that, I mean, somebody can always position to add down just from the judge or something, but that's the likelihood of that is extraordinarily small.

And so yes, so we'll -- we're looking at appeal options with respect to that matter. And -- but I think that in general, I would say that some of the things that with respect to some of those legal aspects of some of that stuff that's been -- we've had to go through over the last couple of years. I think we're kind of moving through most of that. And obviously, you can't forecast the future. But I think most of that stuff is behind us, and we can look forward to focusing on running the business.

[Edward Hemmelgarn, Shaker Investments]

Okay, that helps.

[Operator]

We have reached the end of the question-and-answer session. I'll now turn the call back over to Johnny Lai for closing remarks.

[Johnny Lai, Corporate Development & Investor Relations]

Great. Thanks, everyone, for joining, and we will talk to you next quarter.

[Greg Garrabrants, President & Chief Executive Officer]

Thank you.

[Operator]

This concludes today's conference. And you may disconnect your lines at this time. Thank you for your participation.