Recently, I discussed how to value a bank. Today, we’ll look at a simple yet exciting bank that has caused quite a stir with an entirely new business model: BOFI Holdings Inc (NASDAQ: BOFI). BOFI is a thrift that services 36,000 customers across all fifty states from a single branch in San Diego. BOFI does this via its website,BankofInternetUSA.com. The company’s strategy is to use technology to lower the cost of providing banking services, so as to provide the flexibility to pay above-market interest rates and charge below-market banking fees.
BOFI has been quite successful in its low-cost operating model. It has consistently achieved industry-leading efficiency ratios, which is a measurement of a bank’s non-interest operating expenses to the sum of net interest income and non-interest revenue. For greater clarity, a lower efficiency ratio is desirable, as this translates to lower non-interest operating expenses per unit of revenue.
Now, to put this into context, the following chart shows the quarterly efficiency ratios for all FDIC-insured institutions grouped by assets since 1Q 1984. The source of these data is the FDIC Quarterly Banking Profile, found here.
There are a few interesting things to note here. Note the decoupling of the various categories from the mid 1980s to the present. Smaller institutions with less than $100 million of assets have been placed at a severe disadvantage while the mega-banks with $10 billion+ have achieved significant efficiency gains.
The key takeaway for our purposes is that BOFI’s efficiency ratio has bested even the mega banks. While BOFI has only flirted with rates above 50% (and has recently enjoyed levels below 40%), according to the FDIC data, traditional banks with similar assets have struggled to breach 60%. Additionally, BOFI’s stated goal in its 10-K is to reach a sustainable 35% efficiency ratio. As noted above, a lower efficiency ratio is preferable, and the gap witnessed here is a testament to the successful implementation of the first part of BOFI’s strategy: low overhead.
Beyond low non-interest expense, the company has also managed to bring its cost control focus to bear on its loan portfolio. The company has conservatively managed its loan originations in order to achieve an industry leading ratio of non-performing assets to total assets (again, lower is better).
Here we see that the company’s ratio of non-current assets (including other real estate owned) to total assets has been roughly 1% or less. For comparison, the following chart (again from the FDIC report) shows the same ratio for banks of various asset sizes.
Here we see that even the best category of FDIC insured banks has failed to achieve a ratio non-performing assets as a proportion of total assets of even twice BOFI’s ratio. This is one indicator of prudent risk management.
Another indicator is to look at a bank’s coverage ratio, which is the ratio of a bank’s allowance for loan losses to non-performing loans. Here’s BOFI’s ratio over time, overlaid on total non-performing loans. Note that I had to adjust the scale on the right given the massive coverage ratio in 2007.
BOFI’s coverage ratio is currently hovering around 70%. The following chart shows the coverage ratios reported by the FDIC.
Here we see that only the largest and smallest categories of banks have coverage ratios similar to BOFI, but that the most directly comparable banks are significantly lower, in the mid-50% range. While the above discussion of non-performing assets to total assets showed that BOFI does a good job of avoiding credit risk in the first place, we now see from BOFI’s coverage ratio that it also makes aggressive provisions for potential losses. Combined, this suggests a conservative approach to risk management.
Further evidence of BOFI’s prudent risk management is noted by other analysts, including Kerrisdale Capital in pointing (also, see here) to BOFI’s low Loan-to-Value ratios (the ratio of the value of a loan to the value of the underlying collateral) in the mid 50% range. Some argue that centralized loan origination has helped maintain a risk averse culture that has focused largely on single and multi-family mortgages to borrowers with high credit scores. Whatever the reason, the data show a company that has done well on the expense side of its business.
Now let’s turn to the second part of BOFI’s strategy, which is to pass along the savings of its low cost strategy to its customers through lower fees and higher interest rates on deposits. The drawback of this is that the company is expected to operate with a lower Net Interest Margin (net interest income divided by average interest-earning assets). The following chart shows BOFI’s NIM over time.
Here we see that the company has been operating with a NIM between 3.5% and 4% for the last nine quarters. The following chart shows the NIMs by asset category from the FDIC.
Here’s the shocking part. BOFI’s NIM has been roughly on par with other traditional banks. Its average NIM over the last nine quarters has been about 3.76%. For traditional banks with the same asset level, the FDIC reports a nine-quarter average of 3.68%, less than BOFI!
Another important aspect of the revenue side of the business is deposit growth, which allows the company to fund its interest bearing assets (loans). The following chart shows the growth in interest-bearing liabilities and assets over time.
Here we see that both interest earning assets and interest bearing liabilities have grown dramatically in the last few years. The gap between these figures (the interest earning gap) has held relatively steady around 7%, as the company evidently faces no shortage of demand for mortgages from high credit quality borrowers. What the company has been unable to originate itself, it has purchased from third parties. The company’s stated goal is to reach total assets of $3 billion this year, which represents growth of approximately 50%.
The interest rate sensitivity gap is an important indicator of future performance. In a rising interest rate environment, a large and positive sensitivity gap will lead to increased interest income. Given the prevailing level of interest rates, one can expect rates to rise in the future. Given that BOFI has maintained a steady sensitivity gap, it appears that BOFI management has chosen to focus on asset (portfolio) growth in the near term. From the company’s 10-K disclosure about its interest rate sensitivity gap by asset repricing, repayment or maturity category, it appears that the company believes rates will not be rising in