This is a “cut and paste” of a post I just made on the Rule Breakers BOFI board. I thought a few folks here might find it interesting as well. I certainly don’t intend for this to kickoff another round of arguments, so hopefully people will read this with the spirit in which I offer it. I’d be happy to take any questions or comments over on the Rule Breakers BOFI board.
If you’ve read any of my previous quarterly summaries, you will be familiar with the format below. Also recall that BOFI’s fiscal year ends June 30, so the most recent quarter ending 12/31/15 was actually Q2 of fiscal 2016. Below is my analysis of BOFI’s most recent quarter ending 12/31/15, Q2 of fiscal 2016.
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 deposits both sequentially (Q2 vs. Q1) and year-over-year (current Q2 vs. prior year Q2).
(in $ millions) Deposits Loans Q2 2016 $5,200 $5,735 Q1 2016 $4,755 $5,332 Sequential growth 9% 7.6% Q2 2016 $5,200 $5,735 Q2 2015 $4,005 $4,435 YoY growth 30% 29%
Annual deposit growth of 30% is strong, as is annual loan growth of 29%. And the sequential growth of 9% and 7.6% are even stronger. The annual growth is a touch lower than we’ve seen in some previous quarters, but the sequential increase is quite strong and alleviates any concerns I have of slowing growth. And deposit growth is coming almost entirely from transaction accounts, as opposed to time deposit accounts, which is great. Time deposits (aka CDs) now make up only 15% of total deposits. BOFI continues to make great progress in this area.
Further, the H&R Block transaction, which included the acquisition of $419 million in deposit accounts, closed on August 31 (Q1) meaning the sequential deposit growth from Q1 to Q2 of 9% is all “organic” growth.
Loan originations skyrocketed during the quarter, up something like 50%. Charlie and I both had our eyes on that given some slowdown in origination growth last quarter, but it looks like the engine is revved up again.
Net interest margin for Q2 was 4.07%, up slightly from 4.02% for Q1 and up from 3.85% for Q2 2015. As the NIM is basically the loan portfolio’s profit margin, it’s great to see NIM up both sequentially and year-over-year. 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, and that’s exactly what we got both sequentially and year-over-year. So loan growth is up and the loan portfolio is increasingly profitable. That’s like a manufacturing company both increasing revenue AND gross margin. For comparison, Wells Fargo’s NIM at 9/30/15 (I don’t see the 10-Q yet for their last quarter) was 2.96% compared to BOFI’s 4.02% for the same period. INBK, another internet only bank, had an NIM of 2.84% for the same quarter.
I should point out that not everyone thinks this is a good thing, or at least not an apples to apples comparison. As the NIM is basically the difference between the interest a bank pays on its deposits and the interest it receives from the loans it makes, it doesn’t have anything to do with the “internet only” model or the low efficiency rate. As we’ve explored in the past, BOFI’s loans are generally higher interest rate loans because many of them are “none conforming.” For various reasons that have been discussed, that allows BOFI to charge higher interest rates because there is less competition for these loans as they are deemed (erroneously in my opinion) to be riskier. I, for one, am comfortable with it. Others are not.
Non-performing loans to total loans was .46% for the quarter, which is extremely low. This is a good sign, meaning that BOFI does not appear to be lowering its underwriting standards in order to grow the loan book. There’s no point in growing the loan book 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. This is another area that has been attacked by our friend on Seeking Alpha who has accused management of hiding bad loans in off-balance sheet entities. If you believe that, then the numbers above don’t mean anything. If you don’t believe that, then you’re happy with BOFI’s very high quality loan portfolio.
LTV and DSCR
The loan-to-value at origination for BOFI’s single family and multifamily loan portfolio totaling $4.6 billion is as follows:
LTV Below 60% 61%-70% 71%-80% above 81% Single family 54% 37% 9% 0% LTV Below 65% 66%-75% 76% - 80% above 81% Multifamily 77% 32% 1% 0%
A couple things to point out. LTV is calculated at the time of closing. When you buy or refinance your house you generally have to get an appraisal. That appraised value is what is used to calculate the LTV. The bank generally will not order another appraisal unless there is a compelling reason. So the LTVs above are based on original appraisals. To the extent that current fair market is different than the appraised value at the time of the loan, today’s LTV will be different than what is on the bank’s books. In an appreciating real estate market this means the loans have even more cushion than what the listed LTVs indicate. In a depreciating real estate market, it means just the opposite. Something to keep mind.
I did not see the debt service coverage ratio for the multifamily portfolio. That’s an important metric that I like to review, but it looks like it is only reported once a year in the 10-K.
If you believe management’s numbers, the loan portfolio appears to be in excellent shape.
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, as 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. I don’t give much credit to that source of income as it’s very market dependent. I prefer to see things like transaction account fees, debit card fees, business banking fees, etc. which are much more dependable.
BOFI has several line items of non-interest income, but the one I want to highlight is “Banking service fees and other income”. For Q2 the revenue for this line item was $6.4 million, up from $3.4 million in Q1 and up from $1.6 million from prior year’s Q2. Per the 10-Q notes, this increase is almost entirely directly related to H&R Block branded products and service fee income. So right off the bat we’re seeing an impact from the Block acquisition beyond the deposits, and its one I’m pretty excited about. I do not know how recurring it is though, so I’ll be keeping an eye on it going forward. But it’s a great example of how the acquisition is going to drive earnings. Not only did BOFI pick up a bunch of very cheap deposits it can use to make loans, it also picked up a (hopefully) recurring non-interest income revenue stream.
To provide some further context, BOFI earned $.44 of diluted earnings per share for the quarter. BOFI had roughly 63 million outstanding shares. The $6.4 million of H&R Block related non-interest income therefore translates into around $.10 per share, or almost 23% of the company’s total EPS. That’s not an exact number because I haven’t attached any expenses to the revenue, but I think it illustrates just how important a recurring revenue stream like this can be.
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 a kind of inverse operating margin for banks, but the lower the ratio.
BOFI’s efficiency ratio came in at 34.57%. It continues to be industry leading with no other company even close. There’s not much more that needs to be said about that.
BOFI’s tangible book value per share came in at $9.60 for the quarter, up $.52 (6%) from Q1 and up $2.20 (30%) over Q2 2015. Annual book value growth of 30% is fantastic, and is the single biggest reason in my opinion for the market having previously assigned such a high price-to-book multiple to BOFI (more on that below).
Valuation and EPS
As of today’s closing price, BOFI is trading at a trailing P/E ratio of around 10 and a price-to-book ratio of 1.6x. Diluted earnings per share came in at $.44 for the quarter, up $.04 (10%) from the prior quarter and up $.12 (38%) from the same quarter last year. Return on equity remains very strong at 18.81%.
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
Another great quarter.
Of course the elephant in the room, and the skyscraper on the stock price’s back, is the overhang from the whistleblower accusations and other related criminal and fraudulent activity as alleged in several Seeking Alpha short articles. It is almost hard to believe that only 15 or 16 months ago BOFI was trading for a book-to-value ratio of slightly greater than 5, and now the B/V multiple of 1.6x is in the same range as companies like US Bank and Wells Fargo, who struggle to even reach double digit tangible book value growth, much less BOFI’s 30%. I have been concerned that the negative PR might eventually impact BOFI’s operations. Even if BOFI has done nothing wrong, all of the smoke may simply drive customers and clients away. So far at least, that does not appear to be happening.
If you think management is dirty or fraudulent, and that the Seeking Alpha author will be vindicated, nothing you have read above matters as you don’t believe management’s numbers anyway. If you are in that camp, stay far, far away from this company as financial services fraud never ends well (unless you’re a senior executive of a “too big to fail” bank). If, however, you think the allegations are baseless and BOFI will be cleared of any alleged wrongdoing, you have a company that is growing its EPS by 38% year-over-year and is selling for a trailing P/E of 10 and a likely forward P/E of 7. And a company that is compounding its per share tangible book value by 30% annually and selling for the same price-to-book multiple that the market is assigning to companies growing TBV at literally less than a quarter the rate of BOFI.
You be the judge.