Axos Financial (AX)

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August 4, 2022

We have owned a position in Axos Financial for 2 years, but the stock is off 37% from its high in early 2022. We think Axos is a good example of the opportunity in bank stocks right now. Axos has strong organic growth. It has low credit losses and will benefit from higher rates. No company specific issues have materialized in 2022 to explain the stock decline.

Here is our investment thesis on Axos Financial:

1. Management – Greg Garrabrants has been the CEO since 2007 and has done a nice job of growing the bank. We think his strategy of targeting lending businesses with attractive returns and steadily building out multiple deposit franchises has created value. For example, Axos has built out several loan programs such as Small Balance Commercial Mortgages and Lender Finance. On the deposit side, Axos has diversified its deposit gathering from Consumer Direct to include Fiduciary Deposits and White Label Banking.
2. Nationwide Direct Bank – Axos Financial is a nationwide direct bank. They have customers in every state, but they do not have branches. Previously, Axos operated under the name Bank of the Internet. The direct bank operation allows them to operate more efficiently than other banks with significant branch systems. Operating as a direct bank for two decades has positioned them well for the current trend of remote work and serving customers virtually.
3. Organic Growth Focus – For the most part, Axos has grown organically throughout its history. However, from time to time, the company has made small acquisitions to acquire new capabilities, such as the securities clearing business, which they use as growth platforms. We believe organic growth is more valuable than acquisition growth.
4. Securities Clearing – Over the last several years, Axos has made a couple bolt-on acquisitions that have positioned it to grow in serving Investment Advisors and smaller Broker-Dealers. Axos purchased Apex Clearing to start serving smaller Broker-Dealers. This deal gives Axos access to low-cost deposits in the form of excess cash held by the Broker-Dealer’s customers in their brokerage accounts. Then, last year, Axos purchased E*Trade’s Investment Advisor (“RIA”) servicing business from Morgan Stanley. We think there is a good opportunity for Axos to fill a market need in servicing RIA’s. After Schwab acquired Ameritrade, there are fewer options, especially for smaller RIA’s, to custody their customers’ assets. This acquisition of E*Trade’s RIA relationships gives Axos critical mass to grow this business.
5. Low Valuation – Axos trades at 8x earnings. As recently as January, the bank traded at 14x earnings. We attribute the lower valuation to the general sell-off in regional bank shares since the Russian invasion of Ukraine rather than any Axos specific issue.

Other stock market investors see risks to Axos Financial’s shares:

1. Less Asset Sensitive – Axos has a significant percentage of hybrid fixed-rate loans with initial terms of 3 to 5 years. So, in the current rising rate environment, Axos is less asset sensitive than peers who have a higher percentage of floating rate loans. However, compared to 2015, Axos’ balance sheet is more sensitive to rising interest rates than it had been. Axos has more floating rate commercial loans than it did in 2015. Also, Axos has more low-cost commercial deposits it will not have to reprice to retain. We still think Axos will benefit from higher interest rates, but the benefit will come over a period of several years, instead of in late 2022 and early 2023.
2. Executive Compensation – The CEO has an innovative compensation structure. His compensation increases if the stock outperforms its benchmark. This can lead to remarkably high payouts if the stock does well. If the stock underperforms, he will not receive a bonus. We are not thrilled with this arrangement, but we tolerate it because we believe the opportunity in Axos is outsized.

We like Axos Financial. We think the stock is interesting at the current level. The management team has a strong record of consistent, organic growth. The bank’s current valuation is low, especially compared to recent history. We think the bank has ample opportunity for continued growth. We view Axos as an example of a bank holding in our portfolio that demonstrates low valuation, solid organic growth, and low likelihood of material credit losses in the medium-term. We have a dozen or more holdings with similar characteristics.

Disclaimer: The discussion of any security is meant solely as an illustration of our investment and thought process and should NOT be considered as a recommendation or suggestion to buy or sell any securities. Before you make any investment, do your own research and talk to your own financial adviser. Information in this report is received from external sources. Therefore, we can make no guarantee as to the completeness or accuracy of the information provided.