How BofI Holding Makes Money
With an online-only business model, BofI Holding (NASDAQ:BOFI) is a unique bank. But, like all banks, its primary business is taking deposits, lending money, and profiting from the difference in interest rates. Here’s how BofI does all of those things.
A full transcript follows the video.
This video was recorded on Dec. 4, 2017.
Michael Douglass: Let’s talk through Anand’s framework.
The first part of that is, he asks the question, what does the bank actually do? First of all, generally speaking, banks work off the same underlying business model — they borrow money at one rate, they lend it out at another higher rate, and they pocket the difference, also known as arbitrage. Let’s start with the higher rate. That is loans. How does the bank lend money, Matt?
Matt Frankel: They have historically been a mortgage lender. They focus mainly on jumbo loans, which are loans that are too much, too qualified to be purchased by Fannie Mae and Freddie Mac. I believe the cap is about $417,000 right now. So these are big mortgages, mostly focused in high-cost states. California is one. About a little over half, 54% of their portfolio, comes from these kinds of loans. And they also have multifamily loans, which are generally defined as buildings with two to four residences in them. Think small apartment buildings, duplexes, triplexes, things like that. About 18% comes from commercial and industrial loans, which are business loans. Then they have some other types of loans in their portfolio that make up the other 7%. So, primarily a mortgage lender, small portion of business loans, and that’s about it for right now.
Douglass: Right. Again, Anand’s framework is very good for talking about a snapshot in time, what happened in the most recent quarter. It struggles a little bit more with the historical perspective, which is why we’ll turn to that.
The other thing to keep in mind is, BofI has about $8.6 billion in assets, about $7.5 billion of which are loans and leases net of losses. That’s, 88% of their assets are loans. So, thinking about this from a general banking perspective, the higher the percentage of assets that are loans, the more traditional the bank is. So, BofI, by this measure, is a very traditional bank, at 88% of assets represented by loans. Consider, for example, Bank of America, which has roughly 40% of its assets as loans and leases, just to give you a flavor of what this looks like. Of course, Bank of America and BofI are incredibly different companies. But they’re both, at their core, banks. So that’s why you can see that big difference.
So that’s the talking about how the bank lends money. Let’s flip over to how the bank takes in money, aka deposits.
Frankel: Speaking of what makes something a more traditional bank, if most of their liabilities are deposits, that’s another measure of how traditional they are. BofI takes in mostly low-cost deposits. I say low-cost loosely, because they pay more than most traditional banks, which we’ll get into a little bit later. But most of the way they take in money are consumer deposits. They used to be mostly CD-oriented. Over the past three or four years, they’ve switched to be a more traditional savings or checking account-oriented bank, which now make up the majority of their deposits. But the simple answer is, the bank makes their money by enticing consumers to deposit money with them.
Douglass: And it’s interesting, because deposits are viewed as a liability. If you aren’t familiar with banking, that sounds kind of strange. But the reality is, that’s money that the bank is getting for some period of time, be it brief or long, and they’re going to have to give that back. That’s why it’s a liability. As you point it out, Matt, it’s usually very low or no interest rates, so it’s a very cheap way for the bank to get cash to fund loans and therefore make that money, that arbitrage. If a bank can’t attract deposits, it usually has to take on debt or some stock, both of which can really hurt shareholders when done at scale.
So, the two ratios to look at for this are deposits over liabilities and deposits over loans. The deposit-over-liabilities ratio is 93%, which means that almost all of BofI’s liabilities are these low-cost deposits. And the deposit to loan ratio is 96%, meaning that they are almost entirely funding their loans through deposits, which is awesome. That means they’re pocketing lots of juicy income.
The third component of this is, what money are they actually making, and how are they making it? Put a different way, you want to look again at that delta between what they’re paying out for deposits, and as you noted, Matt, BofI deposits are primarily interest-bearing, so they are paying out money for them; and then, what they’re getting from loans. That is encapsulated in net interest income.
Then, of course, is also non-interest income, which is whatever other money they’re able to pocket. So net interest income for the most recent quarter was $79.6 million. Non-interest income was $13.3 million. So they generate almost all their income from loans, with the non-interest income primarily coming from mortgage banking income, and banking service fees.