Anyone who has been following Bank of the Internet (NASDAQ:BOFI) knows the stock has been under attack for three years thanks to a former employee lawsuit and short-seller attacks. Still, the company recorded what I believe to be a very solid quarter. Mr. Market did not agree, sending the shares down 10% after earnings. Let's dig in to see if there's anything to worry about.
1. Profitable growth
The company's growth was strong, with net income at 14.1% year over year, although that marked a deceleration from previous high-growth years when the company was smaller. Net interest margin -- excluding the impact from the seasonal H&R Block loan product -- was at 3.97%, which is the high end of the proposed range of 3.8% to 4%, and up from 3.85% in the year-ago quarter.
Return on equity was 21.1%, solidly above the long-term target, though down from the previous year. The return on equity may have been diminished due to the excess equity the company held, as the company's equity to assets ratio increase from 8.48% to 9.2% in the current quarter.
To me, it seems the company is being thoughtful and conservative about its growth and is maintaining its discipline with low loan-to-value ratios, good credits, and a deliberate roll-out of new products. Hence, higher equity ratios, lower growth, but more profitability.
Two other instances shed light on this. One, the company only has $3.4 million outstanding in its refund advance portfolio. The company is reserving all $3.4 million on its balance sheet, which means it is already accounting for the $3.4 million not being paid. Two, the company said it was actually turning away C&I loans because they didn't have the capacity to service all of the demand in that segment.
2. C&I was up big and could be the new star segment
The commercial and industrial segment, which was helped by the Pac West acquisition from April 2016, could be the new star. The company grew its book of commercial and industrial loans by $437 million in the quarter -- which is far more than the $228 million the company generated in its single-family jumbo loans, the core earnings engine for years.
The C&I segment has grown to almost 20% of the loan book and is growing at a much higher rate. C&I loans have a higher interest rates than other categories and are mostly floating rate, which sets the company up favorably for a rising rate environment. CFO Andy Micheletti said that looking out six quarters, C&I will be a lot bigger than it is now, which should help the bottom line.
3. The company raised rates
Following the Federal Reserve rate hikes, the company saw "more rational pricing" of its multifamily portfolio, which had lagged behind the single-family portfolio last year. The company raised rates on these loans by 25 to 50 basis points. For its core single-family loans, the company raised rates by an average of 25 basis points. Basically, the company was able to raise rates with not much let-up in its pipeline.
At the same time, the company's costs of deposits stayed relatively flat thanks to an increasing proportion of savings and checking accounts. Checking and savings grew 22.7%, which was faster than the 11.4% experienced by total deposits. CDs, which are higher-interest instruments that previously made up a majority of deposits in prior years, are now only 12% of total deposits. The cost of deposits are only 59 basis points, down from the December quarter, though up seven basis points year over year thanks to rising rates.
4. Future initiatives and cost savings
The company continues to invest in future growth seeds, such as the Universal Digital Bank, which will incorporate in-house loan applications, personal loans, and third-party APIs. The company is also incubating auto and personal unsecured loans, which have been pioneered by companies like Lending Club and also Goldman Sachs. However, Micheletti said, "slow for us on new products means slow." Unsecured personal loans only totaled $1 million in the quarter, but the company is very carefully growing out this new product.
The company is also opening a new office in Las Vegas, Nevada, which should lower its overall labor costs and tax rate in the long run.
Summing it up
Bank of Internet delivered a solid quarter. While growth decelerated from prior years, it was still solid, and I think the company is being conservative by not chasing growth at the expense of profitability. The company is also taking its time incubating new business lines internally.
The company's main competitive advantages of being a branch-less bank and finding profitable lending niches remains intact. At less than 12 times trailing earnings and under two times book value, the company remains a compelling value, assuming, of course, that the short-seller and employee lawsuits come to nothing.