BOFI Fiscal 2015 Q1

For anyone interested:…

I’d be happy to answer any questions either here or on the BOFI boards.


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Those who don’t have an RB sub won’t be able to follow that link. Would you mid just re-posting it here? It’s an awesome post with the sort of analysis I haven’t seen from many. In addition to learning about BOFI’s progress, there’s also much to learn there about analysing a business (and more so a bank).

Many thanks for your continued coverage. When BOFI dipped below $65, I added to my smallish position. Its now more or less at about 70% of my desired allocation. I wrote some puts at $65 to buy more. My comfort level is to buy more around the 2x to 2.5x Book Value, and I figure I can be patient, write some puts and eventually get there.

Thanks a bunch again!



The formatting did not all survive the “copy and paste” but I think it will be easy enough to get the idea. This is coverage I provide for BOFI, a selection of the Rule Breakers service. The cost of membership is extremely reasonable (less than two cups of coffee per month), so if you enjoy this post I’d encourage you to check out a subscription.


PS - And Anirban, thank you for the kind words.

The high level summary is that for Q1 BOFI generate diluted EPS of $1.20 vs. $.85 for Q1 2014, a 41% increase YoY. Fiscal 2014 diluted EPS was up 41% over fiscal 2013, so management has kept up this growth rate for a number of quarters now.

While EPS growth is obviously a good thing, you can’t simply look at revenue growth and EPS growth for a bank the same way you can for a manufacturing company, for example. The concept of “revenue” as it exists for most companies is really quite different for a bank. To really analyze how this company is doing, the primary measures I track for BOFI are 1) deposit and loan growth, 2) spreads, 3) credit quality, 4) non-interest income, 5) efficiency ratio, and 6) capital ratios and book value.

Deposit and Loan Growth
You can’t make loans without deposits, so deposits need to grow. But if you grow deposits too quickly and aren’t able to originate enough quality loans, spreads compress (increasing cost of funds via interest expense not offset by interest income if you can’t loan out those deposits). Below is the percentage change in those numbers both sequentially (Q3 vs. Q2) and year-over-year (current Q3 vs. prior year Q3).

(in $000s)                 	Deposits           Loans
Q4 2014                 	$3,042            $3,668
Q1 2015                 	$3,262            $4,050
Sequential growth                 7.2%               10.4%

Q1 2014                 	$2,193            $2,334
Q1 2015                 	$3,262            $4,050
YoY growth          	         49%               74%

Annual deposit growth of 49% is fantastic, as is annual loan growth of 74%. The sequential growth is strong as well. Both Y-o-Y and Q-o-Q growth rates have been accelerating, so no signs of growth slowing down at all. As is usually the case with BOFI, the loan portfolio is growing at a more rapid pace than deposits. Management is funding the outsized loan growth through both additional equity offerings and advances from the Federal Home Loan Bank. And of course, if the H&R Block transaction closes next year, a big slug of cash will be added to deposits to balance this out.

And deposit growth is coming almost entirely from transaction accounts, as opposed to time deposit accounts, which is great. This is important because the cost of funding on transaction accounts (i.e. the interest rate paid to depositors) can change with the market allowing BOFI to better manage its cost of funds, compared to CD rates which are locked and therefore carry significantly more interest rate risk. All deposits are not created equal. As of 9/30/2014 time deposits (CDs) made up slightly less than 23% of total deposits, an all time low since I’ve been covering this company. And it will probably keep getting lower.

Net interest margin for Q1 was 3.98%, down slightly from 4.02% for Q4 and up from 3.86% for Q1 2014. What does this mean? As the spread is effectively the profit margin BOFI makes on holding and loaning out capital, increasing spreads are what we want to see. A decrease of 4 basis points from the prior quarter is not really material, but is nice to see a 12 basis point increase from the same quarter prior year. So year-over-year loan growth is up 74% and total loan portfolio’s profitability is up as well. That’s a nice double play.

For comparison purposes, Wells Fargo’s net interest margin for this quarter was 3.06%. This was down from 3.15% at 6/30/2014 and down from 3.39% at 9/30/2014. BOFI’s spread on its loan book is nearly a full percentage point higher than Wells’ (and remember that INCLUDES the higher interest rates BOFI pays on its deposits). Plus, while BOFI’s net interest margin decreased sequentially, the decrease was less than Wells’ sequential decrease. And BOFI increased spreads year-over-year by 12 basis points while WFC’s margins decreased by 33 basis points over the same time period. As is often pointed out to me, Wells Fargo is not necessarily a good comp for BOFI, and I agree. But I still think the comparison is at least interesting.

INBK, another internet only bank, had net interest margins at 6/30 of 2.61%, 137 basis points below BOFI’s margin, but INBK also had a lot of cash on its books from the IPO, so it’s not a true apples to apples comparison. One problem INBK has though is that a large percentage of its deposits are higher interest earning CDs. So INBK could have the exact same loan book BOFI has, and INBK’s profits on the loan book would be substantially less due INBK’s higher funding costs. And that won’t change for a long time.

For the most recent quarter ALLY Financial had a net interest margin of 2.38%, even lower than INBK’s. This also could be a function of excess capital from the IPO. I don’t know as I don’t follow ALLY, but I will bet anyone who wants to take the other side of the trade a ham sandwich that whenever an apples to apples comparison is possible, BOFI’s spreads will still materially outperform of its competitors.

Credit Quality
The third piece of our trifecta is credit quality. No point increasing the loan book if you’re filling it with bad loans. So let’s see what we have there.

Non-performing loans to total loans was .62%, up slightly from .57% at 6/30/14. That’s nothing too dramatic, but if we’ll want to keep an eye on this number to see if it continues to creep up with the massive growth in the loan book. During the conference call the CEO stated the increase was primarily due to two big loans, one in Manhattan and one in Malibu. The LTVs on both of the loans was less than 60%. The CEO stated he thought both loans both resume payment soon, and even if they didn’t, there was plenty of collateral to fully collect on both loans if necessary.

There’s no point in growing the loan book at an annual rate of 74% if the growth is being partially fueled by bad loans. That certainly does not appear to be the case here, though this number should always be viewed with some amount of skepticism as we’re forced to take management’s word that it’s correctly evaluating the loans.

Non-interest Income
Non-interest income is important because it provides a revenue stream that is not dependant on spreads and therefore does not carry interest rate risk (that’s not exactly true, there still can be interest rate risk in non-interest income activities, but the general point remains). Think checking account fees, debit card fees, loan origination fees, etc. Theoretically, a bank could have a zero spread and still be profitable via fees and other activities (selling loans, for example). Most banks generate fee income via “mortgage banking” activities which basically means flipping mortgages. BOFI does this as well, but this is also where the health care accounts receivables factoring business and structured finance initiatives revenue show up.

I’m actually fine with this number being even down near zero, as that means BOFI’s profit would come primarily from its loan portfolio, which is how I think a bank should operate. Why? Because it means that BOFI is making the vast majority of its income from what banks are supposed to do: lend. Some banks, especially smaller banks, make their entire net income from originating and selling mortgages, usually through refinance activities. Some of these banks actually LOSE MONEY on their loan portfolios, which I think is just crazy. When mortgage banking and refinancing activity slows down, those banks get killed. Not BOFI, because it makes almost all of its profit in the interest rate spreads on its loans. That’s a much more sustainable, and a much less volatile, business model. Though if the non-interest income is from activities like debit card fees, that’s a different story and is perfectly fine as it’s likely repeating business that isn’t subject to the whims of the Federal Reserve.

Non-interest income for the quarter came in at $5.2 million, up slightly from $4.7 million earned last quarter, but down from $7.0 million earned Q1 2014. There isn’t much to see here, other than banking fees (things like debit card fees), increased 50% from $988K to $1.5 million. While the numbers overall are small, if that level of growth rate keeps up for a while, that line item will be meaningful (and probably recurring).

Efficiency ratio
The efficiency ratio is one of the primary metrics used to measure banks. The efficiency ratio basically tells you how much of controllable expenses (non-interest expenses i.e. salary, marketing, etc.) each new dollar of revenue costs. In other words, an efficiency ratio of 55% means the bank must spend $.55 to generate the next $1 of revenue. Think of it as kind of an operating margin for banks, but an inverse so the lower the ratio, the better.

Management achieved an efficiency ratio of 34.81% for the quarter, down from 34.9% percent last quarter and down from 41.37% at Q1 2014. And interestingly enough, on the conference call the CEO actually stated he thought they could get that number down below 30% if they wanted to, but they were spending money on technology investments as well as on people in anticipation of the H&R Block transaction and that he felt those investments were worthwhile.

So BOFI’s efficiency ratio is already far and away the best in the industry, and it could be even lower (though investing in growth is certainly worthwhile, if not necessary for survival).

As we’ve seen in the past, the dilution has been fairly steady every quarter. We’ve confirmed that the dilution is caused by management selling shares into the market, and at market price, to raise additional capital for it to deploy as loans. This is partially what has allowed BOFI to grow its loan book at a fast rate than its deposits. I don’t have a problem with it as the capital raised appears to be very profitably deployed.

Management raised a little over $20 million in equity during this quarter. However, return on equity for the quarter was 18.61%, up slightly from 18.14% for the prior quarter, and up from 17.73% in Q1 2014. Management is clearly earning solid returns on the additional equity (far in excess of its competition), so I am not concerned about the continued dilution. If ROE starts to decline, I may revisit my conclusion.

Per Share Tangible Book Value
This has now become my favorite running piece of analysis:
Per Share Tangible Book Value (TBV) at 9/30/2014 was $27.57, up 9.1% from $25.27 at 6/30/2014. Below, I’ve included some numbers from my last quarterly review:

1)For Q4 2013 which ended 6/30/2013, BOFI grew book value per share by 21% compared to Q4 2012.
2)For Q1 2014 which ended 9/30/13, BOFI grew book value per share by 23% compared to Q1 2013.
3)For Q2 2014 which ended 12/31/13, BOFI grew book value per share by 27% compared to Q2 2013.
4)For Q3 2014 which ended 3/31/14, BOFI grew book value per share by 29% compared to Q3 2013.
5)For Q4 2014 which ended on 6/30/14, BOFI grew book value per share by 32% compared to Q4 2013 (finally corrected!).
6) And now, for Q1 2015 which ended on 9/30/2014, BOFI grew book value per share by 37% compared to Q1 2014.

This is now the sixth consecutive quarter that management has not only increased book value per share, but increased the rate at which annual per share TBV is growing. For the last six quarters, book value per share has increased year-over-year by 21%, 23%, 27%, 29%, 32%, and now 37%. I think those numbers speak for themselves.

BOFI’s Tier 1 capital ratio (don’t ask) increased to 8.72% which is considered very well capitalized (don’t ask).

BOFI’s stock price has been on a bit of a roller coaster ride this year. At a price of $80.14 as I type this, it’s up over 20% in the last 30 days (though still down nearly 25% from its high of $105 in February). I hope people were able to take advantage of what I thought was an excellent price last month, as the stock dropped to the mid-$60s for absolutely no good reason I could see. Even with the increase in the last 30 days, you can buy the stock today at less than 3x tangible book. Personally, given my analysis in the previous section, I think that’s still an attractive price, but each individual will have to make that decision for him or herself.

Other Considerations
1)Going forward, I’ll likely need to include a new section on BOFI’s business banking initiatives. They will soon grow large enough to merit their own analysis.

2)The main thing that first attracted me to BOFI was its clean model, and lack of the type of activities that make larger commercial banks and all investment banks nearly impossible to analyze. As management introduces more and more products (purchase and sale of structured settlements, entering into the accounts receivable factoring business, some of the initiatives BOFI will partner with H&R Block on if the transaction goes forward), management moves away from the clean banking model. I understand the reasoning for it, and if done correctly these could all be home runs, but I do wonder if there will come a time when I have to lump BOFI in with the other financial service companies I do not feel I can competently analyze.

3)Real estate risk – While management is diversifying away from this product, BOFI’s bread and butter is still the non-conforming single-family jumbo mortgage in Southern California. The loans appear to be well underwritten to strong borrowers at low LTVs, but if the SoCal residential real estate market tanks, BOFI’s stock price will go with it, justified or not. Every quarter the company is diversifying away from this concentration, but it will still be the single biggest risk for the company going forward for a long time.

4)H&R Block - see here, as nothing has changed:…

Strong deposit growth – check
Strong loan growth – check
Maintain credit quality – check
Maintain or increase spreads – check
Non-interest income – check
Strengthening efficiency ratio – check
Growing tangible book value - check

I will summarize by cutting and pasting my conclusion from the last several quarters: Another great quarter and year. In fact, this may be the most impressive quarter (and almost certainly the most impressive fiscal year) we’ve seen from BOFI yet. Not only is the story holding, it’s actually improving as both deposit and loan growth continue to accelerate.

And the accelerating CAGR in tangible book value is about as good as it gets.

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