Cross post from the BOFI discussion boards…
I’ve been lurking on the Saul boards and found that some Fools owned INBK. As an investor in BOFI, I came across this presentation that looked good - http://www.firstinternetbancorp.com/Cache/1500099821.PDF?Y=&……
I don’t fancy myself as a banking analyst, so I reached out to one that I respect very much – Jordan Wathen. I was curious to get his opinion on INBK, so I wrote him an email.
Here was his response:
I looked at this last when I lived in Indiana, decided to pass. I’ll give this 15 minutes and see what I can remember/come up with.
Worth noting that you should all those numbers on a per-share basis. You’ll see that growth, etc. is fiction. The bank is growing. Shareholder wealth isn’t.
More than half of deposits are time deposits (CDs). Deposit costs go up with loan rates as rates rise. Passes on the benefit to depositors.
Compensation structure is garbage. Executives comped for growing: 1) net income 2) net interest income 3) assets. They are also comped for minimizing nonperforming loans, ex-TDRs – LOL. None of the first three are on a per-share basis. Return on equity doesn’t even come into consideration. You can fudge NPAs (turn them into TDRs). Stupid basis for compensation. (Page 20 of DEF 14 https://www.sec.gov/Archives/edgar/data/1562463/000114420417…)
*Brian again. I had to look up TDR’s - stands for “Troubled Debt Restructuring.” I found this video series of the subject: https://www.fdic.gov/regulations/resources/director/technica……
*Back to Jordan now
Board is garbage. There isn’t a real banker on the board, nor anyone who I would describe as an accountant. Red flag. Red flag. Red flag. Very little combined credit experience on the board. No meaningful share owners, ex the CEO.
The CEO’s shares are used as collateral for a personal loan. People who leverage their stock holdings shouldn’t run banks. (in the proxy I linked) I actually use this as a filter for good shorts. It has signal.
A massive amount of its loans are all commercial real estate loans. I don’t like concentration.
*Brian again - Now comes that part that I found most interesting…
*Back to Jordan
But on to internet banks as a collective…
These internet banks are a fool’s game, IMO. That’s not to say you can’t make a ton of money with this stock. Maybe you can. I think it ends in tears, though, because of the above.
These online banks only look good because rates are low right now. That won’t go on forever. (bolding by Brian)
I pulled this data from the FFIEC. Figures are as a percentage of assets as of 12/31/2016:
INBK All banks Interest Expense 1.10% 0.39% Non-Interest Expense 1.84% 2.89% Total as % of assets 2.94% 3.28%
As it stands, INBK’s hurdle is basically 2.94% on all assets on its balance sheet. The average bank’s hurdle is 3.28%. INBK’s low operating costs (online bank) give it an edge, at least by all appearances.
But if rates move up 100 bps, INBK is going to have to raise the rates it pays depositors close to 100 bps. The average bank isn’t. People bank at INBK for one reason – it pays a lot on deposits. That isn’t true of the “average” bank. Convenience, etc., play a bigger role. (bolding added by Brian)
Imagine if in the future rates rise 100 bps. INBK eats it. The average bank passes on only 25 bps (guess)
INBK’s asset costs: 3.94%
All bank average: 3.53%
Not so brilliant business strategy now, is it?*
John Maxfield writes a lot about banking. He’s crazy about efficiency ratios. I share his enthusiasm for efficiency ratios, but really, I care about interest expense and operating expense as a percentage of assets more than anything.
Here’s how I look at it
I think I’d make a below-average credit analyst with the knowledge I have right now. The average credit analyst would destroy me on performance. But if the average credit analyst’s deposits cost his bank 3%, and my deposits only cost 1%, I can make A LOT of errors before his performance tops mine. I like my odds if I start with a 2% advantage.
Actually, I don’t even have to go out on a limb with a 2% advantage. I’ll stick my book in highly-rated corporate bonds and clip my ~3% coupons with virtually no losses. I like my chances against someone who has to earn 5%, after losses, to beat me.
That’s how I think about banks. I’ll take a banker with an IQ of 100 and asset costs of 1% over a banker with an IQ of 140 and asset costs of 3% any day of the week.
Investing in financials is different than investing in any other type of company. You aren’t looking for the upside. That takes care of itself. Eliminate the downside. That’s how you find good financials, IMO.
Footnote: INBK’s operating expenses are lower in the first 6 months of 2016 as a percentage of assets. Likely has to do with timing on compensation, audit, public filing costs, etc., but I didn’t do any digging into that. Might just be a function of rapid asset growth. Dunno. Didn’t go down that rabbit hole, tbh.
P.S. Virtually everything I said about INBK goes for BOFI, too. I wouldn’t touch either stock with a 100 foot pole.
P.P.S. I’ve considered writing up many of these thoughts – about internet banks, not INBK in particular – before. I think I started that post 100x. Might be worth revisiting. This helped me think it through again.
*Brian from now on
I honestly hadn’t thought about this before. I’ve always assumed that BOFI’s efficiency ratio would allow it to price products aggressively and still earn strong returns. However, I must admit that Jordan has an excellent point – people bank with BOFI because of the high rates. Throughout my entire history investing in BOFI the company has operated in an environment where interest rates are basically zero. By offering 1% checking they stand out from other banks, which makes them look like an attractive alternative. As rates rise, will their rates (and hence their costs) rise in lock-step? I’m not sure, but I could see it happening. If so, there amazing growth numbers (which is why I’m invested in them in the first place) could start to disappear.
Now, their relationships with Costco & H&R Block could help to keep new customers coming in even if they don’t move rates up in lock-step with interest rates. However, this is a risk that I hadn’t considered before (could just mean I’m not paying enough attention).
I’m not giving up on BOFI, but I must admit that my enthusiasm for the stock has been knocked back a bit…
Hats off to Jordan for his eye-opening email.