Internet-only bank BofI Holding, Inc. (NASDAQ:AX) reported its third-quarter fiscal 2018 earnings after market close on April 26, delivering a solid 27% increase in earnings per share. Book value per share increased 16.5% in the quarter, spurred higher by 15% growth of its loan portfolio. Deposits also grew an impressive total, up 17% in the quarter, providing BofI with the necessary cash to fund its loan growth.
However, the source of that growth was time deposits, not increased balances in checking and savings accounts. This bears watching closely, since time deposits -- primarily certificates of deposit (CDs) -- carry much higher interest expenses and generally are less "sticky" sources of funding. BofI also continued its recent trend of higher operating expenses as it builds out its internal systems and staffing to continue driving growth across multiple lending and business lines.
Let's take a closer look at what's going on at BofI following its latest earnings release, particularly the items investors may want to pay closest attention to going forward.
A big partnership delivered solid growth for BofI
Here's how BofI compared this quarter to the same period last year:
|Metric||Q3 2018||Q3 2017||Change (YoY)|
|Net income attributable to shareholders||$51.2||$40.9||25.1%|
|Net interest income||$116.7||$88.6||31.8%|
|Net non-interest income||$23.5||$23.2||1.5%|
|Earnings per share||$0.80||$0.63||27%|
|Tangible book value per share||$14.5||$12.4||16.5%|
|Return on assets||2.1%||1.9%||7.2%|
|Return on equity||22.8%||21.1%||8.2%|
With the exception of its efficiency ratio, which measures the percentage of revenues that go toward operating expense (reflected on the earnings statement as non-interest expenses), BofI essentially improved all of the key metrics that measure its profitability and growth.
BofI's loan and lease portfolio increased $1 billion, 14.9% higher year over year. A significant portion of that increase was a product of the company's continued partnership with H&R Block Inc. BofI was the exclusive originator of H&R Block "Refund Advance" tax return loans this tax season, which provided a big boost to loan profitability and represented more than 40% of BofI's loan growth in the quarter. Net interest margin was 4.77%, up from 4.24% last year and 4% in the sequential quarter.
Average yield on the loan portfolio was sharply higher, coming in at 6.61% compared to 5.72% year over year and 5.38% sequentially. This was almost entirely due to the high yields paid on the Refund Advance loans, which give a seasonal boost during tax season.
Here's why deposit expenses increased notably (and why it matters)
While most of the metrics looked great for BofI this quarter, there was one thing that stood out in the 10-Q SEC filing: a sharp increase in time deposits (primarily one-year CDs). The company touted a 17.1% increase in deposits in the quarter. Deposits are the best source of funding for a commercial bank like BofI since it's generally the cheapest source of capital for lending. But all deposits are not created equally, and time deposits are the most expensive and hardest-to-retain source of new deposit capital.
BofI's interest-bearing demand (mainly checking) and savings balances actually declined in the quarter, from $4.8 billion last year to $4.73 billion, and decreased even more from the prior quarter, when average balances were almost $5 billion. Average time deposits were $1.1 billion, up 23% year over year and almost 29% sequentially.
Here's why that's a less-than-ideal source of new capital: BofI paid 1.18% average interest on checking/savings accounts versus 2.51% on time deposits. In other words, it cost more than twice as much to secure capital via time deposits than checking/savings.
Furthermore, there's more deposit loss risk. BofI finished the quarter with $1.5 billion in time deposits on its balance sheet and almost $700 million of that matures within 12 months. Checking and savings accounts generally see less customer churn than CDs -- especially short-term ones. Due to the possibility that interest rates will increase multiple times over the next year, BofI almost certainly will have to increase the rate it pays to retain these deposits at a far higher rate than it increases the payout to checking/savings customers.
Unless BofI is able to increase savings and checking deposits to offset time deposit balances, its interest expenses -- as a percentage of total dollars -- are almost certain to increase over the next year if it aims to retain these CD customers. Yes, it also will benefit from higher rates in its lending, but remember that the capital from its existing deposits has already been lent, and most likely at fixed rates.
The bottom line here: I think it's too early to call this a problem for BofI, particularly with its strong history of checking and savings balance growth over the long term. But it's definitely something investors should monitor, particularly in the current rising-rate environment.
Continued investment in the future
BofI's non-interest expense -- operating expenses -- increased 28% in the quarter, to $45.4 million, an acceleration from the 22% increase through the first three quarters of the fiscal year. This higher spending is a continuation of BofI's growth strategy, with most of the increases coming from wages, technology, and marketing investments as it expands its capacity in auto, commercial and industrial, and business-equipment lending. BofI also has invested substantial resources into its online and app-based platform, which management expects will support better cross-selling of its various deposit, lending, and business-services offerings to customers.
The company also discussed several ways it expects to grow its low-cost deposits in the future, as well as generate higher fees and interest income.
BofI acquired the bankruptcy trustee and fiduciary services business from Epiq in early April after the end of the quarter. The company will initially service approximately $1 billion in deposits held at other financial institutions and generate about $10 million in fee income during the first year. And as existing deposit contracts with other financial institutions expire, BofI will begin taking on those deposits and generate higher income than the current fees.
On the earnings call, CEO Greg Garrabrants also spoke at length about growing the treasury management business. BofI has recently made several key senior management hires in this area, and it sounds like this should be a key source of low-cost deposit growth and fee-based income in the future.
BofI continues to deliver strong growth but also is diversifying its risks and opportunities across multiple business lines. Real estate lending remains its biggest source of income -- and largest risk in its portfolio -- but management isn't just standing pat, as the multiple investments in technology and industry expertise in its people demonstrates.
At the same time, investors would do well to continue monitoring BofI's deposit growth -- and particularly where it's coming from. While a single spike in time deposits isn't a bad thing, it's far better for the bank to grow other more easily obtainable and lower cost sources of capital.
As things stand today, this is simply a short-term "pay attention" area. Hopefully, management can return the bank to its long-term growth of cheap funding to drive its high-quality lending growth.