Internet banks

Investment Analysis Clubs Saul’s Investing Discussions
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Banks are normally way outside my usual remit because I have never had any interest in investing in companies where often no-one, including insiders, seems aware of what long-tail liabilities lurk unseen. The banks discussed here are clearly different.

All I know about banks, and maybe it is out of date, is that you want to see ROA well over 1.5% and ROE near 20%. For thrifts, PB range might be 1 - 2.5, and for savings and loans about 2. PE should be under 11 or so to find value.

I see that BOFI has a good ROA and ROE but a very high PB (3.6). INBK has a poor ROA and ROE and PB is 1.3.

However, I take it from what people say here that they are attractive. Why?

I understand the thesis that new banks are untainted and undespised but note that my traditional bank (one of the oldest and biggest in the world) does everything on-line that I need to do with efficiency. Hmm. I may need educating on the attractions here. I can see the growth. But on the face of it, one looks expensive and the other deservedly cheap.

The chart indicates I am missing something. Any comments welcome.

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Hi Streina, a simple reply is that the Internet only banks make much more money because they have much lower overhead. They don’t have all those branches that they are paying rent, electricity, salary, heat, air-conditioning and whatever on.
Saul

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my traditional bank (one of the oldest and biggest in the world) does everything on-line that I need to do with efficiency. Hmm. I may need educating on the attractions here. I can see the growth. But on the face of it, one looks expensive and the other deservedly cheap. The chart indicates I am missing something. Any comments welcome.

Streina, In midtown Manhattan there’s a bank branch on every block. Often on a street corner there will be two or even three different banks on opposite corners. I’m talking about the big banks, Citibank, etc. These aren’t little tiny offices. They are big, big spaces that they are probably locked into on 20 year leases. They have alcoves for 8 or 10 bankers (or representatives, whatever they are called) in each branch, but only two or three are used. The others sit empty because people now rarely go to a branch. All this prime expensive space is sitting empty. That’s why Internet-only banks can be so much more profitable.
Saul

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Understood and thank you for that. My valuation problems regarding PB and ROA remain though.

Despite recent history, it seems to me small banks might have trouble luring customers away from the perceived security of the big banks if they can get the same service on-line at either.

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Despite recent history, it seems to me small banks might have trouble luring customers away from the perceived security of the big banks if they can get the same service on-line at either.

This was one of my original thoughts before entering BOFI. I watched it for a little over a year and at some point I decided that my perception was not the reality as BOFI sequentially grew deposits and continue to do so.

Ray

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And of course, the lure of being the cost leader is that you can pay more for interest on deposits, charge less for interest on loans, and still make more money than the bank with the higher cost structure.

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Despite recent history, it seems to me small banks might have trouble luring customers away from the perceived security of the big banks if they can get the same service on-line at either.

Here’s my experience in recently switching to an online-only bank. My impetus for changing was that my bank account had been compromised and I needed a new account number. When my credit card information gets stolen, I call up the credit card company and they express ship me a new card with a new number, no issues. When I told my bank, their solution was to apply for a brand new account, keep both accounts open until I could set up my direct deposit and debits with my new account. They didn’t seem concerned that someone had my account number and personal information.

I didn’t have time to set up a new account since I was at work, so I had some time to think about it. I’d been inside a bank branch perhaps 3 times in the past 10 years, mostly because they simply didn’t allow some transactions to be processed online.

I was also annoyed with all the fees. Since I didn’t keep most of my money in the big bank (interest rates too low), I would get nickel and dimed with small fees unless I was careful. The last straw was when I had to go into a branch to pick up a cashier’s check. Wait in line for 15 minutes, then get charged $10 to watch someone type information I provided into a computer and hand me a printed check.

I signed up for an online bank. Interest rates are higher. I can use any ATM and have fees refunded. If I can wait a couple days for a cashier’s check, there’s no fee, and fees are overall lower. Customer service is faster online via chat (which I prefer), hold times are significantly shorter, and both are available at all hours. The web site is more comprehensive and easier to use, and the app is better too.

The downside thus far is not being able to deposit cash. I personally try to use cash as little as possible (suffice it to say, you learn how dirty paper bills can be when you work in a county hospital). It’s only come up a couple times and I’ve figured it out.

My sense is that the younger generation, more used to immediate access to service at all hours and with a less reliance on cash, will lean more toward online banks. Perhaps the big banks will boost their online presence and make things easier and better compete, but it will mean their branches become less and less useful. As Saul points out, those branches cost money.

I also recently read that there’s government regulation stating that banks must maintain enough branches in certain low income areas, even if less profitable, or face penalties. I don’t remember the specifics, but the bottom line was that banks without branches simply didn’t face those issues.

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Despite recent history, it seems to me small banks might have trouble luring customers away from the perceived security of the big banks if they can get the same service on-line at either.

A couple things. First, according to Accenture (as referenced in the INBK investor presentation), over 25% of North American consumers would consider switching to a branchless bank: 39% of 18-34 year olds, 29% of 35-55 year olds, and 16% of 55+ year-olds. So there’s already a sizable market, and it’s undoubtedly growing over time as people get more comfortable with the idea and know more friends or family that use branchless banks and have a good experience.

Second, you’re not limited to one bank :wink: I’ve used a branchless bank as my primary bank for many years, but I also have an account at a local community bank. The two are linked so I can easily transfer funds between them as needed. If there’s something I need to go into a branch for (very rare), I use the community bank; for 99% of everything else I use the branchless bank. In some ways, this shows how bad it can be for banks with branches: not only more overhead in general, but potentially their average interactions with customers could become higher touch over time (and therefore more expensive) while branchless banks reap the benefits.

Neil
Long BOFI, INBK

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Despite recent history, it seems to me small banks might have trouble luring customers away from the perceived security of the big banks if they can get the same service on-line at either.

Why “despite recent history”? I would think the recent history of consistent deposit growth for these institutions would be quite relevant.

Fletch

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Despite recent history, it seems to me small banks might have trouble luring customers away from the perceived security of the big banks if they can get the same service on-line at either.

I’m unclear what is meant by security. If the risk is the bank going under, both BOFI and INBK are FDIC insured, so backed by the Federal government, for up to $250K per customer. Which I am guessing fully covers 99% of customers, and 99.9% of the younger folks. Perhaps people at large are not aware of that though.

Maybe something else is meant by security too, like identity theft?

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Many thanks for those interesting responses, especially Saul, IRdoc and Neil. I take the good point about those who have grown up with computers and are at ease with their financial affairs completely on-line, are increasing as a prop. of the client-base. The point about big institution’s habit of slipping in small fees is also a good one. (Takes me back to the appalling ways of flesh&blood stockbrokers. I discovered they had 9 different ways of making a regular turn on my account of which I was only aware of 4.)

Fletch: by ‘recent history’, I meant the regrettable activities of banks in the past.

utahchris: by ‘security’ I meant that huge banks might be more likely to thwart cyber-attack by spending big bucks. (On the other hand, they are more likely to be the target.)

My question on the valuations remain. If INBK is doing so well, why is ROA so low? And why do we not think BOFI is expensive on PB?

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A couple things. First, according to Accenture (as referenced in the INBK investor presentation), over 25% of North American consumers would consider switching to a branchless bank: 39% of 18-34 year olds, 29% of 35-55 year olds, and 16% of 55+ year-olds. So there’s already a sizable market, and it’s undoubtedly growing over time as people get more comfortable with the idea and know more friends or family that use branchless banks and have a good experience.

The idea to move is easiest enough, I would be part of one of those that would consider a branch less back. I left the US in 2004 which makes it impossible to use their branch but even before that I hadn’t used one of their branches since 1999.

I hold both BOFI and a smaller position in INBK but I am not sure if there is a compelling reason for me to move my bank accounts to them. Though I don’t really have a lot of banking needs.

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Hi strelna,

Fletch: by ‘recent history’, I meant the regrettable activities of banks in the past.

Ah, I see. The best answer I have to whether or not these banks will be able to attract deposits is to see whether they have been attracting deposits. For BOFI at least, deposit growth has been quite strong for several years now. I see no reason this can’t continue.

My question on the valuations remain. If INBK is doing so well, why is ROA so low? And why do we not think BOFI is expensive on PB?

I can’t speak on INBK as I don’t really follow it that closely. For BOFI, the company I pay more attention to, it very much is expensive from a P/B standpoint. I don’t think anyone would say otherwise. The question is whether or not the valuation is justified. I believe it is. If you have access to Rule Breakers, I’d point you to the BOFI board over there. I’ve posted extensively on why I believe the market is rewarding BOFI with an unusually high (for a bank) P/B ratio.

Fletch

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