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Bank of Internet USA (NASDAQ:BOFI)

Wall Street Analyst Forum

May 24, 2007 11:10 am ET

Executives

Andrew Micheletti - CFO and VP

Presentation

Moderator

Good morning ladies and gentlemen, again welcome to Wall Street Analyst Forum 18th conference.

At this time I would like to introduce our next presenting company. BofI Holding Incorporated operates as a holding company for Bank of Internet USA, which operates as a savings bank primarily through the Internet in the United States. Speaking on behalf of Bank of Internet is Andrew Micheletti, CFO and VP; welcome.

Andrew Micheletti

Thank you, Amy. Today I am going to talk about the business of Bank of Internet. Bank of Internet is a wholly owned subsidiary of BofI Holding. In addition we are going to talk about the exciting new results of several business initiatives that we undertook between three and nine months ago.

We get things started and I am going to go ahead and put up a equity snapshot, while we look at and I read the SEC disclosure.

Statements contained in the slide show presentation that state expectations or predictions about the future are forward-looking statements intended to be covered by the safe harbor provisions of the Securities Act and the Exchange Act. The Registrant’s actual results could differ materially from those projected in such forward-looking statements. Factors that could affect those results include “Risk Factors” and the other factors appearing in the documents that the Registrant has filed with the Securities and Exchange Commission.

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With that behind us, BofI Holding, wholly-owned Bank of Internet. Bank of Internet is an Internet only bank which operates in all 50 states with 35 employees in one location. We originate loans online and we originate deposits online.

All the investment opportunity for BofI Holding is the Internet creates a more efficient model. We are taking advantage of the Internet for both efficiency in the back office and efficiency in the distribution and delivery of banking products.

BofI has a unique low cost operating model and we have proprietary software that runs that business. We got a strong record with growth over five consecutive years of increased net income. Our portfolio of assets is one of the strongest in terms of credit quality and we have attractive valuation currently below book value.

Over the long-term our mission statement is BofI will be the premier low cost operator in the consumer financial services. Once we grow with size and scale and get our business up to a very large bank we believe we can be the absolute low cost operator.

Today we are going to break the discussion down into three areas, our top three [playback]; franchise at the bank, how we've been building customer trust for the last seven years, our operations and give some more recent statistics of the types of the deposit accounts that we are bringing in over the Internet.

In addition, I am going to go over the financial results, summary of our last quarter. In our last quarter we had earnings of 862,000 which was a new record for BofI Holding. In addition we increased our net interest income, our net interest margin up from 129, which was at the end of December the prior quarter up to 142 which was at the end of March. So, two good accomplishments in our last quarter. And finally I am going to talk about the changes that we have made in the last six to nine months involving new products and new deliveries.

Our business model is all about Internet efficiency. The graph I am showing you, are actual results for the last four years. Showing on the top line in another words, the blue graph is our net interest income growth. The red line at the bottom is our operating expenses.

Our goal was obviously to keep continuing to grow our net interest income in accelerated rate while maintaining our operating costs. Now the operating costs here exclude employees. But on the employee front, we remain one of the most efficient banks. At the end of March, we had 35 employees which serviced $24.2 million in assets per employee. The typical bank with brick and mortar on average has $6 million in assets per employee.

With the efficiencies of the Internet we actually take that cost savings and pass it through to our customers in the form of higher rates on deposits and lower rates on loans. The efficiency of the Internet allows us to provide customers a better deal than other banks and at the same time our savings in costs produced similar results in operating income.

The graph I've got up is a summary on basis points on average assets. In this graph, compares Bank of Internet's results for the 12 months ended December 31 as pulled off at the FDIC website and lines it up with all savings and loans from $500 million to $1 billion.

In addition, I have lined-up our numbers with, one of the larger more, known Internet banks, which is ING, big orange.

When you study the income statement, you will see that our net interest margin for those 12 months was 140 basis points, or 1.4%.

Our interest income was 5%, our interest expense was 3%. Those numbers are bigger than our S&L competitors, on a brick-and-mortar basis. They had a spread, ultimately 293 basis points. So, we have the smaller spread. But when you look at the operating costs, our personnel cost was 32 basis points on average assets, their operating costs was 149 in personnel costs. So, you have well over a 100 basis points of savings right there, that allow us to flow-through to the bottom line and an opportunity to have income growth, potentially even faster than other banks.

ING is an example of the bankers grew from literally nothing to over 55 billion in assets, over the last six years. So, they really have been able to grow the bank using the Internet Delivery System. The risk spread is 107 basis points and their personnel cost are 20 basis points. Total costs for them are about 53 basis points compared to our 65 basis points. We believe once we grow our bank, our efficiencies will be able to exceed those of ING, who has much larger scale.

We accomplished this through a number of opportunities and organizations that we have developed internally. Our technology scalable, we use work flow software that is proprietary, it allows us to process in number of accounts, at a more rapid rate, we believe than the average bank. We will have some examples in that slide, a couple of slides to go. We have experienced management. We have a cost effective process. You bring these together in an atmosphere of what we described is kai-Zen, Kai-Zen being to steal something from Toyota. An example of where, they improved the process, on an ongoing basis. We don’t build the system in one week and then don’t change it for a year. We change it literally as frequently as every week in order to address one part of efficiency, that we think, we can do better, down the road. Obviously, by having less people touch things, we can process more accounts through the same system.

So, our Online Deposit Franchise is really in all 50 states, out of this, one office in San Diego. The Proprietary Technology & Customer Data Base, we have, has been built over the last six years. This includes a database of fraud detection that includes known bad IP addresses from possible folks. We've got a history of knowing that data and comparing every single account that we take in as a new account.

We have a proprietary process workflow on the front end. We've been able to demonstrate our scalability and we use Target Marketing, when we go to obtain our new deposit and loans of the Internet.

That’s all produced over the last couple of years. Over 6% referral rates from our customers. That’s without any kind of compensation to the customer for the referral.

Just as an example of the kind of scale that we have presently. Over the last 45 days, we have 5.8% growth in our deposits. So, that was a total of $57 million in new account processing of which that produced 1,600 accounts, with weighted average rate of 5.22%. The average balance on that was 34,000. So, these were all prime deposits in that we were offering online, and where customers find us, they see that our rate is attractive, or they've experienced the service before and they go ahead and sign-up online and we process their account and they make a deposit in the form of a CD.

All this was done with a staff of 10 people that opened up these accounts. And not only did they open up the accounts, but they serviced our 24,000 existing customers currently.

We built our online franchise consistently over the last four to five years growing from 6,000 accounts up to 24,000 accounts, as of March of '07.

Switching down and looking at online lending. We've been an online lender since we've opened up the bank. We have a very unique multifamily online origination site. We have single family online originations and we've been doing this for a number of years. So we will practice that authentication and how to underwrite using both the efficiency of the Internet, but also old fashion banking, underwriting principals.

More recently, one of our changes was, we built the home equity origination system in fiscal 2006, we are going to look at some of the results of that new system, here in a couple of slides.

We also commenced in March indirect RV lending. We are going to use the experience of the RV lending to help build our online vehicle lending starting in June. Currently the indirect is not a direct online opportunity, but we want to leverage that to an online opportunity over the next quarter.

We have been disciplined in our lending and our investing, we've avoided some of the pitfalls of many internet banks, such as more recently Netbank which was in the news, CompuBank and Next Card. We got a perfect lending and investing history, no write-offs, no foreclosures. Here's a snapshot of our efficiencies in originating home equity loans. In the last 45 days, we funded $4.4 million in loans across 35 states.

As a comparison, our current home equity portfolio as of March 31, was approximately $8 million. So, literally in the last 45 days we've had almost a 50% increase in our home equity portfolio. That represents 116 loans that were with a interest rate of 7.12%. The average balance was 38,000, but more importantly the combined loan to value that is, both the first and the second together came in at 56%, relatively conservative number considering today's standards.

Those are all based with the first lien that averaged to 166,000 and the weighted average FICO on these loans was 772. So, we got into home equity lending, but as we indicated early on our goal was to find the best credits we can across the country. We are smaller banks, certainly relatively to many commercial banks, so we have the opportunity we believe to use the internet to find the best credits.

Couple of words on our other new initiatives on indirect RV lending, the opportunity in RV lending really focused on adding risk adjusted deal. We believe that the risk adjusted deals on RV loans are superior to many prime mortgage products in the current banking environment. The RV loans have on average higher rates and larger balances than autos, and what's really important for us when we look at the cross sale of opportunities on our current online base of customers, the demographic is very similar. We have an average age of our deposit customers which is approximately 50 years old. And as we will see that’s a pretty close match with the average age of an RV owner at about 49 years old.

So we have used in the indirect dealer network to reduce the start up time and marketing costs while building on our systems for the online business. The RV indirect business is a large business, there were total of $6.9 billion in originations in 2005 according to the RVIA of that about $19 billion is currently outstanding. Some details on average, they put about 12% down, 70% are new, 30% are used.

What also led us to consider indirect RV lending was the opportunity for improved delinquencies relative to other consumers. Consumer type loans as you can see from the delinquency trend RVs are trended more favorably than general consumer loans which would include autos and credit cards.

In summary, when you look at all the demographic pieces of the RV market it's a good fit. As I mentioned the average age of an RV owner is 49 years old, that’s a good fit with us. A large number of these people need online banking because they are traveling and what better fit for an RVier than somebody who actually needs online banking they can bank 24 hours a days, seven days a week with us.

In summary, our franchise value is our people and our service culture. Not only that we build systems but we make out systems better. Our success really in building the low cost delivery systems has been demonstrated in the improved earnings for our bank over the last five years. We are consistent in our competitive pricing, the cross all product lines, customers trust that they are going to get a good deal from us compared to your average bank. We believe we are designed as the bank of the future.

We are going to run through a couple of our historical numbers and dive into a final conclusion in Q&A session.

Our net income as we said is increased over last six years to a 3.3 was our amount last year. We are currently in our third quarter. We finished really on power with last year.

Total asset growth, were currently at $847 million in assets, that's growing from $217 million in 2002.

We invest in multifamily mortgages, single family mortgages, commercial real estate and more recently RV's and home equities. As you can see by the pie, we are predominantly a multifamily shop right now. We have been, over the past two years buying more mortgage-backed securities in order to continue to grow the company and an opportunity that we believe is the best credit risk return.

Question-and-Answer Session

Unidentified Audience Member

Do you buy or originate those multifamily?

Andrew Micheletti

We do both. In the last three years, we've spent more time in buying than originating.

Unidentified Audience Member

Is that more efficient?

Andrew Micheletti

The question was is that more efficient? Yes, it is, in the opportunity again, our focus is on credit risk and the opportunity in the marketplace. As you know, in general, lending standards have loosened dramatically over the last two years, not only in single family lending, but also in multifamily lending. Multifamily lending activity is extremely competitive. So, we backed way from originating multi family loans compared to our first three years of operations.

So, we are primarily a mortgage shop. Our step into RV's and home equities is new. And of course, we do not have any subprime loans or subprime MBS.

Geographic breakdown of our property types, location of our property types, in both multifamily, single family and the seconds. We are predominantly in California. The dark blue is Southern California. The pink is Northern California. That has actually come down over the years as we've used our online access and our ability to buy mortgages outside of the California area. Our second largest is the state of Washington. And then the rest of the states really round out in less than 10% types of increments.

As I mentioned, we had a history of quality assets. Since inception, through the March 31, 2007 BOFI has had no mortgaged loans write-offs for closure sales or restructurings. We have no subprime loans, and when you step back and you look at our portfolio relative to a continued major downturn in real estate, we feel well protected.

The graphic in the lower right, shows what are combined loan-to-values are on our seconds. And what, the loan-to-values are on our first. Then in the case of our first wins, so this would be both single family loans and multifamily loans. The weighted average loan-to-value is 51%. So, that means that, we have almost twice, as much collateral as we have loaned. Should there be a downturn in valuations, we believe that, that will give us cushion sufficient to be credit safe.

The 62% combine loan-to-value for home equity loans, on home equity seconds again is relatively conservative to the marketplace, giving us a cushion should we have a downturn.

Unidentified Audience Member

Could I ask a question?

Andrew Micheletti

Sure.

Unidentified Audience Member

When you are saying, if and should we have a downturn? Having you already probably in the midst of that downturn as you speak?

Andrew Micheletti

Sure. Certainly pricing in certain areas has clearly come down very fast and very hard. One area, which is clearly a target right now is Michigan, where a job lost particularly has hit property values significantly, but we are seeing a property declines really throughout the country in various places that have been very hard. The answer is you just don’t know. We can always predict a future and our point is simply that, we are very conservative in what we built and what we build is well protected from a credit quality perspective.

Little bit about how we fund our assets. The pie chart in the upper right gives you the breakdown of our funding sources. The two pieces of pie, on the right side of the pie are certificates of deposit. We are nothing but a retail shop, we have no brokered CDs.

So while we do have CDs over $100,000, all of those CDs are coming in from retail customers, customers who find us on the Internet and decide to put more than a $100,000 in our bank. We also have $60 million in checking and savings. And we have $300 million or about just shy of, half of our funding is from Federal Home Loan borrowings and reverse repurchase. We use these borrowings to extend the term of our liabilities to hedge against interest rate changes. Many of our loans from which we are earning on are fixed for short period from a one to five year's, and we want to make sure that if rates rise our deposits in combination with our borrowings will provide a fixed opportunity to lock-in and spread. So, we use the borrowing really as a hedge on our balance sheet. Over the history we have grown ourselves from primarily a CD shop to blend both CDs checking in savings and borrowings.

Last quarter as I announced we had record earnings. We are on 862,000 best quarters ever that was up from 828,000 we earned in the same quarter in 2006. G&A to average assets was 82 basis points in the last quarter. So that it means basically we were spending 82 basis points for our operating costs including employees. Assets have grown from $704 million at the end of the prior year to $846 million currently. And our book value per share to very bottom in the chart has grown from 773 up to $8.21, so at $8.21 the book value is currently above our share trading price we are below book which represents an opportunity for our stock. Question.

Unidentified Audience Member

(Question Inaudible)

Andrew Micheletti

The loan portfolio is lower because of the RL action to not originate certain types of loans that we have originated in the past as a result from both regular repayments as well as pre-payments our portfolio declined, specifically in the case of multifamily as we discussed. Multifamily we've seen the underwriting standards deteriorate very significantly. We are traditional underwriters; we underwrite what's called a 125 DCR, that means you have to have about 25% more cash flow than debt service on it in order to make the operation viable.

Today, we are seeing many lenders that are willing to lend at breakeven cash flow and if to be honest also the valuations of new multifamily loans in certain areas have become extremely expensive. They are using cap rates in California that might be in the 4% range and a 4% cap rate really you are better off owning one of our CD's if all you expect to earn is 4% in a multifamily rental operation. So, we backed away from the market, we back filled with mortgage-backed securities. So, if you will see the line below it where we've grown from $73 million up to $252 million. What we felt was the opportunity was there because home loans from a pricing perspective was literally on top of mortgage-backed securities. We elected to buy mortgage-backed securities because they were safer and had a similar yield. So, it was a management decision to really focus that. Now our new lending initiatives as we have indicated ultimately can and will change that trend.

So, in summary, our changes, some of the changes we announced over the last six to nine months. Our opportunity was to generate higher yielding loans and we are now doing that in the course of home equity loans and RV loans. High volume acquisition through Internet. That’s the opportunity we want to build, we've really seen that in our home equity loans. And we believe both these opportunities provide a good risk adjusted alternative in a flat yield curve. Our bank has being impacted by the flattening and the ultimate inversion of the yield curve over last two to three years and our new lending initiatives bring in higher interest rates that will allow us to increase our net interest margin.

Yes, for question

Unidentified Audience Member

(Question Inaudible)

Andrew Micheletti

Let me give you an example by way of numbers. For example, in the RV lending over in our first month, so this is a first numbers. So, it would necessary to say that the entire portfolio as we grow will have this characteristic. But, our weighted average accounting yield was approximately 7.2%. You take our 7.2% and then you look at what kind of loan loss reserves you are adding for that type of loan. In the case of RVs, our loan loss reverses were a little over 50 basis points. Obviously, we don’t have a history yet on how well, how good or bad that reserve will be. But, we believe based on our research that it is a good number for loan loss. So, you take 7.2% and you subtract 50 basis points and now you get to 6.7% after loan loss. That is what we are saying is we believe that 6.7% rate is very favorable compared to mortgages today, where we're seeing mortgage backs and a lots loans trade in the high 5% type range. So, we are picking up may be a 100 basis points in yield. So, that’s what we mean.

Everything that we've done this quarter and we are really excited about it is, we have been able to leverage our online assets by creating affiliate marketing programs. In April, we announced our Camping World initiative, in which Camping World has now has us on their website as a bank sponsor, offering our products in return for a successful account opening fee. We believe again the demographics of shoppers at Camping World and the whole concept of the RV market and the opportunity for RV investors to really have a great checking and savings or time deposit account and work with Camping World is a great opportunity for us.

So, implementing a pay for a performance marketing agreement is an important part of our growth into the future. As we mentioned, the Camping World agreement is the first start. The goal simply is to drive down our account acquisition cost.

So in summary, the investment opportunity for BOFI holding stock is number one, an attractive evaluation. You have an evaluation that’s below book and there are no intangibles on the asset side of the balance sheet. The Internet creates the opportunity, and our low cost structure is taking advantage of that Internet. We have the proprietary software and the people and we have a strong record of growth. We have been able to grow the business for five years. Our portfolio of high quality assets has allowed us to kept our cost down, we haven't hired the higher collectors and repossessors up to this point.

Certainly, as we look at our RV opportunity, it is less likely that we will not have a loss. We will likely at some point in time ultimately have a loss on an RV loan. But historically, we've managed our credit risk very well. So, with that, I'll wrap it up and see if we have any additional questions.

Unidentified Audience Member

(Question Inaudible)

Andrew Micheletti

Yeah. On the conference call, what we said, we had originated is 12 million, it's probably closer to 13 million and some change of what we've originated. During the month of April, that is coming I believe on the conference call you can hear, close to 7.2% is probably around 7.1%, between 7.2% and 7.1% on an effective accounting yield.

Unidentified Audience Member

(Question Inaudible)

Andrew Micheletti

Yes. In a combination of those items, we have to slow our growth compared to the history of the first three to four years of our bank, because the opportunities to earn a profitable spread were less than what we had currently. And the reason that changed in part was because of the yield curve. The yield curve as many of us know is inverted and was flat. What that does is that increases, in the case of inversion, it increases our deposit cost. Because generally our deposits are priced-up the short-end of the yield curve and does not simultaneously increase the earning asset side, because typically earning assets are priced for they are out on the curve in the 5 year and the 10 year and the 20 year space. So, that inversion of the curve has impacted our spread. Our spread has fallen from approximately 2% down to, its low as 129 in December of '06. Now, we've moved it back up to 1.42% and our goal in the long run is to maintain that spread between 1.75 and 2.25.

So, our slow down in growth impart relates to the opportunity to put assets on a larger spread further down the road. Also quite frankly, we did not project that the yield curve is flattening, and inversion would last as long as it lasted. And so, our reaction to adding new home equity loans and other opportunities really is based on the concept that independent of the yield curve, we can grow the yield of our bank.

Unidentified Audience Member

(Question Inaudible)

Andrew Micheletti

In general and we certainly don't provide economic forecast. But in a general sense, we believe the demographics going forward over the next five to ten years will be very favorable to our business. And the reason the demographics will be favorable is because there are more Boomers who are becoming seniors as the Boomers get closer to retirement age, their focus will be less on equities and other real estate price sensitive assets and more on fixed income assets which will be very encouraging for our deposit growth as more people work to save and earn the retirement vis-à-vis CDs. So, that population is growing, which means there is a better opportunity. In addition, our low costs format allows us we believe to compete very effectively to win those customers both with good efficient self service and with high rates.

Unidentified Audience Member

(Question Inaudible)

Andrew Micheletti

Sure, that's in. And again I don’t certainly have the economic data to show you that says, that will absolutely happen. But conceptually that is the view of the Bank.

Unidentified Audience Member

(Question Inaudible)

Andrew Micheletti

Yeah, on our earnings call basically we, if you go back we basically told everyone that we would not make our targets simply because of the yield curve and the deal with that. As we going forward and look at those opportunities in potentially after the ending of the next quarter, we will have the better opportunity to analyze our growth in our new lending products and be able to look forward toward on how our growth will happen in the future. And currently we have enough capital in the bank to grow the bank to $1 billion to $1.2 billion and, grow into $1.5 billion would require some new capital in the bank.

So, very good, thank you all.

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