SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
|☒||ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934|
For the fiscal year ended June 30, 2022
|☐||TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934|
Commission file number: 001-37709
AXOS FINANCIAL, INC.
(Exact name of registrant as specified in its charter)
|(State or other jurisdiction of|
incorporation or organization)
| ||(I.R.S. Employer|
9205 West Russell Road, Suite 400, Las Vegas, NV 89148
(Address of principal executive offices) (zip code)
Registrant’s telephone number, including area code: (858) 649-2218
|Securities registered pursuant to Section 12(b) of the Act:|
|Title of each class||Trading Symbol(s)||Name of each exchange on which registered|
|Common stock, $.01 par value||AX||New York Stock Exchange|
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes ☒ No ☐
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
Yes o No ☒
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports); and (2) has been subject to such filing requirements for the past 90 days.
Yes ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
|Large accelerated filer||☒|
Smaller reporting company
Emerging growth company
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. Yes ☒ No ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ☐ No ☒
The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant, based upon the closing sales price of the common stock on the New York Stock Exchange of $55.91 on December 31, 2021 was $2,687,522,806.
The number of shares of the registrant’s common stock outstanding as of September 6, 2022 was 59,970,728.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant’s definitive Proxy Statement for the registrant’s 2022 Annual Meeting of Stockholders are incorporated by reference into Part III.
AXOS FINANCIAL, INC.
This Annual Report on Form 10-K may contain various forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, Section 21E of the Securities Exchange Act of 1934, and the Private Securities Litigation Reform Act of 1995. Forward-looking statements include projections, statements of the plans, goals and objectives of management for future operations, statements of future economic performance, assumptions underlying these statements, and other statements that are not statements of historical facts. Words such as “anticipates,” “expects,” “intends,” “plans,” “predicts,” “potential,” “believes,” “seeks,” “estimates,” “should,” “may,” “will” and variations of these words or similar expressions are intended to identify forward-looking statements. Forward-looking statements also include the assumptions underlying or relating to any of the foregoing statements.
References in this report to the “Company,” “us,” “we,” “our,” “Axos Financial,” or “Axos” are all to Axos Financial, Inc. on a consolidated basis. References in this report to “Axos Bank,” the “Bank,” or “our bank” are to Axos Bank, one of our consolidated subsidiaries.
Forward-looking statements are subject to significant business, economic and competitive risks, uncertainties and contingencies, many of which are difficult to predict and beyond the control of Axos or the Bank, which could cause our actual results to differ materially from the results expressed or implied in such forward-looking statements. These and other risks, uncertainties and contingencies are described in this Annual Report on Form 10-K, including under “Item 1A. Risk Factors”, and the Company’s other reports filed with the Securities and Exchange Commission (the “SEC”) from time to time.
RISK FACTOR SUMMARY
Investing in our securities involves a high degree of risk. The following is a summary of certain material risks and uncertainties facing our business. This summary is not a complete discussion of the risks and uncertainties affecting us. A more complete discussion of these and other risks and uncertainties is set forth under “Item 1A. Risk Factors” of this Annual Report on Form 10-K. Additional risks not presently known to us or that we presently deem immaterial may also affect us. If any of these risks occur, our business, financial condition or results of operations could be materially and adversely affected.
◦Changes in interest rates;
◦General economic and market conditions, including the risk of a significant and/or prolonged period of inflation or economic downturn;
◦The soundness of other financial institutions;
◦Replacement of the LIBOR benchmark interest rate;
◦Uncertainties surrounding the severity, duration, and effects of the novel coronavirus (“COVID-19”) pandemic;
◦Changes in regulation or regulatory oversight, accounting rules, and laws, including tax laws;
◦Policies and regulations enacted by the Consumer Financial Protection Bureau;
◦Changes in real estate values;
◦Possible defaults on our multifamily residential loans;
◦Mortgage buying activity of Fannie Mae and Freddie Mac;
◦Financial and credit risks associated with commercial and industrial and commercial real estate loans;
◦Seasonal fluctuations in mortgage origination;
◦The adequacy of our allowance for credit losses;
◦Changes in the value of goodwill and other intangible assets;
◦Our risk management processes and procedures effectiveness;
◦Higher FDIC assessments could negatively impact profitability;
◦Our broker-dealer business and entry into the investment advisory business;
◦Our Digital Assets subsidiary;
◦Our ability to access the equity capital markets;
◦Access to adequate funding;
◦Our ability to manage our growth and deploy assets profitably;
◦Competition for customers from other banks and financial services companies;
◦Our ability to maintain and enhance our brand;
◦Reputational risk associated with any negative publicity;
◦Failure or circumvention of our controls and procedures;
◦Extreme weather conditions, a natural disaster, especially in California, rising sea levels, acts of war or terrorism, civil unrest, public health issues, or other adverse external events;
◦Increased regulation related to Environmental, Social and Governance factors
◦Our ability to retain the services of key personnel and attract, hire and retain other skilled managers;
◦Possible exposure to environmental liability;
◦Our dependence on third-party service providers for core banking and securities transactions technology;
◦Privacy concerns relating to our technology that could damage our reputation or deter customers from using our products and services;
◦Risk of systems failure and disruptions to operations;
◦Breach of information security measures and cybersecurity attacks;
◦Our reliance on technology innovation;
◦The market price of our common stock may be volatile;
◦Our charter documents and state law may delay or prevent a change of control or changes in our management;
◦Changes to our size and structure;
◦Our ability to acquire and integrate acquired companies; and
◦The outcome or impact of current or future litigation involving the Company;
The forward-looking statements contained in this Annual Report on Form 10-K are made on the basis of the views and assumptions of management regarding future events and business performance as of the date this Annual Report on Form 10-K is filed with the SEC. We do not undertake any obligation to update these statements to reflect events or circumstances occurring after the date this report is filed.
ITEM 1. BUSINESS
Axos Financial, Inc. is a financial holding company, a diversified financial services company with over $17.4 billion in assets that provides banking and securities products and services to its customers through its online and low-cost distribution channels and affinity partners. Axos Bank has deposit and loan customers nationwide including consumer and business checking, savings and time deposit accounts and financing for single family and multifamily residential properties, small-to-medium size businesses in target sectors, and selected specialty finance receivables. The Bank generates fee income from consumer and business products including fees from loans originated for sale and transaction fees earned from processing payment activity. Our securities products and services are offered through Axos Clearing LLC (“Axos Clearing”), and the entities Axos Invest, Inc. and Axos Invest LLC (together, “Axos Invest”), which generate interest and fee income by providing comprehensive securities clearing services to introducing broker-dealers and registered investment advisor correspondents and digital investment advisory services to retail investors, respectively. On August 2, 2021, Axos Clearing closed its acquisition of E*TRADE Advisor Services, a registered investment advisor custody business and renamed it Axos Advisor Services (“AAS”). The addition of AAS provides new sources of fee income and services that complement the Securities Business products, a proprietary, turnkey technology platform to attract new registered investment advisor custody business, and generate low-cost core deposits. Axos Clearing is a clearing broker-dealer registered with the SEC and the Financial Industry Regulatory Authority, Inc. (“FINRA”). Axos Invest is a Registered Investment Advisor under the Investment Advisers Act of 1940, that is registered with the SEC. Axos Invest, Inc. is an introducing broker-dealer that is registered with the SEC and FINRA. Axos Financial, Inc.’s common stock is listed on the New York Stock Exchange and is a component of the Russell 2000® Index, the S&P SmallCap 600® Index, the KBW Nasdaq Financial Technology Index, and the Travillian Tech-Forward Bank Index.
On June 30, 2022, Axos had total assets of $17.4 billion, loans of $14.1 billion, investment securities of $0.3 billion, total deposits of $13.9 billion and borrowings of $0.6 billion. Because we do not incur the significantly higher fixed operating costs inherent in a branch-based distribution system, the Bank is able to rapidly grow our deposits and assets by providing a better value to our customers and by expanding our low-cost distribution channels.
Our business strategy is to grow our loan originations and our deposits to achieve increased economies of scale and reduce the cost of products and services to our customers by leveraging our distribution channels and technology. We have designed our online banking platform and our workflow processes to handle traditional banking functions with elimination of paperwork and human intervention. Our Bank’s charter allows us to conduct banking operations in all fifty states, and our online presence allows us increased flexibility to target a large number of loan and deposit customers based on demographics, geography and service needs. Our low-cost distribution channels provide opportunities to increase our core deposits and increase our loan originations by attracting new customers and developing new and innovative products and services. Our securities clearing and custody and digital investment management platforms provide a comprehensive set of technology, clearing, cash management and lending services targeted at independent registered investment advisors and introducing broker-dealers, principals and clients of advisory firms and individuals not affiliated with an investment advisor. We are integrating our clearing and wealth management platforms with our banking platform to create an easy-to-use platform for customers’ banking and investing needs. Additionally, our securities clearing and custody businesses generates additional low-cost deposits, which serve as a source of funding for our Bank.
Our long-term business plan includes the following principal objectives:
•Maintain an annualized return on average common stockholders’ equity of 17.0% or better;
•Annually increase average interest-earning assets by 12% or more; and
•Maintain an annualized efficiency ratio at the Bank to a level 40% or lower.
We operate through two operating segments: Banking Business and Securities Business.
The Banking Business has a broad range of banking services including online banking, concierge banking, and mortgage, vehicle and unsecured lending through online and telephonic distribution channels to serve the needs of consumers and small businesses nationally. In addition, the Banking Business focuses on providing deposit products nationwide to industry verticals (e.g., Title and Escrow), cash management products to a variety of businesses, and commercial & industrial and commercial real estate lending to clients. The Banking Business includes a bankruptcy trustee and fiduciary service that provides specialized software and consulting services to Chapter 7 bankruptcy and non-Chapter 7 trustees and fiduciaries.
The Securities Business includes the Clearing Broker-Dealer, Registered Investment Advisor custody business, Registered Investment Advisor, and Introducing Broker-Dealer lines of businesses. These lines of business offer products independently to their own customers as well as to Banking Business clients. The products offered by the lines of business in the Securities Business primarily generate net interest and non-banking service fee income.
The operating segments and segment results of the Company are determined based upon the management reporting system, which assigns balance sheet and income statement items to each of the business segments and by which segment results are evaluated by the Chief Executive Officer in deciding how to allocate resources and in assessing performance. The process is designed around the organizational and management structure and, accordingly, the results derived are not necessarily comparable with similar information published by other financial institutions or in accordance with generally accepted accounting principles.
The Company evaluates performance and allocates resources based on pre-tax profit or loss from operations. There are no material inter-segment sales or transfers. Certain corporate administration costs and income taxes have not been allocated to the reportable segments. Therefore, in order to reconcile the two segments to the consolidated totals, we include parent-only activities and intercompany eliminations.
We distribute our deposit products through a wide range of retail distribution channels, and our deposits consist of demand, savings and time deposits accounts. We distribute our loan products through our retail, correspondent and wholesale channels, and the loans we retain are primarily first mortgages secured by single family real property and by multifamily real property as well as commercial & industrial loans to businesses. Our securities consist of mortgage pass-through securities issued by government-sponsored entities, non-agency collateralized mortgage obligations, municipal securities and whole business securities. We believe our flexibility to adjust our asset generation channels has been a competitive advantage allowing us to avoid markets and products where credit fundamentals are poor or rewards are not sufficient to support our required return on equity.
Our distribution channels for our bank deposit and lending products include:
•A national online banking brand with tailored products targeted to specific consumer segments;
•Affinity groups where we gain access to the affinity group’s members, and our exclusive relationships with financial advisory firms;
•A commercial banking division focused on providing deposit products and loans to specific nationwide industry verticals (e.g., Homeowners’ Associations) and small and medium size businesses;
•Commission-based lending sales force that operates from home, San Diego, and Salt Lake City and originates single and multifamily mortgage loans and commercial and industrial loans and leases to qualified businesses;
•A bankruptcy and non-bankruptcy trustee and fiduciary services team that operates from our Kansas City office focused on specialized software and consulting services that provide deposits; and
•Inside sales teams that originate loans and deposits from self-generated leads, third-party purchase leads, and from our retention and cross-sell of our existing customer base from both our Banking business and Securities business.
Banking Business - Asset Origination and Fee Income Businesses
The Bank has built diverse loan origination and fee income businesses that generate targeted financial returns through our digital distribution channels. We believe the diversity of our businesses and our direct and indirect distribution channels provide us with increased flexibility to manage through changing market and operating environments.
Single Family - Mortgage & Warehouse
We generate earning assets and fee income from our mortgage lending activities, which consist of originating and servicing mortgages secured primarily by first liens on single family residential properties for consumers and providing warehouse lines of credit for third-party mortgage companies. We divide our single-family mortgage originations between loans we retain and loans we sell. Our mortgage banking business generates fee income and gains from sales of those consumer single family mortgage loans we sell. Our loan portfolio generates interest income and fees from loans we retain. We also provide home equity loans for consumers secured by second liens on single family mortgages.
We originate fixed and adjustable-rate prime residential mortgage loans using a paperless loan origination system and centralized underwriting and closing process. Many of our loans have initial fixed rate periods (five, seven or ten years) before starting a regular adjustment period (annually, semi-annually or monthly) as well as, interest rate floors, ceilings and rate change caps. We warehouse our mortgage banking loans and sell to investors conventional, government and non-agency loans. Our mortgage servicing business includes collecting loan payments, applying principal and interest payments to the loan balance, managing escrow funds for the payment of mortgage-related expenses, such as taxes and insurance, responding to customer inquiries, counseling delinquent mortgagors and supervising foreclosures.
We originate single family mortgage loans for consumers through multiple channels on a retail, wholesale and correspondent basis.
•Retail. We originate single family mortgage loans direct to consumers through our relationships with large affinity groups, leads from referral partners, portfolio retention, cross-selling and acquiring leads from third parties.
•Wholesale. We have relationships with licensed mortgage brokers from which the Bank manages wholesale loan pipelines through our originations systems and websites. Through our secure website, our approved brokers can compare programs, terms and pricing on a real time basis and communicate with our staff.
•Correspondent. We acquire closed loans from third-party mortgage companies that originate single family loans in accordance with our portfolio specifications or the specifications of our investors. We may purchase pools of seasoned, single-family loans originated by others during economic cycles when those loans have more attractive risk-adjusted returns than those we may originate.
We originate lender-finance loans to businesses secured by first liens on single family mortgage loans from cross selling, retail direct and through third parties. Our warehouse customers are primarily generated through cross selling to our network of third-party mortgage companies.
Multifamily and Commercial Mortgage
We originate adjustable-rate multifamily residential mortgage loans and project-based multifamily real-estate-secured loans with interest rates that adjust based on the American Interbank Offered Rate (“Ameribor”) or the Secured Overnight Financing Rate (“SOFR”). We hold existing adjustable-rate multifamily residential mortgage loans and project-based multifamily real-estate-secured loans with interest rates that adjust based on U.S. Treasury security yields and London Interbank Offered Rate (“LIBOR”). Many of our loans have initial fixed rate periods (three, five or seven years) before starting a regular adjustment period (annually, semi-annually or monthly) as well as prepayment protection clauses, interest rate floors and rate change caps.
We divide our multifamily residential mortgage portfolio between the loans we retain and the loans we sell. Our mortgage banking business includes gains from those multifamily mortgage loans we sell. Our loan portfolio generates interest income and fees from the loans we retain.
We originate multifamily mortgage loans using a commission-based commercial lending sales force that operates from home offices across the United States or from our San Diego location. Customers are targeted through origination techniques such as direct mail marketing, personal sales efforts, email marketing, online marketing and print advertising. Loan applications are submitted electronically to centralized employee teams who underwrite, process and close loans. The sales force team members operate regionally both as retail originators for apartment owners and wholesale representatives to other mortgage brokers.
Commercial Real Estate Secured
We originate loans across the U.S. secured by real estate properties under a variety of structures that we classify as commercial real estate (“CRE”). A few examples are as follows: Commercial Bridge to Sale, Commercial Bridge to Construction, Commercial Bridge to Refinance and Acquisition, Development, Construction, and Lender Finance. CRE Loans are originated by our sales force dedicated to commercial lending by contacting borrowers directly or by working with third-party partners or brokers to businesses secured by first liens on single family, multifamily, condominium, office, retail, mixed-use, hospitality, undeveloped or to-be-redeveloped land or small business loans. Repayment of CRE loans generally depends on the successful completion of the real estate transition project and permanent take-out or sale of the underlying assets on the line. We attempt to mitigate risk by adhering to underwriting policies in evaluating the collateral and the creditworthiness of borrowers and guarantors.
Commercial & Industrial - Non-Real Estate (Non-RE)
Comprising the majority of this portfolio are commercial and industrial non-real estate, asset-backed loans, lines of credit and term loans made to commercial borrowers secured by commercial assets, including, but not limited to, receivables, inventory and equipment. We typically reduce exposure in these loans by entering into a structured facility, under which we take a senior lien position collateralized by the underlying assets at advance rates well inside the collateral value. Commercial and industrial leases comprise the remainder of this portfolio and are primarily made based on the operating cash flows of the borrower or conversion of working capital assets to cash and secondarily on the underlying collateral provided by the borrower. We provide leases to small businesses and middle market companies that use the funds to purchase machinery, equipment and software essential to their operations. The lease terms are generally between two and ten years and amortize primarily to full repayment, or in some cases, to a de minimis residual balance. The leases are offered nationwide to companies in targeted industries through a direct sales force and through independent third party sales referrals. Although commercial and industrial loans and leases are often collateralized directly or indirectly by equipment, inventory, accounts or loans receivable or other business assets, the liquidation of collateral in the event of a borrower default may be an insufficient source of repayment because accounts or loans receivable may be uncollectible and inventories and equipment may be obsolete or of limited use. We attempt to mitigate these risks through the structuring of these lending products, adhering to underwriting policies in evaluating the management of the business and the credit-worthiness of borrowers and guarantors.
Our automobile lending division originates prime and subprime loans to customers secured by new and used automobiles (“autos”). Our subprime loans are insured via a default risk mitigation product in which we recoup a large percentage of the deficiency balance on charged off loans. We distribute our auto loan products through direct and indirect channels, hold all of the auto loans that we originate and perform the loan servicing functions for these loans. Our loans carry a fixed interest rate for periods ranging from three to eight years and generate interest income and fees.
We originate fixed rate unsecured loans to individual borrowers in all fifty states. We offer loans between $5,000 and $50,000 with terms of thirty-six, forty-eight, sixty and seventy-two months to well qualified borrowers. The minimum credit score since 2018 is 700. All applicants apply digitally and we validate income, identity and funding bank account. One hundred percent of loans are manually underwritten by a seasoned underwriter with a telephone interview conducted in respect of every approved loan prior to funding. We source our unsecured loans through existing bank customers, lead aggregators and additional marketing efforts.
We also originate other loans, which include structure settlements, Small Business Administration (“SBA”) loans, and securities-backed loans. Structured settlements are originated through the wholesale and retail purchase of state lottery prize and structured settlement annuities. These annuities are high credit quality deferred payment receivables having a state lottery commission or primarily highly rated insurance company payor. Purchases of state lottery prize or structured settlement annuities are governed by specific state statutes requiring judicial approval of each transaction. Federal Paycheck Protection Program (“PPP”) loans made by the Bank under the Federal Coronavirus Aid, Relief and Economic Security Act (“CARES”) Act are guaranteed by the Small Business Administration (“SBA”) and, if the loan funds are used by the borrower for specific purposes as provided under the PPP, may be fully or partially forgiven by the SBA at which time, the Bank will receive funds related to the PPP loan forgiveness directly from the SBA. The Bank also provides securities-backed lines of credit (sbloc) to borrowers collateralized by marketable securities at advance rates generally less than 50% of current fair market value.
Our investment analysis capabilities are a core competency of our organization. We decide whether to hold originated assets for investment or to sell them in the capital markets based on our assessment of the yield and risk characteristics of these assets as compared to other available opportunities to deploy our capital. Because risk-adjusted returns available on acquisitions may exceed returns available through retaining assets from our origination channels, we have elected to purchase loans and securities (see discussion below) from time to time. Some of our loans and security acquisitions were purchased at discounts to par value, which enhance our effective yield through accretion into income in subsequent periods.
Loan Portfolio Composition. The following table sets forth the composition of our loan portfolio in amounts and percentages by type of loan at the end of each fiscal year-end for the last three years:
|At June 30,|
|(Dollars in thousands)||Amount||Percent||Amount||Percent||Amount||Percent|
|Single Family - Mortgage & Warehouse||$||3,988,462 ||28.0 ||%||$||4,359,472 ||37.8 ||%||$||4,722,304 ||44.2 ||%|
|Multifamily and Commercial Mortgage||2,877,680 ||20.2 ||%||2,470,454 ||21.4 ||%||2,263,054 ||21.1 ||%|
|Commercial Real Estate||4,781,044 ||33.5 ||%||3,180,453 ||27.5 ||%||2,297,920 ||21.5 ||%|
|Commercial & Industrial - Non-RE||2,028,128 ||14.2 ||%||1,123,869 ||9.7 ||%||885,320 ||8.3 ||%|
|Auto & Consumer||567,228 ||4.0 ||%||362,180 ||3.1 ||%||341,365 ||3.1 ||%|
|Other||11,134 ||0.1 ||%||58,316 ||0.5 ||%||193,479 ||1.8 ||%|
|Total loans held for investment||$||14,253,676 ||100.0 ||%||$||11,554,744 ||100.0 ||%||$||10,703,442 ||100.0 ||%|
|Allowance for credit losses||(148,617)||(132,958)||(75,807)|
|Unamortized premiums/discounts, net of deferred loan fees||(13,998)||(6,972)||3,714 |
|Net loans held for investment||$||14,091,061 ||$||11,414,814 ||$||10,631,349 |
The following table sets forth the amount of loans maturing in our total loans held for investment based on the contractual terms to maturity:
| ||Term to Contractual Maturity|
|(Dollars in thousands)||Less Than Three Months||Over Three Months Through One Year||Over One Year Through Five Years||Over 5 Years Through 15 Years||Over 15 Years||Total|
|June 30, 2022||$||553,013 ||$||1,587,126 ||$||5,135,709 ||$||1,765,334 ||$||5,212,494 ||$||14,253,676 |
The following table sets forth the amount of our loans at June 30, 2022 that are due after June 30, 2023 and indicates whether they have fixed, floating or adjustable interest rates:
|(Dollars in thousands)||Fixed|
|Single Family - Mortgage & Warehouse||$||133,825 ||$||3,561,884 ||$||3,695,709 |
|Multifamily and Commercial Mortgage||52,421 ||2,793,940 ||2,846,361 |
|Commercial Real Estate||209,084 ||2,955,961 ||3,165,045 |
|Commercial & Industrial - Non-RE||286,349 ||1,546,297 ||1,832,646 |
|Auto & Consumer||563,993 ||— ||563,993 |
|Other||9,783 ||— ||9,783 |
|Total||$||1,255,455 ||$||10,858,082 ||$||12,113,537 |
1 Included in this category are hybrid mortgages (e.g., 5/1 adjustable rate mortgages) that carry a fixed rate for an introductory term before transitioning to an adjustable rate.
Our mortgage loans are secured by properties primarily located in the western United States. The following table shows the largest states and regions ranked by location of these properties:
|At June 30, 2022|
|Percentage of Loan Principal Secured by Real Estate Located in State or Region|
|State or Region||Total Real Estate Mortgage Loans||Single Family Mortgage||Multifamily real estate secured||Commercial|
|35.2 ||%||55.2 ||%||54.5 ||%||8.0 ||%|
|10.2 ||%||15.4 ||%||13.8 ||%||3.9 ||%|
|New York||26.0 ||%||13.0 ||%||18.8 ||%||40.5 ||%|
|Florida||5.4 ||%||5.0 ||%||5.1 ||%||6.0 ||%|
|New Jersey||3.2 ||%||0.8 ||%||0.1 ||%||7.0 ||%|
|Texas||2.0 ||%||0.6 ||%||0.6 ||%||3.9 ||%|
|District of Columbia||1.8 ||%||0.3 ||%||0.1 ||%||4.0 ||%|
|Georgia||1.7 ||%||0.3 ||%||0.1 ||%||3.9 ||%|
|Massachusetts||1.1 ||%||0.7 ||%||— ||%||2.0 ||%|
|Virginia||1.1 ||%||0.2 ||%||— ||%||2.4 ||%|
|All other states||12.3 ||%||8.5 ||%||6.9 ||%||18.4 ||%|
|100.0 ||%||100.0 ||%||100.0 ||%||100.0 ||%|
1 Consists of mortgage loans secured by real property in California with ZIP Code ranges from 90000 to 92999.
2 Consists of mortgage loans secured by real property in California with ZIP Code ranges from 93000 to 96999.
The ratio of the loan amount to the value of the property securing the loan is called the loan-to-value ratio (“LTV”). The following table shows the LTVs of our loan portfolio on weighted-average and median bases at June 30, 2022. The LTVs were calculated by dividing (a) the loan principal balance less principal repayments by (b) the appraisal value of the property securing the loan.
|Total Real Estate Mortgage Loans||Single Family - Mortgage & Warehouse||Multifamily and Commercial Mortgage||Commercial|
|Weighted Average LTV||56 ||%||57 ||%||53 ||%||58 ||%|
|Median LTV||54 ||%||56 ||%||50 ||%||26 ||%|
1 Amounts represent combined LTV calculated by adding the current balances of both the first and second liens of the borrower and dividing that sum by an independent estimated value of the property at the time of origination.
Our effective weighted-average LTV of 56.75% for real estate mortgage loans originated during the fiscal year ended June 30, 2022 has resulted, and we believe will continue to result, in relatively low average loan defaults and favorable write-off experience.
Loan Underwriting Process and Criteria. The Bank individually underwrites loans originated and purchased. For our brand partnership lending products, we construct or validate loan origination models to meet our minimum standards. Our loan underwriting policies and procedures are written and adopted by our Bank’s Board of Directors and our Bank’s Credit Committee. Credit extensions generated by the Bank conform to the intent and technical requirements of our lending policies and the applicable lending regulations of our federal regulators.
In the underwriting process we consider all relevant factors including the borrower’s credit score, credit history, documented income, existing and new debt obligations, the value of the collateral, and other internal and external factors. For all multifamily and commercial real estate loans, we rely primarily on the cash flow from the underlying property as the expected source of repayment; often the Bank obtains personal guarantees from all material owners or partners of the borrower. In evaluating multifamily or commercial real estate credit, we consider all relevant factors including the outside financial assets of the material owners or partners, payment history at the Bank or other financial institutions, and the management / ownership experience with similar properties or businesses. In evaluating the borrower’s qualifications, we consider primarily the borrower’s other financial resources, experience in owning or managing similar properties and payment history with us or other financial institutions. In evaluating the underlying property, we consider the recurring net operating income of the property before debt service and depreciation, the ratio of net operating income to debt service and the ratio of the loan amount to the appraised value.
Lending Limits. As a savings association, we are generally subject to the same lending limit rules applicable to national banks. With limited exceptions, the maximum amount that we may lend to any borrower, including related entities of the borrower, at any one time may not exceed 15% of our unimpaired capital and surplus, plus, provided certain conditions are met, an additional 10% of unimpaired capital and surplus for loans fully secured by readily marketable collateral. See “Regulation of Banking Business - Loan-to-One Borrower Limitations” for further information. At June 30, 2022, the Bank’s loans-to-one-borrower limit was $258.8 million, based upon the 15% of unimpaired capital and surplus measurement. At June 30, 2022, our largest outstanding loan balance was $190.0 million.
Loan Quality and Credit Risk. Historically, our level of non-performing mortgage loans as a percentage of our loan portfolio has been relatively low compared to the overall residential lending market. In 2020 and 2021, the global pandemic caused an increase in non-performing mortgage loans industry-wide. Our non-performing mortgage loans have since began trending toward a relatively low level. Additionally, we have increased our efforts to make loans to businesses through lending programs that are not as seasoned as our mortgage lending. Therefore, we anticipate that our rate of non-performing loans and leases may increase in the future, and we have provided an allowance for credit losses.
Non-performing assets are loans and leases which are often on non-accrual status as they are more than 90 days past due; however, there are other conditions which may cause these assets to be non-performing, such as the underlying collateral being acquired by foreclosure or deed-in-lieu. Troubled debt restructurings (“TDRs”) are defined as loans which have been modified to below market terms either by granting interest rate concessions or by deferring principal or interest payments due to financial difficulty of the customer. Our policy with respect to non-performing assets is to place such assets on nonaccrual status when, in the judgment of management, the probability of collection of interest is deemed to be insufficient to warrant further accrual. When a loan or lease is placed on nonaccrual status, previously accrued but unpaid interest will be deducted from interest income. Our general policy is to not accrue interest on loans and leases past due 90 days or more, unless the individual borrower circumstances dictate otherwise.
See Management’s Discussion and Analysis — “Asset Quality and Allowance for credit Losses” for a history of non-performing assets and allowance for credit losses.
Investment Securities Portfolio. Axos classifies each investment security according to our intent to hold the security to maturity, trade the security at fair value or make the security available-for-sale. We invest available funds in government and high-grade non-agency securities. Our investment policy, as established by our Board of Directors, is designed to maintain liquidity and generate a favorable return on investment without incurring undue interest rate risk, credit risk or portfolio asset concentration risk. Under our investment policy, the Bank is authorized to invest in agency mortgage-backed obligations issued or fully guaranteed by the United States government, non-agency asset-backed obligations, specific federal agency obligations, municipal obligations, specific time deposits, negotiable certificates of deposit issued by commercial banks and other insured financial institutions, investment grade corporate debt securities and other specified investments. We also buy and sell securities to facilitate liquidity and to help manage our interest rate risk.
The following table sets forth the dollar amount of our securities portfolio by intent at the end of each of the last three fiscal years:
|(Dollars in thousands)||Fair Value||Carrying Amount||Fair Value||Total|
|Fiscal year end|
|June 30, 2022||$||262,518 ||$||— ||$||1,758 ||$||264,276 |
|June 30, 2021||187,335 ||— ||1,983 ||189,318 |
|June 30, 2020||187,627 ||— ||105 ||187,732 |
The following table sets forth the expected maturity distribution of our mortgage-backed securities and the contractual maturity distribution of our Non-RMBS securities and the weighted-average yield for each range of maturities:
|At June 30, 2022|
|Total Amount||Due Within One Year||Due After One but within Five Years||Due After Five but within Ten Years||Due After Ten Years|
|(Dollars in thousands)||Amount|
|$||27,722 ||1.40 ||%||$||4,794 ||1.65 ||%||$||13,035 ||1.55 ||%||$||7,149 ||1.38 ||%||$||2,744 ||0.35 ||%|
|187,616 ||5.61 ||%||27,386 ||8.08 ||%||158,382 ||5.13 ||%||1,402 ||10.56 ||%||446 ||7.17 ||%|
|Total Mortgage-Backed Securities||$||215,338 ||5.07 ||%||$||32,180 ||7.12 ||%||$||171,417 ||4.86 ||%||$||8,551 ||2.89 ||%||$||3,190 ||1.30 ||%|
|Municipal||3,529 ||3.57 ||%||— ||— ||%||— ||— ||%||— ||— ||%||3,529 ||3.57 ||%|
|Asset-backed securities and structured notes||47,000 ||8.24 ||%||12,260 ||8.24 ||%||34,740 ||8.24 ||%||— ||— ||%||— ||— ||%|
|Total Non-RMBS||$||50,529 ||7.91 ||%||$||12,260 ||8.24 ||%||$||34,740 ||8.24 ||%||$||— ||— ||%||$||3,529 ||3.57 ||%|
|Available-for-sale—Amortized Cost||$||265,867 ||5.61 ||%||$||44,440 ||7.43 ||%||$||206,157 ||5.43 ||%||$||8,551 ||2.89 ||%||$||6,719 ||2.49 ||%|
|Available-for-sale—Fair Value||$||262,518 ||5.62 ||%||$||44,713 ||7.43 ||%||$||203,674 ||5.43 ||%||$||7,987 ||2.89 ||%||$||6,144 ||2.49 ||%|
|Total available-for-sale securities||$||262,518 ||5.62 ||%||$||44,713 ||7.43 ||%||$||203,674 ||5.43 ||%||$||7,987 ||2.89 ||%||$||6,144 ||2.49 ||%|
1 Weighted-average yield is based on amortized cost of the securities. Residential mortgage-backed security yields and maturities include impact of expected prepayments and other timing factors such as interest rate forward curve.
2 Includes securities guaranteed by Ginnie Mae, a U.S. government agency, and the government sponsored enterprises Fannie Mae and Freddie Mac.
3 Private sponsors of securities collateralized primarily by pools of 1-4 family residential first mo prime, Alt-A or pay-option ARM mortgages.
Our available-for-sale securities portfolio of $262.5 million at June 30, 2022 is composed of approximately 9.6% agency residential mortgage-backed securities (“RMBS”) and other debt securities issued by the government-sponsored enterprises primarily, Fannie Mae and Freddie Mac (each, a “GSE” and, together, the “GSEs”); 49.8% Alt-A, private-issue super senior, first-lien RMBS; 2.6% Pay-Option ARM, private-issue super senior first-lien RMBS; 18.8% commercial mortgage-backed securities (“CMBS”); 1.2% Municipal securities and 18.0% whole business securities. We had no asset-backed, sub-prime RMBS or bank pooled trust preferred securities at June 30, 2022.
We manage the credit risk of our non-agency securities by purchasing those securities which we believe have the most favorable blend of historic credit performance and remaining credit enhancements including subordination, over collateralization, excess spread and purchase discounts. Substantially all of our non-agency securities are senior tranches protected against realized loss by subordinated tranches. The amount of structural subordination available to protect each of our securities (expressed as a percentage of the current face value) is known as credit enhancement. At June 30, 2022, the weighted-average credit enhancement in our entire non-agency MBS portfolio was 19.7%. We have experienced personnel monitor the performance and measure the security for impairment in accordance with regulatory guidance. See Management’s Discussion and Analysis—“Critical Accounting Policies—Securities.”
Bank-owned life insurance. The following table summarizes the activity in the Company’s bank-owned life insurance (“BOLI”) as of the dates indicated:
|(Dollars in thousands)||BOLI Values|
|Balance as of June 30, 2019||$||6,969 |
| Death benefits||(763)|
| Change in Contract Value||174 |
|Balance as of June 30, 2020||6,380 |
| Additions||50,000 |
| Change in Contract Value||175 |
|Balance as of June 30, 2021||56,555 |
| Additions||100,000 |
| Change in Contract Value||4,220 |
|Balance as of June 30, 2022||$||160,775 |
Bank-owned life insurance is included in the ‘Other assets’ line in the Consolidated Balance Sheets.
Banking Business - Deposit Generation
We offer a full line of deposit products, which we source through both online and branch distribution channels using an operating platform and marketing strategies that emphasize low operating costs and are flexible and scalable for our business. Our full featured products and platforms, 24/7 customer service and our affinity relationships result in customer accounts with strong retention characteristics. We continuously collect customer feedback and improve our processes to satisfy customer needs.
At June 30, 2022, we had $13.9 billion in deposits of which $12.9 billion, or 92.4% were demand and savings accounts, and $1.1 billion, or 7.6% were time deposits. We generate deposit customer relationships through our distribution channels including websites, sales teams, online advertising, print and digital advertising, financial advisory firms, affinity partnerships and lending businesses which generate escrow deposits and other operating funds. Our distribution channels include:
•A commercial banking division, which focuses on providing deposit and treasury management solutions nationwide to targeted industry verticals through a dedicated team. The comprehensive suite of services offered through the commercial banking division include;
◦Deposit and Liquidity Management: Analyzed Checking Accounts, Interest Checking Accounts, Money Market Accounts, Zero Balance Accounts, Insured Cash Sweep;
◦ Payables: ACH Origination, Wire Transfer, Commercial Check Printing, Business Bill Pay and Account Transfer;
◦ Receivables: Remote Deposit Capture, Mobile Deposit, Lockbox, Merchant Services, Online Payment Portal;
◦ Information Reporting and Reconciliation: Prior Day and Current Day Summary and Detail Reporting;
◦ Security and Fraud Prevention: Direct Link Security, Check Positive Pay, ACH Blocks and Filters; and
◦ API Capabilities: A growing suite of API-enabled capabilities provides an additional channel for clients to perform their banking activities.
•An online consumer platform that delivers an enhanced banking experience with tailored products targeted to specific consumer segments. For example, one tailored product is designed for customers who are looking for full-featured demand accounts and very competitive fees and interest rates, while another product targets primarily tech-savvy, Generation X and Generation Y customers that are seeking a low-fee cost structure and a high-yield savings account;
•A concierge banking offer serving the needs of high net worth individuals with premium products and dedicated service;
•Financial advisory firms who introduce their clients to our deposit products through Axos Advisor;
•A call center that opens accounts through self-generated internet leads, third-party purchased leads, partnerships, and our retention and cross-sell efforts to our existing customer base;
•A full-service fiduciary team catered specifically to support bankruptcy and non-bankruptcy trustees and fiduciaries with their software and banking needs.
Our online consumer banking platform is full-featured with quick and secure access to activity, statements and other features including:
•Purchase Rewards. Customers can earn cash back by using their VISA® Debit Card at select merchants;
•Mobile Banking. Customers can access with Touch ID on eligible devices, review account balances, transfer funds, deposit checks and pay bills from the convenience of their mobile phone;
•Mobile Deposit. Customers can instantly deposit checks from their smart phones using our Mobile App;
•Online Bill Payment Service. Customers can automatically pay their bills online from their account;
•Peer to Peer Payments. Customers can securely send money via email or text messaging through this service;
•My Deposit. Customers can scan checks with this remote deposit solution from their home computers. Scanned images will be electronically transmitted for deposit directly to their account;
•Text Message Banking. Customers can view their account balances, transaction history, and transfer funds between their accounts via these text message commands from their mobile phones;
•Unlimited ATM Reimbursements. With certain checking accounts, customers are reimbursed for any fees incurred using an ATM (excludes international ATM transactions). This provides customers with access to any ATM in the nation, for free;
•Secure Email and Chatbot. Customers can use our chatbot and send or receive secure emails from our customer service department without concern for the security of their information;
•InterBank Transfer. Customers can transfer money to their accounts at other financial institutions from their online banking platform;
•VISA® Debit Cards or ATM Cards. Customers may choose to receive either a free VISA® Debit or an ATM card upon account opening. Customers can access their accounts worldwide at ATMs and any other locations that accept VISA® Debit cards;
•Overdraft Protection. Eligible customers can enroll in one of our overdraft protection programs;
•Digital Wallets. Our Apple Pay™, Samsung Pay™ and Android Pay™ solutions provide the same ease to pay as a debit card with an eligible device. The mobile experience is easy and seamless; and
•Cash Deposit Through Reload @ the Register. Customers can visit any Walmart, Safeway, ACE Cash Express, CVS Pharmacy, Dollar General, Dollar Tree, Family Dollar, Kroger, Rite Aid, 7-Eleven and Walgreens, and ask to load cash into their account at the register. A fee is applied.
Our consumer and business deposit balances consisted of 53.7% and 46.3% of total deposits at June 30, 2022, respectively. Our business deposit accounts feature a full suite of treasury and cash management products for our business customers including online and mobile banking, remote deposit capture, analyzed business checking and money market accounts. We service our business customers by providing them with a dedicated relationship manager and an experienced business banking operations team.
Our deposit operations are conducted through a centralized, scalable operating platform which supports all of our distribution channels. The integrated nature of our systems and our ability to efficiently scale our operations create competitive advantages that support our value proposition to customers. Additionally, the features described above such as online account opening and online bill-pay promote self-service and further reduce our operating expenses.
We believe our deposit franchise will continue to provide lower all-in funding costs (interest expense plus operating costs) with greater scalability than branch-intensive banking models because the traditional branch model with high fixed operating costs will experience continued declines in consumer traffic due to the decline in paper check deposits and due to growing consumer preferences to bank online.
The number of deposit accounts at the end of each of the last three fiscal years is set forth below:
|At June 30,|
|Non-interest-bearing, prepaid and other||42,372 ||36,726 ||27,108 |
|Checking and savings accounts||344,593 ||336,068 ||310,463 |
|Time deposits||8,734 ||12,815 ||18,450 |
|Total number of deposit accounts||395,699 ||385,609 ||356,021 |
Deposit Composition. The following table sets forth the dollar amount of deposits by type and weighted average interest rates at the end of each of the last three fiscal years:
|At June 30,|
|(Dollars in thousands)||Amount|
|Non-interest-bearing||$||5,033,970 ||— ||$||2,474,424 ||— ||$||1,936,661 ||— |
|Demand||3,611,889 ||0.61 ||%||3,369,845 ||0.15 ||%||3,456,127 ||0.37 ||%|
|Savings||4,245,555 ||0.95 ||%||3,458,687 ||0.21 ||%||3,697,188 ||0.78 ||%|
|Total demand and savings||7,857,444 ||0.79 ||%||$||6,828,532 ||0.18 ||%||$||7,153,315 ||0.58 ||%|
|Time deposits||1,055,008 ||1.25 ||%||1,512,841 ||1.22 ||%||2,246,718 ||1.91 ||%|
|$||8,912,452 ||0.85 ||%||$||8,341,373 ||0.37 ||%||$||9,400,033 ||0.90 ||%|
|Total deposits||$||13,946,422 ||0.54 ||%||$||10,815,797 ||0.29 ||%||$||11,336,694 ||0.75 ||%|
1 Based on weighted-average stated interest rates at the end of the period.
2 The total interest-bearing includes brokered deposits of $1,032.7 million as of June 30, 2022, of which $250.0 million are time deposits classified as $250 and under.
The following tables set forth the average balance, the interest expense and the average rate paid on each type of deposit at the end of each of the last three fiscal years:
|For the Fiscal Year Ended June 30,|
|(Dollars in thousands)||Average Balance||Interest Expense||Avg. Rate Paid||Average Balance||Interest Expense||Avg. Rate Paid||Average Balance||Interest Expense||Avg. Rate Paid|
|Demand||$||3,873,382 ||$||12,429 ||0.32 ||%||$||3,817,516 ||$||14,444 ||0.38 ||%||$||2,191,103 ||$||31,882 ||1.46 ||%|
|Savings||2,899,939 ||7,624 ||0.26 ||%||3,387,182 ||14,587 ||0.43 ||%||2,653,597 ||35,001 ||1.32 ||%|
|Time deposits||1,226,774 ||13,567 ||1.11 ||%||1,825,795 ||31,498 ||1.73 ||%||2,482,151 ||60,033 ||2.42 ||%|
|Total interest-bearing deposits||$||8,000,095 ||$||33,620 ||0.42 ||%||$||9,030,493 ||$||60,529 ||0.67 ||%||$||7,326,851 ||$||126,916 ||1.73 ||%|
|Total deposits||$||11,927,290 ||$||33,620 ||0.28 ||%||$||11,212,502 ||$||60,529 ||0.54 ||%||$||9,316,856 ||$||126,916 ||1.36 ||%|
Total deposits that exceeded the FDIC insurance limit of $250 thousand at June 30, 2022 were $2.3 billion. The maturities of certificates of deposit that exceeded the FDIC insurance limit of $250 thousand at June 30, 2022 are as follows:
|(Dollars in thousands)||June 30, 2022|
|3 months or less||$||5,840 |
|3 months to 6 months||2,821 |
|6 months to 12 months||7,057 |
|Over 12 months||13,838 |
The following table shows the maturity dates of our certificates of deposit at the end of each of the last three fiscal years:
|At June 30,|
|(Dollars in thousands)||2022||2021||2020|
|Within 12 months||$||742,804 ||$||1,021,465 ||$||1,079,674 |
|13 to 24 months||155,376 ||214,232 ||540,669 |
|25 to 36 months||141,841 ||125,943 ||180,590 |
|37 to 48 months||9,037 ||138,485 ||132,629 |
|49 months and thereafter||5,950 ||12,716 ||313,156 |
|Total||$||1,055,008 ||$||1,512,841 ||$||2,246,718 |
The following table shows maturities of our time deposits having principal amounts of $100 thousand or more at the end of each of the last three fiscal years:
|Term to Maturity|
|(Dollars in thousands)||Within Three Months||Over Three Months to Six Months||Over Six Months to One Year||Over One Year||Total|
|Fiscal year end|
|June 30, 2022||$||313,508 ||$||151,315 ||$||98,476 ||$||121,411 ||$||684,710 |
|June 30, 2021||469,404 ||163,710 ||140,740 ||175,566 ||949,420 |
|June 30, 2020||487,188 ||94,647 ||321,409 ||469,283 ||1,372,527 |
Our Securities Business consists of two sets of products and services, securities services provided to third-party securities firms and investment management provided to consumers.
Securities services. We offer fully disclosed clearing services through Axos Clearing to FINRA and SEC registered member firms for trade execution and clearance as well as back office services such as record keeping, trade reporting, accounting, general back-office support, securities and margin lending, reorganization assistance, and custody of securities. At June 30, 2022, we provided services to 275 financial organizations, including correspondent broker-dealers and registered investment advisors.
We provide financing to our brokerage customers for their securities trading activities through margin loans that are collateralized by securities, cash, or other acceptable collateral. We earn a spread equal to the difference between the amount we pay to fund the margin loans and the amount of interest income we receive from our customers.
We conduct securities lending activities that include borrowing and lending securities with other broker-dealers. These activities involve borrowing securities to cover short sales and to complete transactions in which clients have failed to deliver securities by the required settlement date, and lending securities to other broker-dealers for similar purposes. The net revenues for this business consist of the interest spreads generated on these activities.
We provide a proprietary, turnkey technology platform for custody services to our registered investment advisor customers. This platform provides fee income and services that complement our securities business products, while also generating low cost core deposits.
We assist our brokerage customers in managing their cash balances and earn a fee through an insured bank deposit cash sweep program.
Through our retail securities business, Axos Invest, we provide our customers with the option of having both self-directed and digital advice services through a comprehensive and flexible technology platform. We have integrated both the digital advice platform and self-directed trading platforms into our universal digital banking platform, creating a seamless user experience and a holistic personal financial management ecosystem. Our digital advice business generates fee income from customers paying an annual fee for advisory services and deposits from cash balances. Our self-directed trading program generates income from traditional transaction charges and fees from customer memberships.
In addition to deposits, we have historically funded our asset growth through advances from the Federal Home Loan Bank of San Francisco (“FHLB”). Our bank can borrow up to 40% of its total assets from the FHLB, and borrowings are collateralized by mortgage loans and mortgage-backed securities pledged to the FHLB. At June 30, 2022, the Company had $117.5 million advances outstanding with an additional $2.0 billion available immediately and an additional $3.9 billion available with additional collateral, for advances from the FHLB for terms up to ten years.
The Bank has federal funds lines of credit with two major banks totaling $175.0 million. At June 30, 2022, the Bank had no outstanding balance on either line.
The Bank can also borrow from the Federal Reserve Bank of San Francisco (“FRBSF”), and borrowings may be collateralized by commercial, consumer and mortgage loans as well as securities pledged to the FRBSF. Based on loans and securities pledged at June 30, 2022, we had a total borrowing capacity of approximately $2.8 billion, none of which was outstanding. The Bank has additional unencumbered collateral that could be pledged to the FRBSF Discount Window to increase borrowing liquidity. Additionally, the Bank can borrow through the Paycheck Protection Program Liquidity Facility (“PPPLF”). The Bank has zero advances outstanding from the Federal Reserve Bank through the Paycheck Protection Program Liquidity Facility, and no Small Business Administration Paycheck Protection Program Loans pledged as of June 30, 2022.
Axos Clearing has $150.0 million uncommitted secured lines of credit available for borrowing. As of June 30, 2022, there was $58.4 million outstanding. These credit facilities bear interest at rates based on the Federal Funds rate and borrowings are due upon demand. The weighted average interest rate on the borrowings at June 30, 2022 was 2.99%.
Axos Clearing has a $175.0 million committed unsecured line of credit available, which includes $100.0 million from Axos Financial, Inc., available for limited purpose borrowing. As of June 30, 2022, there was $53.1 million outstanding after elimination of intercompany balances. This credit facility bears interest at rates based on the Federal Funds rate and borrowings are due upon demand. The unsecured line of credit requires Axos Clearing operate in accordance with specific covenants surrounding capital and debt ratios. Axos Clearing was in compliance with all covenants as of June 30, 2022.
In December 2004, we completed a transaction that resulted in $5.2 million of junior subordinated debentures for our company with a stated maturity date of February 23, 2035. We have the right to redeem the debentures in whole (but not in part) on or after specific dates, at a redemption price specified in the indenture plus any accrued but unpaid interest through the redemption date. Interest accrues at the rate of three-month LIBOR plus 2.4%, for a rate of 3.90% as of June 30, 2022, with interest paid quarterly.
In March 2016, we completed the sale of $51.0 million aggregate principal amount of our 6.25% Subordinated Notes due February 28, 2026 (the “Notes 2026”). We received $51.0 million in gross proceeds as a part of this transaction, before the 3.15% underwriting discount and other offering expenses. The Notes 2026 accrue interest at a rate of 6.25% per annum, with interest payable quarterly. In March 2021, the Company completed the redemption of $51.0 million aggregate principal amount of its Notes 2026. The Notes 2026 were redeemed for cash by the Company at 100% of their principal amount, plus accrued and unpaid interest, in accordance with the terms of the indenture governing the Notes 2026. Remaining unamortized deferred financing costs associated with such notes were expensed and included under Interest Expense - Other Borrowings in the Consolidated Statements of Income.
In January 2019, we issued subordinated notes totaling $7.5 million, to the principal stockholders of COR Securities in an equal principal amount, with a maturity of 15 months, to serve as the sole source of payment of indemnification obligations of the principal stakeholders of COR Securities under the Merger Agreement. Interest accrues at a rate of 6.25% per annum. During the fiscal year ended June 30, 2019, $0.1 million of subordinated loans were repaid. The Company is in the process of making an indemnification claim against the $7.4 million remaining.
In September 2020, the Company completed the sale of $175.0 million aggregate principal amount of its 4.88% Fixed-to-Floating Rate Subordinated Notes due October 1, 2030 (the “Notes 2030”). The Notes 2030 mature on October 1, 2030 and accrue interest at a fixed rate per annum equal to 4.88%, payable semi-annually in arrears on April 1 and October 1 of each year, commencing on April 1, 2021. From and including October 1, 2025, to, but excluding October 1, 2030 or the date of early redemption, the Notes 2030 will bear interest at a floating rate per annum equal to a benchmark rate (which is expected to be the Three-Month Term Secured Overnight Financing Rate) plus a spread of 476 basis points, payable quarterly in arrears on January 1, April 1, July 1 and October 1 of each year, commencing on January 2026. The Notes 2030 may be redeemed on or after October 1, 2025, which date may be extended at the Company’s discretion, at a redemption price equal to principal plus accrued and unpaid interest, subject to certain conditions. Fees and costs incurred in connection with the debt offering amortize to interest expense over the term of the Notes 2030.
In March 2021, we filed a new shelf registration with the SEC, which allows us to issue up to $400.0 million through the sale of debt securities, common stock, preferred stock and warrants.
In February 2022, the Company completed the sale of $150.0 million aggregate principal amount of its 4.0% Fixed-to-Floating Rate Subordinated Notes (the “Notes 2032”). The Notes 2032 are obligations only of Axos Financial, Inc. The Notes 2032 mature on March 1, 2032 and accrue interest at a fixed rate per annum equal to 4.0%, payable semi-annually in arrears on March 1 and September 1 of each year, commencing on September 1, 2022. From and including March 1, 2027, to, but excluding March 1, 2032 or the date of early redemption, the Notes 2032 will bear interest at a floating rate per annum equal to a benchmark rate of the Three-Month Term SOFR plus a spread of 227 basis points, payable quarterly in arrears on March 1, June 1, September 1 and December 1 of each year, commencing on June 1, 2027. The Notes 2032 may be redeemed on or after March 1, 2027, which date may be extended at the Company’s discretion, at a redemption price equal to principal plus accrued and unpaid interest, subject to certain conditions. Fees and costs incurred in connection with the debt offering amortize to interest expense over the term of the Notes 2032.
The table below sets forth the amount of our borrowings, the maximum amount of borrowings in each category during any month-end during each reported period, the approximate average amounts outstanding during each reported period and the approximate weighted average interest rate thereon at or for the last three fiscal years:
|At or For The Fiscal Years Ended June 30,|
|(Dollars in thousands)||2022||2021||2020|
|Advances from the FHLB:|
|Average balance outstanding||$||349,796 ||$||211,077 ||$||747,358 |
|Maximum amount outstanding at any month-end during the period||$||1,360,500 ||$||353,500 ||$||1,462,500 |
|Balance outstanding at end of period||$||117,500 ||$||353,500 ||$||242,500 |
|Average interest rate at end of period||2.26 ||%||1.18 ||%||2.22 ||%|
|Average interest rate during period||1.32 ||%||2.21 ||%||1.60 ||%|
|Paycheck Protection Program Liquidity Facility advances|
|Average balance outstanding||$||— ||$||116,102 ||$||3,092 |
|Maximum amount outstanding at any month-end during the period||— ||151,952 ||151,952 |
|Balance outstanding at end of period||— ||— ||151,952 |
|Average interest rate at end of period||— ||%||— ||%||0.35 ||%|
|Average interest rate during period||— ||%||0.35 ||%||0.35 ||%|
|Borrowings, subordinated notes and debentures:|
|Average balance outstanding||$||310,454 ||$||340,699 ||$||100,560 |
|Maximum amount outstanding at any month-end during the period||$||480,836 ||$||456,380 ||$||162,546 |
|Balance outstanding at end of period||$||562,744 ||$||221,358 ||$||83,837 |
|Average interest rate at end of period||3.86 ||%||4.68 ||%||5.18 ||%|
|Average interest rate during period||4.25 ||%||3.65 ||%||5.60 ||%|
MERGERS AND ACQUISITIONS
From time to time, we undertake acquisitions or similar transactions consistent with our operating and growth strategies. On August 2, 2021 Axos Clearing, LLC, acquired certain assets and liabilities of E*TRADE Advisor Services (“EAS”), the registered investment advisor custody business of Morgan Stanley. This business was rebranded as Axos Advisor Services (“AAS”). AAS adds incremental fee income, a turnkey technology platform used by independent registered investment advisors for trading and custody services, and low-cost deposits that can be used to generate fee income from other bank partners or to fund loan growth at Axos Bank. The purchase price of $54.8 million consisted entirely of cash consideration paid upon acquisition and working capital adjustments. There were no other acquisitions or similar transactions undertaken during fiscal years 2021 and 2020.
Our technology is built on a collection of enterprise and client platforms that have been purchased, developed in-house or integrated with software systems to provide products and services to our customers. The implementation of our technology has been conducted using industry best-practices and using standardized approaches in system design, software development, testing and delivery. At the core of our infrastructure, we have designed and implemented secure and scalable hardware solutions to ensure we meet the needs of our business. Our customer experiences were designed to address the needs of a digital
bank and its customers. Our websites and technology platforms drive our customer-focused and self-service engagement model, reducing the need for human interaction while increasing our overall operating efficiencies. Our focus on internal technology platforms enable continuous automation and secure and scalable processing environments for increased transaction capacity. We intend to continue to improve and adapt technology platforms to meet business objectives and implement new systems with the goal of efficiently enabling our business.
We recognize that information is a critical asset. How information is managed, controlled and protected has a significant impact on the delivery of services. Information assets, including those held in trust, must be protected from unauthorized use, disclosure, theft, loss, destruction and alteration.
We employ a robust information security program to achieve our security objectives. The program is designed to prevent, detect and respond to cyberattacks. We also continue to make significant investments in enhancing our cyber defense capabilities to mitigate the risks from the full spectrum of emerging cybersecurity threats.
INTELLECTUAL PROPERTY AND PROPRIETARY RIGHTS
As part of our strategy to protect and enhance our intellectual property, we rely on a variety of legal protections, including copyrights, trademarks, trade secrets, patents, internet domain names and certain contractual restrictions on solicitation and competition, and disclosure and distribution of confidential and proprietary information. We also undertake measures to control access to and/or disclosure of our trade secrets and other confidential and proprietary information. Policing unauthorized use of our intellectual property, trade secrets and other proprietary information is difficult and litigation may be necessary to enforce our intellectual property rights.
At June 30, 2022, we had 1,335 full-time employees, which does not include seasonal internship employees. None of our employees are represented by a labor union or are subject to a collective bargaining agreement. We have not experienced any work stoppage and consider our relations with our employees to be satisfactory. We offer market-based, competitive wages and benefits in the market where we compete for talent.
We believe in promoting a diverse and inclusive work environment. We believe this is important to recruiting and retaining talent to allow our organization to achieve its goals and objectives.
The safety, health and wellness of our employees is a top priority. In response to the COVID-19 pandemic, we continue to take several actions, including implementing safety measures in buildings and supporting work from home when appropriate.
The market for banking and financial services is intensely competitive, and we expect competition to continue to intensify in the future. The Bank attracts deposits through its banking sales force and online acquisition channels. Competition for those deposits comes from a wide variety of other banks, savings institutions, and credit unions. Money market funds, full-service securities brokerage firms and financial technology companies also compete with us for these funds. The Bank competes for these deposits by offering superior service and a variety of deposit accounts at competitive rates.
In real estate lending, we compete against traditional real estate lenders, including large and small savings banks, commercial banks, mortgage bankers and mortgage brokers. Many of our current and potential competitors have greater brand recognition, longer operating histories, larger customer bases and significantly greater financial, marketing and other resources and are capable of providing strong price and customer service competition. In order to compete profitably, we may need to reduce the rates we offer on loans and investments and increase the rates we offer on deposits, which may adversely affect our overall financial condition and earnings.
In our Securities Business segment, we face significant competition in providing clearing and advisory services based on a number of factors, including price, speed of execution, perceived expertise, quality of advice, reputation, range of services and products, technology, and innovation. There exists significant competition for recruiting and retaining talent. Axos Clearing competes directly with numerous other financial advisory and investment banking firms, broker-dealers and banks, including large national and major regional firms and smaller niche companies, some of whom are not broker-dealers and, therefore, are not subject to the broker-dealer regulatory framework. We separate ourselves from the competition through our excellence in customer service, including a highly attentive and dedicated workforce, while providing an expanding range of clearing and advisory products and services.
SUPERVISION AND REGULATION
We are subject to comprehensive regulation under state and federal laws. This regulation is intended primarily for the protection of our customers, the deposit insurance fund and the U.S. finance system and not for the benefit of our security holders.
Axos Financial, Inc. is supervised and regulated as a savings and loan holding company by the Board of Governors of the Federal Reserve System (the “Federal Reserve”). The Bank, as a federal savings bank, is subject to regulation, examination and supervision by the Office of the Comptroller of the Currency (“OCC”) as its primary regulator, and the Federal Deposit Insurance Corporation (“FDIC”) as its deposit insurer. The Bank must file reports with the OCC and the FDIC and Axos Financial, Inc. with the Federal Reserve, concerning their activities and financial condition. In addition, the Bank is subject to the regulation, examination and supervision by the Consumer Financial Protection Bureau (“CFPB”) with respect to a broad array of federal consumer laws. Our subsidiaries, Axos Clearing LLC and Axos Invest LLC, are broker-dealers and are registered with and subject to regulation by the SEC and FINRA. In addition, Axos Invest, Inc., an investment adviser, is registered with the SEC. Axos Invest, Inc. is subject to the requirements of the Investment Advisers Act of 1940, as amended, and the Investment Company Act of 1940, as amended, and is subject to examination by the SEC.
The following information describes aspects of the material laws and regulations applicable to the Company. The information below does not purport to be complete and is qualified in its entirety by reference to all applicable laws and regulations. In addition, new and amended legislation, rules and regulations governing the Company are introduced from time to time by the U.S. government and its various agencies. Any such legislation, regulatory changes or amendments could adversely affect us and no assurance can be given as to whether, or in what form, any such changes may occur.
REGULATION OF FINANCIAL HOLDING COMPANY.
General. Axos Financial is a unitary savings and loan holding company within the meaning of the Home Owners’ Loan Act (“HOLA”), and is treated as a “financial holding company” under Federal Reserve rules. Accordingly, Axos Financial is registered as a savings and loan holding company with the Federal Reserve and is subject to the Federal Reserve’s regulations, examinations, supervision and reporting requirements. Axos Financial is required to file reports with, comply with the rules and regulations of, and is subject to examination by the Federal Reserve. In addition, the Federal Reserve has enforcement authority over Axos Financial and its subsidiaries. Among other things, this authority permits the Federal Reserve to restrict or prohibit activities that are determined to be a serious risk to the saving and loan holding company or its subsidiaries.
Capital. Our Company and the Bank are subject to the risk-based regulatory capital framework and guidelines established by the Federal Reserve and the OCC. In July 2013, the Federal Reserve and the OCC published final rules (the “Regulatory Capital Rules”) establishing a comprehensive capital framework for U.S. banking organizations. The Regulatory Capital Rules are intended to measure capital adequacy with regard to a banking organization’s balance sheet, including off-balance sheet exposures such as unused portions of loan commitments, letters of credit, and recourse arrangements. The capital requirements for the Company are similar to those for the Bank.
The Regulatory Capital Rules implement the Basel Committee’s December 2010 capital framework known as “Basel III” for strengthening international capital standards as well as certain provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”). The failure of the Company or the Bank to meet minimum capital requirements can result in certain mandatory, and possibly additional discretionary actions by federal banking regulators that could have a material effect on the Company, explained in more detail below under “Regulation of Banking Business – Regulatory Capital Requirements and Prompt Corrective Action”.
The Regulatory Capital Rules require banking organizations (i.e., both the Company and the Bank) to maintain a minimum “common equity Tier 1” (or “CET1”) ratio of 4.5%, a Tier 1 risk-based capital ratio of 6.0%, a total risk-based capital ratio of 8.0%, and a minimum leverage ratio of 4.0% (calculated as Tier 1 capital to average consolidated assets). A capital conservation buffer of 2.5% above each of these levels is required for banking institutions to avoid restrictions on their ability to make capital distributions, including the payment of dividends.
The Regulatory Capital Rules provide for a number of deductions from and adjustments to CET1. In addition, trust preferred securities have been phased out of tier 1 capital for banking organizations that had $15 billion or more in total consolidated assets as of December 31, 2009 unless the banking organization grows above $15.0 billion in assets as a result of an acquisition. The Company’s trust preferred securities currently are grandfathered under this provision. In addition, the Company and the Bank elected the CECL five-year transition guidance for calculating regulatory capital ratios on July 1, 2020
and the June 30, 2022 ratios include this election. This guidance allows an entity to add back to capital 100% of the capital impact from the day one CECL transition adjustment and 25% of subsequent increases to the allowance for credit losses through June 30, 2022. This cumulative amount will then be phased out of regulatory capital over the next three years.
The implementation of certain regulations and standards relating to regulatory capital could disproportionately affect our regulatory capital position relative to that of our competitors, including those that may not be subject to the same regulatory requirements as the Company and the Bank. Various aspects of the Regulatory Capital Rules continue to be subject to further evaluation and interpretation by the U.S. banking regulators.
As of June 30, 2022, the capital ratios of both the Company and the Bank exceeded the minimums necessary to be considered “well-capitalized” under the currently enacted capital adequacy requirements, including after implementation of the deductions and other adjustments to CET1 on a fully phased-in basis. For additional information, please see Note 19 (Minimum Regulatory Capital Requirements) to the financial statements filed with this report.
Source of Strength. The Dodd-Frank Act extends the Federal Reserve “source of strength” doctrine to savings and loan holding companies. Such policy requires holding companies to act as a source of financial strength to their subsidiary depository institutions by providing capital, liquidity and other support in times of an institution’s financial distress. The regulatory agencies have yet to issue joint regulations implementing this policy.
Change in Control. The federal banking laws require that appropriate regulatory approvals must be obtained before an individual or company may take actions to “control” a bank or savings association. The definition of control found in the HOLA is similar to that found in the Bank Holding Company Act of 1956 (“BHCA”) for bank holding companies. Both statutes apply a similar three-prong test for determining when a company controls a bank or savings association. Specifically, a company has control over either a bank or savings association if the company:
•directly or indirectly or acting in concert with one or more persons, owns, controls, or has the power to vote 25% or more of the voting securities of a company;
•controls in any manner the election of a majority of the directors (or any individual who performs similar functions in respect of any company, including a trustee under a trust) of the board; or
•directly or indirectly exercises a controlling influence over the management or policies of the bank.
Regulation LL includes a specific definition of “control” similar to the statutory definition, with certain additional provisions, and modifies the regulations for purposes of determining when a company or natural person acquires control of a savings association or savings and loan holding company under the HOLA or the Change in Bank Control Act (“CBCA”). In light of the similarity between the statutes governing bank holding companies and savings and loan holding companies, the Federal Reserve uses its established rules and processes with respect to control determinations under HOLA and the CBCA to ensure consistency between equivalent statutes administered by the same agency.
Furthermore, the Federal Reserve may not approve any acquisition that would result in a multiple savings and loan holding company controlling savings institutions in more than one state, subject to two exceptions; (i) the approval of interstate supervisory acquisitions by savings and loan holding companies and (ii) the acquisition of a savings institution in another state if the laws of the state of the target savings institution specifically permit such acquisition. The states vary in the extent to which they permit interstate savings and loan holding company acquisitions.
Financial Holding Company. In August 2018 the Company received approval from the Federal Reserve Bank of San Francisco and became a savings and loan holding company that is treated as a financial holding company under the rules and regulations of the Federal Reserve. Financial holding companies are generally permitted to affiliate with securities firms and insurance companies and engage in other activities that are "financial in nature." Such activities include, among other things, securities underwriting, dealing and market making; sponsoring mutual funds and investment companies; insurance underwriting and agency; merchant banking activities; and activities that the Federal Reserve has determined to be closely related to banking. If the Bank ceases to be “well capitalized” or “well managed” under applicable regulatory standards, the Federal Reserve may, among other things, place limitations on our ability to conduct these broader financial activities. In addition, if the Bank receives a rating of less than satisfactory under the Community Reinvestment Act, we would be prohibited from engaging in any additional activities other than those permissible for bank holding companies that are not financial holding companies. If a financial holding company fails to continue to meet any of the prerequisites for financial holding company status, including those described above, the Federal Reserve may order the company to divest its subsidiary banks or discontinue or divest investments in companies engaged in activities permissible only for a bank holding company that has elected to be treated as a financial holding company. No regulatory approval is required for a financial holding company to acquire a company, other than a bank or savings association, engaged in activities that are financial in nature or incidental to activities that are financial in nature, as determined by the Federal Reserve.
Volcker Rule. Under certain provisions of the Dodd-Frank Act known as the Volcker Rule, FDIC-insured depository institutions, their holding companies, subsidiaries and affiliates, are generally prohibited, subject to certain exemptions, from proprietary trading of securities and other financial instruments and from acquiring or retaining an ownership interest in a “covered fund”. The term “covered fund” can include, in addition to many private equity and hedge funds and other entities, certain collateralized mortgage obligations, collateralized debt obligations and collateralized loan obligations, and other items, but does not include wholly owned subsidiaries, certain joint ventures, or loan securitizations generally if the underlying assets are solely loans.
Trading in certain government obligations is not prohibited by the Volcker Rule, including obligations of or guaranteed by the United States or an agency or government-sponsored entity of the United States, obligations of a State of the United States or a political subdivision thereof, and municipal securities. Proprietary trading generally does not include transactions under repurchase and reverse repurchase agreements, securities lending transactions and purchases and sales for the purpose of liquidity management if the liquidity management plan meets specified criteria; nor does it generally include transactions undertaken in a fiduciary capacity. In addition, activities eligible for exemption include, among others, certain brokerage, underwriting and marketing activities, and risk-mitigating hedging activities with respect to specific risks and subject to specified conditions.
In July 2020, the Federal Reserve, FDIC, OCC, SEC, and the Commodity Futures Trading Commission (“CFTC”) finalized a rule modifying the Volcker Rule’s prohibition on banking entities investing in or sponsoring hedge funds or private equity funds (referred to under the rules as covered funds). The final rule streamlines several aspects of the covered funds portion of the rule; allows banking organizations to offer and sponsor venture capital funds and a wider array of loan-related funds; and permits banking entities to offer financial services to, and engage in other activities with, covered funds that do not raise concerns that the Volcker rule was intended to address. The final rule became effective October 1, 2020.
Potential Regulatory Enforcement Actions. If the Federal Reserve or the OCC determines that a saving and loan holding company’s or federal savings bank’s financial condition, capital resources, asset quality, earnings prospects, management, liquidity, or other aspects of its operations are unsatisfactory or that its management has violated any law or regulation, the agency has the authority to take a number of different remedial actions as it deems appropriate under the circumstances. These actions include the power to enjoin any “unsafe or unsound” banking practices; to require that affirmative action be taken to correct any conditions resulting from any violation of law or unsafe or unsound practice; to issue an administrative order that can be judicially enforced; to require that it increase its capital; to restrict its growth; assess civil monetary penalties against it or its officers or directors; and to remove any of its officers and directors.
REGULATION OF BANKING BUSINESS
General. As a federally-chartered savings and loan association whose deposit accounts are insured by the FDIC, Axos Bank is subject to extensive regulation by the OCC and FDIC. The Bank is also subject to regulation by the CFPB with respect to federal consumer financial laws. The following discussion summarizes some of the principal areas of regulation applicable to the Bank and its operations.
Insurance of Deposit Accounts. The FDIC administers a deposit insurance fund (the “DIF”) that insures depositors in certain types of accounts up to a prescribed amount for the loss of any such depositor’s respective deposits due to the failure of an FDIC member depository institution. As the administrator of the DIF, the FDIC assesses its member depository institutions and determines the appropriate DIF premiums to be paid by each such institution. The FDIC is authorized to examine its member institutions and to require that they file periodic reports of their condition and operations. The FDIC may also prohibit any member institution from engaging in any activity the FDIC determines by regulation or order to pose a serious risk to the DIF. The FDIC also has the authority to initiate enforcement actions against savings associations, after giving the primary federal regulator the opportunity to take such action. The FDIC may terminate an institution’s access to the DIF if it determines that the institution has engaged in unsafe or unsound practices or is in an unsafe or unsound condition. We do not know of any practice, condition or violation that might lead to termination of our access to the DIF.
Axos Bank is a member depository institution of the FDIC and its deposits are insured by the DIF up to the applicable limits, which are backed by the full faith and credit of the U.S. Government. The basic deposit insurance limit is $250,000.
Regulatory Capital Requirements and Prompt Corrective Action. The prompt corrective action regulation of the OCC requires mandatory actions and authorizes other discretionary actions to be taken by the OCC against a savings association that falls within undercapitalized capital categories specified in OCC regulations.
In general, the prompt corrective action regulation prohibits an FDIC member institution from declaring any dividends, making any other capital distribution, or paying a management fee to a controlling person if, following the distribution or payment, the institution would be within any of the three undercapitalized categories. In addition, adequately capitalized
institutions may accept brokered deposits only with a waiver from the FDIC, but are subject to restrictions on the interest rates that can be paid on such deposits. Undercapitalized institutions may not accept, renew or roll-over brokered deposits.
If the OCC determines that an institution is in an unsafe or unsound condition, or if the institution is deemed to be engaging in an unsafe and unsound practice, the OCC may, if the institution is well-capitalized, reclassify it as adequately capitalized. If the institution is adequately capitalized, but not well-capitalized, the OCC may require it to comply with restrictions applicable to undercapitalized institutions. If the institution is undercapitalized, the OCC may require it to comply with restrictions applicable to significantly undercapitalized institutions. Finally, pursuant to an interagency agreement, the FDIC can examine any institution that has a substandard regulatory examination score or is considered undercapitalized without the express permission of the institution’s primary regulator.
Capital regulations applicable to savings associations such as the Bank also require savings associations to meet the additional capital standard of tangible capital equal to at least 1.5% of total adjusted assets.
The Bank’s capital requirements are viewed as minimum standards and most financial institutions are expected to maintain capital levels well above the minimum. In addition, OCC regulations provide that minimum capital levels greater than those provided in the regulations may be established by the OCC for individual savings associations upon a determination that the savings association’s capital is or may become inadequate in view of its circumstances. Axos Bank is not subject to any such individual minimum regulatory capital requirement and the Bank’s regulatory capital exceeded all minimum regulatory capital requirements as of June 30, 2022. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources.”
Stress Testing. The Economic Growth, Regulatory Relief, and Consumer Protection Act set the asset threshold for enhanced prudential standards and stress testing at $100 billion of total consolidated assets. Based on asset levels at June 30, 2022, neither the Company nor the Bank are subject to stress test regulations. The federal banking agencies have indicated that the capital planning and risk management practices of financial institutions with total assets less than $100 billion will continue to be reviewed through the regular supervisory process. We plan to continue monitoring our capital consistent with the safety and soundness expectations of the Federal Reserve and will continue to use customized stress testing as part of our capital planning process.
Standards for Safety and Soundness. The federal banking regulatory agencies have prescribed, by regulation, guidelines for all insured depository institutions relating to: (i) internal controls, information systems and internal audit systems; (ii) loan documentation; (iii) credit underwriting; (iv) interest rate risk exposure; (v) asset growth; (vi) asset quality; (vii) earnings; and (viii) compensation, fees and benefits. The guidelines set forth safety and soundness standards that the federal banking regulatory agencies use to identify and address problems at FDIC member institutions before capital becomes impaired. If the OCC determines that the Bank fails to meet any standard prescribed by the guidelines, the OCC may require us to submit to it an acceptable plan to achieve compliance with the standard. OCC regulations establish deadlines for the submission and review of such safety and soundness compliance plans in response to any such determination.
Loans-to-One-Borrower Limitations. Savings associations generally are subject to the lending limits applicable to national banks. With limited exceptions, the maximum amount that a savings association or a national bank may lend to any borrower, including related entities of the borrower, at one time may not exceed 15% of the unimpaired capital and surplus of the institution, plus an additional 10% of unimpaired capital and surplus for loans fully secured by readily marketable collateral. Savings associations are additionally authorized to make loans to one borrower by order of its regulator, in an amount not to exceed the lesser of $30.0 million or 30% of unimpaired capital and surplus for the purpose of developing residential housing, if the following specified conditions are met:
•The savings association is in compliance with its fully phased-in capital requirements;
•The loans comply with applicable loan-to-value requirements; and
•The aggregate amount of loans made under this authority does not exceed 150% of unimpaired capital and surplus.
Qualified Thrift Lender Test. Savings associations must meet a qualified thrift lender, or “QTL,” test. This test may be met either by maintaining a specified level of portfolio assets in qualified thrift investments as specified by the HOLA, or by meeting the definition of a “domestic building and loan association” under the Internal Revenue Code of 1986, as amended, or the “Code”. Qualified thrift investments are primarily residential mortgage loans and related investments, including mortgage related securities. Portfolio assets generally mean total assets less specified liquid assets, goodwill and other intangible assets and the value of property used in the conduct of the Bank’s business. The required percentage of qualified thrift investments under the HOLA is 65% of “portfolio assets” (defined as total assets less: (i) specified liquid assets up to 20% of total assets; (ii) intangibles, including goodwill; and (iii) the value of property used to conduct business). An association must be in compliance with the QTL test or the definition of domestic building and loan association on a monthly basis in nine out of
every 12 months. Savings associations that fail to meet the QTL test will generally be prohibited from engaging in any activity not permitted for both a national bank and a savings association. At June 30, 2022, the Bank was in compliance with its QTL requirement and met the definition of a domestic building and loan association.
Liquidity Standard. Savings associations are required to maintain sufficient liquidity to ensure safe and sound operations. As of June 30, 2022, Axos Bank was in compliance with the applicable liquidity standard.
Transactions with Related Parties. The authority of the Bank to engage in transactions with “affiliates” (i.e., any company that controls or is under common control with it, including the Company and any non-depository institution subsidiaries) is limited by federal law. The aggregate amount of covered transactions with any individual affiliate is limited to 10% of the capital and surplus of the savings institution. The aggregate amount of covered transactions with all affiliates is limited to 20% of a savings institution’s capital and surplus. Certain transactions with affiliates are required to be secured by collateral in an amount and of a type described in federal law. The purchase of low quality assets from affiliates is generally prohibited. Transactions with affiliates must be on terms and under circumstances that are at least as favorable to the institution as those prevailing at the time for comparable transactions with non-affiliated companies. In addition, savings institutions are prohibited from lending to any affiliate that is engaged in activities that are not permissible for bank holding companies, and no savings institution may purchase the securities of any affiliate other than a subsidiary.
The Sarbanes-Oxley Act generally prohibits loans by public companies to their executive officers and directors. However, there is a specific exception for loans by financial institutions, such as the Bank, to its executive officers and directors that are made in compliance with federal banking laws. Under such laws, our authority to extend credit to executive officers, directors, and 10% or more shareholders (“insiders”), as well as entities such persons control, is limited. The law limits both the individual and aggregate amount of loans the Bank may make to insiders based, in part, on its capital position and requires certain board approval procedures to be followed. Such loans are required to be made on terms substantially the same as those offered to unaffiliated individuals and cannot involve more than the normal risk of repayment. There is an exception for loans made pursuant to a benefit or compensation program that is widely available to all employees of the institution and does not give preference to insiders over other employees.
Capital Distribution Limitations. OCC regulations limit the ability of a savings association to make capital distributions, such as cash dividends. These regulations limit the ability of the Bank to pay dividends or other capital distributions to the Company, which in turn may limit our ability to pay dividends, repay debt or redeem or purchase shares of our outstanding common stock. Under these regulations, a savings association may, in circumstances described in those regulations:
•Be required to file an application and await approval from the OCC before it makes a capital distribution;
•Be required to file a notice 30 days before the capital distribution; or
•Be permitted to make the capital distribution without notice or application to the OCC.
Community Reinvestment Act and the Fair Lending Laws. Savings associations have a responsibility under the Community Reinvestment Act and related regulations of the OCC to help meet the credit needs of their communities, including low- and moderate-income neighborhoods. In addition, the Equal Credit Opportunity Act and the Fair Housing Act prohibit lenders from discriminating in their lending practices on the basis of characteristics specified in those statutes. An institution’s failure to comply with the provisions of the Community Reinvestment Act could, at a minimum, result in regulatory restrictions on its activities and the denial of applications for certain expansionary activities. In addition, an institution’s failure to comply with the Equal Credit Opportunity Act and the Fair Housing Act could result in the OCC, other federal regulatory agencies or the Department of Justice, taking enforcement actions against the institution. In the most recent Community Reinvestment Act Report, issued May 2019, the Bank received a ‘Satisfactory’ rating covering calendar years 2016, 2017, and 2018.
Federal Home Loan Bank (“FHLB”) System. The Bank is a member of the FHLB system. Among other benefits, each FHLB serves as a reserve or central bank for its members within its assigned region. Each FHLB is financed primarily from the sale of consolidated obligations of the FHLB system. Each FHLB makes available loans or advances to its members in compliance with the policies and procedures established by the Board of Directors of the individual FHLB. As an FHLB member, the Bank is required to own capital stock in a Federal Home Loan Bank in specified amounts based on either its aggregate outstanding principal amount of its residential mortgage loans, home purchase contracts and similar obligations at the beginning of each calendar year or its outstanding advances from the FHLB.
Activities of Subsidiaries. A savings association seeking to establish a new subsidiary, acquire control of an existing company or conduct a new activity through a subsidiary must provide not less than 30 days prior notice to the FDIC and the OCC and conduct any activities of the subsidiary in compliance with regulations and orders of the OCC. The OCC has the power to require a savings association to divest any subsidiary or terminate any activity conducted by a subsidiary that the OCC
determines to pose a serious threat to the financial safety, soundness or stability of the savings association or to be otherwise inconsistent with sound banking practices.
Consumer Laws and Regulations. The Dodd-Frank Act established the CFPB with broad rule-making, supervisory and enforcement authority over consumer financial products and services, including deposit products, residential mortgages, home-equity loans and credit cards. The CFPB is an independent “watchdog” within the Federal Reserve System with authority to enforce and create (i) rules, orders and guidelines of the CFPB, (ii) all consumer financial protection functions, powers and duties transferred from other federal agencies, such as the Federal Reserve, the OCC, the FDIC, the Federal Trade Commission, and the Department of Housing and Urban Development, and (iii) a long list of consumer financial protection laws enumerated in the Dodd-Frank Act, such as the Electronic Fund Transfer Act, the Consumer Leasing Act of 1976, the Alternative Mortgage Transaction Parity Act of 1982, the Equal Credit Opportunity Act, the Expedited Funds Availability Act, the Truth in Lending Act and the Truth in Savings Act, among many others. The CFPB has broad examination and enforcement authority, including the power to issue subpoenas and cease and desist orders, commence civil actions, hold investigations and hearings and seek civil penalties, as well as the authority to regulate disclosures, mandate registration of any covered person and to regulate what it considers unfair, deceptive, abusive practices.
Depository institutions with more than $10 billion in assets and their affiliates are subject to direct supervision by the CFPB, including any applicable examination, enforcement and reporting requirements the CFPB may establish. As of June 30, 2022, we had $17.4 billion in total assets, placing the Bank under the direct supervision and oversight of the CFPB. The laws and regulations of the CFPB and other consumer protection laws and regulations to which the Bank is subject mandate certain disclosure requirements and regulate the manner in which we must deal with customers when taking deposits from, making loans to, or engaging in other types of transactions with, our customers.
A section of the Dodd-Frank Act, commonly referred to as the Durbin Amendment, reduced the level of interchange fees that could be charged by institutions with greater than $10 billion in total assets. The exemption for small issuers ceases to apply as of July 1st of the year following the calendar year in which the issuer has total consolidated assets of $10 billion or more at calendar year-end. At December 31, 2019, we had total assets in excess of $10 billion. Therefore, as of July 1, 2020, the Durbin Amendment reduced the amount of interchange fees that we can charge and adversely affected our non-interest income. As expected, and previously disclosed, our fee-sharing prepaid card partnerships, including H&R Block, executed their termination rights.
In May 2020, the OCC finalized its “true lender” rule to address the legal uncertainty regarding the effect of a transfer on a loan’s permissible interest rate caused by the Second Circuit’s 2015 decision in Madden v. Midland Funding, LLC. The rule clarified that when a national bank (or federal savings bank, such as the Bank) sells, assigns, or otherwise transfers a loan, the interest permissible before the transfer continues to be permissible after the transfer. On June 30, 2021, President Biden signed a Congressional Review Act resolution repealing the OCC’s true lender rule. The repeal creates uncertainty regarding the ability of nonbank loan purchasers to collect interest on loans originated by a national bank or federal savings bank as originally agreed.
State regulators have been increasingly active in implementing privacy and cybersecurity standards and regulations. Recently, several states have adopted regulations requiring certain financial institutions to implement cybersecurity programs and providing detailed requirements with respect to these programs, including data encryption requirements. Many states have also recently implemented or modified their data breach notification and data privacy requirements. In June 2018, the California legislature passed the California Consumer Privacy Act of 2018 (the “California Privacy Act”), which took effect on January 1, 2020. The California Privacy Act, which covers businesses that obtain or access personal information on California resident consumers, grants consumers enhanced privacy rights and control over their personal information and imposes significant requirements on covered companies with respect to consumer data privacy rights.
New laws or changes to existing laws, including privacy-related enforcement activity, increase our operating and compliance costs (including technology costs) and could reduce income from certain business initiatives or restrict our ability to provide certain products and services. Our failure to comply with privacy, data protection and information security laws could result in potentially significant regulatory or governmental investigations or actions, litigation, fines, sanctions, and damage to our reputation, which could have a material adverse effect on our business, financial condition or results of operations.
Bank Secrecy Act and Anti-Money Laundering
The Bank, its affiliated broker-dealers and in certain cases Axos Financial, Inc., are subject to the Bank Secrecy Act and other anti-money laundering laws and regulations, including the USA PATRIOT Act. The Bank Secrecy Act requires all financial institutions to, among other things, establish a risk-based system of internal controls reasonably designed to prevent money laundering and the financing of terrorism. The Bank Secrecy Act includes various record keeping and reporting requirements such as cash transaction and suspicious activity reporting as well as due diligence requirements. The USA PATRIOT Act gives the federal government broad powers to address terrorist threats through enhanced domestic security measures, expanded surveillance powers, increased information sharing, and broadened anti-money laundering requirements. Failure of a financial institution to maintain and implement adequate programs to combat money laundering and terrorist financing could have serious legal and reputational consequences for the institution.
Office of Foreign Assets Control Regulation
The Bank and its affiliated broker-dealers are also required to comply with the U.S. Treasury’s Office of Foreign Assets Control imposed economic sanctions that affect transactions with designated foreign countries, nationals, individuals, entities and others. These are typically known as the “OFAC” rules, based on their administration by the U.S. Treasury Department Office of Foreign Assets Control. The OFAC-administered sanctions targeting countries take many different forms. Generally, however, they contain one or more of the following elements: (i) restrictions on trade with, or investment in, a sanctioned country, including prohibitions against direct or indirect imports from, and exports to, a sanctioned country and prohibitions on “U.S. persons” engaging in financial transactions relating to making investments in, or providing investment-related advice or assistance to, a sanctioned country; and (ii) a blocking of assets in which the government or specially designated nationals of the sanctioned country have an interest, by prohibiting transfers of property subject to U.S. jurisdiction (including property in the possession or control of U.S. persons). Blocked assets (e.g., property and bank deposits) cannot be paid out, withdrawn, set off, or transferred in any manner without a license from OFAC. Failure to comply with these sanctions could have serious legal and reputational consequences.
REGULATION OF SECURITIES BUSINESS
Out correspondent clearing and custodial firm Axos Clearing and Axos Invest introducing broker are broker-dealers registered with the SEC and members of FINRA and various other self-regulatory organizations. Axos Clearing also uses various clearing organizations, including the Depository Trust Company, the National Securities Clearing Corporation, and the Options Clearing Corporation.
Our broker-dealers are registered with the SEC, FINRA, all 50 U.S. states and the District of Columbia. Much of the regulation of broker-dealers, however, has been delegated to self-regulatory organizations, principally FINRA, the Municipal Securities Rulemaking Board or national securities exchanges. These self-regulatory organizations adopt rules (which are subject to approval by the SEC) for governing their members and the industry. Broker-dealers are also subject to federal regulation and the securities laws of each state where they conduct business. Our broker-dealers are members of, and are primarily subject to regulation, supervision and regular examination by FINRA.
Broker-dealers are subject to extensive laws, rules and regulations covering all aspects of the securities business, including sales and trading practices, public offerings, publication of research reports, use and safekeeping of clients’ funds and securities, capital adequacy, record keeping and reporting, the conduct of directors, officers, and employees, qualification and licensing of supervisory and sales personnel, marketing practices, supervisory and organizational procedures intended to ensure compliance with securities laws and to prevent improper trading on material nonpublic information, limitations on extensions of credit in securities transactions, clearance and settlement procedures, and rules designed to promote high standards of commercial honor and just and equitable principles of trade. Broker-dealers are also regulated by state securities administrators in those jurisdictions where they do business. Regulators may conduct periodic examinations and review reports of our operations, controls, supervision, performance, and financial condition. Our broker-dealers’ margin lending is regulated by the Federal Reserve Board’s restrictions on lending in connection with client purchases and short sales of securities, and FINRA rules also require our broker-dealers to impose maintenance requirements based on the value of securities contained in margin accounts. The rules of the Municipal Securities Rulemaking Board, which are enforced by the SEC and FINRA, apply to the municipal securities activities of Axos Clearing, and the Axos Invest broker-dealer.
Violations of laws, rules and regulations governing a broker-dealer’s actions could result in censure, penalties and fines, the issuance of cease-and-desist orders, the restriction, suspension, or expulsion from the securities industry of such broker-dealer, its registered representatives, officers or employees, or other similar adverse consequences.
Significant new rules and regulations continue to arise as a result of the Dodd-Frank Act, including the implementation of a more stringent fiduciary standard for broker-dealers and increased regulation of investment advisers.
Compliance with these provisions could result in increased costs. Moreover, to the extent the Dodd-Frank Act affects the operations, financial condition, liquidity, and capital requirements of financial institutions with whom we do business, those institutions may seek to pass on increased costs, reduce their capacity to transact, or otherwise present inefficiencies in their interactions with us.
Limitation on Businesses. The businesses that our broker-dealers may conduct are limited by its agreements with, and its oversight by, FINRA, other regulatory authorities and federal and state law. Participation in new business lines, including trading of new products or participation on new exchanges or in new countries often requires governmental and/or exchange approvals, which may take significant time and resources. In addition, our broker-dealers are operating subsidiaries of Axos, which means their activities may be further limited by those that are permissible for subsidiaries of financial holding companies, and as a result, may be prevented from entering new businesses that may be profitable in a timely manner, if at all.
Net Capital Requirements. The SEC, FINRA and various other regulatory authorities have stringent rules and regulations with respect to the maintenance of specific levels of net capital by regulated entities. Rule 15c3-1 of the Exchange Act (the “Net Capital Rule”) requires that a broker-dealer maintain minimum net capital. Generally, a broker-dealer’s net capital is net worth plus qualified subordinated debt less deductions for non-allowable (or non-liquid) assets and other adjustments and operational charges. At June 30, 2022, our broker-dealers were in compliance with applicable net capital requirements.
The SEC, FINRA and other regulatory organizations impose rules that require notification when net capital falls below certain predefined thresholds. These rules also dictate the ratio of debt-to-equity in the regulatory capital composition of a broker-dealer, and constrain the ability of a broker-dealer to expand its business under certain circumstances. If a broker-dealer fails to maintain the required net capital, it may be subject to penalties and other regulatory sanctions, including suspension or revocation of registration by the SEC or applicable regulatory authorities, and suspension or expulsion by these regulators could ultimately lead to the broker-dealer’s liquidation. Additionally, the Net Capital Rule and certain FINRA rules impose requirements that may have the effect of prohibiting a broker-dealer from distributing or withdrawing capital and requiring prior notice to, and approval from, the SEC and FINRA for certain capital withdrawals.
Compliance with the net capital requirements may limit our operations, requiring the intensive use of capital. Such rules require that a certain percentage of a broker-dealer’s assets be maintained in relatively liquid form and therefore act to restrict our ability to withdraw capital from our broker-dealer entities, which in turn may limit our ability to pay dividends, repay debt or redeem or purchase shares of our outstanding common stock. Any change in such rules or the imposition of new rules affecting the scope, coverage, calculation or amount of capital requirements, or a significant operating loss or any unusually large charge against capital, could adversely affect our ability to pay dividends, repay debt, meet our debt covenant requirements or to expand or maintain our operations. In addition, such rules may require us to make substantial capital contributions into one or more of the our broker-dealers in order for such subsidiaries to comply with such rules, either in the form of cash or subordinated loans made in accordance with the requirements of all applicable net capital rules.
Customer Protection Rule. Our broker-dealers that hold customers’ funds and securities are subject to the SEC’s customer protection rule (Rule 15c3-3 under the Exchange Act), which generally provides that such broker-dealers maintain physical possession or control of all fully-paid securities and excess margin securities carried for the account of customers and maintain certain reserves of cash or qualified securities.
Securities Investor Protection Corporation (“SIPC”). Our broker-dealers are subject to the Securities Investor Protection Act and belong to SIPC, whose primary function is to provide financial protection for the customers of failing brokerage firms. SIPC provides protection for customers up to $500,000, of which a maximum of $250,000 may be in cash.
Anti-Money Laundering. Our broker-dealers must also comply with the USA PATRIOT Act and other rules and regulations, including FINRA requirements, designed to fight international money laundering and to block terrorist access to the U.S. financial system. We are required to have systems and procedures to ensure compliance with such laws and regulations.
Axos Financial, Inc. files reports, proxy and information statements and other information electronically with the SEC. You may read and copy any materials that we file with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549. Information may be obtained on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC. The SEC’s website site address is http://www.sec.gov. Our web site address is http://www.axosfinancial.com, and we make our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K and amendments thereto available on our website free of charge.
ITEM 1A. RISK FACTORS
An investment in our common stock is subject to risks inherent in our business. Before making an investment decision, you should carefully consider the risks and uncertainties described below together with all of the other information included in this report. In addition to the risks and uncertainties described below, other risks and uncertainties not currently known to us or that we currently deem to be immaterial may also materially and adversely affect our business, financial condition and results of operations. Risks disclosed in this section may have already materialized. The value or market price of our common stock could decline due to any of these identified or other risks, and you could lose all or part of your investment. This Annual Report on Form 10-K is qualified in its entirety by these risk factors.
Risks Relating to Macroeconomic Conditions
Changes in interest rates could adversely affect our performance.
Our results of operations depend to a great extent on our net interest income, which is the difference between the interest rates earned on interest-earning assets such as loans and investment securities, and the interest rates paid on interest-bearing liabilities such as deposits and borrowings. We are exposed to interest rate risk because our interest-earning assets and interest-bearing liabilities do not react uniformly or concurrently to changes in interest rates, as the two have different time periods for adjustment and can be tied to different measures of rates. Interest rates are sensitive to factors that are beyond our control, including domestic and international economic conditions, including inflation, and the policies of various governmental and regulatory agencies, including the Federal Reserve. The monetary policies of the Federal Reserve, implemented through open market operations, the federal funds rate targets, the discount rate for banking borrowings and reserve requirements, affect prevailing interest rates. A material change in any of these policies could have a material impact on us or our customers (including borrowers), and therefore on our results of operations. Since maintaining a federal funds rate target in the range of 0% to 0.25% from March 2020 through 2021, the Federal Reserve made multiple rate increases during 2022 including increasing the target federal funds rate by 75 basis points to a range of 1.50% to 1.75% as of June 2022 and has indicated it anticipates further rate increases due to high rates of inflation.
Loan originations and repayment rates tend to increase with declining interest rates and decrease with rising interest rates. On the deposit side, increasing interest rates generally lead to interest rate increases on our deposit accounts. We manage the sensitivity of our assets and liabilities. However, large, unanticipated, or rapid increases in market interest rates may have an adverse impact on our net interest income and could decrease our mortgage refinancing business and related fee income, and could cause an increase in delinquencies and non-performing loans and leases in our adjustable-rate loans. In addition, interest rate volatility can affect the value of our loans and leases, investments and other interest-rate sensitive assets and our ability to realize gains on the sale or resolution of these assets. There can be no assurance that we will be able to successfully manage our interest rate risk.
A significant economic downturn could result in increases in our level of non-performing loans and leases and/or reduce demand for our products and services, which could have an adverse effect on our results of operations.
Our business and results of operations are affected by the financial markets and general economic conditions, including factors such as the level and volatility of interest rates, inflation, home prices, unemployment and under-employment levels, bankruptcies, household income and consumer spending. While the national economy and most regions have improved since the onset of the COVID-19 pandemic, we now operate in an uncertain economic environment due to, among other things, the continuing effects of the COVID-19 pandemic, in addition to a variety of other reasons for economic uncertainty, including but not limited to trade policies and tariffs, geopolitical tensions, including escalating military tensions in Europe as a result of Russia’s invasion of Ukraine, concerns about high inflation, rising interest rates, the national debt, the stability of the European Union (“EU”), including Britain’s exit from the EU, and volatile energy prices. The risks associated with our business become more acute in periods of a slowing economy or slow growth. Recessionary conditions, high unemployment or potential negative events in the housing markets, including significant and continuing home price declines and increased delinquencies and foreclosures, would adversely affect our mortgage and construction loans and result in increased asset write-downs. While we take steps to decrease and limit our exposure to problem loans, we nonetheless retain direct exposure to the residential and commercial real estate markets. Declines in real estate values, or an economic downturn and an increase in unemployment levels may result in higher than expected loan and lease delinquencies and a decline in demand for our products and services. Furthermore, given our high concentration of loans secured by real estate in California, the Company remains specifically susceptible to a downturn in California’s economy. These negative events may cause us to incur losses and may adversely affect our capital, financial condition and results of operations.
The weakness of other financial institutions could adversely affect us.
Our ability to engage in routine funding transactions could be adversely affected by the actions and commercial soundness of other financial institutions. Financial services institutions are interrelated as a result of trading, clearing, counterparty and other relationships. We have exposure to many different counterparties, and we routinely execute transactions with counterparties in the financial industry, including brokers-dealers, other commercial banks, investment banks, mutual and hedge funds, and other financial institutions. As a result, defaults by, or even rumors or questions about, one or more financial services institutions, or the financial services industry generally, could lead to market-wide liquidity problems and losses or defaults by us or by other institutions and organizations. Many of these transactions expose us to credit risk in the event of default of our counterparty or client. In addition, our credit risk may be exacerbated when the collateral held by us cannot be liquidated or is liquidated at prices not sufficient to recover the full amount of the financial instrument exposure due to us. There is no assurance that any such losses would not materially and adversely affect our results of operations.
Replacement of the LIBOR benchmark interest rate may have an impact on our business, financial condition or results of operations.
On July 27, 2017, the Financial Conduct Authority (“FCA”), a regulator of financial services firms in the United Kingdom, announced that it intends to stop persuading or compelling banks to submit LIBOR rates after 2021. On November 30, 2020 to facilitate an orderly LIBOR transition, the OCC, the FDIC, and the Federal Reserve jointly announced that entering into new contracts using LIBOR as a reference rate after December 31, 2021 would create a safety and soundness risk. On March 5, 2021, the FCA announced that all LIBOR settings will either cease to be provided by any administrator or no longer be representative immediately after December 31, 2021, in the case of 1-week and 2-month U.S. dollar LIBOR, and immediately after June 30, 2023, in the case of the remaining U.S. dollar LIBOR settings. In the United States, efforts to identify a set of alternative U.S. dollar reference interest rates are ongoing, and the Alternative Reference Rate Committee (“ARRC”) has recommended the use of SOFR.
On March 15, 2022, President Biden signed into law the Consolidated Appropriations Act of 2022, which among other things, provides for the use of interest rates based on SOFR in certain contracts currently based on LIBOR and a safe harbor from liability for utilizing SOFR-based interest rates as a replacement for LIBOR.
Generally, all loans we originated since 2017 have contract language that allow us to replace LIBOR with an alternative index. All of our variable rate mortgage loans underwritten for the U.S. Government Agencies (FNMA, FHLMC & FHA/VA) after December 31, 2020 have used SOFR as the benchmark index. All other variable rate loans approved after December 31, 2021 do not use LIBOR as the benchmark index and have instead used primarily SOFR, Ameribor or BSBY (“Bloomberg Short-Term Bank Yield Index”) as the benchmark index. As of June 30, 2022, there is approximately $9.1 billion, or approximately 64%, of the outstanding balance in our total loan portfolio leveraging LIBOR as the benchmark index. While some LIBOR loans will mature or prepay, a significant portion of our loans will remain and will likely require us to name a replacement index before June 30, 2023, the date LIBOR ceases. We are currently in the process of preparing borrower communications.
Given the inherent differences between LIBOR and SOFR, or any other alternative benchmark rate that may be established, there are many uncertainties regarding a transition from LIBOR, including but not limited to the need to amend all contracts with LIBOR as the referenced rate. We continue to evaluate how this will impact the interest income we earn on our loans currently using LIBOR as a benchmark index, and what the impact of such a transition will have on our business, financial condition, or results of operations, and to develop and implement plans to mitigate the risks associated with the expected discontinuation of LIBOR, including negotiating certain of our agreements on established alternative benchmark rates. The market transition away from LIBOR to an alternative reference rate is complex and could have a range of adverse effects on our business, financial condition and results of operations. In particular, any such transition could:
•adversely affect the interest rates paid or received on, the revenue and expenses associated with, and the value of our floating-rate obligations, loans, deposits, derivatives, and other financial instruments tied to LIBOR rates, or other securities or financial arrangements given LIBOR’s role in determining market interest rates globally;
•prompt inquiries or other actions from regulators in respect of our preparation and readiness for the replacement of LIBOR with an alternative reference rate;
•require extensive changes to the contracts that govern these LIBOR-based products;
•result in disputes, litigation or other actions with counterparties regarding the interpretation and enforceability of certain fallback language in LIBOR-based securities;
•require the transition to or development of appropriate systems and analytics to effectively transition our risk management processes from LIBOR-based products to those based on the applicable alternative pricing benchmark; and
•impact our pricing and interest rate risk models, our loan product structures, our funding costs, our valuation tools and result in increased compliance and operational costs.
Risks Related to COVID-19
The outbreak of COVID-19 has impacted our business and could adversely affect our business activities, financial condition and results of operations.
The COVID-19 pandemic has created global and domestic economic and financial disruptions which could adversely affect our business operations, asset valuations, and financial results in the future. In addition, we also face an increased risk of client disputes, litigation and governmental and regulatory scrutiny as a result of the effects of COVID-19 on market and economic conditions and actions governmental authorities take in response to those conditions, including moratoria and other suspensions of collections, foreclosures, and related obligations.
The Company continues to monitor the ongoing impact on our business, financial condition, liquidity and results of operations, including future developments and uncertainties beyond the Company’s control. Because there have been no comparable recent pandemics that resulted in a similar global impact, the full extent to which the COVID-19 pandemic will impact our business operations, asset valuations and financial results will depend on future developments which remain uncertain and cannot be predicted, including the scope and duration of the pandemic, including new strains of the virus, the efficacy and distribution of, and participation in, vaccination programs, the continued effectiveness of our business continuity plan, the direct and indirect impact of the pandemic on our employees, customers and third-party service providers, as well as other market participants, and the effectiveness of actions taken by governmental authorities and other third parties in response to the pandemic.
The ultimate economic impacts to the Company of the evolving COVID-19 pandemic are uncertain and difficult to predict and could adversely impact our business, financial condition and results of operations.
Risks Relating to Regulation of our Business
Changes in laws, regulations or oversight or increased enforcement activities by regulatory agencies may increase our costs and adversely affect our business and operations.
We operate in a highly regulated industry and are subject to oversight, regulation and examination by federal and/or state governmental authorities under various laws, regulations and policies, which impose requirements or restrictions on our operations, capitalization, payment of dividends, mergers and acquisitions, investments, loans and interest rates charged and interest rates paid on deposits. We must also comply with federal anti-money laundering, bank secrecy, tax withholding and reporting, and various consumer protection statutes and regulations. A considerable amount of management time and resources is devoted to oversight of, and development and implementation of controls and procedures relating to, compliance with these laws, regulations and policies.
The laws, regulation and supervisory policies applicable to us are subject to regular modification and change. New or amended laws, rules and regulations could impact our operations, increase our capital requirements or substantially restrict our growth and adversely affect our ability to operate profitably by making compliance much more difficult or expensive, restricting our ability to originate or sell loans, or further restricting the amount of interest or other charges or fees earned on loans or other products. In addition, further regulation could increase the assessment rate we are required to pay to the FDIC, adversely affecting our earnings. It is very difficult to predict future changes in regulation or the competitive impact that any such changes would have on our business. Any new laws, rules and regulations could make compliance more difficult, expensive, costly to implement or may otherwise adversely affect our business, financial condition or growth prospects. Other changes to statutes, regulations, or regulatory policies, including changes in interpretation or implementation of statutes, regulations, or policies, could affect us in substantial and unpredictable ways including subjecting us to additional costs, limiting the types of financial services and products we may offer, and increasing the ability of non-banks to offer competing financial services and products.
In addition, the federal Bank Secrecy Act, the USA PATRIOT Act, and similar laws and regulations require financial institutions, among other duties, to institute and maintain effective anti-money laundering programs and to file suspicious activity and currency transaction reports as appropriate. The Financial Crimes Enforcement Network (“FinCEN”), a bureau of the United States Department of Treasury, is authorized to impose significant civil money penalties for violations of those
requirements and has engaged in coordinated enforcement efforts with the individual federal banking regulators, as well as the U.S. Department of Justice, Drug Enforcement Administration and the Internal Revenue Service. There is also increased scrutiny of compliance with the rules enforced by the Office of Foreign Assets Control (“OFAC”). Federal and state bank regulators also have focused on compliance with the Bank Secrecy Act and anti-money laundering regulations. If our policies, procedures and systems are deemed deficient, we would be subject to liability, including fines and regulatory actions such as restrictions on our ability to pay dividends and the necessity to obtain regulatory approval to proceed with acquisitions and other strategic transactions, which could negatively impact our business, financial condition, results of operations and prospects. Failure to maintain and implement adequate programs to combat money laundering and terrorist financing could also have material adverse reputational consequences for us.
Our failure to comply with current, or adapt to new or changing, laws, regulations or policies could result in enforcement actions and sanctions against us by regulatory agencies, civil money penalties and/or reputation damage, along with corrective action plans required by regulatory agencies, any of which could have a material adverse effect on our business, financial condition and results of operations, and the value of our common stock.
Our broker-dealer and investment advisory businesses subjects us to regulatory risks.
Our broker-dealer and investment advisory business subjects us to regulation by the SEC, FINRA and other SROs and state securities commissions, among other regulatory bodies. Violations of the laws and regulations governed by these agencies could result in censure, penalties and fines, the issuance of cease-and-desist orders, the restriction, suspension, or expulsion from the securities industry of the company or its officers or employees, or other similar adverse consequences, any of which could cause us to incur losses and adversely affect our capital, financial condition and results of operations. The SEC, FINRA and other SROs and state securities commissions, among other regulatory bodies, can censure, fine, issue cease-and-desist orders or suspend or expel a broker-dealer or any of its officers or employees. Clearing securities firms are subject to substantially more regulatory control and examination than introducing brokers that rely on others to perform clearing functions. Similarly, the attorney general of each state could bring legal action to ensure compliance with state securities laws, and regulatory agencies in foreign countries have similar authority. Our ability to comply with multiple laws and regulations pertaining to the securities industry depends in large part on our ability to establish and maintain an effective compliance function. The failure to establish and enforce reasonable compliance procedures, even if unintentional, could subject us to significant losses or disciplinary or other actions. Federally registered investment advisers are regulated and subject to examination by the SEC. In addition, the Advisers Act imposes numerous obligations on our investment advisory business, including fiduciary duties, disclosure obligations, recordkeeping and reporting requirements, marketing restrictions and general anti-fraud prohibitions. Our failure to comply with the Advisers Act and associated rules and regulations of the SEC could subject us to enforcement proceedings and sanctions for violations, including censure or termination of SEC registration, litigation and reputational harm. In addition, our investment advisory business is subject to notice filings and the anti-fraud rules of state securities regulators. See “Regulation of Securities Business.”
Policies and regulations enacted by the Consumer Financial Protection Bureau may negatively impact our residential mortgage loan business and compliance risk.
Our consumer business, including our mortgage and deposit businesses, may be adversely affected by the policies enacted or regulations adopted by the CFPB, which, under the Dodd-Frank Act, has broad rule-making authority over consumer financial products and services. The CFPB is in the process of reshaping consumer financial protection laws through rule-making and enforcement against unfair, deceptive and abusive acts or practices. The CFPB has broad rule-making authority to administer and carry out the provisions of the Dodd-Frank Act with respect to financial institutions that offer covered financial products and services to consumers. The CFPB has also been directed to write rules identifying practices or acts that are unfair, deceptive or abusive in connection with any transaction with a consumer for a consumer financial product or service, or the offering of a consumer financial product or service. The prohibition on “abusive” acts or practices is being clarified each year by CFPB enforcement actions and opinions from courts and administrative proceedings. In January 2014, a series of final rules issued by the CFPB to implement provisions in the Dodd-Frank Act related to mortgage origination and servicing went into effect and caused an increase in the cost of originating and servicing residential mortgage loans. While it is difficult to quantify any future increases in our regulatory compliance burden, the costs associated with regulatory compliance, including the need to hire additional compliance personnel, may continue to increase.
Risks Relating to Mortgage Loans and Mortgage-Backed Securities
Declining real estate values, particularly in California, could reduce the value of our loan and lease portfolio and impair our profitability and financial condition.
The majority of the loans in our portfolio are secured by real estate. At June 30, 2022, approximately 45.4% of our mortgage portfolio was secured by real estate located in California. In recent years, there has been significant volatility in real estate values in California. If real estate values decrease or more of our borrowers experience financial difficulties, we will experience increased charge-offs, as the proceeds resulting from foreclosure may be significantly lower than the amounts outstanding on such loans. In addition, declining real estate values frequently accompany periods of economic downturn or recession and increasing unemployment, all of which can lead to lower demand for mortgage loans of the types we originate. A decline of real estate values or decline of the credit position of our borrowers in California would have a material adverse effect on our business, prospects, financial condition and results of operations.
Many of our mortgage loans are multifamily residential loans and defaults on such loans would harm our business.
At June 30, 2022, our multifamily residential loans were $2,085.1 million or 15% of our loan portfolio. The payment on such loans is typically dependent on the cash flows generated by the projects, which are affected by the supply and demand for multifamily residential units and commercial property within the relative market. If the market for multifamily residential units and commercial property experiences a decline in demand, multifamily and commercial borrowers may suffer losses on their projects and be unable to repay their loans. If residential housing values were to decline or nationwide unemployment levels rise, we are likely to experience increases in the level of our non-performing loans and foreclosures in future periods.
A decrease in the mortgage buying activity of Fannie Mae, Freddie Mac, and MBS’s guaranteed by Ginnie Mae or a failure by Fannie Mae, Ginnie Mae, and Freddie Mac to satisfy their obligations with respect to their RMBS could have a material adverse effect on our business, financial condition and results of operations.
During the last three fiscal years we have sold approximately $2.8 billion of residential mortgage loans to Fannie Mae and Freddie Mac and into MBS’s guaranteed by Ginnie Mae. As of June 30, 2022, approximately 9.6% of our securities portfolio consisted of RMBS issued or guaranteed by these GSEs. Since 2008, Fannie Mae and Freddie Mac have been in conservatorship, with its primary regulator, the Federal Housing Finance Agency, acting as conservator. The United States government may enact structural changes to one or more of the GSEs, including privatization, consolidation and/or a reduction in the ability of GSEs to purchase mortgage loans or guarantee mortgage obligations. We cannot predict if, when or how the conservatorships will end, or what associated changes (if any) may be made to the structure, mandate or overall business practices of either of the GSEs. Accordingly, there continues to be uncertainty regarding the future of the GSEs, including whether they will continue to exist in their c