Month: December 2017

Why I Sold Bank of Internet (BOFI)

Why I Sold Bank of Internet (BOFI)

Selling a stock is often the hardest decision but BOFI has been a real lesson in my purchase decisions and diligence levels – I should never have bought it. After much soul searching, I discovered that I was misled by my own idealisms of the bank. I wanted it to be something it’s not and actually, I now think Bank of Internet could be in real trouble in the medium term.

Image result for bofi logo

Sound initial investment thesis

BOFI provides consumer banking services, focusing on gathering retail deposits over the Internet and originating and purchasing multifamily, single-family and home equity mortgage loans and, more recently, vehicle loans.

Because of its online-only business model (which I do believe is the future of banking) it earns high returns on its assets (ROA) in the region of 1.65%. The St. Louis Federal Reserve provides data on US bank ROAs, which, since the data started in 1984, have generally hovered around or just above 1%. A small increase in the ROA of a bank can drive large increases in Returns on Equity. 1.65% is extraordinary.

All of the above coupled with the fact that it’s a relatively small bank with a fast-growing asset base meant that I saw it as an undervalued and underappreciated asset. My formula was quite simple – greater efficiencies means BOFI offers higher interest rates to customers which results in increased deposits and more loan underwriting which drives higher profits.

After doing my usual quantitative analysis I decided to invest.

Re-evaluating BOFI with new tools

By not constantly checking and testing your investment thesis then mistakes will eventually erode your returns. Recently, I’ve been applying a new qualitative lens to evaluate my stock holdings – cutting through opacity.

Nassim Taleb’s book, Antifragile, really drove my desire to re-assess BOFI. It states that it’s important to derive as much comfort as possible when confronted with opaque industries.

Banking is certainly one of the opaquest and it, rather unfortunately, entices greed and short-term thinking. A respected institute such as Wells Fargo has created the latest scandal, and this harks back to the 80’s when Solomon Brothers created a similar humiliation for Buffett.

Taleb claims that no one is more aware of the risks around a company than the people who build it. They are as invested in the success of the company as you are – if anything they are more exposed, so it pays to listen to their criticism.

There is also another and more important stakeholder to asses in my opinion – the customer. Disgruntled employees but a great product means that management is poor, this could be rectified with time. Both employees and customers viewing the firm negatively is a definite cause for concern.

Honest stakeholder reviews

Let’s go ahead and look at both stakeholder’s opinions.

Here are some of the google customer reviews below. It’s surprising that they have received only 2 stars overall. Read them all here.

“By far the most miserable banking experience I have ever had in my life. The online banking UI is a complete nightmare. Ironic, because B of I advertise itself has being entirely online without the hassle of needing to go in-person for your banking needs. It takes the team literally months to resolve any issue–and there are issues aplenty, because, again, the online platform is practically useless. Save yourself a major headache and go with a competent bank.”

“This bank is tanking fast. Imagine calling a bank of this magnitude’s technical support line because of a glitch in their online banking. The phone rings, rings, rings, about ten minutes later, voicemail. Try it again, same thing.”

“The online banking access is horrible. If you don’t log in every 90 days you can’t access your account and calling customer service is an exercise in futility.”

It was certainly a sobering development to my personal conception of BOFI. I then decided to read some of the Glassdoor reviews by employees here where it holds 2.7 stars out of 5 overall – this hasn’t changed since 2015.

“New company that doesn’t have everything in order to run as a successful business. No policies or procedures so there was a lot of risk for errors and usually no accountability. Two years since I left so everything could be getting better but if the same management is in place I seriously doubt it.”

“For an internet bank that has been in business 17 years, it is odd that it is not current with the times; astounding really. A lot of things are shrugged off instead of acted upon.”

Whilst the CEO and annual reports may gloss over and even ignore these issues – there is no papering over the cracks of honest online reviews. It’s like the clouds of opacity were lifted and I saw the real beast below.

Idealism vs Realism

Motley Fool compared BOFI with other banks as follows: “One’s a 21st century online-only lender. The other’s a classic bricks-and-mortar incumbent”. Well, perhaps I was the fool in building my investment thesis off the back of that hugely simplistic contrast. The narrative I had created in my mind was a fallacy. I ignored the cold hard facts and was sold on an ideal.

The cold hard facts, in my humble opinion, are that BOFI’s incredible ratios are driven by its lack of investment in its technology, platform and customer service department. Efficiency ratios are certainly going to be high if you are not investing or expending but how long can that kind of business last? It seems counterintuitive then, that a bank named Bank of Internet is apparently more archaic than some of the incumbents.

Past returns are no guarantee of future returns

BOFI’s business model is currently in the Goldilocks zone and that’s been the main driver of its +1500% growth in share price since 2007. It is offering customers deposit rates that are slightly higher than competitor’s rates and, in today’s low interest rate environment, I believe that this is the reason assets have been growing at a rapid pace.

These deposits are then being lent as mortgage loans at high yields. If interest rates normalize and people become less obsessed over the competitive marginal yield spreads which BOFI offers, then asset growth could slow and perhaps even evaporate. Furthermore profits will be pressured by borrowers who might find it more difficult to pay back the high interest rate loans.

Whilst I could be wrong, many alarm bells are ringing over BOFI. This has been a highly valuable lesson for me and luckily a relatively inexpensive one.

See my other investment tips here.

Book influences:

Disclosure: I hold no position in BOFI and don’t intend to open one.