The online revolution has touched nearly every form of commerce, including banking. As most of us are aware by now, it's possible to conduct business with our financial institution of choice almost exclusively from a PC, tablet, or phone.
One of the more prominent online-only lenders is BofI Holding (NYSE:AX), the company behind the aptly named Bank of Internet; another is Ally Financial (NYSE:ALLY). The two have quite a bit in common, yet also differ in major ways. Here's why I feel one of them is a better potential investment.
A digital dynamo
Aside from being online-only, BofI Holding is a traditional bank in many respects. It holds deposits, and is a busy and active lender. It's particularly active in mortgages, which comprised the bulk of its loan book in the most recently reported quarter (Q2 of fiscal 2018).
In that same quarter, the fast-growing bank managed to increase total loans by almost 16% on a year-over-year basis. Meanwhile deposits from customers -- lured by that rarity in the banking industry these days, an interest-paying account -- rose by 12% to nearly $783 million.
BofI Holding can afford to pay out interest on its deposits because as an online-only bank it's a relatively lean enterprise. It has a much lower efficiency ratio (barely above 40%; lower is better) than a typical American big bank, which tends to fall into the 50% to 60% range.
This also helps explain BofI's wide margins. In Q2 it booked an adjusted net profit of just under $40 million, on total revenue of $101 million, for a margin of 39%; the previous three quarters ranged between 34% and 37%.
Cost efficiencies aren't the only factor driving its growth and profitability. It's actually quite a prudent lender, with a net charge-off ratio that was a wafer-thin 0.03% in Q2.
There are some areas of concern with BofI Holding, chiefly that its loan portfolio is still rather one-dimensional. It's neck-deep in real estate lending, which formed nearly 80% of the loan book in Q2. The property market isn't going to go up forever, and though the company is succeeding in efforts to diversify its lending, that figure remains high.
Like BofI Holding, Ally Financial serves its clients exclusively online. Also akin to its peer, it has a loan book concentrated in a particular segment -- in Ally's case, auto loans and leases. That's a legacy business inherited from Ally's predecessor, which grew to prominence as GMAC, the mighty financing arm of carmaker General Motors.
That concentration isn't necessarily a bad thing, as auto sales are still relatively healthy, and such loans generally carry higher interest rates (according to Bankrate.com, a three-year loan costs a borrower nearly 5%; these days, 30-year fixed mortgages are in the vicinity of 4.25%). Car loans are, however, riskier. This is reflected in Ally Financial's Q4 net charge-off rate of slightly over 1%, well above that of its rival and fairly high for the broader U.S. banking sector.
Still, Ally has managed to be profitable lately, for the most part, and it's growing. For the entirety of the bank's fiscal 2017, it managed to increase total revenue by 6% to $5.8 billion, with "core" (adjusted) net income clocking a 5% gain to land at almost $1.1 billion.
These growth figures aren't as hot as those of BofI Holding, but that's to be expected. Ally is a well-established company with roots going back many decades; as a result, it's a much larger company in terms of assets and personnel, and thus more expensive to fund and run. That's a major reason why its efficiency ratio is higher (at a shade under 49%), and its margins typically lower.
This likely also puts a cap on the interest rates it can offer on deposits, which trounce those of most banks, but fall short of BofI Holdings' generosity.
These are two banks on the move. Ally is making a BofI Holdings-like push into diversification; apparently it's preparing a marketing assault for a slate of offerings that includes mortgages, credit cards, and investment services. That's going to take money and time, so I wouldn't expect great leaps in profitability.
BofI Holding, I feel, has much stronger momentum behind it, and more opportunity ahead. Those high interest rates on deposits should hold current customers and attract new ones, giving the company plenty of scope to keep expanding the loan book. I also like that it's maintaining good credit discipline -- no easy feat for a bank growing at this pace.
I like both of these companies. They are managed sensibly, and are being guided in the direction of higher growth. But I believe the more explosive of the two will be BofI Holding, so that's my selection in this contest.