This is a great investment forum. In an effort to contribute, I have applied some of the banking experience in my past to look at BOFI and INBK. My conclusion on BOFI is that Fletch has provided ample support for investment there. I have recently added BOFI to my own portfolio.
INBK is, IMO, lacking the necessary criteria for investment. Here are the main reasons for this belief:
INBK has shown no growth in recent earnings. Net income for the past three years in million dollars – 2014-4.32 2013-4.59 2012-5.61 This is distressing in its own right, but in Q4 of 2013 INBK added $29.1 Mil.
(48%) in capital via a stock offering. Management had this additional 48% available during all of 2014 and “managed” to decrease earnings by 6%?
The rationale for a branchless bank is straight-forward; the bank can deliver services to customers (and returns to shareholders) more efficiently by using the internet as the customer interface. The bank’s costs are reduced by not capitalizing or maintaining the bricks and mortar, and more importantly, by eliminating tellers, branch managers and their assistants and support staff. The bank’s capital is more productive as it can be deployed in true earning assets rather than real estate symbols of prosperity and solidarity. How can we validate this efficiency? The metric of efficiency is called the efficiency ratio. (Old time bankers did not have to work as hard as the government to name things) This is operating costs excluding interest costs divided by revenue. Here is INBK’s trend: 2014-76.92 2013-75.86; 2012-60.93. Lower is better, so INBK is going in the wrong direction. More serious, however, is that they have been in business more than 15 years and their efficiency ratio exceeds most of the traditional branch banking systems. What grade would you give management here?
3.Despite being fraught with risk and regulation, banking can be a very good business. This is because banks have compound interest on their side. Good returns come from come from the spread earned on assets above the costs of funds to acquire the assets. The common measures of management’s effectiveness in producing acceptable returns are the Net Interest Margin and the Allowance for loan losses (or securities losses if applicable). Both BOFI and INBK are exhibiting rapid loan growth. In this case, it is hard to rely on Allowances for Loan losses as losses take some time to be realized in a banking portfolio. Investigation of other metrics that give early indications of probable loan losses such as credit scores in consumer lending and loan to value rations in asset lending would indicate that both of these banks enjoy high credit quality. Then how about Net Interest Margin? For INBK 2014-2.65 2013-2.67 2012-2.67. For BOFI, most recent 3.95. Therefore, IF the credit quality is similar, BOFI is receiving nearly 50% more revenue on every dollar that it loans, and it loans a LOT more dollars. Why is this disparity present here? Early on, INBK was a residential mortgage banker primarily. They found this industry crowded and cyclical as well as highly regulated. Returns were problematic during housing downturns. INBK developed a specialty niche- lending on rv’s and horsetrailers. They had help from dealers in generating these credits. The loans were very high quality. Not many unemployed or homeless could afford horses or RVs. However, the only way to grow this business was to give attractive terms to the borrowers and even then, borrowers were hard to find in the volume desired. INBK then turned to commercial real estate as a way to grow loans. Being risk averse, they jumped into the area of credit tenant leased real estate. Think of a building occupied by McDonalds or Taco Bell on a long term lease. With proper loan to value standards, certainly a safer loan than many as far as risk of the business failing. This is where INBK has generated loan growth in the recent past. How do you think they generated this growth from the borrower’s perspective? Having been there, done that, I can tell you that these borrowers have many lender options. Where they actually borrow the money simply depends on who offers the best terms. Rate or rate/amortization, that is most meaningful to the borrower. Therefore, a lender that will accept a lower rate, or a longer term of amortization or better yet, a lower fixed rate with a longer amortization can get a LOT of business. Has INBK done this? YES, and that will certainly show growth in loans. In spite of this new lending niche, INBK could not attain their desired growth in loans last year through the origination process. 57% of last year’s loan growth was purchased from others.
When I look at INBK, I do not give management high grades. I see evidence of risk aversion that you desire in a bank management, but I see a disturbing history of a lack of perspective concerning how to relate risk to return and how to employ structural cost advantages to the benefit of customers and shareholders. At BOFI it is just the opposite. Management at BOFI has demonstrated cost control and scale leverage, along with a risk/reward understanding in the acquisition of earning assets. Folks like to talk sometimes about the efficient market theory. As BOFI is priced by the market at about 3 times book value and INBK at 80% of book value, I think the market is undervaluing BOFI.
In closing, I would like to state that I have a great deal of admiration for Anirban who teaches us all many things about investing.
To you, Anirban, I would ask the following: In an industry that is beset with the creative destruction of the digital age, why would you invest in a company founded by an IT guy who knows little about banking instead of one founded by a banker who knows how to acquire IT expertise?