"If it grows like a weed, it probably is a weed"--Old Banking Maxim
Bank Of The Internet (NASDAQ:BOFI) has been one of the best performing stocks in the world in recent years. It has also been, by most measures, one of the fastest growing and most profitable banks in the country. Taking advantage of a "branchless" internet banking model, BOFI has crafted a narrative, which has been widely promoted, that it is revolutionizing the banking industry. While much of the focus tends to be on BOFI's supposed dis-intermediation of traditional banks, the key, in my view, has always been it's loan growth.
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When the subprime crisis hit, it took many California banks, mortgage brokers, and related infrastructure with it. In my opinion, BOFI's CEO, Greg Garrabrants, himself a former Indymac executive, has brought much of this infrastructure roaring back to life. Appearing to have the best of both worlds, BOFI's loan portfolio has had sky-high yields while experiencing negligible credit losses. BOFI has generated industry leading net interest margins while setting aside industry low levels of loan loss provisions. This has resulted in enormous (short term) profitability which appears to have emboldened BOFI to become even more aggressive in growing loans and fee income streams. Awarded one of the most expensive stock valuations in the entire banking industry, BOFI appears to have convinced many that the laws of financial gravity do not apply to it.
While exotic mortgages remain the dominant portion of both it's balance sheet and loan originations, BOFI's mortgage growth has slowed. Needing to maintain supersonic growth to keep up with expectations and maintain it's lofty stock valuation, BOFI has pivoted to other categories. This effort, at least on the surface, has been successful. BOFI has reported strong income growth in recent quarters largely as a result of it's expansion into C&I Lending and Structured Settlements. In researching these, it became clear that BOFI has offered only limited disclosure into the actual activities and underlying economics of these businesses. As a result, many investors may have a poor understanding of the activities and underlying risks that are driving BOFI's performance.
Recently, the soundness of BOFI's mortgage lending practices have been questioned in several recent articles, including an unflattering New York Times profile. This writing attempts to shed light on an equally important piece of the mosaic. Sourced entirely from publicly available records, the article exposes how a network of boiler rooms, bad loans, and off-balance sheet maneuvers appears to have boosted BOFI's reported operating results while adding greatly to it's risk profile.
Note: All information for this article was derived from publicly available information. The article makes no representations or judgments as to BOFI's compliance with any applicable laws. Investors are encouraged to conduct their own due diligence into these factors.
BOFI's C&I And Structured Settlements Business.
As it's mortgage lending growth has slowed, BOFI has aggressively expanded into what it calls C&I Lending and Structured Settlements businesses. These have become some of the fastest growing segments of the bank and represent an increasingly large portion of it's earnings. BOFI appears to have averaged over $300 Million in C&I, Specialty, and Structured Settlement originations (just under 25% of it's total loan production) during each the past two quarters. Of the two, the C&I category has been the largest in terms of origination volumes. Production has been growing quickly, especially when compared to just two years ago, when BOFI hardly originated any C&I loans. In the most recent quarter, the contribution from both of these businesses appears to be the primary driver behind the bank's massive 86% quarterly growth in non-interest income. Both of these categories also have yields well above the bank's already high overall average. As a result, these categories have acted to stabilize BOFI's margins at a time when most banks are struggling with margin contraction.
This brings up a fundamental question. Most banks across the country report increasingly intense competition for C&I lending which has pressured yields, profits, and covenants. Almost magically, BOFI is widely believed to have created a fast growing C&I business that is completely immune from the struggles of non-internet based banks. So how does BOFI achieve it's high yields and low loan losses in this environment?
Most investors and sell side analysts appear to have absolutely no idea. Despite becoming an increasingly important driver of the business, the actual activities that have produced these fast growing income streams have remained largely obscured. That is for good reason. Having literally reviewed thousands of 10-K's, BOFI's 10-k, in my opinion, stands out as being a complete "black box". The document offers only limited disclosure of all of the bank's activities, but especially it's C&I and Structured Settlement businesses. BOFI's rosy investor pitch-books offer only cursory references to these businesses and instead dedicate most of their focus to BOFI's internet deposit activities. A review of BOFI's earnings calls gives a similar impression, with BOFI offering only a highly generic description of it's C&I activities. In his brief public comments on the topic, BOFI's CEO, Greg Garrabrants, has assured investors that "the vast majority of our C&I loan book is sole sourced, originated and agented by us". As a result, BOFI's C&I and Structured settlement activities have gone largely unquestioned. After all, most investors and sell-side analysts are focused on how quickly BOFI might be able to grow it's loan originations. To many, understanding how BOFI produces that growth (and the related risks) is of far lesser importance. After all, according to Mr. Garrabrants, BOFI is an "earnings juggernaut"!
The fact that these business appear to be incredibly profitable (at least in the short term) have only acted to embolden analysts and investors. Like most of BOFI's lending categories, the C&I business appears to offer the best of both worlds; sky high yields and pristine credit performance. In fact, BOFI's most recent 10-Q reports that the bank currently has ZERO non-performing C&I assets (page 29).
A search of public records, however, reveals that the courts have been flooded with collections and/or bankruptcy cases involving loans that BOFI has originated. How can this be?
The New Boiler Rooms: "Alternative" Business Lending
A March, 2014 Bloomberg News articled titled, "Wall Street Finds New Subprime With 125% Business Loans", described how:
people trained by a veteran of Jordan Belfort's boiler room call truckers, contractors and florists across the country pitching loans with annual interest rates as high as 125 percent.....Mortgage brokers and former stock salesmen looking for new ways to make fast profits are pushing the loans, which aren't covered by federal consumer safeguards.... Some stock brokers have jumped to business loans after getting kicked out of the securities industry by regulators. "There's lots of people who've been banned from brokerage. There's no license you need to file for. It's pretty much unregulated."
Originations of "alternative" business loans have surged across the country in recent quarters. In what is akin to pay-day lending for businesses, independent loan brokers earn enormous fees by referring borrowers to "specialty" business lenders who have created platforms to originate and service the loans.
One of these lenders is OnDeck Capital (NYSE:ONDK), a controversial recent IPO that was profiled in a February, 2015 Seeking Alpha article, Bad Loans, Bad Interest Rates, Bad Business Plan, authored by The Street Sweeper. OnDeck Capital is a rapidly growing lending & servicing platform that originates loans that, in many cases, have been referred by independent brokers. The servicing is critical because borrowers frequently default, which results in the seizing of the small business owner's cars, assets, and/or bankruptcy. The practices of OnDeck's independent brokers have drawn scrutiny and were profiled in another Bloomberg News article, ..Lender or Boiler Room?. The article describes how "OnDeck has teamed up with brokers convicted of stock scams, insider trading, embezzlement, gambling, and dealing ecstasy". Including an individual who actually coached Vin Diesel for the movie Boiler Room, the article profiles another loan broker who describes that:
OnDeck representatives offered to pay thousands of dollars for every borrower he brought in. He could hardly believe it was legal to charge such high rates, until he learned that most states' usury laws don't apply to business loans. His salesmen, who spend their days cold-calling businesses to offer easy money, are a colorful lot. The list of Figueroa's past and present employees includes a former hedge fund manager convicted of stock fraud and a recovering heroin addict on probation for a motel stickup gone bad. One new hire stopped coming to work after he robbed a bank.
OnDeck's quarterly SEC filings make several references to an "issuing bank partner" that originates roughly 16% of it's total loans. Anyone want to guess who that partner is?
BOFI's Little-Known Partnership With OnDeck Capital
Interestingly, as part of OnDeck's S-1 filing for it's IPO, the SEC pressed it for more disclosure regarding the issuing bank partnership. The SEC's December 2014 comment letter asked OnDeck to "add more detail regarding the role of BoI Federal Bank". OnDeck has disclosed in filings that it has a contract with BOFI where:
"We recommend term loans to BofI that meet BofI's underwriting criteria, at which point BofI may elect to fund the loan. If BofI decides to fund the loan, BofI retains the economics on the loan for the period that it owns the loan. BofI earns origination fees from the customers who borrow from it and in addition retains the interest paid during the period BofI holds the loan. In exchange for recommending loans to BofI, we earn a marketing referral fee based on the loans recommended to, and funded by, BofI. BofI has the right to hold the loans or sell the loans to us or other purchasers, though it generally sells the loans to us on the business day following its origination of the loan. We are generally the purchaser of the loans that we refer to BofI
So, in other words, it appears that OnDeck's network of boiler rooms and unseemly loan brokers passes on loans to OnDeck, who subsequently passes them on to BOFI to originate. BOFI originates the loan, earns origination fees, and in turn, OnDeck buys the loans immediately back from BOFI. Why does OnDeck go through all this maneuvering to originate a loan? Because BOFI has a federal banking charter. This is of critical importance because the laws of some states may otherwise prohibit OnDeck from issuing the loan. As OnDeck describes:
In states that do not require a license to make commercial loans, we make term loans directly to customers....However, nine states and jurisdictions, namely Alaska, California, Maryland, Nevada, North Dakota, Rhode Island, South Dakota, Vermont, and Washington, D.C., require a license to make certain commercial loans and may not honor a Virginia choice of law. They assert either that their own licensing laws and requirements should generally apply to commercial loans made by nonbanks or apply to commercial loans made by nonbanks of certain principal amounts or with certain interest rates or other terms. In such states and jurisdictions and in some other circumstances, term loans are made by an issuing bank partner that is not subject to state licensing, primarily BofI Federal Bank (a federally chartered bank), or BofI,
Thus, by OnDeck's own admission, it appears that BOFI may be using it's federal banking charter to assist OnDeck in circumventing state banking laws that otherwise might prohibit the loans from being originated. Known as "rent-a-charter", this untested model appears fraught with potential regulatory risks. The OCC's own comptroller has historically stated that "the OCC has opposed arrangements in which third parties effectively 'rent out' the preemption privileges of a national bank for the sole purpose of evading state law".
The loan amounts are also significant. OnDeck has stated that BOFI-originated loans amounted to 16% of it's $1.1 Billion in total 2014 loan originations. By extension, this means that BOFI's OnDeck related loan originations likely totaled around $185 Million during calendar year 2014. In OnDeck's most recent 10-Q, it disclosed that it purchased $103 Million in loans from it's bank partner in the first two calendar quarters of 2015. As a result, OnDeck likely has comprised roughly 15-25% of BOFI's C&I and specialty originations in recent quarters. This is a material amount and given the obvious risks, it's fair to question the sustainability of this income stream. The relationship with OnDeck, however, is not the only unique lending relationship that merits significant investor scrutiny.
BOFI's Undisclosed Relationship With Quick Bridge Funding.
BOFI has partnered with several other finance companies across the country. One of these is a Southern California company named Quick Bridge Funding. While BOFI has not specifically disclosed the nature of it's relationship with Quick Bridge, publicly available bankruptcy records confirm a partnership of some kind.
Quick Bridge's website describes that it provides an "alternative to traditional loans", "Poor credit? No Problem...we understand the obstacles that modern business owners face". Business records indicate that Quick Bridge previously did business as "Blackrock Lending Group", which the State of Washington has publicly accused of perpetrating "an advance fee loan scam" whereby "consumers are told to wire the funds and the consumers never receive their loans". According to LinkedIn, Quick Bridge's sales leadership previously held leadership positions at a now defunct San Diego finance company named Five Point Capital. A possible boiler room, Five Point has a consumer alert issued by the Better Business Bureau and was the subject of allegations of deceptive marketing practices.
In June, 2014 Quick Bridge announced that it had closed a $35 Million credit facility with a "Southern California Bank". Since that point, the company's growth has been exponential. In August of this year, Quick Bridge announced that it had attained a three year growth rate of "24,138 percent", making it the fifth fastest growing private company in the country.
Importantly, Quick Bridge states that it relies exclusively on a network of brokers to originate it's loans to small businesses. Quick Bridge's loans come with ridiculously high interest rates, must be paid daily, and have significant fees and penalties. Court documents reveal that many borrowers appear to have never been capable of meeting the onerous terms of the loans and, in some cases, have defaulted within days of the loans being issued. As a result, the courts have been flooded with collections actions and/or bankruptcies of small business owners related to loans originated by BOFI.
Similar to it's arrangement with OnDeck, it appears that a network of brokers passes on loans to Quick Bridge who then passes them onto BOFI for origination. BOFI in turn, originates the loan and then immediately assigns them off it's balance sheet. The loans are then subsequently serviced by Quick Bridge who also manages the collections. As a result, loans that BOFI has originated, but claims to no longer hold, can frequently be seen in court records.
A typical example is included above (obtained from publicly available court records, personal identifying information of the borrower has been redacted by the author). In January, 2015 BOFI originated a loan to a small Ohio based website developer. The loan amount was $50k and included an immediate 2% origination fee. The loan terms included personal guarantees and called for 210 daily payments of $338.10, amounting to a total repayment amount of $71k. This loan was not cherry picked as an example, but instead appears to be consistent with most of the loans that were reviewed. An astronomically high rate, the complaint also states that "BofI is exempt from usury laws" which again calls into question if BOFI is providing assistance in circumventing applicable state lending laws.
Other loans, including one highlighted below made to a small tax preparer, appear to have never even made the first week's payments:
The fine print of these loans also includes onerous penalties. There are extraordinary and immediate pre-payment penalties that act to "lock" the borrower into the loan. If the borrower misses three days of payments, the total amount comes due with the borrower paying additional fees as well as attorney's and collection costs. In the above example, a loan of $30k resulted in a total due of nearly $40k in just five days.
Sadly, having reviewed dozens of individual court records, the story often doesn't end well for borrowers. While BOFI's promoters have cheered it's surging profits, the loans that have generated those earnings appear to have come at the catastrophic expense of many small business owners across the country. Case records reveal that many of the BOFI-originated loans have resulted in devastating asset seizures, the loss of small businesses, and/or ruinous personal bankruptcies. In some cases, the loans appear to have been restructured several times which has just created even greater financial ruin for the borrower.
Court Filings Reveal Details Of The Quick Bridge Agreement
The plaintiff in many of the Quick Bridge related collection filings is an entity named "WCL Holdings I, LLC".
The court filings explain that WCL has been assigned the loan from BOFI and is a wholly owned subsidiary of Blackrock Lending Group, LLC which, as previously mentioned, is believed to be the predecessor firm of Quick Bridge. Quick Bridge is the servicer of the loan and a review of public documents indicates that they are likely the manager of WCL.
Many of the bankruptcy filings also include a "loan assignment schedule" which reference many other BOFI-originated loans. Below is an example of the schedule that was included as part of the above referenced Ohio collection action (author redactions to eliminate borrower information). Readers should take careful note that the schedule clearly states that BOFI is immediately assigning the loans to WCL Holdings.
The schedule sheds light on the large volumes of originations being completed as part of the Quick Bridge partnership. Having originated millions of dollars worth of loans in the several week sample above, it's clear that this arrangement has been a meaningful contributor to BOFI's recent results.
For purposes of brevity, I have chosen to include examples from only two loans. The dozens of court records reviewed appear substantially similar to these examples and their inclusion would simply be redundant. Interested readers can conduct a simple court records search on any of the referenced parties to review the collection actions that have flooded court dockets. Readers are encouraged to make their own judgments as to the legitimacy of these loans.
Potential Existence Of An Undisclosed, Off-Balance Sheet, Special Purpose Entity
By all appearances, WCL Holdings I, LLC , looks like what is known as a special purpose entity ("SPE") or some variation. Readers unfamiliar with these entities should consult their historical abuse by several infamous corporations and financial engineers as well as their role (on behalf of banks) in helping facilitate the subprime mortgage crisis.
Clearly, the type of loans that BOFI is originating in partnership with Quick Bridge have enormous yields but also likely have enormous delinquency rates. For reference, The Street Sweeper's previously mentioned article on OnDeck estimated that the actual losses on it's loan book "approach 25% of gross revenues". Quick Bridge's loans, in my review, appear to actually be of poorer quality than those of OnDeck. As a result, the actual credit performance may be considerably worse than the 25% OnDeck loss estimates. BOFI, on the other hand, has a history of pristine credit quality and has proportionally small loan loss reserves. Holding assets with high loss rates on it's own balance sheet would be highly problematic for it's investor relations narratives.
Thus, originating the loan and immediately assigning it to an SPE serves several key purposes:
There is one very distinct and important difference with BOFI's arrangement with Quick Bridge as compared to that of OnDeck; BOFI appears to be funding WCL Holdings and by extension, BOFI appears to be funding it's own origination activity. As already mentioned, Quick Bridge had press released that it had closed a $35 Million line of credit with a "Southern California Bank". Furthermore, BOFI's own website (below), describes that it's "typical" lender finance structure consists of a "senior secured warehouse facility to a special purpose entity which owns the assets/loan receivables".
This has significant implications. Assuming the Quick Bridge partnership is "typical", then by extension, BOFI appears to be lending to an undisclosed, off-balance sheet SPE whose primary operating purpose is to purchase loans from BOFI. The benefits of this structure to BOFI from a financial statement perspective are clear. BOFI is able report that it's large, on-balance sheet C&I loan (made to the SPE) is fully performing, even though the SPE itself is filled with questionable BOFI-originated loans that appear to be experiencing severe delinquencies. Court documents also confirm that both BOFI's Assistant General Counsel and Cheif Credit Officer have signed off on it's "bulk assignment" activities:
To be clear, there is nothing wrong with lending to an SPE. There is, however, a distinct and important difference between directly funding an SPE whose primary purpose is to buy unrelated assets (which banks do all the time) and directly funding an undisclosed SPE whose primary purpose is to buy the bank's own assets.
Although SPE disclosure requirements have been tightened up by regulators in recent years, the existence of WCL Holdings, to my knowledge, has never been disclosed by BOFI. As a result, investors have no insight into the actual economics of the SPE itself and if BOFI has additional risks (in addition to it's credit facility) that are contingent upon the credit performance of the loans that BOFI itself originated. Obviously, in the most recent financial crisis, there were many banks who thought they had shed their exposure to subprime mortgage CDOs, only to be forced to bring these back on balance sheet later on.
BOFI's Credit Exposures May Be Much Riskier Than Widely Believed
Quick Bridge is not BOFI's only other undisclosed lending relationship. Public records show that BOFI also has provided a credit facility to "Rehab Cash Now". That company's website advertises loan amounts up to $2.5 Million with "no set minimum" FICO score. Since BOFI's website states it's interest in lending to SPE's, it's likely that a good portion of the bank's reported $245 Million in on-balance sheet C&I loans represent large loans to a variety of Special Purpose Entities. These SPE's appear likely to hold highly suspect loans that, at least in one case, BOFI itself has originated.
Most investors, on the other hand, appear to believe that BOFI's C&I loans provide favorable yields while, because of BOFI's "zero" delinquency rate, offering a AA or AAA type credit profile. In my view, BOFI's C&I (on-balance sheet) exposure resembles, at best, an extremely risky, high yield, junk bond fund. Even worse, the company's most recent 10-Q (page 49), reveals that it has set aside a paltry $5.6 Million in loss provisions against this portfolio. With the credit performance of the loans appearing to be dreadful in the current economic environment, investors are left to imagine how these SPE's might perform in a recessionary environment.
Speaking of junk bonds, it's relevant also to note that BOFI's current CFO, Andrew J. Micheletti, was previously the Controller and VP of financial reporting for Imperial Saving Bank. When it was in operation, Imperial had cultivated close ties with Drexel Burnham and Michael Milken and built one of the largest bank-held junk bond portfolios in the country. When this portfolio imploded, the bank was seized by regulators in one of the state's largest bank failures in history at the time (having only been recently dwarfed by that of Indymac).
On a lesser note, the Imperial cease and desist order outlined an apparent web of subsidiaries that the bank had established. I note that I have been unable to locate BOFI's required form 21 ("subsidiaries of the registrant") in any of BOFI's historic 10-Ks. Most of the 10-k's make reference to the form 21 being including in BOFI's 2005 S-1, however, I could not locate it in those filings either. BOFI may have filed it somewhere, but we have simply been unable to locate it on EDGAR. This is relevant because corporate record searches reveal that BOFI may have created additional and potentially undisclosed subsidiaries in recent years.
BOFI's Structured Settlements Business
This article has been focused primarily on BOFI's fast growing C&I business. The structured settlements business has also become a fast growing and important contributor to BOFI's earnings. BOFI describes this business as mostly purchasing lottery winnings, research indicates that there is more to the story. BOFI's own Glassdoor boards suggest that BOFI may be running some version of an internal boiler room in an effort to aggressively grow this business. For purposes of brevity, a detailed analysis of BOFI's Structured Settlement activities will not be included in this article. Instead, a simple example offers insight into BOFI's activities.
A case in New York, (link to docket), described how an individual held a structured settlement in which he was due, in aggregate $652,278, to be paid between 2021 and 2038. BOFI had apparently convinced this individual to sell this structured settlement to the bank for a mere $15k (I am not missing any zeros). Citing his role in preventing the individual from being "victimized or hoodwinked", the judge noted that the individual was not present, had no representation, and it was apparent that all of the individual's documents had been "prepared by Petitioner BOFI". The judge also noted that BOFI's compensation of $15k represented only 2% of the un-discounted value of payments. Stating that he found the case to be "at the very least, greatly troubling", the judge ruled that the transaction was "unconscionable and..Unjustifiable and insupportable".
This example may shed some light on how BOFI may be generating it's windfall Structured Settlement profits. I would simply note that the business hardly appears sustainable and also likely includes significant regulatory risks.
Investors Are Encouraged To Conduct Their Own Due Diligence Into These Factors
This article makes absolutely no representations or judgments as to BOFI's compliance with any applicable laws. The purpose of this writing is to highlight risks that many investors may not be aware of or fully understand. As with any company, investors rely heavily on the judgment of the company's accounting staff, internal controls, and audit committee.
As has been previously reported, BOFI has had both turmoil and high turnover in it's accounting and auditing departments in recent years. An internal auditor recently filed a whistleblower lawsuit alleging, among other things, that executives may be "falsifying the Company's financials". BOFI's stated explanation for it's external auditor change on the most recent call was secretly amended in a false transcript the company filed with the SEC. Independent members of the Board of Directors, including Audit Committee members, have accepted large mortgages at favorable terms from the bank. BOFI's own recent court filings have confirmed the existence of undisclosed subpoenas and nonpublic government investigations. Sell-side analysts are operating under large conflicts of interest and have continued to issue favorable reports amidst a quickly deteriorating fact pattern. Investors who may have been seduced by BOFI's investor relations narratives and reported profits are encouraged to do their own due diligence into these factors.
All information for this article was derived from publicly available information. The article makes no representations or judgments as to BOFI's compliance with any applicable laws. Investors are encouraged to conduct their own due diligence into these factors.
This article was written by
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: 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.