BofI Holding (NYSE:AX) operates at a high net interest margin and delivers some of the best returns in the banking industry. In this clip, Michael Douglass and Matt Frankel discuss how the bank manages to do this without taking on too much risk.
A full transcript follows the video.
This video was recorded on Dec. 4, 2017.
Michael Douglass: What risk is the bank taking on to achieve those earnings? Frankly, all the rest of this is perfectly fine, but if the bank is taking on a great deal of risk to achieve what are really some pretty good numbers, then big problems are going to happen when the credit cycle turns. And the short answer here is, surprisingly little. The long answer, of course, requires a few numbers. One of the key things that we like to look at is assets over equity. This basically helps to see how highly leveraged the bank is. A bigger number is bad, because they're taking on a bunch of risk. A really small number can also be bad because it might be a sign that the bank isn't being sufficiently aggressive. BofI's right at 10, which means that the bank is theoretically about properly extended.
Matt Frankel: Sure. Another thing to look at is the percentage of non-performing assets, which is about 0.4% of the loan portfolio right now. That means people who are delinquent on their mortgage, businesses that haven't paid their loan in a couple of months, things like that. However, in BofI's case, their lifetime losses on mortgages are, I think, less than three basis points, which is 0.3%. That means that they're doing a great job of getting non-performing loans back to performing, and of evaluating credit risk in the first place. I mentioned earlier that their portfolio is primarily jumbo mortgages, which, by definition, because they're not eligible to be purchased by Fannie Mae and Freddie Mac, they're generally held to higher underwriting standards, meaning more than 20% down, high credit scores. So these, by definition, are lower-risk loans, before anything company-specific.
And the multifamily portfolio is even more impressive. The lifetime losses with that are less than one basis point, which is less than 0.1%, or virtually nothing. So the idea that they must be taking a lot of risk to achieve these returns is faulty logic.
Douglass: And one of the other things that really jumped out, this is a quote from BofI's CEO in their most recent quarter. He said, "We have not experienced losses in our C&I Lending Group since the exemption of the group." Think about that for a minute. How many bank CEOs can actually say that there is a part of their portfolio that is, let's say, more than three years old, where they haven't experienced any actual losses? It's incredible. The other thing to keep in mind is, even if a lender is appropriately conservative, one of the things they can do to game the system is decide how they're going to cover their non-performing loans. At a certain point, a lender has to write off the loan, and basically said, "We know we're not going to get this amount of money back."
Frankel: Sure. Banks put money in reserve to cover that. BofI has over 130% of their non-performing loans already covered in reserves, meaning that if all of those had to be written off, the reserves they already have in place would more than take care of it.
Douglass: Right, which is usually a sign, again, of a lender that is behaving appropriately conservatively.