Why, if they are lending at 50-60 LTV, would they be getting higher rates?
In part it’s because they are non-conforming jumbo loans – that is, too big for the government agencies to buy. That’s very common in California given the high housing prices, and that’s where BOFI does most of its mortgage business. So those loans either have to be held on the books or sold on to private investors: it’s not as simple as just originating them, collecting fees, and passing them off to government agencies like most banks do. As a result, higher interest rates can be demanded. If you search around for explanations of jumbo loans, you’ll see that’s very common.
Here’s what the CEO said in an interview with TMF:
We’ve always been very good at the asset (loan) side of the business. We’ve got an excellent network of brokers who aren’t necessarily the cheapest but who can bring us the kind of business that makes sense. 5/1 Jumbo residential loans are the only ones we intend to keep on the book. Right now, we’re getting about 57% LTV on those at yields that are 4.5% or higher. On the C&I (commercial and industrial) side, we’re getting 5.5% - 6% yields on mostly secure paper. That’s a great business for us. We sell almost all of our 15/30 fixed, agency-backed (conforming) loans because they just don’t satisfy our 15% ROE (return-on-equity) bogey.
And here’s what Fletch said about this when responding to a short attack 1.5 years ago that made many of the same allegations:
BOFI does make non-conforming “jumbo” loans, and a lot of them are in Southern California. I believe “jumbo” loans are loans above $417,000. I have relatives who live both in the LA and San Diego area, and I don’t know how most people down there would be able to buy a house without needing a “jumbo” mortgage. Heck, most people in Portland these days need a “jumbo” mortgage to buy anything in the city.
And having a K-1 for your income isn’t a bad thing. For example, a partner in a law firm or a business owner likely receives most of his or her income via a K-1 as a business owner. It is not a stretch to think that some of the people in Southern California buying more expensive homes may be business owners, partners in firms, etc. That doesn’t mean they are somehow bad credits. And BOFI doesn’t make “no doc” loans, which the author also implies.
One thing I notice is that all of these articles and short attacks imply that if a traditional bank isn’t willing to take on a loan, then it must be riskier. But that’s not necessarily true. Here’s what the CEO said in the latest earnings call:
We originated high-quality loans in the fourth fiscal quarter. The average FICO for a single-family agency eligible production was 765 with an average loan-to-value ratio of 66%. The average FICO for the single-family jumbo production was 708, with an average loan-to-value of 62%.
Those don’t sound like low-credit borrowers to me, but that’s what those articles want you to believe. Furthermore, how does anyone know that other banks wouldn’t make those loans? There seems to be this implication that because BOFI made the loans, nobody else would. Again, more FUD (fear, uncertainty, and doubt).
Finally, why do you own BOFI? Seriously: why do you own this bank, out of all the other banks? The reason is that they have a competitive advantage. What is that advantage? It’s a combination of primarily two factors: (1) they are very data driven, and (2) they are willing to use that data to go after very profitable niche business that other banks are ignoring.
The data-driven part is very important. What is it about a FICO score of 700 that magically makes a borrower credit-worthy? Nothing. Nothing at all. We sort of take this for granted, but that FICO score is simply an analysis of various metrics that provides a single data-point. Who is to say that it’s the only way, or even the best way? Who is to say that BOFI is not better at analyzing the quality of borrowers? Certainly the one yardstick we have for measuring that outcome – loans in default – looks very good.
Remember, too, that “risk” – at least if we’re calling it permanent capital loss, which seems like the most reasonable definition to me – requires more than just default. It also requires an inability for the bank to get back its loaned-out capital through repossession and sale of the property. And that’s where the low loan-to-value comes in. Again, the CEO on the latest call:
At June 30, 2015, the weighted average loan-to-value of our entire portfolio of real estate loans was 56%. The very low average loan-to-value ratios in our loan book are not obscuring risk in the tails of our portfolio. For example, in the bank’s entire single-family loan portfolio, both jumbo size and below, excluding loans originated for sale for the government sponsored entities, there is only one loan that was originated at greater than 80% loan-to-value. We have had a direct pledge of liquid collateral that would reduce the collateral exposure levels below 80%.
The advantage of BOFI as an investment, in my opinion, is exactly the behavior that the shorts are attacking: their willingness to be different and their drive to be excellent at being different. Here’s one more quote from the CEO from that TMF interview:
Bankers spend a lot of time trying not to be different, not taking risks. And a lot of banking is ultra-structural.
“I saw an industry ripe for disruption.” I did all my learning at Goldman Sachs and McKinsey. I was ready to be a leader and have a big impact. I felt I could have a larger impact at a smaller organization like BofI where I would have an opportunity to put in the right culture.
What’s the right culture? It’s about empowering individuals, demanding excellence, and focusing on shareholder value. For us, it was also about being very data driven.
If you’re investing in a disruptor, it goes with the territory that they’re going to do things differently. Some people don’t understand that, while others try to use it against investors to spread fear and make a profit. I think the best thing we can do is to understand our investments as well as possible so that we can make our own informed decisions, acknowledge the risks of being wrong, and then allocate appropriately to manage those risks.
Just my 2 cents.