By
Stone
Street Advisors
:
First, apologies for the delay in getting this up, had some
administrative hurdles that got in the way.
Anyway...Back in March,
I first wrote about a stock that we thought had
great upside potential,
Bank of Internet Holdings (
BOFI
). I think its worth mentioning, since I published that article,
BOFI is up ~30%, while the S&P 500 is flattish, the Nasdaq
index is down ~2%, the Financial Sector SPDR (
XLF
) is down ~6%, the Bank SPDR (
KBE
) is down 9%, and the ABA NASDAQ Community Bank Index (ABQI) -- to
which BOFI was recently added -- is down 4.5%!
(click to enlarge)
Whether our posts, tweets, and discussions with investors had
anything to do with BOFI's absolute and relative return over this
time period is up for debate, you simply can't ignore the company's
results and the stock's performance.
Today, I want to update you on our views bringing in Q1 (BOFI's
Q3) results and some work we've done on BOFI's closest -- albeit
far from perfect -- public competitor, Everbank (
EVER
).
Since I'm a skeptic -- first and foremost -- my inclination is
that the market is valuing BOFI correctly, and there must be some
clear risks and problem areas that explain BOFI's valuation
relative to its peer group (although that is quite hard to define
given its unique business model). Let's take a look:
(click to enlarge)
BOFI's Tier 1 Risk-Based Capital Ratio has varied over the past
few years, and at the end of the most recent quarter was 13.47%
versus 13.04% for all FDIC-insured institutions and 15.33% for
banks with $1-$10 billion in assets. While the recent number is
slightly out of line with its peer group (by assets), this doesn't
seem to be too much of an issue as the bank is still well above the
minimum capital adequacy limits and he Q1 number is up 28bps from
the previous quarter.
(click to enlarge)
With the Total Risk-Based Capital Ratio, BOFI is below the
averages for FDIC-insured banks of all sizes and the Raymond James
West Coast group (see below), however its ratio is still
significantly above that required by regulations. For a bank to be
"well capitalized" -- the highest rating -- it must have a >=
10.0% Total Risk-Based Capital Ratio, >= 6% Tier 1 Risk-Based
Capital Ratio (and >=5% leverage ratio). We think it's
impressive that BOFI has been able to not just maintain but exceed
these ratios while showing such strong loan growth performance,
24.6% CAGR from 6/2007 through 12/2011 and +43% over the last 12
months. Additionally, BOFI, despite having the vast majority of its
loans in California, has experienced, and continues to experience
relatively low levels of non-performing assets and charge-offs
relative to banks with similar geographic exposure:
(click to enlarge)
If we take a look at 14 metrics of valuation and risk, BOFI
outperforms this group in 9/14 (with one push since it could be
argued either way), and in those 9, its outperformance is much
higher in magnitude than its underperformance in the categories
where it does so.
Numbers in green are where we think (or know) BOFI is doing
better/presents a better opportunity than its "peers" while numbers
in red are ones where the opposite is the case. Loan loss
reserves/non performing loans is in black since one could argue
BOFI doesn't need to reserve as much given its two other better
credit quality metrics OR that its under-reserving and subjecting
itself to unnecessary risk, so we'll call that one a push to be
fair.
What we see is that BOFI delivers higher return on assets and
equity, has a lower P/E (but higher P/TBV), and seems significantly
less risky than its peer group:
(click to enlarge)
Additionally, and perhaps more importantly, we believe all are
not only explainable but of little concern, at least in the
intermediate term. For example, NIM (net interest margin):
(click to enlarge)
Since BOFI is branchless, in order to attract business, it
generally offers slightly higher interest rates on deposits and
attractive rates on loans, so its not exactly surprising its NIM is
lower than its peers in the RJ group, although as this chart shows,
NIM has been improving substantially and is now close to in-line
with its peer groups. We expect as the firm becomes larger, more
widely known, and the shift to online banking accelerates, this
trend should continue.
Additionally, due to its branchless business model, BOFI's
efficiency ratio is substantially lower (better) than any of its
peers, and almost half that of EVER, so in a sense, BOFI can
"afford" to offer attractive rates on deposits and loans due to its
lower non-interest expense (although this is certainly something to
keep an eye on for sure).
(click to enlarge)
By now, I think it's pretty clear that many of the "flags"
raised by critics that we could identify are, as I previously
mentioned, both explainable and of little if any concern to
investors (again, in the intermediate term).
I think there may still be some room to run in this stock, given
its performance. Look at the Return on average assets trend and
level, for example:
(click to enlarge)
The same is also true of return on average common equity, which
is well above both the mean & median #'s for West Coast banks
and similar to EVER's, although the latter's is far more
volatile:
(click to enlarge)
The only real area of concern I see here is that BOFI purchased
a not-insignificant amount of mortgage securities at very
attractive prices when markets were depressed. As these roll off
(mature) and/or if BOFI has to recognize any currently unrealized
losses on these securities, the company will have to replace these
attractive-yielding assets with new originations (and/or purchases)
with similarly attractive terms. This shouldn't (key word) be too
much of a concern for the intermediate term, after which point the
interest rate and general macroeconomic environment should (let's
hope!) look at least slightly better than it does today. Even so,
most of the non-agency RMBS on the balance sheet doesn't come due
(and isn't forecast to be pre-payed) for the next few years, so
again, the situation isn't dire (unless you go by a nickname like
"Dr. Doom" or something) Even if you're bearish there, though, BOFI
shouldn't fare any worse than other banks who'll face the same
headwinds. That said, it could be very hard to keep up the growth
if those assets can't be replaced with similarly-yielding ones.
Now, one could argue that BOFI is fairly valued on a P/TBV
basis, both relative to banks in the Raymond James peer group and
EVER, but considering its loan growth (while its peer group is
largely facing headwinds in that department) solid risk management,
and impressive outperformance in most categories relative to its
peers, I think its easier to make the argument that the stock price
could still go up.
These are the imputed P/E and P/TBV values for the stock at
different levels from its current price, LTM EPS, and mrq TBV.
Depending on your views on where the market and stock are heading,
fair value, etc, it looks like there's still some upside potential
even after its solid past returns.
(click to enlarge)
Admittedly, those of you concerned about the P/TBV might see
less upside, even though there's a long list of riskier, lower
growth banks that trade at ~2x P/TBV despite those factors (why, I
have no idea!).
(click to enlarge)
Ultimately, the upside opportunity depends on management's
continued ability to execute, maintain discipline, deliver
continued solid growth, and fight off competition from the bigger
banks who are finally sort-of starting to get the whole online
banking idea. The bigger (especially the biggest) banks, by
definition, will have trouble growing at rates like BOFI, and face
greater regulatory and management issues, just to name two limiting
factors. I'd certainly keep an eye on the run-off of the non-agency
MBS since those will likely be pretty difficult to replace, but I
like an underdog, though, a veritable David v. Goliath story, and
with BOFI, that could be exactly what we're watching.
Disclosure:
I have no positions in any stocks mentioned, and no plans to
initiate any positions within the next 72 hours.
Additional disclosure:
Stone Street Advisors' company policy is to keep the bespoke, paid
research and analysis we do for clients confidential. However in
certain circumstances - and only with a client's explicit
permission - we may share some or all of that research publicly.
The above (the analysis/article) contains some of the research we
performed for/with a client and from whom we received compensation
for so doing. The client who paid for this research has a long
position in BOFI and stands to gain if BOFI markedly increases in
price. In addition, following publication of this article, our
client may continue to hold, add or reduce its position. The
opinions presented herein are those of Stone Street Advisors LLC.
Neither Stone Street Advisors LLC nor any of its members has a
position in BOFI, nor do we have any plans to initiate one. The
information and opinion presented in this article is presented
as-is, and does not constitute any offer or solicitation. Stone
Street Advisors LLC makes no representation as to the accuracy or
completeness of the information contained herein and has no duty to
update the information and opinion in the article. The content
presented is not investment advice, nor is Stone Street Advisors
LLC a Registered Investment Advisor.
See also
6 Strong Growth, Low Debt Financial Stocks
on seekingalpha.com