Bofi Holding: Sidesteping the Global Financial Crisis

by: The GeoTeam

In an effort to diversify our China-heavy portfolio, the GeoTeam is taking great efforts to identify U.S-based firms with promising growth stories. This task will obviously pose challenges when compared to the plethora of opportunities available in the U.S-listed China space. In the past year or so, we have highlighted some select U.S.-based stocks that have performed nicely.

Good examples of our top performers:

Orchids Paper Products Co. (NYSEMKT:TIS)
Medifast Inc. (NYSE:MED)
Virgin Mobile Usa Inc. (VM)
Alpha Pro Tech Ltd. (NYSEMKT:APT)
Cpi Aerostructures Inc. (NYSEMKT:CVU)
Air Trans Services (NASDAQ:ATSG)
Coffee Holding Co Inc. (NASDAQ:JVA)

Others stocks that have yet to perform:

Ricks Cabaret Intl Inc. (NASDAQ:RICK)
Yocream Intl Inc (PINK:YOCM.PK)
Merrimac Industries Inc. (MRM)
Halifax Corp. (HX)
Smith Midland Corp. (OTCQX:SMID)

On November 3, 2009 we identified Bofi Holding Inc (BOFI) as a Special Situation.

BOFI is a consumer focused, FDIC insured, nationwide savings bank operating primarily over the Internet.

  • Closing Price November 6, 2009: $9.50
  • Trailing EPS: $1.43
  • P/E: 6.64
  • Book Value per Share: $10.58
  • Price to Book: $0.90
  • Loan to Value: 50% to 60% (Industry average is ~75%. A lower figure implies a more conservative structure)
  • Non-Performing Assets percentage: 0.73%

We have been tracking BOFI for some time, but never established a position in the company. The banking sector is not one that we particularly emphasize. However, certain aspects of the BOFI story have piqued our interest.

Deposit Business (Liability side of the balance sheet)

BOFI's online model has enabled it to offer banking products to its customers with more attractive interest rates and lower fees than traditional brick and mortar banks and its less efficient internet banking competitors. It credits this to a technology driven model that emphasizes automation and user-friendly features. For example, its convenient online check imaging technology reduces mailing costs. Services such as ATM fee reimbursement help to attract and build a loyal customer base.

Loan Origination/Purchase Business (Asset side of the balance sheet)

On the asset side, the company has virtually side stepped the credit crunch by focusing less on loan origination and more on purchasing wholesale products (closed loans originated by other parties) with high credit quality.

During the housing boom, BOFI did not find it prudent to compete against banks originating loans at lax industry standards below its comfort level. Thus, the company focused its efforts on higher quality wholesale loans by purchasing seasoned loans with a good history, as opposed to loans with little history. Furthermore, because of the company’s conservative nature and financial strength, it has been able to purchase favorably priced loan assets from troubled institutions.

The company is also seeing opportunities in the loan origination business:

“In particular, we continue to see significant competitive exits from the multifamily lending business, providing us a strong tailwind as we place resources towards growing our multifamily originations. I am very optimistic that the current market continues to provide us outstanding growth opportunities."

Strategy in a nut shell

“Our business strategy is to lower the cost of delivering banking products and services by leveraging technology while continuing to grow our assets and deposits to achieve increased economies of scale. We have designed our automated Internet-based banking platform and workflow process to handle traditional banking functions with reduced paperwork and human intervention.”

The Company's efforts have produced significant sales and EPS growth since 2007. The momentum has carried into the first quarter of 2010.

Fiscal 2009 10K
Fiscal 2010 First Quarter 10Q

We are not well versed with respect to analyzing the banking sector, but BOFI’s track record of consistent growth, combined with its efficient business model, may give investors a reason to price shares more aggressively than your average financial institution. We think the stock attaining and exceeding its book value of $10.58 is a realistic goal.

Risk of Dilution

Generally speaking, a bank's ability to grow is a function of deposit growth and asset growth. Currently, BOFI has $1.3 billion in total assets and it has aggressive goals to grow assets to more than $3 billion. However, there are certain regulatory requirements tying a bank’s assets size to its equity.( i.e $1.00 of equity per $12.00 in assets). Using this relationship, BOFI is at the top of its asset limit. The company can increase its equity by growing its earnings or raising additional capital. If it does choose to raise capital we cannot predict if such an event would be accretive or dilutive to EPS. However, it is our assumption that it is not difficult to rapidly deploy funds if needed. The Company’s strong financial track record also gives us confidence that management efforts will focus on earnings accretion.