BofI Holding (NYSE:AX), the company behind BofI Federal Bank, is not one of the better-known U.S. banks, but they have one of the most innovative business models in the industry. Specifically, the company's completely Internet-based operation lets them cut costs and offer more attractive products than the competition. How can BofI's larger rivals like Bank of America (NYSE:BAC) learn from this and use it to their advantage?
What BofI does
BofI (which stands for Bank of Internet) provides banking and lending services to U.S. customers, just like most other banks. The company offers checking and savings accounts, business banking, mortgage lending, commercial loans, and more.
However, the one big difference is that BofI does not have branches. In fact, the entire company's operations take place in a single location. Instead, BofI is a true "Internet bank", accomplishing the vast majority of its business online.
The concept of branchless banking is nothing new, but technology seems to have finally advanced to the point where online banking services are practical and scalable enough to replace bricks-and-mortar banks for many people.
Because BofI doesn't have the operating costs associated with operating a branch network, not only is the company able to trim its expenses, but it can afford to offer products which are much more attractive than those offered by the competition. The interest rates on deposit accounts are among the highest available, and the bank's loan rates are some of the lowest.
For example, BofI's personal savings account offers 0.61% interest. This doesn't sound like much, but when you consider Bank of America's savings accounts currently pay 0.01%, it looks like an astronomically better option.
Does it work? The proof is in the numbers
According to the company's latest investor presentation, BofI's business model is creating excellent growth. In fact, the bank's deposits have grown nearly 35% in the past year and the loan portfolio has done even better, growing by more than 41% year-over-year.
So, the company grows because of its attractive products and services, and its low overhead lets it handily outperform peers. Banks average 1.53% of their assets in salary and benefit expenses each year, while BofI spends less than half of that amount. The same is true for premises and equipment costs, which cost BofI just 0.15% of assets, as compared with 0.38% for the banking sector.
As a result, BofI's return on equity is better than 94% of its peers, and it operates at a better efficiency ratio than 98% of other banks. The bank's core business margin (net interest income minus all expenses) is about 2.4% of assets, while the average bank operates at a margin of just 0.3%.
How the big banks could adapt for the future
Now, there will always be some place in the market for branch-based services. For example, you can't open a safe deposit box entirely online, and there are some transactions that are just easier to complete when dealing with an actual human being.
However, I believe that over time some of the big banks will begin to transition their operations away from bricks-and-mortar banks and toward online-only services, if only to stay competitive with banks like BofI.
Sure, BofI's $3.8 billion in assets is not even comparable to Bank of America's $2.15 trillion, but if it keeps growing at a 30-40% annual rate like we've been seeing, it's only a matter of time before the big banks take notice and start paying attention.
Bank of America actually earns a little more than the average bank, and its 2014 consensus earnings of $0.92 per share represents about 0.45% of its total assets. However, bear in mind that BofI operates at a margin of 2.4%.
So, if Bank of America were to consolidate some of its physical operations, and over the next decade or so achieves half the profit margin of BofI (1.2%), it would translate to earnings per share of nearly $2.50, or almost three times the bank's current profitability.
It's only a matter of time before Bank of America and the other big banks begin to take notice and try to capitalize on this very successful business model.