Axos Financial, Inc.

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 4/5

Axos Financial, Inc. is a diversified financial services company that operates a digital banking platform and provides a range of lending and banking services, including mortgage, commercial, and consumer loans.

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The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Axos Financial, Inc. (AX) primarily operates as a digital bank, offering a wide range of financial services without relying on a large physical branch network. This business model aims to leverage lower operating costs, which has been a growing trend in the financial service industry.

Business Overview

Axos Financial operates through two primary business segments: Banking Business and Securities Business. It caters to a diverse range of customers, including commercial, retail, and institutional clients.

  • Banking Business: This segment includes lending activities such as commercial real estate, single-family mortgage, and commercial loans; deposit activities including commercial, retail, and money-market deposit accounts; and fee-based services including banking and cash management solutions for small to medium sized businesses.
  • Securities Business: Primarily provides clearing and custody services, which involves the administration of customer accounts, securities trading and settlement services and also operates an online trading platform for its clients.

While the Bank’s focus is mainly on lending, the interest revenue is not entirely from core lending products. They have a significant amount of loans held for investment which are also a contributor to the revenue along with cash and cash equivalents and investment securities.

  • Digital Banking: The shift towards digital banking is a powerful tailwind for Axos, as it aligns with its business model. This trend also represents an increased competitive intensity, with various fintech companies and established banks bolstering their online offerings.
  • Interest Rates: As a lender, the interest rate environment has a major effect on Axos’ profitability, as can be seen in their most recent results. Rising rates usually increase net interest income, but can also increase the risk of loan defaults.
  • Regulatory Scrutiny: Banks face stringent regulatory oversight and changing standards that they must adjust to, and the banking industry is often subject to new regulations and rules. As such, complying with regulatory frameworks becomes a significant part of their operational strategy.

The banking industry is highly competitive with incumbents and emerging FinTech companies. Digital banks like Axos have advantages of lower operating costs but have to compete with established players’ loyal customer base and wide-ranging product offerings.

Competitive Landscape

Axos’ competitive landscape is characterized by a mix of traditional banks and emerging fintech competitors. It competes with these entities in both the lending and deposit gathering business. Some major competitors include:

  • Large banks with a substantial physical presence.
  • Other online-only banks and fintech companies
  • Financial institutions focusing on specific industries, like real estate lending.

What Makes Axos Different?

Axos has managed to differentiate itself from other banks through its focus on online offerings and customer service. Other aspects that make it different are:

  • Diversified Loan Portfolio: Unlike many institutions which may be specialized in a particular segment like mortgages, it has a wider range of loan products.
  • Low-Cost Business Model: Focus on online banking helps them generate better profitability due to the limited requirement for physical branches.
  • Client Relationships: Emphasis on quality services and maintaining long-term client relationships helps provide it stable cash flows.

Moat Rating: 2/5

Axos has a narrow moat based on cost advantage stemming from the limited need for a large physical branch network. Some aspects like customer lock-in and scale might also provide a minor advantage. However, the bank faces intense competition, regulatory scrutiny, and the constant need to keep on building technological capabilities. As such the moat cannot be classified as durable and strong.

  • Intangible Assets: Limited Brand recognition is an issue. While their customers are loyal, they do not have the brand power that helps companies generate pricing power.
  • Switching Costs: Some customers are reluctant to move due to the hassle involved, but the costs of transferring bank accounts are not substantial. Therefore, it’s not a strong source of moat.
  • Network Effect: There is very little network effect in the banking industry.
  • Cost Advantages: This is Axos’ strongest source of competitive advantage. Operating without an expansive network of physical branches helps them reduce operating costs.
  • Scale: The company operates more efficiently as its scale of operations increases.

The regulatory scrutiny on banks is ever-increasing and might impose new restrictions and rules, making it necessary for Axos to change and adapt its operating style. Also, newer regulations may increase compliance costs, affecting the profit margins and the overall financial position of the bank.

Financial Performance

Here is a financial summary of Axos financial performance based on the reports made available. These figures are based on the consolidated financials for the period ended December 31, 2023 (and where mentioned, for earlier periods):

  • Revenue: Net Interest Income was $175.1 million for the three months ended Dec 31, 2023.
  • Profitability: The company has a strong operating history with profitability and strong earnings, but they have been affected by one-time expenses as well as interest rate increases in recent times. Net income was $49.7 million for the three months ended Dec 31, 2023.
  • Margins: Net interest margin for the quarter ended December 31, 2023, was 4.29%.
  • Growth: The company has expanded its lending book and deposits consistently over the past several years.

Interest income has a huge positive impact on the bank’s performance, as increases in interest rates increase the interest revenues the bank is able to earn on its loan portfolios. However, it also needs to be mentioned that interest rate increases increase borrowing costs for businesses, which can impact loan volumes negatively. A stable interest rate environment is optimal for both the bank and its clientele.

  • ROIC: The most recent ROIC, as determined by looking at the available data for the last four quarters is 12.8%, which is good. This implies that they are able to earn more than their cost of capital.

Balance Sheet Health: 4/5

Axos has a good balance sheet which indicates a positive sign, but some areas of concern also exist that should be given attention.

  • Capital Adequacy: The company has strong capital levels with a total capital ratio of 14.8% which far exceeds the regulatory standards. Additionally, Tier 1 Leverage ratio is 9.99% which is healthy.
  • Liquidity: Loan-to-deposit ratio for the company is good with the total loan balances to 107.9% of total deposits, but a lot of it is used for acquiring and funding new loans and investment activities.
  • Asset Quality: Nonperforming loans (NPL) have increased year over year, although it’s still within a manageable range. A rising NPL level is something that should be closely monitored by management, as it impacts their profitability significantly.

While loan growth is desirable, a fast growth rate and high loan volumes might indicate the company is relaxing its lending criteria which could be a red flag and a potential source of risk. This is also something that needs to be monitored.

Understandability: 3/5

Axos’ business model can be difficult to understand because it is a bank that operates primarily on a digital platform. The way banking operations are conducted also adds an element of complexity. The way it generates its income through lending activities is also complex. Understanding of financial and accounting terms is also necessary to analyze the financial statements.

Recent Concerns

The rapid rise in interest rates has put pressure on banks to reduce their deposits costs, which could lead to lower earnings. The company has also faced volatility in deposits, but still maintains a good position on it. Another aspect that needs to be monitored is the increasing non-performing loans, which if they start rising quickly can be harmful to the bottom line.

It should also be noted that Axos has been under regulatory scrutiny from the OCC, which is not uncommon for banks. This requires compliance and might slow down expansion, but should not cause any major issues with their operations.