BofI Holding, Inc. BOFI
February 05, 2007 - 8:14am EST by
david101
2007 2008
Price: 7.11 EPS
Shares Out. (in M): 0 P/E
Market Cap (in M): 59 P/FCF
Net Debt (in M): 0 EBIT 0 0
TEV: 0 TEV/EBIT

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Description

I'm a thrift banker and I'm OK
I start at nine and I leave at three.

Chorus:
He's a thrift banker and he's OK
He starts at nine and he leaves at three.

I take deposits, I lend money
I go to the lavatory.
On Wednesdays I go golfing and hit the ball from the tee.

CPA’s:
He takes deposits, he lends money
He goes to the lavatory.
On Wednesdays he goes golfing and hits the ball from the tee.

 

And now for something completely different…

 

Bank of Internet is a bank of contradictions. It is a thrift but has no branches. It does business across the US but only has one location and 27 employees. It is a bank but does most of its business over the internet. It started in 2000 but has seasoned management. However, all you really need to know is that it is currently trading at 93% of tangible book value (TBV), on a fully diluted basis.

 

Net interest margin (NIM): The spreads in an inverted yield environment "…are a bitch," to quote the CEO, who says that their goal is 1.75% to 2.25% (currently 1.29%). Since there is not much they can do on the liability side of the balance sheet, they are focusing on the asset side. They hired a new consumer lending officer. He was brought in to ramp up home equity loans (HEL) because they have higher yields, currently around 7.15% vs. 6.0% for residential mortgages. They are also doing auto lending very selectively, starting with an RV program. More than 95% of their loans adjustable rate, although a number come with 1, 3 and 5 year fixed rate starters.

 

Asset duration (loans + MBS) is about 2.5 to 3.0 years, with just loans around 2.0 to 2.5 years. They have not been originating many loans because they said other lenders have been lending money to anyone with a pulse. They believe in old-fashioned underwriting and realize that despite not having any charge-offs yet that they will experience them. They feel the recent shut down of Ownit Mortgage is just the first of many to come. They have bought conforming (i.e. Fannie/Freddie) residential mortgages in the past from third parties but have been less active due to the low rates. They have only $35 million in option ARM loans out $535 million of net loans on their books. The CEO said that he has been in banking since 1971 and has seen these conditions before.

 

They have been buying loans and loan pools, primarily equity loans on multi-family (they do not do construction or cash flow loans). They have been buying seasoned loans originated between 2000 and 2004 because they are seasoned, have a history of payments and have equity. The median loan to value (LTV) for the entire loan book is 51%, which provides a significant margin of safety.

 

Deposits: 87% of their deposits are CD’s, of which ~30% are jumbo CD’s. In a normal thrift, that might be scary but it fits the business model here. BOFI does not require tellers to handle a lot of transactions. While they do not have cheap core deposits, they do have a lean operation. Even so, they have $60 million of core deposits and $395 million in CD’s. Assign a 10% premium to core deposits and 5% for the CD’s, plus tangible book, and BOFI is easily worth $8.60/share or 20% from here. Considering what Citigroup is paying for money-losing, internet-based Egg Bank, I think BOFI could be worth $10/share.

 

Competition: Internet banking is different from brick and mortar because it is product by product, not region. They do not feel like they compete with ING, per se. They do well with checking and CD's. They said NetBank is a case study in doing the opposite. BOFI has partnered with originating loans or used their online origination. They do not feel that they need a physical branch. NetBank bought a mortgage operation three years ago, and are in the midst of unwinding it now that volumes have crashed. They feel banking is rapidly becoming commoditized and being low-cost provider is what matters. It is more effective to offer home equity loans across the country rather than just one region.

 

Scale: Their technology is very scalable. They contract with Jack Henry & Associates to handle the core banking business, but they develop and maintain the web portals where they do business, and wrote the back-end system that handles the customer relationship management (CRM) function. The inverted yield curve is limiting growth now. They have enough capital to support $1 billion in assets (currently at $788 million). They do not advertise through traditional methods, and focus on buying Google search ads. Also, 6-9% of new applications are referrals from existing customers.

 

Ownership: Insiders owns about 30% of the stock and there are three 5%+ holders with 18% of the shares. Both the CEO and CFO made open market purchases of shares in December, albeit small amounts.

 

Performance: This is the weakest area for BOFI, as seen in the following table:

 

Quarter

NIM

ROAA

ROE

Efficiency

6/30/2004

2.04%

0.67%

8.42%

49.5%

9/30/2004

2.06%

0.64%

8.77%

50.5%

12/31/2004

1.91%

0.44%

6.30%

58.3%

3/31/2005

1.88%

0.68%

9.19%

42.7%

6/30/2005

1.98%

0.59%

6.73%

48.1%

9/30/2005

1.62%

0.55%

4.78%

50.9%

12/31/2005

1.49%

0.45%

4.14%

50.5%

3/31/2006

1.54%

0.49%

4.65%

51.3%

6/30/2006

1.51%

0.49%

4.56%

51.2%

9/30/2006

1.31%

0.40%

4.08%

56.3%

12/31/2006

1.29%

0.41%

4.09%

56.0%

 

 

 

Risks:

- microcap

- Sarbanes Oxley, because they have not spent much. Their market cap exempts them from 404 certification (requiring CPA firm sign-off) until June 2008. They are watching to see if Congress will relax the rules further befre spending the money.

- CRA (Community Re-Investment Act, for low-income areas). It is a complex issue but working with the OTS, they have met the challenge for the past six years.

- competitive banking environment

- inverted yield curve continues

- 46% of loans are in California

 

Now back to our regularly scheduled program…


Chorus:
He's a thrift banker and he's OK
He starts at nine and he leaves at three.

I count monies, I skip and jump
I go to lunch for two hours.
I work a little then I take a break on the hour.

CPA’s:
He counts monies, he skips and jumps
He goes to lunch for two hours.
He works a little then takes a break on the hour?!

Chorus:
He's a thrift banker and he's OK
He starts at nine and he leaves at three.

I count monies, I wear wingtips,
Suspenders and a bro,
Like my idol George Costanza on the Seinfeld show.

 
CPA’s:
He counts monies, he wears wingtips,
Suspenders...and a bro?!

...He's a thrift banker and he's OK
He starts at nine and he leaves at three.

...I'm a thrift banker and I'm OK
I sleep all night and I work all day.
  

Catalyst

Trading at 93% of TBV
    sort by   Expand   New

    Description

    I'm a thrift banker and I'm OK
    I start at nine and I leave at three.

    Chorus:
    He's a thrift banker and he's OK
    He starts at nine and he leaves at three.

    I take deposits, I lend money
    I go to the lavatory.
    On Wednesdays I go golfing and hit the ball from the tee.

    CPA’s:
    He takes deposits, he lends money
    He goes to the lavatory.
    On Wednesdays he goes golfing and hits the ball from the tee.

     

    And now for something completely different…

     

    Bank of Internet is a bank of contradictions. It is a thrift but has no branches. It does business across the US but only has one location and 27 employees. It is a bank but does most of its business over the internet. It started in 2000 but has seasoned management. However, all you really need to know is that it is currently trading at 93% of tangible book value (TBV), on a fully diluted basis.

     

    Net interest margin (NIM): The spreads in an inverted yield environment "…are a bitch," to quote the CEO, who says that their goal is 1.75% to 2.25% (currently 1.29%). Since there is not much they can do on the liability side of the balance sheet, they are focusing on the asset side. They hired a new consumer lending officer. He was brought in to ramp up home equity loans (HEL) because they have higher yields, currently around 7.15% vs. 6.0% for residential mortgages. They are also doing auto lending very selectively, starting with an RV program. More than 95% of their loans adjustable rate, although a number come with 1, 3 and 5 year fixed rate starters.

     

    Asset duration (loans + MBS) is about 2.5 to 3.0 years, with just loans around 2.0 to 2.5 years. They have not been originating many loans because they said other lenders have been lending money to anyone with a pulse. They believe in old-fashioned underwriting and realize that despite not having any charge-offs yet that they will experience them. They feel the recent shut down of Ownit Mortgage is just the first of many to come. They have bought conforming (i.e. Fannie/Freddie) residential mortgages in the past from third parties but have been less active due to the low rates. They have only $35 million in option ARM loans out $535 million of net loans on their books. The CEO said that he has been in banking since 1971 and has seen these conditions before.

     

    They have been buying loans and loan pools, primarily equity loans on multi-family (they do not do construction or cash flow loans). They have been buying seasoned loans originated between 2000 and 2004 because they are seasoned, have a history of payments and have equity. The median loan to value (LTV) for the entire loan book is 51%, which provides a significant margin of safety.

     

    Deposits: 87% of their deposits are CD’s, of which ~30% are jumbo CD’s. In a normal thrift, that might be scary but it fits the business model here. BOFI does not require tellers to handle a lot of transactions. While they do not have cheap core deposits, they do have a lean operation. Even so, they have $60 million of core deposits and $395 million in CD’s. Assign a 10% premium to core deposits and 5% for the CD’s, plus tangible book, and BOFI is easily worth $8.60/share or 20% from here. Considering what Citigroup is paying for money-losing, internet-based Egg Bank, I think BOFI could be worth $10/share.

     

    Competition: Internet banking is different from brick and mortar because it is product by product, not region. They do not feel like they compete with ING, per se. They do well with checking and CD's. They said NetBank is a case study in doing the opposite. BOFI has partnered with originating loans or used their online origination. They do not feel that they need a physical branch. NetBank bought a mortgage operation three years ago, and are in the midst of unwinding it now that volumes have crashed. They feel banking is rapidly becoming commoditized and being low-cost provider is what matters. It is more effective to offer home equity loans across the country rather than just one region.

     

    Scale: Their technology is very scalable. They contract with Jack Henry & Associates to handle the core banking business, but they develop and maintain the web portals where they do business, and wrote the back-end system that handles the customer relationship management (CRM) function. The inverted yield curve is limiting growth now. They have enough capital to support $1 billion in assets (currently at $788 million). They do not advertise through traditional methods, and focus on buying Google search ads. Also, 6-9% of new applications are referrals from existing customers.

     

    Ownership: Insiders owns about 30% of the stock and there are three 5%+ holders with 18% of the shares. Both the CEO and CFO made open market purchases of shares in December, albeit small amounts.

     

    Performance: This is the weakest area for BOFI, as seen in the following table:

     

    Quarter

    NIM

    ROAA

    ROE

    Efficiency

    6/30/2004

    2.04%

    0.67%

    8.42%

    49.5%

    9/30/2004

    2.06%

    0.64%

    8.77%

    50.5%

    12/31/2004

    1.91%

    0.44%

    6.30%

    58.3%

    3/31/2005

    1.88%

    0.68%

    9.19%

    42.7%

    6/30/2005

    1.98%

    0.59%

    6.73%

    48.1%

    9/30/2005

    1.62%

    0.55%

    4.78%

    50.9%

    12/31/2005

    1.49%

    0.45%

    4.14%

    50.5%

    3/31/2006

    1.54%

    0.49%

    4.65%

    51.3%

    6/30/2006

    1.51%

    0.49%

    4.56%

    51.2%

    9/30/2006

    1.31%

    0.40%

    4.08%

    56.3%

    12/31/2006

    1.29%

    0.41%

    4.09%

    56.0%

     

     

     

    Risks:

    - microcap

    - Sarbanes Oxley, because they have not spent much. Their market cap exempts them from 404 certification (requiring CPA firm sign-off) until June 2008. They are watching to see if Congress will relax the rules further befre spending the money.

    - CRA (Community Re-Investment Act, for low-income areas). It is a complex issue but working with the OTS, they have met the challenge for the past six years.

    - competitive banking environment

    - inverted yield curve continues

    - 46% of loans are in California

     

    Now back to our regularly scheduled program…


    Chorus:
    He's a thrift banker and he's OK
    He starts at nine and he leaves at three.

    I count monies, I skip and jump
    I go to lunch for two hours.
    I work a little then I take a break on the hour.

    CPA’s:
    He counts monies, he skips and jumps
    He goes to lunch for two hours.
    He works a little then takes a break on the hour?!

    Chorus:
    He's a thrift banker and he's OK
    He starts at nine and he leaves at three.

    I count monies, I wear wingtips,
    Suspenders and a bro,
    Like my idol George Costanza on the Seinfeld show.

     
    CPA’s:
    He counts monies, he wears wingtips,
    Suspenders...and a bro?!

    ...He's a thrift banker and he's OK
    He starts at nine and he leaves at three.

    ...I'm a thrift banker and I'm OK
    I sleep all night and I work all day.
      

    Catalyst

    Trading at 93% of TBV

    Messages


    SubjectComments
    Entry02/05/2007 10:22 AM
    Memberskyhawk887
    I've often though about moving my banking to BOFI, but I haven't yet. The power of inertia and the inconvenience are difficult to over-come.

    I've thought an interesting internet-only bank model would be to market yourself as the highest rate checking account in the country by paying Fed funds minus 100 basis points--Always. No games and no restrictions like with CD's. Invest deposits only in Fed funds (highly liquid, no risk, minimal operating expenses) and get approval from the regulators to go to something like 50-to-1 leverage (because high leverage would be required to get a decent ROE). Now the trick would be to make sure the scaled up after-tax operating costs are 60 basis points or less, so that you can generate an ROE of near 20%. The costs would have to cover ATM reimbursements for using other companies ATMS ( I imagine up to $8 per month) because people will not sign up if they are going to always get dinged with ATM fees. Of course, you'd also have to worry about an environment of ultra-low Fed funds rates, like we had in 2002. Ultimately, this business model would get away from the asset part of banking and the risk involved in lending. (Incidentally, if you look at E-trade, you will note that their success in making RV loans and the like has been minimal.)

    So what type of P/B multiple should a company that only earns a 4% ROE (vs. cash of 5.25%) trade at? Book or slightly below seems reasonable, particularly if there are some regualtory costs they have yet to implement.

    Egg was a $1.1B dollar deal. Therefore, it was of a size that made it interesting. I don't think many companies would be interested in buying BOFI, especially when you have so many mega-banks rolling out their own internet only products (i.e. ING Direct, HSBC Direct, Citi Direct) and have the ability to finance a money losing operation indefinitely.

    Incidentally, cheap valuation (and that is debatable for BOFI at 20 times earnings) for a small, illiquid company with poor fundamentals and no near-term prospects for improvement isn't a very good catalyst.

    SubjectFundamentally, BOFI, has no ba
    Entry02/05/2007 01:09 PM
    Memberskyhawk887
    Fundamentally, BOFI, has no barriers to entry or competitive advantages. Every would-be acquiror already has an internet presence.

    I think the fact that both of our ideas are already posted on VIC creates the challenge you are looking for. HCBK also happens to be much larger and more liquid. It is also a short, which inherently has less return upside than longs, but can add a lot of risk-control/volatility-reducing value as a hedge to long positions, such as Bridge Bank or Barclays.

    But I'll be watching BOFI for the next 18 months!



    SubjectBeautiful Song
    Entry02/06/2007 01:10 PM
    Membergrant387
    I just can't pass up the opportunity to applaud the fabulous lyrics and catchy little tune you've put together in this write-up.

    Combining thrifts, the internet and a song (which brings in George Constanza)....who could ask for anything more????

    Well done.....a standing "O"


    SubjectInteresting
    Entry02/07/2007 06:08 PM
    Memberround291
    David -

    I know you to be a pro on the banks and value your opinions. I've followed NTBK and its travails, a large part of which will shortly be behind it. I've not followed this one though. I am a customer of ING Direct and find its business model to be exemplary. A few days ago I printed out ING's statements and have it on top of my stack for this weekend. It's a much better business than either NTBK or this, despite ING FSB's relatively low current returns.

    From my perspective, it's what a bank in this space does on the asset side that matters as they all are price takers on deposits. This company, despite the conservatism of management, isn't doing much of note.

    I'm curious why you chose this one to invest in over NTBK or ING? All three are cheap, though ING is no pure play.

    What about the through the mail/phone CD takers like CFNB and Intervest? Do you see these guys as materially different from the Internet banks? CFNB is just a big fat pinata with more capital than it will ever need but a good leasing platform.

    Finally, are there other names you're aware of, public or private, that compete with an internet only model?

    Best wishes...always interesting running into you around these parts.

    SubjectRound
    Entry02/07/2007 10:06 PM
    Memberdavid101
    Round,

    Thanks for the kind words. I'm no pro on banks, just looking for cheap, low-risk stuff. As I see it, there is little down-side to BOFI and the question then is what the upside is. The only banks that trade cheaper on a TBV basis are even smaller and more illiquid than BOFI, or have issues (NetBank, Carver). The fact that BOFI operates over the internet is secondary, and not like I woke up one day with a hankerin' to own an internet bank.

    I agree that BOFI is weak on the asset side. In fact, a friend emailed me today, fantasizing about combining BOFI's deposits with NICK's auto loans. Dreaming aside, someone will rationalize BOFI's balance sheet.

    As for thoughts on internet banking, I don't claim any insight. I find it interesting, though, that despite a number of successful online retail strategies, online banking as a stand-alone business is elusive, and why I have no names for you. Part of that is culture and part is need (as I argued in favor of CBH and building branches). Another hurdle to online banking is the P.A.T.R.I.O.T. Act that requires a bank to know their customer. Another hurdle is the transfer of monies. Our current banking system is still antiquated. A lot of these pay-online systems are nothing more than a sophisticated machine that prints a check and stuffs it into an envelope with metered postage.

    I will comment that the advantage that BOFI has over an Intervest is labor costs. Any bank relying on phone and mail for processing CD's has higher staffing.

    David

    SubjectNice qtrly earnings!
    Entry05/02/2007 09:39 AM
    Membermitc567
    Mar 2007 quarterly earnings were best ever.

    SubjectDavid - They seem to be movin
    Entry05/02/2007 11:41 AM
    Membercanuck272
    David -
    They seem to be moving into home equity loans and RV loans, and bought a lot of mortgage backed securities during the quarter. Are you comfortable with these areas, especially home equity loans sourced over the Internet?

    SubjectReply to Mitc and Canuck
    Entry05/02/2007 02:47 PM
    Memberdavid101
    Mitc - I hear your sarcasm about the "record earnings" which is only on an absolute dollar basis and not a per share basis. As a bank CEO, I am not sure I would crow about record earnings on a 0.42% ROA (1 bp of improvement!) and 4.66% ROE. This was never an earnings story, as I consider myself an asset man. Uh, that does not sound good, so let's just say I tend to focus on the balance sheet. This is a paint drying investment.

    Canuck - As I had mentioned in the my write-up, the HEL's and RV loans are a way for them to increase NIM by originating higher interest loans. If I had an issue with them originating loans over the internet, I would have never invested in the first place. Besides, I think the concern over sourcing loans via the internet is a canard when you look at New Century. You should be more concerned about the likes of C, WM and CFC who bombard me with HEL offers every month in the mail. Without having applied for anything, they know about what I owe on my mortgage and roughly what my house is worth based on nearby home sales. They build the risk into the rate, which is usually prime. I can get a HEL at a local bank for about 50-100 bps lower by doing a full application and appraisal. It is all a matter of pricing the risk.

    David

    SubjectQ1 earnings
    Entry05/02/2007 06:36 PM
    Memberskyhawk887
    Asset man. I'll have to remember that one.

    Anything interesting from the call?

    The disclosure on their press release of balance sheet trends is somewhat limited, but here's an interesting comment from the press release:

    "The asset growth this quarter was generally funded by an increase in reverse repurchase borrowings of $45.0 million."

    Funding RV loans with repo's doesn't seem to be an activity worth paying much for. It seems that BOFI's potential value lies in its ability to generate lower cost deposits, which the press release doesn't tell us anything about. When I look at most banks, generating loans is the easier part (although increasingly you must accept lower yields) while sourcing deposits has become extremely difficult. I don't think BOFI will get bought for its asset capabilities.

    But of course, HCBK funds purchased mortgages with repos as well and manages to get a 1.5X P/B valuation for the activity. Maybe BOFI at 91% of book value is too cheap. Of course, a stock that only earns a 4.4% ROE (well below the return on cash of 5.25%), with no real dramatic change in sight, deserves to trade at some sort of discount to book.

    SubjectROE Joe
    Entry05/02/2007 09:53 PM
    Memberdavid101
    Skyhawk,

    If I am asset man, then are you ROE Joe or ROA Toa (for you bionicles fans)?

    Did not listen to the call, and do not expect to listen to it. Not much new going on here and there were other earnings calls to listen to today that needed my attention. This is not a big position in the portfolio and not much to worry about.

    As for whether BOFI gets bought for its assets, it all depends upon how you look at it. There is more to assets than just loans and securities. Why else is there a bidding war for LaSalle or that NCC is paying 3X tangible book value for a Midwest bank sporting a 0.78% ROA and 8.25% ROE? The question is less what was and more what will be.

    By the way, here are the tallies to date:

    BOFI long: $7.44/$7.11 ==> +4.64% return

    HCBK short: ($13.20 + $0.16 dividends - $0.20 rebate)/$13.59 ==> +3.16%

    Figure it is better to claim some moral victory here, like saying the Milwaukee Brewers are going to win the World Series because they have the best record in baseball as of this morning.

    David

    SubjectHCBK vs. BOFI
    Entry05/03/2007 11:56 AM
    Memberskyhawk887
    I appreciate the suggestion for new nicknames, but I'll just stick with Skyhawk, who was a former poker player that got his name from swooping in "like a skyhawk" on a pile of chips after winning a big hand. Personally, however, I do not enjoy gambling.

    I am watching the performance.

    Maybe it's just the weak tape on financials, but I think people are actually starting to pay attention to HCBK's low borrowing costs and starting to discount it. From further research, I have discovered that HCBK is basically selling a very liquid option on its borrowings (to the FHLB, which in turn is selling it off into the capital markets) to get their low introductory rate. Every other bank in the country (or at least within the Northeast district of the FHLB NY) could make the same decision to sell the option and get a similar rate, but they don't, because they don't want to take on the long term interest rate risk. Maybe HCBK will get lucky on its bet, but investors are foolish to pay 26 times for such a bet when so much of the earnings are riding on it.

    By the way, HCBK now accounts for over 10% of the NY FHLB's advances. If I was a politician or regulator, I would start to worry about concentration risk.

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