Banking is one of the most important and necessary industries there is. It has also proved to be a treacherous place to invest. Banks are highly leveraged and have nearly direct exposure to the economy, making them very susceptible to big losses when the economy goes into the eventual and unavoidable recession every so often. History is also littered with both major and minor banking crises that have seen plenty of banks fall victim to bad risk management at the wrong time and wiped out shareholders.
But the best-run banks have proved to be some of the best long-term investments, generating life-changing returns for investors who invest and hold through good and bad times. BofI Holding, Inc. (NYSE:AX) is set to potentially be one of those rare, life-changing investments. Keep reading to learn why the best is yet to come for BofI Holding, and for its investors.
BofI's business model is a big competitive advantage today
If you're like most people, you've found yourself needing to go to a local bank branch less and less in recent years. For most traditional commercial banks, this development means a lot of expense to staff and operate retail branches that generate fewer and fewer new customers and sales of new financial products. And this situation, in turn, has already led some of the biggest banks to reduce the number of branches they operate. Bank of America (NYSE:BAC) ended the second quarter of 2017 with 139 fewer branches than one year before, and 4,000 fewer employees. Wells Fargo (NYSE:WFC) said it closed 54 branches in the second quarter of 2017 alone.
And this is a trend that's certain to continue as more and more people shift to the convenience of online banking and find themselves needing to use their local bank branch less and less.
BofI Holding is already there. The holding company behind Bank of Internet USA, which touts itself as America's oldest online bank, BofI Holding sees enormous financial benefit to operating without retail branches. This slide from a recent company presentation breaks down just how much lower its operating costs are versus its similar-sized peers:
BofI spends about half as much -- as a percentage of assets -- on operating expenses as the average bank with between $1 billion and $10 billion in assets. This difference, combined with a higher net interest income percentage, makes BofI about five times as profitable in core business margin as the average peer.
The big difference? Its peers operate those expensive retail banking centers, while BofI doesn't.
It's not just the branchless model -- it's also a great lender
If BofI's only competitive advantage were its lower operating costs, I probably wouldn't be quite so convinced that its future was great. After all, as time passes, traditional banks will adjust, closing branches and driving down their costs, too. Furthermore, having a "better" model doesn't really address the biggest risk for banking that's caused the most harm to investors over the years: higher-risk lending practices.
Banks are heavily leveraged, generally lending out 10 times as many assets as they have on hand. This practice isn't a problem when the economy is strong, customers are making their loan payments on time, and depositors are putting more money in their accounts. But when the economy struggles, banks that have taken on more risk in their loan portfolios can see big profits evaporate and become even bigger losses very quickly. In the worst-case scenario, as we saw during the financial crisis, banks can get wiped out if depositors make a run on the bank, withdrawing more cash than the bank can afford to give back.
BofI, so far, has proved to be a solid, high-quality lender. Last year, BofI's non-performing loans and leases made up 0.38% of assets, compared with 0.78% for Bank of America and 1.03% of total assets for Wells Fargo in their most-recent financial periods.
BofI is also investing in expanding its lending across multiple lines. Not only will doing so help to diversify its lending away from its current heavy exposure to residential real estate, but it will also provide more avenues for growth. In recent years, the bank has expanded its auto lending, business equipment leasing, and commercial and industrial lending, and has entered into a major partnership with H&R Block to provide tax refund loans and other services for H&R Block customers.
A well-run bank with big advantages over its peers
Add it all up, and there's a lot to like about BofI. Not only does its business model make it far cheaper to run and more profitable than its traditional banking peers, but -- and this is probably more important -- its lending practices have also proved to be conservative, which should make a huge difference when the next inevitable economic downturn or banking crisis occurs.
In other words, it's a combination of wonderful long-term prospects to deliver major upside, but also a management team that's been conservative with lending practices, even as it expands its lending across multiple lines. This combination puts BofI's best days ahead of it.
Jason Hall owns shares of Bank of America and BofI Holding and has the following options: long January 2018 $30 calls on BofI Holding. The Motley Fool owns shares of and recommends BofI Holding. The Motley Fool has a disclosure policy.