Industry Focus: Financials edition host Michael Douglass and contributor Matt Frankel take a close look at two major news items. First, cryptocurrencies have performed terribly so far in 2018, and they explore possible reasons why. Then, two of our favorite smaller bank stocks just reported earnings, and there could be new reasons to get excited about those financial institutions.

A full transcript follows the video.

This video was recorded on Feb. 5, 2018.

Michael Douglass: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. It's Monday, Feb. 5. We're talking through a news round-up: cryptocurrency volatility and earnings for a pair of smaller banks. I'm your host, Michael Douglass, and I'm joined by Matt Frankel. Matt, thanks for joining us!

Matt Frankel: Always fun to be here!

Douglass: Awesome! Before we get into things, I should note, because it might actually matter for some of the numbers we're talking about, we're actually pre-recording this episode on Friday, Feb. 2. We're talking about cryptocurrency prices as they are as of when we're recording, which, of course, if you know anything about cryptocurrency volatility, could be wildly out of date by Monday. [laughs] So, any numbers we mention, just keep that in mind. 

Let's head to our headlines story. Bitcoin plunged below $8,000 this morning, bottoming out around $7,900. It's actually up to about $8,600 as of right now. Still, it's down over 30% this year. And it's not the only one. A number of other cryptocurrencies are, too. Ripple is down around 50% year to date. Bitcoin Cash, upper 40s, around 50%. And a number of others are really underperforming after a lot of investor excitement in January. So, let's hop into the why.

Unlike a fair amount of the time when there's volatility around things and you're like, "Why is this?" there are actually some legitimate reasons, and some legitimate concerns, I think, for people who are really interested in cryptocurrencies. I think for me, the most salient one was Facebook banning advertisements related to cryptocurrencies and initial coin offerings.

Frankel: Yeah. I think that's definitely going to hit what I would call the lower, less mainstream end of the market. Not necessarily bitcoin and the big ones. First of all, the fact that you had to give that disclaimer kind of tells the audience everything they need to know about bitcoin volatility.

Douglass: [laughs] Yes.

Frankel: A little side note: when I wrote the notes for this episode, about two hours ago, bitcoin had rebounded to a little over $9,100, and now it's about $8,700, in just a little over an hour. This is some pretty big volatility, in addition to declines. Declines are one thing, but Ripple, for example, doubled the first two days of the year, and then lost 50% from its Jan. 1 price. So, these are some big swings we're talking about.

Douglass: Yes. And I'll say on the Facebook piece, it's not necessarily the most important piece of news, particularly for, as you noted, these big, major cryptocurrencies, ones that we all heard of like bitcoin and Ripple. But my feed had become completely inundated with advertisements around cryptocurrencies. For whatever reason, the algorithms had decided that I was the person who was going to buy into all this stuff. So, I just have to say, I'm much happier with the advertisements I'm being served today, even though I'm still not acting on them, any of them, just to be clear.

Frankel: That's probably a good idea. [laughs] Another thing that could affect that end of the market is, the SEC, which has been warning investors for months about these initial coin offerings and smaller cryptocurrencies, they recently stepped in and put a stop to what would probably be the biggest initial coin offering so far. Something called Arise Bank -- it's a bank based in Dallas -- was about to do an ICO. They raised $600 million pretty much on false pretenses, it seems like. They told investors that they had acquired an FDIC insured bank, which wasn't true. So that gave investors some jitters, understandably. 

The other big theme going on this year is regulatory concerns. Not so much here in America. The government here has been pretty straightforward about what they think of cryptocurrencies -- they consider them capital assets, exchanges have to follow certain rules if they want to sell them. In general, we know what's what. South Korea has been a big story. They're, I think, the No. 3 bitcoin market in the world, behind Japan and us. South Korea, this saga has been going on all year. At first, they were saying they're going to try to ban cryptocurrency trading altogether. Then they backed off from that. Now they're just planning to take some steps to prevent money laundering and things like that. Making people trade cryptocurrencies under their real names is the big one they just implemented. And India, just recently -- which is another pretty big bitcoin market, about 10% of crypto volume comes from India -- just announced similar things, that bitcoin is all for money launderers and they're going to do what they can to keep it out of their system, etc. So these regulatory fears are really causing investors to take a step back. The price of bitcoin, the speculative interest, is not just in America. We're actually less than half of it. It's all these other markets around the world that we don't know what's their governments are going to do yet that is spooking investors.

Douglass: The other piece that's worth mentioning as well, I would argue it's been more of a story in 2016 and 2017 because we're only a month into 2018, but there was a big crypto exchange hack as well, recently. Of course, hacking has been an issue that we've seen -- there was the OPM hack, there were hacks with a variety of different health insurance companies and hospitals, and Yahoo, there's been a lot of hacking going on. And the biggest crypto exchange hack recently occurred, about $600 million worth of NEM coins were taken. That also makes a big difference.

Frankel: And it's kind of worth noting with that that they weren't really following protocol. Generally, when you have that much of any cryptocurrency, the thing you're supposed to do is not store it online, and theirs were in what's called a hot wallet, which is a wallet that's linked to the internet. For example, Coinbase's billions of dollars in bitcoin are not stored online, so they're not really vulnerable to hacking. But in this case, the coins were, and somebody got smart and took them.

Douglass: Yeah. Bottom line: When approaching cryptocurrencies, I think in general -- and this is personally my stance on investing in currencies in general -- is that it's best to steer clear, particularly when they are this volatile. I tend to favor investments where there's a business that I can theoretically, at least, understand, and that business is generating profits, or hopefully, at least, revenue, that I can then model out and figure out what the opportunity looks like. Generally speaking, I think, if you do believe that there's going to be a lot of money to be made in cryptocurrencies, there's plenty of time for that to happen when a lot of these bigger-picture questions about them have been better sorted out.

Frankel: I completely agree. I bought some bitcoin in the past, just small amounts just to kind of learn how it worked, but I couldn't see myself putting more than $20 or $30 into it at a time. It just, it could be worth half of what it is today, or it could be worth double within a day. So, it's buyer beware.

Douglass: Indeed. With that, let's turn to a couple of other news items. Two -- small is a relative term, I suppose, but, smaller -- banks reported earnings, and we figured we'd hop into those. The first is New York Community Bancorp (NYSE:NYCB). This one, New York Community Bancorp has long been a bank that people like, particularly because it has a nearly 5% dividend yield. And frankly, I thought earnings looked pretty good.

Frankel: Yeah, they had a very good quarter. Loans were up 9% year over year, their earnings were up 20%, they actually got a benefit from tax reform, whereas most banks took a big hit. And they clarified their optimism that the key regulatory threshold where a bank become what's called a SIFI, a systemically important financial institution, there's a bill that's going to be voted on that would raise it from $50 billion in assets, which, New York Community Bank is at $49.1 billion, all the way up to $250 billion, which would pretty much get that concern out of the picture for them. Before they were close to the limit, they had an efficiency ratio of about 36%, which is remarkable for a bank. Internet banks generally don't even get that good. And now they're in the 50% range. So, if this passes, it could definitely be a big catalyst going forward. And the fact that the bank seems so optimistic about it, I think investors are definitely taking it as a good sign.

Douglass: Yes. And one of the key things we should mention here is, when a bank becomes a SIFI, it triggers a great deal of additional regulatory oversight and compliance. And that costs money and time and effort. New York Community Bancorp, one of the reasons their dividend yield is so high is because they've been deliberately trying to find ways to stay under that $50 billion threshold. So, if the threshold does increase, then suddenly they can take the brakes off of their growth, and continue to reinvest more cash into the business, hopefully give out more loans, all that sort of stuff, so that they can then continue to grow up toward whatever their natural number is. Which is probably not as big as $250 billion, but probably bigger than $50 billion.

Frankel: It's worth mentioning that banks have been on fire over the past year and a half.

Douglass: Oh, yeah.

Frankel: Bank of America (NYSE:BAC) more than doubled in price. New York Community has gotten crushed. And one of the biggest reasons is uncertainty about the bank's future. When will they go over the $50 billion cap, what will it mean, is it going to be through an acquisition, is it just going to happen naturally and blindside investors? The big theme here is that some of these questions are finally starting to be answered. And the answer is the best possible scenario, that it might not matter at all.

Douglass: Yeah. A lot of good stuff there. I think, personally, New York Community Bancorp is one of the few smaller banks that I would really consider investing in personally.

Frankel: Yeah, it's one of the few that are actually in my portfolio. I have Bank of America and that one.

Douglass: Nice. And Bank of America is not quite as small. [laughs] 

Frankel: No, that's why we say, "relatively small." Compared to Bank of America ...

Douglass: It's tiny.

Frankel: ... it's 2% of its size. But, $50 billion of assets is not a tiny bank.

Douglass: Right. What's a few billion dollars between friends? Let's turn to our second smaller bank story. This is Bank of Internet, or BofI. Of course, listeners will know we've talked a lot about BofI. We did a deep dive on them late last year. If you haven't heard that, it's a great chance to understand how we think through banks of this size. When you look at BofI, just, pretty across the board a stellar quarter. Loan portfolio up 19%. Earnings per share actually declined a little bit, but that's because of tax reform. Again, for most banks, they had to take a write down on their earnings from tax reform, one time. But if you net out tax reform, earnings per share were up 22% year over year. 12% deposit growth, 9% asset growth. It's hard to overstate how quickly that bank is growing.

Frankel: Their profitability was incredible this quarter, too. To give you an idea, last year, BofI ran a 17.5% return on equity, which is ...

Douglass: Stellar.

Frankel: Yeah. And they beat that this quarter, 18.5% excluding the tax reform. So, their profitability has been fantastic. They started a share buyback, which shows that they're getting on really good financial footing. It's also worth mentioning that BofI is, in every sense, a smaller bank. They're only at about $9 billion worth of assets. So, this growth could conceivably continue for a long time.

Douglass: That ROE number, I want to circle that one more time. Consider that, for banks, a solid ROE is 10% and a great ROE is 12%. We're talking 18.5%. Return on assets of just under 2%. That's just incredible. Of course, the key question we always ask when we're seeing a bank growing really quickly is, but what's the risk? Basically, are they really aggressively giving out loans? And is that going to really hurt them when the tide goes out? Their non-performing loan rate is 0.42%, compared to the peer average which is almost exactly double that at 0.82%. And historically speaking, at least -- of course, we can't speak to the credit culture today as compared to during the Great Recession, but they dramatically outperformed just about everybody else in non-performing loans during the Great Recession. So, I think in general, it's a pretty good look for the bank.

Frankel: And they also gave some pretty optimistic figures for projections going forward. In addition to that ROE number that you highlighted again, which was definitely worth doing ...

Douglass: It was big, right?

Frankel: It is. They say now, because of tax reform, they're expecting to run at an 18% ROE going forward, and a 40% efficiency ratio, which I already mentioned is stellar. They're a big beneficiary of tax reform. They're one of the highest effective tax rates in the banking industry, pretty much because they're based in California, where there's lots of state taxes. So, they're expecting their effective tax rate going forward to drop from the 41% to 42% range to 28% to 30%, which will make a big difference for profitability.

Douglass: And particularly because -- when you look at BofI, they're running about a 40% efficiency ratio these days. Remember, we were talking about New York Community Bancorp just a minute ago running a 36% efficiency ratio --

Frankel: Yeah, before Dodd-Frank.

Douglass: Right, so, back in 2010. But BofI's efficiency ratio has been creeping up a little bit in the past couple of years as they've begun really investing in growth. So, that lower tax rate then basically gives them some extra cushion to continue doing that. For me, one of the things that really makes BofI currently the only true bank that I hold in my portfolio is that its efficiency ratio is so low. Of course, when I see it creeping up, that makes me a little bit concerned, unless you buy, as I do, that this is really management investing in technology and investing in people, to basically make sure that they can continue building that growth in a variety of different areas. If that's the case, then this bank has a long way to go.

Frankel: Yeah. Like I said, even though it's grown exponentially over the past five or six years, it's still a very small bank. There's a lot of room to grow, especially as interest rates rise. These online banks tend to pass on the savings more to their customers than branch-based banks. BofI is already offering some amazing savings rates when compared to a Wells Fargo or a Bank of America. So, I could see their deposit base growing significantly as interest rates continue to rise.

Douglass: Yeah. And for fairly traditional banks like New York Community Bancorp and BofI, interest rates are going to be the name of the game in terms of expanding those margins in the coming years. And frankly, in general, the banking sector looks poised to have at least a good couple of years, assuming that the Fed continues raising interest rates, which assumes, of course, that the economy continues to do well, and as tax reform continues to take hold. So, a lot of good things to like in both of these earnings reports, and definitely stocks we'll be checking in on in the future.

Folks, that's it for this week's Financials show. Questions, comments, you can always reach us at As always, people on the program may have interests in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. The Motley Fool does not recommend any cryptocurrencies. People on the show may or may not have positions in any cryptocurrencies mentioned, so also keep that in mind and check public disclosures on This show is produced by Austin Morgan. For Matt Frankel, I'm Michael Douglass. Thanks for listening and Fool on!

Matthew Frankel owns shares of Bank of America and New York Community Bancorp. Michael Douglass owns shares of BofI Holding and Facebook. The Motley Fool owns shares of and recommends BofI Holding and Facebook. The Motley Fool has the following options: short March 2018 $200 calls on Facebook and long March 2018 $170 puts on Facebook. The Motley Fool has a disclosure policy.