Bank of the Internet (AX 0.45%) recently had to delay its fourth quarter earnings release due to the announcement of a large new acquisition. The company eventually reported earnings Tuesday, August 7, and the stock subsequently sold off in the high-single digits the next day.
But fortunately for investors, the new acquisition, which was announced just a few days prior, should go a long way toward fixing this past quarter's problems. Therefore, the recent pullback could present a compelling opportunity for long-term investors.
Buying liabilities can be good
The acquisition was actually not of a company, but rather roughly $3 billion in deposits from Nationwide Financial Services. The deposits are made up of $1 billion in low-cost checking, savings, and money market accounts, along with $2 billion in higher-interest time deposits. Nationwide has been looking to get out of the consumer banking business to focus on its insurance operations.
If you're not familiar with banking, you might be wondering why a company would pay money to acquire deposits, which are liabilities? The reason is pretty simple – these deposits cost less than Bank of the Internet's overall cost of funds. The cost of funds on the acquired deposits will be 136 basis points, compared with BOFI's current 173 basis point cost of funds.
The improvement will be even greater than the 37-point difference, however, as the new deposits will allow the company to swap out its highest-cost debt, allowing BOFI to lower its interest costs by about $25 million per year. Even better, these ongoing cost savings will likely only cost around $20 million in total, plus some added ongoing costs to service the 100,000 customers the bank is acquiring from Nationwide.
Thus, the deal is expected to be accretive to BOFI's earnings per share in the very first year.
Will this deal grow Bank of the Internet's net interest margins? Image source: Getty Images.
Fixing the flattening yield curve
Lowering interest costs is a key priority for Bank of the Internet because of rising interest rates. Banks make money by borrowing low-cost, short-term debt, and then lending out at higher rates for longer terms. The difference between short- and long-term rates is called the yield curve. The problem banks are experiencing right now is that while short-term interest rates are going up, longer-term rates are not rising as fast. That's causing the company's net interest spreads to compress:
|
Bank of the Internet (millions) |
Q4 2018 |
Q4 2017 |
|---|---|---|
|
Net Interest Income |
$118.9 |
$98.5 |
|
Interest Expense |
$31.9 |
$20.0 |
|
Pre-tax Income |
$50.4 |
$55.9 |
|
Interest Rate Spread |
3.34% |
3.55% |
|
Net Interest Margin |
3.71% |
3.80% |
Data source: Bank of the Internet Q4 2018 earnings release. Table by author.
As you can see, $25 million in annual savings -- or $6.25 million per quarter -- could reduce interest costs by roughly 20% while boosting pre-tax income over 12%, all things being equal.
The benefit from these deposits won't show up until the deal closes toward the end of this year, but the purchase seems like a steal to me.
Another positive
There were other positives surrounding the Nationwide deal as well. For instance, CEO Greg Garrabrants revealed that BOFI wasn't even the highest bidder:
"...frankly when Nationwide came out and looked at what we were doing from a technology perspective, that was in my view the determining factor in us being awarded the transaction. We weren't the highest priced and their concern was, how are you going to do this list of 15 things in your platform, and we were able to deliver those things because we simply could have our team put them in."
The fact that Bank of the Internet was awarded the deposits without being the highest bidder bodes well for the future. Smaller banks like Bank of the Internet are constantly in a battle for good deposits and customers, much more so than bigger banks. So, if Bank of the Internet can win an acquisition due to a best-in-class customer experience, it's not a stretch to think it may win more customer deposits in the future as well.
Nationwide is also the second non-bank partner that has chosen to work with Bank of the Internet. The other is H&R Block (HRB 0.78%), which sold deposits to Bank of the Internet in 2015 and still works closely with BOFI on Refund Advance Loans. In fact, BOFI management also announced a renewal of its agreement with H&R Block on the recent call.
Short term vs. long term
Just like other banks, Bank of the Internet is experiencing challenges with the flattening yield curve; however, the recent Nationwide execution should help fix the problem by next year, and the closing is another great sign that the Bank's technology platform is winning over partners and customers alike.
