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Axos Financial Inc
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Welcome to the BofI Fourth Quarter 2018 earnings call. [Operator Instructions] As a reminder, this conference is being recorded.
It is now my pleasure to introduce your host, Johnny Lai. Thank you. You may begin.
Thanks, Adam. Good afternoon, everyone. Thanks for your interest in BofI. Joining us today for the BofI Holding Inc. Fourth Quarter 2018 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 3 and 12 months ended June 30 and they 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 are 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 the 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 bofiholding.com 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 Greg for his prepared remarks.
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 Fourth Quarter and Fiscal Year 2018 ended June 30, 2018. I thank you for your interest in BofI Holding and BofI Federal Bank.
BofI announced record income of $152.4 million for the fiscal year ended June 30, 2018, up 13.1% over the $134.7 million earned for the fiscal year ended June 30, 2017. BofI's return on average equity for fiscal 2018 was 17.05% and the company's efficiency ratio was 39.58%, up slightly from a year ago but still best-in-class.
Fiscal year 2018 earnings per share increased 14% to $2.36 per diluted share compared to $2.07 per diluted share in the fiscal year of 2017. Net income for BofI's fourth quarter ended June 30, 2018, was $37.1 million, up 14% when compared to the $32.5 million earned in the fourth quarter ended June 30, 2017.
Earnings attributable to BofI's common stockholders were $37 million or $0.58 per diluted share for the quarter ended June 30, 2018 compared to $0.50 per diluted share for the quarter ended June 30, 2017 and $0.80 per diluted share for the linked quarter ended March 31, 2018, in which we recognized the vast majority of our tax-related revenue.
Other highlights of the 2018 fiscal year in the fourth quarter include: net loans and leases increased by $367.6 million in the fourth quarter, representing 4.6% growth linked-quarter and an annualized growth rate of 18.4%. For the full year ended June 30, 2018, net loss and leases grew by $1.1 billion, representing 14% growth year-over-year. Total assets reached $9.5 billion at June 30, 2018, up $1 billion or 12.2% when compared with June 30, 2017.
For the fiscal year ended June 30, 2018, our net interest margin was 4.11%, up 16 basis points from 3.95% in the prior fiscal year. Net interest margin was 3.71% for the quarter ended June 30, 2018, down 9 basis points from 3.8% in the fourth quarter of fiscal 2017.
Excluding average balances associated with short-term H&R Block lending products and excess H&R Block liquidity, net interest margin was 3.8% in the fourth quarter of 2018, within our annual target of 3.8% to 4.0%, and slightly down from 3.84% in the prior quarter.
Loan yields increased 41 basis points year-over-year. Excluding the impact of H&R Block lending products, loan yields increased 21 basis points year-over-year to 5.39%, reflecting higher yields on newly originated single-family Jumbo mortgages and C&I loans, which carry a higher yield than our overall loan yield.
Noninterest income increased by 25.4% in the fourth quarter to $17 million. Growth in noninterest income was boosted by contributions in the trustee and fiduciary services acquisition and higher gain on sale income. We continue to invest in growing our commercial banking verticals, which has helped diversify our noninterest income over time. Return on equity was 17.05% for the fiscal year 2018 compared to 17.78% for fiscal 2017. Our best-in-class return on equity is supported by our efficient scalable business model, disciplined capital allocation and diversified mix of spread and fee-based businesses. Our credit quality remains strong. The bank had 19 basis points of net charge-offs in fiscal 2018 and ended the year with only 37 basis points in nonperforming loans to total loans. Of the 19 basis points of net charge-offs in the fourth quarter, 17 basis points or 89% was attributable to losses for Refund Advance loans we originated in the third quarter of 2018.
Our allowance for loan-loss represents 157.4% coverage of our nonperforming loans. Our effective tax rate was 26.4% in the quarter ended June 30, 2018, compared to 41.8% in the comparable quarter a year ago. Our tax rate in the fourth quarter benefited from the federal rate reductions under the Tax Cuts and Jobs Act of 2017 and tax credits received during fiscal 2018. Our tax rate for the fiscal year 2018 was 36.42%. We expect our GAAP tax rate to be in the 27% to 28% range in our first fiscal quarter of 2019, which starts on July 1, 2018, and remain roughly in this range for the 2019 fiscal year.
We generated strong loan growth in the fourth quarter, led by robust loan originations in Jumbo single-family mortgages, multifamily and C&I lending. Our multiyear initiative to diversify our lending are paying off, as reflected in ending loan balances increasing $368 million in the fourth quarter and $1.06 billion in fiscal 2018.
We originated approximately $1.65 billion of gross loans in the fourth quarter, up 15.2% year-over-year. Originations for investment increased 19.3% year-over-year to $1.4 billion.
Ending loan balances increased by 4.6% year-over-year, representing an 18.4% annualized growth rate. Our loan production for the fourth quarter ended June 30, 2018 consisted of: $138 million of single-family agency eligible gain on sale production, $482 million of single-family Jumbo portfolio production, $157 million of multifamily and other commercial real estate portfolio production, $605 million of C&I production, resulting in $103 million of net C&I loan growth and $39 million of consumer unsecured in auto production. For the fourth fiscal quarter's originations, the average FICO for single-family agency eligible production was 752, with an average loan-to-value ratio of 69.3%.
The average FICO for the single-family Jumbo production was 727, with an average loan-to-value ratio of 60.3%. The average loan-to-value ratio of the originated multifamily loans was 53.0% and the debt service coverage was 1.34%. The average loan-to-value ratio of the originated small balance commercial real estate loans was 48.3% and the debt service coverage was 1.58%. The average FICO of the auto production was 773. At June 30, 2018, the weighted average loan-to-value of our entire portfolio of real estate loans was 55%. These loan-to-value ratios use origination data appraisals over current amortized balances.
As of June 30, 2018, 62% of our single-family mortgages have loan-to-value ratios at or below 60%, 32% have loan-to-value ratios between 61% and 70%, 3% have loan-to-value ratios between 71% and 75% and approximately 1% between 75% and 80% and approximately 2% greater than 80% loan-to-value.
The loan-to-value is calculated using the current principal balance divided by the original appraisal value of the property securing the loan. In a market where home prices are increasing, the loan-to-value ratios will generally understate the level of collateral protection available on our loans.
We have an established track record of strong credit performance in Jumbo single-family mortgage lending with lifetime credit losses in our originated single-family loan portfolio of 3 basis points of loans originated.
Ending balances for our multifamily loan portfolio increased by approximately $69 million or 18.72% annualized to $1.5 billion at June 30, 2018, representing 18% of our total loan book.
The weighted average loan-to-value of our multifamily loan book is 53% based on the appraised value at the time of origination. Approximately 65% of our multifamily loans are under 60% loan-to-value, 28% are between 60% and 70%, and 2% are between 70% and 75%, and less than 1% of our multifamily loans have a loan-to-value ratio above 75%.
The lifetime credit losses in our originated multifamily portfolio are less than 1 basis point of loans originated over the 17 years we've originated multifamily loans.
Our C&I lending businesses has had another strong quarter, with broad-based strength in originations in our single-family, multifamily, lender finance and commercial real estate specialty lending groups. Our experienced bankers continue to expand relationships with established sponsors, which enable us to underwrite high-quality projects in attractive markets with conservative structure and low leverage.
Since the majority of our C&I loans are floating-rate with existing and new loans priced at or above their floors, continued growth in our C&I lending portfolio will help offset future increases in funding costs.
We've not experienced any losses in our C&I lending, leasing and specialty real estate groups since we entered these businesses, despite strong growth in these product areas.
Loan demand remained strong across most of our lending categories, with a loan pipeline of approximately $1.2 billion, consisting of $508 million of single-family Jumbo loans, $170 million of single-family agency mortgages, $108 million of income property loans and $430 million of C&I loans.
With C&I lending becoming a bigger percentage of our loan originations, our average and ending loan balances will fluctuate a bit more from quarter-to-quarter, depending on the timing of new originations, fundings and prepayments.
Switching to funding. Total deposits increased $1.1 billion or 15.7% year-over-year, with growth across consumer and business deposit categories.
At June 30, 2018, approximately 39% of our deposit balances were business and consumer checking, 22% money market accounts, 3% IRA accounts, 6% savings accounts and 5% prepaid accounts.
Checking and savings deposits represented 75% of total deposits at June 30, 2018. We signed an agreement last week to acquire approximately $3 billion of deposits from Nationwide Bank. These deposits comprised of $2 billion of retail CDs and $1 billion of checking, savings and money market deposits adds approximately 100,000 new customers to our bank. The deposits we're acquiring from Nationwide Bank have an overall cost of funds of 136 basis points, lower than our 173 basis points cost of funds for the quarter ended June 30, 2018.
Once we close the transaction and transition the Nationwide deposits, we will -- which we expect to occur in the fourth quarter of 2018 -- calendar 2018, after receiving required regulatory approvals, we will use these lower cost deposits to replace higher cost borrowings and fundings as well as to fund loan growth in our fiscal second quarter of 2019.
Since the overwhelming majority of the acquired deposits will be used to replace current and future funding, we did not anticipate a meaningful increase in our balance sheet as a result of this transaction. Andy will later provide more detail regarding the forecasted net income and balance sheet impacts from the Nationwide deposit acquisition in his prepared remarks. We're excited about adding almost 100,000 new Nationwide Bank customers, including current and former Nationwide associates and policyholders to BofI when the transaction closes.
With our prior success transitioning Principal Bank and H&R Block Bank's deposit customers to our bank, we anticipate a smooth conversion.
Going forward, we see tremendous opportunity to provide a broad range of consumer, small business commercial banking and lending products to Nationwide Banks's customers.
I'd like to thank the Nationwide team for their professionalism and hard work in consummating the transaction. We believe Nationwide selected us as a transaction partner who would thoughtfully service their employees and clients because of the investment we have made in our digital banking platform, our omnichannel customer experience and the breadth of our consumer deposit and loan products [ set ]. The strategic commitment to being a best-in-class digital bank will allow us to provide excellent service to Nationwide's employees and clients after the closing of the transaction.
The acquisition of the trustee and fiduciary service business from Epiq in April of this year added a new specialty deposit vertical that will, over time, provide additional low-cost core deposits to the bank.
The existing $1 billion of Chapter 7 and non-chapter 7 deposits currently held at 7 bank partners have contractual wind down periods ranging from 9 to 24 months. While we do not currently enjoy the full benefits of having these deposits at our bank, we benefit from rising rates through fees paid to us by partner banks rather than the lower funding costs when these deposits are transitioned to BofI.
Our integration plans with respect to capturing those deposits in our trustee and fiduciary service business remain on track.
The integration of our banking platform into the Epiq software has been completed. And we are now just beginning in a methodical manner the board trustees that are utilizing the software on the bank's platform. We're excited about the long-term opportunities to grow this business through market share gains, a cyclical rebound in chapter 7 bankruptcy filings and by entering new deposit verticals with the software.
We intend to utilize the approximately $4 billion of deposits from these 2 acquisitions to improve the quality of the bank's deposit base and lower our funding costs, rather than simply accelerate loan growth beyond our target mid-teens growth rate in the coming year. Additionally, we continue to focus on increasing our non-interest bearing and lower cost deposits as well as generating fee income from our efforts in treasury management.
The personnel, systems, software, marketing and third-party costs associated with our existing treasury management business has resulted in a higher noninterest expense this year. And we plan additional investment in our treasury management business in this coming year.
We have seen early results from this initiative with an increase in business noninterest-bearing deposits of $227 million, or -- up 62.9% and business demand deposits up $439 million or 25% year-over-year.
Our balance sheet sensitivity and a parallel up-shock scenario with 100 basis point instant parallel increase results in our net income -- interest income increasing by 2.8% in the first 12 months and 0.63% in the second 12 months. However, these numbers assume no balance sheet growth, nor potential changes in our loan or funding mix.
Rate shocks that result in flatter yield curves, such as those we had experienced this last year, are generally detrimental to our net interest income relative to parallel shocks. We model with a variety of deposit beta assumptions that range from no sensitivity in our prepaid deposits to 100% for our time deposits.
With increased competition across most consumer online direct deposit channels, which represent approximately 25% of our total deposits at June 30, 2018, we are focused on growing commercial, small business and specialty deposit verticals that are less rate-sensitive and more scalable due to average higher account balances.
We have generally been able to raise our single-family mortgage rates. Last year, we raised our single-family mortgage rates by 37 basis points and our multifamily rates by around 55 basis points. We have maintained or increased loan pipelines despite these rate increases.
Obviously these rate increases must flow through the portfolio, therefore the rate at which our loan yields increase depends upon average balances, prepayments and origination rates.
Our C&I specialty real estate and warehouse funding lending rates are generally floating.
Our deposit betas have trended according to our expectations. Since June 2017, the Federal Reserve has raised short-term rates by 75 basis points. And our total cost of deposits, including noninterest bearing and interest-bearing deposits, have increased by 29 basis points, while our interest-bearing cost of funds has increased by 39 basis points with a 10 basis point difference representing the growth in the mix of our noninterest-bearing deposits.
Our comprehensive rebranding initiative across our entire client-facing brands and corporate entities is proceeding nicely. The evolution of our bank and our business to a tech-enabled software and services model provides us with an exciting and timely opportunity to redefine our next phase of growth. We have a series of targeted branding and marketing initiatives planned for the 3 or 4 quarters following the launch of our new brand. We expect to re-brand by the end of calendar 2018 and launch our marketing campaigns in early calendar of 2019. We completed the successful first quarter of operations since we acquired the trustee and judiciary services business from Epiq. We made good progress integrating the various support functions and have a detailed plan to complete our post-merger integration over the next 3 to 6 months.
We're committed to serving chapter 7 and non-chapter 7 trustees and fiduciaries nationwide. And we look forward to meeting clients and prospects next month at the National Association of Bankruptcy Trustees Conference to discuss the tremendous service and value proposition that our collective banking and trustees services team offers.
We recently renewed our agreement with H&R Block to be the exclusive provider of interest-free Refund Advance loans for the 2019 tax season. The renewal reflects our strong commitment to one of our long-term partners, H&R Block, and another example of our ability to help nonbank partners leverage data and distribution channels to deepen their relationships with their customers.
We completed a successful 2018 tax season, with a total origination volume of Refund Advance loans increased by over 50%, while keeping loss rates within estimated levels. We're excited to apply our learnings to help H&R Block and their clients in the upcoming tax season.
When we purchased H&R Block, we agreed to certain capital and other conditions with the Office of the Comptroller of the Currency. This quarter, after 3 successful years of operating the H&R Block programs, the OCC formally released the conditions that we had agreed to as a component of the acquisition.
I'd like to thank our team members for helping us achieve another record year, with strong credit and regulatory results and exemplary service to our clients and business partners. We took on difficult challenges this year, including the successful launch of our Refund Advance loan product and the development and launch of our new consumer banking platform.
The consistency of profitability and growth and strong credit we've been able to achieve over the past decade is a function of the strength of our vision and strategy, the quality of our people and the process framework we implement.
Our capital and credit metrics, with a Tier 1 leverage to adjusted average output ratio of 8.8% for the bank and 9.45% for the holding company at June 30, 2018, affords us with the flexibility to invest in strategic initiatives, opportunistic M&A, dividends or share repurchases.
We are committed to making prudent capital allocation decisions to maximize the return for our shareholders. With our strong and growing capital base and highly profitable business model, we remain disciplined from a credit perspective and opportunistic in our capital deployment, whether it's for organic growth, dividend, buybacks or M&A. Our high profitably and excess capital position allowed us the ability to finance our bankruptcy services acquisition that we closed in April with available cash and returned capital to shareholders through buybacks, which we did in the second and third quarter of fiscal 2018.
On our third quarter 2018 earnings call, we stated that we had approximately $144 million of excess capital at the bank and the holding company combined December 31, 2017, if we choose to reduce our Tier 1 leverage ratio to 9%.
After funding our recent Epiq acquisition and running of the majority of the tax-related excess liquidity, we ended our fiscal 2018 with a Tier 1 leverage ratio of 9.45% at the holding company and 8.88% at the bank, with the increased difference this quarter between the bank and the holding company, resulting from an approval by the Federal Reserve for a larger than usual dividend of $65 million for the holding company.
We will continue to have excess capital, even after funding the anticipated premium on the checking and savings accounts we are acquiring from Nationwide Bank.
We expect the full step-down in our tax rate on a go-forward basis to be 27% to 28% and this will provide additional tailwind to our return on equity and excess capital. Our priorities for deployment of excess capital will remain focused on funding growth in our existing business, accretive M&A such as the Epiq and Nationwide transactions, a potential dividend or opportunistic share buybacks.
Now I'll turn the call over to Andy, who will provide additional details on our financial results.
Thanks, Greg. Our 8-K was filed with the SEC today. It is available online through EDGAR or through our website at bofiholding.com. In addition to our press release, the 8-K includes additional unaudited financial schedules.
I will highlight a few areas rather than go through every individual line item. Please refer to the press release or 8-K for additional details.
Net income for the year ended June 30, 2018, was a record $152.4 million, up $17.7 million from fiscal 2017. The increase in net income for the fiscal year was the result of a $55.3 million year-over-year increase in net interest income, a $2.8 million increase in noninterest income and a decrease in the effective income tax rate from 42% to 36%. Partially offsetting the revenue growth for this fiscal year were increases in operating expenses and loan loss provisions of $36.3 million and $14.7 million, respectively. Net income for the fourth quarter ended June 30, 2018, was $37.1 million, up 14.1% from the $32.5 million of net income for the fourth quarter of fiscal 2017. The increase in net income for the fiscal year was a result of an $8.5 million year-over-year increase in net interest income, a $3.4 million increase in noninterest income and a decrease in the effective tax rate from 41.8% to 26.4%, Partially offsetting the revenue growth for the fourth quarter were increases in operating expenses and loan loss provisions of $13.7 million and $3.7 million, respectively. I will focus my discussion on Nationwide Bank's deposit transaction, loan quality, income tax rates and operating cost efficiency. As Greg mentioned, we signed an agreement with Nationwide Bank to acquire approximately $3 billion in deposits. We expect to close the acquisition in November of 2018 with about $2.5 billion in deposit balances after expected attrition of maturing time deposits. Between June 30, 2018, and the November 2018 closing date, we expect our own short-term broker deposit balances of about $800 million to mature and about $1 billion of municipal and other high-cost deposits to run off, allowing us to swap about $1.8 billion in our deposits with Nationwide deposits at the closing. We also expect to reduce our borrowings by $700 million at closing. Therefore, we expect no balance sheet growth at December 31, 2018, resulting from the Nationwide transaction and after that date, we expect to be saving about 1% in funding costs on the $2.5 billion or about $25 million per year. Until that time, we are guiding down slightly on our net interest margin from a low of 3.8% to a low of 3.75%. After December 31, 2018, we expect to guide back up to a normal range of 3.8% to 3.9% without the H&R Block loan products. Also to help facilitate the deposit swap, we may need to temporarily fund with borrowings such that our loan-to-deposit ratio in September of 2018 may be higher than normal. My second point is that credit quality remains strong as nonperforming loans to total loans was 37 basis points at June 30, 2018, down from 38 basis points at June 30, 2017.
Consistent with prior year-ends, all of our short-term loans to consumers and small businesses associated with the H&R Block income tax season are at a 0 balance either having been fully paid, sold or in some instances, fully charged off by June 30, the end of our fiscal year. So our level of nonperforming loans to total loans at June 30 reflects only our long-term loan products and compares favorably with banking industry averages. In analyzing our loan loss provisions and our net charge-off activity, I will separate the long-term loan products from the tax season loan products. For the long-term loan products for the year ended June 30, 2018, loan loss provisions were $9.9 million compared to $5.9 million for fiscal 2017 and net charge-offs for the fiscal year 2018 were $1.5 million compared to $0.9 million for fiscal 2017. Of the total loan loss provision increase for 2018 fiscal year of $14.7 million, only $3.9 million of the loan loss provision increase related to our long-term loans and that increase is primarily the result of net loan growth in our single-family, multifamily and C&I loan categories. Our net charge-offs for the year related to long-term loans remains low, representing only 2 basis points on average long-term balances for fiscal year 2018 and 1 basis point on average balances for fiscal 2017. The remainder of the increase in the loan loss provision for the year of $10.8 million is the result of an increase in the volume of our short-term tax season loans, particularly the H&R Block Refund Advance or RA, which had increased funding volume from $280 million in fiscal 2017 to $1,080,000,000 in fiscal 2018 and caused an expected increase in the related loan loss provision from $4.4 million in fiscal 2017 to $14 million in fiscal '18. Charge-offs for tax season loan products for each fiscal year generally match loan loss provisions for the fiscal year, because as noted early, no book balance on the tax season loan is carried into the next fiscal year. For the fourth quarter of fiscal 2018 compared to fourth quarter fiscal 2017, the total loan loss provision increased by $3.7 million, of which $2 million related to long-term loans and $1.7 million related to tax season loans. The increase in provision for long-term loans is primarily due to the increased net growth in the C&I loan category in fiscal 2018 compared to fiscal 2017, and due to fewer recoveries in fiscal 2018 compared to fiscal 2017. Net charge-offs totaled $14.5 million for the fourth quarter of fiscal 2018 compared to $3.5 million for fiscal 2017, an increase of $11 million, which was all generally related to the H&R Block products, particularly the increased volume in the RA, which was provisioned in the third quarter at 1.3% of total RA fundings and any uncollected RAs were charged off in the fourth quarter at the same rate, right in line with our third quarter estimate. As Greg noted earlier, we renewed our contract to be the exclusive provider of H&R Block's RA products for the 2019 tax season. With regard to income tax rates, our effective tax rate for the fourth quarter of fiscal 2018 was 26.4%, lower than expected because of state and federal tax credits and share-based compensation, but not much lower than our expected tax rate in fiscal 2019, which should range between 27% to 28%. As a reminder, since we have a June 30 fiscal year end, our tax benefit from the Tax Act was phased in during fiscal 2018 and as a result, our effective tax rate for fiscal 2018 was 36%. Using our pretax income from fiscal 2018, the tax savings between the 36% rate and the 27% expected rate would have been $22 million. The expected savings from our income tax rate reduction, the Nationwide transaction and the transfer of our note cost funding from the Epiq transaction will be significant, but will mostly impact the second half of fiscal 2019. In the short term, our efficiency ratio, which was 47.75% for the quarter ended June 30, 2018, up from 39% for the quarter ended June 30, 2017, and up from 32% for the quarter ended March 31, '18 reflects additional costs supporting the changes expected to happen in the second half of 2019. The efficiency ratio increased in the fourth quarter compared to the third quarter primarily due to seasonal declines in noninterest income, while our mature business remained highly efficient and scalable, our efficiency ratio was negatively impacted by a few items. First, this was the first quarter that included results, all the results of all the services associated with trustee and fiduciary services from Epiq. This addition added 193 basis points to the efficiency ratio in the quarter ended June 30, 2018. As more deposits move from partner banks to our balance sheet, the efficiency ratio for this business will improve. Assuming we add the $1 billion in deposits from Epiq, our efficiency ratio would have dropped by approximately 196 basis points in the fourth quarter. Another factor that contributed to an increase in our efficiency ratio this quarter was noncash noninterest expense related to RSUs for our employees, including our CEO and staff. Similarly, with respect to the next 2 quarters, forward-looking efficiency ratio will be impacted by various factors, including, but not limited to the timing of the convergence of the deposits on our Epiq acquisition of the bankruptcy services division, our strong expected push into commercial banking, led by planned aggressive hiring in treasury management businesses for the next year, our rebranding initiative, the sunsetting of duplicative online banking systems and the placement of service in-house for development software platforms, our executive compensation expense, including the impact of new executives and the increased compensation due under our employment agreements, particularly with respect to our Chief Executive Officer who was compensated based upon a 61.5% outperformance of the company's share price relative to the total return of the community bank index. Over the next couple of quarters, we will need to increase staff and operations, our call centers in marketing to accommodate the significant increase in customers that we will receive from Nationwide and to service the Epiq trustees that will be converting to our banking platform. We will incur these expenses prior to closing the transaction and receiving the benefits of the deposits. While our core businesses will continue to operate at an efficiency ratio of 40% to 41% outside the March quarter, when significant fee income from the tax products will drive our efficiency well below 40%, the investments we're making and the impacts of the recent acquisitions will add an additional 300 to 400 basis points to our efficiency ratio for the next few quarters. Once we realize the full benefit of transitioning Epiq's deposits to our bank and replacing higher cost funding with the Nationwide bank deposits, we will likely see a normalization of our efficiency ratio. Shifting now to the balance sheet. For the fiscal year, our balance sheet increased $1 billion to $9.5 billion as of June 30, 2018, up from $8.5 billion at June 30, '17. The loan portfolio increased $1.1 billion on a net basis, primarily from portfolio loan originations of $5.9 billion. Investment securities decreased $92 million primarily due to sales and principal repayments.
Total liabilities increased $911 million to $8.6 billion at June 30, 2018, up from $7.7 billion at June 30, 2017. The increase in total liabilities represented -- resulted primarily from growth in deposits of $1.1 billion, partially offset by a decrease in FHLB borrowings of $183 million. Stockholders' equity increased by $126 million or 15% to $960 million at June 30, 2018, up from $834 million at June 30, '17. The increase was primarily the result of our net income for the 12 months ended June 30, 2018, of $152.4 million and stock-based expense of $20 million. Finally, the bank is very well-positioned from a capital perspective. The Tier 1 capital was 9.45% for the holding company and 8.88% for the bank. The holding company had $93 million in cash available at the end of the quarter. With that, I'll turn the call back over to Johnny.
Thanks, Andy. Adam, we're ready to take questions.
[Operator Instructions] Our first question comes from the line of Austin Nicholas from Stephens.
I guess, just on the Nationwide deal, could you -- are you able to disclose the deposit premium that was paid? Or any color into the payment for that, the deposits?
Yes, the agreement was filed and it has the deposit premium in there. The deposit premium is 2% of the checking and savings accounts balances at the time of the closing. So on -- you can do the math, on the roughly $1 billion. And it's in the filing. It's in the agreement.
And then maybe just on the net interest margin, was there any positive impact at all from the H&R Block loan products in that $380 million number? Or is that excluding the liquidity but also excluding any lingering loan product? I know that this quarter is generally relatively clean.
Yes, it's very, very, very small. There is a small amount of balance that is taken out at a higher rate, but to your point, it's not impactful.
But it is a clean number.
Yes, it is. It's apples-to-apples so it does exclude that small balance.
And then I guess just on the efficiency ratio guidance of 300 to 400 basis points for the next couple of quarters, is it correct to assume that, that is incremental to the 40% to 41% core business that you guided to?
Yes.
And then I guess on the commentary on normalization after the businesses are built up and the deposits start to come over from both Epiq and Nationwide, is the normalization, would that still go back down to that 40% ratio? Is that the way we should think about it, as these businesses mature?
Yes. That is how we are thinking about it, as we grow.
And we have to -- obviously, we have some plans to accelerate the timing on getting the Epiq deposits over. The Nationwide deposits are different. There could be run-off associated with them. So there is always some variation moving, but in general, I think that's a good framework.
Understood. And then I guess just the timing of the Epiq deposits, the $1 billion, can you maybe give us some color on any changes in the expectations for windows -- that billion is fully brought over to both these balance sheets? Is it really as we look out to early calendar 2020? Or to your point, is there opportunity to accelerate that full ramp in calendar -- full year calendar 2019?
I think there is opportunity to accelerate it. That's on an individual basis with respect to each individual trustee, and we are looking to do that. It's, I think, that we have some early indications that there will be opportunities. How the quantity of those opportunities relative to the timing associated with the actual legal end days of the partnership agreements with the banks is indeterminate right now.
Understood. And then I guess just a more general question relating to the use of capital and any kind of acquisitions. Can you remind us of what your appetite is for M&A? Obviously, with Nationwide announced, is there other opportunities in the market that you see for further funding transactions?
Yes, there is. [Audio Gap] And those -- I think there is -- I think there's -- I think there's -- with respect to those opportunities, I think Nationwide was the largest one. There are other opportunities. When we look at -- when we think about something like efficiency ratio, I think it's important to remember, clearly it's an important metric and we are very focused on our cost efficiency as part of our model. As we look at fee-based businesses, however, I think few people will can say, well, a fee-based business is probably capital-efficient, it has a 60% efficiency ratio and is synergistic with a broad customer base, would be a bad business to have. So really ultimately efficient ratio is a very crude measurement that really is attempting to get to something more important, which is a return on capital. So to the extent that we look at fee-based businesses, that's something that obviously can change efficiency guidance, given the nature of the capital efficiency of those businesses. And that's partially what's happening with Epiq right now, that the conversion of it from a fee-based business, where it takes no capital because the deposits are off-balance sheet to a point where the deposits are on-balance sheet changes the efficiency ratio. There also happens to be a net benefit to that as well, but the efficiency ratio change is something to consider relating to the capital efficiency of those fee-based businesses.
Our next question come from the line of Michael Perito from KBW.
I had a few things I wanted to hit. I guess, on the Nationwide transaction, I mean, it would seem like even with the kind of funding swap you guys are planning between that and Epiq, you guys will still kind of be through $10 billion at some point in calendar '19, which I think mid-calendar 2020 would be when Durbin would come in. I guess first question is, are you guys at a point where, given that the crossing seems to be of more certainty at this point, to disclose what the potential revenue hit from Durbin would be that we should be considering as we move our models out?
We don't have a number for you right now. There are really a couple of impacts of that. One is our consumer and the other is some of the partnership side and so we don't have an exact number for you right now. But I do think the timing is correct. They will stay under the $10 billion limit in -- until the calendar '19 and then we will cross that $10 billion in calendar 2019.
I guess, presumably, I've always kind of viewed the breakeven point for a more traditional kind of branch community bank to be about $11.5 billion, $12 billion in assets in terms of the Durbin impact. But I always kind of thought that you guys would be a little higher than that just because of the prepaid business and the exposure there. I guess, just a strategic question, was there any thought, I guess, to using the Nationwide deal to kind of more thoroughly move through that barrier? I mean, with the timing of the close, it would still seem like even if you didn't swap out, you would still be able to keep your trailing fourth quarter average sub-$10 billion by calendar-end '19. And it would give you a little bit more scale to offset that. And I guess the reason for the question is I'm trying to think of what the longer-term accretion of the Nationwide transaction is, when you factor in some of these expenses and the eventual impact of Durbin as this will kind of push you over $10 billion?
Yes, I would say that -- so of all the things you said, I'd say that there's a lot in there. I'd say it's inaccurate to say that the Nationwide transaction would push us over $10 billion. I think that you should take essentially the asset growth side of it and that was -- it's somewhat separate than with respect to what we're doing on the depository side, to the extent that we're simply working on continuing improving our deposit base and lowering our cost of funds. So with respect to that, we -- given the current platform we have for asset growth, where we are, it's not as if we can sort of create an additional $2 billion of assets and capital as a result of having 1 leg of a depository stool, right? So that I think is probably not an approach that we want to do. Obviously, we're at a stage in the cycle where you have be thoughtful about the assets you add to the bank. I think we still have good runway there and we have a runway that's leading us into the mid-teens sort of target for asset growth. Is it possible that as we move through there, that there's opportunities with a very strong deposit base and essentially very little borrowing and that the borrowing capacity, that we will be able to do certain things on the asset side? I think that's certainly possible. I just think that it probably wouldn't be prudent to model those right now. With respect to the impact of Durbin, there's lots of different elements that we are considering with respect to certain elements of those. There are certain products, design changes with respect to certain times of debit reward accounts and things like that, that we're changing. So there is a number of changes that are in flight in order to attempt to minimize the impact of Durbin, which is why it's difficult to come up and just provide a number, because depending upon the success of those initiatives, some which are dependent on having lots of excess liquidity, which we will start to have as we add these acquisitions, we can start to change some of the checking account products as to better accommodate profitability without the interchange benefits.
Just want a little bit more color on the accretion side, the $25 million of saved interest expense, I understand that's an eventual number. It's not necessarily a day 1 number. But you also did mention in the higher near-term efficiency guide that there is some cost related to servicing these customers. I was curious if you could maybe just give us a little bit better of a breakdown of the financials of this transaction? What the expected earnings accretion will be more specifically?
Well, with respect to the amount of personnel that we're going to add to service the Nationwide customers, we have some views on that, but I'm not going to go in and specify those in great detail. The transaction is accretive in the first year based on the premium and that savings. It simply is the case that one of the reasons that we were chosen by Nationwide and why we think we have opportunities to work with them in the future is that we are committed to providing a strong customer experience, and that means just simply that by adding that many customers, we're going to have to scale our operations in a manner that will allow that to occur. That scaling is going to have to happen prior to the transaction because essentially, we are not taking any personnel associated with the bank. So think of it as the deposit premium and then essentially their folks are being absorbed into a broader enterprise and those sort of things. So we're not taking their personnel so we have the staff in order to be able to accommodate that and obviously, that's not insignificant because it's a lot of accounts and we have a high standard of which we want to hold ourselves to from a standpoint of customer service. That's going to cost money. We also have -- there's a conversion expense associated with that, that has to occur as well. So there's just -- ultimately it's -- there is a lot of, obviously it's very positive and I think there's lots of opportunities with Nationwide. I think they are an amazing partner and we have a lot of things we may be able to do with them, but we've got to deliver on a great customer experience for their people.
Okay, but just in terms of the -- I'm not trying to be dense here, but the actually like the earnings accretion expectations, I mean -- what are you guys -- what's the, I mean, there's kind of a lot of assumptions are on our end here. I'm just trying to track down what you guys think the impact of this thing. I mean I understand it will be accretive. But are we talking kind of like 1% to 2% year one, mid-single digits in year 2 like Epiq? Or is it a bit more than that? I mean is there any kind of color that you can provide around your expectations there?
No, we provided the color that we have for you. We've given you a number on the savings, with respect to the interest income or interest expense. And we've also given you color on the efficiency ratio. So I think from there, you will be able to estimate it, I think, in a manner that will be helpful.
Okay. And then just one last quick clarification question. In the press release on the Nationwide transaction, you guys mentioned that the deal was going to be accretive to tangible book value. And I was just curious, I mean it seems like it's cash being paid out. And I understand it's a small purchase price relatively so it's not going to be necessarily very dilutive or anything to tangible book value. But can you just help me walk through the math on how that's going to be accretive to tangible book value on the closing date?
Yes, that's not on the closing date, that's over time.
How do you get accretive on the closing date, if you paid a dollar?
Well, that's the reason for the question. I mean that's what the press release suggested so I just wanted to...
Well, no, it doesn't suggest that it's accretive on day -- it's accretive to book value on day 1. I mean, unless you're acquiring it at a discount or something. But obviously, it's a fantastic deal. We paid a very reasonable premium and that savings with respect to interest expense is less than a year. So it's -- okay, thank you.
Our next question comes from the line of Andrew Liesch from Sandler O'Neill.
Just a quick question here. Fee income related to Epiq, did you guys disclose that? What it was in the quarter?
We did not disclose it.
Can you share what it was?
I think that we've given you an overall number. We're not going to provide that particular number.
Okay. And it sounds like some of this, maybe the balance sheet maneuvering ahead of the closing of the Nationwide deal, moving out some deposits, but also maybe adding some overnight funds, just ahead of September and along with some of these recent rate hikes, and especially the most recent one. Why would you not -- why would we not see more than just 5 basis points of core margin compression this quarter? It just seems like funding costs are rising here and are -- they're poised to rise before the deal closes. So I'm just wondering, why we wouldn't see more than 5 basis points of compression. Or maybe it's on the asset side, are you able to get stronger loan yields? Have you raised your rates on multifamily or Jumbo? Just some clarity around that, please.
I think we have stronger loan yields, we have adjustable rates. I mean, remember even over the entire period of last year with respect to the difference between the non-H&R Block loan yields and deposit rates, we didn't have anywhere near a 5% compression -- a 5 basis point compression in the quarter. So obviously, when including H&R Block, we had an increase in net interest margin. If you include those products, there was a slight decrease, but it was slight. So I think that's right. And remember that also, what's interesting about this is obviously you have an average deposit cost, but you're not taking out deposits with respect to the average deposit cost. You're taking out the higher rate deposits. And so to the extent that those higher rate deposits are there or they were borrowings that were extended over a period of time and you are able to replace those with longer-term checking accounts that have better duration, then that allows you to take out a higher cost at funding. So it's a marginal question rather than an average question.
And it is accounting for a decline. Without the block deposits extra liquidity, we were at $380 million. So $375 million would be down slightly.
Our following question comes from the line of Steve Moss with FBR.
Just on the efficiency ratio, I want to circle back to the normalization timeframe, in case I missed it. It sounds like to me it's basically the fourth quarter of fiscal '19 as to when you expect the efficiency ratio should normalize?
Yes, because, of course, the March quarter is always lower because of the excess block revenue in it. So you're talking more of a normalization in Q4.
Right, but even ex the blocks -- the block revenue, it would be -- the fourth quarter -- or maybe it's the third quarter?
Look, I think that, that's -- the fourth quarter is not an unreasonable assumption. Obviously, we will have the full benefit, we believe, unless the transaction is postponed, of a third quarter that includes that benefit. That will be, obviously, it won't be related to cost-cutting as much as it will simply be related to a revenue increase. So that's within the realm of potential outcomes.
Okay, and one other question on the Nationwide transaction. What's the average term on the CDs you are acquiring?
Sure. It's -- by the time we take it over, it's relatively short. It's within a year or 2.
Okay. And then moving on to the margin, just kind of wondering what are the -- your thought process behind lowering the high-end of the range for the margin, you know, previously 4%. Now it's 3.9%. Just color around that.
Yes, I think that this -- remember, this is sort of -- what we're doing is, we've started to have a lot of pro formas here, so we're saying taking out everything with respect to H&R Block, including all the benefits on the lending and deposit side. And then also removing the impact of Epiq and removing the impact of the Nationwide transaction, and what we see there is we just are uncertain as to what sort of loan yield increases we're going to be able to get the flow through at the same speed as what that deposit beta might be. However, there are so many things that are potentially able to work in our favor within this respect. Obviously, we are seeing benefit of the treasury management investments that we are making and that is helping. And so we are going to make making more of those investments and we think that that's going to be helpful. So assuming that, that works as we expect it to, with the cost that is embedded in this increased efficiency ratio, we expect to be able to do better in that regard. So it's just really more about those estimates and picking the right place for it.
Okay. And then on the C&I loan growth for the quarter, just wondering what are the underlying drivers of C&I loan growth? And what's the yield on your C&I and Jumbo originations?
So on our C&I book, when we look at the absolute total, our rate is up at 7.2% on a blended basis for all of that. The leasing side of the book is a little bit lower at 7%. So we're in the 7s, as rates have risen and amounts have repriced.
Okay, and then on the --
[ When you take it ] on the dollar amount --
He asked about single family as well, is that right?
Yes.
Yes. So single family rates are for the newly originated are well into the 5s for that product. Weighted average basis is in the 4 90 in that entire portfolio.
Okay. In terms of the C&I, the drivers of the C&I loan growth, was it -- just wondering what was the primary thing there?
We just continue to establish strong relationships with the sponsors that we work with and we have a wide variety of verticals go under finance, the equipment leasing, specialty real estate. So we're getting contributions across the board there.
Our following question comes from the line of Edward Hemmelgarn from Shaker Investment.
What was the reason behind the sale, I guess, of the Federal Home Loan Bank? Aside from the big reduction there?
I would tell you, Ed, they are no longer allowing us to buy excess. We were able to buy excess, meaning that we could borrow overnight a large amount and leave the stocks there, because it had a nice little excess rate. But they changed their policy in the last 3 months and are repricing and redeeming the stock daily. So they won't let you hold more than your required ratio.
And so, on average as borrowings have gone down with more deposits, then you have less need for the stock, which results in a lower dividend.
But to be clear, we always over-invested. We borrowed enough to get as much as we could, but their policy change is, we won't let you do that. We're going to redeem it daily. So if we have excess amount, we can't keep it. It's a great investment, to your point.
No, I -- that's why I noticed. Yes, okay. That's unfortunate. The other thing is, when do you expect -- you've made, obviously, a lot of investments now in your -- in trying to improve the online experience. Greg, can you talk a little about what you expect to get from that over the next 12 months?
Sure. So we've launched our online platform and converted our customer set. Within that platform, we have essentially an app store and what that app store allows us to do is work with partners to sell their products and to be flexible in deciding what we're going to show our customers, depending upon the cross-sell potential of each of those customers. Over the next 12 months, now that the base product is launched, there's a number of things we need to do. First, we need to tune the cross-sell engine so that we're able to present those offers at the right time in order to sell our consumer products to those customers so that we're developing a broader base and a stickier relationship with each of those consumers. So that's a big part of the product set that we've been developing too on the auto side and on the unsecured side, is to have a broad base of products to sell those customers. So that's one thing that we need to do. The next is, obviously, we are looking for a marquee partner who is interested in utilizing the co-branding and just the ability to sell their products through that platform so that is, that's something critical as well. With respect to every customer that touches the bank, we've made a lot of progress here, but we still have a long way to go and that is that -- so considering a use case where a customer comes in with respect to a single family mortgage product. They're being serviced through the platform and so when they're coming in for that mortgage account, they're getting a deposit account. They're getting a suite of services there and they're utilizing that platform to do everything that they can to interact with the bank. And so by continually bringing the customer back through that platform from a cross-sell perspective, we're able to try to increase the products per customer that we have. And so there is a number of other potential benefits associated with it. With respect to, for example, the purchase funnel, so as we increase advertising and we see a drop-off in the funnel with respect to a particular area, we're now just simply able to immediately put a 2-week fix on it and fix it. And so what we hope is that, obviously, we're in a situation, right, where pretty much every bank is now recognizing the nature of what the future is going to be with respect to branch banking and there are so many direct banks starting. The question is, is how do you avoid competing on rate in those areas? And I think what you have to do is you have to deliver an amazing online banking experience, which really requires that, the team is in place to continually evaluate every little element of that experience and fix it and make sure that it's best-in-class. So before when we had third parties doing that work, we would simply have to get in their product queue and it just wasn't something that was working. So now we're going to be able to improve our funnel and do a bunch of other things that will allow us to optimize our ability to go out and advertise more. Obviously, when you -- frankly when Nationwide came out and looked at what we were doing from a technology perspective, that was, in my view, the determining factor in us being awarded the transaction. We weren't the highest price and their concern was, how are you going to do this list of 15 things in your platform? And we were able to deliver those things because we simply can have our team put them in. So there is a lot of opportunity there with respect to it. We just have to go through and now do the hard work of analyzing the customer experience, looking at the products we can cross-sell and making sure that, that's integrated in an appropriate manner. So that's the -- that's the broader -- the broader scope of that is simply being able to provide better digital services and trying to get away from purely -- you get away from rate-based competition and you certainly will still be fee leaders, but I think if we can surround our customers with all the product sets and tools that we are going to be able to develop, that it will reduce that price sensitivity and that's the overall goal.
Okay and lastly, based upon current rates for yield that you can get off the securities, do you think that there will be any opportunity for you to start growing your securities portfolio profitably beginning into -- in calendar 2019, given that you won't have the restriction of keeping the balance sheet under $10 billion?
Right. The yield curve makes securities purchases very interesting and difficult. I think one of the things that we've done a pretty good job with is, at the right time we obviously sold a lot of our held to maturity securities and we're able to get that positioned well for an up-rate environment. I think that you need a little shape in the yield curve there and you probably need a little more spread, and I'm not saying there is no opportunity, but I just don't see that as some big potential next year. I think what you will see is that as we look at, obviously, we've had -- we no longer have those capital conditions and things like that and we're intending on keeping basically similar capital ratios, but we were running well above those capital minimums that had previously been mandated simply to ensure that we never fell below them. So we now we have the ability to run more at those sort of levels and so to the extent there is incremental capital rather than grow with security deals, we will probably work on returning that capital or doing things that make sense, unless there is a big change in the outlook in the securities market.
I mean, our long-term goal, of course, is generating more no-cost deposits and once we have a better funding on a no-cost deposit basis, the opportunities are wider for us. And that's why there's a big focus on bringing those lower-cost deposits in.
I understand. So your basic intent there will be to wait for a better spread environment and a yield curve that is better than flat.
Yes, so I think that there is -- one of two things is going to happen. Short-term rates are going to start to go down eventually due to some economic blip or you're eventually going to get, you're just going to roll down that curve and rates will have to do something, right? So they're just, it's just nothing right now out -- there's no benefit of taking duration right now. There just is nothing.
Our next question comes from the line of Gary Tenner from D.A. Davidson and Co.
I just had a couple of follow-up questions. I think in the press release, you noted that there were some deal-related costs. Can you tell us what those were in the quarter?
Sure. Legal costs and various expenses related to advisers and other things, and then there's also some amortization of intangibles and those sort of things.
And on the intangible side, we started to amortize the Epiq intangibles and that amount still is relatively small. There might be more down the road as we start to develop software that's being capitalized. But in the end, you can see we put $60 million of intangibles on the balance sheet.
And when we are looking at transactions and we're doing work on those or having legal work done on transactions, whether they're announced or not, we're expensing that. So there's...
As we go.
Fair enough. So your guidance on the efficiency ratio for the back half of the calendar year also incorporates your expectations on deal-related costs for the Nationwide deal, correct?
Correct, it does. Including the conversion cost and the cost of hiring the people that are necessary to service more than 100,000 customers and potential opportunities with respect to cross sell and any other kinds of relationships that we may be able to develop there.
All right. But those are, of course, ongoing costs in terms of headcount as opposed to more one-time type of costs related to...
Yes, well, they are. There is some one-time cost and there's ongoing headcount, but they -- those are also happening before the benefit associated with bringing on the deposits. So the benefit more than offsets the cost, but the cost is coming before the benefit because we are simply having to assume the operations prior to actually getting the benefit of the lower-cost deposits.
Right. Understood. Then on the -- just on the fee side, the gain on sale, structure of settlements this quarter and lottery receivables, a little higher than it's been running at. Anything changed just functionally in that business? Or and just...
No, I think we saw an opportunity in the marketplace. And if we see pricing that's good for longer-term, particularly, long-dated pools, we will execute on it because there's still lots of interest rate risk in this. But amazingly, insurance companies and others are willing to buy this product with a 5 handle for an 18- to 20-year weighted average life. So that generates, when we have an opportunity, a reasonably sized gain.
And then finally as it relates to the renewal of H&R Block program for next year, the RAL program, any changes in terms of the maximum size of the loan? Or your fee on those loans that would be material to thinking about next year?
We don't disclose particular details of any of the program terms with respect to anything, however, I would say that I think the best guidance that you should utilize is a revenue number that is comparable to last year. I think that's the best approach to that and that's, I think, probably what would be useful from a modeling perspective.
All right, thank you, everyone, I'm sorry, go ahead.
All right, thank you, everybody. Thank you for listening. And we'll see you next quarter.
Ladies and gentlemen, this does conclude our teleconference for today. You may now disconnect your line at this time and log off your computers. Thank you for your participation and have a wonderful day.