Should Be Holding BofI Holding Inc. In Your Portfolio?

Thesis

When most investors think banking our minds typically snap to Goldman Sachs (GS), Bank of America (BAC), Citi (C), or other of the larger, traditional banks in America. Unless you are more focused on financials, you may not have heard of BOFI Holding Inc. (BOFI). BOFI is a “branchless bank” which, as you would guess, has no physical branches. This may seem absurd to some, but the proof is in the performance this bank has produced over the past several years, blowing away its peers in metrics such as return on assets, return on equity, and efficiency ratios. With its efficient, branchless, model and strong operating metrics, I believe BOFI to be a buy on the thesis that it will continue to be a strong performer and continues to grow in size.

Performance History and Performance Relative to Peers

Since 2012, BOFI has a 29% CAGR in EPS and a return on average equity in the upper teens. Looking at BOFI’s peer group, there is no doubt that it is a top performer, especially in terms of efficiency ratio and ROE.

img src="https://static.seekingalpha.com/uploads/2018/7/11/29822845-15313363434355648.png" width="624" height="457" data-width="640" data-height="469" data-og-image-twitter_small_card="true" data-og-image-twitter_large_card="true" data-og-image-twitter_image_post="true" data-og-image-msn="true" data-og-image-facebook="true" data-og-image-google_news="true" data-og-image-google_plus="true" data-og-image-linkdin="true"">>Source

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When analyzing traditional bank stocks, the benchmark for return on assets is 1%. Looking at BOFI we see it sits comfortably above that benchmark. This metric is telling investors how much profit the company makes relative to its total assets.

Return on Assets = Net Income / Total Assets x 100

Looking at return on equity, the benchmark is typically around 10% and we see BOFI clocks in at over 18%. This metric is basically measuring the profit BOFI is creating as a percentage of shareholder equity. The higher the return on equity, the more capable the company is at utilizing shareholder equity to generate returns.

ROE = Net Income/Total Shareholder's Equity x 100

Moving to the efficiency ratio, we like to see a value of 60% or lower. BOFI’s efficiency ratio is almost half of that benchmark sitting at 32.75%. We use this metric to see how efficient a bank is at generating revenues. This tells us that BOFI spent about $0.33 per dollar of revenue generated, which is outstanding.

Efficiency Ratio = Noninterest Expense / Net Revenue x 100

Valuation

Currently, BOFI’s price to tangible book value sits at 2.9, which is considerably higher than BAC’s 1.71, GS’s 1.26 and C’s 1.12. Note that these values are not the same as price to book value, which takes intangible assets into account such as goodwill, patents, etc. Using Price to tangible book value gives us a “cleaner” look as we only taking into account physical assets which could be sold should the company close up shop and liquidates.

BOFI’s premium is largely due to the factors mentioned above, as well as the fact that BOFI is relatively small and has high expectations for strong growth to continue into the future. With that being said, let’s take a look at what has been driving the growth and delivering the performance BOFI has experienced over the past 5 years.

Loan Portfolio

BOFI’s lending business is spread across multiple types ranging from general consumer loans for automobiles, unsecured lines, and overdraft lines, to real estate and small business loans.

img src="https://static.seekingalpha.com/uploads/2018/7/11/29822845-153133634460666.png" width="624" height="467" data-width="640" data-height="479" data-og-image-twitter_small_card="true" data-og-image-twitter_large_card="true" data-og-image-twitter_image_post="true" data-og-image-msn="true" data-og-image-facebook="true" data-og-image-google_news="true" data-og-image-google_plus="true" data-og-image-linkdin="true"">>Source

Of their loans, just over half are comprised of single family residential loans, with the second largest segment being multifamily loans coming in at 21% , and C&I loans being third largest at 17%.

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Loan originations continue to grow organically, growing at 31.8% CAGR over the past 5 years thanks to the introduction of new products and expansions. In addition to this growth, the portfolio’s quality of loans are substantially better than its peers, with total net charge-offs annualized being 0.07 vs its peers’ average of 0.26 which means that BOFI believes it can recover more than 3x of the debt outstanding from all its non-performing loans than its peer group. BOFI’s loans in non-accrual to total loans sit at 0.38 vs its peers’ average of 0.78. This means that loans which are not generating interest income due to nonpayment from the borrower are less than half as prevalent in BOFI’s portfolio when compared to its peers. This further speaks to the quality of the loans that BOFI is making while still growing its loan portfolio. img src="https://static.seekingalpha.com/uploads/2018/7/11/29822845-1531336343400512.png" width="624" height="467" data-width="640" data-height="479" data-og-image-twitter_small_card="true" data-og-image-twitter_large_card="true" data-og-image-twitter_image_post="true" data-og-image-msn="true" data-og-image-facebook="true" data-og-image-google_news="true" data-og-image-google_plus="true" data-og-image-linkdin="true"">>Sourceimg src="https://static.seekingalpha.com/uploads/2018/7/11/29822845-1531336345742217.png" width="624" height="466" data-width="640" data-height="478" data-og-image-twitter_small_card="true" data-og-image-twitter_large_card="true" data-og-image-twitter_image_post="true" data-og-image-msn="true" data-og-image-facebook="true" data-og-image-google_news="true" data-og-image-google_plus="true" data-og-image-linkdin="true"">>Source

BOFI is keenly aware of the importance to track, monitor, and manage credit risk by not only employing more personnel, but also by utilizing multiple technologies to provide decision support.

img src="https://static.seekingalpha.com/uploads/2018/7/11/29822845-1531336346302036.png" width="624" height="291" data-width="640" data-height="298" data-og-image-twitter_small_card="true" data-og-image-twitter_large_card="true" data-og-image-twitter_image_post="true" data-og-image-msn="true" data-og-image-facebook="false" data-og-image-google_news="true" data-og-image-google_plus="true" data-og-image-linkdin="true"">>Sourceimg src="https://static.seekingalpha.com/uploads/2018/7/11/29822845-15313363469127457.png" width="624" height="474" data-width="640" data-height="486" data-og-image-twitter_small_card="true" data-og-image-twitter_large_card="true" data-og-image-twitter_image_post="true" data-og-image-msn="true" data-og-image-facebook="true" data-og-image-google_news="true" data-og-image-google_plus="true" data-og-image-linkdin="true"">>Source

Branchless Deposits and Fee/Non-Interest Income

With total deposits increasing nearly 400% since 2013, BOFI has not only grown deposits, but has also significantly changed the deposit mix from nearly 50% time deposits in 2013 to 17% in 2018. In contrast, checking and other demand deposits have grown from 19% in 2013 to 50% in 2018. This shows that more consumers and businesses are utilizing BOFI as a primary source for their primary checking and demand deposits.

img src="https://static.seekingalpha.com/uploads/2018/7/11/29822845-15313363476110942.png" width="624" height="466" data-width="640" data-height="478" data-og-image-twitter_small_card="true" data-og-image-twitter_large_card="true" data-og-image-twitter_image_post="true" data-og-image-msn="true" data-og-image-facebook="true" data-og-image-google_news="true" data-og-image-google_plus="true" data-og-image-linkdin="true"">>Source

These growing volumes of deposits are a key contributor the BOFI’s fee income, as deposit/service fees made up 67% of the company’s fee income for FY17.

Risks

Rising interest rates have put an end to the low deposit costs that banks enjoyed for years. This is particularly a risk to BOFI due to its lack of ability to earn significant amounts of non-interest income to supplement its interest income. Looking at the company’s most recent 10-K (Page 30), Non-interest expenses were almost double non-interest income; detracting over $69 million from the bottom line.

As interest rates rise, BOFI will have to make continue to make smart loans that produce more interest income in order to compensate for higher interest expenses from deposits as well as compensate for continuing losses it experiences in its non-interest segment. When applying the simple risk/reward concept, these higher interest rate loans are likely to be riskier and could lead to increases in non-performing loans.

Rising rates will also have the traditional big banks paying higher interest on their deposits, which may dissuade consumers from either moving to or staying with BOFI as interest rates may be close enough to tilt the scales back in the favor of traditional banks who are able to issue riskier loans as they can supplement their income with non-interest income.

Conclusion

While BOFI has impressive performance metrics and a long runway of growth potentially ahead of it given its size, there are inherent risks such as the bank’s inability to generate income from non-interest items and rising interest rates which will push up its interest expenses. I believe that the bank can overcome these obstacles moving forward though as they have demonstrated the ability to grow deposits substantially over the past five years and their smaller size and branchless model allows them agility to navigate the changing rate environment. Additionally, with more and more things shifting to digital, their model fits well into many consumers’ modern lifestyle of accomplishing daily tasks remotely and without face-to-face encounters. BOFI’s portfolio of loans is still of a high quality and as it has grown larger, they have taken action to ensure the quality is maintained through hiring more employees and implementing technologies to provide decision support.

Disclosure: I am/we are long BOFI, BAC.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Source : https://seekingalpha.com/article/4186917-holding-bofi-holding-inc-portfolio

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