BofI Holding Inc. Q3 2006 Earnings Conference Call Transcript (BOFI)

| About: BofI Holding, (BOFI)

BofI Holding, Inc. (NASDAQ:BOFI)

Q3 2006 Earnings Conference Call

May 10th, 2006 4.00PM

Executives:

Helen Byrne(?)

Gary Lewis Evans, President and Chief Executive Officer

Andrew Micheletti, Chief Financial Officer

Analysts:

John Lucas, Wedbush Morgan Securities

Operator

Good afternoon ladies and gentlemen, my name is Stacy and I will be your conference facilitator today. At this time I would like to welcome everyone to the BofI Holding Inc., Q3 conference call. Operator instructions. It is now my pleasure to turn the floor over to your host, Helen Byrne(?). Ma'am, you may begin your conference.

Helen Byrne(?)

Thanks, Stacy. Good afternoon and welcome to BofI Holding Q3 FY06 conference call. With us today are BofI's President and CEO, Gary Lewis Evans and CFO Andrew Micheletti. Today's call will have the following format. Mr. Evans will provide an overview of the quarter and highlight some recent achievements. He will then turn the call over to Mr. Micheletti who will provide a more detailed discussion of BofI's financial results. Finally, Mr. Evans will make some closing remarks and open the call for any questions you may have.

Before I turn the call over to them, please remember that in this call, management's remarks contain forward-looking statements which are subject to risks and uncertainties. Management may make additional forward-looking statements in response to your questions. Therefore, the company claims the protection of the Safe Harbor for forward-looking statements that is contained in the Private Securities Litigation Reform Act of 1995. These statements are subject to risks and uncertainties that my cause actual results to differ materially from those discussed today, including risks and uncertainties related to the economic environment, particularly in market areas in which BofI operate, competitive products and pricing, fiscal and monetary policies of the US Government, changes in government regulations affecting financial institutions including regulatory fees and capital requirements, changes in prevailing interest rates, risks associated with the conduct of the company's business over the internet, credit risk management, asset liability management, the financial and security market and the ability of and costs associated with sources of liquidity.

Examples of forward-looking statements include statements related to BofI's anticipated or projected asset size, net interest income, net interest margin, loans held for investments, loans available for sale, deposits, and performance ratios like efficiency and return on equity. We would like to encourage all of our listeners to review a more detailed discussion of the risks and uncertainties related to these forward-looking statements that is contained within the company's filings with the Securities and Exchange Commission and in particular on its Form 10-K. Any projections as to the company's future financial performance represent management's estimates as of today, May 10, 2006. BofI assumes no obligation to update these projections in the future due to changing market conditions or otherwise. With those cautionary statements it's my pleasure to turn the call over to BofI's CEO, Gary Lewis Evans. Gary?

Gary Lewis Evans, President and Chief Executive Officer

Thank you, Elaine. I'd like to welcome everyone to BofI Holding Inc., Q3 conference call, and I thank you for your interesting our company. Andy will go into our financials in more detail shortly, but I would like touch briefly on our net income. Compared to our last quarter ended December 31, 2005, I am pleased to report that net income increased $78,000 for the quarter and diluted EPS increased $0.01 due primarily to lower loss provision and higher net interest income. Now comparing this Q3 of FY06 with Q3 FY05, net income was down $31,000. But both net interest income and average earning assets increased. Also it is fair to say that net income in 2006 would have been higher than 2005 were it not for the $109,000 pre-tax expense recorded in 2006 for stock options under the new accounting rule 123R. Our asset quality remains strong, with no non-performing assets at March 31, 2006. Those of you familiar with BofI know of our approach to banking and lending, which we think is conservative. Although the interest rate environment has been difficult over the past year, we have chosen not to sacrifice our high credit standards in order to enhance short-term results.

Instead, we have focused on deploying our capital by investing in high-quality assets with reasonable duration. Even though new earning asset yields left in our target net interest margin of 175-225(?), we have not relaxed our credit quality standards. This quarter we saw some promising change in the slope of the yield curve as the spread between long-term rates and short-term rates widens minimally. While we are hopeful that this trend will continue and that the yield curve will remain as a more normal shape, we are still cautious in our outlook for the remainder of the fiscal year. We believe that the appreciation and the residential real-estate market and the industry-wide decline in real-estate loan losses over the past five years or more, has led many banks an other lending institutions to reduce their credit standards or modify loan terms in order to qualify borrowers. Even with historically low yield interest rates today, single family loan market has become a proliferation of interest-only and 'teaser-rate' loans that were once exceptions but are now the norm for many other lenders.

By maintaining our credit standards we believe we can minimize both the losses and the management distraction that other banks may face in the next real-estate market correction. Since our inception in 2000, we have had no right-offs or foreclosure sales. While it is unlikely that this record will continue, we believe that we are well-positioned to weather price deterioration in the real-estate market if that occurs. BofI is able to generate profits at net interest margins below those of more traditional banks through our low-cost operating structure. We are able to operate our bank, which has total assets of over $700 million, with only 25 full-time equivalent employees. Our efficiency ratio, which measures the ratio of non-interest expense to interest income and non-interest income was 51.3% in the quarter ended March 31 2006.

While this was higher than it was a year ago, period, due to additional costs related to stock option expense and other costs associated with being a public company it was well below the industry average of 66.8% for institutions with assets of less than $1 billion. At the same time, G&A expense excluding stock option expense to average assets dropped from 0.85% to 0.81% in the quarter. This shows our cost control is still in place. We continue to build our franchise value. In January, we launched our new internet branch website, seniorbofi.com, specifically designed as an internet banking community for seniors' banking and personal financial needs, the site features useful links to online stores and other organizations targeted to seniors. We believe that providing our customers with separate website communities targeted to specific demographics will build affinity and long-term relationships.

In Q1 2006, there were more than 5,000 visits to the seniorbofi.com website and we are currently averaging more than 100 visitors per day. Today, BofI has more than 13,000 accounts with seniors, that's people with ages 50 and over whose deposit account balance exceed over $300 million. As we announced in our last call, we plan to launch MyRVBank.com, another internet branch targeting RV owners and their banking needs, in mid-2006. We plan to offer both deposit accounts and eventually RV loans on the site. This is a demographic group that travels consistently and can really benefit from an internet banking platform, including processing their requests through email communication, remote delivery and storage of statements and check images and nationwide lending.

In our last call, we discussed our plan to move into consumer lending. I am pleased to announce that beginning the week of May 15 next week, BofI will begin providing a new line of internet originated home equity loans. We believe our new line of products will be high quality and will generate additional interest income at a better risk-adjusted return for the bank. Our goal at this time is to create the proprietary process and technology to create a competitive advantage in high volume consumer lending. This will take time to completely develop and I will report on our progress in the future. In summary, this was an encouraging quarter for BofI. With the positive turn in the yield curve, however small, we hope and are cautiously optimistic that this trend will continue. We have maintained the quality of our loan portfolio and have developed some exciting new products that will build the BofI franchise. Now I will turn the call over to Andy, who will discuss our financial results. Andy?

Andrew Micheletti, Chief Financial Officer

Thanks, Gary. Before I begin I would like to note that I will discuss our quarterly financial results on a YoverY basis as well as a QoverQ basis. That being said, let me begin by stating that during the quarter ended March 31, 2006, net income totaled $828,000 or $0.09 per fully diluted share, down 3.6% from the $859,000 or $0.13 per diluted share in the same quarter of 2005, but up 10% or up $0.01 per diluted share QoverQ. On a YoverY basis, the $31,000 decrease in net income was largely due to a $109,000 pre-tax non-cash expense for stock-based compensation incurred in the 2006 quarter as a result of BofI's requirement to adopt a new accounting rule known as FAS123R starting on July 1 of 2005. The recording of stock-based compensation expense for market value options was not required in FY05.

Also in 2006, we recorded increases in interest income and non-interest income compared to 2005. These increases totaled $365,000 pre-tax and were partially offset by increased operating expenses of $296,000 excluding stock option expense. On a YoverY basis, the decreased in fully diluted EPS for the quarter ended March 31, 2006, is a result of the 2,639,717 increase in weighted average shares, primarily from BofI's initial public offering in mid-March of 2005. Comparing this quarter to last quarter ended December 31 2005, net income increased $78,000 or 10%, primarily due to a pre-tax increase in net interest income of $122,000 and a decrease in our loan loss provision of $120,000. Now turning to the major components of our income statement, net interest income increased 10% YoverY and increased 5% QoverQ. The increase in net interest income YoverY was due to a 34% growth in our average interest-bearing assets, primarily loans and mortgage-backed securities.

This was partially offset by a 34bps decrease in our net interest margin, which was 1.54% this quarter, down from 1.88% last year. As mentioned before, the flattening of the yield curve over the last year is largely responsible for the decline in our net interest margin YoverY. This quarter compared to last year, our net interest income increased as a result of 1% growth in our average assets and a 5bps increase in our net interest margin to 1.54% up from 1.49%. Total interest and dividend income was $8.4 million in the current quarter, a 42% increased on a YoverY basis and a 5% increase QoverQ. Growth in our average loan portfolio balance of 33% was the primary driver for the increase in interest income YoverY. The yield on our average assets for the quarter ended March 31, 2006 was 5.03% up from 4.75% for Q3 2005 and up from the 4.87% for last quarter. The increased yield on earning assets is primarily due to the purchase of new mortgage loan pools and mortgage-backed securities at higher rates and the re-pricing of our adjustable rate loans and investments at higher rates. Now moving to total interest expense, which in the quarter was $5.8 million, a 63% increase on a YoverY basis, and a 5% increase QoverQ.

These increases in interest expense were the result of increases in average volumes and average rates paid on prime deposits and on average balances of advances with the Federal Home Loan Bank. Average time deposit balances grew(?) 50% and the average rate increased 76bps on a YoverY basis. Average advanced balances also grew 50% and the average rate increased 43bps on a YoverY basis. The 76bps increase in the average time deposit rate reflects the fact that short-term market rates and competition for deposits has increased our average cost of funds which was 3.86% for the current quarter up from 3.09% last year and 3.76% last quarter. During Q3 the growth in average assets was primarily funded through increases in time deposits and advances from the Federal Home Loan Bank, which represented 56% and 33% respectively of our total average interest-bearing liabilities during the quarter.

Time deposits represented 47% of our total average interest-bearing liabilities in 2005 and 54% last quarter. Advances from the Federal Home Loan Bank represented 29% of our total average interest-bearing liabilities in 2005 and 32% last quarter. Provisions for loan losses were $15,000 this quarter, $10,000 for Q3 of FY05 and $135,000 last quarter. Our loan watch provisions are the result of increases in our general loan loss reserves which are calculated based on the loan balances and the loan types. The $120,000 decrease in loan loss provision this quarter versus last quarter was due to the fact that there was a larger increase in loan balances last quarter and that increased included primarily multi-family loans. Non-interest income in Q3 2006 was $312,000, up 70% from the $183,000 in the same quarter last year and down 12% from last quarter.

The increased YoverY was primarily due to higher income from mortgage loan prepayment penalty fees. The higher prepayment penalty income is generally due to the increased size of our multi-family portfolio in 2006 compared to 2005. However there are many factors which influence borrowers to pay off loans early, making prepayment penalty income somewhat unpredictable. The decline this quarter versus last quarter is the result of decreased mortgage banking fees from lower loan volume. Non interest expenses, or operating expense, excluding stock options, increased $296,000 on a YoverY basis and increased $63,000 QoverQ. Comparing on a YoverY basis the increase was generally due to professional services and other expenses associated with being a public company and certain employee relocation and temporary labor costs included in compensation. The increase for employee relocation and temporary labor is also the primary reason for the increased in operating expenses this quarter versus last quarter.

Our efficiency ratio was 61.3% in Q3 FY06 compared to 42.7% in the same quarter last year. Excluding the stock option expense, our efficiency ratio would have been 47.5% this quarter and 46.8% last quarter. The efficiency ratio is calculated by dividing our operating expenses by the sum of our net interest income and our non-interest income. The increase in the efficiency ratio this quarter compared to last year is due to the general increase in costs associated with being a public company and the employee relocation as well as the stock option expense. The 47.5% efficiency ratio this quarter, which excludes stock option expense, was just a little higher than the 46.8% for last quarter, due to the employee relocation items. For the nine-month period ended March 31, 2006, the efficiency ratio was 50.9%, about in line with the 50.4% for this same nine-month period in FY05. Thus for the nine months of 2006 we've absorbed the stock option expense and the added public company expense without a large increase in our efficiency ratio.

As mentioned before, if the yield curve continues to remain flat, our net interest margin and the future growth of our net interest income could be negatively impacted, making it more difficult to reduce our efficiency ratio. Our operating expenses as the percent of average assets for the quarter ended March 31, 2006 was 0.81% when excluding stock option expense, compared to 0.85% for Q3 FY05. Turning to our balance sheet, as of March 31, 2006, total assets were $704.7 million, up $95.2 million from June 30, 2005. Total deposits were $405.7 million at March 31, 2006, up 12% from the $361.1 million at June 30, 2005. Since the end of our last fiscal year the number of deposit accounts at the bank has grown 9% to 21,607 accounts. At March 31, 2006, total loans were $565.6 million, up $78.7 million or 16% from June 30, 2005. Multi-family loans accounted for 74% of our loan balances at March 31, 2006, down from 84% at June 30, 2005. Single-family loans on commercial real-estate and land accounted from 23% and 3% respectively of the loan portfolio at the end of the most recent quarter.

At the end of this quarter, our allowance for loan loss was $1.6 million or 28bps of total loans, down from 29bps at June 30, 2005. As mentioned previously, at March 31, 2006 we had no non-performing loans. Some banks with significant mortgage loan portfolios which are generating a large percentage increase in their interest income from borrowers who are adding deferred interest to their principle balance - this is known as negative amortization - by making cash payments below their monthly interest costs on their option R(?) mortgage loans. Some experts believe that the build-up of deferred interest which increases the mortgage debt and increases the payment shock in a rising rate environment also significantly increases the risk of borrower default. BofI originates and purchases mortgage loans with terms that provide for negative amortization. However BofI's interest earnings from mortgage loans with deferred interest has been immaterial through March 31 2006.

Stockholders' equity was $69.9 million at March 31, 2006, up from $68.6 million at June 30 2005. The $1.3 million increase of stockholders' equity was due to net income of $2.4 million for the first nine months of FY06 and due to the exercise and expensing of stock options, which increased stockholders' equity by $0.6 million. Partially offsetting these increases was a 0.9 million charge for the repurchase of 107,000 shares of our common stock at a price of about $8.25 per share and a $0.5 million charge for unrealized losses in our available for sale securities portfolio, as well as $0.3 million for dividends on our Series A preferred stock. Effective January 1, 2006, holders of 1.5 million of the company's Series A preferred stock converted their holdings into the company's common stock at a price of approximately $10.50 per share. There was no net impact on stockholders' equity as a result of these preferred stock conversions. With that, I'll turn the call back over to Gary for some closing remarks.

Gary Lewis Evans

Thank you, Andy. This was a productive quarter for BofI. Not only did we see a 10% increase in our net income from last quarter, but we started to build our consumer lending staff systems while increasing net interest income, deposits and the number of accounts. We are hopeful that the current trend in interest rates will continue but we are proceeding with caution. Should the flat yield curve environment or near-flat yield curve environment continue, achieving our target goals will be difficult. We will continue to focus on increasing efficiency and controlling costs and increasing our assets while we build our systems and continually improve them. In my opinion, the current economic transition toward what I would call a global neighborhood is causing interesting and counterintuitive forces in the US capital markets. This impacts the value of the dollar, the yield curve and risk premiums to a far greater extent than we have seen in history.

As an example, with 30-year treasury bonds at 5.2%, I would expect 30-year mortgages to price at about 7.55%. This is comparable to the 6.25% that is available today. As the famous baseball innovator/owner Bill Veeck said: 'It isn’t the high price of stars that is expensive, it is the high price of mediocrity'. The minimum risk premiums in the market is our mediocrity challenge. One way that we will address this is with our consumer lending program. As (view of ?) capital markets become more normal, we will move aggressively toward our target. During the quarter, we will continue to execute our plan to expand into consumer lending in order to enhance our net interest income and profitability.

Our new line of internet originated home equity loans will start in less than a week. Our efforts to build our brand franchise were also productive, as Senior BofI has gained acceptance. We can attribute portion of our growth in deposits to the site, but more importantly, the positive customer feedback and the affinity is building. We are also nearing launch of our second online community, MyRVBank.com. That concludes our prepared remarks for today. I'd like to thank everyone for their interest in BofI, we look forward to providing you with an update of our progress next quarter. At this point we'd be happy to answer any questions you may have. Operator Stacy, it's turned back to you.

Questions and Answers

Operator

Operator instructions. Our first question is coming from John Lucas from Wedbush Morgan Securities.

Q - John Lucas, Wedbush Morgan Securities

Gary, or Andy, could you walk me through again the number of shares that were issued on the convertible preferred and the number of shares that you have purchased in the last six months?

A - Andrew Micheletti

Excellent. Let me go through that. This information is in your 10-Q specifically, there was 107,000 shares repurchased in connection with the stock buyback program. There was, on the conversion of the preferred stock, a total of 142,800 shares that were added to common stock from the conversion from preferred stock.

Q - John Lucas, Wedbush Morgan Securities

Did you not purchase any shares during the March quarter?

A - Andrew Micheletti

No, we did not.

Q - John Lucas, Wedbush Morgan Securities

OK. And you still have, in effect, your program to buy in 400,000+ shares? That's what you've purchased?

A - Gary Lewis Evans

The program is still in place. Now, there's so many factors that come into the purchase equation, but we didn't purchase any this last quarter.

Q - John Lucas, Wedbush Morgan Securities

OK. Thank you so much.

A - Gary Lewis Evans

Thank you, John.

Operator

Thank you. Operator instructions. Sir, there appears to be no further questions.

A - Gary Lewis Evans

All right. Thank you all.

Operator

This concludes today's BofI Holding Inc. conference call. You may now disconnect your lines at this time and have a wonderful day.

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