Did I sell out of BOFI? Of course I did!

[SaulR80683]

So, here is my question:
You indicated that you started a very small position in BOFI earlier this week, I believe. Then, the news came out about the class action lawsuit, and we’ve all seen what it has done to the stock price of BOFI over the last few days. Have you now closed out the small position you started earlier this week? Or are you planning on waiting and seeing how it all plays out?
Thanks, az5speedy

Hi Speedy, Of course I sold out. Some people say “Why should we listen to shorts?” Look, there are articles by shorts on almost every stock we own probably every month. Most of them say something like “This company is overvalued because…” or “There is new competition” or “They have too much inventory” or something like that. The author says he’s short the stock. I may look at what he says and usually feel I’ve already taken what he’s saying into consideration. I never sell out of a stock because of one of these articles. The short attack on BOFI is as far from that as a hundred-car pile-up on the Interstate is from a fender-bender in your driveway. The BOFI short attack wasn’t about too much inventory, or competition from another bank, or the stock being overpriced, etc. It was about sleaze!

As Monkey quoted from one of my ancient posts: I’m hearing (especially on the BOFI board):

Okay, so they are giving insiders huge loans at preferential rates… But other companies give insiders lots of stock options.

Okay, so one of their senior vice presidents is a convicted felon… But his felony doesn’t have anything to do with his Bofi duties.

Okay, so BOFI insiders were connected to two banks involved in the biggest scandals and bankruptcies in California… But that could just be coincidence. It doesn’t prove anything.

Okay, so they are helping this shady company evade banking laws by opening loans for them and selling them the loan after 24 hours… But that’s probably not strictly illegal, and it makes good money for the Bofi.

Okay, so one of their ex-internal auditors is suing the company with a huge list of irregularities… But he’s probably just a disgruntled employee, and someone has already dismissed his complaints.

Okay, so they are hiding risky loans in mortgage warehouse loans, a usually safe category of loans (this came out today)… But it’s not proved that Bofi is doing anything strictly illegal.

Okay, so they are involved with this unlicensed Center Street company that specializes in fix and flip homes… But it’s not proved that Bofi is doing anything strictly illegal.

Okay, so…and on, and on, and on…

And this was before it came out that they had hired their chief internal auditor immediately as he came from a similar position at another bank that was going under in a big scandal, and before it turned out that they opened a fake “branch office” in Nevada, consisting of a girl and a desk, so that they could charge usury rates on certain loans, by allegedly running them through that office. It’s all just skating on the edge of being illegal, maybe not quite going over the edge, just shady. This was not your standard short attack.

When the shorts seemed to have gone away, and the price started back up, and it seemed to have all blown over without any consequences, I decided to try a tiny position again. I bought it on Monday. When the news of additional ex-employees coming forth, and the Houston suit, came out on Wednesday after the close, I thought “What was I thinking?” The premise on which I had bought was broken! Of course I sold out! This was not a little shrug-off short article on Seeking Alpha. Not for me. When the premise on which I bought a stock is completely overturned I sell the position. Period!

Hope that this helps.

Saul

[az5speedy]

Thank you, Saul.
I appreciate you answering my question, and I also appreciate you explaining the reason for your decision to sell your shares of BOFI. I am alway interested in hearing your thought process for any given situation.

And, again, as I stated in my prior post, I make my own decisions based upon a variety of factors, as I think we all should and hopefully do. I simply hold you in pretty high esteem and, so, was curious as to how you responded to the news that came out this week about BOFI.

Best,
az5speedy

[NewEchota]

SaulR80683: The BOFI short attack wasn’t about too much inventory, or competition from another bank, or the stock being overpriced, etc. It was about sleaze!

As Monkey quoted from one of my ancient posts: I’m hearing (especially on the BOFI board):

Okay, so they are giving insiders huge loans at preferential rates…

Your decision to sell clearly makes sense for you; but being perhaps the most respected and one of the most highly thought of posters on The Fool, I just wish you hadn’t re-posted this long list of unproven allegations from Seeking Alpha as your rational. We’ve gone over these allegations before in detail so I’ll only address the first one on your list as a refresher.

But before I do, here’s a brief thought about Seeking Alpha. Have you ever noticed that it’s rare for one of their articles to quote an industry expert?

Financial magazines like Fortune or Business Week always turn to experts to analyze the substance of their articles. In the case of preferential rates, it would be easy to bring in a few former regulators, securities law professionals or loan officers to review and comment on the allegations. But then that’s not the objective of Seeking Alpha writers; they want to raise doubts not reach the truth.

And contrary to the Seeking Alpha allegation, there is nothing sleazy about banks providing preferential loan rates to employees as long as certain restrictions are followed. But as always, Seeking Alpha writes in a way that demonstrates it has no facts or evidence to support its allegations by the way the allegations are presented:

“My research suggests many of these loans…” and

“BOFI appears to have made…” and

“The CEO of the company has a BOFI loan that appears…” and

“BOFI does not appear…”.

Is it any wonder that most readers walk away with the thought of “sleaze” in mind even when the Seeking Alpha case is built almost entirely on “appearances” and “ifs” rather than facts and law.

As far as the law is concerned about employee loan rates, please see:

Reg. O: Lower Loan Rates for Employees

§ 215.4 General prohibitions.

(a) Terms and creditworthiness —(1) In general. No member bank may extend credit to any insider of the bank or insider of its affiliates unless the extension of credit:

(i) Is made on substantially the same terms (including interest rates and collateral) as, and following credit underwriting procedures that are not less stringent than, those prevailing at the time for comparable transactions by the bank with other persons that are not covered by this part and who are not employed by the bank; and

(ii) Does not involve more than the normal risk of repayment or present other unfavorable features.

(2) Exception. Nothing in this paragraph (a) or paragraph (e)(2)(ii) of this section shall prohibit any extension of credit made pursuant to a benefit or compensation program—

(i) That is widely available to employees of the member bank and, in the case of extensions of credit to an insider of its affiliates, is widely available to employees of the affiliates at which that person is an insider; and

(ii) That does not give preference to any insider of the member bank over other employees of the member bank and, in the case of extensions of credit to an insider of its affiliates, does not give preference to any insider of its affiliates over other employees of the affiliates at which that person is an insider.

Finally, preferential loan rates were also addressed in a previous BofI 10K, this one dating back to fiscal year 2013:

The Sarbanes-Oxley Act generally prohibits loans by public companies to their executive officers and directors. However, there is a specific exception for loans by financial institutions, such as the Bank, to its executive officers and directors that are made in compliance with federal banking laws. Under such laws, our authority to extend credit to executive officers, directors, and 10% or more shareholders (“insiders”), as well as entities such person’s control is limited. The law limits both the individual and aggregate amount of loans the Bank may make to insiders based, in part, on its capital position and requires certain board approval procedures to be followed. Such loans are required to be made on terms substantially the same as those offered to unaffiliated individuals and cannot involve more than the normal risk of repayment. There is an exception for loans made pursuant to a benefit or compensation program that is widely available to all employees of the institution and does not give preference to insiders over other employees.

http://www.sec.gov/Archives/edgar/data/1299709/0001299709130…

[Thomfranklin]

One word alert:

http://finance.yahoo.com/news/houston-pension-fund-sues-inte…

The suit filed by the Houston Municipal Employees Pension System in U.S. District Court Southern District of California alleges that in one instance, the bank refinanced a loan to a borrower that participated in a gambling ring operated by a Salvadoran gang.

The suit also says the company failed to disclose its use of off-balance-sheet entities to purchase lottery receivables, lacked a robust compliance system and issued loans to foreign nationals with criminal or suspicious backgrounds.

BofI also failed to fully tell investors about government and regulatory subpoenas it had received and pending investigations by federal agencies, the suit claims. It seeks class-action status.

[NewEchota]

Thomfranklin: BofI also failed to fully tell investors about government and regulatory subpoenas it had received and pending investigations by federal agencies, the suit claims. It seeks class-action status.

Perhaps you highlighted the wrong word(s); perhaps it is more correct this way:

BofI also failed to fully tell investors about government and regulatory subpoenas it had received and pending investigations by federal agencies, the suit claims. It seeks class-action status.

Going directly to the Houston Municipal Employees Pension System complaint (comments and emphasis are mine):

223. BofI finally confirmed the existence of government and regulatory investigations [note: this is the attorney’s allegation, not a fact] in supporting documents to a motion it filed in its countersuit against Erhart in this District, BofI Federal Bank v. Charles Matthew Erhart, et al., No. 3:15-cv-02353-BAS-NLS. In a memorandum in support of BofI’s motion to file certain documents under seal (the “BofI Sealing Brief”), BofI revealed that an accompanying declaration by a forensic investigator hired by BofI to examine Erhart’s computer for confidential information “contain[s] the file names of BofI documents” that are confidential because, among other reasons provided by BofI, some file names evidence communications with regulators [what banks don’t communicate with regulators?], which are nonpublic and not to be disclosed, per agency rules. (Id.) Similarly, file names containing the term “subpoena” evidence nonpublic agency investigations, which BofI is not permitted to disclose. [again, the attorney offers no evidence that these are current or ongoing investigations… Erhart removed many files and his attorney has not presented evidence that any of these are from current investigations.]

BofI alleges in their complaint, BofI Federal Bank v. Charles Matthew Erhart, et al., No. 3:15-cv-02353-BAS-NLS, that information removed by Erhart is confidential and Erhart has, possibly, been sharing this confidential information with Seeking Alpha, among others.

In fact, in a quick word search Seeking Alpha is named 35 times in the Houston Municipal Employees Pension System complaint.

[Oforfive]

In a situation such as BofI, it is easy for brain fatigue to set in. Such a large number of issues and accusations to sort through can make one just tune it all out. In time we will find out if the accusations are true, and if true whether laws have been broken. But I think that at the end, any of our views of the morality of any of the alleged actions will matter. I am going to cover just one of Saul’s comments about BofI’s ‘sleaze’.

and before it turned out that they opened a fake “branch office” in Nevada, consisting of a girl and a desk, so that they could charge usury rates on certain loans, by allegedly running them through that office.

Let’s imagine that we are in the penthouse luxury executive clubroom of Bank of Anything Goes in the high rise section of La Jolla. Here we have Mr. Gregory Greasypants, President and CEO; Mr Eshel Bar-None, Executive Vice President and Chief Legal Officer; Andrew J. Machete, Executive Vice President and Chief Financial Officer; John Villain, an expensively dressed attorney with a black handlebar mustache; and a motley fool investor who has 8% of his IRA invested in BOFI.

Mr. Greasypants, swirling a couple ounces of Hennessey Ellipse around in his favorite Waterford Lismore brandy snifter: “Andy, how’s the H&R thing doing?”

Mr. Machete, avoiding eye contact with Gregory, intently inspecting his perfectly manicured right thumbnail: “Well, Greg, I’ve got that idiot down in IA chained down so we’re o.k. there, but Eshel says that bleeding heart liberal AG is crying usury about the RAC rates and fees, and the regulatory risk is too high. We shouldn’t do the deal.”

Mr. Greasypants, spitting $50 worth of brandy onto the Persian carpet: “Cripes sake, Eshel, you get the big bucks and the preferential loans to SOLVE problems, not to BRING them to me. We’re talking $400 million of loan production here!”

Foolish Investor, setting his wet Coca-Cola Zero can down on the Duval side table to his right: “Uhm, this Block deal is a big part of my investment thesis for BOAG. If the doesn’t go down, I’ll probably have to sell for a loss. What’s a TAC anyway and surely BOAG doesn’t charge usurious rates?”
Mr. Machete, suddenly sitting upright, pleased with the diversion: “Hey, Fool, that’s a $1000 table you’re marking with your wimpy-ass Zero can. Use the coaster.”

Mr. Bar-None: “Relax, Andy, it isn’t your table, and besides it was a gift from that cartel guy that we loaned forty million on that dumpy beach house. Look, Fool, Block does taxes for low income people. They get Earned Income Tax Credit so they get refunds. They can’t file their own returns. I can’t figure mine out, and last I heard I’m the chief legal officer here. When was the last time you did your own taxes? So they go to Block, but maybe don’t have the cash to pay for the return. Block does the return. And it’s a RAC, not a TAC… Refund Anticipation Check. They write a RAC. Less, of course, fee for tax return preparation and what not and charge interest. What’s the alternative to the RAC? If they are out of cash do they spend on a credit card? What’s in your wallet? Check the APR on that. Usury is in the eye of the beholder. If the interest and fees are 6% of the return, that’s over 100% APR, but It’s just 6% ‘cause the return is received in less than a month.
Now, Greggy, don’t get your bowels in an uproar. I’ve got your damned solution. Nevada. I’d like you to meet John Villain, of Sly, Villain and Sleaze. Johnny, why don’t you explain how we get around that cry-baby California AG. “

Mr. Villain thoughtfully fingers his handlebar with his right hand as he shifts his gaze from Eshel to Fool then to CEO Greasypants: “Yes, Mr. Greasypants, Nevada. Nevada has no usury limits. Set yourself up a branch office in Nevada and make those refund loans through it—out of the reach of California.”

Mr. Greasypants, greedy smile spreading across his face, then frowning: “But we don’t have branches, Mr. Sleaze,…er, Villain.” Mr. Greasypants glances around the room. “Gentlemen?”

Mr. Machete: “Hey, we have that dumpy building in Reno,… Virginia Street, right? You know, the loan to that Petrobras exec went sour and we hid it in the warehouse. We can stick a desk and chair in there in Reno and call it a branch.”

Mr. Villain: “Hate to be a spoil sport, but under Nevada law it has to be a full service branch.”

Mr. Greasypants: “You mean Nevada has pesky rules, too? I thought it was the land of Marlboro Man and rogue ranchers.”

Mr. Bar-None: “Full service, like usury, is in the eye of the beholder. Make it a desk and two chairs and throw in a file cabinet. I have a niece living in Reno. Unemployed but very bright. She can run the ‘branch’ and then we can give her a preferential house loan, too, and get my sister off my back about how I never help out her and her useless family.”

Foolish Investor, draining the last of his Zero and tossing the empty into the corner waste basket, a legitimate three pointer: “It would be foolish to pass up those $400 million of profitable loans just because my investment thesis also includes your branchless model. Rules are meant to be met, but only just so…. And, Mr. Bar-None, I do do my own taxes. I just send the wife and kids and my dog outside for the month it takes me to finish them. They can’t abide my cursing and crying. I admit that I never do AMT calculations. Let the bastards at IRS figure that out.”

Mr. Greasypants, going to the side bar and pouring a couple of fingers of Ellipse for all (but using the cheap stemware): “Then it’s decided. Branchless no more. A mere bagatelle in the Fool’s thesis, though in truth, Fool, you can take your thesis and put it where the sun don’t shine.” Greasypants smiles and hands Fool the cheap snifter. “God put those 50-percenters here to be exploited. I told the department heads that at 2 a.m. last night in a text message.”

Mr. Bar-None, draining the cheap stemware and heading for the door: “Got to run, guys. I heard something about a Salvadoran gambling gang wanting a loan. Got to draw the line somewhere, right?”

OK, but seriously, the RAL “business” has been around for 30 years and has become more and more regulated. Consumer protection has been added to some degree. Go to the H&R Block web site and see how this service is promoted. I use H&R Block. I sent an email to the franchisee who does my taxes. Asked her about the 21-day funding. How many days the loan is outstanding is important. A small percentage of fees and interest charged for a short term loan will translate into a large APR. Using APR as a criticism is disingenuous, perhaps even sleazy.

and before it turned out that they opened a fake “branch office” in Nevada, consisting of a girl and a desk, so that they could charge usury rates on certain loans, by allegedly running them through that office.

At this point I would say, “Spare me the moral outrage”. If you need a full service branch, make one.

However, I don’t look favorably on the growth through adding other businesses such as structured settlements, tax refund loans, and funding house flipping loans. Why? Because I don’t see these individual businesses as growth businesses. No large addressable markets. I think I see growth opportunity for jumbo loans and probably for equipment loans. But tacking on these other “verticals” wasn’t in my investing thesis.

KC, no current position in BOFI