During the current market tumult, it is easy to stay away from the "sick sectors" like banking. However, often the best investments come from buying a company that is bucking the trend in the sick sector during a downturn.
Bank of the Internet Holdings (NASDAQ:BOFI) has a generic name but a powerful business model. They report earnings after the close today - I would be a buyer before earnings. Here are the major reasons why the stock is a buy:
1) A Growing Bank
Bank of the Internet is a small bank growing very rapidly. The revenue and profit environment for big banks looks bleak at this moment - we have low rates until 2013, Dodd-Frank changes, new capital requirements. Very few big banks will grow revenue.
The crux of the investment thesis on BOFI is their ability to grow rapidly. They have a tremendous track record of growth even during the financial crisis. I believe the stock deserves a premium until that growth model is disproven.
Over the years they have shown accelerating deposit (and loan) growth.
For skeptics who think an internet bank can't grow or gain market share over an extended period: remember ING Direct? It was just bought by Capital One (NYSE:COF) for $9 billion. ING Direct was launched in 2000 and grew rapidly with a big marketing push and the financial might of its former parent. The deposit growth numbers from 2000-2006 are staggering.
2) Low Cost / High Yield Leader
BOFI is like a little Costco (NASDAQ:COST) of banking - in fact, one of their biggest partners is Costco. Just like Costco, BOFI has a low cost structure relative to their competitors. An extended period of very low rates helps the companies with the ability to pay even a modest amount of interest - BOFI's cost structure gives them the flexibility to pay.
BOFI may be the bank that Bankrate (NYSE:RATE) built. If you check Bankrate, BOFI is often at or near the top for yields one can receive for a CD or savings account. Interestingly BOFI has not advertised recently on Bankrate - this means they have been gathering enough deposits without advertising - a very healthy sign.
3) Prudent Risk Management
BOFI was prudent before the financial crisis and also ramped up investments at the right time (they bought safe loans at low rates). Management sailed through the financial crisis better than the vast majority of banks. Their current loan book has low Loan to Value (LTV) ratios - meaning they build in a margin of safety into their loans. Although they operate nationally, they can enter and exit regional markets if things get crazy. For example, even though they are headquartered in San Diego, they were largely absent from the Southern California market from 2005-2010. A bank with local branches can't do that.
4) Competitive Environment Favors Internet Banks
People are becoming more comfortable banking online. This will help all online banks. At major banks, there is a trend of charging for checking accounts now that interest rates are now stuck at zero and banks have new regulations on old fees from Dodd-Frank. Small banks and internet banks like Bank of the Internet can gain share in this environment. Seeking Alpha contributor Adam Stockmeister lays out why the Fed's ZIRP is good for BOFI. Banks that offer even modest interest rates will gain share easily. Lastly, the carnage in the banking industry has displaced a lot of talent - BOFI picked up loan originators from other banks as the industry was roiled in 2008 and 2009
5) Inexpensive Valuation
At $12.46, BOFI is trading below book value of $13.25 (likely close to $13.75 after this quarter). While this may seem unremarkable for a bank (most major banks like JPM and BAC are trading below book), it is remarkable given the growth that BOFI continues to experience. In addition, as a low cost leader their margins are good - enabling a trailing PE ratio of less than 7. When the market recovers, I could see BOFI trading at 2x book if they keep their growth up.
6) Recent Product Innovations
BOFI recently redesigned their website to make it much more customer friendly and usable. For a bank whose primary touchpoint is the web, this is actually a big deal.
The new Rewards Checking Account program launched this week is a brilliant initiative during these low yielding times. The program rewards customers for direct deposit, online bill pay, and using their debit card. It will entice new customers to switch AND incent them to become wedded to BOFI. Debit card use will grow revenues. All important elements of a growth strategy for BOFI. Got cash in these uncertain times? Check out Rewards Checking.
Mobile Deposit (coming soon) - check depositing via your smartphone enabled by companies like Mitek (NASDAQ:MITK). This is becoming a standard feature for banks - it definitely levels the playing field towards banks without branches by increasing the convenience of deposits (no more snail mail!).
One reason not to buy: This is a small cap, illiquid, and risky stock. If the market drops a lot more, BOFI will likely tank even further.
Disclosure: I am long BOFI.