BOFI quarterly review

Hi guys,

At Saul’s request, I’ve reposted my BOFI quarterly update from the Rule Breakers service. I hope you find it helpful. The formatting did not survive the “cut and paste” process, but I hope the quotation marks are somewhat helpful in figuring out who is saying what.

I assume everyone has seen the numbers by now, so I’m not going to go into much quantitative detail this quarter. I’m starting to get bored saying the same things quarter after quarter about how deposit and loan growth are great, spreads are strong, book value growth is awesome, yada yada. I started that analysis, then got bored, and never finished it. Suffice it to say I thought all of the numbers looked good.

Instead, I’m going to focus on the conference call, which I thought contained an unusual amount of interesting information. Quotes are in bold, with my commentary following each item I’ve pulled out.

CEO: “For the second quarter’s originations, the average FICO for single-family agency-eligible production was 765, with an average loan-to-value ratio of 65.9%. The average FICO for the single-family jumbo production was 714, with an average loan-to-value ratio of 62.05%. The average LTV of the originated multi-family loans was 61.49%, and the debt service coverage was 1.335.”


“At December 31, 2014, the weighted average loan-to-value ratio of entire portfolio of real estate was only 54%.”

Fletch:There are a couple things to note here. The first thing is that at a weighted average LTV of 54%, BOFI’s loan portfolio can still be considered very conservative. This means that, assuming appraised values are correct, the real estate collateral of BOFI’s loan book could drop almost in half and still cover the loan balances. The second thing to note, however, is perhaps not as good. All of the loans BOFI originated in the second quarter had LTVs of greater than 60%. I’m not particularly concerned with the agency-eligible productions as BOFI probably won’t that hold that for its own book.

The two categories to monitor are the jumbo production and the multi-family, both of which BOFI is more likely to hold. At 62%, the LTVs of both of those categories are still very strong, but also they are clearly higher than the total portfolio average of 54%. I wish the analysts on the call had asked if this was a one-time thing or the start of a larger trend to higher LTVs due to market conditions, but of course they were worthless on the call, as usual.

A debt service coverage ratio of 1.34x is pretty good for multi-family real estate. Without getting to deep into real estate economics, this basically means that the real estate backing these loans generates $1.34 of cash flow for every $1 of required debt service. Said another way, if a project’s total annual debt service was $100,000 a project with a 1.34x DSCR will generate $134,000 of operating cash. This may not seem very high, but Fannie, Freddie, and HUD loans typically require 1.20 to 1.25. So anything above that is pretty solid.

CEO:“Total non-performing assets as a percentage of total loans was 80 basis points at December 31, 2014, up from 57 basis points at June 30, 2014. The increase is primarily attributable to 2 single-family residences with balances of $7 million and $5 million, with loan-to-value ratios of 70% and 47.6%, respectively. Both properties are located in premier markets, with very strong housing market, and we don’t expect to occur at any loss on either of these loans. We do not see any early-stage delinquency trends increasing in our portfolio.”

Fletch: There is an important distinction between non-performing assets and loan loss reserves. A non-performing asset is simply a loan for which the borrower stops making payments. A loan loss reserve is a reserve set up in anticipation of a loan not being fully paid off. The CEO indicates above that the increase in non-performing assets is primarily a function of two large, residential loans with relatively low LTVs. So, even though these loans are non-performing, the collateral backing the loans is worth much more than the remaining loan balances, so no loss is expected because even if the bank is forced to foreclose, the houses are worth more than loan balances meaning the loans are expected to be fully repaid, one way or another.

CEO:“We made further progress improving the quality of our deposit base by growing checking and savings deposits by approximately $1.6 billion from December 31, 2013, representing growth of 108%. Transaction accounts now make up 67.9% of our deposit base, up from only 52.6% from a year ago.”

Fletch: You’ve seen me hit on this topic before. All deposits are not created equal. Having 2/3 of deposits as transaction accounts is an amazing step forward from where the company was just a few years ago. These accounts are typically cheaper (lower interest rates than CDs and money markets) plus they carry the opportunity for BOFI to earn fee income (like on debit card transactions). All good here.

CEO:“Our Business Banking group had another successful quarter, growing deposits by almost $360 million to $2 billion at December 31, 2014. Business accounts now represent 51% of our total deposit base, up from 29% a year ago. Our core value proposition of saving business customers 30% or more on their monthly fees and providing good customer service is resonating with the growing base of clients who are very comfortable working with a branchless bank.”

Fletch: This is massively important, and I don’t think most people (including Mr. Market) understand just how big this is. I wrote the following in a post on this message board in February 2014 as part of my 2013 review, regarding business banking:

“This is going to be a major growth driver. The sequential growth rate for the business deposits is 47%. I actually think this is BOFI’s long term growth driver and eventual primary deposit source. I think the bank got its start with consumer deposits, but eventually most deposit growth will come from the business banking group, which has huge potential market. This may be the single thing I’m most excited about with BOFI. This runway is very, very long.”

Why is this important? Business accounts tend to be very sticky, and they are not subject to interest rate vagaries. Corporations want to work with banks that keep the corporations fees low, and they don’t care about physical branches. BOFI is saving new business clients an average of 30% or more on their monthly fees. Given BOFI’s low cost business model, I don’t see how almost anyone is going to be able to compete with BOFI on corporate banking fees.

Recall how there has been much conversation on the message board of the years about whether or not BOFI will be able to keep attracting consumer deposits given the website or user interface wasn’t that great, or that BOFI didn’t offer the highest interest rate, or a number of other (valid) concerns. All of those things become moot when a majority of BOFI’s deposits (now 51%) are now business accounts. And the run rate on that number is huge.

More on business banking from the CEO: “We recently added a premier banking offering on an invitation-only basis to our product lineup. Through our analysis of customer needs, we found that many of our best customers prefer, despite our focus on delivering a good call center experience, a relationship manager that would be specifically assigned to their account. Based upon the size and profitability of the relationships, the model is cost-effective, and we will be launching – it will be a launching point for the bank to continue to segment its customers and provide the appropriate level of service to customers that are more used to a personalized level of service.”

Fletch: I really like this. The CEO is saying that despite what he believes to be excellent customer service through BOFI’s call center, it is apparent that some of the larger clients still want one person to run point as a relationship manager. Management recognizes this and is implanting the model where it is cost effective. I like the move because it shows that management is flexible and willing to alter business strategy based on customer feedback.

CEO:“The multi-family market has been competitive over the last few years. We remain selective on multi-family loans we originate and only hold ones with good debt service coverage and low loan-to-value ratios. While valuations have become frothy in some markets, healthy occupancy rates and steady rental rate increases provide solid support for our multi-family loans. If current pricing pressure persists, we will moderate our multi-family loan production and reallocate our capital to assets that generate a superior risk-adjusted return.”

Fletch: As someone who works in the industry, I can vouch for this. The multi-family market has been very hot lately, with large institutional money chasing returns. A good multi-family project in a strong real estate market can provide a very low risk 6% to 8% return, and big money managers have figured this out over the last several years. I appreciate the CEO’s comments about not wanting to chase crazy loans and only allocate capital when the risk adjusted returns merit the investment.

CEO: “We received approval today for our recently announced purchasing assumption agreement last month to acquire approximately $125 million of deposits at par with no purchase premium from Union Federal Bank (sic) [Union Federal Savings Bank] and its parent company, The First Marblehead Corporation. The acquisition of over – a 200,000 [ph] nationwide consumer checking, money market savings and CD accounts will further diversify our deposit base and be mildly accretive to our funding costs. We expect the transaction will close in the second calendar quarter of 2015, and we believe that the timing will not impact our pending transaction with H&R Block Bank.”

Fletch: This is important for one obvious reason, and one not-so-obvious reason. The obvious reason is that BOFI picking up $125 million in deposits at par value is a win. While not necessarily a material transaction, it certainly isn’t bad. The not-so-obvious reason has to do with what this may mean for the H&R Block transaction. One of the “short attacks” on Seeking Alpha had indicated that a reason the Block transaction has been held up is all of the skeletons in the closet, so to speak, that the regulators had uncovered with BOFI. Well, given how fast this deposit acquisition was approved by the regulators (I think it only took a couple of months) I think it’s safe to say that structural issues or ethical concerns about BOFI’s business practices are probably not what is holding up the Block deal.

CEO: “Stockholders’ equity increased $79.6 million or 21.5% to $450.4 million at December 31, 2014, up from $370.8 million at June 30, 2014. The increase was primarily the result of our net income for the 6 months ended December 31, 2014, of $37.2 million and sale of common stock of $38.9 million as well as vesting and issuance of RSUs and options of $2.2 million, less $1.4 million in unrealized gains on incomprehensive income and net of $0.2 million in dividends declared on our preferred stock.”

Fletch: We’ve talked before about how BOFI funds some of its loan growth through at the money stock sales into the market, and that the dilution is not necessarily a bad thing if management is earning an appropriate rate of return on the additional equity. BOFI’s return on equity was 19.08% for this quarter which, quickly looking through my notes, I believe is highest I’ve yet seen.

I’ll now discuss some general topics, paraphrasing the conference call discussion.

On deposit growth: the CEO discussed the need to get the deposit-to-loan ratio a little more in balance given the delay in the Block transaction. During 2014 BOFI had ramped up loan growth assuming it would have the additional $500 million in Block deposits, and since they still didn’t have it and couldn’t guarantee they’d ever get it, management decided to devote more resources (both personnel and market expenses) to driving deposit growth. And it clearly worked. The CEO said that with the deposit growth in the recent quarter, BOFI is in great shape from a deposit-to-loan standpoint even if the Block transaction does not go through.

On the Block transaction: the CEO stated that in retrospect, BOFI should have handled the approval process differently. He said that there are really two separate transactions: the agreement that will allow BOFI to offers products and services to Block, and the acquisition of the Block deposits. The transactions were kind of combined into a single deal that was then submitted for approval. Looking back, BOFI’s management feels that BOFI did not need regulatory approval for the management deal (which is pretty complicated, apparently) but did need regulatory approval for the deposit acquisition (which is relatively straightforward).

The CEO indicated BOFI kind of shot itself in the foot a little bit by submitting the proposal in such a way that required the regulators to have to go through and approve a complicated transaction (the management agreement) when they really should have only needed approval for deposit piece. The CEO stated the he really learned a lesson with this transaction, and that while he still feels the deal will go through (he repeated that part a number of times) BOFI will definitely change its regulatory approach for any similar future transactions. Makes sense to me.

On commercial real estate: the CEO stated that BOFI is selectively testing out some commercial real estate products in certain markets. He said the tests are pretty small at this point, but that management likes what it sees so far. So that could be another potential avenue for loan growth down the road.

On Big Data: it was very interesting throughout the call to hear the CEO talk about all the data collecting and mining the company does to identify potential customers. It sounds like they invest a fair amount of money in the software necessary to generate high quality leads from the data.

What follows are purely my own thoughts. Much has been made about valuation with BOFI, price-to-book ratio, is expensive or not, etc. I want to highlight a couple of things. First, BOFI has a market cap of $1.3 billion. While this seems like a lot, it really isn’t. The generally accepted definition of “small cap” is less than $2 billion. That means that BOFI simply isn’t yet on the radar for a lot of people, especially the big institutional investors that really move the market.

Also, allow me to present a list: FBR Capital Markets; Sandler O’Neill; Raymond James; Sterne Agee; Keefe, Bruyette, & Woods; and Millman Research. As far as I can tell, those are the only research companies covering BOFI (those are at least the only analysts who bothered to ask a question). No Goldman Sachs, no Morgan Stanley, no JPM, no Bank of America Merrill Lynch, no Deutche Bank, no Credit Suisse, no Barlays.

What that tells me is that we simply need to be patient. There is no question in my mind that BOFI is a great company and that the stock price deserves to trade at a substantial valuation premium compared to the larger industry. But it’s still a small, small player that isn’t even on the radar of the bigger research firms yet.

Can you imagine what would happen tomorrow if Merrill Lynch initiated coverage on BOFI with an outperform rating and a price target of $120? As BOFI continues to execute, continues to grow book value, and continues to gain market cap the company will start to show up on more and more analyst research reports. And as the analysts become more familiar with it, and the big research firms start covering it, more and more institutional dollars will flow into it. I think the stock price will do just fine.

BOFI ticker guide


That’s a great write-up Fletch. Well-Done!!!

I love the part about the business banking. That certainly seems like a great market to hit.

I have 2 LLC’s for my 2 different real estate companies. I use BOFA and WFC for those 2 accounts. They are both a pain in the ass. Let me give a few examples:

1)At BOFA, they required that until the account had $10,000 in it, I was required to make a debit purchase each month. It was very annoying. I remember going to my supermarket around the block and buying a $.99 banana just to use the damn debit card. Of course, when I forgot to use it on a particular month they charged me a fee.

2)My WFC business checking account requires a transfer of $150 to that account each month. So, my banker at WFC had to set up an additional business savings account. We put $150 into that savings account. We set it up to do an automatic $150 transfer from the savings account to the checking account and then back to the savings account. Just a silly annoyance.

3)Also, my WFC business checking account charges $3 a month for the right to see old deposited items online. Of course I don’t pay it, but, on the rare occasion I need to see an old deposited item, I can’t see it.

Now, I have no idea what the policies are at BOFI for business accounts. But, if they offer an experience that is even a little better and more cost-effective than the major banks, I would imagine that would be a big plus for them over the long run.

-The biggest risks on owning bank stocks is when banks chase money writing bad loans or entering new markets they don’t fully understand. I’m not worried about recessions/depressions or real estate slowdowns, because those will always be a part of the natural cycles of an economy. When those happen, like 2008/2009 all stocks get destroyed. But, if you pick the right ones, they will eventually come back (unless the world ends). My main worry is when upper management starts making poor decisions. So far it looks like BOFI has done an excellent job making good decisions.


Long BOFI and and getting closer to buying more


THanks Fletch,

Great write up. Amazing value you bring to this board and I’m sure everyone appreciates it as much as I do.

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