Amongst the fastest growing banks in the country, Bank of the Internet (NASDAQ:BOFI) has also been amongst the most profitable. The bank has consistently reported incredible returns on equity and assets which, at over 1.6% ROA & 18% ROE, dwarf the vast majority of the banking universe. The narrative, which has been widely promoted, is that the bank's profits result from BOFI's "transformational" branchless internet banking model and advanced data analytic systems.
The actual driver of BOFI's reported profits, however, is the success executives have had in bringing much of California's dismantled subprime-era lending infrastructure roaring back to life. Having essentially "put the band back together", BOFI's industry-leading performance has been a direct function of the bank's sky-high loan yields and disproportionately small loss reserves. BOFI's loans, the majority of which are obtained through a network of brokers, earn yields which are far higher than the vast majority of lenders. Despite its outsized yields, BOFI asserts that its loans actually come with extremely low credit risks.
Source: Public Records, Data as of 9/30/2015. Reference banks were selected based on BOFI's own periodic self-comparison.
On its $5.2 Billion in total loans, BOFI has set aside a paltry $31 million in loan loss allowances which is amongst the lowest rates in the entire banking industry. Earning industry leading loan yields while setting aside minimal loss reserves, investor relations narratives have convinced many that the laws of financial gravity simply do not apply to an internet bank.
BOFI's stated credit quality and loss history is the absolutely essential piece of the high return/low risk "myth" underpinning its lending activities. Having frequently touted its credit quality publicly, BOFI's CEO, Greg Garrabrants, reiterated on the most recent earnings call that:
Our lifetime loss in our originated single family loan portfolio represents less than 2 basis points of loans originated and our multifamily lifetime loss is also less than 2 basis points of loans originated.
Also widely promoted by the sell-side, BOFI's reported net charge-offs of "zero" (below) have been critical in the face of mounting concerns regarding BOFI's lending activities. In dismissing underwriting issues, BOFI's supporters have continuously pointed to the bank's enormous accounting earnings and pristine reported credit statistics. After all, if BOFI was making bad loans, surely the bank would be reporting increased charge-offs and/or foreclosure activity, wouldn't it?
Cracks in the facade of BOFI's reported credit statistics began to emerge when research confirmed that BOFI is transferring bad loans (that have subsequently flooded the courts with defaults) to an undisclosed, off-balance sheet special purpose entity that it also finances. These dealings now appear to be just the tip of the iceberg. Public records searches have uncovered dozens of undisclosed lending relationships, many of which are highly suspect, that comprise the bulk of BOFI's large and quickly expanding lender finance portfolio (believed to exceed $400 million in size). While these relationships certainly warrant examination, this article focuses on BOFI's dealings with completely undisclosed SPEs that are actually managed by BOFI executives and believed to be held-off balance sheet. Transactions with one of these entities, detailed in public records, appear designed to hide soured BOFI-held mortgages. These dealings cast significant additional doubt on the integrity of BOFI's reported credit quality statistics and accounting. With BOFI's audit committee and audit function believed to be completely defective, the risk of a major accounting fiasco appears extremely high.
Note: All information was derived entirely from public sources. Investors are encouraged to conduct their own due diligence into these factors.
BOFI Reports Minimal Owned Real Estate Balances
Consistent with BOFI's stated low levels of non-performing loans, the bank has reported only minimal balances of other real estate owned ("OREO"). A simple accounting category, OREO includes all real estate that the bank has taken possession of (typically through foreclosures and/or related actions). Consequently, the absence of significant OREO balances is a significant sign of credit quality as it indicates that the bank is experiencing minimal foreclosure activity. At the end of the most recent quarter, BOFI reported that it held only $910k of OREO consisting almost exclusively of single family real estate:
Source: (BOFI 10-Q: Page 14)
Clearly stating that BOFI doesn't own any multi-family real estate, a single example directly contradicts these reported numbers.
The Curious Path Of A Soured Multi-Family Loan
In February, 2012 BOFI underwrote a mortgage to fund a Palm Springs couple's purchase an apartment building (pictured above) named Green West Apartments. Located in Lawton, Oklahoma, BOFI's note on the 78-unit, 60,000 square-foot complex, was slightly over $1 million:
(Source: Comanche County Clerk)
By the start of 2015, the property owners had run into trouble and BOFI's loan had soured. A local business journal would later report in an article that the owners had "mismanaged the facility" and their management company had "spent money on things it shouldn't have". Having clearly become a troubled loan for BOFI, the article reports that "when the money ran out, the owner didn't have the funds to pay the bank on its loan" . Holding a non-performing loan, most banks would be expected to institute a foreclosure (or deed in lieu) proceeding to take possession of the asset (subsequently classifying it as OREO) until it can be liquidated. Before initiating these proceedings, public records reveal that something strange happened.
On April 8th, 2015 at 10:59 AM, BOFI Federal Bank sold the mortgage to a completely undisclosed Delaware SPE named "BOFI Properties, LLC - Series 1":
Oddly, as part of BOFI's purported "sale" of the soured loan to the SPE, Thomas Constantine signed for both parties (below) in his capacity as BOFI's Chief Credit Officer and the "manager" of BOFI Properties. Click to enlarge
Then, only three minutes after the loan was "sold" to the SPE, BOFI Properties purchased the Green West Apartments from the owner. The below public records indicate that this transaction was structured as a deed in lieu of foreclosure, with BOFI Properties clearly assuming ownership of the property and the former owner walking away.
Having taken possession of the Green West apartments, BOFI Properties eventually marketed the property for sale later in the year. With the property's occupancy reportedly having dwindled to a deeply distressed 25%, the local journal described that "since the bank had it for a few months, the property has some deferred maintenance". Never the less, BOFI found a buyer later in the year and sold the property for $900k (roughly $100k below the original principal) on November 6th, 2015:
A critical detail, is that BOFI Federal Bank assisted the sale by providing the financing (copy of document) to facilitate the new buyer's purchase of the apartments from BOFI Properties.
To Recap, the fact sequence is:
- BOFI originates the loan.
- The loan sours.
- BOFI "sells" the loan to BOFI Properties, LLC.
- BOFI Properties immediately conducts a deed in lieu to purchase the underlying property.
- BOFI Properties markets the property for sale and finds a new buyer.
- BOFI issues a mortgage to finance the new buyer's purchase from BOFI Properties, closing the loop.
Importantly, the Green West example does not appear to be simply a "one-off" transaction and a relatively similar fact sequence can be seen in in documents recorded just two weeks ago. In this instance, BOFI Federal Bank began foreclosure proceedings during the summer on a distressed New York mortgage. BOFI Properties subsequently purchased the underlying property from BOFI Federal Bank (via a public referee) on December 11th and is reported to still own the property.
The Undisclosed BOFI Properties Appears To Also Be Unconsolidated
Troubling, the existence of BOFI Properties has gone completely undisclosed. Delaware public records reveal that the SPE was created on February 10, 2015 which was just weeks before "unrest" in BOFI's internal audit department culminated in the departure of two internal auditors. While the Delaware filings contain no identifying information (being registered to the law firm Saul Ewing), the SPE recently filed as a foreign in Florida and that filing specifically names Eshel Bar-Adon (Chief Legal Officer) and Thomas Constantine (Chief Credit Officer) as its managers. This is particularly relevant because one of the former internal auditors has stated, in a whistleblower complaint, his belief that BOFI's management "may be falsifying the Company's financials". The complaint references a conversation in which Mr. Constantine (who also has been awarded a questionable BOFI-funded mortgage) allegedly "reiterated that he could and would not vouch for the accuracy of the numbers once the CFO had them". The existence of this conversation was subsequently repeated by the whistleblower in a sworn declaration filed on Tuesday (Page Number 5).
Mr. Constantine's alleged inability to vouch for the numbers may be for good reason. There appears to be a fundamental and serious problem with BOFI's accounting for its Green West Apartment dealings; research indicates that BOFI Properties is likely unconsolidated and held off-balance sheet.
As a repossessed asset, Green West meets the exact definition of other real estate owned and BOFI Properties clearly owned the Green West Apartments as of September 30th (with its sale not closing until November 6th). Yet, BOFI's SEC filings report that the bank didn't own any multi-family real estate as of September 30th. A fundamental contradiction, the only logical possibility is that BOFI's ownership of the Green West Apartments has not been consolidated (leaving investors to wonder how many other soured loans have also been transferred).
Further supporting this conclusion, recall that BOFI has never filed the legally required Exhibit 21 list of subsidiaries along with any of its 10-Ks. This stands in sharp contrast to many banks such as Huntington Bancshares (NASDAQ:HBAN) which, for example, reported roughly 100 subsidiaries in its most recent 10-k and also filed a specific OCC request to create a (fully consolidated) OREO-holding LLC during the downturn. Instead, BOFI has included a tiny disclosure which specifically names only two subsidiaries (below) and references a 2004/2005 list it claims was included with its S-1 filings (but can't be found). This disclosure indicates that BOFI hasn't created any subsidiaries in over a decade. By implication, BOFI Properties (and other unlisted entities) cannot be a consolidated BOFI subsidiary.
As an additional data point, the Federal Reserve system contains a specific database that lists bank subsidiaries. Again using Huntington as a reference point (because it had specifically created an OREO holding LLC), the website lists 104 Huntington Subsidiaries including numerous LLCs. BOFI's registry, on the other hand, lists only 4 subsidiaries, making no mention of the existence of BOFI Properties or any other LLC.
Unlike other previously profiled SPEs, BOFI Properties is directly managed by BOFI executives. This fact renders both its non-disclosure and apparent non-consolidation completely absurd. Finally, I note that this vehicle has recently registered as a foreign entity in Oklahoma (March, 2015), Florida (September), and New York (November). Thus, BOFI executives appear to have began to broaden the usage of BOFI properties.
BOFI Properties, however, is not the only undisclosed entity that BOFI executives manage. Note that the above registry lists "BOFI Structured Settlement Funding Corporation" (which has been undisclosed in SEC filings) as a subsidiary. California corporate records (below) state that the entity was created by BOFI's CFO in 2009 but lists its status as "FTB Suspended".
While the activities of this corporation remain unclear, the existence of additional structured settlement SPEs raise significant questions.
BOFI's Undisclosed Executive-Created Lottery SPEs
BOFI has historically offered only limited disclosure about its structured settlement unit, managed by Mr. Bar-Adon, which appears to have become an increasingly important earnings "cookie jar". The unit's gain on sale profits (flowing through "gain on sale -other") tripled year-over-year last quarter and have been used to offset declines in mortgage banking fee income and supplement earnings.
BOFI also holds a meaningful amount of structured settlements on its balance sheet under the "factoring" category which amounted to $135 Million last quarter and produce yields higher than its overall loan portfolio. BOFI's previous comments to the SEC confirmed that the "factoring" loan category on its balance sheet consists entirely of structured settlements and lottery prize payments.
Importantly, BOFI's filings (above) also describe that the entire balance of this category as being "in house originated" as opposed to "purchased". This makes sense because BOFI's structured settlement activities are believed to be conducted through its in-house Annuitants Federal origination team. In fact, public records frequently depict "in-house" structured settlement originations that are registered directly to BOFI Federal Bank (examples: here, here).
As a result, it comes as a complete surprise that Mr. Bar-Adon has created three mysterious Delaware special purpose entities. Although BOFI hasn't disclosed any subsidiaries, public record searches identify "B of I Lottery Receivables LLC I" (formed in 2011),
"BOFI Casino Winnings LLC" (formed in 2013)
and "B of I Lottery Receivables LLC II" (formed in 2014).
In public UCC filings, "B OF I Lottery Receivables LLC I" is frequently seen transacting with Stone Street Capital, which is the firm where Mr. Bar-Adon previously spent over eight years of his career, serving on the executive committee. In the UCC filings, Stone Street is consistently observed securing lottery payments from individuals and then immediately selling and assigning them to the special purpose entity. A typical example is included below with Stone Street completing the origination:
And subsequently selling it to B of I Lottery Receivables
Critically, there a four main factors which suggest that the lottery SPEs are actually held off-balance sheet:
- UCC filings associate "B of I Lottery Receivables LLC I" with a completely unknown San Diego P.O. Box instead of BOFI's corporate address.
- The SPEs are not listed as a subsidiaries in either BOFI's SEC filings or the federal reserve website list.
- B of I Lottery Receivables clearly purchases the lottery payments from Stone Street which is obviously inconsistent with the "in-house" origination description of the settlements BOFI reports holding on its balance sheet.
- Many other BOFI-related structured settlement dealings are registered directly to BOFI Federal Bank and not an SPE. Thus, Mr. Bar-Adon's SPEs appear to serve an entirely different purpose.
The existence of undisclosed entities that are believed to be held off-balance sheet despite being created and managed by BOFI executives is simply astounding. The implications for the validity of BOFI's accounting and financial reporting, in my opinion, are self evident.
BOFI's Response To Questions Regarding the SPEs
Seeking clarity on the nature of all of these entities, repeated emails and voicemails were sent to BOFI's investor relations starting last Wednesday (January 15th) and covering a period of four business days (in addition to the holiday weekend). The requests asked very basic questions regarding the nature of BOFI's relationship with the entities and if BOFI consolidates them or owns them. These questions elicited no answers and numerous voicemails were left unreturned. The complete non-disclosure of the existence of these entities coupled with the company's apparent unwillingness to provide clarity is deeply troubling and, in my opinion, speaks volumes. I believe that investors should demand that BOFI immediately describe its relationship with these entities and explain their complete non-disclosure.
Investors are encouraged to conduct their own due diligence into these factors.
Disclosure: I am/we are short BOFI.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I am/we are short BOFI. All information for this article was derived from publicly available information. Investors are encouraged to conduct their own due diligence into these factors. Additional disclosure: This article represents the opinion of the author as of the date of this article. The information set forth in this article does not constitute a recommendation to buy or sell any security. This article represents the opinion of the author as of the date of this article. This article contains certain "forward-looking statements," which may be identified by the use of such words as "believe," "expect," "anticipate," "should," "planned," "estimated," "potential," "outlook," "forecast," "plan" and other similar terms. All are subject to various factors, any or all of which could cause actual events to differ materially from projected events. This article is based upon information reasonably available to the author and obtained from sources the author believes to be reliable; however, such information and sources cannot be guaranteed as to their accuracy or completeness. The author makes no representation as to the accuracy or completeness of the information set forth in this article and undertakes no duty to update its contents. The author may also cover his/her short position at any point in time without providing notice. The author encourages all readers to do their own due diligence.